Accounting theory and practice, Volume 1 (of 3)

by Roy B. Kester

8. Bankruptcy of the firm. This results in the firm’s assets being sold to satisfy the claims of its creditors and the firm as such ceases to exist.

9. Sale or transfer. A firm may sell out to another firm or change its form of organization to that of a corporation. The old firm, therefore, no longer exists.

Problems Incident to Dissolution.—It is purposed to consider some of the problems involved in winding up the affairs of a partnership. From the schedule of causes of dissolution given above it will be seen that a firm may be either solvent or insolvent at dissolution. The three statements sometimes set up in the case of insolvency—the Statement of Affairs, the Deficiency Account, and the Realization and Liquidation Statement—will not be explained here but results obtained through them will be taken into account. These statements are seldom met in practice and are not standardized either as to form or content. Their treatment is deferred to the work of the second year.

Partnership Provisions Covering Liquidation.—Because of the certainty of final dissolution, it is not unusual for the partnership agreement to make definite regulations concerning the method of liquidation. The appointment of one of the members as liquidating partner, the manner of distributing the proceeds from liquidation whether by instalments or otherwise, the manner of paying the liquidator for his services—all these contingencies should be provided for.

Where dissolution is forced by the death of one of the partners, to determine the interest of his heirs it is necessary to take inventory and make appraisal of the firm’s assets. To avoid this inconvenience to the business, provision is sometimes made in the agreement that the remaining partners shall continue the business until the end of the regular fiscal period. The deceased partner’s share in the profits for the current period up to the date of his death is determined by prorating the year’s profit over the period in which the deceased had an interest. The method of calculating the firm’s good-will is usually provided for in the partnership agreement so that the estate of the deceased partner will share in it also. Usually interest is allowed the estate of the deceased partner from the date of his death until the settlement of his share.

Partners’ Rights and Procedure During Liquidation.—When dissolution is accompanied by liquidation, as happens in many instances, all the partners have an equal right to share in the work of liquidation. Since the work usually does not require the time of all the partners, a customary procedure is to appoint one member—or an outsider—as the liquidator. Notice of the dissolution, in which the name of the liquidator is given, is published in the leading newspapers. If liquidation is necessary because of the death of a partner, great responsibility rests upon the liquidator. He must act in strict good faith and endeavor to realize the best price possible for the assets of the firm in the interest of the deceased partner’s estate. A similar responsibility rests upon him when liquidation is carried on in the interest of absent members.

The expenses and losses incident to liquidation must be borne by all in the profit and loss ratio. The liquidator may be paid either by means of a commission on the sums realized or by a salary. If the liquidator is a partner, settlement may take place privately between the partners but usually his commission or salary is charged to the firm’s liquidation expenses.

Liquidation may proceed by sale of the assets in regular order and may even permit the purchase of additional goods where necessary to fulfil existing contracts or to complete partly manufactured goods, or where stock on hand can be disposed of to better advantage by the addition of side lines or specialties.

Distribution of Proceeds.—Upon the realization of the assets, application of the proceeds must be made in the following order: First, the claims of outside creditors must be met in full or by compromise where not fully recognized. Second, the claims of the partners on account of loans or advances made to the firm must be satisfied. Third, the partners share in the remainder, by first taking out their respective capital contributions and then, if there is a balance, by sharing it in their profit and loss ratios. If there is a loss, this must be shared in the profit and loss ratio before withdrawal of any capital contributions. The remainder, if any, is divided among the partners in the ratio of their capitals as diminished by the loss. Whether the net assets are either more or less than the total amount of the capitals, the difference is shared in the profit and loss ratio, and what remains is shared in the capital ratio. If a careful accounting is made of the profit or loss at the time of the sale of each piece of property and these profits and losses together with the dissolution expenses are summarized and distributed to the partners’ capital accounts, those accounts will of course show the claims of the various partners on the net assets of the business after all assets have been converted into cash and all liabilities paid.

Instead of a complete liquidation of the firm’s assets, certain of the assets may, by mutual consent, be taken over by each partner at agreed values and applied toward the satisfaction of his capital and loan interests. Such use of assets is spoken of as a conversion to that particular purpose. It must be distinctly understood that this is not a right which any partner can demand, but only a privilege granted by the mutual agreement of the partners. Any partner can demand that all the assets be sold and that the proceeds be applied in satisfaction of the interests concerned.