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Unformatted text preview: CHAPTER 16 ANSWERS TO QUESTIONS 1. Realization gains or losses are allocated to partners in their profit and loss ratio because the changes in asset values are the result of risk assumed by the partnership. Also, because it may be difficult to separate gains and losses that result from liquidation from the under- or over-statement in book values that result from accounting policies followed in prior years. 2. The final cash distribution is based on capital balances, not on profit and loss ratios, since the capital balance represents the partners' &quot;residual claims&quot; to the assets remaining after settlement of partnership obligations. 3. Because the UPA order of payment ranks partnership obligations to a partner ahead of asset distributions to a partner for capital investments, a debit balance in a partner's capital account will create problems when that partner has an outstanding loan balance. Other partners will have a claim against this partner for the amount of his/her debit balance which is considered to be an asset of the partnership by the UPA. If the partner with a debit balance settles his/her obligation with the partnership, there is no problem. However, if he/she can't settle, the other partners must absorb the deficit as a loss, even though the partner with the debit balance had received cash for his/her outstanding loan balance. To avoid this inequity, the courts have recognized the right of the partnership to offset the loan balance against the debit capital balance. 4. Maintaining separate accounts for outstanding loan and capital accounts recognizes the legal distinction between the two. This would be important if the liquidation is carried on over an extended period, since the UPA provides that a partner is entitled to accrued interest on the loan balance. 5. When the equity interest of one partner is inadequate to absorb realization losses several alternative outcomes are possible. If the partner is personally solvent, he may pay the partnership for the amount he is liable. If he/she is personally insolvent then the other partners must absorb his/her debit balance in their respective profit and loss ratio. If the other partners are unsure of what the partner with the debit balance will do, but still wish to distribute cash, they can assume the worst (absorbing their share of the debit balance) to determine what amount of cash can be safely distributed. 6. Cash should not be distributed to any partner until all liquidation losses are recognized in the accounts or are provided for in determining a safe cash payment. 7. The classification of assets into personal and partnership categories in recognition of the rights of both partnership creditors and creditors of the individual partners is referred to as &quot;marshalling of assets.&quot; 8. To the extent that personal creditors do not recover from personal assets they can seek recovery from those partnerships assets still available after partnership obligations have been met. This recovery, however, is limited to the extent that the partner involved has a credit interest in partnership assets....
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- Spring '08