So, far we have assumed that all the assets are realized immediately on the date of dissolution and the accounts of all the partners and the creditors are settled on the same date.
But this assumption is unrealistic in nature, because normally the process of realizing the assets takes a long time and cash is distributed as and when it is realized. In such a case to avoid unpleasant consequences the assets realized are distributed in such way that the unpaid balance of capitals of each partners is left in their profit sharing ratio.
On a gradual realisation of assets, the cash is distributed in the following order:
1. The debts of the firm to the third parties (outside liabilities) must be paid first.
2. After the creditors, have been paid off, the amount due to a partners as loan should be paid. When the loans are due to more than one partner the cash available should be distributed proportionately.
3. After the payment of outside liabilities and loans due to the partners, the capitals of the partner are paid.
There are two methods for distribution of cash under Piecemeal distribution:
1. PROPORTIONATE CAPITAL METHOD
If the capitals of the partners are in the ratio of their profit sharing arrangement, then each of them is paid out according to his capital ratio at each distribution. If the capitals of the partners are not in the profit sharing ratio then the first cash available (after making payment of outside liabilities and loans due to the partners) for distribution amongst the partners should be paid to those partners whose capitals are more than their profit sharing ratio so as to bring their capitals to their profit sharing levels. After this the cash available is distributed amongst all partners according to their profit sharing ratio.
The unpaid balance of capital accounts will represent loss on realisation and this loss will be exactly in their profit sharing ratio.
2. MAXIMUM LOSS METHOD
An alternative method of piecemeal distribution amongst partner is to calculate the maximum possible loss on every realisation after the outside liabilities and the partners loan has been paid. The amount available for distribution amongst partners is compared with the total amount of capital payable to the partners and the maximum loss is ascertained on the assumption that in future assets will not realize any amount. The maximum possible loss so ascertained is deducted from the capital balances of the partners in their profit and loss sharing ratio and the balance left in the capital account after deducting the maximum possible loss will be the amount payable to the partner.
If a partner’s share of maximum possible loss is more than the amount standing to the credit of his capital account, he should be treated as insolvent and his deficiency should be debited to the capital accounts of the solvent partners in the proportion of their capitals which stood on the dissolution date as stated under the Garner V/s. Murray Rule. The amount standing to the credit of the partners after debiting their share of maximum loss and their share of insolvent partners deficiency will be equal to the cash available for the distribution amongst the partners.
This process of maximum possible loss is repeated on each realisation till all the assets are disposed.
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