Accounting 401
Chapter 14
Partnerships: Ownership Changes and Liquidations
Changes in Ownerships:
● A transfer of a partner’s interest does not necessary result in
○ The dissociation of the transferring partner
○ The dissolution and winding up of the partnership
● Entity Theory
○ Partnership entity should continue if a partner is dissoicated
● Propriety Theory
○ Views a partnership as a group of individual investors
● Presumed to be arms’ length transactions
● Changes may indicate:
○ 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.
● A change in ownership normally suggests the need of both revalue nett assets and
recongize intangible assets
The admission of a new or loss of a partner; Liquidation which is dissolving the partnership and
settling all liabilities and distributing any cash left and exitting the business.
Propriety Theory:
Only views a partnership as a group of individuals. When a new partner joins and one leaves,
the current partnership is dissolved and creates a new one.
Entity Theory:
Partnership is it own entity and is separate from the partners. When a partner is admitted or
withdrawn we do not have to dissolve the partnership.
Admission of a New Partner
● Accompished 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 partnership
■ Generally a transfer of book values from one partner to another
The Value of Assets Contributed to an Existing Partnership
● 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
● May be less than 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 depreciation or write-downs on the recorded net assets of the
original partnership
○ Additional intangible assets being contributed by the incoming partner
Contribution of Assets to an Exsisting Partnership
● Incoming partner’s contribution is different from that indicated by the book values of the
original partnership
● Indicated treatment
○ Adjust existing assets and/or
○ Recognize goodwill
● Mutually exclusive methods
○ Bonus method
○ Goodwill method
The Bonus Method
Total Capital of a new Partnership is:
The book value of the previous partnership
minus Any write-downs in the value of the previous partnership’s net assets
plus The value of the consideration paid to the partnership by the incoming
partner
Note: Only net asset write-downs (versus write-ups) are recognized
● 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 partners
● Bonus is allocated based on profit/loss percentages, not the interest in capital
percentages
Bonus to the Orignal Partners
Percentage Interest
Captial Capital interest Profit Interest
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
Partner C $27,000 For 20% interest on Capital
Invests
$102,000
Partner C’s $20,400 20% of $$102,000
Capital
Bonus of $6,600 Contribution vs Capital
A&B
Assets $27,000
A Capital -$3,300
B Capital -$3,300
C Capital -$20,400
Bonus to the New Partner
Percentage Interest In
Capital Capital Percentage Profit Percentage
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
Partner C $10,000 for a 20% interest in capital
Invests
$85,000
Partner C’s $17,000 20% of $85,000
Capital
Bonus to C $7,000 Contribution vs Capital
Assets $10,000
A Capital- $3,500
B Capital- $3,500
C Captial- $17,000
Overvaluation of the Orignal Partnership
Percentage Interest In
Capital Capital Interest Percentage Interest
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
Partner C $10,000 for a 20% interest in capital
Invests
ABC Capital Implied $50,000 $10,000/20%
traceable to C (10,000) contribution vs capital
Fair value of AB
Capital $40,000
AB Overvalution $35,000
A Capital $17,500
B Capital $17,500
Assets $35,000
Assets $10,000
C Capital $10,000
The Goodwill Method
Total capital of new partnership is:
The book value of the previous partnership
plus Unrecognized appreciation and/or
minus Unrecognized depreciation on the recorded
net assets of the previous partnership
plus Unrecognized goodwill traceable to the previous partnership
plus The value of the consideration, both tangible and intangible,
received from the new incoming partner
Bonus Method vis-a-vis Goodwill Method
Bonus Method appropriate, plus the incoming partner’s
The total capital of the new entity equals the investment
book value of the previous partner’s capital Goodwill Method
adjusted for the asset write-downs, if The total capital of the new partnership
must approximate the fair value of the entity
Asset Appreciation
Percentage Interest in
Capital Capital % Profit %
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
Partner C Invests $27,000 for a 20% interest in capital
ABC capital implied $135,000 $27,000/ 20%
book value of ABC $102,000 ($75,000+$27,000)
difference $33,000
Attributable to:
land appreciation $43,000
inventory write-down ($10,000)
$33,000
Land $43,000
Inventory $10,000
A, Capital $16,500
B, Capital $16,500
Assets $27,000
C, Capital $27,000
Goodwill Attributable to Orginal Partners
Percentage Interest In
Capital Captial % Profit %
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
Partner C invests $27,000 for a 20% interest in capital
ABC capital implied $135,000 $27,000/20%
book value of ABC $102,000 ($75,000+$27,000)
difference $33,000
Goodwill $33,00
A, capital $16,500
B, capital $16,500
Assets $27,000
C, capital $27,000
Asset Write-Down
Percentage Interest In
Capital Captial % Profit %
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
Partner C invests $10,000 for a 20% interest in capital
ABC capital implied $50,000 $10,000/ 20%
book value of ABC $85,000 $75,000 + $10,000
difference $(35,000)
Attributable to:
Land appreciation $20,000
Inventory write-down ($55,000)
$(35,000)
Land $20,000
A, Capital $17,500
B, Capital $17,500
Inventory $55,000
Assets $10,000
C, Capital $10,000
Goodwill Traceable to the New Partner
Percentage Interest In
Capital Captial% Profit%
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
ABC capital implied $93,750 $75,000/80%
book value of AB $75,000
C should have paid $18,750
Partner C invests $10,000 for a 20% interest in capital
Goodwill to C $ 8,750
Assets $10,000
Goodwill $8,750
C,capital $18,750
Revaluation of Assets and Goodwill
Percentage Interest In
Captial Capital% Profit%
Partner A $30,000 40% 50%
Partner B $45,000 60% 50%
$75,000
AB fair value $64,000 AB adjusted book value
ABC capital implied $80,000 $64,000/80%
C should have paid $16,000 ABC vs Ab
Partner C invests $10,000 for a 20% interest in capital
Goodwill to C $6,000
A, Capital $5,500
B, Capital $5,500
Assets $11,000
Assets $10,000
Goodwill $6,000
C, Capital $16,000
Methodology for Determining Goodwill
● Determine the entity’s fair value, as indicated by the new partner’s investment (new
partner’s investment divided by the percentage interest acquired in the partnership).
● If the fair value determined is:
○ Greater than the book value of the new partnership adjusted for net appreciation
or net write-downs, implied goodwill is traceable to the original partners and is
allocated among them according to their original profit ratios.
○ Less than the adjusted book value of the nw partnership, implied goodwill is
traceable to the new partner.
● The initial capital balance of the new partner always is equal to the new partner’s interest
in the total capital of the new partnership after goodwill is recognized.
Contribution of Assets to Existing Partners
● The new partner deals directly with an existing partner(s) rather than with the partnership
entity
● Partnership records transfer of capital
● No assets are received by partnership
A, Capital $15,000
B, Capital $22,500
C, Capital $37,500
Withdrawal of A Partner
● Sell equity interest to an individual
○ Partnership entity records transfer of equity
● Sell equity interest to the partnership
○ Bonus Method
■ Difference between exiting partner equity and fair value
■ Remainign partners grant bonus to exiting partner
■ Bonus charged according to proportionate P&L ratio
○ Goodwill Method
■ Payment to exiting partner indicates fair value of partnership
■ Recognize goodwill only to exiting partner or the entire entity
Selling of an Interest to an Individual
Partners
A B C
Capital Balance $30,000 $50,000 $20,000
P&L Percentage 40% 40% 20%
A sells equity to C for $36,000
A, Capital $30,000
C, Capital $30,000
Selling of an Interest to the Partnership (Bonus)
Partners
A B C
Capital Balance $30,000 $50,000 $20,000
P&L Percentage 40% 40% 20%
A sells equity to the partnership for $36,000
Bonus Method
A, Capital $30,000
B, Capital (4/6) $4,000
C, Capital (2/6) $2,000
Cash $36,000
Selling of an Interest to the Partnership (Goodwill)
Partners
A B C
Capital Balance $30,000 $50,000 $20,000
P&L Percentage 40% 40% 20%
A sells equity to the partnership for $36,000
Goodwill to exiting partner
Goodwill $6,000
A, Capital $6,000
A, Capital $36,000
Cash $36,000
Selling of an Interest to the Partnership (Goodwill Traceable)
Partners
A B C
Capital Balance $30,000 $50,000 $20,000
P&L Percentage 40% 40% 20%
A sells equity to the partnership for $36,000
Goodwill traceable to entire entity
Goodwill ($6,000+40%) $15,000
A, Capital $6,000
B, Capital $6,000
C, Capital $3,000
A, Capital $36,000
Cash $36,000
Partnership Liquidation Guidelines
● RUPA priority (subject to an agreement to the contrary)
○ Use assets to discharge obligations to creditors including partners who are
creditors on parity with other creditors
○ Profits (losses) from liqudation allocated to partners
○ Partners with deficit capital balance
■ Makes contribution equal to the deficit balance
■ Solvent partners proportionally absorb any remaining deficiency
○ Final Cash distribution to partners based on capital balance
● Doctrine of right of offset
○ Not addressed in RUPA
○ Incorporated into partnership agreement
○ Amounts due to partner’s as creditors are combined with the respective partners’
capital balances
○ Avoids possibility of distributing assets to a creditor/partner where that partner
has a debt (deficit) capital balance
Liability for Debit Capital Balances
● Partners contributes assets to clear deficit balance
● Remaining debit balance proportionally allocated to solvent partner(s)
● Amounts owned to partners are on equal basis with personal creditors
Unsatisfied Partnership Creditors
● Unstatisfied partnership creditors look to personal assets of the partners
● RUPA: unsatisfied partnership creditors share pro rata with the partners’ personal or
individual creditors in the assets of the partners’ estate.
Types of Liquidation Approaches
● Lump sum liquidation
○ All assets are in a distributable form and all outside creditors are satisfied before
disbrutions are made to partners
● Installment liquidation
○ Payments may be made to partners only after anticipation all liabilities, possible
losses, and liquidation expenses
○ Payments may be made to partners installments rather than in fial lump sum
○ Caution must be exercised to insure that no premature distributions are made
○ A schedule of safe payments, showing appropriate distributions to partners, is
prepared as amounts become available for distribution
