PARTNERSHIP LIQUIDATION – INSTALLMENT INSTALLMENT B. Partnership Liquidation by INSTALLMENT Under this method, realization of non-cash assets is accomplished over an extended period of time. It is a process of selling some assets, paying the creditors, paying the remaining cash to the partners, realizing additional assets, and making additional payments to the partners. The liquidation will continue until all the noncash assets have been realized and all available cash distributed to partnership creditors and partners.
Installment payments to partners are appropriate if necessary safeguards are used to ensure that all partnership creditors are paid in full and that no partner is paid more than the amount to which he would be entitled after all losses on realization of assets are known. The procedures may be followed in installment liquidation: 1. Realization of non-cash assets and distribution of gain or loss on realization among the partners based on their profit and loss ratio. 2. Payment of liquidation expenses and adjustment for unrecorded liabilities; both of these terms will be distributed among the partners in their profits and loss ratio. 3. Payment of liabilities to outsiders. 4. Distribution of available cash based on a schedule of payments which assumes possible losses due to inability of the partnership to dispose of part or all the remaining non-cash assets and failure of the partners with capital deficiencies to make additional contributions. Payments to partners can also be made based on a cash priority program.
Schedule of Safe Payments a schedule of safe installment payments to partners The use of safe payment schedules is a reliable method of computing the amount of safe payments to partners for it prevents excessive payments to any partner. However, the approach is inefficient if numerous installment distributions are to be made to partners. Based on three assumptions: assumptions : 1. Loan to or from an individual partner will be combined with respective partner’s capital account. 2. Remaining noncash assets will not provide any additional cash. 3. Partner with a debit balance in capital account will be unable to pay amounts owed. A safe payment schedule is prepared each time cash is to be distributed.
Advance Plan for the Distribution of Cash Objective is to derive the order and the amount of cash that should be distributed to each partner such that no partner receiving a cash distribution will have to make an additional investment. Step 1 Determine net capital interest of each partner. Step 2 Provide an order of cash distribution in which the ratio of partners’ capital interest will eventually be equal to their profit and loss ratio. (All partners will then have an equal ability to absorb their share of partnership losses.) Step 3 Determine the amount of cash to distribute to bring the ratios of their capital interests into alignment with their profit and loss ratios. Step 4 Prepare a cash distribution plan.
Profit & Loss Agreement Combined claims of partners Less: Maximum loss possible Capital balances Less: Absorption of capital deficiency Safe payment
A % xxx xxx xxx xxx xxx
Partners B C % % xxx xxx xxx xxx xxx
xxx xxx xxx xxx xxx
Total % xxx xxx xxx xxx xxx
Loss absorption balances represent the maximum loss that the partners can absorb without reducing their equity below zero. The partner with the biggest capital exposure or loss absorption balance should be prioritized in a cash distribution. A partner with a relatively low loss absorption balance can be wiped out by a material realization loss.
Cash priority program This program which is prepared at the start of the liquidation process will help the partners project when they can expect to be included in the cash distribution. If the program is prepared, any amount of cash received from the realization of the partnership assets may be paid immediately to partnership creditors and later, the partners as specified in the program. The pre-distribution plan: 1. Combines partner’s loan balances with their respective capital balances;
2. Anticipates all possible liabilities, losses on realization, and liquidation expenses.
The formula in computing the maximum loss absorption capacity: Maximum loss absorption capacity
=
Total partner’s claims in the partnership Partner’s profit and loss percentage
To complete the cash priority program, the following steps must be observed: 1. Equalize the absorption capacity of all the partners by deducting the difference of first priority and second priority, and so on. 2. Determine the amount of priority cash payments by multiplying the differences with the profit and loss ratio of the partners having the highest capacity. 3. When the absorption capacity for all partners becomes equal to each other, then any succeeding cash for distribution will be shared based on profit and loss ratio at this stage. In other words, after numbers 1 and 2 cash distribution priority are satisfied, the remaining cash available shall be distributed according to the partner’s profit and loss ratio. I t is because the ratio of the partners’ capital balances becomes equal to their respective profit and loss ratio. 4. Compute the cash available for distributions. 5. Distribute the cash available according to cash priority program and the balance shall be distributed based on the profit and loss ratio.