Chapter 15
Partnerships: termination and liquidation
Answers to Questions
1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.
9. A partner’s personal creditors do 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.
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 do not occur. In effect, the accountant works
backwards through the assumed losses to create a pattern of available cash, the
predistribution plan.
Answers to Problems
1. C
2. A
3. D
4. B
5. B Angela, Capital Woodrow, Capital Cassidy, Capital
Reported balances $19,000 $18,000 $(12,000)
Potential loss from
Cassidy deficit
(split 5/8:3/8) (7 , 500) (4,500) 12,000
Cash distributions $11,500 $13,500 -0-
6. B Bell Hardy Dennard Suddath
Reported balances $50,000 $56,000 $14,000 $80,000
Loss on sale of assets ($110,000)
split on a 4:3:2:1 basis (44,000) (33,000) (22,000) (11,000)
Adjusted balances $ 6,000 $23,000 $(8,000) $69,000
Potential loss from Dennard
deficit (split 4:3:1) (4,000) (3,000) 8,000 (1,000)
Minimum cash distributions $2,000 $20,000 $ -0- $68,000
7. A
8. A Art Raymond Darby
Reported balances $18,000 $25,000………………………….. $26,000
Loss on sale of assets ($22,000) split
on a 4:3:3 basis (8,800) (6,600)…………………………… (6,600)
Adjusted balances ……………………………. $ 9,200 $18,400 $19,400
Anticipated liquidation expenses ($12,000)
split on a 4:3:3 basis (4,800) (3,600)…………………………… (3,600)
Anticipated maximum loss on inventory
($31,000) split on a 4:3:3 basis (12,400) (9,300)…………………………… (9,300)
Potential balances ……………………………. $(8,000) $ 5,500 $ 6,500
Potential loss from Art deficit (split 3:3) 8,000 (4,000) (4,000)
Current cash distribution ………………….. $ -0- $ 1,500 $ 2,500
9. 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 B C
Reported balances $100,000 $120,000 $180,000
Anticipated loss ($370,000) split on
a 2:3:5 basis (74,000) (111,000) (185,000)
Potential balances $ 26,000 $ 9,000 $ (5,000)
Potential loss from C’s deficit (split 2:3) (2,000) (3,000) 5,000
Current cash distribution $ 24,000 $ 6,000 $ -0-
10. C A predistribution plan should be created.
Maximum Losses That Can Be Absorbed
Kevin $59,000/40% $147,500
Michael $39,000/30% 130,000 (most vulnerable to losses)
Brendan $34,000/10% 340,000
Jonathan $34,000/20% 170,000
The assumption is made that a $130,000 loss occurs.
Kevin Michael Brendan Jonathan
Reported balances …………………… $59,000 $39,000 $34,000………………………. $34,000
Assumed loss ($130,000) split on
a 4:3:1:2 basis …………………….. (52,000) (39,000) (13,000)………………………. (26,000)
Adjusted balances ……………………. $ 7,000 $ -0- $21,000 $ 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 Brendan Jonathan
Reported balances ……………………………… $7,000 $21,000 $8,000
