F.Y B.COM
SEMESTER - 2
FINANCIAL ACCOUNTING
(FA)
THEORY - UNIT 1
GRADUAL REALIZATION OF ASSETS AND PIECEMEAL DISTRIBUTION OF CASH
INTRODUCTION
On dissolution of partnership firm, it was presumed that all assets were realized on the date of dissolution and liabilities were also paid off that date. Therefore, it makes possible the ascertainment of profit or loss on realization immediately. But in practice, this does not happen. The assets are realized gradually and the liabilities are paid off as and when cash is available.
Following points to be prominent under this system:
• On the event of dissolution of a partnership firm, the assets are realized and liabilities paid off.
• The process of asset realization takes place gradually. As a result of such the liabilities are also paid off as and when such realization takes place.
• “Piece-meal Distribution” represents the process of “Pay as and when you realize” strategy.
When assets are realised gradually, available cash at any point of time should be utilized in the following order
1st Realisation Expenses are paid off or provided for. (It should be paid off or kept in reserve out of either first installment or cash in hand)
2nd Preferential Creditors are paid off, if any. (For Eg. Government Rates and Taxes, etc.)
3rd a. Secured Creditors are paid off, out of cash realised by sale of an assets charged/mortgaged. However, if assets other than charged/mortgaged assets are realised first, then secured creditors are treated at par with unsecured creditors (i.e. payment is to be made all the creditors ratably/proportionately) till the realization of charged assets.
b. Unsecured Creditors, after settling creditors, unsecured creditors are settled. If the available cash is not sufficient to clear all unsecured creditors, it is distributed ratably among all unsecured creditors.
4th Partners’ Loan, after settling all outside creditors, partners’ loan is settled in proportion to their respective claims.
5th Settlement of Partners’ Capital Account, after the payment of all partners’ loan, the balances of partners’ capital are paid off. Before the balances of partners’ capital are paid, as a prudent measure, an adequate provision should be made for a contingent liability, if any. (for Eg. Discounted bills receivable, the maturity date of which has not yet fallen due.)
Methods of Piecemeal Distribution of Cash:
The capital contributed by the partners may or may not be in their profit sharing ratio. In case, the capital of the partners is in their profit sharing ratio, surplus cash can be distributed in their profit sharing ratio. In case, the capital of the partners is not in their profit sharing ratio, surplus cash can be distributed by either Surplus Capital Method or Maximum Loss Method.
Surplus Capital Method/Proportionate Capital Method/ Highest Relative Capital Method
This method is suitable if the following two conditions are satisfied
a. The partners profit sharing ratio is not as per capital contribution and,
b. All the partners are solvent and are likely to remain solvent Under the Surplus Capital Method, it is prerequisite to ascertain the surplus capital of partners for distribution of cash. The practical steps to be followed in determining the surplus capital are as follows;
Step 1 Calculate the adjusted capital of all partners (i.e., after making adjustments of accumulated profit/ loses, reserves and transfer the balance of current accounts, etc. but before making adjustment for profit/ loss of realization)
Step 2 Divide the adjusted capital (step 1) of partners by their profit sharing ratio. The smallest quotient (i.e. least capital of a partner) should be taken as base capital.
Step 3 Calculate the proportionate capital by multiplying Base Capital (step 2) and profit sharing ratio.
Step 4 Calculate the surplus capital by deducting proportionate capital (step 3) from the adjusted capital (step 1).
Step 5 Divide the surplus capital (step 4) of the partners by their profit sharing ratio. The smallest quotient (i.e. least capital of a partner) should be taken as revised base capital.
Step 6 Calculate the revised proportionate capital by multiplying revised base capital (step 5) and profit sharing ratio.
Step 7 Calculate the absolute surplus capital (if no. of partners reduces to one) or revised surplus capital by deducting revised proportionate capital (step 6) from the surplus capital (step 4).
Step 8 Go to step 5 (but considered revised surplus capital) and repeat this process till the no. of partners having excess capital reduces to one.
Distribution of Cash to Partners (Surplus Capital Method):
The partner with the absolute surplus capital is paid of first, followed by payment to other partners who have surplus capital. The distribution of available cash is to be made among the partners in the following manner:
1. If one partner only has the surplus capital, make payment to such partner first.
2. If two or more partners have surplus capital, distribute the cash in their profit sharing ratio.
3. Finally, payment is to be made to all the partners in their profit sharing ratio.
4. The balance left unpaid being loss on realization and it should be in their profit sharing ratio.
Notes:
a. Cash in hand or bank balance is to be considered as first realization in distribution of cash.
b. Once the realization expenses become certain, an amount kept in reserve for estimate realization expenses is no longer required and therefore it should be utilized for distribution. If the actual realization expenses are less than the amount so kept as reserve, the balance is to be distributed among the partners.
c. If an asset of a firm is purchased by the partner, then the agreed value of such asset should be distributed among all partners (including the partner who has purchased the assets).
d. If any partner is taking over an asset of a firm, it should be deducted from the balance due to the partners’ capital account.
We have to prepare:
a. Statement showing Absolute Surplus
[to determine which partner has contributed maximum proportionate capital]
b. Statement Showing Distribution of Cash
Maximum Loss Method
This method is suitable when a partner or (partners) is known to be insolvent or is likely to be so. Under this method, every installment realised is considered as final realisation, i.e. the remaining assets and claim are worthless. The maximum possible loss (Balance due minus assets realised) is distributed among all the partners in the profit – sharing ratio. Any partner(s) whose apportioned loss exceeds his balance due is assumed for this purpose to be insolvent and his negative balance will be shared by solvent partners in their capital ratio (assuming Garner Vs. Murray). This process is repeated till the negative balance is abolished. The partners having positive balance is paid – off first.
Steps (1) Prepare a statement showing distribution of cash
(2) Pay off the external Liabilities
(3) After all the payment is made for the external liabilities, the partners will be paid off.
Total Due of Partners xxx
Less : Net/Balance of Realization (xx)
_____
Maximum Loss xxx
(4) The maximum loss shall be shared amongst the partners in their profit sharing ratio, as if, there will be no further realization.
(5) If any of the partner capitals, after step (4) is negative, that partner shall be treated like an insolvent partner.
(6) The deficiency of the insolvent partner as per step(5) shall be shared by the other solvent partners (i.e. those partners who has positive capital balances) in their capital contribution ratio as per Garner vs. Murray Rule.
(7) Repeat the steps (3) to (6) till final realization.
In the case of insolvency, the deficiency of the insolvent partner shall be taken over by the solvent partners in their capital contribution ratio (fixed or fluctuating capitals).
Solvent Partners Capital A /c Dr.
To Insolvent Partners Capital A/c Cr.
There are two methods followed to share the deficiency of the insolvent partner:
(a) Garner Vs. Murray Rule
(b) Indian Partnership Act, 1932.
Garner Vs. Murray Rule: (The third partner who became insolvent was Mr. Wilkins) The deficiency of the insolvent partner shall be taken over by the solvent partners. The following steps are taken:
(a) The loss on realization shall be shared between all the partners (including the insolvent partner) in their profit-sharing ratio.
(b) The solvent partners shall bring in cash equal to the amount of loss suffered by them.
Cash A /c Dr.
To Solvent Partners Capital A/c Cr.
(c) The deficiency of the insolvent partner shall be taken over by the solvent partners in their capital contribution ratio ( fixed or fluctuating capitals)
Solvent Partners Capital A/c Dr.
To Insolvent Partner’s Capital A/c Cr.
Indian Partnership Act, 1932
As per the Indian Partnership Act, 1932, the deficiency of the insolvent partner is shared as follows:
(a) The loss on realization shall be shared between all the partners (including the insolvent partner) in their profit-sharing ratio.
(b) The deficiency of the insolvent partner shall be taken over by the solvent partners in their capital contribution ratio (fixed or fluctuating capitals)
Solvent Partners Capital A/cs Dr.
To Insolvent Partner’s Capital A/c Cr.
Note: As per Indian Partnership Act, the solvent partners shall not bring in cash, their share of loss on realization.
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