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Unformatted text preview: CHAPTER 14 UNDERSTANDING THE ISSUES 1. The fair value of the net assets reflects the ap- preciation and/or depreciation in the value of existing net assets and the value of net assets not presently recognized on the balance sheet of the existing part- nership. The bonus method is conservative in that it does not recognize the appreciation of existing as- sets or the value of unrecognized assets. The under- lying logic for this position is based on several factors. First, the suggested appreciation is difficult to objectively measure if not all the respective as- sets value has been realized through an arms length transaction. For example, if you sell a 20% in- terest in a partnership, should that 20% transaction serve as the basis for suggesting the value of a 100% interest in the partnership? Second, the bonus method adheres to the long-standing convention of historical cost. Therefore, any value suggested but not actually received as consideration is not part of the historical cost of the transaction. Third, if unreal- ized appreciation were recognized and such values proved overstated, the resulting accounting for the loss in value might be inequitable for the partners. The bonus method avoids this potential inequity by electing not to recognize such appreciation. 2. The first step would be to determine the fair value of the net assets of the original partnership. This would include a valuation of existing net assets as well as the recognition that there may be other net values that are not captured on the financial statements. For example, there may be a contingent liability or goodwill that has not been recognized. Once the fair value of the net assets (e.g., $400,000) has been determined, this amount would represent the percentage interest in the new partnership to be retained by the original partners (e.g., 80%). Dividing the fair value by the percentage interest retained results in a suggested value of the new partnership entity ($400,000 divided by 80% = $500,000). The suggested value of the acquired interest is the differ- ence between the value of the new partnership and that of the original partnership ($500,000 versus $400,000). 3. There are several guidelines that govern the process of liquidating a partnership. First, all assets and liabilities of the partnership should be identified, and the assets should be converted into a distribut- able form. Second, as assets become available for distribution, the order of priority as established by the Uniform Partnership Act should be followed. A practical exception to this priority involves the doc- trine of right of offset. Third, every attempt should be made to secure net personal assets from those part- ners that have deficit capital balances. Finally, of critical importance is the guideline that distributions to parties should not be premature. That is to say, all distributions should be based on the conservative assumptions that remaining assets are worthless and that all partners are personally insolvent. This and that all partners are personally insolvent....
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- Spring '08