Partnerships: Liquidation

16-16-11

McGraw-Hill/ Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Partnerships: Liquidation 16

Electronic Presentation by Douglas Cloud

Pepperdine University

Baker / Lembke / KingBaker / Lembke / King

16-16-22


TerminologyTerminology

Dissolution: A legal concept indicating a change in the legal relationship between partners.

Termination: The end of the normal business function of the partnership. The partnership is no longer a going concern.Liquidation: The sale of the partnership assets, payment of the partnership liabilities, and distribution of any remaining assets to the individual partners.

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1. A new partner is admitted or a partner withdraws.

2. The specified term or task of the partnership has been completed.

3. All partners agree to dissolve the partnership.

4. The partnership or an an individual partner is bankrupt.

5. By court degree:a. A partner is declared insane.

b. A partner seriously breaches the partnership agreement.

c. The court determines that a partnership may be operated only at a loss.

Major Causes of a DissolutionMajor Causes of a Dissolution

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A court so decrees. The partnership is

bankrupt. The partnership’s

business becomes illegal.

Partnership Terminates Immediately if--Partnership Terminates Immediately if--

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Partnership creditors other than partners.

Partners’ claims other than capital and profits, such as loans payable and accrued interest payable.

Partners’ claims to capital or profits, to the extent of credit balances in capital accounts.

Claims Against the Partnership AssetsClaims Against the Partnership Assets

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Personal creditors of individual partners.

For general partners, partnership creditors for unpaid partnership liabilities, regardless of partner’s capital balance in the partnership.

Claims Against Personal AssetsClaims Against Personal Assets

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Basic Facts at LiquidationBasic Facts at Liquidation

Partners Alt Blue Cha

Profit and loss percentage 40% 40% 20%Partnership capital account $34,000 $10,000 $12,000Partnership loan payable to

Cha 4,000

Alt Blue ChaPersonal assets 150,000$ 12,000$ 42,000$ Personal liabilities (86,000) (16,000) (14,000)

Net worth (deficit) 64,000$ (4,000)$ 28,000$

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Cautions About Offsetting Partners’ Cautions About Offsetting Partners’ Loans and CapitalLoans and Capital

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It is important to maintain specific identification of a loan payable (receivable) between the partnership and a partner because of the following considerations:

1. If the loan payable (or receivable) continues to be interest-bearing during the liquidation process.

2. If the loan is secured by a property interest.

3. Actual offsetting of receivables from partners against partners’ capitals may be considered a cancellation of the receivable and should be performed with caution.

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Trial Balance on Liquidation DateTrial Balance on Liquidation Date

ABC PartnershipTrial BalanceMay 1, 20X5

Cash $ 10,000Noncash Assets 90,000Liabilities $ 40,000Loan Payable to Partner Cha 4,000Alt, Capital (40%) 34,000Blue, Capital (40%) 10,000Cha, Capital (20%) 12,000Total $100,000 $100,000

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Case 1: Partnership Solvent--No DeficitsCase 1: Partnership Solvent--No Deficits

ABC PartnershipStatement of Partnership Realization and Liquidation

Lump-Sum Liquidation (in 000s)

Preliquidation balances 10 90 (40) (4) (34) (10) (12)

Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%.

Sale of assets and distri-

bution of $10,000 loss 80 (90) 4 4 2

90 -0- (40) (4) (30) (6) (10)

Lump-sum payments to

partners:

Partner’s loan (4) 4

Partners’ capital (46) 30 6 10

Postliquidation balance -0- -0- -0- -0- -0- -0- -0-

Payment to o/s creditors (40) 40

50 -0- -0- (4) (30) (6) (10)

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May 15, 20X5Cash 80,000Alt, Capital 4,000Blue, Capital 4,000Cha, Capital 2,000

Noncash Assets 90,000Realization of all noncash assets of the ABC Partnership and distribution of $10,000 loss using profit and loss ratio.

Distribution of $10,000 loss


The noncash assets are sold for $80,000, at a $10,000 loss. The loss is distributed using the predetermined profit and loss ratio.

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May 30, 20X5Cha, Loan 4,000Alt, Capital 30,000Blue, Capital 6,000Cha, Capital 10,000

Cash 50,000Lump-sum payments to partners.


The remaining cash is distributed to the partners.

May 20, 20X5

Liabilities 40,000Cash 40,000

Pay outside creditors.

The partnership pays the outside creditors.

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Case 2: Partnership Solvent--Deficit Case 2: Partnership Solvent--Deficit

The three partners’ personal financial statements are as follows:

Alt Blue Cha

Personal assets 150,000$ 12,000$ 42,000$ Personal liabilities (86,000) (16,000) (14,000) Net worth (deficit) 64,000$ (4,000)$ 28,000$

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Lump-Sum Liquidation (in 000s) Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%.


Payment to o/s creditors (40) 40

5 -0- -0- (4) (12) 12 (1)


bution of $55,000 loss 35 (90) 22 22 11

45 -0- (40) (4) (12) 12 (1)

Distribution of deficit of

insolvent partner: (12)

40/60 x $12,000 8

20/60 x $12,000 4

(to next slide) 5 -0- -0- (4) (4) -0- 3

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(from previous slide) 5 -0- -0- (4) (4) -0- 3

Offset Cha’s deficit with

loan 3 (3)

5 -0- -0- (1) (4) -0- -0-Lump-sum payments to

partners:

Partner’s loan (1) -0- -0- 1

Partner’s capital (4) 4

Postliquidation balance -0- -0- -0- -0- -0- -0- -0-


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Case 3: Partnership Insolvent--DeficitCase 3: Partnership Insolvent--Deficit



Preliquidation balances 10 90 (40) (4) (34) (10) (12)Sale of assets and distri-

bution of $70,000 loss 20 (90) 28 28 14

30 -0- (40) (4) (6) 18 2

Offset deficit with loan 4 (4)

(to next slide) 30 -0- (40) -0- 6 -0- 4

Distribution of deficit of

insolvent partner: (18)40/60 x $18,000 12

20/60 x $18,000 6

30 -0- (40) (4) 6 -0- 8

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(from previous slide) 30 -0- (40) -0- 6 -0- 4 Contribution by Alt and

Cha 10 (6) (4)

40 -0- (40) -0- -0- -0- -0-Payment to outside

creditors (40) -0- 40 -0- -0- -0- -0-

Postliquidation balances -0- -0- -0- -0- -0- -0- -0-

Case 3: Partnership Insolvent--DeficitCase 3: Partnership Insolvent--Deficit

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Installment Installment LiquidationsLiquidationsInstallment Installment

LiquidationsLiquidations

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Installment LiquidationInstallment Liquidation

ABC PartnershipTrial BalanceMay 1, 20X5

Cash $ 10,000Noncash Assets 90,000Liabilities $ 40,000Loan Payable to Partner Cha 4,000Alt, Capital (40%) 34,000Blue, Capital (40%) 10,000Cha, Capital (20%) 12,000Total $100,000 $100,000

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Installment Liquidation--May 20X5Installment Liquidation--May 20X5





bution of $10,000 loss 45 (55) 4 4 2

55 35 (40) (4) (30) (6) (10)Payment to o/s creditors (40) 40

15 35 -0- (4) (30) (6) (10)

Safe payment to partners (see Slide 21)

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Schedule of Safe Payments to PartnersSchedule of Safe Payments to Partners

ABC PartnershipSchedule of Safe Payments to Partners, May 31, 20X5

Capital and loan balances, May 31,

before cash distribution (30,000) (6,000) (14,000)Assume full loss of $35,000 on remaining noncash assets and $10,000 in possible future liquidation expenses 18,000 18,000 9,000

(12,000) 12,000 (5,000)Assume Blue’s potential deficit must be absorbed by Alt and Cha: (12,000)

40/60 x $12,000 8,000 20/60 x $12,000 4,000

Safe payment to partners, May 31 (4,000) -0- (1,000)

Partner Alt. Blue Cha

40% 40% 20%

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Installment Liquidation--May 20X5Installment Liquidation--May 20X5





bution of $10,000 loss 45 (55) 4 4 2

55 35 (40) (4) (30) (6) (10)Payment to o/s creditors (40) 40

15 35 -0- (4) (30) (6) (10)

Safe payment to partners (5) 1 4

(to next slide) 10 35 -0- 3 26 (6) (10)

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Installment Liquidation--June 20X5Installment Liquidation--June 20X5



(from previous slide) 10 35 -0- (3) (26) (6) (10)Sale of assets and dis-

tribution of $15,000 loss 15 (30) 6 6 3

25 5 -0- (3) (20) -0- (7)

Safe payment to partners (see Slide 24)

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Schedule of Safe Payments to PartnersSchedule of Safe Payments to PartnersABC Partnership

Schedule of Safe Payments to Partners, June 30, 20X5

Capital and loan balances, June 30 (20,000) -0- (10,000)Assume full loss of $5,000 on remaining noncash assets and $10,000 in possible future liquidation expenses 6,000 6,000 3,000

(14,000) 6,000 (7,000)Assume Blue’s potential deficit must be absorbed by Alt and Cha: (6,000)

40/60 x $6,000 4,000 20/60 x $6,000 2,000

Safe payment to partners, June 30 (10,000) -0- (5,000)

Partner Alt. Blue Cha

40% 40% 20%

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Installment Liquidation--June 19X5Installment Liquidation--June 19X5



(from Slide 23) 25 5 -0- (3) (20) -0- (7)

Safe payment to partners

(from Slide 24) (15) 3 10 2

10 5 -0- -0- (10) -0- (5)Sale of assets at book value 5 (5)

15 -0- -0- -0- (10) -0- (5)

Payment of $7,500 in liquidation cost (7.5) 3 3 1.5 (to next slide) 7.5 -0- -0- -0- (7) 3 (3.5)

ContinuedContinuedContinuedContinued

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Installment Liquidation--July 19X5Installment Liquidation--July 19X5ABC Partnership

Statement of Partnership Realization and LiquidationLump-Sum Liquidation (in 000s)

Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%.

(from previous slide) 7.5 -0- -0- -0- (7) -0- (3.5)Distribution of deficit of insolvent partner: (3)

40/60 x $3,000 2 20/60 x $3,000 1.0

7.5 -0- -0- -0- (5) -0- (2.5)Payment to partners (7.5) 5 2.5 Balance -0- -0- -0- -0- -0- -0- -0-

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Loss Absorption PowerLoss Absorption Power

LAP Partner’s capital and loan account balancesPartner’s profit and loss share

=

LAP =$34,000

.40= $85,000

$85,000 x .40 = $34,000

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Loss Absorption PowerLoss Absorption PowerAlt Blue Cha

Profit and loss sharing percentage 40% 40% 20%

Capital and loan balances (34,000) (10,000) (16,000)

Loss absorption power (LAP)

[(Capital + loan balances) Profit %] (85,000) (25,000) (80,000)

Decrease highest LAP to next-highest:

Decrease Alt by $5,000 5,000

(80,000) (25,000) (80,000)Decrease LAP to next-highest level:

Decrease Alt by $55,000, 55,000

Decrease Cha by $55,000 55,000

(25,000) (25,000) (25,000)

Distribute LAPs by distributing

cash in profit and loss sharing

percentages 40% 40% 20%

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Capital and Loan AccountsCapital and Loan AccountsAlt Blue Cha

Profit and loss sharing percentage 40% 40% 20%

Capital and loan balances (34,000) (10,000) (16,000)Decrease highest LAP to next-highest:

Decrease Alt by $5,000

(cash distribution of $2,000) 2,000

(32,000) (10,000) (16,000)Decrease LAP to next-highest level:

Decrease Alt by $55,000,


Decrease Cha by $55,000


Further payments in profits and loss

sharing percentages (10,000) (10,000) ( 5,000)

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Incorporation of a PartnershipIncorporation of a Partnership

Alt, Capital 4,000Blue, Capital 4,000Cha, Capital 2,000

Noncash Assets 10,000Recognize loss on reduction of assetsto market value.

Distribution of $10,000 loss

ABC Partnership decides to incorporate as Peerless Products Corporation. All the partnership’s assets and

liabilities are appraised and valued at their market values. The noncash assets have a market value of $80,000.

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Cash 10,000Noncash Assets 80,000

Liabilities 40,000Loan Payable to Cha 4,000Common Stock 4,600Paid-In Capital in Excess of Par 41,400

Stock acquisition of partnership’s netassets.

The corporation makes an entry on its books for the issuance of 4,600 shares of $1 par common stock in

exchange for the partnership’s net assets.

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Investment in Peerless Products Stock 46,000Liabilities 40,000Loan Payable to Cha 4,000

Cash 10,000Noncash Assets 80,000

Receipt of stock in Peerless Products for partnership’s net assets.

The partners make the following entry on the partnership’s books:

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Alt, Capital 30,000Blue, Capital 6,000Cha, Capital 10,000

Investment in Peerless Products Stock 46,000

Distribution of Peerless Productsstock to partners.

When the stock is issued to the partners, the partnership’s books are closed by this final entry:

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Chapter SixteenChapter Sixteen

The The EndEnd

Documents

Partnerships: Liquidation