Brief Summary
Alright, so this video by CA Vaibhav Patni is all about "Piecemeal Payment or Distribution" in dissolution of partnership firms. It's a premium topic with high chances of questions coming from it. The video explains two methods: Maximum Loss Method and Higher Relative Capital Method, focusing on how to distribute assets gradually to pay off liabilities.
- Piecemeal payments involve paying off liabilities in chunks as assets are realised over time.
- The two main methods discussed are Maximum Loss Method and Higher Relative Capital Method.
- Priority for payments: external liabilities, partners' loans, and then partners' capital.
Introduction to Piecemeal Distribution
So, piecemeal payment or distribution is all about handling money in bits and pieces. Dissolution rarely happens in a day; assets are sold over time. Unlike textbook problems, this method is more realistic. Assets realise at different times, and liabilities are paid off gradually. Priority is given to external liabilities first, then partners' loans, and finally partners' capital. If there are multiple external liabilities, pay them off in the ratio of their outstanding dues. This method is also known as "Gradual Realisation of Assets and Gradual Payment of Liabilities."
Order of Payments
Payments are made in a specific order: first, to all outside liabilities (including loans from relatives or a partner's spouse), then to partners' loans, and finally to partners' capital. To calculate how much capital is due to a partner, consider the capital balance, current account balance, reserves, and surpluses, while deducting fictitious assets, deferred revenue expenditure, and any loans given to the partner.
Methods of Piecemeal Payment
Since realisation happens gradually, there won't be a single realisation profit or loss. Instead, there are two methods to distribute the money: the Maximum Loss Method and the Higher Relative Capital Method. The Maximum Loss Method is used for paying off partner capital after settling outside liabilities.
Maximum Possible Loss Method: Assumptions
Under the Maximum Possible Loss Method, two key assumptions are made. First, every amount available is considered the final or last amount. Second, if a partner's balance becomes negative after distributing the assumed loss, that partner is considered insolvent, and their deficiency is covered by the solvent partners. This deficiency is distributed among solvent partners in their fixed capital ratio or adjusted capital ratio.
Illustration 6: Initial Setup
Three partners, A, B, and C, share profits and losses in the ratio of 5:3:2. Their capitals are ₹9600, ₹6000, and ₹8400 respectively. The firm has an interest liability of ₹2000 on a loan from a partner's spouse and ₹1000 on a partner's loan. The assets realise in the order of investment, furniture, machinery, and stock. B is insolvent. A statement showing the distribution of cash using the Maximum Possible Loss Method needs to be prepared.
Installment 1 & 2: Payment of Liabilities
Initially, there's no cash. In the first installment, ₹1000 is realised from investments. This amount is used to pay part of the interest on the spouse's loan. In the second installment, ₹2000 is realised from furniture. ₹1000 is used to pay the remaining interest on the spouse's loan, and ₹1000 is used to pay the interest on the partner's loan.
Installment 3: Maximum Loss Calculation
In the third installment, ₹1200 is realised from machinery. The method assumes this is the final payment. The total payment due to partners is ₹24,000. The maximum possible loss is ₹24,000 - ₹1200 = ₹22,800. This loss is distributed among A, B, and C in their profit-sharing ratio (5:3:2), resulting in losses of ₹11,400, ₹6840, and ₹4560 respectively.
Handling Insolvency and Payment to C
After distributing the loss, A's capital becomes negative (₹180), and B's capital also becomes negative. Since B is insolvent, A is also assumed to be insolvent. C, being the only solvent partner, bears the losses of A and B. After adjusting for these losses, C is still owed ₹1200. This ₹1200 is paid to C.
Installment 4: Final Distribution and Realisation Loss
In the fourth installment, ₹4000 is realised from stock. Again, it's assumed this is the final payment. The maximum loss is recalculated, and the available cash is distributed among the partners. The remaining capital balances of A, B, and C, which cannot be paid, represent the actual realisation loss.
Introduction to Higher Relative Capital Method
The Higher Relative Capital Method prioritises payments to partners with relatively higher capital contributions. This method aims to address the logic behind why certain partners are paid first. For example, if A, B, and C have capitals of ₹5 lakh, ₹3 lakh, and ₹5 lakh respectively, with a ratio of 2:1:2, B is considered the bigger partner because they contributed more capital per share.
Calculating Relative Capital
To illustrate, A, B, and C have capitals of ₹9600, ₹6000, and ₹8400 with a ratio of 5:3:2. Dividing their capitals by their respective shares gives ₹1920, ₹2000, and ₹4200 per share. A's capital is used as the base. The excess capital is calculated to determine which partner has relatively higher capital.
Determining Payment Priority
To determine whether B or C has a higher capital, their excess capitals are divided by their ratios. This calculation reveals that C has a higher capital per share. Therefore, C is paid first, followed by B, and then any remaining amount is distributed among A, B, and C in their profit-sharing ratio.
Applying the Method and Comparison
With ₹5200 available, C receives ₹4400 first, followed by B and C receiving ₹240 and ₹160 respectively. The remaining ₹400 is distributed among A, B, and C in their profit-sharing ratio. While the Higher Relative Capital Method is conceptually sound, the Maximum Loss Method is easier to apply, especially in exams. The Maximum Loss Method automatically determines who gets paid first based on the assumed loss distribution.
