AFAR 1 Module Topic 4

Accounting for Partnership Liquidation

Learning Objectives

After studying these topics, students should be able to:

1. Identify the objectives of a partnership during liquidation process
2. Differentiate methods of partnership liquidation.
3. Prepare statement of liquidation using the lump sum method.
4. Prepare statement of liquidation using the installment method.
5. Explain the step by step accounting procedures on lump sum liquidation.
6. Explain what is gain or loss on realization.
7. Explain loss on realization when:
 fully absorbed by partners’ capital balances
 loss result in capital deficiency to a partner with a loan.
 There is a capital deficiency to a solvent partner
 There is a capital deficiency to an insolvent partner
8. Prepare statement of liquidation using installment method.
9. Prepare schedule of safe payment supplement to statement of installment liquidation.
10. Prepare cash distribution program.
11. Solve problem on lumps sum liquidation.
12. Solve problem on installment liquidation

What is LIQUIDATION?

Liquidation of a business involves selling the assets of the firm, paying liabilities, and distributing
any remaining assets. Liquidation may result from the sale of the business by mutual agreement of
the partners, from the death of a partner, or from bankruptcy. Partnership liquidation ends both
the legal and economic life of the entity.

From an accounting standpoint, the partnership should complete the accounting cycle for the final
operating period prior to liquidation. This includes preparing adjusting entries and financial
statements. It also involves preparing closing entries and a post-closing trial balance. Thus, only
balance sheet accounts should be open as the liquidation process begins.

There are two methods of Liquidation

1. Lump-sum Liquidation – all non-cash asset of the partnership is sold at one time or at a short
period of time.

2. Installment Liquidation -Non-cash assets of the partnership are sold on a piecemeal basis.
Accounting procedures will be discuss on the later part of this module

In liquidation, the sale of noncash assets for cash is called realization. Any difference between book
value and the cash proceeds is called the gain or loss on realization. To liquidate a partnership, it is
necessary to:

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 1. Sell noncash assets for cash and recognize a gain or loss on realization.
2. Allocate gain/loss on realization to the partners based on their income ratios.
3. Pay partnership liabilities in cash.
4. Distribute remaining cash to partners on the basis of their capital balances.

Each of the steps must be performed in sequence. The partnership must pay creditors before
partners receive any cash distributions. Also, an accounting entry must record each step.

When a partnership is liquidated, all partners may have credit balances in their capital accounts.
This situation is called no capital deficiency. Or, one or more partners may have a debit balance in
the capital account. This situation is termed a capital deficiency. To illustrate each of these
conditions, assume that JDP Company is liquidated when its ledger shows the following assets,
liabilities, and owners' equity accounts.

Assets Liabilities and Owners’ Equity

Cash P 5,000 Notes payable P15,000
Accounts receivable 15,000 Accounts payable 16,000
Inventory 18,000 J. James Capital 15,000
Equipment 35,000 D. Danes Capital 17,800
Accum. Depr. – Equipment (8,000) P. Tons Capital 1,200
Total P65,000 Total P65,000

No Capital Deficiency
The partners of JDP Company agree to liquidate the partnership on the following terms: (1) The
partnership will sell its noncash assets to Jackson Enterprises for P75,000 cash. (2) The partnership
will pay its partnership liabilities. The income ratios of the partners are 3: 2: 1, respectively.

Required: prepare journal entries to record the liquidation

Cash 75,000
Accum. Depr. – Equipment 8,000
Accounts receivable 15,000
Inventory 18,000
Equipment 35,000
Gain on Realization 15,000

To record sale and gain on realization of non-cash assets

Gain on Realization 15,000

James Capital (15X3/6) 7,500
Danes Capital (15k X 2/6) 5,000
Tons Capital (15Kx 1/6) 2,500

To Adjust capital account on gain on realization

Notes payable 15,000

Accounts Payable 16,000
Cash 31,000
To record settlement of liabilities to outside creditors

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 James Capital 22,500
Danes Capital 22,800
Tons Capital 3,700
Cash 49,000
To record settlement of partners’ capital account

JDP Company
Sttement of Liquidation
1-Jan-21

Cash Non cash Liabilities James Danes Tons

assets Capital Capital Capital
Balances 5,000 60,000 31,000 15,000 17,800 1,200
Sale of non cash asset 75,000 (60,000) 7,500 5,000 2,500
Balances 80,000 - 31,000 22,500 22,800 3,700
Payment of liabilities (31,000) (31,000)
Balances 49,000 - - 22,500 22,800 3,700
cash settlement to partners (49,000) (22,500) (22,800) (3,700)

Capital Deficiency
A capital deficiency may result from recurring net losses, excessive drawings, or losses from
realization suffered during liquidation. To illustrate, assume that JDP Company is on the brink of
bankruptcy. The partners decide to liquidate by having a “going-out-of-business” sale. They sell
merchandise at substantial discounts, and sell the equipment at auction. Cash proceeds from these
sales and collections from customers total only P42,000. Thus, the loss from liquidation is P18,000
(P60,000 - P42,000).

Required: prepare journal entries to record the liquidation

a) All partners are solvent
b) All partners are insolvent

a) All Partners are solvent

Cash 42,000
Accum. Depr. – Equipment 8,000
Loss on Realization 18,000
Accounts receivable 15,000
Inventory 18,000
Equipment 35,000
To record sale and loss on realization of non-cash assets

James Capital (18X3/6) 9,000

Danes Capital (18k X 2/6) 6,000
Tons Capital (18Kx 1/6) 3,000
Loss on Realization 18,000
To Adjust capital account on gain on realization

Notes payable 15,000

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 Accounts Payable 16,000
Cash 31,000
To record settlement of liabilities to outside creditors

Cash 1,800
Tons Capital 1,800
To record additional investment of Tons to eliminate
his capital deficiency

James Capital 6,000

Danes Capital 11,800
Cash 17,800
To record settlement of partners capital account

JDP Company
Sttement of Liquidation
1-Jan-21

Cash Non cash Liabilities James Danes Tons

assets Capital Capital Capital
Balances 5,000 60,000 31,000 15,000 17,800 1,200
Sale of non cash asset 42,000 (60,000) (9,000) (6,000) (3,000)
Balances 47,000 - 31,000 6,000 11,800 (1,800)
Payment of liabilities (31,000) (31,000)
Balances 16,000 - - 6,000 11,800 (1,800)
Additional investment of Tons 1,800 1,800
cash settlement to partners 17,800 - - 6,000 11,800 -

b) All partners are insolvent

Cash 42,000
Accum. Depr. – Equipment 8,000
Loss on Realization 18,000
Accounts receivable 15,000
Inventory 18,000
Equipment 35,000

To record sale and loss on realization of non-cash assets

James Capital (18X3/6) 9,000

Danes Capital (18k X 2/6) 6,000
Tons Capital (18Kx 1/6) 3,000
Loss on Realization 18,000

To Adjust capital account on gain on realization

Notes payable 15,000

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 Accounts Payable 16,000
Cash 31,000
To record settlement of liabilities to outside creditors

James Capital 1,200

Danes Capital 600
Tons Capital 1,800
To allocate Tons capital deficiency to James and Danes

James Capital 4,800

Danes Capital 11,200
Cash 16,000
To record settlement of partners’ capital account

JDP Company
Sttement of Liquidation
1-Jan-21

Cash Non cash Liabilities James Danes Tons

assets Capital Capital Capital
Balances 5,000 60,000 31,000 15,000 17,800 1,200
Sale of non cash asset 42,000 (60,000) (9,000) (6,000) (3,000)
Balances 47,000 - 31,000 6,000 11,800 (1,800)
Payment of liabilities (31,000) (31,000)
Balances 16,000 - - 6,000 11,800 (1,800)
allocation of capital deficiency (1,200) (600) 1,800
cash settlement to partners 16,000 - - 4,800 11,200 -

INSTALLMENT LIQUIDATION
Accounting procedures on Installment liquidation

Initial Disposal of Non-cash Assets

1. Sale of non-cash assets and distribution of gain or loss on realization according to their profit and loss
ratio.
2. Payments of liquidation expenses and unrecorded liabilities if any.
3. Payment of partnership liabilities
4. Payment to partners
Succeeding Sale of Non-Cash Assets
1. Sale of non-cash assets and distribution of gain or loss on realization according to their profit and
loss ratio.
2. Payments of liquidation expenses and unrecorded liabilities if any.
3. Payment of partnership liabilities (unpaid balance)
4. Payment to partners
Final Sale of Non-cash Assets
1. Sale of non-cash assets and distribution of gain or loss on realization according to their profit and loss
ratio.
2. Payments of liquidation expenses and unrecorded liabilities if any.
3. In case of capital deficiency:
a. Solvent partner/s
1) Apply right of offset
2) Additional investment
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 b. Insolvent partner/s
1) Apply right of offset
2) Absorption of loss by solvent partners
4. Final CASH settlement to partners

COMPUTATION OF SAFE PAYMENTS

1. Compute the Total Partner’s Interest (Capital + Loan Balance)
2. Distribution of possible loss to partners:
a. Total amount of unsold non-cash assets;
b. Cash withheld to pay for liquidation expenses and any possible unrecorded liabilities;
3. Additional loss to partners to eliminate any capital deficiency.

Sample Problem
The following is the balance sheet of John and Paul on June 1, 2020:

Assets Liabilities and Partners’ Capital

Cash P 50,000 Liabilities P 150,000

Other Assets P 550,000 John, Loan 50,000
John, Capital 225,000
Paul, Capital 175,000
Total P 600,000 P 600,000

The partners share net income and net losses as follows: John, 60%; Paul, 40%. In June, other, assets with a
carrying amount of P 220,000 realized P 180,000, creditors were paid in full, and available cash was
distributed to partners. In July, other assets with a carrying amount P 100,000 realized P 120,000, and
liquidation cost of P5,000 were paid. In August, the remaining other assets realized P 200,000, and final
settlement was made between the partners

Prepare the necessary journal entries and Statement of Liquidation as of June 1, 2020

June 1. Cash 180,000

Loss on realization 40,000
Other Assets 220,000
To record sale of assets and loss on realization

John Capital 24,000

Paul capital 16,000
Loss on realization 40,000
To record allocation of loss to partners

Liabilities 150,000
Cash 150,000
To record full payment of liabilities

John Loan 50,000

John Capital 3,000
Paul capital 27,000
Cash 80,000
To record 1st installment payment to partners

July 1 cash 120,000

Other Asset 100,000
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 Gain on Realization 20,000
To record sale of assets and gain on realization

Gain on Realization 20,000

John Capital 12,000
Paul capital 8,000
To record allocation on gain realization to partners

Liquidation expenses 5,000

Cash 5,000
To record payment of liquidation expenses

John Capital 69,000

Paul capital 46,000
Cash 115,000
To record 2nd installment payment to partners

August 1Cash 200,000

Loss on realization 30,000
Other Asset 230,000
To record sale of assets and loss on realization

John Capital 18,000

Paul capital 12,000
Loss on realization 30,000
To record allocation on loss realization to partners

John Capital 120,000

Paul capital 80,000
Cash 200,000
To record final cash distribution to partners

John and Paul

Statement of Liquidation
June 1 to August 312020

cash other liab john loan john cap paul cap

assets 60% 40%
Balances before liquidation 50,000 550,000 150,000 50,000 225,000 175,000 -
Realization of assets and distribution of loss 180,000 (220,000) (24,000) (16,000)
Balances 230,000 330,000 150,000 50,000 201,000 159,000
payment of liabilities (150,000) (150,000)
Balances 80,000 330,000 - 50,000 201,000 159,000
Payment to partners 1st installment sched 1 (80,000) (50,000) (3,000) (27,000)
Balances - 330,000 - - 198,000 132,000
Realization of assets and distribution of Gain 120,000 (100,000) 12,000 8,000
Balances 120,000 230,000 - - 210,000 140,000
liquidation cost (5,000) (3,000) (2,000)
Balances 115,000 230,000 - - 207,000 138,000
Payment to partners 2nd installment Sched.2 (115,000) (69,000) (46,000)
Balances - 230,000 - - 138,000 92,000
Realization of assets and distribution of loss 200,000 (230,000) (18,000) (12,000)
Balances 200,000 - - - 120,000 80,000
Final settlement (200,000) (120,000) (80,000)

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 COMPUTATION OF SAFE PAYMENTS
1. Compute the Total Partner’s Interest (Capital + Loan Balance)

2. Distribution of possible loss to partners:

a. Total amount of unsold non-cash assets;
b. Cash withheld to pay for liquidation expenses and any possible unrecorded liabilities;

3. Additional loss to partners to eliminate any capital deficiency.

John and Paul

Safe payments schedule
1-Jun-20

john cap paul cap total

Capital balances 201,000 159,000 360,000
add loan 50,000 50,000
Total 251,000 159,000 410,000
Allocation of possible loss (198,000) (132,000) (330,000)
payment 53,000 27,000 80,000

John and Paul

Safe payments schedule
1-Jul-20

john cap paul cap total

Capital balances 207,000 138,000 345,000
Allocation of possible loss (138,000) (92,000) (230,000)
payment 69,000 46,000 115,000

Assessment / Exercises

On the next page is an illustrative problem for you to solve. Answer and Solution are also provided to check
your answers.

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 ABC partnership
Balance Sheet
July 1, 2019

Cash 10,000 Liabilities 15,000

Other Asset 110,000 A capital 60,000
B capital 30,000
C capital 15,000
Total 120,000 Total 120,000

Realization of Other Assets

Book Cash
value Received gain(loss)
July 30000 25,000 (5,000)
August 35000 20,000 (15,000)
October 45000 50,000 5,000
Total 110000 95,000 (15,000)

Lump sum liquidation 50% 30% 20%

Other A B C
Cash asset Liabilities Capital Capital Capital
Balances
Realization of O/A
Balances
Payment of liabilities
Balances
Cash distribution

Installment liquidation with schedule of safe payments schedule of safe payments

50% 30% 20% schedule1 50% 30% 20%
Other A B C A B C
Cash asset Liabilities Capital Capital Capital Capital Capital Capital
Balances Bal.
July Realization possible loss
Balances Bal.
Payment of liabilities add'l possible loss
Balances cash distribution
Cash dist. Sched. 1
Balances schedule2 50% 30% 20%
Aug. realization A B C
Balances Capital Capital Capital
Cash dist. Sched. 2 Bal.
Balances possible loss
October realization cash distribution
Balances
Final cash distribution

Cash Priority Program

50% 30% 20% Cash Payments
A B C 50% 30% 20%
Capital Capital Capital A B C Total
Balances
Divided by P/L ratio
maximum loss absortion
P-I Excess of loss absorption potential A over B
balances
P-II Excess of loss absorption potential A & B over C
balances
P-III Profit and loss ratio in excess of P30,000

July Cash available for distribution 20,000

August Cash available for distribution 20,000
October Cash available for distribution 50,000

A B C Total
July Priority I
Priority II
Total

A B C Total
August Priority II
PriorityIII P/L ratio
total

A B C Total
October Priority III P/L ratio
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Lump sum liquidation 50% 30% 20%
Other A B C
Cash asset Liabilities Capital Capital Capital
Balances 10,000 110,000 15,000 60,000 30,000 15,000
Realization of O/A 95,000 (110,000) (7,500) (4,500) (3,000) (15,000)
Balances 105,000 - 15,000 52,500 25,500 12,000
Payment of liabilities (15,000) (15,000)
Balances 90,000 - - 52,500 25,500 12,000
Cash distribution (90,000) - - (52,500) (25,500) (12,000)

Installment liquidation with schedule of safe payments schedule of safe payments

50% 30% 20% schedule1 50% 30% 20%
Other A B C A B C
Cash asset Liabilities Capital Capital Capital Capital Capital Capital
Balances 10,000 110,000 15,000 60,000 30,000 15,000 Bal. 57,500 28,500 14,000
July Realization 25,000 (30,000) (2,500) (1,500) (1,000) (5,000) possible loss (40,000) (24,000) (16,000) (80,000)
Balances 35,000 80,000 15,000 57,500 28,500 14,000 Bal. 17,500 4,500 (2,000)
Payment of liabilities (15,000) (15,000) add'l possible loss (1,250) (750) 2,000
Balances 20,000 80,000 - 57,500 28,500 14,000 cash distribution 16,250 3,750 - 20,000
Cash dist. Sched. 1 (20,000) (16,250) (3,750)
Balances - 80,000 - 41,250 24,750 14,000 schedule2 50% 30% 20%
Aug. realization 20,000 (35,000) (7,500) (4,500) (3,000) (15,000) A B C
Balances 20,000 45,000 - 33,750 20,250 11,000 Capital Capital Capital
Cash dist. Sched. 2 (20,000) (11,250) (6,750) (2,000) Bal. 33,750 20,250 11,000
Balances - 45,000 - 22,500 13,500 9,000 possible loss (22,500) (13,500) (9,000) (45,000)
October realization 50,000 (45,000) 2,500 1,500 1,000 5,000 cash distribution 11,250 6,750 2,000 20,000
Balances 50,000 - - 25,000 15,000 10,000
Final cash distribution (50,000) (25,000) (15,000) (10,000) (50,000)

Cash Priority Program

50% 30% 20% Cash Payments
A B C 50% 30% 20%
Capital Capital Capital A B C Total
Balances 60,000 30,000 15,000
Divided by P/L ratio 50% 30% 20%
maximum loss absortion 120,000 100,000 75,000
P-I Excess of loss absorption potential A over B 20,000 10,000 10,000 (20,000 x 50%)
balances 100,000 100,000 75,000
P-II Excess of loss absorption potential A & B over C25,000 25,000 12,500 7,500 20,000 (25,000 x 50%), (25,000x30%) ratio A (12,500/20000) 62.50%
balances 75,000 75,000 75,000 22,500 7,500 - 30,000 ratio B (7,500/20000) 37.50%
P-III Profit and loss ratio in excess of P30,000

July Cash available for distribution 20,000

August Cash available for distribution 20,000
October Cash available for distribution 50,000

A B C Total
July Priority I 10,000
Priority II (20,000-10,000) 3,750 10,000
Total 3,750 - 20,000

August Priority II 3,750 10,000

PriorityIII P/L ratio 3,000 2,000 10,000
total 6,750 2,000 20,000

October Priority III P/L ratio 15,000 10,000 50,000

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