Partnership Capital Accounts

[S T]

Partnership in Service Business on Cash Basis, but does have Accounts Receivable.

I have a "huge headache"! Balance Sheet. In quickbooks balance sheet shows no assets other than the Checking Account. No Receivables, No Payables. Client says no liabilities. All assets (computer equipment) has been Sect 179. They are drawing out at least as much as the net income and then usually more. I am thinking they are negative partnership basis which probably is not an issue as there is $200K income so no losses. Only issue would be Sect 179 expense for 2006.

QB Balance Sheet shows Checking account is negative ($58,000,) which then means my capital accounts by the time the increases/decreases are made is a large negative. I have no partnership basis worksheets to go by at all. I have tried to reconstruct the best I can and they show a total negative between the 2 partners.

12/31 bank statement shows $21,000 ending balance , but then there are checks written that have not cleared. Out of the $58,000 negative approx $22,000 of the checks written are for draw checks to partners, the balance of the checks written are for legitimate expenses. A/R $88,000+

Client says, checks written for expenses in 2006 dated 12/30-12/31, A/R receipts are deposited 1/07.

I am not getting a good feeling on this !

What I am thinking is that they wrote out a lot of checks including draw checks to partners (2) for 12/31/06 expenses/draws, but the money on receivables or invoicing was not received and booked until after 1/1. I know the draw checks to the partners don't really matter except for distributions, but what about the expenses posted for the end of the year.

Thoughts would be appreciated.

Thanks

Sandy

[OldJack]

What I am thinking is that they wrote out a lot of checks including draw checks to partners (2) for 12/31/06 expenses/draws, but the money on receivables or invoicing was not received and booked until after 1/1. I know the draw checks to the partners don't really matter except for distributions, but what about the expenses posted for the end of the year.

Your conclusions and analysis appear to be on target. A partnership can have negative capital accounts that simply mean they owe the partnership. The only real problem is your last sentence "but what about the expenses posted for the end of the year".

As you are doing the books you are equally, if not more, responsible for the accuracy of the numbers on the 1065 tax return than the partners. It is a common practice with small businesses such as your partnership client that they try to write checks to pay all the bills possible at the end of the year since they have a big profit. That is not a problem if they in fact mail all those checks and they eventually clear the bank in the new year. However, in many cases they hold the check until the next year when they know a next year deposit will cover the checks. That is a problem as the checks are not deductible until they have been released or mailed. What makes your problem worse is the checks delivered to the partners is a release, even though not cashed, when it is the expense checks that you want released.

Truth is... the 1065 tax return can be filed with negative capital accounts and a negative bank balance claiming all expenses. It would be difficult for the IRS to prove that checks were being held and therefore not deductible unless a partner or someone admitted they had not mailed the checks. However, such a tax return could be one that would be selected for audit.

Don't make this decision yourself. Don't let this problem be your problem. What to do about this must be brought to the attention of the partners and they make a decision as what to do.

One option would be to record the checks not mailed as a credit to cash and a debt to an asset account called something like "prepaid expenses". When the checks are released, the entry would be to credit/clear-out the prepaid expense account and charge the proper expense account in the new year.

[S T]

Thank you

Jack,

Thank you, your post certainly assisted me to convince the partners that they need to change how they are recording their transactions. They are using QB like a spreadsheet instead of utilizing it's full accounting capabilities. Fortunately, I do not prepare or audit their accounting, I only review as I am compiling the tax returns, then ask questions when I see something that doesn't look quite right.

Sandy