Advanced Accounting by Debra Jeter and Paul Chaney Chapter 16: Partnership Liquidation Slides Authored by Hannah Wong, Ph.D. Rutgers University

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 obj 1

Order of Payment creditors other than partners loans from partners capitals of partners profits of partners obj 2

Simple Liquidation Sequence of events sale of all noncash assets and allocation of loss based on partners’ profit and loss ratio payment to creditors offset partner’s loans against debit capital balance allocate debit capital balance of insolvent partner investment by partners payment to partners based on their capital balances obj 3

Simple Liquidation Cash Noncash Assets Liab. A, Cap. .25 B, Cap. .5 C, Cap Balance before cash distribution 20,000 80,000 (40,000) (10,000) (60,000) 10,000 Sell assets and distribute loss 60,000 (80,000) -0- 5,000 (5,000) (50,000) 15,000 Pay creditors 40,000 Allocate debit capital balance of C (15,000) Payment to B obj 3

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 obj 3

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 obj 4

Installment Liquidation Cash $ 50,000 Noncash assets 50,000 $100,000 Liabilities $ 40,000 A, Capital (25%) 10,000 B, Capital (50%) 60,000 C, Capital (25%) (10,000) A 25% B 50% C Capital and loan balances Allocation of potential loss 20,000 (12,500) 7,500 50,000 (25000) 25,000 (10,000) (22,500) Allocation of C’s potential deficit (7,500) ---0--- (15,000) 10,000 22.500 After the liabilities are paid, B would get the remaining $10,000 and A and B would get no cash obj 4

Safe Payment Approach Procedure a safe payment schedule is prepared each time cash is to be distributed obj 4

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 obj 5

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) obj 5

Incorporation of a Partnership Advantages of incorporation limited liability continuity of existence ability to raise resources obj 6

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 obj 6

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 obj 6

Retention of Partnership Books Valuation JE Inventory 2,000 Land 5,000 Equipment 1,000 Accounts receivable 400 Valuation adjustment 5,600 To adjust assets and liabilities to fair value. The gains and losses are accumulated in the valuation adjustment account. obj 6

Retention of Partnership Books Valuation-Closing JE Valuation adjustment 5,600 Art, capital 2,800 Beck, capital 2,800 To close the valuation adjustment account to the partners’ capital accounts by their profit and loss ratio. obj 6

Retention of Partnership Books Capital-Closing JE Art, capital 10,800 Beck, capital 7,800 Capital stock 18,600 To close the capital account upon transfer of capital stock obj 6

New Books Established All accounts in partnership books will be closed the corporation records the assets received and liabilities assumed at fair value obj 6

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