PARTNERSHIP LIQUIDATION

INTRODUCTION

• Dissolution does not mean the formal termination of a business

• Dissolution can be recognized as change in the capital structure of a

business as a new unit
• Dissolution calling for the winding up of business affairs –
LIQUIDATION

DISSOLUTION WITH LIQUIDATION

• A partnership is liquidated when its business operations are

completely terminated or ended. Partnership assets are sold, the
partnership creditors are paid, and the remaining assets, if any are
distributed to the partners as a return of their investments.

• Causes of Partnership Dissolution with Liquidation

1. Accomplishment of the purpose for which the partnership was
organized
2. Termination of the term/period covered by the partnership contract
3. Bankruptcy of the firm
4. Mutual agreement among the partners to close the business

 Partnership liquidation, the assets and liabilities of the partnership

are directly intertwined with those of the individual partners’
personal assets and liabilities because of the unlimited liabilities of
the partner.
 Priorities for creditor claims involve two concepts:
1. Marshaling of assets
2. Right of offset

MARSHALLING OF ASSETS

• The order of creditors’ rights against the partnership’s assets and the
personal assets of the individual partners

.• The order of which claims against the partnership’s assets will be

marshaled as follows:
1. Partnership creditors other than partners
2. Partners’ claims other than capital and profits, such as loans payable
and accrued interest payable
3. Partners’ claim to capital or profits, to the extent of credit balances in
capital accounts
• The order of claims against the personal assets of the individual partners
are as follow:
1. Personal creditors of individual partners

2. Partnership creditors on unpaid partnership liabilities regardless of a

partner’s capital balance in the partnership.

RIGHT OF OFFSET

• Involves offsetting a deficit in a partner’s capital (debit balance in the

capital account of a partner) against the loan payable to that partner. The
loan payable to a partner has a higher priority in liquidation than a
partner’s capital balance but a lower priority than liabilities to outside
creditors.

TYPES OF LIQUIDATION

• Lump-sum Liquidation or Liquidation by Totals- Distribution of cash to

the partners is done only after all the non-cash assets have been realized,
the total amount of gain or loss on realization is known and all liabilities
have been paid.
• Liquidation by Installments or Piece-meal Liquidation- Assets are
realized on a piecemeal basis and cash is distributed to partners on a
periodic basis as it becomes available, that is, even before all non-assets
are converted into cash.

Procedures in Lump-Sum Liquidation

• Books should be adjusted and balances of nominal accounts are closed

• Net income or loss for the period is transferred to the partners’ capital
account
• Advances and withdrawals are closed to capital account since cash
settlement shall be based on the partners’ capital account balance

• Ready to proceed with liquidation

 Sale of non-cash assets and distribution or allocation of gain or loss

on realization among the partners according to their residual profit
and loss ratios (salary and interest factors disregarded) unless
liquidation ratios are specified in the partnership agreement.
 Distribution of cash to creditors and partners. In this procedure, the
provisions of the marshaling of assets and the exercise of the right
to offset are applied.

• Liquidation expenses may be incurred to facilitate the immediate

realization of non-cash assets. Payment of liquidation expenses reduces
the cash and is recorded as a deduction from the partners’ capital based
on the partners’ profit or loss ratios.
• When realization results in a loss, the loss is carried to the capital
accounts of the partners as a deduction. If a partner’s capital account
results in a debit balance (called capital deficiency) after the distribution
of loss on realization such can be offset against any loan balance of the
partner to the partnership. The amount of offset shall be the amount of
the loan or the amount of the deficiency whichever, is lower.
• If cash is distributed to partners before eliminating the deficiency:
1. Making additional cash investment, if the deficient partner is solvent.

2. Charging the deficiency as additional loss to the remaining partners, if

the deficient partner is insolvent.

• Cash available for distribution is then paid to partners to apply first on

loan then on capital.
Note that the final distribution of cash to partners is made based on
partner’s capital balances and not on any ratio.

• If cash is distributed to partners before eliminating the deficiency:

1. Cash available for distribution is paid to partners based on an
accompanying schedule to determine amounts to be paid to partners.

2. Deficient partner may:

a. If solvent, make additional investments; to be paid to partners as

second cash distribution, or the deficient partner may make direct cash
settlement to other partners.
b. If insolvent, the deficiency shall be absorbed by the other partners as
additional loss according to their profit or loss ratio.

• When personal assets exceed personal liabilities, the partner is solvent

to the extent of the excess.
• When personal assets are less than personal liabilities, the partner is
insolvent.

Statement of Liquidation

• Prepared to summarize the liquidation process

• Basis of the journal entries made to record liquidation
• Presented in working paper form the effect of liquidation on the
statement of financial position
• Shows conversion of assets into cash, the allocation of gain or loss on
realization, and distribution of cash to creditors and partners.

Points of Emphasis in the Preparation of Statement of Liquidation

1. Make sure that the balances before liquidation show equality of debits
and credits. This will always be true after each liquidation transaction.

2. Maintain two columns only for debits. These are cash and other assets
regardless of whether the assets were given itemized like cash,
receivables, inventory, supplies equipment, etc. Noncash assets are
classified as “other assets.”
3. Gain on realization increases capital while loss on realization decreases
capital.
4. Figures in parenthesis for each liquidation transaction represents
reduction in the account.
5. Double rule when all column are brought to zero balance

There may be instances when the cash realized from the sale of other
assets is not sufficient to pay partnership liabilities. In such cases,
remaining liabilities are satisfied by:
1. The additional cash investment by deficient partners.
2. Direct collection by the partnership creditors from any one of the
partners and the latter making cash settlement among themselves.

DEFINITION OF TERMS

• Dissolution- Termination of a partnership as a going concern; it is the

termination of the life of the partnership

• Winding up- Process of settling the business of partnership; it is

synonymous to liquidation

• Termination- Point in time when all partnership affairs are ended

• Liquidation- The interval of time between dissolution and termination of

partnership affairs; it is also the process of winding up a business which is
normally consists of conversion of assets into cash, payment of liabilities
and distribution of remaining cash among the partners

• Realization- The process of converting non-cash assets into cash

• Gain on Realization- Excess of the selling price over the cost or book
value of the assets disposed or sold through realization

• Loss on Realization- Excess of the cost or book value over the selling
price of the assets disposed or sold through realization

• Capital Deficiency- Excess of a partner’s share on losses over his capital

• Deficient Partner- A partner with a debit balance in his capital account

after receiving his share on the loss on realization.

• Free Interest- a partner's capital interest that is available for cash

payment.

• Restricted Interest- a portion of a partner's capital account balance that

is restricted for possible losses on liquidation. It is, not, therefore,
available for cash payment.