 Hello, and welcome to the session. This is Professor Farhad. In this session, we would look at introduction to partnership liquidation. And specifically, we're going to be looking at marshaling of assets. This topic is covered in advanced accounting. It's also covered on the CPA FAR section. As always, I would like to remind you to connect with me on LinkedIn. YouTube is where you would need to subscribe. I have over 1500 plus accounting, auditing, and tax lectures. If you like my YouTube, please like them, share them, put them in the playlist, let the world know about them. If you're benefiting from my lectures, that mean other people might benefit as well, so share the wealth. This is my Instagram account. Please follow me on Instagram. This is my Facebook, and this is my website. On my website, if you'd like to support the channel, you could always donate. That's greatly appreciated. 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We're going out of business. Sometime it's cold, it's cold, winding up the affairs. So let's think about it from a logical perspective. What happened when you closed the business? Well, you have to sell everything, compute your income to date. So basically, you have to sell all your non-cash asset, compute your income to date, then distribute or allocate, not distribute, I like to use the word allocate, income or loss to the partners in the residual profit or loss ratio. This is allocating the income or the loss from step one after you compute your net income. Then you distribute the assets to creditors. Now, we have to determine how are we going to distribute them to creditors because we have many types of creditors, which we will discuss shortly. Then you distribute any remaining asset to partners based on their capital balance. Here, when we distribute any remaining asset, usually that asset is cash, it's based on their capital versus in step two, when we allocate the profit or the loss, it's based on the profit on loss ratio. Well, how do we distribute the asset to creditors? We're going to be following the Uniform Partnership Act. For short, it's called UPA and how do we do so? Well, first, those owning to creditors other than partners. Basically, the partnership will have creditors and the partnership might have the partners as creditors. First, we have to pay the creditors other than the partners. Let me just give you an example. This is a partnership and we bought from Best Buy, we bought material from Best Buy, we bought material from Circuit City. Those are creditors and we borrowed money from the bank. Those are all creditors, creditor, creditor, creditor. Also, partner, we have partner A, B, C and D. Partner B also lend money to the partnership. Partner B also a creditor, but first, we have to pay those creditors, creditors who are outside the partnership. Obviously, that makes sense because they have, if you are a partner, well, guess what? You're going to have to wait until you pay the outsiders. Then you have to pay those owning to partners other than their capital profit, their capital and profit. Then you have to pay the creditors who are your partners. In other words, those owning to partners such as loans. If you lend money to the partnership, then you have a priority. After the creditors outside the partnership, but this priority does not affect your capital or profit ratio. This is separate. Then, those owning to partners in respect to their capital, then you have to pay them in respect to their capital and thus owning the partner in respect to their profit. Bear in mind that three and four usually are combined. Basically, after we paid the outside creditors, the partner's creditors, or somehow satisfy them, three and four are basically combined together because what's left is basically you have to pay their capital balances. Sometime what happens is this, the partners will have a deficit balance. What is a deficit balance? It means under capital account. For example, if I'm a partner, far hat capital, I might have a deficit balance of 5,000. Well, this is deficit balance means basically it's not only I don't have any equity, I owe the partnership $5,000 of equity. Why? Because over the years, I either withdraw money or I absorb losses. Therefore, I have a deficit. If a partner has a deficit, any loan that a partner can use to decrease the deficit, this is called right of deficit. So let's assume I have a deficit. At the same time, I have a loan. I have a loan. I loan the, let's keep it simple. I loaned the corporation $5,000. So this loan belongs to me. This is my loan. I gave them this money. So I gave them this money. So I have a receivable. So I'll have account receivable from my end, okay? Or not an account, notes receivable. But we're talking about the partnership account. The partnership, what we will do is we will offset this loan. We will debit the loan and credit my account to bring my account up to zero. So if I have a loan against that, if I have, if I lend money to the, to the partnership and I have a deficit balance, I have the right to offset that loan against the capital. If a partner has a deficit balance that decrease the other assets access to assets. So if I have a deficit balance, guess what? If I cannot absorb it because I don't have a loan and I don't have cash to pay because if I don't have a loan, I might have to put in some cash to reduce, to bring my capital up to zero. If I can do so, guess what? The other partners will have to absorb that deficit and we'll see how in a moment. And to make things a little bit more complicated, sometimes the partners in a partnership, they might have personal debt. In other words, they have a business debt with a partnership and personal debt. Now what happened to the personal creditors? If you have it, if you have it, if you have a debt, but you have a personal creditors. So personal creditors of an individual partner can seek recovery of payment from personal asset of the respective partner. Of course, if, if you owe me money, I'm going to go after you personally. On top of this, in certain circumstances, I can go after the partnership asset. So it's not only I can recover money from you, I can recover money from the partnership. Now, now we have recognized recognition of the rights of these two groups of creditors, means the creditors, the personal creditors and the business creditors in the classification of asset into personal asset and partnership categories is referred to as more shilling of assets. Now here we have to determine we're going to have a personal asset, personal debt, partnership asset, partnership debt. Now how are we going to, how are we going to recognize the right of each group? Here's what's going to happen. The order of priority of concerning the availability of assets for each group of creditors in state that have adopted the UPA, we're going to be assuming we're adopting the UPA is as follow. So if you have a partnership asset, if you have a partnership asset, guess what? First, the partnership creditors have a priority. That makes sense. Those assets are for the partnership. Now, personal creditors that did not recover their full claim from the personal asset, okay, they can recover from the partnership asset, okay, and that's limited to the extent that the partner has a credit interest in their partnership asset. What does that mean? It means, let's assume I owe someone money, $10,000. I owe someone $10,000. This is a personal debt, personal debt. I'm also a partner, okay? I'm partner A and a partnership, A, B, C, D. At first, the assets from this partnership will have to go to the partnership creditors. And this makes sense. We borrowed money to do business. Therefore, we have to pay them first. Now, if I cannot pay this personal debt, okay, if I cannot pay this personal debt, and I still have a credit balance in my account, in the far hat, I have a credit balance. That means I'm not at a deficit, far hat capital, and I have like $3,000. I still have $3,000. Then this individual or this bank that I borrowed money from on a personal debt, they can go after this, they can go after the partnership, because now I do have a credit balance. I have a credit interest. It means I am in a sense in, quote, solvent in terms of the partnership. I still have some equity in the partnership, okay? And when do we determine this? And during the final distribution, okay? So they can go after you only if you have credit. Otherwise, the assets in the partnership belong to the debt of the partnership, okay? Personal assets, obviously personal asset, just like with partnership asset, personal asset belongs to personal creditors first. So personal creditors, you know, they can go after my personal assets first. Now, partnership creditors who are not satisfied from the partnership asset, again, that's me, but now I did not pay all my debt in the partners in the partnership. Now, they can made such claim may be made against an individual partner regardless of whether the partner has a debit or credit interest in the partnership. They can go after me. They can go after me. But first, the priority is for the personal creditor. The best way to illustrate this is to actually look at an example, okay? So let's take a look at this balance sheet and we're keeping things simple. We have for this company, we have cash of $50,000. We have liabilities for the whole company of $75,000 and we have four partners, partner A, B, Alice, Bill, Carol and Don. Okay? Notice Alice, Amos or Amos and Davis, they have a credit balance. While Bill and Carol, they have a deficit balance. Notice this is a debit balance. That's the first thing we need to look at. So hopefully, you can read this. And notice, I mean, at the same time, I mean, in some textbook, what they do, they show the debit balance here as negative. So they show the, they show in some textbook, what they do is they show Baker, negative $50,000 and Carter, negative, well, together $50,000. So Baker, negative $15,000 and Carter, negative $35,000, which in turn will give you $50,000 on this side. And if you take this out, you'll give you $50,000 on this side. So sometime, but here they have the debit balance. They basically put the debit balance with the assets. That's fine. Now what else do we have to know? We have to know what personal assets do they have? Okay. Well, here's the situation. Amos, they have $20,000 of assets and $50,000 of liabilities. And those are personal. So notice, in the business, Amos has $15,000 credit balance. However, on his personal, he was very, not responsible, very not responsible. He has a lot of debt. Okay. So he has $30,000 of personal, basically net personal obligation, personal debt, because his assets cannot cover his liabilities. He's down $30,000. Okay. Bill, Bill Baker, $33,000 of assets, $30,000 of, $30,000 of debt. Well, that's good. At least he has more assets than liabilities. So he has a plus $3,000, $3,000 net. Okay. And his capital balance is deficit. Well, he's in a deficit. Okay. As far as the partnership concern is not good. Okay. It's a debit balance. All right. Carter, $90,000 and asset, $30,000 in liabilities. Well, on a personal level, Carter is doing pretty good at $50,000 of assets and access to personal asset and access to personal liability, but from a business perspective, not good. From a business perspective, not good. He has a deficit balance. Notice those are deficit balances. Don Davis, they have more assets than liabilities, $30,000 more assets than liabilities. And from a business perspective, he's doing good. He has a credit balance of $10,000. The credit balance of $10,000. Okay. Now the first thing we have to understand that personal asset, they have to be applied first against personal liability. And hopefully this makes sense, right? Personal assets because, so Bill Baker, they have personal asset, they do have personal asset, but of that $33,000, $30,000 goes to eliminate this. So what's left is $3,000. Same thing, out of $90,000. First, we have to eliminate this debt and what's left is $50,000 of the $40,000. What's left is $30,000. So first, we have to do, we have to do so. Okay. So we're going to go ahead and look at the process in which we are going to liquidate this company. Okay. We're going to liquidate this company. All right. So the first thing is, well, what can, let's talk about Amos. What can Amos do? Amos cannot, well, Amos has a credit balance. Okay. So Amos has a credit balance. So we're going to wait to see what's going to happen because he doesn't have any money. Well, he doesn't need to bring any money because he has a credit balance. Baker, Baker, he got $3,000. Okay. Let's take a look. So this is the beginning balances. We have cash of $50,000, liabilities in total of $75,000. And this is the capital and loan balances Amos, credit, debit, debit and credit. Okay. So this is what we are, this is the beginning balances. The first thing we're going to do, we said since Baker or Bill Baker has $3,000, Bill Baker is going to contribute $3,000 to the partnership. So what's going to happen? We're going to increase cash by $3,000. We're going to increase cash by $3,000. And we're going to reduce his balance by $3,000. So basically, if you want to look at it from the journal entry, we debit cash, $3,000, we credit Baker, capital, $3,000. And what that did, that gave us $53,000 in cash, and Baker balance is now negative 12, not negative 15, negative 12. So that's all what Baker can do. Okay. Now, well, if that's all what Baker can do, the next thing we're going to have to do, since we're liquidating, someone will have to absorb Baker's losses. So Baker has $12,000 well, who's going to absorb the losses? Guess what? Amos, Carter, and Davis, A, C, and D. What does that mean? It means we're going to have the, we're going to have to take the $12,000. And basically, those are technically losses, and we're going to allocate them equally between between the three. Well, if we take $12,000 allocated equally between the three, each individual will have to absorb $4,000. Therefore, so we reduce Baker by $12,000. Baker now is down to zero, and we're going to, and Baker's deficit, it's going to go to Amos. It's going to reduce Amos, balances by four, increase Carter deficit by four, and reduce capital, the capital of Davis by four. Notice the credits are capital. So what's the journal entry for this? The journal entry is we're going to credit, we're going to debit, we're going to debit Amos, $4,000, the capital of Amos. We're going to debit Carter, capital $4,000, sorry, debit, debit dose account. We're going to debit Davis, Davis $4,000, and we're going to credit Baker $12,000, and here we go. Baker had a deficit of $12,000, and now we credit it by $12,000, balance is zero, Baker is out of the picture. So those are capital, I'm just writing capital, capital, comma Amos, capital, capital, and capital. So now Baker is out of the picture, we're done with Baker. Basically Baker out, he has a zero balance, and that's that. Now what's going to happen is we're going to have two, since Baker is out, now we have $53,000 in cash, now we're going to have to pay the creditors. We have $75,000, we have $75,000, we have $75,000 in liabilities. So what's going to happen is we're going to pay $53,000 to the creditors, therefore we're going to debit liabilities, whatever those liabilities are, $53,000, we're going to credit cash $53,000. Notice now cash is zero, we no longer have any cash, and the liabilities are $22,000. Now we still have a debit balance, which is Carter. Carter has a debit balance of $34,000, and by the way, the reason I allocated more to Carter, more in other words, I increased Carter's deficit balance, because I know from the get go that Carter got a lot of personal asset, enough personal asset to absorb it. That's why I gave Carter $4,000 of that allocation from Baker. So Carter absorbed $4,000 losses from Baker here, and the reason I did this, you might say he's already at a deficit, why you want to increase his deficit? I know he's at deficit, I know Carter is at deficit, but I know Carter has personal asset. Now Carter is going to come in and cover his personal asset, cover his deficit. Would he need to cover his deficit? He will need $39,000. Well, he's going to have to chip in $39,000. Why to cover his deficit to get out? Because he has the money, so we're going to increase cash, so we're going to debit cash, entry debit cash $39,000, credit capital Carter $39,000. Again, just to show you from a journal entry perspective, so Carter had a debit balance of $39,000, now I credited his balance, $39,000, Carter is out, Carter is out too. But good, Carter gave us some money. He's out, but at least he was able to contribute enough money to absorb his deficit balance. Now the partnership has $39,000 again, but Carter is out. So notice Carter is out, Baker is out. Both of them are out. Now, oh, we have money. Well, guess what? If we have money, we have to pay the creditors. Again, we're going to pay $22,000 for our creditors. Well, we're going to debit liabilities, $22,000, we're going to credit cash, $22,000. Well, liabilities are gone. We paid all our liabilities and after we paid the $22,000, what we are left with is $17,000 cash. And notice Amos balance is $11,000 and Davis balance is $6,000 credit. Well, you got the point. Where's that $17,000 is going to go? Well, that $17,000, it's going to go toward Amos and toward Davis. So who really paid this $17,000? Who paid the $17,000? Carter, because Carter paid us $39,000, $22,000 went to the loan and the $17,000 went to the other partners. So basically who paid for the other two partners, the cash? Carter, Carter paid. So what we do is we distribute the cash. Therefore, we debit Amos $11,000. His balance will debit at $11,000. We debit Davis $11,000 and we credit cash $17,000 of $6,000, not $7,000, $6,000 for Davis. We credit cash $17,000 and we're done. All notice the business is done. All the balances are zero. We no longer have cash. We don't have liabilities. No one has capital. That's it. We're out of business. We're done. We're out of business. We're done. So notice what we started with here, the balances. And when we liquidate, all the balances will be zero. If you have any questions, any comments about this recording, please email me. If you happen to visit my website for additional lectures, please consider donating if you're studying for your CPA exam. As always, study hard. In the next session, I would look at an example that's considered simple liquidation. Good luck and see you on the other side of success.