chapter fifteen partnerships: termination and liquidation copyright © 2013 by the mcgraw-hill...
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Chapter Fifteen
Partnerships: Termination and
Liquidation
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Reasons for Termination
Termination of business activities followed by liquidation of partnership property occurs for a variety of reasons: Personality disputes between partnersRetirementDeathChanged business environmentOther opportunitiesLow profitsBankruptcy (either the business or a partner)
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Termination & Liquidation
When the partners wish to terminate the business:
Convert all assets to cash.Allocate all gains or losses to the
partner capital balances.Pay all liabilities and expenses.Distribute remaining cash to
partners.
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Termination & Liquidation -Example
According to their agreement, Morgan & Houseman divide profits 6:4 respectively. On 6/1, the inventory is sold for $15,000.
Note that the loss on the sale of inventory of $7,000 is assigned $4,200 ($7,000 x 60%) Morgan and $2,800 ($7,000 x 40%) to Houseman.
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Deficit Capital Balance
Deficit balances can be resolved two ways:The deficit partner can make a
contribution to make up the deficit.The remaining partners can absorb the
deficit.(The deficit partner may pay later or
can be sued for the deficit amount.)
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Any payments by Holland will be split 2/3 to Dozier and 1/3 to Ross.
Deficit Capital Balance --Contribution by Deficit Partner
Contributions made by the deficit partner(s) are distributed to the non-
deficit partners based on their relative profit sharing percentages.
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Deficit Capital Balance - Remaining Partners Absorb Deficit
Capital balances after distribution of Holland’s loss:
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Preliminary Distribution of Assets
Debts owed to personal creditors.
Debts owed to partnership creditors.
Debts owed to the other partners.
Under the Uniform Partnership Act, a priority ranking of creditors having claims against individual partners is recognized:
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Predistribution Plan
Used by accountants to guide the distribution of cash resulting from the liquidation process.
Examine the Balance Sheet below. Assume the income sharing % is Rubens 50%, Smith 20%, and Trice 30%.
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Predistribution Plan
First, determine the maximum loss that each partner can absorb. Divide each partner’s capital balance by their respective income
sharing %.
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Predistribution Plan
Since Rubens can ONLY absorb a partnership loss of $60,000, new balances are computed assuming that the partnership has a $60,000 loss.
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Predistribution Plan
With Rubens wiped out, continue calculating maximum absorbable losses using income
sharing percentages of Smith, 20% (2/5) and Trice 30% (3/5).
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Predistribution Plan
As earlier, compute the maximum absorbable loss by dividing the capital balances by the
relative income sharing %.
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Predistribution Plan
Trice can only absorb a loss of $55,000.Now determine new capital balances for a loss
of $55,000.
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Predistribution Plan
With Rubens and Trice both wiped out, and Smith left as the only remaining partner, the
predistribution plan can be prepared.
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