NORTHERN LUZON ADVENTIST COLLEGE

DEPARTMENT OF BUSINESS EDUCATION

COURSE: ACCOUNTING FOR SPECIAL TRANSACTION

LESSON 5: ACCOUNTING FOR PARTNERSHIP LIQUIDATION – LUMP SUM

I. Introduction

Partnership dissolution calling for the winding up of business affairs, called

liquidation, shall be discussed in this chapter. Here, the association of the
partners for purposes of carrying on activities in the usual manner is considered
ended. Partners can only engage in activities leading to final settlement of
business affairs.

II. Learning Outcomes

After reading this chapter, the students should be able to:

 Define partnership liquidation and identify its causes.
 Discuss the various problems encountered in partnership liquidation.
 Identify and differentiate the two types of partnership liquidation.
 Discuss and understand the accounting procedures under lump-sum
liquidation.

III. Integration of Faith:

“If someone’s ox injures a neighbor’s ox and the injured ox dies, then the
two owners must sell the live ox and divide the price equally between them. They
must also divide the dead animal.” Exodus 21:35

IV. Topics for Reading:

Book: Fundamentals of Accounting / Advanced Accounting 1

Additional Readings:
Introduction to accounting
https://bit.ly/34McCUF
https://bit.ly/31yB2ik
https://bit.ly/3b2pzKS

References:
1. Accounting for Partnership and Corporation (Tolentino-Baysa &
Lupisan, 2018)
2. Financial Accounting and Reporting (Cabrera & Cabrera, 2019)
3. Advanced Accounting 1 (Guerrero & Peralta, 2017)
4. Partnership and Corporation Accounting (Aduana, 2016)
5. Financial Accounting and Reporting (Millan, 2019)
 ACCOUNTING FOR PARTNERSHIP LIQUIDATION – LUMP SUM

A partnership is liquidated when its business operations are completely

terminated or ended. The 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.

Partnership dissolution with liquidation may be caused by any of the following factors:
1. The accomplishment of the purpose for which the partnership was organized.
2. The termination of the term/period covered by the partnership contract.
3. The bankruptcy of the firm
4. The mutual agreement among the partners to close the business.

Accounting problems involved in the liquidation of a partnership include:

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; and

4. Liquidation of the business.

In 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 liability of each partner. The priorities for creditors’ claims against the
assets available to pay the partnership liabilities involve two concepts: the marshaling
of assets and the right of offset.

Marshaling of assets involves the order of creditors’ right against the partnership’s assets
and the personal assets of the individual partners. The order in which claims against the
partnership’s assets will be marshaled is as follows:

1. partnership creditors other than partners;

2. partners’ claims other than capital and profits, such as loans payable and
accrued interest payable; and
3. partners’ claim to capital or profits, to the extent of credit balances in capital
accounts.

The order of claims against the personal assets of the individual partners is as follows:

1. personal creditors of individual partners; and

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

Dissolution – the termination of a partnership as a going concern; it is the termination of

the life of a partnership.

Winding up – the process of settling the business or partnership affairs; it is synonymous

to liquidation.

Termination – the point in time when all partnership affairs ended.

Liquidation – the interval of time between dissolution and termination of partnership

affairs; it is also the process of winding up a business which normally consists of
conversion of assets into cash, payment of liabilities and distribution of remaining cash
among the partners.

Realization – the process of converting non-cash assets into cash.

Gain on realization – the excess of the selling price over the cost or book value of the
assets disposed or sold through realization.

Loss on realization – the excess of the cost or book value over the selling price of the
assets disposed or sold through realization.

Capital deficiency – the excess of a partner’s share on losses over his capital.

Deficient partner – a partner with a debit balance in his capital account after receiving
his share on the loss on realization.

Right of offset – the legal right to apply part or all of the amount owing to a partner on a
loan balance against deficiency in his capital account resulting from losses in the
process of liquidation.

Partner’s interest – the sum of a partner’s capital, loan balance and advances to the
partnership.
TYPES OF LIQUIDATION

1. Lump-sum liquidation or liquidation by totals. This is a type of liquidation 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. Liquidation by installment or piece-meal liquidation. This is a type of liquidation

whereby assets are realized on a piecemeal basis and cash is distributed to
partners on a periodic basis as it becomes available, that is, even before all non-
assets are converted into cash.

PROCEDURES IN LUMP-SUM LIQUIDATION

When a partnership is to be liquidated, the books should be adjusted and balances of

nominal accounts are closed. The resulting profit 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
balances. The partnership is then ready to proceed with liquidation as follows:

1. 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 ratio (salary and
interest factors disregarded) unless liquidation ratios are specified in the
partnership agreement.

2. Distribution of cash to creditors and partners. In this procedure, the provision of

the marshaling of assets and the exercise of the right of offset are applied.

Liquidation expenses may be incurred to facilitate the immediate realization of non-

cash assets. Payment of liquidation expenses reduces cash and is recorded as a
deduction from partners’ capital based on the partners’ profit and loss ratios.

When realization of assets in the course of liquidation result 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 (known as 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 to be offset shall be the lower of the amount of the loan or the
amount of deficiency.

Cash can be distributed to partners before or after the elimination of the deficiency. If
cash is distributed after the elimination of the deficiency.

1. Capital deficiency is eliminated by

a. Making additional cash investment, if the deficient partner is solvent.

 b. Charging the deficiency as additional loss to the remaining partners, if the
deficient partner is insolvent.

2. Cash available for distribution is then paid to partners to apply first on loan then
on capital.

Key points. The final distribution of cash to partners is made based on partners’ 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.

2. Deficient partners may

a. If solvent, make additional cash investment, to be paid to partners as

second cash distribution, or the deficient partner may make direct cash
settlement to the other partners.

b. If insolvent, the deficiency shall be absorbed by the other partners as

additional loss according to their profit and loss ratio.

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

The statement of liquidation is a statement prepared to summarize the liquidation

process. It is the basic of the journal entries made to record liquidation. This statement
presents in working paper form the effect of the liquidation on the statement of
financial position. It shows the conversion of assets into cash, the allocation of gain or
loss on realization, and the distribution of cash to creditors and partners.
Illustrative Problem A:

On December 31, 2020, the statement of financial position of the ABC Partnership, just
before liquidation, is as follows:
DEBITS CREDITS
Cash P50,000 Liabilities P25,000
Charlie, Loan from P’ship 2,000 Alpha, Loan to P’ship 55,000
Non-Cash asset 100,000 Alpha, Cap. (50%) 5,000
Bravo, Cap. (30%) 25,000
Charlie, Cap. (20%) 42,000

Independent Cases:

1. The non-cash assets are sold for P120,000. All partners are solvent.
2. The non-cash assets are sold for P80,000. All partners are solvent.
3. The non-cash assets are sold for P15,000. All partners are solvent.
4. The non-cash assets are sold for P15,000. All partners are insolvent.

Instructions:

1. Prepare a statement of liquidation for each of the cases.

2. Present journal entries to record the liquidation process.

Points of emphasis in the preparation of the 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. Gain on realization increases capital while loss on realization decreases capital.

3. Figures in parenthesis for each liquidation transaction represent reduction in the

account.

4. Double rule when all columns are brought to zero balance.

Terms with the same meaning:

Payable to partner is same as loan from partner, loan to partnership, and if the
partner loan is in the asset side.

Receivable from partner is same as loan to partner, loan from partnership, and if
the partner loan is in the liability side.
Case 1: The non-cash assets are sold for P120,000. All partners are solvent.

ABC Partnership
Statement of Liquidation
December 31, 2020

Receivable Payable to CAPITAL

from partner Partner
Particular Cash (Charlie) Other asset Liabilities (Alpha) Alpha (50%) Bravo (30%) Charlie (20%)
Balances Before Liquidation 50,000 2,000 100,000 25,000 55,000 5,000 25,000 42,000
Realization of Asset 120,000 (100,000) 10,000 6,000 4,000
Balances 170,000 2,000 0 25,000 55,000 15,000 31,000 46,000
Payment of Liabilities (25,000) (25,000)
Balances 145,000 2,000 0 55,000 15,000 31,000 46,000
Right of offset (2,000) (2,000)
Balances 145,000 0 55,000 15,000 31,000 44,000
Payment of Loan (55,000) (55,000)
Balances 90,000 0 15,000 31,000 44,000
Payment to Partners (90,000) (15,000) (31,000) (44,000)
Total 0 0 0 0

The other asset with a book value of P100,000 were sold for P120,000 resulting in a
P20,000 gain on realization distributed among the partners in their profit/loss ratio.

The entries to record the liquidation process are:

a. Realization of assets and distribution of gain on realization 5:3:2.

Cash 120,000
Other asset 100,000
Alpha, Capital (20,000x50%) 10,000
Bravo, Capital (20,000x30%) 6,000
Charlie, Capital (20,000x20%) 4,000
b. Payment of Liabilities
Liabilities 25,000
Cash 25,000

c. Right of Offset
Charlie, Capital 2,000
Receivable from Charlie 2,000

d. Payment of partners

Payable to Alpha 55,000

Alpha, Capital 15,000
Bravo, Capital 31,000
Charlie, Capital 44,000
Cash 145,000
Case 2: The non-cash assets are sold for P80 ,000. All partners are solvent.

ABC Partnership
Statement of Liquidation
December 31, 2020

Receivable Payable to
CAPITAL
from partner Partner
Particular Cash (Charlie) Other asset Liabilities (Alpha) Alpha (50%) Bravo (30%) Charlie (20%)
Balances Before Liquidation 50,000 2,000 100,000 25,000 55,000 5,000 25,000 42,000
Realization of Asset 80,000 (100,000) (10,000) (6,000) (4,000)
Balances 130,000 2,000 0 25,000 55,000 (5,000) 19,000 38,000
Payment of Liabilities (25,000) (25,000)
Balances 105,000 2,000 0 55,000 (5,000) 19,000 38,000
Right of offset (2,000) (5,000) 5,000 (2,000)
Balances 105,000 0 50,000 0 19,000 36,000
Payment of Loan (50,000) (50,000)
Balances 55,000 0 19,000 36,000
Payment to Partners (55,000) (19,000) (36,000)
Total 0 0 0

The entries to record the liquidation process are:

a. Realization of assets and distribution of loss on realization 5:3:2.

Cash 80,000
Alpha, Capital (20,000x50%) 10,000
Bravo, Capital (20,000x30%) 6,000
Charlie, Capital (20,000x20%) 4,000
Other asset 100,000
b. Payment of Liabilities
Liabilities 25,000
Cash 25,000

c. Right of Offset
Charlie, Capital 2,000
Receivable from Charlie 2,000
#
Payable to Alpha 5,000
Alpha, Capital 5,000

d. Payment of partners

Payable to Alpha 50,000

Bravo, Capital 19,000
Charlie, Capital 36,000
Cash 105,000
Case 3: The non-cash assets are sold for P15,000. All partners are solvent.

ABC Partnership
Statement of Liquidation
December 31, 2020

Receivable Payable to
CAPITAL
from partner Partner
Particular Cash (Charlie) Other asset Liabilities (Alpha) Alpha (50%) Bravo (30%) Charlie (20%)
Balances Before Liquidation 50,000 2,000 100,000 25,000 55,000 5,000 25,000 42,000
Realization of Asset 15,000 (100,000) (42,500) (25,500) (17,000)
Balances 65,000 2,000 0 25,000 55,000 (37,500) (500) 25,000
Payment of Liabilities (25,000) (25,000)
Balances 40,000 2,000 0 55,000 (37,500) (500) 25,000
Additional Investment by Bravo 500 500
Balances 40,500 2,000 55,000 (37,500) 0 25,000
Right of offset (2,000) (37,500) 37,500 (2,000)
Balances 40,500 0 17,500 0 23,000
Payment of Loan (17,500) (17,500)
Balances 23,000 0 23,000
Payment to Partners (23,000) (23,000)
Total 0 0

The entries to record the liquidation process are:

a. Realization of assets and distribution of loss on realization 5:3:2.

Cash 15,000
Alpha, Capital (85,000x50%) 42,500
Bravo, Capital (85,000x30%) 25,500
Charlie, Capital (85,000x20%) 17,000
Other asset 100,000
b. Payment of Liabilities
Liabilities 25,000
Cash 25,000
c. Additional investment for deficiency
Cash 500
Bravo, Capital 500
d. Right of Offset
Charlie, Capital 2,000
Receivable from Charlie 2,000
#
Payable to Alpha 37,500
Alpha, Capital 37,500
e. Payment of partners
Payable to Alpha 17,500
Charlie, Capital 23,000
Cash 40,500
Case 4: The non-cash assets are sold for P15,000. All partners are insolvent.

ABC Partnership
Statement of Liquidation
December 31, 2020

Receivable Payable to
CAPITAL
from partner Partner
Particulars Cash (Charlie) Other asset Liabilities (Alpha) Alpha (50%) Bravo (30%) Charlie (20%)
Balances Before Liquidation 50,000 2,000 100,000 25,000 55,000 5,000 25,000 42,000
Realization of Asset 15,000 (100,000) (42,500) (25,500) (17,000)
Balances 65,000 2,000 0 25,000 55,000 (37,500) (500) 25,000
Payment of Liabilities (25,000) (25,000)
Balances 40,000 2,000 0 55,000 (37,500) (500) 25,000
Dificiency charged to other partners (357) 500 (143)
Balances 40,000 2,000 55,000 (37,857) 0 24,857
Right of offset (2,000) (37,857) 37,857 (2,000)
Balances 40,000 0 17,143 0 22,857
Payment of Loan (17,143) (17,143)
Balances 22,857 0 22,857
Payment to Partners (22,857) (22,857)
Total 0 0

The entries to record the liquidation process are:

a. Realization of assets and distribution of loss on realization 5:3:2.

Cash 15,000
Alpha, Capital (85,000x50%) 42,500
Bravo, Capital (85,000x30%) 25,500
Charlie, Capital (85,000x20%) 17,000
Other asset 100,000
b. Payment of Liabilities
Liabilities 25,000
Cash 25,000
c. Additional investment for deficiency
Alpha, Capital (500x(50%/70%)) 357
Charlie, Capital (500x(20%/70%)) 143
Bravo, Capital 500
d. Right of Offset
Charlie, Capital 2,000
Receivable from Charlie 2,000
#
Payable to Alpha 37,857
Alpha, Capital 37,857
e. Payment of partners
Payable to Alpha 17,143
Charlie, Capital 22,857
Cash 40,500
SCHEDULE TO ACCOMPANY THE STATEMENT OF LIQUIDATION

The schedule to Accompany the Statement of Liquidation shows amounts to be paid to

partners. Adjusted capital is computed by deducting receivable from partners and
adding payable to partners. Cash to be distributed is computed as cash plus proceed
minus liabilities. Deficiencies should be settled before the cash will be distributed to the
partners.

Format:

A, Partner B, Partner C, Partner Total

Capital xxx xxx xxx xxx
Loan from Partner xxx xxx xxx xxx
Loan to Partner (xxx) (xxx) (xxx) (xxx)
Adjusted Capital xxx xxx xxx xxx
Share in gain/(loss) (xxx) (xxx) (xxx) (xxx) (squeeze)
Total amount to be paid xxx xxx xxx xxx

Note: Any deficiencies in partners would result to another format. The format above is
the general format if there is no deficiencies in the partner’s capital.

Schedule for case 1:

50% 30% 20%

Alpha Bravo Charlie Total
Capital 5,000 25,000 42,000 72,000
Loan from Partner 55,000 55,000
Loan to Partner (2,000) (2,000)
Adjusted Capital 60,000 25,000 40,000 125,000
Share in gain/(loss) 10,000 6,000 4,000 20,000 (squeeze)
Total amount to be paid 70,000 31,000 44,000 145,000 *

*Available cash = 50,000 + 120,000 - 25,000 = 145,000

Schedule for case 2:
50% 30% 20%
Alpha Bravo Charlie Total
Capital 5,000 25,000 42,000 72,000
Loan from Partner 55,000 55,000
Loan to Partner (2,000) (2,000)
Adjusted Capital 60,000 25,000 40,000 125,000
Share in gain/(loss) (10,000) (6,000) (4,000) (20,000) (squeeze)
Total amount to be paid 50,000 19,000 36,000 105,000 *

*Available cash = 50,000 + 80,000 - 25,000 = 105,000

Schedule for case 3:

50% 30% 20%
Alpha Bravo Charlie Total
Capital 5,000 25,000 42,000 72,000
Loan from Partner 55,000 55,000
Loan to Partner (2,000) (2,000)
Adjusted Capital 60,000 25,000 40,000 125,000
Share in gain/(loss) (42,500) (25,500) (17,000) (85,000) (squeeze)
Total amount to be paid 17,500 (500) 23,000 40,000 *
Additional Investment 500 500
Total 17,500 0 23,000 40,500

*Available cash = 50,000 + 15,000 - 25,000 = 40,000

Since Charlie is solvent, additional investment is required to Charlie.

Schedule for case 4:

50% 30% 20%

Alpha Bravo Charlie Total
Capital 5,000 25,000 42,000 72,000
Loan from Partner 55,000 55,000
Loan to Partner (2,000) (2,000)
Adjusted Capital 60,000 25,000 40,000 125,000
Share in gain/(loss) (42,500) (25,500) (17,000) (85,000) (squeeze)
Total amount to be paid 17,500 (500) 23,000 40,000 *
Charged to other partners (357) 500 (143)
Total 17,143 0 22,857 40,000

*Available cash = 50,000 + 15,000 - 25,000 = 40,000

Since Charlie is insolvent, the deficiency is charged to other partners based on their
profit and loss ratio.