How do Schedule L, M-1, and M-2 connect in an audit?
I understand Form 1065 income lines, but the audit request asks for balance sheet and capital support too. What is the exam-level connection?
Schedule L shows the partnership's balance sheet per books. Schedule M-1 reconciles book income to taxable income. Schedule M-2 analyzes partners' capital accounts.
In audit terms:
- Schedule L answers what the books say the partnership owned and owed.
- Schedule M-1 explains why book income differs from return income.
- Schedule M-2 explains how partner capital moved from beginning to ending balances.
These schedules should agree with the general ledger, trial balance, adjusting entries, and partner-level records. If they do not, the EA should prepare a bridge explaining the difference rather than sending disconnected schedules.
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