Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

CHAPTER 5 CHANGE IN CAPITAL STRUCTURE BY WITHDRAWAL OR RETIREMENT OF

A PARTNER
CHANGE IN CAPITAL STRUCUTRE BY WITHDRAWAL,
RETIREMENT, DEATH OT INCAPACITY OF A The partnership may allow any of its partners to withdraw ore retire from the firm. The business
may continue after such withdrawals; on the other hand, the interest of retiring or withdrawing
PARTNER partner may be:

1. Sold to a new partner (outsider)

LEARNING OBJECTIVES 2. Sold to the continuing (remaining) partners
3. Sold to the partnership
1. Discuss and understand the accounting procedures in recording the retirement or withdrawal of
a partner by sale of interest to a new partner or to the continuing or remaining partners. SALES OF INTEREST TO A NEW PARTNER
2. Discuss and understand the accounting procedures in recording the retirement or withdrawal of
a partner by sale of interest to the partnership With the consent of the remaining partners, the retiring partner may sell his interest to an
3. Discuss and understand the accounting procedures in recording the dissolution of a partnership outsider. The sale is recorded in the same manner as in the admission of a new partner by
due to death or incapacity of a partner. purchase. The partnership recognizes only the transfer of capital interest from the retiring
partner to the new partner.

PREVIEW OF THE CHAPTER SALE OF INTEREST TO CONTINUING PARTNERS

CHANGE IN The interest of the retiring partner maybe acquired by any of the continuing partners. The
transaction is recorded in the same manner as in the sale of interest to a new partner The
CAPITAL STRUCTURE partnership recognizes only the transfer of capital interest from the retiring partner to the
acquiring planner or partners.

SALE OF INTEREST TO THE PARTNERSHIP

Retirement or Retirement or Withdrawal Death or Incapacity of a A retiring partner may sell his capital interest to the continuing partners through the
Withdrawal Sale of Interest to the Partner partnership. The partnership has the obligation to make payment to the retiring partner
Sale of Interest to a Partnership either by:
New Partner or • Equal to capital 1. payment in cash;
Continuing Partners • Equal to capital interest interest 2. transfer of noncash assets; or
• At less than or more than • At less than or more 3. recognition of a liability for the full or the balance of the unpaid interest of the retiring
• Equal to capital capital interest than capital interest partner.
interest • Bonus method • Bonus method
The purchase price or amount of settlement by the partnership to the retiring partner may be:
• At less than capital • Asset Revaluation • Asset 1. equal to the interest of the retiring partner (at book value)
interest method Revaluation 2. less than the interest of the retiring partner (at less than book value)
• At more than capital Method 3. more than the interest of the retiring partner (at more than book value)
interest
When the payment to the retiring partner is less than or more than his capital interest, the
Difference between the purchase price and the capital interest may be accounted for using:
1. bonus method
2. asset revaluation method
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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

ACCOUNTING PROBLEMS INVOLVED IN THE RETIREMENT OF A PARTNER Illustrative Problem A: The statement of financial position of the partnership of Dy, David and
Diaz on December 31, 2014 follows:
The interest in the partnership of a retiring partner must be established upon his retirement. A
partner's interest in the partnership is affected by his investments, withdrawals, share on Assets Liabilities and Capital
partnership profits or losses, loans to the partnership and loans from the partnership. Following Cash P 110,000 Liabilities P 20,000
are the accounting problems involved in determining the capital interest of a retiring partner: Other Assets 30,000 Dy, Capital 20,000
David, Capital 40,000
1. Determination of the profit or loss from the beginning of the accounting period to the date Diaz, Capital 60,000
of withdrawal or retirement and the distribution of such profit or loss. P 140,000 Total Liabilities and Capital P 140,000

2. Closing of the partnership books. The partners share profits and losses in the ratio of 4:2:4. On July l, 2015, Diaz asked to be allowed
to withdraw from the partnership. The partners decided to close the books as of this date so as
3. Correction of accounting errors in prior periods like overstatement or understatement of to determine the capital interest of Diaz. Profit for the six months ended amounted P60,000 while
inventories, excessive depreciation charges and failure to provide adequately for doubtful drawings of Dy, David and Diaz amount to P4,000, P6,000 and P2.000, respectively. Profits and
accounts. losses are to be shared equally after the retirement of Diaz.

4. Revaluation of partnership assets to current values. The following entries will be prepared prior to the retirement of Diaz from the partnership:

5. Recording of bonus brought about by the retirement of a partner. a. Income Summary 60,000
Dy, Capital 24,000
6. Settlement of the interest of the retiring partner. David, Capital 24,000 12,000
Diaz. Capital 12,000 24,000
CALCULATION OF RETIRING PARTNER'S INTEREST Net income from Jun. l to June 30 24,000
divided in the ratio of 4:2:4
The interest of a retiring partner must be established upon retirement, as mentioned earlier. The
b. Dy, Capital 4,000
following are considered in the determination of such interest: investments, withdrawals, share
David, Capital 6,000
in profits and losses to the date of retirement, loans, advances and the revaluation of partnership
Diaz, Capital 2,000
assets to current values.
Dy, Drawing 4,000
David, Drawing 6,000
The following schedule will be helpful in determining the interest of a retiring partner:
Diaz, Drawing 2,000
Investments
After considering the preceding entries, the capital interest of the partners as of July 1, 2015 may
- Withdrawals
now be computed as follows:
+ Share in partnership profits to date of retirement or
Diaz Dy David
- Share in partnership losses to date of retirement
Capital balance, Dec. 31, 2014 P60,000 P20,000 P40,000
+ Loans and advances to the partnership or
Share in Profit from Jan. 1 – June 30 24,000 24,000 12,000
- Loans and advances from the partnership
Withdrawals ( 2,000) ( 4,000) ( 6,000)
+ Revaluation of assets increasing their recorded values or
Capital balance, July 1, 2015 P82,000 P40,000 P46,000
- Revaluation of assets decreasing their recorded values
Interest upon retirement
The entries to record the retirement of Diaz using several assumptions are illustrated below and
on the succeeding pages.

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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

Assumption 1 – Sale of interest to a new partner. Diaz sold his interest to Duque for P 100,000. Bonus Method

Diaz, Capital 82.000 Diaz, Capital 82,000

Duque, Capital 82,000 Cash 76,000
Dy, Capital 4,000
The gain of P18,000 (P100,000 - P82,000) is a personal gain of Diaz since the sale of the interest David, Capital 2,000
to an outsider is a personal transaction between the buying partner and Diaz. P6,000 x 4/6 = P4,000
P6,000 x 2/6 = P2,000
Assumption 2 – Sale of interest to the continuing partners. Diaz sold his interest to Dy and
David for P75,000, the interest being divided equally by the remaining partners. Profits and The bonus of P6,000 is shared by the remaining partners in accordance with their original profit
losses after the retirement of Diaz will be divided equally. and loss ratio of 4:2.

Diaz, Capital 82,000 Asset Revaluation Method

Dy, Capital 41,000
David, Capital 41,000 Dy, Capital 6,000
David, Capital 3,000
The loss of P7,000 (P75,000 – P82,000) is a personal loss of Diaz since the sale of the interest to Diaz, Capital 6,000
Dy and David is personal transaction among the partners. Other Assets 15,000

Assumption 3 - Sale of interest to the partnership. Diaz sold his interest to the partnership. The difference of P6,000 is only a portion of the asset revaluation. The total amount of asset
The partners agreed to make immediate cash settlement to the retiring partner. Profits and revaluation is calculated by dividing the difference of P6,000 by the retiring capital balances of
losses after the retirement of Diaz will be divided equally. the partners will be computed as follows:

Case A - Settlement to retiring partner is equal to his capital interest. The Dy = P15,000 x 4/10 = P6,000
partnership paid Diaz P82,000. David = P15,000 x 2/10 = P3,000
Diaz = P15,000 x 4/10 =P6,000
Diaz, Capital 82.000
Cash 82,000 After the preceding entry, the capital balance of Diaz is P76,000 and payment to him will be
recorded as follows:
This settlement involves no bonus nor asset revaluation
Diaz, Capital 76,000
Case B – Settlement is less than the capital interest of the retiring partner (at less than book Cash 76,000
value). The partnership paid Diaz P76,000 which is P6,000 less than his capital interest of
P82,000. A compound entry may be made as follows:

The difference between the amount of payment and the capital interest of Diaz may now be Dy, Capital 6,000
considered as: David, Capital 3,000
Diaz, Capital 82,000
1. Bonus to the remaining partners (Bonus Method) Cash 76,000
Other Assets 15,000
2. Asset Revaluation reducing the capital accounts of all the partners
(Asset Revaluation Method) Case C – Settlement is more than the capital interest of the retiring partner (at more than
book value). The partnership paid Diaz P85,000 which is P3,000 more than his capital interest
The entries to record the retirement of Diaz using the two alternative solutions follow: of P82,000.

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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

The difference between the amount if payment and the capital interest of Diaz may now be Other Assets 7,500
considered as: Diaz, Capital 82,000
Cash 85,000
1. Bonus from the remaining partners (Bonus Method) Dy, Capital 3,000
2. Asset Revaluation increasing the capital accounts of all the partners David, Capital 1,500
(Asset Revaluation Method)
COMPARISON BETWEEN the BONUS AND ASSET REVALUATION METHOD
The entries to record the retirement of Diaz using the two alternative solutions follow:
The two methods discussed may offer different results as to capital balances of the remaining
Bonus Method partners because of the effect on depreciation of the asset revaluation.

To illustrate the effects of the bonus and asset revaluation method, we will use the information
Diaz, Capital 82,000 under Assumption 3 – Case C, i.e., the payment to the retiring partners is more than his capital
Dy, Capital 2,000 interest. The schedule below shows the comparison between the bonus and the asset revaluation
David, Capital 1,000 method:
Cash 85,000 Assets Dy, David,
P3,000 x 4/6= P2,000 Revaluation Capital Capital
P3,000 x 2/6 = P1,000 Balances after retirement of Diaz under the
bonus method P 38,000 P 45,000
The bonus of P3,000 is shared by the remaining partners in accordance with their original profit Balances after retirement of Diaz under the asset
and loss ration of 4:2. revaluation method P 7,500 P 43,000 P 47,500
Depreciation on asset revaluation (divided equally) (7,500) (3,750) (3,750)
Asset Revaluation Method Balances after depreciation P 39,250 P 43,750
Net advantage (disadvantage) of using the
Other Assets 7,500 bonus method (P 1,250) P 1,250
Dy, Capital 3,000
David, Capital 1,500 Based on the above analysis, David will prefer the bonus method while Dy will prefer the asset
Diaz, Capital 3,000 revaluation method.

The difference of P3,000 is only a portion of the asset revaluation of the partnership. The total CHANGE IN CAPITAL STRUCTURE BY DEATH OR INCAPICITY OF A
amount of asset revaluation is calculated by dividing of P3,000 by the retiring partner’s fraction
of interest or P3,000 ÷ 4/10 = P7,500. Thus, the increase in the capital balances of the partners PARTNER
will be computed as follows:
The death or incapacity of a partner legally dissolves the old partnership since a partner ceases
Dy = P7,500 x 4/10 = P3,000 to associated in the carrying of the business. The remaining partners may continue operations
David = P7,500 x 2/10 = P1,500 based on a new contract or Articles of Co-Partnership. The interest of the deceased OI
Diaz = P7,500 x 4/10 = P3,000 incapacitated partner must be determined by the partnership in order to make necessary
settlement with his legal representatives. In case the business is continued without immediate
After the entry recording the asset revaluation, the capital balance of Diaz is P85,000 and settlement, the legal representative of' the deceased is considered. as an ordinary creditor and is
payment to him will be recorded as follows: to receive an amount equal to the interest and profits attributable to this interest.
Diaz, Capital 85,000
Cash 85,000 The following accounting problems are encountered in case of death or incapacity of a
Partner:
A compound entry may be made as follows:

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Chapter 5 – Change in Capital Structure by Withdrawal, Retirement, Death or Incapacity of a Partner

1. Determination of the profit or loss from the beginning of the accounting period to the date
of death or incapacity and the distribution of such profit or loss.
2. Closing of the books of the partnership. Partnership agreement, however, may provide that
the books need not be closed and net income for the fraction of the accounting period to the
date of death or incapacity be determined.
3. Correction of prior year's income, if there is any.
retirement of a partner. Thus, the capital interest of the partner up to the date of his
incapacity or death should be established. Settlement is then made to the heirs of the partner
or to the legal representatives at an amount that may be equal to the partner’s capital
interest, at more than the capital interest, or at less than the capital interest. When the
settlement is not equal to the deceased or incapacitated partner’s capital interest, the
difference is accounted for under any of the following methods: (1) bonus method; or (2)
asset revaluation method.

4. Revaluation of partnership assets to arrive at current values.

GLOSSARY of ACCOUNTING TERMINOLOGIES
5. Recording of bonus.

6. Settlement of the interest of the deceased or incapacitated partner.
The above problems are similar to those of withdrawal or retirement of a partner. Thus,
accounting for settlement to the deceased or incapacitated partner is the same as that of
withdrawal or retirement.
REVIEW of the LEARNING OBJECTIVES
1. Discuss and understand the accounting procedures in recording the retirement or
withdrawal of a partner by sale of interest to a new partner or to the continuing or
remaining partners. A retiring partner may sell his interest to a new partner or to the
remaining partners. The sale of interest is a personal transaction between or among the
partners and any indicated gain or loss is a personal gain or loss of the retiring partner.
However, before recording the sale, the capital interest of the retiring partner should be
updated. The sale is then recorded by transferring the capital interest of the retiring partner
to the acquiring partner.
Bonus method – a case in retirement or death of a partner wherein the excess of amount paid
over the capital interest of the retiring or deceased partner is recorded as at decrease in the
capital balances of the remaining partners (bonus to retiring or deceased partner from the
remaining partners), the excess of the retiring or deceased partner’s capital interest over the
amount paid to him is recorded as an increase in the capital balances of the remaining partners
(bonus to the remaining partners from the retiring or deceased
partner).
Retired or deceased partner's interest – the capital interest of the partner on date of retirement
or death. It is determined share in profits and losses withdrawals, revaluation of partnership
assets to current values. death, loans, advances and the
Asset revaluation method – the asset revaluation is recorded prior to recoding the settlement
with the retiring or deceased partner. The asset revaluation is determined by dividing the
difference between the retiring or deceased partner’s capital interest and the amount of
settlement by his profit and loss sharing ratio.

2. Discuss and understand the accounting procedure in recording the retirement or

withdrawal of a partner by sale of interest to the partnership. The retiring partner may
sell his capital interest to the partnership, which then pays the former either in cash or in
the form of noncash assets. The capital interest of the retiring partner should be established
on the date of his retirement. The partnership may p ay him an amount that is equal to his
capital interest, at more than his capital interest, the difference may be accounted under
any of the following methods: (1) bonus method (either to the retiring partner or to the
remaining partners); or (2) asset revaluation accruing to all the partners.

3. Discuss and understand the accounting procedures in recoding the dissolution of a

partnership due to death or incapacity of a partner. The dissolution of a partnership due to
death or incapacity of a partner is accounted for in almost the same manner as in the

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 Chapter 6 – Partnership Liquidation (Lump-Sum)

DISSOLUTION WITH LIQUIDATION

CHAPTER 6
A partnership liquidated when its business operations are completely terminated or ended.
PARTNERSHIP LIQUIDATION (LUMP-SUM) The partnership assets are sold, the partnership creditors are paid, and the remaining assets, if
any, are distributed to the partners as a return of their investments.
LEARNING OBJECTIVES Partnership dissolution with liquidation may be caused by any of the following factors:

1. Define Partnership liquidation and identify its causes. 1. The accomplishment of the purpose for which the partnership was organized.
2. Discuss the various problems encountered in partnership liquidation. 2. The termination of the term/period covered by the partnership contract.
3. Identify and differentiate the two types of partnership liquidation.
3. The bankruptcy of the firm.
4. Discuss and understand the accounting procedures under lump-sum liquidation
4. The mutual agreement among the partners to close the business

PREVIEW OF THE CHAPTER Accounting problems involved in the liquidation of a partnership include:

PARTNERSHIP 1. Determination of the profit or loss from the beginning of the accounting period to the
date of liquidation and the distribution of such profit or loss.
LIQUIDATION
2. Closing of the partnership books;

3. Correction of accounting errors in prior periods like overstatement or understatement

of inventories, excessive depreciation charges, and failure to provide adequately for
Nature of Partnership Accounting Procedures in
doubtful accounts; and
Liquidation Lump-Sum Liquidation
In partnership liquidation, the assets and liabilities of the partnership are directly intertwined
• Definition • Realization with those of the individual partners' personal assets and liabilities because of the unlimited
• Causes if liquidation • Distribution of gain or loss on liability of each partner. The priorities for creditors' claims against the assets available to pay the
• Accounting problems in realization partnership liabilities involve two concepts: the marshaling of assets and the right of offset.
partnership liquidation • Payment to creditors
Marshaling of assets involves the order of creditors' rights against the partnership's assets and
• Types of liquidation • Distribution of cash to partners
the personal assets of the individual partners. The order in which claims against the
• Lump-Sum partnership's assets will be marshaled is as follows:
• Installment (piece-meal)
1. partnership creditors other than partners,
2. partners' claims other than capital and profits, such as loans payable and accrued
interest payable; and
INTRODUCTION
3. partners' claim to capital or profits, to the extent credit balances in capital accounts.
Dissolution of a partnership does not mean the formal termination of a business. Dissolution of
The order of claims against the personal assets of the individual partners is as follows:
a partnership can be recognized as a change in the capital structure of a business as a new unit.
Partnership dissolution calling for the winding up of business affairs, called liquidation, shall be
1. personal creditors of individual partners, and
discussed in this chapter. Here, the association of the partners for purposes of carrying activities
2. partnership creditors on unpaid partnership liabilities regardless of a partner's capital
in the usual manner is considered ended. Partners can only engage in activities lending to final
balance in the partnership.
settlement of business affairs.

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Chapter 6 – Partnership Liquidation (Lump-Sum)
Right of offset involves offsetting a deficit in a partner’s capital (debit balance in the capital
account of a partner) against the loan payable to that partner. The loan payable to a partner has
a higher priority in liquidation than a partner's capital balance but a lower priority than liabilities
to outside creditors.
DEFINITION OF TERMS
Dissolution – the termination of a partnership as a going concern; it is the termination of the life
of a partnership.
Winding up – the process of settling the business or partnership affairs, it is synonymous to
liquidation.
Termination - the point in time when all partnership affairs are ended.
Liquidation - the interval of time between dissolution and termination of partnership affairs; it
is also the process of winding up a business which normally consists of conversion of assets into
cash, payment of liabilities and distribution of remaining cash among the partners.
Realization -the process of converting non-cash assets into cash.
Gain on realization - the excess of the selling price over the cost book value of the assets
disposed or sold through realization.
Loss on realization - the excess of the cost or book value over the selling price of the assets
disposed or sold through realization.
Capital deficiency - the excess of a partner's share on losses over his capital.
Deficient partner - a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
Right of offset - the legal right to apply part or all of the amount owing to a partner on a loan
balance against deficiency in his capital account resulting from losses in the process liquidation.
Partner’s interest – the sum of a partner’s capital, loan balance and advances to the partnership.
TYPES OF LIQUIDATION
1. Lump-sum liquidation or liquidation by totals. This is a type of liquidation whereby the
distribution of cash to the partners is done only after all the non-cash assets have been
realized, the total amount of gain or loss on realization is known, and ll liabilities have been
paid.
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2. Liquidations by installment or piece-meal liquidation. This is a type of liquidation
whereby assets are realized on a piecemeal basis and cash is distributed to partners on a
periodic basis as it becomes available, that is, even before all non-assets are converted into
cash.
PROCEDURES IN LUMP-SUM LIQUIDATION
When a partnership is to be liquidated, the books should be adjusted and balances of nominal
accounts are closed. The resulting profit or loss for the period is transferred to the partners’
capital account. Advances and withdrawals are closed to capital accounts since cash settlement
shall be based on the partners’ capital account balances. The partnership is then ready to proceed
with liquidation as follows:
1. Sale of non-cash assets and distribution or allocation of gain or loss on realization among
the partners according to their residual profit and loss ratios (salary and interest factors
disregarded) unless liquidation ratios are specified in the partnership agreement.
2. Distribution of cash to creditors and partners. In this procedure, the provisions of the
marshaling of assets and the exercise of the right of offset are applied.
Liquidation expenses may be incurred to facilitate the immediate realization of non-cash assets.
Payment of liquidation expenses reduces cash and is recorded as a deduction from partners’
capital based on the partner’s profit and loss ratios.
When realization of assets in the course of liquidation results in a loss, the loss is carried to the
capital accounts of the partners as a deduction. If a partner’s capital account results in a debit
balance (known as capital deficiency), after the distribution of loss on realization, such can be
offset against any loan balance of the partner to the partnership. The amount to be offset shall be
the lower of the amount of the loan or the amount of the deficiency.
Cash can be distributed to partners before or after the elimination of the deficiency. If cash is
distributed after the elimination of the deficiency,
1. Capital deficiency is eliminated by
a. Making additional cash investment, if the deficient partner is solvent.
b. Charging the deficiency as additional loss to the remaining partners, if the deficient
partner is insolvent.
2. Cash available for distribution is then paid to partners to apply first on loan then
on capital
Key Points. The final distribution of cash to partners is made based on partners’ capital
balances and not on any ratio.
Chapter 6 – Partnership Liquidation (Lump-Sum)

If cash is distributed to partners before eliminating the deficiency: Case (1) The other assets were sold for P140,000.

1. Cash available for distribution is paid to partners based on an accompanying schedule (2) The other assets were sold for P100,000.
to determine amounts to be paid to partners.
(3) The other assets were sold for P74,000.
2. Deficient partners may
(4) The other assets were sold for P68,000. Deficient partner was solvent.

(a) If solvent, make additional cash investment to be paid to partners as second cash (5) The other assets were sold for P68,000. Deficient partner was insolvent.
distribution, or the deficient partner may make direct cash settlement to the other
partners. (6) The other assets were sold for P68,000. Distribution of available cash is:
a. Before eliminating capital deficiency; and
(b) If insolvent, the deficiency shall be absorbed by the other partners as additional b. After eliminating capital deficiency
loss according to their profit and loss ratio.
Instructions:
The personal status of partners (that is, personal assets and personal liabilities) is sometimes 1. Prepare a statement of liquidation for each of the cases. For case 6, prepare also a
provided in the problem to indicate that a partner is solvent or insolvent. When personal assets schedule of cash distribution.
exceed personal liabilities, the partner is solvent to the extent of the excess. When personal
assets are less than personal liabilities, the partner is insolvent. 2. Present journal entries to record the liquidation process.

STATEMENT OF LIQUIDATION
The statement of liquidation is a statement prepared to summarize the liquidation process. It is
the basis of the journal entries made to record liquidation. This statement presents in working
paper form the effect of the liquidation on the statement of financial position. It shows the
conversion of assets into cash, the allocation of gain or loss on realization, and the distribution of
cash to creditors and partners.
Illustrative Problem A:
Points of emphasis in the preparation of the statement of liquidation
1. Make sure that the balances before liquidation show equality of debits and credits. This will
always be true after each liquidation transaction.
2. Maintain two columns only for the debits. These are cash and other assets regardless of
whether the assets were given itemized like cash, receivables, inventory, supplies,
equipment, etc. Non-cash assets are classified as “other assets.”

Encina, Endrada, and Elina 3. Gain on realization increases capital while loss on realization decreases capital.
Statement of Financial Position
December 1, 2014 4. Figures in parenthesis for each liquidation transaction represent reduction in the account.

Assets Liabilities and Equity 5. Double rule when all columns are brought to zero balance.
Cash P 8,000 Liabilities P 44,800
Other Assets 136,000 Endrada, Loan 2,000
Elina, Loan 3,200
Encina, Capital 38,000
Endrada, Capital 224,000
Elina, Capital 32,000
P 144,000 Total Liabilities and Equity P 144,000

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 1 – The other assets were sold for P140,000. (Gain on realization, no capital deficiency)

Encina, Endrada, and Elina

Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of gain 140,000 (136,000) 1,600 1,600 800
Balances P 148,000 - P 44,800 P 2,000 P 3,200 P 39,600 P 25,600 P 32,800
Payment of liabilities (44,800) (44,800)
Balances P 103,200 - - P 2,000 P 3,200 P 39,600 P 25,600 P 32,800
Payment to partners (103,200) - - (2,000) (3,200) (39,600) (25,600) (32,800)

The other assets with a book value of P136,000 were sold for P140,000 resulting in a P4,000 gain on realization distributed among the partners in their 2:2:1 ratio.

The entries to record the liquidation process are:

(c) Payment to partners
(a) Realization of assets and distribution of gain on realization, 2:2:1
Endrada, Loan 2,000
Cash 140,000 Elina, Loan 3,200
Other Assets 136,000 Encina, Capital 39,600
Encina, Capital (4,000 x 2/5) Endrada, Capital 25,600
Endrada, Capital (4,000 x 2/5) 1,600 Elina, Capital 32,800
Elina, Capital (4,000 x 1/5) 800 Cash 103,200

(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 2 – The other assets were sold for P100,000. (loss on realization, no capital deficiency)

Encina, Endrada, and Elina

Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 100,000 (136,000) (14,400) (14,400) (7,200)
Balances P 108,000 - P 44,800 P 2,000 P 3,200 P 23,600 P 9,600 P 24,800
Payment of liabilities (44,800) (44,800)
Balances P 63,200 - - P 2,000 P 3,200 P 23,600 P 9,600 P 24,800
Payment to partners (63,200) - - (2,000) (3,200) (23,600) (9,600) (24,800)

The other assets with a book value of P136,000 were sold for P100,000 resulting in a loss on realization of P36,000 that can be fully absorbed by the capital balances of all the partners.

The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1 (c) Payment to partners

Cash 100,000 Endrada, Loan 2,000

Encina, Capital (36,000 x 2/5) 14,400 Elina, Loan 3,200
Endrada, Capital (36,000 x 2/5) 14,400 Encina, Capital 23,600
Elina, Capital (36,000 x 1/5) 7,200 Endrada, Capital 9,600
Other Assets 136,000 Elina, Capital 24,800
Cash 63,200
(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 3 – The other assets were sold for P74,000. (Loss on realization, capital deficiency, right of offset)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 74,000 (136,000) (24,800) (24,800) (12,400)
Balances P 82,000 - P 44,800 P 2,000 P 3,200 P 13,200 (P 800) P 19,600
Payment of liabilities (44,800) (44,800)
Balances P 37,200 - - P 2,000 P 3,200 P 13,200 (P 800) P 19,600
Offset of loan against the
debit balance in the ( 800) 800
capital of Endrada
Balances P 37,200 - - P 1,200 P 3,200 P 13,200 - P 19,600
Payment to partners (37,200) - - (1,200) (3,200) (13,200) - (19,600)

The other assets with a book value of P136,000 were sold for P74,000 resulting in a loss on realization of P62,000. The distribution of the loss on realization resulted in a debit balance in the
capital of Endrada. The right of offset can be exercised in as much as Endrada has a loan to the partnership.

The entries to record the liquidation process are:

(c) Offset of loan against capital deficiency
(a) Realization of assets and distribution of loss on realization, 2:2:1
Endrada, Loan 800
Cash 74,000 Endrada, Capital 800
Encina, Capital (62,000 x 2/5) 24,800
Endrada, Capital (62,000 x 2/5) 24,800 (d) Payment to partners
Elina, Capital (62,000 x 1/5) 12,400
Other Assets 136,000 Endrada, Loan 1,200
Elina, Loan 3,200
(b) Payment of liabilities Encina, Capital 13,200
Elina, Capital 19,600
Liabilities 44,800 Cash 37,200
Cash 44,800
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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 4 – The other assets were sold for P68,000. Deficient partner invests additional cash before cash distributions to partners. (Loss on realization, capital deficiency, deficient
partner is solvent)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances P 76,000 - P 44,800 P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Payment of liabilities (44,800) (44,800)
Balances P 31,200 - - P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Offset of loan against the
debit balance in the ( 2,000) 2,000
capital of Endrada
Balances P 31,200 - - - P 3,200 P 10,800 (P 1,200) P 18,400
Additional investment
by Endrada 1,200 1,200
Balances P 32,400 - - - P 3,200 P 10,800 - P 18,400
Payment to partners (32,400) - - - (3,200) (10,800) - (18,400)

The other assets with a book value of P136,000 were sold for P68,000 resulting in a loss on realization of P68,000. The distribution of the loss on realization resulted in a debit balance in the
capital of Endrada that cannot be fully absorbed by his loan. The deficient partner cancels his deficiency by making additional cash investment. By doing so, the partnership will satisfy all its
liabilities including the other partner’s equities.

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Chapter 6 – Partnership Liquidation (Lump-Sum)

The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1

Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (68,000 x 2/5) 27,200
Elina, Capital (68,000 x 2/5) 13,600
Other Assets 136,00

(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

(c) Offset of loan against capital deficiency

Endrada, Loan 2,000

Endrada, Capital 2,000

(d) Deficient partner who is solvent makes additional cash investment

Cash 1,200
Endrada, Capital 1,200

(e) Payment to partners

Elina, Loan 3,200

Encina, Capital 10,800
Elina, Capital 18,400
Cash 32,400

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 5 – The other assets were sold for P68,000. Deficient partner is insolvent and his deficiency is shared by the other [artners before cash distribution. (Loss on realization, capital
deficiency, right of offset, deficient partner is insolvent)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances P 76,000 - P 44,800 P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Payment of liabilities (44,800) (44,800)
Balances P 31,200 - - P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Offset of loan against the
debit balance in the ( 2,000) 2,000
capital of Endrada
Balances P 31,200 - - - P 3,200 P 10,800 (P 1,200) P 18,400
Additional loss to
partners for the
deficiency of Endrada
shared 2:1 (800) 1,200 (400)
Balances P 31,200 - - P 3,200 P 10,000 - P 18,000
Payment to partners (31,200) - - - (3,200) (10,000) - (18,000)

The distribution of the P68,000 loss on realization resulted in a debit balance in the capital account of Endrada that cannot bet fully absorbed by his loan. Failure od the deficient partner to
cancel his deficiency is to be regarded as additional loss, allocated to the remaining partners in their profit and loss ratio. Encina and Elina share on the deficiency of Endrada in the ratio 2:1. The
respective share on the deficiency is computed as follows:

Encina P1,200 x 2/3 = P800

Elina P1,200 x 1/3 = P400

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Chapter 6 – Partnership Liquidation (Lump-Sum)

The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1

Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (68,000 x 2/5) 27,200
Elina, Capital (68,000 x 1/5) 13,600
Other Assets 136,000

(b) Payment of liabilities

Liabilities 44,800
Cash 44,800

(c) Offset of loan against capital deficiency

Endrada, Loan 2,000

Endrada, Capital 2,000

(d) Capital deficiency of insolent partner absorbed as additional loss by remaining partners

Encina, Capital (1,200 x 2/3) 800

Elina, Capital (1,200 x 1/3) 400
Endrada, Capital 1,200

(e) Payment to partners

Elina, Loan 3,200

Encina, Capital 10,000
Elina, Capital 18,000
Cash 31,200

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Chapter 6 – Partnership Liquidation (Lump-Sum)

Case 6 – The other assets were sold for P68,000. Additional cash investment by deficient partner is to be made as second cash distribution partners. All available cash is immediately
distributed to partners requiring a schedule to accompany the statement of liquidation in order to determine amounts to be paid to partners. (Loss on realization, capital deficiency,
right of offset, and cash distributions)
Encina, Endrada, and Elina
Statement of Liquidation
December 1 – 31, 2014

Loan
Other Capital
Cash Assets Liabilities Endrada Elina Encina Endrada Elina
Profit and loss ratio 2 (40%) 2 (40%) 1 (20%)
Balances before P 8,000 P 136,000 P 44,800 P 2,000 P 3,200 P 38,000 P 24,000 P 32,000
liquidation
Sales of assets and
distribution of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Balances P 76,000 - P 44,800 P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Payment of liabilities (44,800) (44,800)
Balances P 31,200 - - P 2,000 P 3,200 P 10,800 (P 3,200) P 18,400
Offset of loan against the
debit balance in the ( 2,000) 2,000
capital of Endrada
Balances P 31,200 - - - P 3,200 P 10,800 (P 1,200) P 18,400
Payments to partners
per schedule (31,200) (3,200) (10,000) (18,000)

Balances - - - - - P 800 (P 1,200) P 400

Additional investment
of Endrada 1,200 1,200
Balances P 1,200 - - - - P 800 - P 400
Payment to partners (1,200) - - - - (800) - (400)

The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to partners. Total partners’ interest is reduced by the restricted interest for possible losses in case the
deficient partner fails to pay his deficiency. Restricted interest for possible losses shall continue up to the point when deficiencies or debit balances in capital are eliminated. When deficiencies
are eliminated. When deficiencies are eliminated, balances shall be called Free Interest – Amounts to be Paid to Partners, to apply first on loan, then on capital.

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(d) First cash distribution to partners, per schedule
Encina, Endrada and Elima
Schedule to Accompany Statement of Liquidation Elina, Loan 3,200
December 1 -31, 2014 Eneina, Capital 10,000
Elina, Capital 18,000
Encina Endrada Elina Cash 31,200

Capital balances before cash distribution P10,800 (P1,200) P18,400 (e) Additional cash investment from deficient solvent partner
Add loan balance 3,200
Total partners’ interest P10,800 (P1,200) P21,600 Cash 1,200
Restricted interest – possible loss of Endrada, Capital 1,200
P1,200 to Encina and Elina in the ratio
of 2:1 if Endrana fails to pay his (f) Second cash distribution to parners
deficiency (800) 1,200 (400)
Free Interest – amounts to be paid to Encina, Capital 800
partners P10,000 - P21,200 Elina, Capital 400
Payment to apply on: Cash 1,200
Loan P 3,200
Capital P10,000 18,000 If the deficient partner makes direct cash settlement to partners, the entry is:
Cash distribution P10,000 P21,200
(e) Encina, Capital 800
Elina, Capital 400
Endrada, Capital 1,200
The entries to record the liquidation process are:

(a) Realization of assets and distribution of loss on realization, 2:2:1 CALCULATION OF CASH SETTLEMENT WITHOUT THE AID OF A
STATEMENT OF LIQUIDATION
Cash 68,000
Encina, Capital (68,000 x 2/5) 27,200
Endrada, Capital (68,000 x 2/5) 27,200 Usually, liquidation problems do not require the preparation of a statement of liquidation but
Elina, Capital (68,000 x 1/5) 13,600 calls only for the calculation of cash settlement to partners. In such cases, however, non-cash
Other Assets 136,000 assets have already been converted into cash, liabilities have been settles but capital remain as
to their balances before liquidation since the gain or loss on realization of non-cash assets has
(b) Payment of liabilities not yet been carries to capital. Any difference, therefore, between the debits (available cash to
partners) and total credits (loans and capitals) is a gain or loss on realization that must first be
Liabilities 44,800 carried to capital before proceeding with the liquidation process.
Cash 44,800
Illustrative Problem B:
(c) Offset of loan against capital deficiency
At December 31, 2014, the capital balances of the partners Ebora, Esteban, and Echavez are
Endrada, Loan 2,000 P160,000; P100,000; and P20,000; respectively, sharing profits and losses in the ratio 3:2:1. The
Endrada, Capital 2,000 partners decided to liquidate, and sold all the non-cash assets for P148,000 cash. After paying all
the liabilities amounting to P48,000, they still have P112,000 cash left for distribution.

The loss on realization is the excess of the credits (total capital) over the debits )cash left for
distribution).
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Chapter 6 – Partnership Liquidation (Lump-Sum)
liquidation (piecemeal liquidation). Under lump-sum liquidation, distribution of cash to the
Total capital (P160,000 + P100,000 + P20,000) P 280,000 partners is done only after realization of all non-cash assets, distribution of gain or loss on
Less Cash left for distributions t partners 112,000 realization and payment of partnership liabilities. Under installment liquidation, asset
Loss on realization of assets P 168,000 realization is on a piece-meal basis and cash is distributed to partners as it becomes
available even if there are still unrealized non-cash assets.
Cash settlement to partners is computed as follows:
4. Discuss and understand the accounting procedures under lump-sum liquidation. Lump-
Ebore Esteban Ecahvez sum liquidation requires the following procedures: (1) realization of non-cash assets (sale
of non-cash assets for cash); (2) distribution of gain or loss on realization to the partners
Capital balances before liquidation P 160,000 P 100,000 P 20,000 according to their liquidation ratio, if there is any, or according to their residual profit and
Loss on realization shared in the loss ratio; 93) payment of liabilities to outside creditors; and (4) distribution of cash to
ration of 3:2:1 (84,000) (56,000) (28,000) partners.
Balances P 76,000 P 44,000 (P 8,000)
Additional loss to Ebora and
Esteban for the deficiency of ( 4,800 ( 3,200) 8,000 GLOSSARY of ACCOUNTING TERMINOLOGIES
Echavez shared in the ratio of 3:2
Cash settlement P 71,200 P 40,800
Capital deficiency – the excess of a partner’s share pf losses over his capital credit balance.
There may be instances when the cash realized from the sale of other assets is not sufficient to
pay partnership liabilities. In such cases, remaining liabilities are satisfied by: Deficient partner – a partner with a debit balance in his capital account after receiving his share
on the loss on realization.
1. The additional cash investment by deficient solvent partners.
Insolvent partner – a partner whose personal assets are less than his personal liabilities.
2. Direct collection by the partnership creditors from any one of the partners and the latter
making cash settlement among themselves. Free interest – a partner’s capital interest that is available for cash payment.

Liquidation – the winding up of the business affairs of a partnership.

REVIEW of the LEARNING OBJECTIVES
Realization – the process of converting non-cash assets into cash.

1. Define partnership liquidation and identify its causes. Partnership liquidation is the Restricted interest – a portion of a partner’s capital account balance that is restricted for
winding up of the business affairs of a partnership; hence the business operation is possible losses on liquidation. It is not, therefore, available for cash payment.
completely terminated or ended. Partnership liquidation may be caused by any of the
following: (1) accomplishment of the purpose of the partnership; (2) termination of the Right of offset – the legal right to apply all or part of a partner’s loan to the partnership against
term/period covered by the partnership contract; (3) bankruptcy of the partnership; and capital deficiency.
(4) mutual agreement among the partners to close the business.
Solvent partner – a partner whose personal assets are more than his personal liabilities.
2. Discuss the various problems encountered in partnership liquidation. The liquidation of
a partnership will give rise to the following problems: (1) determining partnership profit or
loss from the beginning of the accounting period to the date of liquidation and distributing
such profit or loss to the partners: (2) closing the partnership books; (3) correcting
accounting errors in prior periods; and (4) liquidating the business.

3. Identify and differentiate the two types of partnership liquidation. The two types of
partnership liquidation are lump-sum liquidation (liquidation by totals) and installment

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