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By Charles E. Jordan and Stanley J. Clark

Since its inception in 1977 in Wyoming, the limited liability company (LLC) has attained legal status in varying forms in almost all states. The LLC's increasing popularity as an alternative business entity stems from its hybrid nature. It provides owners (called members) with the limited liability protection of a corporation, but without the potential for double taxation. An LLC may elect to be taxed as a partnership and have the income/loss flow through to the members for tax purposes. LLCs provide the primary advantages of S corporations but without limitations on the number of owners, types of owners, and classes of stock.

As a new business form, questions arose concerning the proper accounting and reporting treatment for LLCs. In April 1995, the AICPA's Accounting Standards Executive Committee (AcSEC) answered these questions by issuing Practice Bulletin (PB) 14, Accounting and Reporting by Limited Liability Companies and Limited Liability Partnerships. The Bulletin's provisions already apply, as its effective date was for financial statements issued after May 31, 1995.

Breadth of Coverage

Reporting guidelines for LLCs have not been provided by the FASB. Thus, as the only authoritative source, PB 14 establishes GAAP, and any LLC that purports to present its financial statements in conformity with GAAP should adhere to the bulletin's requirements. Actually, PB 14 provides guidelines for LLCs and limited liability partnerships (LLPs), both of which are referred to in the bulletin as simply LLCs. For any accounting and reporting issues not addressed in PB 14, LLCs should be guided by existing GAAP.

Accounting for LLCs

The Bulletin addresses some areas specific to LLCs.

Valuation at Formation. One such area is the valuation of an LLC's assets and liabilities when the LLC is formed from an ongoing entity. Whether the LLC is formed by combining entities under common control or by conversion from another business type (e.g., partnership, C corporation, S corporation, etc.), the assets and liabilities should be recorded at a carry-over basis of the transferring entity. The assets and liabilities are not revalued because their function has not changed; only the legal status of the entity or entities has changed. This treatment parallels accounting for pooling of interests under APB No. 16, "Business Combinations."

Income Taxes. Typically, LLCs are taxed as partnerships for Federal income tax purposes and therefore have no tax liability. However, some states have enacted statutes that treat LLCs as taxable entities for state income tax purposes. Thus, LLCs formed in these states or simply operating in these states may be subject to taxation on income generated within the states' boundaries. For those LLCs facing income taxation, PB 14 requires that income taxes be accounted for in accordance with SFAS No. 109, Accounting for Income Taxes.

Deferred Taxes. If the formation of an LLC results in a nontaxable entity where a taxable entity had existed previously (e.g., conversion of a C corporation into an LLC), PB 14 follows SFAS No. 109 and requires the elimination of any existing deferred tax assets or liabilities. The entry would affect current year's income by adjusting the provision for income taxes.

Notes Receivable for Contributions. A final accounting issue concerns an LLC receiving a note instead of cash as a capital contribution from a member. AcSEC concluded the note generally should not be accounted for as an asset, but rather as a deduction from members' equity. Only in rare cases where there is strong evidence of the intent and ability to pay within a short period of time would the note be classified as an asset. This is similar to the current practice for regular corporations of treating receivables on subscribed stock as contra equity.

Financial Statement Presentation

In general, the financial statements of an LLC should resemble those of a partnership and include a balance sheet, income statement, statement of cash flows, and footnote disclosures. Also, an LLC must present a schedule showing changes in members' equity either presented in a separate statement, combined with the income statement, or disclosed in the footnotes.

The headings of the financial statements should clearly label the entity as an LLC. The equity section of the balance sheet should be titled "members' equity." LLCs with more than one class of members must report separately the equity of each class either in the equity section of the balance sheet or in the footnotes; balance sheet disclosure is preferred. Unlike corporations, LLCs should not report equity contributed by members separately from earned equity. If the total amount of members' equity is less than zero, a deficit should be reported in the equity section of the balance sheet.

If comparative financial statements are presented, the financial statements must be truly comparable to the prior years or any reasons for the noncomparability must be disclosed. For example, assume that during the transformation of an S corporation to an LLC part of the entity's assets are distributed to the owners. As a result of the asset distribution, the financial statements of the S corporation for the preceding year are not comparable to the current year's statements for the LLC. The reason for this lack of comparability should be fully disclosed in the footnotes.

A special situation arises when the formation of an LLC results in a new reporting entity. Forming an LLC through conversion of another entity type usually does not result in a new reporting entity because the economic make-up of the entity remains unchanged. A new reporting entity occurs when an LLC is formed by combining entities under common control where those entities were not previously presented in combined financial statements. The resulting firm is a new reporting entity because it contains a different group of companies after the conversion (i.e., their economic make-up has changed).

If the formation of an LLC produces a new reporting entity, PB 14 states that all prior periods' financial statements presented should be restated to show financial information for the new reporting entity for all periods. This reflects the requirements for new reporting entities under APB No. 20, Accounting Changes.

Financial Statement Disclosures

In addition to GAAP disclosures required for all types of entities, PB 14 prescribes some unique disclosures for LLCs. For example, the footnotes should provide a description of the members' limited liability. Also, when different classes of members exist, these classes should be disclosed along with their respective rights, preferences, and privileges.

AcSEC believes any limited life status of an LLC is extremely important to those conducting business with the entity. Therefore, if an LLC has a limited life, PB 14 requires disclosure of the entity's expected expiration date.

If an LLC is formed by conversion from another entity type or by combining entities under common control, the footnotes in the year of formation should clearly state that the assets and liabilities were held by a different entity in the past. PB 14 encourages an LLC formed by combining entities under common control to provide the disclosures in paragraph 64 of APB No. 16, Business Combinations, that are pertinent to the newly formed LLC. Among other things, this disclosure would provide information on the separate companies combined as well as the method of effecting the

Finally, as noted above, the issuance of comparative financial statements that are not truly comparable requires disclosure explaining the reason(s) for the lack of comparability. *

Charles E. Jordan, DBA, CPA, is an associate professor and Stanley J. Clark, PhD, CPA, an assistant professor, at the University of Southern Mississippi.

Douglas R. Carmichael, PhD, CPA
Baruch College

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