Chapter Fifteen Partnerships: Termination and Liquidation Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Reasons for Termination Termination of business activities followed by liquidation of partnership property occurs for a variety of reasons:  Personality disputes between partners  Retirement  Death  Changed business environment  Other opportunities  Low profits  Bankruptcy (either the business or a partner) 15-2

Termination & Liquidation When the partners wish to terminate the business:  Convert all assets to cash.  Allocate all gains or losses to the partner capital balances.  Pay all liabilities and expenses.  Distribute remaining cash to partners. LO

Termination & Liquidation - Example According to their agreement, Morgan & Houseman divide profits 6:4 respectively. On 6/1, the inventory is sold for $15,000. Note that the loss on the sale of inventory of $7,000 is assigned $4,200 ($7,000 x 60%) Morgan and $2,800 ($7,000 x 40%) to Houseman. LO

Deficit Capital Balance Deficit balances can be resolved two ways:  The deficit partner can make a contribution to make up the deficit.  The remaining partners can absorb the deficit.  (The deficit partner may pay later or can be sued for the deficit amount.) LO

Any payments by Holland will be split 2/3 to Dozier and 1/3 to Ross. Deficit Capital Balance -- Contribution by Deficit Partner Contributions made by the deficit partner(s) are distributed to the non- deficit partners based on their relative profit sharing percentages. 15-6

Deficit Capital Balance - Remaining Partners Absorb Deficit Capital balances after distribution of Holland’s loss: 15-7

Preliminary Distribution of Assets Debts owed to personal creditors. Debts owed to partnership creditors. Debts owed to the other partners. Under the Uniform Partnership Act, a priority ranking of creditors having claims against individual partners is recognized: LO

Predistribution Plan Used by accountants to guide the distribution of cash resulting from the liquidation process. Examine the Balance Sheet below. Assume the income sharing % is Rubens 50%, Smith 20%, and Trice 30%. LO

Predistribution Plan First, determine the maximum loss that each partner can absorb. Divide each partner’s capital balance by their respective income sharing %

Predistribution Plan Since Rubens can ONLY absorb a partnership loss of $60,000, new balances are computed assuming that the partnership has a $60,000 loss

Predistribution Plan With Rubens wiped out, continue calculating maximum absorbable losses using income sharing percentages of Smith, 20% (2/5) and Trice 30% (3/5)

Predistribution Plan As earlier, compute the maximum absorbable loss by dividing the capital balances by the relative income sharing %

Predistribution Plan Trice can only absorb a loss of $55,000. Now determine new capital balances for a loss of $55,

Predistribution Plan With Rubens and Trice both wiped out, and Smith left as the only remaining partner, the predistribution plan can be prepared

Predistribution Plan To inform all parties of the pattern by which available cash will be disbursed, the predistribution plan should be formally prepared in a schedule format prior to beginning liquidation