Partnership Dissolution. Alex Sokratous Economics Department

Transcription

1 Partnership Dissolution Alex Sokratous Economics Department 1

2 Introduction A partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business. The assets of the partnership will be realized to pay off the liabilities. The sales proceeds should be applied in the following order, as required by the Hong Kong Ordinance: Pay off creditors first, then the partners advances, and Finally the partners capital 2

3 Realization Account In the partnership dissolution, an account named as Realization Account will be opened to compute the profit or loss from realization which should be shared among the partners according to the profit or loss sharing ratio 3

4 Nature of partnership dissolution Dissolution where the assets are sold separately Dissolution where partnership is sold as a whole 4

5 Dissolution where Assets are sold separately 5

6 Procedures of Dissolution 1. All assets will be sold to other persons or taken over by partners 2. Settle the liabilities of the partnership to outsider or partners 3. Transfer any profit or loss on realization to each partner s capital accounts in profit/loss sharing ratio 4. Merge the balances in the partners current accounts to their capital accounts 6

7 5. Any credit balance in each partner s capital account represents the amount which can be withdrawn from the partnership to each partner; any debit balance in a partner s capital account represents additional cash to be injected by that partners 7

8 Transactions Close all asset accounts with net book value to the realization account (except cash and bank because these assets need not be disposed of) Cost of dissolution or any losses or expenses incurred on realization Proceeds from the disposal of assets Assets taken over by a partner without payment Accounting entries Dr Realization Cr Assets Dr Realization Cr Bank Dr Bank Cr Realization Dr Capital Cr Realization 8

9 Transactions Asset taken over by partners as a gift Creditors taken over by a partner Accounting entries No entries required Dr Creditors Cr Capitals Payment to creditors with discounts received Profit or loss on realization to be shared among the partners according to the profit-sharing ratio Dr Creditors Cr Realization discount Cr Bank Dr Realization profit Cr Capitals or Dr Capital Cr Realization - loss 9

10 Transactions Repayment of loan to an partner Repayment of loan to an outsider ( creditors) Accounting entries Dr Loan from partner Cr Bank Dr Loan from outsider Cr Bank Transfer any balances in partners current accounts Repayment of remaining capital to partners Dr Current (for credit balance) Cr Capitals Or Dr Capital Cr Current (for debit balance) Dr Capital Cr Bank 10

11 Example 1 11

12 John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Premises Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Bank Less: Current Liabilities Creditors Working Capital

13 Capital: John Peter Tom Current: John Peter (10000) Tom Long term liabilities Loan from Tom Assets and liabilities were disposed of as follows: 1. The premises were sold at $ and legal charges from the sale amount to $ Tom took over the stock and motor vehicles at book value 3. Except for $2500, all debts were collected 4. The creditors were discharged for $ Realization expenses of $10000 were paid Required: Prepare the realization, Bank, Capital and Current account for the dissolution of partnership 13

14 Realization Premises Premises Bal b/f Prov. for depreciation Realization Premises Provision for depreciation Bal b/f

15 Realization Premises Motor Vehicles Motor Vehicles Bal b/f Prov. for depreciation 5500 Realization Motor Vehicles 5500 Provision for depreciation Bal b/f

16 Realization Premises Motor Vehicles Debtors Debtors Bal b/f Prov. for bad debts 1265 Realization Motor Vehicles 1265 Provision for Bad Debts Bal b/f

17 Realization Premises Motor Vehicles Debtors Stock Stock Bal b/f Realization

18 Realization Premises Bank premises ( ) Motor Vehicles Debtors ( ) Debtors Stock Creditors discount received 4000 Bank- realization expenses Loan from Tom Bank 7550 Bal b/f 7550 Bank Bal b/f Realization - expenses Realization premises Creditors debtors Loan from Tom 7550 Creditors Bank Realization discount received 4000 Bal b/f

19 Premises Motor Vehicles Debtors Stock Bank- realization expenses Realization Bank premises ( ) Debtors ( ) Creditors discount received 4000 Tom stock MV Gain on realization: John 1/ Peter 1/ Tom 3/ Capital John Peter Tom John Peter Tom Realization: Bal b/f Stock Gain on realizaiton MV

20 Capital John Peter Tom John Peter Tom Realization: Bal b/f Stock Gain on realizaiton MV Current Current Bank Current John Peter Tom John Peter Tom Bal b/f apital Bal b/f Capital Bank Bal b/f Realization - expenses Realization premises Creditors debtors Loan from Tom 7550 Capital: John Peter Tom

21 Dissolution where partnership is sold as a whole 21

22 Purchase consideration The purchase consideration is to be discharged by the limited company (buyer) to partners(seller) to take over the business Goodwill = Purchase consideration ( assets at take-over value liabilities at take-over value) 22

23 Transactions Accounting entries For dissolution of Old partnership (seller) Close all asset accounts with net book value to the realization account (Bank and cash may be taken over) Cost of dissolution or any losses or expenses incurred on realization Proceeds from sale of the business (purchase consideration) Dr Realization Cr Assets Dr Realization Cr Bank Dr Vendee (buyer) Cr Realization 23

24 Transactions Liabilities taken over by the buyer The purchase consideration settled by cheque, shares and debentures Repayment of remaining capital to partners Accounting entries Dr Liabilities Cr Realization Dr Bank/ Shares/ debentures in purchaser s company Cr Bank Dr capital Cr Bank/ shares/ debentures in purchaser s company 24

25 Transactions Accounting entries For opening entries of New Company (buyer) Assets taken over Liabilities taken over The purchase consideration offered The purchase consideration settled by cheques, shares and debentures Dr Assets Cr Business Purchase Dr Business Purchase Cr Liabilities Dr Business Purchase Cr Vendor (seller) Dr Vendor (seller) Cr Bank/Shares/Debentures 25

26 Example 2 26

27 John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Premises Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Bank Less: Current Liabilities Creditors Working Capital

28 Capital: John Peter Tom Current: John Peter (10000) Tom Long term liabilities Loan from Tom On 31 December 1996, they incorporated a limited company, Fortune limited, to take over the partnership business. Fortune Limited had an authorized capital of $ ordinary shares of $1 each. 28

29 Assets and liabilities were disposed of as follows: 1. John took over the stock at book value. Tom collected all the debts except $ The company took over the premises at a valuation of $200000, motor vehicles at $25000, cash at bank and all the liabilities. Goodwill was valued at $70000 for the purpose of the takeover 3. The purchase consideration was to be discharged by the issue to the partners of ordinary shares at $1.2 each, according to the profit-sharing ratio, and the balance was to be in cash 4. The company also issued ordinary shares at $1.2 for cash to outsiders Required: Prepare the realization, Capital and the opening balance sheet for the new company 29

30 Premises MV Stock Bank be taken over Debtors Bank Capital: John Peter Tom Realization Liabilities taken over by Ltd. Co. Creditors Loan from Tom 7550 Tom: debtors ( ) John: stock Fortune Ltd purchase consideration [( ) ] Purchase consideration=asset-liabilities +goodwill 30

31 Capital John Peter Tom John Peter Tom Current Realization Stock Debtors Shares in Fortune Ltd Bank (Bal. fig.) Bal b/f Current Realization -profit Shares in Fortune Ltd *1.2 = John 1/ Peter 1/ Tom 3/

32 Fortune Limited Balance sheet as at 1 Jan 1996 Fixed Assets Goodwill Premises MV Current Assets Bank [ (50000*1.2) ( )] Less: Current liabilities Creditors Working Capital (47450) Share Capital Ordinary Shares (150000*$ *$1) Share Premium (150000*$ *$0.2) Long-term liabilities Loan from Tom

33 Cash distribution among partners 33

34 Cash Distribution Among Partners With the application of the Garner vs. Murray rule When cash is to be distributed as soon as possible ( Piecemeal realization) 34

35 With the application of Garner vs. Murray rule 35

36 With the application of Garner vs. Murray rule Any CREDIT balance in each partner s capital account represents the amount which can be withdrawn from the partnership to each partner Any DEBIT balance in a partner s capital account represents additional cash to be injected by that partner. If he is insolvency to repay the amount, the solvency partners will be shared the amount in: Profit & loss sharing ratio Any agreed ratio given in the examination question GARNER vs. MURRAY rule may be applied 36

37 What is Garner vs. Murray rule? 37

38 Garner vs. Murray rule Under the rule, a partner is required to contribute cash to eliminate the debit balance in his capital account In the court case of Garner vs. Murray (1904), it was held that subject to any agreement to the contrary, such a debit balance deficiency was to be shared by the other partner not in their profit and loss sharing ratio but the ratio of their last agreed capitals 38

39 If one partner is insolvent, his capital deficiency will be shared by other partners according to the last agreed capital ratio (the ratio of the balances in the capital accounts before the dissolution, in the absence of any agreement to the contrary 39

40 Piecemeal Realization 40

41 Piecemeal realization Cash is distributed as it becomes available, instead of waiting for all the assets to be realized first Assets are sold piecemeal, and then outstanding debts are paid and the remaining cash is finally distributed to the partners as soon as possible This situation occurs because some assets can be sold quickly, and some assets take longer time to be sold (i.e. less liquid) 41

42 Assumed Loss/Notional Loss Method This is possible loss by assuming that the remaining assets do not have any scrap value Any unsold assets will be assumed loss in each distribution 42

43 Steps on Piecemeal Dissolution 1. Find out the maximum possible loss Maximum possible loss = NBV of assets to be realized - Total proceeds form disposal OR Maximum possible loss = Total capital balances - Total cash to be distributed to partners( i.e. cash available) 43

44 2. The maximum possible loss is shared by the partners according to the profitsharing ratio 3. Apply the Garner vs. Murray rule if there is any capital deficiency 4. Distribute any available cash to the partners according to their remaining capital balances 5. Repeat the process until all assets have been realized 44

45 Example 3 45

46 Au, Chow and Lee were partners sharing profits and losses in the ratio 2:2:1. The balance sheet as at 31 December 1996 was as follows: Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBV Goodwill Land Plant & Machinery Fixture & Fittings Motor Vehicles Current assets Stock Debtors Less: provision for bad debt Cash Less: Current Liabilities Creditors Bank Overdraft Working Capital

47 Capital: Au Chow Lee Current: Au Chow Long term liabilities Bank loan On 31 December 1996 the partners agreed to dissolve the partnership due to a disagreement between the partners. Assets were to be realized, outstanding debts to be paid and the remainder to be shared by the partners in an equitable manner. Distributions of cash were to be made as soon as possible. January Provision was made for dissolution expenses of $2400 Land was sold for $ The cash available was utilized to settle in full the bank overdraft, the bank overdraft, the bank loan and all creditors after receiving discounts 47

48 March Stock which had originally costed $40000 was sold for $32000 $15000 was received form debtors April Plant & Machinery were sold for $51000 after paying carriage of $2000 Fixtures and fittings were sold for $12000 May All the outstanding debtors, with the exception of a customer who owed $4000 settled their accounts Motor vehicles were sold for $25000 The remaining stock was sold for $22000 Dissolution expenses amounted to $2100 Prepare distribution statement of cash at each stage 48

49 Distribution Statement Total Au Chow Lee $ $ $ $ Capital accounts Current accounts st Distribution: Cash available (w1) Maximum possible loss (2:2:1) ( 47000) Lee s capital deficiency shared by Au (14600) And Chow in the last agreed capital ratio (120000:80000) (8760) (5840) Cash distributed nd Distribution: Capital balance Cash available ( ) (63000) Maximum possible loss (2:2:1) (2000) Lee s capital deficiency shared by Au And Chow in the last agreed capital ratio (120000:80000) (1200) (800) Cash distributed

50 3 rd Distribution: Capital balance Cash available (W2) (93300) Maximum possible loss (2:2:1) Cash distributed

51 W1 Cash available for 1st distribution: January Opening balance 160 Receipt from land Less: Payment Assumed dissolution expenses 2400 Settle in full means no more payment will be paid. => the difference between and is discount received (i.e. not actual expenses) Bank overdraft Bank loan Creditors (Bal. Fig.) => no cash distribution to partners on January March Receipts: Stock Debtors First cash distributed to partners Back 51

52 Notes: Very often no cash is distributed to partners at first or second month since outstanding debts must be repaid first and then the remaining cash can then be distributed to partners. Even though the questions have not mentioned to repay outstanding debts, you should make sure to keep some cash to prepare to repay debts and could not be distributed it to partners 52

53 W3 Cash available for 3rd distribution: May Receipts Surplus in dissolution expenses( ) 300 Collection remaining debtors balance ( ) Receipts from MV Receipts from remaining stock Back 53

54 Realization Goodwill Cash: Land Land Plant & Machinery Stock ( ) Fixtures & fittings Debtors ( ) Motor Vehicles 8000 Plant & machinery Stock Fixture & fittings Debtors Motor vehicles Cash - dissolution expenses 2100 Creditors discount rececived ( ) 7600 Capital: Au (2/5) Chow (2/5) Lee (1/5)

55 Capital Au Chow Lee Au Chow Lee Cash in March In April in May Realization -loss Bal b/f Current