installment-liquidation.pdf

Page 1 of 7 UNIVERSITY OF THE CORDILLERAS COLLEGE OF ACCOUNTANCY INSTALLMEN...

Page 1 of 7 UNIVERSITY OF THE CORDILLERAS COLLEGE OF ACCOUNTANCY INSTALLMENT LIQUIDATION Installment Liquidation. Also termed as “piecemeal liquidation,” this method involves payments to creditors and partners as proceeds of sale of noncash assets are made. Consequently, cash payments to creditors and partners are on installment basis as cash becomes available. Safe Payments Schedule This statement shows a conservative approach to liquidation. It is prepared when there is availability of cash after payment to outside creditors was made. It indicates how the available cash should be distributed to partners. The preparation of safe payments schedule assumes the following as possible losses: 1. Anticipation of all possible liabilities and expected losses/expenses to be incurred in the process of liquidation. 2. All unsold noncash assets will be worthless. The assumed losses are allocated to the partners’ capital balances based on the profit and loss agreements. This may result in an assumed partner debit capital balance. The assumed debit capital balance of a partner is allocated to those partners with credit balances according to their profit and loss ratio. The amount of safe payments is the remaining credit capital balance of partners after allocating the assumed debit capital balance. The basic format of the safe payments schedule would appear as: Partners A B C Total Profit and loss agreement % % % % Combined claims of partners xxx xxx xxx xxx Less: Maximum loss possible xxx xxx xxx xxx Capital balances xxx xxx xxx xxx Less: Absorption of capital deficiency xxx xxx xxx xxx Safe payment xxx xxx xxx xxx Note: The maximum loss possible may be comprised of the following items: 1. Unsold noncash assets 2. Estimated liabilities 3. Expected liquidation expenses Cash Priority Program In lieu of safe payment schedule, the other tool to guarantee that no overpayment will happen in making premature payments under installment liquidation is the Predistribution Plan or Cash Priority Program. The cash priority program will determine the partner to whom and how much available cash (after payment to creditors and liquidation expenses are made) shall be distributed even prior to the total actual realization. Maximum loss Total partner’s claims in the partnership absorption capacity = Partner’s profit and loss percentage To complete the cash priority program, the following steps must be observed: 1. Rank the partners’ maximum loss absorption capacity from highest to lowest. 2. Get the difference in the MLA of the highest then next highest partner. 3. Determine the amount of priority cash payments by multiplying the differences with the profit and loss ratio of the partner having the highest capacity. 4. 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. CASH PRIORITY PROGRAM Equalize the absorption capacity of all the partners by deducting the difference of first priority and second priority, and so on...  Page 2 of 7 Cash Priority Partner Partner Partner A B C Capital balances Xx Xx Xx Divide by P&L ratio % % % Maximum loss absorption Pxx Pxx Pxx Difference in MLA of first partner having highest over (Pxx) the second partner having next highest MLA (1). (Pxx – Pxx). Balance Pxx Pxx Pxx Difference in MLA of the PARTNERS having (Pxx) Pxx (Pxx – Pxx). Equal balances of absorption capacity Pxx Pxx Pxx Determine the amount of priority cash payments by multiplying the differences with the profit and loss ratio of the partner having the highest capacity. A) B C P&L ratio % % % First cash priority to A (difference in Pxx MLA (1) above x P&L ratio of A) Second cash priority to A (difference in MLA (1) above x Pxx P&L ratio of B) C (difference in MLA (1) above x Pxx P&L ratio of B). Totals Pxx Pxx 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. Installment Method of Cash Distribution There are two keys to preparing a statement of partnership liquidation under the installment method: the determination of the available cash balance at any given point in time and the determination of which partner(s) is(are) to receive the payment of that cash. The reason that the cash is not distributed in accordance with the P&L ratio is twofold: first the final cash distribution is based upon the balance in each partner’s capital account, not the P&L ratio, and second, there will be situations, as illustrated in the previous example, where one or more partners will have deficit balances in their capital accounts. If this is the case, they should never receive a cash distribution, even if the deficit does not arise until late in the liquidation process. The determination of the available cash balance is generally very straightforward. The beginning cash balance (cash on hand at the start of the liquidation process) is adjusted for the cash receipts from receivables, sale of noncash assets, payment to creditors, and liquidation expenses incurred. A situation may occur where a certain amount of cash is to be reserved for payment of future liabilities that may arise. If this is the case, this cash should be treated as noncash asset which makes it unavailable for current distribution to the partners. The determination of which partner(s) is(are) to receive the available cash is somewhat more difficult. There are a number of ways to make this computation, all of which are equally correct in the eyes of the examiners. This determination can be made at the beginning of the liquidation process or at the time of each payment. In making this determination there are two key assumptions that must be made: (1) the individual partners are assumed to be personally insolvent, and (2) the remaining noncash assets are deemed to be worthless (thus creating a maximum possible amount of loss). One method of determining the amount of the “safe payment” is the use of an Installment Cash Distribution Schedule. This schedule is prepared by determining the amount of loss required to eliminate each partner’s capital account. As noted above, all of the remaining noncash assets are to be considered worthless at the time a safe payment is determined. Thus if we determine the amount of loss required to eliminate each partner’s capital balance, we can determine the order in which the partners should receive the cash payments. When preparing this schedule it is important to make sure that the proper capital balance is used. The capital balance used must be inclusive of any loans or advances between the partnership and partners. Thus, the capital balance at the beginning of the liquidation process is increased by any amount owed to the partner by the partnership, and decreased by any amount owed to the partnership by the partner. Assume the following: The capital balances are as given below. The P&L ratio is 5:3:2 for A, B, and C, respectively. Statement of Partnership Liquidation Cash Other Assets Liabilities A B C Balances P 50,000 P750,000 P450,000 P120,000 P170,000 P60,000  Page 3 of 7 Example: Schedule of Possible Losses and Installment Cash Distribution Assume the same data as used for the previous example. A, capital B, capital C, capital Total Capital balances P120,000 P170,000 P60,000 P350,000 Loss to eliminate A (120,000) ( 72,000) (48,000) 240,000 0 98,000 12,000 Additional loss to eliminate C ( 18,000) (12,000) 30,000 80,000 0 Additional loss to eliminate B ( 80,000) 80,000 0 P350,000 The total capital balance of P350,000 indicates that if the noncash assets are sold for P350,000 less than their book value, then none of the partners will receive a cash distribution. The purpose of this schedule is to determine how much of a loss each partner’s capital account can withstand based on that partner’s P&L ratio. In this example A’s capital would be eliminated if the partnership incurred a P240,000 (P120,000/50%) loss, B’s would be eliminated by a P566,667 (P170,000/30%) loss, and C’s by a P300,000 (P60,000/20%) loss. A is assumed to be eliminated first because it would take the smallest amount of loss to eliminate his account Once A is eliminated as a partner, the P&L ratios change to reflect the relative P&L ratio of the remaining partners, in this case B and C. Based on the remaining capital balances and the relative P&L ratio, it would take a P163,333 (P98,000/60%) loss to eliminate B and a P30,000 (P12,000/40%) loss to eliminate C. Now that C is eliminated, B will share all of the profits and losses as a sole partner (i.e., 100%). It will now take an P80,000 loss to eliminate B’s capital. The resulting installment cash distribution schedule would appear as follows (this schedule assumes that all creditors have already received full payment; thus, the cash amount represents available cash): Installment Cash Distribution Schedule Partner A B C First P 80,000 100% Next 30,000 60% 40% Next 240,000 50% 30% 20% Any other 50% 30% 20% While the example shown in the previous page was not an installment liquidation, the Installment Cash Distribution Schedule shown above could still be used to determine how the available cash of P100,000 is to be distributed. This is illustrated below. Partner A B C First P 80,000 P80,000 Next 20,000 12,000 P8,000 P100,000 P92,000 P8,000 The above amounts can also be determined by simply computing the loss absorption capacity of each partner. The loss absorption capacity pertain to the amount of loss a partner’s capital can absorbed. As already explained above, A’s capital can only absorb P240,000 loss (P120,000/50%), whereas, B’s capital can absorb P566,667 loss (P170,000/30%) and C’s capital can absorb up to P300,000 loss (P60,000/20%). In this case, B’s capital has the highest loss absorption capacity in which the amount of cash to be paid to B before other partners can share should be P80,000 (P566,667 - P300,000) x 30%, known as priority 1 or allocation 1. After giving P80,000 to B his capital balance will have a loss absorption capacity equal that of C P300,000, (P170,000 - P80,000 = P90,000/30%). The next available cash to be distributed known as priority 2 or allocation 2 can be determined by simply getting the difference between the loss absorption capacity of B or C and that of A multiply by B and C’s P&L ratio. In this case, B’s share under priority 2 is P18,000 (P300,000 - P240,000) x 30% and C’s share is P12,000 (P300,000 - P240,000) x 20%. After giving P18,000 to B and P12,000 to C, their capital balances will be P72,000 for B (P90,000 - P18,000) and P48,000 for C (P60,000 - P12,000). The partners capital balances after priority 2 will have the same amount of loss absorption capacity in which case any additional cash distributed can be made based on the partners’ P&L ratio, in this case, 50%;30%;20%. 2. On December 31, 2006, the balance sheet of XX, YY, and ZZ is as follows: XYZ Partnership Balance Sheet December 31, 2006 Cash P 15,000 Liabilities P 50,000 Non- cash Assets 265,000 Loan Payable, YY 20,000 Loan Payable, ZZ 10,000 XX, Capital 48,000 YY, Capital 72,000 ________ ZZ, Capital 80,000 P280,000 P280,000 Profits and losses were shared as follows: XX, 30%; YY, 30%; and ZZ, 40%. It was decided to liquidate the business. The following is a summary of the realization and liquidation: Book Value  Page 4 of 7 Of Asset Cash Expenses Liabilities __Month_ _Realized_ Collected _Paid__ Paid__ January P 50,000 P 20,000 P 1,000 P 24,000 February 80,000 60,000 3,000 --- March 75,000 50,000 4,000 26,000 April 60,000 30,000 2,000 --- Required: Prepare a Statement of Partnership Liquidation. When necessary, this statement should be supplemented by supporting schedules. In the general ledger, the loan accounts are not to be closed into the capital account. CASH PRIORITY PROGRAM BALANCES PAYMENTS XX YY ZZ XX YY ZZ TOTAL Total Interests 48,000 92,000 90,000 Divide by: P/L ratio 30% 30% 40% Loss Absorption Bal. 160,000 306,667 225,000 1st Priority – YY (81,667) -- P24,500 -- P24,500 Balances P160,000 P225,000 P225,000 2nd Priority – YY, ZZ (65,000) (65,000) -- 19,500 26,000 45,500 Balances P160,000 P160,000 P160,000 30% 30% 40% XYZ PARTNERSHIP Statement of Partnership Liquidation January 1 to April 30, 2006 CASH NON-CASH LIAB. L/P- YY L/P- ZZ XX,CAP. YY,CAP. ZZ,CAP. Balances P 15,000 P 265,000 P50,000 P20,000 P10,000 P48,000 P72,000 P80,000 JANUARY Sale at a loss 19,000 (50,000) ______ _______ _______ ( 9,300) ( 9,300) (12,400) Balances P34,000 P 215,000 P50,000 P 20,000 P10,000 P38,700 P62,700 P 67,600 Payment of liabilities ( 24,000) ________ (24,000) _______ _______ _______ ______ _______ Balances P10,000 P 215,000 P26,000 P 20,000 P10,000 P38,700 P62,700 P 67,600 FEBRUARY Sale at a loss 57,000 ( 80,000) _______ _______ _______ ( 6,900) ( 6,900) ( 9,200) Balances P67,000 P 135,000 P26,000 P 20,000 P10,000 P31,800 P55,800 P 58,400 Distribution to partners (41,000) _______ _______ (20,000) ( 9,429) _______ (11,571) _______ Balances P26,000 P 135,000 P26,000 --- P 571 P31,800 P44,229 P 58,400 MARCH Sale at a loss 46,000 ( 75,000) _______ _______ _______ ( 8,700) ( 8,700) (11,600) Balances P72,000 P 60,000 P26,000 --- P 571 P23,100 P35,529 P 46,800 Payment of Liabilities (26,000) ________ (P26,000) --- _______ _______ _______ _______ Balances P 46,000 P 60,000 --- --- P 571 P23,100 P35,529 P46,800 Distribution to Partners (46,000) ________ ________ _______ ( 571) ( 5,100) (17,529) (22,800) Balances --- P60,000 --- --- --- P18,000 P8,000 P24,000 APRIL Sale at a loss 28,000 ( 60,000) ________ _______ _______ ( 9,600) ( 9,600) (12,800) Balances P 28,000 --- --- --- P 8,400 P 8,400 P11,200 Payments to Partners ( 28,000) --- --- --- --- ( 8,400) ( 8,400) (11,200) SCHEDULE OF CASH DISTRIBUTION Total XX, Cap. YY, Loan YY, Cap. ZZ, Loan ZZ, Cap. FEBRUARY Payment to partners P41,000 1st priority (full) ( 24,500) P 20,000 P 4,500 2nd priority (partial) ( 16,500) 7,071 P 9,429 Cash distribution in February P 20,000 P 11,571 P 9,429 MARCH Payment to partners P46,000 2 priority (balance) nd (29,000) P 12,429 P 571 P 16,000 3rd priority (17,000) P 5,100 5,100 6,800 Cash distribution in March P 5,100 P 17,529 P 571 P 22,800  Page 5 of 7 The supporting computation in the preceding example is the Cash Priority Program, which can be prepared before the start of the liquidation process. It is then, supported by the Schedule of Cash Distribution for a clearer presentation of how the distribution to the partners were arrived at. Another supporting computation that may be used is the Schedule of Safe Payments. This schedule is done on a monthly basis with the same purpose in mind. And that is to determine the proper distribution of cash among the partners. Using the same example, we are now going to prepare a Schedule of Safe Payments: SCHEDULE OF SAFE PAYMENTS FEBRUARY XX YY ZZ__ Total Interests* P31,800 P75,800 P68,400 Less: Possible Loss** ( 40,500) ( 40,500) ( 54,000) Balances P( 8,700) P35,300 P14,400 Absorption of Deficit 8,700 ( 3,729) ( 4,971) Payments P31,571 P 9,429 MARCH Total Interests P23,100 P35,529 P47,371 Less: Possible Loss ( 18,000) ( 18,000) ( 24,000) Payments P 5,100 P17,529 P23,371 * TOTAL INTERESTS = CAPITAL + PAYABLE TO PARTNER -- RECEIVABLE FROM PARTNER. ** POSSIBLE LOSS = NON- CASH ASSET BALANCE + CASH WITHHELD FOR FUTURE EXPENSES. PROBLEMS 1. A, B, and C are partners sharing profits in the ratio of 5:3:2, respectively. A balance sheet prepared just prior to partnership liquidation shows the following: A B C Capital Balances P122,000 P 72,000 P 47,000 Loan Balances 43,000 48,000 6,000 Assets are sold and cash is distributed to partners in monthly installments during the course of liquidation as follows: January P20,000 February 50,000 March 80,000 April (final distribution) 20,000 Required: a. Prepare a program to show how cash is to be distributed during the entire course of liquidation. b. Using the program developed above, prepare a schedule summarizing the payments to be made to partners at the end of each month. 2. D, E and F are partners sharing profits in the ratio of 40:35:25, respectively. On December 31, 2006, they agree to liquidate. A balance sheet prepared on this date follows: STO Partnership Balance Sheet As of December 31, 2006 Cash P 2,000 Liabilities P 6,000 Other Assets 46,000 E, Loan 5,000 F, Loan 2,500 D, Capital 14,450 E, Capital 12,550 _ F, Capital 7,500 P48,000 P48,000 The results of liquidation are summarized below: Book Cash Expenses of Cash W/held at end of month for Liability paid Realizations Value Realized Realization estd. Future exps. January P12,000 P10,500 P500 P2,000 P4,000 February 7,000 6,000 750 1,250 2,000 March 15,000 10,000 600 500 --- April 12,000 4,000 400 --- --- All cash available, except the amount withheld for future expenses, is distributed at the end of each month. Required: Determine the share of each partner every month of distribution. 3. The balance sheet of J, K and L Partnership shows the following information as of December 31, 2006: Cash P 2,000 Liabilities P 5,000 Other Assets 28,000 J, Loan 2,500 J, Capital 12,500 K, Capital 7,000 L, Capital 3,000 P30,000 P30,000  Page 6 of 7 Profit and loss ratio is 3:2:1,respectively, for J, K, and L. Other assets were realized as follows: Date Cash Received Book Value January, 2006 P 8,000 P 9,000 February, 2006 3,500 7,700 March, 2006 12,500 11,300 Cash is distributed as assets are realized. a. How much is the total loss to J? b. How much is the total cash received by K? c. How much cash does L receive in January? MULTIPLE CHOICE Items 1 and 2 are based on the following: The partnership of Daniel, Keith, and Ross is to be liquidated as soon as possible after December 31, 2002, and all cash on hand except for P20,000 contingency balance is to be distributed at the end of each month until the liquidation is complete. Profits and losses are shared 50%, 30%, and 20% to Daniel, Keith, and Ross, respectively. A balance sheet of the partnership at December 31, 2002 contains the following accounts and balances: Cash P 240,000 Accounts Payable P 300,000 Accounts Receivable 280,000 Notes Payable 200,000 Loan to Ross 40,000 Loan from Keith 20,000 Inventories 400,000 Daniel, Capital 340,000 Land 100,000 Keith, Capital 340,000 Equipment (net) 300,000 Ross, Capital 200,000 Goodwill 40,000 P1,400,000 P1,400,000 In January, 2003, the loan to Ross was offset against his capital balance and the goodwill is written off. P200,000 is collected on account, inventory items that cost P160,000 are sold for P200,000, and cash is distributed. 1. If available cash is distributed on January 31, 2003, Daniel, Keith, and Ross, respectively, should receive: a. P0; P132,000; and P6,000. c. P 0; P100,000; and P 0. b. P0; P120,000; and P 0. d. P 0; P120,000; and P8,000. 2. If a cash distribution plan is developed as of January 1, 2003, the vulnerability ranks (1 is most vulnerable) for Daniel, Keith, and Ross is: a. 1, 2, and 3, respectively. c. 2, 1, and 3, respectively. b. 1, 3, and 2, respectively. d. 2, 3, and 1, respectively. 3. The partnership of Jill, Bill, and Will presented the following data prior to its liquidation. The profit and loss ratio was 2:2:1. Non- cash assetsP561,900 Liabilities P110,580 Jill, capital 204,960 Bill, capital 99,780 Will, capital 146,580 P561,900 P561,900 During the first month, assets carried at P111,000 were sold for P90,000 and the cash was distributed. During the second month, assets carried at P134,400 were sold for P108,000. At that time, Bill was anxious to get his money out of the partnership in order to get started in another business. He offered to take P60,000 from the second realization as his final payment, releasing all other partners from all other claims. The other partners agreed. All cash was distributed. During the next three months, the remaining assets were sold for P210,000. How much did Jill gain or lose by accepting Bill’s proposal? a. P13,881 gain b. P14,520 loss c. P26,520 gain d. P25,479 loss 4. After paying all their liabilities, Mark, Lark, and Park had the following balances: Partner Capital Loans P & L ratio Mark P102,960 P90,000 12/25 Lark 89,040 30,000 8/25 Park 68,100 39,900 5/25 Cash available for distribution amounts to P37,800, remaining assets of P382,200 will be realized piecemeal in the next month. How much of the P37,800 cash should Park receive? a. P30,600 b. P7,200 c. P7,560 d. Zero Items 7 and 8 are based on the following: Dick, Hick, Kick, and Lick were partners who decided to liquidate the affairs of the partnership. Prior to dissolution, the condensed balance sheet together with the profit and loss sharing ratio was derived as follows: Cash P 100,000 Liabilities P 750,000 Other assets 1,800,000 Hick, loan 60,000  Page 7 of 7 Lick, loan 50,000 Dick, capital (30%) 420,000 Hick, capital (30%) 315,000 Kick, capital (20%) 205,000 Lick, capital (20%) 100,000 P1,900,000 P1,900,000 The other assets were sold for P1,200,000. Payments were made to creditors and final distributions of cash were made to partners. 5. The partner who got paid the most was: a. Hick, for loan of P60,000 and capital of P270,000. c. Dick, for capital of P240,000. b. Hick, for loan of P60,000 and capital of P315,000. d. Dick, for capital of P420,000. 6. The cash received by Lick will be applied: a. First to loan and then to capital. c. To capital only and none to loan. b. To loan only and none to capital. d. To capital first and next to loan. Items 7 to 9 are based on the following: The balance sheet for Coney, Honey, and Money partnership shows the following information as of December 31, 2001: Cash P 40,000 Liabilities P100,000 Other assets 560,000 Coney, loan 50,000 Coney, capital 250,000 Honey, capital 140,000 Money, capital 60,000 P600,000 P600,000 Profit and loss ratio is 3:2:1 for Coney, Honey, and Money, respectively. Other assets were realized as follows: Date Cash Received Book Value January 2002 P120,000 P180,000 February 2002 70,000 154,000 March 2002 250,000 226,000 Cash is distributed as assets are realized. 7. The total loss to Coney is: a. P60,000 b. P40,000 c. P20,000 d. None 8. The total cash received by Honey is: a. P40,000 b. Zero c. P100,000 d. P30,000 9. Cash received by Money in January 2002 is: a. P4,000 b. P20,000 c. P10,000 d. Zero END!