Chapter Fifteen

Partnerships:
Termination and
Liquidation

McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Reasons for Termination

Termination of business activities followed by

liquidation of partnership property occurs for a
variety of reasons:
Personality disputes between partners
Retirement
Death
Changed business environment
Other opportunities
Low profits
Bankruptcy (either the business or a partner)

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LO 1
Termination & Liquidation

When the partners wish to terminate

the business:
Convert all assets to cash.
Allocate all gains or losses to the
partner capital balances.
Pay all liabilities and expenses.
Distribute remaining cash to
partners.

15-3
LO 2 Termination & Liquidation -
Example
According to their agreement, Morgan & Houseman
divide profits 6:4 respectively. On 6/1, the inventory
is sold for $15,000.
Note that the loss on the sale of inventory of
$7,000 is assigned $4,200 ($7,000 x 60%) Morgan
and $2,800 ($7,000 x 40%) to Houseman.

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LO 3
Deficit Capital Balance

Deficit balances can be resolved two ways:

The deficit partner can make a
contribution to make up the deficit.
The remaining partners can absorb the
deficit.
(The deficit partner may pay later or
can be sued for the deficit amount.)

15-5
 Deficit Capital Balance --
Contribution by Deficit Partner
Contributions made by the deficit
partner(s) are distributed to the non-
deficit partners based on their relative
profit sharing percentages.
Any payments
by Holland
will be split 2/3
to Dozier and
1/3 to
Ross.
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 Deficit Capital Balance -
Remaining Partners Absorb Deficit

Capital balances after distribution of Hollands loss:

15-7
LO 4
Preliminary Distribution of Assets

Under the Uniform Partnership Act, a priority

ranking of creditors having claims against
individual partners is recognized:

Debts owed to
partnership Debts owed to
creditors. the other
partners.
Debts owed to
personal
creditors.
15-8
LO 5
Predistribution Plan

Used by accountants to guide the distribution of cash

resulting from the liquidation process.
Examine the Balance Sheet below. Assume the income
sharing % is Rubens 50%, Smith 20%, and Trice 30%.

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 Predistribution Plan

First, determine the maximum loss that each

partner can absorb. Divide each partners
capital balance by their respective income
sharing %.

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 Predistribution Plan

Since Rubens can ONLY absorb a

partnership loss of $60,000, new balances are
computed assuming that the partnership has
a $60,000 loss.
15-11
 Predistribution Plan

With Rubens wiped out, continue calculating

maximum absorbable losses using income
sharing percentages of Smith, 20% (2/5) and
Trice 30% (3/5).
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 Predistribution Plan

As earlier, compute the maximum absorbable

loss by dividing the capital balances by the
relative income sharing %.

15-13
 Predistribution Plan

Trice can only absorb a loss of $55,000.

Now determine new capital balances for a loss
of $55,000.

15-14
 Predistribution Plan

With Rubens and Trice both wiped out, and

Smith left as the only remaining partner, the
predistribution plan can be prepared.
15-15
 Predistribution Plan
To inform all parties of the pattern by which
available cash will be disbursed, the predistribution
plan should be formally prepared in a schedule
format prior to beginning liquidation.

15-16