alex sokratous economics...

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Partnership

Dissolution

Alex Sokratous – Economics

Department

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Introduction

A partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business.

The assets of the partnership will be realized to pay off the liabilities.

The sales proceeds should be applied in the following order, as required by the Hong Kong Ordinance: Pay off creditors first,

then the partners‟ advances, and

Finally the partners‟ capital

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Realization Account

In the partnership dissolution, an account

named as „Realization Account‟ will be

opened to compute the profit or loss from

realization which should be shared among

the partners according to the profit or loss

sharing ratio

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Nature of partnership dissolution

Dissolution where the assets are sold

separately

Dissolution where partnership is sold as a

whole

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Dissolution where

Assets are sold

separately

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Procedures of Dissolution

1. All assets will be sold to other persons or

taken over by partners

2. Settle the liabilities of the partnership to

outsider or partners

3. Transfer any „profit or loss on realization‟

to each partner‟s capital accounts in

profit/loss sharing ratio

4. Merge the balances in the partners‟

current accounts to their capital accounts

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5. Any credit balance in each partner‟s

capital account represents the amount

which can be withdrawn from the

partnership to each partner; any debit

balance in a partner‟s capital account

represents additional cash to be injected

by that partners

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Transactions Accounting entries

Close all asset accounts with

net book value to the

realization account (except

cash and bank because

these assets need not be

disposed of)

Dr Realization

Cr Assets

Cost of dissolution or any

losses or expenses incurred

on realization

Dr Realization

Cr Bank

Proceeds from the disposal

of assets

Dr Bank

Cr Realization

Assets taken over by a

partner without payment

Dr Capital

Cr Realization

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Asset taken over by partners

as a gift

No entries required

Creditors taken over by a

partner

Dr Creditors

Cr Capitals

Payment to creditors with

discounts received

Dr Creditors

Cr Realization – discount

Cr Bank

Profit or loss on realization

to be shared among the

partners according to the

profit-sharing ratio

Dr Realization – profit

Cr Capitals

or

Dr Capital

Cr Realization - loss

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Repayment of loan to an

partner

Dr Loan from partner

Cr Bank

Repayment of loan to an

outsider ( creditors)

Dr Loan from outsider

Cr Bank

Transfer any balances in

partners‟ current accounts

Dr Current (for credit balance)

Cr Capitals

Or

Dr Capital

Cr Current (for debit balance)

Repayment of remaining

capital to partners

Dr Capital

Cr Bank

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Example 1

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John, Peter and Tom were partners sharing profits and losses in the

ratio 1:1:3.

The balance sheet as at 31 December 1996 was as follows:

Balance Sheet as at 31 December 1996

Fixed Assets Cost Dep NBV

Premises 180000 10000 170000

Motor Vehicles 27500 5500 22000

207500 15500 192000

Current assets

Stock 68250

Debtors 172500

Less: provision for bad debt 1265 171235

Bank 26065

265550

Less: Current Liabilities

Creditors 60000

Working Capital 205550

397550

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Capital: John 100000

Peter 40000

Tom 160000 300000

Current: John 30000

Peter (10000)

Tom 70000 90000

Long – term liabilities

Loan from Tom 7550

397550

Assets and liabilities were disposed of as follows:

1. The premises were sold at $ 200000 and legal charges from the

sale amount to $10000

2. Tom took over the stock and motor vehicles at book value

3. Except for $2500, all debts were collected

4. The creditors were discharged for $56000

5. Realization expenses of $10000 were paid

Required:

Prepare the realization, Bank, Capital and Current account for the dissolution

of partnership

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Realization

Premises

Provision for depreciation

Bal b/f 180000 Prov. for depreciation 10000

Realization 170000

180000 180000

Bal b/f 10000Premises 10000

Premises 170000

15

Realization

Motor Vehicles

Provision for depreciation

Bal b/f 27500 Prov. for depreciation 5500

Realization 22000

27500 27500

Bal b/f 5500Motor Vehicles 5500

Premises 170000Motor Vehicles 22000

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Realization

Debtors

Provision for Bad Debts

Bal b/f 172500 Prov. for bad debts 1265

Realization 171235

172500 172500

Bal b/f 1265Motor Vehicles 1265


Debtors 171235

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Realization

Stock

Bal b/f 68250 Realization 68250


Debtors 171235Stock 68250

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Realization

Bank

Bal b/f 26065 Realization - expenses 10000



Bank- realization expenses 10000

Bank – premises (200000-10000) 190000

- Debtors (172500-2500) 170000

Realization – premises 190000

- debtors 170000

Creditors

Bal b/f 60000Bank 56000

Realization – discount received 4000

60000 60000

Creditors – discount received 4000

Creditors 56000

Loan from Tom

Bal b/f 7550Bank 7550

Loan from Tom 7550

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Realization



Bank- realization expenses 10000

Bank – premises (200000-10000) 190000

- Debtors (172500-2500) 170000

Creditors – discount received 4000

Capital

John Peter Tom John Peter Tom

Bal b/f 100000 40000 160000Realization:

Stock 68250

MV 22000

Tom – stock 68250

- MV 22000Gain on realization:

John 1/5 2553

Peter 1/5 2553

Tom 3/5 7659 12765454250 454250

Gain on realizaiton 2553 2553 7659

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Capital


Bal b/f 100000 40000 160000Realization:

Stock 68250

MV 22000Gain on realizaiton 2553 2553 7659

Current


Bal b/f 30000 - 70000Bal b/f 10000

Capital 10000Capital 30000 70000

30000 10000 70000 30000 10000 70000

Bank

Bal b/f 26065 Realization - expenses 10000

Realization – premises 190000

- debtors 170000

Creditors 56000

Loan from Tom 7550


Peter 32553

Tom 147409

386065 386065

Current 30000 70000

Current 10000

Bank 132553 32553 147409

132553 32553 147409 132553 32553 147409

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Dissolution where

partnership is sold

as a whole

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Purchase consideration

The purchase consideration is to be

discharged by the limited company (buyer)

to partners(seller) to take over the business

Goodwill = Purchase consideration –

( assets at take-over value –

liabilities at take-over value)

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For dissolution of Old partnership (seller)

Close all asset accounts with

net book value to the

realization account (Bank

and cash may be taken over)

Dr Realization

Cr Assets

Cost of dissolution or any

losses or expenses incurred

on realization

Dr Realization

Cr Bank

Proceeds from sale of the

business (purchase

consideration)

Dr Vendee (buyer)

Cr Realization

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Liabilities taken over by the

buyer

Dr Liabilities

Cr Realization

The purchase consideration

settled by cheque, shares

and debentures

Dr Bank/ Shares/

debentures in purchaser‟s

company

Cr Bank

Repayment of remaining

capital to partners

Dr capital

Cr Bank/ shares/ debentures

in purchaser‟s company

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For opening entries of New Company (buyer)

Assets taken over Dr Assets

Cr Business Purchase

Liabilities taken over Dr Business Purchase

Cr Liabilities


offered

Dr Business Purchase

Cr Vendor (seller)


settled by cheques, shares

and debentures

Dr Vendor (seller)

Cr Bank/Shares/Debentures

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Example 2

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John, Peter and Tom were partners sharing profits and losses in the

ratio 1:1:3.




Premises 180000 10000 170000


207500 15500 192000

Current assets

Stock 68250

Debtors 172500


Bank 26065

265550


Creditors 60000


397550

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Peter 40000

Tom 160000 300000

Current: John 30000

Peter (10000)

Tom 70000 90000


Loan from Tom 7550

397550

On 31 December 1996, they incorporated a limited company, Fortune limited,

to take over the partnership business. Fortune Limited had an authorized

capital of $500000 ordinary shares of $1 each.

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Assets and liabilities were disposed of as follows:

1. John took over the stock at book value. Tom collected all the debts except

$2500

2. The company took over the premises at a valuation of $200000, motor

vehicles at $25000, cash at bank and all the liabilities. Goodwill was

valued at $70000 for the purpose of the takeover

3. The purchase consideration was to be discharged by the issue to the

partners of 150000 ordinary shares at $1.2 each, according to the

profit-sharing ratio, and the balance was to be in cash

4. The company also issued 50000 ordinary shares at $1.2 for cash to

outsiders

Required:

Prepare the realization, Capital and the opening balance sheet for the new

company

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Realization

Premises 170000

MV 22000

Stock 68250

Debtors 171235

Bank 26065

Bank be taken over Tom: debtors (172500-2500) 170000

John: stock 68250

Creditors 60000

Loan from Tom 7550

Liabilities taken over by Ltd. Co.

Fortune Ltd – purchase consideration

[(200000+25000+26065-7550-60000)

+70000] 253515

Purchase consideration=Asset-liabilities +goodwill

Capital:

John 20353

Peter 20353

Tom 61059 101765

559315 559315

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Capital


Bal b/f 100000 40000 160000Current 30000 70000

Current 10000Realization

Stock 68250

Debtors 170000

Shares in

Fortune Ltd 36000 36000 108000

Realization

-profit 20353 20353 61059

Bank 46103 14353 13059

(Bal. fig.)

Shares in Fortune Ltd.

150000*1.2 = 180000

John 1/5 36000

Peter 1/5 36000

Tom 3/5 108000 180000

150353 60353 291059 150353 60353 291059

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Fortune Limited

Balance sheet as at 1 Jan 1996

Fixed Assets

Goodwill 70000

Premises 200000

MV 25000 295000

Current Assets

Bank [26065 + (50000*1.2) –(46103+14353+13059)] 12550

Less: Current liabilities

Creditors 60000

Working Capital (47450)

247550

Share Capital

Ordinary Shares (150000*$1+50000*$1) 200000

Share Premium (150000*$0.2+150000*$0.2) 40000

240000

Long-term liabilities

Loan from Tom 7550247550

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Cash distribution

among partners

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Cash Distribution Among Partners

With the application of the Garner vs.

Murray rule

When cash is to be distributed as soon as

possible ( Piecemeal realization)

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With the application of

Garner vs. Murray

rule

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With the application of Garner vs.

Murray rule

Any CREDIT balance in each partner‟s capital account represents the amount which can be withdrawn from the partnership to each partner

Any DEBIT balance in a partner‟s capital account represents additional cash to be injected by that partner. If he is insolvency to repay the amount, the solvency partners will be shared the amount in: Profit & loss sharing ratio

Any agreed ratio given in the examination question

GARNER vs. MURRAY rule may be applied

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What is Garner vs.

Murray rule?

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Garner vs. Murray rule Under the rule, a partner is required to

contribute cash to eliminate the debit balance in his capital account

In the court case of Garner vs. Murray (1904), it was held that subject to any agreement to the contrary, such a debit balance deficiency was to be shared bythe other partner not in their profit and loss sharing ratio but “ the ratio of their lastagreed capitals”

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If one partner is insolvent, his capital deficiency will be shared by other partners according to the „last agreed capital ratio‟ (the ratio of the balances in the capital accounts before the dissolution, in the absence of any agreement to the contrary

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Piecemeal

Realization

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Piecemeal realization

Cash is distributed as it becomes available,

instead of waiting for all the assets to be realized

first

Assets are sold piecemeal, and then outstanding

debts are paid and the remaining cash is finally

distributed to the partners as soon as possible

This situation occurs because some assets can

be sold quickly, and some assets take longer

time to be sold (i.e. less liquid)

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Assumed Loss/Notional Loss

Method

This is possible loss by assuming that the

remaining assets do not have any scrap

value

Any unsold assets will be assumed loss in

each distribution

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Steps on Piecemeal Dissolution

1. Find out the maximum possible loss

Maximum possible loss

= NBV of assets to be realized - Total

proceeds form disposal

OR

Maximum possible loss

= Total capital balances - Total cash to be

distributed to partners( i.e. cash available)

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2. The maximum possible loss is shared by

the partners according to the profit-

sharing ratio

3. Apply the Garner vs. Murray rule if there

is any capital deficiency

4. Distribute any available cash to the

partners according to their remaining

capital balances

5. Repeat the process until all assets have

been realized

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Example 3

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Au, Chow and Lee were partners sharing profits and losses in the ratio 2:2:1.




Goodwill 100000 100000

Land 150000 150000

Plant & Machinery 133000 55800 77200

Fixture & Fittings 30000 13000 17000


445000 92800 352200

Current assets

Stock 64000

Debtors 65000


Cash 160

123160


Creditors 57000

Bank Overdraft 128360


290000

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Capital: Au 120000

Chow 80000

Lee 30000 230000

Current: Au 20000

Chow 20000 40000


Bank loan 20000

290000

On 31 December 1996 the partners agreed to dissolve the partnership

due to a disagreement between the partners. Assets were to be realized,

outstanding debts to be paid and the remainder to be shared by the

partners in an equitable manner.

Distributions of cash were to be made as soon as possible.

January

• Provision was made for dissolution expenses of $2400

• Land was sold for $200000

• The cash available was utilized to settle in full the bank overdraft, the

bank overdraft, the bank loan and all creditors after receiving discounts

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March

• Stock which had originally costed $40000 was sold for $32000

• $15000 was received form debtors

April

• Plant & Machinery were sold for $51000 after paying carriage of $2000

• Fixtures and fittings were sold for $12000

May

• All the outstanding debtors, with the exception of a customer who owed

$4000 settled their accounts

• Motor vehicles were sold for $25000

• The remaining stock was sold for $22000

• Dissolution expenses amounted to $2100

Prepare distribution statement of cash at each stage

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Distribution Statement

Total Au Chow Lee

$ $ $ $

Capital accounts 230000 120000 80000 30000

Current accounts 40000 20000 20000

270000 140000 100000 30000

1st Distribution:

Cash available (w1) ( 47000)Maximum possible loss (2:2:1) 223000 89200 89200 44600

50800 10800 (14600)Lee‟s capital deficiency shared by Au

And Chow in the last agreed capital ratio

(120000:80000) (8760) (5840) 14600

Cash distributed 42040 4960 02nd Distribution:

Cash available (51000+12000) (63000)Maximum possible loss (2:2:1) 160000 64000 64000 32000

33960 31040 (2000)Lee‟s capital deficiency shared by Au

And Chow in the last agreed capital ratio

(120000:80000) (1200) (800) 2000

Cash distributed 32760 30240 0

Capital balance 223000 97960 95040 30000

140000-42040

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3rd Distribution:

Cash available (W2) (93300)Maximum possible loss (2:2:1) 66700 26680 26680 13340

Cash distributed 38520 38120 16660

Capital balance 160000 65200 64800 30000

97960-32760

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W1 Cash available for 1st distribution:

January Opening balance 160

Receipt from land 200000

200160

Less: Payment

Assumed dissolution expenses 2400

(i.e. not actual expenses)

Bank overdraft 128360

Bank loan 20000

Creditors (Bal. Fig.) 49400 200160

0

=> no cash distribution to partners on January

March Receipts:

Stock 32000

Debtors 15000

First cash distributed to partners 47000

„Settle in full‟ means

no more payment will be

paid. => the difference

between 57000 and 49400

is discount received

Back

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•Very often no cash is distributed to partners at first or second month

since outstanding debts must be repaid first and then the remaining

cash can then be distributed to partners.

•Even though the questions have not mentioned to repay outstanding

debts, you should make sure to keep some cash to prepare to repay debts

and could not be distributed it to partners

Notes:

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W3 Cash available for 3rd distribution:

May Receipts

Surplus in dissolution expenses(2400-2100) 300

Collection remaining debtors balance

(65000-15000-400) 46000

Receipts from MV 25000

Receipts from remaining stock 22000

93300

Back

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Realization

Goodwill 100000

Land 150000

Plant & Machinery 77200

Fixtures & fittings 17000

Motor Vehicles 8000

Stock 64000

Debtors 59000

Cash:

Land 200000

Stock (32000+22000) 54000

Debtors (15000+46000) 61000

Plant & machinery 51000

Fixture & fittings 12000

Motor vehicles 25000

Creditors – discount rececived

(57000-49400) 7600Capital:

Au (2/5) 26680

Chow (2/5) 26680

Lee (1/5) 13340 66700477300 477300

Cash - dissolution expenses 2100

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Capital

Au Chow Lee Au Chow Lee

Bal b/f 120000 80000 30000Current 20000 20000

Cash

in March 40240 4960

In April 32760 30240

in May 38520 38120 16660

Realization

-loss 26680 26680 26680

140000 100000 30000 140000 100000 30000

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