PARTNERSHIP LIQUIDATION - LUMPSUM

ACCOUNTING PROBLEMS IN PARTNERSHIP LIQUIDATION

The basic objectives of a partnership during the liquidation process are to

convert the partnership assets to cash (called realization of assets), to pay off
partnership obligations and to distribute cash and any unrealized assets to the
individual partners. The purpose of accounting during this period is to have an
equitable distribution of partnership cash to creditors and partners. Hence, it is no
longer income determination that is the focus of accounting but rather, the
computation of gains or losses on realization of assets which are to be
subsequently allocated among the partners, the payment of liabilities in
accordance with law, and the final distribution of cash to the partners.

There are certain rules that should be followed in the liquidation of the partnership,
namely:
1. Always allocate and close gains or losses to the partners’ capital accounts
prior to distributing any cash to the partners.
2. When the business is liquidated, the partner is entitled to an amount
depending upon his capital contribution, his drawing, his share in the net
income or loss from operations before liquidation, gains and losses on
realization, and the balance of his loan account, if any.

As a general rule, the cash should be distributed as follows:

1. First, to outside creditors.
2. Second, to partners for loan accounts.
3. Third, to partners for capital accounts.

METHODS OF PARTNERSHIP LIQUIDATION

When a partnership is to be liquidated by the sale of assets, the following methods

may be used:

1. Lump-Sum Liquidation, otherwise called Total Liquidation or Single

Distribution.
 A process whereby the 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.

2. Installment Liquidation, otherwise called Installment Distribution.

 A process whereby 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-assets into cash.
A. LUMP-SUM Liquidation
 Under this method, all non-cash assets are realized and all liabilities are
settled before a single final cash distribution is made to the partners. The
procedures below may be followed in lump sum liquidation:

1. Realization of non-cash assets and distribution of gain or loss on realization

among the partners based on their profit and loss ratio.
2. Payment of Expenses
3. Payment of liabilities.
4. Elimination of partners’ deficiencies. If after the distribution of loss on
realization a partner incurs a capital deficiency must be eliminated by
using one of the following methods, in the order of priority:
a. If the deficient partner has a loan balance, exercise the right of
offset.
b. If the deficient partner is solvent, make him invest cash to eliminate
his deficiency.
c. If the deficient partner is insolvent, let the other partners absorb his
deficiency.
5. Payment to partners in the order of priority;
a. Loan accounts
b. Capital accounts

The term no capital deficiency means that all partners have credit
balances in their capital accounts; if at least one partner’s capital account has
a debit balance, the situation is termed a capital deficiency.

Partnership is Insolvent but Partners are Personally Solvent

If the partnership is insolvent, which means that the available cash is

insufficient to pay creditors, at least one, all of the partners will have deficiencies
In their capital. In any event, the total amount of deficiencies will exceed the
unpaid liabilities. If the partner or partners with capital deficiencies pay the
required amounts, the partnership will have enough cash to pay its liabilities in full.
However, in accordance with law, the creditors may demand payment from any
partner regardless of whether his capital account shows a debit balance (i.e.,
there is deficiency) or a credit balance. It should be noted that in terms of the
relationship with creditors, the partnership is not viewed as a separate entity.

Partnership is Insolvent and Partners are Personally Insolvent

This situation raises a question as to the relative rights of two groups of

creditors, namely (1) the creditors of the partnership, and (2) the personal creditors
of the partners. The relative rights of these two groups of creditors are governed
by the Partnership Law which provides that the assets of the partnership are first
available to creditors of the partnership, and that the personal assets of the
partners are first available to his personal creditors. If after the debts of the
partnership have been paid in full and some assets still remain in the partnership,
the creditors of a partner have a claim against the assets of the partnership only
to the extent of his share.

After the personal creditors of a partner have been paid in full from his
personal assets, any remaining asset is available to partnership creditors regardless
of whether the partner’s capital account shows a credit or a debit balance. The
claims of creditors of the partnership on the separate property of a partner are
permitted only when these creditors are unable to obtain payment from the
partnership.