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08 - CHAPTER 8 UNDERSTANDING THE ISSUES 1 Partnerships are...

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CHAPTER 8 UNDERSTANDING THE ISSUES 1. Partnerships are generally less formal than oth- er types of organizations and yet it is important to consider a number of factors in a partnership agreement. Individual partners have more legal exposure in a partnership because, unlike a corporation, partnerships are characterized by unlimited liability. However, limited partners, limited liability corporations, and limited liability partnerships provide for a significant reduction in such liability. Partnerships offer significant tax advantages over a corpora- tion in that they are not taxed as a separate entity and, therefore, avoid double taxation issues. However, other types of tax option or- ganizations are also available that avoid double taxation. 2. The use of a salary or bonus as a means of al- locating profits would be appropriate when there is a desire to reward partners for personal services or significant personal time commit- ments to the partnership. The use of interest on capital as a means of allocating profits would be appropriate when the business is capital in- tensive versus labor intensive or if the partners are not significantly involved in the day-to-day operations. 3. Unless the profit-sharing agreement states oth- erwise, all provisions of the agreement should be satisfied except the final allocation of any re- maining profits. Rather than finally allocating any remaining profits, the profit/loss percent- ages would be used to allocate the resulting deficiency. In contemplation of such a condi- tion, it is possible that a profit-sharing agree- ment would call for satisfying each provision, in order of priority, to whatever extent possible. In the case of a loss, the only provision that could be satisfied would be that which allocates the loss between the partners per their profit/loss percentages. 4. Generally speaking, a partner’s capital account would be debited for the following: their share of any partnership losses, the closing of the drawing account to capital, and any withdraw- als whose amount is deemed to be excessive per the partnership agreement and therefore to be considered as a direct reduction of capital. 147
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Ch. 8—Exercises EXERCISES EXERCISE 8-1 (1) Differences to be found in the assets listed on the balance sheet of the corporation and the bal- ance sheet of the partnership would be: a. Cost of assets—Assets of the partnership were acquired during a period of rising prices. It would be expected that the original cost of the land would be much less than its present fair value, which would be the cost to the corporation. The value of the land (and to a lesser de- gree, the building) would also probably be greatly enhanced by the location in a large shop- ping center in a fashionable suburban area. It would also be expected that other depreciable assets, such as fixtures and equipment, would have greater value than their depreciated cost on the partnership balance sheet. However, in a going concern, some items might reflect un- recovered cost in a greater amount than their fair value; for example, a new delivery truck.
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