Question on LLC member distributions w/o closing books

Matt Kowske jmk at cmail.nu
Mon Feb 23 10:12:22 EST 2015


On 02/22/2015 01:09 PM, Buddha Buck wrote:
> If I understand the question properly, I don't think it's so much a
> question of how to handle the owner's draw, but rather how to "replenish"
> the owner's equity accounts.

Yes, I think this is exactly where I am struggling.

> I mean, let's say there is a business which has run for years and never
> "closed the books". The balance sheet says there's $100K in assets, $10K in
> liabilities, $5K equity for each of 2 owners ($10K total), and $80K in
> retained earnings.
>
> If one owner takes a $10K draw, twice his original investment, that's OK
> since his share of the business is $45K.
>
> But that would leave a balance sheet of $90K in assets, $10K in
> liabilities, $5K for one owner, -$5K for the second owner, and $80K in
> retained earnings.
>
> This is accurate, but it looks weird. It would look better if the retained
> earnings were distributed among the owner's equity accounts. But retained
> earnings is not a "real" account, it's a pseudo account computed from
> income and expenses.
>
> So what's the best way to distribute retained earnings without closing the
> income and expense accounts?

This is the question I have been trying to ask in more words than were
needed...

> I can think of a couple of ways:
>
> I) Create an Equity:Distributed Earnings account, intended to have a
> negative balance, which distributions come from. It offsets the retained
> earnings. So in this case, the balance sheet would say $25K for owner 1,
> $15K for owner 2, $80K in retained earnings, and -$40K for distributed
> earnings. The total equity is still $80K, but more money has been
> distributed to the owner's accounts (if not pockets) than before.

This type of thing could work, but wouldn't the "Distributed Earnings"
account continue to become more and more in the negative over time
eventually canceling out Owner's Equity and showing a negative equity
for the LLC on the balance sheet? If 'Equity = Assets - Liabilities'
then this would no longer show a correct balance sheet. Or what am I
missing? How does the equity become replenished? You are replenishing
from another equity account so doesn't it cancel itself out? For an even
simpler example, the LLC has 100 in assets, 10 in liabilities, and 90 in
equity.

1) After a distribution of 10 from a checking account it would then be:
90 in assets, 10 in liabilities, 80 in equity.
2) Another distribution of the same: 80 in assets, 10 in liabilities, 70
in equity. The 70 in equity is now a sum of the two equity accounts: 90
in the Initial Equity account and 20 in the Distributed Earnings.
3) Now the LLC receives income of 10 -> 90 in assets, 10 in liabilities,
80 in equity. Equity has gone back up by 10 -- because the calculated
Retained Earnings will now show an additional 10.

Ok, so I seem to have come to an understanding by writing that out. The
balance sheet, over time, will have a larger and larger negative balance
for Distributed Earnings and a larger and larger positive balance for
Retained Earnings (calculated, assuming a positive profit is generated).
This seems a little weird to me but it is correct accounting, yes? The
total equity should remain close to the original amount of equity each
member put in if payouts are made consistently and for all profits.
Retained profits will be represented by the "Retained Earnings" on the
balance sheet. The "Retained Earnings" account I have in my CoA should
just be removed, as this is auto-calculated on the balance sheet. For
some reason this approach seems a little "messy" but maybe that's just
how it's done... I'm new with this.

Correct me if I'm wrong, but a balance sheet shows a business financial
position up to the current point in time. The difference in using the
approach outlined above, and the old school closing of the books, would
be that the balance sheet would show the amount of retained earnings
over the entire course of time of the business if you do not close the
books vs. retained earnings for the year (or whatever period the books
were 'open'). Is that right?





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