Chapter 15
Partnerships: termination and liquidation
Answers to Questions
- A dissolution refers to the cessation of a partnership. In many cases, this process is simply a preliminary step in the transfer of business property to a newly formed partnership. Therefore, a dissolution does not necessarily affect the operations of the business. In a liquidation, however, actual business activities must cease. Partnership property is sold with the remaining cash distributed to creditors and to any partners with positive capital balances. Dissolution refers to changes in the composition of a partnership whereas liquidation is the selling of a partnership's assets.
- Many reasons can exist that would lead to the termination and liquidation of a partnership. The business might simply have failed to generate sufficient profits or the partners may elect to enter other lines of work. Liquidation can also be required by the death, retirement, or withdrawal of one of the partners. In such cases, liquidation is often necessary to settle the partner's interest in the business. The bankruptcy of an individual partner can also force the termination of the business as can the bankruptcy of the partnership itself.
- During the liquidation process, monitoring the balance of the partners' capital accounts becomes of paramount importance. That amount will eventually indicate either the cash to be received by the partners as final distributions or the additional contributions that they are required to pay. Consequently, all liquidation gains and losses are recorded directly as changes to these capital balances. Such recording enhances the informational value of the accounts. As an additional factor, the computation of a net income figure is of diminished importance since normal operations have ceased.
- Final distributions made to the various partners are based solely on their ending capital account balances unless the partners have agreed otherwise. If any partner has a deficit balance, an additional contribution should be made to offset the negative amount. In some situations, a question may arise as to whether compensation for a deficit will ever be forthcoming from the responsible party. The remaining partners may choose to allocate the available cash immediately based on the assumption that the deficit balance eventually will prove to be a total loss.
- A schedule of liquidation provides financial data about the liquidation process as it has progressed to date. Information to be presented includes the balances of all remaining assets, the liability total, and the capital account of each partner. In addition, the allocation of all gains and losses incurred in the liquidation process as well as the payment of expenses should be evident.
- From a legal viewpoint, any partner who incurs a negative (or deficit) capital balance is obligated to make an additional contribution to offset that amount.
- A safe capital balance is the amount of a partner's capital account that exceeds all possible needs of a partnership as it goes through liquidation. A partner should, therefore, be able to receive this balance immediately without endangering the future amount to be received by any other party connected with the liquidation. Safe capital balances are computed by projecting a series of assumptions whereby the partnership undergoes maximum losses during the remainder of the liquidation process. All noncash assets are assumed to have no resale value, liquidation expenses are set at the largest possible estimation, and all partners are viewed as personally insolvent. Any capital balance that would remain after this series of anticipated events can be distributed to the partners immediately without incurring any risk.
- The marshaling of assets doctrine is a provision within the Uniform Partnership Act that indicates the priority of claims when a partner becomes personally insolvent. By providing a ranking of these claims, an orderly and fair distribution of available property can be made. The marshaling of assets provision states:
Where a partner has become bankrupt or his estate is insolvent, the claims against his separate property shall rank in the following order:
(I)Those owing to separate creditors,
(II)Those owing to partnership creditors,
(III)Those owing to partners by way of contributions.
- A partner's personal creditors do have a limited claim against partnership assets. Recovery is possible but only if payment of all partnership debts is assured and the insolvent partner has a positive capital balance.
- For distribution purposes, the Uniform Partnership Act states that loans from partners rank ahead of the partners’ capital balances. Thus, the handling of loans in a liquidation would seem to be obvious: When money becomes available for the partners, all loans from partners should be repaid before any amount is given to a partner because of a safe capital balance.
A problem arises, though, in the above solution if a partner (especially if the partner is currently insolvent) has made a loan to a partnership but has a potentially negative capital balance. The final capital balance may require a contribution to the partnership that the partner may be unable or unwilling to make. If the Uniform Partnership Act is followed precisely, a partner could collect money on a loan while still having an obligation to the partnership because of a negative capital balance.
To avoid this problem, in practice a partner’s loan balance is usually merged with that partner’s capital balance to minimize the chance of a negative capital balance occurring. This particular partner may get less money from the liquidation because of this treatment but the other partners are better protected.
- A proposed schedule of liquidation is used by the accountant to determine the allocation of any cash balances generated during the early stages of liquidation. Often, sufficient cash will be collected to pay all liabilities as well as potential liquidation expenses. Additional cash should then be distributed to the partners to allow them immediate use of their funds. A proposed schedule of liquidation can be produced to determine the allocation of this available cash. The statement is based on anticipating a series of assumed losses from the current day forward: all remaining noncash assets are scrapped, maximum liquidation expenses are incurred, and each partner is personally insolvent. The ending balances that would result from these simulated transactions represent safe capital balances. This amount of cash can be distributed presently and the partners will still retain enough capital to absorb all future losses.
- A predistribution plan is produced based on an assumed series of losses. Each loss is calculated to eliminate in turn the capital balance of one of the partners. In this manner, the accountant can determine the vulnerability to losses exhibited by each capital account. When the last balance is eliminated, the accountant will have established a series of losses that exactly offsets each balance. The predistribution plan is then developed by measuring the effects that are created if the losses do not occur. In effect, the accountant works backwards through the assumed losses to create a pattern of available cash, the predistribution plan.
Answers to Problems
1.C
2.A
3.D
4.B
5.BAngela, CapitalWoodrow, CapitalCassidy, Capital
Reported balances $19,000 $18,000 $(12,000)
Potential loss from
Cassidy deficit
(split 5/8:3/8) (7,500) (4,500) 12,000
Cash distributions $11,500 $13,500 -0-
6.BBellHardy DennardSuddath
Reported balances $50,000 $56,000 $14,000 $80,000
Loss on sale of assets ($110,000)
split on a 4:3:2:1 basis (44,000) (33,000) (22,000) (11,000)
Adjusted balances $ 6,000 $23,000 $(8,000) $69,000
Potential loss from Dennard
deficit (split 4:3:1) (4,000) (3,000) 8,000 (1,000)
Minimum cash distributions $2,000 $20,000$ -0- $68,000
7.A
8.AArtRaymondDarby
Reported balances ...... $18,000 $25,000 $26,000
Loss on sale of assets ($22,000) split
on a 4:3:3 basis ...... (8,800) (6,600) (6,600)
Adjusted balances ...... $ 9,200 $18,400 $19,400
Anticipated liquidation expenses ($12,000)
split on a 4:3:3 basis ...... (4,800) (3,600) (3,600)
Anticipated maximum loss on inventory
($31,000) split on a 4:3:3 basis ...... (12,400) (9,300) (9,300)
Potential balances ...... $(8,000) $ 5,500 $ 6,500
Potential loss from Art deficit (split 3:3) 8,000 (4,000) (4,000)
Current cash distribution ...... $ -0- $ 1,500 $ 2,500
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9.DSince the partnership currently has total capital of $400,000, the $30,000 that is available would indicate maximum potential losses of $370,000.
A B C
Reported balances $100,000 $120,000 $180,000
Anticipated loss ($370,000) split on
a 2:3:5 basis (74,000) (111,000) (185,000)
Potential balances $ 26,000 $ 9,000 $ (5,000)
Potential loss from C's deficit (split 2:3) (2,000) (3,000) 5,000
Current cash distribution $ 24,000 $ 6,000 $ -0-
10.CA predistribution plan should be created.
Maximum Losses That Can Be Absorbed
Kevin $59,000/40%$147,500
Michael $39,000/30% 130,000 (most vulnerable to losses)
Brendan $34,000/10% 340,000
Jonathan $34,000/20% 170,000
The assumption is made that a $130,000 loss occurs.
Kevin MichaelBrendan Jonathan
Reported balances $59,000 $39,000 $34,000 $34,000
Assumed loss ($130,000) split on
a 4:3:1:2 basis (52,000) (39,000) (13,000) (26,000)
Adjusted balances $ 7,000 $ -0- $21,000 $ 8,000
Maximum Losses That Can Now Be Absorbed
Kevin $7,000/4/7$12,250(most vulnerable to losses)
Brendan$21,000/1/7147,000
Jonathan$8,000/2/7 28,000
KevinBrendan Jonathan
Reported balances $7,000 $21,000 $8,000
Assumed loss ($12,250) split on a
4:1:2 basis (7,000) (1,750) (3,500)
Adjusted balances $ -0- $19,250 $4,500
Maximum Losses That Can Now Be Absorbed
Brendan$19,250/1/3$57,750
Jonathan$4,500/2/3 6,750 (most vulnerable to losses)
The assumption is made that a $6,750 loss occurs.
BrendanJonathan
Reported balances...... $19,250 $4,500
Assumed loss ($6,750) split on a 1:2 basis .. (2,250) (4,500)
Adjusted balances ...... $17,000$ -0-
11.CTo work this problem, a predistribution schedule is necessary. That schedule, which is computed below, is as follows:
- First $3,000 goes to Menton
- Next $15,000 goes to Menton (2/3) and Hoehn (1/3)
- Next $42,000 goes to Carney (4/7), Menton (2/7), and Hoehn (1/7)
- All remaining cash goes to Carney (4/10), Pierce (3/10), Menton (2/10), and Hoehn (1/10)
CarneyPierce MentonHoehn
Beginning balances $60,000$27,000$43,000$20,000
Assumed loss of $90,000 (see
Schedule 1)(4:3:2:1) (36,000) (27,000) (18,000) (9,000)
Step one balances $24,000$ 0 $25,000 $11,000
Assumed loss of $42,000 (see
Schedule 2) (allocated on
a 4:0:2:1 basis) (24,000)$ 0 (12,000) (6,000)
Step two balances $ 0 $ 0 $13,000 $ 5,000
Assumed loss of $15,000 (see
Schedule 3) (allocated on a
0:0:2:1 basis) 0 0 (10,000) (5,000)
Step three balances $ 0 $ 0 $ 3,000 $ 0
Schedule 1
Maximum Loss
Capital Balance/That Can
PartnerLoss AllocationBe Absorbed
Carney$60,000/40%$150,000
Pierce$27,000/30%$ 90,000 (most vulnerable)
Menton$43,000/20%$215,000
Hoehn$20,000/10%$200,000
Schedule 2
Maximum Loss
Capital Balance/That Can
PartnerLoss AllocationBe Absorbed
Carney$24,000/(4/7)$ 42,000(most vulnerable)
Menton$25,000/(2/7)$ 87,500
Hoehn$11,000/(1/7)$ 77,000
Schedule 3
Maximum Loss
Capital Balance/That Can
PartnerLoss AllocationBe Absorbed
Menton$13,000/(2/3)$ 19,500
Hoehn$ 5,000/(1/3)$ 15,000(most vulnerable)
12.CThe $16,000 available cash can be distributed but should be done under the assumption that all deficit balances will be total losses. After offsetting Jones' loan, the two deficits total $4,000. Fuller and Rogers, the two partners with positive capital balances, share profits in a 30:20 relationship (the equivalent of a 60%:40% ratio). Fuller would absorb $2,400 of the potential loss with Rogers being allocated $1,600. The remaining capital balances ($10,600 and $5,400) are safe capital balances and those amounts can be immediately distributed.
13.(8 Minutes) (Payment of safe capital balances)
$6,800 to Cleveland and $1,200 to Pierce
Since the partnership currently has total capital of $350,000, the $8,000 that is available would indicate maximum potential losses of $342,000.
Nixon Cleveland Pierce
Reported balances ...... $170,000 $110,000 $70,000
Anticipated loss ($342,000) split
on a 5:3:2 basis ...... (171,000) (102,600) (68,400)
Potential balances ...... $ (1,000) $ 7,400 $ 1,600
Potential loss from Nixon's deficit (split 3:2) 1,000 (600) (400)
Current cash distribution ...... $ -0- $6,800 $ 1,200
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14. (20 Minutes) (Final settlement of a partnership being liquidated)
Part a.Brown gets $21,000, Fish gets $12,000, and Stone gets $2,000.
Brown Fish Stone
Reported balances ...... $25,000 $15,000 $5,000
Loss on sale of land ($10,000) split
on a 4:3:3 basis...... (4,000) (3,000) (3,000)
Cash distribution ...... $21,000 $12,000 $2,000
Part b. Brown gets $16,429 and Fish gets $8,571
Brown Fish Stone
Reported balances ...... $25,000 $15,000 $5,000
Loss on sale of land ($20,000) split on
a 4:3:3 basis...... (8,000) (6,000) (6,000)
Adjusted balances ...... $17,000 $ 9,000 $(1,000)
Potential loss from Stone's deficit (split 4:3) (571) (429) 1,000
Cash distribution ...... $16,429 $ 8,571 $ -0-
Part c. Brown gets $10,714 and Fish gets $4,286
Brown Fish Stone
Reported balances ...... $25,000 $15,000 $5,000
Loss on sale of land ($30,000) split on
a 4:3:3 basis...... (12,000) (9,000) (9,000)
Adjusted balances ...... $13,000 $ 6,000 $(4,000)
Potential loss from Stone's deficit (split 4:3) (2,286) (1,714) 4,000
Cash distribution ...... $10,714 $ 4,286 $ -0-
15.(10 Minutes) (Distribution made of contribution made by partner with deficit balance)
The entire $20,000 goes to Atkinson.
AtkinsonKaporale Dennsmore Rasputin
Reported balances $60,000 $20,000 $(30,000) $(50,000)
Capital contribution -0- -0- -0- 20,000
Adjusted balances $60,000 $20,000 $(30,000) $(30,000)
Potential loss from Dennsmore
and Rasputin ($60,000) split
on a 4:3 basis (34,286) (25,714) 30,000 30,000
Adjusted balances $25,714 $(5,714) $ -0- $ -0-
Potential loss from Kaporale
($5,714) (5,714) 5,714 -0- -0-
Cash distribution $20,000$ -0-$ -0- $ -0-
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16. (8 Minutes) (Determine safe capital balances)
Ball gets $143, Eaton gets $1,429, and Lake gets $3,428.
AceBallEatonLake
Reported balances ...... $25,000 $28,000 $20,000 $22,000
Maximum losses on land and building
($85,000) split on a 3:3:2:2 basis (25,500) (25,500) (17,000) (17,000)
Estimated liquidation expenses
($5,000) split 3:3:2:2...... (1,500) (1,500) (1,000)(1,000)
Potential balances ...... $(2,000) $ 1,000 $ 2,000 $ 4,000
Potential loss from Ace ($2,000) split
on a 3:2:2 basis ...... 2,000 (857) (571) (572)
Cash distributions ...... $ 0 $ 143 $ 1,429$ 3,428
17.(15 Minutes) (Prepare a proposed schedule of liquidation)
HARDWICK, SAUNDERS, AND FERRIS
Proposed Schedule of Liquidation
Hardwick, Ferris,
Other AccountsLoan and Saunders, Loan &
CashAssetsPayableCapitalCapitalCapital
Beginning
balances 90,000 820,000 210,000 270,000 200,000 230,000
Sold assets 200,000 (328,000) (51,200) (38,400) (38,400)
Assumed: loss
on remaining
assets (492,000) (196,800) (147,600) (147,600)
Paid liabilities (210,000) (210,000)
Safe balances 80,000 0 0 22,000 14,000 44,000
Of the available $80,000, $22,000 will go to Hardwick, $14,000 to Saunders, and $44,000 to Ferris.
18.(7 Minutes) (Amount of cash needed to assure payments to all partners)
Watson is the partner most vulnerable to a loss. A loss of only $50,000 would completely eliminate Watson's capital balance:
Miller $50,000/60% = $ 83,333 loss to eliminate capital
Tyson $50,000/20% = $250,000 loss to eliminate capital
Watson $10,000/20% = $ 50,000 loss to eliminate capital
Thus, if the loss on disposal is less than $50,000, all partners will retain positive capital balances and receive some cash in liquidation. Because of this, since "other assets" are $140,000, they must be sold for any amount over $90,000 for all partners to get cash.
19.(5 Minutes) (Determine safe capital balances)
Maximum potential losses are $128,000, $8,000 in liquidation expenses and a complete $120,000 loss on the noncash assets. Such a loss would reduce the capital balances to: Babb $8,800, Whitaker ($5,600), and Edwards ($1,200). Babb must retain sufficient capital ($6,800) to be able to absorb the possible losses of Whitaker and Edwards. The remaining $2,000 is a safe capital balance for Babb.
20.(10 Minutes) (Determine amount to be contributed by partner with a deficit balance)
White and Blue are both insolvent and have negative capital balances (after offsetting the loan from White) totaling $15,000. Absorption by the other partners of these losses would be as follows (on a 30:10:20 basis):
Partner Share of Loss New Capital Balance
Black 30/60 x $15,000 = $7,500 $ (4,500)
Green 10/60 x $15,000 = $2,500 $ (5,500)
Brown 20/60 x $15,000 = $5,000 $10,000
Black, who is also insolvent, now has a deficit capital of $4,500 that would have to be absorbed by Brown and Green (on a 10:20 basis):
Partner Share of Loss New Capital Balance
Green 10/30 x$4,500 = $1,500 $ (7,000)
Brown 20/30 x $4,500 = $3,000 $ 7,000
Thus, Green must contribute $7,000 that will go to Brown.
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21.(50 Minutes) (Compute effects of a liquidation under a variety of circumstances)
a.Dobbs receives the entire $10,000.
Maximum potential losses of $250,000 on noncash assets would be allocated as follows:
Partner Share of Loss New Capital Balance
Adams 2/10 x $250,000 = $50,000 $ 30,000
Baker 3/10 x $250,000 = $75,000 $(45,000)
Carvil 3/10 x $250,000 = $75,000 $(15,000)
Dobbs 2/10 x $250,000 = $50,000 $ 40,000
Maximum total potential losses of $60,000 to be absorbed from Baker and Carvil above would then be allocated as follows on a 2:2 basis:
Adams 2/4 x $60,000 = $30,000 -0-
Dobbs 2/4 x $60,000 = $30,000 $ 10,000
Absorbing the final loss would leave Dobbs with a safe capital balance of $10,000.
b.Adams receives the entire $10,000.
Maximum potential losses of $250,000 on noncash assets would be allocated as follows:
Partner Share of Loss New Capital Balance
Adams 2/10 x $250,000 = $50,000 $ 30,000
Baker 2/10 x $250,000 = $50,000 $(20,000)
Carvil 3/10 x $250,000 = $75,000 $(15,000)
Dobbs 3/10 x $250,000 = $75,000 $ 15,000
Maximum total potential losses of $35,000 to be absorbed from Baker and Carvil above would be allocated as follows on a 2:3 basis:
Adams 2/5 x $35,000 = $14,000 $ 16,000
Dobbs 3/5 x $35,000 = $21,000 $ (6,000)
Absorbing the final $6,000 loss from Dobbs would leave Adams with a safe capital balance of $10,000.
c.Adams receives $57,500 and Dobbs gets $22,500.
The $50,000 loss on sale of the building would be allocated as follows:
Partner Share of Loss New Capital Balance
Adams 10% x $50,000 = $5,000 $ 75,000
Baker 30% x $50,000 = $15,000$ 15,000
Carvil 30% x $50,000 = $15,000 $ 45,000
Dobbs 30% x $50,000 = $15,000 $ 75,000
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21.c.(continued)
Maximum potential loss of $130,000 on the land would be allocated as follows:
Partner Share of Loss New Capital Balance
Adams 10% x $130,000 = $13,000 $ 62,000
Baker 30% x $130,000 = $39,000$ (24,000)
Carvil 30% x $130,000 = $39,000 $ 6,000
Dobbs 30% x $130,000 = $39,000 $ 36,000
Maximum potential loss of $24,000 to be absorbed from Baker would be allocated as follows on a 1:3:3 basis:
Adams 1/7 x $24,000 = $3,428 $ 58,572
Carvil 3/7 x $24,000 = $10,286 $ (4,286)
Dobbs 3/7 x $24,000 = $10,286 $ 25,714
Maximum potential loss of $4,286 to be absorbed from Carvil would be allocated as follows on a 1:3 basis:
Adams 1/4 x $4,286 = $1,072$57,500
Dobbs 3/4 x $4,286 = $3,214 $22,500
These amounts represent safe capital balances for distribution purposes.
d.The land and building must be sold for over $115,000 to ensure that Carvil will receive some cash.
Adams Baker Carvil Dobbs
Beginning balances $ 80,000 $ 30,000 $ 60,000 $ 90,000
Assumed loss of $100,000 (see
Schedule 1) (1:3:4:2) (10,000) (30,000) (40,000) (20,000)
Step One balances $ 70,000 $ 0 $ 20,000 $ 70,000
Assumed loss of $35,000 (see
Schedule 2) (allocated on a
1:0:4:2 basis) (5,000) 0 (20,000) (10,000)
Step Two balances $ 65,000 $ 0 $ 0 $ 60,000
Assumed loss of $90,000 (see
Schedule 3) (allocated on a
1:0:0:2 basis) (30,000) 0 0 (60,000)
Step Three balances $ 35,000$ 0$ 0 $ 0
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21.d.(continued)
PREDISTRIBUTION PLAN
The first $35,000 available goes to Adams. Next $90,000 is split between Adams and Dobbs on a 1:2 basis. Next $35,000 is split between Adams, Carvil, and Dobbs on a 1:4:2 basis. All remaining cash is split between Adams, Baker, Carvil, and Dobbs on the original profit and loss ratio.
Total cash of $125,000 ($35,000 + $90,000) has to be available before Carvil will receive any cash. Since the partnership already has $10,000 cash in excess of its liabilities, the land and building must be sold for over $115,000 to ensure Carvil of receiving some amount.
As another approach to the problem, Carvil's capital balance is eliminated through the $100,000 Step One loss and the $35,000 Step Two loss. Thus, avoiding a complete $135,000 loss ensures that Carvil will receive cash. Since the land and buildings have a book value of $250,000, such losses would be avoided by receiving over $115,000.
Schedule 1
Maximum Loss
Capital Balance/That Can
PartnerLoss AllocationBe Absorbed
Adams$80,000/10%$800,000
Baker$30,000/30%$100,000 (most vulnerable)
Carvil$60,000/40%$150,000
Dobbs$90,000/20%$450,000
Schedule 2
Maximum Loss
Capital Balance/That Can
PartnerLoss AllocationBe Absorbed
Adams$70,000/(1/7)$490,000
Carvil$20,000/(4/7)$ 35,000 (most vulnerable)
Dobbs$70,000/(2/7)$245,000
Schedule 3
Maximum Loss
Capital Balance/That Can
PartnerLoss AllocationBe Absorbed
Adams$65,000/(1/3)$195,000
Dobbs$60,000/(2/3)$ 90,000 (most vulnerable)
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22. (30 Minutes) (Prepare a predistributlon plan)
An assumed series of losses is simulated which eliminates each partner's capital account in turn:
LarsonNorrisSpencerHarrison
Beginning balances $ 15,000 $ 60,000 $ 75,000 $ 41,250
Assumed loss of $75,000 (see
Schedule 1) (allocated on a
2:3:2:3 basis) (15,000) (22,500) (15,000) (22,500)
Step One balances $ -0-$ 37,500$ 60,000$ 18,750
Assumed loss of $50,000 (see
Schedule 2) (allocated on a
0:3:2:3 basis) 0 (18,750) (12,500) (18,750)
Step Two balances $ 0 $ 18,750 $ 47,500 $ -0-
Assumed loss of $31,250 (see
Schedule 3) (allocated on a
0:3:2:0 basis) -0- (18,750) (12,500) -0-