Answer & Question : If a company wants to protect its three investors against personal liability risk, which of the following business forms would not be a suitable option?

101. If a company wants to protect its three investors against personal liability risk, which of the following business forms would not be a suitable option?

A. C Corporation

B. S Corporation

C. Limited liability partnership

D. Partnership

E. Limited liability company

AACSB: Communication
AICPA: BB Legal
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-C1 Identify characteristics of partnerships and similar organizations.
Topic: Partnership Form of Organization

102. Reno contributed $104,000 in cash plus equipment valued at $27,000 to the RD Partnership. The journal entry to record the transaction for the partnership is:

A. Debit Cash $104,000; debit Equipment $27,000; credit RD Partnership, Capital $131,000.

B. Debit Cash $104,000; debit Equipment $27,000; credit Common Stock $131,000.

C. Debit Cash $104,000; debit Equipment $27,000; credit Reno, Capital $131,000.

D. Debit Reno, Capital $131,000; credit RD Partnership, Capital $131,000.

E. Debit RD Partnership, Capital $131,000; credit Reno, Capital $131,000.

AACSB: Analytical Thinking
AICPA: BB Industry
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-P1 Prepare entries for partnership formation.
Topic: Organizing a Partnership

103. Bloom and Plant organize a partnership on January 1. Bloom’s initial investment consists of $800 cash, $1,700 equipment and a $500 note payable reflecting a bank loan for the new business. Plant’s initial investment is cash of $2,000. These amounts are the values agreed on by both partners. The journal entry to record Bloom’s investment is:

A. Debit Cash $800; debit Equipment $1,700; credit Note Payable $500; credit Bloom, Capital $2,000.

B. Debit Cash $2,000; credit Bloom, Capital $2,000.

C. Debit Cash $800; debit Equipment $1,700; credit Bloom, Capital $2,500.

D. Debit Cash $800; debit Equipment $1,200; credit Bloom, Capital $2,000.

E. Debit Bloom, Capital $3,000; credit Common Stock $3,000.

104. Bloom and Plant organize a partnership on January 1. Bloom’s initial investment consists of $800 cash, $1,700 equipment and a $500 note payable reflecting a bank loan for the new business. Plant’s initial investment is cash of $2,000. These amounts are the values agreed on by both partners. The journal entry to record Plant’s investment is:

A. Debit Cash $1,500; debit Note Payable $500; credit Plant, Capital $2,000.

B. Debit Cash $2,000; credit Note Payable $500, credit Plant, Capital $1,500.

C. Debit Bloom, Capital $2,000; credit Cash $2,000.

D. Debit Cash $2,500; credit Note Payable $500; credit Plant, Capital $2,500.

E. Debit Cash $2,000; credit Plant, Capital $2,000.

105. Wallace and Simpson formed a partnership with Wallace contributing $60,000 and Simpson contributing $40,000. Their partnership agreement calls for the income (loss) division to be based on the ratio of capital investments. The partnership had income of $150,000 for its first year of operation. When the Income Summary is closed, the journal entry to allocate partner income is:

A. Debit Income Summary $150,000; credit Wallace, Capital $75,000; credit Simpson, Capital $75,000.

B. Debit Wallace, Capital $75,000; debit Simpson, Capital $75,000; credit Income Summary $150,000.

C. Debit Income Summary $150,000; credit Wallace, Capital $90,000; credit Simpson, Capital $60,000.

D. Debit Cash $150,000; credit Wallace, Capital $90,000; credit Simpson, Capital $60,000.

E. Debit Wallace, Capital $90,000; debit Simpson, Capital $60,000; credit Cash $150,000.
Partner’s Share of Income = Partnership Income * Ratio of Capital Investments
Wallace’s Share of Income = $150,000 * [$60,000/($60,000 + $40,000)] = $90,000
Simpson’s Share of Income = $150,000 * [$40,000/($60,000 + $40,000]) = $60,000

AACSB: Analytical Thinking
AICPA: BB Industry
AICPA: FN Measurement
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 12-P2 Allocate and record income and loss among partners.
Topic: Dividing Income or Loss

106. Wallace and Simpson formed a partnership with Wallace contributing $60,000 and Simpson contributing $40,000. Their partnership agreement calls for the income (loss) division to be based on the ratio of capital investments. Wallace sold one-half of his partnership interest to Prince for $55,000 when his capital balance was $78,000. The partnership would record the admission of Prince into the partnership as:

A. Debit Wallace, Capital $55,000; credit Prince, Capital $55,000.

B. Debit Wallace, Capital $39,000; credit Prince, Capital $39,000.

C. Debit Prince, Capital $55,000; credit Wallace, Capital $55,000.

D. Debit Wallace, Capital $30,000; credit Prince, Capital $30,000.

E. Debit Wallace, Capital $39,000; debit Cash $16,000; credit Prince, Capital $55,000.
Wallace’s capital balance at the time of the transaction $78,000 * ½ = $39,000.
The cash received by Wallace from Prince is a personal transaction.

AACSB: Analytical Thinking
AICPA: BB Industry
AICPA: FN Measurement
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 12-P3 Account for the admission and withdrawal of partners.
Topic: Admission and Withdrawal of Partners

107. Wallace, Simpson, and Prince are partners and share income and losses in a 3:4:3 ratio. The partnership’s capital balances are Wallace, $68,000; Simpson, $90,000; and Prince, $42,000. Royal is admitted to the partnership on July 1 with a 20% equity and invests $50,000. The partnership would record the admission of Royal into the partnership as:

A. Debit Wallace, Capital $15,000; debit Simpson, Capital, $20,000; debit Prince, Capital $15,000; credit Royal, Capital $50,000.

B. Debit Cash $20,000; credit Prince, Capital $20,000.

C. Debit Cash $40,000; debit Wallace, Capital $3,000; debit Simpson, Capital, $4,000; debit Prince, Capital $3,000; credit Royal, Capital $50,000.

D. Debit Cash $50,000; credit Royal, Capital $50,000.

E. Debit Cash $50,000; credit Simpson, Capital $10,000, credit Royal, Capital $40,000.
($68,000 + $90,000 + $42,000 + 50,000) * 20% = $50,000.
Since the contribution by Royal is equal to 20% of total equity, no bonus is involved.

Matching Questions

108. Match each of the following terms with the appropriate definitions.

1. The legal relationship among partners whereby each partner can commit or bind the partnership to any contract within the scope of the partnership’s business. Statement of partners’ equity 4
2. A corporation with 100 or fewer stockholders that can elect to be treated as a partnership for income tax purposes but retain the same limited liability as other corporations. Limited partnership 7
3. The legal relationship among general partners that makes each of them personally responsible for paying the debts of the partnership if the partnership cannot pay. Limited liability partnership 5
4. A financial statement that shows total capital balances at the beginning of the period, any additional investment by partners, the income or loss of the period, the partners’ withdrawals, and the ending capital balances. Unlimited liability of partners 3
5. A partnership that protects innocent partners from malpractice or negligence claims resulting from the acts of another partner. Partnership contract 8
6. A corporation that does not qualify for nor elect to be treated as a partnership for income tax purposes and therefore is subject to income taxes. Partnership 10
7. A partnership that has two classes of partners, limited partners and general partners. Limited partners have no personal liability beyond the amount they invest in the partnership, and have no active role except as specified in the partnership agreement. General partner 9
8. The agreement between partners that sets terms under which the affairs of the partnership are conducted. Mutual agency 1
9. A partner who assumes unlimited liability for the debts of the partnership. C corporation 6
10. An unincorporated association of two or more persons to pursue a business for profit as co-owners. S corporation 2

AACSB: Communication
AICPA: BB Industry
AICPA: BB Legal
AICPA: FN Decision Making
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-C1 Identify characteristics of partnerships and similar organizations.
Topic: Partnership Form of Organization

Short Answer Questions

109. Identify and discuss the key characteristics of partnerships. Also, identify other organizations that possess partnership characteristics.

Partnerships are unincorporated associations of two or more persons who join to pursue a business for profit as co-owners. Partners sign a partnership agreement and are subject to mutual agency and unlimited liability for acts of the partnership. Partnerships have limited life, and are not taxable entities. Several types of business organizations such as S corporations, limited liability partnerships and limited liability companies have partnership characteristics related to taxability and/or liability of the partners.

AACSB: Communication
AICPA: BB Industry
AICPA: BB Legal
AICPA: FN Decision Making
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-C1 Identify characteristics of partnerships and similar organizations.
Topic: Partnership Form of Organization

110. Define the partner return on equity ratio and explain how a specific partner would use this ratio.

The partner return on equity ratio is calculated by dividing the partner’s income by the average equity of that partner. This ratio can be calculated for individual partners or for the total partnership. It can be used by a partner to help determine whether additional investment or withdrawal of resources is best for that partner.

AACSB: Communication
AICPA: BB Resource Management
AICPA: FN Risk Analysis
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-A1 Compute partner return on equity and use it to evaluate partnership performance.
Topic: Partner Return on Equity

111. How are partners’ investments in a partnership recorded?

When partners invest in a partnership, their individual contributions are credited to each partner’s capital account at an agreed-on value. The assets contributed are debited to the appropriate asset account. Partners may contribute assets that are encumbered by liabilities that are credited to the appropriate liability account and reduce their capital investment.

AACSB: Communication
AICPA: BB Industry
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-P1 Prepare entries for partnership formation.
Topic: Organizing a Partnership

112. Discuss the options for the allocation of income and loss among partners, including with and without a partnership agreement.

A partnership agreement should specify how to allocate partnership income or loss among partners. Allocation can be made based on stated ratios, capital balances, salary allowances, interest allowances or a combination of the above methods. In the absence of a partnership agreement, income and loss are shared equally by the partners.

AACSB: Communication
AICPA: BB Industry
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-P2 Allocate and record income and loss among partners.
Topic: Dividing Income or Loss

113. What are the ways that a new partner can be admitted to an existing partnership? Explain how to account for the admission of the new partner under each of these circumstances.

A new partner may purchase a partnership interest from one or more existing partners. In this case, a capital account is established for the new partner equal to the portion of the existing partners’ interest that was purchased from that partner or partners. This transaction is a personal transaction between one or more current partners and the new partner. A new partner may invest assets in the existing partnership. This is a transaction between the new partner and the partnership. In this case, a capital account is established for the new partner equal to the portion of the partnership purchased. When the current value of a partnership is greater than the recorded amounts of equity, the partners usually require the new partner to pay a bonus for the privilege of joining. When the partnership needs additional cash or the new partner has exceptional talents, the existing partners may grant a bonus to the new partner.

AACSB: Communication
AICPA: BB Industry
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-P3 Account for the admission and withdrawal of partners.
Topic: Admission and Withdrawal of Partners

114. What are the ways a partner can withdraw from a partnership? Explain how to account for the withdrawal of a current partner from a partnership.

A partner may sell his or her interest in the partnership to a new partner who pays for it in cash or other assets. In this case, the partnership debits the old partner’s capital account and credits the new partner’s capital account. A partner may also withdraw and have cash or other assets of the partnership distributed to him or her in settlement of his or her interest. If the recorded value of the withdrawing partner’s interest is overstated, then the withdrawing partner would give the remaining partners a bonus. If the withdrawing partner’s interest is understated, the withdrawing partner receives a bonus from the remaining partners.

AACSB: Communication
AICPA: BB Industry
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-P4 Prepare entries for partnership liquidation.
Topic: Admission and Withdrawal of Partners

115. Explain the steps involved in the liquidation of a partnership.

Four steps are involved in the liquidation process: (1) Record the sale of noncash assets for cash and any gain or loss from their liquidation; (2) Allocate any gains or losses from liquidation to the partners’ capital accounts using their income-and-loss sharing ratio; (3) Liabilities of the partnership are paid or settled; and, (4) Any remaining cash is distributed to the partners based on their capital balances.

116. What factors should be considered before establishing a partnership?

Anyone considering forming a partnership would be wise to consider the manner in which partnerships are taxed, the mutual agency aspect of partnerships, the unlimited liability aspect of partnerships and the fact that partnership assets are considered to be jointly owned by all partners. Moreover, a formal, written partnership agreement should be developed to detail each partner’s expectations.

AACSB: Communication
AICPA: BB Industry
AICPA: FN Measurement
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-C1 Identify characteristics of partnerships and similar organizations.
Topic: Partnership Form of Organization

Essay Questions

Answer & Question

Tuesday 23 October 2018

If a company wants to protect its three investors against personal liability risk, which of the following business forms would not be a suitable option?

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