MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY

COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY

DEPARTMENT OF ACCOUNTANCY

ACT130: Accounting for Special Transactions

Partnership Dissolution
Part 2

LESSON OBJECTIVES
At the end of this module, you will be able to:
1. Know the order of priority in the settlement of claims in cases of liquidation
2. Account for the liquidation of the partnership

OVERVIEW
In the preceding module, it discussed about the dissolution of the partnership in which the
business operations were continued without interruption. In this module, we will consider
dissolutions in which the partnership is terminated. The phase of partnership operations which
begins after dissolution and ends with the termination of partnership activities is referred to as
“winding up of the affairs”. These events may occur over relatively short period of time (lump-sum
liquidation), or over a period of several years (installment liquidation).

ABSTRACTION
Marshalling of Assets
As mentioned, one of the characteristics of a partnership is “unlimited liability”. This is because
the personal assets of the general partners are subject to the claims of partnership’s creditors ub
case of partnership insolvency.

The legal doctrine of marshalling assets is applied when the partnership and some of the partners
are insolvent. The following are the rules when applying this doctrine:
1. Any available assets of the partnership are used to settle the partnership’s liabilities
2. In case the assets of the partnership are insufficient to pay all liabilities, the solvent general
partners are required to provide additional funds from their personal assets.
The claims to the personal assets of a partner are ranked in the following order:
a. Those owing to personal creditors
b. Those owing to partnership creditors
c. Those owing to partners by way of contribution
3. In case some partners are insolvent or limited partners, their capital deficiency is offset
to the capital balances of the other partners. If after allocating the capital deficiency of an
insolvent or limited partner, a solvent partner’s capital balance results to a negative
amount, the solvent partner is required to provide additional contribution. (See application)

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 NCA 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 NCA and the agreed settlement amount is treated
as either gain or loss to be appropriated to all of the partner’s capital balances.

Safe Payments Schedule and Cash Priority Program

Installment liquidation may be presented in a formal manner either through:
1. Safe payments schedule; or
2. Cash Priority Program
The basic purpose of these schedules is to prevent overpayments to partners during installment
liquidation

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Safe Payment Schedule

The safe payment schedule shows how much cash can be “safely” paid to partners during
installment liquidation, which avoids any overpayment. The preparation of this schedule requires
the application of these concepts, namely:
a) Unsold non-cash assets are treated as loss; and
b) Expected future liquidation costs and potential unrecorded liabilities are recognized
immediately as losses.
The sum of (a) and (b) above is referred to as “maximum loss possible”. The safe payment
schedule may be used as supporting information to a Statement of Liquidation. (see application)

Cash Priority Program

Another method of ensuring that there are no overpayments to the partners is by preparing a
“cash priority program” or “cash distribution program”. This schedule determines which partner
shall be paid first and which partner shall be paid last, after all the liabilities are settled. This
schedule can be prepared even prior to the sale of any asset.

The preparation of this schedule requires the application of the same concepts as those we have
applied earlier, namely:
a) Unsold non-cash assets are treated as loss; and
b) Expected future liquidation costs and potential unrecorded liabilities are recognized
immediately as losses.

An additional procedure when preparing a cash priority program is to rank the partners to their
maximum loss absorption capacity. The partner with the highest maximum loss absorption
capacity shall be paid first. The partner with the lowest maximum loss absorption capacity shall
be paid last. The maximum loss absorption capacity is computed as follows:

MAXIMUM LOSS ABSORPTION CAPCITY = TOTAL PARTNER’S INTEREST IN THE

PARTNERSHIP ÷ PARTNER’S P/L PERCENTAGE

APPLICATION

ILLUSTRATION 1: Insolvency of partnership

Use the following information for the next two independent cases:
On January 1, 2019, the partners of ABC Partnership 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

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

CASE 1: All partners are personally solvent

All of the partners are personally solvent. Information on the conversion of noncash assets are as
follows:
a. P10,000 was collected on the accounts receivable; the balance is uncollectible.
b. P5,000 was received for the entire inventory
c. The equipment was sold for P53,000
d. P2,000 liquidated expenses were paid.

Requirement: determine the amounts of cash distributed to the partners in the final settlement of
their interests.

Solution:
STEP 1: Compute for gain or loss
a. Collection of A/R P10,000
b. Sale of Inventory 5,000
c. Sale of Equipment 53,000
d. Actual liquidation expense (2,000)
Net Proceeds P66,000
Less: Carrying Amounts of all NCA (480,000)
Total Loss (P414,000)

STEP 2: Allocate the gain or loss to the partner’s capital balances (include their right of offset)
A (20%) B (30%) C (50%) Total
Capital Balances 100,000 150,000 200,000 450,000
Payable to B 20,000 _
Total 100,000 170,000 200,000 450,000
Allocation of Loss
[414K * (20%;30%;50%)] (82,800) (124.200) (207,000) (414,000)
Totals 17,200 45,800 (7,000) 56,000
Additional Contribution by C 7,000 __
Amts Received by Each Partners 17,200 45,800 NONE 63,000

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 interests.

Solution:

STEP 1: SAME AS FOR CASE 1

STEP 2: Allocate the gain or loss to the partner’s capital balances (include their right of offset)
A B C Total
Capital Balances 100,000 150,000 200,000 450,000
Payable to B 20,000 _
Total 100,000 170,000 200,000 450,000
Allocation of Loss
[414K * (20%;30%;50%)] (82,800) (124.200) (207,000) (414,000)

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Totals 17,200 45,800 (7,000) 56,000

Allocation of Capital
deficiency to the other partners
[7K * (20%/50%; 30%/50%)] (2,800) (4,200) 7,000 __
Amts Received by the Partners 14,400 41,600 NONE 56,000

Since C is personally insolvent, his capital deficiency is allocated to the other partners with positive
with positive capital balances. The allocation is based on the solvent partners’ P/L Ratio.
(20%/50%) and (30%/50%)

ILLUSTRATION 2: Marshalling of Assets

On January 1, 2019, the partners of XYZ Partnership 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

X, Capital (20%) 50,000
Y, Capital (30%) 100,000
Z, Capital (50%) 200,000
TOTAL 500,000

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:

Requirements:
A. How much additional contributions shall be made by the partners in order to settle all of the
partnership liabilities?
Solution:
Cash 20,000
Proceeds 40,000
Payments of Liabilities (150,000)
Additional Contributions Needed to Settle Liabilities (90,000)

B. Determine the amounts of cash distributed to the partners in the final settlement of their capital
accounts.
Solution:
Net Proceeds 40,000
Carrying Amount (480,000)
Total Loss (440,000)

Then determine which partners are solvent and which are insolvent, we shall apply “marshalling
of assets”.

X Y Z
Personal Assets 300,000 260,000 200,000

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Personal Liabilities (220,000) (220,000) (320,000)

Available assets for partnership 80,000 40,000 (120,000)

✓ Notice that A and B are solvent up to 80,000 and 40,000, respectively, while C is insolvent.

Now let us determine how the capital balances of ye partners are settled:
X Y Z Total
Capital Balances before
liquidation 50,000 100,000 200,000 350,000

Allocation of Loss
[440K * (20%;30%;50%)] (88,000) (132,000) (220,000) (440,000)
TOTALS (38,000) (32,000) (20,000) (90,000)

(a) Allocation of capital

deficiency of Z to the
other partners (8,000) (12,000) 20,000 -_______
TOTALS (46,000) (44,000) 0 -

(b) Additional contributions

by solvent partners 46,000 40,000 - 86,000___
TOTALS 0 (4,000) - (4,000)

(c) Allocation of capital

deficiency of Y to X (4,000) 4,000 - - ___
TOTALS (4,000) 0 - (4,000)

(d) Additional Contributions

by X 4,000 - - 4,000____
Payments to Partners 0 0 0 0_______

NOTE:
✓ Since Z is personally insolvent, his capital deficiency is allocated to the other partners with
positive capital balances.
✓ X and Y are solvent. Therefore, they are required to provide additional contributions
necessary to cover their capital deficiencies. However, since Y is solvent only up to
P40,000, he is required to contribute only up to that amount.
✓ The remaining capital deficiency of Y is allocated to X.
✓ X is required to provide additional contribution necessary to cover the capital deficiency of
Y.

ILLUSTRATION 3: Safe Payment Schedule

On January 1, 2019, the partners of ABC Partnership 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

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

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 will be made as
cash becomes available. The following transactions occurred in January 2019.
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 the 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.

Requirement: Prepare the safe payment schedule on January 31, 2019

Solution:
1st Step: determine the actual loss on realization

Loss on collection of A/R [30k – (60k*75%)] (P15,000)

Loss on sale of Inventory [40k – (120k*50%)] (20,000)
Loss on sale of equipment (120k – 200k) (80,000)
Actual liquid expenses (2,000)___
Actual loss on realization (P117,000)

2nd Step: Compute the maximum loss possible

Carrying amount of unsold NCA

(60K*25%) + (120K*50%) + (300K-200K) (P175,000)
Estimated future liquidation expense (1,000)
Cash set aside for potential unrecorded liabilities (9,000)___
Maximum Possible Loss (P185,000)

3rd Step: Safe Payment Schedule preparations

ABC Partnership
Safe Payment Schedule
January 31, 2019

A (20%) B (30%) C (50%) TOTAL

Payable to B 20,000 20,000
Capital Balances before
liquidation 100,000 150,000 200,000 450,000
Total Interest – Jan. 01 100,000 170,000 200,000 470,000
Allocation of loss on
realization – Jan. 2019 (23,400) (35,100) (58,500) (117,000)

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

TOTAL 76,600 134,900 141,500 353,000

Allocation of Maximum
loss possible – Jan. 2019 (37,000) (55,500) (92,500) (185,000)
First Installment Payment 39,600 79,400 49,000 168,000

✓ Notice that when preparing a safe schedule, the actual and estimated expenses losses are
computed separately. The computations presented earlier, where we did not compute for
these losses separately, are just a simplification of the computation for distributions to the
partners. If you use the simplified method, you should be able to come up with the same
amounts for distributions to the partners.

ILLUSTRATION 4: Cash Priority Program

On January 1, 2019, the partners of ABC Partnership 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 will be made as
cash becomes available

✓ Even prior to the sale of any asset, we can determine the amount of minimum safe payments
to the partners (when or as cash becomes available) by preparing a cash priority program.

1st step: Determine the Maximum loss absorption capacities (MLAC). This will be the basis in
ranking the partners according to their priority over cash payments.

A (20%) B (30%) C (50%)

Payable to B 20,000
Capital Balances before
liquidation 100,000 150,000 200,000
Total Interest – Jan. 01 100,000 170,000 200,000
Divided by: P/L Ration 20% 30% 50%___
Max loss absorption cap. 500,000 566,667 400,000
Rank of Payment 2nd 1st 3rd

2nd Step: the partners’ MLAC are equalized. This will be the basis in preparing the Cash Priority
Program.

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

Rank of Payment 2nd 1st 3rd

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Maximum loss absorption cap 500,000 566,667 400,000

Difference between 1st 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

3rd Step: the cash priorities are computed by multiplying the differences above by the respective
partners’ P/L ratio

Cash Priority Program

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

Rank of Payment 2nd 1st 3rd
1st Priority (66,667*30%) 20,000
2nd Priority (100,000*20%; 30%) 20,000 30,000
Totals 20,000 50,000

The cash priority program above means that when cash becomes available:
1. B is paid P20,000 first.
2. Next, A and B are paid P20,000 and P30,000, respectively; and
3. Any remaining cash will be distributed to all partners based on their P/L ratio

APPLICATION OF CPP

The following transactions occurred in January 2019.

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 the 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.

Requirement: Prepare the cash payments to the partners on January 31, 2019 using a CPP.
Solution:

The amount of cash available for distribution to the partners on January 31, 2019 is computed as
follows:

a. Collection of A/R P30,000

b. Sale of Inventory 40,000
c. Sale of Equipment 120,000
d. Actual liquidation expense (2,000)
e. Cash set aside for estimated liquidation expense (1,000)
f. Cash retained for potential future costs (9,000)
NET PROCEEDS 178,000
Add: Cash Balance, Beg 20,000
Less: Accounts Payable (30,000)
Cash available for Distribution 168,000

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Using the cash priority program, the amounts of distribution to the partners on January 31, 2019
are determined as follows:
A (20%) B (30%) C (50%) Total
Available Cash – Jan. 31, 2019 168,000
Allocation:
1st Priority 20,000 (20,000)
2nd Priority 20,000 30,000 (50,000)
Balance 20,000 50,000 98,000
Payment after priorities
[98k * (20%;30%;50%) 19,600 29,400 49,000 (98,000)
1st Installment Payment 39,600 79,400 49,000

NOTE:
✓ 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”

REFERENCES
Dayag, A. J. (2015). Advanced Accounting 1. Manila: Lajara Publishing House.
MILLAN, Z. V. (2018). Accounting for Special Transactions. Baguio City: Bandolin Enterprise.