CHAPTER
9
Partnerships:
Ownership Changes
and Liquidation
Fundamentals of Advanced Accounting
1st Edition
Fischer, Taylor, and Cheng
Ownership Changes
Dissolution – 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
Chapter 9, Slide #2
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Ownership Changes (continued)
• Changes may suggest:
– The existing assets of the original partnership should
be revalued
– Previously unrecorded intangible assets exist that are
traceable to the original partnership
– Intangible assets, such as goodwill, exist that are
traceable to a new partner
Chapter 9, Slide #3
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Admission of a New Partner
• Admission of new partner requires approval from
existing partners
• Accomplished by either:
– A contribution of assets to an existing partnership
• Either the bonus or goodwill method of accounting is
employed
– A contribution of assets to an existing partner
• Generally a transfer of book values from one partner to
another
Chapter 9, Slide #4
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Contribution Of Assets To An Existing
Partnership
• Gain admission to partnership by contributing
assets directly to the partnership
• If book value of partnership net assets approximates
fair value
• New partner’s contribution should be equal to
their %age interest in the new capital
• May be in excess of that suggested by the book
value of the original partnership’s net assets which
suggests that the partnership may have one of the
following:
• Unrecognized appreciation on recorded net assets
• Unrecognized goodwill
Chapter 9, Slide #5
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Contribution Of Assets To An Existing
Partnership (continued)
• Value of contribution may be less than that
indicated by book value of the original partnership’s
net assets
• Suggests that the partnership may have one of the
following:
– Unrecognized depreciation or write-downs on
recorded net assets of the original partnership
– Additional intangible assets being contributed by the
incoming partner
Chapter 9, Slide #6
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Contribution of Assets to an Existing
Partnership
• Bonus method
• Goodwill method
Chapter 9, Slide #7
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method
Total capital of new partnership is:
The book value of the previous partnership
– Any write-downs in the value of the previous
partnership’s net assets
+ The value of the consideration paid to the partnership
by the incoming partner
Note: Only net asset write-downs (versus write-ups) are
recognized.
Chapter 9, Slide #8
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method (continued)
• New partner’s initial capital balance equals the
percent interest in the capital of the new
partnership
• Bonus may be either to old partners or the new
partner
• Bonus is allocated based on profit/loss
percentages, not interest in capital percentages
Chapter 9, Slide #9
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method:
Bonus to Old Partners
Facts
• A & B are original partners with a partnership net
book value of $75,000
• Profit/loss percentages: A = 50%, B = 50%
• C acquires 20% interest in capital for $27,000
cash
Chapter 9, Slide #10
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method: Bonus to Old Partners
Continued
Analysis
• Value of new partnership suggested by
incoming partner: $135,000 ($27,000  20%)
• Book value of new partnership: $102,000
($75,000 + $27,000)
• C’s interest in new partnership: $20,400
(20%  $102,000)
Chapter 9, Slide #11
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method: Bonus to Old Partners
Continued
Journal Entry
Cash
A, Capital
B, Capital
C, Capital
27,000
Chapter 9, Slide #12
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
3,300
3,300
20,400
The Bonus Method:
Bonus To The New Partner
Facts
• A & B are original partners with a partnership net
book value of $75,000
• Profit/loss percentages: A = 50%, B = 50%
• C acquires 20% interest in capital for $10,000
cash
Chapter 9, Slide #13
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method:
Bonus To New Partner (continued)
Analysis
• Book value of new partnership: $85,000
•
($30,000 + $45,000 + $10,000)
C’s interest in new partnership: $17,000 (20% 
$85,000)
Chapter 9, Slide #14
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Bonus Method:
Bonus To New Partner (continued)
Journal Entries
Cash
A, Capital
B, Capital
C, Capital
10,000
3,500
3,500
Chapter 9, Slide #15
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
17,000
Overvaluation Of Original Partnership
• Previous example assumed the new partner
brought some intangible asset to the partnership
• That same transaction may indicate that the
partnership assets are overvalued.
Chapter 9, Slide #16
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Goodwill Method
Total capital of new partnership is:
The book value of the previous partnership
 Unrecognized appreciation or depreciation on the
recorded net assets of the previous partnership
+ Unrecognized goodwill traceable to the previous
partnership
+ The value of the consideration, both tangible and
intangible, received from the new incoming partner
Chapter 9, Slide #17
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
The Goodwill Method (continued)
• Both net asset write-downs and write-ups are
recorded
• New partner’s initial capital balance equals the
percent interest in the capital of the new
partnership
• Goodwill may be traceable to the original partners
and/or the new partner
Chapter 9, Slide #18
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Identifying and Measuring Goodwill
Traceable to the Previous Partnership
1. Calculate the value of the partnership
suggested by the incoming partner (incoming
partner’s contribution divided by the percent
interest in capital acquired)
2. Adjust the book value of the original
partnership for any unrecognized net asset
appreciation or depreciation
(continued ...)
Chapter 9, Slide #19
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Identifying and Measuring Goodwill
Traceable to the Previous Partnership
(... continued)
3. Calculate adjusted book value of original
partnership plus investment of new partner
4. If #1 above is greater than #3 above,
goodwill exists and is traceable to the
original partners
5. Goodwill is the difference between the value
in #1 above and the value in #3 above
Chapter 9, Slide #20
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the Previous
Partnership
Facts
• A and B are original partners with a partnership
net book value of $75,000
• Recorded net assets have a fair value of
$135,000
• Profit/loss percentages: A = 50%, B = 50%
• C acquires 20% interest in capital for $27,000
cash
Chapter 9, Slide #21
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the Previous
Partnership (continued)
Analysis
• Value of new partnership suggested by
•
incoming partner: $135,000 ($27,000  20%)
$33,000 of unrecognized net asset
appreciation and/or goodwill is suggested:
($135,000 – [$75,000 + $27,000])
Chapter 9, Slide #22
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the Previous
Partnership (continued)
Analysis, continued
• The $33,000 is all allocated to Goodwill
Chapter 9, Slide #23
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the Previous
Partnership (continued)
Journal Entry
Cash
Goodwill
A, Capital
B, Capital
C, Capital
27,000
33,000
Chapter 9, Slide #24
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
16,500
16,500
27,000
Goodwill Traceable to the Previous
Partnership (continued)
• The new partner’s capital account balance
represents a 20% interest in the total capital of the
new partnership
Original capital
$75,000
C’s investment
27,000
Goodwill
33,000
135,000
C’s interest
x 20%
C’s Capital balance
$27,000
Chapter 9, Slide #25
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Identifying and Measuring Goodwill
Traceable to the New Partner
1. Calculate the value of the partnership
suggested by the incoming partner
(incoming partner’s contribution divided by
the percent interest in capital acquired)
2. Adjust the book value of the original
partnership for any unrecognized net asset
appreciation or depreciation
(continued ...)
Chapter 9, Slide #26
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Identifying and Measuring Goodwill
Traceable to the New Partner (continued)
3. Calculate adjusted book value of original
partnership plus investment of new partner
4. If #1 above is less than #3 above, then
goodwill exists and is traceable to the new
partner
(continued ...)
Chapter 9, Slide #27
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Identifying and Measuring Goodwill
Traceable to the New Partner (continued)
5. Goodwill is the difference between:
a) The amount that should have been paid
by the new partner, as indicated by the
adjusted book value of the previous
partnership [(adjusted book value of the
original partnership  total percentage
interest of the original partners in the
new partnership) – the adjusted book
value] and
b) The amount actually paid by the new
partner
Chapter 9, Slide #28
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the New Partner
Facts
• A and B are original partners with a
partnership net book value of $75,000
• The $75,000 capital for A & B makes up
80% of the new capital (after C is admitted)
• $75,000 / 20% = $93750
• Profit/loss percentages: A = 50%, B = 50%
• C acquires 20% interest in capital for
$10,000 cash
Chapter 9, Slide #29
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the New Partner
(continued)
Analysis
• Value of new partnership suggested by
•
•
•
incoming partner: $93,750 ($75,000  80%)
New partner should have paid: $18,750
($93,750 -$75,000)
New partner only paid: $10,000
The difference between what the new partner
should have paid: $18,750 and what they
actually did pay: $10,000 is goodwill
traceable to the new partner: $8,750
Chapter 9, Slide #30
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Traceable to the New Partner
(continued)
Journal Entry
Cash
Goodwill
C, Capital
10,000
8,750
Chapter 9, Slide #31
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
18,750
Goodwill
• Previous examples allocated differences to either
revaluation of assets or goodwill
– Most often a combination of both
• Goodwill may be traceable to either the original
partners or the incoming partners
Chapter 9, Slide #32
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Goodwill Method Vs. Bonus Method
• Bonus method establishes total capital of new
partnership based on actual consideration received
from the new partner
• Goodwill method results in recognition of an asset
implied by a transaction rather than recognizing an
asset actually purchased
• Goodwill method could produce inequitable results
– If new partner’s interest in profits ≠ initial interest in
capital
– After formation of new partnership, old partners share
profits and losses in different percentages than before
Chapter 9, Slide #33
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Contribution of Assets to Existing Partners
• Generally, a portion of the selling partner’s book value
of capital is transferred to the buying partner
• New partner pays directly to partner selling their share
Example:
The book value of A’s capital interest is $30,000.
C acquires one-half of A’s capital interest for $50,000.
A, Capital
C, Capital
15,000
Chapter 9, Slide #34
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
15,000
Withdrawal of a Partner
• Partnership agreement should be consulted to
determine any guidelines that would influence the
procedure
• Requires determination of fair value of
partnership entity and
• Measurement of partnership income to date of
withdrawal
• Recognizing differences between book and fair
value maybe appropriate
• Withdrawing partner may sell interest to:
– The partnership and/or
– An individual partner
Chapter 9, Slide #35
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Selling Interest To Existing Partners
• Equity of withdrawing partner purchased with
personal assets of existing partner
• Not assets of the partnership!
Chapter 9, Slide #36
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Selling of an Interest to the Partnership
• The bonus or goodwill method may be employed
• The bonus method will only recognize net asset
write-downs (versus write-ups)
Chapter 9, Slide #37
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Selling of an Interest to the Partnership
(continued)
• Goodwill method focuses on the payment to
withdrawing partner as indication of fair value of
the partnership
• Two alternatives available
– Recognize only goodwill traceable to selling partner
– Recognize goodwill traceable to the whole entity
Chapter 9, Slide #38
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Partnership Liquidation
• Partnership liquidation results in
partnership ending or terminating its
business
• Underlying them is equitable distribution
of assets
Chapter 9, Slide #39
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Partnership Liquidation Guidelines
•
•
The UPA establishes rules governing the priority
in which partnership assets are distributed
Following sequence of payments should be
observed
1. Amounts owed to creditors other than partners
2. Amounts owed to partners other than capital and
profits
3. Amounts owed to partners as capital
4. Amounts owed to partners as profits
Chapter 9, Slide #40
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Partnership Liquidation Guidelines
(continued)
• The doctrine of “right of offset” combines loans due
to partners with the capital balances of partners
• The liability for debit capital balances is covered by
the doctrine of “marshalling of assets”
• If debit capital balances are not eliminated, they are
allocated to the other partners with credit capital
balances
• All attempts should be made to avoid premature
liquidation payments to partners
Chapter 9, Slide #41
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Marshalling of Assets Doctrine
•
Applies when a partnership or one of more of its
partners is insolvent (liabilities exceed assets)
1. Partnership assets are first available for payment of
partnership debts
1. Available for partners’ personal debts
2. Only to extent of partner’s interest in capital of the
partnership
2. Personal assets of a partner are applied against
personal debts, ranked in order of priority
1. Amounts owed to personal creditors
2. Amounts owed to partnership creditors
3. Amounts owed to partners by way of contribution
Chapter 9, Slide #42
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Types of Liquidation Approaches
• Lump sum liquidation – All assets are in a
distributable form and all outside creditors are
satisfied before distributions are made to partners
• Installment liquidation – Payments may be made
to partners in installments rather than in a final
lump sum
– Caution must be exercised to insure that no premature
distributions are made
Chapter 9, Slide #43
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Installment Liquidation Guidelines
• The “right of offset” doctrine is employed
• All liabilities, possible losses, and liquidation
expenses are anticipated before payments may
be made to partners
• Prior to a cash distribution, all remaining noncash
assets are assumed to be worthless
Chapter 9, Slide #44
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Installment Liquidation Guidelines
(continued)
• With respect to potential debit capital balances, all
partners are assumed to be personally insolvent
• Actual distributions are based on a schedule of
safe payments or a predistribution plan
– Assumes all remaining assets are worthless
– Assumes any partner with deficit capital balance is
insolvent
• New schedule of safe payments is calculated
before every cash distribution
Chapter 9, Slide #45
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Predistribution Plan
• Based on how much loss a partner could absorb
(i.e., maximum loss absorbable, the MLA)
• MLA = partner’s capital balance  partner’s profit
and loss percent
• Partner with the largest MLA is the strongest and
should be the first to receive a distribution
Chapter 9, Slide #46
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Predistribution Plan (continued)
• Actual distributions reduce partners’ capital
balances and their respective MLAs
• When all partners have equal MLAs they will all
receive a distribution
Chapter 9, Slide #47
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.