Chapter 14 Partnerships: Ownership Changes and Liquidation Chapter 14 Ownership changes


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Chapter 14

  • Partnerships: Ownership Changes and Liquidation
  • Chapter 14

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

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

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

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

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

Contribution of assets to an existing partnership

  • Bonus Method
  • Goodwill Method

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

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

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

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)

Bonus method: No asset write-down suggested, continued

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

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

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])

Bonus method: Asset write-down suggested, continued

  • 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)

Bonus method: Asset write-down suggested, continued

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

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

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

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 . . .)

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

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

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])

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

Goodwill traceable to the previous partnership, continued

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

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 . . .)

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 . . .)

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

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

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)

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)

Goodwill traceable to the new partner, continued

  • Journal Entries
  • Net Assets 20,000
  • A, Capital 12,000
  • B, Capital 8,000
  • Cash 45,000
  • Goodwill 10,000
  • C, Capital 55,000

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 25,000
  • C, Capital 25,000

Withdrawal of a partner

  • Withdrawing partner may sell interest to
  • the partnership and/or
  • an individual partner

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)

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

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

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

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

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

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

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

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

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

Installment liquidation

Installment liquidation

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

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

Katalog: accounting

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