----------------------- Page 1-----------------------

CHAPTER 14

UNDERSTANDING THE ISSUES

1. The fair value of the net assets reflects the apof the original partnership ($500,000 versus
preciation and/or depreciation in the value of
$400,000).
existing net assets and the value of net assets
3.
Several guidelines govern the process of liquinot presently recognized on the balance sheet
dating a partnership. First, all assets and liabiliof the existing partnership. The bonus method
ties of the partnership should be identified, and
is conservative in that it does not recognize the
the assets should be converted into a distributappreciation of existing assets or the value of
able form. Second, as assets become available
unrecognized assets. The underlying logic for
for distribution, the order of priority as estabthis position is based on several factors. First,
lished by the Uniform Partnership Act should be
the suggested appreciation is difficult to objecfollowed. A practical exception to this priority

tively measure if not all the respective assets

involves the doctrine of right of offset. Third,
value has been realized through an armsevery

attempt

should

be

made

to

secure

length transaction. For example, if you sell a

net personal assets from those partners that
20%

interest

in

partnership,

should

that

have deficit capital balances. Finally, of critical

20% transaction serve as the basis for suggestimportance is the guideline that distributions to
ing the value of a 100% interest in the partnerparties should not be premature. That is to say,
ship? Second, the bonus method adheres to
all distributions should be based on the conthe long-standing convention of historical cost.
servative assumptions that remaining assets
Therefore, any value suggested but not actually
are worthless and that all partners are persoreceived as consideration is not part of the
nally insolvent. This overly conservative posihistorical

cost

of

the

transaction.

Third,

tion will ensure that no partner receives a payunrealized appreciation were recognized and
ment

if

such values proved overstated, the resulting

before he/she is entitled to it. The use of scheaccounting for the loss in value might be inedules of safe payments is a practical way to
quitable for the partners. The bonus method
calculate appropriate and safe payments to
avoids this potential inequity by electing not to
partners.
recognize such appreciation.
4.
A partners maximum loss absorbable (MLA) is
2. The first step would be to determine the fair
determined by dividing the sum of loans payavalue of the net assets of the original partnerble to a partner plus his/her capital balance by
ship. This would include a valuation of existing
his/her respective interest in profits. The resultnet assets as well as the recognition that there
ing value suggests how much loss in the value
may be other net values that are not captured
of partnership assets could be experienced
on the financial statements. For example, there
before a partner developed a deficit capital balmay be a contingent liability or goodwill that
ance. Obviously, the larger the MLA the more

has not been recognized. Once the fair value

loss a partner could withstand and the stronger
of the net assets (e.g., $400,000) has been
he/she is. Therefore, in a liquidation available
determined, this amount would represent the
distributions will first be made to the strongest
percentage interest in the new partnership to
partner. As such distributions are made, the rebe retained by the original partners (e.g., 80%).
spective partners capital balance is reduced
Dividing the fair value by the percentage interand his/her MLA is reduced. When two or more
est retained results in a suggested value of
partners have equal MLAs, then they would
the new partnership entity ($400,000 divided
share (according to their P&L ratios) in any
by 80% = $500,000). The suggested value of
available distributions.
the acquired interest is the difference between
the

value

of

the

new

partnership

and

that

621
----------------------- Page 2-----------------------

Ch. 14Exercises

EXERCISES

EXERCISE 14-1

(1)
Inventory ...............................................................
..........................
58,000
Accounts Receivable ................................................
................
18,000
Warranty Obligations ...............................................
.................
10,000
Pearson, Capital ...................................................
....................
18,000
Murphy, Capital ....................................................
....................
12,000
To adjust book values to market values.

Cash ....................................................................
...........................
84,000
Goodwill ................................................................
..........................
56,000
Pearson, Capital ...................................................
....................
33,600
Murphy, Capital ....................................................
....................
22,400
Warner, Capital ....................................................
.....................
84,000
To record admission of Warner and recognition of goodwill.
If Warner contributes $84,000 for a 30% interest in capital,
this suggests a total new partnership value of $280,000.

(2) If the $56,000 of goodwill proved to be worthless, Warner would be charged

35% of $56,000, or
$19,600. However, the real harm to Warner would be that of having paid mo
re to enter the partnership than s/he should have. If the goodwill did not exist, then the ad
justed assets of the previous partners would have been $140,000 ($45,000 + $65,000 + $30,000), wh
ich represents 70%
of a total partnership value of $200,000. In that case, Warner would have
only paid $60,000 for a
30% interest in capital. Therefore, Warner would have paid an e
xtra $24,000 ($84,000 versus
$60,000) for the goodwill that proved to be worthless.

EXERCISE 14-2

June 20, 20X5

To:

My client

From:

Student, CPA

Re:

Issues involving goodwill and the liquidation of a partnership

With respect to the questions you had regarding the above referenced matter, ple
ase consider the following responses which correspond to your questions (1) through (7).

(1) It is correct that a corporation cannot record goodwill unless it has been
purchased through the acquisition of another company. However, in the case of a partnership, when
a new partner invests in

the partnership or the partnership acquires the interest of an existing p

artner the transaction may
be recorded under either the bonus method or the goodwill method. Under t
he goodwill method,
goodwill is recognized on the partnership financial statements in
order to reflect the economic
goodwill suggested by the consideration conveyed in the transaction.

622
----------------------- Page 3-----------------------

Ch. 14Exercises

Exercise 14-2, Concluded

(2) The goodwill method involves recording goodwill and/or the appreciation on n
et assets and results
in measuring net assets at amounts that are more in line with economic mar
ket value. However,
this typically results in an increase in assets as compared to the bonus m
ethod, which does not
adjust to market values. Therefore, the bonus method would be most appropr
iate in that it understates the asset values and results in a higher return on assets and partne
rship capital. Furthermore, income would typically be lower under the goodwill method
in that the depreciation and
amortization associated with revised asset values would be charged against
income.

(3) The capital of a partner is the last claim against assets to be satisfied gi
ven the liquidation of a partnership. Technically, the claims are satisfied in the following order: amo

unts owed to creditors other than partners, amounts owed to partners other than for capital and prof
its (such as partners
loans to the partnership), amounts owed to partners as capital, and amoun
ts owed to partners as
profits not currently closed to partners capital accounts. Generall
y speaking, amounts owed to
partners as profits will be closed to their capital accounts prior to liqu
idation.

(4) A net deficit of the partnership is satisfied under a doctrine known as marsh
aling of assets. Following this doctrine, the unsatisfied liabilities would attach to any one or
more partners that had net
personal assets. Obviously, the unsatisfied creditors would seek out those
partners that have the
greatest and most liquid net personal assets. Which partner unsatisfied cr
editors will seek out is in
no way controlled by which partner has the greatest positive capital balan
ce in the partnership.

(5) Given the above response, it would be better to have a corporation own the o
ffice building and thereby shelter it from being directly included in your personal assets. This
does not mean that the
stock you hold in the corporation is not ultimately a personal
asset, but the value of that stock
would first be reduced by any liabilities of the corporation as well as ot
her factors that may influence its value such as real estate values.

(6) Per the response to item (3) above, a loan to the partnership would have a h
igher priority in liquidation than a capital investment. However, loans typically have a rate of re
turn that is below the rate
of return that may be experienced on a capital investment. The answer to t
his question lies in the
expected rate of return on capital versus the rate of interest on the debt
. Debt generally is less

risky and therefore offers a lower return on investment. One should be cau
tioned against thinking
that invested capital always experiences a higher return than debt capital
.

(7) In theory, the sales price should not differ between what is offered by the
partnership and that offered by an individual partner. In that case, the key factor would be whic
h party has the greatest
ability to pay the sales price. If any portion of the sales price is to be
paid over time, the partnership
as an entity may have a greater ability to pay over that of an individual
partner. Receiving a lower
sales price in the form of cash up front may be more advisable than a pric
e paid over time which is
subject to default risk.

After you have had an opportunity to review this memo, I would be happy to discu
ss these issues with you at your
convenience. Please feel free to contact me.

623
----------------------- Page 4-----------------------

Ch. 14Exercises

EXERCISE 14-3

(1) Both methods recognize asset write-downs. The recognition of such write-d
owns would normally
be recognized even outside of the area of accounting for partnerships. Cur
rent examples of write-

downs relate to measuring inventory at lower of cost or market and recogni

zing the impairment of
value on long-lived assets. However, only the goodwill method allows write
-ups that would otherwise not be recognized by generally accepted accounting principles (GAAP).

(2) Under the bonus method, goodwill traceable to the original partnership is
accounted for by crediting the original partners capital balances. This credit, in substance, reco
gnizes that their equity in
the partnership is increased by virtue of the goodwill. However, these cre
dits do not reflect the entire amount of the goodwill due to the fact that the bonus method does not
allow for the write-up of
assets.

(3) If a new incoming partner contributes net assets, both tangible and intang
ible, it is possible that
his/her capital balance may be more than the value contributed. This would
occur under the bonus
method when intangibles, including goodwill, are traceable to the new inco
ming partner.

(4) Use of the goodwill method will always result in a greater amount of total
partnership capital due to
the recognition of write-ups. This would suggest that resulting interest o
n invested capital would also be higher under this method.

(5) A risk associated with the goodwill method is that the amortization and/or
write-off of goodwill may
occur using a profit/loss percentage that is different from an original pa
rtners interest in profits and
losses. For example, assume that goodwill traceable to the original partne
rs, A and B, was allocated among them 40% to A and 60% to B. If the goodwill is subsequently wr
itten off and As new

interest in profits and losses is different from 40%, the resulting capita
l balance will be different
than if the bonus method had originally been used. A similar result may oc
cur when a new partners interest in profits is different from his/her initial interest in capi
tal.

EXERCISE 14-4

(1) Acquiring an interest directly from the partnership would have several adv
antages for the partnership entity. First, the partnership would receive the consideration being
paid by the new partner
and would therefore have the use of this additional working capital. If th
e goodwill method were
used to record the admission of the new partner, the partnership could rec
ognize the suggested
appreciation on recorded assets and/or goodwill. This would increa
se the new partnerships net
assets and more accurately reflect the fair value of the partnership. Fina
lly, if the new partner acquired an interest directly from the partnership, Ross would continue to b
e a partner. This would
result in continuity of management and ownership, which in turn could prov
ide for more stability
within the partnership.

(2) If Lane had purchased Rosss interest directly from Ross, Lane would have ac
quired a one-third
interest in the capital of the partnership [$160,000 ($160,000 + $120,000
+ $200,000)]. This onethird interest would have cost Lane $210,000, which suggests that the fair
value of the previous
partnership was $630,000 ($210,000 1/3), of which $315,000 ($945,000 $630,
000) would have
been contributed directly to the partnership by Lane.

624

----------------------- Page 5-----------------------

Ch. 14Exercises

Exercise 14-4, C
oncluded

(3) Land......................................................................
..........................
30,000
Ross, Capital ....................................................
........................
1
0,000
Gilmore, Capital .................................................
.......................
1
0,000
Bates, Capital ...................................................
........................
1
0,000

Goodwill ................................................................
..........................
120,000
Ross, Capital ....................................................
........................
4
0,000
Gilmore, Capital .................................................
.......................
4
0,000
Bates, Capital ...................................................
........................
4
0,000

Cash ....................................................................
...........................
210,000
Lane, Capital ....................................................

........................
,000

210

EXERCISE
14-5

(1)
Partnership

Fair market value of original partnership:

$

Assets at book value .........................

500,000
$
600,000

800

,000
Liabilities at book value and fair
market value ...................................
(369,500)
(410,000)

(558,

000)
(a)
$

Book value of original partnership .....

130,500
$
190,000

242

,000
Asset appreciation (depreciation) ......
(50,000)
125,000

0,000
(b)
$

Net assets .........................................

80,500
$
315,000

292

,000

Percent of new partnership represented by the:

(c)

Investment of new partner .................

30%
25%

20

%
(d)

Fair value of the original partnership .

70%
75%

80%

(e)

Fair value of new partnership

suggested by the fair value of

the original partnership (b d) .......

115,000
$
420,000

(f)

Fair value of original partnership .......

80,500
315,000

365,0

00
292

,000
(g)

Fair value of consideration that

should be conveyed by the
new partner (e f) ..........................
34,500
$
105,000

73,

000

625
----------------------- Page 6-----------------------

Ch. 14Exercises

Exercise 14-5, Conclud

ed

(2)
Partnership
A

Amount of consideration to be conveyed:

Value of land .....................................
50,000
$
50,000
$
50,000
Value of cash ....................................
4,000
60,000

15,000

(h)

Total consideration ............................

54,000
$
110,000
$

(i)

$
65,000

Fair value of new partnership

suggested by the fair value of the
new partners investment (h c) ....
$
440,000
$

180,000
(b)

$
325,000

Fair value of the original

partnership .....................................
80,500
$
315,000
$
292,000

(h)

Investment of new partner .................

54,000
110,000

(j)

65,000

Adjusted value of new partnership

excluding goodwill (d + h)...............
134,500
$
425,000
$

$
357,000

If (i) exceeds (j), goodwill is ...............

Original

Original

traceable to ....................................
Partners

Partners

In the amount of (i j) .......................

45,500
$
15,000

If (j) exceeds (i), goodwill is ..............

New
traceable to ....................................
Partner
In the amount of (e j) ......................
$

8,000

Proof:
(a)

Book value of original partnership .....

130,500
$
190,000

$
$

Asset appreciation (depreciation) ......

(50,000)
125,000

242,000

Goodwill traceable to original

partnership .....................................
45,500
15,000
Goodwill traceable to new partner .....

50,000

8,000
(h)

Investment of new partner .................

54,000
110,000
Total capital of new partnership ........
180,000
$
440,000

65,000

(c)
30%

New partners interest in capital ........

25%

65,000

20%

New partners capital balance ...........

54,000
$
110,000
$

$
73,000

626
----------------------- Page 7-----------------------

Ch. 14Exercis
es

EXERCI
SE 14-6

(1)

Distribution of personal assets per the UPA:

Pfarr

Will

iams

Personal assets ........................................................

......................
$
30,000 $
22,000
Loan offset ............................................................
..........................
(5,000)

Net personal assets ....................................................

....................
$
30,000 $
17,000
Personal liabilities ...................................................
........................
(15,000)
(17,000)
Further contribution toward capital deficit ............................
...........
Balance ................................................................
...........................
$
15,000 $
0

(2)

Distribution of personal assets per the UPA without the right of offset:

Pfarr

Will

iams

Personal assets ........................................................

......................
$
30,000 $
22,000
Loan offset ............................................................
..........................
Net personal assets ....................................................
....................
$
30,000 $
22,000
Personal liabilities ...................................................
........................
(15,000)
(21,000)
Further contribution toward capital deficit ............................
...........
0
(1,000)
Balance ................................................................
...........................
$
15,000 $
0

Note: In entry (1) above, the right of offset resulted in a total contrib
ution of $5,000 toward Wil-

liamss capital deficit. However, ignoring this doctrine in entry (2) resul
ted in only $1,000 being contributed toward Williamss capital deficit.

(3)

Distribution of assets per common law with the right-of-offset doctrine:

Pfarr

Will

iams

Personal assets ........................................................

......................
$
30,000 $
22,000
Loan offset ............................................................
..........................
(5,000)
Net personal assets ....................................................
....................
$
30,000 $
17,000
Personal liabilities ...................................................
........................
(15,000)*
(11,900)*
Balance ................................................................
...........................
$
15,000 $
5,100

*The personal assets are allocated as follows:

Pfarr

Will

iams

Payable to personal creditors ..........................................

...............
$
15,000 $
21,000
......

Payable to partnership for debit capital balance .......................

0
9,000

Balance ................................................................
...........................
$
15,000 $
30,000

Percentage of net personal assets

available to personal creditors ..................................
................
15/15 = 100%
21/30 =
70%
70% $17,000

= $1
1,900

627
----------------------- Page 8-----------------------

Ch. 14Exercises

EXERCISE 147

Given the adjustment of selected assets to net realizable value, the result is n
et assets of $90,000. It is
assumed that the net assets can be disposed of at book value. As a result of the
adjustment, Crawford
has developed a deficit of $15,000 (see Schedule A). If Crawford is personally s
olvent to the extent of
the deficit, then it would contribute the $15,000 to the partnership and net ass
ets would be liquidated
and distributed. This would result in Crawford and Meyer receiving $0 and $73,00
0, respectively. However, if Crawford were personally insolvent, then Meyer and Jensen would have t
o absorb Crawfords
deficit balance. If this were the case, the $15,000 deficit would be absorbed by

Meyer and Jensen in

the amount of $9,000 and $6,000, respectively. This would cause Meyer to have a
capital balance of
$64,000. I would advise Meyer to take Jensens offer for several reasons. First, C
rawfords personal
solvency is at issue. Second, the Jensen offer is not significantly less than t
he $73,000 they would receive if Crawford were solvent. Finally, there are no guarantees that the net as
sets could actually net
the amounts suggested. After all, the company is in a distressed condition, and
there would likely be
transaction costs associated with the liquidation.

Schedule
A
Partial Liqui
dation

Crawford

Assets
Jensen

Meyer

Profit and loss percentages ..........

50%
30%

Beginning balances ......................

$
55,000
$115,000

20%

$
$

Adjust net assets ..........................

(70,000)
(42,000)
Balances .......................................
$
(15,000) $
73,000

230,000
60,000
(140,000)
(28,000)

$
$

90,000
32,000

EXERCISE 148

(1)

Allocation of typical profits under the original partnerships agreement:

Cumulative
A
B

Salaries ..................................
$30,000
$40,000

Total

$30,000
$100,000

Bonus to A* ............................

12,000
112,000

Remaining profits ...................

4,000
6,000
Total.......................................
$34,000
$46,000

10,000
132,000
$52,000

*Bonus = 10% (Net Income Bonus)

110% Bonus = 10% (Net Income)
110% Bonus = $13,200
Bonus = $12,000

62
8
----------------------- Page 9-----------------------

Ch. 14Exercises

Exercise 14-8, Concl

uded

Allocation of new partnership profits necessary to satisfy Bower:

Cumulative
B

A
Total

Salaries .......................................
$30,000
$40,000
$30,000 $130,000
Remaining profits* ......................
14,000
42,000

$30,000
42,000

42,000

270,000
Bonus to Dawson** .....................
20,000
290,000
Total............................................
$44,000
$82,000
$92,000

$72,000

*In order for Bower to increase his allocation by $10,000, he would need
to receive a $14,000 allocation based on the profit percentage. Therefore, the total amount o
f profit subject to this allocation would be $140,000 ($14,000 divided by 10%).

**If the cumulative total of income allocated before the bonus to Dawson
is $270,000, then Dawson
would be entitled to the $20,000 bonus under the revised partnership a

greement.

(2) The fair value of the net assets of the original partnership is $56,000 ($
530,000 $474,000). If
Dawson acquires a 30% interest in the capital of the partnership, this wo
uld mean that the fair value traceable to the original partnership would represent 70% of the new p
artnerships total capital.
Therefore, the total capital of the new partnership would be $80,000 ($56
,000 70%), and Dawson
would have to pay $24,000 ($80,000 $56,000) for a 30% interest in the new
partnership.

(3) If the partnership were liquidated as described, Bower would receive addit
ional cash of $88,200,
determined as follows:

Noncash
Offset Capital Balances

Cash
Liabilities

,000

Arnold

Assets

Beginning balances .......

$
430,000$

Bower

Chambers

50,000

$
$140,000

(2,000)

(800)

680

$.......................... 60,000
Recognition of liability ....
4,000
(1,200)
Vehicle transfer ..............
0,000)

(2
(2,500)

(16,000)*

(1,500)
Sales of assets ..............
,000)

(72,500)
(43,500)

515,000
(29,000)

(660

Payment of liabilities ......

(434,000)

Balances ........................
$
0
$

(434,000)

81,000
94,200 $

(27,000)$

13,800
Contribution of assets ....

12,000
12,000

Allocation of deficit .........

15,000

(6,000)

(9,000)
$

Balances ........................
$
0
$

$
0

93,000
88,200 $

4,800

*$15,000 fair value + (20% $5,000 book value vs. fair value) = $16,000

62
9
----------------------- Page 10-----------------------

Ch. 14Exercises

630
----------------------- Page 11-----------------------

Ch. 14Exercises

EXERCISE 14-9

Installment Liquidation Sc
hedule

Noncash

Capital and Loan Balance

Date
Assets

June 1, 20X7
,000

Circumstance
Liabilities
Coleman

Beginning balance ......................

96,000 $
63,000 $
47,000 $

Cash
Ramsey

Moore

8
(9,000)$

3,000
June 15, 20X7 Sale of assets .............................
(30,000)
(20,000)
(6,000)

(2,000)

(2,000)
,000

Balance ......................................
66,000 $
43,000 $
41,000

$(11,000) .................................. $ 1,000

July 1, 20X7
,000
000

Contribution of personal assets ..

9
9,000

Balance ...................................... $
17,
66,000 $
43,000 $
41,000 $
(2,000)$

1,000
July

Distribution of assets ..................

(21,200)

(20,000)

600

600
000

Balance ...................................... $
17,
46,000 $
43,000 $
19,800 $
(1,400)$

1,600
July
,000

Sale of assets .............................

(40,000)
8,400
2,800

54

2,800
Payment of liabilities ..................
(43,000)

000)

000

(43,

Balance ...................................... $
6,000 $
0
$
28,200 $
1,400 $

28,

4,400
Distribution to partners
(see Schedule A) .................
(24,600)

000)

(28,
(200)

(3,200)
$

6,000

Balance ...................................... $
$
0
$
3,600
$
1,200 $

1,200

Schedule
A
Schedule of Safe Payme
nts

Coleman

Moore

60%

Ramsey

Total

Profit and loss percentages ...........................

20%
20%
100%

July Distribution
Combined capital and loan balance
$28,200 $

before distribution .............................

1,400
$
4,400

$34,000
Maximum loss possible ............................
(3,600)
(1,200)
(1,200)
(6,000)
Safe payments .........................................
$24,600 $
200
$
3,200 $28,000

631

----------------------- Page 12-----------------------

Ch. 14Exercises

EXERCISE 14-10

(1) None of the cash would be distributed to Partner A because the outside cre
ditors claims must be
satisfied before any distributions to partners occur. Even after the sale
, there is only $32,000 of
cash available to service the liabilities of $35,000.

(2)

Partner A would receive $5,000 determined as follows:

Partners Loan
Non
cash
sets

and Capital Balance

Liabilities

Cash
C

As

Beginning balance .......................

180,000$ 35,000 $
60,000 $

$
70,000 $

12,000

27,000
Sale of assets...............................
(60,000)
5,000
3,000

70,000

2,000
Payment of liabilities ....................
(35,000)

(35,000)

Balance ........................................ $
120,000$ 0
$
65,000 $
73,000 $

47,000

29,000
Assume assets are worthless ......
(60,000)

(120,000)

(36,000)

(24,000)
$

Balance ........................................ $
0
$
0
$
5,000 $
37,000 $

47,000

5,000

(3) If Partner B received $27,000 from the first safe payment, then
he/she would need to receive
another $52,000 to reach the target of $79,000 in total. If his/her capit
al balance after the first sale
of assets and the distribution of $27,000 is $37,000 ($64,000 $27,000), t
hen his/her share of a
gain on the sale of the remaining assets would have to bring the capital
balance to the desired
amount of $52,000. The necessary share of the gain is $15,000
($52,000 $37,000), which
represents 30% of a total gain of $50,000. Therefore, the remaining asset
s would have to sell for
$160,000 in order to produce a gain of $50,000.

Partners Loan
Non
cash

and Capital Balance

sets

Liabilities

Beginning balance .......................

180,000$ 35,000 $
60,000 $

Cash
C

$
70,000 $

As

12,000

27,000
Sale of assets...............................
(70,000)
(10,000)
(6,000)

50,000

(4,000)
Payment of liabilities ....................
(35,000)

(35,000)

Balance ........................................ $
110,000$ 0
$
50,000 $
64,000 $

27,000

23,000
Assume assets are worthless ......
(55,000)

(110,000)

(33,000)

(22,000)
$

Balance ........................................ $
0
$
0
$
(5,000) $
31,000 $

27,000

1,000
Absorb deficit balance ..................
5,000

(3,000)

(2,000)
Absorb deficit balance ..................
(1,000)
1,000
$

Balance ........................................ $
0
$
0
$
0
$
27,000 $

27,000

632
----------------------- Page 13-----------------------

Ch. 14Exercises

633
----------------------- Page 14-----------------------

Ch. 14Problems

PROBLE
MS

PROBLE
M 14-1

Capital Balances

eber

Stansbury

Laidlaw

Carlton
Wilson

Balances as of December 31, 20X4 .......

70,000 $
80,000
0,000

W
Total

120,000 $
$27

Withdrawal of Stansbury ............................

(80,000) $
80,000
Allocation of 20X5 income (see
Schedule A)..........................................
87,500
112,500

100,000

Quarterly withdrawals in 20X5 ...................

(90,000)
Balances as of December 31, 20X5 ..........

(120,000)
(90,000)
$

100,000 $

67,500 $

$102,500

70,000
Withdrawal of bonus amount .....................
(12,500)
(37,500)
Allocation of first six months of 20X6
income (see Schedule A) .....................
35,000
45,000

40,000

Quarterly withdrawals thru June 30 ...........

(45,000)

(60,000)
(45,000)

Balances as of June 30, 20X6 ...................

45,000 $
0
$
65,000
90,000

80,000 $
1

Acquisition of Laidlaws interest .................

(6,000)
(65,000)

(8,000)

Allocation of second six months of

20X6 income (see Schedule A) ............
36,500

36,500

Quarterly withdrawals thru December 31 ...

(20,000)
Balances as of December 31, 20X6 ..........
55,500 $
0
$
44,000

(20,000)
$

88,500 $

Admit Wilson to partnership

($144,000/60% = $240,000) ................
$

96,000

Allocation of 20X7 income (see

Schedule A)..........................................
140,000

140,000
140,000

Quarterly withdrawals in 20X7 ...................

(120,000)

(120,000)

(120,000)
Balances as of December 31, 20X7 ..........
75,500 $
0
$
00,000

$
0

108,500 $
116,000

Allocation of first six months of 20X8

income (see Schedule A) .....................
85,000
Quarterly withdrawals thru June 30 ...........
(60,000)
0,000)

85,000
85,000
(60,000)
(6

Balances as of June 30, 20X8 ...................

100,500 $
0
$
0
75,000

$
$

133,500 $
141,000

Withdrawal of Carlton:
Recognition of goodwill ........................
26,500

26,500
26,500

Payment of $160,000 ...........................

(160,000)

Balances as of July 1, 20X8 .......................

127,000 $
0
$
0
$
94,500

167,500

634
----------------------- Page 15-----------------------

Ch. 14Problems

Problem 14-1, Concluded

Schedule AAllocation of Net Income

Carlton
r

Laidlaw

20X5
$

Wilson

Salary .....................................
90,000 $
90,000
$300,000

12,500

Total

Bonus (Note A) .......................

37,500
50,000

$120,000

Webe

Subtotal ..................................
$127,500
$350,000

$102,500

$120,000

Remaining profit (loss) ...........

(15,000)
(15,000)

(20,000)

(50,000)
Total .......................................
87,500
$112,500

$100,000

$300,000

1st 3 mos.
20X6

Salary .....................................
45,000 $
45,000

60,000

$150,000
Bonus (Note B) .......................
15,000

5,000

20,000
Subtotal ..................................
50,000 $
60,000

60,000

$170,000
Remaining profit (loss) ...........
(15,000)
(15,000)

(20,000)

(50,000)
Total .......................................
35,000 $
45,000

40,000

$120,000

2nd 6 mos.
20X6

Per profit and loss

$

percentages .....................
36,500

36,500
$

73,000

20X7
140,000

Per profit and loss

percentages .....................
$140,000

140,000
420,000

1st 6 mos.
20X8

Per profit and loss

percentages .....................
85,000

85,000

Note A:

85,000
255,000

Bonus = 20% (Net Income Bonus)

Bonus = 20% ($300,000 Bonus)
120% Bonus = $60,000
Bonus = $50,000

Note B:

Bonus = 20% (Net Income Bonus)

Bonus = 20% ($120,000 Bonus)
120% Bonus = $24,000
Bonus = $20,000

635
----------------------- Page 16-----------------------

Ch. 14Problems

PROBLEM
14-2

(1) The net assets of the partnership have a book value of $200,000
and a fair value of $108,000
($437,000 less $329,000). The decline in value of $92,000 ($200,000 vs. $1
08,000) would be allocated to Rowe in the amount of $36,800 (40% of $92,000). Therefore, Rowes a

djusted capital balance at fair value would be $43,200 ($80,000 less $36,800), or $21,600 for
a half interest.

(2) The fair value of the original partnership is $108,000. This amount would re
present 60% of the new
partnerships total capital of $180,000 ($108,000 divided by 60%). Therefore
, a new partner would
have to convey assets with a value of $72,000 ($180,000 less $108,000).

(3) Rowes capital = $80,000 $36,800 $2,880 = $40,320 based on the following entri
es:

Capital, Kravitz .........................................................

........................
55,200
Capital, Rowe ............................................................
.......................
36,800
Net Assets .......................................................
.........................
9
2,000
To recognize write-down of net assets.

Cash .....................................................................
............................
60,000
Capital, Kravitz .........................................................
........................
4,320
Capital, Rowe ............................................................
.......................
2,880
Capital, New Partner .............................................
...................
67
,200*
To recognize investment of new partner.

*($108,000 + $60,000) 40%

(4) Rowes capital = $80,000 $36,800 = $43,200.

If the goodwill method were employed, the difference between the new partn
ers cash contribution
of $60,000 and a suggested contribution of $72,000 [see item (2) above] wo
uld be recognized as
goodwill traceable to the new partner.

(5) New partners capital = 30% ($108,000 + $55,000) = $48,900.

636
----------------------- Page 17-----------------------

Ch. 14Problems

PROBLEM 14-3

(1) The previous partnership has a fair value as follows:

Value of recorded net assets ........................................

.........................
$268,000

Value of goodwill ...................................................

.................................
40,000
Total fair value ....................................................
....................................
$308,000

The fair value of $308,000 would represent 70% of the new partne
rships capital. Therefore, the
new partnership would have total capital of $440,000. The amount of Carvers
cash contribution can
be calculated as follows:

Capital of new partnership ..........................................

...........................
$440,000
Value of previous partnership .......................................
.........................
308,000
Total contribution needed from Carver ...............................
....................
$132,000
Fair value of recorded assets contributed ...........................
...................
(90,000)
Fair value of intangible contributed ................................
........................
(20,000)
Necessary cash contribution .........................................
.........................
$
22,000

(2) If Carvers intangibles prove worthless, each of the partners would

be allocated one-third of the
write-off, or $6,667 ($20,000 1/3). Therefore, Carver, who originally recei
ved a capital credit for
the entire $20,000 of intangibles, would lose only $6,667 of capital if it
proved to be worthless. The
advantage of $13,333 ($20,000 $6,667) to Carver is a disadvantage to Andre
ws and Block in the
amount of $6,667 and $6,667, respectively.

If the intangibles traceable to the previous partnership prove worthless, e

ach of the partners would

be allocated one-third of the write-off, or $13,333 ($40,000 1/3). Andrewss

capital was originally
increased by $16,000 (40% $40,000) for the goodwill, yet he/she is experie
ncing only a $13,333
decrease in capital as a result of the write-off. Block also is not being
disadvantaged by the write-off
because he/she originally had a capital increase of $24,000 (60% $40,000)
when goodwill was
recognized. Carver is the only partner being disadvantaged because
he received no capital increase when the goodwill was recognized, yet he experienced a $1
3,333 capital decrease upon
write-off of the goodwill.

(3) If the intangibles have value, they will take the form of future earnings in
excess of some otherwise
expected level. Therefore, granting the new partner a favorable interest (
perhaps via a bonus or
progressive P&L ratio) in these excessive earnings would recognize the val
ue of the intangibles and
increase the partners capital balance. In effect, this approach recognizes
the value of goodwill only
when it is realized through excessive earnings.

637

----------------------- Page 18-----------------------

Ch. 14Problems

PROBLEM 14-4

(1)

Capital Balances
Davis
Clay

Rayburn

Murray

Total

Balances as of
December 31, 20X3 ...............
80,000 $
70,000

50,000

Distribution of Clays 20X3 bonus

(see Schedule A) ....................
(36,000)
Distribution of 20X3 other income
(see Schedule A; 80%
38,400)

$144,000) ...............................
(38,400)

(38,400)

Allocation of 20X4 income* (see

Schedule A)............................
84,000

108,000

Quarterly distributions ..................

(100,000)
(70,000)

(100,000)

08,000

Balances as of
December 31, 20X4 ...............
49,600 $
9,600

$
$

19,600

78,800

Admission of Rayburn (see

(3,300)

Schedule B)............................
(3,300)
$
68,900

(3,300)

Distribution of Clays 20X4 bonus

(see Schedule A) ....................
(6,000)
Distribution of 20X4 other income
(see Schedule A; 80%
(6,400)

$24,000) .................................
(6,400)

(6,400)

Allocation of 20X5 income* (see

Schedule A)............................
50,000
36,100
5,900
Subtotal ........................................

50,000
$

59,900

89,900 $

30,000 $

74,800

Withdrawal of Davis** ..................

4,500
4,500

(59,900)
1,500

Balances as of
94,400 $

December 31, 20X5 ...............

34,500
$

76,300

205,200
Distribution of Clays 20X5 bonus
(see Schedule A) ....................
(1,100)
Distribution of 20X5 other income
(see Schedule A) ....................
0
0

Allocation of 20X6 income* (see

Schedule A)............................
40,948
28,104

40,948

Balances as of June 30, 20X6 .....

35,348 $
74,348
$104,404

0
0

314,100

*Not yet distributed

**Davis balance of $59,900 cash paid to Davis $49,400 = $10,500, which is a
llocated to the remaining partners (Murray and Clay each get 3/7 and Rayburn gets 1/7)

638
----------------------- Page 19-----------------------

Ch. 14Problems

Problem 14-4, Continued

Schedule A
Allocation of Profits and Losses
Cumulative
20X3 Income
Clay

Rayburn

Profit and loss percentages ..

33.3%

Davis
Total
33.3%

Salaries ................................. $100,000

$ 70,000
$270,000
Bonus (see Note A) ...............
36,000
Remaining profits ..................
48,000
Total ......................................
$154,000

Murray
33.3%

$100,000

306,000
48,000
450,000
$148,000

48,000
$148,000

20X4 Income
Salaries .................................
$70,000
Bonus (see Note B) ...............
6,000
Remaining profits ..................
8,000
Total ......................................
$84,000

$100,000
270,000

$100,000

276,000
8,000
300,000
$108,000

8,000
$108,000

20X5 Income
Salaries .................................
$35,000
$
0

$50,000
135,000

Interest ..................................
5,900
140,900
Bonus (see Note C) ..............
1,100

142,000

$50,000

Remaining profits ..................

0

142,000

Total ......................................
$36,100
$
5,900

$50,000

$50,000

20X6 Income
Salaries .................................
$
0
$
0

Interest (10% $76,300) ......

7,630
Remaining profits ..................
40,948
20,474

40,948

110,000
$

$40,948

Bonus = 20% (Net Income Salaries)

Bonus = 20% ($450,000 $270,000)
Bonus = 20% ($180,000)
Bonus = $36,000

Note B:

Bonus = 20% (Net Income Salaries)

Bonus = 20% ($300,000 $270,000)
Bonus = 20% ($30,000)
Bonus = $6,000

Note C:

7,630

Total ......................................
$40,948
$28,104

Note A:

0
0

Bonus = 20% (Net Income Salaries)

Bonus = 20% ($142,000 $135,000)
Bonus = 20% ($7,000)
Bonus = $1,400 but limited to available net income

639

----------------------- Page 20-----------------------

Ch. 14Problems

Problem 14-4, Concl

uded

Schedule
B
Changes in Partnership In
terests

Admission of Rayburn:
Total capital of previous partners ..................................
.........................
$
78,800
Investment of Rayburn ...............................................
............................
59,000
Total capital of new partnership ....................................
.........................
$137,800
50% interest allocated to Rayburn ...................................
......................
68,900
Balance allocated to previous partners ..............................
....................
$
68,900
Investment of Rayburn ...............................................
............................
59,000
Balance of negative bonus to previous partners ......................
..............
$
9,900

(2) Distribution of Available Cash on September 15, 20X6

Liabilities

Murray

Available cash (see Schedule C) ......

Clay

Cash
Rayburn
$

277

,000
Payment of liabilities .........................
$84,000

(8

4,000)

Payment to partners (see Note D) ....

(183

,000)

$112,908

$1,908

$68,184
Total ..................................................
$
$84,000
$112,908
$1,908 $68,184

0,000

Schedule
C
Partial Liquidation S
chedule

Noncash
Loan from

Liabilities

Murray

Capital Balances
Cash
Clay

Murray

Balances at June 30, 20X6 .....

$84,000
$50,000 $135,348

Assets
Rayburn

15,000
$74,348

$433,100

$104,404
August 1 Sale of assets ..........
00)

180,000
(16,000)

(16,000)

(220,0

(8,000)
September 1 Sale of assets ....
(70,000)

82,000
4,800

4,800 ....................................... 2,400

Balances..................................
$84,000
$50,000 $124,148

$277,000
$63,148

$143,100
$

98,804

Note D:
Murray

Schedule of Safe Payments

Clay

Rayburn

Total

Profit and loss percentages ..........................

40%
40%
20%

Combined capital and loan balances ............

$174,148
$
63,148 $

100%

98,804

336,100
Estimated cash reserve ................................
(4,000)
(4,000)
(2,000) (10,000)
Maximum loss possible .................................
(57,240)
(57,240)
(28,620)
(143,100)
Safe payment ................................................
$112,908
$
1,908
$
68,184

183,000

64
0
----------------------- Page 21-----------------------

Ch. 14Problems

PROBLE
M 14-5

Admission of new partner:

(1) Bonus method: Total capital in the new partnership equals $160,000
($60,000 + $40,000 +
$60,000). Nelsons 30% interest equals $48,000.

Cash .....................................................................
............................
60,000
Nelson, Capital ..................................................
.......................
48,000
Buckner, Capital .................................................
......................
6,000
Pressey, Capital .................................................
......................
6,000

(2) Goodwill method: Nelsons $30,000 investment for a 20% interest implies that t
he capital of the new
partnership equals $150,000 ($30,000 20%). The $150,000 less the
$130,000 book value
represents $20,000 of goodwill to be recognized.

Cash .....................................................................
............................
30,000
Goodwill .................................................................
..........................
20,000
Nelson, Capital ..................................................
.......................
30,000
Buckner, Capital .................................................
......................
10,000
Pressey, Capital .................................................
......................
10,000

(3) Because Nelsons acquisition of a 30% interest in the partnership was from a p
artner, the consideration is not used to suggest the imputed fair value of the par
tnership. The partnership merely

records the transfer of Presseys capital interest to Nelsons capital account

.

Pressey, Capital (50% $60,000) ...........................................

........
30,000
Nelson, Capital ..................................................
.......................
30,000

Withdrawal of previous partner:

(4) Bonus method: The payment of $48,000 to Buckner for the 40% interest in capi
tal indicates a bonus
of $8,000 ($48,000 $40,000).

Buckner, Capital .........................................................

......................
40,000
Pressey, Capital .........................................................
......................
8,000
Cash .............................................................
............................
48,000

(5) Goodwill method: The payment of $25,000 to Buckner for the 20% interest in c
apital implies that the
fair value of the partnership is $125,000 ($25,000 20%). The goodwill trac
eable to the withdrawing
partner is $5,000 ($25,000 $20,000).

Goodwill .................................................................
..........................
5,000
Buckner, Capital .................................................
......................
5,000

Buckner, Capital .........................................................

......................
25,000
Cash .............................................................
............................
25,000

641
----------------------- Page 22-----------------------

Ch. 14Problems

Problem 14-5, Con

cluded

(6) Goodwill method: The payment of $39,000 to Buckner for a 30% interest in cap
ital suggests that
$9,000 is being paid for goodwill. This amount represents 75% of Buckner s
50% interest (the profit
and loss percentage) in the total goodwill. If 75% of Buckner s 50% intere
st in goodwill is $9,000,
then his/her half of total goodwill is $12,000.

Goodwill .................................................................
..........................
24,000
Buckner, Capital ..................................................
.....................
12,
000
Pressey, Capital ..................................................
.....................
12,
000

Buckner, Capital .........................................................

......................
39,000
Cash ..............................................................
...........................
39,
000

642
----------------------- Page 23-----------------------

Ch. 14Problems

PROBLEM 14-6

Capital Balances
Murphy
Hepburn

Pioso

Reinartz

Total

Balance as of
$

December 31, 20X5 ...........

76,000 $

54,000
$

130,000
20X6
,400

Allocation of profits
(see Note A).......................
230,000
Distributions ...........................
(100,000)

127,600
(100,000)

(200,000)
$

Year-end balance ...................

78,400 $

$
$

81,600

102

160,000

20X7
Beginning balance ..................
$
78,400

$
$

81,600

160,000
Admission of Hepburn
(see Note C) ......................
20,000 $
70,000

30,000

120,000
Allocation of profits
(see Note A).......................
85,875
330,000

,875

Distributions ...........................
(80,000)
(80,000)

145,250

98

(80,000)

(240,000)
Year-end balance ...................
117,275$
75,875 $

$
$

176,850

$
$

176,850

370,000

20X8
Beginning balance ..................
$
117,275$
75,875 $

370,000
Sale of interest to Reinartz .....
176,850

(176,850)

Allocation of profits
(see Note A).......................
100,000

00

100,0

200,000
Distributions ...........................
(80,000)

,000)

(60

(140,000)
25

Year-end balance ...................

$
$
95,875 $

$
430,000

334,1

20X9
25

Beginning balance ..................

$
$
95,875 $

334,1

430,000
Adjustment of net assets ........
(5,000)

5,000)

(10,000)
Recognition of Reinartz
goodwill (see Note C) ........
,875

20
20,875

Sale of interest by Reinartz ....

,000)

(350

(350,000)
$

Subtotal ..................................
90,875
$

90,875
Admission of Pioso

643
----------------------- Page 24-----------------------

Ch. 14Problems

(see Note C) ......................

21,625

75,000

96,625
$

Ending balance ......................

$
112,500
187,500

75,000

Note A:
Cumulative
Reinartz

Total

20X6 Allocation Profit

Murphy

Profit and loss percentages .............................

40%
60%
Salary ..............................................................
$ 80,000
$100,000
$180,000
Bonus (see Note B) .........................................
46,000
226,000
Balance ............................................................
1,600
2,400
230,000
Totals ...............................................................
$127,600
$102,400

64
4
----------------------- Page 25-----------------------

Ch. 14Problems

Problem 14-6, Concluded

Cumulative
20X7 Allocation
Reinartz

Murphy
Hepburn

Total

Profit and loss percentages ...

45%
25%

30%

Salary ....................................
$100,000
$70,000

$ 80,000
$250,000

Bonus (see Note B) ...............

16,500

332,500

66,000

Balance ..................................
(1,125)
(625)

330,000

(750)

Totals .....................................
98,875
$85,875

$145,250

Cumulative
20X8 Allocation
Reinartz

Murphy
Hepburn

Total

Profit and loss percentages ...

50%
50%
Balance ..................................
$100,000
100,000

$200,000

Totals .....................................
100,000
$100,000

Note B:

20X6 Bonus

Percent of
Partner
Murphy

Income
20%

20X7 Bonus

Income
$230,000

Bonus
$46,000

Percent of
Partner
Murphy
Hepburn

Income
20%
5%

Income
$330,000
330,000

Bonus
$66,000
16,500
$82,500

Note C:
Admission of Hepburn: If Hepburn paid $70,000 for a 25%
interest in capital, this would
suggest that the new partnership had a value of $280,000. This v
alue exceeds the capital of
the old partnership ($160,000) plus the investment of the new pa
rtner ($70,000). Therefore,
goodwill of $50,000 [$280,000 ($160,000 + $70,000)] is traceable
to the original partnership. The goodwill is allocated to the original partners per the
ir profit percentages.

Sale of Reinartz Interest: If Reinartz s capital balance has a b

ook value of $329,125 after the
adjustment of net assets, a sale to the partnership for
$350,000 suggests goodwill of
$20,875 as being traceable to Reinartz.

Admission of Pioso: If Pioso paid $75,000 for a 40% interest in

capital, this would suggest
that the new partnership had a value of $187,500. This value exc
eeds the capital of the old
partnership ($90,875) plus the investment of the new partner ($7
5,000). Therefore, goodwill
of $21,625 [$187,500 ($90,875 + $75,000)] is traceable to the or
iginal partnership. The
goodwill is allocated to the original partners per their profit
percentages (in this case, Hep-

burn gets 100%).

.

645
----------------------- Page 26-----------------------

Ch. 14Problems

PROBLEM 1
4-7

If the partnership were liquidated on March 31, 20X6, Klaproth would recei
ve $48,750, determined as follows:

No
ncash

Partners Capital Balances

Event/Circumstance
Liabilities

Assets
on

Cash
Klaproth

Stone

Jacks

Profit and loss percentages........

35%

30%

35%

Beginning balances ....................

$ 1,500,000$
1,400,000
$

120,000
110,000

20,000 ...................................... $ 90,000

Liquidation of assets ..................
(1,500,000)

1,380,000
(42,00

0)
(36,000) ......................................

(42,000)

Settlement of liabilities ...............

(1,400,000)

(1,350,000)
17,500

15,000 ........................................

17,500

Unrecorded contingent
liabilities .................................
(21,000)

(60,000)
(18,00

0)
(21,000)
Payment of liquidation
expenses ...............................

(25,000)
(7,500

(8,750)
)
(8,750)
Subtotal ...................................... $
$
$

$
55,750 $

65,000
(26,500)$

35,750
Contribution of personal assets .

12,500
12,500

Absorption of deficit ....................

(7,000)

14,000

(7,000)
Subtotal ......................................
$
$

$
48,750$

77,500

28,750
Final payment to partners ..........

(77,500)

(48,750)

(28,750)
Final balances ............................
$

$
$

$
$

If Klaproth continued in the partnership until March 31, 20X8, he would re

ceive draws of $20,000 and a final
payment of $117,040 (110% of final capital balance of $106,400) less an in
vestment of $50,000, determined

as follows:

No
ncash

Partners Capital Balances

Event/Circumstance
Liabilities

Assets
n

Cash
Klaproth

Stone

Jackso

Profit and loss percentages........

35%

30%

35%

Beginning balances ....................

$ 1,500,000$
1,400,000$

110,000 $

$120,000
20,000

$
90,000
Allocation of 20X6 net income
(See Note A) ..........................
120,000

32,000

46,000

42,000
Partnership draws ......................
(20,000)

(80,000)
(40,00

0)
(20,000)
Investment of capital ..................
50,000

80,000
30,000

Allocation of 20X7 net income

(See Note B) ..........................
200,000

56,900

62,200

80,900
Partnership draws ......................

(20,000)

(60,000)
(40,000)

646
----------------------- Page 27-----------------------

Ch. 14Problems

Subtotal ......................................
$1,820,000
$1,400,000
$

$ 60,000
228,900 $

78,200 $................................ 172,900

Adjustment of receivables and
Inventory to market value ......
0) ..........
(122,500)

(105,000) ....................................

(350,00

(122,500)

Final balances ............................

,470,000 $1,400,000 .. $
106,400 $

$ 60,000 ......... $1
(26,800)$

50,400

647
----------------------- Page 28-----------------------

Ch. 14Problems

Problem 14-7, Conclu

ded

Note A
Cumulative
Allocation of 20X6 income:
Stone
Jackson

Klaproth
Total

Profit and loss percentages .......

30%
35%

35%

Salary .........................................
$130,000
$
90,000
Bonus as a percent of sales ......

50,000

400,000

30,000

Balance ......................................
(84,000)
(98,000)

(98,000)
120,000

Totals .........................................
46,000
$
42,000

$100,000
$320,000

32,000

Note B
Cumulative
Allocation of 20X7 income:
Stone
Jackson

Klaproth
Total

Profit and loss percentages .......

30%
35%
Salary .........................................
$130,000
$
90,000

$100,000
$320,000

Bonus as a percent of sales ......

70,000

426,000

Balance ......................................
(67,800)
(79,100)

(79,100)
200,000

Totals .........................................
62,200
$
80,900

35%

36,000

56,900

It would appear that Klaproth would be well advised to continue in the par
tnership if forecasted results are
realized. Even if the cash flows from the two alternatives were expressed
as present values, it appears that
continuing in the partnership would be the best alternative.

648

----------------------- Page 29-----------------------

Ch. 14Problems

PROBLEM 14-8

(1)
chedule

Installment Liquidation S

Nonca
sh

Partners Loan and Capital Balance

Event/Circumstance
Liabilities
Dvorak

ets

Cash
Kelsen

Profit and loss percentages........

30%

Beginning balances ....................

$ 722,000 $
613,000$

Ass
Morgan

30%

$
20,000 $

40%

15,000
87,000 $

17,000
Liquidate receivables and
inventory ................................
(130,000)
(12,000)

90,000
(12,000)

(16,000)
Refund of prepaids .....................
(12,000)
(600)
(800)

10,000
(600)

Balances.....................................
$ 580,000 $
613,000$
7,400

$115,000
74,400 $

200
Payoff of accounts payable ........
(80,000)

(80,000)

Balances.....................................
$
580,000 $
533,000$
7,400

35,000
74,400 $

200
Distribution of assets to partners
(25,000)

(9,500)

(1,500)

(2,100)

28,000
(2,100)

(14,000)
Sale of office
equipment/vehicles................
(35,000)
(2,800)
Settle contingent liability .............
(83,000)
12,000

(43,000)
12,000

16,000
Balances.....................................
$
520,000 $
450,000$
7,800

20,000
82,800 $

(600)
Payment to partners
(see Schedule A) ...................

(18,000)
(18,000)

Balances.....................................
$
520,000 $
450,000$
7,800

2,000
64,800 $

(600)
Sale of furniture and fixtures ......
(150,000)

(9,000)

120,000
(9,000)

(4,500)

5,000
(4,500)

(12,000)
Collection agency proceeds .......
(20,000)
(6,000)
Sale of home and payoff of loan
(350,000)
(450,000)
6,000 ..........................................

(80,000)
6,000
8,000

Balances.....................................
$
0
$
0
$
300

47,000
57,300 $

(10,600)
Contribution of deficit partners ...

10,000

10,000
Allocation of deficit balances ......
(300)

(300)

600

Final payment to partners ..........

Balances.....................................
0 $
0
$
0
$

(57,000)
(57,000)
$

0
$

$
0

Schedule
A
Schedule of Safe Pa
yments

Dvo
rak

30%

Kelsen

Morgan

Profit and loss percentages ......................

30%
40%

Combined capital and loan balances .......

7,800
$
82,800 $
(600)

64
9
----------------------- Page 30-----------------------

Ch. 14Problems

Cash retained/expenses anticipated ........

(600)
(800)

(600)

Maximum loss possible

($520,000 $450,000) ........................
(21,000)
(28,000)

(21,000

00)

Balances ...................................................
$
61,200 $
(29,400)

00

Allocation of deficits..................................
(43,200)
29,400
$

Safe payments .........................................

18,000
$
0

$ (13,8
13,8

(2) The distributions of the equipment and vehicles were not safe. First of all,
distributions should not
be made unless all liabilities have been settled. Furthermore, if a schedul
e of safe payments had
been made at that time, the partners would not have had adequate capital ba
lances to absorb potential losses.

(3) Solvent partners will have a legal claim against those partners who are not
able to satisfy their deficit balance. The ultimate collectibility of these amounts is dependent upon
the insolvent partner(s)
subsequently becoming solvent.

650
----------------------- Page 31-----------------------

Ch. 14Problems

PROBLEM 14-9

King Alternative #1Liquidate now:

Based on the schedule below, King would receive a total of $45,000 represe
nted by its loan balance of $20,000 and its capital balance of $25,000.

Net Assets
Capital Balances
Excluding
Partner
Loans

Through Year-End 20X5

Skeeba

Profit and loss percentages .........

40%

December 31, 20X4, balances ....

$40,000
$

Partner Loans
King

Tank

30%

80,000 $

30%

$250,000
90,000 $

40,000
Adjust to liquidating
value......................................
(20,000)

(50,000)
(15,000)

(15,000)
Net liquidation values (80%) .......
$40,000
$

60,000 $

$200,000
75,000 $

25,000

King Alternative #2Sell interest to Tank for $60,000 plus collect loan of $20,000

for a total of $80,000.

King Alternative #3Continue through 20X5 and then liquidate:

Based on the schedule below, King would receive a total of $75,250 represe
nted by its loan balance of $20,000 and its capital balance of $55,250.

Net Assets
Capital Balances
Excluding
Partner
Loans

Through Year-End 20X5

Skeeba

Partner Loans
King

Tank

Profit and loss percentages .........

40%

December 31, 20X4, balances ....

$40,000
$

30%

30%

$250,000
90,000 $

80,000 $

40,000
Operating income ........................
12,000
Capital contribution .....................
10,000

30,000
9,000

9,000

30,000
10,000

10,000

Nonrecurring income ...................

16,000

40,000
12,000

12,000
Subtotal .......................................
$40,000
$118,000
$121,000
71,000
Adjust to liquidating

$350,000
$

value......................................
(21,000)

(52,500)
(15,750)

(15,750)
Net liquidation values (85%) .......
$40,000
$
$

$297,500
97,000 $105,250

55,250

In conclusion, it would appear that King should accept Tanks offer to purchase it
s interest. This provides King with the highest payment and also avoids the uncertainties associated
with future operating
results. However, this assumes that King will collect its loan from the partners
hip upon leaving the partnership. The possibility of this not happening should be considered.

65
1
----------------------- Page 32-----------------------

Ch. 14Problems

PROBLEM 14-10

Installment Liquidation Sche

dule
Partners Loan
Noncash
and Capital Balance
Event/Circumstance
Liabilities
Schmidt

Profit and loss percentages .......

Cash
Janis

Assets
Glomski

30%

35%

Beginning balance .....................

$
404,000 $
274,000$
85,000 $

35%

25,000
47,000 $

23,000
Estimated liquidation expense ...
(3,000)

(10,000)
(3,500)

(3,500)
Projected sale of assets ............
(404,000)
(39,600)

272,000
(46,200)

(46,200)
Projected settlement of
liabilities ...............................
(264,000)
(274,000)
3,000
3,500
................................... 3,500
Balance ...................................... $
0
$
0
$
45,400 $

23,000

$
800

$(23,200)
Estimated capital contribution ....

10,000

10,000
Balance ...................................... $
0
$
0
$
45,400 $

33,000

$
800

$(13,200)
Absorption of partners deficit ....
(6,092)

(7,108)

13,200
Balance ...................................... $
0
$
0
$
39,308 $

33,000
(6,308) $

0
Absorption of partners deficit ....
(6,308)
Balance ...................................... $
0
$
0
$
33,000 $
0

6,308
33,000
0

$
$

Memo to Schmidt

Date:

March 2, 20X8

To:

R. J. Schmidt

From: William James Taylor, CPA, CVA, Ph.D.

Re:

Contemplated liquidation/purchase of partnership

The enclosed installment liquidation schedule shows the effect on partnership ne

t assets and capital
balances if a liquidation of the company were to occur. The estimated current va
lue of net assets is significantly lower than their book value. This results in significant losses to th
e partnership. These losses
are allocated to the respective partners according to their profit and loss perc
entages. This results in
Glomski having a deficit in his/her capital account. Unfortunately, Glomski has
net personal assets of
only $10,000 that can be used toward eliminating the deficit. This results in bo
th you and Janis absorbing the balance of Glomskis deficit. This in turn creates a deficit for Janis tha
t he/she cannot totally
cure through the use of net personal assets.

The net effect of all of the above deficit situations is that neither Janis nor
Glomski will receive a distribution of assets if the partnership is liquidated. Furthermore, Glomski will ha
ve to contribute personal
assets to the partnership in the amount of $10,000. Unfortunately, you end up ab
sorbing the net deficits
of your partners due to their inadequate capital balances and insuffic
ient personal net assets. If the

652

----------------------- Page 33-----------------------

Ch. 14Problems

partnership proceeds with the liquidation, it is estimated that you will receive
only $33,000 in cash as a
final distribution. However, you will have claims against Glomski and Janis in t
he amounts of $6,092
and $6,308 resulting from your absorption of their deficit capital balances. The
likelihood of collecting
those amounts must be viewed cautiously.

653
----------------------- Page 34-----------------------

Ch. 14Problems

Problem 14-10, Concluded

With respect to what you might offer each of your partners in lieu of liquidatin
g the company, the answer is simple. Neither of the partners would receive a distribution
of assets upon liquidation and
Glomski would actually have to contribute personal net assets. Anything you offe
r them would be more
than they would otherwise receive. If your partners merely walked away from the
business, you would
be left with a net value of $33,000, which is the same as what you would receive
if the partnership were
liquidated. It is clear that you are not benefiting by buying your partners out.
Furthermore, if you wanted

to liquidate the assets, it is possible that you would also incur liquidation ex
penses similar to those estimated for the partnership. Although the facts suggest that you need not pay ei
ther of your partners
any consideration, the reality is that it may take some consideration on your pa
rt to get the job done.
The answer to what you can afford to pay should also consider the significant ex
penditures you will be
required to make if you continue the business. I believe that you are in a stron
g negotiating position and
you should begin by offering them nothing. If you must pay something to your par
tners, it should be a
very minimum amount.

With respect to your continuing the business with your nephew, I would welcome t
he opportunity to assist you in any other areas. It will be important to develop projections of futu
re operations that reflect the
change in ownership and the expenditures necessary to comply with new federal la
ws and regulations.

Thank you for the opportunity to be of service.

654
----------------------- Page 35-----------------------

Ch. 14Problems

PROBLEM 14-11

Installment Liquidation Sche

dule

Partners Loan
Noncash
and Capital Balance
Event/Circumstance
Liabilities
Ziegler

Cash
Nolan

Profit and loss percentages .......

30%

Assets
Petersen

30%

Beginning balance .....................

$120,000 $
20,000

40%
$
$

12,000
50,000 $

$228,000

50,000
Additional adjustment ................
17,400
(5,220)

(5,220)

(6,960)
Conveyance of vehicles .............
0)

(14,00
(20,300)

2,700

3,600
Sale of assets ............................
(90,000)
(6,000)

70,000
(6,000)

(8,000)
Balance ......................................
$137,400
$(11,520)

$
$

82,000
41,480 $

$124,000

38,640
Payment of liabilities ..................
(82,000)

(82,000)

Balance ...................................... $
$
55,400
$(11,520)
41,480 ............................... $
Sale of assets ............................
(80,000)
3,600

38,640
92,000
3,600

4,800
Payment of subcontractor ..........
(4,500)
(6,000)

$124,000
$

(15,000)
(4,500)

Bill customer for subcontractor ..

0

20,00
6,000

6,000

8,000
Balance ...................................... $
64,000 $
55,400 $
(6,420) $

77,000
46,580 $

45,440
Payment of liabilities (see Note A)
(42,400)

(42,400)

Balance ...................................... $
64,000 $
13,000 $
(6,420) $

34,600
46,580 $

45,440
Payment to partners
(see Schedule A) .................
0

(16,600)
(14,257)

(2,343)
Balance ...................................... $
64,000 $
13,000 $
(6,420) $

18,000
32,323 $

43,097
Conveyance of vehicles .............
00)

(8,0
1,200

1,200

(10,400)
Settle liabilities ...........................
( 13,000)
900

(10,000)
900

1,200
Collect receivables .....................
(20,000)
Balance ...................................... $
36,000 $
0
$
(4,320) $

20,000
28,000
34,423 $

33,897
Payment to partners
(see Schedule A) .................
0

(28,000)
(17,143)

(10,857)
Final sale of assets ....................
(36,000)
(3,600)
(4,800)

24,000
(3,600)

Payment of professional fees ....

(1,800)

(6,000)
(1,800)

(2,400)
Balance ...................................... $
0
$
0
$
(9,720) $

18,000
11,880 $

15,840

655
----------------------- Page 36-----------------------

Ch. 14Problems

Contribution of capital ................

9,720
9,720

Payment to partners ..................

(27,720)

(11,880)
(15,840)
Balance ......................................
$
0
$
0
$
0
$
0

Note A: The contingent liability of $13,000 remains unpaid.

656
----------------------- Page 37-----------------------

$
0

0
$

Ch. 14Problems

Problem 14-11, Conc

luded

Schedul
e A
Schedule of Safe Pay
ments

Ziegler

Nolan

Petersen

Profit and loss percentages ..............................................

30%
30%
40%

July 15 Distribution

Combined capital and loan balance ..................................

$
(6,420) $
46,580 $

45,440

Cash retained/expenses anticipated .................................

(1,500)
(1,500)
)

(2,000

Maximum loss possible .....................................................

(19,200)
(19,200)
(25,600)
Balance ........................................................................
.....
$(27,120) $
25,880 $
17,840
Allocation of deficits .........................................................
.
27,120
(11,623)
(15,497)
Safe payments ..................................................................
$
0
$
14,257 $
2,34
3

August 1 Distribution

Combined capital and loan balance ..................................

$
(4,320) $
34,423 $
Cash retained/expenses anticipated .................................
0
0

33,897

Maximum loss possible .....................................................

(10,800)
(10,800)
(14,400)
Balance ........................................................................
.....
$(15,120) $
23,623 $
19,497
Allocation of deficits .........................................................
.
15,120
(6,480)
(8,640
)
Safe payments ..................................................................
$
0
$
17,143 $
10,857

657