PARTNERSHIP LIQUIDATION Chapter 8 Dissolution Due to a

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PARTNERSHIP LIQUIDATION

• Chapter 8

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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

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Termination

• Partnership ceases normal business operations

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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 difficulty

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Liquidation (cont)

• May be
• Voluntary the partners may choose to liquidate
• Involuntary creditors force the partnership to
  liquidate

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Accountants Liquidation Responsibilities

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

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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 depending on source of payment

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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)

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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 capital balance

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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

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Uniform Partnership Act Partnership Claims (cont)

• 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 and undistributed
  income are often combined into one account

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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 over partnership capital account
  balances in the distribution

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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 partners receive any
  distribution

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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

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Partnership Distributions 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 made and there
  are insufficient assets to pay creditors, the
  accountant may be liable to the creditors

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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

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Statement of Realization and Liquidation

• 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 of
  offset)

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Statement of Realization and Liquidation (cont)

• 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 not exist on the
  statement because they are only relevant to a
  going concern

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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

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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 respective residual profit and loss
  ratios

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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 Johnson Mitchell
• 55,250 (129,250) (6,000)

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Statement of Realization and Liquidation

• Briscoe deficit allocation
• (.35) (.20)
• Johnson Mitchell
• .35/(.35.20) x 55,250 35,159
• .20/(.35.20) x 55,250 20,091

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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 equal distributable cash
• Allocation may result in other capital deficits
  and further allocations

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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 make additional
  contributions to eliminate capital deficits

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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

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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

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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 partners respective
  capital account to -0-

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Loss Absorption Power

• Calculation
• Loss Partner Residual Profit
• Absorption Capital and Loss
• Power Balance Percentage
• Example 4 (Johnson)
• 577,000 201,950 / .35

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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 power by 2.86 (1/.35)

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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 - 240,000) .35 117,950

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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 - 207,700) 32,300

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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

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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

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Schedule of Safe Payments

• 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
  assumptions