Partnership Liquidation is the process of closing the partnership and distributing its assets.

Many times
partners choose to dissolve and liquidate their partnerships to start new ventures. Other times,
partnerships go bankrupt and are forced to liquidate in order to pay off their creditors. The partnership
liquidation process starts with the partnership selling off all of its non-cash assets at auction. Most of the
time these assets will create a loss because they will be sold for less than what the partnership purchased
them for, but some assets, like land, can appreciate and be sold at a gain.

After successful completion of this module, you should be able to:

 Understand lump-sum partnership liquidation

 Apply the concepts of marshaling of assets & partner’s right of offset
 Prepare a statement of liquidation (lump-sum)
 Make a schedule of cash distribution to partners

Under this type of liquidation, the distribution of cash to the 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.

Steps in Lump-sum Liquidation

 Sale of non-cash assets and distribution or allocation of gain or loss on realization

 The distribution must be based on residual P/L ratio, unless liquidation ratios
are specified
 The distribution might result to a capital deficiency (debit balance) in capital
accounts of the partners
 Payment of liabilities
 If there are any liquidation expenses not yet recorded, record it as deduction in
cash and capital balance of the partners
 If cash is not enough to pay for liabilities, then pay only to the extent of cash
available.
  Distribution of cash to partners (observe the marshaling of asset concept here)
 If there is still a capital deficiency to any partner, exercise the right of offset
first before distribution
 Then, if there is no loan payable to the deficient partner, or if the loan amount
is not sufficient to cover the deficiency, the partners can either eliminate the
deficiency or not before the distribution of cash.
i. Cash can be distributed after eliminating the remaining deficiency
through [1] additional investment by deficient partner (if solvent) or
[2] charge the deficiency as loss to the remaining partners (if
insolvent).
ii. Cash can be distributed before eliminating the remaining deficiency
through a ‘Schedule of Cash Distribution’. The remaining
deficiency after the cash distribution would then be eliminated either
through:
 If solvent: [1] as additional investment to be paid to the
partner(s) as second cash distribution or [2] as direct cash
settlement to the partners
 If insolvent, as additional loss to the remaining partners

The concept of marshaling of assets defines the priority of claims in partnership assets and the personal
assets of the partners in the event of a partnership liquidation. This determines the order in which the
partnership liabilities are going to be paid.

The proceeds from the sale of the partnership assets must be distributed in the following order of priority:
1. Partnership creditors other than partners;
2. Partners’ claims other than capital and profits, such as loans payable and accrued interest
payable; and
3. Partners’ capital and profit claims (if there is a remaining credit balance in their capital
accounts)
The order of claims against the personal assets of unlimited partners are as follows:
1. Personal creditors of individual partners; and
2. Partnership creditors on unpaid partnership liabilities regardless of a partner’s capital
balance in the partnership.
NOTE: If the personal assets exceed the personal liabilities of a partner, then that partner is solvent.
Otherwise, he is insolvent.
This refers to the partners’ right to offset any deficit (negative or debit balance) in his capital
account against any loan payable to him. This is because a partner’s loan balance have higher
priority compared to his capital balance but a lower priority compared to partnership creditors. In
the event that a partner’s capital balance results to a deficit at any point during the partnership
liquidation process, the right of offset must automatically be exercised and applied.

The statement of liquidation is a statement prepared to summarize the liquidation process. It is the basis
of the journal entries made to record liquidation. The columns on a statement of liquidation shall include:
1. Cash
2. Non Cash Assets
3. Liabilities (other than those owed to partners)
4. Loans Payable to Partners
5. Partners’ Capital Accounts (net of drawing)

The schedule of cash distribution must be prepared when the partners decide to distribute cash before
eliminating any capital deficiency. This is done to ensure that the partners would receive the right amount
of distribution and that sufficient capital balances would remain to absorb the deficiency if the deficient
partner fails to pay. The schedule of cash distribution is prepared as follows:

Partner 1 Partner 2 Partner 3

Capital balances before distribution XX XX XX
Add: Loan balance XX XX XX
Total partner’s interest XX XX XX
Add (Less): Restricted interest (possible loss if
deficient partner is insolvent, to be absorbed by other (XX) XX (XX)
partners)
Free interest − Amounts paid to partners (first
XX XX XX
applied to loan, then on capital balance)