CHAPTER 14
UNDERSTANDING THE ISSUES
1. A major concern is that the value used as a
existing partnership’s net assets. Existing
capital balances most often do not reflect
30% interest by paying 30% of the existing
partnership’s capital will not result in the in-
However, the incoming partner’s capital
balance of $30,000 will only represent a
2. The first step would be to determine the fair
value of the net assets of the original part-
been recognized. Once the fair value of the
net assets (e.g., $400,000) has been
suggested value of the new partnership
entity ($400,000 ÷ 80% = $500,000). The
partnership and that of the original partner-
3. Several guidelines govern the process of
liquidating a partnership. First, all assets
ception to this priority involves the doctrine
of right of offset. Third, every attempt
say, all distributions should be based
on the conservative assumptions that re-
4. If a fellow partner has a deficit capital
balance, it is possible that other partners
will have to absorb that deficit partner’s
during the liquidation process, it is hoped
that the deficit will be eliminated. If the
creditors and that those creditors will attach
to the personal assets of individual part-
14–2
with personal wealth could end up having
to contribute additional assets to the part-
14–3 Ch. 14—Exercises
EXERCISES
(1)
Inventory ……………………………………………………………………….. 58,000
Accounts Receivable …………………………………………………. 18,000
(2) If the $56,000 of goodwill proved to be worthless, Warner would be charged 35% of
$56,000, or $19,600. However, the real harm to Warner would be that of having paid more
EXERCISE 14-2
Date:
To: My client
From: Student, CPA
Re: Issues involving goodwill and the liquidation of a partnership
With respect to the questions you had regarding the above referenced matter, please consider
the following responses which correspond to your questions (1) through (7).
(1) It is correct that a corporation cannot record goodwill unless it has been purchased through
the acquisition of another company. However, in the case of a partnership, when a new
Exercise 14-2, Concluded
(2) The goodwill method involves recording goodwill and/or the appreciation on net assets and
results in measuring net assets at amounts that are more in line with economic market val-
(3) The capital of a partner is the last claim against assets to be satisfied given the liquidation
of a partnership. Technically, the claims are satisfied in the following order: amounts owed
(4) Unsatisfied partnership liabilities could attach to any one or more partners that had person-
al assets. Obviously, the unsatisfied creditors would seek out those partners that have the
(5) Given the above response, it would be better to have a corporation own the office building
and thereby shelter it from being directly included in your personal assets. This does not
(6) Per the response to item (3) above, a loan to the partnership would have a higher priority in
liquidation than a capital investment. However, loans typically have a rate of return that is
(7) In theory, the sales price should not differ between what is offered by the partnership and
that offered by an individual partner. In that case, the key factor would be which party has
EXERCISE 14-3
(1) A sale by Freeman to another individual, as compared to a sale to the partnership, would
(2) The $125,000 paid to Freeman relative to their capital balance of $80,000 represents a bo-
nus of $45,000 that is allocated between the remaining partners according to their propor-
(3) The $45,000 over excess over Freeman’s capital balance represents two things: 1) Free-
(4) Once again, the $45,000 over excess over Freeman’s capital balance represents two
things: 1) Freeman’s share of the appreciation in value of the recorded net assets and 2)
Freeman’s share of the total entity goodwill. If the partnership is going to recognize goodwill
(5) Given the movement toward recognizing net assets at fair value, the method set forth in (4)
(6) If the current method were to be retained, it is imperative that the method for determining
“average capital” be clearly set forth. Is it a simple or a weighted average? What impact do
draws and loans have on the calculation, etc. Using just capital as a basis for allocation
EXERCISE 14-4
(1) The note payable has a market value greater than the book value that will reduce the net
asset value of the partnership by $15,000. However, the assets whose market values differ
(2) If the value of Petersen’s interest before consideration of goodwill is $104,500 as set forth
(3) Both Jacobsen and Olsen would be acquiring equal interests in the net asset values asso-
ciated with Petersen’s interest; therefore, one would expect them to value these assets at
(4) Based on the $104,500 value in item (1) above, a half interest in that would be $52,250.
Therefore, selling a half interest for $60,000 suggests that $7,750 represents Petersen’s
(5) In either case, Petersen should sell his interest for the same price. However, the ability for
him to collect the sales price may be a factor. The partnership itself may have a greater
ability to pay the sales price. The partnership may have a greater ability to borrow the ne-
14–7 Ch. 14—Exercises
EXERCISE 14-5
(1) Partnership
A B C
Fair market value of original partnership:
Assets at book value ……………………. $ 500,000 $ 600,000 $ 800,000
Liabilities at book value and fair
market value …………………………….. (369,500) (410,000) (558,000)
(a) Book value of original partnership ….. $ 130,500 $ 190,000 $ 242,000
(2) Partnership
A B C
Amount of consideration to be conveyed:
Value of land ………………………………. $ 50,000 $ 50,000 $ 50,000
Value of cash ……………………………… 4,000 60,000 15,000
(h) Total consideration ………………………. $ 54,000 $ 110,000 $ 65,000
(i) Fair value of new partnership
suggested by the fair value of the
Exercise 14-5, Concluded
Proof:
(a) Book value of original partnership ….. $130,500 $190,000 $242,000
Asset appreciation (depreciation) …… (50,000) 125,000 50,000
Goodwill traceable to original
EXERCISE 14-6
1. Combined Capital
Noncash and Loan Balances
Cash Assets Liabilities A (50%) B (30%) C (20%)
Beginning balance ……………. $ 20,000 $ 358,000 $ 92,000 $116,000 $ 90,000 $ 80,000
Liquidation of receivables
2. Combined Capital
Noncash and Loan Balances
Cash Assets Liabilities A (50%) B (30%) C (20%)
Beginning balance ……………. $ 20,000 $ 358,000 $ 92,000 $116,000 $ 90,000 $ 80,000
Exercise 14-6, Concluded
3. Combined Capital
Noncash and Loan Balances
Cash Assets Liabilities A (50%) B (30%) C (20%)
Beginning balance ……………. $ 20,000 $ 358,000 $ 92,000 $116,000 $ 90,000 $ 80,000
EXERCISE 14-7
1. None of the available cash would be available to Boyd.
Noncash Combined Capital and Loans
Cash
Assets Liabilities Adams Boyd Chambers
Beginning balances …………… $ 12,000 $ 255,000 $ 170,000 $ 25,000 $(5,000) $ 47,000
Schedule A
Schedule of Safe Payments
Adams
Boyd Chambers Total
Profit and loss percentages ……… 40% 20% 40% 100%
Combined capital and loan balances $ 33,000 $ (1,000) $55,000 $ 87,000
Estimated liquidation expenses
Exercise 14-7, Concluded
2. $6,000 of the available cash would be available to Boyd.
Noncash Combined Capital and Loans
Cash
Assets Liabilities Adams Boyd Chambers
3. Boyd would be liable to Adams for $10,000.
Noncash Combined Capital and Loans
Cash
Assets Liabilities Adams Boyd Chambers
Beginning balances …………… $ 12,000 $ 255,000 $ 170,000 $ 25,000 $(5,000) $ 47,000
Sales of assets …………………. 150,000 (255,000) (30,000) (15,000) (30,000)
Balances …………………………. $ 162,000 $ 0 $ 170,000 $ (5,000) $ (20,000) $ 17,000
4. Boyd would need a final capital balance of $16,000 represented by their personal deficit of
$16,000. Therefore, their share of the gain on the sale of assets would have to be $21,000
so that after offsetting their $5,000 deficit capital balance, they would have a final balance of
$16,000. Therefore the assets would have to be sold for $330,000 ($225,000 + ($21,000 di-
vided by 20%).
Noncash Combined Capital and Loans
Cash
Assets Liabilities Adams Boyd Chambers
EXERCISE 14-8
(1) Allocation of typical profits under the original partnership’s agreement:
Cumulative
A
B C Total
Salaries …………………………… $30,000 $30,000 $40,000 $100,000
Bonus to A* ……………………… 12,000 112,000
Remaining profits ……………… 10,000 4,000 6,000 132,000
Total ……………………………….. $52,000 $34,000 $46,000
Allocation of new partnership profits necessary to satisfy Bower:
Cumulative
A
B C D Total
Salaries ………………………………… $30,000 $30,000 $40,000 $30,000 $130,000
Remaining profits* …………………. 42,000 14,000 42,000 42,000 270,000
(2) The fair value of the net assets of the original partnership is $56,000 ($530,000 –
$474,000). If Dawson acquires a 30% interest in the capital of the partnership, this would
(3) If the partnership were liquidated as described, Bower would receive additional cash of
$88,200, determined as follows:
Noncash Offset Capital Balances
Cash
Assets Liabilities Arnold Bower Chambers
Beginning balances ……. $ 0 $ 680,000 $ 430,000 $ 50,000 $140,000 $ 60,000
Recognition of liability …. 4,000 (2,000) (800) (1,200)
EXERCISE 14-9
1. Partner B could contribute $12,000 determined as follows:
Other
Cash
Assets Liabilities Partner A Partner B Partner C
Beginning balances …………… $ — $ 180,000 $ 150,000 $ 34,000 $(15,000) $ 11,000
Sales of assets …………………. 165,000 (180,000) (5,000) (5,000) (5,000)
2. After Partner A contributes $22,500 toward the $24,000 of remaining partnership liabilities,
Partner C would contribute the remaining $1,500 since they have net personal assets of
$8,000. Determined as follows:
Other
Cash
Assets Liabilities Partner A Partner B Partner C
Beginning balances …………… $ — $ 180,000 $ 150,000 $ 34,000 $(15,000) $ 11,000
Exercise 14-9, Concluded
Partner A
Allocation of
Amount
% of Total Personal Assets
Partnership creditors …………. $ 24,000 37.50% $ 22,500
3. The amounts contributed by Partners B and C are adequate to satisfy the remaining part-
nership creditors. Therefore, Partner A would not need to contribute any additional funds to
the partnership.
Other
Cash
Assets Liabilities Partner A Partner B Partner C
Beginning balances …………… $ — $ 180,000 $ 150,000 $ 34,000 $(15,000) $ 11,000
Sales of assets …………………. 135,000 (180,000) (15,000) (15,000) (15,000)
Payment of liabilities …………. (135,000) (135,000)
Partner B
Allocation of
Amount
% of Total Personal Assets
Partnership deficit …………….. $ 30,000 33.33% $ 15,000
Personal liabilities …………….. 60,000 66.67% 30,000
4. Partner A would first have to absorb the remaining deficit balances of Partners B and C
leaving Partner A with a final capital balance of $3,200. This $3,200 is all that the personal
Ch. 14—Problems 14–14
PROBLEMS
PROBLEM 14-1
Capital Balances
Carlton Weber Stansbury Laidlaw Wilson Total
Balances as of December 31, 2014 …….. $ 120,000 $ 70,000 $ 80,000 $270,000
Withdrawal of Stansbury ………………………. (80,000) $ 80,000
Balances as of June 30, 2016 ……………….. $ 80,000 $ 45,000 $ 0 $ 65,000 190,000
Acquisition of Laidlaw’s interest …………….. (8,000) (6,000) (65,000)
Allocation of second six months of
2016 income (see Schedule A) ………… 36,500 36,500
Quarterly withdrawals through December 31 (20,000) (20,000)
Balances as of December 31, 2016 ……….. $ 88,500 $ 55,500 $ 0 $ 0 144,000
Admit Wilson to partnership
($144,000/60% = $240,000) ……………. $ 96,000
Allocation of 2017 income (see
Schedule A)…………………………………… 140,000 140,000 140,000
14–15 Ch. 14—Problems
Problem 14-1, Concluded
Schedule A—Allocation of Net Income
Carlton
Weber Laidlaw Wilson Total
2015 Salary ………………………………. $120,000 $ 90,000 $ 90,000 $300,000
Bonus (Note A) ………………….. 12,500 37,500 50,000
Subtotal ……………………………. $120,000 $102,500 $127,500 $350,000
2nd 6 mos.
2016 Per profit and loss
percentages …………………. $ 36,500 $ 36,500 $ 73,000
2017 Per profit and loss
percentages …………………. 140,000 140,000 $140,000 420,000
1st 6 mos.
PROBLEM 14-2
(1) Partner B’s capital balance will now be 80% of $30,000 or $24,000.
(2) The understatement of $25,000 is traceable to the original partnership and the total part-
ners’ capital would increase $25,000 to a revised total of $140,000. The $140,000 would
(3) The overstatement of $25,000 is traceable to the original partnership and the total partners’