Find more slides, ebooks, solution manual and testbank on www.downloadslide.com CHAPTER 15 PARTNERSHIPS: TERMINATION AND LIQUIDATION Chapter Outline I The termination of a partnership and liquidation of its property may take place for a number of reasons A The death, withdrawal, or retirement of a partner can lead to cessation of business activity B The bankruptcy of either an individual partner or the partnership as a whole can necessitate this same conclusion II Because of the importance of liquidating and distributing assets fairly, all parties look to the accountant to play an important role in the process A The accountant provides timely financial information B The accountant works to ensure an equitable settlement of all claims III The schedule of liquidation A The liquidation process usually involves the disposal of noncash assets, payment of liabilities and liquidation expenses, and distribution of any remaining cash to the partners based on their final capital balances B A schedule of liquidation should be produced periodically by the accountant to disclose losses and gains that have been incurred, remaining assets and liabilities, and current capital balances IV Deficit capital balances A By the end of the liquidation process, one or more partners may have a negative (or deficit) capital balance often as a result of losses incurred in disposing of assets B Legally, any deficit should be eliminated by having that partner contribute enough additional assets to offset the negative balance C If this contribution is not immediately received, the remaining partners may request a preliminary distribution of any partnership cash that is available This payment is based on safe capital balances, the amounts that will remain in the individual capital accounts even if all deficits and other properties prove to be complete losses that must be absorbed by the remaining partners If a portion (or all) of a deficit is subsequently recovered from a partner, a further distribution to the other partners is made based on newly computed safe capital balances Any deficit that is not recovered from a partner must be charged to the remaining partners based on their relative profit and loss ratio McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com V Marshaling of assets A To provide an equitable system for distributing assets during liquidation, the Uniform Partnership Act states that claims against an insolvent partner shall be ranked as follows: Claims by separate creditors Claims by partnership creditors Claims by partners B This priority listing is referred to as the marshaling of assets doctrine C The Uniform Partnership Act also provides that an individual partner's own creditors may seek recovery of losses directly from the partnership Payment of all partnership debts must be assured before any distribution to an individual partners' creditors Payment of personal debts cannot exceed the capital balance of the specific partner Vl Preliminary distribution of assets to the partners A The liquidation process can extend over a lengthy period of time as business activities wind down and property is sold B More cash may be generated than the amount needed to extinguish all potential liabilities and liquidation expenses C If possible, the distribution of excess cash amounts should be made as quickly as possible to enable the partners to make use of their funds The accountant may choose to produce a proposed schedule of liquidation at such times to determine the equitable distribution of cash amounts that become available The proposed schedule of liquidation is developed based upon simulating the accounting recognition that would be required by a possible series of transactions: assets are sold, expenses are paid, etc a These events are simulated with the anticipation of maximum losses in each case b Noncash assets are assumed to have no resale value; maximum possible liquidation expenses are included; all partners are considered personally insolvent; etc Ending potential capital balances that remain on a proposed schedule of liquidation are safe capital balances, the amounts that could be immediately paid to each partner without jeopardizing future payments Safe capital balances indicate that the partner will still have a sufficient interest in the partnership to absorb all potential losses even after a preliminary distribution Vll Predistribution plan A The proposed schedule of liquidation (described above) indicates safe capital balances but a newly revised schedule must be prepared frequently B Accountants often prefer to produce a single predistribution plan at the start of a liquidation to provide guidance for all payments made to the partners throughout this process McGraw-Hill/Irwin 15-2 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com C Information for the predistribution plan is generated by assuming the occurrence of a series of losses, each just large enough to eliminate one partner's claim to any partnership property D Once a series of losses has been simulated that would eliminate the capital balances of all partners, the actual plan is developed by measuring the effects that occur if the losses not materialize E By working backwards through this series of possible losses, a predistribution plan can be produced that will direct all payments made within the liquidation Learning Objectives Having completed Chapter 15 of this textbook, "Partnerships: Termination and Liquidation," students should be able to fulfill each of the following learning objectives: Discuss the roles played by the accountant in the termination and liquidation of a partnership Produce journal entries to record the transactions incurred in the liquidation of a partnership Prepare a schedule of liquidation Determine the appropriate distribution of any cash that remains at the end of a liquidation when one or more of the partners has a deficit capital balance Explain the meaning of the term "safe capital balance." Discuss “marshaling of assets” and explain how this doctrine is applied in distributing the assets of an insolvent partnership Prepare a proposed schedule of liquidation to determine an equitable preliminary distribution of available partnership assets Develop a predistribution plan and explain the advantages of such a plan over a proposed schedule of liquidation McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answer to Discussion Question What Happens if a Partner Becomes Insolvent? This case demonstrates one of the nightmares of a partnership: the apparent insolvency of a partner is threatening the future of a successful business The problem is especially acute to Wilkinson and Walker since this partnership was created solely for convenience; the partners share the facilities but not actually work together Therefore, the presence of Rogers is not essential to the other partners except that he pays a portion of the business's expenses However, the claim that has been filed could lead to the actual liquidation of the entire business Obviously, the partners should take no immediate action until they have spoken with Rogers The entire issue may prove to be a mistake Conversely, numerous other claims against Rogers may also be outstanding with the initial claim simply being the first to be filed Because of the various possibilities, Wilkinson and Walker should consult with a lawyer to learn of the partnership laws that apply in their state They should also begin considering possible alternatives to salvage their business if Rogers is indeed insolvent One course of action is for Wilkinson and Walker to buy out the partnership interest of Rogers In that way, Rogers would receive his money and the remaining partnership could be left intact However, they would have to prove—for legal reasons—that a fair price was being paid They would also be forced to come up with a significant amount of cash in a short period of time Finally, Wilkinson and Walker would have a building that was apparently larger than their needs Unless they could utilize the space in some manner, they might have no way of recouping their additional investment As a second possibility, a new dentist could be brought in to acquire Rogers’ interest in the partnership Again, the money is conveyed to Rogers but now the original partners are not forced to make the payment The building would continue to be fully utilized so that the partners' expenses would not escalate In this case, though, a new partner may have to be identified in a short period of time Furthermore, since the partners are sharing space, Wilkinson and Walker will probably want to ensure that the new partner is someone with whom they can work comfortably Because of time considerations, they may not have the opportunity of getting the new partner they would like Finally, the partnership can be liquidated Wilkinson and Walker could then take their share of the proceeds and buy a new building for the continuation of their practices Unfortunately, in liquidation, assets not always bring fair market value Thus, the partners may be forced to absorb significant losses as a result of Rogers' insolvency In addition, the moving of any business can disrupt service and have a possible adverse impact on profitability Although Wilkinson and Walker have several possible actions that can be taken, none of these is without problems Therefore, partners should always include agreements within their Articles of Partnership to specify actions that will be taken in such cases The insolvency of a partner is not a particularly unusual event Hence, the partners (or their lawyers and accountants) should have the forethought to arrange the resolution of the business if insolvency of a partner does occur McGraw-Hill/Irwin 15-4 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions A dissolution refers to the cessation of a partnership In many cases, this process is simply a preliminary step in the transfer of business property to a newly formed partnership Therefore, a dissolution does not necessarily affect the operations of the business In a liquidation, however, actual business activities must cease Partnership property is sold with the remaining cash distributed to creditors and to any partners with positive capital balances Dissolution refers to changes in the composition of a partnership whereas liquidation is the selling of a partnership's assets Many reasons can exist that would lead to the termination and liquidation of a partnership The business might simply have failed to generate sufficient profits or the partners may elect to enter other lines of work Liquidation can also be required by the death, retirement, or withdrawal of one of the partners In such cases, liquidation is often necessary to settle the partner's interest in the business The bankruptcy of an individual partner can also force the termination of the business as can the bankruptcy of the partnership itself During the liquidation process, monitoring the balance of the partners' capital accounts becomes of paramount importance That amount will eventually indicate either the cash to be received by the partners as final distributions or the additional contributions that they are required to pay Consequently, all liquidation gains and losses are recorded directly as changes to these capital balances Such recording enhances the informational value of the accounts As an additional factor, the computation of a net income figure is of diminished importance since normal operations have ceased Final distributions made to the various partners are based solely on their ending capital account balances unless the partners have agreed otherwise If any partner has a deficit balance, an additional contribution should be made to offset the negative amount In some situations, a question may arise as to whether compensation for a deficit will ever be forthcoming from the responsible party The remaining partners may choose to allocate the available cash immediately based on the assumption that the deficit balance eventually will prove to be a total loss A schedule of liquidation provides financial data about the liquidation process as it has progressed to date Information to be presented includes the balances of all remaining assets, the liability total, and the capital account of each partner In addition, the allocation of all gains and losses incurred in the liquidation process as well as the payment of expenses should be evident From a legal viewpoint, any partner who incurs a negative (or deficit) capital balance is obligated to make an additional contribution to offset that amount McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com A safe capital balance is the amount of a partner's capital account that exceeds all possible needs of a partnership as it goes through liquidation A partner should, therefore, be able to receive this balance immediately without endangering the future amount to be received by any other party connected with the liquidation Safe capital balances are computed by projecting a series of assumptions whereby the partnership undergoes maximum losses during the remainder of the liquidation process All noncash assets are assumed to have no resale value, liquidation expenses are set at the largest possible estimation, and all partners are viewed as personally insolvent Any capital balance that would remain after this series of anticipated events can be distributed to the partners immediately without incurring any risk The marshaling of assets doctrine is a provision within the Uniform Partnership Act that indicates the priority of claims when a partner becomes personally insolvent By providing a ranking of these claims, an orderly and fair distribution of available property can be made The marshaling of assets provision states: Where a partner has become bankrupt or his estate is insolvent, the claims against his separate property shall rank in the following order: (I) Those owing to separate creditors, (II) Those owing to partnership creditors, (III) Those owing to partners by way of contributions A partner's personal creditors have a limited claim against partnership assets Recovery is possible but only if payment of all partnership debts is assured and the insolvent partner has a positive capital balance 10 For distribution purposes, the Uniform Partnership Act states that loans from partners rank ahead of the partners’ capital balances Thus, the handling of loans in a liquidation would seem to be obvious: When money becomes available for the partners, all loans from partners should be repaid before any amount is given to a partner because of a safe capital balance A problem arises, though, in the above solution if a partner (especially if the partner is currently insolvent) has made a loan to a partnership but has a potentially negative capital balance The final capital balance may require a contribution to the partnership that the partner may be unable or unwilling to make If the Uniform Partnership Act is followed precisely, a partner could collect money on a loan while still having an obligation to the partnership because of a negative capital balance To avoid this problem, in practice a partner’s loan balance is usually merged with that partner’s capital balance to minimize the chance of a negative capital balance occurring This particular partner may get less money from the liquidation because of this treatment but the other partners are better protected McGraw-Hill/Irwin 15-6 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 11 A proposed schedule of liquidation is used by the accountant to determine the allocation of any cash balances generated during the early stages of liquidation Often, sufficient cash will be collected to pay all liabilities as well as potential liquidation expenses Additional cash should then be distributed to the partners to allow them immediate use of their funds A proposed schedule of liquidation can be produced to determine the allocation of this available cash The statement is based on anticipating a series of assumed losses from the current day forward: all remaining noncash assets are scrapped, maximum liquidation expenses are incurred, and each partner is personally insolvent The ending balances that would result from these simulated transactions represent safe capital balances This amount of cash can be distributed presently and the partners will still retain enough capital to absorb all future losses 12 A predistribution plan is produced based on an assumed series of losses Each loss is calculated to eliminate in turn the capital balance of one of the partners In this manner, the accountant can determine the vulnerability to losses exhibited by each capital account When the last balance is eliminated, the accountant will have established a series of losses that exactly offsets each balance The predistribution plan is then developed by measuring the effects that are created if the losses not occur In effect, the accountant works backwards through the assumed losses to create a pattern of available cash, the predistribution plan McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Problems C A D B B Reported balances Potential loss from Cassidy deficit (split 5/8:3/8) Cash distributions Angela, Capital Woodrow, Capital Cassidy, Capital $19,000 $18,000 $(12,000) (7,500) $11,500 (4,500) $13,500 12,000 -0- B Bell Reported balances $50,000 Loss on sale of assets ($110,000) split on a 4:3:2:1 basis (44,000) Adjusted balances $ 6,000 Potential loss from Dennard deficit (split 4:3:1) (4,000) Minimum cash distributions $2,000 Hardy $56,000 Dennard $14,000 Suddath $80,000 (33,000) $23,000 (22,000) $(8,000) (11,000) $69,000 (3,000) $20,000 8,000 $ -0- (1,000) $68,000 A A Reported balances Loss on sale of assets ($22,000) split on a 4:3:3 basis Adjusted balances Anticipated liquidation expenses ($12,000) split on a 4:3:3 basis Anticipated maximum loss on inventory ($31,000) split on a 4:3:3 basis Potential balances Potential loss from Art deficit (split 3:3) Current cash distribution McGraw-Hill/Irwin 15-8 Art $18,000 Raymond $25,000 Darby $26,000 (8,800) $ 9,200 (6,600) $18,400 (6,600) $19,400 (4,800) (3,600) (3,600) (12,400) $(8,000) 8,000 $ -0- (9,300) $ 5,500 (4,000) $ 1,500 (9,300) $ 6,500 (4,000) $ 2,500 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com D Since the partnership currently has total capital of $400,000, the $30,000 that is available would indicate maximum potential losses of $370,000 A $100,000 Reported balances Anticipated loss ($370,000) split on a 2:3:5 basis (74,000) Potential balances $ 26,000 Potential loss from C's deficit (split 2:3) (2,000) Current cash distribution $ 24,000 B $120,000 C $180,000 (111,000) $ 9,000 (3,000) $ 6,000 (185,000) $ (5,000) 5,000 $ -0- 10 C A predistribution plan should be created Maximum Losses That Can Be Absorbed Kevin Michael Brendan Jonathan $59,000/40% $39,000/30% $34,000/10% $34,000/20% $147,500 130,000 340,000 170,000 (most vulnerable to losses) The assumption is made that a $130,000 loss occurs Kevin Reported balances $59,000 Assumed loss ($130,000) split on a 4:3:1:2 basis .(52,000) Adjusted balances $ 7,000 Michael $39,000 (39,000) $ -0- Brendan $34,000 Jonathan $34,000 (13,000) $21,000 (26,000) $ 8,000 Maximum Losses That Can Now Be Absorbed Kevin $7,000/4/7 $12,250 (most vulnerable to losses) Brendan $21,000/1/7 147,000 Jonathan $8,000/2/7 28,000 Kevin Reported balances $7,000 Assumed loss ($12,250) split on a 4:1:2 basis (7,000) Adjusted balances $ -0- Brendan $21,000 Jonathan $8,000 (1,750) $19,250 (3,500) $4,500 Maximum Losses That Can Now Be Absorbed Brendan Jonathan $19,250/1/3 $4,500/2/3 $57,750 6,750 (most vulnerable to losses) The assumption is made that a $6,750 loss occurs Reported balances Assumed loss ($6,750) split on a 1:2 basis Adjusted balances McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Brendan $19,250 (2,250) $17,000 Jonathan $4,500 (4,500) $ -0- © The McGraw-Hill Companies, Inc., 2009 15-9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 11 C To work this problem, a predistribution schedule is necessary That schedule, which is computed below, is as follows: First $3,000 goes to Menton Next $15,000 goes to Menton (2/3) and Hoehn (1/3) Next $42,000 goes to Carney (4/7), Menton (2/7), and Hoehn (1/7) All remaining cash goes to Carney (4/10), Pierce (3/10), Menton (2/10), and Hoehn (1/10) Beginning balances Assumed loss of $90,000 (see Schedule 1)(4:3:2:1) Step one balances Assumed loss of $42,000 (see Schedule 2) (allocated on a 4:0:2:1 basis) Step two balances Assumed loss of $15,000 (see Schedule 3) (allocated on a 0:0:2:1 basis) Step three balances Carney Pierce $60,000 $27,000 Menton $43,000 (36,000) (27,000) $24,000 $ -0- (18,000) (9,000) $25,000 $11,000 (24,000) $ -0- $ -0$ -0- (12,000) $13,000 (6,000) $ 5,000 -0$ -0- (10,000) $ 3,000 (5,000) $ -0- -0$ -0- Hoehn $20,000 Partner Carney Pierce Menton Hoehn Schedule Maximum Loss Capital Balance/ That Can Loss Allocation Be Absorbed $60,000/40% $150,000 $27,000/30% $ 90,000 (most vulnerable) $43,000/20% $215,000 $20,000/10% $200,000 Partner Carney Menton Hoehn Schedule Maximum Loss Capital Balance/ That Can Loss Allocation Be Absorbed $24,000/(4/7) $ 42,000 (most vulnerable) $25,000/(2/7) $ 87,500 $11,000/(1/7) $ 77,000 Partner Menton Hoehn Schedule Maximum Loss Capital Balance/ That Can Loss Allocation Be Absorbed $13,000/(2/3) $ 19,500 $ 5,000/(1/3) $ 15,000 (most vulnerable) McGraw-Hill/Irwin 15-10 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 29 (35 Minutes) (Determine cash distributions for four different partnership liquidations) Part A Beginning balances Contribution by Jackson Capital balances Elimination of Jackson's deficit (40:20 basis) Final distribution Part B Beginning balances $82,000 loss on disposal (allocated on a 50:40:10 basis) Liquidation expenses (50:40:10 basis) Capital balances Allocation of Luck's deficit (50:10 basis) Final distribution Part C Beginning balances $82,000 loss on disposal (allocated on a 2:4:4 basis) Liquidation expenses (2:4:4 basis) Capital balances Allocation of Cummings' deficit balance (2:4 basis) Capital balances Allocation of Luck's deficit balance Final distribution McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Simon, Capital $16,000 -0$16,000 (6,000) $10,000 Hough, Loan and Capital $82,000 (41,000) (10,500) 30,500 (1,000) $29,500 Hough, Loan and Capital $82,000 Haynes, Loan and Capital $ 4,000 -0$ 4,000 (3,000) $ 1,000 Jackson, Capital ($12,000) 3,000 ($ 9,000) 9,000 $ -0- Luck, Loan and Cummings, Capital Capital $40,000 $20,000 (32,800) (8,400) (1,200) 1,200 $ -0- (8,200) (2,100) 9,700 (200) $ 9,500 Luck, Loan and Cummings, Capital Capital $40,000 $20,000 (16,400) (1,200) $64,400 (32,800) (2,400) $ 4,800 (32,800) (2,400) ($15,200) (5,067) $59,333 (5,333) $54,000 (10,133) ($ 5,333) 5,333 $ -0- 15,200 -0-0$ -0- © The McGraw-Hill Companies, Inc., 2009 15-29 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 29 (continued) Part D Beginning balances Allocation of Redmond's deficit balance (10:30:40 basis) Capital balances $32,000 contribution by Ledbetter and $3,000 contribution by Watson Final distribution* Redmond, Loan and Ledbetter, Capital Capital Watson, Capital Sandridge, Capital ($16,000) ($30,000) $ 3,000 $15,000 16,000 -0- (2,000) ($32,000) (6,000) ($3,000) (8,000) $ 7,000 32,000 $ -0- 3,000 $ -0- -0$ 7,000 -0$ -0- *Remaining $28,000 is used to pay liabilities McGraw-Hill/Irwin 15-30 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 30 (40 Minutes) (Produce a schedule of liquidation) FRICK, WILSON, AND CLARKE Schedule of Partnership Liquidation Final Balances Beginning balances Cash $48,000 Noncash Assets $177,000 Liabilities $35,000 Frick, Capital (60%) $101,000 Wilson, Capital (20%) $28,000 Clarke, Capital (20%) $61,000 Distribution of $4,000 (cash in excess of liabilities and estimated liquidation expenses) in accordance with predistribution plan – Schedule Updated balances Noncash assets sold Updated balances All liabilities are paid Updated balances (4,000) $44,000 48,000 $92,000 (35,000) $57,000 $177,000 (80,000) $97,000 $97,000 $35,000 $35,000 (35,000) $-0- $101,000 (19,200) $81,800 $28,000 (6,400) $21,600 (4,000) $57,000 (6,400) $50,600 $81,800 $21,600 $50,600 Distribution of $48,000 (cash in excess of liabilities and estimated liquidation expenses) in accordance with predistribution plan – Schedule 1: First $23,333 (remainder of first distribution) Next $22,667 Next $2,000 Updated balances Noncash assets sold Updated balances Paid liquidation expenses Updated balances Final distribution based on ending capital account balances Ending balance McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e (23,333) (22,667) (2,000) $9,000 44,000 $53,000 (7,000) $46,000 (46,000) $-0- $97,000 (97,000) $-0- (17,000) (1,200) $63,600 (31,800) (400) $21,200 (10,600) (23,333) (5,667) (400) $21,200 (10,600) $10,600 (1,400) $9,200 $10,600 (1,400) $9,200 (9,200) $-0- (9,200) $-0- $-0- $-0- $-0- $-0- $31,800 (4,200) $27,600 $-0- (27,600) $-0- $-0- © The McGraw-Hill Companies, Inc., 2009 15-31 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 30 (continued) Schedule Development of Predistribution Schedule Beginning balances Loss of $140,000 assumed—Schedule (allocated on a 60:20:20 basis) Step One balances Loss of $22,667 assumed—Schedule (allocated on a 60:20 basis) Step Two balances Frick, Capital $101,000 Wilson, Capital $28,000 Clarke, Capital $61,000 (84,000) $ 17,000 (28,000) $ -0- (28,000) $33,000 (17,000) $ -0- $ -0-0- (5,667) $27,333 PREDISTRIBUTION PLAN Payment of liabilities and liquidation expenses must be assured Next $27,333 goes to Clarke Next $22,667 is split between Frick and Clarke on a 60:20 basis Any further cash is split among Frick, Wilson, and Clarke on a 60:20:20 basis Schedule Partner Frick Wilson Clarke Capital Balance/ Loss Allocation $101,000/60% $ 28,000/20% $ 61,000/20% Maximum Loss That Can Be Absorbed $168,333 $140,000 (most vulnerable to loss) $305,000 Schedule Partner Frick Clarke McGraw-Hill/Irwin 15-32 Capital Balance/ Loss Allocation $17,000/(60/80) $33,000/(20/80) Maximum Loss That Can Be Absorbed $ 22,667 (most vulnerable to loss) $132,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 31 (50 Minutes) (Produce a predistribution plan and journal entries for a partnership liquidation) Rodgers, Part A Wingler, Norris, Loan and Guthrie, Capital Capital Capital Capital Beginning balances $120,000 $88,000 $109,000 $60,000 Loss of $150,000 assumed (allocated on a 30:10:20:40 basis) see Schedule (45,000) (15,000) (30,000) (60,000) Step One balances $ 75,000 $73,000 $ 79,000 $ -0Loss of $150,000 assumed (allocated on a 30:10:20 basis) see Schedule (75,000) (25,000) (50,000) -0Step Two balances $ -0$48,000 $ 29,000 $ -0Loss of $43,500 assumed (allocated on a 10:20 basis) see Schedule -0(14,500) (29,000) -0Step Three balances $ -0$33,500 $ -0$ -0PREDISTRIBUTION PLAN Payment of all liabilities and liquidation expenses must be assured Next $33,500 goes entirely to Norris Next $43,500 is allocated to Norris (10/30) and Rodgers (20/30) Next $150,000 is allocated to Wingler (30/60), Norris (10/60), and Rodgers (20/60) Any further cash distributions are divided on the original profit and loss ratio: Wingler (30%), Norris (10%), Rodgers (20%), and Guthrie (40%) Schedule Partner Capital Balance/ Loss Allocation Wingler Norris Rodgers Guthrie $120,000/30% $ 88,000/10% $109,000/20% $ 60,000/40% McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Maximum Loss That Can Be Absorbed $400,000 $880,000 $545,000 $150,000 (most vulnerable to loss) © The McGraw-Hill Companies, Inc., 2009 15-33 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 31 a (continued) Schedule Partner Wingler Norris Rodgers Capital Balance/ Loss Allocation $75,000/(30/60) $73,000/(10/60) $79,000/(20/60) Maximum Loss That Can Be Absorbed $150,000 (most vulnerable to loss) $438,000 $237,000 Schedule Partner Norris Rodgers McGraw-Hill/Irwin 15-34 Capital Balance/ Loss Allocation $48,000/(10/30) $29,000/(20/30) Maximum Loss That Can Be Absorbed $144,000 $ 43,500 (most vulnerable to loss) © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 31 (continued) Part B Cash 65,600 Wingler, Capital (30% of $16,400 loss) 4,920 Norris, Capital (10%) 1,640 Rodgers, Capital (20%) 3,280 Guthrie, Capital (40%) 6,560 Accounts Receivable Receivables are collected with losses allocated to partners 82,000 Cash 150,000 Wingler, Capital (30% of $103,000 loss) 30,900 Norris, Capital (10%) 10,300 Rodgers, Capital (20%) 20,600 Guthrie, Capital (40%) 41,200 Land 85,000 Building and Equipment 168,000 Land, building and equipment are sold with losses allocated to partners Wingler, Capital 31,800 Norris, Capital 58,600 Rodgers, Loan 35,000 Rodgers, Capital 15,200 Cash 140,600 Above entry distributes safe capital balances as shown below (see predistribution plan in part A) based on a current cash balance of $230,600 First $90,000 is held to pay liabilities ($74,000) and estimated liquidation expenses ($16,000) Next $33,500 goes entirely to Norris Next $43,500 is split between Norris ($14,500) and Rodgers ($29,000) Remaining $63,600 is allocated to Wingler ($31,800), Norris ($10,600) and Rodgers ($21,200) No journal entry is currently required by Guthrie's insolvency Liabilities Cash All liabilities are paid McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 74,000 74,000 © The McGraw-Hill Companies, Inc., 2009 15-35 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 31 b (continued) Cash 71,000 Wingler, Capital (30% of $30,000 loss) 9,000 Norris, Capital (10%) 3,000 Rodgers, Capital (20%) 6,000 Guthrie, Capital (40%) 12,000 Inventory Inventory is sold with loss allocated to partners 101,000 Wingler, Capital 35,500 Norris, Capital 11,833 Rodgers, Capital 23,667 Cash 71,000 Above entry distributes available cash according to predistribution plan Although $87,000 in cash is being held, $16,000 must be retained to pay liquidation expenses The remaining $71,000 is divided among Wingler, Norris, and Rodgers on a 30:10:20 basis According to the predistribution plan, a total of $150,000 must be divided on this ratio but only $63,600 was allocated in this manner in the first distribution above Therefore, all $71,000 (making a total of $134,600) is paid out on this 30:10:20 basis Wingler, Capital (30% of expenses) Norris, Capital (10%) Rodgers, Capital (20%) Guthrie, Capital (40%) Cash Liquidation expenses are paid 3,300 1,100 2,200 4,400 11,000 Wingler, Capital (30/60 of deficit) 2,080 Norris, Capital (10/60) 693 Rodgers, Capital (20/60) 1,387 Guthrie, Capital 4,160 To eliminate the deficit balance of insolvent partner as computed on the next page McGraw-Hill/Irwin 15-36 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 31 b (continued) CAPITAL ACCOUNT BALANCES Beginning balances Loss on accounts receivable Loss on land, building, and equipment Cash distribution Loss on inventory Cash distribution Liquidation expenses Subtotal Guthrie insolvent Current balances Wingler, Capital $120,000 (4,920) Norris, Capital $88,000 (1,640) Rodgers, Loan and Capital $109,000 (3,280) (30,900) (31,800) (9,000) (35,500) (3,300) 4,580 (2,080) $2,500 (10,300) (58,600) (3,000) (11,833) (1,100) 1,527 (693) $ 834 (20,600) (50,200) (6,000) (23,667) (2,200) 3,053 (1,387) $1,666 Wingler, Capital 2,500 Norris, Capital 834 Rodgers, Capital 1,666 Cash To distribute remaining cash based on final capital balances McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e Guthrie, Capital $60,000 (6,560) (41,200) -0(12,000) -0(4,400) (4,160) 4,160 $ -0- 5,000 © The McGraw-Hill Companies, Inc., 2009 15-37 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Develop Your Skills Cases Research Case a Students often seem to believe that definitive answers can be discovered for all accounting and legal questions if a serious enough investigation is performed However, here, there simply may be no easy answer to the question as to the amount of liability that the other six doctors in this case are facing b Several questions can be raised that may impact the ultimate resolution: In what state will the court case be handled? Different states have somewhat different laws as to the potential liabilities incurred by partners and different courts seem to have varying ways of interpreting those laws How difficult was the surgery that was performed? Should the doctor have been able to perform the work without accident? Or, perhaps, was it an extremely risky surgery where death might have been anticipated under any conditions? How much did the other doctors know about this doctor‘s ability to this particular surgery? Did they have any reason to believe that such work should not be undertaken? What is meant in the case by the term ―very poor judgment?‖ How serious was the mistake made by the doctor? The answers to such questions as these can have a huge impact on the extent of the liability of the other doctors Here are several quotes from The Wall Street Journal article mentioned in the case that might pertain to the issue at hand: ―Concerns are growing among Andersen's roughly 1,750 U.S partners that even those who had nothing to with the firm's work for Enron Corp could eventually face personal liability stemming from the botched audit Worried about what protection the limited-liability partnership provides them, many are now consulting lawyers for advice.‖ ―The limited-liability partnership is a comparatively new corporate structure, untested by the kind of stress now besetting Andersen But that testing appears to be just around the corner as Enron creditors, shareholders and employees seek to recover the billions of dollars they have lost from someone.‖ ―Because it is unclear how much protection the LLP structure will provide Andersen partners, partnership and bankruptcy lawyers are expected to be following the matter closely ‗As far as I know, there has never been a litigation McGraw-Hill/Irwin 15-38 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com test of the extent of the LLP shield, and there have been very few LLP cases about liability at all,‘ said Larry Ribstein, a law professor at George Mason University.‖ ―The limited-liability partnership was invented about a decade ago in the wake of the savings-and-loan debacle to protect members of partnerships from being wiped out by claims against their firms Under the structure, capital invested by partners into the firm is fair game for creditors In theory, no partner is supposed to lose more than what he or she has invested in the firm.‖ "‗There is a strong legal tradition that you don't pierce the corporate veil and go after individual partners except under extraordinary circumstances,‘ said Lynn LoPucki, a professor at the University of California Los Angeles law school ‗But the law is very vague and lets the courts what they feel appropriate It is very case specific and fact intensive.‘‖ ―In 1990, prior to the advent of limited-liability partnerships, the accounting firm of Laventhol & Horwath filed for Chapter 11 bankruptcy-court protection, in part due to lawsuits over questionable accounting The firm's assets were insufficient to cover the claims of creditors and litigants Under a plan negotiated with the firm's creditors, the 360 partners and former partners who had spent time at the firm since 1984 were required to dig into their own pockets to share a $46 million liability.‖ Analysis Case a In looking at the financial statements of a partnership, a number of obvious differences can be spotted in comparison to the statements of a corporation For example, in looking at this set of statements, the following differences can be noted: The balance sheet shows ―partners‘ (deficiency) capital‖ rather than stockholders‘ equity The income statement (statement of operations) reports ―net loss allocated to general partner‖ and ―net loss allocated to limited partners.‖ This statement also reports ―net loss per limited partnership interest‖ rather than earnings/loss per share A ―statement of changes in partners‘ (deficiency) capital‖ is presented rather than a statement of changes in stockholders‘ equity A potential investor in this partnership would become one of the ―limited partners,‖ whose aggregate capital is disclosed in the balance sheet b There is a considerable amount of information provided in the notes to the financial statements about the unique characteristics of a limited partnership: Note – Organization and Summary of Significant Accounting Policies discusses the creation and structure of this limited partnership McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-39 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Note – Investments in and Advances to Local Partnerships provides information about the entity‘s investment in other limited partnerships Note – Transactions with Affiliated Parties describes the obligation of the partnership to the General Partner Note – Income Taxes describes the manner in which individual partners are taxed on their share of partnership income In addition, in Item (page 7), which precedes the financial statements, disclosures are provided related to the market for partnership interests Because the partnership‘s ―shares‖ are not publicly traded, an individual investor may not be able to sell his/her limited partner interest in the partnership As a limited partnership, potential investors (other than the general partner) would probably view an investment in NTCI II as being fairly similar to that of holding shares in a corporation The major difference relates to the possible inability to sell a limited partner interest in the company Communication Case The bankruptcy of Laventhol & Horwath was one of the main reasons for the creation of the limited liability partnership business structure As a general partnership, the litigation losses of this partnership that arose from poor accounting and auditing practices fell on all partners and not just on those involved Partners were required to make contributions from their own personal funds, often in amounts of up to several hundred thousand dollars to pay off the debts of the partnership after its failure A number of the partners eventually went bankrupt as a result of the litigation that arose Today, the partners in a general partnership would still seem to have the same risk that the partners of Laventhol & Horwath faced However, the alternatives such as a limited liability partnership or a Subchapter S corporation would place fewer individuals in this precarious position Thus, more than anything else, these articles on Laventhol & Horwath may be educational in showing why such alternatives have been created and why they have become so popular McGraw-Hill/Irwin 15-40 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Excel Case There are a number of different ways that a spreadsheet could be created to solve this particular problem Here is one possible approach: —Create Column Headings: In Cell A1, enter label text ―Partner‖ In Cell B1, enter label text ―Capital Balance‖ In Cell C1, enter label text ―Share P/L‖ In Cell D1, enter label text ―Initial Loss Share‖ In Cell E1, enter label text ―Subsequent Loss Share‖ In Cell F1, enter label text ―Remaining Balance‖ —Enter Account Information for each partner: In Cell A2, enter label text ―Wilson.‖ In Cell B2, enter Wilson‘s Capital Balance of $200,000 and, in Cell C2, enter 40% as share of profit and loss In Cell A3, enter label text ―Cho.‖ In Cell B3, enter Cho‘s Capital Balance of $180,000 and, in Cell C3, enter 20% as share of profit and loss In Cell A4, enter label text ―Arrington.‖ In Cell B4, enter Arrington‘s Capital Balance of $110,000 and, in Cell C4, enter 40% as share of profit and loss —Enter the amounts on which to base the calculations for each partner: In Cell A7, enter label text ―Losses during liquidation‖ and, in Cell B7, enter the amount of $50,000 In Cell A8, enter label text ―Final Losses‖ and, in Cell B8, enter the amount of $100,000 —Calculate Initial Loss Share: Multiply the ―Losses during liquidation‖ amount by the percentage of ―Share P/L‖ for each partner To calculate the Initial Share Loss for Wilson, create the following formula in Cell D2: =+B7*C2 We need to also use this same general formula for both Cho and Arrington However, if we drag the fill handle in Cell D2 into Cell D3 and D4, the reference to Cell B7 will automatically change to B8 and B9 respectively and the reference to Cell C2 will change to C3 and C4 respectively in order to adjust for the new cell position The change to C3 and C4 is correct because those are the individual profit and loss percentages No change, though, should be made to the reference to B7 because that is the overall loss in question In order to ―hold‖ the reference to Cell B7 when it is copied, we need to create what is known as an ―ABSOLUTE‖ reference Absolute references, which are cell references that always refer to cells in a specific location, can be created by placing a $ symbol before the Column letter and/or the Row number Thus, in Cell McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-41 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com D2, change the formula to read =$B$7*C2, and then copy this formula to cells D3 and D4 The resulting formula in Cell D3 will be =$B$7*C3 and in Cell D4 it will be =$B$7*C4 The location of the reference to Cell B7 does not change due to the $ symbol in front of the B and in front of the —Calculate the Partners‘ Share of any Subsequent Losses: Repeat the same process as above, creating a formula in Cell E2 as follows: =+$B$8*C2 Copy this formula to Cells E3 and E4 —Calculate the Remaining Capital Balance: To calculate the Remaining Capital Balance, the beginning Capital Balance must be reduced by the Initial Loss Share and Subsequent Loss Share In creating this last formula, it is important to note that the losses should be added together and then subtracted in total from the beginning capital balance Therefore, enter the following function in Cell F2: =+B2-(D2+E2) The computation inside the parenthesis is performed first and then subtracted from the beginning capital balance (B2) Copy this formula to Cells F3 and F4 to complete the worksheet Note that the use of the $ is not used here because we want B2, D2, and E2 to adjust to the new position when copied Once this spreadsheet has been created, any of the variables may be changed and the results will adjust automatically There are eight variables that can be changed: B2, B3, B4, B7, B8, C2, C3, and C4 C2, C3,and C4 must always add to 100% McGraw-Hill/Irwin 15-42 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Spreadsheet to Determine the Remaining Capital Balances for Wilson, Cho, and Arrington A B C Partner Capital Balance Share P/L Wilson $200,000 40% $20,000 $40,000 $140,000 Cho 180,000 20% 10,000 20,000 150,000 Arrington 110,000 40% 20,000 40,000 50,000 $490,000 100% $50,000 $100,000 $340,000 D Initial Loss Share E F Subsequent Loss Share Remaining Balance Losses during liquidation Final losses 50,000 100,000 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-43 ... Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com C Information for the predistribution plan is generated by assuming the occurrence... liquidation McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 15-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com... the resolution of the business if insolvency of a partner does occur McGraw-Hill/Irwin 15-4 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual