Partnership Dissolution. Chapter 14: Partnership Ownership Changes & Liquidations. Dissolution is a legal termination UPA 31 & 32:

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1 1 Partnership Ownership Changes & Liquidations - Heading 2 Partnership Dissolution - Heading Chapter 14: Partnership Ownership Changes & Liquidations Partnership Dissolution 3 Partnership Dissolution - #1 4 Partnership Dissolution - #2 Dissolution is a legal termination UPA 31 & 32: admission or withdrawal of Pr results in Pp dissolution When act of dissolution occurs, Prs may continue business as new Pp or liquidate Remember dissolution is not liquidation Dissolution Pp legally ends Liquidation - winding up of the Pp s business affairs 1

2 5 Admission of Partner - Heading 6 Admission of Partner - #3 Admission of Partner Assume new GP gives money/property directly to existing Pp New GP is promised a % of Pp capital When: promised share of capital = capital contribution Then no problem E.g., Assume New Pr contributes $10K and is promised share of Pp capital = $10K: D. Contribution (e,g, ) $10,000 C. New Partner, $10,000 7 Admission of Partner - #4 8 Admission of Partner - #5 When incoming Pr contributes property worth more than new Pr s share of Pp s capital 2 possible reasons: Pp s net assets worth more than their BVs; or Pp is worth more than sum of its net assets (GW) When an incoming Pr contributes property worth less than share of Pp s capital One of two reasons: Pp s net assets are worth less than their BVs; or Incoming Pr is contributing more than the FMV of contributed net assets (GW) 2

3 9 Admission of Partner - #6 10 Admission of Partner - #6 When FMV of new Pr s contribution new Pr s share of Pp capital Pp can use on of two following methods: the Bonus method; or the GW method These methods are mutually exclusive GW Method: Write up all Pp assets to FMV & recognize any Pp GW Then record assets being contributed by incoming Pr at FMV & recognize any GW being contributed by incoming Pr Give incoming Pr capital equal to this contribution 11 Admission of Partner - #6 12 Bonus Method - Heading Bonus Method Record assets being contributed by incoming Pr at FMV (no GW) Give incoming Pr capital equal to amount of Pp capital promised (e.g., 10% of Pp capital accts (BV)) If amt contributed Promised cap acct bal for Incoming Pr Make it balance by taking/giving difference to existing Prs Allocate between existing Prs using ratio they share gains/losses This amount is called a bonus bonus is only recognition of increased value of Pp assets or GW Bonus Method 3

4 13 Bonus Method - #1 14 Bonus Method - #2 Under Bonus Method: 1 st if any Pp assets have declined in value write BV down to FMV If assets went up & down - recognize only the decreases Give loss to old Prs Allocate loss using ratio old Prs share losses E.g., Assume that FMV of Pp asset is $10K less than BV & Pp has 2 equal Prs (A&B). Before admitting C, write down asset: D. A, $5,000 B, 5,000 C. Asset $10,000 2 nd Value new Pr s contribution at FMV No GW 3 rd Add contributed property to Pp books at FMV 4 th Give incoming Pr his/her share of Pp capital Old Prs get remaining Pp capital 5 th Give existing Prs gain/loss to get the journal entry to balance 15 Bonus Method - #3 E.g., Assume: Pp capital equal to $40K before addition of new Pr, C Pp uses Bonus Method. New Pr, C, contributes $10K to Pp for 20% interest in Pp capital New Pp capital accts should total $50K ($10K (new) + $40K(old)) C is entitled to 20% of Pp capital [($40K + $10K) x 20% = $10K] D. Net Assets $10,000 C. C, $10, Bonus Method - #4 E.g., Assume: Pp capital equal to $75,000 before addition of new Pr, C Pp uses Bonus Method C contributes $10K to Pp for 20% interest in Pp capital New Pp capital accts should total $85K ($10K(new) + $75K(old)) contribution C is entitled to 20% of Pp capital [($75K + $10K) x 20% = $17K] D. Net Assets $10,000 A, 3,500 B, 3,500 C. C, $17,000 4

5 17 Bonus Method - #5 E.g., Assume: Pp capital equal to $75K before addition of new Pr, C Pp uses Bonus Method. C contributes $27K to Pp for 20% interest in Pp capital New Pp capital accts should total $102K ($27K(new) + $75K(old)) contribution C is entitled to 20% of Pp capital [($75K + $27K) x 20% = $20,400] 18 Goodwill Method - Heading Goodwill Method D. Net Assets $27,000 C. A, $3,300 B, 3,300 C, 20, Goodwill Method - #1 GW Method relies on following: Remember Pp dissolves on admission of new Prs Legally, on dissolution of Pp all Prs get their share of Pp assets & contribute them to a new Pp GAAP says contributed property is valued at FMV Thus, all Pp assets should be valued at FMV because all Pp assets are contributed to a new Pp GW Method: 1 st Write all of Pp s net assets (old & new) to FMV & recognize any GW 2 nd Give gain/loss to old Prs 3 rd Admit new Pr giving capital acct = to FMV of contribution (including GW) 20 Goodwill Method - #2 E.g., Assume (GW is with Old Pp) Pp capital equal to $75K before addition of new Pr, C Old Prs, A&B share profits 50%/50% Pp uses GW Method C contributes $27K to Pp for 20% interest in Pp capital C contribution suggests New Pp capital should be $135K: 20% (New Pp capital) = $27K New Pp capital = ($27K/.2) = $135K New Pp capital accts should total $135K Pp has GW of $33K $27K(new) + $75K(old) + $33K(GW) = $135K 5

6 21 Goodwill Method - #3 Give GW to old Prs in % they share profits: D. Goodwill $33,000 C. A, $16,500 B, 16,500 Admit C to the Pp: D. Net Assets $27,000 C. C, $27, Goodwill Method - #4 E.g., Assume: (GW is with New GP) Pp capital equal to $75K before addition of new Pr, C Use GW Method C contributes $10K to Pp for 20% interest in Pp capital Assume C contributes GW as well Before: C s Contribution = 20%(New Pp ) C s Contribution/.2 = New Pp $27K/.2 = New Pp = $135K = ($75K + $27K + GW) Now: C s Contribution = 20%(New Pp ) $10K + GW =.2 ($75K + $10K + GW) (C s contributed GW is in both new Pp cap & contribution) $10K + GW =.2($85K) +.2GW GW -.2GW = $17K - $10K.8GW = $7K GW = $7K/.8 = $8, Goodwill Method - #5 24 Goodwill Method - #6 Admit new Pr & recognize GW of $8,750: D. Net Assets $10,000 Goodwill 8,750 C. C, $18,750 People feel uncomfortable with GW Method Pp is writing-up its existing assets and creating GW Not verified by arm s-length transaction like purchase Procedure violates concept of Historical Cost Others argue that admission of new Pr is arm slength transaction Bonus Method is more popular 6

7 25 Transferring Partnership Interests - Heading 26 Transferring Partnership Interests - #1 Transferring Partnership Interests Now let the new Pr buy Pp interest from existing Pr Pp receives nothing Two approaches: 1 st Just transfer capital from old Pr to new Pr Don t change Pp assets Pp is not involved in the transaction Popular method 2 nd Write Up/Down net assets/recognize GW then transfer capital Use purchase price of Pp interest to calculate FMV of Pp Less used method 27 Transferring Partnership Interests - #2 E.g., Assume: Pp has BV/ Accts of $30K A s Acct balance is $15K (50%) C buys A s interest in Pp for $50,000 With 1 st method, Pp transfers A s capital acct balance to C: 28 Transferring Partnership Interests - #3 With 2 nd approach determine FMV suggested by $50K payment to A FMV of the Pp s net assets is $100,000 ($50,000/50%) D. A, $15,000 C. C, $15,000 7

8 29 Transferring Partnership Interests - #4 30 Transferring Partnership Interests - #5 Assuming that increase in value comes from appreciation in Pp net assets (or GW), the Pp would recognize the appreciation or GW Gain from appreciation/gw goes to old Prs A s capital acct has increased from $15K to $50K The Pp then transfers A s capital acct to C: D. Net Assets/GW $70,000 C. A, $35,000 B, 35,000 D. A, $50,000 C. C, $50, Withdrawal of Partner - Heading 32 Withdrawal of Partner - #1 Withdrawal of Partner When a Pr retires (withdraws) Pr sells his/her Pp interest to the Pp Pp can use either Bonus Method or GW Method As was true above, the Bonus Method is the more popular method 8

9 33 Withdrawal of Partner - #2 With Bonus method Eliminate exiting Pr s capital acct Reduce Give gain/loss to remaining Prs With GW method Use retirement payment to calculate FMV of Pp assets Can either: Write up/down exiting Pr s share of net assets/fw Write up/down all net assets/goodwill 34 Withdrawal of Partner - #3 E.g., Assume: A retires from Pp with cash payment of $36K A s capital acct balance is $30K The Pp allocates profits: 4:4:2 to A, B & C Remaining Prs absorb loss of capital with Bonus method using % they share losses B:C 2/3 vs 1/3 D. A, $30,000 B, 4,000 C, 2,000 C. $36, Withdrawal of Partner - #4 Using the GW Method: $6K payment in excess of A s capital acct balance suggests that that the Pp GW exists in the amount of $15K ($6K/40%) Use Profit % not capital because GW increase is shared the way profits are shared 2 different approaches exist under the GW Method. 1 st approach record only the GW that belongs to A ($6K) 2 nd approach records the GW for the entire Pp ($15K) 36 Withdrawal of Partner - #5 With 1 st GW approach, Pp recognizes the GW associated with A s interest: D. Goodwill $6,000 C. A, $6,000 9

10 37 Withdrawal of Partner - #6 38 Withdrawal of Partner - #7 A s capital acct has increased from $30K to $36K Pp then records the liquidation of A s interest: With the 2 nd GW approach, Pp would record the GW for the entire Pp Allocate GW using profit % E.g., 40%-40%-20%: D. A, $36,000 C. $36,000 D. Goodwill $15,000 C. A, $6,000 B, 6,000 C, 3, Withdrawal of Partner - #8 40 Partnership Liquidations - Heading A s capital acct has increased from $30K to $36K Pp then records the liquidation of A s interest: Creditor Priorities (Marshalling of Assets) D. A, $36,000 C. $36,000 10

11 41 Partnership Liquidations - #4 42 Partnership Liquidations - #4 A Pr s personal creditors can seize any & all of the Pr s personal assets With respect to Pp assets, personal creditors can only step into the shoes of the Pr & take what the Pr is entitled to Personal creditors get a share of Pp assets after all Pp creditors are paid A Pp s creditors can seize any & all of the Pp s assets With Unlimited Liability Pp creditors can also seize any Pr s personal assets 43 Partnership Liquidations - #4 Because: Personal creditors can only seize personal assets Partnership creditors can seize both Pp and personal assets Doesn t seem fair to personal creditors Have to share personal assets Pp creditor don t have to share Pp assets The law says if there is not enough personal assets to satisfy both personal & Pp creditors personal assets are 1 st used to pay Pr personal creditors Personal assets can be paid to Pp creditors only after personal creditors are paid 44 Partnership Liquidations - #5 E.g., Assume: Pp has assets of $23K and liabilities of $25K A has capital acct balance of $500 & B has negative capital acct balance of -$2,500 Pp creditors go after A for $2K Pp debt B only has $1K available to pay Pp creditors Assets Liabilities A, B, Beg. Bal. $23,000 $25,000 $500 -$2,500 Pay Liabilities -23,000-23,000 $0 $2,000 $500 -$2,500 A Pays Pp Liabilities -$2,000 $2,000 $0 $0 $2,500 -$2,500 11

12 45 Partnership Liquidations - #6 Assets Liabilities A, B, $0 $0 $2,500 -$2,500 B only has $1K Given to Pp $1,000 $1,000 $1,000 $2,500 -$1,500 A Withdraws -$1,000 -$1,000 $1,500 -$1,500 A loses $1, Partnership Liquidations - #7 E.g., Assume: Pp has assets of $20K and liabilities of $25K A s capital acct has a deficit of $7K & B has capital acct balance of $2K Pp creditors go after A for Pp debt A only has $3K available to pay Pp creditors B is insolvent Assets Liabilities A, B, Beg. Bal. $20,000 $25,000 -$7,000 $2,000 Pay Liabilities -20,000-20,000 $0 $5,000 -$7,000 $2,000 A Pays Pp Liabilities -$3,000 $3,000 $0 $2,000 -$4,000 $2, Partnership Liquidations - Heading 48 Partnership Liquidations - #1 Partnership Liquidations UPA establishes following priorities for creditors & Prs for getting Pp assets when Pp liquidates: 1 st Pay creditors other than Prs 2 nd Pay Prs for loans 3 rd Pay Prs for capital 4 th Pay Prs for profits 12

13 49 Partnership Liquidations - #3 50 Partnership Liquidations - #2 But: UPA 40 requires Pr to restore deficit in Pr s capital acct & Pp have Right of Offset Pp can say Pr owes us $2 & Pp owes Pr $3 So, Pp will only pay Pr $1 Rt of offset means Pp can hold back amounts owed on loan until Pp is sure that Pr doesn t owe Pp anything because of a capital acct deficit So, Pp really makes payments in following order: 1 st Pp pays creditors other than Prs 2 nd Sell assets & pay expenses Allocate gains/losses from sales & expenses to Prs capital accts 3 rd Use cash to pay Prs their capital acct balances & pay loans to Prs 51 Lump Sum Liquidations - Heading 52 Lump Sum Liquidations - #1 Lump Sum Liquidations Make a chart giving the Pp BS across the top For each row record Pp s payment of a liability Pp s payment of an expense Pp s sale of an asset For each row also allocate & record Any Pp loss/gain to Prs When all assets, exp, liabilities handled give Prs their cap acct bal/loan balances 13

14 53 Lump Sum Liquidations - #2 54 Lump Sum Liquidations - #3 Assume that Prs share profits/losses:a(40%), B(40%) & C(20%) Non- Assets Liabilities Loan from A A, B, C, Beg.Bal $10000 $ $80000 $9000 $25000 $10000 $6000 Feb 15 sale March 2 sale Pay Liq. Exp. March 7 sale $98000 $0 $80000 $9000 $ $2800 -$400 Pay Liab. B Covers Deficit Non- Assets Liabilities Loan from A A, B, C, $98000 $0 $80000 $9000 $ $2800 -$ $18000 $0 $0 $9000 $ $2800 -$ $20800 $0 $0 $9000 $12200 $0 -$ Lump Sum Liquidations - #4 56 Lump Sum Liquidations - #5 B & C don t have any more $ Recog. Loss on C s Deficit Non- Assets Liabilities Loan from A A, B, C, $20800 $0 $0 $9000 $12200 $0 -$400 -$200 -$200 $400 Pay Loan and Balance to A Non- Assets Liabilities Loan from A A, B, C, $20800 $0 $0 $9000 $11800 $0 $ Recog. Loss on B s Deficit -$200 $200 $20800 $0 $0 $9000 $11800 $0 $0 $0 $0 $0 $0 $0 $0 $0 14

15 57 Schedule of Safe Payments - Heading 58 Schedule of Safe Payments - #1 Schedule of Safe Payments Prs don t want to wait until after Pp liquidated to get cash Prs ask, Can t Pp put $ aside for Pp debts/expenses & given us something now? A Schedule of Safe Payments calculates: How much cash Pp can pay to the Prs at any given time during the liquidation & still be sure that Pp has all the cash it needs for Pp debts/expenses 59 Partnership Liquidations - #4 60 Schedule of Safe Payments - #2 Schedule of Safe Payments assumes that: Non-cash assets are worthless Assumes total loss on asset Prs cannot make up deficits in their cap acct These assumptions basically say Pp only has cash on hand After making these assumptions, if Pp has cash left over after paying Pp creditors Pp can distribute cash to Prs according to their capital acct balances A new Schedule of Safe Payments is prepared with each Pp distribution Non- Assets Liab. Loan from A A, B, C, Beg.Bal $10000 $ $30000 $5000 $25000 $55000 $15000 Feb 15 sale Pay Liab $50000 $60000 $30000 $5000 $17000 $47000 $ Bal. $20000 $60000 $0 $5000 $17000 $47000 $

16 61 Schedule of Safe Payments - #3 62 Schedule of Safe Payments - #3 Schedule of Safe Payments February 17 A B C Total & Loan Balances Before Distribution $22000 $47000 $11000 $80000 Estimated Liquidation Exp $10000 Balances $18000 $43000 $9000 $70000 Maximum Loss Possible ($60,000) -24, $6000 $ $3000 $10000 Allocation of Debit Balances $3000 Safe Payment $10000 $10000 Bal. Feb 17 Feb. 17 distrib. March 2 sale Pay Liq. Exp. Non- Assets Liabilities Loan from A A, B, C, $20000 $60000 $0 $5000 $17000 $47000 $ $10000 $60000 $0 $5000 $17000 $37000 $ $17000 $30000 $0 $5000 $7800 $27800 $ Schedule of Safe Payments - #4 64 Schedule of Safe Payments - #5 Schedule of Safe Payments March 5 Combined and Loan Balances Before Distribution A B C Total $12800 $27800 $6400 $47000 Maximum Loss Possible ($30,000) -12, Safe Payment $800 $15800 $400 $17000 Non- Assets Liab. Loan from A A, B, C, Bal. March 5 $17000 $30000 $0 $5000 $7800 $27800 $6400 March 5 Distribution March 17 sale $ $0 $30000 $0 $4200 $7800 $12000 $ $20000 $20000 $0 $4200 $11800 $16000 $

17 65 Schedule of Safe Payments - #6 66 Schedule of Safe Payments - #7 Combined and Loan Balances Before Distribution Schedule of Safe Payments March 18 A B C Total $16000 $16000 $8000 $40000 Maximum Loss Possible -8, ($20,000) Safe Payment $8000 $8000 $4000 $20000 Bal. March 18 March 18 Distrib. April 1 sale Final Distrib. Non- Assets Liab. Loan from A A, B, C, $20000 $20000 $0 $4200 $11800 $16000 $ $4200 -$3800 -$8000 -$4000 $0 $20000 $0 $0 $8000 $8000 $ $24000 $0 $0 $0 $9600 $9600 $ $0 $0 $0 $0 $0 $0 $0 67 Predistribution Plan - Heading 68 Predistribution Plan - #1 Predistribution Plan Instead of preparing Schedule of Safe Payments with each distribution At the beginning of liquidation process, Pp can create a Predistribution Plan that sets forth the amounts and order in which Prs get money Pr loans treated like capital 17

18 69 Predistribution Plan - #1 What you may have noticed in prior e.g. is that B got cash before the other Prs Why? B had disproportionately more capital than his/her % in Pp profits/losses justified When other Prs were allocated their share of Pp losses, their capital was eliminated BUT B still had capital The early cash payments to B wiped out the disproportionate nature of B s capital Once disproportionate nature of Pp capital accts eliminated Then Prs received cash equal to their % in Pp profits/losses 70 Predistribution Plan - #5 A B C Profit & Loss Percentage 40% 40% 20% February 17 th Distribution $10,000 March 5 th Distribution $800 $15,800 $400 March 17 th Distribution $8,000 $8,000 $4,000 Final Distribution $9,600 $9,600 $4, Predistribution Plan - #2 72 Predistribution Plan - #3 A Predistribution Plan recognizes that a Pr who will still have a pos cap acct when other Prs are wiped out will receive distributions 1 st Pp needs to calculate the amount of Pp losses that will wipe out each partner This is total Pp loss from which a Pr will be allocated a share Called Maximum Loss Absorbable (MLA): Pr s Balance Pr s Profit & Loss % MLA give point when each Pr s capital account balance will be wiped out E.g.,: Pr gets 50% of profits/losses & has $40K capital account balance If Pp has $80K in losses, Pr gets 50% ($40K) Pr can absorb $80K in Pp losses before Pr is wiped out MLA = $40K/.5 = $80K 18

19 73 Predistribution Plan - #4 74 Predistribution Plan - #5 Balances Prs with lower MLA will be wiped out while Prs with large MLA will still have pos cap acct bals & be entitled to distribution This creates the priority of Pp liquidation payments A B C 1 Profit & Loss Percentage 30% 50% 20% & Loan Balances $33000 $45000 $14000 Allocate Liquidation Expenses 2 Balances $30000 $40000 $12000 Maximum Loss Absorbable(2/1) $ $80000 $60000 At $80,000 of Pp losses B & C will be wiped out A will get $24,000 of losses (.3 x $80,000) and have a remaining capital account balance of $6,000 ($30K-$24K). So, Before B& C get a dime A will get the first $6, Predistribution Plan - #5 Balances 76 Predistribution Plan - #8 A B C 1 Profit & Loss Percentage 30% 50% 20% 2 New Balances $24000 $40000 $12000 Maximum Loss Absorbable(2/1) $80000 $80000 $60000 At $60,000 of Pp losses C will be wiped out After A s share of the $60K loss ($60 x.3 = $18K) A will have $6K of capital left ($24K - $18K) After B s share of the $60K loss ($60 x.5 = $30K) B will have $10K of capital left ($40K - $30K) So, Before C gets a dime A will get $6,000 more & B will get $10,000 Thereafter, A, B & C share cash 30%,50% & 20% The following Pre-distribution Plan results from the foregoing calculations: Level Amount Payable To 1 $20,000 To Creditor For Liabilities 2 $10,000 To Professionals For Liquidation Expenses 3 $6,000 To A 4 $16,000 To A [37.5% (6/16)] & B [62.5% (10/16)] 5 Remaining Payments To A (30%), B (50%) & C (20%) 19