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Partnership - Liquidation.ppt

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Partnership - Liquidation.ppt

  1. 1. 16-1 Partnership Liquidation: Objectives 1. Understand the legal aspects of partnership liquidation. 2. Apply simple partnership liquidation computations and accounting. 3. Perform safe payment computations. 4. Understand installment liquidations. 5. Learn about cash distribution plans for installment liquidations. 6. Comprehend liquidations when either the partnership or the partners are insolvent.
  2. 2. 16-2 1: Legal Aspects of Liquidation Partnership Liquidation
  3. 3. 16-3 Process of Liquidation 1. Convert noncash assets to cash 2. Recognize gains or losses and expenses 3. Settle all liabilities 4. Distribute cash to partners according to balances in capital accounts Assumes – Business is solvent – Partners have equity in net assets – No partner loans – Assets are converted to cash before cash is distributed to partners
  4. 4. 16-4 Order of Payment The following rank ordering for payments in partnership liquidations 1. Amounts owed to creditors other than partners 2. Amounts owed to partners other than for capital and profits 3. Amounts due to partners liquidating their capital balance upon conclusion of the liquidation of partnership assets and liabilities
  5. 5. 16-5 2: Lump-sum Liquidation Partnership Liquidation
  6. 6. 16-6 Lump-sum Liquidation • Converts all assets to cash • Makes a single distribution to partners in final settlement • Gains and losses on conversion of assets are distributed to partners – Use established profit and loss ratios – Ignore salary, bonus, interest allowances
  7. 7. 16-7 Debit Capital in Solvent Firm • One or more (not all) partners has a debit balance in capital • Firm has sufficient cash and other assets of value to pay all creditors • Partner with debit capital balance – Contribute that amount to the firm – If unable, the debit balance is absorbed by the remaining partners • Profit and loss ratios of remaining partners
  8. 8. 16-8 Partnership Statement of Partnership Liquidation Beginning balances in cash, noncash assets, liabilities and partner accounts are adjusted as assets are converted to cash, and cash payments are made.
  9. 9. 16-9 3: Safe Payments Partnership Liquidation
  10. 10. 16-10 Safe Payments (def.) Safe payments are distributions that can be made to partners with assurance that the amounts distributed will not need to be returned to the partnership at some later date to cover known liabilities or realign partner capital. Assumptions: – All partners are personally insolvent – Noncash assets represent possible losses – Additional cash may be needed for liquidation expenses
  11. 11. 16-11 What Safe Payments Do /Don't Do • Safe payments schedules – Determine the amount of advance payment – Must be prepared for each cash distribution unless capital balances align with profit and loss ratios • Don't – Change the capital balances – Affect the statement of partnership liquidation – Help project timing of distributions
  12. 12. 16-12 Compute Safe Payments • Begin with partner capital adjusted for outstanding loans • Assume all noncash assets are losses – Distribute losses to partners • Plan for other loss contingencies – Distribute contingent losses to partners • Redistribute possible losses from partners – Adjust profit and loss ratio Safe payments are made after non-partner creditors have been paid.
  13. 13. © Pearson Education, Inc. publishing as Prentice Hall 16-13 Example of Safe Payments BMN Partnership has the following balances: Procedure: • Net out partner loans/capital • Assume noncash assets are losses • Allow for other losses, assume $10 • Redistribute potential partner losses Cash $80 Loan payable to Nancy $20 Loan from Maxine 10 Buzz Capital (50%) 50 Land 20 Maxine Capital (30%) 70 Building, net 140 Nancy Capital (20%) 110 $250 $250
  14. 14. 16-14 Safe Payment Calculations Safe payments: Partner amounts are zero or positive. Possible losses Buzz (50%) Maxine (30%) Nancy (20%) Equity (net of loans) $50 $60 $130 Assumed losses: Loss on assets ($160) (80) (48) (32) Other losses (10) (5) (3) (2) Subtotal ($35) $9 $96 Assume Buzz loss New ratio 3:2 35 (21) (14) Subtotal $0 ($12) $82 Assume Maxine loss 12 (12) Safe Payments $0 $0 $70
  15. 15. 16-15 4: Installment Liquidations Partnership Liquidation
  16. 16. 16-16 Installment Liquidations • Involve distributions of cash to partners – As it is available – Before all gains and losses are realized • Orderly liquidation of solvent partnership – Liabilities, other than those to partners, are paid first – Then, partners can receive distributions • Prepare a safe payment schedule for each distribution
  17. 17. 16-17 Frequent Reports • A Statement of Partnership Liquidation is prepared showing – Sale of noncash assets, distributions of P/L – Payment of creditors – Distributions to partners • Safe Payment Schedule is prepared – Before distributions to partners • An updated Statement of Partnership Liquidation is prepared • New Safe Payment Schedule …
  18. 18. 16-18 Liquidation Statement, Jan. 31 Kemp's total investment is $360
  19. 19. 16-19 Duro, Kemp and Roth At Jan. 31, there is $640 in cash. – Liabilities still due are $500 – Can we give the $140 to the partners, and if so, to whom? The safe payment schedule answers this. – Assume the remaining noncash assets are losses and allow for an extra $20 loss
  20. 20. 16-20 Safe Payment Schedule, Jan. 31 Kemp can receive safe payments up to $120. Duro and Ross must agree.
  21. 21. © Pearson Education, Inc. publishing as Prentice Hall 16-21 Updating the Liquidation Statement
  22. 22. 16-22 January Distributions The liquidation schedule shows that – The creditors were paid their $500 – Kemp was paid $20 on the loan and $100 of capital (Maximum safe payment) Cash of $20 remained in the partnership
  23. 23. 16-23 Lump-sum vs Installment Lump-Sum Installment 1. All of the non-cash assets are converted to cash 1. Some of the non-cash assets are converted to cash 2. The total gain or loss on the sale is allocated to the partners’ capital balances base on their P&L ratios 2. The carrying amount of any unsold non-cash assets is considered a loss. This is allocated based on their P&L ratios 3. Actual liquidation expenses are allocated to the partners’ based on their P&L ratios 3. Actual and estimated future liquidation expenses are allocated to the partners’ based on their P&L ratios 4. The Liabilities to outside creditors are fully settled 4. The Liabilities to outside creditors are partially or fully settled 5. The liabilities to inside creditors are fully settled 5. The liabilities to inside creditors are partially or fully settled but only after full settlement of liabilities to outside creditors. 6. Any remaining cash is distributed to the owners in full settlement of their interest 6. If both the liabilities to outside and inside creditors are fully settled, any remaining cash less cash set aside for future liquidation expenses is distributed to the owners as partial settlement of their interests.
  24. 24. 16-24 5: Cash Distribution Plans Partnership Liquidation
  25. 25. 16-25 Cash Distribution Plan • a.k.a. Cash Pre-distribution Plan 1. Rank the partners • Vulnerability to partnership losses • Most vulnerable to least 2. Prepare a schedule of assumed loss absorption • Assume most vulnerable partner's equity loss first, then next, … 3. Prepare a cash distribution plan 4. Then, a cash distribution schedule
  26. 26. 16-26 1. Vulnerability Ranking • Partners are ranked according to loss absorption potential Loss absorption potential = Partner equity / loss ratio Duro, Kemp and Roth have $340, $360 and $160 equity with profit-loss ratios of 50%, 30%, and 20% Duro: 340/.5 = $680 Kemp: 360/.3 = $1,200 Roth: 160/.2 = $800 Duro is most vulnerable, Kemp is least.
  27. 27. 16-27 2. Assume Loss Absorption Assume partnership losses sufficient to wipe out Duro first, then additional losses to eliminate Roth. $680 is from Kemp's vulnerability ranking $60 = (800–680) x (30%+20%) additional loss for Roth. Duro Kemp Roth Total* Equity (net of loans) $340 $360 $160 $860 Assumed losses: (680) Share 5:3:2 (340) (204) (136) Subtotal $0 $156 $24 Assume additional losses: New ratio 3:2 (36) (24) (60) Subtotal $0 $120 $0 $120
  28. 28. 16-28 3. Cash Distribution Plan If the $500 liabilities have not yet been paid, and two cash distributions are planned for $550 and $250, a cash distribution schedule is prepared.
  29. 29. 16-29 4. Cash Distribution Schedule
  30. 30. 16-30 6: Insolvency Partnership Liquidation
  31. 31. 16-31 Insolvent Partnership After all noncash assets are converted to cash • Cash is insufficient to pay all creditors Creditor options • Accept only partial payment • Look to partners for personal resources – May go to most solvent partners – Requires partners to • Pay own share of unsatisfied liabilities • Pay proportionate share for partners who can't or don't
  32. 32. 16-32 Case Study Partnership Liquidation
  33. 33. 16-33 Case No. 1: Installment Liquidation Asset Liabilities and Equity Cash 20,000 AP 30,000 AR 60,000 Payable to B 20,000 Inventory 120,000 A, Capital(20%) 100,000 Equipment 300,000 B, Capital(30%) 150,000 C, Capital(50%) 200,000 Total 500,000 Total 500,000
  34. 34. 16-34 Case No. 1: Installment Liquidation Assuming that the partnership will be liquidated over a prolonged period of time. Distributions to the partners will be made as cash becomes available. Information on the conversion of non-cash assets is as follows: a. 75% of the AR was collected for only 30,000 b. Half of the inventory was sold for 40,000 c. Equipment with carrying amount of 200,000 was sold for 120,000 d. Actual liquidation expenses of 2,000 were paid e. Estimated future liquidation expenses totaled 1,000 f. 9,000 cash was retained in the business for professional unrecorded liabilities and anticipated expenses Requirement: Determine the amounts of cash distributed to the partners from the partial realization of partnership assets.
  35. 35. 16-35 Case No. 2: Installment Liquidation On January 1, 20x1, partners A and B, who share profits and losses on a 3:1 ratio, decided to liquidate their business. As of this date, the following information has bee determined: In the first month of liquidation, 180,000 were received on the sale of some assets, liquidation expenses of 5,000 were paid, and additional liquidation expenses of 2,000 were anticipated before the liquidation is completed. Creditors were paid 28,000. Available cash was distributed to the partners. Requirement: Determine the amounts of cash distributed to the partners Cash Other Assets Liabilities A, Capital B, Capital 20,000 480,000 50,000 250,000 200,000

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