1 Partnership Dissolution

2 Introduction A partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business. The assets of the partnership will be realized to pay off the liabilities. The sales proceeds should be applied in the following order, as required by the Hong Kong Ordinance:  Pay off creditors first,  then the partners’ advances, and  Finally the partners’ capital

3 Realization Account In the partnership dissolution, an account named as ‘Realization Account’ will be opened to compute the profit or loss from realization which should be shared among the partners according to the profit or loss sharing ratio

4 Nature of partnership dissolution Dissolution where the assets are sold separately Dissolution where partnership is sold as a whole

5 Dissolution where Assets are sold separately

6 Procedures of Dissolution 1. All assets will be sold to other persons or taken over by partners 2. Settle the liabilities of the partnership to outsider or partners 3. Transfer any ‘profit or loss on realization’ to each partner’s capital accounts in profit/loss sharing ratio 4. Merge the balances in the partners’ current accounts to their capital accounts

7 5. Any credit balance in each partner’s capital account represents the amount which can be withdrawn from the partnership to each partner; any debit balance in a partner’s capital account represents additional cash to be injected by that partners

8 TransactionsAccounting entries Close all asset accounts with net book value to the realization account (except cash and bank because these assets need not be disposed of) Dr Realization Cr Assets Cost of dissolution or any losses or expenses incurred on realization Dr Realization Cr Bank Proceeds from the disposal of assets Dr Bank Cr Realization Assets taken over by a partner without payment Dr Capital Cr Realization

9 TransactionsAccounting entries Asset taken over by partners as a gift No entries required Creditors taken over by a partner Dr Creditors Cr Capitals Payment to creditors with discounts received Dr Creditors Cr Realization – discount Cr Bank Profit or loss on realization to be shared among the partners according to the profit-sharing ratio Dr Realization – profit Cr Capitals or Dr Capital Cr Realization - loss

10 TransactionsAccounting entries Repayment of loan to an partner Dr Loan from partner Cr Bank Repayment of loan to an outsider ( creditors) Dr Loan from outsider Cr Bank Transfer any balances in partners’ current accounts Dr Current (for credit balance) Cr Capitals Or Dr Capital Cr Current (for debit balance) Repayment of remaining capital to partners Dr Capital Cr Bank

11 Example 1

12 John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Premises Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Bank Less: Current Liabilities Creditors Working Capital

13 Capital: John Peter Tom Current: John Peter (10000) Tom Long – term liabilities Loan from Tom Assets and liabilities were disposed of as follows: 1. The premises were sold at $ and legal charges from the sale amount to $ Tom took over the stock and motor vehicles at book value 3.Except for $2500, all debts were collected 4. The creditors were discharged for $ Realization expenses of $10000 were paid Required: Prepare the realization, Bank, Capital and Current account for the dissolution of partnership

14 Realization Premises Provision for depreciation Bal b/f Prov. for depreciation Realization Bal b/f 10000Premises Premises

15 Realization Motor Vehicles Provision for depreciation Bal b/f Prov. for depreciation 5500 Realization Bal b/f 5500Motor Vehicles 5500 Premises Motor Vehicles 22000

16 Realization Debtors Provision for Bad Debts Bal b/f Prov. for bad debts 1265 Realization Bal b/f 1265Motor Vehicles 1265 Premises Motor Vehicles Debtors

17 Realization Stock Bal b/f 68250Realization Premises Motor Vehicles Debtors Stock 68250

18 Realization Bank Bal b/f 26065Realization - expenses Premises Motor Vehicles Debtors Stock Bank- realization expenses Bank – premises ( ) Debtors ( ) Realization – premises debtors Creditors Bal b/f 60000Bank Realization – discount received Creditors – discount received 4000 Creditors Loan from Tom Bal b/f 7550Bank 7550 Loan from Tom 7550

19 Realization Premises Motor Vehicles Debtors Stock Bank- realization expenses Bank – premises ( ) Debtors ( ) Creditors – discount received 4000 Capital John Peter Tom Bal b/f Realization: Stock MV Tom – stock MV Gain on realization: John 1/ Peter 1/ Tom 3/ Gain on realizaiton

20 Capital John Peter Tom Bal b/f Realization: Stock MV Gain on realizaiton Current John Peter Tom Bal b/f Bal b/f Capital Capital Bank Bal b/f 26065Realization - expenses Realization – premises debtors Creditors Loan from Tom 7550 Capital: John Peter Tom Current Current Bank

21 Dissolution where partnership is sold as a whole

22 Purchase consideration The purchase consideration is to be discharged by the limited company (buyer) to partners(seller) to take over the business Goodwill = Purchase consideration – ( assets at take-over value – liabilities at take-over value)

23 TransactionsAccounting entries For dissolution of Old partnership (seller) Close all asset accounts with net book value to the realization account (Bank and cash may be taken over) Dr Realization Cr Assets Cost of dissolution or any losses or expenses incurred on realization Dr Realization Cr Bank Proceeds from sale of the business (purchase consideration) Dr Vendee (buyer) Cr Realization

24 TransactionsAccounting entries Liabilities taken over by the buyer Dr Liabilities Cr Realization The purchase consideration settled by cheque, shares and debentures Dr Bank/ Shares/ debentures in purchaser’s company Cr Bank Repayment of remaining capital to partners Dr capital Cr Bank/ shares/ debentures in purchaser’s company

25 TransactionsAccounting entries For opening entries of New Company (buyer) Assets taken overDr Assets Cr Business Purchase Liabilities taken overDr Business Purchase Cr Liabilities The purchase consideration offered Dr Business Purchase Cr Vendor (seller) The purchase consideration settled by cheques, shares and debentures Dr Vendor (seller) Cr Bank/Shares/Debentures

26 Example 2

27 John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Premises Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Bank Less: Current Liabilities Creditors Working Capital

28 Capital: John Peter Tom Current: John Peter (10000) Tom Long – term liabilities Loan from Tom On 31 December 1996, they incorporated a limited company, Fortune limited, to take over the partnership business. Fortune Limited had an authorized capital of $ ordinary shares of $1 each.

29 Assets and liabilities were disposed of as follows: 1.John took over the stock at book value. Tom collected all the debts except $ The company took over the premises at a valuation of $200000, motor vehicles at $25000, cash at bank and all the liabilities. Goodwill was valued at $70000 for the purpose of the takeover 3.The purchase consideration was to be discharged by the issue to the partners of ordinary shares at $1.2 each, according to the profit-sharing ratio, and the balance was to be in cash 4.The company also issued ordinary shares at $1.2 for cash to outsiders Required: Prepare the realization, Capital and the opening balance sheet for the new company

30 Realization Premises MV Stock Debtors Bank Bank be taken over Tom: debtors ( ) John: stock Creditors Loan from Tom 7550 Liabilities taken over by Ltd. Co. Fortune Ltd – purchase consideration [( ) ] Purchase consideration=Asset-liabilities +goodwill Capital: John Peter Tom

31 Capital John Peter Tom Bal b/f Current Current Realization Stock Debtors Shares in Fortune Ltd Realization -profit Bank (Bal. fig.) Shares in Fortune Ltd *1.2 = John 1/ Peter 1/ Tom 3/

32 Fortune Limited Balance sheet as at 1 Jan 1996 Fixed Assets Goodwill Premises MV Current Assets Bank [ (50000*1.2) –( )] Less: Current liabilities Creditors Working Capital (47450) Share Capital Ordinary Shares (150000*$ *$1) Share Premium (150000*$ *$0.2) Long-term liabilities Loan from Tom

33 Cash distribution among partners

34 Cash Distribution Among Partners With the application of the Garner vs. Murray rule When cash is to be distributed as soon as possible ( Piecemeal realization)

35 With the application of Garner vs. Murray rule

36 With the application of Garner vs. Murray rule Any CREDIT balance in each partner’s capital account represents the amount which can be withdrawn from the partnership to each partner Any DEBIT balance in a partner’s capital account represents additional cash to be injected by that partner. If he is insolvency to repay the amount, the solvency partners will be shared the amount in:  Profit & loss sharing ratio  Any agreed ratio given in the examination question  GARNER vs. MURRAY rule may be applied

37 What is Garner vs. Murray rule?

38 Garner vs. Murray rule Under the rule, a partner is required to contribute cash to eliminate the debit balance in his capital account In the court case of Garner vs. Murray (1904), it was held that subject to any agreement to the contrary, such a debit balance deficiency was to be shared by the other partner not in their profit and loss sharing ratio but “ the ratio of their last agreed capitals”

39 If one partner is insolvent, his capital deficiency will be shared by other partners according to the ‘last agreed capital ratio’ (the ratio of the balances in the capital accounts before the dissolution, in the absence of any agreement to the contrary

40 Example 3

41 Au, Chow and Lee were partners sharing profits and losses in the ratio 2:2:1. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Goodwill Land Plant & Machinery Fixture & Fittings Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Cash Less: Current Liabilities Creditors Bank Overdraft Working Capital

42 Capital: Au Chow Lee Current: Au Chow Long – term liabilities Bank loan On 31 December 1996 the partners agreed to dissolve the partnership due to a disagreement between the partners. Assets were to be realized, outstanding debts to be paid and the remainder to be shared by the partners in an equitable manner. Distributions of cash were to be made as soon as possible. January Provision was made for dissolution expenses of $2400 Land was sold for $ The cash available was utilized to settle in full the bank overdraft, the bank overdraft, the bank loan and all creditors after receiving discounts

43 March Stock which had originally costed $40000 was sold for $32000 $15000 was received form debtors April Plant & Machinery were sold for $51000 after paying carriage of $2000 Fixtures and fittings were sold for $12000 May All the outstanding debtors, with the exception of a customer who owed $4000 settled their accounts Motor vehicles were sold for $25000 The remaining stock was sold for $22000 Dissolution expenses amounted to $2100 Prepare distribution statement of cash at each stage

44 Distribution Statement Total Au Chow Lee $ $ $ $ Capital accounts Current accounts st Distribution: Cash available (w1) ( 47000)(w1) Maximum possible loss (2:2:1) (14600) Lee’s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (8760) (5840) Cash distributed nd Distribution: Cash available ( ) (63000) Maximum possible loss (2:2:1) (2000) Lee’s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (1200) (800) 2000 Cash distributed Capital balance

45 3 rd Distribution: Cash available (W2) (93300)(W2) Maximum possible loss (2:2:1) Cash distributed Capital balance

46 W1 Cash available for 1st distribution: JanuaryOpening balance160 Receipt from land Less: Payment Assumed dissolution expenses2400 (i.e. not actual expenses) Bank overdraft Bank loan20000 Creditors (Bal. Fig.) => no cash distribution to partners on January March Receipts: Stock Debtors First cash distributed to partners ‘Settle in full’ means no more payment will be paid. => the difference between and is discount received Back

47 Very often no cash is distributed to partners at first or second month since outstanding debts must be repaid first and then the remaining cash can then be distributed to partners. Even though the questions have not mentioned to repay outstanding debts, you should make sure to keep some cash to prepare to repay debts and could not be distributed it to partners Notes:

48 W3 Cash available for 3rd distribution: MayReceipts Surplus in dissolution expenses( ) 300 Collection remaining debtors balance ( ) Receipts from MV Receipts from remaining stock Back

49 Realization Goodwill Land Plant & Machinery Fixtures & fittings Motor Vehicles 8000 Stock Debtors Cash: Land Stock ( ) Debtors ( ) Plant & machinery Fixture & fittings Motor vehicles Creditors – discount rececived ( ) 7600 Capital: Au (2/5) Chow (2/5) Lee (1/5) Cash - dissolution expenses 2100

50 Capital Au Chow Lee Au Chow Lee Bal b/f Current Cash in March In April in May Realization -loss