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Partnerships: Termination and Liquidation: Answers To Questions
Partnerships: Termination and Liquidation: Answers To Questions
Answers to Questions
1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
8. 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.
9. 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.
10. 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.
12. 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.
1. C
2. A
3. D
4. B
7. A
Brendan Jonathan
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-
Since the partnership currently has total capital of $350,000, the $8,000 that is
available would indicate maximum potential losses of $342,000.
Part a. Brown gets $21,000, Fish gets $12,000, and Stone gets $2,000.
15. (10 Minutes) (Distribution made of contribution made by partner with deficit
balance)
Ball gets $143, Eaton gets $1,429, and Lake gets $3,428.
Hardwick, Ferris,
Other Accounts Loan and Saunders, Loan &
Cash Assets Payable Capital Capital Capital
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
Watson is the partner most vulnerable to a loss. A loss of only $50,000 would
completely eliminate Watson's capital balance:
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.
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):
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):
d. The land and building must be sold for over $115,000 to ensure that Carvil will
receive some cash.
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.
Schedule 1
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be 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
Partner Loss Allocation Be 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
Partner Loss Allocation Be Absorbed
Adams $65,000/(1/3) $195,000
Dobbs $60,000/(2/3) $ 90,000 (most vulnerable)
PREDISTRIBUTION PLAN
First $55,000 goes to pay liabilities ($47,000) and liquidation expenses
(estimated at $8,000).
Next $35,000 available goes to Spencer.
Next $31,250 is split between Norris and Spencer on a 3:2 basis.
Next $50,000 is split among Norris, Spencer, and Harrison on a 3:2:3 basis.
All remaining cash is split among Larson, Norris, Spencer, and Harrison on
the original profit and loss ratio.
Schedule 1
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Larson $15,000/20% $ 75,000 (most vulnerable)
Norris $60,000/30% $200,000
Spencer $75,000/20% $375,000
Harrison $41,250/30% $137,500
Schedule 2
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Norris $37,500/(3/8) $100,000
Spencer $60,000/(2/8) $240,000
Harrison $18,750/(3/8) $ 50,000 (most vulnerable)
Schedule 3
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Norris $18,750/(3/5) $ 31,250 (most vulnerable)
Spencer $47,500/(2/5) $118,750
Part a.
Able Moon
Reported balances $30,000 $30,000
Assumed loss ($50,000) split on a 2:3 basis (20,000) (30,000)
Adjusted balances $10,000 $ 0
PREDISTRIBUTION PLAN
The first $62,000 will go to pay liquidation expenses ($12,000) and liabilities
($50,000).
The next $10,000 goes entirely to Able (to pay off loan).
The next $50,000 is split between Able and Moon based on a 2:3 basis,
respectively.
All remaining cash will be divided among the partners according to their
profit and loss ratio.
Part b.
After this sale, the partnership has $76,000 in cash. The first $62,000 should be
held for the liabilities and the liquidation expenses. The next $10,000 goes to
Able. The remaining $4,000 is divided between Able ($1,600 or 40%) and Moon
($2,400 or 60%).
Bobb Reidl
Reported balances $28,000 $115,000
Assumed loss ($56,000) split on a 2:2 basis (28,000) (28,000)
Adjusted balances $ 0 $ 87,000
PREDISTRIBUTION PLAN
The first $59,000 goes to pay liabilities and expected liquidation expenses.
The next $87,000 goes entirely to Reidl.
The next $56,000 is split evenly between Bobb and Reidl.
The next $8,000 is split among Hart (4/8), Bobb (2/8), and Reidl (2/8).
All remaining cash is split among the partners according to their original
profit and loss ratio.
Part A.
(a) $48,000. Maximum losses of $100,000 on the noncash assets would
increase Milburn's deficit balance by $40,000 (or 40%). Maximum losses
would not create any other deficit balances.
(b) All $19,000 should go to Thomas. As Ross and Thomas view the current
situation, maximum potential losses total $108,000: $100,000 on the
noncash assets and $8,000 on Milburn's deficit balance. In determining safe
capital balances, these assumed losses would be allocated on a 4:2 basis
or $72,000 to Ross and $36,000 to Thomas. Since such a loss would entirely
eliminate Ross' capital account, only Thomas has a safe capital balance at
the current time.
Part B.
(a) Carton will have to contribute $7,429. The $29,000 in deficits will have to be
absorbed by Sampson and Carton on a 4:3 basis. Thus, Carton will be
allocated $12,429 of this amount which creates a deficit of $7,429.
(b) Klingon will have to contribute $19,667 [$17,000 + (20/90 x $12,000)] that will
be distributed as follows:
Creditors $15,000
Sampson $ 3,667
Carton $ 1,000
Since Romulan is insolvent, the remaining partners will have to absorb the
$12,000 deficit on a 4:2:3 basis. This allocation increases Klingon's deficit
by 2/9 of $12,000 or $2,667. Klingon must contribute an amount equal to the
new deficit balance of $19,667. The first $15,000 will go to the creditors that
remain after the $9,000 in partnership cash is distributed. The remaining
$4,667 is distributed to the two partners in accordance with their remaining
positive capital balances after absorbing Romulan's loss, 4/9 to Sampson
and 3/9 to Carton. Sampson has a postive capital balance of $3,667 [$9,000
– ($12,000 x 4/9)] and Carton has a positive capital balance of $1,000 [$5,000
– ($12,000 x 3/9)].
(c) Sampson should receive $500. If Klingon is insolvent, the $17,000 deficit
balance will have to be absorbed by the remaining three partners on a 4:3:1
basis. This loss would decrease Sampson's capital balance by $8,500 (4/8)
to $500.
JOURNAL ENTRIES
a. Cash . .......................................................................... 56,000
March, Capital (2/6 of loss) ...................................... 6,000
April, Capital (3/6) ..................................................... 9,000
May, Capital (1/6) ...................................................... 3,000
Inventory .............................................................. 74,000
Based on the above potential losses, March would have a deficit capital
balance of $9,167 which in turn has to be allocated to the two partners having
positive capital balances:
i. Since $28,700 cash remains and each partner has a positive capital
balance, the money left can be distributed based on these ending totals.
For this creditor to get $5,000 from Z's portion of partnership property, $27,000
in cash above the current level must first be generated for creditors and
liquidation expenses. Based on the predistribution schedule below, the next
$10,000 is received solely by Y. A third $8,000 would be split evenly between Y
and Z (giving Z $4,000 of the $5,000 needed). Z needs $1,000 from the next
cash generated in order to satisfy this personal claim. Since the next level
(Step Two balances) is split on a 3:1:1 basis, Z is entitled to 1/5 of the
proceeds. Thus, $5,000 must be collected for Z to receive $1,000. For Z's
creditor to get $5,000, the other assets have to be sold for $50,000 ($27,000 +
$10,000 + $8,000 + $5,000).
W X Y Z
Beginning capital $ 60,000 $ 78,000 $ 40,000 $ 30,000
Assumed loss of $120,000 (see
Schedule 1) (5:3:1:1) (60,000) (36,000) (12,000) (12,000)
Step One balances $ -0- $ 42,000 $ 28,000 $ 18,000
Assumed loss of $70,000 (see
Schedule 2) (allocated on a
0:3:1:1 basis) -0- (42,000) (14,000) (14,000)
Step Two balances $ -0- $ -0- $ 14,000 $ 4,000
Assumed loss of $8,000 (see
Schedule 3) (allocated on a
0:0:1:1 basis) -0- -0- (4,000) (4,000)
Step Three balances $ -0- $ -0- $ 10,000 $ -0-
PREDISTRIBUTION PLAN
Schedule 1
Capital Balance/ Maximum Loss to
Partner Loss Allocation Be Absorbed
W $60,000/50% $120,000 (most vulnerable)
X $78,000/30% $260,000
Y $40,000/10% $400,000
Z $30,000/10% $300,000
Schedule 2
Capital Balance/ Maximum Loss to
Partner Loss Allocation Be Absorbed
X $42,000/(3/5) $ 70,000 (most vulnerable)
Y $28,000/(1/5) $140,000
Z $18,000/(1/5) $ 90,000
Schedule 3
Capital Balance/ Maximum Loss to
Partner Loss Allocation Be Absorbed
Y $14,000/(1/2) $ 28,000
Z $ 4,000/(1/2) $ 8,000 (most vulnerable)
Schedule 1
Computation of Actual and Potential Liquidation Losses
January 2007
Actual Potential
Losses Losses
Collection of accounts receivable ($66,000 – $51,000) $15,000
Sale of inventory ($52,000 – $38,000) ........................... 14,000
Liquidation expenses .................................................... 2,000
Gain resulting from January credit memorandum
reducing liability to creditors .................................. (3,000)
Machinery and equipment, net ..................................... $189,000
Potential unrecorded liabilities and anticipated expenses 10,000
Totals ......................................................................... $ 28,000 $199,000
Haynes,
Part A Simon, Loan and Jackson,
Capital Capital Capital
Beginning balances $16,000 $ 4,000 ($12,000)
Contribution by Jackson -0- -0- 3,000
Capital balances $16,000 $ 4,000 ($ 9,000)
Elimination of Jackson's deficit
(40:20 basis) (6,000) (3,000) 9,000
Final distribution $10,000 $ 1,000 $ -0-
Hough, Luck,
Part B Loan and Loan and Cummings,
Capital Capital Capital
Beginning balances $82,000 $40,000 $20,000
$82,000 loss on disposal (allocated on a
50:40:10 basis) (41,000) (32,800) (8,200)
Liquidation expenses (50:40:10 basis) (10,500) (8,400) (2,100)
Capital balances 30,500 (1,200) 9,700
Allocation of Luck's deficit (50:10 basis) (1,000) 1,200 (200)
Final distribution $29,500 $ -0- $ 9,500
Hough, Luck,
Part C Loan and Loan and Cummings,
Capital Capital Capital
Beginning balances $82,000 $40,000 $20,000
$82,000 loss on disposal (allocated on a
2:4:4 basis) (16,400) (32,800) (32,800)
Liquidation expenses (2:4:4 basis) (1,200) (2,400) (2,400)
Capital balances $64,400 $ 4,800 ($15,200)
Allocation of Cummings' deficit balance
(2:4 basis) (5,067) (10,133) 15,200
Capital balances $59,333 ($ 5,333) -0-
Allocation of Luck's deficit balance (5,333) 5,333 -0-
Final distribution $54,000 $ -0- $ -0-
Part D
Redmond,
Loan and Ledbetter, Watson, Sandridge,
Capital Capital Capital Capital
Schedule 1
Development of Predistribution Schedule
PREDISTRIBUTION PLAN
Schedule 2
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Frick $101,000/60% $168,333
Wilson $ 28,000/20% $140,000 (most vulnerable to loss)
Clarke $ 61,000/20% $305,000
Schedule 3
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Frick $17,000/(60/80) $ 22,667 (most vulnerable to loss)
Clarke $33,000/(20/80) $132,000
PREDISTRIBUTION PLAN
Schedule 1
Maximum Loss
Capital Balance/ That Can Be
Partner Loss Allocation Absorbed
Maximum Loss
Capital Balance/ That Can Be
Partner Loss Allocation Absorbed
Wingler $75,000/(30/60) $150,000 (most vulnerable to loss)
Norris $73,000/(10/60) $438,000
Rodgers $79,000/(20/60) $237,000
Schedule 3
Maximum Loss
Capital Balance/ That Can Be
Partner Loss Allocation Absorbed
Norris $48,000/(10/30) $144,000
Rodgers $29,000/(20/30) $ 43,500 (most vulnerable to loss)
Part B
There are a number of different ways that a spreadsheet could be created to solve
this particular problem. Here is one possible approach:
In Cell A2, enter label text “Wilson.” In Cell B2, enter Wilson’s Capital Balance of
$200,000 and, in Cell C2, enter 40% as share of profit and loss.
In Cell A3, enter label text “Cho.” In Cell B3, enter Cho’s Capital Balance of
$180,000 and, in Cell C3, enter 20% as share of profit and loss.
In Cell A4, enter label text “Arrington.” In Cell B4, enter Arrington’s Capital
Balance of $110,000 and, in Cell C4, enter 40% as share of profit and loss.
—Enter the amounts on which to base the calculations for each partner:
In Cell A7, enter label text “Losses during liquidation” and, in Cell B7, enter the
amount of $50,000.
In Cell A8, enter label text “Final Losses” and, in Cell B8, enter the amount of
$100,000.
Multiply the “Losses during liquidation” amount by the percentage of “Share P/L”
for each partner. To calculate the Initial Share Loss for Wilson, create the
following formula in Cell D2: =+B7*C2. We need to also use this same general
formula for both Cho and Arrington. However, if we drag the fill handle in Cell D2
into Cell D3 and D4, the reference to Cell B7 will automatically change to B8 and
B9 respectively and the reference to Cell C2 will change to C3 and C4 respectively
in order to adjust for the new cell position. The change to C3 and C4 is correct
because those are the individual profit and loss percentages. No change, though,
should be made to the reference to B7 because that is the overall loss in question.
In order to “hold” the reference to Cell B7 when it is copied, we need to create
what is known as an “ABSOLUTE” reference. Absolute references, which are cell
references that always refer to cells in a specific location, can be created by
placing a $ symbol before the Column letter and/or the Row number. Thus, in Cell
To calculate the Remaining Capital Balance, the beginning Capital Balance must
be reduced by the Initial Loss Share and Subsequent Loss Share.
In creating this last formula, it is important to note that the losses should be
added together and then subtracted in total from the beginning capital balance.
Therefore, enter the following function in Cell F2: =+B2-(D2+E2). The
computation inside the parenthesis is performed first and then subtracted from
the beginning capital balance (B2). Copy this formula to Cells F3 and F4 to
complete the worksheet. Note that the use of the $ is not used here because we
do want B2, D2, and E2 to adjust to the new position when copied.
Once this spreadsheet has been created, any of the variables may be changed
and the results will adjust automatically. There are eight variables that can be
changed: B2, B3, B4, B7, B8, C2, C3, and C4. C2, C3,and C4 must always add to
100%.
A B C D E F
1 Initial
Capital Share Loss Subsequent Remaining
Partner Balance P/L Share Loss Share Balance
2
Wilson $200,000 40% $20,000 $40,000 $140,000
3
Cho 180,000 20% 10,000 20,000 150,000
4
Arrington 110,000 40% 20,000 40,000 50,000
5
$490,000 100% $50,000 $100,000 $340,000
6
7 Losses during
liquidation 50,000
8 Final losses 100,000