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Business Entities—Partnerships and Corporations

Assume Target Corporation is involved in a major lawsuit and the probable damages are estimated to be $2,000,000.

A. Describe the effects damage estimates would have on the financial statements of a corporation and a partnership. $2 Million is not significant for any of the companies...So, answer it assuming the $ amount is and is not significant.  

B. How do disclosure requirements differ from a corporation to a partnership and what information is required?  Here - be specific on what the SEC requires vs. what partnership accounting would look like

C. Are the shareholders at risk for any personal liability with the company set up as a corporation? Defend your response.  Here you might indicate what if any circumstances the shareholders would be liable

D. If Target Corporation was set up as a partnership, would the partners be at risk for personal liability? Defend your response. Same as C. above. You might indicate what if any circumstances the partners would be liable

Wrap up it with a conclusion that brings it all together.  

Answer 1

A)If Target was involved in a major lawsuit, any potential losses that could arise from the lawsuit should be treated as a contingent liability. According to FASB guidelines, contingent liabilities can be recorded in the books of accounts only if the contingency is probable and the amount of the liability can be estimated. Since it meets all the requirements, the potential loss would be recorded in the balance sheet and income statement. As soon as Targets legal team gets the estimate, there should be a debit to legal expense account for two million and a credit to the accrued liabilities account for two million. When the lawsuit is settled, target will debit accrued liability and credit cash. There will no impact on cash flow for the recording of the contingent liabilities till the liabilities are actually paid

B)Companies that are privately owned are not required to release financial and operating information by law. So some companies may decide to provide such information only on a need to know basis.
The disclosure requirements for the lawsuit liability or material loss contingencies are based on both the likelihood of occurrence as well as the estimated loss. The likelihood of occurrence is divided in to three main categories, probable, reasonably possible, and remote. Since the amount of the contingency (two million) has been determined, a full disclosure of the nature of the accrual recognized is required and the amount has to be disclosed. This means notes need to identify that the increase in the loss contingency is as a result the major lawsuit and the amount accrued needs to be listed. If there is at least a reasonable possibility that a loss in excess of the amount recognized exists, the company is required to disclose an estimate of the possible loss or range of loss or a statement that such an estimate cannot be made. The potential loss should be included in the footnotes or disclosure category of the financial statements.
Partnerships must lack at least two of the following characteristics; Limited liability, free transferability of interest, centralized managements, and continuity of life.
Partnership must ensure that both of the following disclosures are included in notes to the financial statements:
•A description of any limitation associated with member liability
•The different classes of member interests and respective rights, preferences and privileges of each class; also, in circumstances where partnerships do not report separately amounts for each class in the equity section of statements of financial position, disclosure of those amounts
These disclosures primarily pertain to the identities of the partnership and the partners, as well as information regarding the state of activities and financial status of the business.
Disclosure of information on the state of activities and financial status of the business requires a balance between providing partners the access to information and safeguarding vital business information. This balancing act is better explained in the context of fiduciary duties. Limited partners do not have fiduciary duties of care and loyalty to the limited partnership or to other partners, by virtue of the limited powers vested on them. In contrast, these fiduciary duties rest heavily on the general partners. These duties oblige the general partners to protect information which are confidential to the limited partnership or otherwise unfit for dissemination. Thus, a partner's requests for information are thoroughly evaluated such that only information that is reasonably within the partner's interests is provided to him or her.
C)The Shareholders are not at risk for any personal liability. Corporations are a group of people who have legal authority to act as a single entity and are recognized as such in law. The shareholders benefit from no personal liability. Their total liability is limited to their investment. Shareholders do not typically actively manage a corporation; shareholders instead elect or appoint a board of directors to control the corporation in a fiduciary capacity.
D)If Target was set up as a partnership, the amount of personal liability faced by its partners will be based on the type of partnership the company operates with. In general partnership, the owners are all personally liable for any legal actions and debts the company may face, unless otherwise provided by law or in the agreement. So if the partnership is not able to completely pay the liability from the lawsuit, its partners will be personally liable for what’s left of the liability.
A limited partnership (LP) is a form of partnership similar to a general partnership, except that with a limited partnership must have at least one GP and at least one limited partner. If Target was a limited partnership, only the general partner will be risk for personal liability.
A limited liability partnership (LLP) is a partnership in which some or all partners (depending on the jurisdiction) have limited liabilities. In an LLP one partner is not responsible or liable for another partner's misconduct or negligence. In a limited liability partnership, none of the partners would be at risk for personal liability. In a situation where the lawsuit is a result of a partner’s negligence or misconduct, the alleged partners would be at risk for personal liability.