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Advanced Accounting by Debra Jeter and Paul Chaney

Chapter 17: Partnership

Liquidation

Slides Authored by Hannah Wong, Ph.D.Rutgers University

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Steps in Liquidation Process

Compute net income or loss up to the date of dissolution, allocate to partners

Convert assets into cash if necessary, record gain or loss and allocate to partners

Distribute assets to creditors and partners

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Order of Payment

creditors other than partners

loans from partners

capitals of partners

profits of partners

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Joint and Several Liability

legal action may be brought against all partners together or against any one or more of the partners in separate suits

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Marshaling of Assets

recognition of the rights of partnership and personal creditors and the classification of assets into partnership and personal categories

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Right of Offset

A partner with an outstanding loan to the partnership can offset the loan against his debit capital balance

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Priorities of Claims against Partnership Assets

partnership creditors

personal creditors that did not recover their claims in full from personal assets

limited to the partner’s capital interest in the partnership

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Priorities of Claims against Personal Assets

personal creditors

partnership creditors that did not recover their claims in full from partnership assets regardless of the partner’s capital

interest in the partnership

claims of partnership against the partner i.e., a deficit equity interest

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Simple Liquidation

Sequence of events sale of all noncash assets and allocation of loss

based on their profit and loss ratio

payment to creditors offset loan against debit capital balance allocate debit capital balance of insolvent

partner investment by partners payment to partners

based on their capital balances

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Installment Liquidation

noncash assets are sold over an extended period

partners receive cash in installments

problems: distribution of cash to partners before

total liquidation loss is known potential wrongful distributions against

the interest of creditors or individual partners

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Safe Payment Approach

Assumptions:

a loan to or from a partner will be combined with the partner’s capital account

remaining noncash assets will not provide additional cash

a partner with a deficit capital account will be unable to make additional investment

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Safe Payment Approach

Procedure

a safe payment schedule is prepared each time cash is to be distributed

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Advance Cash Distribution Plan

A schedule that specifies

the order in which each partner will participate in cash distribution

the amount of cash each partner will receive as it becomes available for distribution

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Advance Cash Distribution Plan - Steps

net capital interest of each partner = capital account +/- loans to

(from) partnership

order of participation = ranking by:

loss absorption potential (= net capital interest / profit and loss ratio)

amount of cash distributed to each partner= (difference in loss absorption

potentials of partner and next ranking partner) x (profit and loss ratio)

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Incorporation of a Partnership

Advantages of incorporation

limited liability

continuity of existence

ability to raise resources

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Incorporation of a Partnership

Procedures

assets and liabilities are transferred to the corporation

partners receive capital stock in settlement of their interests

partnership accounts restated to fair values

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Incorporation of a Partnership

Accounting Steps

The partnership books may be retained for use by the corporation or

a new set of books may be established

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Retention of Partnership Books

Inventory 2,000

Land 5,000

Equipment 1,000

Accounts receivable 400

Valuation adjustment 5,600

Valuation JE

To adjust assets and liabilities to fair value. The gains and losses are accumulated in the

valuation adjustment account.

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Retention of Partnership Books

Valuation adjustment 5,600

Art, capital 2,800

Beck, capital 2,800

Valuation-Closing JE

To close the valuation adjustment account to the partners’ capital accounts by their

profit and loss ratio.

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Retention of Partnership Books

Art, capital 10,800

Beck, capital 7,800

Capital stock 18,600

Capital-Closing JE

To close the capital account upon transfer of capital stock

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New Books Established

All accounts in partnership books will be closed

the corporation records the assets received and liabilities assumed at fair value

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Advanced Accounting by

Debra Jeter and Paul Chaney

Copyright © 2001 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.