PARTNERSHIP LIQUIDATION

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 the
partners.
Realization is the conversion of non-cash assets into cash.
Capital deficiency is the excess of partner’s share in loses over the partner’s capital credit
balance.
Partner’s interest is the sum of his capital and loan accounts.

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; and
2. Additional contributions of the partners needed for the payment of all liabilities
Order of Preference
The assets of a general partnership shall be applied in the following order:
1. First, those owing to outside creditors (accounts, notes, mortgage, and other payables,
including liquidation expenses);
2. Second, those owing to inside creditors in the form of loans or advances for business
expenses by the partners (loan account of partners, usually has the account “Partner,
Loan” in the liabilities section of the statement of financial position);
3. Third, those owing to the partners with respect to their capital contributions; and
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/her right of offset. This privilege is the legal right of a partner to apply part or all of his loan
account balance against his capital deficiency resulting from losses in the realization of the
partnership assets.
Insufficient Partnership Assets
In cases when the partnership assets are insufficient to settle all outside liabilities, the partners
should make additional contribution in the partnership. Any partner who contributed in excess of
his/her share in this liabilities has a right to collect the supposed additional contributions form
the other partners.

METHODS OF PARTNERSHIP LIQUIDATION

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 or loss ratio;
2. Payment of liabilities;
3. Elimination of partners’ capital deficiency. If after the distribution of loss on realization a
partner incurs a capital deficiency, 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. Payment to partners, in the order of priority:
a. Loan accounts
b. Capital accounts.

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, realizing additional assets and making additional payments to partners. The liquidation
will continue until all the non-cash assets have been realized and all available cash distributed to
partnership creditors and partners.
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 or 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 or loss ratio);
3. Payment of liabilities to outside creditors; and
4. Distribution of available cash based on a schedule of safe payments/cash priority
program.