Partnership Solutions

Partnership Solutions - EXERCISE 13-1 1. Investors in a...

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EXERCISE 13-1 1. Investors in a partnership are not issued stock and have a capital balance rather than a capital stock at par value account. Regarding the question of legal liability, a partnership is characterized by unlimited liability in that claims against the partnership can proceed against individual partners’ net assets if necessary. Therefore, unlike in the case of a corporation, there is no level of minimum liability. It is possible, however, to structure a partnership as a limited partnership in which case a limited partner’s liability may not extend to their personal net assets. 2. A partnership is not a separate distinct taxable entity for income tax purposes; therefore, the balance sheet would have no income tax accruals and the income statement would not include a related tax expense account. The pretax income of a partnership is allocated to the individual partners, and the respective income tax is assessed at the individual partner level. 3. Salaries in a partnership are considered to be an allocation component for the purpose of allocating profits rather than an expense of the partnership. The absence of a salary expense does not mean that partners did not receive consideration equal to the salary amount. However, the consideration received is recorded as a draw or direct reduction of capital rather than an expense. Obviously, if one were comparing a partnership’s net income to that of a corporation in which employed shareholders’ salaries are shown as an expense, the partnership income statement should be adjusted to reflect some level of salaries in order to improve comparability. 4. As is the case with salaries, interest on capital balances is a component for the purpose of allocating profits rather than an actual expense of the partnership. If consideration is conveyed to a partner in an amount equal to their interest on invested capital, the consideration conveyed would be classified as a draw or direct reduction of capital rather than an expense. The purpose of allocating some portion of profits as interest on invested capital is to recognize that in certain cases a partner’s contribution to the profits of an entity is highly dependent on the level of their capital contribution. If significant capital were not retained in a partnership, the partner could invest such capital in alternative ways and receive a return on investment. However, if the capital is retained in the partnership, the partner should be rewarded for their investment as they would be in any other set of circumstances.
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EXERCISE 13-2 Some potential problems and concerns associated with the agreement include the following: It is unclear as to why a salary would be allocated to O’Connor given the fact that he/she will not be active in the business. The agreement states that the partners will receive a salary. Is this intended to mean that they
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This note was uploaded on 06/15/2011 for the course ACT 4491 taught by Professor Magrath during the Spring '11 term at Troy.

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Partnership Solutions - EXERCISE 13-1 1. Investors in a...

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