Chap 015

Chapter 15 - Partnerships: Termination and Liquidation

CHAPTER 15 PARTNERSHIPS: TERMINATION AND LIQUIDATION Chapter Outline I.

The termin terminatio ation n of a partners partnership hip and liquid liquidatio ation n of its property property may take take place place for a number  of reasons.  A. The death, withdrawal, or retirement of a partner can lead to cessation of  business activity. B. The bankruptcy of either either an individual individual partner or the the partnership partnership as a whole can necessitate this same conclusion.

distributing assets f airly, airly, all parties look to the II. Because of the importance of liquidating and distributing accountant to play an important role in the process.  A. The account ant provides timely financial financ ial information. informat ion. B. The accountant accountant works works to ensure ensure an equitable equitable settlement settlement of of all claims. claims. III. III. The sched schedule ule of liqu liquidat idation ion  A. The liquidation process usually involves the disposal of noncash assets, payment of liabilities and liquidation expenses, and distribution of any remaining cash to the partners based on their final capital balances. B. A schedule schedule of liquida liquidation tion should should be produced produced periodica periodically lly by the accounta accountant nt to disclose losses and gains that have been incurred, remaining assets and liabilities, and current capital balances. IV. Deficit Deficit capital capital balan balances ces  A. By the end of the liquidation liquidatio n process, proces s, one or more partners p artners may have a negative (or deficit) capital capital balance often as a result of losses incurred incurred in disposing of assets. B. The Uniform Partnership Act indicates that any deficit capital balance should be

eliminated by having that partner contribute enough additional assets to offset the negative balance. C. If this this contri contribut butio ion n is not not imme immedi diate ately ly recei received ved,, the rema remain ining ing partn partner ers s may request a preliminary distribution of any partnership cash that is available. balances, the amounts that will remain remain 1. This payment is based on safe capital balances, in the individual capital accounts even if all deficits and other assets prove to be complete losses that must be absorbed by the remaining remaining partners. 2. If a portion portion (or all) all) of a deficit deficit is subsequen subsequently tly recovere recovered d from a partner partner,, a further distribution to the other partners is made based on newly computed safe capital balances. 3. Any defici deficitt that that is not recov recovere ered d from from a partne partnerr must must be charg charged ed to the remaining partners based on their relative profit and loss ratio. V. Treatmen Treatmentt of partner’ partner’s s loan loan to partner partnership ship

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Chapter 15 - Partnerships: Termination and Liquidation

Uniform Partnership Partnership Act states states that, in a liquida liquidation tion,, partner partnership ship assets A. The Uniform should be used to first settle claims of partnership creditors, including claims of  partners who are creditors. 1. This implies that the partnership would first repay partners’ loans before distributing any cash to partners based on their capital balances. B. Howeve However, r, in practi practice, ce, to avoid avoid maki making ng a cash cash distr distrib ibuti ution on to a partn partner er who who subsequently develops a deficit capital balance, partners’ loan accounts typically are combined with partners’ capital accounts and funds are distributed accordingly. Vl. Preliminary Preliminary distribu distribution tion of assets to the partners partners  A. The liquidation process can extend over a lengthy period of time as business activities wind down and property is sold. B. More More cash cash may may be gene genera rate ted d than than the the amou amount nt need needed ed to exti exting ngui uish sh all all pote potent ntia iall liabilities and liquidation expenses. C. If possi possible ble,, the distri distribut bution ion of excess excess cash amounts amounts should should be made as quick quickly ly as possible to enable the partners to make use of their funds. 1. The accoun accountan tantt may may choos choose e to produce produce a propo proposed sed schedul schedule e of liqu liquida idatio tion n at such time times s to deter determi mine ne the equi equitab table le distr distrib ibuti ution on of cash cash amount amounts s that that become available. The prop propos osed ed sche schedu dule le of liqu liquid idat atio ion n is deve develo lope ped d base based d upon upon simu simula lati ting ng the the 2. The accounting recognition that would be required by a possible series of  transactions: transactions: assets are sold, expenses are paid, etc. a. These events are simulated with the anticipation of maximum losses in each case. b. Noncas Noncash h asset assets s are assumed assumed to have have no resal resale e valu value; e; maxi maximu mum m possi possibl ble e liqu liquid idati ation on expenses are included; all partners are considered personally insolvent; etc. liquidation are 3. Ending potential capital balances that remain on a proposed schedule of liquidation safe capital balances, the amounts that could be immediately paid to each each partne partnerr witho without ut jeopa jeopardi rdizin zing g future future paym payment ents. s. Safe Safe capi capital tal balances indicate that the partner will still have a sufficient interest in the partnership to absorb all potential losses even after a preliminary distribution. Vll. Predistribution Predistribution plan plan liquidation (described above) indicates safe capital balances A. The proposed schedule of liquidation but a newly revised schedule must be prepared frequently. B. Accoun Accountan tants ts often often prefe preferr to produce produce a singl single e pred predis istri tribu butio tion n plan plan at the start start of a liqui liquida datio tion n to prov provide ide guida guidance nce for all all paymen payments ts made made to the partn partners ers throughout this process. C. Informat Information ion for the predistri predistributi bution on plan is generated generated by assuming assuming the occurren occurrence ce of a series of losses, each just large enough to eliminate one partner's claim to any partnership property. D. Once a series series of losses losses has been simulated simulated that would would eliminate eliminate the capital capital balances balances of  all partners, partners, the actual actual plan is developed developed by measuring measuring the effects effects that occur if the losses do not materialize.

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Chapter 15 - Partnerships: Termination and Liquidation

E. F. By working working backwar backwards ds through through this series series of possibl possible e losses, losses, a predistri predistributi bution on plan can be produced that will direct all payments made within the liquidation.

Learning Objectives Having completed Chapter 15 of this textbook, "Partnerships: Termination and Liquidation," students should be able to fulfill each of the following learning learning objectives: 1.

Determine amounts to be paid to partners in a liquidation.

2. Prepare journal entries to record the transactions transactions incurred incurred in the liquidation liquidation of a partnership. partnership. 3.

Determine Determine the distribution distribution of available available cash when one or more partners has a deficit capital balance or becomes personally insolvent.

4.

Prepare a proposed schedule of liquidation from safe capital balances to determine an equitable preliminary distribution of available partnership assets.

5.

Develop a predistribution plan to guide the distribution of assets in a partnership liquidation.

Answer to Discussion Question What Happens if a Partner Becomes Insolvent?

This case demonstrates one of the nightmares of a partnership: the apparent insolvency of a partner is threatening the future of a successful business. The problem is especially acute to Wilkinson and Walker since this partnership was created solely for convenience; the partners share the facilities but do not actually work together. Therefore, the presence of Rogers is not essentia essentiall to the other other partner partners s except except that he pays pays a portion portion of the business's business's expenses. expenses. Howeve However, r, the claim claim that that has has been been filed filed could could lead lead to the actua actuall liqui liquida datio tion n of the entir entire e business. Obviously, the partners should take no immediate action until they have spoken with Rogers. The entire entire issue issue may prove to be a mistake mistake.. Convers Conversely ely,, numerou numerous s other other claims claims against against Rogers may also be outstanding with the initial claim simply simply being the first to be filed. Because of the various possibilities, Wilkinson and Walker should consult with a lawyer to learn of the partn partner ershi ship p laws laws that that apply apply in their their state. state. They They shoul should d also also begin begin consi consider derin ing g possi possibl ble e alternatives to salvage their business if Rogers is indeed insolvent. One course of action is for Wilkinson and Walker to buy out the partnership interest of Rogers. In that way, Rogers would receive his money and the remaining partnership partnership could be left intact. However, they would have to prove—for legal reasons—that a fair price was being paid. They would also be forced to come up with a significant amount of cash in a short period of time. Finally, Wilkinson and Walker would have a building that was apparently larger than their  needs needs.. Unle Unless ss they they coul could d utili utilize ze the space space in some some manne manner, r, they they might might have no way way of  recouping their additional investment.

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Chapter 15 - Partnerships: Termination and Liquidation

 As a second possibility, a new dentist could be brought in to acquire Rogers’ interest in the partnership. Again, the money is conveyed to Rogers but now the original partners are not forced forced to make make the paym payment ent.. The buildi building ng would would conti continu nue e to be fully fully utili utilized zed so that that the partners' expenses would not escalate. In this case, though, a new partner may have to be ident identifi ified ed in a short short perio period d of time time.. Furth Further ermo more, re, since since the partn partners ers are are sharin sharing g space space,, Wilkinson and W alker will probably probably want to ensure that the new partner is someone with whom they can work comfortably. Because of time considerations, they may not have the opportunity of getting the new partner they would like. Finally, the partnership can be liquidated. Wilkinson and Walker could then take their share of  the proceeds and buy a new building for the continuation of their practices. Unfortunately, in liquidation, assets do not always bring fair market value. Thus, the partners may be forced to absorb significant losses as a result of Rogers' insolvency. In addition, the moving of any business can disrupt service and have a possible adverse impact on profitability.  Although Wilkinson and Walker W alker have several possible po ssible actions ac tions that can be taken, none of these is without problems. problems. Therefore, partners should always include agreements within within their Articles Articles of Partnership to specify actions that will be taken in such cases. The insolvency insolvency of a partner is not a particularly particularly unusual event. Hence, the partners (or their lawyers and accountants) should have the forethought to arrange the resolution of the business if insolvency of a partner does occur.

Answers to Questions 1. A dissoluti dissolution on refers to the cessati cessation on of a partnersh partnership. ip. In many cases, cases, this proces process s 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 business.. In a liquid liquidatio ation, n, however, however, actual actual business business activit activities ies must cease. Partnership Partnership property is sold with the remaining cash distributed to creditors 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 Many reas reason ons s can can exis existt that that woul would d lead lead to the the term termin inat atio ion n and and liqu liquid idat atio ion n of a partnership. partnership. The business might simply have failed to generate sufficient profits or  the partn partner ers s may may elect elect to enter enter other other line lines s of work. work. Liqu Liquida idatio tion n can also also be required by the death, retirement, or withdrawal of one of the partners. In such cases, liquidation liquidation is often necessary to settle the partner's interest in the business. The bankru bankruptc ptcy y of an indi indivi vidua duall partne partnerr can can also also force force the termi termina natio tion n of the business as can the bankruptcy of the partnership itself. 3. During During the liquidatio liquidation n process, process, monitori monitoring ng the balance balance of the partners' partners' capital capital accounts accounts becomes of paramount paramount importance. That amount will eventually indicate either the cash cash to be rece receive ived d by the partn partners ers as final final distr distribu ibutio tions ns or the addit additio ional nal contributions 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 computat computation ion of a net income income figure is of dimini diminished shed importance importance since normal normal operations operations have ceased.

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Chapter 15 - Partnerships: Termination and Liquidation

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

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Chapter 15 - Partnerships: Termination and Liquidation

5. 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. 6. 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. 7. 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. A safe capital balance is the amount of a partner's capital account that exceeds all possible needs of a partnership as it goes through liquidation. A partner should, therefore, be able to receive this balance immediately without endangering the future amount to be received by any other party connected with the liquidation. Safe capital balances are computed by projecting a series of assumptions whereby the partnership undergoes maximum losses during the remainder of the liquidation process. All noncash assets are assumed to have no resale value, liquidation expenses are set at the largest possible estimation, and all partners are viewed as personally insolvent. Any capital balance that would remain after this series of anticipated events can be distributed to the partners immediately without incurring any risk. 9.

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. 10. A proposed schedule of liquidation is used by the accountant to determine the allocation of any cash balances generated during the early stages of liquidation. Often, sufficient cash will be collected to pay all liabilities as well as potential liquidation expenses. Additional cash should then be distributed to the partners to allow them immediate use of their funds. A proposed schedule of  liquidation can be produced to determine the allocation of this

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Chapter 15 - Partnerships: Termination and Liquidation

available cash. The statement is based on anticipating a series of assumed losses from the current day forward: all remaining noncash assets are scrapped, maximum liquidation expenses are incurred, and each partner is personally insolvent. The ending balances that would result from these simulated transactions represent safe capital balances. This amount of  cash can be distributed presently and the partners will still retain enough capital to absorb all future losses. 11. 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.

Answers to Problems 1. C (LO1) 2. A (LO1) 3. D (LO3) 4. B Partner with Deficit Capital Balance (LO3)  Angela, Capital

Reported balances Potential loss from Cassidy deficit (split 5/8:3/8 ) Cash distributions

Woodrow, Capital

Cassidy, Capital 

$19,000

$18,000

$(12,000)

(7,500) $11,500

(4,500) $13,500

12,000 -0-

5. B Insolvent Partner (LO3) Bell $50,000

Reported balances Loss on sale of assets ($110,000) split on a 4:3:2:1 basis (44,000) Adjusted balances $ 6,000 Potential loss from Dennard deficit (split 4:3:1) (4,000) Minimum cash distributions $2,000 6. A Predistribution Plan (LO5)

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Hardy $56,000

Dennard $14,000

Suddath $80,000

(33,000) $23,000

(22,000) $(8,000)

(11,000) $69,000

(3,000) $20,000

8,000 $ -0-

(1,000) $68,000

Chapter 15 - Partnerships: Termination and Liquidation

7. A Proposed Schedule of Liquidation; Partner has Deficit (LO3, LO4) Reported balances ..................................... Loss on sale of assets ($22,000) split on a 4:3:3 basis ........................................ Adjusted balances ..................................... Anticipated liquidation expenses ($12,000) split on a 4:3:3 basis ............................... Anticipated maximum loss on inventory ($31,000) split on a 4:3:3 basis ............... Potential balances ..................................... Potential loss from Art deficit (split 3:3) . Current cash distribution ..........................

 Art $18,000

Raymond $25,000

Darby  $26,000

(8,800) $ 9,200

(6,600) $18,400

(6,600) $19,400

(4,800)

(3,600)

(3,600)

(12,400) $(8,000) 8,000 $ -0-

(9,300) $ 5,500 (4,000) $ 1,500

(9,300) $ 6,500 (4,000) $ 2,500

8. D Proposed Schedule of Liquidation; Partner has Deficit (LO1, LO3, LO4) Since the partnership currently has total capital of $400,000, the $30,000 that is available would indicate maximum potential losses of $370,000. A $100,000

Reported balances Anticipated loss ($370,000) split on a 2:3:5 basis (74,000) Potential balances $ 26,000 Potential loss from C's deficit (split 2:3) (2,000) Current cash distribution $ 24,000

B $120,000

C $180,000

(111,000) $ 9,000 (3,000) $ 6,000

(185,000) $ (5,000) 5,000 $ -0-

9. C Predistribution Plan (LO5) A predistribution plan should be created. Maximum Losses That Can Be Absorbed 

Kevin $59,000/40% Michael $39,000/30% Brendan $34,000/10% Jonathan $34,000/20%

$147,500 130,000 340,000 170,000

(most vulnerable to losses)

The assumption is made that a $130,000 loss occurs. Kevin Reported balances ..........................$59,000 Assumed loss ($130,000) split on a 4:3:1:2 basis .............................(52,000) Adjusted balances ............................$ 7,000

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Michael Brendan $39,000 $34,000

(39,000) $ -0-

(13,000) $21,000

Jonathan $34,000

(26,000) $ 8,000

Chapter 15 - Partnerships: Termination and Liquidation

Maximum Losses That Can Now Be Absorbed  Kevin $7,000/4/7 $12,250 (most vulnerable to losses) Brendan $21,000/1/7 147,000 Jonathan $8,000/2/7 28,000 Kevin Reported balances .......................................$7,000 Assumed loss ($12,250) split on a 4:1:2 basis ................................................(7,000) Adjusted balances $ -0-

Brendan $21,000

Jonathan $8,000

(1,750) $19,250

(3,500) $4,500

Maximum Losses That Can Now Be Absorbed 

Brendan $19,250/1/3 $57,750 Jonathan $4,500/2/3 6,750 (most vulnerable to losses) The assumption is made that a $6,750 loss occurs. 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 $ -010. C Predistribution Plan (LO5) To solve this problem, a predistribution plan is necessary. That plan, which is created below, is as follows: • • • •

First $3,000 goes to Menton Next $15,000 goes to Menton (2/3) and Hoehn (1/3) Next $42,000 goes to Carney (4/7), Menton (2/7), and Hoehn (1/7) All remaining cash goes to Carney (4/10), Pierce (3/10), Menton (2/10), and Hoehn (1/10) Beginning balances Assumed loss of $90,000 (see Schedule 1)(4:3:2:1) Step one balances Assumed loss of $42,000 (see Schedule 2) (allocated on a 4:0:2:1 basis) Step two balances Assumed loss of $15,000 (see Schedule 3) (allocated on a 0:0:2:1 basis) Step three balances

Carney Pierce $60,000 $27,000

Menton $43,000

(36,000) (27,000) $24,000 $ -0-

(18,000) (9,000) $25,000 $11,000

(24,000) $ -0-

$ -0$ -0-

(12,000) $13,000

(6,000) $ 5,000

-0$ -0-

(10,000) $ 3,000

(5,000) $ -0-

-0$ -0-

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Hoehn $20,000

Chapter 15 - Partnerships: Termination and Liquidation

Partner Carney Pierce Menton Hoehn

Schedule 1 Maximum Loss Capital Balance/ That Can Loss Allocation Be Absorbed  $60,000/40% $150,000 $27,000/30% $ 90,000 (most vulnerable) $43,000/20% $215,000 $20,000/10% $200,000

Partner Carney Menton Hoehn

Schedule 2 Maximum Loss Capital Balance/ That Can Loss Allocation Be Absorbed  $24,000/(4/7) $ 42,000 (most vulnerable) $25,000/(2/7) $ 87,500 $11,000/(1/7) $ 77,000

Partner Menton Hoehn

Schedule 3 Maximum Loss Capital Balance/ That Can Loss Allocation Be Absorbed  $13,000/(2/3) $ 19,500 $ 5,000/(1/3) $ 15,000 (most vulnerable)

11.C Partners with Deficit Capital Balances; Proposed Schedule of Liquidation; Safe Capital Balances (LO3, LO4) The $16,000 available cash can be distributed but should be done under the assumption that all deficit balances will be total losses. After offsetting Jones' loan against his deficit capital balance, both Jones and Wayman have deficits of $2,000; total $4,000. Fuller and Rogers, the two partners with positive capital balances, share profits in a 30:20 relationship (the equivalent of a 60%:40% ratio). Fuller would absorb $2,400 of the potential $4,000 loss with Rogers being allocated $1,600. The remaining capital balances ($10,600 and $5,400) are safe capital balances and those amounts can be immediately distributed. 12.Determine Safe Capital Balances; Partner has Deficit (LO1, LO3, LO4) (8 minutes) Cleveland receives $6,800 and Pierce receives $1,200 Since the partnership currently has total capital of $350,000, the $8,000 that is available would indicate maximum potential losses of $342,000.

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Chapter 15 - Partnerships: Termination and Liquidation

Nixon

Cleveland

Pierce

Reported balances .............................. $170,000 Anticipated loss ($342,000) split on a 5:3:2 basis .............................. (171,000) Potential balances ............................... $ (1,000) Potential loss from Nixon's deficit (split 3:2) 1,000 Current cash distribution ................... $ -0-

$110,000

$70,000

(102,600) $ 7,400 (600 ) $6,800

(68,400) $ 1,600 (400) $ 1,200

13. Final Settlement of a Partnership Being Liquidated; Various Amounts of Loss on Sale of Assets (LO1, LO3) (20 minutes) Part a. Brown gets $21,000, Fish gets $12,000, and Stone gets $2,000. Reported balances ...................................... Loss on sale of land ($10,000) split on a 4:3:3 basis....................................... Cash distribution ......................................... Part b.

Brown $25,000

Fish $15,000

Stone $5,000

(4,000) $21,000

(3,000) $12,000

(3,000) $2,000

Fish $15,000

Stone $5,000

Brown gets $16,429 and Fish gets $8,571 Brown $25,000

Reported balances ...................................... Loss on sale of land ($20,000) split on a 4:3:3 basis............................................ (8,000) Adjusted balances ....................................... $17,000 Potential loss from Stone's deficit (split 4:3) (571) Cash distribution ......................................... $16,429 Part c.

(6,000) $ 9,000 (429) $ 8,571

(6,000) $(1,000) 1,000 $ -0-

Brown gets $10,714 and Fish gets $4,286 Brown $25,000

Reported balances ...................................... Loss on sale of land ($30,000) split on a 4:3:3 basis............................................ (12,000) Adjusted balances ....................................... $13,000 Potential loss from Stone's deficit (split 4:3) (2,286) Cash distribution ......................................... $10,714

Fish $15,000

(9,000) $ 6,000 (1,714) $ 4,286

Stone $5,000

(9,000) $(4,000) 4,000 $ -0-

14.Distribute Cash Contributed by Partner with Deficit Balance (LO3)(10 minutes) The entire $20,000 goes to Atkinson.  Atkinson Reported balances Capital contribution Adjusted balances

$60,000 -0$60,000

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Kaporale Dennsmore

$20,000 -0$20,000

$(30,000) -0$(30,000)

Rasputin

$(50,000) 20,000 $(30,000)

Chapter 15 - Partnerships: Termination and Liquidation

Potential loss from Dennsmore and Rasputin ($60,000) split on a 4:3 basis Adjusted balances Potential loss from Kaporale ($5,714) Cash distribution

(34,286) $25,714 (5,714) $20,000

(25,714) $(5,714) 5,714 $ -0-

30,000 $ -0-

30,000 $ -0-

-0$ -0-

-0$ -0-

15. Determine Safe Capital Balances (LO4) (8 minutes) Ball gets $143, Eaton gets $1,429, and Lake gets $3,428.  Ace Reported balances . ...................... $25,000 Maximum losses on land and building ($85,000) split on a 3:3:2:2 basis (25,500) Estimated liquidation expenses ($5,000) split 3:3:2:2.................... (1,500) Potential balances ........................ $(2,000) Potential loss from Ace ($2,000) split on a 3:2:2 basis .......................... 2,000 Cash distributions ........................ $ 0

Ball $28,000

Eaton $20,000

Lake $22,000

(25,500)

(17,000)

(17,000)

(1,500) $ 1,000

(1,000) $ 2,000

(1,000) $ 4,000

(857) $ 143

(571) $ 1,429

(572) $ 3,428

16. Prepare a Proposed Schedule of Liquidation (LO4) (15 minutes) HARDWICK, SAUNDERS, AND FERRIS Proposed Schedule of Liquidation

Cash

Other Assets

Hardwick, Accounts Loan and Payable Capital 

Beginning balances 90,000 820,000 210,000 270,000 Sold assets 200,000 (328,000) (51,200) Assumed: loss on remaining assets (492,000) (196,800) Paid liabilities (210,000) (210,000) Safe balances 80,000 0 0 22,000

Saunders, Capital 

Ferris, Loan & Capital 

200,000 (38,400)

230,000 (38,400)

(147,600) (147,600) 14,000

44,000

Of the available $80,000, $22,000 will go to Hardwick, $14,000 to Saunders, and $44,000 to Ferris. 17.Determine Amount of Cash Needed to Assure Payments to All Partners (LO5) (7 minutes)

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Chapter 15 - Partnerships: Termination and Liquidation

Watson is the partner most vulnerable to a loss. A loss of only $50,000 would completely eliminate Watson's capital balance: Miller $50,000/60% = $ 83,333 loss to eliminate capital Tyson $50,000/20% = $250,000 loss to eliminate capital Watson $10,000/20% = $ 50,000 loss to eliminate capital 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. 18.Determine Safe Capital Balances (LO4) (5 minutes) Maximum potential losses are $128,000, $8,000 in liquidation expenses and a complete $120,000 loss on the noncash assets. Such a loss would reduce the capital balances to: Babb $8,800, Whitaker ($5,600), and Edwards ($1,200). Babb must retain sufficient capital ($6,800) to be able to absorb the possible losses of Whitaker and Edwards. The remaining $2,000 is a safe capital balance for Babb. 19.Determine Amount to be Contributed by Partner with a Deficit Capital Balance (LO3) (10 minutes) 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): Partner

Black Green Brown

Share of Loss

30/60 x 10/60 x 20/60 x

New Capital Balance

$15,000 = $7,500 $15,000 = $2,500 $15,000 = $5,000

$ (4,500) $ (5,500) $10,000

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): Partner Green Brown

Share of Loss New Capital Balance 10/30 x $4,500 = $1,500 $ (7,000) 20/30 x $4,500 = $3,000 $ 7,000

Thus, Green must contribute $7,000 that will go to Brown. 20.Determine Payments under a Variety of Circumstances; Safe Capital Balances; Predistribution Plan (LO4, LO5) (50 minutes) a. Dobbs receives the entire $10,000.

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Chapter 15 - Partnerships: Termination and Liquidation

Maximum potential losses of $250,000 on noncash assets would be allocated as follows: Partner

Share of Loss

New Capital Balance

Adams Baker Carvil Dobbs

2/10 x $250,000 = $50,000 3/10 x $250,000 = $75,000 3/10 x $250,000 = $75,000 2/10 x $250,000 = $50,000

$ 30,000 $(45,000) $(15,000) $ 40,000

Maximum total potential losses of $60,000 to be absorbed from Baker and Carvil above would then be allocated as follows on a 2:2 basis: Adams Dobbs

2/4 x $60,000 = $30,000 2/4 x $60,000 = $30,000

-0$ 10,000

Absorbing the final loss would leave Dobbs with a safe capital balance of  $10,000. b. Adams receives the entire $10,000. Maximum potential losses of $250,000 on noncash assets would be allocated as follows: Partner

Share of Loss

New Capital Balance

Adams Baker Carvil Dobbs

2/10 x $250,000 = $50,000 2/10 x $250,000 = $50,000 3/10 x $250,000 = $75,000 3/10 x $250,000 = $75,000

$ 30,000 $(20,000) $(15,000) $ 15,000

Maximum total potential losses of $35,000 to be absorbed from Baker and Carvil above would be allocated as follows on a 2:3 basis: Adams Dobbs

2/5 x $35,000 = $14,000 3/5 x $35,000 = $21,000

$ 16,000 $ (6,000)

Absorbing the final $6,000 loss from Dobbs would leave Adams with a safe capital balance of $10,000. c. Adams receives $57,500 and Dobbs gets $22,500. The $50,000 loss on sale of the building would be allocated as follows: Partner

Share of Loss

New Capital Balance

Adams Baker Carvil Dobbs

10% x $50,000 = $5,000 30% x $50,000 = $15,000 30% x $50,000 = $15,000 30% x $50,000 = $15,000

$ 75,000 $ 15,000 $ 45,000 $ 75,000

20.c. (continued) Maximum potential loss of $130,000 on the land would be allocated as follows:

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Chapter 15 - Partnerships: Termination and Liquidation

Partner

Share of Loss

New Capital Balance

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Chapter 15 - Partnerships: Termination and Liquidation

Adams Baker Carvil Dobbs

10% x $130,000 = $13,000 30% x $130,000 = $39,000 30% x $130,000 = $39,000 30% x $130,000 = $39,000

$ 62,000 $ ( 24,000) $ 6,000 $ 36,000

Maximum potential loss of $24,000 to be absorbed from Baker would be allocated as follows on a 1:3:3 basis: Adams Carvil Dobbs

1/7 x $24,000 = $3,428 3/7 x $24,000 = $10,286 3/7 x $24,000 = $10,286

$ 58,572 $ (4,286) $ 25,714

Maximum potential loss of $4,286 to be absorbed from Carvil would be allocated as follows on a 1:3 basis: Adams Dobbs

1/4 x $4,286 = $1,072 3/4 x $4,286 = $3,214

$57,500 $22,500

These amounts represent safe capital balances for distribution purposes. d. The land and building must be sold for over $115,000 to ensure that Carvil will receive some cash.  Adams Beginning balances $ 80,000 Assumed loss of $100,000 (see Schedule 1) (1:3:4:2) (10,000) Step One balances $ 70,000 Assumed loss of $35,000 (see Schedule 2) (allocated on a 1:0:4:2 basis) (5,000) Step Two balances $ 65,000 Assumed loss of $90,000 (see Schedule 3) (allocated on a 1:0:0:2 basis) (30,000) Step Three balances $ 35,000

Baker $ 30,000

Carvil $ 60,000

Dobbs $ 90,000

(30,000) $ -0-

(40,000) $ 20,000

(20,000) $ 70,000

(20,000) $ -0-

(10,000) $ 60,000

$

-0-0-

$

-0-0-

$

-0-0-

(60,000) $ -0-

20.d. (continued) 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.

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Chapter 15 - Partnerships: Termination and Liquidation

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 

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Chapter 15 - Partnerships: Termination and Liquidation

its liabilities, the land and building must be sold for over $115,000 to ensure Carvil of receiving some amount. As another approach to the problem, Carvil's capital balance is eliminated through the $100,000 Step One loss and the $35,000 Step Two loss. Thus, avoiding a complete $135,000 loss ensures that Carvil will receive cash. Since the land and buildings have a book value of $250,000, such losses would be avoided by receiving over $115,000. Schedule 1 Partner

Adams Baker Carvil Dobbs

Capital Balance/ Loss Allocation

$80,000/10% $30,000/30% $60,000/40% $90,000/20%

Maximum Loss That Can Be Absorbed 

$800,000 $100,000 (most vulnerable) $150,000 $450,000

Schedule 2 Partner

Adams Carvil Dobbs

Capital Balance/ Loss Allocation

$70,000/(1/7) $20,000/(4/7) $70,000/(2/7)

Maximum Loss That Can Be Absorbed 

$490,000 $ 35,000 (most vulnerable) $245,000

Schedule 3 Partner

Adams Dobbs

Capital Balance/ Loss Allocation

$65,000/(1/3) $60,000/(2/3)

Maximum Loss That Can Be Absorbed 

$195,000 $ 90,000 (most vulnerable)

21. Prepare a Predistributlon Plan (LO5) (30 minutes) An assumed series of losses is simulated which eliminates each partner's capital account in turn: Beginning balances Assumed loss of $75,000 (see Schedule 1) (allocated on a 2:3:2:3 basis) Step One balances Assumed loss of $50,000 (see Schedule 2) (allocated on a 0:3:2:3 basis) Step Two balances

Larson $ 15,000

(15,000) $ -0-

$

-0-015-18

Norris $ 60,000

Spencer $ 75,000

Harrison $ 41,250

(22,500) $ 37,500

(15,000) $ 60,000

(22,500) $ 18,750

(18,750) $ 18,750

(12,500) $ 47,500

(18,750) $ -0-

Chapter 15 - Partnerships: Termination and Liquidation

Assumed loss of $31,250 (see

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Chapter 15 - Partnerships: Termination and Liquidation

Schedule 3) (allocated on a 0:3:2:0 basis) Step Three balances

•

• • • •

$

-0-0-

(18,750) $ -0-

(12,500) $ 35,000

$

-0-0-

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 Capital Balance/ Loss Allocation $15,000/20% $60,000/30% $75,000/20% $41,250/30%

Partner Larson Norris Spencer Harrison

Maximum Loss That Can Be Absorbed  $ 75,000 (most vulnerable) $200,000 $375,000 $137,500

Schedule 2 Capital Balance/ Loss Allocation $37,500/(3/8) $60,000/(2/8) $18,750/(3/8)

Partner Norris Spencer Harrison

Maximum Loss That Can Be Absorbed  $100,000 $240,000 $ 50,000 (most vulnerable)

Schedule 3 Capital Balance/ Loss Allocation $18,750/(3/5) $47,500/(2/5)

Partner Norris Spencer

Maximum Loss That Can Be Absorbed  $ 31,250 (most vulnerable) $118,750

22. Prepare and Use a Predistribution Plan (LO5) (20 minutes) Part a. Maximum Losses That Can Be Absorbed 

Able* Moon  Yerkl

$50,000/.2 $60,000/.3 $50,000/.5

$250,000 200,000 100,000 (most vulnerable to losses)

*Able's balance includes capital and the loan to the partnership.

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Chapter 15 - Partnerships: Termination and Liquidation

The assumption is made that a $100,000 loss occurs.

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Chapter 15 - Partnerships: Termination and Liquidation

 Able Reported balances $50,000 Assumed loss ($100,000) split on a 2:3:5 basis (20,000) Adjusted balances $30,000

Moon $60,000 (30,000) $30,000

Yerkl  $50,000 (50,000) $ 0

Maximum Losses That Can Now Be Absorbed 

Able Moon

$30,000/.4 $30,000/.6

$75,000 50,000 (most vulnerable to losses)

The assumption is made that a $50,000 loss occurs. Reported balances Assumed loss ($50,000) split on a 2:3 basis Adjusted balances

 Able $30,000 (20,000) $10,000

Moon $30,000 (30,000) $ 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%).

23. Prepare a Predistribution Plan for a Partnership Liquidation (LO5)(25 minutes) Maximum Losses That Can Be Absorbed 

Simpson Hart Bobb Reidl

$18,000/20% $40,000/40% $48,000/20% $135,000/20%

$ 90,000 (most vulnerable to losses) 100,000 240,000 675,000

The assumption is made that a $90,000 loss occurs.

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Chapter 15 - Partnerships: Termination and Liquidation

Simpson

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Hart

Bobb

Reidl  

Chapter 15 - Partnerships: Termination and Liquidation

Reported balances $18,000 Assumed loss ($90,000) split on a 2:4:2:2 basis (18,000) Adjusted balances $ 0

$40,000

$48,000

$135,000

(36,000) $ 4,000

(18,000) $30,000

(18,000) $117,000

Maximum Losses That Can Now Be Absorbed 

Hart Bobb Reidl

$4,000/4/8 $30,000/2/8 $117,000/2/8

$ 8,000 (most vulnerable to losses) 120,000 468,000

The assumption is made that an $8,000 loss occurs. Hart Reported balances $4,000 Assumed loss ($8,000) split on a 4:2:2 basis (4,000) Adjusted balances $ 0

Bobb $30,000 (2,000) $28,000

Reidl   $117,000 (2,000) $115,000

Maximum Losses That Can Now Be Absorbed 

Bobb Reidl

$28,000/2/4 $115,000/2/4

56,000 (most vulnerable to losses) 230,000

The assumption is made that a $56,000 loss occurs. Reported balances Assumed loss ($56,000) split on a 2:2 basis Adjusted balances

Bobb $28,000 (28,000) $ 0

Reidl   $115,000 (28,000) $ 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.

24.Determine the Ramifications of a Variety of Liquidation Situations (LO3) (30 minutes) Part A. Partner with Deficit Capital Balance (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.

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Chapter 15 - Partnerships: Termination and Liquidation

(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. (c) The minimum cash payment to Thomas would be $35,667 ($19,000 + $16,667). As shown in (b) above, the available $19,000 is distributed to Thomas, thus reducing that partner's capital balance to $39,000. A loss of  $59,000 on the noncash assets would further reduce this partner's balance by $11,800 ($59,000 x 20%) to $27,200. That same loss would reduce Ross' capital to $45,400 and Milburn's deficit to ($31,600). The minimum cash amount would be caused by Milburn's failure to contribute this $31,600 so that it has to be absorbed by Ross (4/6 or $21,067) and Thomas (2/6 or  $10,533). The remaining safe capital balance of $16,667 would be paid to Thomas. 24. (continued) Part B. Partners with Deficit Capital Balances; Insolvent Partner  (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 Sampson Carton

$15,000 $ 3,667 $ 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. 25. Prepare Journal Entries for a Partnership Liquidation (LO2) (25 minutes) 15-25

Chapter 15 - Partnerships: Termination and Liquidation

JOURNAL ENTRIES a. Cash ............................................................................. March, Capital (2/6 of loss) ....................................... April, Capital (3/6) ....................................................... May, Capital (1/6) ........................................................ Inventory ................................................................

56,000 6,000 9,000 3,000 74,000

b. March, Capital (2/6 of expenses) .............................. April, Capital (3/6) ....................................................... May, Capital (1/6) ........................................................ Cash .......................................................................

2,500 3,750 1,250

c. Liabilities ..................................................................... Cash .......................................................................

40,000

d. Cash ............................................................................. Accounts Receivable ............................................

45,000

e. Partner March April May

Current Capital Adjusted $16,500 $62,250 $41,750

7,500 40,000 45,000

Share of Potential   Maximum Loss* Capital  2/6 x $77,000 = $25,667 $ (9,167) 3/6 x $77,000 = $38,500 $23,750 1/6 x $77,000 = $12,833 $28,917

*Maximum losses could be suffered on the remaining $39,000 in accounts receivable and the $38,000 in land, building, and equipment. 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: Partner April May

Potential Capital (above) $23,750 $28,917

Share of March's Deficit 3/4 x $9,167 = $6,875 1/4 x $9,167 = $2,292

Potential   Capital  $16,875 $26,625

25. (continued) As the above amounts represent safe capital balances, payments can be presently made to these two partners. April, Capital ............................................................... 16,875 May, Capital ................................................................. 26,625 Cash ....................................................................... 43,500 f. Cash (30%) .................................................................. March, Capital (2/6 of loss) ....................................... April, Capital (3/6)........................................................ 15-26

11,700 9,100 13,650

Chapter 15 - Partnerships: Termination and Liquidation

May, Capital (1/6)......................................................... Accounts Receivable ............................................

4,550

g. Cash ............................................................................ March, Capital (2/6 of loss) ....................................... April, Capital (3/6) ....................................................... May, Capital (1/6) ........................................................ Land, Building and Equipment ............................

17,000 7,000 10,500 3,500

h. Liabilities ..................................................................... Cash .......................................................................

21,000

39,000

38,000 21,000

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. March, Capital ............................................................. April, Capital ............................................................... May, Capital ................................................................. Cash .......................................................................

400 21,225 7,075 28,700

26. Determine Liquidation Proceeds Necessary to Give Partner a Specified Amount; Predistribution Plan (LO5) (30 minutes) The other assets must be sold for at least $50,000. 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). A predistribution plan must be developed to generate this information: W

15-27

X

Y

Z

Chapter 15 - Partnerships: Termination and Liquidation

Beginning capital Assumed loss of $120,000 (see Schedule 1) (5:3:1:1) Step One balances Assumed loss of $70,000 (see Schedule 2) (allocated on a 0:3:1:1 basis) Step Two balances Assumed loss of $8,000 (see Schedule 3) (allocated on a 0:0:1:1 basis) Step Three balances

$ 60,000 $ 78,000

$ 40,000

$ 30,000

(60,000) (36,000) $ -0- $ 42,000

(12,000) $ 28,000

(12,000) $ 18,000

(14,000) $ 14,000

(14,000) $ 4,000

(4,000) $ 10,000

(4,000) $ -0-

$

-0-0-

$

-0-0-

(42,000) $ -0-

$

-0-0-

PREDISTRIBUTION PLAN • •

• • • •

Current cash of $30,000 goes to creditors. Next $27,000 generated goes to remaining creditors ($12,000) and to pay liquidation expenses estimated at ($15,000). Next $10,000 goes to Y. Next $8,000 goes to Y and Z on a 1:1 basis. Next $70,000 goes to X, Y, and Z on a 3:1:1 basis. Any remaining cash is split among all four partners based on a 5:3:1:1 basis.

26. (continued) Schedule 1 Partner W X  Y Z

Capital Balance/ Loss Allocation $60,000/50% $78,000/30% $40,000/10% $30,000/10%

Maximum Loss to Be Absorbed  $120,000 (most vulnerable) $260,000 $400,000 $300,000

Capital Balance/ Loss Allocation $42,000/(3/5) $28,000/(1/5) $18,000/(1/5)

Maximum Loss to Be Absorbed  $ 70,000 (most vulnerable) $140,000 $ 90,000

Capital Balance/ Loss Allocation

Maximum Loss to Be Absorbed 

Schedule 2 Partner X  Y Z

Schedule 3 Partner

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Chapter 15 - Partnerships: Termination and Liquidation

 Y Z

$14,000/(1/2) $ 4,000/(1/2)

$ 28,000 $ 8,000 (most vulnerable)

27. Determine Monthly Payments to Partners based on Safe Capital Balances (LO4) (35 minutes) VAN, BAKEL, AND COX PARTNERSHIP Safe Installment Payments to Partners January 31 Profit and loss ratio

Total 100%

Preliquidation capital balances $282,000 Add (deduct) loans (10,000) 272,000 January losses (Schedule 1) (28,000) Equity of partnership— January 31 244,000 Potential losses (Schedule 1) (199,000) 45,000 Potential loss—Van's deficit balance (Bakel 3/5; Cox 2/5) -0Safe payments to partners $45,000

Van 50%

Bakel 30%

Cox   20%

$118,000 (30,000) 88,000 (14,000)

$ 90,000 20,000 110,000 (8,400)

$74,000 -074,000 (5,600)

74,000 (99,500) (25,500)

101,600 (59,700) 41,900

68,400 (39,800) 28,600

25,500 $ -0-

(15,300) $ 26,600

(10,200) $18,400

Schedule 1 Computation of Actual and Potential Liquidation Losses January  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 27. (continued) VAN, BAKEL, AND COX PARTNERSHIP Safe Installment Payments to Partners February 28

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Chapter 15 - Partnerships: Termination and Liquidation

Total

Equity of partnership – January 31 (above) ............ $244,000 Safe payments (above) ........... (45,000) February liquidation expenses (3,000) Equity of partnership – February 28......................... 196,000 Potential liabilities and expenses (6,000) Potential loss on machinery and equipment .......................... (189,000) 1,000 Potential loss—Van's deficit balance (Bakel 3/5; Cox 2/5) ........... -0Safe payments to partners ..... $ 1,000

Van

Bakel

Cox  

$74,000 -0(1,500)

$101,600 (26,600) (900)

$68,400 (18,400) (600)

72,500 (3,000)

74,100 (1,800)

49,400 (1,200)

(94,500) (25,000)

(56,700) 15,600

(37,800) 10,400

25,000 $ -0-

(15,000) $ 600

(10,000) $ 400

VAN, BAKEL, AND COX PARTNERSHIP Safe Installment Payments to Partners March 31 Total

Equity of partnership— February 28 (above)... $196,000 Safe payments (above).............. (1,000) Loss on sale of machinery and equipment ($189,000 – $146,000) (43,000) Liquidation expenses (5,000) Safe payments to partners $147,000

Van

Bakel

Cox  

$72,500 -0-

$74,100 (600)

$49,400 (400)

(21,500) (2,500) $48,500

(12,900) (1,500) $59,100

(8,600) (1,000) $39,400

28. Determine Cash Distributions for Four Different Partnership Liquidations; Insolvent Partners (LO3) (35 minutes) Part A Simon, Capital $16,000 -0$16,000

Beginning balances Contribution by Jackson Capital balances Elimination of Jackson's deficit (40:20 basis) Final distribution

(6,000) $10,000 Hough, Loan and

Part B

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Haynes, Loan and Capital $ 4,000 -0$ 4,000

(3,000) $ 1,000

Jackson, Capital   ($12,000) 3,000 ($ 9,000)

9,000 $ -0-

Luck, Loan and Cummings,

Chapter 15 - Partnerships: Termination and Liquidation

Beginning balances $82,000 loss on disposal (allocated on a 50:40:10 basis) Liquidation expenses (50:40:10 basis) Capital balances Allocation of Luck's deficit (50:10 basis) Final distribution

Part C Beginning balances $82,000 loss on disposal (allocated on a 2:4:4 basis) Liquidation expenses (2:4:4 basis) Capital balances Allocation of Cummings' deficit balance (2:4 basis) Capital balances Allocation of Luck's deficit balance Final distribution

Capital $82,000

Capital $40,000

Capital   $20,000

(41,000) (10,500) 30,500 (1,000) $29,500

(32,800) (8,400) (1,200) 1,200 $ -0-

(8,200) (2,100) 9,700 (200) $ 9,500

Hough, Loan and Capital $82,000

Luck, Loan and Cummings, Capital Capital   $40,000 $20,000

(16,400) (1,200) $64,400

(32,800) (2,400) $ 4,800

(32,800) (2,400) ($15,200)

(5,067) $59,333 (5,333) $54,000

(10,133) ($ 5,333) 5,333 $ -0-

15,200 -0-0$ -0-

28. (continued) Part D

Beginning balances Allocation of Redmond's deficit balance (10:30:40 basis) Capital balances $32,000 contribution by Ledbetter and $3,000 contribution by Watson Final distribution*

Redmond, Loan and Ledbetter, Capital Capital ($16,000) ($30,000)

16,000 -0-0$ -0-

*Remaining $28,000 is used to pay liabilities.

15-31

Watson, Capital $ 3,000

Sandridge, Capital   $15,000

(2,000) ($32,000)

(6,000) ($3,000)

(8,000) $ 7,000

32,000 $ -0-

3,000 $ -0-

-0$ 7,000

Chapter 15 - Partnerships: Termination and Liquidation

29.

Produce a Schedule of Liquidation using a Predistribution Plan (LO1, LO5) (40 minutes) FRICK, WILSON, AND CLARKE Schedule of Partnership Liquidation Final Balances

Cash

Beginning balances

$48,000

Noncash  Assets

$177,000

Liabilities

$35,000

Frick, Capital  (60%)

$101,000

Wilson, Capital  (20%)

$28,000

Clarke, Capital  (20%)

$61,000

Distribution of $4,000 (cash in excess of liabilities and estimated liquidation expenses) in accordance with predistribution plan – Schedule 1

Updated balances Noncash assets sold Updated balances All liabilities are paid Updated balances

(4,000) $44,000 48,000 $92,000 (35,000) $57,000

$177,000 (80,0 00) $97,000 $97,000

$35,000 $35,000 (35,000) $-0-

$101,000 (19,200) $81,800

$28,000 (6,400 ) $21,600

(4,000) $57,000 (6,400) $50,600

$81,800

$21,600

$50,600

Distribution of $48,000 (cash in excess of liabilities and estimated liquidation expenses) in accordance with predistribution plan – Schedule 1:

First $23,333 (remainder of first distribution) Next $22,667 Next $2,000 Updated balances Noncash assets sold Updated balances Paid liquidation expenses Updated balances Final distribution based on ending capital account balances Ending balance

(23,333) (22,667) (2,000) $9,000 44,000 $53,000 (7,000) $46,000 (46,000) $-0-

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(17,000) (1,200 ) $63,600 (31,800)

(400) $21,200 (10,600)

(23,333) (5,667) (400) $21,200 (10,600)

$10,600 (1,400 ) $9,200

$10,600 (1,400) $9,200

(9,200 ) $-0-

(9,200) $-0-

$97,000 (97,0 00)

$-0-

$-0-

$-0-

$-0-

$-0-

$31,800 (4,200 ) $27,600

$-0-

$-0-

(27,600) $-0-

Chapter 15 - Partnerships: Termination and Liquidation

29. (continued) Schedule 1 Development of Predistribution Plan

Beginning balances ................................ Loss of $140,000 assumed—Schedule 2 (allocated on a 60:20:20 basis) ........... Step One balances .................................. Loss of $22,667 assumed—Schedule 3 (allocated on a 60:20 basis) ................ Step Two balances ..................................

Frick, Capital $101,000

Wilson, Capital $28,000

(84,000) $ 17,000

(28,000) $ -0-

(17,000) $ -0-

$

-0-0-

Clarke, Capital  $61,000

(28,000) $33,000 (5,667) $27,333

PREDISTRIBUTION PLAN •

• •

Payment of liabilities and liquidation expenses must be assured. Next $27,333 goes to Clarke. Next $22,667 is split between Frick and Clarke on a 60:20 basis. Any further cash is split among Frick, Wilson, and Clarke on a 60:20:20 basis. Schedule 2

Partner Frick Wilson Clarke

Capital Balance/ Loss Allocation $101,000/60% $ 28,000/20% $ 61,000/20%

Maximum Loss That Can Be Absorbed  $168,333 $140,000 (most vulnerable to loss) $305,000

Schedule 3

Partner Frick Clarke

Capital Balance/ Loss Allocation $17,000/(60/80) $33,000/(20/80)

Maximum Loss That Can Be Absorbed  $ 22,667 (most vulnerable to loss) $132,000

30. Prepare a Predistribution Plan and Journal Entries for a Partnership Liquidation (LO2, LO5) (50 minutes) Rodgers, Part A Wingler, Norris, Loan and Guthrie,

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Chapter 15 - Partnerships: Termination and Liquidation

Capital $120,000

Beginning balances ............... Loss of $150,000 assumed (allocated on a 30:10:20:40 basis) see Schedule 1 ......... (45,000) Step One balances .................. $ 75,000 Loss of $150,000 assumed (allocated on a 30:10:20 basis) see Schedule 2 ..................... (75,000) Step Two balances ................. $ -0Loss of $43,500 assumed (allocated on a 10:20 basis) see Schedule 3 ........................... -0Step Three balances ............... $ -0-

Capital $88,000

Capital $109,000

Capital   $60,000

(15,000) $73,000

(30,000) $ 79,000

(60,000) $ -0-

(25,000) $48,000

(50,000) $ 29,000

(14,500) $33,500

(29,000) $ -0-

$

-0-0-

$

-0-0-

PREDISTRIBUTION PLAN • • • •

•

Payment of all liabilities and liquidation expenses must be assured. Next $33,500 goes entirely to Norris. Next $43,500 is allocated to Norris (10/30) and Rodgers (20/30). Next $150,000 is allocated to Wingler (30/60), Norris (10/60), and Rodgers (20/60). Any further cash distributions are divided on the original profit and loss ratio: Wingler (30%), Norris (10%), Rodgers (20%), and Guthrie (40%). Schedule 1

Partner

Capital Balance/ Loss Allocation

Wingler Norris Rodgers Guthrie

$120,000/30% $ 88,000/10% $109,000/20% $ 60,000/40%

Maximum Loss That Can Be Absorbed 

$400,000 $880,000 $545,000 $150,000 (most vulnerable to loss)

30. a. (continued) Schedule 2

Partner Wingler

Maximum Loss That Can Be Absorbed  $150,000 (most vulnerable to loss)

Capital Balance/ Loss Allocation $75,000/(30/60)

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Chapter 15 - Partnerships: Termination and Liquidation

Norris Rodgers

$73,000/(10/60) $79,000/(20/60)

$438,000 $237,000

Schedule 3

Partner Norris Rodgers

Maximum Loss That Can Be Absorbed  $144,000 $ 43,500 (most vulnerable to loss)

Capital Balance/ Loss Allocation $48,000/(10/30) $29,000/(20/30)

30. (continued) Part B Cash ............................................................................. 65,600 Wingler, Capital (30% of $16,400 loss) ............... 4,920 Norris, Capital (10%) ............................................. 1,640 Rodgers, Capital (20%) ......................................... 3,280 Guthrie, Capital (40%) ........................................... 6,560 Accounts Receivable ...................................... Receivables are collected with losses allocated to partners.

82,000

Cash ....................................................................... 150,000 Wingler, Capital (30% of $103,000 loss) ............ 30,900 Norris, Capital (10%) ............................................ 10,300 Rodgers, Capital (20%) ........................................ 20,600 Guthrie, Capital (40%) .......................................... 41,200 Land ................................................................. 85,000 Building and Equipment ................................ 168,000 Land, building and equipment are sold with losses allocated to partners. Wingler, Capital ................................................... Norris, Capital ...................................................... Rodgers, Loan ..................................................... Rodgers, Capital .................................................. Cash .................................................................. Above entry distributes safe capital balances shown below (see predistribution plan in part based on a current cash balance of $230,600. •

• •

31,800 58,600 35,000 15,200 140,600 as A)

First $90,000 is held to pay liabilities ($74,000) and estimated liquidation expenses ($16,000). Next $33,500 goes entirely to Norris. Next $43,500 is split between Norris ($14,500) and Rodgers ($29,000).

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Chapter 15 - Partnerships: Termination and Liquidation

•

Remaining $63,600 is allocated to Wingler ($31,800), Norris ($10,600) and Rodgers ($21,200). No journal entry is currently required by Guthrie's insolvency. Liabilities ................................................... Cash ....................................................... All liabilities are paid.

74,000 74,000

30.b. (continued) Cash .................................................................. 71,000 Wingler, Capital (30% of $30,000 loss) ......... 9,000 Norris, Capital (10%) ....................................... 3,000 Rodgers, Capital (20%) ................................... 6,000 Guthrie, Capital (40%) ..................................... 12,000 Inventory..................................................... Inventory is sold with loss allocated to partners.

101,000

Wingler, Capital................................................ 35,500 Norris, Capital................................................... 11,833 Rodgers, Capital............................................... 23,667 Cash............................................................ 71,000 Above entry distributes available cash according to predistribution plan. Although $87,000 in cash is being held, $16,000 must be retained to pay liquidation expenses. The remaining $71,000 is divided among Wingler, Norris, and Rodgers on a 30:10:20 basis. According to the predistribution plan, a total of $150,000 must be divided on this ratio but only $63,600 was allocated in this manner  in the first distribution above. Therefore, all $71,000 (making a total of $134,600) is paid out on this 30:10:20 basis. Wingler, Capital (30% of expenses)................ Norris, Capital (10%)........................................ Rodgers, Capital (20%).................................... Guthrie, Capital (40%)...................................... Cash............................................................ Liquidation expenses are paid.

3,300 1,100 2,200 4,400

Wingler, Capital (30/60 of deficit)................... Norris, Capital (10/60)...................................... Rodgers, Capital (20/60)..................................

2,080 693 1,387

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Chapter 15 - Partnerships: Termination and Liquidation

Guthrie, Capital.......................................... 4,160 To eliminate the deficit balance of insolvent partner as computed on the next page. 30.b. (continued) CAPITAL ACCOUNT BALANCES

Beginning balances................. Loss on accounts receivable. Loss on land, building, and equipment .............................. Cash distribution..................... Loss on inventory.................... Cash distribution..................... Liquidation expenses.............. Subtotal .............................. Guthrie insolvent...................... Current balances......................

Wingler, Capital $120,000 (4,920)

Norris, Capital $88,000 (1,640)

Rodgers, Loan and Capital $109,000 (3,280)

(30,900) (31,800) (9,000) (35,500) (3,300) 4,580 (2,080) $2,500

(10,300) (58,600) (3,000) (11,833) (1,100) 1,527 (693) $ 834

(20,600) (50,200) (6,000) (23,667) (2,200) 3,053 (1,387) $1,666

Wingler, Capital........................................................... 2,500 Norris, Capital.............................................................. 834 Rodgers, Capital.......................................................... 1,666 Cash ................................................................. To distribute remaining cash based on final capital balances.

Guthrie, Capital   $60,000 (6,560)

(41,200) -0(12,000) -0(4,400) (4,160) 4,160 $ -0-

5,000

Answers to Develop Your Skills Cases Research Case 1. Students often seem to believe that definitive answers can be discovered for  all accounting and legal questions if a serious enough investigation is performed. However, here, there simply may be no easy answer to the question as to the amount of liability that the other six doctors in this case are facing. 2. Several questions can be raised that may impact the ultimate resolution: 

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In what state will the court case be handled? Different states have somewhat different laws as to the potential liabilities incurred by partners and different courts seem to have varying ways of interpreting those laws. How difficult was the surgery that was performed? Should the doctor have been able to perform the work without accident? Or, perhaps, was it an

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Chapter 15 - Partnerships: Termination and Liquidation





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extremely risky surgery where death might have been anticipated under any conditions? How much did the other doctors know about this doctor’s ability to do this particular surgery? Did they have any reason to believe that such work should not be undertaken? What is meant in the case by the term “very poor judgment?” How serious was the mistake made by the doctor?

The answers to such questions as these can have a huge impact on the extent of  the liability of the other doctors. Here are several quotes from The Wall Street Journal  article mentioned in the case that might pertain to the issue at hand: “Concerns are growing among Andersen's roughly 1,750 U.S. partners that even those who had nothing to do with the firm's work for Enron Corp. could eventually face personal liability stemming from the botched audit. Worried about what protection the limited-liability partnership provides them, many are now consulting lawyers for advice.” “The limited-liability partnership is a comparatively new corporate structure, untested by the kind of stress now besetting Andersen. But that testing appears to be just around the corner as Enron creditors, shareholders and employees seek to recover the billions of dollars they have lost from someone.” “Because it is unclear how much protection the LLP structure will provide Andersen partners, partnership and bankruptcy lawyers are expected to be following the matter closely. ‘As far as I know, there has never been a litigation test of the extent of the LLP shield, and there have been very few LLP cases about liability at all,’ said Larry Ribstein, a law professor at George Mason University.” “The limited-liability partnership was invented about a decade ago in the wake of  the savings-and-loan debacle to protect members of partnerships from being wiped out by claims against their firms. Under the structure, capital invested by partners into the firm is fair game for creditors. In theory, no partner is supposed to lose more than what he or she has invested in the firm.” "‘There is a strong legal tradition that you don't pierce the corporate veil and go after individual partners except under extraordinary circumstances,’ said Lynn LoPucki, a professor at the University of California Los Angeles law school. ‘But the law is very vague and lets the courts do what they feel appropriate. It is very case specific and fact intensive.’”

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Chapter 15 - Partnerships: Termination and Liquidation

“In 1990, prior to the advent of limited-liability partnerships, the accounting firm of  Laventhol & Horwath filed for Chapter 11 bankruptcy-court protection, in part due to lawsuits over questionable accounting. The firm's assets were insufficient to cover the claims of creditors and litigants. Under a plan negotiated with the firm's creditors, the 360 partners and former partners who had spent time at the firm since 1984 were required to dig into their own pockets to share a $46 million liability.” Analysis Case 1. In looking at the financial statements of a partnership, a number of obvious differences can be spotted in comparison to the statements of a corporation. For example, in looking at this set of statements, the following differences can be noted: The balance sheet shows “partners’ (deficiency) capital” rather than stockholders’ equity. The income statement (statement of operations) reports “net loss allocated to general partner” and “net loss allocated to limited partners.” This statement also reports “net loss per limited partnership interest” rather  than earnings/loss per share. A “statement of changes in partners’ (deficiency) capital” is presented rather than a statement of changes in stockholders’ equity. 





A potential investor in this partnership would become one of the “limited partners,” whose aggregate capital is disclosed in the balance sheet. 2. There is a considerable amount of information provided in the notes to the financial statements about the unique characteristics of a limited partnership: Note 1 – Organization and Summary of Significant Accounting Policies discusses the creation and structure of this limited partnership. Note 2 – Investments in and Advances to Local Partnerships provides information about the entity’s investment in other limited partnerships. Note 4 – Transactions with Affiliated Parties describes the obligation of the partnership to the General Partner. Note 5 – Income Taxes describes the manner in which individual partners are taxed on their share of partnership income. 

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In addition, in Item 5 (page 7), which precedes the financial statements, disclosures are provided related to the market for partnership interests. Because the partnership’s “shares” are not publicly traded, an individual investor may not be able to sell his/her limited partner interest in the partnership. As a limited partnership, potential investors (other than the general partner) would probably view an investment in NTCI II as being fairly similar to that of 

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Chapter 15 - Partnerships: Termination and Liquidation

holding shares in a corporation. The major difference relates to the possible inability to sell a limited partner interest in the company. Communication Case The bankruptcy of Laventhol & Horwath was one of the main reasons for the creation of the limited liability partnership business structure. As a general partnership, the litigation losses of this partnership that arose from poor  accounting and auditing practices fell on all partners and not just on those involved. Partners were required to make contributions from their own personal funds, often in amounts of up to several hundred thousand dollars to pay off the debts of the partnership after its failure. A number of the partners eventually went bankrupt as a result of the litigation that arose. Today, the partners in a general partnership would still seem to have the same risk that the partners of Laventhol & Horwath faced. However, the alternatives such as a limited liability partnership or a Subchapter S corporation would place fewer individuals in this precarious position. Thus, more than anything else, these articles on Laventhol & Horwath may be educational in showing why such alternatives have been created and why they have become so popular. Excel Case There are a number of different ways that a spreadsheet could be created to solve this particular problem. Here is one possible approach: —Create Column Headings: In Cell A1, enter label text “Partner”. In Cell B1, enter label text “Capital Balance”. In Cell C1, enter label text “Share P/L”. In Cell D1, enter label text “Initial Loss Share”. In Cell E1, enter label text “Subsequent Loss Share”. In Cell F1, enter label text “Remaining Balance”. —Enter Account Information for each partner: 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.

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Chapter 15 - Partnerships: Termination and Liquidation

—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. —Calculate Initial Loss Share: 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 D2, change the formula to read =$B$7*C2, and then copy this formula to cells D3 and D4. The resulting formula in Cell D3 will be =$B$7*C3 and in Cell D4 it will be =$B$7*C4. The location of the reference to Cell B7 does not change due to the $ symbol in front of the B and in front of the 7. —Calculate the Partners’ Share of any Subsequent Losses: Repeat the same process as above, creating a formula in Cell E2 as follows: =+ $B$8*C2 Copy this formula to Cells E3 and E4. —Calculate the Remaining Capital Balance: 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

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