Chapter 3 Partnership Liquidation and Incorporation

All examples are from textbook by Larsen ACCT 501

Chapter 3

Partnership Liquidation and Incorporation; Joint Ventures

Partnership Liquidation and Incorporation2

Objectives of the Chapter

To learn the accounting procedures for liquidation of limited liability partnerships (LLPs).

To discuss accounting issues related to incorporation of a LLP.

To discuss accounting for corporate and unincorporated joint ventures.


Liquidation of a Partnership

The liquidation of a LLP means discontinuing its activities.

The procedures usually include selling assets, paying liabilities, and distributing any remaining cash to the partners.

The liquidation process often starts with the realization of noncash assets.


Liquidation of a Partnership (contd.)

Any gains or losses resulting from the assets realization are divided among partners based on the income sharing ratio.

The capital balances after the allocation of gains/losses are the basis for settlement.

No cash can be distributed to partners until all liabilities are paid off.


Liquidation of a Partnership (contd.)

If cash of LLP is insufficient to pay liabilities in full, an unpaid creditor may collect from the personal assets of any solvent partner whose actions caused the partnership's insolvency, regardless whether that partner has a credit or a debit capital account balance.


Distribution of Cash or Other Assets to Partners

The Uniform Partnership Act lists the order for distribution of cash by a liquidating partnership as:

1. Payment of creditors in full,

2. Payment of loans from partners, and

3. Payment of partners' capital account credit balances.


Distribution of Cash or Other Assets to Partners (contd.) However, if a partner's capital account

has a deficit, that partner's loan to the partnership must be offset against the deficit in his/her capital account (referred to as the right of offset).

Thus, the cash received by a partner is the same as if loans to the partnership had been recorded in the partner's capital account.


Distribution of Cash or Other Assets to Partners (contd.) The existence of partner's loan

account will not advance the time of payment of any partner during the liquidation.

Consequently,the loan to the partnership is often treated as capital during the liquidation.


Distribution of Cash or Other Assets to Partners (contd.) It is possible that partners are willing to

receive assets other than cash for settlement.

Regardless whether assets other than cash are distributed to partners, the distribution rule must be followed.


Payment to Partners of an LLP after All Noncash Assets Realized Five situations are discussed:

A. Equity of every partner is sufficient to absorb loss from realization.

B. Equity of one partner is not sufficient to absorb that partner's share of loss from realization.

C. Equity of two partners are not sufficient to absorb their shares of loss from realization.


Payment to Partners of an LLP after All Noncash Assets Realized(contd.)D. Partnership is insolventa but

partners are solventb.E. General partnership is insolvent

and partners are insolvent.

a. The partnership is unable to pay all outside creditors and at least one partner has a deficit capital account.


Payment to Partners of an LLP after All Noncash Assets Realized(contd.)b. The partner has personal assets in

excess of liabilities.

Note: the partnership is solvent in situations A, B and C.


Payment to Partners after All Noncash Assets realized

A. Equity of Each Partner is Sufficient to Absorb Loss from Realization

Assume that Abra and Barg, who share income/losses equally, decide to liquidate Abra & Barg LLP. A balance sheet on 6/3/99, just prior to liquidation follows:



A. Equity of Each Partner is Sufficient to Absorb Loss from Realization (contd.)

Assets Liabilities & Partners’ Capital

Cash $10,000 Liabilities $20,000Other assets 75,000 Loan payable to

Barg20,000

Abra, capital 40,000

Barg, capital 5,000

Total $85,000 Total $85,000

ABRA & BARG LLP Balance Sheet June 30, 1999



A. Equity of Each Partner is Sufficient to Absorb Loss from Realization (contd.)

Additional information: The noncash assets with a carrying

amount of $75,000 realized cash of $35,000.

The loss of $40,000 is divided equally by the partners.

After the allocation of realization loss, Barg's capital has a deficit of $15,000.


statement of realization and liquidation for Abra & Barg LLP

Assets Partner’ CapitalCash Other Liabilitie

sBarg, loan

Abra(50%) Barg (50%)

Balances before liquidation

$10,000 $75,000 $20,000 $20,000 $40,000 $ 5,000

Realization of other assets at a loss of $40,000

35,000 (75,000) (20,000) (20,000)

Balances $45,000 $20,000 $20,000 $20,000 $(15,000)Payment to creditors

(20,000) (20,000)

Balances $25,000 $20,000 $20,000 $(15,000)Offset Barg’s capital deficit against Barg’s loan

(15,000) 15,000

Balances $25,000 $5,000 $20,000 $ -0-Payments to partners

(25,000) (5,000) (20,000) $ -0-


Note to the statement of realization and liquidation for Abra & Barg LLP Partners Abra and Barg received

$20,000 and $5,000, respectively, after partnership creditors had been paid in full.

The checks to both partners should be delivered to the partners at the same time.


Note to the statement of realization and liquidation for Abra & Barg LLP Thus, the legal priority of a partner's loan

account has no significance in determining either the amount of cash paid to a partner or the timing of cash payments to partners during liquidation.

In the above statement, Barg's loan account balance of $20,000 and capital account balance of $5,000 can be combined to obtain an equity of $25,000 for Barg prior to allocation/distribution.


Note to the statement of realization and liquidation for Abra & Barg LLP (contd.) In the following examples, a

partner's loan account balance (if any) is combined with the partner's capital account balance in the statement of realization and liquidation.



B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization In this case, the loss on realization of

assets results in a deficit balance in the capital account of one of the partners.

Assume the balance sheet below for Diel, Ebbs & Frey LLP just prior to liquidation:


B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization (contd.)


Cash $20,000 Liabilities $30,000Other assets 80,000 Diel, capital 40,000

Ebbs, capital 21,000

Frey, capital 9,000

Total $100,000 Total $100,000

Diel, Ebbs & Frey LLP Balance Sheet May 20, 1999


B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization (contd.) The income sharing ratio is Diel, 20%; Ebbs;

40% and Grey, 40%. The other assets with a carrying amount of

$80,000 realized $50,000 cash. After dividing the loss of $30,000 among the

partners, Frey has a deficit of $3,000 in his capital account.

Assuming Frey pays the $3,000 to the partnership immediately, the statement of realization and liquidation is as follows:


Statement of Realization and Liquidation for Deil, Ebbs & Frey LLP (5/21 through 5/31/99)

Assets Partner’ CapitalCash Other Liabilities Diel(20%) Ebbs(40%) Frey(40%)


$20,000 $80,000 $30,000 $40,000 $21,000 $ 9,000


50,000 (80,000) (6,000) (12,000) (12,000)

Balances $70,000 $30,000 $34,000 $9,000 $(3,000)Payment to creditors

(30,000) (30,000)

Balances $40,000 $34,000 $9,000 $(3,000)Cash received from Frey

3,000 3,000

Balances $43,000 $34,000 $9,000 $ -0-Payments to partners

(43,000) (34,000) (9,000) $ -0-


B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization (contd.) Assuming Grey was not able to pay

the $3,000 deficit to the partnership immediately and the cash available after payment to creditors is to be distributed to Deil and Ebbs without a delay, the statement of realization and liquidation would be as follows:


Statement of Realization and Liquidation for Deil, Ebbs & Frey LLP – Frey Cannot Pay $3,000 immediately

Assets Partner’ CapitalCash Other Liabilities Diel(20%) Ebbs(40%) Frey(40%)


$20,000 $80,000 $30,000 $40,000 $21,000 $ 9,000


50,000 (80,000) (6,000) (12,000) (12,000)

Balances $70,000 $30,000 $34,000 $9,000 $(3,000)

Payment to creditors

(30,000) (30,000)

Balances $40,000 $34,000 $9,000 $(3,000)

Payments to partners

(40,000) (33,000) (7,000)

Balances $1,000 $2,000 $ (3,000)


Notes to the above Statement

The possible additional loss if Frey is unable to pay $3,000 is charged to Diel and Ebbs in the ratio of 1/3 ($1,000) and 2/3 ($2,000), respectively.

Therefore, the cash available of $40,000 to partners is divided between Diel and Ebbs in a manner that reduces Deil's capital and Ebb's capital to $1,000 and $2,000, respectively.


Notes to the above Statement (contd.)

Thus, if Frey is not able to pay $3,000, the loss can be all absorbed by remaining partners based on their income sharing ratio.

If the $3,000 is later collected from Frey, this amount will be divided $1,000 to Diel and $2,000 to Ebbs.

The forgoing statement then can be completed as follows:


The Completion of the Statement of Realization and Liquidation When $3,000 Collected from Frey

Assets Partner’ Capital

Cash Liabilities Diel (20%)

Ebbs (40%)

Frey (40%)

Balances (from page 25)

$1,000 $2,000 $(3,000)

Cash received from Frey

$3,000 3,000

Payments to partners (3,000) (1,000) (2,000)


The Completion of the Statement of Realization and Liquidation When $3,000 is Uncollectible from Frey


Cash Liabilities Diel (20%)

Ebbs (40%)

Frey (40%)

Balances (from page 25)

$1,000 $2,000 $(3,000)

Additional loss from Frey’s uncollectible capital deficit

(1,000) (2,000) 3,000

However, if the $3,000 is uncollectible, the statement would be completed with the write-off Frey's Capital as follows:



C. Equity of Two Partners Are Not Sufficient to Absorb Their Shares of Loss from Realization It is apparent that the inability to

collect deficit of a partner will result in additional loss to the other partners as in example B when $3,000 is uncollectible.

This additional loss could cause a second partner to have a deficit in the capital account, which may or may not be collectible.


C. Equity of Two Partners Are Not Sufficient to Absorb Their Shares of Loss from Realization (contd.)

Example: Assume that Judd, Kamb. Long and Marx, partners of Judd, , Kamb. Long & Marx LLP, share income /losses 10%, 20%, 30% and 40%, respectively.

Their capital account balances for the period 8/1 through 8/15, 1999, are as shown in the following statement of realization and liquidation (p29), supported by the exhibit that follows (p30).


Statement of Realization and Liquidation for Judd, Kamb, Long& Marx LLP (8/1 through 8/15/1999)

Assets Partners’ Capital

Cash Other Liabilities

Judd (10%)

Kamb (20%)

Long (30%)

Marx (40%)


$20,000 $200,000 $120,000 $30,000 $32,000 $30,000 $8,000


120,000 (200,000) (8,000) (16,000) (24,000) (32,000)

Balances $140,000 $120,000 $22,000 $16,000 $6,000 $(24,000)


(120,000) (120,000)

Balances $20,000 $22,000 $16,000 $6,000 $(24,000)

Payments to partners

(20,000) (16,000) (4,000)

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


Exhibit: Computation of Cash Payments to Partners of Judd, Kamb, Long & Marx LLP – 8/15/1999

Partners’ Capital

Judd(10%) Kamb(20%) Long(30%) Marx(40%)

Capital account balances before distribution of cash to partners

$22,000 $16,000 $6,000 $(24,000)

Additional loss to Judd, Kamb, and Long if Marx’s deficit is uncollectible (ratio of 10:20:30)

(4,000) (8,000) (12,000) 24,000

Balances $18,000 $8,000 $(6,000)

Additional Loss to Judd and Kamb if Long’s deficit is uncollectible (ratio of 10:20)

(2,000) (4,000) 6,000

Amounts that may be paid to partners

$16,000 $4,000



D. Partnership Is Insolvent but Partners Are Solvent

In the case of insolvency in a LLP, the total of the capital account debit balance will exceed the total of the credit balances.

If the partner(s) with a deficit capital balance pay off the deficit to the partnership, the LLP will have sufficient cash to pay its liabilities in full.



D. Partnership Is Insolvent but Partners Are Solvent (contd.)

The creditors of LLP may demand payment from any solvent partner whose actions caused the partnership's insolvency, regardless of whether the partner's capital had a debit or a credit balance.

A partner who makes payments to partnership creditors receives a credit to his/her capital account.





Cash $15,000 Liabilities $65,000Other assets 85,000 Nehr, capital 18,000

Ordo, capital 10,000

Page, capital 7,000

Total $100,000 Total $100,000

Example: Assume that Nehr, Ordo & Page LLP, whose partners share net income/losses equally,had the following balance sheet prior to liquidation on 5/1/1999:




On 5/12/99, the other assets with a carrying amount of $85,000 realize $40,000 cash. The loss of $45,000 is to be divided equally among the partners.

The total cash of $55,000 is paid to the creditors, which leaves unpaid liabilities of $10,000.

The capital balances of partner Nehr, Ordo and Page are $3,000, ($5,000) and ($8,000), respectively after absorbing the realization loss of noncash assets.




Assuming that on 5/30/99, Ordo and Page pay off their deficiencies, the LLP will use $10,000 of the $13,000 available cash to pay the remaining liabilities.

The LLP will then distribute $3,000 to Nehr.

These events are summarized in the statement of Realization and Liquidation on the following page.


The Statement of Realization and Liquidation of Nehr, Ordo & Page LLP


Cash Other Liabilities Nehr(1/3) Ordo(1/3) Page(1/3)


$15,000 $85,000 $65,000 $18,000 $10,000 $ 7,000


40,000 (85,000) (15,000) (15,000) (15,000)

Balances $55,000 $65,000 $3,000 $(5,000) $(8,000)


(55,000) (55,000)

Balances $ -0- $10,000 $3,000 $(5,000) $(8,000)

Cash invested by Ordo and Page

13,000 5,000 8,000

BalancesFinal Payment to CreditorsBalancesPayment to Nehr

(10,000)3,000

(3,000)

(10,000)

$3,000

3,000

(3,000)




If the insolvency of the LLP is due to an adverse award of damages in a lawsuit, and the partner(s) responsible for the damages are solvent, they alone must pay the damages that the LLP is unable to pay.

However, if such partner(s) also are insolvent, both they and the LLP may have to file for liquidation under Chapter 7 of the U.S. Bankruptcy Code.



E. General Partnership Is Insolvent and Partners Are Insolvent All the above cases applies to both LLP

and general partnership. The case discussed here only applies to

the general partnership and both the partnership and some partners are insolvent.

The question raised here is the relative rights of creditors of the partnership and the partners.



E. General Partnership Is Insolvent and Partners Are Insolvent (contd.) The rule provided by the UPA is that

assets of the partnership (including partners' capital deficits) are first available to creditors of the partnership.

Assets of the partners are first available to their creditors.



E. General Partnership Is Insolvent and Partners Are Insolvent (contd.) After the liabilities of the partnership

have been paid in full, the creditors of an individual partner have a claim against the assets of the partnership to the extent of that partner's equity in the partnership.



E. General Partnership Is Insolvent and Partners Are Insolvent (contd.) On the other hand, after the creditors of

a partner have been paid in full, any remaining assets of that partner are available to partnership creditors.

This principle applies regardless of whether that partner's capital balance has a credit or a debit balance.

One condition of this principle is that these creditors are unable to obtain payment from the partnership.


The Relative rights of Creditors of an Insolvent General Partnership and Personal Creditors- An Example


Cash $10,000 Liabilities $60,000Other assets 100,000 Rich, capital 5,000

Sand, capital 15,000

Toll, capital 30,000

Total $110,000 Total $100,000

Assume that the Rich,Sand & Toll Partnership, a general partnership whose partners share net income and losses equally,has the partnership balance sheet below prior to liquidation on 11/30/99:


The Relative rights of Creditors of an Insolvent General Partnership and Personal Creditors- An Example (contd.)

Partner Personal Assets Personal LiabilitiesRich $100,000 $25,000Sand 50,000 50,000Toll 5,000 60,000

Assume that on 11/30/99, the partners have the following assets and liabilities other than their equities in the partnership:


The Relative rights of Creditors of an Insolvent General Partnership and Personal Creditors- An Example (contd.)

Assume that the realization of other assets of the partnership results in a loss of $60,000, as shown in the following statement of realization and liquidation for the period 12/1/ through 12/12/99:


The Statement of Realization and Liquidation of Rich, Sand & Toll (12/1 through 12/12/99)

Assets Partner’ CapitalCash Other Liabilitie

sRich(1/3) Sand(1/3) Tall(1/3)


$10,000 $100,000 $60,000 $5,000 $15,000 $30,000


40,000 (100,000) (20,000) (20,000) (20,000)

Balances $50,000 $60,000 $(15,000) $(5,000) $10,000


(50,000) (50,000)

Balances $10,000 $(15,000) $(5,000) $10,000


Notes to the Statement

There is still $10,000 liabilities unpaid after exhausting all cash available in the partnership.

The creditors of the partnership can onlya collect these liabilities in full from Rich (who is personally solvent) regardless whether Rich's capital balance has a debit or credit balance.


The Statement of Realization and Liquidation of Rich, Sand & Toll (12/1 through 12/12/99)(contd.)

Partner’ Capital

Cash Liabilities Rich(1/3) Sand(1/3) Toll(1/3)

Balances (from above) $10,000 $(15,000) $(5,000) $10,000

Payment by Rich to partnership creditors

(10,000) 10,000

Balances $(5,000) $(5,000) $10,000

Cash invested by Rich $5,000 5,000

Balances $5,000 $(5,000) $10,000

Payment to Toll (or Toll’s creditors)

(5,000) (5,000)

Balances $(5,000) $5,000

The Statement is continued below (on p50 & 51) to show Rich's Payment of the final $10,000 owed to partnership's creditors:


The Statement of Realization and Liquidation of Rich, Sand & Toll (12/1 through 12/12/99)(contd.)

Partner’ Capital

Cash Rich (1/3)

Sand (1/3)

Toll (1/3)

Balances (from Page 50) $(5,000) $5,000

Write-off of Sand’s capital deficit as uncollectible

$(2,500) 5,000 (2,500)

Balances $(2,500) $2,500

Cash invested by Rich $2,500 2,500

Balances $2,500 $2,500

Payment to Toll (or Toll’s creditors)

(2,500) (2,500)


Notes to the Statement on p50

1. Due to the abundant personal assets, Rich is able to paid $5,000 needed to offset its capital deficit in the partnership.

2. This $5,000 cash is paid to partner Toll (or Toll's creditors), the only partner with a credit balance of capital account.


Notes to the Statement on p51

1. The continued statement shows that Sand owes $5,000 to the partnership.

2. Nevertheless, Sand's personal assets are just sufficient to cover his personal liabilities.

3. Therefore, Sand's deficit of $5,000 in his capital is a loss to the partnership and will be absorbed by the other two partners equally.


Notes to the Statement on p51 (contd.)

4. As a result, Rich and Toll have capital balances of deficit $2,500 and credit $2,500, respectively, after absorbing the $5,000 loss from Sand's deficit in capital.

5. Since Rich is personally solvent, he will pay $2,500 to the partnership to offset his deficit.

6. This $2,500 cash will go to Toll (or Toll's creditors) since Toll is the one with credit balance in capital.


Conclusions of this Liquidation

The final result of this liquidation is that the partnership creditors receives payment in full due to the financial status of Rich.

The personal creditors of Sand are paid in full.

The personal creditors of Toll are paid $12,500 (Toll's personal assets of $5,000 + $7,500 from Rich's payment to the partnership to cover Rich's deficit).


Installment Payments to Partners

In all previous case, cash payments to partners in liquidation are made only after all noncash assets being realized and realized losses being divided.

Due to the liquidation process can extent to several months, the partners may want to receive cash as it becomes available rather than waiting until all noncash assets have been realized.


Installment Payments to Partners (contd.) Liquidation in installments is a process

of realizing some assets, paying creditors, paying the remaining available cash to partners, realizing additional assets and making additional cash payments to partners.

Installment payments to partners are appropriate if necessary safeguards are used to ensure that all partnership creditors are paid in full.


Installment Payments to Partners (contd.) Also no partners are paid more than the

amount to which they would be entitled after all losses on realization of assets are known.

The danger to an installment liquidations is that the liquidator authorizes cash payment to partners before all losses in the liquidation are known.


Installment Payments to Partners (contd.) If payments are made to partners and

later losses cause deficits in the partner's capital accounts, the liquidator will be responsible for the recovery of these deficits.

Due to this danger, the safe policy for determining installment cash payments to partners is the following worst-case scenario:


General Rules for Installment Payments to Partners

1. Assume a total loss on all remaining noncash assets, and provide for all possible losses, including potential liquidation costs and unrecorded liabilities.

2. Assume that partner(s) with potential capital deficits will be unable to pay anything to the partnership.


General Rules for Installment Payments to Partners (contd.) Thus, the distribution of cash in

installment payment as if no more cash will be forthcoming, either from realization of assets or from collection of capital deficits from partners.

Therefore, cash payment to a partner only if that partner has a capital (plus loan) account credit balance in excess of the amount required to absorb his/her share of maximum possible loss that may incur on liquidation.


General Rules for Installment Payments to Partners (contd.) When these installment payment rules

are followed, the effect is to bring the equities of the partner to the income-sharing ratio as quickly as possible.

The following example (from P3-4 of the textbook) illustrates an installment payment on liquidation following the aforementioned rules.


Installment Payments to Partners- an Example Carson and Worden decided to dissolve

and liquidate Carson& Worden LLP on 9/23/99. On that date, the balance sheet of the partnership was as follows:


Installment Payments to Partners- an Example (contd.)


Cash $5,000 Liabilities $15,000Other assets 100,000 Loan payable to

Worden10,000

Carson, capital 60,000

Worden,capital 20,000

Total $105,000 Total $100,000

Carson &Worden LLP Balance Sheet Sep. 23, 1999


Installment Payments to Partners- an Example (contd.) On Sep. 23, 1999, noncash assets with

a carrying amount of $70,00 realized $60,000 and $64,000 was paid to creditors and partner.

$1,000 is retained to cover possible liquidation cots.

On 10/1/1999, the remaining noncash assets realized $18,000 (net of liquidation costs), and all available cash was distributed to partner.


Installment Payments to Partners- an Example (contd.) Carson and Worden share net income

and losses 40% and 60%, respectively. Required:1) Prepare a cash distribution program for

Carson &Worden LLP on 9/23/99.2) Determine the appropriate distribution of

cash to partners as it becomes available.3) Prepare journal entries for the LLP on

9/23 and 10/1 to record the realization of assets and distribution of cash to creditors and partners.


Cash Distribution Program for Carson &Worden LLP

Carson & Worden LLPCash Distribution Program

September 23, 1999Creditors Carson Worden

First $15,000 100%

Next 40,000 100%

All over $55,000 40% 60%


Distribution of Cash to Partners

Carson & Worden LLPWorking Paper for Cash Distribution to Partners during

LiquidationsSeptember 23, 1999

Capital account balances before liquidation (including $10,000 loan payable to Warden)

$60,000 $30,000

Income-sharing ratio 2 3

Capital per unit of income (loss) sharing $30,000 $10,000

Reduce Carson’s balance to Worden’s balance;

Carson receives $40,000 ($20,000X2) (20,000)

Capital per unit of income (loss) sharing $10,000 $10,000


Journal Entries to Record the Realization of Assets and Distribution of Cash to Creditors and Partners.

Carson & Worden LLPJournal Entries

1999

Sept 23 Cash 60,000

Carson,Capital ($10,000X0.40) 4,000

Worden, Capital ($10,000X0.60) 6,000

Other Assets 70,000

To record realization of assets at a loss of $10,000, divided between Carson and Worden in 2:3 ratio.

23 Trade Accounts Payable 15,000

Loan Payable to Worden 5,400

Carson, Capital 43,600

Cash 64,000


Journal Entries (contd.)

1999

Oct 1 Loan Payable to Worden ($10,000-$5,400) 4,600

Carson, Capital (balance of capital account) 7,600

Worden, Capital (balance of capital account) 6,800

Cash 19,000

To record distribution of cash to partners.


Withholding of Cash for Liabilities and Liquidation Costs Costs of liquidation are treated as part of

the total loss from liquidation and are deducted from partner's capital accounts.

It is reasonable to withhold cash for the payments of recorded liability or costs when these liabilities or costs were not paid prior to the payments to partners.


Liquidation of Limited Partnerships

Most of the prior discussion of the liquidation of LLP and general partnerships applies to the liquidation of limited partnerships except the following:

The ULP Act provides that after outside creditors of a limited partnership have been paid, the equities of the limited partners must be paid before the general partner(s) may receive any cash.


Liquidation of Limited Partnerships

Also, the limited partners may agree that one or more of them may have priority over the others regarding payments in liquidation.

Chapter 3 Partnership Liquidation and Incorporation

Documents

Transcript of Chapter 3 Partnership Liquidation and Incorporation