CHAPTER 4 - LIQUIDATION

Liquidation - 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. The conversion of non-cash assets into cash is referred to as
realization. This may either result to a gain or loss on realization and shall be
divided in the profit and loss ratio of the partners. In some cases, a substantial loss
on realization may yield for partner a capital deficiency, which is the excess of a
partner’s share in losses over the partners’ capital credit balance. This deficiency will
certainly affect the partner’s interest – the sum of his capital and loan accounts in
the partnership.

40% 60%
Other AP LP Espeleta, De Guia,
Cash Assets Trade De Guia Capital Capital
Balances before Liquidation 5,000 100,000 15,000 10,000 60,000 20,000
Sept 23 - Realization of OA 5,000 (100,000) (38,000) (57,000)
22,000 (37,000)
Loss on Sale is P95,000

The following rules are subject to revision 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,
2. Additional contribution of the partners needed for the payment of all liabilities
consistent with the discussion below.

Order of Preference
The assets of a general partnership shall apply in the following order:

1. First, those owning to outside creditors,

2. Second, those owning to inside creditors in the form of loans or advance for
business expenses by the partners,
3. Third, those owning to the partners with respect to their capital contributions,
4. Lastly, those owning 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 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.
 Assets Liabilities Capital
40% 60%
Other AP LP Espeleta, De Guia,
Cash Assets Trade De Guia Capital Capital
Balances before Liquidation 5,000 100,000 15,000 10,000 60,000 20,000 -
Sept 23 - Realization of OA 5,000 (100,000) (38,000) (57,000) -
Balances after realization 10,000 - 15,000 10,000 22,000 (37,000) -
- 10,000 10,000
10,000 15,000 - 22,000 - 27,000

Insufficient Partnership Assets

In cases when the partnership assets are insufficient to settle all outside liabilities,
the partners should make additional contributions in the partnership. Any partner who
contributed in excess of his share in this liability has a right to collect the supposed
additional contributions from the other partners.

Preference of Partnership Creditors and Partnership’s Separate Creditors

The creditors of the partnership shall have priority in payments over those of the
partner’s separate creditors as regards the partnership properties. On the other
hand, the creditors of the partner are preferred with respect to the separate or
personal properties of the partners.

Distribution of Separate Properties of an Insolvent Partner

If a partner is insolvent, his personal properties shall be distributed as follows:

1. First, those owing to separate creditors,

2. Second, those owing to partnership creditors,
3. Lastly, those owing to the partners by way of additional contributions when the
assets of the partnership were insufficient to settle all obligation.

The procedures in liquidation after the adjustment and closing of books will be
dependent on the above rules. It will be advisable to have mastery of these
principles to be able fully understand the liquidation of partnership.

The use of a statement of liquidation will greatly aid the liquidating partner
summarize the events and transaction associated with the liquidation of the
partnership.

METHODS OF PARTNERSHIP LIQUIDATION

The following methods may be used when a partnership is liquidated.

1. Lump-sum method - Under this method, all non-cash assets are realized and
the related gains or losses distributed and all liabilities are paid before a single
final cash distribution is made to be partners.
2. Installment method - Under this method, realization of non-cash assets is
accomplished over an extended period of time. When cash is available,
creditors, may be partially or fully paid. Any excess may be distributed to the
partners in accordance with a program of sale payments or a cash priority
program. This process persists until all the non-cash assets are sold.
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 partner based on their profit and loss ratio.
2. Payment of liabilities.
3. Elimination of partners’ 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, then exercise the right of offset.
b. If the deficient partner is solvent, then he should invest cash to eliminate
his deficiency.

Assets Liabilities Capital

0 1
Other AP LP Espeleta, De Guia,
Cash Assets Trade De Guia Capital Capital
Balances before Liquidation 5,000 100,000 15,000 10,000 60,000 20,000 -
Sept 23 - Realization of OA 5,000 - 100,000 - 38,000 - 57,000 -
Balances after realization 10,000 - 15,000 10,000 22,000 - 37,000 -
Right of offset - 10,000 10,000 -
Balances 10,000 15,000 - 22,000 - 27,000 -
Cash Contribution 27,000 27,000 -

c. If the deficient partner is insolvent, then other partners should absorb his
deficiency.

Assets Liabilities Capital

40% 60%
Other AP LP Espeleta, De Guia,
Cash Assets Trade De Guia Capital Capital
Balances before Liquidation 5,000 100,000 15,000 10,000 60,000 20,000 -
Sept 23 - Realization of OA 5,000 - 100,000 - 38,000 - 57,000 -
Balances after realization 10,000 - 15,000 10,000 22,000 - 37,000 -
Right of Offset - 10,000 10,000
Balances 10,000 15,000 - 22,000 - 27,000
Absorption by Espleta - 27,000 27,000

4. Payment to partners, in the order of priority:

a. Loan accounts
b. Capital accounts
Sample Problem: After several years of operations, the partnership of Arenas,
Dulay and Laurente is to be liquidated. After making the closing entries on June 30,
2018, the following accounts remained open:

Account Title Account Balance

Debit Credit

Cash 50,000
Non-cash Assets 2,350,000
Liabilities 400,000
Arenas, Capital 900,000
Dulay, Capital 500,000
Laurente, Capital 600,000

Profits and losses are shared equally.

Required: Prepare a statement of partnership liquidation and the entries to record

the sale of non-cash assets, distribution of gain on realization to the partners,
payment of the liabilities, and distribution of cash to the partners. Assume that the
non-cash assets are sold for:
1. P2,650,000
2. P1,900,000

SOLUTION:
1. Non-cash Assets are sold P2,650,000:

Arenas, Dulay and Laurente Partnership

Statement of Liquidation
June 30, 2018

Assets Liabilities Capital

1/3 1/3 1/3
Cash Non-cash Liabilities Arenas, Dulay, Laurente,
Assets Capital Capital Capital
Balances before Liquidation 50,000 2,350,000 400,000 900,000 500,000 600,000
Realization of Non-cash Assets 2,650,000 (2,350,000) 100,000 100,000 100,000
Balances 2,700,000 - 400,000 1,000,000 600,000 700,000
Payment of Liabilities (400,000) (400,000)
Balances 2,300,000 - - 1,000,000 600,000 700,000
Distribution to Partners (2,300,000) (1,000,000) (600,000) (700,000)

General Journal Entries

Cash 2,650,000
Non-cash Assets 2,350,000
Arenas, Capital 100,000
Dulay, Capital 100,000
Laurente, Capital 100,000

Liabilities 400,000
Cash 400,000

Arenas, Capital 1,000,000

Dulay, Capital 600,000
Laurente, Capital 700,000
Cash 2,300,000
2. Non-cash Assets are sold P1,900,000:

Arenas, Dulay and Laurente Partnership

Statement of Liquidation
June 30, 2018

Assets Liabilities Capital

1/3 1/3 1/3
Cash Non-cash Liabilities Arenas, Dulay, Laurente,
Assets Capital Capital Capital
Balances before Liquidation 50,000 2,350,000 400,000 900,000 500,000 600,000
Realization of Non-cash Assets 1,900,000 (2,350,000) (150,000) (150,000) (150,000)
Balances 1,950,000 - 400,000 750,000 350,000 450,000
Payment of Liabilities (400,000) (400,000)
Balances 1,550,000 - - 750,000 350,000 450,000
Distribution to Partners (1,550,000) (750,000) (350,000) (450,000)

General Journal Entries

Cash 1,900,000
Arenas, Capital 150,000
Dulay, Capital 150,000
Laurente, Capital 150,000
Non-cash Assets 2,350,000

Liabilities 400,000
Cash 400,000

Arenas, Capital 750,000

Dulay, Capital 350,000
Laurente, Capital 450,000
Cash 1,550,000

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 the partners. The liquidation will continue until all the non-cash assets
have been realized and all available cash distributed to partnership creditors and
partners.

Installment payments to partners are appropriate if necessary safeguards are used

to ensure that all partnership creditors are paid in full and that no partner is paid
more than the amount to which he would be entitled after all losses on realization of
assets are known. 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 and loss ratio.
2. Payments of liquidation expenses and adjustment for unrecorded liabilities:
both of these items will be distributed among the partners in their profit and
loss ratio as reduction to capital balances.
3. Payments of liabilities to outsiders.
4. Distribution of available cash based on a schedule of safe payments which
assumes possible losses due to inability of the partnership to dispose of part
of all the remaining non-cash assets and failure of the partners with capital
deficiencies to make additional. Payments to partners can also be made
based on a cash priority program.
Sample Problem: Espleta and De Guia to dissolve and liquidate Espleta and De Guia
Partnership on September 23, 2018. On that date, the statement of financial position of the
partnership is as follows:

Assets Liabilities and Capital

Cash 5,000 Accounts Payable-Trade 15,000

Other Assets 100,000 Loan Payable-De Guia 10,000
Espleta, Capital 60,000
De Guia, Capital 20,000
Total Assets 105,000 Total Liabilities and Capital 105,000

On September 23, 2018, non-cash assets with a carrying amount of P70,000 realized
P60,000, and P64,000 was paid to creditors and partners, P1,000 being retained to cover
possible liquidation costs. On October 1, 2018, the remaining non-cash assets realized
P18,000 (net of liquidation costs), and all available cash was distributed to partners. Espleta
and De Guia share profits and losses 40% and 60%, respectively.

Required: prepare the statement of liquidation and journal entries using the following
methods for determining the amount of cash to be distributed to partners:
1. Cash priority program
2. Schedule of Safe Payments.

Espeleta and De Guia

Statement of Installment Liquidation
September 23 - October 1, 2016
40% 60%
Other AP LP Espeleta, De Guia,
Cash Assets Trade De Guia Capital Capital
Balances before Liquidation 5,000 100,000 15,000 10,000 60,000 20,000
Sept 23 - Realization of OA 60,000 (70,000) (4,000) (6,000)
Balances 65,000 30,000 15,000 10,000 56,000 14,000
Payment of Liabilities (15,000) (15,000)
Balances 50,000 30,000 - 10,000 56,000 14,000
Distribution to Partners (49,000) (5,400) (43,600)
Balances 1,000 30,000 - 4,600 12,400 14,000
October 1 Realization of OA 18,000 (30,000) (4,800) (7,200)
Balances 19,000 - - 4,600 7,600 6,800
Payment of Liquidation Expenses (19,000) (4,600) (7,600) (6,800)

General Journal Entries

Cash 60,000
Espeleta, Capital 4,000
De Guia, Capital 6,000
Other Assets 70,000

Accounts Payable - Trade 15,000

Cash 15,000

Espeleta, Capital 43,600

Loans Payable-De Guia 5,400
Cash 49,000

Cash 18,000
Espeleta, Capital 4,800
De Guia, Capital 7,200
Other Assets 30,000

Espeleta, Capital 7,600

Loans Payable-De Guia 4,600
De Guia, Capital 6,800
Other Assets 19,000
CASH PRIORITY PROGRAM
The use of safe payment schedules in support of the illustration I Figure 4-7 is a
reliable method of computing the amount of safe payments to partners for it prevents
excessive payments to any partner. However, the approach is inefficient, if numerous
installment distribution is to be made to partners. Let’s take the illustration I the
previous section. The partnership made two payments and for each, a schedule of
safe payments is made. The procedure of preparing safe payment schedules will go
on as long as there is cash to be to be distributed and until the capital balances are
aligned with the P/L ratio.

These repetitious procedures can be avoided with the introduction of an alternatives

device called the cash priority program. This program which is prepared at the start
of the liquidation process will help the partners project when they can expect to be
included in the cash distribution. If the program is prepared, any amount of cash
received from the realization of partnership assets may be paid immediately to
partnership creditors and later, the partners as specified in the program.

Espeleta and De Guia

Cash Prioty Program
September 23, 2016

Cash Payments to
Espeleta De Guia Espeleta De Guia
Capital Balances 60,000 20,000
Add (Less) : Loan Interest 10,000
Total Partner's Interests 60,000 30,000
Divide by: P/L Ratio 40% 60%
Loss Absorption Balances 150,000 50,000
Priority I: to Espeleta (100,000) 40,000
Balances 50,000 50,000 40,000 -
Priority II: to all partners at their respective P/L ratio

40% 60%
Espeleta De Guia
Installment 1 49,000
P-I to Espleta (40,000) 40,000
P-II to to partners (9,000) 3,600 5,400
43,600 5,400
Installment 2 19,000
P-II to to partners (19,000) 7,600 11,400
- 7,600 11,400
 Espleta De Guia
Installment 1 35,000
Priority I-Espleta - 35,000 35,000

Installment 2 3,000
Priority I-Espleta - 3,000 3,000

Installment 3 10,000
Priority I-Espleta - 2,000 2,000
Priority II-to partners - 8,000 3,200 4,800

Schedule 1 Sched
Schedule of Safe Payments Schedule of Sa
Espeleta and De Guia Paraiso and Liger

Espeleta De Guia
Balances 56,000 14,000
Add Loan Balances 10,000
Total Partner's Interests 56,000 24,000
Less: Restricted Interest
(30,00+1,000) (12,400) (18,600)
Balances 43,600 5,400

RESTRICTED INTEREST = UNSOLD NON-CASH ASSETS + ANY CASH

WITHHELD – UNPAID LIABILITIES