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Chapter 3

Chapter 3. Partnership Liquidation and Incorporation; Joint Ventures. Objectives of the Chapter. To learn the accounting procedures for liquidation of limited liability partnerships (LLPs). To discuss accounting issues related to incorporation of a LLP.

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Chapter 3

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  1. Chapter 3 Partnership Liquidation and Incorporation; Joint Ventures

  2. Objectives of the Chapter • To learn the accounting procedures for liquidation of limited liability partnerships (LLPs). • To discuss accounting issues related to incorporation of a LLP. • To discuss accounting for corporate and unincorporated joint ventures. Partnership Liquidation and Incorporation

  3. Liquidation of a Partnership • The liquidation of a LLP means discontinuing its activities. • The procedures usually include selling assets, paying liabilities, and distributing any remaining cash to the partners. • The liquidation process often starts with the realization of noncash assets. Partnership Liquidation and Incorporation

  4. Liquidation of a Partnership (contd.) • Any gains or losses resulting from the assets realization are divided among partners based on the income sharing ratio. • The capital balances after the allocation of gains/losses are the basis for settlement. • No cash can be distributed to partners until all liabilities are paid off. Partnership Liquidation and Incorporation

  5. Liquidation of a Partnership (contd.) • If cash of LLP is insufficient to pay liabilities in full, an unpaid creditor may collect from the personal assets of any solvent partner whose actions caused the partnership's insolvency, regardless whether that partner has a credit or a debit capital account balance. Partnership Liquidation and Incorporation

  6. Distribution of Cash or Other Assets to Partners • The Uniform Partnership Act lists the order for distribution of cash by a liquidating partnership as: • Payment of creditors in full, • Payment of loans from partners, and • Payment of partners' capital account credit balances. Partnership Liquidation and Incorporation

  7. Distribution of Cash or Other Assets to Partners (contd.) • However, if a partner's capital account has a deficit, that partner's loan to the partnership must be offset against the deficit in his/her capital account (referred to astheright of offset). • Thus, the cash received by a partner is the same as if loans to the partnership had been recorded in the partner's capital account. Partnership Liquidation and Incorporation

  8. Distribution of Cash or Other Assets to Partners (contd.) • The existence of partner's loan account will not advance the time of payment of any partner during the liquidation. • Consequently,the loan to the partnership is often treated as capital during the liquidation. Partnership Liquidation and Incorporation

  9. Distribution of Cash or Other Assets to Partners (contd.) • It is possible that partners are willing to receive assets other than cash for settlement. • Regardless whether assets other than cash are distributed to partners, the distribution rule must be followed. Partnership Liquidation and Incorporation

  10. Payment to Partners of an LLP after All Noncash Assets Realized • Five situations are discussed: • Equity of every partner is sufficient to absorb loss from realization. • Equity of one partner is not sufficient to absorb that partner's share of loss from realization. • Equity of two partners are not sufficient to absorb their shares of loss from realization. Partnership Liquidation and Incorporation

  11. Payment to Partners of an LLP after All Noncash Assets Realized(contd.) • Partnership is insolventa but partners are solventb. • General partnership is insolvent and partners are insolvent. • The partnership is unable to pay all outside creditors and at least one partner has a deficit capital account. Partnership Liquidation and Incorporation

  12. Payment to Partners of an LLP after All Noncash Assets Realized(contd.) • The partner has personal assets in excess of liabilities. • Note: the partnership is solvent in situations A, B and C. Partnership Liquidation and Incorporation

  13. Payment to Partners after All Noncash Assets realized A. Equity of Each Partner is Sufficient to Absorb Loss from Realization • Assume that Abra and Barg, who share income/losses equally, decide to liquidate Abra & Barg LLP. A balance sheet on 6/3/99, just prior to liquidation follows: Partnership Liquidation and Incorporation

  14. Payment to Partners after All Noncash Assets realized A. Equity of Each Partner is Sufficient to Absorb Loss from Realization (contd.) ABRA & BARG LLP Balance Sheet June 30, 1999 • Assets Liabilities & Partners’ Capital Partnership Liquidation and Incorporation

  15. Payment to Partners after All Noncash Assets realized A. Equity of Each Partner is Sufficient to Absorb Loss from Realization (contd.) • Additional information: • The noncash assets with a carrying amount of $75,000 realized cash of $35,000. • The loss of $40,000 is divided equally by the partners. • After the allocation of realization loss, Barg's capital has a deficit of $15,000. Partnership Liquidation and Incorporation

  16. statement of realization and liquidation for Abra & Barg LLP Partnership Liquidation and Incorporation

  17. Note to the statement of realization and liquidation for Abra & Barg LLP • Partners Abra and Barg received $20,000 and $5,000, respectively, after partnership creditors had been paid in full. • The checks to both partners should be delivered to the partners at the same time. Partnership Liquidation and Incorporation

  18. Note to the statement of realization and liquidation for Abra & Barg LLP • Thus, the legal priority of a partner's loan account has no significance in determining either the amount of cash paid to a partner or the timing of cash payments to partners during liquidation. • In the above statement, Barg's loan account balance of $20,000 and capital account balance of $5,000 can be combined to obtain an equity of $25,000 for Barg prior to allocation/distribution. Partnership Liquidation and Incorporation

  19. Note to the statement of realization and liquidation for Abra & Barg LLP (contd.) • In the following examples, a partner's loan account balance (if any) is combined with the partner's capital account balance in the statement of realization and liquidation. Partnership Liquidation and Incorporation

  20. Payment to Partners after All Noncash Assets realized B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization • In this case, the loss on realization of assets results in a deficit balance in the capital account of one of the partners. • Assume the balance sheet below for Diel, Ebbs & Frey LLP just prior to liquidation: Partnership Liquidation and Incorporation

  21. B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization (contd.) Diel, Ebbs & Frey LLP Balance Sheet May 20, 1999 • Assets Liabilities & Partners’ Capital Partnership Liquidation and Incorporation

  22. B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization (contd.) • The income sharing ratio is Diel, 20%; Ebbs; 40% and Grey, 40%. • The other assets with a carrying amount of $80,000 realized $50,000 cash. • After dividing the loss of $30,000 among the partners, Frey has a deficit of $3,000 in his capital account. • Assuming Frey pays the $3,000 to the partnership immediately, the statement of realization and liquidation is as follows: Partnership Liquidation and Incorporation

  23. Statement of Realization and Liquidation for Deil, Ebbs & Frey LLP (5/21 through 5/31/99) Partnership Liquidation and Incorporation

  24. B. Equity of One Partner is Not Sufficient to Absorb That Partner's Share of Loss from realization (contd.) • Assuming Grey was not able to pay the $3,000 deficit to the partnership immediately and the cash available after payment to creditors is to be distributed to Deil and Ebbs without a delay, the statement of realization and liquidation would be as follows: Partnership Liquidation and Incorporation

  25. Statement of Realization and Liquidation for Deil, Ebbs & Frey LLP – Frey Cannot Pay $3,000 immediately Partnership Liquidation and Incorporation

  26. Notes to the above Statement • The possible additional loss if Frey is unable to pay $3,000 is charged to Diel and Ebbs in the ratio of 1/3 ($1,000) and 2/3 ($2,000), respectively. • Therefore, the cash available of $40,000 to partners is divided between Diel and Ebbs in a manner that reduces Deil's capital and Ebb's capital to $1,000 and $2,000, respectively. Partnership Liquidation and Incorporation

  27. Notes to the above Statement (contd.) • Thus, if Frey is not able to pay $3,000, the loss can be all absorbed by remaining partners based on their income sharing ratio. • If the $3,000 is later collected from Frey, this amount will be divided $1,000 to Diel and $2,000 to Ebbs. • The forgoing statement then can be completed as follows: Partnership Liquidation and Incorporation

  28. The Completion of the Statement of Realization and Liquidation When $3,000 Collected from Frey Partnership Liquidation and Incorporation

  29. The Completion of the Statement of Realization and Liquidation When $3,000 is Uncollectible from Frey However, if the $3,000 is uncollectible, the statement would be completed with the write-off Frey's Capital as follows: Partnership Liquidation and Incorporation

  30. Payment to Partners after All Noncash Assets realized C. Equity of Two Partners Are Not Sufficient to Absorb Their Shares of Loss from Realization • It is apparent that the inability to collect deficit of a partner will result in additional loss to the other partners as in example B when $3,000 is uncollectible. • This additional loss could cause a second partner to have a deficit in the capital account, which may or may not be collectible. Partnership Liquidation and Incorporation

  31. C. Equity of Two Partners Are Not Sufficient to Absorb Their Shares of Loss from Realization (contd.) • Example: Assume that Judd, Kamb. Long and Marx, partners of Judd, , Kamb. Long & Marx LLP, share income /losses 10%, 20%, 30% and 40%, respectively. • Their capital account balances for the period 8/1 through 8/15, 1999, are as shown in the following statement of realization and liquidation (p29), supported by the exhibit that follows (p30). Partnership Liquidation and Incorporation

  32. Statement of Realization and Liquidation for Judd, Kamb, Long& Marx LLP (8/1 through 8/15/1999) Partnership Liquidation and Incorporation

  33. Exhibit: Computation of Cash Payments to Partners of Judd, Kamb, Long & Marx LLP – 8/15/1999 Partnership Liquidation and Incorporation

  34. Payment to Partners after All Noncash Assets realized D. Partnership Is Insolvent but Partners Are Solvent • In the case of insolvency in a LLP, the total of the capital account debit balance will exceed the total of the credit balances. • If the partner(s) with a deficit capital balance pay off the deficit to the partnership, the LLP will have sufficient cash to pay its liabilities in full. Partnership Liquidation and Incorporation

  35. Payment to Partners after All Noncash Assets realized D. Partnership Is Insolvent but Partners Are Solvent (contd.) • The creditors of LLP may demand payment from any solvent partner whose actions caused the partnership's insolvency, regardless of whether the partner's capital had a debit or a credit balance. • A partner who makes payments to partnership creditors receives a credit to his/her capital account. Partnership Liquidation and Incorporation

  36. Payment to Partners after All Noncash Assets realized D. Partnership Is Insolvent but Partners Are Solvent (contd.) • Assets • Example: Assume that Nehr, Ordo & Page LLP, whose partners share net income/losses equally,had the following balance sheet prior to liquidation on 5/1/1999: Liabilities & Partners’ Capital Partnership Liquidation and Incorporation

  37. Payment to Partners after All Noncash Assets realized D. Partnership Is Insolvent but Partners Are Solvent • On 5/12/99, the other assets with a carrying amount of $85,000 realize $40,000 cash. The loss of $45,000 is to be divided equally among the partners. • The total cash of $55,000 is paid to the creditors, which leaves unpaid liabilities of $10,000. • The capital balances of partner Nehr, Ordo and Page are $3,000, ($5,000) and ($8,000), respectively after absorbing the realization loss of noncash assets. Partnership Liquidation and Incorporation

  38. Payment to Partners after All Noncash Assets realized D. Partnership Is Insolvent but Partners Are Solvent • Assuming that on 5/30/99, Ordo and Page pay off their deficiencies, the LLP will use $10,000 of the $13,000 available cash to pay the remaining liabilities. • The LLP will then distribute $3,000 to Nehr. • These events are summarized in the statement of Realization and Liquidation on the following page. Partnership Liquidation and Incorporation

  39. The Statement of Realization and Liquidation of Nehr, Ordo & Page LLP Partnership Liquidation and Incorporation

  40. Payment to Partners after All Noncash Assets realized D. Partnership Is Insolvent but Partners Are Solvent (contd.) • If the insolvency of the LLP is due to an adverse award of damages in a lawsuit, and the partner(s) responsible for the damages are solvent, they alone must pay the damages that the LLP is unable to pay. • However, if such partner(s) also are insolvent, both they and the LLP may have to file for liquidation under Chapter 7 of the U.S. Bankruptcy Code. Partnership Liquidation and Incorporation

  41. Payment to Partners after All Noncash Assets realized E. General Partnership Is Insolvent and Partners Are Insolvent • All the above cases applies to both LLP and general partnership. • The case discussed here only applies to the general partnership and both the partnership and some partners are insolvent. • The question raised here is the relative rights of creditors of the partnership and the partners. Partnership Liquidation and Incorporation

  42. Payment to Partners after All Noncash Assets realized E. General Partnership Is Insolvent and Partners Are Insolvent (contd.) • The rule provided by the UPA is that assets of the partnership (including partners' capital deficits) are first available to creditors of the partnership. • Assets of the partners are first available to their creditors. Partnership Liquidation and Incorporation

  43. Payment to Partners after All Noncash Assets realized E. General Partnership Is Insolvent and Partners Are Insolvent (contd.) • After the liabilities of the partnership have been paid in full, the creditors of an individual partner have a claim against the assets of the partnership to the extent of that partner's equity in the partnership. Partnership Liquidation and Incorporation

  44. Payment to Partners after All Noncash Assets realized E. General Partnership Is Insolvent and Partners Are Insolvent (contd.) • On the other hand, after the creditors of a partner have been paid in full, any remaining assets of that partner are available to partnership creditors. • This principle applies regardless of whether that partner's capital balance has a credit or a debit balance. • One condition of this principle is that these creditors are unable to obtain payment from the partnership. Partnership Liquidation and Incorporation

  45. The Relative rights of Creditors of an Insolvent General Partnership and Personal Creditors- An Example Assume that the Rich,Sand & Toll Partnership, a general partnership whose partners share net income and losses equally,has the partner- ship balance sheet below prior to liquidation on 11/30/99: • Assets Liabilities & Partners’ Capital Partnership Liquidation and Incorporation

  46. The Relative rights of Creditors of an Insolvent General Partnership and Personal Creditors- An Example (contd.) Assume that on 11/30/99, the partners have the following assets and liabilities other than their equities in the partnership: Partnership Liquidation and Incorporation

  47. The Relative rights of Creditors of an Insolvent General Partnership and Personal Creditors- An Example (contd.) • Assume that the realization of other assets of the partnership results in a loss of $60,000, as shown in the following statement of realization and liquidation for the period 12/1/ through 12/12/99: Partnership Liquidation and Incorporation

  48. The Statement of Realization and Liquidation of Rich, Sand & Toll (12/1 through 12/12/99) Partnership Liquidation and Incorporation

  49. Notes to the Statement • There is still $10,000 liabilities unpaid after exhausting all cash available in the partnership. • The creditors of the partnership can onlya collect these liabilities in full from Rich (who is personally solvent) regardless whether Rich's capital balance has a debit or credit balance. Partnership Liquidation and Incorporation

  50. The Statement of Realization and Liquidation of Rich, Sand & Toll (12/1 through 12/12/99)(contd.) The Statement is continued below (on p50 & 51) to show Rich's Payment of the final $10,000 owed to partnership's creditors: Partnership Liquidation and Incorporation

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