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Principles of Accounting, Volume 1: Financial Accounting

15.5 Discuss and Record Entries for the Dissolution of a Partnership

Principles of Accounting, Volume 1: Financial Accounting15.5 Discuss and Record Entries for the Dissolution of a Partnership
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  1. Preface
  2. 1 Role of Accounting in Society
    1. Why It Matters
    2. 1.1 Explain the Importance of Accounting and Distinguish between Financial and Managerial Accounting
    3. 1.2 Identify Users of Accounting Information and How They Apply Information
    4. 1.3 Describe Typical Accounting Activities and the Role Accountants Play in Identifying, Recording, and Reporting Financial Activities
    5. 1.4 Explain Why Accounting Is Important to Business Stakeholders
    6. 1.5 Describe the Varied Career Paths Open to Individuals with an Accounting Education
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
  3. 2 Introduction to Financial Statements
    1. Why It Matters
    2. 2.1 Describe the Income Statement, Statement of Owner’s Equity, Balance Sheet, and Statement of Cash Flows, and How They Interrelate
    3. 2.2 Define, Explain, and Provide Examples of Current and Noncurrent Assets, Current and Noncurrent Liabilities, Equity, Revenues, and Expenses
    4. 2.3 Prepare an Income Statement, Statement of Owner’s Equity, and Balance Sheet
    5. Key Terms
    6. Summary
    7. Multiple Choice
    8. Questions
    9. Exercise Set A
    10. Exercise Set B
    11. Problem Set A
    12. Problem Set B
    13. Thought Provokers
  4. 3 Analyzing and Recording Transactions
    1. Why It Matters
    2. 3.1 Describe Principles, Assumptions, and Concepts of Accounting and Their Relationship to Financial Statements
    3. 3.2 Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions
    4. 3.3 Define and Describe the Initial Steps in the Accounting Cycle
    5. 3.4 Analyze Business Transactions Using the Accounting Equation and Show the Impact of Business Transactions on Financial Statements
    6. 3.5 Use Journal Entries to Record Transactions and Post to T-Accounts
    7. 3.6 Prepare a Trial Balance
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  5. 4 The Adjustment Process
    1. Why It Matters
    2. 4.1 Explain the Concepts and Guidelines Affecting Adjusting Entries
    3. 4.2 Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries
    4. 4.3 Record and Post the Common Types of Adjusting Entries
    5. 4.4 Use the Ledger Balances to Prepare an Adjusted Trial Balance
    6. 4.5 Prepare Financial Statements Using the Adjusted Trial Balance
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  6. 5 Completing the Accounting Cycle
    1. Why It Matters
    2. 5.1 Describe and Prepare Closing Entries for a Business
    3. 5.2 Prepare a Post-Closing Trial Balance
    4. 5.3 Apply the Results from the Adjusted Trial Balance to Compute Current Ratio and Working Capital Balance, and Explain How These Measures Represent Liquidity
    5. 5.4 Appendix: Complete a Comprehensive Accounting Cycle for a Business
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  7. 6 Merchandising Transactions
    1. Why It Matters
    2. 6.1 Compare and Contrast Merchandising versus Service Activities and Transactions
    3. 6.2 Compare and Contrast Perpetual versus Periodic Inventory Systems
    4. 6.3 Analyze and Record Transactions for Merchandise Purchases Using the Perpetual Inventory System
    5. 6.4 Analyze and Record Transactions for the Sale of Merchandise Using the Perpetual Inventory System
    6. 6.5 Discuss and Record Transactions Applying the Two Commonly Used Freight-In Methods
    7. 6.6 Describe and Prepare Multi-Step and Simple Income Statements for Merchandising Companies
    8. 6.7 Appendix: Analyze and Record Transactions for Merchandise Purchases and Sales Using the Periodic Inventory System
    9. Key Terms
    10. Summary
    11. Multiple Choice
    12. Questions
    13. Exercise Set A
    14. Exercise Set B
    15. Problem Set A
    16. Problem Set B
    17. Thought Provokers
  8. 7 Accounting Information Systems
    1. Why It Matters
    2. 7.1 Define and Describe the Components of an Accounting Information System
    3. 7.2 Describe and Explain the Purpose of Special Journals and Their Importance to Stakeholders
    4. 7.3 Analyze and Journalize Transactions Using Special Journals
    5. 7.4 Prepare a Subsidiary Ledger
    6. 7.5 Describe Career Paths Open to Individuals with a Joint Education in Accounting and Information Systems
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  9. 8 Fraud, Internal Controls, and Cash
    1. Why It Matters
    2. 8.1 Analyze Fraud in the Accounting Workplace
    3. 8.2 Define and Explain Internal Controls and Their Purpose within an Organization
    4. 8.3 Describe Internal Controls within an Organization
    5. 8.4 Define the Purpose and Use of a Petty Cash Fund, and Prepare Petty Cash Journal Entries
    6. 8.5 Discuss Management Responsibilities for Maintaining Internal Controls within an Organization
    7. 8.6 Define the Purpose of a Bank Reconciliation, and Prepare a Bank Reconciliation and Its Associated Journal Entries
    8. 8.7 Describe Fraud in Financial Statements and Sarbanes-Oxley Act Requirements
    9. Key Terms
    10. Summary
    11. Multiple Choice
    12. Questions
    13. Exercise Set A
    14. Exercise Set B
    15. Problem Set A
    16. Problem Set B
    17. Thought Provokers
  10. 9 Accounting for Receivables
    1. Why It Matters
    2. 9.1 Explain the Revenue Recognition Principle and How It Relates to Current and Future Sales and Purchase Transactions
    3. 9.2 Account for Uncollectible Accounts Using the Balance Sheet and Income Statement Approaches
    4. 9.3 Determine the Efficiency of Receivables Management Using Financial Ratios
    5. 9.4 Discuss the Role of Accounting for Receivables in Earnings Management
    6. 9.5 Apply Revenue Recognition Principles to Long-Term Projects
    7. 9.6 Explain How Notes Receivable and Accounts Receivable Differ
    8. 9.7 Appendix: Comprehensive Example of Bad Debt Estimation
    9. Key Terms
    10. Summary
    11. Multiple Choice
    12. Questions
    13. Exercise Set A
    14. Exercise Set B
    15. Problem Set A
    16. Problem Set B
    17. Thought Provokers
  11. 10 Inventory
    1. Why It Matters
    2. 10.1 Describe and Demonstrate the Basic Inventory Valuation Methods and Their Cost Flow Assumptions
    3. 10.2 Calculate the Cost of Goods Sold and Ending Inventory Using the Periodic Method
    4. 10.3 Calculate the Cost of Goods Sold and Ending Inventory Using the Perpetual Method
    5. 10.4 Explain and Demonstrate the Impact of Inventory Valuation Errors on the Income Statement and Balance Sheet
    6. 10.5 Examine the Efficiency of Inventory Management Using Financial Ratios
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  12. 11 Long-Term Assets
    1. Why It Matters
    2. 11.1 Distinguish between Tangible and Intangible Assets
    3. 11.2 Analyze and Classify Capitalized Costs versus Expenses
    4. 11.3 Explain and Apply Depreciation Methods to Allocate Capitalized Costs
    5. 11.4 Describe Accounting for Intangible Assets and Record Related Transactions
    6. 11.5 Describe Some Special Issues in Accounting for Long-Term Assets
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  13. 12 Current Liabilities
    1. Why It Matters
    2. 12.1 Identify and Describe Current Liabilities
    3. 12.2 Analyze, Journalize, and Report Current Liabilities
    4. 12.3 Define and Apply Accounting Treatment for Contingent Liabilities
    5. 12.4 Prepare Journal Entries to Record Short-Term Notes Payable
    6. 12.5 Record Transactions Incurred in Preparing Payroll
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  14. 13 Long-Term Liabilities
    1. Why It Matters
    2. 13.1 Explain the Pricing of Long-Term Liabilities
    3. 13.2 Compute Amortization of Long-Term Liabilities Using the Effective-Interest Method
    4. 13.3 Prepare Journal Entries to Reflect the Life Cycle of Bonds
    5. 13.4 Appendix: Special Topics Related to Long-Term Liabilities
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  15. 14 Corporation Accounting
    1. Why It Matters
    2. 14.1 Explain the Process of Securing Equity Financing through the Issuance of Stock
    3. 14.2 Analyze and Record Transactions for the Issuance and Repurchase of Stock
    4. 14.3 Record Transactions and the Effects on Financial Statements for Cash Dividends, Property Dividends, Stock Dividends, and Stock Splits
    5. 14.4 Compare and Contrast Owners’ Equity versus Retained Earnings
    6. 14.5 Discuss the Applicability of Earnings per Share as a Method to Measure Performance
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  16. 15 Partnership Accounting
    1. Why It Matters
    2. 15.1 Describe the Advantages and Disadvantages of Organizing as a Partnership
    3. 15.2 Describe How a Partnership Is Created, Including the Associated Journal Entries
    4. 15.3 Compute and Allocate Partners’ Share of Income and Loss
    5. 15.4 Prepare Journal Entries to Record the Admission and Withdrawal of a Partner
    6. 15.5 Discuss and Record Entries for the Dissolution of a Partnership
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  17. 16 Statement of Cash Flows
    1. Why It Matters
    2. 16.1 Explain the Purpose of the Statement of Cash Flows
    3. 16.2 Differentiate between Operating, Investing, and Financing Activities
    4. 16.3 Prepare the Statement of Cash Flows Using the Indirect Method
    5. 16.4 Prepare the Completed Statement of Cash Flows Using the Indirect Method
    6. 16.5 Use Information from the Statement of Cash Flows to Prepare Ratios to Assess Liquidity and Solvency
    7. 16.6 Appendix: Prepare a Completed Statement of Cash Flows Using the Direct Method
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  18. Financial Statement Analysis
  19. Time Value of Money
  20. Suggested Resources
  21. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
    14. Chapter 14
    15. Chapter 15
    16. Chapter 16
  22. Index

Partnerships dissolve. Sometime the decision is made to close the business. Sometimes there is a bankruptcy. Partner negligence, retirement, death, poor cash flow, and change in business practices are just some of the reasons for closing down.

Ethical Considerations

Ethical Partnership Dissolution

In most dissolutions of a partnership, the business partners need to decide what will happen to the partnership itself. A partnership may be dissolved, but that may not end business operations. If the partnership’s business operations are to continue, the partnership must decide what to do with its customers or clients, particularly those primarily served by a partner leaving the business. An ethical partnership will notify its customers and clients of the change and whether and how the partnership is going to continue as a business under a new partnership agreement. Partners who are unable to agree on how to notify their customers and clients should look to the Uniform Partnership Act, Article 8, which outlines the general obligations and duties of partners when a partnership is dissolved.

A partner’s duties and obligation upon dissolution describe what the departing partner owes to the partnership and the other partners in duties of loyalty and care, which are the basic fiduciary duties of a partner prior to dissolution, as outlined in Section 409 of the Uniform Partnership Act. The one change upon dissolution is that “each partner’s duty not to compete ends when the partnership dissolves.” The Act states that “the dissolution of a partnership is 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.”1 This may not terminate the partnership’s business operations, but the partner’s obligations under the dissolved partnership agreement will end, regardless of how the remaining partners create a new partnership.

The departure or removal of a partner or partners and the resulting creation of a new partnership may be tricky, because all original partners owe each other the duty of fairness and loyalty until the dissolution has been completed. All the partners, departing or otherwise, are required to behave in a fashion that does not hurt business operations and avoid putting their individual interests ahead of the interests of the soon-to-be-dissolved partnership. Once the partnership has been dissolved, the departing partners no longer have an obligation to their old business partners.

Fundamentals of Partnership Dissolution

The liquidation or dissolution process for partnerships is similar to the liquidation process for corporations. Over a period of time, the partnership’s non-cash assets are converted to cash, creditors are paid to the extent possible, and remaining funds, if any, are distributed to the partners. Partnership liquidations differ from corporate liquidations in some respects, however:

  1. General partners, as you may recall, have unlimited liability. Any general partner may be asked to contribute additional funds to the partnership if its assets are insufficient to satisfy creditors’ claims.
  2. If a general partner does not make good on his or her deficit capital balance, the remaining partners must absorb that deficit balance. Absorption of the partner’s deficit balance gives the absorbing partner legal recourse against the deficit partner.

Recording the Dissolution Process

As discussed above, the liquidation or dissolution of a partnership is synonymous with closing the business. This may occur due to mutual partner agreement to sell the business, the death of a partner, or bankruptcy. Before proceeding with liquidation, the partnership should complete the accounting cycle for its final operational period. This will require closing the books with only balance sheet accounts remaining. Once that process has been completed, four steps remain in the accounting for the liquidation, each requiring an accounting entry. They are:

  • Step 1: Sell noncash assets for cash and recognize a gain or loss on realization. Realization is the sale of noncash assets for cash.
  • Step 2: Allocate the gain or loss from realization to the partners based on their income ratios.
  • Step 3: Pay partnership liabilities in cash.
  • Step 4: Distribute any remaining cash to the partners on the basis of their capital balances.

These steps must be performed in sequence. Partnerships must pay creditors prior to distributing funds to partners. At liquidation, some partners may have a deficiency in their capital accounts, or a debit balance.

Let’s consider an example. Football Partnership is liquidated; its balance sheet after closing the books is shown in Figure 15.8.

Football Partnership, Balance Sheet, For the Month Ended December 31, 2019. Assets: Cash $5,000; Accounts Receivable 10,000; Inventory 22,000; Equipment 30,000; Less Accumulated Depreciation (5,000); Total Assets $62,000. Liabilities and Partner Capital: Notes Payable $15,000; Accounts Payable 15,000; Raven, Capital 15,000; Brown, Capital 10,000; Eagle, Capital 7,000; Total Liabilities and Partner Capital $62,000.
Figure 15.8 Balance Sheet for Football Partnership. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

The partners of Football Partnership agree to liquidate the partnership on the following terms:

  1. All the partnership assets will be sold to Hockey Partnership for $60,000 cash.
  2. The partnership will satisfy the liabilities.
  3. The income ratio will be 3:2:1 to partners Raven, Brown, and Eagle respectively. (Another way of saying this is 3/6:2/6:1/6.)
  4. The remaining cash will be distributed to the partners based on their capital account basis.

The journal entry to record the sale of assets to Hockey Partnership (Step 1) is as shown:

Journal entry dated January 1, 2020. Debit Cash 60,000; Accumulated Depreciation 5,000; Credit Accounts receivable 10,000; Inventory 22,000; Equipment 30,000; Gain on Realization 3,000. Explanation: “To record the sale of assets to Hockey Partnership.”

The journal entry to allocate the gain on realization among the partners’ capital accounts in the income ratio of 3:2:1 to Raven, Brown, and Eagle, respectively (Step 2), is as shown:

Journal entry dated January 1, 2020. Debit Gain on realization, 3,000. Credit Raven, Capital (three-sixth times $3,000), 1,500; Brown, Capital (two-sixth times $3,000), 1,000; Eagle, Capital (one-sixth times $3,000), 500. Explanation: “To allocate gain on realization among partner capital accounts.”

The journal entry for Football Partnership to pay off the liabilities (Step 3) is as shown:

Journal entry dated January 1, 2020. Debit Notes payable 15,000; Accounts payable 15,000. Credit Cash 30,000. Explanation: “To record payment of liabilities.”

The journal entry to distribute the remaining cash to the partners based on their capital account basis (Step 4) is as shown:

Journal entry dated January 1, 2020. Debit Raven, Capital 16,500; Brown, Capital 11,000; Eagle, Capital 7,500. Credit Cash, 35,000. Explanation: “To distribute remaining cash to the partners based on their capital account balances.”

Footnotes

  • 1 Uniform Law Commission. Uniform Partnership Act (1997) (Last Amended 2013). https://www.uniformlaws.org/viewdocument/final-act-with-comments-118?CommunityKey=52456941-7883-47a5-91b6-d2f086d0bb44&tab=librarydocuments
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