WESLEYAN UNIVERSITY – PHILIPPINES

College of Business and Accountancy

Cabanatuan City

ACCOUNTING FOR SPECIAL TRANSACTION

MODULE 4
Partnership Liquidation

LEARNING OUTCOMES
At the end of the topic the learners are expected to understand liquidation and know the
different methods of liquidation. Students must also know how to make safe payment schedule and
cash priority program.

BIBLICAL VALUES INTEGRATION

2 Corinthians 4:18

"So we fix our eyes not on what is seen, but on what is unseen, since
what is seen is temporary, but what is unseen is eternal."

INTRODUCTION
This module covers the discussion on Partnership dissolution. It provides information
regarding the nature, concept and the effects dissolution on the operation of the partnership. It gives
facts, figures and other relevant data concerning the accounting procedures in dissolving a partnership
which are relevant for accounting students in the event of encountering the same accounting concern
in the practice of profession.

BODY
Required Readings: Accounting for Special Transaction (Advanced Accounting 1) 2021 Edition by
Zeus Vernon B. Millan – Partnership Liquidation Page 102-157

Liquidation means winding up affairs of the partnership by realizing its non-cash assets until
cash becomes sufficient to settle its liabilities and distributing the remaining cash and other assets
to the partners. All matters concerning liquidation process must be agreed upon by all the partners
and should be incorporated in the articles of co-partnership.

PROCEDURES IN PARTNERSHIP LIQUIDATION

When partnership needs to be liquidated, the profit or loss needs to be determined and
distributed to partners, the books of accounts need to be adjusted and closed.

Upon liquidation, non-cash assets are to be realized. Gains or losses on realization of asset
including liquidation expenses are charged to the capital accounts of the partners. Available cash is
used for the settlement of obligations to creditors. Finally, after all obligations are settled, the
remaining cash is to be distributed to the partners as settlement of their interest in the partnership.

Article 1389 of the New Civil Code of the Philippines provides the following provisions
concerning partnership liquidation.
1. The assets of the partnership are:

a. The partnership property,

b. The contribution of the partners necessary for the payment of all liabilities specified
below.

2. Payment of the liabilities of the partnership should be made in the following order:

a. First, those owing to outside creditors.

b. Second, that owing to partners for loan accounts or other than their capital. Balances
and shares in the profit.
 c. Third, those owing to partners for their capitalcontributions.
d. Lastly, those owing to partners fortheir share in the profits.

The rule indicating priority of partner’s loan account over the partner’s capital account gives
the partners the option to exercise his right of offset. When partners’ capital account shows a
debit balance, the said partner has a loan receivable from the partnership, the partner is given
the legal right to apply part of his entire loan against his capital deficiency, this legal doctrine
is called the right of offset.

3. When the partnership assets are not enough to settle the claims off all outside creditors,
solvent partners should make additional contributions to the partnership. Any contributions in
excess of his share in the liability can be eventually recovered by the solvent partner by way of
collecting the additional contributions from the other partners.

4. Partners’ creditors have priority over the partnership properties, in the same manner that
the partners’ personal creditors have priority over the partners’ personal properties.

5. If a partner becomes insolvent, his personal properties shall be distributed as follows:

a. First, those owing to personal creditors

b. Second, those owing to partnership creditors

c. Lastly, those owing to the partners for contribution made when the assets of the
partnership were insufficient to settle all obligations.

6. In case the partnership is insolvent, an industrial partner is liable to pay the partnership
creditors out of his personal properties since he is a general partner. A limited partner, on the
other hand is liable only to the extent of his contribution in the partnership (Article 1843).

METHODS OF PARTNERSHIP LIQUIDATION

When a partnership is to be liquidated by selling non-ash assets, the following methods may be used:

1. Lump-sum Liquidation or Total Liquidation

2. Installment liquidation or Piece-meal liquidation

PRO-FORMA ENTRIES RELATED TO LIQUIDATION

The following are the pro;-forma entries in the liquidation process.

1. Sale of non-cash assets

Cash xx

Non-cash Assets xx

To record sale at book value.

Cash xx

Non-cash Assets xx
Partner, Capital xx
Partner, Capital xx

To record sale of non-cash asset with the gain distributed

to partners’ capital.

Cash xx
Partner, Capital xx
Partner, Capital xx

Non-cash Assets xx
To record sale of non-cash asset with the
loss distributed to partners’ capital.
 2. Payment of Liabilities
Liabilities xx

Cash xx

To record payment of liabilities

3. Exercise of right of offset

Loan payable to partner xx

Partner, Capital xx

To offset partner’s deficiency against loan owed to him.

4. Additional investment by deficient partner

Partner, Capital xx

Cash xx

To record additional investment by deficient partner.

5. Absorption of Deficiency by the solvent partner

Solvent Partner, Capital xx

Deficient Partner, Capital xx

To record absorption of deficiency by the solvent partner

6. Distribution of cash to partners

Partner, Capital xx
Partner, Capital xx

Cash xx

To record distribution of remaining cash to partners

LUMP-SUM LIQUIDATION
A lump-sum liquidation of a partnership is one in which all non-cash assets are converted into
cash over a short period of time and all liabilities to outside creditors are paid, and a single lump-sum
payment is made to the partners for their total interest.

The following accounting procedures are used in lump-sum liquidation:

1. The following to be adjusted and the nominal accounts are closed.

2. Realization of non-cash asset and the distribution of gain or loss on realization among the
partners based on their profit or loss ratio.

3. Payment of expense. Certain costs and expenses may be incurred during the liquidation
process to facilitate the immediate realization of non-cash assets. Payment of these
expenses should be allocated to the partners based on their profit or loss ratio.

4. Elimination of partners’ capital deficiency by using one or more of the flowing methods:

a. If the deficient partner has a loan account balance, exercise the right of offset.
b. If the deficient partner is solvent, require him to make additional investment to
eliminate deficiency.

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

5. Payment of liabilities or claims owing to outside creditors.

 6. Payment of partners’ interest, in order of priority:
a. Loan accounts
b. Capital accounts

INSTALLMENT LIQUIDATION
Realization of non-cash asset under this method is accomplished over an extended period of
time. It is a process whereby assets are realized on piece-meal basis. Cash is periodically distributed
to partners as it becomes available. This is because instalment payment may be made to partners only
after anticipating all the liabilities, possible losses and liquidating expenses. The procedures to
follow in the liquidating process is the same as the procedures discussed in lump-sum
liquidation, except that cash distributed on instalment basis and it depends upon its availability
after possible losses have been apportioned to partners or in accordance with an advance distribution
plan.
To avoid errors in making payments and any liabilities arising from such errors, payments
should be made only to the partners who have credit balances after dividing the possible losses
among the partners. One of the tools to guarantee that substantial care is followed in distributing
the available cash to the partners is the schedule of safe payments.

SCHEDULE OF SAFE PAYMENTS

It is a schedule prepared periodically to support statement of partnership liquidation. It indicates
how much cash available for distribution to the partners. As previously mentioned, cash will be
distributed only to the partners with credit balances after distributing all possible losses among the
partners. All possible losses consist of the following:

a) Total value of unsold non-cash assets

b) Cash withheld to pay anticipated liquidation expenses and liabilities that may arise

c) Additional possible losses due to inability of the other deficient partner to settle their
deficiency.

Take note that payment to partners based on periodic computation of safe payments brings, at
some point of the liquidation process, the partners’ capital balances to the profit and loss ratio. The
absence of any deficiency after distributing possible loss indicates that the ratios of the capital balance
are proportion to the profit or loss ratio. Schedule of safe payments in the subsequent period are no
longer necessary because all subsequent payments can be based solely on the profit and loss ratio.
Meaning each partner’s capital is enough to absorb his share of the maximum anticipated possible loss.

CASH PRIORITY PROGRAM

As previously discussed, to ensure the proper and correct distribution of available cash to
partners, there is needed to prepare a schedule of safe payments. However, it has been observed that
we have to continue preparing it until such time that partners’ interest are in proportion to their P&L
ratio. Should the liquidation process extend over the long period of time, there is a need to prepare a
schedule of safe payments repeatedly.

To address such concern, in lieu to the schedule of safe payments, an advance planning for
cash distribution may be prepared, which is called the Cash Priority Program. The program will be
prepared prior to the liquidation process to determine how cash should be safely distributed if and
when it becomes available.

SUMMARY:

 Liquidation is the termination of business operations or the winding up of affairs.

 Orders of priority in the settlement of claims in cases of liquidation:
(1) Outside creditors; (2) Inside creditors; and (3) owners’ capital balances.
 In case of partnership insolvency, only the excess of partner’s personal assets over his personal
liabilities can be used to settle partnership debt. Any capital deficiency of an insolvent partner
is absorbed by the solvent partner.
 Accounting procedures when computing for settlement of the partners’ interests in cases of
liquidation:
o Step 1 – Compute the net proceeds. Deduct all expenses, whether paid or not, as well
as any cash retention for future costs.
 o Step 2 – Compute for the gain or loss by comparing the net proceeds with the total
carrying amount of non-cash assets, whether sold or not.

o Step 3 – allocate the gain or loss to the partners’ interests. Any residual amount in a
partner’s capital balance represents the settlement of his interest in the partnership.

 Under the cash priority program, when all the priorities are paid, any remaining cash
distribution is allocated to the partners based on their respective P/L ratio.

REFERENCES:
*Accounting for Special Transaction (Advanced Accounting 1) by Zeus Vernon Millan
*Advanced Accounting 1 by Antonio J. Dayag