PARTNERSHIP LIQUIDATION

ACCOUNTING FOR SPECIAL TRANSACTIONS

LEARNING OBJECTIVES

 Differentiate dissolution from liquidation

 Identify and explain causes of partnership liquidation
 Differentiate lump-sum liquidation from installment liquidation
 Understand and apply the concepts of “marshalling of assets” and
“right of offset” on selected problems
 Identify and apply the procedures in lump-sum and installment
liquidation
 Prepare a statement of partnership liquidation
 Prepare a schedule of Cash distribution to Partners
 Record transactions relating to partnership liquidations
ACCOUNTING FOR PARTNERSHIP
LIQUIDATION

• CONCEPT OF LIQUIDATION
• LUMP-SUM LIQUIDATION
• INSTALLMENT LIQUIDATION
PARTNERSHIP LIQUIDATION
 Liquidation or Winding up of the Affairs. Phase of partnership
operations which begins after dissolution and ends with the
termination of partnership activities.
 Liquidation is defined as the termination of the business activities
carried on by the partnership and the winding up of partnership affairs
preparatory to going out of business.
 Includes activities such as conversion of the noncash assets to cash,
payment of the partnership’s obligations, and the distribution of any
remaining net balance to the partners, in cash according to their
capital interests.
 May occur in short-term (lump-sum) or over a period of several years
(installment).
PARTNERSHIP LIQUIDATION
 A partnership is liquidated when its business operations are
completely terminated or ended.
 Partnership dissolution leading to liquidation may be caused by any
of the following
 Accomplishment of the purpose for which partnership was organized
 Termination of the period covered by the partnership contract
 Bankruptcy of the firm
 Mutual agreement among the partners to close the business
 By court decree
 Realization of Assets. Conversion of assets into cash by selling them
PARTNERSHIP LIQUIDATION
 Liquidation. Payment of claims (creditors and partners).
 Basic Liquidation Procedures to Minimize Inequities
 1. Sharing Gains or Losses.
 Always allocate and close gains or losses (e.g. adjustment in the value
of the assets and liabilities) to the partners’ capital accounts prior to
distributing any cash to the partners.
 2. Advance Planning When the Partnership is Formed
 Each partner will receive in the final settlement the amount of his equity
in the business. If the partners have capital deficiency (debit balance)
and will not be able to eliminate it through contribution, this will be
absorbed by the other partners, thus forming inequity. This must be
agreed since the start of the partnership.
PARTNERSHIP LIQUIDATION
 Basic Liquidation Procedures
 3. Right of Offset. Partnership Loan (receivable) from the Partners
 Partnership receivable should be subtracted or offset from the partner’s
capital account.
 4. Right of Offset. Partner Loans (payable) to the Partnership
 Loan outstanding to the partnership may be offset from the partner’s
capital. This may violate ranking of priority of payment, but is allowed by
law
 5. Liquidation Expense
 Priority costs that are incurred during liquidation process and treated as
reduction of the proceeds from the sale of noncash assets and must be
shared among the partners
PARTNERSHIP LIQUIDATION
 Basic Liquidation Procedures
 6. Marshalling of Assets
 Involves the order of creditors’ rights against the partnership assets and the
personal assets of the individual partners.
 Priority System over Partnership Assets
 Amounts owed to creditors other than partners.
 Amounts owed to partners other than capital and profits (e.g. loans)
 Amounts owed to partners as capital; and
 Amounts owed to partners as profits not currently closed to partners’ capital accounts.

 The order of claims against personal assets of the individual is:

 Personal creditor of individual partners
 Partnership creditors for unpaid partnership liabilities, regardless of a partner’s capital
balance in the partnership
PARTNERSHIP LIQUIDATION
 Basic Liquidation Procedures
 7. Distribution of Cash and Other Assets to Partners
 Partners may opt to receive non-cash assets rather than cash in the
event of liquidation. These non-cash assets must be revalued first
to reflect their fair value.
 Whether cash or non-cash, partners must still follow order of
priority of payment
PARTNERSHIP LIQUIDATION
 Types of Liquidation
 Lump-Sum Liquidation. Also called total or simple. No
distributions are made to the partners until all the realization
process is completed when the full amount of the realization
gain or loss is known.
 Installment Liquidation. Also called piece-meal. Distributions
are made to some or all of the partners as cash become
available. Thus cash distributions are made to partners before
the full amount of the realization gain or loss is known.
PARTNERSHIP LIQUIDATION
 Lump-Sum Liquidation Procedures
 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.
 If deficient partner has loan balance, exercise right of offset
 If deficient partner is solvent, then additional investment is necessary
 If deficient partner is insolvent, remaining partners will absorb the capital deficiency

 5. Payment to partners in this order

 Loan account
 Capital account
PARTNERSHIP LIQUIDATION
 Lump-Sum Liquidation Cases (See examples)
 1. Gain on Realization Fully Allocated to Partner's
 2. Loss on Realization Creates Deficit Balance in Partner's Capital Account
Requiring Right of Offset
 3. Loss on Realization Creates a Deficit Balance in Partner's Capital Account
Requiring Transfer from Partner's Loan Account
 4. Loss on Realization Creates a Deficit Balance in One Partner's Capital Account
Requiring Right of Offset with Additional Investment but Partner's Personally
Insolvent
 5. Loss on Realization Creates a Deficit Balance in Partner's Capital Account
Requiring Right of Offset and Additional Investment while All Partners are
Personally Solvent
 6. Loss on Realization Creates a Deficit balance in Partner's Capital Account
Requiring Right of Offset with Revaluation of Assets
PARTNERSHIP LIQUIDATION
 Installment Liquidation. The liquidation continues until all
noncash assets had been realized and cash had been distributed to
partnership creditors and partners. As a result, partnership realizes
more proceeds that would be possible in lump-sum liquidation.
 Significant element of installment liquidation is that the liquidator
authorizes cash payment to partners before all losses that may be
incurred in the liquidation are known. If distributions are made
and later losses cause deficits in the partners’ capital accounts, the
liquidator will have to demand the return of the payments.
PARTNERSHIP LIQUIDATION
 Guidelines to Safe Payment to Partners during Installment Liquidation
 1. Distribute no cash to partners until all liabilities and actual liquidation
expense have been paid.
 2. Distribute cash. After every realization period, the following schedules
may be used to determine cash payment to partners:
 A. Schedule of Cash/Safe Payments (Schedule to Accompany Statement of
Liquidation). Anticipate two case scenario leading to possible loss
 1. Assume a total loss on all remaining noncash assets, and provide all possible
losses including potential liquidation costs and unrecorded liabilities (allocated
to all partners through P/L ratio) – maximum total loss
 2. Assume that partners with a potential capital deficit is personally insolvent
and will be unable to pay anything to the partnership. (allocated to other
partners who have credit balances)
PARTNERSHIP LIQUIDATION
 Guidelines to Safe Payment to Partners during Installment
Liquidation
 2. Distribute cash. After every realization period, the following
schedules may be used to determine cash payment to partners:
 A. Schedule of Cash/Safe Payments (Schedule to Accompany Statement of
Liquidation). Anticipate two case scenario leading to possible loss
 The effect is to bring the partners’ capitals to their profit and loss sharing
ratio
 This is an effective method of safely distributing cash to partners
preventing excessive payments. However it is inefficient if numerous
installment distributions until the capital balances are aligned with the
profit and loss ratios.
PARTNERSHIP LIQUIDATION
 Guidelines to Safe Payment to Partners during Installment
Liquidation
 2. Distribute cash. After every realization period, the following
schedules may be used to determine cash payment to partners:
 B. Cash Payment Priority Program. Shows when partners will receive cash
in relation to the other partners.
 Also tells to whom cash distribution will be made as cash may become
available. This is prepared prior to liquidation.
 1. Determine total partner’s interest. Equal to the capital balances before
liquidation plus loans by partners to the partnership less loans by the
partnership to the partners.
 2. Divide total partners’ interest by their profit and loss ratio to get each
partner’s loss absorption capacity.
PARTNERSHIP LIQUIDATION
 Guidelines to Safe Payment to Partners during Installment
Liquidation
 2. Distribute cash. After every realization period, the following
schedules may be used to determine cash payment to partners:
 B. Cash Payment Priority Program. Shows when partners will receive cash
in relation to the other partners.
 3. Compute the amount of cash each partner is to receive as it becomes
available for distribution. Allocations may be made starting with
Allocation I wherein the highest loss absorption balance is reduced to the
next highest.
 The objective is to determine the amount of cash to distribute to each
partner to bring the ratios of their equity interest to their profit and loss
sharing ratio.
PARTNERSHIP LIQUIDATION
 Guidelines to Safe Payment to Partners during Installment
Liquidation
 2. Distribute cash. After every realization period, the following
schedules may be used to determine cash payment to partners:
 B. Cash Payment Priority Program. Shows when partners will receive cash
in relation to the other partners.
 3... Each reduction in the loss absorption balance requires payment to
partner or partners computed by multiplying the amount of reduction by
the partner’s profit and loss ratio.
 One limitation of CPP is that it is operable only after outside creditors have
been paid in full.
*See example on separate file
PARTNERSHIP LIQUIDATION
ACCOUNTING FOR SPECIAL TRANSACTIONS
PARTNERSHIP LIQUIDATION

 Liquidation
 Causes of Liquidation
 Realization of Asset
 Lump-sum vs Installment Liquidation
 Right of Offset and Marshalling of Assets
 Statement of Realization and Liquidation
 Safe Payment Schedule
 Cash Priority Program