PARTNERSHIP LIQUIDATION

PARTNERSHIP LIQUIDATION – LUMP SUM

Liquidation is the process of converting partnership assets into cash and distributing the cash to creditors and
partners. Frequently, the sale of assets (realization) will not provide sufficient cash to pay both creditors and
partners. The creditors have priority on any distribution. The basic rule is that no distribution is made to ANY
partner until all possible losses and liquidation expenses have paid or provided for (i.e. funds have been allocated).

The purpose of accounting during the liquidation process is to have an equitable distribution of partnership cash
creditors and partners. It is no longer income determination that is the focus of accounting but rather, the
computation of gains and losses on realization of assets which are subsequently to be allocated among partners,
payment of liabilities in accordance with law, and the final distribution of cash to the partners.

The proceeds of liquidation may be distributed in a lump sum after all assets have been sold and all creditors
satisfied with their claims, or the proceeds may be distributed to partners in installments as excess cash is
available.

Lump Sum Liquidation

First step in the liquidation is to sell all non-cash assets and allocate the resulting gain or loss to the capital
accounts of the partners in accordance with their profit and loss sharing ratio. The second step is to satisfy the
liabilities owing to outside creditors (creditors other than the partners themselves). The third step is to satisfy
liabilities owing to partners other than for capital or profits (i.e. loans from partner/s). The final step is to distribute
any remaining cash to the partners their share of capital and profits.

Any deficiency (i.e. debit balance) in a solvent partner’s capital will require that partner to contribute cash equal to
the debit balance. If the deficient partner is insolvent, the debit balance must be absorbed by the remaining
partners usually in accordance with their profit and loss sharing ratios.

Note, however that in order to achieve an equitable distribution, a partner’s loan to the partnership will first be
used to offset a debit balance in his capital account. Therefore, under this so-called “right to offset” doctrine, a
partners’ loan to the partnership will have distribution priority only to the extent it exceeds a debit balance in the
partner’s capital account.

Lump Sum Liquidation Procedures:

1. Realization of assets and distribution of gain or loss on realization among the partners based on the profit
and loss sharing ratio
2. Payment of Expenses and Liabilities
3. Elimination of partner’s capital deficiency. If after the distribution of loss on realization, a partner incurs a
deficit, it must be eliminated by using one of the following methods:
a. If there is an existing loan balance, exercise the right of offset

b. If the deficient partner is solvent, make him invest additional cash

c. If the deficient partner is insolvent, let the other partners absorb the deficiency

4. Payment to the partners (Loan and Capital Accounts)

Partnership Liquidation

Cash Distribution Schedule

Partner A Partner B Total
Total interest xxx xxx xxx
Less: Loss (Actual and possible*) (xxx) (xxx) (xxx)
Cash payment to partners xxx xxx xxx

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 = Partner’s interest – cash to be distributed to partners.

When liquidation is undertaken in installment, non-cash assets are sold in piecemeal and as such, partners may

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distribute cash among themselves as it becomes available. The liquidation of a partnership may take place over a
period of several months. Installment distributions may be made to partners on the basis of a schedule of safe
payments to partners or cash priority program, in conjunction with a liquidation schedule similar to the one used
for lump sum liquidation. The schedule of safe payments takes to a conservative approach to the distribution by
assuming that noncash assets are worthless; thus distribution may be made to partners on the basis of the value
of partnership assets, until the assets are sold.

Note:

Partnership Assets (Art. 1839(2), Civil Code)

1. Those owing to creditors other than partners, (external)
2. Those owing to partners other than for capital and profits, (internal)
3. Those owing to partners in respect of capital,
4. Those owing to partners in respect of profits.

Personal asset (Art. 1839(9)) Civil code

1. Those owing to separate creditors;
2. Those owing to partnership creditors;
3. Those owing to partners by way of contribution

"Marshalling of Assets" doctrine from the Uniform Partnership Act

Establishes the priority order of various "creditor claims" against a partner's personal assets when a partner has
become personally insolvent or bankrupt.

Capital Interest

Capital balance X
Add: Payable X
Less: Receivable (x)
Equity/Interest X

Receivable Payable
Loan to partner Loan from partner
Advances to partner Advances from partner
Due from partner Due to partner
Loan from partnership Loan to partnership
Advances from partnership Advances to partnership
Due to partnership Due from partnership

Installment Liquidation

Under this method, non-cash assets are sold in a piecemeal fashion. To compute cash settlement partners, should
have the following procedures:
1. Realized assets and distributed gain or loss on sales to partners in accordance in P/L ratio.
2. Pay liquidation expense, if any. This is absorbed by the partners in their profit and loss ratio.
3. Pay all outside liabilities or retain sufficient cash (cash withheld) to insure their total liquidation.
4. Cash settlement to partners is now equal to the partner’s capital balances after possible future losses (unsold
non-cash assets plus any cash withheld) have been apportioned to the partners or in accordance with an
advance cash distribution plan.

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Installment method of cash distribution

There are two keys to preparing a statement of partnership liquidation under the installment method: the
determination of the available cash balance at any given point in time and the determination of which partner(s)
is(are) to receive the payment of that cash. The reason that the cash is not distributed in accordance with the P&L
ratio is twofold:

• First, the final cash distribution is based upon the balance in each partner’s capital account, not the P&L
ratio, and

• Second, there will be situations, where one or more partners will have deficit balances in their capital
accounts. If this is the case, they should never receive a cash distribution, even if the deficit does not
arise until late in the liquidation process. The determination of the available cash balance is generally very
straightforward. The beginning cash balance (cash on hand at the start of the liquidation process) is
adjusted for the cash receipts from receivables, sale of noncash assets, payment to creditors, and
liquidation expenses incurred. A situation may occur where a certain amount of cash is to be reserved for
payment of future liabilities that may arise. If this is the case, this cash should be treated as an escrowed
or restricted asset, which makes it unavailable for current distribution to the partners.

The determination of which partner(s) is(are) to receive the available cash is somewhat more difficult. This
determination can be made at the beginning of the liquidation process or at the time of each payment. In making
this determination there are two key assumptions that must be made: (1) the individual partners are assumed to
be personally insolvent, and (2) the remaining noncash assets are deemed to be worthless (thus creating a
maximum possible amount of loss).

One method of determining the amount of the “safe payment” is the use of an Installment Cash Distribution
Schedule. This schedule is prepared by determining the amount of loss required to eliminate each partner’s capital
account. As noted above, all of the remaining noncash assets are to be considered worthless at the time a safe
payment is determined. Thus, if we determine the amount of loss required to eliminate each partner’s capital
balance, we can determine the order in which the partners should receive the cash payments. When preparing this
schedule it is important to make sure that the proper capital balance is used. The capital balance used must be
inclusive of any loans or advances between the partnership and partners. Thus, the capital balance at the
beginning of the liquidation process is increased by any amount owed to the partner by the partnership, and
decreased by any amount owed to the partnership by the partner.

Note:

Liquidation

Liquidation – is the process of converting partnership assets into cash and distributing the cash to creditors
and partners. Frequently, the sale of assets will not provide sufficient cash to pay both creditors and partners.
The creditors have priority on any distribution. The basic rule is that no distribution is made to any partner until
all possible losses and liquidation expenses have been paid or provided for. An individual prematurely
distributing cash to a partner whose capital account later shows a deficit maybe held personally liable if the
insolvent partner is unable to repay such a distribution. Partnership liquidation may be undertaken in total
(lump sum) or by installment.

Total Liquidation (lump sum) Installment Liquidation

Under this method, non-cash assets are sold at one Under this method, non-cash assets are sold in a
time. To compute the cash settlement to the piecemeal fashion. To compute cash settlement
partners, the following procedures should be followed: partners, should have the following procedures:

1. Realized assets and distributed gain or loss on 1. Realized assets and distributed gain or loss on
sales to partners in accordance in P/L ratio. sales to partners in accordance in P/L ratio.

2. Pay all outside creditors and expenses in 2. Pay liquidation expense, if any. This is
connection of liquidation. absorbed by the partners in their profit and loss
ratio.
3. Eliminate partner’s capital deficiency, if after the
distribution of loss on realization, a partner incurs 3. Pay all outside liabilities or retain sufficient cash
a capital deficiency, this deficiency must be (cash withheld) to insure their total liquidation.
eliminated by using one of the following methods:
a. If deficient partner has a loan balance,
exercise the right of offset. (transfer the loan
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 balance to his capital account)
b. If the deficient partner is solvent, make
additional investment of cash to cancel
capital deficiency.
c. If the deficient partner is insolvent, let the
other solvent partners absorb the deficiency.
(part of the capitals of the solvent partners in
their P/L ratio will be transferred to the
capital of the deficient partner.)
4. Cash settlement to partners is now equal to the:
a. Partner’s loan balance 4. Cash settlement to partners is now equal to the
b. Partner’s capital balance partner’s capital balances after possible future
losses (unsold non-cash assets plus any cash
withheld) have been apportioned to the
partners or in accordance with an advance cash
distribution plan.

PROBLEMS

Problem 1: (Lump-sum Liquidation)

The statement financial position of A and B Partnership as of December 31, 20X1 is as follows:
Cash P20,000 Liabilities P132,000
Other assets 200,000 A, loan 18,000
B, loan 20,000
A, Capital 40,000
B, Capital 10,000
Total assets P220,000 Total liabilities and capital P220,000

The other assets were realized for P134,000, and all cash is distributed. Additional information are as follows:
A B
Case 1: (A is solvent) 90% 10%
Case 2: 70% 30%
Case 3: (B is insolvent) 50% 50%
a. Prepare the statement of liquidation
b. Prepare indicated journal entries

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 Case 1

Cash Other asset Liabilities A, loan B, loan A, capital-90% B, capital-10%

Balances 20,000 200,000 132,000 18,000 20,000 40,000 10,000

Realization of assets 134,000 (200,000) (59,400) (6,600)

Balances 154,000 - 132,000 18,000 20,000 (19,400) 3,400

Payment of liabilities (132,000) (132,000)

Balances 22,000 - - 18,000 20,000 (19,400) 3,400

Loan offset (18,000) 18,000

Balances 22,000 - - - 20,000 (1,400) 3,400

Additional investment 1,400 1,400

Balances 23,400 - - - 20,000 - 3,400

Payment to B (23,400) (20,000) (3,400)

Case 2

Cash Other asset Liabilities A, loan B, loan A, capital-70% B, capital-30%

Balances 20,000 200,000 132,000 18,000 20,000 40,000 10,000

Realization of assets 134,000 (200,000) (46,200) (19,800)

Balances 154,000 - 132,000 18,000 20,000 (6,200) (9,800)

Payment of liabilities (132,000) (132,000)

Balances 22,000 - - 18,000 20,000 (6,200) (9,800)

Loan offset (6,200) (9,800) 6,200 9,800

Balances 22,000 - - 11,800 10,200 - -

Payment to partners (22,000) (11,800) (10,200)

Case 3

Cash Other asset Liabilities A, loan B, loan A, capital-50% B, capital-50%

Balances 20,000 200,000 132,000 18,000 20,000 40,000 10,000

Realization of assets 134,000 (200,000) (33,000) (33,000)

Balances 154,000 - 132,000 18,000 20,000 7,000 (23,000)

Payment of liabilities (132,000) (132,000)

Balances 22,000 - - 18,000 20,000 7,000 (23,000)

Loan offset (20,000) - 20,000

Balances 22,000 - - 18,000 - 7,000 (3,000)

Absorption to B - (3,000) 3,000

Balances 22,000 - - 18,000 - 4,000 -

Payment to Partner A (22,000) (18,000) - (4,000) 4,000

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Problem 2: (Lump sum vs. Installment Liquidation)

EFGH Partnership
Statement of Financial Position
Month of April, Year 6

Cash P6,500 Liabilities P13,000

Non-cash assets 78,000 E, capital(50%) 20,800
F, capital(20%) 24,050
G, capital(20%) 16,900
H, capital(10%) 9,750
P84,500 P84,500

Required: Prepare Statement of Liquidation (assuming):

Case 1 (Lump sum)

• All non-cash assets sold for the month of April in the amount of P31,000
• Additional liquidation expenses incurred P4,200

Case 2 (Installment)
• The cash sale proceeds and expenses are the same as before, but this time we assume that the assets
sold over a two-month period as follows:
Cash proceeds Book value Loss
Month of April, year 6 P16,400 P22,000 (P5,600)
Month of May, year 6 14,600 56,000 (41,400)
P31,000 P78,000 (P47,000)
• At the end of April, outside creditors were paid P4,000, future expenses were estimated as P5,100, and a
cash installment was paid to partners in accordance with a safe payment schedule.
• At the end of May, the remaining creditors were paid, the actual liquidation expenses incurred out to be
P4,200, and the cash on hand was distributed to the partners.
Schedule of Partnership Liquidation(Lumpsum)

Month of April, Year 6

Cash Assets Liabilities E-50% F-20% G-20% H-10%

Balance before liquidation 6,500 78,000 13,000 20,800 24,050 16,900 9,750

Sale of assets and distribution of loss 31,000 (78,000) (23,500) (9,400) (9,400) (4,700)

Payment of liabilities (13,000) (13,000)

Payment of expenses (4,200) (2,100) (840) (840) (420)

20,300 - - (4,800) 13,810 6,660 4,630

Allocate E's debit balance 4,800 (1,920) (1,920) (960)

20,300 11,890 4,740 2,670

Final payment to partners (20,300) (11,890) (4,740) (2,670)

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Schedule of Partnership Liquidation (Installment)

Month of April and May, Year 6

Cash Assets Liabilities E-50% F-20% G-20% H-10%

Balance before liquidation 6,500 78,000 13,000 20,800 24,050 16.900 9,750

April transactions:

Sale of assets and distribution of loss 16,400 (22,000) (2,800) (1,120) (1,120) (560)

Payment of liabilities (4,000) (4,000)

Balances before payment 18,900 56,000 9,000 18,000 22,930 15,780 9,190
Safe payment to partners (see
schedule 1)

(4,800) (4,717) (83)

Balances, end of April 14,100 56,000 9,000 18,000 18,213 15,780 9,107

May transactions:

Sale of assets and distribution of loss 14,600 (56,000) (20,700) (8,280) (8,280) (4,140)

Payment of liabilities (9,000) (9,000)

Payment of expenses (4,200) (2,100) (840) (840) (420)

15,500 (4,800) 9.093 6,660 4,547

Allocate E's debit balance 4,800 (1,920) (1,920) (960)

15,500 7.173 4,740 3,587

Final payment to partners (15,500) (7,173) (4,740) (3,587)

- - - - - - -

Summary:

April (4,717) - (83)

May (7,173) (4,740) (3,587)

(11,890) (4,740) (3,670)

SCHEDULE 1 (SAFE PAYMENT)

Safe payment calculation (Schedule of Safe Payments)

April 30, Year 6

Cash Assets Liabilities E-50% F-20% G-20% H-10%

Account balances 18,900 56,000 9,000 18,000 22,930 15,780 9,190

Possible future loss (56,000) (28,000) (11,200) (11,200) (5,600)

Cash holdbacks:

For future expenses (5,100) (2,550) (1,020) (1,020) (510)

For liabilities (9,000) (9,000)

Balances 4,800 (12,550) 10,710 3,560 3,080

Allocate E's debit balance 12,550 (5,020) (5,020) (2,510)

Balances in capital 4,800 5,690 (1,460) 570

Allocate G's debit balance (973) 1,460 (487)

Safe payment 4,800 4,717 83

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Plan of Cash Distribution to Partners (Cash Payment Priority Program) (Schedule of cash distribution plan) (Pre-
distribution Plan)
Interest Payment
E- H-
E-50% F-20% G-20% H-10% 50% F-20% G-20% 10% Total

Capital 20,800 24,050 16,900 9,750 -

(+) Loans payable / (-) Loans
receivable -

Capital interest 20,800 24,050 16,900 9,750 -

/ (divided by) 50% 20% 20% 10% -

Loss Absorption Abilities 41,600 120,250 84,500 97,500 -

Priority 1 (22,750) 4,550 4,550

41,600 97,500 84,500 97,500 -

Priority 2 (13,000) (13,000) 2,600 1,300 3,900

41,600 84,500 84,500 84,500 -

Priority 3 (42,900) (42,900) (42,900) 8,580 8,580 4,290 21,450

41,600 41,600 41,600 41,600

E F G H

Loss Absorption Abilities 41,600 120,250 84,500 97,500

Order of Cash Distribution 4 1 3 2

Vulnerability rankings (1 is most
vulnerable) 1 4 2 3

Orders of Cash Distribution Creditors E -5 F-2 G-2 H-1

1. First P13,000 100%
2. Next P4,550 100%
(1/3)33
3. Next P3,900 (2/3)67% %
(1/5)20
4. Next P21,450 (2/5)40% (2/5)40% %
5. Remainder 50% 20% 20% 10%

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