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Partnerships: Liquidation

Baker / Lembke / King. 16. Partnerships: Liquidation. Electronic Presentation by Douglas Cloud Pepperdine University. Terminology. Dissolution : A legal concept indicating a change in the legal relationship between partners.

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Partnerships: Liquidation

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  1. Baker / Lembke / King 16 Partnerships: Liquidation Electronic Presentation by Douglas Cloud Pepperdine University

  2. Terminology 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.

  3. Major Causes of a Dissolution 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.

  4. Partnership Terminates Immediately if-- • A court so decrees. • The partnership is bankrupt. • The partnership’s business becomes illegal.

  5. Claims Against the Partnership Assets • 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.

  6. Claims Against Personal Assets • Personal creditors of individual partners. • For general partners, partnership creditors for unpaid partnership liabilities, regardless of partner’s capital balance in the partnership.

  7. Basic Facts at Liquidation Partners Alt Blue Cha Profit and loss percentage 40% 40% 20% Partnership capital account $34,000 $10,000 $12,000 Partnership loan payable to Cha 4,000

  8. Cautions About Offsetting Partners’ Loans and Capital 16-8 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.

  9. Trial Balance on Liquidation Date ABC Partnership Trial Balance May 1, 20X5 Cash $ 10,000 Noncash Assets 90,000 Liabilities $ 40,000 Loan Payable to Partner Cha 4,000Alt, Capital (40%) 34,000 Blue, Capital (40%) 10,000 Cha, Capital (20%) 12,000 Total $100,000 $100,000

  10. Case 1: Partnership Solvent--No Deficits Sale of assets and distri- bution of $10,000 loss 80 (90) 4 4 2 90 -0- (40) (4) (30) (6) (10) Payment to o/s creditors (40) 40 50 -0- -0- (4) (30) (6) (10) Lump-sum payments to partners: Partner’s loan (4) 4 Partners’ capital (46) 30 610 Postliquidation balance -0- -0- -0- -0- -0- -0- -0- ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s) Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%. Preliquidation balances 10 90 (40) (4) (34) (10) (12)

  11. Case 1: Partnership Solvent--No Deficits May 15, 20X5 Cash 80,000 Alt, Capital 4,000 Blue, Capital 4,000 Cha, Capital 2,000 Noncash Assets 90,000 Realization 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.

  12. Case 1: Partnership Solvent--No Deficits May 20, 20X5 Liabilities 40,000 Cash 40,000 Pay outside creditors. May 30, 20X5 Cha, Loan 4,000 Alt, Capital 30,000 Blue, Capital 6,000 Cha, Capital 10,000 Cash 50,000 Lump-sum payments to partners. The partnership pays the outside creditors. The remaining cash is distributed to the partners.

  13. Case 2: Partnership Solvent--Deficit The three partners’ personal financial statements are as follows:

  14. Case 2: Partnership Solvent--Deficit ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s) Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%. Preliquidation balances 10 90 (40) (4) (34) (10) (12) Sale of assets and distri- bution of $55,000 loss 35 (90) 22 22 11 45 -0- (40) (4) (12) 12 (1) Payment to o/s creditors (40) 40 5 -0- -0- (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

  15. Case 2: Partnership Solvent--Deficit (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- ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s) Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%.

  16. Case 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) 282814 30 -0- (40) (4) (6) 18 2 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 Offset deficit with loan 4 (4) (to next slide) 30 -0- (40) -0- 6 -0- 4 ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s) Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%.

  17. Case 3: Partnership Insolvent--Deficit (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- ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s) Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%.

  18. 16-19 Installment Liquidations

  19. Installment Liquidation ABC Partnership Trial Balance May 1, 20X5 Cash $ 10,000 Noncash Assets 90,000 Liabilities $ 40,000 Loan Payable to Partner Cha 4,000Alt, Capital (40%) 34,000 Blue, Capital (40%) 10,000 Cha, Capital (20%) 12,000 Total $100,000 $100,000

  20. Installment Liquidation--May 20X5 Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%. Preliquidation balances 10 90 (40) (4) (34) (10) (12) Sale of assets and distri- 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) ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s)

  21. Schedule of Safe Payments to Partners ABC Partnership Schedule of Safe Payments to Partners, May 31, 20X5 Partner Alt. Blue Cha 40% 40% 20% 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 18,00018,000 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)

  22. Installment Liquidation--May 20X5 Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%. Preliquidation balances 10 90 (40) (4) (34) (10) (12) Sale of assets and distri- 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) ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s)

  23. Installment Liquidation--June 20X5 Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%. (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) ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s)

  24. Schedule of Safe Payments to Partners ABC Partnership Schedule of Safe Payments to Partners, June 30, 20X5 Partner Alt. Blue Cha 40% 40% 20% 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 6,0006,000 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)

  25. Installment Liquidation--June 19X5 Noncash Cha Alt, Cap. Blue, Cap Cha, Cap. Cash Assets Liab. Loan 40% 40% 20%. (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 31.5 (to next slide) 7.5 -0- -0- -0- (7) 3 (3.5) ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s) Continued

  26. Installment Liquidation--July 19X5 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) Payment to partners (7.5) 5 2.5 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) Balance -0- -0- -0- -0- -0- -0- -0- ABC Partnership Statement of Partnership Realization and Liquidation Lump-Sum Liquidation (in 000s)

  27. Loss Absorption Power Partner’s capital and loan account balances LAP = Partner’s profit and loss share $34,000 .40 LAP = = $85,000 $85,000 x .40 = $34,000

  28. Loss Absorption Power 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 percentages40% 40% 20% Alt 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)

  29. Capital and Loan Accounts 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, (cash distribution of $22,000) 22,000 Decrease Cha by $55,000 (cash distribution of $11,000) 11,000 Further payments in profits and loss sharing percentages (10,000) (10,000) ( 5,000) Alt Blue Cha Profit and loss sharing percentage 40% 40% 20% Capital and loan balances (34,000) (10,000) (16,000)

  30. Incorporation of a Partnership Alt, Capital 4,000 Blue, Capital 4,000 Cha, Capital 2,000 Noncash Assets 10,000 Recognize loss on reduction of assets to 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.

  31. Incorporation of a Partnership 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. Cash 10,000 Noncash Assets 80,000 Liabilities 40,000 Loan Payable to Cha 4,000 Common Stock 4,600 Paid-In Capital in Excess of Par 41,400 Stock acquisition of partnership’s net assets.

  32. Incorporation of a Partnership The partners make the following entry on the partnership’s books: Investment in Peerless Products Stock 46,000 Liabilities 40,000 Loan Payable to Cha 4,000 Cash 10,000 Noncash Assets 80,000 Receipt of stock in Peerless Products for partnership’s net assets.

  33. Incorporation of a Partnership When the stock is issued to the partners, the partnership’s books are closed by this final entry: Alt, Capital 30,000 Blue, Capital 6,000 Cha, Capital 10,000 Investment in Peerless Products Stock 46,000 Distribution of Peerless Products stock to partners.

  34. Chapter Sixteen The End

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