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CHAPTER 4 ACCOUNTING FOR PARTNERSHIPS (Liquidation)

DEFINITION

The liquidation of a partnership is the winding up of its business activities characterized by sale of all non-cash assets, settlement of
all liabilities and distribution of the remaining cash to partners. The conversion of non-cash assets into cash is referred to as
realization. This may either result to a gain or loss on realization and shall be divided in the profit and loss ration of the partners. In
some cases, a substantial loss on realization may yield for a partner a capital deficiency, which is the excess of a partner’s share in
losses over the partner’s capital credit balance. This deficiency will certainly affect the partner’s interest—the sum of his capital and
loan accounts—in the partnership.

RULES IN SETTLING ACCOUNTS AFTER DISSOLUTION

The following rules are subject to revisions by the agreement of the partners, either in their original partnership agreement or in a
dissolution agreement (Civil Code of the Philippines, Article 1839).

Assets of the Partnership

The assets of the partnership consist of the following:

1. Partnership property,
2. Additional contributions of the partners needed for the payment of all liabilities consistent with the discussions below.

Order of Preference

The assets of a general partnership shall be applied in the following order:

1. First, those owing to outside creditors,

2. Second, those owing to inside creditors in the form of loans or advances for business expenses by the partners,
3. Third, those wing to the partners with respect to their capital contributions,
4. Lastly, those owing to the partners with respect to their share of the profits.

The second preference above gives the partner with the loan account the option to exercise his right of offset. This privilege is the
legal right of a partner to apply part or all his loan account balance against his capital deficiency resulting from losses in the
realization of the partnership assets.

Illustration. Winston Apalisoc, Beatriz Onate and Emerita Geron are partners in a prawn export business. Initially, Winston Apalisoc
contributed P300,000; Beatriz Onate, P200,000 and Emerita Geron, P100,000. On the date of dissolution, the remaining assets of the
partnership amounted to P1,000,000. The partnership has outstanding obligations with Neo Aglugub, P140,000; Placido Tuddao,
P100,000 and loans payable to Winston Apalisoc, P40,000. The accounts of the Apalisoc, Onate and Geron partnership shall be
settled as follows:

1. First, Neo Aglugub and Placido Tuddao who are outside creditors shall be paid the total sum of P240,000; thus, leaving a
balance of P760,000 (P1,000,000 – P240,000) in partnership assets;
2. Second, Winston Apalisoc who is an inside creditor shall be paid his loan to the partnership of P40,000; balance at P720,000
(P760,000 – P40,000);
3. Third, the total contributions of Apalisoc, Onate and Geron to the initial partnership capital in the amount of P600,000 will
be paid; balance of assets at P120,000 (P720,000 – P600,000);
4. Lastly, the balance of P120,000 shall be distributed to the partners in the ratio of their capital contributions since there was
no mention of an agreement governing the division of profits or losses. Therefore, Winston Apalisoc shall be entitled to 3/6
of P120,000 or P60,000; Beatriz Onate, 2/6 or P40,000 and Emerita Geron, 1/6 or P20,000.

Insufficient Partnership Assets

In cases when the partnership assets are insufficient to settle all outside liabilities, the partners should make additional contributions
in the partnership. Any partner who contributed in excess of his share in this liability has a right to collect the supposed additional
contributions from the other partners.

Illustration. Assume in the illustration above that the outstanding obligations of the partnership, all accruing to outside creditors,
amounted to P1,120,000. The partnership assets of P1,000,000 will be insufficient to fully settle these liabilities. The unpaid balance
will be P120,000. Therefore, the partners should contribute sufficient assets to cover the deficiency or loss. In the absence of an
agreement, the basis of the additional contributions shall be the ratio of their capital contributions.

As a result, Winston Apalisoc is still liable from his separate properties in the amount of P60,000; Beatriz Onate, P40,000, and
Emerita Geron, P20,000; these contributions will be used to settle the remaining liabilities of P120,000. This sum of money is
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properly considered as partnership assets. In the event of payment by Emerita Geron of the full amount of P120,000, she will have
the right to recover the amount that she has paid in excess of her share of the liability from Winston Apalisoc, P60,000 and from
Beatriz Onate, P40,000.

Preference of Partnership Creditors and Partners’ Separate Creditors

The creditors of the partnership shall have priority in payments over those of the partners’ separate creditors as regards the
partnership properties. On the other hand, the creditors of the partners are preferred with respect to the separate or personal
properties of the partners. This will be illustrated in Case 6—the Cardenas, Go and Balocating partnership later in the chapter.

Distribution of Separate Properties of an Insolvent Partner

If a partner is insolvent, his personal properties shall be distributed as follows:

1. First, those owing to separate creditors,

2. Second, those owing to partnership creditors,
3. Lastly, those owing to the partners by way of additional contributions when the assets of the partnership were insufficient
to settle all obligations.

Illustration. Assuming that because of the total partnership liabilities amounting to P1,120,000. Emerita Geron is still personally
liable to partnership creditors in the amount of P20,000. Her separate properties in the amount of P90,000 shall first be applied to
settle her personal obligations of P80,000 to Mary Paz Abad and the balance of P10,000 to pay one-half of her liability of P20,000 to
the creditors of the partnership. This is in consonance with the rule that separate creditors are preferred over partnership creditors
as regards separate properties of a partner.

The procedures in liquidation after the adjustment and closing of books will be dependent on the above rules. It will be advisable to
have a mastery of these principles to be able to fully understand the liquidation of partnerships.

The use of a statement of liquidation will greatly aid the liquidating partner summarizes the events and transactions associated with
the liquidation of the partnership.

METHODS OF PARTNERSHIP LIQUIDATION

The following methods may be used when a partnership is liquidated:

1. Lump-sum method
Under this method, all non-cash assets are realized and the related gains or losses distributed and all liabilities are paid
before a single final cash distribution is made to the partners.
2. Installment method
Under this method, realization of non-cash assets is accomplished over an extended period of time. When cash is available,
creditors may be partially or fully paid. Any excess may be distributed to the partners in accordance with a program of safe
payments or a cash priority program. This process persists until all the non-cash assets are sold.

ENTRIES RELATED TO LIQUIDATION

The steps in the liquidation of a partnership will need the following pro-forma entries:

1. Sale of Non-Cash Assets

a. At Book Value

Cash xx
Non-Cash Assets xx
b. Above Book Value

Cash xx
Non-Cash Assets xx
Gain on Realization xx
c. Below Book Value

Cash xx
Loss on Realization xx
Non-Cash Assets xx
2. Distribution of Gain or Loss on Realization based on Partners’ P/L Ratio
a. Distribution of Gain on Realization

Gain on Realization xx
Teresita Galang, Capital xx
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Wilhelmina Neis, Capital xx

Henry Labasan, Capital xx
b. Distribution of Loss on Realization

Teresita Galang, Capital xx

Wilhelmina Neis, Capital xx
Henry Labasan, Capital xx
Loss on Realization xx
3. Payment of Liabilities

Liabilities xx
Cash xx
4. Exercise of Right of Offset

Teresita Galang, Loan xx

Teresita Galang, Capital xx
5. Additional Investment by Deficient Partner

Cash xx
Teresita Galang, Capital xx
6. Deficiency Absorbed by Solvent Partner

Wilhelmina Neis, Capital xx

Teresita Galang, Capital xx
7. Distribution of Cash to Partners

Teresita Galang, Capital xx

Wilhelmina Neis, Capital xx
Henry Labasan, Capital xx
Cash xx
LUMP-SUM LIQUIDATION

Under this method, all non-cash assets are realized and all liabilities are settled before a single final cash distribution is made to the
partners. The procedures below may be followed in lump-sum liquidation:

1. Realization of non-cash assets and distribution of gain or loss on realization among the partners based on their profit and
loss ratio.
2. Payment of liabilities.
3. Elimination of partners’ capital deficiencies. If after the distribution of loss on realization a partner incurs a capital deficiency
(i.e., partner’s share of realization loss exceeds his capital credit), this deficiency must be eliminated by using one of the
following methods, in the order of priority:
a. If the deficient partner has a loan balance, then exercise the right of offset.
b. If the deficient partner is solvent, then he should invest cash to eliminate his deficiency.
c. If the deficient partner is insolvent, then the other partners should absorb his deficiency.
4. Payments to partners, in the order of priority:
a. Loan accounts
b. Capital accounts

Illustration. Joel Feliciano, Evelyn Tria and Nick Marasigan are partners in a public relations firm and share profits and losses in the
ratio of 2:2:1, respectively. They decided to liquidate their business on Dec. 31,2014. The following is the condensed statement of
financial position prepared prior to liquidation:

Feliciano, Tria and Marasigan

Statement of Financial Position
Dec.31, 2014

Assets
Cash P 200,000
Non-Cash Assets 3,400,000
Total Assets P3,600,000
Liabilities and Capital
Liabilities P1,120,000
Evelyn Tria, Loan 50,000
Nick Marasigan, Loan 80,000
Joel Feliciano, Capital 950,000
Evelyn Tria, Capital 600,000
Nick Marasigan, Capital 800,000
Total Liabilities and Capital P3,600,000
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The above given details will be applicable for Cases 1 to 5. Only two categories for both Assets—Cash and Non-Cash Assets, and
Liabilities—Liabilities and Loans, are used to avoid exercise details in our illustrations. To avoid omissions in postings to the statement
of liquidation, the equality of the accounting equation should be verified after every step in the liquidation process.

Case 1. Loss on Realization Fully Absorbed by Partners’ Capital Balances

Assume that the non-cash assets are sold at P2,500,000 with a resulting loss on realization of P900,000 which was distributed in the
ratio 4:4:2. The capital balance of each partner was sufficient to fully absorb the share in the loss. The payment of cash to
partnership creditors and the final distribution of the remaining cash to the partners presented no problem. A statement of
liquidation (refer to Figure 4-1) will summarize the steps involved in the liquidation.

The entries pertinent to this case follow:

1. Sale of Non-Cash Assets

Cash 2,500,000
Loss on Realization 900,000
Non-Cash Assets 3,400,000
Distribution of Loss on Realization based on Partners’ P/L Ratio

Joel Feliciano, Capital 360,000

Evelyn Tria, Capital 360,000
Nick Marasigan, Capital 180,000
Loss on Realization 900,000
2. Payment of Liabilities

Liabilities 1,120,000
Cash 1,120,000
3. Distribution of Cash to Partners

Evelyn Tria, Loan 50,000

Nick Marasigan, Loan 80,000
Joel Feliciano, Capital 590,000
Evelyn Tria, Capital 240,000
Nick Marasigan, Capital 620,000
Cash 1,580,000

Figure 4 – 1 Loss on Realization Fully Absorbed by Partners’ Capital Balances

Feliciano, Tria and Marasigan

Statement of Liquidation
Dec. 31, 2014

Cash Non-Cash Liabilities Tria, Loan Marasigan, Feliciano, Tria, Capital Marasigan
Assets Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before P 200,000 P3,400,000 P1,120,000 P50,000 P80,000 P950,000 P600,000 P800,000
Liquidation
Sale of Non-Cash
Assets and
Distribution of
Losses1 2,500,000 (3,400,000) - - - (360,000) (360,000) (180,000)
Balances P2,700,000 P1,120,000 P50,000 P80,000 P590,000 P240,000 P620,000
Payment of
Liabilities to
Outsides2 (1,120,000) (1,120,000) - - - - -
Balances P1,580,000 P50,000 P80,000 P590,000 P240,000 P620,000
Payments to
Partners3 (1,580,000) (50,000) (80,000) (590,000) (240,000) (620,000)

Case 2. Loss on Realization Resulting to a Capital Deficiency with Right of Offset

Assume that the non-cash assets are sold at P1,850,000 with a resulting loss on realization of P1,550,000 which was distributed in
the ratio 4:4:2. The capital balance of partner Evelyn Tria was insufficient to fully absorb her share in the loss and thus, incurred a
capital deficiency of P20,000. Instead of making an additional investment, Tria opted to exercise her right of offset. A portion of her
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loan to the partnership was applied to her deficient capital. Outside creditors were paid and a final distribution of the remaining cash
to the partners was made. A statement of liquidation (see Figure 4-2) will summarize the steps involved in the liquidation.

The entries are shown below:

1. Sale of Non-Cash Assets

Cash 1,850,000
Loss on Realization 1,550,000
Non-Cash Assets 3,400,000
Distribution of Loss on Realization based on Partners’ P/L Ratio

Joel Feliciano, Capital 620,000

Evelyn Tria, Capital 620,000
Nick Marasigan, Capital 310,000
Loss on Realization 1,550,000
2. Payment of Liabilities

Liabilities 1,120,000
Cash 1,120,000
3. Exercise of Right of Offset

Evelyn Tria, Loan 20,000

Evelyn Tria, Capital 20,000
4. Distribution of Cash to Partners

Evelyn Tria, Loan 30,000

Nick Marasigan, Loan 80,000
Joel Feliciano, Capital 330,000
Nick Marasigan, Capital 490,000
Cash 930,000

Figure 4 – 2 Loss on Realization Resulting to a Capital Deficiency with Right of Offset

Feliciano, Tria and Marasigan

Statement of Liquidation
Dec. 31, 2014

Cash Non-Cash Liabilities Tria, Loan Marasigan, Feliciano, Tria, Capital Marasigan
Assets Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before P 200,000 P3,400,000 P1,120,000 P50,000 P80,000 P950,000 P600,000 P800,000
Liquidation
Sale of Non-Cash
Assets and
Distribution of
Losses1 1,850,000 (3,400,000) - - - (620,000) (620,000) (310,000)
Balances P2,050,000 P1,120,000 P50,000 P80,000 P330,000 P(20,000) P490,000
Payment of
Liabilities to
Outsides2 (1,120,000) (1,120,000) - - - - -
Balances P930,000 P50,000 P80,000 P330,000 P(20,000) P490,000
Offset of Tria’s
Loan against
her Deficiency3 - (20,000) - - 20,000 -
Balances P930,000 P30,000 P80,000 P330,000 P490,000
Payments to
Partners4 (1,580,000) (50,000) (80,000) (330,000) (620,000)

Case 3. Loss on Realization Resulting to a Capital Deficiency to a Personally Solvent Partner

Assume that the non-cash assets are sold at P1,700,000 with a resulting loss on realization of P1,700,000 which was distributed in
the ratio 4:4:2. The capital balance of partner Evelyn Tria was again insufficient to fully absorb her share in the loss and thus, incurred
a capital deficiency of P80,000. Tria exercised her right of offset but it was not enough to cover her losses; she has no recourse but to
invest additional cash of P30,000 to fully eliminate her deficiency. A statement of liquidation (see Figure 4-3) will summarize the steps
involved in the liquidation.
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The entries to illustrate the steps in liquidation are given below:

1. Sale of Non-Cash Assets

Cash 1,700,000
Loss on Realization 1,700,000
Non-Cash Assets 3,400,000
Distribution of Loss on Realization based on Partners’ P/L Ratio

Joel Feliciano, Capital 680,000

Evelyn Tria, Capital 680,000
Nick Marasigan, Capital 340,000
Loss on Realization 1,700,000
2. Payment of Liabilities

Liabilities 1,120,000
Cash 1,120,000
3. Exercise of Right of Offset

Evelyn Tria, Loan 50,000

Evelyn Tria, Capital 50,000
4. Additional Investment by Deficient Partner

Cash 30,000
Evelyn Tria, Capital 30,000
5. Distribution of Cash to Partners

Nick Marasigan, Loan 80,000

Joel Feliciano, Capital 270,000
Nick Marasigan, Capital 460,000
Cash 810,000

Figure 4 – 3 Loss on Realization Resulting to a Capital Deficiency to a Personally Solvent Partner

Feliciano, Tria and Marasigan

Statement of Liquidation
Dec. 31, 2014

Cash Non-Cash Liabilities Tria, Loan Marasigan, Feliciano, Tria, Capital Marasigan
Assets Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before P 200,000 P3,400,000 P1,120,000 P50,000 P80,000 P950,000 P600,000 P800,000
Liquidation
Sale of Non-Cash
Assets and Dist.
of Losses1 1,700,000 (3,400,000) - - - (680,000) (680,000) (340,000)
Balances P1,900,000 P1,120,000 P50,000 P80,000 P270,000 P(80,000) P460,000
Payment of
Liabilities to
Outsides2 (1,120,000) (1,120,000) - - - - -
Balances P780,000 P50,000 P80,000 P270,000 P(80,000) P460,000
Right of Offset by
Tria3 - (50,000) - - 50,000 -
Balances P780,000 P80,000 P270,000 P(30,000) P460,000
Additional
Investments by
Tria4 30,000 - - 30,000 -
Balances P810,000 P80,000 P270,000 P460,000
Payments to
Partners5 (810,000) (80,000) (270,000) (460,000)

Case 4. Loss on Realization Resulting to a Capital Deficiency to a Personally Insolvent Partner

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Assume the same facts as in case 3 except that Evelyn Tria is personally insolvent and is unable to make additional investments for
her remaining deficiency of P30,000. In this case, Joel Feliciano and Nick Marasigan have to absorb this deficiency as additional loss
to them in the ratio of 4:2. A statement of liquidation (see Figure 4-4) will summarize the steps involved in the liquidation.

The entries to summarize the result of the liquidation process follow:

1. Sale of Non-Cash Assets

Cash 1,700,000
Loss on Realization 1,700,000
Non-Cash Assets 3,400,000
Distribution of Loss on Realization based on Partners’ P/L Ratio

Joel Feliciano, Capital 680,000

Evelyn Tria, Capital 680,000
Nick Marasigan, Capital 340,000
Loss on Realization 1,700,000
2. Payment of Liabilities

Liabilities 1,120,000
Cash 1,120,000
3. Exercise of Right of Offset

Evelyn Tria, Loan 50,000

Evelyn Tria, Capital 50,000
4. Deficiency Absorbed by Solvent Partners

Joel Feliciano, Capital 20,000

Nick Marasigan, Capital 10,000
Evelyn Tria, Capital 30,000
5. Distribution of Cash to Partners

Nick Marasigan, Loan 80,000

Joel Feliciano, Capital 250,000
Nick Marasigan, Capital 450,000
Cash 780,000

Figure 4 – 4 Loss on Realization Resulting to a Capital Deficiency to a Personally Insolvent Partner

Feliciano, Tria and Marasigan

Statement of Liquidation
Dec. 31, 2014

Cash Non-Cash Liabilities Tria, Loan Marasigan, Feliciano, Tria, Capital Marasigan
Assets Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before P 200,000 P3,400,000 P1,120,000 P50,000 P80,000 P950,000 P600,000 P800,000
Liquidation
Sale of Non-Cash
Assets and Dist.
of Losses1 1,700,000 (3,400,000) - - - (680,000) (680,000) (340,000)
Balances P1,900,000 P1,120,000 P50,000 P80,000 P270,000 P(80,000) P460,000
Payment of
Liabilities to
Outsides2 (1,120,000) (1,120,000) - - - - -
Balances P780,000 P50,000 P80,000 P270,000 P(80,000) P460,000
Right of Offset by
Tria3 - (50,000) - - 50,000 -
Balances P780,000 P80,000 P270,000 P(30,000) P460,000
Additional Losses
to Feliciano and (
Marasigan4, 2:1 - - 20,000) 30,000 (10,000)
Balances P780,000 P80,000 P250,000 P450,000
Payments to
Partners5 (780,000) (80,000) (250,000) (450,000)
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Case 5. Partnership Insolvent but Partners Personally Solvent

Assume that the non-cash assets are sold at P900,000 with a resulting loss on realization of P2,500,000 distributed in the ratio 4:4:2.
The cash balance after full realization of the non-cash assets in the amount of P1,100,000 was not enough to settle all the liabilities
to outsiders. Also, the capital balances of Joel Feliciano and Evelyn Tria were insufficient to fully absorb their share in the loss and
thus, incurred capital deficiencies of P50,000 and P400,000, respectively.

Tria exercised her right of offset but it was not enough to cover her losses; she has no recourse but to invest additional cash of
P350,000 to fully eliminate her deficiency. Feliciano also invested P50,000. From these investments, the partnership was able to pay
in full the outside creditors. The balance of P380,000 is paid to Marasigan for his loan and capital account balances of P80,000 and
P300,000, respectively. A statement of liquidation (see Figure 4-5) will summarize the steps involved in the liquidation.

The pertinent entries for this case illustration are shown below:

1. Sale of Non-Cash Assets

Cash 900,000
Loss on Realization 2,500,000
Non-Cash Assets 3,400,000
Distribution of Loss on Realization based on Partners’ P/L Ratio

Joel Feliciano, Capital 1,000,000

Evelyn Tria, Capital 1,000,000
Nick Marasigan, Capital 500,000
Loss on Realization 2,500,000
2. Partial Payment of Liabilities

Liabilities 1,100,000
Cash 1,100,000
3. Exercise of Right of Offset

Evelyn Tria, Loan 50,000

Evelyn Tria, Capital 50,000
4. Additional Investment by Partners

Cash 400,000
Joel Feliciano, Capital 50,000
Evelyn Tria, Capital 350,000
5. Full Payment of Liabilities

Liabilities 20,000
Cash 20,000
6. Distribution of Cash to Partners

Nick Marasigan, Loan 80,000

Nick Marasigan, Capital 300,000
Cash 380,000
Figure 4 – 5 Partnership Insolvent but Partners Personally Solvent

Feliciano, Tria and Marasigan

Statement of Liquidation
Dec. 31, 2014

Cash Non-Cash Liabilities Tria, Loan Marasigan, Feliciano, Tria, Capital Marasigan
Assets Loan Capital Capital
P/L Percentages 40% 40% 20%
Balances before P 200,000 P3,400,000 P1,120,000 P50,000 P80,000 P950,000 P600,000 P800,000
Liquidation
Sale of Non-Cash
Assets and Dist.
of Losses1 900,000 (3,400,000) - - - (1,000,000) (1,000,000) (500,000)
Balances P1,100,000 P1,120,000 P50,000 P80,000 P(50,000) P(400,000) P300,000
Payment of
Liabilities
(partial)2 (1,100,000) (1,100,000) - - - - -
Balances P-0- P20,000 P50,000 P80,000 P(50,000) P(400,000) P300,000
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Right of Offset by
Tria3 - - (50,000) - - 50,000 -
Balances P-0- P20,000 P80,000 P(50,000) P(350,000) P300,000
Additional
Investments4 400,000 - - 50,000 350,000 -
Balances P400,000 P20,000 P80,000 P300,000
Payment of
Liabilities (full)5 (20,000) (20,000)
Payments to
Partners6 (380,000) (80,000) (300,000)
Case 6. Partnership Insolvent and Partners Personally Insolvent

Loida Cardenas, Aristotle Go and Renante Balocating are partners who are sharing profits and losses in the ratio of 4:3:2, respectively.
They decided to liquidate their business on Nov. 1, 2014, because of constant credit problems. The partnership and partners Go and
Balocating are currently unable to meet their financial obligations. The partnership’s condensed balance sheet and the personal
status of the partners are as follows:

Cardenas, Go and Balocating

Statement of Financial Position
Nov. 1, 2014
Assets Liabilities and Capital
Cash P 5,000 Liabilities P370,000
Non-Cash Assets 605,000 Loida Cardenas, Capital 100,000
Aristotle Go, Capital 60,000
- Renante Balocating, Capital 80,000
Total Assets P610,000 Total Liabilities and Capital P610,000

Personal Status of Partners

(Excluding Interests in the Partnership)

Partner Personal Assets Personal Liabilities

Loida Cardenas P310,000 200,000
Aristotle Go 94,500 119,000
Renante Balocating 40,000 50,000

The non-cash assets are sold for P335,000, resulting to a loss on realization of P270,000. The cash generated from the realization of
all non-cash assets is inadequate for the full payment of the liabilities. The partnership is insolvent and will depend on its solvent
partners for relief.

After the distribution of loss on realization, Aristotle Go is deficient by P30,000. He cannot make additional investments since he is
personally insolvent—his current personal deficit is P24,500 (P94,500 minus P119,000). The two other partners absorbed the
deficiency, even if Cardenas has her own deficiency, he is made to share in the loss due to insolvency of Go though he is already
personally insolvent because in the partnership his capital balance is still a positive P20,000.

In the meantime, an additional investment of P40,000 is necessary from the solvent Cardenas to be used to pay the remaining
liabilities and the P10,000 balance in Balocating’s capital account. The P10,000 that Balocating received can now be used to pay off
his personal creditors. Cardenas and Balocating can later claim from Go his supposed additional investment due to capital deficiency
after he has satisfied his personal liabilities. This is if Go becomes solvent in the future.

The statement of liquidation is as follows:

Figure 4 – 6 Partnership Insolvent and Partners Personally Insolvent

Cardenas, Go and Balocating

Statement of Liquidation
Nov. 1, 2014

Cash Non-Cash Liabilities Cardenas, Go, Capital Balocating,

Assets Capital Capital
P/L Ratio 4/9 3/9 2/9
Balances before
Liquidation P 5,000 P605,000 P370,000 P100,000 P60,000 P80,000
Sale of Non-Cash
Assets and Dist.
of Losses1 335,000 (605,000) - (120,000) (90,000) (60,000)
Balances P340,000 P370,000 P(20,000) P(30,000) P20,000
Payment of
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Liabilities2
(partial) (340,000) (340,000) - - -
Balances P-0- P30,000 P(20,000) P(30,000) P20,000
Additional Losses
to Cardenas and
Balocating3, 4:2 - - (20,000) 30,000 (10,000)
Balances P-0- P30,000 P(40,000) P10,000
Additional
Investments by
Cardenas4 40,000 - 40,000 -
Balances P40,000 P30,000 P10,000
Payment of
Liabilities5 (full) (30,000) (30,000) -
Balances P10,000 P10,000
Payment to
Balocating6 (10,000) (10,000)

Cardenas Go Balocating
Personal Assets P310,000 P 94,500 P 40,000
Less: Personal Liabilities 200,000 119,000 50,000
Excess (Deficit) P110,000 P(24,500) P(10,000)
Amount recovered from
liquidation of the partnership 10,000
Loss to Personal Creditors None P24,500 None

The related entries follow:

1. Sale of Non-Cash Assets

Cash 335,000
Loss on Realization 270,000 Distribution of Loss on
Non-Cash Assets 605,000 Realization based on
Partners’ P/L Ratio

Loida Cardenas, Capital 120,000

Aristotle Go, Capital 90,000
Renante Balocting, Capital 60,000
Loss on Realization 2,500,000
2. Partial Payment of Liabilities

Liabilities 340,000
Cash 340,000
3. Additional Losses to Partners with Positive Capital Balances

Loida Cardenas, Capital 20,000

Renante Balocating, Capital 10,000
Aristotle Go, Capital 30,000
4. Additional Investment by Partner

Cash 40,000
Loida Cardenas, Capital 40,000
5. Full Payment of Liabilities

Liabilities 30,000
Cash 30,000
6. Distribution of Cash to Partner

Renante Balocating, Capital 10,000

Cash 10,000
INSTALLMENT LIQUIDATION

Under this method, realization of non-cash assets is accomplished over an extended period of time. It is a process of selling some
assets, paying the creditors, paying the remaining cash to the partners. The liquidation will continue until all the non-cash assets have
been realized and all available cash distributed to partnership creditors and partners.
 11

Installment payments to partners are appropriate if necessary safeguards are used to ensure that all partnership creditors are paid in
full and that no partner is paid more than the amount to which he would be entitled after all losses on realization of assets are
known. The procedures below may be followed in installment liquidation:

1. Realization of non-cash assets and distribution of gain or loss on realization among the partners based on their profit and
loss ratio.
2. Payment of liquidation expenses and adjustment for unrecorded liabilities; both of these items will be distributed among
the partners in their profit and loss ratio.
3. Payment of liabilities to outsiders.
4. Distribution of available cash based on a schedule of safe payments which assumes possible losses due to inability of the
partnership to dispose of part or all the remaining non-cash assets and failure of the partners with capital deficiencies to
make additional contributions (see figure 4-7). Payments to partners can also be made based on a cash priority program
(see Figure 4-8).

Illustration. The balance sheet for Christine Gamba, Nancy Mulles and Violeta Pitular, partners sharing profits in the ratio of 4:3:3
respectively, showed the following balances on April 30, 2014, just before liquidation:

Gamba, Mulles and Pitular

Statement of Financial Position
April 30, 2014
Assets Liabilities and Capital
Cash P 315,000 Liabilities P 435,000
Non-Cash Assets 1,250,000 Violeta Pitular, Loan 30,000
Christine Gamba, Capital 600,000
Nancy Mulles, Capital 350,000
- Violeta Pitular, Capital 150,000
Total Assets P1,565,000 Total Liabilities and Capital P1,565,000
In May, part of the assets are sold at book value, P300,000. In June, the remaining assets are sold for P210,000. Assume that the
available cash is distributed to the proper parties at the end of May and at the end of June. Assume further that partners are solvent
and that any partner who is deficient made appropriate payment to the partnership on July 31.

Schedule A:

Gamba, Mulles and Pitular

Schedule of Safe Payments
May 31, 2014
Gamba Mulles Pitular
Cash balances before Distribution of Cash P600,000 P350,000 P150,000
Loan Balance - - 30,000
Partners’ Total Interests P600,000 P350,000 P180,000
Restricted Interests – possible loss of
P950,000 if nothing is realized on the
Remaining non-cash assets; 4:3:3 ratio (380,000) (285,000) (285,000)
Balances P220,000 P65,000 P(105,000)*
Restricted Interests – additional possible loss
of P105,000* if Pitular is unable to satisfy
her possible deficiency; 4:3 ratio (60,000) (45,000) (105,000)
Free Interests – amounts to be paid to
Partners P160,000 P20,000 P-0-

Schedule B:

Gamba, Mulles and Pitular

Schedule of Safe Payments
June 30, 2014
Gamba Mulles Pitular
Cash balances before Distribution of Cash P144,000 P108,000 P(42,000)
Loan Balance
Partners’ Total Interests
Restricted Interests – additional possible loss
of P42,000 if Pitular is unable to satisfy
her possible deficiency; 4:3 ratio (24,000) (18,000) 42,000
Free Interests – amounts to be paid to
Partners P120,000 P90,000 P-0-
It can be observed that the total partners’ interests are continuously restricted for possible losses. A partner’s restricted interest
represents the portion of a partner’s interest which should remain available to absorb possible future losses. Restricted interests are
provided for assumed non-sale of remaining non-cash assets and for assumed insolvency of deficient partners. When all these
 12

restricted interests are satisfied, the resulting balances will be referred to as free interests which are simply the amounts to be paid
to the partners. This payment should first be applied to loan then to capital in accordance with the rules on the order of preference
in liquidation. The entries related to Figure 4-7 follow:

1. Sale of Non-Cash Assets

Cash 300,000
Non-Cash Assets 300,000
2. Payment of Liabilities

Liabilities 435,000
Cash 435,000
3. May Distribution of Cash to Partners

Christine Gamba, Capital 160,000

Nancy Mulles, Capital 20,000
Cash 180,000
4. Sale of Non-Cash Assets and Distribution of Loss on Realization

Cash 210,000
Christine Gamba, Capital 296,000
Nancy Mulles, Capital 222,000
Violeta Pitular, Capital 222,000
Non-Cash Assets 950,000
5. Exercise of Right of Offset

Violeta Pitular, Loan 30,000

Violeta Pitular, Capital 30,000
6. June Distribution of Cash to Partners

Christine Gamba, Capital 120,000

Nancy Mulles, Capital 90,000
Cash 210,000
7. Additional Investment by a Partner

Cash 42,000
Violeta Pitular, Capital 42,000
8. July Distribution of Cash to Partners

Christine Gamba, Capital 24,000

Nancy Mulles, Capital 18,000
Cash 42,000

Figure 4 – 7 Installment Liquidation

Gamba, Mulles and Pitular

Statement of Liquidation
May 1 to July 31, 2014
Cash Non-Cash Liabilities Pitular, Gamba Mulles, Pitular,
Assets Loan Capital Capital Capital
Balances before Liquidation P315,000 P1,250,000 P435,000 P30,000 P600,000 P350,000 P150,000
May – Sale of Non-Cash Assets1 300,000 (300,000) - - - - -
Balances P615,000 P950,000 P435,000 P30,000 P600,000 P350,000 P150,000
May – Payment of Liabilities2 (435,000) - (435,000) - - - -
Balances P180,000 P950,000 P30,000 P600,000 P350,000 P150,000
May - Installment to Partners3
(Sch. A) (180,000) - - (160,000) (20,000) -
Balances P-0- P950,000 P30,000 P440,000 P330,000 P150,000
June – Sale of Non-Cash Assets
and Dist. Of Losses4 210,000 (950,000) - (296,000) (222,000) (222,000)
Balances P210,000 P30,000 P144,000 P108,000 P(72,000)
Right of Offset by Pitular5 - (30,000) - - 30,000
Balances P210,000 P144,000 P108,000 P(42,000)
June – Installment to Partners6
(Sch. B) (210,000) (120,000) (90,000) -
Balances P-0- P24,000 P18,000 P(42,000)
July – Investment7 42,000 - - 42,000
 13

Balances P42,000 P24,000 P18,000

July-Final Installment8 (42,000) (24,000) (18,000)

CASH PRIORITY PROGRAM

The use of safe payment schedules in support of the illustration in Figure 4-7 is a reliable method of computing the amount of safe
payments to partners for it prevents excessive payments to any partner. However, the approach is inefficient if numerous installment
distributions are to be made to partners. Let’s take the illustration in the previous section. The partnership made two payments and
for each, a schedule of safe payments is made. The procedure of preparing safe payment schedules will go on as long as there is cash
to be distributed and until the capital balances are aligned with the P/L ratio.

This repetitious procedure can be avoided with the introduction of an alternative device called the cash priority program. This
program which is prepared at the start of the liquidation process will help the partners project when they can expect to be included
in the cash distribution. If the program is prepared, any amount of cash received from the realization of partnership assets may be
paid immediately to partnership creditors and later, the partners are specified in the program. This program is illustrated in Figure 4-
8.

Illustration. Cecille Laguna, Ma. Concepcion Manalo and Doris Marie Pateno divide profits 60%, 25% and 15% respectively. A balance
sheet on June 30, 2014, just before partnership liquidation, showed the following balances:

Laguna, Manalo and Pateno

Statement of Financial Position
June 30, 2014
Assets Liabilities and Capital
Cash P 50,000 Liabilities P350,000
Non-Cash Assets 925,000
Cecille Laguna, Capital 450,000
Ma. Concepcion Manalo, 100,000
Capital
- Doris Marie Pateno, Capital 75,000
Total Assets P975,000 Total Liabilities and Capital P975,000
Certain assets are sold in July at book value of P500,000 and available cash is distributed to appropriate parties. Remaining assets are
sold in August for P150,000 and cash is distributed in final settlement.

Figure 4 – 8 Cash Priority Program

Laguna, Manalo and Pateno
Cash Priority Program
June 30, 2014
Cash Priority Payments to
Laguna Manalo Pateno Laguna Manalo Pateno
Capital Balances P450,000 P100,000 P75,000
Add: Loan Balances - - -
Partners’ Total Interests P450,000 P100,000 P75,000
Divide by: Profit and Loss Ratio 60% 25% 15%
Loss Absorption Balances P750,000 P400,000 P500,000
Priority I: To Laguna (250,000) - - P150,000*
P500,000 P400,000 P500,000
Priority II: To Laguna and Pateno (100,000) - (100,000) 60,000** - P15,000**
P400,000 P400,000 P400,000 P210,000 P-0- P15,000
Priority III: Amounts in excess of
P225,000*** based on P/L Ratio 60% 25% 15%
* P250,000 x 60% = P150,000.
** P100,000 x 60% = P60,000; P100,000 x 15% = P15,000.
***P210,000 + P15,000 = P225,000.

Loss absorption balances represent the maximum loss that the partners can absorb without reducing their equity below zero. The
partner with the biggest capital exposure or loss absorption balance should be prioritized in a cash distribution. A partner with a
relatively low loss absorption balance can be wiped out by a material realization loss.

Looking at Figure 4-8, Manalo has the lowest loss absorption balance and this means that she is most vulnerable or susceptible to
losses. Assume that a loss on realization amounted to P400,000, Manalo’s capital balance will become zero because her share in the
loss will be P100,000 (P400,000 x 25%) which is equivalent to her capital interest. Laguna will be prioritized in a cash distribution
because of her higher loss absorption balance about by a larger capital interest and a higher profit and loss sharing ratio. This is being
done to be fair with her since she has the biggest capital exposure.
 14

The next step in the preparation of the program would be to make the highest loss absorption balance equal to the next highest. The
difference will be the basis for the computation of the cash priority payments to the partners. The cash priority payments can be
obtained by multiplying the excess or the difference in the loss absorption balances by the profit and loss ratio of the respective
partner. The above procedure is continued until the loss absorption balances of all the partners are equal. If the loss absorption
balances are already equal, cash may be distributed to the partners in their profit and loss ratio. The entries related to this illustration
follow:

For the month of July, 2014

1. Sale of Non-Cash Assets

Cash 500,000
Non-Cash Assets 500,000
2. Payment of Liabilities

Liabilities 350,000
Cash 350,000
3. Distribution of Cash to Partners

Cecille Laguna, Capital 190,000

Doris Marie Pateno, Capital 10,000
Cash 200,000
Computation:

Laguna Pateno Total

Priority I: To Laguna P150,000 P150,000
Priority II: 60:15 ratio 50,000

Laguna: P50,000 x 60/75 40,000

Pateno: P50,000 x 15/75 - P10,000 -
P190,000 P10,000 P200,000
The initial cash balance is P50,000 and this is increased by the P500,000 proceeds from the sale of non-cash assets. The balance after
settlement of liabilities of P350,000 is P200,000. This amount is now available for distribution. Based on the priority program in
Figure 4-8, Laguna should be given P150,000 being the first priority. The total cash for allocation in priority II is P75,000. For this
month, only P50,000 is available after the P150,000 allocation to Laguna.

When cash is insufficient to fully satisfy the cash requirement in a particular priority, then the available cash will be distributed in the
ratio of the supposed allocation in that priority. In this instant case, the P50,000 will be allocated in the ratio of the supposed
allocation in priority II—P60,000 and P15,000 for a total of P75,000. The ratio is 60/75 for Laguna and 15/75 for Pateno. The ratio
only considered the two partners since they are the only included in priority II. Meanwhile, the balance of P25,000 in priority II will
be allocated next month.

For the month of August, 2014

1. Sale of Non-Cash Assets

Cash 150,000
Loss on Realization 275,000
Non-Cash Assets 425,000
Distribution of Loss on Realization based on Partners’ P/L Ratio

Cecille Laguna, Capital 165,000

Ma. Concepcion Manalo, Capital 68,750
Doris Marie Pateno, Capital 41,250
Loss on Realization 275,000
2. Distribution of Cash to Partners

Cecille Laguna, Capital 95,000

Ma. Concepcion Manalo, Capital 31,250
Doris Marie Pateno, Capital 23,750
Cash 150,000
Computation:
Laguna Manalo Pateno Total
Priority II: Balance of P25,000 P 25,000
Laguna: P25,000 x 60/75 P20,000
Pateno: P25,000 x 15/75 P 5,000
Priority III: To all partners in the
 15

ratio of 60:20:15 125,000

Laguna: P125,000 x 60% 75,000
Manalo: P125,000 x 25% P31,250
Pateno: P125,000 x 15% 18,750
P95,000 P31,250 P23,750 P150,000
Last month, the balance in priority II is P25,000. This will be satisfied since there is sufficient cash for distribution this month. After
satisfaction of the first two priorities, any excess will be distributed in the profit and loss ratio of the partners since there is no more
priority to satisfy other than the last priority.

Cash payments may be made in the profit and loss ratio only when installment payments have caused the ratio of the partners’
capital account balances to be the same as the profit and loss ratio. The mathematical basis for payments in accordance with the
previous statement—profit and loss ratio, will be proven in Figure 4-9 by using the figures in the Laguna, Manalo and Pateno
partnership.

First, subtract the July payments to the partners, the distribution of loss on realization and the August payments to the partners to
fully satisfy priority II, from the capital balances before liquidation. The result of these series of subtractions will be the capital
balances after the satisfaction of the first two priorities in the amounts of P75,000; P31,250 and P18,750 for Laguna, Manalo and
Pateno in that order. The total of these balances is P125,000. The ratio of each capital balance to the total capital balances will then
be computed—Laguna, P75,000/P125,000 or 60%; Manalo, P31,250/P125,000 or 25% and Pateno, P18,750/P125,000 or 15%.
Observe that the capital ratio yielded the same ratio as that in priority III of the cash priority program. This piece of information may
prove very useful in handling cash priority programs.

Figure 4 – 9

Laguna, Capital Manalo, Capital Pateno, Capital Total

Balances before Liquidation P450,000 P100,000 P75,000 P625,000
July – Sale of Non-Cash Assets, No
gain or loss - - - -
Balances P450,000 P100,000 P75,000 P625,000
July – Payments to Partners (190,000) - (10,000) (200,000)
Balances P260,000 P100,000 P65,000 P425,000
June – Sale of Non-Cash Assets
and Dist. Of Losses (165,000) (68,750) (41,250) (275,000)
Balances P95,000 P31,250 P23,750 P150,000
August – Payments to Partners,
Balance of Priority II (20,000) - (5,000) (25,000)
Balances after 1st Two Priorities P75,000 P31,250 P18,750 P125,000

Ratio of Capital Balances 60% 25% 15% 100%