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16 Partnerships Liquidation



Advanced Accounting, Fifth Edition Slide 16-1



Learning Objectives



Slide 16-2



1.



Describe the steps used to distribute available partnership assets in liquidation under the Uniform Partnership Act (UPA).



2.



List the order of priority for each class of creditors in partnership liquidation under the UPA.



3.



Prepare a liquidation schedule to settle debts and allocate assets.



4.



Prepare a “safe payment approach” liquidation schedule.



5.



Describe the four steps in the preparation of an advance plan for the distribution of cash in a partnership liquidation.



6.



Prepare the journal entries to incorporate a partnership.



Steps in the Liquidation Process First Step: Compute net income or loss up to the date of dissolution. Second Step: Assets not acceptable for distribution in their present form are converted into cash. Last Step: Distribute available assets to creditors and partners.



Slide 16-3



LO 1 Steps in the liquidation process.



Steps in the Liquidation Process



Review Question The first step in the liquidation process is to a. Convert noncash assets into cash. b. Pay partnership creditors. c. Compute any net income (loss) up to the date of dissolution. d. Allocate any gains or losses to the partners.



Slide 16-4



LO 1 Steps in the liquidation process.



Steps in the Liquidation Process Liabilities rank in order of payment, as follows: I.



Liabilities to creditors other than partners,



II.



Liabilities to partners other than for capital and profits (such as loans),



III. Liabilities to partners in respect of capital, IV.



Slide 16-5



Liabilities to partners in respect of profits.



LO 1 Steps in the liquidation process.



Priorities of Partnership and Personal Creditors UPA (Section 15) provides that partners are jointly liable for all contracts and other obligations of the partnership. Order of Priority concerning availability of assets: A. Partnership assets 1.



Partnership creditors.



2. Personal creditors that did not recover their claims in full from personal assets. B. Personal assets 1.



Personal creditors.



2. Partnership creditors not satisfied from partnership assets. 3. Claims of partnership against partner with deficit equity. Slide 16-6



LO 2 Order of priority for each class of creditors.



Priorities of Partnership and Personal Creditors



Review: True/False: Personal assets are first allocated to partnership creditors and then to personal creditors.



False



Slide 16-7



LO 2 Order of priority for each class of creditors.



Priorities of Partnership and Personal Creditors



Review Question If a partner with a debit capital balance during liquidation is insolvent, the following results: a. The partner must borrow money to invest in the partnership. b. The partnership will give the partner cash to the extent of the partners’ debit balance. c. The partner’s debit balance will be allocated to the other partners. d. None of the above.



Slide 16-8



LO 2 Order of priority for each class of creditors.



Priorities of Partnership and Personal Creditors



Review Question In accordance with the marshaling of assets provision of the Uniform Partnership Act, rank the following liabilities of a partnership in order of payment. 1) $20,000 loan from B. Barry who is a partner. 2) $30,000 of profits from the last year of operations. 3) $3,000 payable to a supplier. 4) $100,000 in capital balances of the partners.



Slide 16-9



a. 2,3,4,1.



c. 3,1,4,2.



b. 4,2,1,3.



d. 3,1,2,4. LO 2 Order of priority for each class of creditors.



Simple Liquidation Illustrated Exercise 16-6: Pete, Tom, and Zack have operated a laundromat for 10 years. The partners, who share profits 4:3:3, respectively, decide to liquidate the partnership. The firm’s balance sheet just before the partners sell other assets for $30,000 is as follows: Assets Cash $ Other assets



15,000 110,000



$



125,000



Liabilities and Capital Liabilities $ 42,000 Pete, Capital 55,000 Tom, Capital 14,000 Zack, Capital 14,000 $ 125,000



Personal status of each partner just before liquidation is as follows: Pete Tom Zack Slide 16-10



Assets $ 55,000 30,000 30,000



Liabilities $ 80,000 10,000 50,000



LO 3 Preparing a liquidation schedule.



Simple Liquidation Illustrated Exercise 16-6: Determine the amount of cash each partner will receive in liquidation and how much cash each partner must invest in the firm, given their personal positions. Part A Balances Sale of assets and allocation of loss



Cash 15,000 30,000 45,000



Noncash Assets 110,000 (110,000) -



Liabilities (42,000) (42,000)



Allocate Zack's balance Investment by Tom Payment to creditors Payment to Pete



Slide 16-11



45,000 14,286 59,286 (42,000) 17,286 (17,286) -



-



(42,000)



-



(42,000) 42,000 -



-



-



Pete 40% (55,000) 32,000 (23,000) 5,714 (17,286) (17,286) (17,286) 17,286 -



Capital Balances Tom Zack 30% 30% (14,000) (14,000) 24,000 10,000 4,286 14,286 (14,286) -



24,000 10,000 (10,000) -



-



-



-



-



LO 3 Preparing a liquidation schedule.



Simple Liquidation Illustrated Exercise 16-6: Determine the amounts that the personal creditors will receive from personal assets and any distribution from the partnership. Part B Personal Assets Pete



$



55,000



Personal Liabilities $



80,000



Excess (Deficiency) $



Distribution from Partnership



(25,000) $



17,286



Total Payable to Creditors $



72,286



Tom



30,000



10,000



20,000



-



10,000



Zack



30,000



50,000



(20,000)



-



30,000



Slide 16-12



LO 3 Preparing a liquidation schedule.



Installment Liquidation Partners receive cash in installments before Total liquidation losses and Total cash available are known. Many of the procedures followed are necessary to satisfy legal requirements and to protect the person in charge of the liquidation and the residual partners’ interests.



Slide 16-13



LO 4 Safe payment approach.



Installment Liquidation Safe Payment Approach Based on three assumptions: 1. Loan to or from an individual partner will be combined with respective partner’s capital account. 2. Remaining noncash assets will not provide any additional cash. 3. Partner with a debit balance in capital account will be unable to pay amounts owed. A safe payment schedule is prepared each time cash is to be distributed. Slide 16-14



LO 4 Safe payment approach.



Installment Liquidation Exercise 16-5: Following is the balance sheet of the BDO Partnership: Cash



$ 10,000



Liabilities



$ 18,000



Accounts Receivable



40,000



Brink, Capital



45,000



Inventory



30,000



Davis, Capital



27,000



Equipment



60,000



Olsen, Capital



50,000



$140,000



$140,000



The partners share income 40:40:20, respectively. Assume that 70% of the receivables are collected and that inventory with a book value of $15,000 is sold for $10,000. All cash available at this time is to be distributed. Slide 16-15



LO 4 Safe payment approach.



Installment Liquidation Exercise 16-5: Determine the proper distribution of cash, using the safe payment approach.



Account balances Sale of inventory, collect A/R, allocate loss Payment to creditors Payment to partners



Cash $ 10,000



Noncash Assets $ 130,000



Capital Balances Brink Davis Olsen Liabilities 40% 40% 20% $ (18,000) $ (45,000) $ (27,000) $ (50,000)



38,000 (43,000) 2,000 48,000 87,000 (18,000) (43,000) (18,000) 18,000 30,000 87,000 (43,000) (30,000) 1,667 $ $ 87,000 $ $ (41,333) $



Capital balances before safe payment to partners Allocation of potential loss



(43,000) 34,800 (8,200) 6,533 (1,667) $



2,000 (25,000)



1,000 (49,000)



(25,000)



(49,000) 28,333 (25,000) $ (20,667) (25,000) (49,000) 34,800 17,400 9,800 (31,600) (9,800) 3,267 $ (28,333)



Allocation of deficit Safe payment



$



Slide 16-16



LO 4 Safe payment approach.



Installment Liquidation Advance Plan for the Distribution of Cash Objective is to derive the order and the amount of cash that should be distributed to each partner such that no partner receiving a cash distribution will have to make an additional investment.



Slide 16-17



LO 5 Four steps in an advance plan.



Installment Liquidation Advance Plan for the Distribution of Cash Step 1



Determine net capital interest of each partner.



Step 2



Provide an order of cash distribution in which the ratio of partners’ capital interest will eventually be equal to their profit and loss ratio. (All partners will then have an equal ability to absorb their share of partnership losses.)



Slide 16-18



Step 3



Determine the amount of cash to distribute to bring the ratios of their capital interests into alignment with their profit and loss ratios.



Step 4



Prepare a cash distribution plan.



LO 5 Four steps in an advance plan.



Installment Liquidation Problem 16-5: Baker, Strong, and Weak have called on you to assist them in winding up the affairs of their partnership. 1. The trial balance of the partnership at June 30, 2008, is: Cash Accounts Receivable Inventory Plant and Equipment (net) Baker, Advance Weak, Advance Accounts Payable Baker, Capital Strong, Capital Weak, Capital Total Slide 16-19



Debit $ 6,000 22,000 14,000 99,000 12,000 7,500



$160,500



Credit



$ 17,000 67,000 45,000 31,500 $160,500



LO 5 Four steps in an advance plan.



Installment Liquidation Problem 16-5: 2. The partners share profits and losses as follows: Baker, 40%; Strong, 40%; and Weak, 20%. 3. The partners are considering an offer of $100,000 for the accounts receivable, inventory, and plant and equipment as of June 30. The $100,000 would be paid to the partners in installments, the number and amounts of which are to be negotiated. Required: Prepare an advance cash distribution plan as of June 30, 2008. Prepare a schedule to show how the potential cash ($106,000) would be distributed as it becomes available. Slide 16-20



LO 5 Four steps in an advance plan.



Installment Liquidation Problem 16-5: Step 1 Determine net capital interest of each partner.



Capital balance Advance balance Net capital interest



Slide 16-21



Baker Strong Weak $ 67,000 $ 45,000 $ 31,500 12,000 0 7,500 $ 55,000 $ 45,000 $ 24,000



LO 5 Four steps in an advance plan.



Installment Liquidation Problem 16-5: Step 2 Provide an order of cash distribution in which the ratio of partners’ capital interest will eventually be equal to their profit and loss ratio. Capital and advance balances Profit and loss ratio Loss absorption potential Order of cash distribution



Slide 16-22



Baker Strong Weak $ 55,000 $ 45,000 $ 24,000 40% 40% 20% $ 137,500 $ 112,500 $ 120,000 1 3 2



LO 5 Four steps in an advance plan.



Installment Liquidation Problem 16-5: Step 3 Determine the amount of cash to distribute to bring the ratios of their capital interests into alignment with their profit and loss ratios. Profit and loss rates Loss absorption potential Net capital interest Reduce loss absorption potential of Baker



Loss Absorption Potential Baker Strong Weak 40% 40% 20% $ 137,500 $ 112,500 $ 120,000 17,500 120,000



Reduce loss absorption potential of -Baker -Weak



Slide 16-23



120,000



7,500 $



Remainder



112,500



112,500 $ 112,500



Cash Distribution Baker Strong Weak 40% 40% 20% $ 55,000 $ 45,000 $ 24,000 7,000 48,000 45,000 24,000 3,000



7,500 $ 112,500



$ 45,000 40%



1,500 $ 45,000 $ 22,500 40% 20%



LO 5 Four steps in an advance plan.



Installment Liquidation Problem 16-5: Step 4 Prepare a cash distribution plan.



First Next Next Remainder



To Creditors To Baker To Baker and Weak Remainder -Profit and Loss Ratio



Slide 16-24



$ 17,000 7,000 4,500



Cash Distribution Baker Strong



Creditors 100%



100% 67% 40%



Total Creditors $ 17,000 $ 17,000 7,000 $ 4,500 77,500 $ 106,000



33% 20%



40%



Cash Distribution Baker Strong 7,000 3,000



Weak



Weak



$



1,500



31,000 $ 31,000 15,500 $ 17,000 $ 41,000 $ 31,000 $ 17,000



LO 5 Four steps in an advance plan.



Installment Liquidation



Review Question In a partnership liquidation, the final cash distribution to the partners should be made in accordance with the: a. partners' profit and loss sharing ratio. b. balances of the partners' capital accounts. c. ratio of the capital contributions by the partners. d. ratio of capital contributions less withdrawals by the partners.



Slide 16-25



LO 5 Four steps in an advance plan.



Incorporation of a Partnership Incorporation may be attractive because of: Limited liability. Continuity of existence. Ability to raise needed resources.



Slide 16-26



LO 6 Incorporation of a partnership.



Incorporation of a Partnership Retention of Partnership Books by Corporation Steps to record the incorporation ● ●



●



Slide 16-27



Assets and liabilities are transferred to corporation. Partners receive capital stock in settlement of their interests. Partnership accounts restated to fair values.



LO 6 Incorporation of a partnership.



Incorporation of a Partnership Problem 16-7: Jan and Sue have engaged successfully as partners in their law firm for a number of years. The partners decide to organize a corporation to take over the business. The Dec. 31, 2008, after-closing trial balance is as follows: Cash Accounts Receivable Allowances for Uncollectibles Prepaid Insurance Office Equipment Accumulated Depreciation Jan, Loan (outstanding since 2000, at 5%) Jan, Capital (50%) Sue, Capital (50%) Slide 16-28



Debit



$15,000 32,400 800 30,200



$78,400



Credit $ 2,000



12,600 6,400 29,400 28,000 $78,400



LO 6 Incorporation of a partnership.



Incorporation of a Partnership Problem 16-7: The partners have hired you as an accountant to adjust the recorded assets and liabilities to their market values and to close the partners’ capital accounts to the new corporate capital stock. The corporation is to retain the partnership’s books, and the assets of the partnership should be taken over by the corporation in the following amounts: Cash Accounts receivable Allowance for uncollectibles Office equipment Prepaid insurance



$15,000 32,400 2,900 16,000 800



Jan’s loan is to be transferred to her capital account in the amount of $6,600. Slide 16-29



LO 6 Incorporation of a partnership.



Incorporation of a Partnership Problem 16-7: A. Prepare the necessary journal entries to express the agreement described. Valuation Adjustment Accumulated Depreciation Office Equipment Allowance for Uncollectibles Jan, Loan



Slide 16-30



2,700 12,600



Jan, Loan Jan, Capital



6,600



Jan, Capital Sue, Capital Valuation Adjustment



1,350 1,350



14,200 900 200 6,600



2,700



LO 6 Incorporation of a partnership.



Incorporation of a Partnership Problem 16-7: B. Prepare the journal entries assuming the issuance of 400 shares (par value $100) of stock to Jan and Sue. Jan, Capital ($29,400 + $6,600 Sue, Capital ($28,000 – $1,350) Capital Stock (400 x $100) Additional Paid-in Capital Proof Cash Accounts receivable Allowance for uncollectibles Prepaid insurance Office equipment Total stockholders' equity Slide 16-31



$1,350)



34,650 26,650



40,000 21,300



$15,000 32,400 - 2,900 800 16,000 $61,300 LO 6 Incorporation of a partnership.



Incorporation of a Partnership



Review Question If a partnership is undergoing a transformation to a corporation, which of the following is a result? a. Assets and liabilities are adjusted to fair value. b. The net assets are distributed to the partners in their profit and loss ratio. c. The partners receive stock in the new corporation. d. Both (a) and (c) are correct.



Slide 16-32



LO 6 Incorporation of a partnership.



Copyright Copyright © 2012 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Slide 16-33