16

Partnerships:
Liquidation

McGraw-Hill/Irwin

Copyright 2009 The McGraw-Hill Companies, Inc. All rights reserved.

Overview of Partnership Liquidations

The Uniform Partnership Act of 1997

includes 7 sections which deal specifically
with the dissolution and winding up of a
partnership
Creditors have first claim to the partnerships
assets
After the creditors are fully satisfied, any
remaining assets are distributed to the
partners based on the balances in their capital
accounts
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Overview of Partnership Liquidations

Dissociation
The legal description of the withdrawal of a
partner, including the following:
1. A partners death
2. A partners voluntary withdrawal
3. A judicial determination

Not all dissociations result in a partnership

liquidation

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Overview of Partnership Liquidations

Dissolution
The dissolving of a partnership
Events that cause dissolution and winding up:
1. In a partnership at will, a partners express notice
to leave the partnership
2. In a partnership for a definite term or specific
undertaking:
a) When after a partners death or wrongful dissociation,
at least half of the remaining partners decide to wind up
the partnership business
b) When all of the partners agree to wind up the business
c) When the term or specific undertaking has expired or
been completed
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Overview of Partnership Liquidations

Events that cause dissolution and winding up:
3. An event that makes it unlawful to carry on a
substantial part of the partnership business
4. A judicial determination

On dissolution, the partnership begins the

winding up of the partnerships business

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Overview of Partnership Liquidations

Winding up and liquidation begins after the

dissolution of the partnership
The partnership continues for the limited
purpose of winding up the business and
completing work in process
Winding up process includes the transactions
necessary to liquidate the partnership
Some partnerships change to the liquidation
basis of accounting once they no longer
consider the business to be a going concern
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Overview of Partnership Liquidations

Loans with partners

Liabilities to partners for loans the partners
made to the partnership have the same status
as liabilities to the partnerships third party
creditors
These loans have no priority for payment
Receivables from partners for loans or other
advances made by the partnership to partners
have the same status as other assets of the
partnership
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Overview of Partnership Liquidations

Deficits in partners capital accounts

Each partner with a deficit in his or her capital
account must make a contribution to the
partnership to remedy that capital deficit
Liquidating distributions, in cash, are made to
each partner with a capital credit balance
If a partner fails to remedy his or her capital
deficit, all other partners must contribute, in
the proportion to which those partners share
partnership losses, the additional amount
necessary to pay the partnerships obligations
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Overview of Partnership Liquidations

Statement of partnership realization and

liquidation
May be prepared to guide and summarize the
partnership liquidation process
Often called a statement of liquidation
It presents, in workpaper form, the effects of
the liquidation on the partnership balance
sheet accounts

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Lump-Sum Liquidations

All assets are converted into cash within a

very short time, creditors are paid, and a
single, lump-sum payment is made to the
partners for their capital interests
Most partnership liquidations take place over
an extended period

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Lump-Sum Liquidations

Realization of assets
Typically, a partnership experiences losses on
the disposal of its assets
Going out of Business sale
Goodwill on the books is generally written off

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Lump-Sum Liquidations

Realization of assets
The partnership attempts to collect its
accounts receivable
Large cash discounts may be offered for the
prompt payment
The receivables may also be sold to a factor,
a business that specializes in acquiring
accounts receivables and immediately paying
cash to the seller of the receivables

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Lump-Sum Liquidations

Expenses of liquidation
The liquidation process also involves some
expenses, such as additional legal and
accounting costs
They may also incur costs of disposing of the
business, such as special advertising and
costs of locating specialized equipment
dealers
These expenses are allocated to partners
capital accounts in the profit and loss ratio
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Lump-Sum Liquidations
Case: Partnership Solvent and Deficit Created in Partners Capital Account

A deficit in a partners capital account can occur if the

credit balance of that capital account is too low to
absorb his or her share of losses
This may be remedied in one of the following ways:

The partner invests cash or other assets to eliminate the

capital deficit
The partners capital deficit is distributed to the other
partners in their resulting loss-sharing ratio

The approach used depends on the solvency of the

partner with the capital deficit

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Lump-Sum Liquidations
Case: Partnership Is Insolvent and Deficit Created in Partners Capital Account

A partnership is insolvent when existing cash

and cash generated by the sale of the assets
is not sufficient to pay the partnerships
liabilities
In this case, the individual partners are liable
for the remaining unpaid partnership liabilities

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Installment Liquidations

Installment liquidation
Requires several months to complete and
includes periodic payments to the partners
during the liquidation period
Most partnership liquidations take place over
an extended period in order to obtain the
largest possible amount from the realization of
the assets

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Installment Liquidations
Some partnerships using installment
liquidations prepare a Plan of Liquidation and
Dissolution prior to the beginning of the
liquidation
Some adopt the liquidation basis of
accounting

These partnerships may prepare a Statement of

Net Assets in Liquidation and a Statement of
Changes in Net Assets in Liquidation

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Installment Liquidations
Those partnerships using GAAP apply FASB
144 to value their long-lived assets to be
disposed of by sale
FASB 144 states that these assets are to be
classified separately and valued at the lower
of carrying amount or fair value less costs to
sell
FASB 146 requires that costs associated with
an exit activity be recognized and measured
at fair value in the period in which the liability
is incurred, not in earlier periods
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Installment Liquidations
Most partnerships use the Statement of
Partnership Realization and Liquidation during
the installment liquidation process and
recognize gains or losses from the liquidation
events

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Installment Liquidations

Determining safe installment payments:

Distribute no cash to the partners until all liabilities

and actual plus potential liquidation expenses have
been paid or provided for by reserving the necessary
cash
Anticipate the worst possible case before determining
the amount of cash installment each partner receives:

Assume that all remaining noncash assets will be written

off as a loss
Assume that deficits created in the partners capital
accounts will be distributed to the remaining partners

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Installment Liquidations

Determining safe installment payments:

After the accountant has assumed the worst
possible cases, the remaining credit balances
in capital accounts represent safe distributions
of cash that may be distributed to partners in
those amounts

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Installment Liquidations

Cash distribution plan

Prepared at the beginning of the liquidation
process
Gives the partners an idea of the installment
cash payments each will receive
The actual installment distributions are
determined using the statement of realization
and liquidation, supplemented with the
schedule of safe payments to partners

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Installment Liquidations

Loss absorption power

An individual partners LAP is defined as the
maximum loss that the partnership can realize
before that partners capital account balance
is extinguished

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Additional Considerations

Incorporation of a partnership
As a partnership continues to grow, the
partners may decide to incorporate the
business
At the incorporation, the partnership is
terminated, and the assets and liabilities are
revalued to their fair values
The gain or loss on revaluation is allocated to
the partners capital accounts in the profit and
losssharing ratio
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Additional Considerations

Incorporation of a partnership
Capital stock in the new corporation is then
distributed in proportion to the partners capital
accounts
The separate business entity of the
partnership should now close its accounting
records and the corporation, as a new
business entity, should open its own new
accounting records to record the issuance of
its capital stock to the prior partners
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