1.

Overview
This learning material provides discussion of Partnership Liquidation concepts. It
introduces the learner to the subject, guides the learner through the official text, develops the
learner’s understanding of the requirements through the use of examples and indicates significant
judgements that are required in accounting for partnerships. Furthermore, the module includes
questions that are designed to test the learner’s knowledge of the concepts pertaining to
accounting for special transactions.

2. Desired Learning Outcomes

At the end of the learning session, you should be able to:
a. Define partnership liquidation.
b. Identify the types of partnership liquidation.
c. Enumerate the general procedures in partnership liquidation.
d. Differentiate lump-sum liquidation from installment liquidation.
e. Understand the accounting procedures, concepts of partnership liquidation and
how it affects partnership equity.

3. Content/Discussion

4. Progress Check
PARTNERSHIP LIQUIDATION
Liquidation refers to the winding up of the affairs of the partnership. This involves
realization of all non-cash assets of the partnership into cash and settling all claims to the
partnership. It involves the termination of the partnership as a legal entity as well as the cessation
of its operating activities. In this chapter, the discussion will center on liquidation or formal
termination of the partnership and the problems and procedures involved in winding up or
liquidating its affairs.

Liquidation may be accomplished in three steps:

a) converting the firm's assets into cash,
b) discharging the firm's liabilities and
c) distributing the cash and or other unsold assets to the partners based on their equity or
interest over the partnership.

LEGAL PROVISIONS
Some legal provisions applicable to partnership liquidation as provided for in Philippine
Partnership Law are the following:

1. Payment of partnership liabilities should be made in the following order:

a. those owing the creditors other than the partners;
b. those owing the partners other than for their capital balances and share in the profits;
c. those owing the partners for their capital balances;
d. those owing the partners for their share in their profits.

2. Partnership creditors have priority over partnership properties in the same manner that
partners' personal creditors have priority over partners' personal properties.
 3. When a partner becomes insolvent, the claims against his separate properties shall be
ranked in the following orders:
a. owing to his personal creditors
b. owing to partnership creditors
c. owing to other partners for contribution made.

A partner's loan (based on no. 1-b above) has priority in the payment but this may be
decreased or eliminated if such partner has a capital deficiency. This legal doctrine is called
Right of Offset. Also, other partners may be given priority over the partner with a loan balance if
a cash schedule that has been prepared shows that the capital balance of the latter would be
insufficient to absorb additional partnership losses. Loans and advances, aside from the capital
balances, are considered in determining cash distribution to partners. No. 2 above informs
readers that in case the partnership becomes insolvent (its liabilities exceed assets) then available
partnership cash shall all be distributed to partnership creditors and the individual partners may
be called upon to satisfy the remaining unpaid claims of the partnership creditors from their
personal assets.

TERMINOLOGIES PECULIAR TO PARTNERSHIP LIQUIDATION

1. Realization - this is the process of converting or selling the assets or properties into cash.
A gain results when the cash proceeds is higher than the book value of the property sold.
2. Right of offset - this is a legal right to apply a part or all of an amount owing to a partner
(or to the partnership) on a loan balance against his capital deficiency (or capital credit); a
debtor-creditor relationship must exist between the partnership and the partner for the
right of offset to be exercised. In a loan payable to the partner, the partnership is a debtor
of the partner, while in a capital deficiency, the partner is a debtor of the partnership.
3. Capital Deficiency - a debit balance in the capital account which results when the
partner’s share in the partnership losses exceeds his capital account.
4. Partner's Interest - the sum of the partner's loan and capital balance.
5. Partner's Free Interest - the partner's interest that can be immediately recovered or paid in
cash.
6. Partner's Restricted Interest - the partner's interest that is used to absorb future losses; it
cannot be immediately recovered because of insufficient or restricted cash.
7. Theoretical Loss - the possible loss that may arise from the unsold assets or from the
partners' capital deficiency.

Basic Concepts on Partnership Liquidation

1. Unlimited Liability – partners have unlimited liability hence external creditors can run after their
separate personal property in case the partnership asset is insufficient to satisfy their claims. The
personal creditors; however, of a partner is preferred over partnership creditors with respect to the
personal assets of a partner. When a partner is personally insolvent and has capital deficiency, the
other solvent partners absorbs his capital deficiency.
2. Right of offset – the right of a partner to set-off his loan to the partnership against his capital
deficiency

General Approaches to Liquidation:

External claims must first be satisfied before any distributions are made to any partners. After
external claims are paid, remaining cash is distributed to the partners based on either:

I. Installment Liquidation – cash distributions to partners are made once cash becomes
available from the realization of non-cash assets.

ACCOUNTING PROCEDURES IN LIQUIDATION BY LUMP-SUM

1. Books should be adjusted, nominal accounts closed and a balance sheet should be
prepared.
2. Assets sold with the resulting gain or loss distributed to the partners either by increasing
or decreasing their capital accounts.
3. Deficient capital, if any, is eliminated by:
a. applying the right of offset
b. additional investment of the partner or
c. if deficient partner is personally insolvent, absorption of the deficiency as a loss by
other partners.
4. Payment of liabilities.
5. Distribution of remaining cash to partners.

II. Lump Sum Liquidation – is the process whereby the liquidation is carried over an
extended period of time thus realization and cash distribution are made on installment
basis.

In a liquidation by installment, any cash distribution to the partners is considered as though it

will be the last and this may be achieved by preparing a schedule of safe payment computing for
free interest and restricted interest which will be used to absorb future losses arising from:
1. Non-cash assets which are still on hand
2. Any partner's deficiency which will not be paid
3. Cash withheld to cover future liquidation expenses

ACCOUNTING PROCEDURES IN LIQUIDATION BY INSTALLMENT

1. Record the sale of assets and the distribution of either a gain or loss from realization.
2. Charge liquidation expenses, if any, against cash and the partners' capital balances based
on the profit and loss ratio.
3. Payment of liabilities. If in the meantime not all the liabilities are to be paid, an equal
amount of cash should be set aside for the unpaid balance.
4. If there is cash available for the partners but it is insufficient, prepare a schedule of safe
payment by observing the following rules:
a. Start with the partners' interests before the cash distribution
b. Compute for restricted interest (book value of non-cash assets still unsold, cash withheld for
future liquidation expenses and partner(s) capital deficiency.
c. The balance will represent free interest representing partners' interest that can be
immediately recovered.
d. Ensure that free interest is equal to the amount of available cash for distribution to the
partners.
5. Repeat the steps until the final sale, then observe the rules in liquidation by total.
Cash Distribution Schedule
Partner A Partner B Total
Total interest xx xx xx
Less: Loss (actual and *possible) (xx) (xx) (xx)
Cash payments to partners xx xx xx
If difference results in negative amount, distribute deficiency to remaining solvent
partners.
*Possible loss = Non-cash assets balance + Estimated future expenses

Loss can also be computed as: Loss = Partners’ interest – cash to be distributed to
partners.
1. Lump-sum liquidation – single distribution
2. Installment liquidation – “piece meal”

The installment liquidation is common in practice. Cash installment may be based on a:

a. Schedule of safe payment – this is regarded as the presumptive loss approach. Every time
a realization is made, the balance of the unrealized non-cash asset is presumed a total loss
which is then distributed to the partners. Any positive balance in the partners’ capital
balances represents the safe payments.
b. Cash priority program – the loss absorption capacity of each partner is determined and
ranked from highest to lowest. The incremental differences in the partner’s loss
absorption capacity multiplied by the partners’ respective profit sharing ratio indicate the
priority payments.
Loss absorption capacity = Net interest/Profit sharing ratio

CASH PRIORITY PROGRAM

(*Receive cash-given)
1. Determine the capital interest
2. Compute loss absorption balance (LAB): Capital Interest ÷ P’L Ratio
3. Equalize the LAB – deduct the second highest from the highest until equal
4. Distribution: Difference in LAB x P/L Ratio

When to use Cash Priority Program?

- When the problem says, what amount should be distributed to the partners.
- If the assets, liabilities and partner’s capital are not available (there is missing
information)
EXAMPLE:
A G J

Capital Interest P100,000 P80,000 P75,000

P/L % ÷ 50% ÷ 20% ÷ 30%
LAB P200,000 P400,000 P250,000
Priority 1 0 150,000 0
P200,000 P250,000 P250,000
Priority 2 0 50,000 50,000
P200,000 P200,000 P200,000

 If received P35,500, how much was given to J?

A G J Total
Priority 1 P 0 P30,000 P 0 P30,000
Priority 2 0 10,000 15,000 25,000
NPP 35,500 14,200 21,300 71,000
P35,500 P54,200 P36,300 P126,000

Capital beginning Pxx

1. Determine the capital interest Gain/Loss +/- xx
2. Deduct the maximum possible loss MPL - xx
3. Absorb deficiency Elimination of deficiency - xx
4. Distribute Condonation +/- xx
Cash Distribution Pxx

Illustrative: Lump sum Liquidation

The partnership of X, Y and Z is being liquidated. The summarized balance sheet below depicts
their financial position before liquidation:

Cash P 30,000 Accounts payables P 280,000

Loans to Z 70,000 X, loan 30,000
Other non-cash assets 600,000 X, capital (40%) 90,000
Y, capital (20%) 150,000
- Z, capital (40%) 150,000
Total assets P 700,000 Total liabilities and capital P 700,000

The personal assets and liabilities of each partner is shown as follows:

Personal Assets Personal Liabilities

X P 620,000 P 600,000
Y P 400,000 P 480,000
Z P 250,000 P 246,000

Assuming that the other non-cash assets will be realized at P300,000, how should the excess cash
be distributed?

4. Progress Check
1. Explain what is meant by partnership liquidation?
2. Differentiate liquidation by total against liquidation by installment.
3. Enumerate the principal steps involved in partnership liquidation.
4. Explain the legal doctrine of the right of offset.
5. Explain the accounting procedures to be followed if there are two or more deficient partners
 5. Exercises
1. The following condensed balance sheet is presented for the partnership of Smith and Jones,
who share profits and losses in the ratio of 60:40, respectively:
Other assets P 450,000
Smith, loan 20,000
P 470,000
Accounts payable P 120,000
Smith, capital 195,000
Jones, capital 155,000
P 470,000

The partners have decided to liquidate the partnership. If the other assets are sold for P385,000,
what amount of the available cash should be distributed to Smith?
a. P136,000 c. P159,000
b. P156,000 d. P195,000

2. On January 1, 2009, the partners of Cobb, Davis, and Eddy, who share profits and losses in
the ratio of 5:3:2, respectively, decided to liquidate their partnership. On this date the
partnership condensed balance sheet was as follows:

Assets
Cash P 50,000
Other assets 250,000
P 300,000
Liabilities and Capital
Liabilities P 60,000
Cobb, capital 80,000
Davis, capital 90,000
Eddy, capital 70,000
P 300,000

On January 15, 2009, the first cash sale of other assets with a carrying amount of P150,000
realized P120,000. Safe installment payments to the partners were made the same date. How
much cash should be distributed to each partner?
Cobb Davis Eddy
a. P15,000 P51,000 P44,000
b. P40,000 P45,000 P35,000
c. P55,000 P33,000 P22,000
d. P60,000 P36,000 P24,000

3. On August 16, 2008, Tyron, Dana and Ira form a partnership investing cash of P105,000,
P94,500 and P29,400, respectively. The partners share profits 3:2:2 and on October 29, 2008,
they have cash of P7,000, and other assets of P332,500; liabilities are P179,200. On this date
 they decided to go out of business and sell all the assets for P210,000. Ira has personal assets
of P10,500 that may, if necessary, be used to meet partnership obligations.

How much should be distributed to Dana upon liquidation of the partnership?

a. P14,280 b. P -0- c. P34,020 d. P 28,000
4. The partnership of Undoy, Vennie and Wally was dissolved on June 30, 2005 and account
balances after non-cash assets were converted into cash on September 1, 2005 are:

Cash P 50,000
Accounts payable 120,000
Undoy, capital (30%) 90,000
Vennie, capital (30%) ( 60,000)
Wally, capital (40%) ( 100,000)

Personal assets and liabilities of the partners at September 1, 2004 are:

Partners Personal Personal liabilities

assets
Undoy P 80,000 P 90,000
Vennie P 100,000 P 61,000
Wally P 190,000 P 80,000

If Wally contributes P70,000 to the partnership to provide cash to pay creditors, what amount of
Undoy’s P90,000 partnership equity would appear to be recoverable?
a. P 90,000 b. P 79,000 c. P 81,000 d. P 75,000

5. W,X,Y and Z are partners sharing earnings in the ratio of 3/21, 4/21, 6/21 and 8/21,
respectively. The balances of their capital accounts on December 31, 2006 are as follows:
W P 1,000
X 25,000
Y 25,000
Z 9,000
P 60,000

The partners decide to liquidate, and they accordingly convert the non-cash assets into P23,200
of cash After paying the liabilities amounting to P3,000, they have P22,200 to divide. Assume
that the debit balance of any partner’s capital is uncollectible. After the P22,200 was divided, the
capital balance of X was:
a. P3,200 b. P3,920 c. P4,500 d. P17,800

6. Evaluation
Answer the following questions:
The following condensed balance sheet is presented for the partnership of Smith and Jones, who
share profits and losses in the ratio of 60:40, respectively:
Other assets P 450,000
Smith, loan 20,000
 P 470,000
Accounts payable P 120,000
Smith, capital 195,000
Jones, capital 155,000
P 470,000

The partners have decided to liquidate the partnership. If the other assets are sold for P385,000,
what amount of the available cash should be distributed to Smith?
P136,000 c. P159,000
P156,000 d. P195,000

On January 1, 2009, the partners of Cobb, Davis, and Eddy, who share profits and losses in the
ratio of 5:3:2, respectively, decided to liquidate their partnership. On this date the partnership
condensed balance sheet was as follows:

Assets
Cash P 50,000
Other assets 250,000
P 300,000
Liabilities and Capital
Liabilities P 60,000
Cobb, capital 80,000
Davis, capital 90,000
Eddy, capital 70,000
P 300,000

On January 15, 2009, the first cash sale of other assets with a carrying amount of P150,000
realized P120,000. Safe installment payments to the partners were made the same date. How
much cash should be distributed to each partner?
Cobb Davis Eddy
P15,000 P51,000 P44,000
P40,000 P45,000 P35,000
P55,000 P33,000 P22,000
P60,000 P36,000 P24,000

On August 16, 2008, Tyron, Dana and Ira form a partnership investing cash of P105,000,
P94,500 and P29,400, respectively. The partners share profits 3:2:2 and on October 29, 2008,
they have cash of P7,000, and other assets of P332,500; liabilities are P179,200. On this date
they decided to go out of business and sell all the assets for P210,000. Ira has personal assets of
P10,500 that may, if necessary, be used to meet partnership obligations.

How much should be distributed to Dana upon liquidation of the partnership?

P14,280 b. P -0- c. P34,020 d. P 28,000
The partnership of Undoy, Vennie and Wally was dissolved on June 30, 2005 and account
balances after non-cash assets were converted into cash on September 1, 2005 are:
Cash P 50,000
Accounts payable 120,000
Undoy, capital (30%) 90,000
Vennie, capital (30%) ( 60,000)
Wally, capital (40%) ( 100,000)

Personal assets and liabilities of the partners at September 1, 2004 are:

Partners Personal assets Personal liabilities

Undoy P 80,000 P 90,000
Vennie P 100,000 P 61,000
Wally P 190,000 P 80,000

If Wally contributes P70,000 to the partnership to provide cash to pay creditors, what amount of
Undoy’s P90,000 partnership equity would appear to be recoverable?
P 90,000 b. P 79,000 c. P 81,000 d. P 75,000

W,X,Y and Z are partners sharing earnings in the ratio of 3/21, 4/21, 6/21 and 8/21, respectively.
The balances of their capital accounts on December 31, 2006 are as follows:
W P 1,000
X 25,000
Y 25,000
Z 9,000
P 60,000

The partners decide to liquidate, and they accordingly convert the non-cash assets into P23,200
of cash After paying the liabilities amounting to P3,000, they have P22,200 to divide. Assume
that the debit balance of any partner’s capital is uncollectible. After the P22,200 was divided, the
capital balance of X was:
P3,200 b. P3,920 c. P4,500 d. P17,800

As of December 31, 2004, the books Ton Partnership showed capital balances of: T, P40,000; O,
P25,000; N, P5,000. The partners’ profit and loss ratio was 3:2:1, respectively. The partners
decided to liquidate and they sold all non-cash assets for P37,000. After settlement of all
liabilities amounting P12,000, they still have cash of P28,000 left for distribution. Assuming that
any capital debit balance is uncollectible, the share of T in the distribution of the P28,000 cash
would be:
P17,800 b. P18,000 c. P 19,000 d. P17,000

A, B and C are partners in textile distribution business, sharing profits and losses equally. On
December 31, 2004 the partnership capital and partners drawings were as follows:
A B C Total
Capital P100,000 P 80,000 P300,000 P480,000
Drawing 60,000 40,000 20,000 120,000
The partnership was unable to collect on trade and was forced to liquidate. Operating profit in
2004 amounted to P72,000 which was all exhausted including the partnership assets. Unsettled
creditors’ claims at December 31, 2004 totaled P84,000. B and C have substantial private
resources but A has no personal assets. Final cash distribution to C was:
P78,000 b. P84,000 c. P108,000 d. P162,000

Gardo and Gordo formed a partnership on July 1, 2004 to operate two stores to be managed by
each of them. They invested P30,000 and P20,000 and agreed to share earnings 60% and 40%,
respectively. All their transactions were for cash, and all their subsequent transactions were
handled through their respective bank accounts as summarized below:
Gardo Gordo
Cash receipts ……………………………………. P79,100 P65,245
Cash disbursements……………………………… 62,275 70,695

On October 31, 2004, all remaining noncash assets in the two stores were sold for cash of
P60,000. The partnership was dissolved, and cash settlement was effected. In the distribution of
the P60,000 cash, Gardo received:
P24,000 b. P26,000 c. P34,000 d. P36,000

B. References

1. Manuel, Z.V. (2016). Advanced Accounting. Manila, Philippines: GIC Enterprises

2. Advanced Financial Accounting and Reporting review materials by Wency Giron