Hey everyone here we are now live. My name is David Krug. I have been a full-time professor at JCCC for 11 years. I am very excited to be taping these videos for you what have been watching these videos at home or on YouTube we taped Accounting I videos back in fall of 2011. Everyone thought they were taped earlier because of the cheesy music. I keep get emails from people that always say when are you going to do Accounting II videos, when are you going to do Accounting II videos. I keep telling them that we don't have any plans to do that. Well, we finally decided to do Accounting 2 videos. That is what you are watching now. We finally said yes to the public demand. It's just like the Star Wars movies, they just keep begging for more Star Wars movies, so now they are making more Star Wars movies. It's just like that. A few introductory things, this is actually lecture number 202. Lecture 201 is the lecture that I will tape about class policies and procedures. I decided to number these videos differently than my Accounting 1 videos because I didn't want some to watch accounting lecture number 6 and then went to lecture number 7 but it was for Accounting II and all the sudden they are all mixed up. I made the numbering very specifically different, so this is lecture 202 and lecture 201 was class policies and procedures, and there was no lecture 200 or 199 or anything like that. The other thing I want to say really quickly and remind everyone is the textbook we are using for this class. The textbook we are for this class is, O let me just put it on the overhead. It is Fundamental of Accounting Principles volume 2 chapters 12-25, by Wild, Shaw and Chiappetta and it is the 21st Edition of this book. There is picture of a lonely guy at the lake and is on his iPad. I think it's sad because if he didn't spend so much time on his iPad at the lake maybe he would have friends with him at the lake. I'm going to go ahead and do a close up of the ISBN number for this class if you want to go purchase this book. The other thing that we did really quickly here and I want to talk about is, anyone have that? Can I show that real quickly? We took a quiz here in class and go ahead and leave this on the screen as I talk. One of the things I like to do is ask my Accounting II students, I give them this quiz to see if they still remember what accounts are debit balance accounts and what accounts are credit balance accounts. So I ask them these questions, if you want to pause this folks and take this quiz to see how well you did and here are the questions I asked on the second page. Once again you can pause this if you like to see if you know the answers. But you need to get most of these questions right. If you don't most of these right maybe you need to go back to chapter 1 chapter 2 and maybe chapter 3 of Accounting I and review your account balances and review what financial statement accounts go on because that is very important, we presume you have that knowledge. Really quick let's go through this. Accounts Receivable is a debit account balance, Consulting Revenue is a credit balance, Advertising Expense is a Debit balance account, Automobile is a debit, capital is a credit balance, Salaries Payable is a credit balance, Cash is a debit, unearned revenue is a credit, owner withdrawal is a debit, prepaid rent is also a debit account. For you folks here this is quiz version C, if you have version D these are in a different order. On your Scantron how would you indicate how each of these accounts change. Well how do you decrease account receivable? You credit it. How do you decrease withdrawals? You credit it. How do you increase advertising expense? You debit it. How do you increase capital? You credit it. How do you decrease equipment? You credit it, and how do you decrease consulting revenue? You debit it. And then quickly what financial statement do these items go on? Well unearned revenue goes on balance sheet. Depreciation goes on income statement, total revenue goes on the income statement, taxes payable goes on the balance sheet, withdrawals go on the statement of equity, accounts receivable goes on the balance sheep and interest earned goes on the income statement. Are you with me? Are there any questions on that? So you folk that are watching can kind of assess how you did on that and if you know that information or if you need to review it. Now does anyone remember what type of account we mostly talked about in Accounting 1? Yes sole proprietorship. There was one owner and only one owner and they did not incorporate there business. It was a sole proprietorship that was the main type of business we talked about in Accounting 1. Well in Accounting II we are going to talk about partnerships and let us talk about what a partnership is. Do you all have these slides here in class? For the folks watching at home the slides are on the website in the appropriate section that I have showed you. Let's talk about the partnership form of organization. First of all the partnership form of organization is voluntary. You cannot make someone be your partner in business just like you can force someone to marry you or something like that. It is voluntary. There is also a limited life. Coming off that to the cameras let's say Daniel and Michael had a partnership. Let's say a landscaping partnership. Well if one of you would die heaven forbid, that partnership would be over. You may opt to go into partnership with someone else but the partnership between you two guys is over. Just like if you're married to someone and one of the spouses dies that marriage is over. You can marry someone else but that marriage is over. So it has a limited life unlike a corporation which has an unlimited life. Co-ownership of property, what does that mean? Well co-ownership means let's say if Daniel puts a truck into the business then Michael can use the truck as well. You're not saying this is my truck. The partnership now owns the truck. What you have is a partnership agreement; well what you should have is a partnership agreement. What is a partnership agreement? Well this is usually done with the help of an attorney. What it does is it is a written document that explains how the income and loses be divided. What will we do if someone wants to withdraw from the partnership? What will be done if someone wants to bring on someone else as an addition? What will we do if we have cash trouble? It tries to walk through all those what if scenarios while everyone still loves each other, so that they know what to do if it comes to that time. "STUDENT" Is it basically a contract between two people? You can think of it as a contract. In a way it is kind of like a prenuptial. When I got married 24 years ago we didn't have a prenuptial because we didn't have anything. I think we would have just decided who got the Atari game system or whatever if there was a divorce. But you hear of movie stars that say I love you and will love you forever, but in case we get divorced this is how it will play out. Well I'm not a big fan of prenuptials for marriages I am a big fan of partnership agreements for partnerships. These don't cost that much to do with an attorney; they probably cost around a thousand bucks, depending on how complicated everything is. What do you think the number 1 reason that people do not pay the money to get a partnership agreement? "STUDENT": because they cannot agree on a partnership agreement? That's usually not it, but that might be, if that's the case you might not want to go into business with that person anyways. "STUDENT"; they say they trust the other person. They say you know what we don't need a partnership agreement we will just talk things out. That seems ideal when you're first starting out. Does anyone have a friend that's been through a messy divorce? Wait a few years and you will know a few people. Maybe you know some people that have gone through a messy divorce. I have friend of mine that have gone through a messy divorce. I can think back to when I was in their wedding and they were standing up there in their church and looking into each other's eyes and holding the hands and saying I will always love you as God has given you to me and me to you, and we will run through the forest with butterflies and rainbows and everything is going to be wonderful and they ride in on the Cinderella horse and carriage and happily ever after. Everything is so full of love that day. Then three years later there are divorces and going I hate that person's gut. Well sometimes partnerships are like this. When you start a business you're like this is going to be great. We will just talk out our problems. But then when troubles come you may wish that you have invested into the partnership agreement. Are you with me? Another characteristic of partnership is mutual agency. What do we mean by mutual agency? That is usually discussed in a partnership agreement. What that means is this. Going back to Michael and Daniel again, if you guys are in that partnership, let's say the landscaping business. Daniel you can go to the landscaping store and buy some grass seed or something, you don't have to have Michael with you. You can act as an agent of that partnership. This makes scene, what if all 13 of you were in a partnership together? When you go buy office supplies would you all have to get on a little school bus to go, no you wouldn't. Certainly individuals could conduct business for that partnership if that business is reasonable for that type of business, and certainly buying grass seed or something would be reasonable expenditure for a landscape company. Alright now let's talk about two real important items. One great thing about a partnership is that the partnership itself does pay taxes. Now does that mean that Daniel and Michael get to live the benefits of a tax free life? No, what that means is this; the business itself does not have to pay taxes. Now let me clear that up a little bit more if that's still fuzzy. Know what we are going to talk about is a corporation. Quick side note and let's talk about a corporation. Know a corporation here rights? Here you have what is called Sprint Inc. c-corp. well they have to pay taxes; the company itself has to pay taxes to the US government. They may give some money to their shareholders in the form of dividends. Those shareholders they also have to pay taxes to the government. That is double taxations on c-corps. Sprint hates that they have this, the owners of Sprint the shareholders hate that they have to pay taxes on money that Sprint has already paid taxes on. That's double taxation. But going back to the partnership, one of the big advantages to a partnership is that the partnership its self does not pay taxes. Your business will fill out an information tax return where there is not money or anything and then report whatever you need to on your individual return when you do your individual for you or your family and that's when you pay your taxes. You are only taxed once at the individual level. That is the great thing about partnerships. Now let me tell you the big bummer about partnership organization. There is what we call unlimited liability of partners. What does that mean? Well, coming off the cameras. To Daniel and Michael let's say you have that landscaping business and your partnership that means you have unlimited liability. So let's say Michael is foolishly texting while mowing a lawn and runs over a child. That would be a bit messy wouldn't it? Well the partners could come sue the partnership and try to take the partnerships assets. They could also go after your personal assets Michael. They could take your home or lake house or go after your savings account that you funded with grandma's inheritance or whatever. "STUDENT"; so you can't LLC a partnership? We are talking about a pure partnership. We will talk about that is a second. Now here is the real bummer about a partnership, let's say Michael has this very unfortunate lawn mowing accident and you're a partnership, he doesn't have any personal assets but Daniel does. Who do you think they are going to go after? Daniel. So that is a big disadvantage of a true form of a partnership. Alright let's talk about a couple other organizations that have partnership characteristics. Know there is something called a limited partnership. This is where you have general partners who conduct the operations of the business. But you also have what is called a limited partner or a couple limited partners. These are individuals that are partners of the business but are they are not in the daily operations; maybe they are just the money person. Maybe you guys decide to bring in Jeramiah because he has lots of cash. He is a limited partner, you two are general partners. Now in every limited partnership you have to have at least one general partner to conduct the operations. But the limited partners such has Jeramiah, they have no personal liability beyond whatever they have invested. So in that unfortunate lawn mowing example they could not go after limited partner Jeramiah and take his personal assets. Another thing you may have heard of is a limited liability partnership, this is a partnership however there is protection in regards to malpractice and negligent claims among the different partners. Now when you see words like malpractice and negligent what types of partnerships would you think you would find the LLP form to be in existence? Medical groups like doctors; and attorneys. So let's say there were five of you that were in a doctor's office together and you were each physicians and you where an LLP. Well if Henry is negligent they could not go after someone else and go after their personal assets. There is that protection. You know doctors, there getting sued all of the time so there has to be that sort of form to kind of protect them. Now the next form of business is what Michael was referring to. Have you ever heard of the limited liability corporation? Or sometimes call LLC. The LLC has kind of the best of both worlds. The owners have limited liability, so they don't have to worry about someone coming after their personal assets. The business itself does not pay taxes. If you were going to start a business today in the United States, I would recon to say they would advise you to be a LLC because of these two great benefits. You might ask yourself why every company doesn't become a LLC. Well the main reason is, well let me back up. We're talking about these different forms of business for accounting class if and when you guys take a law class you're going to go a lot deeper into these forms, I don't know all the legal stipulations and requirements and all those for each of these forms. In the general sense the main reason the main reason not every business can be an LLC is there is a certain size or certain complexity that once a business grows to they are not allowed to be an LLC. I don't know what all the little legalese thing is but suffice it to say that companies like Pepsi Co or Sprint they would love if they would love if they could be a LLC and no longer have double taxation. But they are way too large and way too complex to qualify to be and LLC. The reason the LLC was mainly to put into place was to provide an avenue for small businesses to be able to start and have both advantages of no taxation and limited liabilities. "Student"; so does the Government set that up like what the max is. Yes the government establishes that, again if this was a law class we would go through the stipulation of what you have to qualify as and LLC. But that is kind of beyond the scope of the class. "Student"; It's just like a form of insurance more or less right? Well you can think of it like that way even though it's not technically insurance; but by being an LLC the main reason people do it so they have that protection, if there is a lawsuit. We know in the US everyone likes to sue everybody. I had a business for 5 to 10 years and it was a LLC. It's really not that expensive to do, you have to pay a few fees there is a few things you have to do, forms have to fill out but it's really not that complicated at all. "Student"; if you were to start a branch of an existing company like Starbucks do you have stipulations through that company already that you have to follow? Starbucks I guarantee you is a corporation. So that would be a franchise, so you wouldn't really be your own separate entity. Know I take that back a little bit if you owned several Starbucks yourself and had a franchise I'm not sure but I think the protection you would receive would be form the corporation itself. But maybe you could be an LLC as well. Again if you guys are asking more legal questions that are attorney type things I'm not going to know. "Student"; I didn't know if you had premade stipulations that have to be followed. Starbucks and any sort of franchise definite have a list of thing to protect you as well as a list of things you have to do to qualify to be a franchise. Let just generalize here and move beyond this. Take a look at this chart. Let me get my pointer I'm not really good at writing with a mouse. A proprietorship is what we talked about in Accounting I. Partnerships is what we are going to talk about in chapter 12 and we are going to kind of touch on a little bit of these as well. And S Corp is real similar to a LLC. Then there is corporation sometimes we call it a C Corp. That's like Sprint and we will talk about that in chapter 13. Know regardless how you separate your business it is going to be a separate business entity. Now remember the business entity concept for Accounting I? You are going to keep those records separate from your personal records or if you have more than one business, you're going to keep everything separate. But looking at this chart in regards to a legal entity, only items that are corporations' whether an LLC, S Corp or C Corp are a separate legal entities. That means you have almost created an artificial person. Corporations have rights and responsibilities; they can sue and be sued. So only Corporation are separate legal entities. Limited liability as I said partnerships and proprietorships do not have limited liability they have unlimited liability, which is a real bummer. Is the business taxed? Only a C corporation has this double taxation. Is one owner allowed? Well any kind of business can have one owner unless it is a partnership. If you have a partnership there is more than one owner. But coming off of that, when you think of corporations you think of Pepsi Co, Garmin International, or Hallmark. There are lots of corporations that are just two people there are more of those then the others; I don't want you to just think corporations are always gigantic. You could be a C Corp if you wanted your two person landscaping business but I'm going to guessing your attorney would advise you to be an LLC. We're laying some ground work here. Remember how when in a sole proprietorship in Accounting I; going over to the document camera. Remember how we talked about in a sole proprietorship Accounting I, John Doe invests $10,000 and then we credit capital for $10,000. Remember how we did that in Accounting I? A lot of time we didn't even put the partners name behind their capital account. But one thing I want you to know is that in a partnership each partner has their own capital account, and each partner has their own withdrawal account. So there is an account called capital Dan, and an account called capital Michael, and there is an account called withdrawal Dan and withdrawal Michael and you keep track of that separately. And just like with the sole proprietorship you as the owner can invest assets and liabilities into the company and it increases your capital. Remember in Accounting I how I made a big deal about how investing assets into a company and net income are the things that increase your capital. The things that decrease the capital are the owner taking assets out of the company or if the company has a net loss they decrease capital. Same thing with a partnership except you each have your own capital account and your own withdrawal account. Let's take a quick look at this. On May 1, Bob and Jane organize and partnership. Bob contributes cash of $19,000 and Equipment of $4,000. So we debit cash for $19,000 and $4,000. You notice we don't put Bob's name by it or anything like that because the partnership owns it. Then what do we credit? We credit Capital - Bob or sometimes people will put the name first like Bob - capital. Let's say that Jane contributes cast of $3,000 and an Automobile with a fair market value of $24,000. Now there is a note payable of $6,000 that is due on that automobile that is also assumed by the partnership. What would that journal entry look like? I always say list all the assets and or liabilities going into the business and ask yourself what you would have to credit here to make this journal entry balance. In this case you have to credit capital Jane for $21,000. Of course your total credits have to equal your total debits. If there is withdrawals, if Bob withdraws $3,200 from the partnership for personal expenses the journal entry is the same except you debit withdrawals for Bob, credit cash. If Jane withdrawals $2,900 we debit withdrawals for Jane and credit cash. I have yacked long enough what I want you all to do is just take a few minutes, I have given you the Lucinda and Donna handout. I only want you to do required A and B. Now you folks at home who are watching this if you are an online student you should have all these work papers. If you are watching these overseas or something for your own benefit, if you email me at the email address that is given many times throughout these lectures I will send you these handouts. Don't leave a comment on the YouTube page I don't read those, send me an email. Now let's do A and B of the Lucinda and Donna handout. Music Playing form 31:57 to 34:48 Okay we are back. Let's take a look at the answers to this. Well there is cash and equipment for Lucinda invested into the business of $4,000 and $3,680 so we credit capital I just put L for $7,680. For Donna she put in cash of $8,820, vehicle for $9,800 and note payable of $2,300. You might ask yourself the partnership doesn't want any note payable, they don't want any debt. Why would there be a debt they take on. Well they are more than happy to take the vehicle even if there is some debt because wouldn't you take a $9,800 vehicle even if there was $2,300 debt? You don't get one without the other. So the vehicle goes in at $9,800 and the notes payable goes in at $2,300 and we credit capital for Donna $16,320. All the debits equal the credits. Okay let's go back to the lecture. Let's review the closing process. Remember chapter 4 well was for us in Accounting I, remember when you closed the books at the end of the period. First you would close the Revenue by debiting them. They would have some amount. Let's say the total over the revenue was for 100,000 so we would credit income summary. And then you would close all of the expense accounts. Let's say the total of the expenses 60,000 so we would debit income summary. Does anyone remember the third closing entry? You would close the income summary to capital. Now do we have a net income or net lost? The revenue is 100,000 and the expenses are 60,000 so we have a net income of 40,000. So what the third closing entry was in Accounting I with a sole proprietorship we would debit income summary for 40,000 and credit capital for 40,000. Now it's the same way with partnerships of course you have to close the withdrawals account too. Just know that, but let's concentrate on this. This is all the same for partnership except we have more than one capital account now. We might have capital for Daniel and capital for Michael and we need to know how that income is allocated between the two partners. "Student"; as far as revenue and expenses would you put as an expense that Daniel paid for? For were you are in your education no it would just be listed as an expense of the partnership. But we need to know how to divide up that income summary. Know where do you thing we would go to find out how we would divide up that income between partners? Partnership agreement is where it's going to state it. If you don't have anything written down then it's going to be divided evenly. But what I want to talk about know is how we divide income or lose. We don't report salary as and expense on the income statement for partners. The way that there compensated is through their capital account increasing and being able to draw on it. So again if the partnership agreement does not state how to divide up income or lose then it will be done evenly. But there are some other ways that is can be done. Know I want you to look real quick switching back to this docket cam. When we do this entry to divide or allocate the net income, there is no cash. Sometimes people will incorrectly credit cash here. This doesn't mean we are giving out money to the partners. We are increasing their capital accounts. If they choose to withdrawal cash in the future that is the prerogative. But when you are allocating net income or net loss it is not a cash transaction. Just like in Accounting 1 you didn't credit cash in the third journal entry when you closed income summary. Now let's talk about common ways to divide income or loss. Two of these are pretty straight forward and the third will need a little more explanation. So what if we divided based on a stated ratio that's listed in the partnership agreement. Let's look at an example. Smith and Jones agree to divide profits or losses 3/4 for Smith and 1/4 for jones. Now why might net income not be allocated evenly among partners? Because one might be doing more work than the other, maybe one has put in more assets into the business or maybe someone has more expertise. Henry if you wanted to start an accounting practice with me then I would probably say well I have more experience than you do, right? So I'm going to get more of the net income than you do. LeBron James does not get paid the same amount on his team as the 12th guy on the bench. He has more skills. In this analogy I'm LeBron James. Let's go back to this example. Smith and Jones agree to divide profits or losses 3/4 for Smith and 1/4 for Jones. For the current year they reported net income of 60,000. Well it's pretty easy to see how we came up with those numbers. 3/4 of 60,000 is 45,000 for Smith, and of course 15,000 are 1/4 of 60,000. There is not cash to distribute or anything this is just how there capital accounts increase. You can see here they put the person's name first and then capital, I usually got capital and then the person's name. Look at the next method. What about allocation based on capital balances. Well Smith's capital balance before division of profits or losses is 80,000 and Jones is 40,000. Know the partnership agreement call for income or loss to be allocation based of the relative capital balances. Net income is 60,000. Okay let's take a look at this. So you have the capital balances for Smith and Jones, Smith is 80,000 and Jones is 40,000 for a total of 120,000. Then we figure out the ratio. What's 80,000 divided by 120,000? It is 2/3 or 66.67percent. What is 40 divided by 120,000? It's 1/3 or 33.33 percent. Then we take the percentage times the net income of 60,000 and that gives us how much we allocate to each partner. Of course the journal entry looks like this. Now this method might be used remember when we invested assets this would reward the person who has the higher capital balance perhaps invested more assets into the company. Are there any questions on those first two methods? Let's look at the third method in what time we have left. It's a little bit more complicated but it's a perfect example of something will be best illustrated by doing an example or two so we will get to that in a minute. Let's say Smith and Jones has a partnership agreement with the following agreement. Smith receives 15,000 salary allowances and Jones receives 10,000 salary allowances. What is a Salary allowance? A Salary allowance is simply a number that is written in the partnership agreement in regards to doing the computation we are going to do. Now Smith gets a 15,000 salary allowance more the Jones 10,000 because perhaps he has more expertise. Now each partner is also allowed an annual interest allowance. It is going to be computed by taking 5% times the beginning of the year capital balance. Remember from the previous slides that the beginning-of-year capital balances for Smith and Jones are 80,000 and 40,000. So they are going to receive an interest allowance of 5% based on those beginning of the year capital balances. Any remaining balance of income or loss will be divided equally. Let's take a look at an example. We have a net income of 60,000. The first thing we need to do is list out the salary allowances that were given in the partnership agreement. It said that Smith will receive 15,000 and Jones will receive 10,000 salary allowances so write that down. Then it says they received interest allowances of 5% of their beginning of the year capital balance. For smith it would be 5% times 80,000 equaling 4,000 and 40,000 times 5% equaling 2,000. So now we add up these 4 numbers and those numbers equal 31,000. We subtract that from the net income of 60,000 and we get 29,000, and then it says to divide that equally. What is half of 29,000? It is 14,500. So we hand that to each partner. Then we add these 3 numbers up and we get 33,500. Now we add these 3 up and we get 26,500. The key thing is that the 33,550 and the 26,500 equal the next income of 60,000. If the two numbers on the bottom line do not add up to the net income then you have made a mistake. So that is a little more complicated way of allocating income, it's one that grants certain salary allowances to each partner based on the knowledge or expertise, or how much time they are putting in. It also rewards them by keeping a high capital balance because there is a percentage paid on capital. Student; is this the most common way used? No, I think the most common way is equally. But this is certainly used a lot. Now taking a look back at the screen the journal entry would be debit to income summary of 60,000, and Smith capital and Jones Capital is credited or increased because capital balance is a credit balance account. Those accounts are increased by 33,500 and 26,500 respectably. Know I want to note something we have about 3 more in here. If we change the net income instead of 60,000 is 81,000, I want you to know that everything here stays exactly the same no matter what the net income or net loss is. But now if we subtract 31,000 from 81,000 we get 50,000 and what is half of 50,000? 25,000. Now we add those up and we get 44,000 and 37,000. Does 44,000 plus 37,000 equal 81,000? Yes it does. So everything in that circle stays the same in that box. So what if they only have a net income of 22,000? Well once again everything in the circle stays the same. But now you subtract the 31,000 from 22,000 and what do you get? You get -9,000. What's half of -9,000? It's -4,500. Does 14,500 plus 7,500 equal 22,000? Yes it does. One more example, what if they had a net loss of? Well you can think of it as a negative net income. Well let's say their net income is -9,000. This is all the same. What is -9,000 minus 31,000? It is -40,000. What's 1/2 of -40,000? -20,000. When you add those us you get -1,000 and -8,000 that adds up to -9,000. In this case the capital accounts would actually be decreased. Capital Smith and Capital Jones would be debited and income summary would be credited because it's a loss. Here is what I want you to do for homework, finish Lucinda and Donna handout. Do the Scott and Mike handout. And then what I want you to do is Quickstudy 12.1 and exercise 12.1 and 12.4. Now the Scott and Mike handout looks like that. This is not three separate plans. This is all one plan and you're only going to make one journal entry, just like we did when we were doing this right here. So the homework I want you to do is finish Lucinda and Donna handout Scott and Mike handout and Quick study 12.1 and exercise 12.1 and 12.4. If you need to review those account balances go ahead and do that as well.