lOMoARcPSD|9687031

TOPIC: Partnership Liquidation

OBJECTIVES
1. Illustrate the steps in a partnership liquidation.
2. Compare the lump-sum liquidation with an installment liquidation.
3. Solve problems on lump-sum liquidation and installment liquidation.

Keywords:
Liquidation - is the termination of business operations or the winding up of affairs.
Realization – conversion of non-cash assets of the partnership into cash through sale.
Right of offset – off-setting of partner’s accounts to capital.
Marshalling of assets – a form of elimination deficit on partner’s capital through additional investment of
the solvent partner.
Maximum loss absorption capacity – an amount of loss at which a partner can sustain without incurring
a deficit.
Cash priority program – a technique used to determine the priority payments among partners.

Presentation of Lesson
Liquidation
Liquidation is the termination of business operations or the winding up of affairs. It is a process by which
the non-cash assets are realized into cash, liabilities are paid and the remaining amount is distributed to
partners.

“Liquidation may either be voluntary (e.g., per agreement of partners of a solvent partnership) or
involuntary (e.g., per government mandate or bankruptcy).” (Millan, 2018)

Methods of liquidation
Liquidation may be accomplished either through:
1. Lump-sum liquidation - where all non-cash assets are realized in one single transaction or
simultaneously. The proceeds shall be used to pay the liabilities and the partners.

2. Installment liquidation – when the non-cash assets of the partnership are realized in installments.
For every realization, the partnership shall pay off its liabilities and its partners an amount that is not
prejudicial to the creditors.

Steps in partnership liquidation

1. Realization phase – the step where the assets are sold and realized and liquidation expenses are
incurred.
a. Selling/realizing of the non-cash assets at its realizable values.
b. Recognizing gain or loss on realization directly in partner’s capital accounts.
c. Allocating the actual liquidation expenses incurred.
2. Elimination of deficit – when after realization a partner’s capital had a deficit (debit balance), it shall
be eliminated through the followings steps:
a. Marshalling of assets – when there is a solvent partner, a partner whose personal assets exceeds
personal liabilities, he is required to make additional investment. As a rule, a general partner is
liable up to the extent of its properties.
b. Right of offset – the payable to a partner may be offset against the deficit balance of that partner.

1
 lOMoARcPSD|9687031

c. Absorption – if after exhausting the steps above there is still a deficit, it shall be eliminated by
absorption of the partners that has credit balance.
3. Payment to creditors and partners – the following is the priority of payment after the deficit in the
previous step has been eliminated.
a. Payment to outside creditors or third party.
b. Payment to inside creditors or the liabilities to partners, if it has not been eliminated in the
previous steps.
c. The remaining amount shall be paid to partners.

Specific points in Lump-sum

1. All of the non-cash assets are realized.
2. Gain or loss in realization are allocated directly to the partners’ capital.
3. Actual liquidation expenses are allocated to the partners’ capital.
4. The deficit, if there is any, are eliminated.
5. Outside creditors are first to be paid in full.
6. Liability to partners are second to be paid, if not yet offset.
7. The balance shall be paid to the partners as settlement of their interest.

Installment liquidation follows the same procedure as the lump-sum liquidation, except that, in
installment liquidation, it is required to compute for the amount safe to be distributed to partners
without affecting the interest of the outside creditors. Such amount is called the safe payments. The safe
payments may be computed as follows:
1. By preparing a schedule of safe payments – a document that shows how much is to be paid safely to
partners. This schedule requires the same steps for liquidation except for the following assumptions
in the realization phase:
a. The unsold/unrealized non-cash asset are assumed loss and to be allocated to partners’ capital.
b. Future liquidation expenses are estimated and allocated to partners.
c. The partnership may also withheld cash for future unanticipated expenses which will also be
allocated to the partners’ capital.
2. By preparing a cash priority program.

Illustration 1: Lump-sum vs. Installment liquidation

(Adopted: Millan 2018) Use the following information for the next two independent cases: Fact pattern
On January 1, 20x1, the partners of ABC Co. decided to liquidate their partnership. The following
information was made available:

Cash 20,000
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total 500,000

Accounts payable 30,000

Payable to B 20,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000

2
 lOMoARcPSD|9687031

Total 500,000

Case #1: Lump-sum liquidation

Information on the conversion of non-cash assets is as follows;
a. P50,000 was collected on accounts receivable; the balance is uncollectible.
b. P70,000 was received for the entire inventory.
c. The equipment was sold for P250,000.
d. P2,000 liquidation expenses were paid.

Requirement:
Determine the amounts of cash distributed to the partners in the final settlement of their capital
accounts.

Solution:
The total loss on the sale is computed as follows:

Collection on accounts receivable 50,000

Sale of inventory 70,000
Sale of equipment 250,000
Proceeds from sale 370,000
Book value of assets realized
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total book value 480,000
Loss on realization 110,000
Liquidation expenses 2,000
Total loss on realization 112,000

The pertinent entries are as follows:

Jan. 1, 20x1

Cash 368,000
Loss on sale
(inclusive of liquidation expenses) 112,000

3
 lOMoARcPSD|9687031

Receivables 60,000
Inventory 120,000
Equipment 300,000
to record the realization of non-cash assets

A, Capital 22,400
B, Capital 33,600
C, Capital 56,000
Loss on sale 112,000
to close loss on sale to the respective capital balances of the

partners Accounts payable 30,000

Cash 30,000
to record settlement of liabilities to outside creditors

Payable to B 20,000
Cash 20,000
to record settlement of liability to inside creditor

A, Capital 77,600
B, Capital 116,400
C, Capital 114,000
Cash 308,000
to record settlement of the partners' capital balances

Notes:
 The losses and expenses are allocated based on P/L.
 There were no deficit to be eliminated.
 The Accounts Payable, a liability to outside creditors are paid first.
 Payable to B was paid second.
 The remaining amounts are the settlement of the partners for their interests.

Case #2: Installment liquidation

Use the fact pattern above but assume that the partnership will be liquidated over a prolonged period
of time. Distributions to owners shall be made as cash becomes available. Information on the
conversion of non-cash assets is as follows:
a. 75% of the accounts receivable was collected for only P30,000.
b. Half of the inventory was sold for P40,000.
c. Equipment with carrying amount of P200,000 was sold for P120,000.
d. P2,000 liquidation expenses were paid. Estimated future liquidation expenses totaled P1,000.
e. P9,000 cash was retained in the business for potential unrecorded liabilities and anticipated
expenses.
f. The outside creditors are paid in full.

Requirement:
Determine the amounts of cash distributed to the partners from the partial-realization of partnership
assets.

4
 lOMoARcPSD|9687031

Solution:
The total loss on the sale is computed as follows:

Collection on account receivable 30,000

Sale of inventory 40,000
Sale of equipment 120,000
Proceeds from sale 190,000

Accounts receivable (60,000 x 75%) 45,000

Inventory (120,000/2) 60,000
Equipment 200,000
Total non-cash assets realized 305,000
Loss on realization 115,000

Unsold assets
Accounts receivable (60,000 x 25%) 15,000
Inventory 60,000
Equipment 100,000
Assumed to be loss 175,000

Liquidation expenses
Actual expenses 2,000
Future expenses 1,000
Cash withheld 9,000
Total 12,000

The partial settlement to partners is computed as follows:

The amount computed will be substituted as follows in the Statement of Liquidation:

5
 lOMoARcPSD|9687031

Illustration 2: Lump-sum liquidation

(Adopted: Millan 2018) On January 1, 20x1, the partners of ABC Co. decided to liquidate their
partnership. The following information was made available;

Cash 20,000
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total 500,000

Accounts payable 50,000

A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%)200,000
Total500,000

A third party offered to buy for P480,000 the partnership assets including liabilities but excluding cash
and after certain assets are revalued as follows:

Accounts receivable 45,000

Inventory 75,000
Equipment 320,000

Requirement: Determine the amounts of cash distributed to the partners.

Solution:

Proceeds from sale 480,000

Net assets sold
Accounts receivable 60,000
Inventory 120,000

6
 lOMoARcPSD|9687031

Equipment 300,000
Total book value 480,000
Less liabilities 50,000
Net assets sold 430,000
Gain on sale 50,000

Notes:
 Revaluation is no longer considered.

Illustration 3: Installment liquidation

(Adopted: Millan 2018) On January 1, 20x1, partners A and B, who share profits and losses on a 3:1
ratio, decided to liquidate their business. As of this date, the following information has been
determined:

Other
Cash assets Liabilities A, Capital B, Capital
20,000 480,000 50,000 250,000 200,000

In the first month of liquidation, P180,000 was received on the sale of certain assets, liquidation
expenses of P5,000 were paid, and additional liquidation expenses of P2,000 are anticipated before
liquidation is completed. Creditors were paid P28,000. Available cash was distributed to the partners.

Requirement:
Determine the amounts of cash distributed to the partners.

Solution:

Sale of certain non-cash assets 180,000

Carrying amount of all non-cash assets (480,000)
Total loss on realization (300,000)

Actual liquidation expenses (5,000)

Estimated future liquidation expenses (2,000)
Total expenses (7,000)

Notes:
The loss on realization includes the assumed loss.

7
 lOMoARcPSD|9687031

*Before payment can be made to the partners, all of the liabilities must be settled first or sufficient
funds must be set aside to settle any unpaid liabilities.

Illustration 1: Insolvency of partnership

(Adopted: Millan 2018) Use the following information for the next two independent cases:
On January 1, 20x1, the partners of ABC Co. decided to liquidate their partnership. The following
information was made available:

Cash 20,000
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total 500,000

Accounts payable 30,000

Payable to B 20,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
Total 500,000

Case #1: All partners are personally solvent

Information on the conversion of non-cash assets is as follows:
P10,000 was collected on accounts receivable; the balance is uncollectible.
P5,000 was received for the entire inventory.
The equipment was sold for P50,000.
P2,000 liquidation expenses were paid.
P27,000 was paid to outside creditors, after offset of a P3,000 credit memorandum received on
January 2, 20x1.
All of the partners are personally solvent.

Requirement:
Determine the amounts of cash distributed to the partners in the final settlement of their capital
accounts.

Solution:
The total loss on the sale is computed as follows:

Collection on account receivable 10,000

Sale of inventory 5,000

8
 lOMoARcPSD|9687031

Sale of equipment 50,000

Proceeds from sale 65,000

Accounts receivable 60,000

Inventory 120,000
Equipment 300,000
Book value of non-cash assets 480,000
Loss on realization 415,000

Actual liquidation expenses (2,000)

The final settlement to partners is computed as follows:

Notes:
 The deficit was eliminated through marshalling of assets
 C is personally solvent and should make an additional investement.
 The credit memo was a gain in the perspective of the partnership.

Case #2: Some partners are personally insolvent

Use the same information, except that C is insolvent.

Requirement:
Determine the amounts of cash distributed to the partners in the final settlement of their capital
accounts.

Solution:

9
 lOMoARcPSD|9687031

Notes:
The deficit was eliminated by absorption of the partners’ whom have credit balances.
The allocation is based on their relative P/L ratio.

Illustration 2: Marshalling of assets

(Adopted: Millan 2018) On January 1, 20x1, the partners of ABC Co. decided to liquidate their
partnership. The following information was made available:

Cash 20,000
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total 500,000

Accounts payable 150,000

A, Capital (20%) 50,000
B, Capital (30%) 100,000
C, Capital (50%)200,000
Total500,000

The net proceeds from the sale of non-cash assets amounted to P40,000. The personal assets and
personal liabilities of the partners are as follows:

A B C
Personal assets 300,000 260,000 200,000
Personal liabilities (220,000) (220,000) (320,000)

Requirements:
a. How much additional contributions shall be made by the partners in order to settle all of the
partnership liabilities?

10
 lOMoARcPSD|9687031

b. Determine the amounts of cash distributed to the partners in the final settlement of their capital
accounts.

Solutions:
Requirement (a): Additional contributions by partners

Cash 20,000
Proceeds 40,000
Payment for liabilities (150,000)
Additional contributions needed to settle liabilities (90,000)

Requirement (b): Distribution to partners

Net proceeds 40,000

Carrying amount (480,000)
Total loss (440,000)

Let us determine which partners are solvent and which are insolvent.
We shall apply the rules of marshalling of assets.
A B C
Personal assets 300,000 260,000 200,000
Personal liabilities (220,000) (220,000) (320,000)
Available assets for
partnership creditors 80,000 40,000 (120,000)

Notice that A and B are solvent up to P80,000 and P40,000, respectively, while C is insolvent.

Now let us how the capital balances of the partners are determine settled.

Notes:
 Partner C is personally insolvent.
 Partner B can contribute only up to 40,000.

11
 lOMoARcPSD|9687031

 The elimination of deficit phase shall continue until all deficit are eliminated.

Illustration: Reconstruction of information

(Adopted: Millan 2018) On January 1, 20x1, A and B decided to liquidate their partnership. As of this
date, their capital balances were P100,000 and P200,000, respectively. The partners share profits and
losses on a 60:40 ratio. Before liquidation, the partnership has a P20,000 balance in its cash and a
P30,000 balance in liabilities. The partnership incurred loss of P120,000 on the sale of non-cash
assets. A is solvent but B is insolvent.

Requirements:
a. How much was the carrying amount of the non-cash assets?
b. How much was the net proceeds from the sale of non-cash assets?
c. How much did A and B receive from the settlement of their capital balances?

Solutions:
Requirement (a): Carrying amount of non-cash assets
Using the basic accounting equation, the non-cash assets are squeezed as follows:

Assets = Liabilities + Equity

Cash + Others = Payables + Partners' capital
20,000 + ? = 30,000 + 300,000

A, Capital 100,000
B, Capital 200,000
Liabilities 30,000
Total credits 330,000
Less Cash 20,000
Non-cash assets sold 310,000

Requirement (b): Net proceeds

Net proceeds 190,000 (squeeze)
Carrying amount of non-cash assets (310,000)
Loss on sale (120,000) (start)

Requirement (c): Payment to partners

12
 lOMoARcPSD|9687031

Illustration 3.3: Reconstruction of information

(Adopted: Millan 2018) On January 1, 20x1, A and B, who share profits and losses on a 60:40 ratio,
decided to liquidate their partnership. As of this date, their capital balances were P300,000 and
P150,000, respectively. Before liquidation, the partnership has total assets of P500,000. Net proceeds
received from the sale of non-cash assets amounted to P300,000. A received P192,000 in the
settlement of the partners’ capital balances.

Requirements:
a. How much is the total loss on the sale of partnership assets?
b. How much did B receive in the settlement of his capital balance?
c. How much was the total liabilities of the partnership?
d. How much was the balance of cash before the sale of non-cash assets?

Solutions:
A, Capital
Capital balance before liquidation 300,000
Allocation of loss: (108,000) (squeeze)
Amount received by partner A 192,000

Requirement (a):
A's share in loss (108,000)
Divide by: A’s profit or loss ratio 60%
Total loss on sale (180,000)

Requirement (b):
B, Capital
Capital balance before liquidation 150,000
Allocation of loss: (180K x 40%) (72,000)
Amount received by partner B 78,000

Requirement (c):
Assets = Liabilities + Equity
500,000 = ? + 450,000
Liabilities = (500,000 - 450,000) = 50 000

Requirement (d):
Beginning balance of cash 20,000 (squeeze)
Net proceeds from sale of non-cash assets 300,000
Payment to outside creditors (50,000)
Cash available for distribution to partners (192K+ 78K) 270,000 (start)
(All figures were adopted from Millan 2018)

Illustration 3.4; Reconstruction of information

On January 1, 20x1, A and B, who share profits and losses on a 60:40 ratio, decided to liquidate their
partnership. After all of the non-cash assets of the partnership were sold for P190,000 and all of the
P30,000 liabilities were settled, the partners had P180,000 to distribute among themselves. A
received P28,000 in the settlement of his P100,000 capital balance.

13
 lOMoARcPSD|9687031

Requirements:
a. How much was the total assets immediately before liquidation?
b. How much was the beginning capital balance of B?
c. How much did B receive in the settlement of his capital account?

Solutions:
Requirement (a): Total assets

A's capital before liquidation 100,000

Loss allocated to A (72,000) (squeeze)
Amount received by A 28,000

Loss allocated to A (72,000)

Divide by: A's profit or loss ratio 60%
Total loss on sale (120,000)

Net proceeds 190,000

Carrying amount of non-cash assets (310,000) (squeeze)
Total loss on sale (120,000)

Cash 20,000 (squeeze)

Proceeds 190,000
Payment for liabilities (30,000)
Amount for distribution 180,000 (start)

Cash 20,000
Non-cash assets 310,000
Total assets 330,000

Requirement (b): B’s capital balance before liquidation

Assets = Liabilities + Equity
330,000 = 30,000 + ?
Total equity = 330,000 - 30,000 = 300,000

Total partners' equity before liquidation 300,000

A's capital before liquidation (100,000)
B's capital before liquidation 200,000

Requirement (c): Payment to B

B (40%)
B's capital before liquidation 200,000
Allocation of loss (120K x 40%) (48,000)
Amount received by partner B 152,000
(All figures were adopted from Millan 2018)

Illustration 4.1: Drawing accounts

14
 lOMoARcPSD|9687031

(Adopted: Millan 2018) On January 1, 20x1, the partners of ABC Co. decided to liquidate their
partnership on installment basis. Distributions to partners shall be made as cash becomes available.
The following information was made available:

Debit Credit
Cash 20,000
Accounts receivable 60,000
Receivable from C 10,000
Inventory 120,000
Equipment 300,000
Accounts payable 30,000
Payable to B 20,000
A, Capital (20%) 100,000
A, Drawing 20,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
C, Drawings 30,000
Totals 530,000 530,000

During January, non-cash assets with carrying amount of P130,000 were sold for P60,000. Cost of
disposing the assets amounted to P20,000. All of the partners are personally insolvent.

Requirement: Compute for the amounts of cash received by each of the partners in January.

Solution:
The total loss on the sale is computed as follows;

Sale of non-cash assets 60,000

Disposal cost (20,000)
Net cash proceeds 40,000
Carrying amount (130,000)
Loss on realization (90,000)

Accounts receivable 60,000

Inventory 120,000
Equipment 300,000
Total book value of non-cash assets 480,000
Non-cash assets sold (230,000)
Assumed loss 250,000

The distribution to owners is computed as follows:

15
 lOMoARcPSD|9687031

Notes:
The drawings of C has a credit balance so it will increase its capital when offset. All of the partners are
insolvent so the deficit of A shall be absorbed by B.

Non-cash asset used as payment for claim

If a creditor or a partner agrees to receive non-cash assets as settlement of his claim, the non-cash asset
is considered sold at the amount agreed to be debited to the creditor’s or partner’s claim. The
difference between the carrying amount of the non-cash asset and the agreed settlement amount is
treated as either gain or loss to be apportioned to all of the partners’ capital balances.

Illustration: Non-cash asset used as payment for claim

(Adopted: Millan 2018) On January 1, 20x1, the partners of ABC Co. decided to liquidate their
partnership. The partners’ capital balances as of this date are shown below;

A, Capital (40%) 200,000

B, Capital (30%) 150,000
C, Capital (20%) 100,000
D, Capital (10%)50,000
Total500,000

The partners agree to the following:

A partnership equipment with a carrying amount of P100,000 is to be taken over by B a price of
P120,000.
Partnership liabilities are to be paid off and the balance of cash on hand of P182,000 is to be divided in
a manner that will avoid the need for any possible recovery of cash from a partner.

Requirement:
How much did C received in the settlement of the partners’ capital accounts?

Solution:

Cash 182,000

16
 lOMoARcPSD|9687031

Book value of the equipment100,000

Total assets for distribution282,000 Total equity(500,000)
Assumed loss218,000

Settlement price of equipment 120,000

Book value(100,000)
Gain on settlement20,000

Notes:
The gain is allocated using their relative P/L ratio.

Safe payments schedule and Cash priority program

The computations presented earlier for installment liquidation may be presented in a formal manner
through either;
1. Safe payments schedule; or
2. Cash priority program

The basic purpose of these schedules is to prevent overpayments to partners during installment
liquidation.

Safe payment schedule

The purpose of this schedule is to prevent overpayment to partners by determining the “safe amount”
to be paid when cash is available in an installment liquidation. The procedure in preparing such
document is the same as the procedure prescribed in a lump sum liquidation. The only difference is that
the “Payment to Partners” is lifted from the schedule of safe payments. Under schedule of safe
payment, the unsold/unrealized assets are considered loss and there is a provision for future liquidation
expenses and cash withheld.

Illustration; Safe payment schedule

(Adopted: Millan 2018) On January 1, 20x1, the partners of ABC Co. decided to liquidate their
partnership. The following information was made available:

Cash 20,000

17
 lOMoARcPSD|9687031

Accounts receivable 60,000

Inventory 120,000
Equipment 300,000
Total 500,000

Accounts payable 30,000

Payable to B 20,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
Total 500,000

The partnership will be liquidated on an installment basis. Distributions to owners shall be made as cash
becomes available.
The following transactions occurred in January 20x1:
a. 75% of the accounts receivable was collected for only P30,000,
b. Half of the inventory was sold for P40,000.
c. Equipment with carrying amount of P200,000 was sold for P120,000.
d. P2,000 liquidation expenses were paid. Estimated future liquidation expenses totaled P1,000.
e. P9,000 cash was retained in the business for potential unrecorded liabilities and anticipated
expenses.

The following transactions occurred in February 20x1.

a. P10,000 was collected on the remaining accounts receivable; the balance was deemed
uncollectible.
b. The other half of the inventory was sold for P20,000.
c. The remaining items included in the equipment account are sold for P30,000.
d. P10,000 liquidation expenses and previously unrecorded liabilities were paid.
e. The liquidation process ended on February 28, 20x1.

Requirements: Prepare the schedule of safe payments as of

a. January 31, 20x1; and
b. February 28, 20x1.

Solutions:
Requirement (a):

Realization of assets in January 20x1

Accounts receivable 30,000
Inventory 40,000
Equipment 120,000
Proceeds from realization 190,000

Book value of assets realized

Accounts receivable (60,000 x 75%) 45,000
Inventory (120,000 x 50%) 60,000
Equipment 200,000
Total book values 305,000

18
 lOMoARcPSD|9687031

Loss on realization 115,000

Book value of assets not realized

Accounts receivable (60,000 x 25%) 15,000
Inventory (120,000 x 50%) 60,000
Equipment (300,000 – 200,000) 100,000
Assumed loss 175,000

Liquidation expenses
Actual liquidation expenses 2,000
Future liquidation expenses 1,000
Cash withheld 9,000
Total 12,000

The schedule of safe payments will be as follows:

The amount of payment to partners are then substituted in preparing the Statement of Liquidation as
of January 20x1.

19
 lOMoARcPSD|9687031

Notes:
 There were still balances on the books of partnership.
 This balances shall await the next realization of assets.
 The cash balance is equal to an amount set aside for future liquidation expenses and cash withheld.

Requirement (b):
On final settlement, there is no need to compute for maximum loss possible.

Realization of assets in February 20x1

Accounts receivable 10,000
Inventory 20,000
Equipment 30,000
Proceeds from realization 60,000
Book value of assets realized
Accounts receivable (60,000 x 25%) 15,000
Inventory (120,000 x 50%) 60,000
Equipment (300,000 – 200,000) 100,000
Total book value 175,000
Loss on realization 115,000

Liquidation expenses
Future liquidation expenses 1,000
Cash withheld 9,000
Total 10,000

20
 lOMoARcPSD|9687031

Since the liquidation is complete, the last schedule of safe payments may be the basis for preparing the
Statement of Liquidation as of February 20x1.

Cash priority program

Another method is computing the safe payments to partners is the preparation of cash priority program.
The cash priority program or cash distribution program determines the amount of payments to partners
as cash became available. It serves as a limit on the amount cash a partner should receive. The
preparation of cash priority program follows the following procedures:
1. Offsetting the partners’ accounts with their respective capital accounts. Accounts payable to partners
are added to their capital while the accounts receivable from partners are deducted from their
capital.
2. Computing the maximum loss absorption. The maximum loss absorption is an amount of loss that a
partner can sustain without having a deficit. It is also termed as the vulnerability rankings of the
partners to losses. The partner who has the lowest amount is the most vulnerable to losses while
the partner that has the highest amount is the most likely to receive cash first. It is computed by
dividing the adjusted capital computed in step 1 by their P/L ratio.

𝑡𝑜𝑡𝑎𝑙 𝑝𝑎𝑟𝑡𝑛𝑒𝑟′𝑠𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑎𝑟𝑡𝑛𝑒𝑟𝑠ℎ𝑖𝑝

𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑙𝑜𝑠𝑠 𝑎𝑏𝑠𝑜𝑟𝑜𝑝𝑡𝑖𝑜𝑛 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦 =
𝑃𝑎𝑟𝑡𝑛𝑒𝑟′𝑠𝑝𝑟𝑜𝑓𝑖𝑡 𝑜𝑟 𝑙𝑜𝑠𝑠 𝑠ℎ𝑎𝑟𝑒 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒

3. Calculating the difference as the basis for priority payments. This is computed from the maximum
loss absorption starting from the highest. The next highest amount will be deducted from the
highest amount. The difference represents the amount of profit the partner can benefit from. The
procedure will go on until all maximum loss absorption amounts equalize.
4. Computing the priority payments. The first difference computed above shall be the first priority
payment, and so on. The priority payment shall be computed by multiplying the differences by the
P/L ratio of the partners.

21
 lOMoARcPSD|9687031

5. The priority payment will then serve as a guide in distributing cash regardless of the preparation of
the schedule of safe payments.

Illustration 1: Cash priority program

(Adopted: Millan 2018) On January 1, 20x1, the partners of ABC Co. decided to liquidate their
partnership. The following information was made available:

Cash 20,000
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total 500,000

Accounts payable 30,000

Payable to B 20,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
Total 500,000

The partnership will be liquidated on an installment basis. Distributions to owners shall be made as cash
becomes available.

The following transactions occurred in January 20x1:

a. 75% of the accounts receivable was collected for only P30,000.
b. Half of the inventory was sold for P40,000.
c. An equipment with carrying amount of P200,000 was sold for P120,000.
d. P2,000 liquidation expenses were paid. Estimated future liquidation expenses totaled P1,000.
e. P9,000 cash was retained in the business for potential unrecorded liabilities and anticipated
expenses.

The following transactions occurred in February 20x1:

a. P10,000 was collected on the remaining accounts receivable; the balance was deemed
uncollectible.
b. The other half of the inventory was sold for P20,000,
c. The remaining items included in the equipment account are sold for P30,000.
d. P10,000 liquidation expenses and previously unrecorded liabilities were paid.
e. The liquidation process ended on February 28, 20x1.

Requirements:
Determine the cash payments to the partners on (a) January 31, 20x1 and (b) February 28, 20x1 by
preparing a cash priority program.

Solution:
First, let us compute for the maximum loss absorption capacities (MLAC) of the partners. The partners'
MLAC shall be our basis in ranking them in accordance with their priority over cash payments.

22
 lOMoARcPSD|9687031

A (20%) B (30%) C (30%)

Payable to B - 20,000
Capital balances before liquidation 100,000 150,000 200,000
Total interest in partnership 100,000 170,000 200,000
Divide by: Profit or loss percentage 20% 30% 50%
Maximum loss absorption
Capacity 500,000 566,667 400,000
Rank of payment 2nd 1st 3rd

Second, let us equalize the partners’ MLAC. This shall be our basis in preparing the cash priority
program.

A (20%) B (30%) C (30%)

Rank of payment 2nd 1st 3rd
Maximum loss absorption capacity 500,000 566,667 400,000
Difference of 1 st and 2nd (66,667)
Balance 500,000 500,000 400,000
Difference between 1st, 2nd and 3rd (100,000) (100,000)
Equal balance of MLAC 400,000 400,000 400,000

Third, the cash priorities are computed by multiplying the differences above by the respective partners’
profit or loss ratio.

Cash priority program

A (20%) B (30%) C (30%)
Rank of payment 2nd 1st 3rd
1st priority (66,667x30%) 20,000
2nd priority (100Kx 20% & 30%) 20,000 30,000
Totals 20,000 50,000

After partners A and B are paid their cash priorities of P20,000 and P50,000, respectively, any available
cash shall be distributed to the partners based on their profit or loss ratio.

Requirement (a):
Now let us determine the actual cash distributions to the partners on January 31, 20x1.

Cash - Jan. 1, 20x1 20,000

Collection of accounts receivable 30,000
Sale of inventory 40,000
Sale of equipment 120,000
Payment for liquidation expenses (2,000)
Payment to outside creditors (30,000)
Cash set aside for future costs (10,000)
Available cash for distribution to loans and capital of
partners - Jan. 31, 20x1 168,000

Using the cash priority program, the distribution to the partners on January 31, 20x1 are computed as
follows:

23
 lOMoARcPSD|9687031

A B C
(20%) (30%) (50%) Total
Amount available for cash
distribution - Jan. 31, 20x1 168,000
Allocation:
1st priority 20,000 (20,000)
2nd priority 20,000 30,000 (50,000)
Balance 98,000
Payment after priorities
[98K x (20%: 30% & 50%)] 19,600 29,400 49,000 (98,000)
First installment payment
to partners - Jan. 20x1 39,600 79,400 49,000

Notes:
 After A and B are allocated their cash priorities, any balance is allocated to the partners based on
their respective profit or loss ratios.
 The amounts computed above are equal to the amounts computed in the previous illustration for
“safe payment schedule (and also on the illustration of installment liquidation ‘case #2')

Requirement (b):
The actual cash distributions to the partners on February 28, 20x1 are computed as follows:

Cash-Feb. 1,20x1 10,000

Collection of accounts receivable 10,000
Sale of inventory 20,000
Sale of equipment 30,000
Payment for liquidation expenses (10,000)
Available cash for distribution to loans and capital
of partners - Feb. 28, 20x1 60,000

A B C
(20%) (30%) (30%) Total
Amount available for cash
distribution - Feb. 28, 20x1 60,000
Allocation:
Payment after priorities
[60K x (20%; 30% & 50%)] 12,000 18,000 30,000 (60,000)
Final installment payment
to partners - Jan. 20x1 12,000 18,000 30,000
(All figures were adopted from Millan 2018)

Illustration 2: Cash priority program

(Adopted: Millan 2018) The partners in ABC Co. decided to liquidate their business when their capital
balances were:

A, Capital (40%) 240,000

24
 lOMoARcPSD|9687031

B, Capital (40%) 390,000

C, Capital (20%) 288,000

The non-cash assets were sold on installment and partial distributions to the partners were made as
cash was made available. After the second sale of non-cash assets, all of the three partners received
the same amounts om the partial distribution. On the third sale of non-cash assets, the available cash
for distribution to the partners is P10,000,

Requirement: Using cash priority program, compute for the amount received by partner C on the
third distribution.

Solution:

Cash available for distribution 10,000

Multiplied by: C’s P/L ratio 20%
Amount received by C 2,000

Recall that under cash priority program, when all of the priorities are paid, any remaining cash
distribution is allocated to the partners based on their respective profit or loss ratios.

It is stated in the problem that all of the partners received cash from the second distribution. This
means that after the second distribution, all of the priorities were paid. Thus, the third distribution is
allocated based on the partners’ respective profit or loss ratios.

Chapter Summary
 Liquidation is the termination of business operations or the winding up of affairs.
 The available cash of the partnership is used to settle claims in the following descending order: (1)
First, to outside creditors; (2) Second, to inside creditors; and (3) Third, to owners’ interests.
 In case of partnership insolvency, the rule of marshalling of assets is applied. Under this rule, only
the excess of a partner’s personal assets over his personal liabilities can be used to settle
partnership debt. Any capital deficiency of an insolvent partner is absorbed by the other partners
who are solvent.
• The following are the accounting procedures when computing for the settlement of the partners’
interests in cases of liquidation:
Step #1: Compute for the net proceeds. It doesn’t matter if non-cash assets are wholly or partially
sold. Liquidation expenses, whether paid or not, are deducted when computing for the
net proceeds.
Step #2: Compute for any gain or loss by comparing the net proceeds with the total carrying
amount of all non-cash assets:
Step #3: Allocate the gain or loss to the partners’ interests. Any residual amount in a partner’s
capital balance represents the settlement of his interest in the partnership.
• Under the cash priority program, when all of the priorities are paid, any remaining cash distribution
is allocated to the partners based on their respective profit or loss ratios.

Concept Map

25