14- partnerships- ownership changes and liquidation

Chapter 14Partnerships: Ownership Changes and Liquidation

Chapter 14

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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 3

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 4

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

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The value of assets contributed to an existing partnership

• unrecognized appreciation on recorded net assets

• and/or unrecognized goodwill

May be in excess of that suggested by the book value of the original partnership’s net assets which suggests that the partnership may have

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The value of assets contributed to an existing partnership, continued

• suggests unrecognized depreciation or write-downs on recorded net assets of the original partnership

• and/or additional intangible assets being contributed by the incoming partner

May be less than that suggested by the book value of the original partnership’s net assets

C14 7

Contribution of assets to an existing partnership• Bonus Method

• Goodwill Method

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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 partnership’s 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 9

The bonus method, continued

• New partner’s 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

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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

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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)

• C’s interest in new partnership: $54,000 (20% $270,000)

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Cash 70,000A, Capital 9,600B, Capital 6,400C, Capital 54,000

Journal Entry

Bonus method:No asset write-down suggested, continued

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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

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• $32,000 asset write-down suggested ($210,000 – [$200,000 + $42,000])

Bonus method:Asset write-down suggested, continued

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Analysis, concluded

• Book value of new partnership: $210,000 ($200,000 - $32,000 + $42,000)

• C’s interest in new partnership: $42,000 (20% $210,000)


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A, Capital 19,200B, Capital 12,800

Net Assets 32,000

Cash 42,000C, Capital 42,000

Journal Entries


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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

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The goodwill method, continued• Both net asset write-downs and write-ups are

recorded

• New partner’s 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 19

Identifying and measuring goodwill traceable to the previous partnership

1. Calculate the value of the partnership suggested by the incoming partner (incoming partner’s 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 . . .)

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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 21

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

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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])

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Analysis, continued

• The $80,000 is allocated

–$20,000 ($200,000 vs. $220,000) to unrecorded net appreciation

–$60,000 to goodwill


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Goodwill 60,000Net Assets 20,000

A, Capital 48,000B, Capital 32,000

Cash 70,000C, Capital 70,000


Journal Entries

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Identifying and measuring goodwill traceable to the new partner

1.Calculate the value of the partnership suggested by the incoming partner (incoming partner’s 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 . . .)

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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 . . .)

Identifying and measuring goodwill traceable to the new partner, continued

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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

Identifying and measuring goodwill traceable to the new partner, continued

C14 28

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

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• Unrecognized net asset appreciation traceable to original partners: $20,000 ($220,000 - $200,000)

Goodwill traceable to the new partner, continued

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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 31

Journal Entries

Net Assets 20,000A, Capital 12,000B, Capital 8,000

Cash 45,000Goodwill 10,000

C, Capital 55,000


C14 32

Contribution of assets to existing partners

Generally, a portion of the selling partner’s book value of capital is transferred to the buying partner

Example: The book value of B’s capital interest is $50,000. C acquires one-half of B’s capital interest for $30,000:

B, Capital 25,000C, Capital 25,000

C14 33

Withdrawal of a partner

Withdrawing partner may sell interest to

• the partnership and/or

• an individual partner

C14 34

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 35

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

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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”

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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

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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

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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 partner’s capital balance

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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

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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

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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

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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

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Installment liquidation

Non-CashCash Assets Liabilities A B

Beginning Balance $12,000 $100,000 $42,000 $50,000 $20,000Sale of Assets 40,000 (60,000) - (10,000) (10,000)Payment of Liabilities (42,000) - (42,000) - -Balances $10,000 $40,000 $0 $40,000 $10,000Distributions (10,000) (10,000)

Loan & Capital Balances

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Installment liquidation

A BCapital Balances $40,000 $10,000Maximum Loss Possible (20,000) (20,000)Allocate Debit Balances (10,000) 10,000Safe Payment 10,000 -

Schedule of Safe Payments

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Predistribution plan• Based on how much loss a partner could

absorb (i.e., maximum loss absorbable, the MLA)

• MLA = partner’s capital balance partner’s profit and loss percent

• Partner with the largest MLA is the strongest and should be the first to receive a distribution

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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

14- partnerships- ownership changes and liquidation

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