1. Termination and Liquidation
Chapter Ten
Partnerships:
Termination and Liquidation
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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.
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 their 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.
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3. Termination & 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 prepares a cash predistribution plan.
The accountant can summarize and keep track of these steps in a statement of partnership liquidation.
The liquidation of a partnership becomes more complicated when:
 One or more partners have a negative (deficit) capital balance. A deficit (debit) capital balance can
exist either at the beginning of the liquidation process or can arise during the liquidation as
partners’ capital balances absorb losses from non‐cash asset sales. In some cases, a partner with a
deficit capital balance will have sufficient personal assets to be able to make a contribution to the
partnership to eliminate the deficit. In other cases, a partner will be personally insolvent and the
other partners will have to absorb the deficit through reductions in their capital accounts.
 The liquidation takes place over an extended period of time. In this case, the partners are likely to
request that cash be distributed to them as it becomes available through the liquidation of
partnership assets. The accountant can facilitate the distribution of cash in installments by
calculating the safe payments that can be made without running the risk that an individual partner
will incur a deficit capital balance. The accountant might choose to prepare a cash predistribution
plan in advance of any sales of non‐cash assets to guide the distribution of installment payments
during the course of the partnership liquidation.
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4. 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. (Deficit partner may pay later or can be sued for the amount.)
Profit / loss ratio: Holland 40%; Dozier 40%; Ross 20%
Holland, Dozier, and Ross balances just prior to liquidation.
Cash $20, Holland, Capital $ (6,000)
Dozier, Capital ,000
Ross, Capital ,000
Total $ 20,000
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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5. Deficit Capital Balance -- Contribution by Deficit Partner
Holland legally is required to convey an additional $6,000 to the partnership to eliminate the deficit balance. This contribution raises the cash balance to $26,000, which allows a complete distribution to be made to Dozier ($15,000) and Ross ($11,000) in line with their capital accounts.
Deficit Capital Balance -- Holland has a negative capital balance of $6,000; the assigned share of partnership
losses has exceeded this partner’s capital balance at the date the partnership terminated.
In such cases, the Uniform Partnership Act (Section 807[b]) stipulates that the partner
“shall contribute to the partnership an amount equal to any excess charges over the
credits in the partner’s account . . .” Therefore, Holland legally is required to convey
an additional $6,000 to the partnership to eliminate the deficit balance. This contribution
raises the cash balance to $26,000, which allows a complete distribution to be made
to Dozier ($15,000) and Ross ($11,000) in line with their capital accounts.
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6. Deficit Capital Balance - Remaining Partners Absorb Deficit
If the partner resists, the loss will be written off against the capital accounts of Dozier and Ross.
Allocation of Potential $6,000 Loss
Dozier ⁄3 of $(6,000) $(4,000)
Ross ⁄3 of $(6,000) $(2,000)
Allocation of the loss is based on the relative profit and loss ratio specified in the articles of partnership. Dozier and Ross are credited with 40 percent and 20 percent of partnership income, respectively. The 40:20 ratio equates to a 2:1 relationship (or 2⁄3:1⁄3) between the two.
Unfortunately, an alternative scenario can easily arise for the previous partnership liquidation.
Although Holland’s capital account shows a $6,000 deficit balance, this partner
could resist any attempt to force an additional investment, especially because the
business is in the process of being terminated. The possibility of such recalcitrance is
enhanced if the individual is having personal financial difficulties. Thus, the remaining
partners may eventually have to resort to formal litigation to gain Holland’s contribution.
Until that legal action is concluded, the partnership records remain open although
inactive.
Should Holland’s $6,000 deficit (or any portion of it) prove uncollectible, the loss
will be written off against the capital accounts of Dozier and Ross. Allocation of this
potential loss is based on the relative profit and loss ratio specified in the articles of partnership.
According to the information provided, Dozier and Ross are credited with 40
percent and 20 percent of all partnership income, respectively. This 40:20 ratio equates
to a 2:1 relationship (or 2⁄3:1⁄3) between the two. Thus, if no part of the $6,000 deficit balance
is ever recovered from Holland, $4,000 (two-thirds) of the loss will be assigned to
Dozier and $2,000 (one-third) to Ross.
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7. Deficit Capital Balance - Remaining Partners Absorb Deficit
Capital balances after distribution of Holland’s loss:
Holland Dozier Ross
Capital Balances $ (6,000) $ 15,000 $ 11,000
Allocation of Holland’s deficit balance 6, (4,000) (2,000)
Capital Balances $ $ 11,000 $ 9,000
A safe payment of $11,000 may be made to Dozier that reduces that partner’s capital account from $15,000 to the minimum $4,000 level. A $9,000 payment to Ross decreases the $11,000 capital balance to the $2,000 limit. Thus, $11,000 and $9,000 are the safe payments that can be distributed to the partners without creating new deficits.
Capital balances after distribution of Holland’s loss:
Holland Dozier Ross
Capital Balances $ (6,000) $ 15,000 $ 11,000
Allocation of Hollands deficit balance , (4,000) (2,000)
Capital Balances $ $ 11,000 $ 9,000
Hence, a safe payment of $11,000 may be made to Dozier at the
present time; this distribution reduces that partner’s capital account from $15,000 to the
minimum $4,000 level. Likewise, a $9,000 payment to Ross decreases the $11,000 capital
balance to the $2,000 limit. Thus, $11,000 and $9,000 are the safe payments that can be
distributed to the partners without fear of creating new deficits in the future.
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8. Preliminary Distribution of Assets
Under the Uniform Partnership Act, a priority ranking of creditors having claims against individual partners is recognized:
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: Debts owed to partnership creditors, Debts owed to the other partners, and Debts owed to personal creditors.
Debts owed to personal creditors.
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9. Claims Against the Partnership
Individual partner’s creditors can make a claim against the assets of the partnership.
All partnership creditors must be satisfied.
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.
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.
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10. 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.
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.
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11. Predistribution Plan
Assume the following partnership is to be liquidated Assume the income sharing percentage is Rubens 50%, Smith 20%, and Trice 30%.
Assume the following partnership is to be liquidated Assume the income sharing percentage is Rubens 50%, Smith 20%, and Trice 30%.
The partnership capital reported by this organization totals $121,000. However, the individual balances for the partners range from $30,000 to $51,000, and profits and losses are assigned according to three different percentages. Thus, differing losses would reduce each partner’s current capital balance to zero. As a prerequisite to developing a predistribution plan, the sensitivity to losses exhibited by each of these capital accounts must be measured:
Partnership capital reported totals $121,000. Differing losses would reduce each partner’s current capital balance to zero. As a prerequisite to developing a predistribution plan, the sensitivity to losses exhibited by each of these capital accounts must be measured.
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12. Predistribution Plan
First, determine the maximum loss that each partner can absorb. Divide each partner’s capital balance by their respective income sharing percent.
First, determine the maximum loss that each partner can absorb. Divide each partner’s capital balance by their respective income sharing percent.
According to this initial computation, Rubens is the partner in the most vulnerable position at the present time. Based on a 50 percent share of income, a loss of only $60,000 would reduce this partner’s capital account to a zero balance. If the partnership does incur a loss of this amount, Rubens can no longer hope to recover any funds from the liquidation process.
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13. 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.
Since Rubens can ONLY absorb a partnership loss of $60,000, new balances are computed assuming that the partnership has a $60,000 loss. With Rubens wiped out, continue calculating maximum absorbable losses using income sharing percentages of Smith, 20% (2/5) and Trice 30% (3/5).
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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14. Predistribution Plan
Because Rubens’s capital balance already has been eliminated, Trice is now in the most vulnerable position: Only a $55,000 Step 2 loss is required to reduce this partner’s capital balance to zero. According to this second schedule, a total loss of $115,000 ($60,000 from Step 1 plus $55,000 from Step 2) leaves capital of only $6,000, a balance attributed entirely to Smith. At this final point in the simulation, an additional loss of this amount also ends Smith’s right to receive any funds from the liquidation process. Having the sole positive capital balance remaining, this partner would have to absorb the entire amount of the final loss.
According to the schedule, a total loss of $115,000 ($60,000 from Step 1 plus $55,000 from Step 2) leaves capital of only $6,000, a balance attributed entirely to Smith.
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15. 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. Liquidation expenses have been estimated.
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. To complete this illustration, liquidation expenses of $12,000 have been estimated. Because these expenses have the same effect on the capital accounts as losses, they do not change the sequential pattern by which assets eventually will be distributed.
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