Advanced Accounting

Accounting for Partnership Liquidation

PART V: ACCOUNTING FOR PARTNERSHIP LIQUIDATION

5.1 Introduction In this part of the chapter the 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 accounts must be adjusted and closed, and the resulting income or loss in the final period is transferred to the capital accounts of the partners. Liquidation of a partnership means winding up the business/operation usually by selling the assets, paying the liabilities, and distributing the remaining cash to partners. Liquidation of a partnership involves the termination of the firm to operate as a going concern usually by realization of non-cash assets, payment of the Partnerships liabilities and the distribution of any remaining assets to the partners. A partnership is liquidated when its business operations are completely terminated Or ended. A business which is in the process of converting its assets into cash and making settlement with creditors and partners is said to be in liquidation. A business under liquidation passes through the following summarized physical process. Realization of non cash assets the process of converting non-cash assets into cash. Payment for Liabilities- pay off partnership obligations Payment to PartnersRemaining assets are distributed to the partners as

a return of their investments. The distribution of cash to partners is made

based on the partners capital balances and not based on the profit and loss ratio.

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Advanced Accounting

Accounting for Partnership Liquidation

5.2 ACCOUNTING PROCEDURES IN PARTNERSHIP LIQUIDATION During liquidation of a partnership the following summarized accounting process are followed:
1.

Adjust the Books of the firm a) Determine the net income/net loss and close the net income/net loss to Partners capital accounts close Revenue and Expense accounts to Income summary b) Close all drawing accounts to their respective capital accounts.

2. Record the realization of non-cash assets and the resulting gain or loss on realization .profit and loss ratio. 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. 3. Record allocation of the gain or loss on realization account balances to the partners capital accounts using profit and loss ratio. 4. Record payment for liabilities 5. Record distribution of remaining cash to individual partners in accordance with their final capital balance after the effect of all allocated losses

Note: Upon liquidation of a partnership, the following concepts and their respective accounting are to be considered.

The right-of-offset doctrine is important in liquidation in order to make sure

that partners with the potential for debit capital balances do not receive premature distributions of assets.

The doctrine of marshaling of assets comes into play when either a

partnership is insolvent and/or individual partners are personally insolvent.

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Advanced Accounting

Accounting for Partnership Liquidation

when cash is not sufficient to pay creditors, the personally solvent partners
shall

Contribute the difference using their loss ratio. When there is a capital deficiency, the partners with the deficiency shall
make additional contribution and the deficiency is eliminated.

if a partner with a capital deficiency is unable to pay the amount owed to the Partnership, The partners with credit balances or surplus must absorb the loss on the
basis of their income and loss ratio.

The cash distributed to each partner is the difference between the partner's present capital balance and the share of loss from deficient partner. 5.3 Types or Forms of Partnership Liquidation

The actual liquidation of a partnership may follow several approaches, including lump-sum liquidation or an installment liquidation supported by a schedule of safe payments. In all cases, the goal is to convert assets into a distributable form, respect the rights of those with claims against the partnership, and not make premature distributions. I. Lump-sum Liquidation It is a form of liquidation in which all the assets of the partnership are converted into cash within a very short time, creditors are paid, and a single payment is made to the partners for their capital interests.

It involves cash distribution to partners only after complete realization of

non cash assets.

It does not allow for cash distribution during realization process

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Advanced Accounting

Accounting for Partnership Liquidation

It is appropriate for small size business that takes a shorter period for
complete realization.

II. Installment Liquidations It is a form of liquidation that involves the selling of some assets, paying the liabilities of the partnership, dividing the available cash to the partners, selling additional assets and making further payments to partners. this process continues until all the assets have been sold and all cash has been distributed to the creditors and to the partners.

Installment liquidations involve the distribution of cash to partners before

complete liquidation of assets occurs.

It allows for cash payment to partners whenever it is available during

realization process

It includes periodic, or installment payments rather than in a final Lump sum

payment to the partners

It is appropriate for large size partnership s they take a longer period for
complete realization. The firm must be especially cautious when distributing available cash, because future event may change the amount to be paid to each partner. Thus, Worst Case Scenario is assumed i.e. the worst possible case is anticipated before determining the amount of installment payment each partner receives. The worst possible case will be aggregate sum of the following elements:

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Advanced Accounting

Accounting for Partnership Liquidation Anticipate Maximum Possible Loss --it is

I. REMAINING NON CASH ASSETS:

assumed that nothing will be realized from the sale of the remaining assets of the partnership
II.

Unrecorded liabilities and

Expenses--any potential liabilities and

liquidation expenses are added to the maximum possible loss from sale of the remaining assets of the partnership
III.

Partner Insolvency--it is assumed that the partners will not be able to make up any capital deficiencies

NOTE: The remaining credit balances in the partners loan and capital accounts

represent amount of safe distribution of assets to partners

5.4 Definition of key terminologies

Liquidation the process of winding up a business which normally consists of

Conversion of assets into cash, payment of liabilities and distribution of remaining among the partners.

Realization the process of converting non-cash assets into cash. Gain on realization the excess of the selling price over the carrying
amount of the non cash assets sold through realization.

Loss on realization the excess of the carrying amount over the selling
price of the non cash assets sold through realization.

Capital deficiency the excess of a partners 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. 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.

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Accounting for Partnership Liquidation

Partners interest the sum of a partners capital, loan balance and advances
to the partnership.

Solvent partner personal assets of the partner exceed his personal

liabilities.

Insolvent partner personal assets of the partner are less than his personal
liabilities.

Statement of Realization & Liquidation an accounting statement

summarizing the winding up of the business affairs of the partnership.

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