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liquidation of a partnership means winding up the business usually by selling the assets, paying the liabilities, and distributing the remaining cash to partners. a business which is in the process of converting its assets into cash and making settlement with creditors is said to be in liquidation.
in this unit, emphasis will be placed on the accounting problems and procedures involved in the winding up (liquidation) of the partnership affairs. when the business is to be liquidated, the account must be adjusted and closed, and the resulting income or loss in the final period is transferred to the capital accounts of the partners.
the basic objectives of a partnership during liquidation process are to convert the partnership assets to cash, to pay off partnership obligations and to distribute cash and any unrealized assets to the individual partners.
dissolution with liquidation 1. a partnership is liquidated when its business operations are completely terminated or ended. 2. it may be caused by any of the following factors: a. the purpose for which the partnership was organized has been accomplished. b. the term/period covered by the partnership contract has terminated. c. the firm became bankrupt. d. the partners mutually agree to close the business. 3. partnership assets are sold. 4. partnership creditors are paid. 5. remaining assets are distributed to the partners as a return of their investments.
definition of terms
lump-sum liquidation – a liquidation method whereby all assets are converted into cash.1. dividing the available cash to the partners. 5. 2. all liabilities are paid. capital deficiency – the excess of a partner’s share on losses over his capital balance resulting to a debit balance in the capital account. deficient partner – a partner with a debit balance in his capital account. loan balance and advances to the partnership. 4. dissolution – the termination of the life of the partnership. types of liquidation 1. 8. installment method – involves the selling of some assets. insolvent partner – personal assets of the partner are less than his personal liabilities. realization – the process of converting non-cash assets into cash. partner’s interest – the sum of a partner’s capital. selling additional assets and making further payments to partners. solvent partner – personal assets of the partner exceed his personal liabilities. liquidation – the process of winding up a business which normally consists of conversion of assets into cash. 10. this process continues until all the assets have been sold and all cash has been distributed to the creditors and to the partners. loss on realization – the excess of the carrying amount over the selling price of the non cash assets sold through realization. 12. 11. right of offset – the legal right to apply part or all of the amount owing to a partner on a loan balance against a deficiency in his capital account resulting from losses in the process of liquidation. marivic valenzuela-manalo 2 . 6. 7. 3. payment of liabilities and distribution of remaining among the partners. and all profits or losses are charged to the partners followed by a single liquidating distribution to the partners. 9. 2. paying the liabilities of the partnership. statement of liquidation – an accounting statement summarizing the winding up of the business affairs of the partnership. gain on realization – the excess of the selling price over the carrying amount of the non cash assets sold through realization.
close all nominal accounts.1 if partner is solvent and a general partner – deficient partner makes additional cash investment to remove his capital deficiency. b. close all drawing accounts to their respective capital accounts. third. 3. determine the net income/net loss and close the net income/net loss to partners’ capital accounts. any difference between the selling price and carrying amount of the sold assets shall be recorded in an account called gain or loss on realization. a. if a partner has a loan balance – exercise the right of offset (apply the loan balance against the debit balance). the gain or loss on realization account shall be closed to the partners’ capital accounts using profit and loss ratio. 4. d. marivic valenzuela-manalo 3 . b.2 if partner is insolvent and general partner or if limited partner – deficient partner is unable to pay. 2.procedures in lump sum liquidation 1. finish the accounting cycle. b. c. first. b. the remaining solvent partners will absorb the deficiency. second. to partners for loan accounts. to partners for capital accounts. a. the following may happen: a. note: the final distribution of cash to partners is made based on the partners’ capital balances and not based on the profit and loss ratio. c. adjust the books. sell non-cash assets and distribute gain or loss on realization among partners using profit and loss ratio. if partner’s capital balance results in a debit balance (deficient balance). b. if there is no loan or if capital balance still results in a debit balance: b. to outside partnership creditors. cash is to be distributed in the following order of priority: a.
the solvent general partners shall contribute the difference using their loss ratio.5. when cash is not sufficient to pay creditors. marivic valenzuela-manalo 4 .
capital guada. capital rose. This means that gains are directly credited to the partner's individual capital accounts marivic valenzuela-manalo 5 .pro-forma statement of liquidation (lump-sum method) name of partnership statement of liquidation date covered by the liquidation noncash cash liabilities guada. capital Selling/Realization of non-cash asset at a loss July 1 Cash Allowance for doubtful accounts Accummulated depreciatiom Loss on realization Non-cash assets X X X X X X X X X X X X X X X X X X X X X X X X X Important note: Gain or loss on realization account may not be used when liquidation statement is prepared before actually recording the realization of assets in the general journal. loan assets profit & loss ratio balances before realization realization and distribution of gain or loss on realization balances payment of liabilities balances payment of partner’s loan balances return of partners’ capital pro-forma entries DATE P A R T I C U L A R S Selling/Realization of non-cash asset at a gain July 1 Cash Allowance for doubtful accounts Accummulated depreciatiom Gain on realization Non-cash assets P/R D E B I T X X X X X X X X X X X X X X X X X X X X X X X X X C R E D I T guada.
loan Guada. Capital Guada. capital X X X X X X X X X X marivic valenzuela-manalo 6 . Capital Guada.DATE P AR TIC ULAR S P/R D E B I T C R E D I T Closing the Gain or loss account when used July 1 Gain on realization Rose. Payment of partnership liabilities Liabilities Cash X X X X X X X X X X Payment of loan to partner/s Rose. Loan Cash X X X X X X X X X X Return of partners' capital Rose. Capital Loss on realization X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Important note: Gain or loss on realization account is closed to partners' capital accounts using profit & loss ratio. Capital Cash X X X X X X X X X X X X X X X Important note: Return of partners' capital is based on their final capital balances and not based on P & L ratio. Capital Rose. capital X X X X X X X X X X Payment of deficient but solvent partner Cash Guada. Capital OR July 1 Rose. Exercise right of off set Guada. Capital Guada. capital X X X X X X X X X X Exercise absorption of losses due to capital defiency of an insolvent and deficient partner/s Guada.
special notes 1. 3. the partners with the deficiency may pay the amount owed and the deficiency is eliminated. the partners with credit balances must absorb the loss as follows: a. in a liquidation. c. 2. allocate gain/loss on realization to the partners based on their income ratios. this will always be true after each liquidation transaction. 5. when there is a capital deficiency. 6. important notes to remember in lump sum partnership liquidation 1. figures in parentheses represent reduction in the account. distribute remaining cash to partners on the basis of their remaining capital balances. 3. b.) 4. each of the steps must be performed in sequence. gain on realization increases capital while loss on realization decreases capital. maintain two columns for the debits – one for cash and one for non-cash assets. maintain separate columns for liabilities to outside creditors and liabilities to partners. if a partner with a capital deficiency is unable to pay the amount owed to the partnership. the allocation of the deficiency is made on the income/profit ratios that exist between the partners with credit balances. the cash distributed to each partner is the difference between the partner's present capital balance and the loss that the partner may have to absorb if the capital deficiency is not paid. the allocation is journalized and posted. it is necessary to: a. d. marivic valenzuela-manalo 7 . the liquidation of a partnership terminates the business. make sure that the balances before liquidation show equality of debits and credits. b. pay partnership liabilities in cash. 2. sell non-cash assets for cash and recognize a gain or loss on realization. double rule all columns when all columns are brought to zero balance. 5. 4. the liquidation of a partnership may result in no capital deficiency (all partners have credit balances in their capital accounts) or in a capital deficiency (at least one partner's capital account has a debit balance.
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