PARTNERSHIP LIQUIDATION – LUMP SUM LIQUIDATION

PARTNERSHIP LIQUIDATION

As per defined in the previous discussion on partnership dissolution, it does not necessary mean
termination of the business, instead, it refers to the termination of the partnership as a going concern.
In some cases, dissolution results in the reorganization of the partnership as a new unit that will not
necessitate the liquidation process. However, if the recognized condition calls for winding up of
business affairs, this will require the process of liquidation. The association of the partners for the
purpose of carrying on the business activities in the usual manner is considered ended. Termination is
that point in time when all partnership affairs are completely ended and finally settled. It signifies the
end of the life of an existing partnership.

Some of the causes where there is partnership dissolution with liquidation include the
accomplishment of the objective for which the partnership was formed, termination of the period
covered as stated in the contract and mutual agreement among the partners to dissolve and liquidate
the partnership.

Partnership liquidation is the process of winding up the business operations/affairs after

dissolution. This is the process where non-cash assets are reduced to cash and distributing the
proceeds to the proper parties.

The following procedures are to be followed in the process of liquidation:

1. Conversion of non-cash assets into cash

2. Payment of liabilities to creditors other than partners
3. Payment to partners in the following order:
a. Loans to the partnership
b. Capital contribution
c. Share in profits

1. Conversion of non-cash assets into cash

The process of converting non-cash assets into cash is called realization. This involves the
collection of receivables, selling of inventories, and selling of property and equipment. Realization
of non-cash assets may either result in a gain or loss on realization and will be distributed to the
partners based on their profit and loss agreement. Gain on realization is the excess of the selling
price over the cost or book value of the assets being disposed, otherwise, the result would be a loss
on realization. There is not much problem if the result is a gain since there would be enough cash
to settle all the outside creditors and the partners. However, problem arises when the realization
resulted in a loss since this will be distributed among the partners as a deduction from their capital
balance. If the partner’s capital balance resulted in a negative amount (debit balance) after the
distribution of the loss, this is known as capital deficiency and must be eliminated and the affected
partner will be known as the deficient partner.
if there is a loss
on realization
share of partner
< adjusted capital

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 solvent: personal assets>personal
liabilities

Capital deficiency may be eliminated in the following manner:

a) If the deficient partner has a loan to the partnership, he may exercise the right of offset, which
is the legal right to apply part or all of the amount owing to a partner on a loan balance against
deficiency in his capital account resulting from losses in the process of liquidation. The loan
payable to a partner has a higher priority in liquidation than a partner’s capital balance but a
lower priority than liabilities to outside creditors.

b) If the deficient partner is solvent and has no loan to the partnership, he may make an additional
investment equal to the amount of his capital deficiency, and

c) If the deficient partner is insolvent, his capital deficiency will be absorbed by the remaining
partners as additional loss based on their profit and loss sharing.

A partner is considered solvent if his personal assets exceed his personal liabilities while an
insolvent partner is one whose personal liabilities exceed his personal assets.

Liquidation expenses maybe incurred to facilitate the realization of non-cash assets and will
result in reduction to cash and will be distributed to partners as a deduction in their capital balances
according to their profit and agreement.

2. Payment of liabilities to creditors other than partners

In the distribution of proceeds from realization, the partnership creditors other partners has the
top priority. If the cash available is sufficient, liabilities to this group of creditors must first be
settled in full before making any payment to the partners in whatever capacity they are entitled
into.

In case the partnership cannot meet its obligation to outside creditors, the personal assets of
the partners will be applied as payment but only if there is an excess over his personal liabilities. In
other words, priority is given to the partner’s personal creditors and any excess will be applied as
payment to the partnership creditors.

Marshalling of assets involves the order of priorities or creditors’ rights against the partnership
assets and the personal assets of the individual partners. The order in which claims against the
assets of the partnership will be marshaled is as follows:

1) partnership outside creditors;

2) partners’ claims other than capital and profits, such as loan payable; and
3) partners’ claims to capital or profits, to the extent of credit balances in capital accounts

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3. Payment to partners

After the settlement of the liabilities to the partnership outside creditors, any capital deficiency
resulting from the distribution of loss on realization, must first be eliminated before making
payments to the partners. Settlement with the partners follows this order of priority:

1) Loans to the partnership

2) Capital contributed
3) Share in the profits

Accounting problems involved in partnership liquidation include the following:

1. Determining the profit or loss from the beginning of the accounting period to the date of
liquidation and the distribution of the such profit or loss;

2. Closing of the partnership books;

3. Correction of the discovered accounting errors of prior periods; and

4. Liquidation of the partnership.

TYPES OF LIQUIDATION

1. Lump-sum liquidation – this is a process whereby the distribution of cash to partners is done
only after all the non-cash assets have been realized, the gain or loss is distributed, and the
obligation with the partnership outside creditors have been settled.

2. Liquidation by installment or piece-meal liquidation – this is the process whereby assets are
realized on a piecemeal basis and cash is distributed to partners on a periodic basis as it
becomes available even before all non-cash assets are realized.

STATEMENT OF LIQUIDATION

The statement of liquidation is a statement prepared to show the summary of the process of
liquidation. It is the basis for the preparation of journal entries to record the liquidation. It presents the
realization of non-cash assets and the distribution of the proceeds to the proper parties.

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ILLUSTRATIVE PROBLEM

Assume that the statement of financial position of King, Jolly and Donald shows the following
account balances before liquidation:

KING, JOLLY and DONALD

Statement of Financial Position
October 1, 2019

ASSETS LAIBILITIES AND CAPITAL

Cash P 16,000 Liabilities P 89,600
Other Assets 272,000 Jolly, Loan 4,000
Donald, Loan 6,400
King, Capital 76,000
Jolly, Capital 48,000
Donald, Capital 64,000
Total Assets P 288,000 Total Liabilities and Capital P 288,000

Profit and loss ratio: 4:4:2 to King, Jolly and Donald, respectively.

Required:

1. Prepare a Statement of Liquidation for each case below:

Case 1 – The other assets were sold for P 280,000
Case 2 – The other assets were sold for P 200,000
Case 3 – The other assets were sold for P 148,000
Case 4– The other assets were sold for P 136,000. Deficient partner is solvent.
Case 5 – The other assets were sold for P 136,000. Deficient partner is insolvent.
Case 6 – The other assets were sold for P 136,000. Additional cash investment of deficient
partner is considered as second cash distribution to partners requiring a schedule to accompany
the statement of liquidation to determine amounts paid to partners.

2. Journal entries to record the liquidation process.

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1. Other assets were sold for P 280,000. There is a gain on realization

King, Jolly and Donald

Statement of Liquidation
October 1-31, 2019

Loan Capital
Cash Other Assets Liabilities
Jolly Donald King Jolly Donald
Profit and loss ratio 4 4 2
Balances before liquidation 16,000 272,000 89,600 4,000 6,400 76,000 48,000 64,000
Realization and distribution of gain 280,000 (272,000) 3,200 3,200 1,600
Balances 296,000 89,600 4,000 6,400 79,200 51,200 65,600
Payment of liabilities 89,600 (89,600)
Balances 206,400 4,000 6,400 79,200 51,200 65,600
Payment to partners (206,400) (4,000) (6,400) (79,200) (51,200) (65,600)

Journal entries:

a) Sale of other assets and distribution of gain

Cash 280,000
Other assets 272,000
King, capital 3,200
Jolly, Capital 3,200
Donald, Capital 1,600

b) Payment of liabilities

Liabilities 89,600
Cash 89,600

c) Payment to partners

Jolly, loan 4,000

Donald, loan 6,400
King, Capital 79,200
Jolly, Capital 51,200
Donald, Capital 65,600
Cash 206,400

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2. Other assets were sold for P 200,000. There is a loss on realization but no capital deficiency.

King, Jolly and Donald

Statement of Liquidation
October 1-31, 2019

Other Loan Capital

Cash Assets Liabilities Jolly Donald King Jolly Donald
Profit and loss ratio 4 4 2
Balances before liquidation 16,000 272,000 89,600 4,000 6,400 76,000 48,000 64,000
Realization and distribution of loss 200,000 (272,000) (28,800) (28,800) (14,400)
Balances 216,000 89,600 4,000 6,400 47,200 19,200 49,600
Payment of liabilities (89,600) (89,600)
Balances 126,400 4,000 6,400 47,200 19,200 49,600
Payment to partners (126,400) (4,000) (6,400) (47,200) (19,200) (49,600)

Journal entries
a) Sale of other assets and distribution of loss c) Payment to partners

Cash 200,000 Jolly, loan 4,000

King, Capital 28,800 Donald, loan 6,400
Jolly Capital 28,800 King, Capital 47,200
Donald, Capital 147,400 Jolly, Capital 19,200
Other Assets 272,000 Donald, Capital 49,600
Cash 126,400

b) Payment of liabilities

Liabilities 89,600
Cash 89,600

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3. Other assets were sold for P 148,000. There is a loss on realization with capital deficiency., right of offset is exercised.

King, Jolly and Donald

Statement of Liquidation
October 1-31, 2019

Other Loan Capital

Cash Assets Liabilities Jolly Donald King Jolly Donald
Profit and loss ratio 4 4 2
Balances before liquidation 16,000 272,000 89,600 4,000 6,400 76,000 48,000 64,000
Realization and distribution of loss 148,000 (272,000) (49,600) (49,600) (24,800)
Balances 164,000 89,600 4,000 6,400 26,400 (1,600) 39,200
Payment of liabilities (89,600) (89,600)
Balances 74,400 4,000 6,400 26,400 (1,600) 39,200
Offset Jolly, loan to Jolly’s capital deficiency (1,600) 1,600
Balances 74,400 2,400 6,400 26,400 39,200
Payment to partners (74,400) (2,400) (6,400) (26,400) (39,200)

Journal entries
a) Sale of other assets and distribution of loss d) Payment to partners

Cash 148,000 Jolly, loan 2,400

King, Capital 49,600 Donald, loan 6,400
Jolly Capital 49,600 King, Capital 26,400
Donald, Capital 24,800 Donald, Capital 39,200
Other Assets 272,000 Cash 74,400

b) Payment of liabilities

Liabilities 89,600
Cash 89,600

c) Offset loan to capital deficiency

Jolly, loan 1,600

Jolly, Capital 1,600

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4. Other assets were sold for P 136,000. There is a loss on realization with capital deficiency, deficient partner is solvent

King, Jolly and Donald

Statement of Liquidation
October 1-31, 2019

Other Loan Capital

Cash Assets Liabilities Jolly Donald King Jolly Donald
Profit and loss ratio 4 4 2
Balances before liquidation 16,000 272,000 89,600 4,000 6,400 76,000 48,000 64,000
Realization and distribution of loss 136,000 (272,000) (54,400) (54,400) (27,200)
Balances 152,000 89,600 4,000 6,400 21,600 (6,400) 36,800
Payment of liabilities (89,600) (89,600)
Balances 62,400 4,000 6,400 21,600 (6,400) 36,800
Offset Jolly, Loan to Jolly’s capital deficiency (4,000) 4,000
Balances 62,400 6,400 21,600 (2,400) 36,800
Additional investment of Jolly 2,400 2,400
Balances 64,800 6,400 21,600 36,800
Payment to partners (64,800) (6,400) (21,600) (36,800)

Journal entries
a) Sale of other assets and distribution of loss d) Additional investment of Jolly

Cash 136,000 Cash 2,400

King, Capital 54,400 Jolly Capital 2,400
Jolly Capital 54,400
Donald, Capital 27,200
Other Assets 272,000

b) Payment of liabilities e) Payment to partners

Liabilities 89,600 Donald, Loan 6,400

Cash 89,600 King, Capital 21,600
Donald, Capital 36,800
c) Offset loan to capital deficiency Cash 64,800

Jolly, loan 4,000

Jolly, Capital 4,000

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5. Other assets were sold for P 136,000. There is a loss on realization with capital deficiency, deficient partner is insolvent
King, Jolly and Donald
Statement of Liquidation
October 1-31, 2019

Other Loan Capital

Cash Assets Liabilities Jolly Donald King Jolly Donald
Profit and loss ratio 4 4 2
Balances before liquidation 16,000 272,000 89,600 4,000 6,400 76,000 48,000 64,000
Realization and distribution of loss 136,000 (272,000) (54,400) (54,400) (27,200)
Balances 152,000 89,600 4,000 6,400 21,600 (6,400) 36,800
Payment of liabilities (89,600) (89,600)
Balances 62,400 4,000 6,400 21,600 (6,400) 36,800
Offset Jolly, Loan to Jolly’s capital deficiency (4,000) 4,000
Balances 62,400 6,400 21,600 (2,400) 36,800
Add’l loss to other partners due to Jolly’s insolvency (1,600) 2,400 (800)
Balances 62,400 6,400 20,000 36,000
Payment to partners (62,400) (6,400) (20,000) (36,000)

Journal entries
a) Sale of other assets and distribution of loss d) Additional loss to other partners due to Jolly’s insolvency

Cash 136,000 King, Capital 1,600

King, Capital 54,400 Donald, Capital 800
Jolly Capital 54,400 Jolly, Capital 2,400
Donald, Capital 27,200
Other Assets 272,000

b) Payment of liabilities e) Payment to partners

Liabilities 89,600 Donald, Loan 6,400

Cash 89,600 King, Capital 20,000
Donald, Capital 36,000
c) Offset loan to capital deficiency Cash 62,400

Jolly, loan 4,000

Jolly, Capital 4,000

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6. The other assets were sold for P 136,000. Additional cash investment of deficient partner is considered as second cash distribution to partners
requiring a schedule to accompany the statement of liquidation to determine amounts paid to partners.

King, Jolly and Donald

Statement of Liquidation
October 1-31, 2019

Other Loan Capital

Cash Assets Liabilities Jolly Donald King Jolly Donald
Profit and loss ratio 4 4 2
Balances before liquidation 16,000 272,000 89,600 4,000 6,400 76,000 48,000 64,000
Realization and distribution of loss 136,000 (272,000) (54,400) (54,400) (27,200)
Balances 152,000 89,600 4,000 6,400 21,600 (6,400) 36,800
Payment of liabilities (89,600) (89,600)
Balances 62,400 4,000 6,400 21,600 (6,400) 36,800
Offset Jolly, Loan to Jolly’s capital deficiency (4,000) 4,000
Balances 62,400 6,400 21,600 (2,400) 36,800
Payment to partners (see schedule) (62,400) (6,400) (20,000) (36,000)
Balances - 1,600 (2,400) 800
Additional investment of Jolly 2,400 2,400
Balances 2,400 1,600 800
Payment to partners (2,400) (1,600) (800)

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Journal entries

a) Sale of other assets and distribution of loss d) Payment to partners with accompanying schedule

Cash 136,000 Donald, loan 6,400

King, Capital 54,400 King, Capital 20,000
Jolly Capital 54,400 Donald, Capital 36,000
Donald, Capital 27,200 Cash 62,400
Other Assets 272,000

b) Payment of liabilities e) Additional investment of Jolly

Liabilities 89,600 Cash 2,400

Cash 89,600 Jolly, Capital 2,400

c) Offset loan to capital deficiency f) Final payment to partners

Jolly, loan 4,000 King, Capital 1,600

Jolly, Capital 4,000 Donald, Capital 800
Cash 2,400

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The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to the partners.
Total partners’ interest will be reduced by the restricted interest for possible losses if the deficient
partner fails to pay his capital deficiency. Restricted interest for possible loss will continue until all
deficiencies or debit capital balances are eliminated, after which, balances will now be called as Free
Interest-amounts to be paid to partners, where payments are applied first t loan, then on capital.

King, Jolly and Donald

Schedule To Accompany Statement of Liquidation
October 1-31, 2019

King Jolly Donald

Capital balances P 21,600 (P 2,400) P 36,800
Add: loan balances 6,400
Total partners’ Interest P 21,600 (P2,400) P 43,200
Restricted interests – possible loss to P 2,400 to King and Donald in
the ratio of 4:2 if Jolly fails to pay his deficiency (1,600) 2,400 (800)
Free interest – amount to be paid to partner P 20,000 P 42,400

Payment to apply on:

Loan P 6,400
Capital P 20,000 36,000
Cash settlement P 20,000 P 42,400

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COMPUTATION OF CASH SETTLEMENT TO PARTNERS

There are some problems that ask for the computation of cash settlement to partners but do
not require the preparation of a statement of liquidation. In such cases, the following must have taken
place before computing the cash settlement to partners:

a) Non-cash assets must have been realized

b) Liabilities to outside creditors are already settled
c) Gain or loss on realization have not been distributed to partners’ capital accounts

To determine if there is a gain or loss on realization, comparison must be made between the debits
(cash available to partners) and the total credits (partners’ loans and capital balances). If total debit
exceeds total credit, the excess is a gain on realization, and if the total debit is less than the total credit,
the difference is a loss on realization. Such gain or loss on realization must first be distributed before
proceeding with the liquidation process.

ILLUSTRATIVE PROBLEM

On June 30, 2019, the capital balances of Joe, Andy and Greg are P 80,000, P 50,000 and P 10,000,
respectively. Profits and losses are shared 3:2:1. The partners decided to liquidate and the non-cash A
assets were realized for P 74,000. After paying the liabilities amounting to P 24,000, cash balance
showed P 56,000 for distribution to partners. C B
GAIN: Cash avail to partners > Partners loan and
The loss on realization would then be computed as follows: cap. Balance

Total capital (credit) 80,000+50,000+10,000 P 140,000

Less cash balance for distribution to partners 56,000
Loss on realization P 84,000
=======

Settlement of cash to partners would be distributed as follows:

Joe Andy Greg

Capital balances P 80,000 P 50,000 P 10,000
Loss on realization (42,000) (28,000) ( 14,000)
Balances P 38,000 P 22,000 (P 4,000)
Additional loss to Joe and Andy for the deficiency of Greg in the ratio
of 3:2 (2,400) (1,600) 4,000
Free interest – amount to be paid to partner P 35,600 P 20,400 -

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 EXERCISES

A. Tik, Tak and Toe, who share profits and losses in the ratio of 4:4:2, respectively, decide to liquidate
their partnership on December 31, 2019. The condensed statement of financial position is
presented below just prior to liquidation.

3T Partnership
Statement of Financial Position
December 31, 2019
ASSETS LIABILITIES AND EQUITY
Cash P 40,000 Liabilities P 224,000
Other Assets 680,000 Tak, Loan 10,000
Toe, Loan 16,000
Tik, Capital 190,000
Tak, Capital 120,000
Toe, Capital 160,000

Total Assets P 720,000 Total Liabilities and Equity P 720,000

Instruction: Prepare a statement of Liquidation and the required journal entries for each of the following
cases and supporting schedule of cash distribution, if necessary assuming cash is immediately
distributed to the proper parties. Assume also that the deficient partner/s will invest cash which is then
distributed as second payment to the proper parties.

Case A P 700,000 Case C P 370,000 Case E P 250,000

Case B 500,000 Case D 340,000 Case F 180,000

B. Doy, Rey, May and Fay are partners with capitals of P 22,000, P 20,600, P 27,400 and P 18,000
respectively. Doy has a loan balance of P 4,000. Profits and losses are shared 40%; 30%; 20%;
10% by Doy, Rey, May and Fay respectively. Assuming assets were sold and liabilities paid and the
balance of cash showed P 24,000. Prepare a schedule showing how the P 24,000 will be
distributed to the partners.

C. The partnership accounts of Guess, Jag and Levis are shown below as of December 31, 2019.
Profits and losses are shared 50%; 30%; and 20%, respectively.

Guess, Drawing (debit balance) P (32,000)

Levis, Drawing (debit balance) (12,000)
Jag, Loan 40,000
Guess, Capital 164,000
Jag, Capital 134,000
Levis, Capital 144,000

Total assets amounted to P 638,000, including cash of P 70,000, and P 200,000 worth of liabilities. On
January 2019, the partnership was liquidated, and Jag received P 111,000 cash as final settlement.

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Required:

1. The total loss from the liquidation of the partnership

2. Prepare the statement of liquidation.
3. Journal entries to record the liquidation.

D. Red, White, and Blue are partners who share profits and losses 20%; 30%; and 50% respectively.
The partners have decided to liquidate the partnership. Their capital accounts show the following
balances: Red – P 60,000 credit; White – P 90,000 credit; Blue – P 30,000 debit. What is the
amount of cash available for distribution?

E. Orange and Lemon share profits and losses equally. They decided to liquidate their partnership
when their net assets amounted to P 260,000. Capital balances were P 170,000 and P 90,000,
respectively. If the non-cash assets were sold for an amount equal to book value, what amount of
cash should Orange and Lemon respectively received?

F. The partnership of Anthony and Davis had an unprofitable year and agreed to liquidate their
business on December 31, 2019. The Statement of Financial Position as of December 31, 2019 is
presented below:

ASSETS
Cash P 1,000
Accounts Receivable P 80,000
Less Allowance for Bad Debts 20,000 60,000
Merchandise Inventory 50,000
Prepaid Advertising 2,000
Office Equipment P 100,000
Less Accumulated Depreciation 60,000 40.000
TOTAL ASSETS P 153,000
LIABILITIES AND EQUITY
Accounts Payable P 20,000
Notes Payable (due October 31, 2020) 86,000
Anthony, Capital 30,000
Davis, Capital 17,000
TOTAL LIABILITIES AND EQUITY P 153,000

The information concerning liquidation are as follows:

1. Accounts receivable’s net carrying value plus 20% of the estimated bad debts were collected.
2. Merchandise inventory were realized for P 25,000
3. The contract for Prepaid Advertising has a cancellation value of P 800.
4. Office Equipment were realized equal to 60% of their book value.
5. Unrecorded Accounts Payable of P 2,000 were discovered.
6. Bank charges of P 1,000 was added to the note for early payment than the due date.

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 Anthony is personally insolvent. However, Davis’ personal assets exceeded his personal liabilities
by P 4,000. Anthony and Davis share profits and losses 40%; 60%, respectively.

Required:
1. Prepare a schedule showing the net amount of liquidation gain or loss.
2. Prepare a Statement of Liquidation.
3. Journal entries to record the liquidation.

G. Bench, Mark, Spencer, and Lee are partners, sharing earnings in the ratio of 3:4:6:8, respectively.
The balances of their capital accounts on December 31, 2019 are as follows:

Bench – P 1,000 Mark – P 25,000 Spencer – P 25,000 Lee – P 9,000

The partners decide to liquidate, and they accordingly convert the non-cash assets into P 23,200
of cash. After paying the liabilities amounting to P 3,000, they have P 22,200 cash to divide.
Assume that a debit balance of any partners’ capital is uncollectible.

1. How much is the cash balance before realization?

2. How much is the share of Bench in the loss upon conversion of the non-cash assets into cash?

H. Marie, Len and Ann decided to dissolve their partnership on august 31, 2019. Profits and and losses
are shared 4:3:3, respectively and their capital balances as of January 1, 2019 were as follows:

Marie – P 75,000 Len – P 90,000 Ann – P 30,000

The operations of the partnership for the period January 1, 2019 to August 31, 2019 resulted to a
profit of P 66,000. As of August 31, 2019, cash balance is P 60,000 and the liabilities are P 135,000.

For Marie to receive P 60,000 in final settlement of her equity, how much should the non-cash assets
be sold?

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