1. Termination and Liquidation
Chapter Ten
Partnerships:
Termination and Liquidation
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Reasons for Termination
10-2
Reasons for Termination
Personality disputes between partners
Retirement
Death
Changed business environment
Other opportunities
Low profits
Bankruptcy (either of the business or an individual partner)

3. Termination & Liquidation
10-3
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.
Distribute remaining cash to partners.

4. Termination & Liquidation - Example
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Termination & Liquidation - Example
Stor & Lille want to liquidate their partnership. Balances at 3/31/08 are:

5. Termination & Liquidation - Example
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Termination & Liquidation - Example
According to their partnership agreement, Stor and Lille divide profits 60:40 respectively. On 4/1, the inventory is sold for $35,000.
Prepare the journal entry to record the sale of the inventory.

6. Termination & Liquidation - Example
10-6
Termination & Liquidation - Example
Note that the loss on the sale of inventory of $7,000 is assigned $4,200 ($7,000 x 60%) to Stor and $2,800 ($7,000 x 40%) to Lille.

7. Termination & Liquidation - Example
10-7
Termination & Liquidation - Example
The balances after selling the inventory were:

8. Termination & Liquidation - Example
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Termination & Liquidation - Example
Assume that 70% of the Accounts Receivable are collected. The remaining accounts receivables are written off.
Prepare the entry to record the collection of the receivables.

9. Termination & Liquidation - Example
10-9
Termination & Liquidation - Example
Stor and Lille collects $24,500 of the A/R. The loss is $10,500. Allocate 60% of the loss to Stor and 40% of the loss to Lille.

10. Termination & Liquidation - Example
10-10
Termination & Liquidation - Example
Stor and Lille sell the fixed assets for $175,000.
Prepare the journal entry to record the sale of fixed assets.

11. Termination & Liquidation - Example
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Termination & Liquidation - Example
The gain on fixed assets is $15,000. Allocate 60% to Stor and 40% to Lille.

12. Termination & Liquidation - Example
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Termination & Liquidation - Example
Once all the assets are sold, the accounts payable are paid off.
Prepare the entry to pay off the accounts payable.

13. Termination & Liquidation - Example
10-13
Termination & Liquidation - Example
Once all the assets are sold, the accounts payable are paid off.

14. Termination & Liquidation - Example
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Termination & Liquidation - Example
The pre-distribution balances are:

15. Termination & Liquidation - Example
10-15
Termination & Liquidation - Example
Once the remaining cash is distributed, the partnership is considered terminated.

16. Schedule of Liquidation
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Schedule of Liquidation
The process of liquidation can take time.
Partners may experience deficit balances during the liquidation period.
Partners may want cash distributions prior to the completion of the liquidation.

17. Schedule of Liquidation
10-17
Schedule of Liquidation
Because the various parties want to be updated on the progress of the liquidation, a report can be prepared to disclose:
Property still being held by the partnership.
Transactions to date.
Liabilities remaining to be paid.
Current cash and capital balances.

18. Schedule of Liquidation - Interim Cash Distributions
10-18
Schedule of Liquidation - Interim Cash Distributions
Prior to making a cash distribution to the partners, assume:
1. All non-cash assets will be complete losses.
2. All liabilities will be paid.
3. All deficit partners will be written off.
Even though assumptions #1 and #3 may be unrealistic, they allow the computation of “safe” balances.

19. Deficit Capital Balance
10-19
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.)

20. Deficit Capital Balance - Loss to Remaining Partners
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Deficit Capital Balance - Loss to Remaining Partners
Contributions made by the deficit partner(s) are distributed to the non-deficit partners based on their relative profit sharing %.

21. Deficit Capital Balance Loss to Remaining Partners
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Deficit Capital Balance Loss to Remaining Partners
Contributions made by the deficit partner(s) are distributed to the non-deficit partners based on their relative profit sharing %.
Any payments by Sabaka will be split 4/5 to Loup and 1/5 to Lobo.

22. Deficit Capital Balance - Example
10-22
Deficit Capital Balance - Example
Hund, Chien and Cano have the following balances just prior to liquidation.

23. Deficit Capital Balance - Example
10-23
Deficit Capital Balance - Example
Hund, Chien and Cano share profits 35:25:40. On 7/5/08, the inventory is sold for $25,000, a $50,000 loss.
Prepare the entry.
Prepare the entry to record the sale of inventory.

24. Deficit Capital Balance - Example
10-24
Deficit Capital Balance - Example
Hund, Chien and Cano share profits 35:25:40. On 7/5/08, the inventory is sold for $25,000, a $50,000 loss.
Prepare the entry.

25. Deficit Capital Balance - Example
10-25
Deficit Capital Balance - Example
With a 40% share of the $50,000 loss, Cano’s capital account moves to a deficit balance of $(15,000).

26. Deficit Capital Balance – Example
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Deficit Capital Balance – Example
The $25,000 for the inventory sale, increases the cash balance to $55,000. $35,000 must be kept to pay off the accounts payable.
How will the remaining $20,000 be distributed?

27. Deficit Capital Balance - Example
10-27
Deficit Capital Balance - Example
Notice that, after Gill’s deficit has been allocated on the basis of 35:25, there is now a deficit balance in Finn’s account!

28. Deficit Capital Balance - Example
10-28
Deficit Capital Balance - Example
After allocating Hund’s deficit to Chien, the $20,000 can be distributed to Chien.

29. 10-29
Marshaling of Assets
Under the Uniform Partnership Act, a Marshaling of Assets is a priority ranking of creditors having claims against individual partners:
Debts owed to separate creditors.
Debts owed to partnership creditors.
Debts owed to the other partners.

30. Claims Against the Partnership
10-30
Claims Against the Partnership
Individual partner’s creditors can make a claim against the assets of the partnership.
All partnership creditors must be satisfied first.
The creditors can only assert claims to the extent of the specific partner’s positive capital balance.
Each partner is liable for ALL the debts of the partnership.
Partners are NEVER liable for the personal debts of the other partners.

31. Pre-distribution Plan
10-31
Pre-distribution 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 Hund 10%, Chien 40%, and Cano 50%.

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

33. Pre-distribution Plan
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Pre-distribution Plan
Since Cano can ONLY absorb a partnership loss of $10,000, we will first compute new balances assuming that the partnership has a $10,000 loss.

34. Pre-distribution Plan
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Pre-distribution Plan
With Cano wiped out, we will proceed with determining maximum absorbable losses using income sharing percentages of Hund 20% (1/5) and Chien 80% (4/5).

35. Pre-distribution Plan
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Pre-distribution Plan
As earlier, we will compute the maximum absorbable loss by dividing the capital balances by the relative income sharing %.

36. Pre-distribution Plan
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Pre-distribution Plan
As we can see above, Chien can only absorb a loss of $45,000.
Let’s determine new capital balances for a loss of $45,000.

37. Pre-distribution Plan
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Pre-distribution Plan
With Cano and Chien both wiped out, and Hund remaining as the only partner, we can now determine the Pre-distribution plan.

38. Pre-distribution Plan
10-38
Pre-distribution Plan

39. Summary Partnerships may be terminated for a variety of reasons.
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Summary
Partnerships may be terminated for a variety of reasons.
When terminated, partnership assets must be systematically liquidated.
Actual liquidation can require an extended period to accomplish. This promotes the use of proposed schedules of liquidation.
Marshaling of assets may be necessary when one or more partners have negative capital balances.

40. 10-40
Possible Criticisms
Development of Pre-distribution plans and schedules of liquidation may involve speculation. Some critics feel that this violates the traditionally conservative role of accountants
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