Accounting for Partnerships and Limited Liability Companies

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12
Accounting for Partnerships and Limited Liability
Companies
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Learning Objective 1
Learning Objective 1
Accounting for Partnerships and Limited Liability
Companies
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3-1
After studying this chapter you should be able
to
Insert Chapter Objectives
Describe the nature of the adjusting process.
Describe the nature of the adjusting process.
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12-2
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Accounting for Partnerships and Limited Liability
Companies (continued)
12-3
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Describe the characteristics of proprietorships
partnerships and limited liability companies.
12-4
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Four Most Common Legal Forms of Business

• Proprietorship

• Corporation

• Partnership

• Limited liability company

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Proprietorship
A proprietorship is a company owned by a single
individual.

• Lawyers
• Architects
• Realtors
• Physicians

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Characteristics of a Proprietorship

• Simple to form

• No limitation on legal liability

• Not taxable

• Limited life

• Limited ability to raise capital (funds)

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Partnership
A partnership is an association of two or more
individuals who own and manage a company for
profit.
Less widely used than proprietorships.
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Characteristics of a Partnership

• Moderate to form

• No limitation on legal liability

• Not taxable

• Limited life

• Limited ability to raise capital (funds)

(continued)
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Characteristics of a Partnership (continued)

• Co-ownership of partnership property

• Mutual agency

• Participation in income

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Limited Partnership
A variant of the regular partnership is a limited
partnership. This form of partnership allows
partners who are not involved in the operations
of the partnership to retain limited liability.
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Limited Liability Companies
A limited liability company (LLC) is a form of
legal entity that provides limited liability to
its owners but is treated as a partnership for
tax purposes.
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Characteristics of a Limited Liability Partnership

• Moderate to form

• Limited legal liability

• Not taxable

• Unlimited life

• Moderate ability to raise capital (funds)

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Characteristics of Proprietorships Partnerships
and Limited Liability Companies
Ease of Formation
Proprietorship Simple
Partnership Moderate
LLC Moderate
(continued)
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Characteristics of Proprietorships Partnerships
and Limited Liability Companies (continued)
Legal Liability
Proprietorship No limitation
Partnership No limitation
LLC Limited liability
(continued)
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Characteristics of Proprietorships Partnerships
and Limited Liability Companies (continued)
Taxation
Proprietorship Nontaxable
Partnership Nontaxable
LLC Nontaxable
Pass-through entity Pass-through entity by
election
(continued)
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Characteristics of Proprietorships Partnerships
and Limited Liability Companies (continued)
Limitation on Life of Entity
Proprietorship Limited
Partnership Limited
LLC Unlimited
(continued)
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Characteristics of Proprietorships Partnerships
and Limited Liability Companies (concluded)
Access to Capital
Proprietorship Limited
Partnership Limited
LLC Moderate
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Describe and illustrate the accounting for
forming a partnership and for dividing the net
income and net loss of a partnership.
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Forming a Partnership
Joseph Stevens and Earl Foster agree to combine
their hardware businesses in a partnership. Each
is to contribute certain amounts of cash and
other assets. They also agree that the
partnership is to assume the liabilities of the
separate businesses.
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The entry to record the assets and liabilities
contributed by Stevens is as follows
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A similar entry would record the assets
contributed and the liabilities transferred by
Foster. In each entry the noncash assets are
recorded at values agreed upon by the partners.
These values normally represent current market
values.
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If a limited liability company is formed the
following entry is made
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Example Exercise 12-1
Journalize Partners Original Investment
Reese Howell contributed equipment inventory
and 34000 cash to a partnership. The equipment
had a book value of 23000 and market value of
29000. The inventory had a book value of
60000 but only had a market value of 15000
due to obsolescence. The partnership also assumed
a 12000 note payable owed by Howell that was
used originally to purchase the
equipment. Provide the journal entry for Howells
contribution to the partnership.
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Example Exercise 12-1 (continued)
Cash. 34000 Inventory.. 15
000 Equipment 29000 Notes
Payable. 12000 Reese Howell
Capital 66000
12-25
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Dividing IncomeServices of Partners
The partnership agreement of Jennifer Stone and
Crystal Mills provides for Stone to receive a
monthly allowance of 5000 (60000 annually)
and Mills is to receive 4000 a month (48000
annually). If there is any remaining net income
it is to be divided equally. The firm had a net
income of 150000 for the year.
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Division of Net Income
J. Stone C. Mills Total
Annual salary allowance 60000 48000 108000 R
emaining income 21000 21000 42000
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Division of Net Income
J. Stone C. Mills Total
Annual salary allowance 60000 48000 108000 R
emaining income 21000 21000 42000
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Dividing IncomeServices of Partners and
Investments
The partnership agreement for Stone and Mills
divides income as follows

• Monthly salary allowance of 5000 for Stone and
  4000 for Mills.
• Interest of 12 on each partners capital balance
  on January 1.
• If there is any remaining net income it is to be
  divided equally between the partners.

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Each partners annual salary is calculated.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000
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Interest on each partners January 1 capital
balance is determined.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000 Interest
allowance 19200
12 Stones capital account balance on Jan. 1
of 160000
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Interest on each partners January 1 capital
balance is determined.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000 Interest
allowance 19200 14400
12 Mills capital account balance on Jan. 1
of 120000
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Interest on each partners January 1 capital
balance is determined.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000 Interest
allowance 19200 14400 33600
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The remaining income is divided equally.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000 Interest
allowance 19200 14400 33600 Remaining
income 4200 4200 8400
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Dividing IncomeAllowances Exceed Net Income
Assume the same facts as before except that the
net income is only 100000. In this case the
total of the allowance exceeds the net income by
41600 (100000 141600).
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Net income of 100000 is divided.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000 Interest
allowance 19200 14400 33600
Total 79200 62400 141600
This amount exceeds net income by 41600.
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Net income of 100000 is divided.
J. Stone C. Mills Total
Salary allowance 60000 48000 108000 Interest
allowance 19200 14400 33600
Total 79200 62400 141600 Deduct excess of
allowance over income 20800 20800

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Example Exercise 12-2
Dividing Partnership Net Income
Steve Prince and Chelsy Bernard formed a
partnership dividing income as follows

• Annual salary allowance to Prince of 42000.
• Interest of 9 on each partners capital balance
  on January 1.
• Any remaining net income divided equally.

Prince and Bernard had 20000 and 150000 in
their January 1 capital balances respectively.
Net income for the year was 240000. How much
net income should be distributed to Prince
12-39
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Example Exercise 12-2 (continued)
Monthly salary 42000 Interest (9
20000) 1800 Remaining income 91350 Total
distributed to Prince 135150
240000 42000 1800 13500
(150000 9) 50
12-40
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Describe and illustrate the accounting for
partner admission and withdrawal.
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Admitting a Partner
A person may be admitted to a partnership only
with the consent of all the current partners by

• Purchasing an interest from one or more of the
  current partners.
• Contributing assets to the partnership.

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Two Methods of Admitting a Partner
(continued)
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Two Methods of Admitting a Partner (continued)
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Purchasing an Interest in a Partnership
Partners Tom Andrews and Nathan Bell have capital
balances of 50000 each. On June 1 each sells
one-fifth of his equity to Joe Canter for 10000
in cash.
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The only entry required in the partnership
accounts is as follows
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The effect of the transaction on the partnership
accounts is presented in the following diagram
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Contributing Assets to a Partnership
Partners Tom Andrews and Nathan Bell each have
capital balances of 50000. On June 1 Joe
Canter contributes 20000 cash to Bring It
Consulting for ownership equity of 20000.
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The entry to record this transaction is as
follows
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The effect of the transaction on the partnership
accounts is presented in the following diagram
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Revaluation of Assets
If the asset accounts do not reflect approximate
current market values when a new partner is
admitted the accounts should be adjusted
(increased or decreased) before the new partner
is admitted.
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Partners Andrews and Bell each have capital
balances of 50000. The balance in Merchandise
Inventory is 14000 and the current replacement
value is 17000. The partners share net income
equally.
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The entry to record this transaction is as
follows
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Example Exercise 12-3
Revaluing and Contributing Assets to a Partnership
Blake Nelson invested 45000 in the Lawrence
Kerry partnership for ownership equity of
45000. Prior to the investment land was
revalued to a market value of 260000 from a
book value of 200000. Lynne Lawrence and Tim
Kerry share net income in a 12 ratio.

• Provide the journal entry for the revaluation of
  land.
• Provide the journal entry to admit Nelson.

12-54
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Example Exercise 12-3 (continued)

• Cash.. 45000
• Blake Nelson Capital... 45000

12-55
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Partner Bonuses
Exhibit 3
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Partner Bonuses
On March 1 the partnership of Marsha Jenkins and
Helen Kramer admit Alex Diaz as a new partner.
The assets of the old partnership are adjusted to
current market values and the resulting capital
balances for Jenkins and Kramer are 20000 and
24000 respectively.
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Jenkins and Kramer agree to admit Diaz as a
partner for 31000. In return Diaz will receive
a one-third equity in the partnership and will
share income and losses equally with Jenkins and
Kramer.
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Equity of Jenkins 20000 Equity of
Kramer 24000 Diazs Contribution 31000 Total
equity after admitting Diaz 75000 Diazs
interest (1/3 75000) 25000
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The entry to record this transaction is as
follows
(1/2 of 6000)
(1/2 of 6000)
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Paying the New Partner a Bonus
After adjusting the market values the capital
balance of Janice Cowen is 80000 and the
capital balance of Steve Dodd is 40000. Ellen
Chou receives a one-fourth interest in the
partnership for a contribution of 30000. Before
admitting Chou Cowen and Dodd shared net income
using a 21 ratio.
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The bonus is computed as follows
Equity of Cowen 80000 Equity of
Dodd 40000 Chous Contribution 30000 Total
equity after admitting Chou 150000 Chous
equity interest after
admission 25 Chous equity after
admission 37500 Chous contribution
30000 Bonus paid to Chou 7500
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The entry to record this transaction is as
follows
¹7500 2/3 ²7500 1/3
For a limited liability company the following
entry is required
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Example Exercise 12-4
Partner Bonus
Lowman has a capital balance of 45000 after
adjusting assets to fair market value. Conrad
contributes 26000 to receive a 30 interest in
a new partnership with Lowman.
Determine the amount and recipient of the partner
bonus.
12-64
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Example Exercise 12-4 (continued)
Equity of Lowman 45000 Conrad contribution
26000 Total equity after admitting
Conrad 71000 Conrads equity interest
30 Conrads equity after admission 21300
12-65
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Withdrawal of a Partner
If the existing partners purchase the withdrawing
partners interest the purchase and sale of the
partnership interest is between the parties as
individuals.
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Death of a Partner
When a partner dies the partnership accounts
should be closed as of the date of death. The net
income for the current period should then be
determined and divided among the partners
capital accounts.
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Describe and illustrate the accounting for
liquidating a partnership.
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Liquidating Partnerships
When a partnership goes out of business the
winding-up process is called the liquidation of a
partnership.
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Liquidation Process

• Sell the partnership assets. This step is called
  realization.

• Distribute any gains or losses from realization
  to the partners based upon their income-sharing
  ratio.
• Pay the claims of creditors using the cash from
  step 1 realization.
• Distribute the remaining cash to the partners
  based on the balances in their capital accounts.

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Steps in Liquidating a Partnership
Exhibit 4
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Liquidation Process
Farley Green and Hall share income and losses
in a ratio of 532. On April 9 after
discontinuing operations the firm had the
following trial balance.
Cash 11000 Noncash Assets 64000 Liabilities
9000 Jean Farley Capital 22000 Brad Green
Capital 22000 Alice Hall Capital 22000
Total 75000 75000
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Gain on Realization
Between April 10 and April 30 Farley Green and
Hall sell all noncash assets for 72000. Thus a
gain of 8000 (72000 64000) is realized.
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Statement of Partnership Liquidation Gain on
Realization
Exhibit 5
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Sale of assets (Step 1)
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Division of the gain (Step 2)
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Payment of liabilities (Step 3)
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Distribution of cash to partners (Step 4)
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Loss on Realization
Farley Green and Hall sell all noncash assets
for 44000. A loss of 20000 (64000
44000) is realized. The loss is distributed to
Farley Green and Hall in the income-sharing
ratio of 532.
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Statement of Partnership Liquidation Loss on
Realization
Exhibit 6
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Sale of assets (Step 1)
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Division of the loss (Step 2)
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Payment of liabilities (Step 3)
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Distribution of cash to partners (Step 4)
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Example Exercise 12-5
Liquidating PartnershipGain
Prior to liquidating their partnership Todd and
Gentry had capital accounts of 50000 and
100000 respectively. The partnership assets
were sold for 220000. The partnership had
20000 of liabilities. Todd and Gentry share
income and losses equally. Determine the amount
received by Gentry as a final distribution from
liquidation of the partnership.
12-85
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Example Exercise 12-5 (continued)
Gentrys equity prior to liquidation 100000
Realization of asset sale 220000 Book value of
assets (50000 100000 20000)
170000 Gain on liquidation 50000 Gentrys
share of gain (50 50000) 25000 Gentrys
cash distribution 125000
12-86
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Loss on RealizationCapital Deficiency
Farley Green and Hall sell all of the noncash
assets for 10000. A loss of 54000 (64000
10000) is realized. The share of the loss
allocated to Farley 27000 (50 of 54000)
exceeds the 22000 balance in her capital
account. Farley contributes 5000 to the
partnership.
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Statement of Partnership Liquidation Loss on
RealizationCapital Deficiency
Exhibit 7
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Sale of assets (Step 1)
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Division of the loss (Step 2)
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Payment of liabilities (Step 3)
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Receipt of deficiency (Step 4)
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Distribution of cash to partners (Step 5)
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Partner Does Not Pay Deficiency
If Farley does not pay her deficiency the
deficiency would be allocated to Green and Hall
based on their income-sharing ratio of 32. The
remaining cash would be distributed to Green and
Hall as shown below
Capital Balance After Deficiency and Cash
Distributed to Partners
Capital Balances Before (Deficiency)
Allocated (Deficiency)
Farley (5000) 5000
0 Green 5800 (3000) 2800 Hall
11200 (2000) 9200 Total 12000 120
00
3000 5000 (3/5) or (5000
60) 2000 5000 (2/5) or (5000 40)
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Allocation of deficiency
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Distribution of cash to partners
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Example Exercise 12-6
Liquidating PartnershipGain
Prior to liquidating their partnership Short and
Bain had capital accounts of 20000 and 80000
respectively. The partnership assets were sold
for 40000. The partnership had no liabilities.
Short and Bain share income and losses equally.

• Determine the amount of Shorts deficiency.
• Determine the amount distributed to Bain assuming
  Short is unable to satisfy the deficiency.

12-97
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Example Exercise 12-6 (continued)

• Shorts equity prior to liquidation 20000
• Realization of asset sale 40000
• Book value of assets 100000
• Loss on liquidation 60000
• Shorts share of loss (50 60000)
  30000
• Shorts deficiency (10000)

b. 40000 80000 30000 share of loss
10000. Shorts deficiency also equals the
amount realized from asset sales.
12-98
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Prepare the statement of partnership equity.
12-99
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Statement of Partnership Equity
The change in the owners capital accounts for a
period of time is reported in a statement of
partnership equity.
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Statement of Partnership Equity
Exhibit 8
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Financial Analysis and Interpretation
Washburn Lovett CPAs had the following
information for the last two years
2011 2010
Revenues 220000000 180000000 Number of
employees 1600 1500
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Financial Analysis and Interpretation
The revenues per employee showed improvement in
2011. Thus each employee is producing more
revenues in 2011 than in 2010 which may
indicate improved productivity. Overall it
appears the firm is properly managing the growth
in staff.
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