Advanced Accounting Exam 4

In what order must partnership assets be distributed?

#1: creditors #2: partners for other than capitals + profits #3: partners capital #4: partners profit

Ownership changes admission: Bonus method

*recording changes in membership of partnership -assets increased by assets of new partner -difference between assets and capital accounts is adjusted with the capital accounts of other partners

Ownership changes admission: Goodwill method

*recording changes in membership of partnership new asset is recorded that is based on difference between value implied by the amount of consideration negotiated and the values reported on the books

What is the "loss absorption potential"?

-Capital balance / profit or loss ratio = loss we can absorb -how much your capital balances can be eaten up by your losses

Ownership Changes: Withdrawal of partners

-Retiring partner -Death of a partner

Operation of partnerships: reporting

-changes in partner's equity (on BS or supplementary schedule) -salary is generally allocation of income rather than expenses -no income tax expense pass through -interest paid to a partner on a loan is an expense

Why does a debit balance in a partners' capital account create problems in the UPA order of payment for a partnership liquidation?

-debit balance ---> negative capital (concern) -problem- arises if a partner also has a loan due from the partnership, offset loans before you handle a debit balance. Loans add to the capital balance; loans claims against partnership. -close loan against debit balance -partner could put more money in or allocate money out -can offset loan or add money back The UPA then provides for an order of payment that ranks partnership obligations to a partner ahead of asset distribution to a partner for capital investment. However, if a partner has a debit capital balance and has lent money to the partnership, it is legally permissible to offset the loan balance against the debit capital balance. The courts have recognized that this "right of offset" is necessary in order to avoid the potential inequity of distributing cash to a partner to satisfy an outstanding loan balance when the partner has either a debit capital balance or potential for a debit capital balance.

Partnerships

-influenced by their agreements and state -profits, management, and interest equal unless agreed to otherwise -purchases of another partner's interest does not have the right to management unless accepted by ALL the partners -joint venture is limited to that of the undertaking -major difference is the recording of the capital -no revenue or expense in dealing with partners

Formation of partnerships

-non-cash assets and liabilities are recorded at FV -net assets should equal capital interests agreed upon

Discuss the 3 basic assumptions necessary for calculating a safe cash distribution. How is this safe cash distribution computed?

1) a loan to or from an individual partner is combined with the partner's capital balance to determine his or her interest in the partnership assets. 2) the remaining non-cash assets will not provide any additional cash 3) any partner with a debit balance is assumed unable to the pay the amounts owed to the partnership -the result of applying these assumptions is that cash will not be distributed to any partner whose capital balance is insufficient to absorb his or her share of potential losses.

Under UPA partnerships need:

1) agreement 2) profit purpose 3) co-owners

Two methods of partnership liquidation

1) simple liquidation 2) installment liquidation

In what manner should the final cash distribution be made in partnership liquidation?

Any partnership cash remaining after paying liabilities and liquidation expenses is distributed to the individual partners on the basis of their representative capital balances.

Contribute assets (3 cases)

BV = FV of assets invested BV > FV of assets invested BV < FV of assets invested

Moore invests 90,000 cash and receives a 1/3 capital interest Current capital: 180,000

BV = FV of assets invested neither bonus or goodwill method

Moore invests $40,00 cash for a 1/4 capital interest. The partners should agree that assets and the firm as a whole should not be revalued Current capital: 180,000

Bonus method only (firm as a whole should not be revalued)

Moore invests land in the partnership as a site for a new office building. The land, which originally cost Moore $90,000 now has a current MV of $150,000. Moore is admitted with a 1/3 capital interest. Current capital: 180,000

Both bonus and goodwill method

Moore invests 120,000 cash for a 45% capital interest. Total capital after admission is to be $300,000. Current capital: 180,000

Capped amount of $300,000 means bonus method only (can't add an asset)

How are unexpected costs such as liquidation expenses, disposal costs, or unrecorded liabilities covered in the safe distribution schedule?

Certain expenses such as the reasonable cost of carrying out the liquidation, have priority over payment to creditors. Furthermore, the disposal cost of assets may exceed the proceeds from the sale of assets so that the resulting loss is greater than the asset's recorded book value. Such items can be considered in the safe payment schedule adding the estimated liquidation expenses, disposal cost, and unrecorded liabilities to the BV of non cash assets.

Moore invests $35,000 cash for a 1/5 capital interest. The partners agree that total capital after the admission of Moore should be $225,000 Current capital: 180,000

Goodwill method only (capital doesn't match # given to us: 215,000 calculated vs 225,000 given)

Moore agrees to invest $120,000 cash for 1/3 capital interest, but will not accept a capital credit less than his investment Current capital: 180,000

Goodwill method only (won't accept a capital credit less than his investment)

Why are realization gain or losses allocated to partners in their P/L ratio?

Procedurally gains and losses on the realization of assets may be collected in one account and then closed to the capital accounts of the individual partner. The allocation of realization G/L's should be based on the residual P/L ratio, unless specific provisions for such allocation are made in the partnership agreement. The rationale for this procedure is that since the changes in asset values are the result of risk assumed by the partnership the G/L should be shared in the agreed P/L ratio. In addition, it may be difficult to separate G/L that result from liquidation from the under or overstatement of book values that results from accounting policies followed in prior years.

What is "marshaling of assets"?

Recognition of the rights of these two groups of creditors and the classification of assets into personal and partnership categories. (protect partners and personal creditors)

SaPODIP

Sell assets Pay creditors Offset loans Debit balances Investment Payments (based on capital balances, not P/L ratio)

In an installment liquidation, why should the partners view each cash distribution as if it were the final distribution?

The amount of cash to be generated from the sale of non-cash assets and the resulting G/L is not known. Therefore, the partners should view each cash distribution as if it were the final distribution. Installment---> assume can sell nothing else out of value, additional future sales and cash is unknown , operate under assumption it is the final one.

What is the objective of the procedures used for the preparation of an advance cash distribution plan?

The objective is to determine the amount of cash to distribute to each partner to bring the ratios of their capital interests in the partnership into alignment with their P/L ratios.

Discuss the possible outcomes in the situation where the equity interest of one partner is inadequate to absorb realization losses.

a partner who has a negative equity interest - partner invest in the partnership or other partners cover the losses. (pg 510)

Goodwill method (admission or withdrawal of a partner)

adds or subtract goodwill (intangible benefit) to the books (non-GAAP) **method is only consistent with GAAP when the change qualifies as a business combination but may not be used for internal purposes

Simple liquidation

all non-cash assets are converted into cash before any assets are distributed to creditors and partners

Bonus method (admission or withdrawal of a partner)

always good with GAAP

Capital similar to

an equity account

BV > FV of assets invested

bonus to NEW partner goodwill based on existing partners

BV < FV of assets invested

bonus to existing partners goodwill based on new partner (goodwill: won't take less than assets invested)

Partner withdraws in violation

entitled only to interest in the firm without consideration of goodwill

Partner forced to withdraw

entitled to compensation for his full interest including goodwill

Operation of partnerships: allocation of NI

equal unless otherwise stated: -fixed ratio -ratio of capital balances -interest on capital investments -salary and/or bonus

Drawing accounts

how much cash you take out (debit: to record withdrawal of assets)

Capital account

how much of assets a partner owns

Goodwill method

intangible asset booked to reflect "extra" capital (something extra that can't be specifically identifiable)

Capital interest

is a partner's claim against the net assets of the partnership

Debit capital

loss

Partners are all personally insolvent

no investments

Installment liquidation

non-cash assets are sold in installment and cash is distributed to various equity accounts as it becomes available

Retiring partner: payment of less

only the bonus method should be used. extra added to remaining partner's capital accounts.

Credit capital

profit

Salaries

recognized as an allocation of profit rather than as an expense in the determination of NI

Bonus method

transfer from one partner to another in reluctance to book an intangible asset

2. Distinguish between a partner's interest in capital and his interest in the partnership's income and losses. Also, make a general distinction between a partner's capital account and his drawing account. Capital interest is in the net assets of the firm. In the partnership agreement you can get a different percentage. Capital account is how much you own. 8. Discuss the methods used to record changes in partnership membership. Clarify when the goodwill method may be useful for internal purposes but is not consistent with GAAP, and when the goodwill method is appropriate under GAAP. Bonus is always good with GAAP. Goodwill method adds or subtracts goodwill from the books. There must be an intangible benefit and reason to have it on the books. There must be a reason that qualifies it to be GAAP. 9. Differentiate between the admission of a new partner through assignment of an interest and through investment in the partnership. If you buy the partnership from a partner, it's simple. If you add a new partner you have to reallocate capital, and contribute to the partnership. 11. Describe the circumstances where neither the goodwill nor the bonus method should be used to record the admission of a new partner. When you get exactly the credit you put in. Book Value = Assets Invested 12. How might a partner withdrawing in violation of the partnership agreement and without the consent of the other partners be treated? What about a partner who is forced to withdraw? If a partner wants to leave in violation of the agreement, you get back the capital interest (what's owed), nothing extra. When forced to withdraw, they receive capital interest + goodwill.

Chapter 15

3. Why does a debit balance in a partners' capital account create problems in the UPA order of payment for a partnership liquidation? Here you have a partner owing the partnership, instead of the partnership owing the partner. The partner has to put in more money or the other partners have to cover the balance. This problem can also arise if the partner has a loan. Loans have to be offset before a debit balance is determined. 4. Is it important to maintain separate accounts for a partner's outstanding loan and capital accounts? Explain why or why not. There is a legal distinction that makes it important, so we need to keep it separate for as long as possible 5. Discuss the possible outcomes in the situation where the equity interest of one partner is inadequate to absorb realization losses. A partner with a negative interest can either cover his negative balance, or the other partners would have to. 7. What is "marshaling of assets"? A separation of partner and partnership assets 9. In an installment liquidation, why should the partners view each cash distribution as if it were the final distribution? Very valuable concept. We assume that we can sell nothing els for value. Assume everything is out of the partnership we can get and distribute the cash. It is safer to assume that everything is the final distribution 13. What is the "loss absorption potential"? If you take (capital bal) / (profit loss ratio) tells how much of you balance can be eaten up by losses. How many losses you can afford 14. In what order must partnership assets be distributed? A) Creditors B) Partners for reasons other than capital and profits C) Partners for their capital balances D) Partners for profits

Chapter 16

BV = FV of assets invested

Debit cash Credit capital

Retiring partner: payment in excess

Either method is okay to use with extra going against existing partners (decreasing their capital) or to partnership (increase identifiable assets or add intangible assets) Can record partial goodwill: only what relates to partner leaving Complete goodwill: full new value of partnership based on value leaving

Steps of simple liquidation

First: distribute any NI to date Then: SaPODIP

Is it important to maintain separate accounts for a partner's outstanding loan and capital accounts?

Legal distinction close loan out to capital account. Keep separate for as long as possible.

During liquidation, at which point may cash be distributed to any of the partners?

No cash can be distributed to partners until all liabilities are paid off.

Moore is admitted to the partnership by purchasing a 30% capital interest from each partner. A payment of 35,000 is made outside the partnership and is split between Brown and Cost Current capital: 180,000

No cash-made outside the partnership debit: brown & coss capital accounts credit: moore capital (reallocate to partner's capital accounts)

To what extent can personal creditors seek recovery from partnership assets?

Personal creditors of an individual partner can seek recovery of payment from personal assets of the respective partner and under certain conditions from partnership assets.