Chapter 15 questions

Why are liquidation gains and losses usually recorded as direct adjustments to the partners' capital accounts?

During the liquidation process, monitoring the balance of the partners' capital accounts becomes of paramount importance. That amount will eventually indicate iether the cash to be received by the partners as final distributions or the additional contributions that they are required to pay to the partnership. Consequently, all liquidation gains and losses are recorded directly as changes to the partners' capital balances. Such recording enhances the informational value of the accounts. As an additional factor, the computation of the net income figure is of diminished importance since normal operations have ceased.

According to the UPA, what events should occur if a partner incurs a negative capital balance during the liquidation process?

From a legal viewpoint, any partner who incurs a negative capital balance is obligated to make an additional contribution to offset that amount.

Why would the members of a partnership elect to terminate business operations and liquidate all noncash assets?

Many reasons can exist that would lead to the termination and liquidation of a partnership. The business might simply have failed to generate sufficient profits or the partners may elect to enter other lines of work. Liquidation can also be required by death, retirement, or withdrawal of one of the partners. In such cases, liquidation is often necessary to settle the partner's interest in the business. The bankruptcy of an individual partner can also force the termination of the business as can the bankruptcy of the partnership itself.

After liquidating all property and paying partnership obligations, what is the basis for allocatiing remaining cash among the partners?

Final distributions made to the various partners are based solely on their ending capital account balances unless the partners have agreed otherwise. If any partner has a deficit balance, that partner should make an additional contribution to the partnership to offset the negative capital balance. In some situations, a question may arise as to whether compensation for a deficit will ever be forthcoming from the responsible party. The remaining partners may choose to allocate the available cash immediately based on the assumption that the deficit balance eventually will prove to be a total loss.

What is the difference between dissolution of a partnership and the liquidation of partnership property?

A dissolution refers to the cessation of a partnership. In many cases, this process is simplya a preliminary step in the transfer of business property to a newly formed partnership. Therefore, a dissolution does not necessarily affect the operations of the business or the sale of assets. In a liquidation, actual business activities cease. Partnership property is sold with the remaining cash distributed to creditors and to any partners with positive capital balances. Dissolution refers to changes in the composition of a partnership whereas liquidation is the selling of a partnership's assets.

How is a predistribution plan created for a partnership liquidation?

A predistribution plan is produced based on an assumed series of losses. Each loss is calculated to eliminate in turn the capital balance of one of the partners. In this manner, the accountant can determine the vulnerability to losses exhibited by each capital account. When the last balance is eliminated, the accountant will have established a series of losses that exactly offsets each balance. The predistribution plan is then developed by measuring the effects that are created if the losses do not occur. In effect, the accountant works backwards through the assumed losses to create a pattern of available cash, the predistribution plan.

What is the purpose of a proposed schedule of liquidation, and how is it developed?

A proposed schedule of liquidation is prepared by the accountant to determine the allocation of any cash available in the early stages of a liquidation that exceeds the amount needed to pay all liabilities and estimated liquidation expenses. The schedule is based on anticipating a series of assumed losses from the current day forward: all remaining noncash assets are scrapped, maximum liquidation expenses are incurred, and each partner is personally insolvent. The ending balances that would result from these simulated transactions represent safe capital balances. The amounts calculated as safe capital balances can be distributed as safe payments to individual partners and the partnership will still retain enough capital to absorb all future losses

How are safe capital balances computed when preliminary distributions of cash are to be made in a partnership liquidation?

A safe capital balance is the amount of a partner's capital account that texceeds all possible needs of a partnership as it goes through liquidation. A partner should be able to receive this balance immediately without endangering the future amount to be received by any other party connected with the liquidation. Safe capital balances are computed by making a series of assumptions whereby the partnership undergoes maximum losses during the remainder of the liquidation process: all noncash assets are assumed to have no resale value, liquidations expeses are set at the largest possible estimation, and all partners are viewed as personally insolvent. Any capital balance remaining after this can be distributed to the partners immediately without incurring any risk.

What is the purpose of a statement of liquidation? What information does it convey to its readers?

A statement of liquidation summarizes the financial effect of the liquidation process as it has progreesed to date. Information to be presented includes the balances of all remaining assets, the liability total, and the capital account of each partner. In addition, the allocation of all gains and losses incurred in the liquidation process as well as the payment of liquidation expenses should be reflected in the statement.

How do loans from partners affect the distribution of assets in a partnership liquidation?

Although the Uniform Partnership Act states that loans from partners rank ahead of the partners' capital balances in the distribution of partnership assets, in practice a partner's loan balance is usually merged with that partner's capital balance to minimize the chance of a negative capital balance arising during the liquidation. This particular partner may get less money from the liquidation because of this treatment but the other partners are better protected.