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Accounting for Partnership Liquidation


The process of winding up a business normally consists of the conversion of a portion or all of the assets into cash,
settlement with creditors, and the distribution of remaining assets to the partners.

The conversion of assets into cash is referred to as realization. The payment of liabilities is referred to as
liquidation; however, it is also used in a broader sense to refer to the complete winding up process.

Procedure in Liquidation

When a partnership is to be liquidated, the books should be adjusted and closed and the net income or loss for the
period should be carried to the partners’ capital accounts. The partnership is then ready to proceed with

As assets are converted into cash, any differences between the book values and the amounts realized represent
gains or losses to be divided among partners in the profit and loss ratio. Such gains and losses are carried to the
capital accounts, which will become the basis for settlement.

In the course of liquidation, when a partner’s capital account reports a debit balance and such partner has a loan
balance, the law permits exercise of the right of offset, that is, the offset of a part or the entire loan against the
capital deficiency. A debit balance in the capital account in the absence of a loan balance or after offset of a loan
balance indicates the need for a contribution by the deficient partner. The inability of a partnership to recover a
capital deficiency will mean the remaining partners will have to absorb such amount.

As cash becomes available for distribution, it is first applied to the payment of outside creditors. It may then be
applied in settlement of partner’s loan and capital balances. It may be observed that the Philippine Partnership Law
provides that partners’ loan shall rank ahead of partners’ capital in order of payment.

Procedure in summarized form:

1. Realization of assets and distribution of gain or loss on realization among the partners based on the profit
and loss ratio.

2. Payments of expenses – During the liquidation process, expenses are usually incurred, such as legal and
accounting expenses and advertising cost of selling the assets. The expenses are allocated to partners’
capital accounts in their profit and loss ratio.

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 of offset.

b. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.