Partnership Liquidation With Problem.1.2.4

Partnership Liquidation
Learning Objectives
1. Define partnership liquidation and identify its causes.
2. Discuss the various problems encountered in
partnership liquidation.
3. Identify and differentiate the two types of liquidation.
4. Discuss and understand the accounting procedures
under lump-sum 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
• Association of the partners for the purposes of carrying
on activities in the usual manner is considered ended
• Partners engage in activities leading to final settlement
Dissolution with Liquidation
• 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
Accounting Problems
1. Determination of the profit or loss from the beginning
of the accounting period to the date of liquidation and
the distribution of such profit or loss
2. Closing of the partnership books
3. Correction of accounting errors in prior periods like
overstatement or understatement of inventories,
excessive depreciation charges, and failure to provide
adequately for doubtful accounts
4. Liquidation of the business
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
Accounting Problems (Cont’d)
• At this point of 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
Marshaling 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
Marshaling of Assets (Cont’d)
• 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.
Definition of Terms
• Termination of a partnership as a going concern; it
Dissolution is the termination of the life of the partnership
• Process of settling the business of partnership

Winding up affairs; it is synonymous to liquidation
• Point in time when all partnership affairs are

Termination ended
• The interval of time between dissolution and

termination of partnership affairs; it is also the
process of winding up a business which is
Liquidation normally consists of conversion of assets into
cash, payment of liabilities and distribution of
remaining cash among the partners
Definition of Terms (Cont’d)
• The process of converting non-cash assets into
Realization cash
Gain on • Excess of the selling price over the cost or book

value of the assets disposed or sold through
Realization realization
• Excess of the cost or book value over the selling
Loss on Realization price of the assets disposed or sold through
realization
• Excess of a partner’s share on losses over his
Capital Deficiency capital
• A partner with a debit balance in his capital
Deficient Partner account after receiving his share on the loss on
realization
Definition of Terms (Cont’d)
• Legal right to apply part or all of the amount
Right of Offset owing to a partner on the loan balance against
deficiency in his capital account resulting from
losses in the process of liquidation
• Sum of a partner’s capital, loan balance and

Partner’s Interest advances to the partnership
Types of Liquidation
Lump-sum
• Distribution of cash to the partners is done only
Liquidation or after all the non-cash assets have been realized,
Liquidation by the total amount of gain or loss on realization is
known and all liabilities have been paid
Totals
Liquidation by
• Assets are realized on a piecemeal basis and cash
Installments or is distributed to partners on a periodic basis as it
Piece-meal becomes available, that is, even before all non-
assets are converted into cash
Liquidation
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
(Cont’d)
• 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
(Cont’d)
• 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
(Cont’d)
be the amount of the loan or the amount of the deficiency
whichever, is lower.
• Cash can be distributed to partners before or after the
elimination of the deficiency. If cash is distributed after the
elimination of the deficiency.
• Capital deficiency is eliminated by:
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.
(Cont’d)
• 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.
(Cont’d)
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.
(Cont’d)
• The personal status of partners (that is, personal

assets and personal liabilities) is sometimes
provided in the problem to indicate that a partner is
solvent or insolvent.
• 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.
Illustrative Problem A
Encina, Endrada and Elina
Statement of Financial Position
December 1, 2010
Assets Liabilities and Equity

Cash 8,000 Liabilities 44,800
Other Assets 136,000 Endrada, Loan 2,000
Elina, Loan 3,200
Encina, Capital 38,000
Endrada, Capital 24,000
Elina, Capital 32,000
Total Assets 144,000 Total Liabilities and Capital 144,000
Illustrative Problem A (Cont’d)
CASE:
1. The other assets were sold for P140,000.
4. The other assets were sold for P68,000. Deficient partner
was solvent.
5. The other assets were sold for P68,000. Deficient partner
was insolvent.
Illustrative Problem A (Cont’d)
6. The other assets were sold for P68,000. Distribution of
available cash is:
a) Before eliminating capital deficiency; and
b) After eliminating capital deficiency
Instructions:
1. Prepare a statement of liquidation of the cases. For case 6,
prepare also a schedule of cash distribution.
2. Present journal entries to record the liquidation process.
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.
Points of Emphasis in the Preparation
of Statement of Liquidation (Cont’d)
4. Figures in parenthesis for each liquidation transaction
represents reduction in the account.
5. Double rule when all column are brought to zero balance.
CASE 1 – Gain on realization, no capital
deficiency
December 1 to 31, 2010
Other Loan Capital

Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balance before liquidation 8,000 136,000 44,800 2,000 3,200 38,000 24,000 32,000
Sale of assets and distribution of gain 140,000 (136,000) 1,600 1,600 800
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Payment of liabilities (44,800) (44,800)
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
Payment to partners (103,200) (2,000) (3,200) (39,600) (25,600) (32,800)
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
1. The other assets were sold 2,000
Balances for P140,000.103,200
3,200 39,600 25,600 - - 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Sale of assets and distribution of gain 140,000 (136,000) nca-assets of P136,000 sold 1,600 1,600thus gain
for 140,000, 800of
Balances 148,000 - 44,800P4,0002,000 3,200
which will 39,600 to25,600
be distributed partners, 32,800
as
follows:
4,000 x 40% = 1,600 Ecina
Balances 103,200 - - 4,0002,000 3,200Endrada
x 40% = 1,600 39,600 25,600 32,800
Payment to partners (103,200) 4,000(2,000)
x 20% = (3,200) (39,600) (25,600) (32,800)
800 Elina
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Journal Entry ??
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Journal Entry
Cash 140,000
NCa-assets 136,000
Encina, Capital 1,6001 to 31, 2010
December
Endrada, Capital 1,600
Other Loan Capital
Elina, Capital Cash 800Liabilities Endrada Elina
Assets Encina Endrada Elina
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
2. Payment of Outside Creditors
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
J/E Liabilities
Balances 103,20044,800- -
2,000 3,200 39,600 25,600 32,800
Cash
Payment to partners (103,200)
44,800
(2,000) (3,200) (39,600) (25,600) (32,800)
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
J/E Liabilities
Balances 103,20044,800- -
2,000 3,200 39,600 25,600 32,800
Cash
Payment to partners (103,200)
44,800
(2,000) (3,200) (39,600) (25,600) (32,800)
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
3. Payment to internal creditors and O/E balance of partners
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
CASE 1 –
Journal
Debit
Entry?Gain on realization,
Loans Payable to Endrada
no
2,000
capital
deficiency
Loans Payable to Elina 3,200
Endrada, Capital Encina, Endrada and25,600
Elina
Elina, Capital Statement of Liquidation
32,800
Credit Cash 103,200
Other Loan Capital
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
CASE 1 –
Journal
Debit
Entry?Gain on realization,
Loans Payable to Endrada
no
2,000
capital
deficiency
Loans Payable to Elina 3,200
Endrada, Capital Encina, Endrada and25,600
Elina
Elina, Capital Statement of Liquidation
32,800
Credit Cash 103,200
Other Loan Capital
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
deficiency
Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
CASE 2 – Loss on realization, no capital
deficiency
Other Loan Capital

Sale of assets and distribution of loss 100,000 (136,000) (14,400) (14,400) (7,200)
Balances 108,000 - 44,800 2,000 3,200 23,600 9,600 24,800
Balances 63,200 - - 2,000 3,200 23,600 9,600 24,800
CASE 4 – Loss on realization, capital deficiency,
right to offset, deficient partner is solvent
Other Loan Capital

Sale of assets and distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances 76,000 - 44,800 2,000 3,200 10,800 (3,200) 18,400
Balances 31,200 - - 2,000 3,200 10,800 (3,200) 18,400
Offset of loan against the debit balance
in the capital deficiency of Endrada (2,000) 2,000
Balances 31,200 - 3,200 10,800 (1,200) 18,400
Additional investment by Endrada 1,200 1,200
Balances 32,400 - 3,200 10,800 - 18,400
Payment to partners (32,400) - (3,200) (10,800) - (18,400)

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Partnership Liquidation

• Process of settling the business of partnership

• Point in time when all partnership affairs are

• The interval of time between dissolution and

Gain on • Excess of the selling price over the cost or book

• Sum of a partner’s capital, loan balance and

• The personal status of partners (that is, personal

Assets Liabilities and Equity

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

Other Loan Capital

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