Partnership Liquidation

Liquidation is the termination of business operations or the winding up of affairs. It is a process by which
1. assets are converted into cash
2. liabilities are settled, and
3. any remaining amount is distributed to the owners

Liquidation may be either voluntary (e.g. per agreement of partners of a solvent partnership) or involuntary (e.g. bankruptcy)

Conversion of non-cash assets into cash

The conversion of assets into cash is referred to as ‘realization,” while the settlements of claims of creditors and owners is referred
to as “liquidation”. However, the term liquidation is used in a broader sense to include the entire winding up process.

Methods of liquidation
Liquidation may be accomplished either through:

1. Lump-sum liquidation – all the non-cash assets of the partnership are sold simultaneously, or within a very short period of time,
and the proceeds are used to settle first all the liabilities and any remaining amount is paid to the partners under a lump-sum
payment.

2. Installment liquidation – in most cases, it would take some time before all the assets of a business are converted into cash. In
such case, the partners’ claims are settled on an installment basis, as cash becomes available, but only after all partnership liabilities
are fully settled.

Settlement of claims
The available cash of the partnership is used to settle claims using the following order of priority:
1. outside creditors
2. inside creditors (e.g. payables to partners)
3. owners’ capital balances

Right to offset
As shown above, a loan payable to a partner has a higher priority over the partner’s capital balance. However, the legal right of
offset allows a deficit in a partner’s capital account to be offset by a loan payable to that partner.

Illustration:
On January 1, 2022, the partners of ABC Co. decided to liquidate their partnership. The following information was made available:

Cash 20,000
Accounts receivable 60,000
Inventory 120,000
Equipment 300,000
Total 500,000
Accounts payable 30,000
Payable to B 20,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
Total 500,000

Case 1: Lump-sum liquidation

Information on the conversion of no-cash assets is as follows:
a. P50,000 was collected on the accounts receivable; the balance is uncollectible
b. P70,000 was received for the entire inventory
c. the equipment was sold for P250,000
d. P2,000 liquidation expenses were paid

Step 1: compute for the gain or loss on the sale

a. collection of accounts receivable 50,000
b. sale of inventory 70,000
c. sale of equipment 250,000
d. liquidation expenses (2,000)
net cash proceeds 368,000
Less: carrying amount of non-cash (480,000)
Total loss on sale (112,000)

Step 2: allocate the gain or loss to the partners’ capital balances (include their right to offset)

A B C Totals
Capital balances 100,000150,000200,000450,000
Payable to B 20,000 20,000
Total 100,000170,000200,000470,000
Allocation of loss (22,400) (33,600) (56,000) (112,000)
Amounts received by partners 77,600 136,400 144,000358,000

Case 2: Installment liquidation

a. 75% of the accounts receivable was collected for only P30,000
b. half of the inventory was sold for P40,000
c. equipment with carrying amount of P200,000 was sold for P120,000
d. actual liquidation expenses of P2,000 were paid
e. estimated future liquidation expenses totaled P1,000
f. P9,000 cash was retained in the business for potential unrecorded liabilities and anticipated expenses

Step 1: compute for the gain or loss

a. collection of accounts receivable 30,000
b. sale of inventory 40,000
c. sale of equipment 120,000
d. actual liquidation expenses (2,000)
e. estimated liquidation expenses (1,000)
f. cash retained for future expenses (9,000)
net cash proceeds 178,000
less; carrying amount of non-cash (480,000)
total loss (302,000)

Step 2: allocate the gain or loss to the partners’ capital balances (include their right to offset)

A B C Totals
Capital balances 100,000150,000200,000450,000
Payable to B 20,000 20,000
Total 100,000170,000200,000470,000
Allocation of loss (60,400) (90,600) (151,000) (302,000)
Amounts received by partners 39,600 79,400 49,000 168,000