Using the two class method as defined in ASC 260 (which you need to search, read, and understand), what are the distributed earnings (i.e., the partnership's available cash) and undistributed earnings? What are the distributed, undistributed, and total earnings per unit (to the LPs) under the following two scenarios? a. Net income of $50,000 and Cash available for distribution of $25,000 b. Net income of $5,000 and Cash available for distribution of $6,000

University of Illinois Case Study: Earnings Per Share/Unit (EPS/U) EPU Case Study I. Background Characteristics of a partnership A partnership is an unincorporated association of two or more individuals to carry on a business for profit. Many small businesses, including retail, service, and professional practitioners, are organized as partnerships. The partnership agreement should identify the partners; their respective business-related duties and responsibilities; how income will be shared; the criteria for additional investments and withdrawals; and the guidelines for adding partners, the withdrawal of a partner, and liquidation of the partnership. For income tax purposes, the partnership is considered a "pass-through entity" and files an information return only. Each partner shares in the net income or loss of the partnership and includes this amount on his/her own tax return. Limited life The life of a partnership may be established as a certain number of years by the agreement. If no such agreement is made, the death, inability to carry out specific responsibilities, bankruptcy, or the desire of a partner to withdraw automatically terminates the partnership. Every time a partner withdraws or is added, a new partnership agreement is required if the business will continue to operate as a partnership. With proper provisions, the partnership's business may continue and the termination or withdrawal of the partnership will be a documentation issue that does not impact ongoing operations of the partnership. Mutual agency In a partnership, the partners are agents for the partnership. As such, one partner may legally bind the partnership to a contract or agreement that appears to be in line with the partnership's operations. As most partnerships create unlimited liability for its partners, it is important to know something about potential partners before beginning a partnership. Although partners may limit a partner's ability to enter into contracts on the company's behalf, this limit only applies if the third party entering into the contract is aware of the limitation. It is the partners' responsibility to notify third parties that a particular partner is limited in his or her ability to enter into contracts. Unlimited liability Partners may be called on to use their personal assets to satisfy partnership debts when the partnership cannot meet its obligations. If one partner does not have sufficient assets to meet his/her share of the partnership's debt, the other partners can be held individually liable by the creditor requiring payment. A partnership in which all partners are individually liable is called a general partnership. A limited partnership has two classes of partners and is often used when investors will not be actively involved in the business and do not want to risk their personal assets. A limited partnership must include at least one general partner who maintains unlimited liability. The liability of other partners is limited to the amount of their investments. Therefore, they are called limited partners. A limited partnership usually has LLP in its name. Characteristics of a MLP An MLP is a limited partnership organization whose limited partnership units are available to investors and traded on public exchanges, just like corporate stock. MLPs usually consist of (1) a general partner (GP), who typically holds a small percentage of the outstanding partnership units and manages the operations of the partnership and (2) limited partners (LPs), who provide capital and hold most of the ownership but have limited influence over the operations. The primary benefit of the MLP business structure is to pass through its income to the limited partners without paying federal or state income tax, thereby eliminating the double taxation of distributions, increasing free cash flow and lowering its cost of capital, MLPs generally will not hold investments in common stock or corporate joint ventures. Typically, MLPs will hold investments in general partnerships, limited partnerships or limited liability companies (LLCs) in order to avoid having their earnings in these investments taxed. EPU calculations in partnership Earnings per unit Publiclytraded MLPs typically issue multiple classes of securities that participate in partnership distributions according to a formula specified in the partnership agreement. A typical MLP consists of publiclytraded common units (and in some cases, subordinated common units) held by LPs, a GP interest and IDRs. IDRs may be a separate nonvoting limited partner interest that the GP initially holds, but may be transferable apart from its GP interest. IDRs may also be embedded in the GP interest such that they cannot be transferred separately from the GP's overall interest in the MLP . In many cases, the partnership agreement obligates the GP to distribute onehundred percent of the partnership's available cash (as that term is defined in the partnership agreement) to the LPs, GP and, when certain thresholds are met, the holder(s) of IDRs, based on a distribution waterfall schedule included in the partnership agreement. Partnership agreements may state that the holder(s) of IDRs are not entitled to distributions other than those provided in the distribution waterfall of available cash. Under this case, undistributed earnings, defined as net income (or less) excluding available cash is allocated to the capital accounts of the GP and LPs based on their ownership percentages. As the name suggests, IDRs are intended to encourage the general partner to operate the MLP and its business in a way that increases cash distributions to unit holders, which effectively give the GP a disproportionate share of the upside associated with the MLP and its business. Because the GP and LPs both participate in the distribution of earnings, MLPs are required to calculate EPU using the twoclass method as defined in ASC 260. Generally, EPU follow the same guidance as EPS. II. Case study facts The MLP has 9,000 Common Units held by the limited partners (LPs), a 10% general partner (GP) interest held by the GP which is represented by 1,000 notional units1, and incentive distribution rights (IDRs) outstanding, also held by the GP. The IDRs are held by the GP and represent a separate class of non-voting limited partnership interests that are transferable by the GP separate from its ownership interest. The GP is obligated to distribute 100% of the partnership's Available Cash based on a distribution waterfall specified in the partnership agreement and shown below. Distributions to the holders of IDRs are limited to the holder's share of Available Cash distributed for the current reporting period. Undistributed earnings (net income excluding available cash for distribution) is allocated to GP and LP based on their ownership percentage. Waterfall Percentage Distribution Per Common LPs GP IDR Unit (LP) Minimum Quarterly Distribution 0.20 90% 10% 0% 1 The notional units represent the units that the GP would hold if it held units as opposed to the GP interest. (a) First Target Distribution (a) 0.40 90% 10% 0% Second Target Distribution (b) 0.50 85% 10% 5% Third Target Distribution 0.60 75% 10% 15% Thereafter N/A 50% 10% 40% (a) For the Minimum Quarterly Distribution and the First Target Distribution, earnings are split 90%/10% to the LP/GP until the target level is reached (b) To calculate the Second Target Distribution, first calculate the incremental distribution per common unit (e.g. $0.50 - $0.40 = $0.10), second multiply the incremental distribution per common unit times the number of common units (e.g. $0.10 times 9,000 = $900), third calculate the total distribution using the amount and percentage allocated to the common units distribution (e.g. $900/85% = $1,059), fourth calculate the GP interest by multiplying the total distribution times the GP% (e.g. $1,059 times 10% = $106), and fifth calculate the IDR by multiplying the total distribution by the IDR % (e.g. $1,059 times 5% = $53). III. Question Using the two class method as defined in ASC 260 (which you need to search, read, and understand), what are the distributed earnings (i.e., the partnership's available cash) and undistributed earnings? What are the distributed, undistributed, and total earnings per unit (to the LPs) under the following two scenarios? a. Net income of $50,000 and Cash available for distribution of $25,000 b. Net income of $5,000 and Cash available for distribution of $6,000