ISMChap015

Chapter 15 SM 8e

Chapter 15 - Partnerships: Termination and LiquidationChapter 15 - Partnerships: Termination and Liquidation

Chapter 15

Partnerships: termination and liquidation

Chapter Outline

I. The termination of a partnership and liquidation of its property may take place for a number of reasons.

A. The death, withdrawal, or retirement of a partner can lead to cessation of business activity.

B. The bankruptcy of either an individual partner or the partnership as a whole can necessitate termination and liquidation.II. Because of the importance of liquidating and distributing assets fairly, all parties look to the accountant to play an important role in the process.

A.The accountant provides timely financial information.

B.The accountant works to ensure an equitable settlement of all claims.

III.The statement of liquidation

A. The liquidation process usually involves the disposal of noncash assets, payment of liabilities and liquidation expenses, and distribution of any remaining cash to the partners based on their final capital balances.

B. A statement of liquidation should be produced periodically by the accountant to disclose losses and gains that have been incurred, remaining assets and liabilities, and current capital balances.

IV.Deficit capital balances

A. By the end of, or even during, the liquidation process, one or more partners may have a negative (or deficit) capital balance often as a result of losses incurred in disposing of assets.

B. The Uniform Partnership Act indicates that any deficit capital balance should be eliminated by having that partner contribute enough additional assets to offset the negative balance.

C. If this contribution is not immediately received, the remaining partners may request a preliminary distribution of any partnership cash that is available.

1. Safe payments of cash to individual partners are determined based on safe capital balances, the amounts that will remain in the individual capital accounts even if all deficits and other assets prove to be complete losses that must be absorbed by the remaining partners.

2. If a portion (or all) of a deficit is subsequently recovered from a partner, a further distribution to the other partners is made based on newly computed safe capital balances.

3. Any deficit that is not recovered from a partner must be charged to the remaining partners based on their relative profit and loss ratio.

V.Treatment of partners loan to partnershipA. The Uniform Partnership Act states that, in a liquidation, partnership assets should be used to first settle claims of partnership creditors, including claims of partners who are creditors.

1. This implies that the partnership would first repay partners loans before distributing any cash to partners based on their capital balances.

B. However, in practice, to avoid making a cash distribution to a partner who subsequently develops a deficit capital balance, partners loan accounts typically are combined with partners capital accounts and funds are distributed accordingly. This text uses this practice.Vl.Preliminary distribution of assets to the partners

A. The liquidation process can extend over a lengthy period of time as business activities wind down and property is sold.

B. When the partnership terminates activity, or during the course of the liquidation, more cash may be available than the amount needed to extinguish all potential liabilities and liquidation expenses.

C. If possible, the distribution of excess cash amounts should be made as quickly as possible to enable the partners to make use of their funds.

1. The accountant may choose to produce a proposed schedule of liquidation at such times to determine the equitable distribution of cash amounts that become available.

2. The proposed schedule of liquidation is developed based upon simulating the accounting recognition that would be required by a possible series of transactions: assets are sold, expenses are paid, etc.a. These events are simulated with the anticipation of maximum losses in each case.

b. Noncash assets are assumed to have no resale value; maximum possible liquidation expenses are included; all partners are considered personally insolvent; etc.

3. Ending potential capital balances that remain on a proposed schedule of liquidation are safe capital balances, the amounts that could be immediately paid to each partner without jeopardizing future payments. Safe capital balances indicate that the partner will still have a sufficient interest in the partnership to absorb all potential losses even after a preliminary distribution.

Vll. Predistribution plan

A. The proposed schedule of liquidation (described above) can be used to determine safe payments based on safe capital balances but a newly revised schedule must be prepared each time a distribution of cash to partners is contemplated.B. Accountants often prefer to produce a single predistribution plan at the start of a liquidation to provide guidance for all payments made to the partners throughout this process.

C. Information for the predistribution plan is generated by assuming the occurrence of a series of losses, each just large enough to eliminate one partner's claim to any partnership property.

D. Once a series of losses has been simulated that would eliminate the capital balances of all partners, the actual plan is developed by measuring the effects that occur if the losses do not materialize.

E. By working backwards through this series of possible losses, a predistribution plan can be produced that serves as a guide for all payments made during the liquidation.

Answer to Discussion Question: What Happens if a Partner Becomes Insolvent?This case demonstrates one of the nightmares of a partnership: the apparent insolvency of a partner is threatening the future of a successful business. The problem is especially acute to Wilkinson and Walker since this partnership was created solely for convenience; the partners share the facilities but do not actually work together. Therefore, the presence of Rogers is not essential to the other partners except that he pays a portion of the business's expenses. However, the claim that has been filed could lead to the actual liquidation of the entire business.

Obviously, the partners should take no immediate action until they have spoken with Rogers. The entire issue may prove to be a mistake. Conversely, numerous other claims against Rogers may also be outstanding with the initial claim simply being the first to be filed. Because of the various possibilities, Wilkinson and Walker should consult with an attorney to learn of the partnership laws that apply in their state. They should also begin considering possible alternatives to salvage their business if Rogers is indeed insolvent.

One alternative is for Wilkinson and Walker to buy out Rogers partnership interest. Rogers would receive his money and the remaining partnership could be left intact. However, they would have to provefor legal reasonsthat a fair price was being paid, and they would need to come up with a significant amount of cash in a short period of time. Finally, Wilkinson and Walker would have a building that was apparently larger than their needs. Unless they could utilize the space in some manner, they might have no way of recouping their additional investment.

As a second possibility, a new dentist could be brought in to acquire Rogers interest in the partnership. Again, the money is conveyed to Rogers but now the original partners are not forced to make the payment. The building would continue to be fully utilized so that the partners' expenses would not escalate. In this case, though, a new partner may have to be identified in a short period of time. Furthermore, since the partners are sharing space, Wilkinson and Walker will probably want to ensure that the new partner is someone with whom they can work comfortably. Because of time considerations, they may not have the opportunity of getting the new partner they would like.

Finally, the partnership can be liquidated. Wilkinson and Walker could then take their share of the proceeds and buy a new building for the continuation of their practices. Unfortunately, in liquidation, assets do not always bring fair market value. Thus, the partners may be forced to absorb significant losses as a result of Rogers' insolvency. In addition, the moving of any business can disrupt service and have a possible adverse impact on profitability.

Although Wilkinson and Walker have several possible actions that can be taken, none of these is without problems. Therefore, partners should always include agreements within their Articles of Partnership to specify actions that will be taken in such cases. The insolvency of a partner is not a particularly unusual event. Hence, the partners (or their attorneys and accountants) should have the forethought to arrange the resolution of the business if insolvency of a partner does occur.

Answers to Questions

1. A dissolution refers to the cessation of a partnership. In many cases, this process is simply a preliminary step in the transfer of business property to a newly formed partnership. Therefore, a dissolution does not necessarily affect the operations of the business or the sale of assets. In a liquidation, actual business activities cease. Partnership property is sold with the remaining cash distributed to creditors and to any partners with positive capital balances. Dissolution refers to changes in the composition of a partnership whereas liquidation is the selling of a partnership's assets.

2. Many reasons can exist that would lead to the termination and liquidation of a partnership. The business might simply have failed to generate sufficient profits or the partners may elect to enter other lines of work. Liquidation can also be required by the death, retirement, or withdrawal of one of the partners. In such cases, liquidation is often necessary to settle the partner's interest in the business. The bankruptcy of an individual partner can also force the termination of the business as can the bankruptcy of the partnership itself.

3. During the liquidation process, monitoring the balance of the partners' capital accounts becomes of paramount importance. That amount will eventually indicate either the cash to be received by the partners as final distributions or the additional contributions that they are required to pay to the partnership. Consequently, all liquidation gains and losses are recorded directly as changes to the partners capital balances. Such recording enhances the informational value of the accounts. As an additional factor, the computation of a net income figure is of diminished importance since normal operations have ceased.

4. Final distributions made to the various partners are based solely on their ending capital account balances unless the partners have agreed otherwise. If any partner has a deficit balance, that partner should make an additional contribution to the partnership to offset the negative capital balance. In some situations, a question may arise as to whether compensation for a deficit will ever be forthcoming from the responsible party. The remaining partners may choose to allocate the available cash immediately based on the assumption that the deficit balance eventually will prove to be a total loss.

5. A statement of liquidation summarizes the financial effect of the liquidation process as it has progressed to date. Information to be presented includes the balances of all remaining assets, the liability total, and the capital account of each partner. In addition, the allocation of all gains and losses incurred in the liquidation process as well as the payment of liquidation expenses should be reflected in the statement.6. From a legal viewpoint, any partner who incurs a negative (or deficit) capital balance is obligated to make an additional contribution to offset that amount.7. A safe capital balance is the amount of a partner's capital account that exceeds all possible needs of a partnership as it goes through liquidation. A partner should, therefore, be able to receive this balance immediately without endangering the future amount to be received by any other party connected with the liquidation. Safe capital balances are computed by making a series of assumptions whereby the partnership undergoes maximum losses during the remainder of the liquidation process: all noncash assets are assumed to have no resale value, liquidation expenses are set at the largest possible estimation, and all partners are viewed as personally insolvent. Any capital balance that would remain after this series of anticipated events can be distributed to the partners immediately without incurring any risk.

8. Although the Uniform Partnership Act states that loans from partners rank ahead of the partners capital balances in the distribution of partnership assets, in practice a partners loan balance is usually merged with that partners capital balance to minimize the chance of a negative capital balance arising during the liquidation. This particular partner may get less money from the liquidation because of this treatment but the other partners are better protected.

9. A proposed schedule of liquidation is prepared by the accountant to determine the allocation of any cash available in the early stages of a liquidation that exceeds the amount needed to pay all liabilities and estimated liquidation expenses. The schedule is based on anticipating a series of assumed losses from the current day forward: all remaining noncash assets are scrapped, maximum liquidation expenses are incurred, and each partner is personally insolvent. The ending balances that would result from these simulated transactions represent safe capital balances. The amounts calculated as safe capital balances can be distributed as safe payments to individual partners and the partnership will still retain enough capital to absorb all future losses.

10. A predistribution plan is produced based on an assumed series of losses. Each loss is calculated to eliminate in turn the capital balance of one of the partners. In this manner, the accountant can determine the vulnerability to losses exhibited by each capital account. When the last balance is eliminated, the accountant will have established a series of losses that exactly offsets each balance. The predistribution plan is then developed by measuring the effects that are created if the losses do not occur. In effect, the accountant works backwards through the assumed losses to create a pattern of available cash, the predistribution plan.

Answers to Problems

1.C

2.A

3.D

4.B(Partner with deficit capital balance)

Angela, CapitalWoodrow, Capital Cassidy, Capital

Reported balances$19,000$18,000$(12,000)

Potential loss from

Cassidy deficit

(split 5/8:3/8) (7,500)(4,500)12,000

Cash distributions$11,500$13,500

-0-5.B(Insolvent partner) BellHardy DennardSuddath

Reported balances $50,000$56,000$14,000$80,000

Loss on sale of assets ($110,000)

split on a 4:3:2:1 basis (44,000)(33,000)(22,000)(11,000)

Adjusted balances $ 6,000$23,000$(8,000)$69,000

Potential loss from Dennard

deficit (split 4:3:1) (4,000) (3,000)8,000 (1,000)

Minimum cash distributions $2,000$20,000$ -0-$68,0006.A(Predistribution plan)7.A(Proposed schedule of liquidation to determine safe payments before the liquidation begins; partner has deficit)

ArtRaymondDarby

Reported balances

$18,000$25,000$26,000

Loss on sale of assets ($22,000) split

on a 4:3:3 basis

(8,800)(6,600)(6,600)

Adjusted balances

$ 9,200$18,400$19,400

Anticipated liquidation expenses ($12,000)

split on a 4:3:3 basis

(4,800)(3,600)(3,600)

Anticipated maximum loss on inventory

($31,000) split on a 4:3:3 basis

(12,400)(9,300)(9,300)

Potential balances

$(8,000)$ 5,500$ 6,500

Potential loss from Art deficit (split 3:3)

8,000 (4,000) (4,000)

Safe payments

$ -0-$ 1,500$ 2,5008.D(Proposed schedule of liquidation; partner has deficit)

Since the partnership currently has total capital of $400,000, the $30,000 that is available would indicate maximum potential losses of $370,000.

A B C

Reported balances

$100,000$120,000$180,000

Anticipated loss ($370,000) split on

a 2:3:5 basis

(74,000)(111,000)(185,000)

Potential balances

$ 26,000$ 9,000$ (5,000)

Potential loss from C's deficit (split 2:3)(2,000)(3,000) 5,000

Current cash distribution

$ 24,000$ 6,000$ -0-9.C(Predistribution plan)

To solve this problem a predistribution plan should be created.

Maximum Losses That Can Be Absorbed

Kevin $59,000/40%$147,500

Michael $39,000/30% 130,000 (most vulnerable to losses)

Brendan $34,000/10% 340,000

Jonathan $34,000/20% 170,000

The assumption is made that a $130,000 loss occurs:

Kevin Michael Brendan Jonathan

Reported balances $59,000 $39,000$34,000$34,000

Assumed loss ($130,000) split

on a 4:3:1:2 basis (52,000) (39,000)(13,000)(26,000)

Adjusted balances $ 7,000$ -0-$21,000$ 8,000

Maximum Losses That Now Can Be Absorbed

Kevin $7,000 / 4/7$12,250(most vulnerable to losses)

Brendan$21,000 / 1/7147,000

Jonathan$8,000 / 2/7 28,000


Kevin Brendan Jonathan

Reported balances $7,000$21,000$8,000


on a 4:1:2 basis (7,000)(1,750)(3,500)

Adjusted balances $ -0-$19,250$4,500

Maximum Losses That Now Can Be Absorbed

Brendan$19,250/1/3$57,750

Jonathan$4,500/2/3 6,750 (most vulnerable to losses)


BrendanJonathan

Reported balances

$19,250 $4,500

Assumed loss ($6,750) split on a 1:2 basis

(2,250) (4,500)

Adjusted balances

$17,000$ -0-

Brendan will receive a $17,000 distribution from the partnership before any of the other partners collect any cash.

10.C(Predistribution plan)

To solve this problem, the following predistribution plan is created:

First $3,000 goes to Menton

Next $15,000 goes to Menton (2/3) and Hoehn (1/3)

Next $42,000 goes to Carney (4/7), Menton (2/7), and Hoehn (1/7)

All remaining cash goes to Carney (4/10), Pierce (3/10), Menton (2/10), and Hoehn (1/10)

Carney Pierce Menton Hoehn

Beginning balances

$60,000$27,000$43,000$20,000

Assumed loss of $90,000 (see

Schedule 1) (4:3:2:1 basis)

(36,000)(27,000)(18,000)(9,000)

Step one balances

$24,000$ 0$25,000$11,000



(24,000)$ 0(12,000)(6,000)

Step two balances

$ 0$ 0$13,000$ 5,000



0 0(10,000) (5,000)

Step three balances

$ 0$ 0$ 3,000 $ 0Schedule 1

Maximum Loss

Capital Balance/That Can

PartnerLoss AllocationBe Absorbed

Carney

$60,000/40%$150,000

Pierce

$27,000/30%$ 90,000 (most vulnerable)

Menton

$43,000/20%$215,000

Hoehn

$20,000/10%$200,000

Schedule 2

Maximum Loss



Carney

$24,000/(4/7)$ 42,000(most vulnerable)

Menton

$25,000/(2/7)$ 87,500

Hoehn

$11,000/(1/7)$ 77,000

Schedule 3

Maximum Loss



Menton

$13,000/(2/3)$ 19,500

Hoehn

$ 5,000/(1/3)$ 15,000(most vulnerable)

11.C(Partners with deficit capital balances; proposed schedule of liquidation; safe capital balances)

The $16,000 available cash can be distributed but should be done under the assumption that all deficit balances will be total losses. After offsetting Jones' loan against his deficit capital balance, both Jones and Wayman have deficits of $2,000; total $4,000. Fuller and Rogers, the two partners with positive capital balances, share profits in a 30:20 relationship (the equivalent of a 60%:40% ratio). Fuller would absorb $2,400 of the potential $4,000 loss with Rogers being allocated $1,600. The remaining capital balances ($10,600 and $5,400) are safe capital balances and those amounts can be immediately distributed.

WaymanJonesFullerRogers

(30%)(20%)(30%)(20%)

Reported balances $(2,000)$(2,000)$13,000$7,000

Potential losses from Wayman

and Jones split on a 3:2 basis 2,0002,000(2,400)(1,600)

Adjusted balances $ -0-$ -0-$10,600$5,40012.(8 minutes) (Determine safe payments; partner has deficit) Cleveland receives $6,800 and Pierce receives $1,200

Since the partnership currently has total capital of $350,000, the $8,000 that is available would indicate maximum potential losses of $342,000.

Nixon Cleveland Pierce

Reported balances

$170,000$110,000$70,000

Anticipated loss ($342,000) split

on a 5:3:2 basis

(171,000)(102,600)(68,400)

Potential balances

$ (1,000) $ 7,400$ 1,600

Potential loss from Nixon's deficit (split 3:2)1,000 (600) (400)

Safe payments

$ -0- $6,800 $ 1,20013. (20 minutes) (Final settlement of a partnership being liquidated; various amounts of loss on sale of assets) Part a.Brown gets $21,000, Fish gets $12,000, and Stone gets $2,000.

Brown Fish Stone

Reported balances

$25,000$15,000$5,000

Loss on sale of land ($10,000) split

on a 4:3:3 basis

(4,000) (3,000)(3,000)

Cash distribution

$21,000$12,000$2,000Part b. Brown gets $16,429 and Fish gets $8,571

Brown Fish Stone

Reported balances

$25,000$15,000$5,000

Loss on sale of land ($20,000) split on

a 4:3:3 basis

(8,000) (6,000) (6,000)

Adjusted balances

$17,000$ 9,000$(1,000)

Potential loss from Stone's deficit (split 4:3) (571) (429) 1,000

Cash distribution

$16,429$ 8,571$ -0-Part c. Brown gets $10,714 and Fish gets $4,286

Brown FishStone

Reported balances

$25,000$15,000$5,000

Loss on sale of land ($30,000) split on

a 4:3:3 basis

(12,000) (9,000) (9,000)

Adjusted balances

$13,000$ 6,000$(4,000)

Potential loss from Stone's deficit (split 4:3) (2,286) (1,714) 4,000

Cash distribution

$10,714$ 4,286$ -0-14.(10 minutes) (Distribute cash contributed by partner with deficit balance)

The entire $20,000 goes to Atkinson.

Atkinson Kaporale Dennsmore Rasputin

Reported balances

$70,000$30,000$(42,000) $(58,000)

Capital contribution

-0- -0- -0- 20,000

Adjusted balances

$70,000$30,000$(42,000) $(38,000)

Potential loss from Dennsmore

and Rasputin ($80,000) split

on a 4:3 basis

(45,714)(34,286) 42,000 38,000

Adjusted balances

$24,286$(4,286)$ -0-$ -0-

Potential loss from Kaporale

($4,286)

(4,286) 4,286 -0- -0-

Cash distribution $20,000$ -0-$ -0- $ -0-15. (8 minutes) (Determine safe payments)

Ball gets $143, Eaton gets $1,429, and Lake gets $3,428.

AceBallEatonLake

Reported balances

$25,000$28,000$20,000$22,000

Maximum losses on land and building

($85,000) split on a 3:3:2:2 basis (25,500)(25,500)(17,000)(17,000)

Estimated liquidation expenses

($5,000) split 3:3:2:2

(1,500)(1,500)(1,000)(1,000)

Potential balances

$(2,000)$ 1,000$ 2,000$ 4,000

Potential loss from Ace ($2,000) split

on a 3:2:2 basis

2,000 (857) (571) (572)

Safe payments

$ 0$ 143$ 1,429$ 3,42816. (15 minutes) (Prepare a proposed schedule of liquidation) HARDWICK, SAUNDERS, AND FERRIS

Proposed Schedule of Liquidation

Hardwick,

Ferris,

Other AccountsLoan and Saunders, Loan &

CashAssetsPayableCapitalCapitalCapital

Beginning

balances90,000820,000(210,000)(270,000)(200,000)(230,000)Sold assets 200,000(328,000)

51,20038,40038,400

Assumed: loss

on remaining

assets

(492,000)

196,800147,600147,600

Paid liabilities(210,000) (210,000)

Safe balances80,000 0 0(22,000)(14,000)(44,000)Of the available $80,000 in cash, $22,000 can be paid safely to Hardwick, $14,000 to Saunders, and $44,000 to Ferris.

17.(7 minutes) (Determine amount of cash needed to assure payments to all partners)

Watson is the partner most vulnerable to a loss. A loss of only $100,000 would completely eliminate Watson's capital balance:

Miller $69,000/60% = $115,000 loss to eliminate capital

Tyson $69,000/20% = $345,000 loss to eliminate capital

Watson $20,000/20% = $100,000 loss to eliminate capital

Thus, if the loss on disposal is less than $100,000, all partners will retain positive capital balances and receive some cash in liquidation. Because of this, since "other assets" are $150,000, they must be sold for any amount over $50,000 for all partners to get cash.

18.(5 minutes) (Determine safe capital balances and safe payments) Maximum potential losses are $128,000: $8,000 in liquidation expenses and a complete $120,000 loss on the noncash assets. Such a loss would reduce the capital balances to: Babb $8,800, Whitaker ($5,600), and Edwards ($1,200). Babb must retain capital of $6,800 ($5,600 + $1,200) to be able to absorb the possible losses of Whitaker and Edwards. The remaining $2,000 ($8,800 - $6,800) is a safe capital balance for Babb, and a safe payment of $2,000 can be made to this partner.

19.(10 minutes) (Determine amount to be contributed by partner with a deficit capital balance) White and Blue are both insolvent and have negative capital balances (after offsetting the loan from White) totaling $15,000 (White, $3,000; Blue, $12,000). Absorption by the other partners of these losses would be as follows (on a 30:10:20 basis):

Current

AdjustedPartner Capital Balance Share of Loss

Capital Balance

Black $ 3,00030/60 x $15,000 = $7,500 $ (4,500)Green $ (3,000)10/60 x $15,000 = $2,500 $ (5,500)

Brown $15,00020/60 x $15,000 = $5,000 $10,000

Black, who is also insolvent, now has a deficit capital balance of $4,500 that would have to be absorbed by Brown and Green (on a 10:20 basis):

Current

Adjusted

Partner Capital Balance Share of Loss

Capital Balance

Green $ (5,500)1/3 x $4,500 = $1,500 $(7,000)

Brown $10,0002/3 x $4,500 = $3,000 $ 7,000

Thus, Green must contribute $7,000 that will go to Brown.

20.(50 minutes) (Determine payments under a variety of circumstances; safe capital balances; predistribution plan) a.Dobbs receives the entire $10,000.

Maximum potential losses of $250,000 on noncash assets would be allocated as follows:

Partner Share of Loss New Capital Balance

Adams 2/10 x $250,000 = $50,000 $ 30,000

Baker 3/10 x $250,000 = $75,000 $(45,000)

Carvil 3/10 x $250,000 = $75,000 $(15,000)

Dobbs 2/10 x $250,000 = $50,000 $ 40,000

Maximum total potential losses of $60,000 to be absorbed from Baker and Carvil above would then be allocated to Adams and Dobbs as follows on a 2:2 basis:


Adams 2/4 x $60,000 = $30,000 -0-

Dobbs 2/4 x $60,000 = $30,000 $ 10,000

Absorbing this potential loss would leave Dobbs with a safe capital balance of $10,000.

b.Adams receives the entire $10,000.

Maximum potential losses of $250,000 on noncash assets would be allocated as follows:


Adams 2/10 x $250,000 = $50,000 $ 30,000

Baker 2/10 x $250,000 = $50,000 $(20,000)

Carvil 3/10 x $250,000 = $75,000 $(15,000)

Dobbs 3/10 x $250,000 = $75,000 $ 15,000

Maximum total potential losses of $35,000 to be absorbed from Baker and Carvil above would be allocated to Adams and Dobbs as follows on a 2:3 basis:


Adams 2/5 x $35,000 = $14,000 $ 16,000

Dobbs 3/5 x $35,000 = $21,000 $ (6,000)

Absorbing the final $6,000 loss from Dobbs would leave Adams with a safe capital balance of $10,000.

20. (continued)c.Adams receives $57,500 and Dobbs gets $22,500.

The $50,000 loss on sale of the building would be allocated as follows:


Adams 10% x $50,000 = $5,000 $ 75,000

Baker 30% x $50,000 = $15,000$ 15,000

Carvil 30% x $50,000 = $15,000 $ 45,000

Dobbs 30% x $50,000 = $15,000 $ 75,000

Maximum potential loss of $130,000 on the land would be allocated as follows:


Adams 10% x $130,000 = $13,000 $ 62,000

Baker 30% x $130,000 = $39,000$(24,000)

Carvil 30% x $130,000 = $39,000 $ 6,000

Dobbs

30% x $130,000 = $39,000 $ 36,000

Maximum potential loss of $24,000 to be absorbed from Baker would be allocated as follows on a 1:3:3 basis:


Adams 1/7 x $24,000 = $3,428 $ 58,572

Carvil 3/7 x $24,000 = $10,286 $ (4,286)

Dobbs 3/7 x $24,000 = $10,286 $ 25,714

Maximum potential loss of $4,286 to be absorbed from Carvil would be allocated as follows on a 1:3 basis:


Adams 1/4 x $4,286 = $1,072$57,500

Dobbs 3/4 x $4,286 = $3,214 $22,500

These amounts represent safe capital balances for distribution purposes.

20. (continued)d.The land and building must be sold for over $115,000 to ensure that Carvil will receive some cash.

This can be determined by preparing a predistribution plan as follows:

AdamsBakerCarvilDobbs

Beginning balances

$ 80,000 $ 30,000$ 60,000$ 90,000

Assumed loss of $100,000

(Schedule 1) (1:3:4:2 basis) (10,000) (30,000)(40,000)(20,000)

Step One balances

$ 70,000 $ 0$ 20,000$ 70,000


(Schedule 2) (1:0:4:2)

(5,000) 0(20,000)(10,000)

Step Two balances

$ 65,000 $ 0$ 0$ 60,000


(Schedule 3) (1:0:0:2)

(30,000) 0 0(60,000)

Step Three balances

$ 35,000 $ 0$ 0$ 0

Schedule 1

Maximum Loss


Partner

Loss AllocationBe Absorbed

Adams$80,000/10%$800,000

Baker

$30,000/30%$100,000 (most vulnerable)

Carvil

$60,000/40%$150,000

Dobbs$90,000/20%$450,000

Schedule 2

Maximum Loss


Partner


Adams$70,000/(1/7)$490,000

Carvil

$20,000/(4/7)

$ 35,000 (most vulnerable)

Dobbs$70,000/(2/7)$245,000

Schedule 3

Maximum Loss


Partner


Adams

$65,000/(1/3)$195,000

Dobbs

$60,000/(2/3)

$ 90,000 (most vulnerable)

20.d.(continued)

PREDISTRIBUTION PLAN

The first $35,000 available goes to Adams. Next $90,000 is split between Adams and Dobbs on a 1:2 basis. Next $35,000 is split between Adams, Carvil, and Dobbs on a 1:4:2 basis. All remaining cash is split between Adams, Baker, Carvil, and Dobbs on the original profit and loss ratio.

Total cash of $125,000 ($35,000 + $90,000) has to be available before Carvil will receive any cash. Since the partnership already has $10,000 cash in excess of its liabilities, the land and building must be sold for over $115,000 to ensure Carvil of receiving some amount.

As another approach to the problem, Carvil's capital balance is eliminated through the $100,000 Step One loss and the $35,000 Step Two loss. Thus, avoiding a complete $135,000 loss ensures that Carvil will receive cash. Since the land and buildings have a book value of $250,000, such losses would be avoided by receiving over $115,000.

21. (30 minutes) (Prepare journal entries for a partnership liquidation; prepare a final statement of partnership liquidation)

Part A. Preparation of journal entries.

a.The partnership has $100,000 in cash, liabilities of $80,000 and estimated liquidation expenses of $10,000. Thus, there is $10,000 that can be safely paid to the partners before the liquidation of noncash assets. This amount is allocated to the two partners on the basis of their potential capital balances assuming that noncash assets are scrapped for a loss of $200,000 and liquidation expenses are $10,000:

Current CapitalShare ofPotential

PartnerBalanceMaximum Loss*Capital

Fred

$100,00060% x $210,000 = $126,000$(26,000)

George$120,00040% x $210,000 = $84,000$36,000

Because Fred has a potential deficit capital balance, the entire $10,000 currently available is distributed to George, which reduces this partners capital balance to $110,000.

George, Capital

10,000

Cash

10,000

b.Liabilities

40,000

Cash

40,000

c.Cash.

220,000

Fred, Capital (60% of gain)

12,000

George, Capital (40%)

8,000

Noncash assets

200,000

Fred and George now have capital balances of $112,000 and $118,000, respectively.

21. (continued)d.To determine the safe payments to be made at this point in the liquidation, the accountant prepares the following proposed schedule of liquidation:

Fred,George,

Non-cash

CapitalCapital

CashAssetsLiabilities(60%)(40%)

Beginning balances$100,000$200,000$(80,000)$(100,000)$(120,000)

Distribution to partners(10,000)-0--0--0-10,000

Paid liabilities(40,000)-0-40,000-0--0-

Sold noncash assets220,000(200,000)-0-(12,000)(8,000)

Updated balances270,000-0-(40,000)(112,000)(118,000)

Maximum liabilities(40,000)

40,000

Max. liquidation expenses(10,000)-0--0-6,0004,000Safe balances$220,000-0--0-$(106,000)$(114,000)Safe payments of $106,000 and $114,000 can be made to Fred and George, respectively at this point in the liquidation.

Fred, Capital

106,000

George, Capital

114,000

Cash

220,000

e.Liabilities

40,000

Cash

40,000

f.Fred, Capital (60% of expense)

4,800

George, Capital (40%)

3,200

Cash

8,000

g.The statement of partnership liquidation presented on the next page shows that $2,000 cash remains after paying liquidation expenses. The partners have positive capital balances of $1,200 and $800, respectively, and the remaining partnership cash can be distributed based on these ending totals.

Fred, Capital

1,200

George, Capital

800

Cash

2,000

21. (continued)Part B. Prepare a final statement of partnership liquidation.

Fred and George Partnership

Statement of Partnership Liquidation

CashNon-cash AssetsLiabilitiesFred, Capital (60%)George, Capital (40%)

Beginning balances $100,000 $200,000 $(80,000) $(100,000) $(120,000)

Distribution to partners (10,000)-0--0--0- 10,000

Paid liabilities (40,000)-0- 40,000 -0--0-

Sold noncash assets 220,000 (200,000) -0- (12,000) (8,000)

Updated balances 270,000 -0- (40,000) (112,000) (118,000)

Distribution to partners (220,000) -0- -0- 106,000 114,000

Updated balances 50,000 -0- (40,000) (6,000) (4,000)

Paid liabilities (40,000) -0- 40,000 -0--0-

Paid liquidation expenses (8,000) -0- -0- 4,800 3,200

Updated balances 2,000 -0- -0- (1,200) (800)

Distribution to partners (2,000) -0- -0- 1,200 800

Closing balances$ -0- $ -0- $ -0- $ -0- $ -0-

22. (30 minutes) (Prepare a predistributlon plan) An assumed series of losses is simulated which eliminates each partner's capital account in turn:

LarsonNorrisSpencer Harrison

Beginning balances

$ 15,000$ 60,000$ 75,000$ 41,250


(Schedule 1) (2:3:2:3 basis) (15,000)(22,500)(15,000)(22,500)

Step One balances

$ -0-$ 37,500$ 60,000$ 18,750


(Schedule 2) (0:3:2:3 basis) 0(18,750)(12,500)(18,750)

Step Two balances

$ 0$ 18,750$ 47,500$ -0-


(Schedule 3) (0:3:2:0 basis) -0- (18,750)(12,500) -0-

Step Three balances

$ -0-$ -0-$ 35,000 $ -0-Schedule 1

Maximum Loss


Partner


Larson$15,000/20%$ 75,000 (most vulnerable)

Norris

$60,000/30%$200,000

Spencer$75,000/20%$375,000

Harrison$41,250/30%$137,500

Schedule 2

Maximum Loss


Partner


Norris

$37,500/(3/8)$100,000

Spencer$60,000/(2/8)$240,000

Harrison$18,750/(3/8)$ 50,000 (most vulnerable)Schedule 3

Maximum Loss


Partner


Norris

$18,750/(3/5)$ 31,250 (most vulnerable)

Spencer

$47,500/(2/5)$118,750


First $55,000 goes to pay liabilities ($47,000) and liquidation expenses (estimated at $8,000).

Next $35,000 available goes to Spencer.

Next $31,250 is split between Norris and Spencer on a 3:2 basis.

Next $50,000 is split among Norris, Spencer, and Harrison on a 3:2:3 basis.

All remaining cash is split among Larson, Norris, Spencer, and Harrison on the original profit and loss ratio.

23. (20 minutes) (Prepare and use a predistribution plan)

Part a.

Maximum Losses That Can Be Absorbed

Able* $50,000/.2 $250,000

Moon $60,000/.3 200,000

Yerkl $50,000/.5 100,000 (most vulnerable to losses)

*Able's balance includes capital and the loan to the partnership.


Able MoonYerkl

Reported balances

$50,000$60,000$50,000

Assumed loss ($100,000) split on a 2:3:5 basis(20,000)(30,000)(50,000)

Adjusted balances

$30,000$30,000$ 0Maximum Losses That Now Can Be Absorbed

Able $30,000/.4 $75,000

Moon $30,000/.6 50,000 (most vulnerable to losses)


Able Moon

Reported balances

$30,000$30,000


(20,000)(30,000)

Adjusted balances

$10,000$ 0PREDISTRIBUTION PLAN

The first $62,000 will go to pay liquidation expenses ($12,000) and liabilities ($50,000). The next $10,000 goes entirely to Able. The next $50,000 is split between Able and Moon based on a 2:3 basis, respectively. All remaining cash will be divided among the partners according to their profit and loss ratio.

Part b.

After the sale of assets for $40,000, the partnership has $76,000 in cash. The first $62,000 should be held for the liabilities and the liquidation expenses, leaving $14,000 for immediate distribution to partners. The next $10,000 goes to Able. The remaining $4,000 is divided between Able ($1,600 or 40%) and Moon ($2,400 or 60%). Thus, Able receives $11,600 and Moon receives $2,400.24. (25 minutes) (Prepare a predistribution plan for a partnership liquidation) Maximum Losses That Can Be Absorbed

Simpson $18,000/20% $ 90,000 (most vulnerable to losses)

Hart $40,000/40% 100,000

Bobb $48,000/20% 240,000

Reidl $135,000/20% 675,000


SimpsonHartBobbReidl

Reported balances

$18,000$40,000$48,000$135,000


on a 2:4:2:2 basis

(18,000)(36,000)(18,000)(18,000)

Adjusted balances

$ 0$ 4,000$30,000$117,000Maximum Losses That Now Can Be Absorbed

Hart $4,000/4/8 $ 8,000(most vulnerable to losses)

Bobb $30,000/2/8 120,000

Reidl $117,000/2/8 468,000

The assumption is made that an $8,000 loss occurs:

HartBobbReidl

Reported balances

$4,000$30,000$117,000

Assumed loss ($8,000) split on a 4:2:2 basis(4,000)(2,000) (2,000)

Adjusted balances

$ 0$28,000$115,000Maximum Losses That Now Can Be Absorbed

Bobb$28,000/2/4 56,000 (most vulnerable to losses)

Reidl $115,000/2/4 230,000


BobbReidl

Reported balances

$28,000$115,000


(28,000)(28,000)

Adjusted balances

$ 0$ 87,000PREDISTRIBUTION PLAN

The first $59,000 goes to pay liabilities and expected liquidation expenses. The next $87,000 goes entirely to Reidl. The next $56,000 is split evenly between Bobb and Reidl. The next $8,000 is split among Hart (4/8), Bobb (2/8), and Reidl (2/8). All remaining cash is split among the partners according to their original profit and loss ratio.

25.(30 minutes) (Determine the ramifications of a variety of liquidation situations)

Part A. Partner with Deficit Capital Balance

(a)$48,000. Maximum losses of $100,000 on the noncash assets would increase Milburn's deficit balance by $40,000 (40%).

(b)All $19,000 should go to Thomas. As Ross and Thomas view the current situation, maximum potential losses total $108,000: $100,000 on the noncash assets and $8,000 on Milburn's deficit balance. In determining safe capital balances, these assumed losses would be allocated on a 4:2 basis or $72,000 to Ross and $36,000 to Thomas. Since such a loss would entirely eliminate Ross' capital account, only Thomas has a safe capital balance at the current time.

(c)The minimum cash payment to Thomas would be $35,667.

A loss of $59,000 on the noncash assets would result in the following capital balances:

Ross: $ 45,400 = $69,000 (40% x $59,000)

Milburn: $(31,600) = $(8,000) (40% x $59,000)

Thomas: $ 46,200 = $58,000 (20% x $59,000)

Milburns deficit further reduces the remaining partner's balances as follows:

Ross:

$24,333 = $45,400 (4/6 x $31,600)

Thomas: $35,667 = $46,200 (2/6 x $31,600)

25. (continued)

Part B. Partners with Deficit Capital Balances; Insolvent Partner

(a)Carton will have to contribute $7,429. The $29,000 in deficits will have to be absorbed by Sampson and Carton on a 4:3 basis. Thus, Carton will be allocated $12,429 of this amount which creates a deficit for this partner of $7,429 ($5,000 - $12,429).

(b)Klingon will have to contribute $19,667 [$17,000 + (20/90 x $12,000)] that will be distributed as follows:

Creditors $15,000

Sampson $ 3,667

Carton

$ 1,000

Since Romulan is insolvent, the remaining partners will have to absorb the $12,000 deficit on a 4:2:3 basis. This allocation increases Klingon's deficit by 2/9 of $12,000 or $2,667. Klingon must contribute an amount equal to the new deficit balance of $19,667. The first $15,000 will go to the creditors that remain after the $9,000 in partnership cash is distributed. The remaining $4,667 is distributed to the two partners in accordance with their remaining positive capital balances after absorbing Romulan's loss, 4/9 to Sampson and 3/9 to Carton. Sampson has a postive capital balance of $3,667 [$9,000 ($12,000 x 4/9)] and Carton has a positive capital balance of $1,000 [$5,000 ($12,000 x 3/9)].

(c)Sampson should receive $500. If Klingon is insolvent, the $17,000 deficit balance will have to be absorbed by the remaining three partners on a 4:3:1 basis. This loss would decrease Sampson's capital balance by $8,500 (4/8 x $17,000) to $500.

26. (25 minutes) (Prepare journal entries for a partnership liquidation)

JOURNAL ENTRIES

a.Cash .

56,000

March, Capital (2/6 of loss)

6,000

April, Capital (3/6)

9,000

May, Capital (1/6)

3,000

Inventory

74,000

b.March, Capital (2/6 of expenses)

2,500


3,750

May, Capital (1/6)

1,250

Cash

7,500

c.Liabilities

40,000

Cash

40,000

d.Cash

45,000

Accounts Receivable

45,000

e.

Current CapitalShare ofPotential

PartnerAdjustedMaximum Loss*Capital

March$16,5002/6 x $77,000 = $25,667$ (9,167)

April$62,2503/6 x $77,000 = $38,500$23,750

May$41,7501/6 x $77,000 = $12,833$28,917

*Maximum losses could be suffered on the remaining $39,000 in accounts receivable and the $38,000 in land, building, and equipment.

Based on the above potential losses, March would have a deficit capital balance of $9,167 which in turn has to be allocated to the two partners having positive capital balances:

Potential CapitalShare ofPotential

Partner (above)March's DeficitCapital

April $23,7503/4 x $9,167 = $6,875$16,875

May $28,9171/4 x $9,167 = $2,292$26,625

26. (continued)

As the above amounts represent safe capital balances, payments can be presently made to these two partners.

April, Capital

16,875

May, Capital

26,625

Cash

43,500

f.Cash (30%)

11,700


9,100


13,650

May, Capital (1/6)

4,550

Accounts Receivable

39,000

g.Cash

17,000


7,000


10,500

May, Capital (1/6)

3,500

Land, Building and Equipment

38,000

h.Liabilities

21,000

Cash

21,000

i.Since $28,700 cash remains and each partner has a positive capital balance, the money left can be distributed based on these ending totals.

March, Capital

400

April, Capital

21,225

May, Capital

7,075

Cash

28,700

27.(30 minutes) (Determine liquidation proceeds necessary to give partner a specified amount; predistribution plan) Answer: For Z to be able to pay his personal creditor $5,000 from the distribution of partnership property, the partnerships other assets must be sold for at least $50,000.

$27,000 in cash above the current level must first be generated for creditors and liquidation expenses. Based on the predistribution schedule below, the next $10,000 is received solely by Y. A third $8,000 would be split evenly between Y and Z (giving Z $4,000 of the $5,000 needed). Z needs $1,000 from the next cash generated in order to satisfy this personal claim. Since the next level (Step Two balances) is split on a 3:1:1 basis, Z is entitled to 1/5 of the proceeds. Thus, $5,000 must be collected for Z to receive $1,000. For Z's creditor to get $5,000, the other assets have to be sold for $50,000 ($27,000 + $10,000 + $8,000 + $5,000).

A predistribution plan must be developed to generate this information:

WXYZ

Beginning capital

$ 60,000$ 78,000$ 40,000$ 30,000


Schedule 1) (5:3:1:1)

(60,000)(36,000)(12,000)(12,000)

Step One balances

$ 0$ 42,000$ 28,000$ 18,000


Schedule 2) (allocated on a

0:3:1:1 basis)

0 (42,000)(14,000)(14,000)

Step Two balances

$ 0$ 0$ 14,000$ 4,000


Schedule 3) (allocated on a

0:0:1:1 basis)

0 0(4,000)(4,000)

Step Three balances

$ 0$ 0$ 10,000$ 0

Schedule 1

Capital Balance/Maximum Loss to


W$60,000/50%$120,000(most vulnerable)

X$78,000/30%$260,000

Y$40,000/10%$400,000

Z$30,000/10%$300,000

27. (continued)

Schedule 2



X$42,000/(3/5)$ 70,000(most vulnerable)

Y$28,000/(1/5)$140,000

Z$18,000/(1/5)$ 90,000

Schedule 3



Y$14,000/(1/2)$ 28,000

Z$ 4,000/(1/2)$ 8,000(most vulnerable)


Current cash of $30,000 goes to creditors.

Next $27,000 generated goes to remaining creditors ($12,000) and to pay liquidation expenses estimated at ($15,000).

Next $10,000 goes to Y.

Next $8,000 goes to Y and Z on a 1:1 basis.

Next $70,000 goes to X, Y, and Z on a 3:1:1 basis.

Any remaining cash is split among all four partners based on a 5:3:1:1 basis.

28.(35 minutes) (Determine monthly safe installment payments to partners)

28. (continued)

28. (continued)

29.(35 minutes) (Determine cash distributions for four different partnership liquidations; insolvent partners)

Part A

Haynes,

Simon,Loan andJackson,

CapitalCapitalCapital

Beginning balances

$16,000$ 4,000($12,000)

Contribution by Jackson

0 0 3,000

Capital balances

$16,000$ 4,000($ 9,000)

Elimination of Jackson's deficit

(40:20 basis)

(6,000)(3,000)9,000

Final distribution

$10,000$ 1,000$ 0

Hough,Luck,

Part B

Loan and Loan and Cummings,


Beginning balances

$82,000$40,000$20,000

$82,000 loss on disposal (allocated on a

50:40:10 basis)

(41,000)(32,800)(8,200)

Liquidation expenses (50:40:10 basis)

(10,500)(8,400)(2,100)

Capital balances

30,500(1,200)9,700

Allocation of Luck's deficit (50:10 basis)

(1,000) 1,200 (200)

Final distribution

$29,500$ 0$ 9,500

Hough,Luck,

Part C

Loan and Loan and Cummings,


Beginning balances

$82,000$40,000$20,000

$82,000 loss on disposal (allocated on a

2:4:4 basis)

(16,400)(32,800)(32,800)

Liquidation expenses (2:4:4 basis)

(1,200)(2,400)(2,400)

Capital balances

$64,400$ 4,800($15,200)

Allocation of Cummings' deficit balance

(2:4 basis)

(5,067)(10,133)15,200

Capital balances

$59,333($ 5,333)0

Allocation of Luck's deficit balance

(5,333)5,333 0

Final distribution

$54,000$ 0$ 029. (continued)

Part D

Redmond,

Loan andLedbetter,Watson, Sandridge,

CapitalCapitalCapitalCapital

Beginning balances

($16,000)($30,000)$ 3,000$15,000

Allocation of Redmond's

deficit balance (10:30:40

basis)

16,000 (2,000) (6,000)(8,000)

Capital balances

0($32,000)($3,000)$ 7,000

$32,000 contribution by

Ledbetter and $3,000 con-

tribution by Watson

032,0003,000 0

Final distribution*

$ 0$ 0$ 0$ 7,000*Remaining $28,000 is used to pay liabilities.

30.(60 minutes) (Prepare a predistribution plan, a final statement of liquidation, and journal entries for a partnership liquidation)

Part APreparation of Predistribution PlanSchedule 1

Maximum Loss



Frick$129,000/60%$215,000

Wilson$ 35,000/20%$175,000 (most vulnerable to loss)

Clarke$ 75,000/20%$375,000

Schedule 2

Maximum Loss



Frick$24,000/(60/80)$ 32,000 (most vulnerable to loss)

Clarke$40,000/(20/80)$160,000

Schedule 3

Frick, Wilson, Clarke,

Capital Capital Capital

Beginning balances

$129,000$35,000$75,000

Loss of $175,000 assumedSchedule 1

(allocated on a 60:20:20 basis)

(105,000)(35,000)(35,000)

Step One balances

24,000 040,000

Loss of $32,000 assumedSchedule 2

(allocated on a 60:20 basis)

(24,000) 0 (8,000)

Step Two balances

0 032,000

Loss of $32,000 assumed

-0-

-0-(32,000)Final balances

$ -0-$-0-$ -0-


First, payment of liabilities and liquidation expenses must be assured.

Next $32,000 goes to Clarke.

Next $32,000 is split between Frick and Clarke on a 60:20 basis.

Any further cash is split among Frick, Wilson, and Clarke on a 60:20:20 basis.30.

(continued)

Part B Preparation of Final Statement of Partnership Liquidation FRICK, WILSON, AND CLARKE

Statement of Partnership Liquidation

Final Balances

*$12,000 in cash is immediately available for distribution: Cash of $60,000 less Liabilities of $40,000 and Estimated Liquidation Expenses of $8,000.**$60,000 in cash is available for distribution: Cash of $68,000 less Estimated Liquidation Expenses of $8,000.30. (continued)

Part C Journal Entries

1. Clarke, Capital

12,000

Cash

12,000

Cash payments are made to partners in accordance with predistribution plan.

2.Cash

60,000

Frick, Capital (60% of $34,000 loss)

20,400

Wilson, Capital (20%)

6,800

Clarke, Capital (20%)

6,800

Noncash Assets

94,000

Noncash assets are sold with losses allocated to partners.

3. Liabilities 40,000

Cash

40,000

All liabilities are paid.

4. Frick, Capital

28,800

Wilson, Capital

1,600

Clarke, Capital

29,600

Cash

60,000

Cash payments are made to partners in accordance with predistribution plan.

5.Cash

51,000

Frick, Capital (60% of $74,000 loss)

44,400

Wilson, Capital (20%)

14,800

Clarke, Capital (20%)

14,800

Noncash Assets

125,000

Noncash assets are sold with losses allocated to partners.

6. Frick, Capital

3,600

Wilson, Capital

1,200

Clarke, Capital

1,200

Cash

6,000

Liquidation expenses are paid.

7. Frick, Capital

31,800

Wilson, Capital

10,600

Clarke, Capital

10,600

Cash

53,000

Final cash payments are made to partners based on ending capital balances.

31.(50 minutes) (Prepare a predistribution plan and journal entries for a partnership liquidation)

Part APreparation of Predistribution PlanSchedule 1

Maximum Loss

Capital Balance/That Can Be

PartnerLoss AllocationAbsorbed

Wingler$120,000/30%$400,000

Norris$ 88,000/10%$880,000

Rodgers$109,000/20%$545,000

Guthrie$ 60,000/40%$150,000(most vulnerable to loss)Schedule 2

Maximum Loss



Wingler$75,000/(30/60)$150,000(most vulnerable to loss)

Norris$73,000/(10/60)$438,000

Rodgers$79,000/(20/60)$237,000

Schedule 3Maximum Loss



Norris$48,000/(10/30)$144,000

Rodgers$29,000/(20/30)$ 43,500(most vulnerable to loss)31. (continued)Schedule 4

Rodgers,

Wingler,Norris,Loan andGuthrie,

CapitalCapitalCapitalCapital

Beginning balances

$120,000$88,000$109,000$60,000

Loss of $150,000 assumed (al-

located on a 30:10:20:40

basis) see Schedule 1

(45,000)(15,000)(30,000)(60,000)

Step One balances

$ 75,000$73,000$ 79,000$ -0-

Loss of $150,000 assumed (al-

located on a 30:10:20 basis)

see Schedule 2

(75,000)(25,000)(50,000) -0-

Step Two balances

$ -0-$48,000$ 29,000$ -0-

Loss of $43,500 assumed

(allocated on a 10:20 basis) see

Schedule 3

-0- (14,500)(29,000) -0-

Step Three balances

$ -0-$33,500$ -0-$ -0-PREDISTRIBUTION PLAN

Payment of all liabilities and liquidation expenses must be assured. Next $33,500 goes entirely to Norris. Next $43,500 is allocated to Norris (10/30) and Rodgers (20/30). Next $150,000 is allocated to Wingler (30/60), Norris (10/60), and Rodgers (20/60). Any further cash distributions are divided on the original profit and loss ratio:

Wingler (30%), Norris (10%), Rodgers (20%), and Guthrie (40%).

31. (continued) Part B Journal Entries

1.Cash

65,600

Wingler, Capital (30% of $16,400 loss)

4,920

Norris, Capital (10%)

1,640

Rodgers, Capital (20%)

3,280

Guthrie, Capital (40%)

6,560

Accounts Receivable

82,000

Receivables are collected with losses allocated to partners.

2.Cash

150,000


30,900


10,300


20,600


41,200

Land

85,000

Building and Equipment

168,000

Land, building and equipment are sold with losses allocated to partners.

3.Wingler, Capital

31,800

Norris, Capital

58,600

Rodgers, loan

35,000

Rodgers, Capital

15,200

Cash

140,600

Payments made to partners in accordance with the predistribution plan based on a current cash balance of $230,600. The first $35,000 paid to Rodgers extinguishes the loan made to the partnership. First $90,000 is held to pay liabilities ($74,000) and estimated liquidation expenses ($16,000); $140,600 is paid to partners. Next $33,500 goes entirely to Norris.

Next $43,500 is split between Norris ($14,500) and Rodgers ($29,000).

Remaining $63,600 is allocated to Wingler ($31,800), Norris ($10,600) and Rodgers ($21,200).

Total payments: Norris, $58,600; Rodgers, $50,200; Wingler, $31,800.

31.b.(continued)

4.No journal entry is currently required by Guthrie's insolvency.

5.Liabilities

74,000

Cash

74,000

All liabilities are paid.

6.Cash

71,000


9,000


3,000


6,000


12,000

Inventory

101,000

Inventory is sold with loss allocated to partners.

7.

Wingler, Capital

35,500

Norris, Capital

11,833

Rodgers, Capital

23,667

Cash

71,000

Distribution of available cash according to predistribution plan. Although $87,000 in cash is held by the partnership, $16,000 must be retained to pay liquidation expenses. The remaining $71,000 is divided among Wingler, Norris, and Rodgers on a 30:10:20 basis. According to the predistribution plan, a total of $150,000 must be divided on this ratio but only $63,600 was allocated in this manner in the first distribution above. Therefore, all $71,000 (making a total of $134,600) is paid out on this 30:10:20 basis.

8.Wingler, Capital (30% of expenses)

3,300


1,100


2,200


4,400

Cash

11,000

Liquidation expenses are paid.

9.a.

Wingler, Capital (30/60 of deficit)

2,080

Norris, Capital (10/60)

693

Rodgers, Capital (20/60)

1,387

Guthrie, Capital

4,160

To eliminate the deficit balance of insolvent partner as computed on the next page.

31.b.(continued)

CAPITAL ACCOUNT BALANCES

Rodgers,

Wingler,Norris,Loan andGuthrie,

CapitalCapitalCapitalCapitalBeginning balances

$120,000$88,000$109,000$60,000

Loss on accounts receivable

(4,920)(1,640)(3,280)(6,560)

Loss on land, building, and

equipment

(30,900)(10,300)(20,600)(41,200)

Cash distribution

(31,800)(58,600)(50,200)-0-

Loss on inventory

(9,000)(3,000)(6,000)(12,000)

Cash distribution

(35,500)(11,833)(23,667)-0-

Liquidation expenses

(3,300)(1,100)(2,200)(4,400)

Subtotal

4,5801,5273,053(4,160)

Guthrie insolvent

(2,080)(693)(1,387)4,160Current balances

$2,500$ 834$1,666$ -0-

9.b.Wingler, Capital

2,500

Norris, Capital

834

Rodgers, Capital

1,666

Cash

5,000

To distribute remaining cash based on final capital balances.

Chapter 15 Develop Your Skills

Research Case

1.Students often seem to believe that definitive answers can be found for all accounting and legal questions if a serious enough investigation is performed. However, here, there simply may be no easy answer to the question as to the amount of liability that the other six doctors in this case are facing.

2.Several questions can be raised that may impact the ultimate resolution:

In what state will the court case be handled? Different states have somewhat different laws as to the potential liabilities incurred by partners and different courts seem to have varying ways of interpreting those laws.

How difficult was the surgery that was performed? Should the doctor have been able to perform the work without accident? Or, perhaps, was it an extremely risky surgery where death might have been anticipated under any conditions?

How much did the other doctors know about this doctors ability to do this particular surgery? Did they have any reason to believe that such work should not be undertaken?

What is meant in the case by the term very poor judgment? How serious was the mistake made by the doctor?

The answers to such questions as these can have a huge impact on the extent of the liability of the other doctors.

Here are several quotes from The Wall Street Journal article mentioned in the case that might pertain to the issue at hand:

Concerns are growing among Andersen's roughly 1,750 U.S. partners that even those who had nothing to do with the firm's work for Enron Corp. could eventually face personal liability stemming from the botched audit. Worried about what protection the limited-liability partnership provides them, many are now consulting lawyers for advice.

The limited-liability partnership is a comparatively new corporate structure, untested by the kind of stress now besetting Andersen. But that testing appears to be just around the corner as Enron creditors, shareholders and employees seek to recover the billions of dollars they have lost from someone.

Because it is unclear how much protection the LLP structure will provide Andersen partners, partnership and bankruptcy lawyers are expected to be following the matter closely. As far as I know, there has never been a litigation test of the extent of the LLP shield, and there have been very few LLP cases about liability at all, said Larry Ribstein, a law professor at George Mason University.

The limited-liability partnership was invented about a decade ago in the wake of the savings-and-loan debacle to protect members of partnerships from being wiped out by claims against their firms. Under the structure, capital invested by partners into the firm is fair game for creditors. In theory, no partner is supposed to lose more than what he or she has invested in the firm.

"There is a strong legal tradition that you don't pierce the corporate veil and go after individual partners except under extraordinary circumstances, said Lynn LoPucki, a professor at the University of California Los Angeles law school. But the law is very vague and lets the courts do what they feel appropriate. It is very case specific and fact intensive.

In 1990, prior to the advent of limited-liability partnerships, the accounting firm of Laventhol & Horwath filed for Chapter 11 bankruptcy-court protection, in part due to lawsuits over questionable accounting. The firm's assets were insufficient to cover the claims of creditors and litigants. Under a plan negotiated with the firm's creditors, the 360 partners and former partners who had spent time at the firm since 1984 were required to dig into their own pockets to share a $46 million liability.

Analysis Case

1.In looking at the financial statements of a partnership, a number of obvious differences can be spotted in comparison to the financial statements of a corporation. For example, in looking at this set of statements, the following differences can be noted:

The balance sheet shows partners (deficiency) capital rather than stockholders equity.

The income statement (statement of operations) reports net loss allocated to general partner and net loss allocated to limited partners. This statement also reports net loss per limited partnership interest rather than earnings (loss) per share.

A statement of changes in partners (deficiency) capital is presented rather than a statement of changes in stockholders equity.

A potential investor in this partnership would become one of the limited partners, whose aggregate capital is disclosed in the balance sheet.

2.There is a considerable amount of information provided in the notes to the financial statements about the unique characteristics of a limited partnership:

Note 1 Organization and Summary of Significant Accounting Policies discusses the creation and structure of this limited partnership under the heading Organization.

Note 2 Investments in and Advances to Local Partnerships provides information about the entitys investment in other limited partnerships.

Note 5 Transactions with Affiliated Parties describes the obligation of the partnership to the General Partner.

Note 6 Income Taxes describes the manner in which individual partners are taxed on their share of partnership income.

In addition, in Item 5 (page 5), which precedes the financial statements, disclosures are provided related to the market for partnership interests. Because the partnerships shares are not publicly traded, an individual investor may not be able to sell his/her limited partner interest in the partnership.

As a limited partnership, potential investors (other than the general partner) would probably view an investment in NTCI II as being fairly similar to that of holding shares in a corporation. The major difference relates to the possible inability to sell a limited partner interest in the company.

Communication CaseThe bankruptcy of Laventhol & Horwath was one of the main reasons for the creation of the limited liability partnership business structure. As a general partnership, the litigation losses of this partnership that arose from poor accounting and auditing practices fell on all partners and not just on those involved. Partners were required to make contributions from their own personal funds, often in amounts of up to several hundred thousand dollars to pay off the debts of the partnership after its failure. A number of the partners eventually went bankrupt as a result of the litigation that arose.

Today, the partners in a general partnership would still seem to have the same risk that the partners of Laventhol & Horwath faced. However, the alternatives such as a limited liability partnership or a Subchapter S corporation would place fewer individuals in this precarious position. Thus, more than anything else, these articles on Laventhol & Horwath may be educational in showing why such alternatives have been created and why they have become so popular.

Excel Case

There are a number of different ways that a spreadsheet could be created to solve this particular problem. Here is one possible approach:

Create Column Headings:

In Cell A1, enter label text Partner.

In Cell B1, enter label text Capital Balance.

In Cell C1, enter label text Share P/L.

In Cell D1, enter label text Initial Loss Share.

In Cell E1, enter label text Subsequent Loss Share.

In Cell F1, enter label text Remaining Balance.

Enter Account Information for each partner:

In Cell A2, enter label text Wilson. In Cell B2, enter Wilsons Capital Balance of $200,000 and, in Cell C2, enter 40% as share of profit and loss.

In Cell A3, enter label text Cho. In Cell B3, enter Chos Capital Balance of $180,000 and, in Cell C3, enter 20% as share of profit and loss.

In Cell A4, enter label text Arrington. In Cell B4, enter Arringtons Capital Balance of $110,000 and, in Cell C4, enter 40% as share of profit and loss.

Enter the amounts on which to base the calculations for each partner:

In Cell A7, enter label text Losses during liquidation and, in Cell B7, enter the amount of $50,000.

In Cell A8, enter label text Final Losses and, in Cell B8, enter the amount of $100,000.

Calculate Initial Loss Share:

Multiply the Losses during liquidation amount by the percentage of Share P/L for each partner. To calculate the Initial Share Loss for Wilson, create the following formula in Cell D2: =+B7*C2. We need to also use this same general formula for both Cho and Arrington. However, if we drag the fill handle in Cell D2 into Cell D3 and D4, the reference to Cell B7 will automatically change to B8 and B9 respectively and the reference to Cell C2 will change to C3 and C4 respectively in order to adjust for the new cell position. The change to C3 and C4 is correct because those are the individual profit and loss percentages. No change, though, should be made to the reference to B7 because that is the overall loss in question. In order to hold the reference to Cell B7 when it is copied, we need to create what is known as an ABSOLUTE reference. Absolute references, which are cell references that always refer to cells in a specific location, can be created by placing a $ symbol before the Column letter and/or the Row number. Thus, in Cell D2, change the formula to read =$B$7*C2, and then copy this formula to cells D3 and D4. The resulting formula in Cell D3 will be =$B$7*C3 and in Cell D4 it will be =$B$7*C4. The location of the reference to Cell B7 does not change due to the $ symbol in front of the B and in front of the 7.

Calculate the Partners Share of any Subsequent Losses:

Repeat the same process as above, creating a formula in Cell E2 as follows: =+$B$8*C2

Copy this formula to Cells E3 and E4.

Calculate the Remaining Capital Balance:

To calculate the Remaining Capital Balance, the beginning Capital Balance must be reduced by the Initial Loss Share and Subsequent Loss Share.

In creating this last formula, it is important to note that the losses should be added together and then subtracted in total from the beginning capital balance. Therefore, enter the following function in Cell F2: =+B2-(D2+E2). The computation inside the parenthesis is performed first and then subtracted from the beginning capital balance (B2). Copy this formula to Cells F3 and F4 to complete the worksheet. Note that the use of the $ is not used here because we do want B2, D2, and E2 to adjust to the new position when copied.

Once this spreadsheet has been created, any of the variables may be changed and the results will adjust automatically. There are eight variables that can be changed: B2, B3, B4, B7, B8, C2, C3, and C4. C2, C3,and C4 must always add to 100%.

Spreadsheet to Determine the Remaining Capital Balances for

Wilson, Cho, and ArringtonABCDEF

1PartnerCapital BalanceShare P/LInitial Loss ShareSubsequent Loss ShareRemaining Balance

2Wilson $200,000 40% $20,000 $40,000 $140,000

3Cho 180,000 20% 10,000 20,000 150,000

4Arrington 110,000 40%20,000 40,000 50,000

5$490,000 100%$50,000 $100,000 $340,000

6

7Losses during liquidation 50,000

8Final losses 100,000

15-10Copyright 2015 McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.15-9Copyright 2015 McGraw-Hill Education.All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

ISMChap015

Documents

remaining partners

partners capital accounts

individual partners

partnership assets

deficit capital balances

liquidation chapter

partners loans

liquidation process