Reporting entities frequently are formed as limited liability entities, particularly limited liability companies and limited liability partnerships.
The accounting literature that particularly relates to these types of entities, herein referred to collectively as LLCs, is found in the FASB Accounting Standards Codification (FASB ASC) Topic 272, Limited Liability Entities.
LLCs have characteristics of both corporations and partnerships, but these types of entities also are dissimilar in many respects.
LLCs are formed in accordance with laws of the various jurisdictions under which the entities are organized. Given that laws in this arena are not uniform, characteristics of LLCs may likely vary from jurisdiction to jurisdiction.
As clearly delineated in FASB ASC 272-10-05-6, for LLCs to be classified as partnerships for federal income tax purposes, they must lack at least two of the following corporate characteristics:
- Limited liability
- Free transferability of interest
- Centralized management
- Continuity of life
It should be noted that many jurisdictions have adopted similar requirements for LLCs to be classified as partnerships for state income or franchise tax purposes. However, certain jurisdictions have enacted LLC legislation that includes income tax requirements.
LLC Financial Statements
Using the guidance in FASB ASC 272-10-45-1, a complete set of LLC financial statements needs to include all of the following:
- A statement of financial position at the end of the reporting period
- A statement of operations for the reporting period
- A statement of cash flows for the reporting period
- Accompanying notes to the financial statements
In addition to the above-noted financial statements and note disclosures, LLCs need to present information related to changes in member equity for the reporting period. As with entities other than LLCs, this information may be presented as a separate financial statement, combined with the statement of operations or disclosed in the notes to the financial statements.
Statement of Financial Position Equity Section Presentation
From a presentation perspective, financial statements of LLCs are required to be similar to those of partnerships. Since LLC owners are referred to as members, the equity section in statements of financial position is required to be titled “Members’ Equity.”
Where LLCs are formed so that more than one class of members exist – each having varying rights, preferences and privileges – using the guidance in FASB ASC 272-10-45-3, LLCs are encouraged to report each class separately within the equity section. In circumstances in which LLCs do not report amounts for each class separately within the equity section of statements of financial position, they are required to disclose those amounts in notes to the financial statements.
Using the guidance in FASB ASC 272-10-45-4, even though LLC member liability may be limited, if the total balance of the members’ equity account or accounts falls below zero, LLCs are required to report the deficits in statements of financial position.
Using the guidance in FASB ASC 272-10-45-5, when LLCs record amounts due from members for capital contributions, those amounts are required to be presented as deductions from members’ equity. Presenting these amounts as assets is considered to be inappropriate except in very limited circumstances where there is substantial evidence of ability and intent to pay within a reasonable period of time.
Financial Statement Note Disclosures
LLCs should 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 LLCs do not report separately amounts for each class in the equity section of statements of financial position, disclosure of those amounts
In circumstances where LLCs have finite lives, the dates associated with when they will cease to exist need to be disclosed.
As discussed previously, LLCs must lack at least two characteristics typically associated with corporate forms of entities, where one of those characteristics relates to continuity of life. If this is one of the characteristics LLCs lack, that fact needs to be disclosed since it may be of significant interest to users of financial statements entering into transactions with the LLCs.
Related to income taxes, while LLCs generally are classified as partnerships for federal income tax purposes and, as such, are exempt from taxes in that tax liabilities flow through to LLC members, the disclosure requirements in FASB ASC 740, Income Taxes, need to be followed. In addition, the recognition and measurement provisions within FASB ASC 740 might be applicable in certain circumstances where LLCs have income generated that is subject to income tax.