Slide 26-1 26 CHAPTER 26 PARTNERSHIPS: LIQUIDATIONS.

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26CHAPTER 26

PARTNERSHIPS:LIQUIDATIONS

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26FOCUS OF CHAPTER 26

Fundamental Procedures in Liquidation

Lump-Sum Liquidations Installment Liquidations

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26 Sharing of Gains & LossesDuring Liquidation

Gains and losses incurred on the realizationof noncash assets during liquidation are: Allocated among the partners in the

profit-and-loss sharing ratio (such as 4:3:1).

UNLESS agreed to otherwise by the partners.

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26 Consequences of A PartnerBeing Personally Insolvent

A partner having a capital account deficitmay be able to eliminate the deficit by: Capital contribution. Setoff.

A deficit that cannot be eliminated, is allocated to: The remaining partners who have

POSITIVE capital balances(using their P/L sharing ratio).

+

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26 Consequences of A PartnerBeing Personally Insolvent

A partner that winds up absorbing someor all of another partner’s capital deficit has: Legal recourse against that partner.

Because that partner has broken the terms of the partnership agreement.

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26 Sharing Profits and Losses:In The Ratio of Capital Balances

Sharing profits and losses in the ratio of capital balances: Is one of the most important safeguards

used in partnership agreements. Results in no partner EVER having a

capital account deficit balance until the losses incurred in liquidation exceed the TOTAL partnership capital. Thus ALL partners go into a deficit

position SIMULTANEOUSLY.

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26The Rule of Setoff

A deficit balance in a partner’s capital account can be eliminated to the extent that such partner has a loan to the partnership.

Note Payable Capital, to Jones JonesBalances before setoff....... $30,000 $(11,000) Apply rule of setoff........ (11,000) 11,000Balances after setoff....….. $19,000 $ -0-

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26No More “Marshaling of Assets”

In liquidation: PARTNERSHIP CREDITORS have first

priority as to PARTNERSHIP ASSETS. PERSONAL CREDITORS of an

insolvent partner do NOT have first priority as to PERSONAL ASSETS of that partner. They share on a pro rata basis

with partnership creditors.

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26 Installment Liquidations:Priority In Distributing Cash

No cash distributions are made to partners until creditors have been

paid in full (100%).

This holds true for BOTH: Lump-sum liquidations. Installment liquidations.

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26 Installment Liquidations:Different Strokes For Different Folks

The amount to be distributed to each partner at any point in time can be determined by preparing either of the following items: Schedules of safe payments at each

cashdistribution date. Will have to be done several times.

A cash distribution plan at the beginning of the liquidation process. Need be done only once.

#1

#2

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26Installment Liquidations

The EFFECT of distributing cash to partners based on either (a) schedules of safe payments or (b) cash distribution plans, is to:

Bring the capital balances into the profit-and-loss sharing ratio.

“CONVERGENCE”

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26 Installment Liquidations:Loss Absorption Potentials

Conceptually, the first cash distribution to partners goes to that partner who has:

THE HIGHEST LOSS ABSORPTION POTENTIAL. This is NOT necessarily the partner

that has the highest capital balance.

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26 Installment Liquidations: Loss Absorption Potentials--Calculating

The loss absorption potential of each partner is calculated by:

Dividing the partner’s capital balance by his or her profit-and-loss sharing percentage.Capital balance of Jones............ $80,000

= $400,000Jones’ P/L sharing percentage.. 20% Loss Absorption Potential

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26 Installment Liquidations: Loss Absorption Potentials--Implications

Consequences of Having the Highest Loss Absorption Potential: He or she will be: The first partner to receive cash.

The partner that could suffer the greatest inequity inrelation to his or her capital balance. It is NOT a good thing to have

the highest loss absorption potential.

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26 Installment Liquidations: Loss Absorption Potentials--Loans “To”

In calculating a partner’s loss absorption potential, a partner’s loan to the partnership

is ADDED TO the partner’s capital balance.

Capital balance, Jones................ $80,000Note payable to Jones............... 10,000 Total.......................................... $90,000 = $450,000Jones’ P/L sharing percentage... 20% Loss Absorption Potential

PLUS

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26 Installment Liquidations: Loss Absorption Potentials--Loans “From”

In calculating a partner’s loss absorption potential, a partner’s loan from the partnership is SUBTRACTED FROM the partner’s capital balance.

Capital balance, Jones................ $80,000Note receivable from Jones...... (5,000) Total.......................................... $75,000 = $375,000Jones’ P/L sharing percentage... 20% Loss Absorption Potential

MINUS

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26 The Statement of Realizationand Liquidation

The STATEMENT OF REALIZATION AND LIQUIDATION is A historical statement. It portrays what actually

happened in the past(during the liquidationprocess).

Income statements are not prepared duringthis period.

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26The Schedule of Safe Payments

In contrast to the Statement of Realization and Liquidation, the SCHEDULE OF SAFE PAYMENTS is A pro forma (what if) statement. It portrays what could happen in

the future--on a worst-case basis.

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26Review Question #1

In liquidation, cash distributions to partnersare determined based on:

A. Who has the highest capital balance.B. How profits and losses are shared .C. Partners’ loans to the partnership having priority over partners’ capital balances.D. The marshalling of assets principle.E. The rule of setoff .F. None of the above.

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26Review Question #1--With Answer

In liquidation, cash distributions to partnersare determined based on:

A. Who has the highest capital balance.B. How profits and losses are shared .C. Partners’ loans to the partnership having priority over partners’ capital balances.D. The marshalling of assets principle.E. The rule of setoff .F. None of the above. (Loss absorption potential)

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26Review Question #2

In liquidation, Kelly (who shares in 25% of profits and losses) was given equipment having a carrying value of $10,000 and a fair value of $14,000. Kelly’s capital account is debited :

A. $10,000B. $11,000C. $13,000 D. $14,000 E. $15,000

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26Review Question #2--With Answer

In liquidation, Kelly (who shares in 25% of profits and losses) was given equipment having a carrying value of $10,000 and a fair value of $14,000. Kelly’s capital account is debited :

A. $10,000B. $11,000C. $13,000 ($14,000 - [$4,000 x 25%])D. $14,000 E. $15,000

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26End of Chapter 26

Time to Clear Things Up--Any Questions?

Slide 26-1 26 CHAPTER 26 PARTNERSHIPS: LIQUIDATIONS.

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