INSTALMENT LIQUIDATION

INTRODUCTION
Liquidation is the final stage in a partnership’s life which
comes after dissolution. Dissolution is different from
liquidation. There are some however who confuses
dissolution from liquidation and vice versa. Dissolution is
the process of ending the partnership’s life while
termination or liquidation is where the partnership
concerns are settled. This means that non-cash assets are
converted into cash to pay off partnership liabilities.
Rafael, L. M. (2014)
 
There are two types of liquidation, the lump sum
liquidation where everything is settled all at once, and the
instalment liquidation which happens over a period of
time.
SUMMARY
Liquidation is the fourth and final stage in a
partnership’s life. This is where realization or the
conversion of non-cash assets into cash happens,
and where partnership obligations are settled.
 
Instalment liquidation is a liquidation method
used in instances where non-cash assets are not
realized in a one-time settlement. Instalment
method uses the schedule of safe payments in
determining how much each partner and who of
the partners would receive cash when a realization
happens
In instances where a partner has a debit capital balance or
meaning he has an insufficient capital but he has a loan or
a receivable from the partnership, the loan would be used
to absorb the deficiency. If there is no loan, or that the loan
is not enough to absorb the insufficiency of the partner’s
capital, the partner would need to invest cash of equal
amount to his insufficiency. However, if the partner is
insolvent meaning his personal assets is less than or is
equal to his personal liabilities, the other partners will be
responsible of absorbing his insufficient capital.
 
Instalment liquidation is an important method to learn as
most liquidation doesn’t happen with a one-time
realization of non-cash assets. Most liquidation is done
over some time or in a piecemeal manner. Patricia, M.E.,
etc. (2014)
The steps in doing instalment liquidation are as follows.
1. Sale of non-cash assets.
2. Division of gain or loss in realization.
3. Payment of liquidation expenses and adjustment for
unrecorded liabilities to be adjusted in the partner’s capital
balances according to their profit and loss ratio.
4. Payment of liabilities to outside creditors.
5. Distribution of remaining cash to the partners.
It is important to remember the order of preference in
distributing available cash. The first is to be distributed to
outside creditors. Outside creditors include the government,
other private corporations or individuals. Next are the inside
creditors or loans owed by the partnership to the partners.
Third is to pay the partners of their investment. And lastly is
to pay the partners of their share in the partnership profits.
Ballada, W. (2015)
There are two ways or methods used under the instalment
liquidation for safe distribution of cash to be possible even if
not all non-cash assets were converted into cash. The first
method is the preparation of the schedule of safe payments.
The assumption under this is that the remaining unrealized
non-cash assets would remain to be unrealized and capital
deficiency is uncollectible. This method enables or shows the
distribution of cash if there will be no more expected cash that
will be received.

Safe payments are the difference of each partner’s total

interest and their share in the possible loss. Total interest is the
sum of each partner’s credit capital balance and their loans or
receivable from the partnership if they have. Possible loss is
the total carrying value of the remaining unrealized non-cash
assets plus the cash withheld for contingencies and the
negative capital of a partner to be absorbed by other partners.
Total interest (cr. capital balance + partner’s loan)
L: Possible loss or restricted interest (total
possible loss x p/l ratio)
Payment to partners
 
Restricted interest is the amount in the partner’s
total interest which should stay accessible to
absorb possible losses in the future.
For example, partners X, Y, and Z had the following
information in their books just before liquidation.
Cash 315
Non-cash Assets 1,200
Liabilities 435
Z, Loan 30
X, Capital 600
Y, Capital 350
Z, Capital 100
The partners have a profit and loss ratio of 40%, 40%,
and 20% respectively. The first sale was made with
assets sold at book value in the amount of 450. The rest
was sold for 50. Partners are to be considered as
insolvent
The first sale schedule of safe payments will be as follows.
  X Y Z
Capital Balance 600 350 100
Loan/advances     30
Total Interest 600 350 130
Possible Loss (1,200-450) = 750 x p/l ratio (300) (300) (150)
Balance 300 50 (20)
Additional possible Loss (20 x p/l ratio of
(10) (10) 20
remaining)
Payment to partners 290 40 -

The next schedule of safe payments will be as follows.

  X Y Z
Remaining Interest considering loss on sale
30 30 (10)
Additional possible Loss (10 x p/l ratio of
remaining) (5) (5) 10

Payment to partners 25 25 -
 The statement of liquidation will be as
follows.
  Cash Non-Cash Liabilities Z, Loan X, Cap Y, Cap Z, Cap
Balances 315 1,200 435 30 600 350 100
1st Sale 450 (450)          
Balance 765 750 435 30 600 350 100
Payment of
(435)   (435)        
Liab.
Balance 330 750 - 30 600 350 100
1st Sale cash
(330)       (290) (40)  
dist.
Balance - 750 - 30 310 310 100
2nd Sale 50 (750)     (280) (280) (140)
Balance 50 - - 30 30 30 (40)
Offset       (30)     30
Balance 50 - - - 30 30 (10)
Cap. Bal.
        (5) (5) 10
absorption
Balance 50 - - - 25 25 -
2nd Sale
(50)       (25) (25)  
cash dist.
Balance - - - - - - -
The other method is the preparation of a cash priority program.
This is prepared for maximum possible loss after every
instalment distribution happens until the partner’s interest is
equal to their profit and loss ratio. The advantage or benefit of
using this is that it enables the partners to be able to know the
amount of cash that is safe to distribute when available even
when not all non-cash assets are realized. Cash priority
program, as the name says, determines the amount and to whom
such amount is to be given, the priority, the last being always
according to the partners’ profit and loss ratio. The first priority
is determined by whoever has the highest loss absorption
balance and the next priority being the highest and the next
highest loss absorption balance.
 
The loss absorption balance is computed by dividing the sum
of the credit balance of a partner’s equity or capital and the loan
owed to him by the partnership by the partner’s profit/loss ratio.
 For example, partners A, B, and C have a capital
balance of 100, 200, and 150 and profit/loss ratios of
35%, 40%, and 25% respectively. Partners A and C has
a loan payable to them with the amounts of 75 and 80
respectively. The computation of the loss absorption
balance is as follows.

  A B C
Capital 100 200 150
Loan 75 - -
Total 175 200 150
P/L ratio 25% 40% 35%
Loss
Absorption 700 500 600
Balance
The first priority is the partner with the highest loss
absorption balance. In the example, it would be partner
A. The second priority would be partner A and C. The
last priority would be that of all the partners.
 
The amount that would be given to the partners
according to the first priority would be computed by
getting the difference of the highest loss absorption
balance and the next highest amount and so on. Using
the example, the computation would be as follows.
  A B C      
Capital 100 200 150      
Loan 75 - -      
Total 175 200 150      
P/L ratio 25% 50% 25% Cash Priority Program
Loss Absorption Balance 700 400 600 A B C
Less (600)          
Difference 100 - -      
P/L ratio 25% 50% 25%      
Priority 1       25    
Loss Absorption Balance 600 400 600      
Less (400)   (400)      
Difference 200 - 200      
P/L ratio 25% 50% 25%      
Priority 2       50   50
Loss Absorption Balance 400 400 400      
Priority 3       25% 50% 25%
The cash priority program ends with priority 3 where all
partners having the same loss absorption balance
making their share equal to their profit/loss ratio. Any
balance or gain/loss in sale will be distributed or
absorbed by the partners according to their profit/loss
ratio.
 
Continuing on the problem, let’s say that the partners
had a cash balance of 30 and a non-cash asset balance of
300, and the liabilities having a balance of 100. A non-
cash asset with a book value of 150 was sold for 125.
The remaining non-cash assets where sold for 10%
above their book value. The liquidation using the cash
priority will be as follows.
 Non- A B C
  Cash Liabilities A Loan
cash Capital Capital Capital
Beg. Bal. 130 495 100 75 100 200 150
Priority 1 (130)   (100) (25)      
Priority 2       (2.5)     (2.5)
Balance - 495 - 47.5 100 200 147.5
1st Sale 125 (150)     (6.25) (12.5) (6.25)
Balance 125 345 - 47.5 93.75 187.5 141.25
Priority 2 (125)     (47.5)     (47.5)
Priority 3         (7.5) (15) (7.5)
Balance - 345 - - 86.25 172.5 86.25
2st Sale 379.5 (345)     8.625 17.25 8.625
Balance 379.5 - - - 94.875 189.75 94.875
Priority 3 (379.5)       (94.875) (189.75) (94.875)
Balance - - - - - - -
There are cases however where there is one or more
partners which has a debit or a negative capital balance.
In cases like this the partners have the following options
according to priority.
1. If the debtor partner has a loan payable to him from
the partnership, he may use the right of offset where in
his loan amount will be used to decrease, cancel or
pay-off his debit capital balance.
2. If the debtor partner is a solvent partner meaning that
his personal assets can cover his personal liabilities
and has some left over, he is to invest an additional
cash of equal amount to cover his debit capital
balance.
3. If the debtor partner is however insolvent or is a
limited partner, the remaining partners with credit
capital balances will absorb the debit capital balance
according to their profit and loss ratio.
 The entries to record the distribution of available cash of the
example is as follows.
Distribution of available cash
Liabilities 100    
A, Loan 27.5    
C, Capital 2.5    
  Cash   130  
 
First instalment sale-loss
Cash 125    
A, Capital 6.25    
B, Capital 12.5    
C, Capital 6.25    
  Non-cash Asset   150  
 
Distribution of cash from first sale
A, Loan 47.5    
A, Capital 7.5    
B, Capital 15    
C, Capital 55    
Second instalment sale-gain
Cash 379.5    
  Non-cash Asset   345  
  A, Capital   8.625  
  B, Capital   17.25  
  C, Capital   8.625  
 
Distribution of cash from second sale
A, Capital 94.875    
B, Capital 189.75    
C, Capital 94.875    
  Cash   379.5  
END