Problem 25 - Accounting

Question

Gordon, Hightower, and Mills are members of Capital Sales, LLC, sharing income and losses in the ratio of 2:2:1, respectively. The members decide to liquidate the limited liability company. The members’ equity prior to liquidation and asset realization on May 1, 2010, are as follows: $$ \begin{array}{lr} \text { Gordon } & \$ 15,000 \\ \text { Hightower } & 35,000 \\ \text { Mills } & 22,000 \\ \hline \text { Total } & \$ 72,000 \\ \hline \end{array} $$ In winding up operations during the month of May, noncash assets with a book value of \(\$ 94,000\) are sold for \(\$ 116,500\), and liabilities of \(\$ 30,000\) are satisfied. Prior to realization, Capital Sales has a cash balance of \(\$ 8,000\). a. Prepare a statement of LLC liquidation. b. Provide the journal entry for the final cash distribution to members.

Step-by-Step Solution

Answer

Distribute \( \$24,000 \) to Gordon, \( \$44,000 \) to Hightower, and \( \$26,500 \) to Mills. Journal entry debits member capitals and credits cash.

Step 1: Calculate Total Cash Available

First, let's calculate the total cash available for distribution after selling the noncash assets. The original cash is \( \\(8,000 \). The noncash assets had a book value of \( \\)94,000 \) and were sold for \( \\(116,500 \). This generates a cash inflow of \( \\)116,500 \). The total cash available is therefore \( \\(8,000 + \\)116,500 = \$124,500 \).

Step 2: Settle Liabilities

Next, we pay off all liabilities amounting to \( \\(30,000 \). After settling all liabilities, the remaining cash is \( \\)124,500 - \\(30,000 = \\)94,500 \).

Step 3: Calculate Gain on Realization

The gain from selling noncash assets is the difference between the sale price and the book value: \( \\(116,500 - \\)94,000 = \$22,500 \). This gain increases the members’ equity.

Step 4: Distribute Gain Based on Profit Sharing Ratio

Distribute the gain of \( \\(22,500 \) according to the profit-sharing ratio of 2:2:1. Each 2-part gets \( \\)9,000 \) (\( \\(22,500 \times \frac{2}{5} \)) and 1-part gets \( \\)4,500 \) (\( \\(22,500 \times \frac{1}{5} \)). So, Gordon gets \( \\)9,000 \), Hightower gets \( \\(9,000 \), and Mills gets \( \\)4,500 \).

Step 5: Calculate Final Equity Balances

Add the gain on realization to the initial member balances. Gordon: \( \\(15,000 + \\)9,000 = \\(24,000 \), Hightower: \( \\)35,000 + \\(9,000 = \\)44,000 \), Mills: \( \\(22,000 + \\)4,500 = \$26,500 \).

Step 6: Cash Distribution to Members

Distribute the remaining cash of \( \\(94,500 \) to members according to their final equity balances calculated previously: Gordon: \( \\)24,000 \), Hightower: \( \\(44,000 \), Mills: \( \\)26,500 \).

Step 7: Prepare Journal Entry for Final Cash Distribution

Record the journal entry to close the books: Debit Gordon's Capital \( \\(24,000 \), Debit Hightower's Capital \( \\)44,000 \), Debit Mill's Capital \( \\(26,500 \), and credit Cash \( \\)94,500 \).

Key Concepts

Profit Sharing Ratio

The profit-sharing ratio is an agreed-upon proportion in which members of a partnership or LLC share profits and losses. In this exercise, Gordon, Hightower, and Mills share according to a 2:2:1 ratio. This means:

• Gordon receives 2 parts of any profit or loss.
• Hightower also receives 2 parts.
• Mills receives 1 part.

This specific ratio helps to establish financial expectations for each member. It dictates how gains or losses from asset liquidation and other operations are distributed. In the context of LLC liquidation, understanding this ratio ensures each member receives their fair share of the proceeds or covers their part of any shortfall.

Journal Entries

Journal entries are records of financial transactions in the books of a business. During LLC liquidation, these entries record the final distribution of cash and the closing of members' capital accounts. For this exercise:

• A debit to each member's capital account signifies a reduction in their investment or equity.
• A credit to the cash account decreases the company's cash, reflecting distribution to members.

The final journal entry distributes the remaining cash based on each member's ending equity balances, such as "Debit Gordon's Capital $24,000, Debit Hightower's Capital $44,000, Debit Mill's Capital $26,500, Credit Cash $94,500." These entries not only book the transaction but confirm that the equity accounts balance with the cash distributed.

Members' Equity

Members' equity represents each member's stake in the LLC, factoring in initial investments and subsequent changes from profits, losses, or withdrawals. Before liquidating, Gordon, Hightower, and Mills had respective equities of $15,000, $35,000, and $22,000. After realizing noncash assets, the gain from the sale is added to the original equity balances:

• Gordon's new balance: $24,000
• Hightower's new balance: $44,000
• Mills's new balance: $26,500

Understanding these balances is crucial as they dictate the final cash payouts to each member. Essentially, members' equity must reflect all changes ensuring that the correct amounts are distributed in the end.

Noncash Assets Realization

Noncash assets realization refers to converting company assets, like equipment or property, into cash. Here, noncash assets valued at $94,000 were sold for $116,500, yielding a gain. This gain of $22,500 is significant during liquidation as it boosts the company's cash, subsequently increasing the members' equity.

• Initial noncash asset book value: $94,000
• Sale price of noncash assets: $116,500
• Gain from realization: $22,500

Realizing noncash assets efficiently is essential in wind-ups, as it directly impacts the financial return to members. Profit from the sale must be appropriately shared among members according to their profit-sharing ratio, ensuring equitable distribution of the added value.