Chapter Accounting for Partnership Termination of Operations Review Questions The three steps in liquidating a partnership are (1) selling the assets of the entity, (2) paying its liabilities, and (3) disbursing any remaining cash to the partners J & E share (a) gains and losses on the sale of noncash assets based on their profit-and-loss ratio and (b) the final cash distribution based on their capital balances In addition to considering remaining assets worthless, the schedule of safe payments further must reduce capital balances by any additional estimated disposition costs The right of offset allows partners to treat any loan to the partnership as a contribution to capital if the partner’s capital account becomes deficient The significance of this right is that the two amounts are summed to determine the amount of interim distributions that are allocable to the partner during liquidation Payments are first applied, however, against the loan balance Dissolution of a partnership terminates the partnership as a legal entity, but the partnership business may continue under a new agreement When a partnership is liquidated, however, the partnership is terminated both as a legal and as a business entity Thus, a partnership may be dissolved without liquidation, but it may not be liquidated without dissolution A simple partnership liquidation is the liquidation of a solvent partnership in which all partners have equity capital and all gains and losses are realized and recognized before any distributions are made to the partners In simple partnership liquidations, only one cash distribution is made and the amounts distributed to individual partners are equal to their predistribution capital account balances The distribution of assets for capital interests prior to the payment of loan balances to the partners is not in accordance with Partnership Act But the partners may agree to distribute cash or other assets for capital interests Chapter before all losses on liquidation are known With agreement among all partners, distributions to the partners would be based on each partner’s equity (combined capital and loan balances) in relation to his share of possible future losses A partner with sufficient equity to absorb his share of possible future losses would be included in distributions, but a partner with loans to the partnership would not be included in distributions until his equity is sufficient to absorb his share of possible future losses A statement of partnership liquidation is a summary of transactions and balances for a partnership during its liquidation stage Such statements provide continuous records of liquidation events Interim liquidation statements are particularly helpful in showing the progress that has been made toward liquidation to date and in identifying remaining assets to be liquidated and liabilities to be paid Interim liquidation statements are helpful to partners and creditors in providing a basis for current decisions as well as future planning Liquidation statements are important legal documents for partnership liquidations that come under the jurisdiction of a court Available cash may be distributed to partners according to their profit and loss sharing ratios only when nonpartner liabilities have been satisfied and partner equities (capital and loan balances combined) are aligned with the relative profit and loss sharing ratios of the partners In the absence of loans or advances payable to or receivables from individual partners, cash can be distributed to partners in their profit and loss sharing ratios when capital balances are in the relative profit and loss sharing ratios of the partners and all nonpartner liabilities have been paid 10 Partnership insolvency occurs when partnership liabilities exceed partnership assets In this case, all available cash is distributed to partnership creditors Individual partners will be called upon to use their personal assets to satisfy the remaining claims of the partnership creditors 11 Partners with credit capital balances after all partnership assets have been distributed in liquidation have a claim against partners with debit capital balances If the partners with debit balances are personally solvent, they should pay amounts equal to their partnership claims in full If partners with debit capital balances are insolvent, the partners with credit balances will absorb the losses of the insolvent partners with debit capital balances in relation to their relative profit and loss sharing ratios Accounting for Partnership Termination of Operations Exercises Exercise Schedule of Capital Balances Capital balances January 1, 2007 January losses: Lumber Receivables Capital balances before distribution P15,000 4,000 Cash distribution: Accounts payable Black White Total cash 60% Black P40,000 (9,000) (2,400) P28,600 40% White P20,000 (6,000) (1,600) P12,400 P15,000 28,600 12,400 P56,000 Exercise Sale of inventory Cash Inventory To record sale of inventory items P10,000 P10,000 Distribution of cash Accounts payable Cash To record payment to creditors P5,000 P5,000 Blue, capital P12,600 Pink, capital 6,200 Yellow, capital 25,200 Cash P44,000 To record distribution of available cash to partners computed as follows: Chapter Blue capital Pink capital Yellow capital Totals Possible Loss from Unsold Inventory P2,400 1,800 1,800 P6,000 Capital Balance P15,000 8,000 27,000 P50,000 Balance P12,600 6,200 25,200 P25,200 Exercise January balances Contingency fund of P10,000 Possible losses on asset disposal (P120,000) Loss on Violet’s possible default divided 3/7 and 4/7 Available cash is distributed 30% Teal P 85,000 (3,000) 30% Violet 40% Magenta P 25,000 P 90,000 (3,000) (4,000) (36,000) 46,000 (36,000) (14,000) (48,000) 38,000 (6,000) P 40,000 P 14,000 (8,000) P 30,000 Exercise Beginning balances Offset Orange’s loan Loss on sale of assets (P180,000 – P120,000) Additional liability Distribute Orange’s debit balance, 5/7, 2/7 Cash distribution Creditors P60,000 50% Carnation P59,000 30% Orange P29,000 (20,000) 20% Mocha P52,000 5,000 65,000 (30,000) (2,500) 26,500 (18,000) (1,500) (10,500) (12,000) (1,000) (1,000) P65,000 (7,500) P19,000 10,500 (3,000) P36,000 Orange owes P7,500 to Carnation and P3,000 to Mocha Accounting for Partnership Termination of Operations Exercise Schedule to Correct Capital Accounts December 31, 2008 Overvalued inventory Corrected balances P10,000 Red Capital P40,000 (5,000) P35,000 Green Capital P35,000 (3,000) P32,000 Gray Capital P25,000 (2,000) P23,000 The capital balances are adjusted for the error in computing net income in the partners’ residual equity ratios Exercise Requirement (1) Value of total investment 1/5 (P250,000 + X) P50,000 + 1/5X P50,000 P62,500 = = = = = X X X 4/5 X X Requirement (2) (a) Investment recorded as bonus: Cash Lime, Capital Moss, Capital Neon, Capital Green, Capital 88,000 10,200 7,650 2,550 67,600 * * (P88,000 – P62,500) x 1/5 = P5,100; P62,500 + P5,100 = P67,600 (b) Investment recorded as goodwill: Cash Goodwill Lime, Capital Moss, Capital Neon, Capital Green, Capital 88,000 102,000 51,000 38,250 12,750 88,000 Chapter + - #0 Lump sum liquidation schedule: ; Beginning balances Sale of assets Balances Cash distributions Ending balances P 45,000 249,000 P294,000 (294,000) -0- < = P297,000 (297,000) -0– -0- P92,000 P92,000 (92,000) -0- P160,000 (24,000) P136,000 (136,000) -0- ;- > ; & P 65,000 (18,000) P 47,000 (47,000) -0- = P 25,000 (6,000) P 19,000 (19,000) -0- Exercise Beginning balances Capital and loan balance Allocation of expected liquidation expenses Balances Maximum loss absorbed (MLA) Amount needed to reduce highestranked MLA to next higher MLA New MLA Reduction in capital needed to achieve reduction in MLA New capital balances > 30% 30% P33,000 P33,000 (3,000) P30,000 (3,000) P30,000 & ; – – ;– P24,000 – – – (4,000) P24,000 – – – – – – 40% – – – P100,000 P100,000 P100,000 – – – – – – (50,000) P 50,000 (50,000) P 50,000 – P 50,000 (15,000) P15,000 (15,000) P15,000 – P20,000 All above transactions should be profit and loss ratios ? I II III IV ; First P20,000 Next P10,000 Next P30,000 Any additional payments P20,000 ?5 > ;- P10,000 50% 30% 50% 30% 40% Accounting for Partnership Termination of Operations Exercise Part a Square gets P21,000, Circle gets P12,000, and Triangle gets P2,000 Square Circle Triangle Reported balances P25,000 P15,000 P5,000 Loss on sale of land (P10,000) split on a 4:3:3 basis (4,000) (3,000) (3,000) Cash distribution P21,000 P12,000 P2,000 Part b Square gets P16,429 and Circle gets P8,571 Square Circle Triangle Reported balances P25,000 P15,000 P5,000 Loss on sale of land (P20,000) split on a 4:3:3 basis (8,000) (6,000) (6,000) Adjusted balances P17,000 P 9,000 P(1,000) Potential loss from Triangle's deficit (split 4:3) (571) (429) 1,000 Cash distribution P16,429 P 8,571 P -0Part c Square gets P10,714 and Circle gets P4,286 Square Circle Triangle Reported balances P25,000 P15,000 P5,000 Loss on sale of land (P30,000) split on a 4:3:3 basis (12,000) (9,000) (9,000) Adjusted balances P13,000 P 6,000 P(4,000) Potential loss from Triangle's deficit (split 4:3) (2,286) (1,714) 4,000 Cash distribution P10,714 P 4,286 P -0Exercise The entire P20,000 goes to Faith Reported balances Capital contribution Adjusted balances Potential loss from Love and Joy (P60,000) split on a 4:3 basis Adjusted balances Potential loss from Hope (P5,714) Cash distribution Faith P60,000 -0P60,000 Hope P20,000 -0P20,000 Love P(30,000) -0P(30,000) (34,286) P25,714 (25,714) P(5,714) P (5,714) P20,000 P 5,714 -0- P Joy P(50,000) 20,000 P(30,000) 30,000 -0- P 30,000 -0- -0-0- P -0-0- Chapter Multiple Choice Questions C A D B B Sunshine, Capital Reported balances Potential loss from Sunset deficit (split 5/8:3/8) Cash distributions Sunrise, Capital Sunset, Capital P19,000 P18,000 P(12,000) (7,500) P11,500 (4,500) P13,500 12,000 -0- B Reported balances Loss on sale of assets (P110,000) split on a 4:3:2:1 basis Adjusted balances Potential loss from Dennard deficit (split 4:3:1) Minimum cash distributions Lualm Michelle Snowie Jovie P50,000 P56,000 P14,000 P80,000 (44,000) P 6,000 (33,000) P23,000 (22,000) (11,000) P(8,000) P69,000 (4,000) P2,000 (3,000) P20,000 8,000 P -0- (1,000) P68,000 C A predistribution plan should be created Maximum Losses That Can Be Absorbed JC PJ Tin Bers P59,000/40% P39,000/30% P34,000/10% P34,000/20% P147,500 130,000 340,000 170,000 (most vulnerable to losses) The assumption is made that a P130,000 loss occurs Accounting for Partnership Termination of Operations JC Reported balances P59,000 Assumed loss (P130,000) split on a 4:3:1:2 basis (52,000) Adjusted balances P 7,000 Maximum Losses That Can Now Be Absorbed JC P7,000/4/7 P12,250 Tin P21,000/1/7 147,000 Bers P8,000/2/7 28,000 PJ P39,000 Tin P34,000 Bers P34,000 (39,000) P -0- (13,000) (26,000) P21,000 P 8,000 (most vulnerable to losses) JC Reported balances P7,000 Assumed loss (P12,250) split on a 4:1:2 basis (7,000) Adjusted balances P -0Maximum Losses That Can Now Be Absorbed Tin P19,250/1/3 P57,750 Bers P4,500/2/3 6,750 Tin Bers P21,000 P8,000 (1,750) P19,250 (3,500) P4,500 (most vulnerable to losses) The assumption is made that a P6,750 loss occurs Reported balances Assumed loss (P6,750) split on a 1:2 basis Adjusted balances Tin P19,250 (2,250) P17,000 Bers P4,500 (4,500) P -0- C To work this problem, a predistribution schedule is necessary That schedule, which is computed below, is as follows: —First P3,000 goes to Ayen —Next P15,000 goes to Ayen (2/3) and Det (1/3) —Next P42,000 goes to Tins (4/7), Ayen (2/7), and Det (1/7) —All remaining cash goes to Tins (4/10), Bert (3/10), Ayen (2/10), and Det (1/10) 10 Chapter Beginning balances Assumed loss of P90,000 (see Schedule 1)(4:3:2:1) Step one balances Assumed loss of P42,000 (see Schedule 2) (allocated on a 4:0:2:1 basis) Step two balances Assumed loss of P15,000 (see Schedule 3) (allocated on a 0:0:2:1 basis) Step three balances Tins P60,000 Bert P27,000 Ayen P43,000 Det P20,000 (36,000) P24,000 (27,000) P -0- (18,000) P25,000 (9,000) P11,000 (24,000) P -0- P -0P -0- (12,000) P13,000 (6,000) P 5,000 -0- (10,000) P -0- P 3,000 (5,000) P -0- -0P -0Schedule Partner Tins Bert Ayen Det Capital Balance/ Loss Allocation P60,000/40% P150,000 P27,000/30% P 90,000 P43,000/20% P215,000 P20,000/10% P200,000 Maximum Loss That Can Be Absorbed (most vulnerable) Schedule Partner Tins Ayen Det Capital Balance/ Loss Allocation P24,000/(4/7) P 42,000 P25,000/(2/7) P 87,500 P11,000/(1/7) P 77,000 Maximum Loss That Can Be Absorbed (most vulnerable) Schedule Partner Ayen Det Capital Balance/ Loss Allocation P13,000/(2/3) P 19,500 P 5,000/(1/3) P 15,000 Maximum Loss That Can Be Absorbed (most vulnerable) C The P16,000 available cash can be distributed but should be done under the assumption that all deficit balances will be total losses After offsetting Jack’ loan, the two deficits total P4,000 Hansel and Gretel, the two partners with positive capital balances, share profits in a 30:20 relationship (the equivalent of a 60%:40% ratio) Hansel would absorb P2,400 of the potential loss with Gretel Accounting for Partnership Termination of Operations 11 being allocated P1,600 The remaining capital balances (P10,600 and P5,400) are safe capital balances and those amounts can be immediately distributed Test Materials Test Material 6-1 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 A B C D Good, Better, and Best Sale of Noncash Assets (For P145,000) E F Noncash Good Better Best Cash Assets Liabilities Capital Capital Capital -P 6,000 P126,000 P77,000 P12,000 P37,000 P6,000 145,000 (126,000) 4,750 10,450 3,800 -P151,000 P P77,000 P16,750 P47,450 P9,800 ======= ====== ====== ====== ====== ===== (For P95,000) Noncash Good Better Best Cash Assets Liabilities Capital Capital Capital -P 6,000 P126,000 P77,000 P12,000 P37,000 P 6,000 95,000 (126,000) (7,750) (17,050) (6,200) -P101,000 P P77,000 P4,250 P19,950 P (200) ======= ======= ====== ====== ====== ====== Two ways the partners can deal with Best’s capital deficiency include: Best may contribute assets of P200 to the partnership to erase the deficiency Good and Better can absorb Best’s deficiency in proportion to their remaining profit-sharing percentages: Good, 25/80; Better, 55/80 12 Chapter Test Material 6-2 Requirement (a) Single, Double, and Triple Summary of Liquidation Transactions Noncash Assets Cash Balances before sale of assets Sales of assets and sharing of gain Balances Payment of liabilities Balances Disbursement of cash to partners Balances P 27,000 P202,000 212,000 239,000 (131,000) 108,000 (202,000) -0- (108,000) P -0- P Liabilities P131,000 -0- 131,000 (131,000) -0- -0- P -0- Single 10% P21,000 Double 30% P39,000 Triple 60% P38,000 1,000* 22,000 3,000* 42,000 6,000* 44,000 22,000 42,000 (44,000) (22,000) P -0- (42,000) P -0- (44,000) P -0- * Allocation of gain to partners: Gain: P212,000 – P202,000 Single: P 10,000 x 0.10 Double: P 10,000 x 0.30 Triple: P 10,000 x 0.60 = = = = P10,000 P 1,000 P 3,000 P 6,000 Requirement (b) Single, Double, and Triple Summary of Liquidation Transactions Cash Balances before sale of assets Sales of assets and sharing of gain Balances Payment of liabilities Balances Disbursement of cash to partners Balances Noncash Assets P 27,000 P202,000 182,000 209,000 (131,000) 78,000 (202,000) -0- (78,000) P -0- P = = = = P131,000 -0- 131,000 (131,000) -0- -0- P * Allocation of gain to partners: Gain: P182,000 – P202,000 Single: P 20,000 x 0.10 Double: P 20,000 x 0.30 Triple: P 20,000 x 0.60 Liabilities P10,000 P 3,000 P 6,000 P12,000 -0- Single 10% P21,000 Double 30% P39,000 Triple 60% P38,000 (2,000)* 19,000 (6,000)* 33,000 (12,000)* 26,000 19,000 33,000 26,000 (19,000) P -0- (33,000) P -0- P 26,000 -0- Accounting for Partnership Termination of Operations 13 Requirement GENERAL JOURNAL Date Dec 31 31 31 Accounts and Explanation Cash Single, Capital Double, Capital Triple, Capital Noncash Assets To sell noncash assets in liquidation and distribute loss to partners Liabilities Cash To pay liabilities in liquidation Single, Capital Double, Capital Triple, Capital Cash To distribute cash to partners in liquidation Post Ref Debit 182,000 2,000 6,000 12,000 Credit 202,000 131,000 131,000 19,000 33,000 26,000 78,000 14 Chapter Test Material 6-3 Morales Beginning balances Pay liabilities Balances Morales contribution Modena contribution Pay MMC creditors Balances Chariya contribution* Pay MMC creditors Balances Absorption of Chariya’s balance Balances Payment to Morales Payment to Modena Balances Assets P 52,000 (47,000) P 5,000 (5,000) Modena Liab P 47,000 (47,000) -0- Assets P 41,500 (33,500) P 8,000 -0- -0- -0- -0- -0- -0- -0- -0- -0- -0- -0- Assets P 149,000 (149,000) -0P 5,000 8,000 (13,000) -0P 10,000 (3,000) P 7,000 -0- -0- -0- -0- -0- -0- P -0- -0- -0- -0- -0- -0- P 6,000 3,000 2,000 5,000 P16,000 Existing unsatisfied claims: Due Morales Due Modena Liab P 33,500 (33,500) -0- Assets P 28,000 (28,000) -0- Liab P 34,000 (28,000) P 6,000 (8,000) * Claims against Chariya’s inheritance exist in the following priority: Chariya’s personal creditors MMC partnership creditors Due Morales Due Modena Chariya P10,000 6,000 P16,000 P 6,000 (6,000) 7,000 (2,000) (5,000) -0- MMC Construction Company Morales, Modena, Liab Capital Capital P 165,000 P 7,000 P 3,000 (149,000) P 16,000 P 7,000 P 3,000 5,000 8,000 (13,000) P 3,000 P 12,000 P 11,000 (3,000) -0-0-0- P 12,000 (10,000) P 2,000 (2,000) -0- P 11,000 (6,000) P 5,000 (5,000) -0- Chariya, Capital P(26,000) P(26,000) P(26,000) 10,000 P(16,000) 16,000 -0-0- Accounting for Partnership Termination of Operations 15 Test Material 6-4 Joo and Yun Statement of Financial Position October 31, 2007 ASSETS Cash Accounts receivable (net) Inventory Plant assets (net) Total assets P 11,700 26,500 81,100 180,900 P300,200 LIABILITIES Accounts payable Accrued expenses payable Notes payable Total liabilities P 32,700 3,600 75,000 P111,300 CAPITAL Joo, Capital Yun, Capital Total liabilities and capital 92,600 * 96,300 * P300,200 Note: All amounts are the sum of the current market value of the assets, liabilities, and capital of the two proprietorships For example, Cash of P11,700 = P8,000 + P3,700 and accounts receivable (net) of P26,500 = P6,300 + P20,200 * Total assets – Total liabilities = Partner capital Joo: P193,400 – (P23,600 + 2,200 – P75,000) = P92,600 Yun: P106,800 – (P9,100 + P1,400) = P96,300 ... Triple Summary of Liquidation Transactions Noncash Assets Cash Balances before sale of assets Sales of assets and sharing of gain Balances Payment of liabilities Balances Disbursement of cash to... and Triple Summary of Liquidation Transactions Cash Balances before sale of assets Sales of assets and sharing of gain Balances Payment of liabilities Balances Disbursement of cash to partners... are the sum of the current market value of the assets, liabilities, and capital of the two proprietorships For example, Cash of P11,700 = P8,000 + P3,700 and accounts receivable (net) of P26,500