Solution manual advanced accounting 4e jeter ch16

The final cash distribution is based on capital balances, not on profit and loss ratios, since the capital balance represents the partners' "residual claims" to the assets remaining afte

CHAPTER 16 ANSWERS TO QUESTIONS

1 Realization gains or losses are allocated to partners in their profit and loss ratio because the changes

in asset values are the result of risk assumed by the partnership Also, because it may be difficult to separate gains and losses that result from liquidation from the under- or over-statement in book values that result from accounting policies followed in prior years

2 The final cash distribution is based on capital balances, not on profit and loss ratios, since the capital balance represents the partners' "residual claims" to the assets remaining after settlement of partnership obligations

3 Because the UPA order of payment ranks partnership obligations to a partner ahead of asset distributions to a partner for capital investments, a debit balance in a partner's capital account will create problems when that partner has an outstanding loan balance Other partners will have a claim against this partner for the amount of his/her debit balance which is considered to be an asset

of the partnership by the UPA If the partner with a debit balance settles his/her obligation with the partnership, there is no problem However, if he/she can't settle, the other partners must absorb the deficit as a loss, even though the partner with the debit balance had received cash for his/her outstanding loan balance To avoid this inequity, the courts have recognized the right of the partnership to offset the loan balance against the debit capital balance

4 Maintaining separate accounts for outstanding loan and capital accounts recognizes the legal distinction between the two This would be important if the liquidation is carried on over an extended period, since the UPA provides that a partner is entitled to accrued interest on the loan balance

5 When the equity interest of one partner is inadequate to absorb realization losses several alternative outcomes are possible If the partner is personally solvent, he may pay the partnership for the amount he is liable If he/she is personally insolvent then the other partners must absorb his/her debit balance in their respective profit and loss ratio If the other partners are unsure of what the partner with the debit balance will do, but still wish to distribute cash, they can assume the worst (absorbing their share of the debit balance) to determine what amount of cash can be safely distributed

6 Cash should not be distributed to any partner until all liquidation losses are recognized in the accounts or are provided for in determining a safe cash payment

7 The classification of assets into personal and partnership categories in recognition of the rights of both partnership creditors and creditors of the individual partners is referred to as "marshalling of assets."

8 To the extent that personal creditors do not recover from personal assets they can seek recovery

9 Because in an installment liquidation the amount of cash to be received from the unsold assets and the resulting gain or loss is unknown, the partners should view each cash distribution as if it were the final distribution

10 The three assumptions upon which a safe cash distribution is determined are (1) any loan balances

to partners are offset against their capital accounts, (2) the remaining noncash assets will not generate any more cash, and (3) any partner with a deficit capital balance will not settle his/her obligation to the partnership In other words, assume the worst

The safe cash balance is computed as the difference between the current capital balances and the balance required to maintain the above assumptions

11 Unexpected costs are added to the book value of noncash assets When the potential loss on the noncash assets is allocated in the determination of a safe payment, these costs are also included

12 The objective of the procedure is to bring the balance of the partners' capital accounts into the agreed profit and loss ratio as soon as possible so that no one partner is placed in a better position than any other partner

13 The "loss absorption potential" is determined by dividing the partners' net capital balances by their respective profit ratio This determines the maximum amount of loss each partner can absorb

14 The Uniform Partnership Act provides that the liabilities of the partnership shall rank in order of payment as follows:

(1) Those owing to creditors other than partners,

(2) Those owing to partners other than for capital and profits,

(3) Those owing to partners in respect of capital,

(4) Those owing to partners in respect of profits

Business Ethics Solution

Business ethics solutions are merely suggestions of points to address The objective is to raise the students' awareness of the topics, and to invite discussion In most cases, there is clear room for disagreement or conflicting viewpoints

1) Partnership laws grant each partner the right to information about the firm’s business This allows each partner to monitor the firm’s activities Given the circumstances of the case, it would be your duty to inspect any questionable transaction Furthermore, you should ask the partner to explain the reason for increasing the cost by $10,000 This would give you the

opportunity to raise the concern regarding the presence of the previously undetected rock If the additional charge is not based on fact, the cost should be removed

2) In the present scenario, it appears that the partner might be experiencing personal financial pressures However, the firm’s reputation and future implications of the action must be

considered for the benefit of the partnership Your loyalty to your partner does not alter these responsibilities You may wish to find other, more constructive ways to offer assistance to your partner in meeting his personal obligations, and surviving what may be a difficult time in his life However, ignoring the situation is dishonest to the client and is likely to result in more serious long-term consequences

Reference: http://www.lrc.ky.gov/KRS/362-01/403.PDF

Exercise 16-2

Part A Noncash Capital Balances

Cash Assets Liabilities John Jake Joe

The first $40,000 is paid to satisfy the claims of creditors

Cash Assets Liabilities 40% 40% 20%

$ 0 $87,000 $ 0 $(41,333) $(25,000) $(20,667) Schedule 1

Brink Davis Olsen

Exercise 16-6

Capital Balances

Cash Assets Liabilities 40% 30% 30%

Balances $15,000 $110,000 $(42,000) $(55,000) $(14,000) $(14,000) Sale of other assets and allocation of loss 30,000 (110,000) 0 32,000 24,000 24,000 45,000 0 (42,000) (23,000) 10,000 10,000 Allocate Zack's debit balance 5,714 4,286 (10,000) 45,000 0 (42,000) (17,286) 14,286 0

Investment by Tom 14,286 (14,286)

59,286 0 (42,000) (17,286) 0 0

Payment to creditors (42,000) 42,000

17,286 0 0 (17,286) 0 0

Payment to Pete (17,286) 17,286

$0 $0 $0 $0 $0 $0 Pete receives $17,286

Tom makes an additional investment of $14,286

Zack receives zero and cannot make an investment in the partnership because he is personally insolvent

Part B Personal Personal Excess Distribution from Total Payable

Assets Liabilities (Deficiency) Partnership to Creditors

Exercise 16-7 Exercise 16-8

1 c 1 c; X = ¼ ($690,000 + X); X = $230,000

Exercise 16-9

Part A The partnership creditors will receive payment before any distributions are made to the partners The creditors can seek recovery

from Q and S's personal assets after their personal creditors have been paid from their personal assets

Part B The personal creditors have first claim to the personal assets If they have not fully recovered the amount owed, they have a right

to partnership assets after partnership creditors to the extent the partner has a credit interest in the partnership

Exercise 16-10 Matt Allen Dave

Part A Net capital interest $54,000 $30,000 $18,000

Loss Absorption Potential Assets Distribution Matt Allen Dave Matt Allen Dave

Distribution to Matt to reduce loss potential to Allen's 20,000 9,000

Distribution to Matt and Allen to reduce loss potential to Dave's 28,000 28,000 12,600 8,400

$72,000 $72,000 $72,000 $32,400 $21,600 $18,000

Order of Cash Distribution Liabilities 45 30 25

First $9,000 available to partner $9,000

ANSWERS TO PROBLEMS

Problem 16-1

Schedule of Partnership Liquidation

January 14, 2008

Capital Balances

Balances before realization $25,000 $120,000 $(40,000) $(31,000) $(65,000) $(9,000) Sales of noncash assets 60,000 (120,000) 18,000 24,000 18,000

Problem 16-1 (continued) DISCOUNT PARTNERSHIP

Schedule of Partnership Liquidation

Capital Balances Explanation Cash Other Assets Liabilities Dawson Feeney Hardin Balances before realization $25,000 $120,000 $(40,000) $(31,000) $(65,000) $(9,000) Sales of noncash assets 50,000 (120,000) 21,000 28,000 21,000

Problem 16-2 Capital & Loan Balances

Sale of asset and allocation of gain 16,000 (12,000) - (1,600) (1,200) (1,200)

21,000 48,000 (20,000) (21,600) (13,200) (14,200) Payment to creditors (20,000) - 20,000 - - -

1,000 48,000 0 (21,600) (13,200) (14,200) Payment to partners (Schedule 1) (1,000) - - 1,000 -

0 48,000 0 (20,600) (13,200) (14,200) Sale of assets and allocation of gain 12,000 (10,000) - (800) (600) (600)

12,000 38,000 0 (21,400) (13,800) (14,800) Payment to partners (Schedule 2) (12,000) - - 6,200 2,400 3,400

0 38,000 0 (15,200) (11,400) (11,400) Sale of assets and allocation of loss 10,000 (20,000) - 4,000 3,000 3,000

Problem 16-3 Capital & Loan Balances

Cash Assets Liabilities 0.50 0.30 0.20

6,000 98,000 0 (43,000) (37,800) (23,200) 3/18 cash distribution (Schedule 1) (5,000) - - - 4,200 800

1,000 98,000 0 (43,000) (33,600) (22,400) 3/19 adjustment to fair value - 3,000 - (1,500) (900) (600)

1,000 101,000 0 (44,500) (34,500) (23,000) 3/19 withdrawal by Murphey - (13,000) - - 13,000 -

1,000 88,000 0 (44,500) (21,500) (23,000) 3/21 sale – allocate loss 30,000 (50,000) - 10,000 6,000 4,000

31,000 38,000 0 (34,500) (15,500) (19,000) 3/25 assign lease 12,000 - - (6,000) (3,600) (2,400)

3/25 cash distribution (Schedule 2) (43,000) - - 21,500 7,700 13,800

0 38,000 0 (19,000) (11,400) (7,600) 4/1 adjustment to fair value - (2,000) - 1,000 600 400

0 36,000 0 (18,000) (10,800) (7,200) 4/1 withdrawal by Hamm - (8,000) - 8,000 - -

0 28,000 0 (10,000) (10,800) (7,200) 4/5 sale and allocate loss 4,000 (28,000) - 12,000 7,200 4,800

4,000 0 0 2,000 (3,600) (2,400) 4/6 investment by Hamm 2,000 - - (2,000) - -

6,000 0 0 0 (3,600) (2,400) 4/6 final distribution (6,000) - - - 3,600 2,400

$0 $0 $0 $0 $0 $0

Problem 16-3 (continued)

Schedules to Compute Safe Payments

0.50 0.30 0.20

Capital balances $(43,000) $(37,800) $(23,200) Allocation of potential loss ($99,000) 49,500 29,700 19,800 6,500 (8,100) (3,400) Allocation of deficit balance (6,500) 3,900 2,600 Safe cash payment $0 $(4,200) $(800)

Schedule 2 Hann Murphey Ryan Capital balance $(40,500) $(19,100) $(21,400) Allocation of potential loss ($38,000) 19,000 11,400 7,600 Safe cash distribution $(21,500) $(7,700) $(13,800) Problem 16-4 MARY, PAULA, AND RAY Schedule of Partnership Liquidation Other Mary Paula Ray Cash Assets Liabilities 0.40 0.30 0.30 Part A Balances before realization $10,000 $100,000 $(40,000) $(50,000) $(10,000) $(10,000) Sale of assets 20,000 (100,000) 32,000 24,000 24,000 30,000 0 (40,000) (18,000) 14,000 14,000 Allocate Ray's debit balance 8,000 6,000 (14,000) 30,000 0 (40,000) (10,000) 20,000 0

Investment by Paula 20,000 (20,000)

50,000 0 (40,000) (10,000) 0 0

Distribution of cash (50,000) 40,000 10,000

$0 $0 $0 $0 $0 $0 Mary will receive $10,000

Paula must invest $20,000

Ray is personally insolvent and cannot make an investment in the partnership to eliminate the deficit balance

Problem 16-4 (continued)

Partnership Personal Distribution Total

Problem 16-5

Baker Strong Weak

Part A Capital and loan balances $55,000 $45,000 $24,000

Loss Absorption Potential Cash Distribution Baker Strong Weak Baker Strong Weak

Reduce loss absorption potential of Baker 17,500 7,000

Problem 16-5 (continued) Cash Distribution

Total Creditors Baker Strong Weak

Plant and Equipment

Accounts Payable

Baker 0.40

Strong 0.40

Weak 0.20 Account balances $6,000 $22,000 $14,000 $99,000 $(17,000) $(55,000) $(45,000) $(24,000)

Cash distribution (Schedule 1) (23,500) 17,000 6,500 Account balances (end of July) 8,000 0 0 99,000 0 (44,300) (40,800) (21,900)

$0 $0 $0 $0 $0 $0 $0 $0