Partnership Liquidation

General Concept of Partnership Liquidation

Partnership Liquidation- This is the “winding up the affairs” which is the business completely
terminated or ended.
- The transactions necessary to liquidate the partnership, such as collection of
receivables, conversion of noncash assets to cash, payment of the partnership obligations,
and distribution of any remaining net balance.
Realization- conversion of assets into cash.
Liquidation- payment of claims. Broader sense to refer to the complete winding up process.
Basis Procedures in Liquidation:

1. Sharing Gains and Losses- books should be adjusted and has closed the net profit or
loss for the period in the partnership agreement and carried to partners’ capital accounts
following profit and loss sharing ratio incurred during the liquidation.

a) The cumulative profit and loss of a partnership during its existence is the
difference between total capital contribution and total capital withdrawals.
b) Certain gains and losses during the liquidation process actually may have
occurred during normal operating periods.
2. Advance Planning when the partnership is formed- Inequities may arise if a deficit
balance is created in a partner’s capital account and that partner cannot contribute to
eliminate the deficit.
- Partners who do not have deficit balance must absorb the deficit balance. In other
words, they must absorb losses larger than their agreed-upon profit and loss ratio.

3. Rule on Setoff – Partnership Loans (Receivable) to the Partners –

Partnership receivable should be subtracted, or set off, from the partner’s capital
account

- The partner’s capital account less the receivable represents the partners’ true
capital investments.

4. Rule on Setoff – Partner Loans (Payable) to the Partnership – Loan may or may
not rank equal with other partnership liabilities as to priority.

Priority of Payment:

➢ Amounts owed to creditors other than partners.

➢ Amounts owed to partners other than for capital and profits.
➢ Amounts owed to partnership as capital.
➢ Amounts owed to partners as profit not currently closed to partners’ capital
accounts.
Legal Doctrine of Set-Off – deficit balance in partner’s capital account may be set off
against any balance existing in his/her loan account. Procedure effectively treat loan as
an additional investment.
5. Liquidation Expense – Certain costs incurred during the liquidation process treated as
a reduction of the proceeds from the sale of noncash assets such as costs to complete
inventory, sales commissions and shipping costs related to disposal of inventory, escrow and
title transfer fees, and costs of removing equipment. And Other liquidation costs should be
treated as expenses.
6. Marshalling – applies when the partnership and/or one or more of the partners are
insolvent.

A. Partnership Assets

1. Partnership Creditors
2. Personal creditors that did not recover their claims in full from their personal assets.
B. Personal Assets
1. Personal Creditors
2. Partnership Creditors who were not satisfied from partnership assets.
3. Amounts owed to partnership as represented by the partners’ deficit balance.
7. Distribution of Cash or Other Assets to Partners

Types of Liquidations:
1. Lump-Sum (Simple or Total) Liquidation – No distributions until the realization
process is complete.

➢ All assets are converted to cash.

➢ Rare or nonexistent.
The following procedures may be followed in a lump-sum liquidation:
1. Realization and distribution of gain or loss to all partners on the basis of profit and loss
ratio.

2. Payment of liquidation expenses, if any.

3. Payment of liabilities to third parties

4. Elimination of capital deficiencies in the order of priority:

A. If the deficient partner has a loan balance, exercise right of set off.
B. If the deficient partner is solvent, then additional investment is necessary.
C. If the deficient partner is insolvent, the remaining partners will absorb the capital
deficiency.

5. Payment to partners should be in the order of priority:

A. Loan accounts
B. Capital accounts

2. Installment Liquidation - Distributions are made to some or all of the partners as

cash becomes available.
➢ Process of realizing some assets, paying creditors, paying remaining available
cash to partners, realizing additional assets, and additional cash payments to
partners.
Basic Principles of Installment Liquidation
1. Significant element is that liquidator authorizes cash payment to partners before all
losses that may be incurred in the liquidation are known.

2. If payments cannot be recovered, liquidator may be liable for the loss caused
by inappropriate payment of cash.

Process of Installment Liquidation

1. Piece-meal realization and distribution of gain or loss to all partners on the basis of profit
and loss ratio.

2. Payment of liquidation expenses, if any.

3. Payment of liabilities to third parties.

4. Distribute *cash available using the following schedules to determine cash

payments to partners:
A. Schedule of cash/safe payments. – Anticipate the two worst-case scenarios before
determining the amount of cash installment each partner receives.
a. Assume a total loss on all remaining noncash assets, and provide all possible
losses, including potential liquidation costs and unrecorded liabilities.
b. Assume that partners with a potential capital deficit will be unable to pay anything to
the [partnership. (Assume to be personally insolvent)
B. Cash payment priority program. – advantage of informing the partners at the
beginning of the liquidation process when they will receive cash in relation to the other
partners.
Cash available for distribution:

Beginning Cash + Proceeds – Liquidation Expense – Liabilities – Cash Withheld = Cash

Available

5. Repeat process until all assets are fully realized.

Cash Priority Program:

Schedule of Safe Payments: