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Chapter Fifteen Partnerships: Termination and Liquidation Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution.

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Presentation on theme: "Chapter Fifteen Partnerships: Termination and Liquidation Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution."— Presentation transcript:

1 Chapter Fifteen Partnerships: Termination and Liquidation Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2 Termination and Liquidation The liquidation of a partnership generally involves three important steps: 1. Non ‐ cash partnership assets are sold for cash, and gains and loss on the sales are allocated to the capital accounts of individual partners on the basis of the profit and loss ratios. 2. Partnership liabilities and expenses incurred during the liquidation are paid out of the partnership’s available cash. 3. Any partnership cash remaining after paying liabilities and liquidation expenses is distributed to the individual partners on the basis of their respective capital balances. 15-2

3 Termination & Liquidation The accountant summarizes and keeps track of the process in a statement of partnership liquidation. The liquidation of a partnership becomes complicated if: One or more partners have a negative (deficit) capital balance. The liquidation takes place over an extended period of time. The accountant can facilitate distribution of cash in installments by calculating the safe payments. The accountant might prepare a cash predistribution plan. 15-3

4 Learning Objective 15-1 Determine amounts to be paid to partners in a liquidation. 15-4

5 Termination & Liquidation To liquidate a partnership, the process calls for: 1) Assets converted into cash to pay business obligations and liquidation expenses. 2) Remaining assets distributed to partners based on their final capital balances. 3) Partnership books closed. 15-5

6 Learning Objective 15-2 Prepare journal entries to record the transactions incurred in the liquidation of a partnership. 15-6

7 Termination & Liquidation - Example On 6/1, inventory is sold for $15,000. Note the loss on the sale of inventory of $7,000 is assigned $4,200 ($7,000 x 60%) to Morgan and $2,800 ($7,000 x 40%) to Houseman. 15-7

8 Termination & Liquidation - Example $9,000 of the Accounts Receivable are collected. Remaining accounts receivables are written off, and the loss is allocated between Morgan (60%, $1,800) & Houseman (40%, $1,200). Fixed assets are sold for $29,000. The loss of $12,000 is allocated to Morgan (60%, $7,200) & Houseman (40%, $4,800). 15-8

9 Termination & Liquidation - Example Once assets are sold and accounts payable paid, the partnership incurs an additional $3,000 in liquidation expenses. After calculating ending capital balances, the remaining cash is distributed to the partners to close out the financial records. 15-9

10 Learning Objective 15-3 Determine the distribution of available cash when one or more partners have a deficit capital balance or become personally insolvent

11 Deficit Capital Balance Deficit balances can be resolved two ways:  Deficit partner can make a contribution to cover deficit.  Remaining partners can absorb the deficit.  Allocation of the loss is based on the relative profit and loss ratio specified in the articles of partnership.  A safe payment may be made to partners that reduces that partner’s capital account to the minimum dollar level.  safe payments can be distributed to the partners without creating new deficits

12 Learning Objective 15-4 Prepare a proposed schedule of liquidation from safe capital balances to determine an equitable preliminary distribution of available partnership assets

13 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: 15-13

14 Claims Against the Partnership  Individual partner’s creditors can make a claim against the assets of the partnership.  All partnership creditors must be satisfied first.  The creditors can only assert claims to the extent of the specific partner’s positive capital balance.  Each partner is liable for ALL the debts of the partnership.  Partners are NEVER liable for the personal debts of the other partners

15 Learning Objective 15-5 Develop a predistribution plan to guide the distribution of assets in a partnership liquidation

16 Predistribution Plan At the start of a liquidation, accountants produce a single predistribution plan to serve as a guide for all future payments. Whenever cash becomes available, the plan indicates the appropriate recipient(s) without drawing up ever- changing proposed schedules of liquidation. The plan is developed by simulating a series of losses, each of which is just large enough to eliminate, one at a time, all of the partners’ claims to partnership property

17 Predistribution Plan As a prerequisite to developing a predistribution plan, the sensitivity to losses exhibited by each of these capital accounts must be measured. Determine the maximum loss that each partner can absorb. Divide each partner’s capital balance by their respective income sharing percent. Once a partner’s maximum loss is absorbed, new balances are computed until all losses are absorbed

18 Predistribution Plan To inform all parties of the pattern by which available cash will be disbursed, the predistribution plan should be formally prepared in a schedule format prior to beginning liquidation

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