Transcript Advanced Accounting by Hoyle et al, 6th Edition

Chapter Fifteen
Partnerships:
Termination and
Liquidation
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
15-2
Reasons for Termination







Personality disputes between partners
Retirement
Death
Changed business environment
Other opportunities
Low profits
Bankruptcy (either of the business or
an individual partner)
15-3
Termination & Liquidation
When the partners wish
to terminate the
business:




Convert all assets to cash.
Allocate all gains or losses
to the partner capital
balances.
Pay all liabilities.
Distribute remaining cash to
partners.
15-4
Termination & Liquidation Example
Stor & Lille want to liquidate their
partnership. Balances at 3/31/08
are:
Stor & Lille
Balance Sheet
3/31/2008
Assets
Cash
$ 8,000
A/R
35,000
Inventory
42,000
Land, Bldg, & Equip.
160,000
Total
$ 245,000
Liabilities and Capital
Accts. Payable $ 45,000
Stor, Capital
80,000
Lille, Capital
120,000
Total
$ 245,000
Termination & Liquidation Example
15-5
According to their partnership
agreement, Stor and Lille divide
profits 60:40 respectively. On 4/1,
the inventory is sold for $35,000.
Date
Description
Debit
Prepare the journal entry to
record the sale of the inventory.
Credit
Termination & Liquidation Example
15-6
Note that the loss on the sale of
inventory of $7,000 is assigned
$4,200 ($7,000 x 60%) to Stor and
$2,800 ($7,000 x 40%) to Lille.
Date
Description
Cash
Stor, Capital
Lille, Capital
Inventory
Debit
Credit
35,000
4,200
2,800
42,000
15-7
Termination & Liquidation Example
The balances after selling the inventory were:
Stor & Lille
Balance Sheet
4/1/2008
Assets
Cash
$ 43,000
A/R
35,000
Land, Bldg, & Equip.
160,000
Total
$ 238,000
Liabilities and Capital
Accts. Payable $ 45,000
Stor, Capital
75,800
Lille, Capital
117,200
Total
$ 238,000
Termination & Liquidation Example
15-8
Assume that 70% of the
Accounts Receivable are
collected. The remaining
accounts receivables are
written off.
Date
Description
Debit
Prepare the entry to record the
collection of the receivables.
Credit
Termination & Liquidation Example
15-9
Stor and Lille collects $24,500 of
the A/R. The loss is $10,500.
Allocate 60% of the loss to Stor
and 40% of the loss to Lille.
Date
Description
Cash
Stor, Capital
Lille, Capital
Accounts Receivable
Debit
Credit
24,500
6,300
4,200
35,000
Termination & Liquidation Example
15-10
Stor and Lille sell the
fixed assets for
$175,000.
Date
Description
Debit
Prepare the journal entry to
record the sale of fixed assets.
Credit
Termination & Liquidation Example
15-11
The gain on fixed assets is
$15,000. Allocate 60% to
Stor and 40% to Lille.
Date
Description
Cash
Stor, Capital
Lille, Capital
Land, Bldg, Equipment
Debit
Credit
175,000
9,000
6,000
160,000
Termination & Liquidation Example
15-12
Once all the assets are sold,
the accounts payable are
paid off.
Date
Description
Debit
Prepare the entry to pay off the
accounts payable.
Credit
Termination & Liquidation Example
15-13
Once all the assets are sold,
the accounts payable are
paid off.
Date
Description
Accounts Payable
Cash
Debit
Credit
45,000
45,000
15-14
Termination & Liquidation Example
The pre-distribution balances are:
Stor & Lille
Balance Sheet
4/1/2008
Assets
Cash
$ 197,500
Total
$ 197,500
Liabilities and Capital
Stor, Capital
$ 78,500
Lille, Capital
119,000
Total
$ 197,500
Termination & Liquidation Example
15-15
Once the remaining cash is
distributed, the partnership is
considered terminated.
Date
Description
Stor, Capital
Lille, Capital
Cash
Debit
Credit
78,500
119,000
197,500
15-16
Schedule of Liquidation
The process of
liquidation can take
time.
Partners may experience
deficit balances during
the liquidation period.
Partners may want cash
distributions prior to
the completion of the
liquidation.
15-17
Schedule of Liquidation
Because the various parties want to be updated
on the progress of the liquidation, a report can
be prepared to disclose:
Transactions to
date.
Liabilities
remaining to be
paid.
Property still
being held by the
partnership.
Current cash
and capital
balances.
15-18
Schedule of Liquidation Interim Cash Distributions
Prior to making a cash
distribution to the
partners, assume:
1. All noncash assets will
be complete losses.
2. All liabilities will be paid.
3. All deficit partners will be
written off.
Even though
assumptions #1
and #3 may be
unrealistic, they
allow the
computation of
“safe”
balances.
15-19
Deficit Capital Balance
Deficit balances can be
resolved two ways:
 The deficit partner can
make a contribution to
make up the deficit.
 The remaining partners
can absorb the deficit.
(The deficit partner may pay
later or can be sued for the
deficit amount.)
15-20
Deficit Capital Balance Loss to Remaining Partners
Contributions made by the deficit partner(s) are
distributed to the non-deficit partners based
on their relative profit sharing %.
15-21
Deficit Capital Balance
Loss to Remaining Partners
Contributions made by the deficit partner(s) are
distributed to the non-deficit partners based
on their relative profit sharing %.
Partner
Loup
Lobo
Sabaka
Capital Profit & Loss
Balance
Ratio
$ 100,000
40%
$ 86,000
10%
$ (25,000)
50%
Any payments
by Sabaka will
be split 4/5 to
Loup and 1/5
to Lobo.
Deficit Capital Balance Example
15-22
Hund, Chien and Cano have the
following balances just prior to
liquidation.
Hund, Chien & Cano
Balance Sheet
6/30/2008
Cash
Inventory
Total
Assets
$
30,000
75,000
$ 105,000
Liabilities and Capital
Accts. Payable $ 35,000
Hund, Capital
25,000
Chien, Capital
40,000
Cano, Capital
5,000
Total
$ 105,000
Deficit Capital Balance Example
15-23
Hund, Chien and Cano share profits
35:25:40. On 7/5/08, the inventory
is sold for $25,000, a $50,000 loss.
Prepare the entry.
Date
Description
Debit
Prepare the entry to record the
sale of inventory.
Credit
Deficit Capital Balance Example
15-24
Hund, Chien and Cano share profits
35:25:40. On 7/5/08, the inventory
is sold for $25,000, a $50,000 loss.
Prepare the entry.
Date
Description
Cash
Hund, Capital
Chien, Capital
Cano, Capital
Inventory
Debit
Credit
25,000
17,500
12,500
20,000
75,000
Deficit Capital Balance Example
15-25
With a 40% share of the $50,000
loss, Cano’s capital account
moves to a deficit balance of
$(15,000).
Date
Description
Cash
Hund, Capital
Chien, Capital
Cano, Capital
Inventory
Cano Capital
5,000
20,000
(15,000)
Debit
Credit
25,000
17,500
12,500
20,000
75,000
Deficit Capital Balance –
Example
15-26
The $25,000 for the inventory sale,
increases the cash balance to
$55,000. $35,000 must be kept to
pay off the accounts payable.
Date
Description
Cash
Hund, Capital
Chien, Capital
Cano, Capital
Inventory
How will the
remaining
$20,000 be
distributed?
Debit
Credit
25,000
17,500
12,500
20,000
75,000
15-27
Deficit Capital Balance Example
Capital Balances
Hund Chien
Cano
$ 7,500 $ 27,500 $ (15,000)
Allocation of Cano's
Notice that, after
Gill’s deficit
has been
deficit balance
(8,750)
(6,250)
15,000
allocated on the basis of 35:25, there is now
Capital Balances
$ (1,250)
$ 21,250
$
a deficit balance
in Finn’s
account!
15-28
Deficit Capital Balance Example
Capital Balances
Hund
Chien
$ 7,500 $ 27,500
Cano
$ (15,000)
Allocation of Cano's
deficit balance
(8,750)
(6,250)
Capital Balances
$ (1,250) $ 21,250 $
15,000
-
Allocation of Hund's
deficit balance
1,250
(1,250)
Capital Balances
$
- $ 20,000
After allocating
Hund’s
deficit to Chien, the
$20,000 can be distributed to Chien.
15-29
Marshaling of Assets
Under the Uniform Partnership Act, a
Marshaling of Assets is a priority ranking of
creditors having claims against individual
partners:
Debts owed to
separate
creditors.
Debts owed to
partnership
creditors.
Debts owed to
the other
partners.
15-30
Claims Against the Partnership
Individual partner’s creditors
can make a claim against
the assets of the
partnership.
 All partnership creditors
must be satisfied first.
 The creditors can only
assert claims to the extent
of the specific partner’s
positive capital balance.
Each partner is
liable for ALL the
debts of the
partnership.
Partners are
NEVER liable for
the personal debts
of the other
partners.
15-31
Predistribution Plan
Used by accountants to guide the distribution
of cash resulting from the liquidation process.
Examine the Balance Sheet below. Assume the
income sharing % is Hund 10%, Chien 40%, and
Cano 50%.
Hund, Chien & Cano
Balance Sheet
6/30/2008
Cash
Inventory
Total
Assets
$
30,000
75,000
$ 105,000
Liabilities and Capital
Accts. Payable $ 35,000
Hund, Capital
25,000
Chien, Capital
40,000
Cano, Capital
5,000
Total
$ 105,000
15-32
Predistribution Plan
First, determine the maximum loss that
each partner can absorb. Divide each
partner’s capital balance by their
respective income sharing %.
Partner
Hund
Chien
Cano
Capital
Balance
$
25,000
40,000
5,000
Income
Sharing %
10%
40%
50%
Maximum
Loss That
Can Be
Absorbed
$
250,000
$
100,000
$
10,000
15-33
Predistribution Plan
Partner
Hund
Chien
Cano
Capital
Balance
$
25,000
40,000
5,000
Income
Sharing %
10%
40%
50%
Maximum
Loss That
Can Be
Absorbed
$
250,000
$
100,000
$
10,000
Since Cano can ONLY absorb a
partnership loss of $10,000, we will first
compute new balances assuming that
the partnership has a $10,000 loss.
15-34
Predistribution Plan
Beginning Balances
Assume a $10,000 loss
Remaining Balances
Hund,
Cano,
Capital
Chien,
Capital
(10%)
Capital (40%)
(50%)
$
25,000 $
40,000 $
5,000
(1,000)
(4,000)
(5,000)
$
24,000 $
36,000 $
-
With Cano wiped out, we will proceed with
determining maximum absorbable losses using
income sharing percentages of Hund 20% (1/5)
and Chien 80% (4/5).
15-35
Predistribution Plan
As earlier, we will compute the maximum
absorbable loss by dividing the capital
balances by the relative income sharing
%.
Partner
Hund
Chien
Capital
Balance
$
24,000
36,000
Income
Sharing %
20%
80%
Maximum
Loss That
Can Be
Absorbed
$
120,000
$
45,000
15-36
Predistribution Plan
Partner
Hund
Chien
Capital
Balance
$
24,000
36,000
Income
Sharing %
20%
80%
Maximum
Loss That
Can Be
Absorbed
$
120,000
$
45,000
As we can see above, Chien can only
absorb a loss of $45,000.
Let’s determine new capital balances for
a loss of $45,000.
15-37
Predistribution Plan
Beginning Balances
Assume a $45,000 loss
Remaining Balances
Hund,
Capital
Chien,
(20%)
Capital (80%)
$
24,000 $
36,000
(9,000)
(36,000)
$
15,000 $
-
Cano,
Capital
(50%)
N/A
N/A
N/A
With Cano and Chien both wiped out, and Hund
remaining as the only partner, we can now
determine the predistribution plan.
15-38
Predistribution Plan
Hund, Chien & Cano
Predistribution Plan
Available Cash
First $35,000
Next $15,000
Next $45,000
All other cash
benefits
Recipient
Creditors
Hund
Hund(20% and Chien(80%)
Hund(10%), Chien(40%) and
Cano(50%)
15-39
Summary

Partnerships may be terminated for a
variety of reasons.
 When terminated, partnership assets
must be systematically liquidated.
 Actual liquidation can require an
extended period to accomplish. This
promotes the use of proposed
schedules of liquidation.
 Marshaling of assets may be
necessary when one or more partners
have negative capital balances.
15-40
Possible Criticisms

Development of predistribution plans
and schedules of liquidation may
involve speculation. Some critics feel
that this violates the traditionally
conservative role of accountants
WHAT DO YOU THINK???