Accounting for Partnerships A. Formation 1.

Accounting Treatment--the assets and liabilities contributed to the partnership should be recorded at their fair market value at the date of formation of the partnership, and the partners' capital accounts are credited for their capital interests multiplied by the recorded value of the net assets of the partnership a. Contribution Not Equal to Capital Interest--if the recorded value of the net assets contributed by each partner is not equal to his capital interest multiplied by the recorded value of the net assets of the partnership, the difference is accounted for under a bonus method or a goodwill method 1) Bonus Method--goodwill is not recognized, and each partner's capital account is credited for his capital interest multiplied by the recorded value of the net assets of the partnership (the difference between the recorded value of the net assets contributed by each partner and his capital account balance is a bonus payment) 2) Goodwill Method--goodwill is recognized for the amount of the bonus payment calculated in 1) divided by the capital interest of the partner or partners making the bonus payment and is allocated entirely to the partner receiving the bonus payment, and each partner's capital account is credited for the recorded value of the assets, other than goodwill, that he contributed to the partnership b. Profit-and-loss Sharing Ratios--if the profit-and-loss sharing ratios of the partners are equal to their capital interests, the partners should be indifferent whether the bonus method or the goodwill method is used to record the formation of the partnership 2. Illustrations a. A, B, and C formed a partnership; A contributed inventory with a fair market value of $100,000 for a 20% capital interest in the partnership; B contributed equipment with a fair market value of $180,000 and a building with a fair market value of $600,000 and subject to a $480,000 mortgage for a 60% capital interest in the partnership; C contributed $100,000 in cash for a 20% capital interest in the partnership Goodwill = (100,000 20% x (100,000 + 180,000 + 600,000 480,000 + 100,000) or (300,000 60% x 500,000) or (100,000 20% x 500,000) = 0

Cash Inventory Equipment Building Mortgage Payable A, Capital (20% x 500,000) B, Capital (60% x 500,000) C, Capital (20% x 500,000) b.

100,000 100,000 180,000 600,000 480,000 100,000 300,000 100,000

A, B, and C formed a partnership; A contributed inventory with a fair market value of $100,000 for a 20% capital interest in the partnership; B contributed equipment with a fair market value of $180,000 and a building with a fair market value of $600,000 and subject to a $480,000 mortgage for a 60% capital interest in the partnership; C contributed $60,000 in cash and goodwill with a fair market value of $40,000 for a 20% capital interest in the partnership Goodwill = (100,000 + 180,000 + 600,000 480,000 (20% + 60%) x (400,000 + 60,000)) / 80% = 40,000 Bonus Method: Cash Inventory Equipment Building Mortgage Payable A, Capital (20% x 460,000) B, Capital (60% x 460,000) C, Capital (20% x 460,000) Goodwill Method: Goodwill C, Capital 60,000 100,000 180,000 600,000 480,000 92,000 276,000 92,000

40,000 40,000

Cash Inventory Equipment Building Mortgage Payable A, Capital B, Capital C, Capital B.

60,000 100,000 180,000 600,000 480,000 100,000 300,000 60,000

Division of Profits--the objective of the partnership's profit-and-loss sharing arrangement is to allocate the profit and loss of the partnership among the partners in a way that reflects each partner's contribution to the success of the firm 1. Allocation Methods--bases for the allocation of the profit and loss of the partnership usually take one or a combination of the following forms: a. Fixed Ratios--profit and loss is allocated to the partners by providing a fixed percentage of profit and loss to the individual partners b. Service Contributions--salary allowances are provided to the partners to reward the individual partners for their different service contributions to the operation of the partnership c. Capital Investments--capital allowances, usually in the form of interest on the capital balances of the individual partners, are provided to the partners to reward the individual partners for their different capital investments 2. Insufficient Earnings--when net income fails to meet the provision for salaries and interest in the partnership agreement, the partnership agreement usually handles the earnings deficiency in one of the following ways: a. Total Distribution--the total amount of salaries and interest provided in the partnership agreement is allocated to the individual partners with the resulting earnings deficiency allocated to the individual partners using their profit-and-loss sharing ratios b. Partial Distribution--salaries and interest provided in the partnership agreement are allocated to the individual partners in a specified sequence to the extent that profits are sufficient to provide then 3. Correction of Prior Years' Net Income--when an error in the computation of a prior year's net income is discovered, the allocation of profit and loss for the prior year should be recalculated using the corrected net income 4. Illustrations a. A, B, and C are partners with profit-and-loss sharing ratios of 30%, 25%, and 45%, respectively, and capital balances of $50,000, $100,000, and $350,000, respectively; the partnership agreement

provided for salaries of $20,000 for A, $25,000 for B, and $15,000 for C and 10% interest on the partners' capital balances; net income was $140,000; salaries and interest are to be allocated in full _ A B C Total_ Salaries 20,000 25,000 15,000 60,000 Interest 5,000 10,000 35,000 50,000 Fixed Ratio _ 9,000 7,500 13,500 30,000 _34,000 42,500 63,500 140,000 Interest: A = 10% x 50,000 = 5,000 B = 10% x 100,000 = 10,000 C = 10% x 350,000 = 35,000 Fixed A B C b. Ratio: = 30% x (140,000 (60,000 + 50,000)) = 9,000 = 25% x 30,000 = 7,500 = 45% x 30,000 = 13,500

A, B, and C are partners with profit-and-loss sharing ratios of 30%, 25%, and 45%, respectively, and capital balances of $50,000, $100,000, and $350,000, respectively; the partnership agreement provided for salaries of $20,000 for A, $25,000 for B, and $15,000 for C and 10% interest on the partners' capital balances; net income was $100,000; salaries and interest are to be allocated in full _ A B C Total_ Salaries 20,000 25,000 15,000 60,000 Interest 5,000 10,000 35,000 50,000 Fixed Ratio ( 3,000) ( 2,500) ( 4,500) ( 10,000) _22,000 32,500 45,500 100,000 Interest: A = 10% x 50,000 = 5,000 B = 10% x 100,000 = 10,000 C = 10% x 350,000 = 35,000 Fixed A B C Ratio: = 30% x (100,000 (60,000 + 50,000)) = (3,000) = 25% x (10,000) = (2,500) = 45% x (10,000) = (4,500)

c.

A, B, and C are partners with profit-and-loss sharing ratios of 30%, 25%, and 45%, respectively, and capital balances of $50,000, $100,000, and $350,000, respectively; the partnership agreement provided for salaries of $20,000 for A, $25,000 for B, and $15,000

for C and 10% interest on the partners' capital balances; net income was $100,000; salaries and interest are to be allocated to the extent of net income with salaries being allocated first _ A B C Total_ Salaries 20,000 25,000 15,000 60,000 Interest _ 4,000 8,000 28,000 40,000 _24,000 33,000 43,000 100,000 Interest: A = (100,000 350,000) B = 40,000 / C = 40,000 / C. 60,000) / (10% x (50,000 + 100,000 + x 10% x 50,000 = 4,000 50,000 x 10% x 100,000 = 8,000 50,000 x 10% x 350,000 = 28,000

Changes in Ownership--since a change in ownership creates a new partnership, the assets and liabilities of the old partnership should be revalued to reflect fair market value at the date of change in ownership 1. Investment in the Partnership--the new partner gains admission to the partnership by investing assets directly into the partnership a. Accounting Treatment--the assets and liabilities invested in the partnership should be recorded at their fair market value at the date of investment in the partnership, and the new partner's capital account is credited for his capital interest multiplied by the recorded value of the net assets of the partnership after the investment of the new partner 1) Payment Not Equal to Capital Interest--if the recorded value of the net assets invested by the new partner is not equal to his capital interest multiplied by the recorded value of the net assets of the partnership after the investment of the new partner, the difference is accounted for under either a bonus method or a goodwill method a) Bonus Method--goodwill is not recognized, and the new partner's capital account is credited for his capital interest multiplied by the recorded value of the net assets of the partnership after the investment of the new partner with the difference between the recorded value of the net assets invested by the new partner and the amount recorded in his capital account (bonus payment) allocated to the old partners on the basis of their profit-and-loss sharing ratios before the investment of the new partner b) Goodwill Method--goodwill is recognized for the amount of the bonus payment calculated in a) divided by either the capital interest of the old partners if the new partner is receiving the bonus payment or the capital interest of the new partner if the old partners are receiving the bonus payment and is allocated either entirely to the new partner if the new partner is receiving the bonus payment or to the

b.

old partners on the basis of their profit-and-loss sharing ratios before the investment of the new partner if the old partners are receiving the bonus payment, and the new partner's capital account is credited for the recorded value of the net assets, other than goodwill, invested by the new partner 2) Profit-and-loss Sharing Ratios--if the profit-and-loss sharing ratio of the new partner is equal to his capital interest and the profit-and-loss sharing ratios of the old partners are in the same proportion as before the investment of the new partner, the partners should be indifferent whether the bonus method or the goodwill method is used to record the investment of the new partner Illustrations 1) A and B are partners with profit-and-loss sharing ratios of 25% and 75%, respectively, and capital balances of $130,000 and $70,000, respectively; C invested $50,000 in cash for a 20% capital interest in the partnership C = 20% x (200,000 + C) C = 50,000 Goodwill = 50,000 - 20% x (200,000 + 50,000) = 0 Cash C, Capital (50% x 250,000) 2) 50,000 50,000

A and B are partners with profit-and-loss sharing ratios of 25% and 75%, respectively, and capital balances of $130,000 and $70,000, respectively; C invested $60,000 in cash for a 20% capital interest in the partnership; C agreed that the partnership had goodwill of $40,000 C = 20% x (200,000 + 40,000 + C) C = 60,000 Goodwill = (60,000 - 20% (200,000 + 60,000)) / 20% = 40,000 Bonus Method: Cash C, Capital (20% x 260,000) A, Capital (25% x 8,000) B, Capital (75% x 8,000) 60,000 52,000 2,000 6,000

Goodwill Method: Goodwill A, Capital (25% x 40,000) B, Capital (75% x 40,000) Cash C, Capital (20% x 300,000) 3)

40,000 10,000 30,000 60,000 60,000

A and B are partners with profit-and-loss sharing ratios of 25% and 75%, respectively, and capital balances of $130,000 and $70,000, respectively; C invested $30,000 in cash for a 20% capital interest in the partnership; A and B agreed that C had goodwill of $20,000 C + 20,000 = 20% x (200,000 + C + 20,000) C = 30,000 Goodwill = (30,000 - 20% x (200,000 + 30,000)) / 80% = 20,000 Bonus Method: Cash A, Capital (25% x 16,000) B, Capital (75% x 16,000) C, Capital (20% x 230,000) Goodwill Method: Goodwill C, Capital Cash C, Capital (20% x 250,000 - 20,000) 30,000 4,000 12,000 46,000

20,000 20,000 30,000 30,000

2.

Purchase of an Interest--the new partner gains admission to the partnership by transferring assets directly to one or more of the old partners a. Accounting Treatment--the new partner's capital account is credited for the fair market value of the net assets transferred by the new partner to the old partners, and the old partners' capital accounts are debited for the fair market value of the net assets received by each from the new partner

1)

b.

Payment Not Equal to Capital Interest--if the fair market value of the net assets transferred by the new partner to the old partners is not equal to his capital interest multiplied by the recorded value of the net assets of the partnership, the difference is accounted for under either a bonus method or a goodwill method a) Bonus Method--goodwill is not recognized, and the new partner's capital account is credited for his capital interest multiplied by the recorded value of the net assets of the partnership with the difference between the purchase price of the partnership interest by the new partner and the amount recorded in his capital account (bonus payment) allocated to the old partners on the basis of their profitand-loss sharing ratios before the purchase of the partnership interest by the new partner b) Goodwill Method--goodwill is recognized for the amount of the bonus payment in a) divided by either the capital interest of the old partners if the new partner is receiving the bonus payment or the capital interest of the new partner if the old partners are receiving the bonus payment and is allocated either entirely to the new partner if the new partner is receiving the bonus payment or to the old partners on the basis of their profit-and-loss sharing ratios before the purchase of the partnership interest by the new partner if the old partners are receiving the bonus payment, and the new partner's capital account is credited for the purchase price, other than goodwill, of the partnership interest by the new partner 2) Profit-and-loss Sharing Ratios--if the profit-and-loss sharing ratio of the new partner is equal to his capital interest and the profit-and-loss sharing ratios of the old partners are in the same proportion as before the purchase of the partnership interest by the new partner, the partners should be indifferent whether the bonus method or the goodwill method is used to record the purchase of the partnership interest by the new partner Illustrations 1) A and B are partners with profit-and-loss sharing ratios of 25% and 75%, respectively, and capital balances of $130,000 and $70,000, respectively; C purchased a 20% capital interest in the partnership from A for $40,000 C = 20% x 200,000 C = 40,000 Goodwill = 40,000 - 20% x 200,000 = 0

A, Capital C, Capital (20% x 200,000) 2)

40,000 40,000

A and B are partners with profit-and-loss sharing ratios of 25% and 75%, respectively, and capital balances of $130,000 and $70,000, respectively; C purchased a 20% capital interest from A for $48,000; C agreed that the partnership had goodwill of $40,000 C = 20% x (200,000 + 40,000) C = 48,000 Goodwill = (48,000 - 20% x 200,000) / 20% = 40,000 Bonus Method: A, Capital C, Capital C, Capital (48,000 - 20% x 200,000) A, Capital (25% x 8,000) B, Capital (75% x 8,000) Goodwill Method: Goodwill A, Capital (25% x 40,000) B, Capital (75% x 40,000) A, Capital C, Capital (20% x 240,000) 48,000 48,000 8,000 2,000 6,000

40,000 10,000 30,000 48,000 48,000

3)

A and B are partners with profit-and-loss sharing ratios of 25% and 75%, respectively, and capital balances of $130,000 and $70,000, respectively; C purchased a 20% capital interest in the partnership from A for $30,000; A and B agreed that C had goodwill of $12,500 C + 12,500 = 20% x (200,000 + 12,500) C = 30,000 Goodwill = (30,000 - 20% x 200,000) / 80% = 12,500

Bonus Method: A, Capital C, Capital A, Capital (25% x 10,000) B, Capital (75% x 10,000) C, Capital (20% x 200,000 - 30,000) Goodwill Method: Goodwill C, Capital A, Capital C, Capital (20% x 212,500 - 12,500) 3.

30,000 30,000 2,500 7,500 10,000

12,500 12,500 30,000 30,000

Withdrawl of a Partner--the old partner leaves the partnership by withdrawing assets from the partnership to liquidate his capital interest a. Accounting Treatment--the retiring partner's capital account is debited for the recorded value of the net assets withdrawn by the retiring partner 1) Payment Not Equal to Capital Balance--if the recorded value of the net assets withdrawn by the retiring partner is not equal to the balance in his capital account, the difference is accounted for under either a bonus method or a goodwill method a) Bonus Method--goodwill is not recognized, and the retiring partner's capital account is closed with the difference between the recorded value of the net assets withdrawn from the partnership and the balance in the retiring partner's capital account (bonus payment) allocated to the remaining partners on the basis of their relative profit-and-loss sharing ratios before the withdrawl of the retiring partner b) Goodwill Method--goodwill is recognized for the amount of the bonus payment calculated in a) divided by the retiring partner's profit-and-loss sharing ratio and is allocated to the partners on the basis of their profit-and-loss sharing ratios, and the retiring partner's capital account is debited for the recorded value of the net assets withdrawn by the retiring partner I) Fractional Goodwill--goodwill is recognized for the amount of the bonus payment calculated in a) and is allocated entirely to the retiring partner, and the retiring partner's capital account is debited for the

10

b.

recorded value of the net assets withdrawn by the retiring partner 2) Profit-and-loss Sharing Ratios--if the profit-and-loss sharing ratios of the remaining partners are in the same proportion as before the withdrawl of the old partner, the partners should be indifferent whether the bonus method or the goodwill method is used to record the withdrawl of the old partner Illustrations 1) A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively, and capital balances of $135,000, $70,000, and $55,000, respectively; C withdrew $55,000 in cash from the partnership to liquidate his capital interest in the partnership C = 55,000 + 20% x 0 C = 55,000 Goodwill = 55,000 - 55,000 = 0 C, Capital Cash 2) 55,000 55,000

A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively, and capital balances of $135,000, $70,000, and $55,000, respectively; C withdrew $65,000 in cash from the partnership to liquidate his capital interest in the partnership; A, B, and C agreed that the partnership had goodwill of $50,000 C = 55,000 + 20% x 50,000 C = 65,000 Goodwill = (65,000 - 55,000) / 20% = 50,000 Bonus Method: C, Capital A, Capital (20% / 80% x 10,000) B, Capital (60% / 80% x 10,000) Cash 55,000 2,500 7,500 65,000

11

Goodwill Method: 1) Goodwill A, Capital (20% x 50,000) B, Capital (60% x 50,000) C, Capital (20% x 50,000) C, Capital Cash 2) Goodwill C, Capital C, Capital Cash D.

50,000 10,000 30,000 10,000 65,000 65,000 10,000 10,000 65,000 65,000

Liquidation--the sale of the partnership assets, payment of the partnership's liabilities, and the distribution of any remaining assets to the partners 1. Lump-sum Liquidation--a liquidation in which all the assets of the partnership are converted into cash within a very short time, creditors are paid, and a single payment is made to the partners for their capital interests a. Accounting Treatment 1) Realization of Assets--any gains or losses realized from the sale of partnership assets are allocated to the partners using their profit-and-loss sharing ratios 2) Distribution of Realization Proceeds a) Solvent Partnership--the claims against the assets of the partnership are satisfied in the following order: I) Creditors--amount owed to partnership creditors other than partners II) Liabilities to Partners--amounts owed to partners other than for their capital balance A) Right of Offset--a deficit balance in a partner's capital account is offset against any loan payable to that partner III) Capital Balances--amounts owed to partners for their capital balances to the extent of credit balances in their capital accounts A) Right of Offset--a loan receivable from a partner is offset against any credit balance in that partner's capital account B) Capital Deficiency--a debit balance in a partner's capital account represents a claim of the

12

b.

partnership against that partner 1) Cash Contribution--if a partner with a debit balance in his capital account contributes cash to the partnership to make up his capital deficiency, the debit balance in his capital account is reduced for the amount of cash contributed 2) No Contribution--if a partner with a debit balance in his capital account does not contribute cash to the partnership to make up his capital deficiency or contributes insufficient cash to the partnership to make up his capital deficiency, the debit balance in his capital deficiency is allocated to the other partners in their relative profit-andloss sharing ratios b) Insolvent Partnership--the claims against the personal assets of the individual partners of the partnership are satisfied in the following order: I) Personal Creditors--personal creditors of the individual partners II) Partnership Creditors--partnership creditors for unpaid liabilities, regardless of the individual partner's capital balance Illustrations 1) A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated by selling the noncash assets for $310,000; the partners have sufficient cash to make up any capital deficiencies Noncash A B C _ Cash_ _Assets Payables Capital Capital Capital 20,000 270,000 40,000 140,000 60,000 50,000 310,000 (270,000) _ _ 8,000 _24,000 _ 8,000 330,000 _ --- _ 40,000 148,000 84,000 58,000 ( 40,000) (_40,000) _ _ _ _ _ _ 290,000 _ --- _ 148,000 84,000 58,000 (290,000) (148,000) ( 84,000) ( 58,000) _ --- _ _ --- _ _ --- _ _ --- _ Gain Allocation: A = 20% x (310,000 270,000) = 8,000 B = 60% x 40,000 = 24,000 C = 20% x 40,000 = 8,000

13

2)

A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated by selling the noncash assets for $220,000; the partners have sufficient cash to make up any capital deficiencies Noncash A B C _ Cash_ _Assets Payables Capital Capital Capital 20,000 270,000 40,000 140,000 60,000 50,000 220,000 (270,000) _ (_10,000) (_30,000) (_10,000) 240,000 _ --- _ 40,000 130,000 30,000 40,000 ( 40,000) (_40,000) _ _ _ _ _ _ 200,000 _ --- _ 130,000 30,000 40,000 (200,000) (130,000) ( 30,000) ( 40,000) _ --- _ _ --- _ _ --- _ _ --- _ Loss Allocation: A = 20% x (220,000 270,000) = (10,000) B = 60% x (50,000) = (30,000) C = 20% x (50,000) = (10,000)

3)

A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated by selling the noncash assets for $160,000; the partners have sufficient cash to make up any capital deficiencies Noncash A B C _ Cash_ _Assets Payables Capital Capital Capital 20,000 270,000 40,000 140,000 60,000 50,000 160,000 (270,000) _ (_22,000) (_66,000) (_22,000) 180,000 _ --- _ 40,000 118,000 ( 6,000) 28,000 ( 40,000) (_40,000) _ _ _ _ _ _ 140,000 _ --- _ 118,000 ( 6,000) 28,000 _ 6,000 _ 6,000 146,000 _ --- _ (146,000) (118,000) ( 28,000) _ --- _ _ --- _ _ --- _ Loss Allocation: A = 20% x (160,000 270,000) = (22,000) B = 60% x (110,000) = (66,000) C = 20% x (110,000) = (22,000)

14

4)

A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated by selling the noncash assets for $160,000; the partners are personally insolvent Noncash A B C _ Cash_ _Assets Payables Capital Capital Capital 20,000 270,000 40,000 140,000 60,000 50,000 160,000 (270,000) _ (_22,000) (_66,000) (_22,000) 180,000 _ --- _ 40,000 118,000 ( 6,000) 28,000 ( 40,000) (_40,000) _ _ _ _ _ _ 140,000 _ --- _ 118,000 ( 6,000) 28,000 _ ( 3,000) _ 6,000 ( 3,000) 140,000 115,000 _ --- _ 25,000 (140,000) (115,000) ( 25,000) _ --- _ _ --- _ _ --- _ Loss Allocation: A = 20% x (160,000 270,000) = (22,000) B = 60% x (110,000) = (66,000) C = 20% x (110,000) = (22,000) Bs Deficit Allocation: A = 20% / (20% + 20%) x (6,000) = (3,000) C = 20% / 40% x (6,000) = (3,000)

5)

A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $0, liabilities of $50,000, and capital balances of $15,000 for A, ($55,000) for B, and ($10,000) for C; the partnership was being liquidated; A is personally insolvent; B and C are personally solvent in the amount of $35,000 and $80,000, respectively; the creditors obtained judgment against C for $50,000

15

A _ Cash_ Payables Capital --50,000 15,000 _50,000 _ _ _ _ 50,000 50,000 15,000 ( 50,000) ( 50,000) _ _ --_ --- _ 15,000 _35,000 _ _ 35,000 15,000 _ _ ( 10,000) 35,000 5,000 ( 35,000) ( 5,000) _ --- _ _ --- _

B C Capital Capital ( 55,000) ( 10,000) _ _ _50,000 ( 55,000) 40,000 _ _ _ _ ( 55,000) 40,000 _35,000 _ _ ( 20,000) 40,000 _20,000 ( 10,000) _ --- _ 30,000 ( 30,000) _ --- _

Bs Deficit Allocation: A = 20% / (20% + 20%) x (20,000) = (10,000) C = 20% / 40% x (20,000) = (10,000) 2. Installment Liquidations--a liquidation in which all the assets of the partnership are converted into cash over a longer period of time, outside creditors are paid, and periodic payments are made to the partners for their capital interests a. Safe Payment Schedule 1) Accounting Treatment a) Creditors--no cash is distributed to the partners until all liabilities and all actual and potential liquidation expenses are paid or provided for by reserving the necessary cash b) Worst Case Scenario--the worst possible case is anticipated before determining the amount of installment payment each partner receives I) Maximum Possible Loss--it is assumed that nothing will be realized from the sale of the remaining assets of the partnership A) Unrecorded Expenses--any potential liquidation expenses are added to the maximum possible loss from sale of the remaining assets of the partnership II) Partner Insolvency--it is assumed that the partners will not be able to make up any capital deficiencies c) Distribution to Partners--the remaining credit balances in the loan and the capital accounts of the partners represent the amount of cash to be distributed to each partner 2) Illustrations a) A, B, and C are partners with profit-and-loss sharing

16

ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated; during the first month noncash assets with a book value of $75,000 were sold for $60,000; during the second month noncash assets with a book value of $60,000 were sold for $65,000; during the third month noncash assets with a book value of $80,000 were sold for $70,000; during the fourth month noncash assets with a book value of $55,000 were sold for $35,000 Noncash A B C _ Cash_ _Assets Payables Capital Capital Capital 20,000 270,000 40,000 140,000 60,000 50,000 _60,000 ( 75,000) _ _ ( 3,000) ( 9,000) ( 3,000) 80,000 195,000 40,000 137,000 51,000 47,000 ( 40,000) _ _ ( 40,000) _ _ _ _ _ _ 40,000 195,000 _ --- _ 137,000 51,000 47,000 ( 40,000) _ _ ( 40,000) _ _ _ _ --195,000 97,000 51,000 47,000 _65,000 ( 60,000) _ 1,000 _ 3,000 _ 1,000 65,000 135,000 98,000 54,000 48,000 ( 65,000) _ _ ( 57,500) _ _ ( 7,500) --135,000 40,500 54,000 40,500 _70,000 ( 80,000) ( 2,000) ( 6,000) ( 2,000) 70,000 55,000 38,500 48,000 38,500 ( 70,000) _ _ ( 27,500) ( 15,000) ( 27,500) --55,000 11,000 33,000 11,000 _35,000 ( 55,000) ( 4,000) ( 12,000) ( 4,000) 35,000 _ --- _ 7,000 21,000 7,000 ( 35,000) ( 7,000) ( 21,000) ( 7,000) _ --- _ _ --- _ _ --- _ _ --- _ Loss Allocation: A = 20% x (60,000 75,000) = (3,000) B = 60% x (15,000) = (9,000) C = 20% x (15,000) = (3,000) Gain Allocation: A = 20% x (65,000 60,000) = 1,000 B = 60% x 5,000 = 3,000 C = 20% x 5,000 = 1,000 Loss Allocation: A = 20% x (70,000 80,000) = (2,000) B = 60% x (10,000) = (6,000) C = 20% x (10,000) = (2,000)

17

Loss Allocation: A = 20% x (35,000 55,000) = (4,000) B = 60% x (20,000) = (12,000) C = 20% x (20,000) = (4,000) Safe Payment Schedules: First Month: A B C Capital Capital Capital 137,000 51,000 47,000 ( 39,000) (117,000) ( 39,000) 98,000 ( 66,000) 8,000 ( 33,000) _66,000 ( 33,000) 65,000 _ --- _ ( 25,000) ( 25,000) _25,000 _40,000 _ --- _

Maximum loss B's deficit C's deficit

Loss Allocation: A = 20% x (195,000) = (39,000) B = 60% x (195,000) = (117,000) C = 20% x (195,000) = (39,000) Bs Deficit Allocation: A = 20% / (20% + 20%) x (66,000) = (33,000) C = 20% / 40% x (66,000) = (33,000) Cs Deficit Allocation: A = 20% / 20% x (25,000) = (25,000) Second Month: A B C Capital Capital Capital 98,000 54,000 48,000 ( 27,000) ( 81,000) ( 27,000) 71,000 ( 27,000) 21,000 ( 13,500) _27,000 ( 13,500) _57,500 --7,500

Maximum loss B's deficit

Loss Allocation: A = 20% x (135,000) = (27,000) B = 60% x (135,000) = (81,000) C = 20% x (135,000) = (27,000) Bs Deficit Allocation: A = 20% / (20% + 20%) x (27,000) = (13,500) C = 20% / 40% x (27,000) = (13,500)

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Third Month: A B C Capital Capital Capital 38,500 48,000 38,500 ( 11,000) ( 33,000) ( 11,000) 27,500 15,000 27,500

Maximum loss

Loss Allocation: A = 20% x (55,000) = (11,000) B = 60% x (55,000) = (33,000) C = 20% x (55,000) = (11,000) b) A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated; during the first month noncash assets with a book value of $75,000 were sold for $60,000; during the first month $8,000 in cash was to be withheld from the distribution to cover unrecorded liabilities; during the second month unrecorded liabilities of $7,500 were discovered and paid; during the second month noncash assets with a book value of $60,000 were sold for $65,000; during the third month noncash assets with a book value of $80,000 were sold for $70,000; during the fourth month noncash assets with a book value of $55,000 were sold for $35,000

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_ Cash_ 20,000 _60,000 80,000 ( 40,000) 40,000 ( 32,000) 8,000 ( 7,500) 500 _65,000 65,500 ( 65,500) --_70,000 70,000 ( 70,000) --_35,000 35,000 ( 35,000) _ --- _

Noncash A _Assets Payables Capital 270,000 40,000 140,000 ( 75,000) _ _ ( 3,000) 195,000 40,000 137,000 _ _ ( 40,000) _ _ 195,000 _ --- _ 137,000 _ _ ( 32,000) 195,000 105,000 ( 1,500) 195,000 103,500 ( 60,000) _ 1,000 135,000 104,500 _ _ ( 61,750) 135,000 42,750 ( 80,000) ( 2,000) 55,000 40,750 _ _ ( 29,750) 55,000 11,000 ( 55,000) ( 4,000) _ --- _ 7,000 ( 7,000) _ --- _

B Capital 60,000 ( 9,000) 51,000 _ _ 51,000 _ _ 51,000 ( 4,500) 46,500 _ 3,000 49,500 _ _ 49,500 ( 6,000) 43,500 ( 10,500) 33,000 ( 12,000) 21,000 ( 21,000) _ --- _

C Capital 50,000 ( 3,000) 47,000 _ _ 47,000 _ _ 47,000 ( 1,500) 45,500 _ 1,000 46,500 ( 3,750) 42,750 ( 2,000) 40,750 ( 29,750) 11,000 ( 4,000) 7,000 ( 7,000) _ --- _

Loss Allocation: A = 20% x (60,000 75,000) = (3,000) B = 60% x (15,000) = (9,000) C = 20% x (15,000) = (3,000) Unrecorded Liabilities Allocation: A = 20% x (7,500) = (1,500) B = 60% x (7,500) = (4,500) C = 20% x (7,500) = (1,500) Gain Allocation: A = 20% x (65,000 60,000) = 1,000 B = 60% x 5,000 = 3,000 C = 20% x 5,000 = 1,000 Loss Allocation: A = 20% x (70,000 80,000) = (2,000) B = 60% x (10,000) = (6,000) C = 20% x (10,000) = (2,000)

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Loss Allocation: A = 20% x (35,000 55,000) = (4,000) B = 60% x (20,000) = (12,000) C = 20% x (20,000) = (4,000) Safe Payment Schedules: First Month: A B C Capital Capital Capital 137,000 51,000 47,000 ( 40,600) (121,800) ( 40,600) 96,400 ( 70,800) 6,400 ( 35,400) _70,800 ( 35,400) 61,000 _ --- _ ( 29,000) ( 29,000) _29,000 _32,000 _ --- _

Maximum loss B's deficit C's deficit

Loss Allocation: A = 20% x (195,000 + 8,000) = (40,600) B = 60% x (203,000) = (121,800) C = 20% x (203,000) = (40,600) Bs Deficit Allocation: A = 20% / (20% + 20%) x (70,800) = (35,400) C = 20% / 40% x (70,800) = (35,400) Cs Deficit Allocation: A = 20% / 20% x (29,000) = (29,000) Second Month: A B C Capital Capital Capital 104,500 49,500 46,500 ( 27,000) ( 81,000) ( 27,000) 77,500 ( 31,500) 19,500 ( 15,750) _31,500 ( 15,750) _61,750 --3,750

Maximum loss B's deficit

Loss Allocation: A = 20% x (135,000) = (27,000) B = 60% x (135,000) = (81,000) C = 20% x (135,000) = (27,000) Bs Deficit Allocation: A = 20% / (20% + 20%) x (31,500) = (15,750) C = 20% / 40% x (31,500) = (15,750)

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Third Month: A B C Capital Capital Capital 40,750 43,500 40,750 ( 11,000) ( 33,000) ( 11,000) 29,750 10,500 29,750

Maximum loss

Loss Allocation: A = 20% x (55,000) = (11,000) B = 60% x (55,000) = (33,000) C = 20% x (55,000) = (11,000) b. Advanced Cash Distribution Plan 1) Accounting Treatment a) Maximum Absorbable Loss--the maximum absorbable loss is computed for each partner by dividing his capital account balance by his profit-and-loss sharing ratio b) Distribution Plan I) Creditors--cash is distributed 100% to the creditors up to the amount of the partnership liabilities II) Partners A) Cash is distributed 100% to the partner with the largest maximum absorbable loss in the amount of the difference between the largest maximum absorbable loss and the second largest maximum absorbable loss multiplied by his profit-and-loss sharing ratio B) Cash is then distributed to the partners with the two largest maximum losses using their relative profit-and-loss sharing ratios in the amount of the difference between the second largest maximum absorbable loss and the third largest maximum absorbable loss multiplied by their combined profit-and-loss sharing ratios C) Step b) is repeated, adding one partner at a time, until all the partners are included in the distribution plan 2) Illustration--A, B, and C are partners with profit-and-loss sharing ratios of 20%, 60%, and 20%, respectively; the partnership balance sheet consisted of cash of $20,000, noncash assets of $270,000, liabilities of $40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership was liquidated; during the first month noncash assets with a book value of $75,000 were sold for $60,000; during the second month noncash assets with a book value of $60,000 were sold for $65,000; during the third month noncash assets with a book value of $80,000 were sold for

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$70,000; during the fourth month noncash assets with a book value of $55,000 were sold for $35,000 Maximum Absorbable Loss: A = 140,000 / .20 = 700,000 B = 60,000 / .60 = 100,000 C = 50,000 / .20 = 250,000 Advanced Cash Distribution Plan: Payables A First $40,000 100% Next $90,000 100% ((700,000 250,000) x .20) Next $60,000 50% ((250,000 100,000) x (.20 + .20)) Any additional cash 20% Cash Payments: First Month: First $40,000 Next $40,000 B C

50% 60% 20%

40,000 40,000 40,000 40,000 50,000 7,500 57,500 22,500 5,000 27,500 7,000 15,000 15,000 21,000 7,500 7,500 22,500 5,000 27,500 7,000

Second Month: Next $50,000 (90,000 40,000) Next $15,000 Third Month: Next $45,000 (60,000 15,000) Next $25,000 Fourth Month: Next $35,000

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