(208)-DISSOLUTION OF PARTNERSHIPS

Dissolution of Partnerships

Presidential realization and interim distributions

When assets are realized piecemeal, the partners may desire, as soon as all liabilities have been discharged, to withdraw immediately such as is available for decision between them rather than wait until all the assets have been sold. In such circumstances, subject to any contrary agreement between the partners, the interim payments to the partners should be of such amounts that even though the remaining assets prove to be worthless no partner will receive more than the amount to which he is ultimately found to be entitled after being debited with his proper share of the total loss sustained on realization of all assets. To enable this to be done the proceeds of realization of assets must first be applied in repaying to partners any sums necessary to reduce their capitals to amounts which will bear the same proportion to the total capital as those in which profits and losses are shared.

Amalgamation of firms

Where members of two or more partnerships decide to amalgamate, the transaction resolves itself into the dissolution of the existing partnerships and the formation of a new one. For the purposes of the amalgamation, it is probable that the goodwill and other assets of the original firms will be revalued, and the capitals of the respective partners adjusted by reference to the profit or loss arising on such revaluation, before arriving at the amount of capital introduced by each partner into the new firm. Where the capital of the new firm is a fixed amount, to be provided by the partners in specified proportions or sums, it may be necessary, after giving effect to the agreed revaluation of assets, for cash to be withdrawn or paid in by one or more of the partners in order to adjust the capitals to the agreed amounts.

(207)-CONVERSION OF A PARTNERSHIP INTO A LIMITED COMPANY

Conversion of a Partnership into a Limited Company

Frequently a private business is converted into a limited company. The partners give up their partnership stakes in exchange for shares in the company. This conversion is usually seen as a necessary stage of development of the growth of the business. A larger stage may see the conversion of the private company into a public limited company.

Accounting entries

Such a transaction will necessitate the books of the firm being closed, and new books being opened for the company. The following will be the procedure for closing the firms’ books:

1. Open the realization account, and transfer to the debit thereof the book value of the assets taken over by the purchasing company, crediting the various asset accounts.
2. Transfer to the credit of the realization account the liabilities assumed by the company, debiting the respective liability accounts.
3. Debit the purchasing company’s account, and credit realization account with the agreed purchase price of the net assets taken over by the company. (The term net assets mean the assets less the liabilities).
4. The balance on the realization account, after debiting expenses, will represent the profit or loss on realization of the net assets, and will be transferred to the partners’ capital accounts in the proportions in which they share profits and losses.
5. Debit the accounts of the assets received as purchase consideration, and credit the purchasing company’s account.
6. Pay off any liabilities not taken over by the new company, crediting cash and debiting the liability accounts.
7. Distribute between t6he partners the shares, debentures and so on received from the company in the proportions agreed between them, debiting their capital accounts and crediting the accounts of the shares, debentures and so on.
8. Any balances remaining on capital accounts must now be cleared by the withdrawal or payment on of cash.
   

(206)-THE RULE IN GARNER VERSUS MURRAY

The Rule in Garner versus Murray

This is the situation where, on dissolution, a partner, capital account is in debt and he is unable to discharge his indebtedness.

Prior to the decision in Garner versus Murray it was generally supposed that any loss occasioned by one of the partners of a firm being unable to make good a debit balance on his account should be borne by the remaining partners in the proportions in which they shared profits and losses.

In this case, however, it was held that a deficiency of assets occasioned through the default of one of the partners must be distinguished from an ordinary trading loss, and should be regarded as a debt due to the remaining partners individually and not to the firm.

The decision of the case gave rise to considerable controversy. The circumstances were as follows: Garner, Murray and Wilkins were in partnership under a parole agreement by the terms of which capital was to be contributed by them in unequal shares, but profits and losses were to be divided equally. On the dissolution of the partnership, after payment of the creditors and of advances made by two of the partners, there was a deficiency of assets of 635 $, in addition to which Wilkins’ capital account was overdrawn by 263$, which he was unable to pay. There was thus a total deficiency of 898$, and the plaintiff claimed that this should be borne by the solvent partners, Garner and Murray, in their agreed profit and loss ration, via equally. Mr. Justice Joyce held, however, that each of the three partners was liable to make good his share of the 635$ deficiency of assets, after which the available assets should be applied in repaying to each partner what was due to him on account of capital. Since, however, one of the assets was the debt balance on Wilkins’ account, which was valueless, the remaining assets were to be applied in paying to Garner and Murray ratable what was due to them in respect of capital, with the result that Wilkins’ deficiency was borne by them in respect of capital, with the result that Wilkins’ deficiency was borne by them in proportion to their capitals.

(205)-ACCOUNTING FOR CLOSING PARTNERSHIP BOOKS ON DISSOLUTION

Accounting for Closing Partnership Books on Dissolution

Apart from special circumstances, the following outline of the steps necessary to close the books of a partnership when the assets are sold en bloc, may be found useful:

1. Open a realization account, and debit there to the book value of the assets, crediting the various asset accounts. The realization account will also be debited with any expenses of realization, and cash credited.
2. Debit cash and credit realization account with the amount realized on the sale of assets.
3. Pay off the liabilities, crediting cash and debiting sundry creditors. Any discount allowed by creditors on discharging liabilities should be debited to the creditors’ accounts and credited to realization account.
4. The balance of the realization account will be the amount of the profit or loss on realization, which will be divided between the partners in the proportion in which they share profits and losses and transferred to their capital accounts.
5. Pay off partners’ advances as distinct from capital, first setting off any debit balance on the capital account of a partner against his loan account.
6. The balance on the cash book will now be exactly equal to the balances on the capital accounts, provided they are in credit; credit cash and debit the partners’ capital accounts with the amounts paid to them to close their accounts.
   

(204)-BASIC PRINCIPLES FOR DISSOLUTION OF PARENERSHIPS

Basic Principles for Dissolution of Partnerships

Upon the dissolution of a partnership, the partnership act provides that the assets of the firm, including the sums contributed by the partners to make up losses or deficiencies of capital, must be applied in the following manner and order:

1. In paying the debts and liabilities of the firm to persons who are not partners therein.
2. In paying to each partner rateable what is due from the firm to him for advances as distinguished from capital.
3. In paying to each partner the amount due to him in respect of his capital and current account balances.

In the absence of agreement to the contrary, the partnership act provides that the following shall be grounds for the dissolution of a partnership:

1. The expiration of the term for which the partnership was entered into, if a fixed term was agreed upon.
2. The termination of the advantage or undertaking, when a single adventure or undertaking was the purpose of the partnership.
3. When one partner gives notice to the others of his intention to dissolve the firm.
4. The death of a partner.
5. The bankruptcy of a partner.
6. The happening of an event which causes the partnership to become illegal.
7. When a partner allows his share of the partnership to be charged for his separate debt.

(203)-GOODWILL IN PARTNERSHIP ACCOUNTS

Goodwill in Partnership Accounts

From the accountants’ viewpoint, goodwill, in the sense of attracting custom, has little significance unless it has a saleable value. To the accountant, therefore, goodwill may be said to be that elements arising from the reputation, connection or other advantages possessed by a business which enables it to earn grater profits than the return normally to be expected on the capital represented by the net tangible assets employed in the business. In considering the return normally to be expected, regard must be had to the nature of business, the risks involved, fair management remuneration and any other relevant circumstances.

The goodwill possessed by a firm may be due, inter Alia, to the following:

• The location of the business premises.
• The nature of the firms’ products or the reputation of its service.
• The possession of favorable contracts, complete or partial monopoly.
• The personal reputation of the partners.
• The possession of efficient and contented employees.
• The possession of trade marks, partners or well known business name.
• The continuance of advertising campaigns.
• The maintenance of the quality of the firms’ product, and development of the business with changing conditions.
• Freedom from legislative restrictions.

Although a firm may possess goodwill, it is not customary to raise an accountant for it in the books expected to the extent that cash or other assets of the firm have been used to pay for it. It follows, therefore, that when goodwill exists and is unrecorded in the books, the capitals of the partners of the firm are under stated to the extent of the value of their respective share of the goodwill.

Even though a goodwill account may at some time have been raised in the books, the goodwill account would not be adjusted to give effect to every variation in its value, and in most cases, therefore, the partners’ capitals are at all times understated or overstated in the books to some extent by their shares of the unrecorded appreciation or depreciation in the value of goodwill.
As the amount by which goodwill is undervalued or overvalued in the books is a profit or loss to be shared by the partners in their agreed profit sharing ratio, any alteration in the proportions in which profits and losses are shared, without first making an adjustment on the book value of goodwill, will result in an advantage to one or more partners and a disadvantage to others.

(202)-PARTNERS' ACCOUNTS AND ALLOCATION OF PROFITS

Partners’ Accounts and Allocation of Profits

Capital and current accounts

The partnership agreement provides for a fixed amount of capital to be contributed by each partner, it is preferable for the amounts therefore to be credited to the respective partners’ capital accounts, and for partners’ drawings, salaries, interests on capital and shares of profits to be dealt with the current account.

This enables a clear distinction to be made in the accounts between fixed capital and not drawn profits.

Partners’ loan accounts

Where a partner makes an advance to the firm as distinct from capital, the amount therefore should be credited to a separate loan account and not to the partners’ capital account.
Interest on a partners’ advance or loan at the agreed rate or, in absence of agreement, at 5% per annul should be credited to his current account and debited to profit and loss account as an expense of the business in arriving at net profit.

Allocation of partnership profits

The formula for allocation of partnership profits between the partners will usually be set out in the partnership agreement. The formula may take account of some or all of the following adjustments:

• Interest on capital
• Interest on drawings
• Partners’’ salaries
• Profit-sharing ratios

Interest on capital

By making notional charge against profits for this expense at a fair commercial rate on the capital employed in a business, it can be seen whether the balance of profit remaining is sufficient to satisfy the continuance of the firm with unlimited liability, since the interest charged may be regarded as approximately the income the partners would have derived from the interest of their capital in securities involving little or no risk. Apart from this, however, where there are two or more partners with unequal capitals, the effect of charging interest on capital is to adjust the rights of the partners as between themselves as regards capital, giving each a reasonable return on his capital before dividing the balance of profit in the agreed proportions.

Interest on drawings

Where that is charged, it is usually calculated at a fixed rate per annul from the date of each drawing to the date the accounts are closed and taken account of in the statement of allocation of net profit in a similar way to interest on capital.

Partners’ salaries

In the absence of agreement no partner is entitled before arriving at the amount of divisible profits to remuneration for his services to the firm.

Where the agreement provides for the payment of salaries to partners, it should be appreciated that such payments, although designated salaries are, like above expenses, merely in the nature of preferential shares of the divisible profit. The amounts such salaries should therefore be taken into account in the statement of allocation of net profit.