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Partnership Liquidation

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  1. Partnership Liquidation Chapter 16

  2. Learning Objective 1 Understand legal aspects of partnership liquidation.

  3. The Liquidation Process – Converting noncash assets into cash – Recognizing gains and losses and liquidating expenses incurred during the liquidation period – Settling all liabilities – Distributing cash to partners according to the final balances in their capital accounts

  4. Rank Order of Payments I – Amounts owed to creditors other than partners II – Amounts owed to partners other than for capital and profits III – Amounts due to partners with respect to their capital interests IV – Amounts to partners with respect to profits

  5. Learning Objective 2 Apply simple partnership liquidation computations and accounting.

  6. AssetsLiabilities and Equity Cash $ 10,000 Accounts payable $ 40,000 A/R, net 30,000 Loan from Holmes 10,000 Inventory 30,000 Holmes, capital 25,000 Plant assets, net 40,000 Kaiser, capital 35,000 $110,000 $110,000 Simple Partnership Liquidation Holmes and Kaiser Balance Sheet December 31, 2003

  7. Simple Partnership Liquidation Profits and losses are distributed as follows: 70% to Holmes and 30% to Kaiser They agreed to liquidate the partnership as soon as possible after January 1, 2004. Inventory items are sold for $25,000, plant assets are sold for $30,000, $22,000 is collected from accounts receivable.

  8. AssetsLiabilities and Equity Cash $87,000 Accounts payable $40,000 A/R, net Loan from Holmes 10,000 Inventory Holmes, capital 8,900 Plant assets, net Kaiser, capital 28,100 $87,000 $87,000 Simple Partnership Liquidation Holmes and Kaiser Balance Sheet January 5, 2004

  9. Simple Partnership Liquidation Order of Payment I To creditors for accounts payable $40,000 II To Holmes for his loan balance 10,000 III To Holmes for his capital balance 8,900 To Kaiser for his capital balance 28,100 Total distribution $87,000

  10. Debit Credit Cash $25,000 Jay, capital (40%) 3,000 Jim, capital (40%) $16,000 Joe, capital (20%) 12,000 Total $28,000 $28,000 Debit Capital Balancesin a Solvent Partnership The partnership of Jay, Jim, and Joe is in the process of liquidation.

  11. Debit Capital Balancesin a Solvent Partnership If Jay is unable to pay $3,000 to the partnership, his debit balance represents a loss to be charged to Jim and Joe. Jim’s share: 4/6 × $3,000 = $2,000 Joe’s share: 2/6 × $3,000 = $1,000

  12. Learning Objective 3 Perform safe payment computations.

  13. 1 All partners are personally insolvent. 2 All noncash assets represent possible losses. Safe Payments to Partners The calculation of safe payments is based on the following assumptions:

  14. (000) Debits Credits Cash $ 80 Loan payable to Nancy $20 Loan due from Maxine 10 Buzz, capital (50%) 50 Land 20 Maxine, capital (30%) 70 Building, net 140 Nancy, capital (20%) 110 $250 $250 Application of SafePayments Schedule

  15. (000) Possible Losses Buzz Equity (50%) Maxine Equity (30%) Nancy Equity (20%) Partners’ equities (capital ± loan balances Possible loss on noncash assets Book value of land and buildings Possible loss on contingencies Cash withheld for contingencies $160 10 $50 (80) (30) (5) (35) $60 (48) 12 (3) 9 $130 (32) 98 (2) 96 Safe Payment Schedule

  16. Safe Payment Schedule (000) Possible Losses Buzz Equity (50%) Maxine Equity (30%) Nancy Equity (20%) Possible loss from Buzz Buzz’s debit balance allocated 60:40 to Maxine and Nancy Possible loss from Maxine Maxine’s debit balance assigned to Nancy 35 0 (21) (12) 12 0 (14) 82 (12) $ 70

  17. Safe Payment Schedule Loan payable to Nancy 20,000 Nancy, Capital 50,000 Cash 70,000

  18. (000) Debits Credits Cash $ 10 Buzz, capital (50%) $ 50 Loan due from Maxine 10 Maxine, capital (30%) 70 Land 20 Nancy, capital (20%) 60 Building, net 140 $180 $180 Account Balances

  19. Advance Distribution Any distribution to partners before all gains and losses have been realized and recognized requires approval of all partners.

  20. Learning Objective 4 Understand installment liquidations.

  21. Installment Liquidation An installment liquidation involves the distribution of cash to partners as it becomes available during the liquidation period and before all liquidation gains and losses have been realized.

  22. Installment LiquidationIllustration The partnership of Duro, Kemp, and Roth is to be liquidated as soon as possible after December 31, 2003. All cash on hand, except for $20,000 is to be distributed at the end of each month. Profit and losses are shared 50%, 30%, and 20% to Duro, Kemp, and Roth.

  23. Installment LiquidationIllustration Duro, Kemp, and Roth Balance Sheet December 31, 2003 (000) AssetsLiabilities and Equity Cash $ 240 Accounts payable $ 300 A/R, net 280 Note payable 200 Loan to Roth 40 Loan from Kemp 20 Inventories 400 Duro, capital (50%) 340 Land 100 Kemp, capital (30%) 340 Equipment, net 300 Roth, capital (20%) 200 Goodwill 40 $1,400 $1,400

  24. Installment LiquidationIllustration Statement of Partnership Liquidation for the Period 1/1/2004 to 2/1/2002 (000) Cash Non- cash Assets Priority Liabil- ities 50% Duro Capital Kemp Loan 30% Kemp Capital 20% Roth Capital Balances January 1 Offset Roth loan Write-off of goodwill Collection of receivables Sale of inventory items Predistribution balances January 31 January distribution Creditors Kemp Balances February 1 $240 200 200 $640 (500) (120) $ 20 $1,160 (40) (40) (200) (160) $ 720 $ 720 $500 $500 (500) $ 0 $340 (20) 20 $340 $340 $20 $20 (20) $ 0 $340 (12) 12 $340 (100) $240 $200 (40) (8) 8 $160 $160

  25. Installment LiquidationIllustration First Installment – Schedule of Safe Payments January 31, 2004 (000) Possible Losses 50% Duro Capital 30% Kemp Capital and Loan 20% Roth Capital Partners’ equities January 31, 2004 Possible loss on noncash assets Possible loss on contingencies: cash withheld Possible loss from Duro: debit balance allocated 60:40 $720 20 $340 (360) $ (20) (10) $ (30) 30 — $360 (216) $144 (6) $138 (18) $120 $160 (144) $ 16 (4) $ 12 (12) —

  26. February Liquidation Events Cash 60,000 Duro, Capital 10,000 Kemp, Capital 6,000 Roth, Capital 4,000 Equipment, net 80,000 To record sale of equipment at a $20,000 loss Cash 180,000 Duro, Capital 30,000 Kemp, Capital 18,000 Roth, Capital 12,000 Inventories 240,000 To record sale of remaining inventory items at a $60,000 loss

  27. February Liquidation Events Duro, Capital 2,000 Kemp, Capital 1,200 Roth, Capital 800 Cash 4,000 To record payment of liquidation expenses Duro, Capital 4,000 Kemp, Capital 2,400 Roth, Capital 1,600 Accounts Payable 8,000 To record identification of an unrecorded liability

  28. February Liquidation Events Accounts Payable 8,000 Cash 8,000 To record payment of accounts payable Duro, Capital 84,000 Kemp, Capital 86,400 Roth, Capital 57,600 Cash 228,000 To record distribution of cash to partners

  29. Learning Objective 5 Learn about cash distribution plans for installment liquidations.

  30. $$$ Cash Distribution Plans The development of a cash distribution plan for the liquidation of a partnership involves ranking the partners in terms of their vulnerability to possible losses.

  31. Partner’s Equity Profit Sharing Ratio Loss Absorption Potential Vulnerability Ranking (1 most vulnerable) Duro $340 ÷ 0.5 = $ 680 1 Kemp 360 ÷ 0.3 = 1,200 3 Roth 160 ÷ 0.2 = 800 2 Vulnerability Ranking

  32. Assumed Loss Absorption A schedule of assumed loss absorption is prepared as a second step in developing the cash distribution plan.

  33. Assumed Loss Absorption Schedule of Assumed Loss Absorption (000) Duro (50%) Kemp (30%) Roth (20%) Total Preliquidation equities Assumed loss to absorb Duro’s equity (allocated 50:30:20) Balances Assumed loss to absorb Roth’s equity (allocated 60:40) Balances $340 (340) — $360 (204) $156 (36) $120 $160 (136) $ 24 (24) — $860 (680) $180 (60) $120

  34. Priority Liabilities Kemp Loan Duro Kemp Roth First $500,000 100% Next $20,000 100% Next $100,000 100% Next $60,000 60 40% Remainder 50% 30 20 Cash Distribution Plan

  35. Learning Objective 6 Comprehend liquidations when either the partnership or partners are insolvent.

  36. Insolvent Partners and Partnerships Ranking for claims against the separate property of a bankrupt partner: I Those owing to separate creditors II Those owing to partnership creditors III Those owing to partners by way of contribution

  37. Partnership Solvent – One or MorePartners Personally Insolvent In the liquidation of a solvent partnership, partnership creditors are entitled to recover the full amount of their claims from partnership property. West, York, and Zeff are partners sharing profits 30%, 30%, and 40%, respectively. West is personally insolvent with personal assets of $50,000 and personal liabilities of $100,000.

  38. Case A Case B Case C Cash $60,000 — — West, capital (30%) 18,000 $18,000 $21,000 York, capital (30%) 18,000 27,000 9,000 Zeff, capital (40%) 24,000 9,000 12,000 Partnership Account Balances

  39. Insolvent Partnership When a partnership is insolvent, the cash available is not enough to pay partnership creditors. Creditors will obtain partial recovery from partnership assets and will call upon individual partners to use their personal resources to satisfy remaining claims.

  40. End of Chapter 16