PARTNERSHIP LIQUIDATION

Liquidation

Liquidation is the termination of business operations or the winding up of affairs. It is a process by

which:

1. the assets of the business are converted into cash,

2. the liabilities of the business are settled, and

3. any remaining amount is distributed to the owners.

Methods of Liquidation

1. Lump-sum liquidation – the partners’ claims are settled in a single, lump-sum payment after all
non-cash assets are realized and after all liabilities are settled.

2. Installment liquidation – the partners’ claims are settled on an installment basis as non-cash
assets are realized and as cash becomes available, but only after all liabilities are fully settled.

The installment liquidation is common in practice. Cash installment may be based on a:

1. Schedule of safe payments – this is reagrded as the presumptive loss approach. Every time a
realization is made, the balance of the unrealized non-cash asset is presumed to be a total loss
which is then distributed to the partners. Any positive balance in the partners’ capital balances
represent the safe payments.
2. Cash priority program – the loss absorption capacity of each partner is determined and ranked
from highest to lowest. The incremental differences in the partner’s loss absorption capacity
multiplied by the partners’ respective profit-sharing ratio indicate the priority payments.

Settlement of Claims

The available cash of the partnership is used to settle claims in the following descending order:

1. First, to outside creditors;

2. Second, to inside creditors (e.g., payables to partners);

3. Third, to owners’ interests.

Lump-Sum vs. Installment Liquidation

Marshalling of Assets

A partner who is solvent, shall be required to make additional contributions to settle any deficiency in
his capital balance, subject to the following order of priority over his personal assets:

1. The partner’s separate creditors

2. The partnership creditors

3. To the other partners by way of contribution

The capital deficiency of an insolvent partner shall be offset to the capital credits of the other partners.

Steps on Computing the Settlement Amount for the Partner’s Interest

1. Compute for the net proceeds. Any liquidation expenses incurred, whether paid or not, are
deducted in the net proceeds.
2. Compute the gain or loss by comparing the net proceeds with the total carrying amount of non-
cash assets.
3. Allocate the gain or loss to the partners. Any residual amount in the partner’s interest
represents the settlement of his interest in the partnership.
Lump-Sum Liquidation

Realization of noncash assets:

- Collection of receivables xx
- Sale of inventories, PPE, and other noncash assets xx
Liquidation expenses (paid or unpaid) (xx)
Net proceeds xx
Carrying amount of all noncash assets except loans to partners (xx)
Gain/(Loss) xx

A B Totals

Capital balance xx xx xx
Payable to (Receivable from) partner xx xx xx

Total xx xx xx
Allocation of gain/(loss) (using P/L ratio) (xx) (xx) (xx)

Amounts received by the partners xx xx xx

Installment Liquidation

Beginning cash balance xx

Net proceeds xx
Total liabilities (xx)
Total liquidation expenses (xx)
Cash to be distributed xx

Safe Payments Schedule A B Totals

Capital balance xx xx xx
Payable to (Receivable from) partner xx xx xx

Total xx xx xx
Allocation of gain/(loss) (using P/L ratio) (xx) (xx) (xx)
Allocation of maximum possible loss
(xx) (xx) (xx)
(unsold noncash assets + future liquidation expense)
Elimination of deficiency (xx) (xx) (xx)

Amounts received by the partners xx xx xx

Cash Priority Program

A B

Capital balance xx xx
Payable to (Receivable from) partner xx xx

Total xx xx
Divided by: P/L Ratio xx% xx%

Loss absorption (ranked from highest to lowest*) xx xx

* Whoever has the highest loss absorption shall be the 1st priority

1st Priority Partner loss absorption xx

2nd Priority Partner loss absorption (xx)

Excess xx
Multiplied by: P/L Ratio of the 1st Priority Partner xx%

Cash to be distributed to 1st Priority Partner xx

Any excess cash after paying all the priorities shall be distributed to all partners based on their P/L ratio.