1 – Partnership Ownership Changes & Liquidations - Heading 2 – Partnership Dissolution - Heading

Chapter 14: Partnership Ownership Partnership Dissolution

Changes & Liquidations

3 – Partnership Dissolution - #1 4 – Partnership Dissolution - #2

• Dissolution is a legal termination

• UPA § 31 & 32: • Remember dissolution is not liquidation
– admission or withdrawal of Pr results in Pp • Dissolution – Pp legally ends
dissolution
• Liquidation - winding up of the Pp’s business
• When act of dissolution occurs, Prs may affairs
– continue business as new Pp or
– liquidate

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5 – Admission of Partner - Heading
Admission of Partner
7 – Admission of Partner - #4
• 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)
6 – Admission of Partner - #3
• 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, Cash) $10,000
C. New Partner, Capital $10,000
8 – Admission of Partner - #5
• 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)
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9 – Admission of Partner - #6 10 – Admission of Partner - #6

• When FMV of new Pr’s contribution ≠ new Pr’s share of Pp GW Method:

capital  Pp can use on of two following methods:
– the Bonus method; or
• Write up all Pp assets to FMV & recognize
any Pp GW
– the GW method
• These methods are mutually exclusive • 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) Bonus Method
• 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

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13 – Bonus Method - #1 14 – Bonus Method - #2

• Under Bonus Method:

– 1st  if any Pp assets have declined in value  write
BV down to FMV • 2nd  Value new Pr’s contribution at FMV
• If assets went up & down - recognize only the decreases – No GW
• Give loss to old Prs • 3rd  Add contributed property to Pp books at
– Allocate loss using ratio old Prs share losses FMV
• E.g., Assume that FMV of Pp asset is $10K less • 4th  Give incoming Pr his/her share of Pp
than BV & Pp has 2 equal Prs (A&B). capital
– Before admitting C, write down asset:
– Old Prs get remaining Pp capital
D. A, Capital $5,000 • 5th  Give existing Prs gain/loss to get the
B, Capital 5,000 journal entry to balance
C. Asset $10,000

15 – Bonus Method - #3 16 – Bonus Method - #4

• E.g., Assume:
• E.g., Assume:
– Pp capital equal to $75,000 before addition of new Pr, C
– Pp capital equal to $40K before addition of new Pr, C
– Pp uses Bonus Method
– Pp uses Bonus Method. – C contributes $10K to Pp for 20% interest in Pp capital
– New Pr, C, contributes $10K to Pp for 20% interest in – New Pp capital accts should total $85K ($10K(new) +
Pp capital $75K(old)) contribution
– New Pp capital accts should total $50K ($10K (new) + • C is entitled to 20% of Pp capital [($75K + $10K) x 20% =
$40K(old)) $17K]
• C is entitled to 20% of Pp capital [($40K + $10K) x 20% =
$10K]
D. Net Assets $10,000
D. Net Assets $10,000 A, Capital 3,500
B, Capital 3,500
C. C, Capital $10,000 C. C, Capital $17,000

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17 – Bonus Method - #5 18 – Goodwill Method - Heading

• 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 Goodwill Method
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]
D. Net Assets $27,000
C. A, Capital $3,300
B, Capital 3,300
C, Capital 20,400

19 – Goodwill Method - #1 20 – Goodwill Method - #2

• GW Method relies on following: • E.g., Assume (GW is with Old Pp)

– 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
– 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

• GW Method: – New Pp capital accts should total $135K

– 1st
 Write all of Pp’s net assets (old & new) to FMV & • Pp has GW of $33K
recognize any GW – $27K(new) + $75K(old) + $33K(GW) = $135K
– 2nd  Give gain/loss to old Prs
– 3rd  Admit new Pr giving capital acct = to FMV of
contribution (including GW)

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21 – Goodwill Method - #3 22 – Goodwill Method - #4
• E.g., Assume: (GW is with New GP)
• Give GW to old Prs in % they share profits: – Pp capital equal to $75K before addition of new Pr, C
– Use GW Method
D. Goodwill $33,000 – C contributes $10K to Pp for 20% interest in Pp capital
C. A, Capital $16,500 – Assume C contributes GW as well
B, Capital 16,500 • Before: C’s Contribution = 20%(New Pp Capital)
– C’s Contribution/.2 = New Pp Capital
• Admit C to the Pp: – $27K/.2 = New Pp Capital = $135K = ($75K + $27K + GW)

• Now: C’s Contribution = 20%(New Pp Capital)

D. Net Assets $27,000 – $10K + GW = .2 ($75K + $10K + GW)
C. C, Capital $27,000 – (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 = $8,750

23 – Goodwill Method - #5 24 – Goodwill Method - #6

• People feel uncomfortable with GW Method

• Admit new Pr & recognize GW of $8,750:
– Pp is writing-up its existing assets and creating GW
– Not verified by arm’s-length transaction like purchase
D. Net Assets $10,000 • Procedure violates concept of Historical Cost
Goodwill 8,750 • Others argue that admission of new Pr is arm’s-
C. C, Capital $18,750 length transaction
• Bonus Method is more popular

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25 – Transferring Partnership Interests - Heading 26 – Transferring Partnership Interests - #1

• Now let the new Pr buy Pp interest from existing Pr

• Pp receives nothing
• Two approaches:
Transferring Partnership Interests – 1st Just transfer capital from old Pr to new Pr
• Don’t change Pp assets  Pp is not involved in
the transaction
• Popular method
– 2nd 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 28 – Transferring Partnership Interests - #3

• E.g., Assume:
– Pp has BV/Capital Accts of $30K • With 2nd approach  determine FMV
– A’s Capital Acct balance is $15K (50%) suggested by $50K payment to A
– C buys A’s interest in Pp for $50,000 – FMV of the Pp’s net assets is $100,000
– With 1st method, Pp transfers A’s capital acct ($50,000/50%)
balance to C:

D. A, Capital $15,000
C. C, Capital $15,000

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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
• A’s capital acct has increased from $15K to
would recognize the appreciation or GW
$50K
– Gain from appreciation/GW goes to old Prs
• The Pp then transfers A’s capital acct to C:

D. A, Capital $50,000
D. Net Assets/GW $70,000
C. A, Capital $35,000 C. C, Capital $50,000
B, Capital 35,000

31 – Withdrawal of Partner - Heading 32 – Withdrawal of Partner - #1

• When a Pr retires (withdraws) Pr sells

his/her Pp interest to the Pp
Withdrawal of Partner
• Pp can use either Bonus Method or GW
Method
• As was true above, the Bonus Method is
the more popular method

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33 – Withdrawal of Partner - #2 34 – Withdrawal of Partner - #3

• E.g., Assume:
• With Bonus method – A retires from Pp with cash payment of $36K
– Eliminate exiting Pr’s capital acct – A’s capital acct balance is $30K
– Reduce Cash – The Pp allocates profits: 4:4:2 to A, B & C
– Give gain/loss to remaining Prs • Remaining Prs absorb loss of capital with
• With GW method Bonus method using % they share losses
– Use retirement payment to calculate FMV of – B:C  2/3 vs 1/3
Pp assets
D. A, Capital $30,000
– Can either:
B, Capital 4,000
• Write up/down exiting Pr’s share of net assets/FW
• Write up/down all net assets/goodwill C, Capital 2,000
C. Cash $36,000

35 – Withdrawal of Partner - #4 36 – Withdrawal of Partner - #5

• Using the GW Method:

– $6K payment in excess of A’s capital acct
balance suggests that that the Pp GW exists
• With 1st GW approach, Pp recognizes the GW
in the amount of $15K ($6K/40%)
associated with A’s interest:
– Use Profit % not capital because GW increase
is shared the way profits are shared
• 2 different approaches exist under the GW
Method. D. Goodwill $6,000
– 1st
approach  record only the GW that
belongs to A ($6K) C. A, Capital $6,000
– 2nd approach records the GW for the entire Pp
($15K)

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37 – Withdrawal of Partner - #6 38 – Withdrawal of Partner - #7

• A’s capital acct has increased from $30K to

$36K • With the 2nd GW approach, Pp would record the
• Pp then records the liquidation of A’s interest: GW for the entire Pp
– Allocate GW using profit %
• E.g., 40%-40%-20%:

D. A, Capital $36,000 D. Goodwill $15,000

C. A, Capital $6,000
C. Cash $36,000
B, Capital 6,000

C, Capital 3,000

39 – 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, Capital $36,000

C. Cash $36,000

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41 – Partnership Liquidations - #4 42 – Partnership Liquidations - #4

• A Pr’s personal creditors can seize any & • A Pp’s creditors can seize any & all of the
all of the Pr’s personal assets Pp’s assets
– With respect to Pp assets, personal creditors • With Unlimited Liability Pp creditors can
can only step into the shoes of the Pr & take also seize any Pr’s personal assets
what the Pr is entitled to
– Personal creditors get a share of Pp assets
after all Pp creditors are paid

43 – Partnership Liquidations - #4 44 – Partnership Liquidations - #5

• E.g., Assume:
• Because:
– Personal creditors can only seize personal assets – Pp has assets of $23K and liabilities of $25K
– Partnership creditors can seize both Pp and personal – A has capital acct balance of $500 & B has negative
assets capital acct balance of -$2,500
• Doesn’t seem fair to personal creditors – Pp creditors go after A for $2K Pp debt
– Have to share personal assets – B only has $1K available to pay Pp creditors
– Pp creditor don’t have to share Pp assets
Assets Liabilities A, Capital B, Capital
• The law says if there is not enough personal
Beg. Bal. $23,000 $25,000 $500 -$2,500
assets to satisfy both personal & Pp creditors 
Pay Liabilities -23,000 -23,000
personal assets are 1st used to pay Pr personal
$0 $2,000 $500 -$2,500
creditors
A Pays Pp Liabilities -$2,000 $2,000
– Personal assets can be paid to Pp creditors only after
personal creditors are paid $0 $0 $2,500 -$2,500

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45 – Partnership Liquidations - #6 46 – Partnership Liquidations - #7

• E.g., Assume:
Assets Liabilities A, Capital B, Capital
$0 $0 $2,500 -$2,500
– Pp has assets of $20K and liabilities of $25K
B only has $1K – Given to Pp $1,000 $1,000 – A’s capital acct has a deficit of $7K & B has capital
$1,000 $2,500 -$1,500 acct balance of $2K
A Withdraws Capital -$1,000 -$1,000 – Pp creditors go after A for Pp debt
$1,500 -$1,500 – A only has $3K available to pay Pp creditors
– B is insolvent
Assets Liabilities A, Capital B, Capital
Beg. Bal. $20,000 $25,000 -$7,000 $2,000
A loses $1,500 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 $2,000

47 – Partnership Liquidations - Heading 48 – Partnership Liquidations - #1

• UPA establishes following priorities for

Partnership Liquidations creditors & Prs for getting Pp assets when
Pp liquidates:
– 1st  Pay creditors other than Prs
– 2nd  Pay Prs for loans
– 3rd  Pay Prs for capital
– 4th  Pay Prs for profits

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49 – Partnership Liquidations - #3
• 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
51 – Lump Sum Liquidations - Heading
Lump Sum Liquidations
50 – Partnership Liquidations - #2
• So, Pp really makes payments in following
order:
– 1st  Pp pays creditors other than Prs
– 2nd  Sell assets & pay expenses
• Allocate gains/losses from sales & expenses to
Prs’ capital accts
– 3rd  Use cash to pay Prs their capital acct
balances & pay loans to Prs
52 – Lump Sum Liquidations - #1
• 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
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53 – Lump Sum Liquidations - #2 54 – Lump Sum Liquidations - #3

Assume that Prs share profits/losses:A(40%), B(40%) & C(20%)

Cash Non- Liabilities Loan A, B, C,
Cash from A Capital Capital Capital
Cash Non- Liabilities Loan A, B, C,
Assets
Cash from A Capital Capital Capital $98000 $0 $80000 $9000 $12200 -$2800 -$400
Assets
Beg.Bal $10000 $120000 $80000 $9000 $25000 $10000 $6000
Pay -80000 -80000
Feb 15 60000 -50000 4000 4000 2000 Liab.
sale
$18000 $0 $0 $9000 $12200 -$2800 -$400
March 2 10000 -30000 -8000 -8000 -4000
sale
Pay Liq. -2000 -800 -800 -400 B 2800 2800
Exp. Covers
Deficit
March 7 20000 -40000 -8000 -8000 -4000
$20800 $0 $0 $9000 $12200 $0 -$400
sale
$98000 $0 $80000 $9000 $12200 -$2800 -$400

55 – Lump Sum Liquidations - #4 56 – Lump Sum Liquidations - #5

B & C don’t have any more $

Cash Non- Liabilities Loan A, B, C,
Cash from A Capital Capital Capital
Cash Non- Liabilities Loan A, B, C, Assets
Cash from A Capital Capital Capital
Assets $20800 $0 $0 $9000 $11800 $0 $0
$20800 $0 $0 $9000 $12200 $0 -$400
Pay -20800 -9000 -11800
Recog. -$200 -$200 $400 Loan
and
Loss
Capital
on C’s
Balance
Deficit to A

Recog. -$200 $200

Loss $0 $0 $0 $0 $0 $0 $0
on B’s
Deficit

$20800 $0 $0 $9000 $11800 $0 $0

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57 – Schedule of Safe Payments - Heading 58 – Schedule of Safe Payments - #1

• Prs don’t want to wait until after Pp liquidated

to get cash
Schedule of Safe Payments – 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:

Cash Non- Liab. Loan A, B, C,
– Non-cash assets are worthless Cash from A Capital Capital Capital
Assets
• Assumes total loss on asset
– Prs cannot make up deficits in their cap acct Beg.Bal $10000 $120000 $30000 $5000 $25000 $55000 $15000

– These assumptions basically say  Pp only has cash Feb 15 40000 -60000 -8000 -8000 -4000
on hand sale

• After making these assumptions, if Pp has cash $50000 $60000 $30000 $5000 $17000 $47000 $11000
left over after paying Pp creditors  Pp can
distribute cash to Prs according to their capital Pay
Liab.
-30000 -30000

acct balances
Bal. $20000 $60000 $0 $5000 $17000 $47000 $11000
• A new Schedule of Safe Payments is prepared
with each Pp distribution

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61 – Schedule of Safe Payments - #3 62 – Schedule of Safe Payments - #3

Schedule of Safe Payments – February 17

A B C Total
Cash Non- Liabilities Loan A, B, C,
Cash from A Capital Capital Capital
Assets
Capital & Loan Balances Before Distribution $22000 $47000 $11000 $80000
Bal. Feb $20000 $60000 $0 $5000 $17000 $47000 $11000
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Estimated Liquidation Exp -4000 -4000 -2000 -$10000
Feb. 17 -10000 -10000
Balances $18000 $43000 $9000 $70000 distrib.

Maximum Loss Possible ($60,000) -24,000 -24000 -12000 -60000 $10000 $60000 $0 $5000 $17000 $37000 $11000
-$6000 $19000 -$3000 $10000
March 2 15000 -30000 -6000 -6000 -3000
sale
Allocation of Debit Capital Balances 6000 -9000 $3000
Pay Liq. -8000 -3200 -3200 -1600
Exp.
Safe Payment $10000 $10000
$17000 $30000 $0 $5000 $7800 $27800 $6400

63 – Schedule of Safe Payments - #4 64 – Schedule of Safe Payments - #5

Schedule of Safe Payments – March 5

Cash Non- Liab. Loan A, B, C,
A B C Total Cash from A Capital Capital Capital
Assets
Bal. March 5 $17000 $30000 $0 $5000 $7800 $27800 $6400
Combined Capital and Loan $12800 $27800 $6400 $47000
Balances Before Distribution
March 5 $17000 -800 -15800 -400
Distribution
Maximum Loss Possible ($30,000) -12,000 -12000 -6000 -30000
$0 $30000 $0 $4200 $7800 $12000 $6000
Safe Payment $800 $15800 $400 $17000
March 17 20000 -10000 4000 4000 2000
sale
$20000 $20000 $0 $4200 $11800 $16000 $8000

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65 – Schedule of Safe Payments - #6 66 – Schedule of Safe Payments - #7

Cash Non- Liab. Loan A, B, C,

Schedule of Safe Payments – March 18 Cash from A Capital Capital Capital
Assets
A B C Total Bal. $20000 $20000 $0 $4200 $11800 $16000 $8000
March
18
March -20000 -$4200 -$3800 -$8000 -$4000
Combined Capital and Loan $16000 $16000 $8000 $40000 18
Balances Before Distribution Distrib.
$0 $20000 $0 $0 $8000 $8000 $4000
Maximum Loss Possible -8,000 -8000 -4000 -20000 April 1 24000 -20000 1600 1600 800
($20,000) sale
Safe Payment $8000 $8000 $4000 $20000 $24000 $0 $0 $0 $9600 $9600 $4800
Final -24000 -9600 -9600 -4800
Distrib.
$0 $0 $0 $0 $0 $0 $0

67 – Predistribution Plan - Heading 68 – Predistribution Plan - #1

• Instead of preparing Schedule of Safe

Payments with each distribution
Predistribution Plan • 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

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69 – Predistribution Plan - #1 70 – Predistribution Plan - #5

• What you may have noticed in prior e.g. is

that B got cash before the other A B C
Prs…Why?
– B had disproportionately more capital than Profit & Loss Percentage 40% 40% 20%
his/her % in Pp profits/losses justified February 17th Distribution $10,000
– When other Prs were allocated their share of
Pp losses, their capital was eliminated BUT B March 5th Distribution $800 $15,800 $400
still had capital
– The early cash payments to B wiped out the March 17th Distribution $8,000 $8,000 $4,000
disproportionate nature of B’s capital
– Once disproportionate nature of Pp capital Final Distribution $9,600 $9,600 $4,800
accts eliminated  Then Prs received cash
equal to their % in Pp profits/losses

71 – 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 1st
• 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 Capital 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

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73 – Predistribution Plan - #4 74 – Predistribution Plan - #5

Capital Balances

A B C
• Prs with lower MLA will be wiped out while 1 Profit & Loss Percentage 30% 50% 20%
Prs with large MLA will still have pos cap Capital & Loan Balances $33000 $45000 $14000
acct bals & be entitled to distribution Allocate Liquidation
Expenses
-3000 -5000 -2000

• This creates the priority of Pp liquidation 2 Balances $30000 $40000 $12000

Maximum Loss $100000 $80000 $60000
payments Absorbable(2/1)

• 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 $6,000

75 – Predistribution Plan - #5 76 – Predistribution Plan - #8

Capital Balances

A B C
• The following Pre-distribution Plan results
1 Profit & Loss Percentage 30% 50% 20%
2 New Balances $24000 $40000 $12000 from the foregoing calculations:
Maximum Loss $80000 $80000 $60000
Absorbable(2/1)
Level Amount Payable To
1 $20,000 To Creditor For Liabilities
• At $60,000 of Pp losses
– C will be wiped out 2 $10,000 To Professionals For Liquidation
– After A’s share of the $60K loss ($60 x .3 = $18K)  A will Expenses
have $6K of capital left ($24K - $18K)
– After B’s share of the $60K loss ($60 x .5 = $30K)  B will 3 $6,000 To A
have $10K of capital left ($40K - $30K)
4 $16,000 To A [37.5% (6/16)] & B [62.5%
• So, Before C gets a dime 
– A will get $6,000 more &
(10/16)]
– B will get $10,000 5 Remaining To A (30%), B (50%) & C (20%)
• Thereafter, A, B & C share cash 30%,50% & 20% Payments

19