A. The Process and Methods used to account for partnership formation.
A partnership is an entity formed when two or more persons come together to establish an entity for profit-making purposes. The transactions in a partnership company entail the investment of a partner and how to share profits or losses incurred by the company among the partners. Also, is the withdrawal of a partner from the business and the partnership liquidation process. There are several methods for accounting for the transactions in a partnership. They are exact, bonus or goodwill methods. In exact method, a partners investment is often equal to the book value of the purchased capital interest. In bonus method, a difference between the book value of the investment and a partners distribution is then distributed as a bonus to either the new or old partners. If an investment amount is greater than that of the book value of interest, a bonus is given to the old partners. However, if the investment amount is lesser than book value, the bonus is given to new partner(s) (Callison & Sullivan, 2012).
Moreover, upon the admission of a new partner, the contributions that he or she makes are recorded using the current market value while the original book value is what will be used in the calculation of tax purposes.
How Partnership Company split profits and losses
At the end of the year, a partnership company can either make losses or profits and the incomes are recorded on the capital accounts of each partner. The value allocated to each partner is on the basis of the agreement agreed upon during the formation of the partnership. In the case where no agreement had been made, profit or loss is shared evenly (Callison & Sullivan, 2012).
What happens if the partnership does not do well and the company has to dissolve it, or one of the partners becomes insolvent?
When a company becomes insolvent and cannot pay its obligations in due time, then its operations is most likely to be halted. All assets are sold and the cash is shared between the lenders and the companys shareholders. However, if cash is available to pay all the obligations then this is used prior to the selling of the noncash assets. In a situation where a partners capital balance is negative, then the value is to be distributed among the other partners in their percentages or ratio of relative profit and loss.
There are several ways through which dissolution can take place. It can be by a mutual agreement or by conforming to the terms and conditions of the partnership deed. Secondly, is if a partner decides to pull out thus prompting the partnership to dissolve. Thirdly, is, after the agreed life-span of the partnership reaches expires. Fourthly, death of a partner or bankruptcy on both or one of the partners necessitates dissolution. Finally, is dissolvent by law, a court, through valid reasons (Martin, 2010).
It is important to consider several factors during the dissolution process. They include liability for the companys obligations, apportionment of the companys assets among the partners and final compilation of the partnership account. Also, is the storage of the companys records in accordance to the requirements as per the law and professional code of ethics regardless of the need for indemnity insurance (Martin, 2010).
Illustrating the dissolution process through a hypothetical cash distribution schedule
The observations from the illustration are as follows:
1. Each partner's loss absorption potential is computed as his or her capital balance divided by that partner's loss-sharing percentage. Aurum has the highest LAP ($170,000), Cooper has the next highest ($140,000), and Bronze has the lowest ($50,000). Each partner's LAP is the amount of loss that would completely eliminate his or her net capital credit balance.
2. The least vulnerable partner is the first to receive cash distributions after settling the creditors. Aurum is the only partner to receive cash until his LAP is reduced to a level of Cooper. To decrease Aurum's LAP by $30,000 requires paying Alt $10,500 ($30,000 X 0.35). After payment of $10,500 to Aurum, his new loss absorption potential will be the same as Coopers, calculated as Aurum's remaining capital balance of $49,000 divided by his loss-sharing percentage of 35 percent ($49,000/0.35 = $140,000).
Section II. Corporation
Financial restructuring involves collateralizing assets, refinancing credit, securing exit financing, resolving pre-petition debt at deep discount and establishing debt for equity ways. Short term cash improvements involve the disposition of executor contracts, rationalizing headcount, and managing risks with troubled suppliers, reducing external expenditure, liquidation of assets, adjusting wages, benefits and overhead costs, reducing inventory and reevaluating capital plan.
Various forms of bankruptcy and restructuring
Bankruptcy is when an organization is declared in law unable to pay its outstanding debts. The company is deemed insolvent. Various forms of bankruptcy include Chapter 7 Bankruptcy, Chapter 13 Bankruptcy, Chapter 11 Bankruptcy, Chapter 9 Bankruptcy, Chapter 12 Bankruptcy and Chapter 15 Bankruptcy (Epstein, 2013).
Chapter 11 Bankruptcy is used by many organizations in a bid to rationalize and restructure its finances. Chapter 7 Bankruptcy is applied for the purposes of liquidation. Here, the organization gives all its non-exempt property to a party that has been given a legal obligation to administer the property. The non-exempt property is sold to pay off debts. If the value of the property does not fully repay the debt, a person may be fully absolved from the remainder. On the other hand, Chapter 13 Bankruptcy entails forming a plan for loan repayment either in portions or in full. The company must make a plan based on the amount it can accumulate. It must also set out a time limit for loan repayment. Hence, Chapter 11 Bankruptcy is more desirable because it allows for the continuance of all activities even in a state of bankruptcy (Epstein, 2013)..
1. Key points of interest if the firm falls on hard times and has to file voluntary bankruptcy and ethical implications should be considered when debating whether or not to file bankruptcy.
Before filing for a bankruptcy a company must determine if it can repay the creditors outside of bankruptcy, if lenders are taking legal action against it for loan defaulting and if a creditor is threatening to take possession of mortgaged property. Finally, is how much property the company owns (Hemel, 2010). Key areas of concern if the firm fell on hard times and their creditors forced them into bankruptcy.
A court considers the number of debts, the value and form of the delinquencies, the nature of a debtors business, the implications of non-payment and the devaluation of the company when its assets are sold and the value of the debt vis a vis the companys yearly revenue (net). Also is if the amount owed is a subject of a bona fide conflict or if the creditor is the only one who has not been repaid and all the others have. Moreover, if there exist an optional discretionary closure of the company and sale of assets can finance the loan repayment (Altman & Hotchkiss, 2010).
A company must take up measures to fight off involuntary bankruptcy petitions so that its assets are not forcefully sold to repay the loans. Hence, a company should get a bankruptcy lawyer. Secondly, it should
provide monthly financial reports and bank statements showing records of how it has been paying its debts. Thirdly, the company should present a case against the creditor before the expiry of twenty days upon the issuance of the involuntary bankruptcy petition. However, the financial statements and reports should portray an improved financial position of the company despite the economic upheavals the company is experiencing (Fischer, Tayler & Cheng, 2015). Fourthly, if everything fails, the company should apply for Chapter 13 Bankruptcy. In the application, the company should indicate that can cover some of its running expenses sufficiently thus and as it should be granted more time. Finally, prove that the creditor has filed the Involuntary Bankruptcy petition for selfish personal reasons (Hemel, 2010).
3. Illustrating hypnotical calculations that would be done to help creditors understand how much money they might receive if the company were to liquidate.
The illustration refer to Exhibit 13.2 page 592, Advanced Accounting 12/e Mcgrawhill
1. The current and noncurrent distinctions usually applied to assets and liabilities are omitted from this financial statement. Since a company is on the verge of closing business, such classifications are meaningless. Instead, the statement is designed to separate secured from unsecured balances.
2. Book values are included on the left side of the schedule but only for informational purposes. All assets are reported at estimated net realizable value, whereas liabilities are shown at the amount required for settlement.
3. Both dividend receivable and the interest payable are included. The payroll tax liability represent the companys present debt. The statement of financial affairs is designed to disclose currently updated figures (Hoyle & Doupnik, 2012).
4. Liabilities are individually identified within the liability section (Point A). since the claims will be paid before unsecured creditors, the $45,625 total is subtracted directly from the free assets (Point B). Although not yet incurred, estimated administrative costs are included because such expenses will be necessary for a liquidation. Salaries are also considered priority liabilities. However, the $1,250 owed to one employee in excess of the individual $12,475 limit is separated and shown as an unsecured claim (Point C).
5. According to this statement, if liquidation occurs, Chaplin expects to remain witsh $71,250 in free assets after settling all liabilities (Point D). Unfortunately, the liability section shows unsecured claims of $118,750. These creditors, therefore, face a $47,500 loss ($118,750 $71,250) if the company is liquidated (Point E). This final distribution is often stated as a percentage:
Free assets / Unsecured claims = 71,250 / 118,750 = 60%
Unsecured creditors can anticipate receiving 60 percent of their claims. An individual, for example, to whom this company owes an unsecured balance of $800, should anticipate collecting approximately $480 ($800 60%) following liquidation.6. If the statement of financial affairs had shown the company with more free assets (after subtracting liabilities with priority) than the total amount of unsecured claims, all of the creditors could expect to be paid in full with any excess money going to Chaplin's stockholders (Hoyle & Doupnik, 2012).
Altman, E. I., & Hotchkiss, E. (2010). Corporate financial distress and bankruptcy: Predict and avoid bankruptcy, analyze and invest in distressed debt (Vol. 289). John Wiley & Sons.
Epstein, D. G. (2013). Bankruptcy and related law in a nutshell.
Callison, J. W., & Sullivan, M. A. (2012). Partnership Law and Practice: General and Limited Partnerships. West.
Hemel, D. (2010). Empty creditors and debt exchanges. Yale J. on Reg., 27, 159.
Hoyle, J. B., Schaefer, T., & Doupnik, T. (2012). Fundamentals of Advanced Accounting. McGraw-Hill Higher Education.
Fischer, P. M., Tayler, W. J., & Cheng, R. H. (2015). Advanced accounting. Cengage Learning.
Martin, A. R. (2010). Limited liability company & partnership answer book. Aspen Publishers.
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