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Partnership Dissolution
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Introduction A partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business. The assets of the partnership will be realized to pay off the liabilities. The sales proceeds should be applied in the following order, as required by the Hong Kong Ordinance: Pay off creditors first, then the partners’ advances, and Finally the partners’ capital
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Realization Account In the partnership dissolution, an account named as ‘Realization Account’ will be opened to compute the profit or loss from realization which should be shared among the partners according to the profit or loss sharing ratio
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Nature of partnership dissolution
Dissolution where the assets are sold separately Dissolution where partnership is sold as a whole
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Dissolution where Assets are sold separately
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Procedures of Dissolution
All assets will be sold to other persons or taken over by partners Settle the liabilities of the partnership to outsider or partners Transfer any ‘profit or loss on realization’ to each partner’s capital accounts in profit/loss sharing ratio Merge the balances in the partners’ current accounts to their capital accounts
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Any credit balance in each partner’s capital account represents the amount which can be withdrawn from the partnership to each partner; any debit balance in a partner’s capital account represents additional cash to be injected by that partners
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Transactions Accounting entries Close all asset accounts with net book value to the realization account (except cash and bank because these assets need not be disposed of) Dr Realization Cr Assets Cost of dissolution or any losses or expenses incurred on realization Cr Bank Proceeds from the disposal of assets Dr Bank Cr Realization Assets taken over by a partner without payment Dr Capital
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Transactions Accounting entries Asset taken over by partners as a gift No entries required Creditors taken over by a partner Dr Creditors Cr Capitals Payment to creditors with discounts received Cr Realization – discount Cr Bank Profit or loss on realization to be shared among the partners according to the profit-sharing ratio Dr Realization – profit or Dr Capital Cr Realization - loss
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Transactions Accounting entries Repayment of loan to an partner Dr Loan from partner Cr Bank Repayment of loan to an outsider ( creditors) Dr Loan from outsider Transfer any balances in partners’ current accounts Dr Current (for credit balance) Cr Capitals Or Dr Capital Cr Current (for debit balance) Repayment of remaining capital to partners
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Example 1
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John, Peter and Tom were partners sharing profits and losses in the
ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Premises Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Bank 265550 Less: Current Liabilities Creditors Working Capital 397550
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Capital: John Peter Tom Current: John Peter (10000) Tom Long – term liabilities Loan from Tom 397550 Assets and liabilities were disposed of as follows: 1. The premises were sold at $ and legal charges from the sale amount to $10000 2. Tom took over the stock and motor vehicles at book value 3. Except for $2500, all debts were collected 4. The creditors were discharged for $56000 5. Realization expenses of $10000 were paid Required: Prepare the realization, Bank, Capital and Current account for the dissolution of partnership
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Realization Premises Premises Prov. for depreciation Bal b/f Realization Provision for depreciation Premises Bal b/f
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Realization Premises Motor Vehicles Motor Vehicles Prov. for depreciation Bal b/f Realization Provision for depreciation Motor Vehicles Bal b/f
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Realization Premises Motor Vehicles Debtors Debtors Prov. for bad debts Bal b/f Realization Provision for Bad Debts Motor Vehicles Bal b/f
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Realization Premises Motor Vehicles Debtors Stock Stock Bal b/f Realization
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Realization Bank – premises ( ) - Debtors ( ) Premises Motor Vehicles Debtors Creditors – discount received Stock Bank- realization expenses Loan from Tom Bank Bal b/f Bank Bal b/f Realization - expenses Realization – premises - debtors Creditors Loan from Tom Creditors Bank Bal b/f Realization – discount received
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Realization Bank – premises ( ) - Debtors ( ) Premises Motor Vehicles Debtors Creditors – discount received Stock Tom – stock - MV Bank- realization expenses Gain on realization: John 1/ Peter 1/ Tom 3/ Capital John Peter Tom John Peter Tom Realization: Stock MV Bal b/f Gain on realizaiton
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Capital John Peter Tom John Peter Tom Realization: Stock MV Bal b/f Gain on realizaiton Current Current Bank Current John Peter Tom John Peter Tom Bal b/f Bal b/f Capital Capital Bank Bal b/f Realization - expenses Realization – premises - debtors Creditors Loan from Tom Capital: John Peter Tom
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Dissolution where partnership is sold as a whole
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Purchase consideration
The purchase consideration is to be discharged by the limited company (buyer) to partners(seller) to take over the business Goodwill = Purchase consideration – ( assets at take-over value – liabilities at take-over value)
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Transactions Accounting entries For dissolution of Old partnership (seller) Close all asset accounts with net book value to the realization account (Bank and cash may be taken over) Dr Realization Cr Assets Cost of dissolution or any losses or expenses incurred on realization Cr Bank Proceeds from sale of the business (purchase consideration) Dr Vendee (buyer) Cr Realization
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Transactions Accounting entries Liabilities taken over by the buyer Dr Liabilities Cr Realization The purchase consideration settled by cheque, shares and debentures Dr Bank/ Shares/ debentures in purchaser’s company Cr Bank Repayment of remaining capital to partners Dr capital Cr Bank/ shares/ debentures in purchaser’s company
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Transactions Accounting entries For opening entries of New Company (buyer) Assets taken over Dr Assets Cr Business Purchase Liabilities taken over Dr Business Purchase Cr Liabilities The purchase consideration offered Cr Vendor (seller) The purchase consideration settled by cheques, shares and debentures Dr Vendor (seller) Cr Bank/Shares/Debentures
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Example 2
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John, Peter and Tom were partners sharing profits and losses in the
ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Premises Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Bank 265550 Less: Current Liabilities Creditors Working Capital 397550
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Capital: John Peter Tom Current: John Peter (10000) Tom Long – term liabilities Loan from Tom 397550 On 31 December 1996, they incorporated a limited company, Fortune limited, to take over the partnership business. Fortune Limited had an authorized capital of $ ordinary shares of $1 each.
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Assets and liabilities were disposed of as follows:
John took over the stock at book value. Tom collected all the debts except $2500 The company took over the premises at a valuation of $200000, motor vehicles at $25000, cash at bank and all the liabilities. Goodwill was valued at $70000 for the purpose of the takeover The purchase consideration was to be discharged by the issue to the partners of ordinary shares at $1.2 each, according to the profit-sharing ratio, and the balance was to be in cash The company also issued ordinary shares at $1.2 for cash to outsiders Required: Prepare the realization, Capital and the opening balance sheet for the new company
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Fortune Ltd – purchase consideration [(200000+25000+26065-7550-60000)
Realization Liabilities taken over by Ltd. Co. Creditors Loan from Tom Premises MV Stock Debtors Bank Tom: debtors ( ) John: stock Bank be taken over Fortune Ltd – purchase consideration [( ) +70000] Capital: John Peter Tom Purchase consideration=Asset-liabilities +goodwill
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John Peter Tom John Peter Tom Current 10000
Capital John Peter Tom John Peter Tom Current Bal b/f Realization Stock Debtors Current Realization -profit Shares in Fortune Ltd Bank (Bal. fig.) Shares in Fortune Ltd. 150000* = John 1/ Peter 1/ Tom 3/
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Fortune Limited Balance sheet as at 1 Jan 1996 Fixed Assets Goodwill Premises MV 295000 Current Assets Bank [ (50000*1.2) –( )] Less: Current liabilities Creditors Working Capital (47450) 247550 Share Capital Ordinary Shares (150000*$ *$1) Share Premium (150000*$ *$0.2) 240000 Long-term liabilities Loan from Tom 247550
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Cash distribution among partners
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Cash Distribution Among Partners
With the application of the Garner vs. Murray rule When cash is to be distributed as soon as possible ( Piecemeal realization)
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With the application of Garner vs. Murray rule
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With the application of Garner vs. Murray rule
Any CREDIT balance in each partner’s capital account represents the amount which can be withdrawn from the partnership to each partner Any DEBIT balance in a partner’s capital account represents additional cash to be injected by that partner. If he is insolvency to repay the amount, the solvency partners will be shared the amount in: Profit & loss sharing ratio Any agreed ratio given in the examination question GARNER vs. MURRAY rule may be applied
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What is Garner vs. Murray rule?
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Garner vs. Murray rule Under the rule, a partner is required to contribute cash to eliminate the debit balance in his capital account In the court case of Garner vs. Murray (1904), it was held that subject to any agreement to the contrary, such a debit balance deficiency was to be shared by the other partner not in their profit and loss sharing ratio but “ the ratio of their last agreed capitals”
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If one partner is insolvent, his capital deficiency will be shared by other partners according to the ‘last agreed capital ratio’ (the ratio of the balances in the capital accounts before the dissolution, in the absence of any agreement to the contrary
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Example 3
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Au, Chow and Lee were partners sharing profits and losses in the ratio 2:2:1.
The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Goodwill Land Plant & Machinery Fixture & Fittings Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Cash 123160 Less: Current Liabilities Creditors Bank Overdraft Working Capital 290000
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Capital: Au Chow Lee Current: Au Chow Long – term liabilities Bank loan 290000 On 31 December 1996 the partners agreed to dissolve the partnership due to a disagreement between the partners. Assets were to be realized, outstanding debts to be paid and the remainder to be shared by the partners in an equitable manner. Distributions of cash were to be made as soon as possible. January Provision was made for dissolution expenses of $2400 Land was sold for $200000 The cash available was utilized to settle in full the bank overdraft, the bank overdraft, the bank loan and all creditors after receiving discounts
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March Stock which had originally costed $40000 was sold for $32000 $15000 was received form debtors April Plant & Machinery were sold for $51000 after paying carriage of $2000 Fixtures and fittings were sold for $12000 May All the outstanding debtors, with the exception of a customer who owed $4000 settled their accounts Motor vehicles were sold for $25000 The remaining stock was sold for $22000 Dissolution expenses amounted to $2100 Prepare distribution statement of cash at each stage
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Distribution Statement
Total Au Chow Lee $ $ $ $ Capital accounts Current accounts 1st Distribution: Cash available (w1) ( 47000) Maximum possible loss (2:2:1) (14600) Lee’s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (8760) (5840) Cash distributed 2nd Distribution: Capital balance Cash available ( ) (63000) Maximum possible loss (2:2:1) (2000) Lee’s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (1200) (800) Cash distributed
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97960-32760 3rd Distribution: Capital balance 160000 65200 64800 30000
Cash available (W2) (93300) Maximum possible loss (2:2:1) Cash distributed
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=> no cash distribution to partners on January
W1 Cash available for 1st distribution: January Opening balance Receipt from land 200160 Less: Payment Assumed dissolution expenses 2400 (i.e. not actual expenses) Bank overdraft Bank loan Creditors (Bal. Fig.) ‘Settle in full’ means no more payment will be paid. => the difference between and 49400 is discount received => no cash distribution to partners on January March Receipts: Stock Debtors First cash distributed to partners Back
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Notes: Very often no cash is distributed to partners at first or second month since outstanding debts must be repaid first and then the remaining cash can then be distributed to partners. Even though the questions have not mentioned to repay outstanding debts, you should make sure to keep some cash to prepare to repay debts and could not be distributed it to partners
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Back W3 Cash available for 3rd distribution: May Receipts
Surplus in dissolution expenses( ) Collection remaining debtors balance ( ) Receipts from MV Receipts from remaining stock 93300 Back
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Realization Goodwill Land Plant & Machinery Fixtures & fittings Motor Vehicles Stock Debtors Cash: Land Stock ( ) Debtors ( ) Plant & machinery Fixture & fittings Motor vehicles Creditors – discount rececived ( ) Cash - dissolution expenses Capital: Au (2/5) Chow (2/5) Lee (1/5)
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Capital Au Chow Lee Au Chow Lee Cash in March In April in May Bal b/f Current Realization -loss
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