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Partnership Dissolution

Partnership Dissolution. Introduction. A partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business. The assets of the partnership will be realized to pay off the liabilities.

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Partnership Dissolution

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  1. Partnership Dissolution

  2. Introduction • A partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business. • The assets of the partnership will be realized to pay off the liabilities. • The sales proceeds should be applied in the following order, as required by the Hong Kong Ordinance: • Pay off creditors first, • then the partners’ advances, and • Finally the partners’ capital

  3. Realization Account • In the partnership dissolution, an account named as ‘Realization Account’ will be opened to compute the profit or loss from realization which should be shared among the partners according to the profit or loss sharing ratio

  4. Nature of partnership dissolution • Dissolution where the assets are sold separately • Dissolution where partnership is sold as a whole

  5. Dissolution where Assets are sold separately

  6. Procedures of Dissolution • All assets will be sold to other persons or taken over by partners • Settle the liabilities of the partnership to outsider or partners • Transfer any ‘profit or loss on realization’ to each partner’s capital accounts in profit/loss sharing ratio • Merge the balances in the partners’ current accounts to their capital accounts

  7. Any credit balance in each partner’s capital account represents the amount which can be withdrawn from the partnership to each partner; any debit balance in a partner’s capital account represents additional cash to be injected by that partners

  8. Example 1

  9. John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed AssetsCostDep NBV Premises 180000 10000 170000 Motor Vehicles 27500 5500 22000 207500 15500 192000 Current assets Stock 68250 Debtors 172500 Less: provision for bad debt 1265 171235 Bank 26065 265550 Less: Current Liabilities Creditors 60000 Working Capital 205550 397550

  10. Capital: John 100000 Peter 40000 Tom 160000 300000 Current: John 30000 Peter (10000) Tom 70000 90000 Long – term liabilities Loan from Tom 7550 397550 Assets and liabilities were disposed of as follows: 1. The premises were sold at $ 200000 and legal charges from the sale amount to $10000 2. Tom took over the stock and motor vehicles at book value 3. Except for $2500, all debts were collected 4. The creditors were discharged for $56000 5. Realization expenses of $10000 were paid Required: Prepare the realization, Bank, Capital and Current account for the dissolution of partnership

  11. Realization Premises 170000 Premises Prov. for depreciation 10000 Bal b/f 180000 Realization 170000 180000 180000 Provision for depreciation Premises 10000 Bal b/f 10000

  12. Realization Premises 170000 Motor Vehicles 22000 Motor Vehicles Prov. for depreciation 5500 Bal b/f 27500 Realization 22000 27500 27500 Provision for depreciation Motor Vehicles 5500 Bal b/f 5500

  13. Realization Premises 170000 Motor Vehicles 22000 Debtors 171235 Debtors Prov. for bad debts 1265 Bal b/f 172500 Realization 171235 172500 172500 Provision for Bad Debts Motor Vehicles 1265 Bal b/f 1265

  14. Realization Premises 170000 Motor Vehicles 22000 Debtors 171235 Stock 68250 Stock Bal b/f 68250 Realization 68250

  15. Realization Bank – premises (200000-10000) 190000 - Debtors (172500-2500) 170000 Premises 170000 Motor Vehicles 22000 Debtors 171235 Creditors – discount received 4000 Stock 68250 Bank- realization expenses 10000 Loan from Tom Bank 7550 Bal b/f 7550 Bank Bal b/f 26065 Realization - expenses 10000 Realization – premises 190000 - debtors 170000 Creditors 56000 Loan from Tom 7550 Creditors Bank 56000 Bal b/f 60000 Realization – discount received 4000 60000 60000

  16. Realization Bank – premises (200000-10000) 190000 - Debtors (172500-2500) 170000 Premises 170000 Motor Vehicles 22000 Debtors 171235 Creditors – discount received 4000 Stock 68250 Tom – stock 68250 - MV 22000 Bank- realization expenses 10000 Gain on realization: John 1/5 2553 Peter 1/5 2553 Tom 3/5 7659 12765 454250 454250 Capital John Peter Tom John Peter Tom Realization: Stock 68250 MV 22000 Bal b/f 100000 40000 160000 Gain on realizaiton 2553 2553 7659

  17. Capital John Peter Tom John Peter Tom Realization: Stock 68250 MV 22000 Bal b/f 100000 40000 160000 Gain on realizaiton 2553 2553 7659 Current 30000 70000 Current 10000 Bank 132553 32553 147409 132553 32553 147409 132553 32553 147409 Current John Peter Tom John Peter Tom Bal b/f 10000 Bal b/f 30000 - 70000 Capital 30000 70000 Capital 10000 30000 10000 70000 30000 10000 70000 Bank Bal b/f 26065 Realization - expenses 10000 Realization – premises 190000 - debtors 170000 Creditors 56000 Loan from Tom 7550 Capital: John 132553 Peter 32553 Tom 147409 386065 386065

  18. Dissolution where partnership is sold as a whole

  19. Purchase consideration • The purchase consideration is to be discharged by the limited company (buyer) to partners(seller) to take over the business • Goodwill = Purchase consideration – ( assets at take-over value – liabilities at take-over value)

  20. Example 2

  21. John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed AssetsCostDep NBV Premises 180000 10000 170000 Motor Vehicles 27500 5500 22000 207500 15500 192000 Current assets Stock 68250 Debtors 172500 Less: provision for bad debt 1265 171235 Bank 26065 265550 Less: Current Liabilities Creditors 60000 Working Capital 205550 397550

  22. Capital: John 100000 Peter 40000 Tom 160000 300000 Current: John 30000 Peter (10000) Tom 70000 90000 Long – term liabilities Loan from Tom 7550 397550 On 31 December 1996, they incorporated a limited company, Fortune limited, to take over the partnership business. Fortune Limited had an authorized capital of $500000 ordinary shares of $1 each.

  23. Assets and liabilities were disposed of as follows: • John took over the stock at book value. Tom collected all the debts except • $2500 • The company took over the premises at a valuation of $200000, motor • vehicles at $25000, cash at bank and all the liabilities. Goodwill was • valued at $70000 for the purpose of the takeover • The purchase consideration was to be discharged by the issue to the • partners of 150000 ordinary shares at $1.2 each, according to the • profit-sharing ratio, and the balance was to be in cash • The company also issued 50000 ordinary shares at $1.2 for cash to • outsiders • Required: • Prepare the realization, Capital and the opening balance sheet for the new • company

  24. Realization Liabilities taken over by Ltd. Co. Creditors 60000 Loan from Tom 7550 Premises 170000 MV 22000 Stock 68250 Debtors 171235 Bank 26065 Tom: debtors (172500-2500) 170000 John: stock 68250 Bank be taken over Fortune Ltd – purchase consideration [(200000+25000+26065-7550-60000) +70000] 253515 Capital: John 20353 Peter 20353 Tom 61059 101765 559315 559315 Purchase consideration=Asset-liabilities +goodwill

  25. Capital John Peter Tom John Peter Tom Current 10000 Bal b/f 100000 40000 160000 Realization Stock 68250 Debtors 170000 Current 30000 70000 Realization -profit 20353 20353 61059 Shares in Fortune Ltd 36000 36000 108000 Bank 46103 14353 13059 (Bal. fig.) 150353 60353 291059 150353 60353 291059 Shares in Fortune Ltd. 150000*1.2 = 180000 John 1/5 36000 Peter 1/5 36000 Tom 3/5 108000 180000

  26. Fortune Limited Balance sheet as at 1 Jan 1996 Fixed Assets Goodwill 70000 Premises 200000 MV 25000 295000 Current Assets Bank [26065 + (50000*1.2) –(46103+14353+13059)] 12550 Less: Current liabilities Creditors 60000 Working Capital (47450) 247550 Share Capital Ordinary Shares (150000*$1+50000*$1) 200000 Share Premium (150000*$0.2+150000*$0.2) 40000 240000 Long-term liabilities Loan from Tom 7550 247550

  27. Cash distribution among partners

  28. Cash Distribution Among Partners • With the application of the Garner vs. Murray rule • When cash is to be distributed as soon as possible ( Piecemeal realization)

  29. With the application of Garner vs. Murray rule

  30. With the application of Garner vs. Murray rule • Any CREDIT balance in each partner’s capital account represents the amount which can be withdrawn from the partnership to each partner • Any DEBIT balance in a partner’s capital account represents additional cash to be injected by that partner. If he is insolvency to repay the amount, the solvency partners will be shared the amount in: • Profit & loss sharing ratio • Any agreed ratio given in the examination question • GARNER vs. MURRAY rule may be applied

  31. What is Garner vs. Murray rule?

  32. Garner vs. Murray rule • Under the rule, a partner is required to contribute cash to eliminate the debit balance in his capital account • In the court case of Garner vs. Murray (1904), it was held that subject to any agreement to the contrary, such a debit balance deficiency was to be shared by the other partner not in their profit and loss sharing ratio but “ the ratio of their lastagreed capitals”

  33. If one partner is insolvent, his capital deficiency will be shared by other partners according to the ‘last agreed capital ratio’ (the ratio of the balances in the capital accounts before the dissolution, in the absence of any agreement to the contrary

  34. Piecemeal Realization

  35. Piecemeal realization • Cash is distributed as it becomes available, instead of waiting for all the assets to be realized first • Assets are sold piecemeal, and then outstanding debts are paid and the remaining cash is finally distributed to the partners as soon as possible • This situation occurs because some assets can be sold quickly, and some assets take longer time to be sold (i.e. less liquid)

  36. Assumed Loss/Notional Loss Method • This is possible loss by assuming that the remaining assets do not have any scrap value • Any unsold assets will be assumed loss in each distribution

  37. Steps on Piecemeal Dissolution • Find out the maximum possible loss • Maximum possible loss = NBV of assets to be realized - Total proceeds form disposal OR • Maximum possible loss = Total capital balances - Total cash to be distributed to partners( i.e. cash available)

  38. The maximum possible loss is shared by the partners according to the profit-sharing ratio • Apply the Garner vs. Murray rule if there is any capital deficiency • Distribute any available cash to the partners according to their remaining capital balances • Repeat the process until all assets have been realized

  39. Example 3

  40. Au, Chow and Lee were partners sharing profits and losses in the ratio 2:2:1. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed AssetsCostDep NBV Goodwill 100000 100000 Land 150000 150000 Plant & Machinery 133000 55800 77200 Fixture & Fittings 30000 13000 17000 Motor Vehicles 32000 24000 8000 445000 92800 352200 Current assets Stock 64000 Debtors 65000 Less: provision for bad debt 6000 59000 Cash 160 123160 Less: Current Liabilities Creditors 57000 Bank Overdraft 128360 Working Capital 62200 290000

  41. Capital: Au 120000 • Chow 80000 • Lee 30000 230000 • Current: Au 20000 • Chow 20000 40000 • Long – term liabilities • Bank loan 20000 • 290000 • On 31 December 1996 the partners agreed to dissolve the partnership • due to a disagreement between the partners. Assets were to be realized, • outstanding debts to be paid and the remainder to be shared by the • partners in an equitable manner. • Distributions of cash were to be made as soon as possible. • January • Provision was made for dissolution expenses of $2400 • Land was sold for $200000 • The cash available was utilized to settle in full the bank overdraft, the bank overdraft, the bank loan and all creditors after receiving discounts

  42. March • Stock which had originally costed $40000 was sold for $32000 • $15000 was received form debtors • April • Plant & Machinery were sold for $51000 after paying carriage of $2000 • Fixtures and fittings were sold for $12000 • May • All the outstanding debtors, with the exception of a customer who owed $4000 settled their accounts • Motor vehicles were sold for $25000 • The remaining stock was sold for $22000 • Dissolution expenses amounted to $2100 • Prepare distribution statement of cash at each stage

  43. Distribution Statement Total Au Chow Lee $ $ $ $ Capital accounts 230000 120000 80000 30000 Current accounts 40000 20000 20000 270000 140000 100000 30000 1st Distribution: Cash available (w1) ( 47000) Maximum possible loss (2:2:1) 223000 89200 89200 44600 50800 10800 (14600) Lee’s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (8760) (5840) 14600 Cash distributed 42040 4960 0 2nd Distribution: Capital balance 223000 97960 95040 30000 Cash available (51000+12000) (63000) Maximum possible loss (2:2:1) 160000 64000 64000 32000 33960 31040 (2000) 140000-42040 Lee’s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (1200) (800) 2000 Cash distributed 32760 30240 0

  44. 3rd Distribution: Capital balance 160000 65200 64800 30000 Cash available (W2) (93300) Maximum possible loss (2:2:1) 66700 26680 26680 13340 Cash distributed 38520 38120 16660 97960-32760

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