Business Partnership: Limited Liability Partnership

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Business structure

Christina and David should consider starting their business as a limited liability partnership (LLP). Nobles et al. (2012, p. 774) describes that LLPs are the most common type of business organization for professionals such as lawyers and accounts. The main advantage of an LLP over other business structures is the limited liability of partners. Christina and David will be operating in an industry that has a threat of litigation brought against the firm for wrongful filing of taxation or other misappropriation of figures. Some of claims may not be intended, but any responsibility for a tax evasion claim against a client may be passed over to the firm. The partners must ensure that they do not expose other personal assets to the threat of malpractice (Miller & Cross, 2013).

An LLP has an advantage over the sole proprietorship because funds are contributed by more than one person (Nobles et al., 2012). In Christina and David’s business, Christina may consider a sole proprietorship because she contributes a larger portion of the initial capital. However, David brings in expert knowledge as a contribution to the firm. It is one of the benefits that a sole proprietorship lacks. If Christina decides to open a sole proprietorship business, she will not need to share the profits with anyone. On the other hand, any losses that may occur will reduce her equity in the business. In general, an LLP provides better sharing of risk and knowledge than a sole proprietorship.

The main advantage of an LLP over a company is that the business is not taxed at the corporate level. The partners are taxed through their personal income after the sharing of profits. In case of losses, the partners have the advantage of using the negative values to reduce the amount of tax from other income sources. The main disadvantage may occur when the individual earnings fall over higher tax bracket than it would have been under the corporate tax rate.

A high amount on the individual income may fall under a lower tax bracket on the corporate tax. However, an LLP will provide better tax rates than a company because it is only taxed once. A company is taxed at the corporate level as corporate tax and the individual level as the tax on dividends. As a result of these factors, an LLP is likely to provide better tax rates. However, a limited liability company (LLC) provides partners with the option of choosing whether to be taxed at the corporate level or individual level (Miller & Cross, 2013). Partners can choose the corporate level in case they need to keep profits as retained earnings.

An LLP will have more requirements before it can be started than a sole proprietorship. A sole proprietorship requires only a license to start operation. An LLP will require the filing of a partners’ agreement document. They need to seek approval from the secretary of state if they are operating in the U.S. Not only is the LLP more complicated to start but also to dissociate from it. Miller & Cross (2013, p. 236) elaborates that a partner may only be allowed to dissociate from the LLP after certain conditions in the agreement have been met. In a sole proprietorship, an individual may decide to close the business at any time. In a company, ownership is easily transferable.

Sharing of profits

Christina and David can choose between using an interest on capital contributed and sharing according to the proportion of their contributions. Using interest rates on capital invested encourages partners to retain their earnings (Nobles et al. 2012). Sharing according to the size of their contribution simplifies the sharing of profits. When they share, according to the ratio of their contribution, Christina will get 85.4% of the profits and David will get 14.6% of the profits. Both partners will contribute their financial expertise to the profitability of the firm. The best option for the LLP to use is the interest rate on capital invested option.

They will share the remaining amount equally after interest on capital invested has been paid. David will be motivated to work hard for the organization as a partner. An 8% interest rate may be suitable. The rate should be slightly higher than the cost of capital in a commercial bank so that it can cover the opportunity cost of capital. The only challenge on the interest rate is that sometimes profits may provide a lower rate than the selected interest rate. It may need the partners to review the interest rate downwards to accommodate profit sharing.

Worksheet, income statement, balance sheet, and cash flow statement

Table 2: Income statement.

Table 3: Balance sheet.

Table 4: Cash flow statement.

Notes to financial statements

1. Stationery, business cards and letterheads were purchased at $700. They are supposed to last a year. Assuming that the business consumes an equal amount every month, it will consume one twelfth of $700 in the month of July. As a result, what remains as an asset to be recorded in the balance sheet is $700 – (1/12 * 700). The part consumed is 700/12. It is recorded in the income statement as an expense.
2. Rent was paid for the entire year. Christina and David made a rental payment of $3600 to last twelve months. The business has only used a single month’s payment. The remaining 11-months’ payment will be considered as rent prepayment. The rent prepayment is recorded in the balance sheet as a current asset and the single month is an expense recorded in the income statement. In July, amount used as rent is calculated as 3600/12 = $300. Prepayment = 3600 – 300 = 3300.
3. Payment to Clayton Office Supplies Ltd. for the lease of furniture and equipment for $220 is recorded as $220 in the cash flow statement and income statement. It is a monthly payment and no adjustment is needed to record the payment.
4. Kathrine Lee was employed. There is no exchange of cash at the time of her employment, which makes it unnecessary to make any entries.
5. Annual accounting fees as an expense is recorded in the income statement and the cash flow statement. The partners paid $400 each, which amounts to $800 in total. Assuming that the amount is distributed evenly in a year, the amount used in July is calculated as 800/12 = $66.67. The amount used in July (66.67) is recorded in the income statement as an expense. The remaining amount $733.33 (obtained by deducting $66.67 from $800) is recorded in the balance sheet as prepayments. The amount paid in cash ($800) is recorded in the cash flow statement.
6. Promotional signboard purchased for $2000. Assuming that the promotional signboard will be repainted at the end of two years, the $2000 is distributed evenly in the 24 months. Each month’s depreciation expense is equal to $2000/24 = $83.33. The expense is recorded in the income statement as $83.33. Warren, Reeve & Duchac (2009, p. 398) explains that obsolescence is one of the functional factors for which a property can be depreciated.
7. Advertisement of in a newspaper amounted to $270. The amount is recorded wholly in the month of July. There is no method to indicate that the benefits of the advertisement are distributed in the entire year. There will be months that incur advertisement costs and those that lack.
8. The purchase of computers affects cash flow, income statement, and the balance sheet. In the balance sheet, it is recorded as a fixed asset. In the income statements, it appears through provision for depreciation. Depreciation is usually calculated annually. The annual figure has been divided by 12 to arrive at the monthly value. Warren, Reeve & Duchac (2009, p. 400) elaborate that the depreciation is calculated as “(cost – residual value) / useful life”. The calculation follows the straight-line method where the cost of depreciation is distributed evenly in the equipment’s useful life.
9. Stationery, business cards and letterheads payment to Stuart on July 11 clears the accounts payable of $700. A record is made on the cash flow statement for $700 cash outflow.
10. When Christina completed work for a client totaling $5300, it is considered revenue even before the payment has been made (Kimmel, Weygandt & Kieso 2011). The conventional accounting practices allow services delivered and accepted by the customer to be recognized as earned and realized revenues. It is recorded as part of the revenues in the income statement. It is also recorded in the balance sheet as account receivables until full payment has been made.
11. When the business signs a contract with XYZ Ltd., no entry is made because no service has been delivered. No payment has been made as well.
12. Fortnight salary paid to Christina and David is $2800 each. The total amount paid is $5600. One payment of the salary is made on July 15 and another on July 31. An amount of $5600 is recorded in the income statement as salaries expense and cash outflow in the cash flow statement.
13. Kathrine is paid $1200.17 as a fortnight salary. It is recorded as an expense in the income statement and the cash flow statement.
14. Cash received from a client to clear services completed for credit. When $2300 is paid by a client, it affects the cash flow statement and the balance sheet. The account receivable is reduced by $2300. Cash inflow increases cash available by the same amount.
15. Personal withdrawal by Christina is recorded as a cash outflow in the cash flow statement. Gilbertson, Lehman &Harmon-Gentene (2013, p. 20) explain that the amount taken by the owner for personal use are known as withdrawals. They reduce the amount that the owner has as equity. It also reduces cash flow. The $6000 withdrawn by Christina affects the owner’s equity (balance sheet) and cash flow.
16. When the business pays for the computer bought on credit, it reduces accounts payables by $6000. It also reduces cash flow by $6000.
17. The business received $4550 from XYZ Ltd. It is recorded in the income statement as revenues and the cash flow statement as cash inflow. The amounts are received on July 22 and 27. The deal was signed on July 14.
18. Tax returns service completed by Christina has been scheduled for future payment. The business was supposed to receive $4800 within 30 days. It is recorded as revenues in the income statement and as in the balance sheet as accounts receivable. There is no real cash flow in the transaction. As a result, it does not affect the cash flow statement.
19. Christina and David were paid $4800 in cash for work completed. The amount affects the income statement as revenue and the cash flow statement.
20. A provision for bad debt is made when a customer will be unable to meet the obligation under all circumstances. When the customer who was served by Christina between July 4 and July 11 is unable to pay for part of the debt, it is written off as a bad debt. It is recorded in the income statement as a provision for bad debts. It reduces accounts receivable by $900. Nobles et al. (2012, p. 647) elaborates that the bad debt provision is used to adjust the accounts receivables and operating expenses.
21. The salary paid to Kathrine ($900 in cash) reduces cash flow by $900. It is added in the salaries found in the income statement. There is no information indicating that there is an accrual in salaries. As a result, only the $900 is recorded.
22. There is a slight difference in the income statement for the service business and the commodities business. The cost of goods sold is not clearly outlined in a service business. As a result, the service business income statement may lack the gross profit part (Hettinger & Dolan-Heitlinger 2011).

Reference List

Gilbertson, C, Lehman, M, & Harmon-Gentene, D 2013, Fundamentals of accounting: course 1, South-Western Cengage Learning.

Hettinger, W & Dolan-Heitlinger, J 2011, Finance without fear: a guide to creating and managing a profitable business, The Institute of Finance and Enterpreneurship, Windham.

Kimmel, P, Weygandt, J, & Kieso, D 2011, Accounting tools for business decision making, John Wiley & Sons, Hoboken.

Miller, R & Cross, F 2013, Cengage advantage books: essentials of the legal environment, 4^th edn, South-Western Cengage Learning, Mason.

Nobles, T, Scott, c, McQuaig, D, & Billie, P 2012, College accounting, chapters 1-24, South-Western Cengage Learning, Mason.

Warren, c, Reeve, J, & Duchac, J 2009, Financial and managerial accounting, South-Western Cengage Learning, Mason.

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