Partnership Liquidation

Partnership Liquidation

Liquidation

The process of winding-up a business which normally consists of the conversion of a portion or all of the assets
into cash, settlement with creditors, and the distribution of remaining assets to the partners. It marks end of
both the legal and economic life of the business and is always preceded by dissolution but dissolution may not
always lead to liquidation.

Realization

It is the conversion of assets into cash (sale of non-cash assets).

Gain on Realization

It is the excess of the selling price over the cost or book value of the non-cash assets sold.

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Loss on Realization

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It is the excess of the cost or book value over the selling price of the non-cash assets sold.

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Capital Deficiency
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It is the excess of the partner’s share on losses over his capital—a debit balance in a capital account. It is only
realizable when there is a loss on realization.
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Deficient Partner
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A partner with a debit balance in his capital account after receiving his share on the loss realization or having a
capital deficiency; He/she may be solvent or insolvent.
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Solvent Deficient Partner

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A deficient partner whose personal assets exceed his personal liabilities; hence, he is able to make additional
investment into the partnership to cover his capital deficiency.
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Insolvent Deficient Partner

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A deficient partner whose personal liabilities exceed his personal assets; hence, he is unable to make additional
investment into the partnership to cover his capital deficiency. The other partners will have to cover/absorb his
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capital deficiency.

Right of Offset

The legal right to apply part or all of the amount owing to a partner (loan balance) against a deficiency in his
capital account resulting from losses in the process of liquidation.

Partner’s Interest

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Partnership Liquidation

The sum of the partner’s capital, loan balance, and advances to the partnership decreased/increased by his
drawing account, if any

Methods of Liquidation

1. Lump-Sum Liquidation
2. Installment Liquidation (or Piecemeal Liquidation)

Lump-Sum Liquidation

Cash distribution to partners is made only after realization of all non-cash assets has been completed and the
full gain or loss from realization is known, and that all liabilities to outsiders have been settled.

Installment Liquidation

Non-cash assets are realized on a piecemeal basis and cash is distributed to partners on a periodic basis as it
becomes available even before converting all non-cash assets into cash.

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Procedure in Lump-Sum Liquidation

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1. The books should be adjusted and closed, the net income or loss for the period carried to the partners’

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drawing accounts, if any, and the drawing accounts are closed to the capital accounts.
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2. Assets are sold and any difference between the book values and the amount realized represents gains or
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losses to be divided among the partners according to their profit and loss sharing ratio.
3. The gains or losses are carried to their capital accounts, after which the capital account balances will
become the basis for settlement.
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4. When a partner’s capital account reports a debit balance and such partner has a loan balance (collectible
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from partnership), the law permits the exercise of the right of offset.
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5. A debit capital balance in the absence of a loan balance or after the exercise of the right of offset indicates
the need for contribution by the deficient partner. A deficient but solvent partner is able to make cash
contribution to settle his deficiency.
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6. If the deficient partner is unable to contribute any further, he is said to be insolvent thus the partners with
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credit capital balances will have to absorb the deficiency. A partner is insolvent if his personal assets are
less than his personal liabilities.
7. As cash becomes available for distribution, it is first applied to the payment of outside creditors, after
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which, it is applied in settlement of partner’s loan and capital balances.

8. The final cash distribution to partners is made based on the partners’ capital balances and not on any
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ratios.
9. In recording sale of accounts receivable and plant assets, their related contra-accounts, if any, should be
debited. These are Allowance for Doubtful Accounts and Accumulated Depreciation.
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10. Liquidation expenses may be incurred to facilitate the immediate realization of non-cash assets. Payment of
liquidation expense reduces cash and is recorded as deduction from partners’ capital based on existing
profit and loss ratio.

Statement of Liquidation

 An accounting statement that summarizes the winding-up of the affairs of the partnership.

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Partnership Liquidation

 It shows the balances of the asset, liability, and capital accounts before realization; sale of non-cash assets,
the payment of liabilities, and the distribution of the remaining cash to the partners.
 Minimum set of column headings include cash, non-cash assets (carrying amount), liabilities, and
partners’ capital accounts (individually provided), with profit and loss ratio indicated at the column
heading.

Installment Liquidation

Characteristics:

 Non-cash assets are sold on a piecemeal basis because the complete liquidation process might take several
months.
 Cash payments to creditors and partners are on installment basis as the cash becomes available.
 To guarantee that premature cash distribution to partners would not result to overpayment, tools are
available to direct accurate premature cash distribution.

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Tools for Installment Cash Distribution

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1. Schedule of Safe Payments

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2. Cash Priority Program

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Schedule of Safe Payments
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This statement is prepared when there is available cash after payment to outside creditors is made. It indicates
how the available cash should be distributed to partners.
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Procedure of Installment Liquidation

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1. Provide appropriate columns for the capital accounts of the partners. The last column is for the total
(optional).
2. Indicate the profit and loss ratio of each partner.
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3. Enter the total interest of the partners (capital account after the closing process plus any loan of the
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partner to the partnership.)

4. Indicate the maximum loss absorption capacity of each partner.
5. The partner’s maximum capacity to absorb losses is the total of the following data multiplied by the
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partner’s profit and loss ratio: book value of unsold non-cash assets, estimated liabilities incurred, if any,
and estimated liquidation expenses, if any.
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6. If there is any capital deficiency at this point, assume that the partner is insolvent so that the remaining
partners with positive capital balance are to absorb the capital deficiency.
7. The final balance of the capital account represents the amount of cash that can be safely distributed to the
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partner.

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