Define fair value.
Fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date.
Define the valuation techniques that can be used to measure the fair value of an asset or liability.
1. Market Approach -- Uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure fair value.
2. Income Approach -- Converts future amounts, including cash flows or earnings, to a single discounted amount to measure the fair value of assets or liabilities.
3. Cost Approach -- Uses current replacement cost to measure the fair value of assets.
Describe the hierarchy of fair value inputs. Which inputs have the highest priority?
1. Level 1 Inputs -- Quoted prices in active markets for identical assets or liabilities.
2. Level 2 Inputs -- Inputs other than quoted market parices that are directly or indirectly observable for an asset or liability.
3. Level 3 Inputs -- Unobservable inputs for the asset or liability that reflect the entities assumptions and are based on the best available information.
Note: Level 1 inputs have the highest priority.
In creating a new partnership interest with an investment of additional capital, what three methods can be used?
- Bonus method
- Goodwill method
Describe the exact method of creating a new partnership interest with an investment of additional capital.
The purchase price equals the book value of the capital account purchased.
- No adjustments to the existing partners' capital accounts
- No goodwill or bonus
Note: If new partner is getting 1/4 interest; in order to figure out how much the new partner must invest, take the denominator; in this case it's 4 and minus 1 = 3. Take the capital balance of the old partners and divide by 3. This is the amount the new partner must invest to get a 1/4 interest.
Describe the bonus method of creating a new partnership interest with an investment of additional capital.
New partner's capital account = (A + B + C) x C's percentage ownership. Excess of new partner's contribution over capital interest received is a bonus to the old partners. Excess of capital interest received over new partner's contribution is a bonus to the new partner.
Note: New partner pays more, excess goes to Old partner's.
New partner pays less, difference goes to New partner.
Describe the goodwill method of creating a new partnership interest with an investment of additional capital.
Goodwill is recognized based on the total value of the partnership implied by the new partner's contribution.
- Implied GW = New partners contribution x % interest
- Implied GW - Total Partner's capital = GW to be distributed to old partner's
Goodwill is shared by the existing partners using the agreed profit/loss ratio.
Describe the bonus method of withdrawal of a partner.
The difference between the balance of the withdrawing partner's capital account and the amount that person is paid is the amount of the bonus
- The bonus is allocated among the remaining partners' capital accounts in accordance with their remaining profit and loss ratios.
Describe the goodwill method of withdrawal of a partner.
The partners may elect to record the implied goodwill in the partnership based on the payment to the withdrawing partner. The amount of the implied goodwill is allocated to all of the partners in accordance with their profit and loss ratios.
After allocating goodwill, the balance in the withdrawing partner's capital account should equal the final distribution to the withdrawing partner.
In liquidating a partnership, what is the order of preference?
Loans and advances to partners
Capital accounts of partners
Remember that all losses must be provided for before disposal; that is, maximum potential losses before distribution of cash.