Partnership Liquidation – Lump Sum

Introduction

In the event that the partners decide to terminate its partnership business, they have to liquidate all its assets and liabilities. All
the non-cash assets must be converted to cash and pay its obligations.

A partnership is liquidated when its business operations are completely terminated or ended. The partnership assets are sold,
the partnership creditors are paid, and the remaining assets, if any, are distributed to the partners as a return of their
investments.

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

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

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

Liquidation – the interval of time between dissolution and termination of partnership affairs; it is also the process of winding
up a business which normally consists of conversion of assets into cash, payment of liabilities and distribution of remaining
cash among the partners.

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

Types of liquidation

1. Lump-sum Liquidation or liquidation by totals – this is a type of liquidation whereby the distribution of cash to
partners is done only after all the non-cash assets have been realized, the total amount of gain or loss on realization is
known, and all liabilities have been paid.

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

Partnership dissolution with liquidation may be caused by any of the following factors:

1. The accomplishment of purpose for which the partnership was organized.

2. The termination of the term/period covered by the partnership contract.
3. The bankruptcy of the firm.
4. The mutual agreement among the partners to close the business.

As a general rule, the cash should be distributed as follows:

1. First, to outside creditors.

2. Second, to partners for loan accounts.
3. Third, to partners for capital accounts.

Liquidation Procedures.

The following procedure may be used in lump-sum liquidation.

1. Realization of assets and distribution of gain and loss on realization among the partners based on the P/L ratio.
2. Payment of expenses.
3. Payment of liabilities.
4. Elimination of partner’s 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, exercise the right to offset.
b. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.
c. If the deficient partner is insolvent, let the other partner absorb his deficiency.
5. Payment to partners (in order of priority)
a. Loan Accounts
b. Capital Accounts
Illustration 1. The following illustration will be used to present the lump-sum liquidation of DEF Partnership in which D, E, and
F are partners. A condensed statement of financial position of the company on April 27, 2020, the day the partners decide to
liquidate the business is presented below.

DEF PARTNERSHIP
Statement of Financial Position
April 27, 2020
Assets Liabilities and Capital
Cash 20,000 Liabilities 28,000
Other Assets 80,000 D, Loan 2,000
D, Capital (40%) 9,000
E, Capital (40%) 21,000
F, Capital (20%) 40,000
Total 100,000 Total 100,000

Case 1. Gain on Realization

Assume that the other assets, 80,000, were realized at 100,000, thus resulting to a gain of 20,000. A statement of Liquidation is
shown below:

DEF Partnership
Statement of Liquidation
April 27, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities D, Loan D (40%) E (40%) F (20%)
Bal. Before Liquidation 20,000 80,000 28,000 2,000 9,000 21,000 40,000
Realization 100,000 (80,000) 8,000 8,000 4,000
Balances 120,000 -0- 28,000 2,000 17,000 29,000 44,000
Payment of liabilities (28,000) (28,000)
Balances 92,000 -0- -0- 2,000 17,000 29,000 44,000
Payment to Partners (92,000) -0- -0- (2,000) (17,000) (29,000) (44,000)

The journal entry to required to record the realization of assets and to complete the liquidation appear below:

To record the sale of other assets and the division of gain of 20,000 among partners
Cash 100,000
Other Assets 80,000
D, Capital 8,000
E, Capital 8,000
F, Capital 4,000

To record the payment to outside creditors

Liabilities 28,000
Cash 28,000

To record the payment of loan to partners and partner’s capital account

D, Loan 2,000
D, Capital 17,000
E, Capital 29,000
F, Capital 44,000
Cash 92,000

Case 2. Loss on Realization

Assume that the other assets, 80,000, were realized at 60,000, thus resulting to a loss of 20,000. A statement of Liquidation is
shown below:

DEF Partnership
Statement of Liquidation
April 27, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities D, Loan D (40%) E (40%) F (20%)
Bal. Before Liquidation 20,000 80,000 28,000 2,000 9,000 21,000 40,000
Realization 60,000 (80,000) (8,000) (8,000) (4,000)
Balances 80,000 -0- 28,000 2,000 1,000 13,000 36,000
Payment of liabilities. (28,000) (28,000)
Balances 52,000 -0- -0- 2,000 1,000 13,000 36,000
Payment to Partners. (52,000) -0- -0- (2,000) (1,000) (13,000) (36,000)
The journal entry to required to record the realization of assets and to complete the liquidation appear below:

To record the sale of other assets and the division of gain of 20,000 among partners
Cash 60,000
D, Capital 8,000
E, Capital 8,000
F, Capital 4,000
Other Assets 80,000

To record the payment to outside creditors

Liabilities 28,000
Cash 28,000

To record the payment of loan to partners and partner’s capital account

D, Loan 2,000
D, Capital 1,000
E, Capital 13,000
F, Capital 36,000
Cash 52,000

Case 3. Loss on Realization Resulting Capital Deficiency to a Partner with a Loan Account.
Assume that the other assets, 80,000, were realized at 55,000, thus resulting to a loss of 25,000. After the distribution of loss
among the partners using the P/L ratio, D’s Capital account results in a debit balance of 1,000. To cancel his deficiency, D has to
exercise the right to offset by transferring 1,000 from his loan account to his capital account. The partners are still paid in the
amounts equal to their outstanding loan and capital balance. A statement of Liquidation is shown below:

DEF Partnership
Statement of Liquidation
April 27, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities D, Loan D (40%) E (40%) F (20%)
Bal. Before Liquidation 20,000 80,000 28,000 2,000 9,000 21,000 40,000
Realization 55,000 (80,000) (10,000) (10,000) (5,000)
Balances 75,000 -0- 28,000 2,000 (1,000) 11,000 35,000
Payment of liabilities. (28,000) (28,000)
Balances 47,000 -0- -0- 2,000 (1,000) 11,000 35,000
Right of offset (1,000) 1,000
Balances 47,000 -0- -0- 1,000 -0- 11,000 35,000
Payment to Partners. (47,000) -0- -0- (1,000) -0- (11,000) (35,000)

To record the application of D’s loan to his capital deficiency.

D, Loan 1,000
D, Capital 1,000

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

Assume that the other assets, 80,000, were realized at 49,500, thus resulting to a loss of 30,500. After the distribution of loss
among the partners using the P/L ratio, D’s Capital account results in a debit balance of 3,200. Offsetting the entire amount of
D’s loan account against his capital account still leaves his capital account with a debit balance of 1,200. D has to invest
additional cash to fully eliminate his deficiency. A statement of Liquidation is shown below:

DEF Partnership
Statement of Liquidation
April 27, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities D, Loan D (40%) E (40%) F (20%)
Bal. Before Liquidation 20,000 80,000 28,000 2,000 9,000 21,000 40,000
Realization 49,500 (80,000) (12,200) (12,200) (6,100)
Balances 69,500 -0- 28,000 2,000 (3,200) 8,800 33,900
Payment of liabilities. (28,000) (28,000)
Balances 41,500 -0- -0- 2,000 (3,200) 8,800 33,900
Right of offset (2,000) 2,000
Balances 41,500 -0- -0- -0- (1,200) 8,800 33,900
Additional Investment 1,200 1,200
Balances 42,700 -0- -0- -0- -0- 8,800 33,900
Payment to Partners. (42,700) -0- -0- -0- -0- (8,800) (33,900)

To record the additional investment of D to eliminate his capital deficiency.

Cash 1,200
D, Capital 1,200
Case 5. Loss on Realization Resulting Capital Deficiency to an Insolvent Partner.
Let’s assume that in the preceding case, partner D is personally insolvent and the 1,200 due to him is uncollectible. In this case,
the 1,200 is to be proportionately absorbed by E and F.. A statement of Liquidation is shown below:

DEF Partnership
Statement of Liquidation
April 27, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities D, Loan D (40%) E (40%) F (20%)
Bal. Before Liquidation 20,000 80,000 28,000 2,000 9,000 21,000 40,000
Realization 49,500 (80,000) (12,200) (12,200) (6,100)
Balances 69,500 -0- 28,000 2,000 (3,200) 8,800 33,900
Payment of liabilities. (28,000) (28,000)
Balances 41,500 -0- -0- 2,000 (3,200) 8,800 33,900
Right of offset (2,000) 2,000
Balances 41,500 -0- -0- -0- (1,200) 8,800 33,900
Additional Investment 1,200 (800) (400)
Balances 41,500 -0- -0- -0- -0- 8,000 33,500
Payment to Partners. (41,500) -0- -0- -0- -0- (8,000) (33,500)

To record the absorption of D’s deficiency by E and F.

E, Capital 800
F, Capital 400
D, Capital 1,200

Deficiency absorbed is determined as follows:

E: 4/6 x 1,200 = 800
F: 2/6 x 1,200 = 400

Partnership is insolvent but the partners are personally solvent

If the partnership is insolvent, which means that the available cash is insufficient to pay creditors, at least once, or perhaps, all
of the partners will have deficiencies and will exceed the unpaid liabilities of the partnership. If the partner or partners with
capital deficiencies pay the required amount, the partnership will have enough cash to pay its liabilities in full. However, in
accordance with law, the creditors may demand payment from any partner regardless of whether his capital accounts shows a
debit balance (i.e., there’s deficiency) or a credit balance. It should be noted that in terms of the relationship with creditors,
the partnership is not viewed as separate entity.

Illustration 2. Assume that L, M, and N, who share profit and loss equally, present the following statement of financial
position just prior to liquidation.

LMN
Statement of Financial Position
March 31, 2020
Assets Liabilities and Capital
Cash 8,000 Liabilities 33,000
Other Assets 42,000 L, Capital 9,000
M, Capital 5,000
N, Capital 3,000
Total Assets 50,000 Total Liab and Capital 50,000

The other assets with carrying amount of 42,000 are sold for 19,500 cash, which resulted in a loss of 22,500 to be divided
equally among the partners.

LMN Partnership
Statement of Liquidation
March 31, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities L (1/3) M (1/3) N (1/3)
Bal. Before Liquidation 8,000 42,000 33,000 9,000 5,000 3,000
Realization 19,500 (42,000) (7,500) (7,500) (7,500)
Balances 27,500 -0- 33,000 1,500 (2,500) (4,500)
Payment of liabilities. (27,500) (27,500)
Balances -0- -0- 5,500 1,500 (2,500) (4,500)
Cash Invested M & N 7,000 2,500 4,500
Balances 7,000 -0- 5,500 1,500 -0- -0-
Full payment of Liab (5,500) (5,500)
Balances 1,500 -0- -0- 1,500 -0- -0-
Payment to Partners (1,500) -0- -0- (1,500) -0- -0-
Partnership is insolvent and Partners are personally insolvent

The situation raises a question as to the relative rights of two groups of creditors, namely, (1) the creditors of the partnership,
and (2) the personal creditors of the partners. The relative rights of these two groups of creditors are governed by the
partnership law which provides that the assets of the partnership are first available to his personal creditors. If after the debts
of the partnership have been paid in full and some assets still remain in the partnership, the creditors of a partner have a claim
against the assets of the partnership only to the extent of his share.

After the personal creditor of a partner have been paid in full from his personal assets, any remaining assets is available to
partnership creditors regardless of whether the partner’s capital account show a credit or debit balance. The claims of
creditors of the partnership on the separate property of the partner are permitted only when these creditors are unable to
obtain payment from partnership.

Illustration 3. Assume that A, B, and C, who share profit and loss equally, present the following statement of financial position
just prior to liquidation.

ABC
Statement of Financial Position
March 31, 2020
Assets Liabilities and Capital
Cash 10,000 Liabilities 60,000
Other Assets 100,000 A, Capital 5,000
B, Capital 15,000
C, Capital 30,000
Total Assets 110,000 Total Liab and Capital 110,000

The personal assets and liabilities of the partners on this date apart from their equities in the partnership are:
Partners Personal Asset Personal Liabilities
A 100,000 25,000
B 50,000 50,000
C 5,000 60,000

Other assets were sold for 40,000 resulting to a loss of 60,000.

ABC Partnership
Statement of Liquidation
March 31, 2020
Assets Liabilities Partners’ Capital
Cash Other Liabilities A (1/3) B (1/3) C (1/3)
Bal. Before Liquidation 10,000 100,000 60,000 5,000 15,000 30,000
Realization 40,000 (100,000) (20,000) (20,000) (20,000)
Balances 50,000 -0- 60,000 (15,000) (5,000) 10,000
Payment of liabilities. (50,000) (50,000)
Balances -0- -0- 10,000 (15,000) (5,000) 10,000
Cash Invested by A 15,000 15,000
Balances 15,000 -0- 10,000 -0- (5,000) 10,000
Full payment of Liab. (10,000) (10,000)
Balances 5,000 -0- -0- -0- (5,000) 10,000
Loss of A and C (2,500) 5,000 (2,500)
Balances 5,000 -0- -0- (2,500) -0- 7,500
Cash Invested by A 2,500 2,500
Balances 7,500 -0- -0- -0- -0- 7,500
Payment to Partners (7,500) -0- -0- -0- -0- (7,500)