PARTNERSHIP LIQUIDATION

Chapter 8

Dissolution
Due to a change in the legal relationship among partners Typically due to Admission of a new partner Withdrawal of a partner Death of a partner

Termination
Partnership ceases normal business operations

Liquidation
Occurs when the partnership sells its assets, pays its liabilities, and distributes remaining assets to partners May occur due to Partnership fulfilling its business purpose Partners desire to not continue the business Partnership is in financial

Liquidation (cont)
May be Voluntary the partners may choose to liquidate Involuntary creditors force the partnership to liquidate

Accountants Liquidation Responsibilities

Manage liquidation to ensure the payment to creditors Manage liquidation that will result in an appropriate distribution to partners

Marshalling of Assets
Keeping the partnership assets and liabilities separated from the partners personal assets and liabilities Partnership creditors and individual partner creditors can each have claims against partnership and partner assets but the priority of claims differ

Partnership Creditors Claims

Order of priority By partnership creditors By personal creditors if claim not fully paid from partner personal assets (limited to partners capital balance)

Partners Personal Creditor Claims

Order of priority By personal creditors By partnership creditors if claim not fully paid from partnership assets (not limited to partners capital balance) By other partners if partner capital account has a deficit

Uniform Partnership Act Partnership Claims

Partnership liabilities shall rank in the following order Creditors other than partners Partners other than for capital and profits Partners in respect of capital Partners in respect of profits

 Partners three claims (i.e., loans to from partners, partners capital contributions, partners undistributed partnership income) are often combined into a single category in practice (e.g., right of offset) Partners capital contributions

Uniform Partnership Act Partnership Claims (cont)

 Right of offset importance is to ensure that payment is not made on a partner loan when there is a capital account deficit Right of offset requires an agreement in the Articles of Partnership because partnership loans have priority

Uniform Partnership Act Partnership Claims (cont)

Partnership Priority Claims

Creditor claims does not mean that partnership creditors must be fully paid before partners can receive any distribution Creditor claims means that the accountant has the duty to ensure that sufficient funds will be available for creditors if

Liquidation Process
Close books and allocate profit or loss to capital accounts Liquidate noncash assets, allocate gains and losses directly to capital accounts using residual profit and loss ratios Pay liabilities and distribute assets to partners

 Lump-sum liquidation: all liabilities are paid and then a single (lump-sum) distribution is made to partners Installment liquidation: partner distributions are made while liabilities are still outstanding or noncash assets are still owned If distributions to partners are

Partnership Distributions to Partners

Lump-Sum Liquidation
Noncash assets generally sold in a relatively short period of time Liabilities are all paid Remaining cash is distributed Accountants duty is to search for unrecognized liabilities and to unsure that priority of creditor claims are followed

 May be used as an alternative to journal entries to recognize liquidation events Trial balance before liquidation (balance sheet accounts only) are presented as column headings Loans to and from partners are collapsed into the respective partners capital account (right

Statement of Realization and Liquidation

 Liquidation events (sale of assets, payment of expenses or liabilities) are posted directly to the columns with income statement items (e.g., gains, losses, expenses) posted directly to capital accounts using the residual profit and loss ratios Income statement accounts do

Statement of Realization and Liquidation (cont)

 Deficit capital accounts created during liquidation may occur due to the partner with the deficit Having a large profit and loss residual ratio Having withdrawn a larger portion of his/her profits

Statement of Realization and Liquidation (cont)

 Removal of deficit partner balance Additional contribution by partner with deficit capital account desired If additional contribution is not made, deficit must be absorbed by other partners in proportion to their

Statement of Realization and Liquidation (cont)

 Absorption of partner capital deficit by other partners in proportion to their respective residual profit and loss ratios Example 3 Partner capital balances after item 4 (.45) (.35) (.20) Briscoe JohnsonMitchell

Statement of Realization and Liquidation (cont)

 Briscoe deficit allocation (.35) (.20) Johnson Mitchell .35/(.35+.20) x $55,250 35,159 .20/(.35+.20) x $55,250 20,091

Statement of Realization and Liquidation

 Briscoes capital deficit means that the other partners will not receive the amount in their respective capital accounts Sum of the other capital balances exceeds the amount of cash available for distribution Allocation of deficit makes sum of remaining capital balances

Statement of Realization and Liquidation

Installment Liquidation
Issues to be considered when deciding when and how much to distribute to partners before the liquidation is complete include amount still owed creditors estimated remaining liquidation expenses the inability of partners to

Cash Distribution Plan

Outlines order partners will receive cash during an installment liquidation No guarantee that any cash will be distributed Does not indicate when cash distributions will occur

Cash Distribution Plan (cont)

Focuses on capital balances loans to and from partners residual profit and loss ratios to determine the relative ability of each partners capital account to absorb losses before becoming deficit

Loss Absorption Power

Cash distribution plan component outlining the amount of liquidation expenses losses Indicates the relative risk of distributing cash a partner before the liquidation is completed necessary to reduce each

Loss Absorption Power

Calculation Loss Partner Residual Profit Absorption = Capital and Loss Power Balance Percentage Example 4 (Johnson):

Loss Absorption Power

Losses and expenses of $577,000 would decrease Johnsons capital account $201,950 = ($577,000 x .35) Cash distributions made first to the partner with the largest loss absorption power Each $1distribution decreases Johnsons loss absorption

Loss Absorption Power

Distributions made until the receiving partners loss absorption power equals the next highest loss absorption power (i.e., risk of two capital accounts becoming $-0- is equal) Example 4 (cont): Johnsons first cash allocation ($577,000

Loss Absorption Power

Briscoes and Johnsons loss absorption power now equals Next cash allocation to Briscoe and Johnson relative to profit and loss residual ratios Distribute cash to Briscoe and Johnson until their loss absorption powers equally Mitchells ($240,000 -

Loss Absorption Power

Briscoe: $32,300 x .45 = $14,535 Johnson: $32,300 x .35 = 11,305 Any additional cash is allocated to all three partners based on profit and loss residual ratios

Schedule of Safe Payments

Must be prepared when cash distribution plan does not provide a useable foundation for distribution allocation, i.e., when profit residual ratio is not the same as loss residual ratio May be prepared for any liquidation

 Schedule calculated distribution under the presumptions that All remaining non cash assets are worthless Partners cannot make contributions to eliminate deficit capital balances Resulting distribution allocates cash to least risky partner(s) under most conservative

Schedule of Safe Payments