Since the excess capital contribution is found out by comparing with PSR and paid first, this method is called Surplus/Excess Method. This is called Proportionate Capital/Quotient Method because the capitals are ought to be bought in proportion to PSR.
What is piecemeal distribution?
In actual practice the assets are not realised at once on a single day unless
the business is sold to somebody. The partners expect a good price for the
assets and therefore, they gradually realise them depending on the market
condition. Thus, the whole process of realisation takes some time i.e. may
be a few months or even a year or even more. The process followed to discharge
the liabilities and claims of the partners as and when the assets are realised
is called Piecemeal distribution of cash.
What is gradual realisation and distribution of cash?
In the process of realising the assets and discharging liabilities, the assets
are usually realised slowly, steadily and gradually depending on the demand
and the liabilities are discharged as and when the assets are realised. Therefore
this process is also known as "gradual realisation and distribution of
cash". It is also known as "interim distribution of cash" because
when the amount realised is not sufficient to discharge the liability fully,
an interim payment is made to the extent of cash available. For the balance,
the liability holder should wait for another asset to be realised. Thus, the
liabilities are paid off as and when the assets are realised.
What is the basis of distribution of cash to capitals of partners in piecemeal
distribution of cash? or
What is the purpose behind adjusting the capitals of partners in their
profit sharing ratio in the case of piecemeal distribution of cash?
As long as the capital contribution ratio and profit sharing ratio of the
partners are one and the same, the distribution of cash as and when realised
does not create any problem when pro-rata distribution is made in accordance
with their claim. But when these two ratios are different, the pro-rata distribution
of cash in accordance with their claims creates problem. If the cash available
is distributed in the capital ratio the loss or profit on dissolution to be
shared by the partners may not be in the profit sharing ratio. On the contrary,
if the cash available is distributed in the profit sharing ratio there is
a possibility that one or two partners may get more than what is due to them.
What does Surplus or Excess Capital Method mean?
What are the methods of distribution on the schemes followed to distribute
cash as and when realised in piecemeal?
These are the methods of distributing cash in piecemeal namely:
(1) Surplus/Excess/Proportionate/Quotient Capital Method.
(2) Maximum Possible/Notional Loss Method.
It is necessary to adjust the capital of the partners to the profit sharing ratio and pay excess contribution to the partners first as and when the cash is realised. This process should be repeated till the capitals become proportionate to profit sharing ratio. When once the excess contribution of the partner is paid (capitals get adjusted to PSR) the realisation of cash may be distributed to all the partners in their capital PSR.
What is meant by maximum possible loss method? or
What are the assumptions under maximum loss method?
Maximum loss method is an improved method of distribution of cash as and when realised. Here at every stage of distribution of cash realised, it is assumed that there will be no more realisations and the firm is going to suffer the maximum loss. Thus, the loss calculated on an assumption is distributed to partners in their profit sharing ratio before the partner's claims are paid. The assumption of no more realisations result in a notional loss caused at this stage of realisation.
Specify about the order of discharging liabilities in piecemeal distribution
When the assets are realised gradually piece by piece, there is a need to
follow a proper order to discharge the liabilities. Out of the scale proceeds,
the expenses of dissolution should be met first and the balance should be
utilised to pay the outside creditors (Bank O/D, B/P, Creditors, Loans, etc.)
in the following order:
(1) Payment of fully secured creditors
(2) Payment to partly secured creditors to the extent of the securities realisation
(3) Payment to preferential creditors (salary, dues to Government)
(4) Payment to unsecured creditors
(5) Only after completely discharging the unsecured outside creditors, payment
to internal liabilities in the form of partners loan should be made
(6) Lastly partners should be paid their dues towards their capital.
If the creditors cannot be distinguished under the categories stated above,
the payment should be made 'pro-rata' based on their outstanding claims as
and when the assets are realised.