3. Personal Insolvency of One Partner
| Balance Sheet of Smith, Jones & Green | |||
| Cash | $16,000.00 | Smith, Capital | $15,000.00 |
| Jones, Capital | 9,000.00 | Green, Capital | 10,000.00 |
| $25,000.00 | $25,000.00 | ||
Smith and Jones each have a ⅖ share and Green a ⅕ share in profits and losses.
The above balance sheet shows the financial condition of the firm after taking into consideration the losses incident to liquidation. From this it is seen that Jones owes the business $9,000. Assume that he is personally insolvent and cannot contribute the share due from him. The net assets available for distribution consist of $16,000 in cash. Inasmuch as Jones’ interest is entirely wiped out and a contribution is due from him which he cannot pay, the amount of that contribution is an additional loss to be borne by the two remaining partners. Their respective shares in this loss are determined by their original profit and loss ratios ⅖ and ⅕, so that as between themselves Smith must bear ⅔ of the loss or $6,000, and Green ⅓ or $3,000; after which Smith’s capital and share in the net assets is $9,000, and Green’s $7,000.
Where a partner, in his private capacity, and the firm of which he is a member are both bankrupt, his personal creditors have first claim on his personal estate and the firm’s creditors on the assets of the firm.
Distribution by Instalments.—Where the liquidation is of long duration, the partners may desire to receive what is due them by instalments rather than wait to receive their respective shares in one amount. Where the capital ratio differs from the profit and loss ratio, it is difficult to determine the proper ratio in which the instalments should be paid, due to the fact that expenses and losses have not yet been determined. Consequently it is impossible to tell what the ultimate ratios will be in which the partners are to share the net assets. As the payment of instalments on an arbitrary basis might result ultimately in an overpayment of some partners and an underpayment of others, the only safe method of handling the situation is to pay the first instalments to those partners whose capital ratios are in excess of their profit and loss ratios until their capitals are reduced to the point where the capital ratios of all the partners are the same as their profit and loss ratios. As soon as this point is reached, the proceeds of the assets may be distributed to the partners on the basis of their profit and loss ratios, because these are now identical with their capital ratios. A more complete treatment of this problem will be found on pages 650 to 654 of the author’s second volume.
Treatment of Good-Will upon Liquidation by Sale.—When dissolution is brought about by the sale of the entire business, it may happen that the amount realized on the assets is smaller than their book value, and the difference must be treated as a loss in accordance with the principles previously stated. Similarly, where the assets are sold and the price realized is larger than their book value, the excess constitutes a profit and must be distributed among the partners in profit and loss ratio. Usually such an excess is treated as a receipt on account of good-will, and two standard methods of booking it are employed. When good-will is mentioned in the sale contract and its value has been determined, it is brought on the books as an asset and transferred immediately to the partners’ accounts. Thus, if the value is $15,000 and the profit and loss ratio is ⅖ to A, ⅖ to B, and ⅕ to C, the entry is:
| Good-Will | 15,000.00 | ||
| A, Capital | 6,000.00 | ||
| B, Capital | 6,000.00 | ||
| C, Capital | 3,000.00 | ||
Good-will is now shown as an asset, and the entry closing it off is the same as for the sale of the other assets, viz., a debit to Cash and a credit to Good-Will.
On the other hand, when good-will is not specified as such in the sale contract, but the amount realized on the sale of the assets is larger than their book values, this excess may be credited to Good-Will, which is then treated not as an asset account (as in the case given above) but as a profit and loss account. The balance of this account is closed out to the partners’ accounts in profit-sharing ratios in the same way as above. The ultimate result is the same in either case; the first method is a little more complete since it shows the value of the asset good-will previous to its sale.