A partnership is formed between two or more individuals who enter a contract to invest in a business and share its responsibilities. There are different forms of partnership, and it is not always necessary that all partners provide finance for the company.
Moreover, it is not essential that every partner engages in business activities and decision making. The Internet Revenue Service refers to a partnership as a relationship between individuals or groups or companies to carry out a business based on pre-agreed terms and conditions which are legally binding (Kumar & Gupta, 2017). In addition, all partners share profit and loss of the business according to the contract between them.
When a partnership is setup by individuals contributing to the company’s equity in the form of cash, the current assets in the balance sheet will be debited, and the equity will be credited. Moreover, if partners invest in a business by contributing assets other than cash, then it will be shown as an investment on the asset side of the balance sheet and the equity will be credited (Beams, Anthony, Bettinghaus, & Smith, 2017).
The illustration of how the company could split profits and losses is based on a hypothetical scenario in which there are three partners including John, Jonathan, and Julie who have set up a partnership. They share profit and loss according to their profit/loss ratio. John has invested $15,000 cash, Jonathan invested $20,000 cash, and Julie invested $30,000 cash. It means that the total capital of the company is $65,000. The partnership distribution ratio is calculated by dividing each partner’s investment by the total equity of the company(Beams et al., 2017). The distribution of profit and loss is calculated in Excel and provided in Table 1.
Table 1. Profit and Loss Distribution.
|Investment||Partnership Ratio||Profit Distribution|
|Investment||Partnership Ratio||Profit Distribution|
Any alteration to the partnership setup leads to legal dissolution. However, partners can decide to process with or without court intervention. When a partnership is dissolved a certificate of dissolution is submitted to the authority and all creditors and partners are notified. All noncash assets are converted to cash and the subsequent gain/loss is recorded. Furthermore, all liabilities of the company are settled.
General partners have unlimited liability, and they are required to settle remaining debts of the partnership personally, whereas limited partners have an obligation no more than their investment in the company. The balance cash and gain/loss on assets are distributed to all partners according to the partnership ratio. If only one partner decides to quit the partnership, then his or her share in the company is bought by other partners according to the value of the business or an agreed amount between them. The leaving partner is paid, and his or her name is removed from the partnership contract (Kumar & Gupta, 2017).
Partnership: Cash Distribution Schedule
The dissolution process is illustrated in Excel and provided in Table 2. It shows that all assets are sold to generate cash. The net loss is added to the cash balance after settling all liabilities of the company.
Table 2. Partnership Dissolution.
|Assets (Book Value)||$225,000|
|Liabilities (Book Value)||$12,000|
|Remaining Cash Balance||$23,000|
|Total Loss for Distribution||-$30,000 + $23,000||-$7,000|
Corporation: Voluntary Bankruptcy
The US Securities and Exchange Commission set out the guidelines and requirements for filing a voluntary bankruptcy which may be sought by the owner(s) of a business to go out of a poor performing business or recover from the company’s mounting debt. It is an attempt by business owners to rescue their companies and make them profitable again. They can do so under Chapter 11 of the US Bankruptcy Code.
A voluntary bankruptcy requires a petition to be filed with the bankruptcy court which may ask for the submission of the details of the petitioner’s income and expenditures (Twomey, Jennings, &Greene, 2016).
The petition may be rejected if the owner fails the mean test which implies that his or her disposable income is sufficient to pay debt service (Twomey et al., 2016). The personal ethics of a voluntary bankruptcy suggest that an individual will be better off financially and emotionally by filing a bankruptcy rather than continuing with the troubled business. Moreover, investors’ interests can be protected from further dilution by declaring a bankruptcy. However, it is an ethical duty of the owners to repay lenders which is avoided in such situations. Individuals abuse bankruptcy laws by filing voluntary bankruptcies that have huge costs and this must be monitored and controlled.
Corporation: Forced Bankruptcy
The creditors can force a company into bankruptcy if it does not consent to do so. Section 303 of the Bankruptcy code provides specific conditions that have to be met to pursue a forced bankruptcy. The minimum number of creditors required for filing bankruptcy is three or more when the total number of creditors is 12 or more. Furthermore, a solitary creditor can force bankruptcy if there are less than 12 creditors of the company.
The creditors must select either Chapter 7 and Chapter 11 of the bankruptcy code when submitting a petition. Moreover, forced bankruptcy can be pursued if the debtor fails to repay debt and has appointed a custodian of the company’s assets and operations within the last 120 days (Beams et al., 2017). The countermeasures include selling assets, restructuring mortgage, and settling/negotiating debts with creditors.
The creditors can expect to receive $49,500 when the company liquidates. The calculation of this amount is provided in Table 3.
Table 3. Corporation Liquidate.
|Statement of Financial Affairs|
|March 31, 2019|
|Book Values||Available for unsecured creditors|
|Pledged with fully secured creditors:|
|$100,000||Land and building||$125,000|
|Less: Notes payable (long term)||-$65,000|
|Pledged with partially secured creditors|
|Less: Notes payable (current)||-$24,000||-$9,000|
|$8,000||Investment in marketable securities||$8,500|
|Total available to pay liabilities with priority and unsecured creditors||$75,250|
|Less: Liabilities with priority (See Working A)||-$31,000|
|Available for unsecured creditors||$44,250|
|Book Values||Unsecured – Nonpriority liabilities|
|Liabilities and Stockholders’ Equity|
|Liabilities with priority:|
|$16,500||Salaries payable (accrued expenses)||$14,500||$2,000|
|Payroll taxes payable (accrued expenses)||$1,500|
|Fully secured creditors|
|Less: Land and building||-$125,000||$0|
|Partially secured creditors|
|$3,500||Accrued expenses (other than salaries and payroll taxes)||$3,500|
Beams, F. A., Anthony, J. H., Bettinghaus, B., & Smith, K. (2017). Advanced accounting (13th ed.). New York, NY: McGraw-Hill/Irwin.
Kumar, S., & Gupta, P. (2017). Partnership accounts. New Delhi, India: Educreation Publishing.
Twomey, D. P., Jennings, M. M., &Greene, S. M. (2016). Business law: Principles for today’s commercial environment (2nd ed.). Boston, MA: Cengage Learning.