Chapter 14

Chapter 14
Partnerships: Ownership Changes and Liquidation

Ownership changes
Dissolution - the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business

C14

Ownership changes, continued

Changes may suggest: The existing assets of the original partnership should be revalued; Previously unrecorded intangible assets exist that are traceable to the original partnership; and/or Intangible assets, such as goodwill, exist that are traceable to a new partner

C14

Admission of a new partner

Accomplished by either A contribution of assets to an existing partnership
either the bonus or goodwill method of accounting is employed

A contribution of assets to an existing partner

generally a transfer of book values from one partner to another

C14

The value of assets contributed to an existing partnership

May be in excess of that suggested by the book value of the original partnerships net assets which suggests that the partnership may have unrecognized appreciation on recorded net assets and/or unrecognized goodwill

C14

The value of assets contributed to an existing partnership, continued

May be less than that suggested by the book value of the original partnerships net assets

suggests unrecognized depreciation or writedowns on recorded net assets of the original partnership and/or additional intangible assets being contributed by the incoming partner

C14

Contribution of assets to an existing partnership

Bonus Method Goodwill Method

C14

The bonus method

Total capital of new partnership is:
The book value of the previous partnership Any write-downs in the value of the previous partnerships net assets + The value of the consideration paid to the partnership by the incoming partner
Note: only net asset write-downs (versus write-ups) are recognized
C14 8

The bonus method, continued

New partners initial capital balance equals the
percent interest in the capital of the new partnership Bonus may be either to old partners or the new partner Bonus is allocated based on profit/loss percentages, not interest in capital percentages

C14

Bonus method: No asset write-down suggested

Facts

A & B are original partners with a

partnership net book value of $200,000 Profit/loss percentages: A = 60%, B = 40% C acquires 20% interest in capital for $70,000 cash

C14

10

Bonus method: No asset write-down suggested, continued

Analysis Value of new partnership suggested by incoming partner: $350,000 ($70,000 20%) No asset write-down suggested [$350,000 > ($200,000 + $70,000)] Book value of new partnership: $270,000 ($200,000 + $70,000) Cs interest in new partnership: $54,000 (20% $270,000)
C14 11

Bonus method: No asset write-down suggested, continued

Journal Entry
Cash A, Capital B, Capital C, Capital 70,000

9,600 6,400 54,000

C14

12

Bonus method: Asset write-down suggested

Facts

A & B are original partners with a partnership

net book value of $200,000 Profit/loss percentages: A = 60%, B = 40% C acquires 20% interest in capital for $42,000 cash

C14

13

Bonus method: Asset write-down suggested, continued

Analysis Value of new partnership suggested by incoming partner: $210,000 ($42,000 20%) $32,000 asset write-down suggested ($210,000 [$200,000 + $42,000])

C14

14

Bonus method: Asset write-down suggested, continued

Analysis, concluded

Book value of new partnership: $210,000

($200,000 - $32,000 + $42,000) Cs interest in new partnership: $42,000 (20% $210,000)

C14

15

Bonus method: Asset write-down suggested, continued

Journal Entries A, Capital B, Capital Net Assets Cash C, Capital 19,200 12,800 32,000 42,000 42,000

C14

16

The goodwill method

Total capital of new partnership is:

The book value of the previous partnership

Unrecognized appreciation or depreciation on the recorded net assets of the previous partnership + Unrecognized goodwill traceable to the previous partnership

+ The value of the consideration, both tangible and intangible, received from the new incoming partner
C14 17

The goodwill method, continued

Both net asset write-downs and write-ups are
recorded New partners initial capital balance equals the percent interest in the capital of the new partnership Goodwill may be traceable to the original partners and/or the new partner

C14

18

Identifying and measuring goodwill traceable to the previous partnership

1. Calculate the value of the partnership suggested by the incoming partner (incoming partners contribution divided by the percent interest in capital acquired) 2. Adjust the book value of the original partnership for any unrecognized net asset appreciation or depreciation (continued . . .)
C14 19

Identifying and measuring goodwill traceable to the previous partnership

(. . . continued) 3. Calculate adjusted book value of original partnership plus investment of new partner 4. If 1. above is greater than 3. above, goodwill exists and is traceable to the original partners 5. Goodwill is the difference between the value in 1. above and the value in 3. above

C14

20

Goodwill traceable to the previous partnership

Facts

A and B are original partners with a

partnership net book value of $200,000 Recorded net assets have a fair value of $220,000 Profit/loss percentages: A = 60%, B = 40% C acquires 20% interest in capital for $70,000 cash
C14 21

Goodwill traceable to the previous partnership, continued

Analysis.

Value of new partnership suggested by

incoming partner: $350,000 ($70,000 20%) $80,000 of unrecognized net asset appreciation and/or goodwill is suggested: ($350,000 [$200,000 + $70,000])

C14

22

Goodwill traceable to the previous partnership, continued

Analysis, continued

The $80,000 is allocated $20,000 ($200,000 vs. $220,000) to

unrecorded net appreciation $60,000 to goodwill

C14

23

Goodwill traceable to the previous partnership, continued

Journal Entries Goodwill Net Assets A, Capital B, Capital Cash C, Capital 60,000 20,000 48,000 32,000 70,000 70,000

C14

24

Identifying and measuring goodwill traceable to the new partner

1. Calculate the value of the partnership suggested by the incoming partner (incoming partners contribution divided by the percent interest in capital acquired) 2. Adjust the book value of the original partnership for any unrecognized net asset appreciation or depreciation (continued . . .)
C14 25

Identifying and measuring goodwill traceable to the new partner, continued

3. Calculate adjusted book value of original partnership plus investment of new partner 4. If 1. above is less than 3. above, then goodwill exists and is traceable to the new partner (continued . . .)

C14

26

Identifying and measuring goodwill traceable to the new partner, continued

5. Goodwill is the difference between a) The amount that should have been paid by the new partner, as indicated by the adjusted book value of the previous partnership
[(adjusted book value of the original partnership total percentage interest of the original partners in the new partnership) the adjusted book value]

and b) The amount actually paid by the new partner

C14 27

Goodwill traceable to the new partner

Facts

A and B are original partners with a

partnership net book value of $200,000 Recorded net assets have a fair value of $220,000 Profit/loss percentages: A = 60%, B = 40% C acquires 20% interest in capital for $45,000 cash
C14 28

Goodwill traceable to the new partner, continued

Analysis

Value of new partnership suggested by

incoming partner: $225,000 ($45,000 20%) Unrecognized net asset appreciation traceable to original partners: $20,000 ($220,000 $200,000)

C14

29

Goodwill traceable to the new partner, continued

Analysis, continued

The amount that should have been paid by the

new partner: $55,000 [($220,000 80%) $220,000] Goodwill traceable to the new partner: $10,000 ($55,000 - $45,000)

C14

30

Goodwill traceable to the new partner, continued

Journal Entries Net Assets A, Capital B, Capital Cash Goodwill C, Capital 20,000 12,000 8,000 45,000 10,000

55,000

C14

31

Contribution of assets to existing partners

Generally, a portion of the selling partners book value of capital is transferred to the buying partner Example: The book value of Bs capital interest is $50,000. C acquires one-half of Bs capital interest for $30,000:

B, Capital C, Capital

25,000
25,000

C14

32

Withdrawal of a partner
Withdrawing partner may sell interest to the partnership and/or an individual partner

C14

33

Selling of an interest to the partnership

The bonus or goodwill method may be
employed The bonus method will only recognize net asset write-downs (versus write-ups)

C14

34

Selling of an interest to the partnership, continued

If the goodwill method is used generally only net unrecorded appreciation and/or goodwill traceable to the selling partner is recognized net asset write-downs should be recognized to the extent that they are traceable to the whole entity

C14

35

Partnership liquidation guidelines

The UPA establishes rules governing the
priority in which partnership assets are distributed The doctrine of right of offset combines loans due to partners with the capital balances of partners The liability for debit capital balances is covered by the doctrine of marshalling of assets
C14 36

Partnership liquidation guidelines, continued

If debit capital balances are not eliminated,
they are allocated to the other partners with credit capital balances All attempts should be made to avoid premature liquidation payments to partners

C14

37

Marshalling of assets doctrine

Applies when a partnership is insolvent
(liabilities exceed assets) unsatisfied partnership creditors can attach to net personal assets unsatisfied partnership creditors can attach to any solvent individual partner

C14

38

Marshalling of assets doctrine, continued

Applies when individual partners are
insolvent (personal liabilities exceed personal assets) unsatisfied personal creditors can attach to partnership net assets unsatisfied personal creditors can attach only to the extent of an insolvent partners capital balance
C14 39

Types of liquidation approaches

Lump sum liquidation - all assets are in a
distributable form and all outside creditors are satisfied before distributions are made to partners Installment liquidation - payments may be made to partners in installments rather than in a final lump sum. Caution must be exercised to insure that no premature distributions are made
C14 40

Types of liquidation approaches, continued

A predistribution plan - developed in advance
of actual distributions which serves as a guideline for the order and amount of future distributions

C14

41

Installment liquidation guidelines

The right of offset doctrine is employed All liabilities, possible losses, and liquidation
expenses are anticipated Prior to a distribution, all remaining non-cash assets are assumed to be worthless

C14

42

Installment liquidation guidelines, continued

With respect to potential debit capital balances,
all partners are assumed to be personally insolvent Actual distributions are based on a schedule of safe payments or a predistribution plan

C14

43

Installment liquidation
Cash $12,000 40,000 (42,000) $10,000 (10,000) Loan & Capital Non-Cash Balances Assets Liabilities A B $100,000 $42,000 $50,000 $20,000 (60,000) - (10,000) (10,000) (42,000) $40,000 $0 $40,000 $10,000 (10,000)

Beginning Balance Sale of Assets Payment of Liabilities Balances Distributions

C14

44

Installment liquidation
Schedule of Safe Payments A B Capital Balances $40,000 $10,000 Maximum Loss Possible (20,000) (20,000) Allocate Debit Balances (10,000) 10,000 Safe Payment 10,000 -

C14

45

Predistribution plan
Based on how much loss a partner could absorb
(i.e., maximum loss absorbable, the MLA) MLA = partners capital balance partners profit and loss percent Partner with the largest MLA is the strongest and should be the first to receive a distribution

C14

46

Predistribution plan, continued

Actual distributions reduce partners capital
balances and their respective MLAs When all partners have equal MLAs they will all receive a distribution

C14

47