Advanced Accounting

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 Partnership’s 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.

Prepared By: Firezer A

Page 1

Advanced Accounting Accounting for Partnership Liquidation 5.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. Record payment for liabilities 5. Record the realization of non-cash assets and the resulting gain or loss on realization . 3. 4. 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 doctrine of marshaling of assets comes into play when either a partnership is insolvent and/or individual partners are personally insolvent. the following concepts and their respective accounting are to be considered. Prepared By: Firezer A Page 2 . • 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. Record allocation of the gain or loss on realization account balances to the partners’ capital accounts using profit and loss ratio.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.

5. and not make premature distributions. • It involves cash distribution to partners only after complete realization of non cash assets. • if a partner with a capital deficiency is unable to pay the amount owed to the • Partnership. 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. • It does not allow for cash distribution during realization process Prepared By: Firezer A Page 3 . I.3 Types or Forms of Partnership Liquidation The actual liquidation of a partnership may follow several approaches. • The cash distributed to each partner is the difference between the partner's present capital balance and the share of loss from deficient partner. the partners with the deficiency shall make additional contribution and the deficiency is eliminated. and a single payment is made to the partners for their capital interests. the goal is to convert assets into a distributable form. In all cases. creditors are paid. the personally solvent partners shall • Contribute the difference using their loss ratio.Advanced Accounting Accounting for Partnership Liquidation • when cash is not sufficient to pay creditors. respect the rights of those with claims against the partnership. • The partners with credit balances or surplus must absorb the loss on the basis of their income and loss ratio. including lump-sum liquidation or an installment liquidation supported by a schedule of safe payments. • When there is a capital deficiency.

dividing the available cash to the partners. Thus. • Installment liquidations involve the distribution of cash to partners before complete liquidation of assets occurs.e. 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.Advanced Accounting Accounting for Partnership Liquidation • It is appropriate for small size business that takes a shorter period for complete realization. because future event may change the amount to be paid to each partner. paying the liabilities of the partnership. II. Worst Case Scenario is assumed i. The worst possible case will be aggregate sum of the following elements: Prepared By: Firezer A Page 4 . • It allows for cash payment to partners whenever it is available during realization process • It includes periodic. the worst possible case is anticipated before determining the amount of installment payment each partner receives. this process continues until all the assets have been sold and all cash has been distributed to the creditors and to the partners. selling additional assets and making further payments to partners. The firm must be especially cautious when distributing available cash. Installment Liquidations It is a form of liquidation that involves the selling of some assets.

• 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.Advanced Accounting Accounting for Partnership Liquidation Anticipate Maximum Possible Loss --it is I. • Deficient partner – a partner with a debit balance in his capital account. • Capital deficiency – the excess of a partner’s share on losses over his capital balance resulting to a debit balance in the capital account. 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 partner’s loan and capital accounts represent amount of safe distribution of assets to partners 5. payment of liabilities and distribution of remaining among the partners. • Gain on realization – the excess of the selling price over the carrying amount of the non cash assets sold through realization.4 Definition of key terminologies • Liquidation – the process of winding up a business which normally consists of Conversion of assets into cash. 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. REMAINING NON CASH ASSETS: assumed that nothing will be realized from the sale of the remaining assets of the partnership II. Prepared By: Firezer A Page 5 . • Realization – the process of converting non-cash assets into cash. • Loss on realization – the excess of the carrying amount over the selling price of the non cash assets sold through realization.

• Solvent partner – personal assets of the partner exceed his personal liabilities. • Statement of Realization & Liquidation – an accounting statement summarizing the winding up of the business affairs of the partnership. loan balance and advances to the partnership. Prepared By: Firezer A Page 6 .Advanced Accounting Accounting for Partnership Liquidation • Partner’s interest – the sum of a partner’s capital. • Insolvent partner – personal assets of the partner are less than his personal liabilities.

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