Chapter 3

Partnership
Liquidation And
Incorporation; Joint
Ventures

McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc. 2006

 Chapter 3:
Scope of Chapter
 Liquidation of LLPs & LPs
 Meaning of Liquidation
 Division of Losses & Gains
 Distribution of Cash or Other
Assets
 Case Studies
 Payments to Partners in
Different Scenarios
 Preparation of Cash
Distribution Plan
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 Incorporation of LLP
 Joint Ventures
 Accounting Methods &
Accounting Issues
 Accounting for Incorporated &
Unincorporated Joint
Ventures
 SEC Enforcement Actions for
Wrongful Application of
Accounting Standard
 Liquidation of Partnership
 Meaning of Liquidation
 Division of Losses & Gains
 Distribution of Cash or Other Assets
 Payments to Partners of an LLP
 Explanation of different case scenarios
 Illustrations & Case Studies
 Preparation of Cash Distribution Program
 Installment Payments to Partners
 General Principles Guiding Installment Payments

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 Incorporation of a Limited Liability
Partnership

 Advantages of incorporating LLP

 Accounting Concerns during Incorporation
 Illustrations

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 Joint Ventures
 Definition
 Present-Day Joint Ventures
 Accounting for Corporate or LLC Joint Ventures
 Accounting for Unincorporated Joint Ventures
 Brief description of Equity Method of Accounting for
Investment in Common Stock
 SEC Enforcement Actions Dealing with Wrongful
Application of Accounting Standards
 Illustrations & Case Studies
 Review Questions, Problems & Exercises
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 The Meaning of Liquidation

 The LIQUIDATION of a limited liability partnership

means winding up its activities, usually by selling
assets, paying liabilities, and distributing any remaining
cash to the partners.

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 Liquidation of Partnership

 The partnership net assets may be sold as a

unit or in installments.
 The cash received must be used to pay
partnership creditors.
 The accounting records of the partnership
should be adjusted and closed and net income
of loss for the final period of operations entered
in the capital accounts.

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 Meaning of Liquidation
 The liquidation usually starts with “Realization” of non-cash
assets.
 Before any payments to partners, all outside creditors must
be paid in full.
 An unpaid creditor may enforce collection from the personal
assets of any solvent partner whose actions caused the
partnership’s insolvency.
 Partnership is treated as an entity for many purposes
however, it may not use the shield of a separate entity to
protect culpable partners’ personal assets against the
claims of unpaid creditors.

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 Division of Loss and Gains
 Always first divide the loss / gain from the realization of non-
cash assets before distributing cash.
 As assets are realized, allocate any gains or loss to
partners’ capital accounts in the income-sharing ratio.
 All creditors must have been paid before distribution of
cash.
 The final credit balances of the partners’ capital & loan
ledger accounts should be equal to the cash available for
distribution.
 Payments are then made in the amounts of the partners’
respective equities in the partnership.

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 Distribution of Cash or Other
Assets

 Payment of Creditors in full.

 Payment of Loans from partners.
 Payment of partners’ Capital Account Credit Balances.
 If a partner’s capital account has a debit balance or
potential debit balance after possible future realization
of losses, then any credit balance in partner’s loan
account must be offset against the deficit in the capital
account. This is “Right of Offset”.

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 Payments to Partners After All Non-
cash Assets Realized

 Equity of Each Partners is Sufficient to Absorb Loss

from Realization.
 Equity of One Partner is not Sufficient to Absorb that
Partner’s Share of Loss from Realization.
 Equities of Two Partners are not Sufficient to Absorb
Their Shares of Loss from Realization.
 Partnership is Insolvent but Partners are Solvent.
 General Partnership is Insolvent and Partners are
Insolvent.

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 Case 1:
Equity of One Partner Is Not Sufficient to Absorb
That Partner’s Share of Loss From Realization

 The loss on realization of assets, when distributed in

the income-sharing ration, results in a debit balance in
the capital (or capital & loan combined) account of one
of the partners.
 That partner must pay the deficit to the partnership.
 If the partner is unable to do so, the deficit must be
absorbed by other partners as an additional loss to be
shared in the same proportion as they have previously
shared net income or losses.

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 Case 1:
Balance Sheet of DE&F LLP (Prior to
Liquidation)

ASSETS LIABILITIES
 Cash $ 20,000  Liabilities $ 30,000
 Other Assets $ 80,000  D, Capital $ 40,000
 E, Capital $ 21,000
 F, Capital $ 9,000

 Total $ 100,000  Total $ 100,000

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 Case 1:
Assumptions for the Illustration:

 Income Sharing Ratio is D – 20%; E – 40%;

and F – 40%
 The other assets of $ 80,000 realized $ 50,000
cash
 Resulting loss of $ 30,000 from Realization
 Partner F is charged with 40% of this loss ($
12,000)
 Resulting deficit of $ 3,000 in F’s capital a/c

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 Assets Liabilities Partners' Capital
Cash Other D (20%) E(40%) F(40%)
Balances Before Liquidation 20,000 80,000 30,000 40,000 21,000 9,000
Realization of Other Assets
@ loss of $30,000 50,000 (80,000) - (6,000) (12,000) (12,000)
Balances 70,000 - 30,000 34,000 9,000 (3,000)
Payments to Creditors (30,000) - (30,000) - - -
Balances 40,000 - - 34,000 9,000 (3,000)
Payment From F 3,000 - - - - 3,000
Balances 43,000 - - 34,000 9,000 -
Payments to Partners (43,000) - - (34,000) (9,000) -

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 Case 2:
Equities of Two Partners Are Not Sufficient To
Absorb Their Shares of Loss From Realization

 Inability of a partner to pay the partnership for a

capital deficit may cause additional loss to the
other partners.
 A partner may have sufficient capital (or
combination of capital & loan accounts) to absorb
any direct share of loss on the realization of non-
cash assets, but not sufficient to absorb additional
actual or potential losses caused by inability of the
partnership to collect the deficit in another
partner’s capital account.

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 Case 2:
Assumptions for Illustration

 JKL&M LLP is the partnership firm

 The partners J, K, L & M share net income and
losses 10%, 20%, 30% and 40% respectively
 Their capital account balances are as shown in
statement of realization and liquidation on next
slide

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 Assets Liabilities J (10%) K (20%) L (30%) M (40%)
Cash Other
Balances before Liquidation 20,000 200,000 120,000 30,000 32,000 30,000 8,000
Realization of Other Assets
@ loss of $ 80,000 120,000 (200,000) (8,000) (16,000) (24,000) (32,000)
Balances 140,000 120,000 22,000 16,000 6,000 (24,000)
Payments to Creditors (120,000) (120,000)
Balances 20,000 22,000 16,000 6,000 (24,000)
Payments to Partners (20,000) (16,000) (4,000)
Balances 6,000 12,000 6,000 (24,000)

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 Partnership Is Insolvent but
Partners Are Solvent

 If a limited liability partnership is insolvent, it is

unable to pay all outside creditors, and at least
one and perhaps all of the partners will have
debit balances in their capital accounts.
 The partnership creditors may demand payment
from any solvent partner whose actions caused
the partnership’s insolvency, regardless of
whether the partner’s capital account has a debit
balance or a credit balance.

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 Installment Payments to Partners

 Liquidation in installments means to realize

some assets, paying creditors, paying the
remaining available cash to partners, realizing
additional assets and making additional cash
payments to partners. The liquidation
continues until all non-cash assets are realized
and all cash has been distributed to creditors
and partners.

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 General Principles Guiding
Installment Payments

 Assume a total loss on all remaining non-cash

assets and provide for tall possible losses,
including potential liquidation costs and
unrecorded liabilities.
 Assume that any partner with a potential
capital deficit will be unable to pay any thing to
the partnership.
 Distribute each installment of cash as if no
more cash will be forthcoming.

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 General Principles Guiding
Installment Payments

 The liquidator should authorize a cash

payment to a partner only if that partner has a
capital account ( or capital & loan combined
account) credit balance enough to absorb a
portion of maximum possible loss that may
incur on realization.

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 Cash Distribution Program

Why to have a Cash Distribution Program?

 It’s more efficient to have in advance a
complete “Cash Distribution Program”
 Ease, efficiency and accuracy of distributing
cash as soon as it’s available

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 Cash Distribution Program

Procedure to develop Cash Distribution Program.

 Determine the equity of each partner before liquidation.
 Determine the capital per unit of income (loss) sharing
for each partner, by dividing capital account balance by
each partner’s income-sharing ratio.
 If for some reason, original relationship among the
partners’ capital account balance has been disrupted, a
“Revised Cash Distribution Program” must be
prepared.

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 Liquidation of Limited Partnerships
 Most of the procedures & rulings of the liquidation of
LLPs and General Partnerships apply to the liquidation
of Limited Partnerships.
 The Uniform Limited Partnership Act provides that after
outside creditors have been paid, the equities of the
limited partners must be paid before the general
partner(s) may receive any cash.
 Limited partners may agree that one or more of them
may have priority over the others regarding payments
in liquidation of the limited partnership.

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 Incorporation of Limited Liability
Partnership

Why to incorporate the Limited Liability

Partnership?
 Limited Liability of stockholders.
 Ease of attracting additional Capital.
 Possible income tax advantages.

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 Incorporation of Limited Liability
Partnership

 Each partner receives an equitable portion of the

capital stock issued by the new corporation.
 The assets of the partnership must be adjusted to
current fair value before being transferred to the
corporation.
 Identify any intangible asset or goodwill developed by
the partnership should be included in the assets
transferred to Corporation.

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 Joint Ventures

 A Joint Venture is different from partnership in

a way that it’s limited in carrying out a single
project.
 When the capital required is larger than an
individual can provide and risks are too high to
be bourn alone – the Joint Ventures came into
existence.
 The individuals (Venturers) would come
together to undertake a venture of this type.

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 Present-day Joint Ventures

Today, JVs are less common but still employed

for many projects such as –
 The acquisition, development and sale of real
property
 Exploration for Oil & Gas
 Construction of Bridges, Buildings and Dams
 Corporate Joint Ventures

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