Pship Liquidation

Partnership Liquidation
Learning Objectives
1. Define partnership liquidation and identify its causes.
2. Discuss the various problems encountered in partnership
liquidation.
3. Identify and differentiate the two types of liquidation.
4. Discuss and understand the accounting procedures under lump-
sum liquidation.
Introduction
• Dissolution does not mean the formal termination of a business
• Dissolution can be recognized as change in the capital structure
of a business as a new unit
• Dissolution calling for the winding up of business affairs –
LIQUIDATION
• Association of the partners for the purposes of carrying on
activities in the usual manner is considered ended
• Partners engage in activities leading to final settlement
Dissolution with Liquidation
• Completely terminated or ended
• 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
Accounting Problems
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
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
doubtful accounts
4. Liquidation of the business
Causes of Partnership Dissolution with
Liquidation
1. Accomplishment of the purpose for which the partnership was
organized
2. Termination of the term/period covered by the partnership
contract
3. Bankruptcy of the firm
4. Mutual agreement among the partners to close the business
Accounting Problems (Cont’d)
• At this point of partnership liquidation, the assets and liabilities
of the partnership are directly intertwined with those of the
individual partners’ personal assets and liabilities because of the
unlimited liabilities of the partner
• Priorities for creditor claims involve two concepts:
1. Marshaling of assets
2. Right of offset
Marshaling of Assets
• The order of creditors’ rights against the partnership’s assets and
the personal assets of the individual partners.
• The order of which claims against the partnership’s assets will
be marshaled as follows:
1. Partnership creditors other than partners
2. Partners’ claims other than capital and profits, such as loans
payable and accrued interest payable
3. Partners’ claim to capital or profits, to the extent of credit
balances in capital accounts
Marshaling of Assets (Cont’d)
• The order of claims against the personal assets of the individual
partners are as follow:
1. Personal creditors of individual partners
2. Partnership creditors on unpaid partnership liabilities
regardless of a partner’s capital balance in the partnership
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.
a
pa • Pro
rt
ces
ne
s
rs
of
hi
sett
p • The interval of
lin •
as Po time between
g
a int dissolution and
the
go in termination of
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ine
g me affairs; it is
ss
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of
nc en process of
par
er all winding up a
tne
n; par business which
rsh
it tne is normally
ip
is rsh consists of
aff
th ip conversion of
air
e aff assets into
s;
te air cash, payment
it
r s of liabilities
is
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m are and
syn
in en distribution of
on
ati de remaining cash
ym
on d among the
ous
of partners
to
th
liq
e
uid
Definition
lif
ati
e
on
Termination
Winding up
Liquidation
Dissolution
of
th
e
pa
rt
ne
rs
hi
p
r t
o b
c al
• Exc • E a
e
n
s ess • Exce x c
s of ss of ce e
o the the ss in
f selli cost of hi
c ng or a s
o pric book p c
n e valu ar a
v over e tn pi
ta
e the over er
l
rt cost the ’s a
i or selli sh c
n boo ng ar c
g k price e o
n valu of o u
Terms (Cont’d)
o e of the n nt
n the asset lo af
- asse s ss te
r
c ts disp es
re
a disp osed o c
s osed or v ei
h or sold er vi
a sold thro hi n
s thro ugh s g
s ugh reali ca hi
on Realization of
et reali zatio pi s
s zati n ta s
Loss on Realization
Capital Deficiency
GainDefinition
Deficient Partner
i on l
ar
n
Realization
e
t o
o n
c th
a e
s lo
h ss
o
n
re
• Legal
right to
apply
part or
all of
the
amount • Sum
owing
of a
to a
partne
partner
r’s
on the
capital
loan
, loan
balance
balanc
against
Definition of Terms (Cont’d)
e and
deficien
advan
cy in his
ces to
capital
the
account
partne
resulting
rship
from
losses in
the
process
of
liquidati
on
Partner’s Interest
Right of Offset
• Distributio
• Assets are
n of cash to
realized on
the partners
a piecemeal
is done
basis and
only after
cash is
all the non-
distributed
cash assets
to partners
have been
on a
realized,
periodic
the total
basis as it
amount of
becomes
gain or loss
available,
on
that is, even
realization
ofbyLiquidation
before all
is known
non-assets
and all
are
liabilities
converted
have been
into cash
paid
Lump-sum Liquidation
Installments or Piece-
meal Liquidation
Liquidation by
Liquidation
Totals
or Types
Procedures in Lump-Sum Liquidation
• Books should be adjusted and balances of nominal accounts are
closed
• Net income or loss for the period is transferred to the partners’
capital account
• Advances and withdrawals are closed to capital account since cash
settlement shall be based on the partners’ capital account balance
• Ready to proceed with liquidation
(Cont’d)
• 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.
• Distribution of cash to creditors and partners. In this procedure,
the provisions of the marshaling of assets and the exercise of the
right to offset are applied
(Cont’d)
• Liquidation expenses may be incurred to facilitate the immediate
realization of non-cash assets. Payment of liquidation expenses
reduces the cash and is recorded as a deduction from the partners’
capital based on the partners’ profit or loss ratios.
• When realization 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 (called 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 of offset shall
(Cont’d)
be the amount of the loan or the amount of the deficiency whichever,
is lower.
• Cash can be distributed to partners before or after the elimination of
the deficiency. If cash is distributed after the elimination of the
deficiency.
• Capital deficiency is eliminated by:
1. Making additional cash investment, if the deficient partner is
solvent.
2. Charging the deficiency as additional loss to the remaining
partners, if the deficient partner is insolvent.
(Cont’d)
• Cash available for distribution is then paid to partners to apply first
on loan then on capital.
• Note that the final distribution of cash to partners is made based on
partner’s capital balances and not on any ratio.
• If cash is distributed to partners before eliminating the deficiency:
1. Cash available for distribution is paid to partners based on an
accompanying schedule to determine amounts to be paid to
partners.
(Cont’d)
2. Deficient partner may
a. If solvent, make additional investments; to be paid to partners as
second cash distribution, or the deficient partner may make direct
cash settlement to other partners.
b. If insolvent, the deficiency shall be absorbed by the other partners
as additional loss according to their profit or loss ratio.
(Cont’d)
• The personal status of partners (that is, personal assets and
personal liabilities) is sometimes provided in the problem to
indicate that a partner is solvent or insolvent.
• When personal assets 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.
Statement of Liquidation
• Prepared to summarize the liquidation process
• Basis of the journal entries made to record liquidation
• Presented in working paper form the effect of liquidation on
the statement of financial position
• Shows conversion of assets into cash, the allocation of gain
or loss on realization, and distribution of cash to creditors
and partners.
Illustrative Problem A
E n cin a , E n dra da a n d E lin a
St a t em en t of F in a n cia l P osit ion
Decem ber 1, 2010
Assets Liabilities and Equity

Ca sh 8,000 Lia bilit ies 44,800
Ot h er Asset s 136,000 E n dra da , Loa n 2,000
E lin a , Loa n 3,200
E n cin a , Ca pit a l 38,000
E n dra da , Ca pit a l 24,000
E lin a , Ca pit a l 32,000
Tot a l Asset s 144,000 Tot a l Lia bilit ies a n d Ca pit a l 144,000
Illustrative Problem A (Cont’d)
CASE:
1. The other assets were sold for P140,000.
4. The other assets were sold for P68,000. Deficient partner was
solvent.
5. The other assets were sold for P68,000. Deficient partner was
insolvent.
Illustrative Problem A (Cont’d)
6. The other assets were sold for P68,000. Distribution of available
cash is:
a) Before eliminating capital deficiency; and
b) After eliminating capital deficiency
Instructions:
7. Prepare a statement of liquidation of the cases. For case 6, prepare
also a schedule of cash distribution.
8. Present journal entries to record the liquidation process.
Points of Emphasis in the Preparation of
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 debits. These are cash and other
assets regardless of whether the assets were given itemized like cash,
receivables, inventory, supplies equipment, etc. Noncash assets are
classified as “other assets.”
3. Gain on realization increases capital while loss on realization
decreases capital.
Points of Emphasis in the Preparation of
Statement of Liquidation (Cont’d)
4. Figures in parenthesis for each liquidation transaction represents
reduction in the account.
5. Double rule when all column are brought to zero balance.
CASE 1 – Gain on realization, no capital deficiency
Encina, Endrada and Elina

December 1 to 31, 2010
Other Loan Capital

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

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 2,000 103,200
3,200 39,600 - - 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Sale of assets and distribution of gain 140,000 (136,000) nca-assets of P136,000 sold 1,600 1,600thus gain
for 140,000, 800of
Balances 148,000 - 44,800P4,0002,000
which will be distributed
3,200 39,600 to25,600
partners, 32,800
as
Payment of liabilities (44,800) follows:
(44,800)
4,000 x 40% = 1,600 Ecina
Balances 103,200 - - 4,000 2,000 3,200Endrada
x 40% = 1,600 39,600 25,600 32,800
Payment to partners (103,200) 4,000(2,000)
x 20% = (3,200) (39,600) (25,600) (32,800)
800 Elina

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
CASE 1 –
Journal Entry ??
Gain on realization, no capital deficiency

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
CASE 1
Journal Entry
– Gain on realization, no capital deficiency
Cash 140,000
NCa-assets 136,000
Encina, Capital 1,6001 to 31, 2010
December
Endrada, Capital 1,600

Other Loan Capital
Elina, Capital Cash 800Liabilities Endrada Elina
Assets Encina Endrada Elina
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
2. Payment of Outside Creditors

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
J/E Liabilities
Balances 44,800
103,200 - - 2,000 3,200 39,600 25,600 32,800
Cash 44,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
J/E Liabilities
Balances 44,800
103,200 - - 2,000 3,200 39,600 25,600 32,800
Cash 44,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
3. Payment to internal creditors and O/E balance of partners

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
Journal Entry?
CASELoans
Debit 1 – Payable
Gain to onEndrada
realization,2,000 no capital deficiency
Loans Payable to Elina 3,200
Encina, Capital 39,600
Endrada, Capital Encina, Endrada and25,600
Elina
Elina, Capital 32,800
Credit Cash 103,200
Other Loan Capital
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
Journal Entry?
CASELoans
Debit 1 – Payable
Gain to onEndrada
realization,2,000 no capital deficiency
Loans Payable to Elina 3,200
Encina, Capital 39,600
Endrada, Capital Encina, Endrada and25,600
Elina
Elina, Capital 32,800
Credit Cash 103,200
Other Loan Capital
Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800

Other Loan Capital

Balances 148,000 - 44,800 2,000 3,200 39,600 25,600 32,800
Balances 103,200 - - 2,000 3,200 39,600 25,600 32,800
CASE 2 – Loss on realization, no capital deficiency

Other Loan Capital

Sale of assets and distribution of loss 100,000 (136,000) (14,400) (14,400) (7,200)
Balances 108,000 - 44,800 2,000 3,200 23,600 9,600 24,800
Balances 63,200 - - 2,000 3,200 23,600 9,600 24,800
CASE 4 – Loss on realization, capital deficiency,
right to offset, deficient partner is solvent
E n cin a , E n dra da a n d E lin a
Sta tem en t of Liqu ida tion
Decem ber 1 to 31, 2010
Oth er Loa n Ca pita l

Ca sh Assets Lia bilities E n dra da E lin a E n cin a E n dra da E lin a
P rofit a n d loss ra tio 2 (40%) 2 (40%) 1 (20%)
Ba la n ce before liqu ida tion 8,000 136,000 44,800 2,000 3,200 38,000 24,000 32,000
Sa le of a ssets a n d distribu tion of loss 68,000 (136,000) (27,200) (27,200) (13,600)
Ba la n ces 76,000 - 44,800 2,000 3,200 10,800 (3,200) 18,400
P a ym en t of lia bilities (44,800) (44,800)
Ba la n ces 31,200 - - 2,000 3,200 10,800 (3,200) 18,400
Offset of loa n a ga in st th e debit ba la n ce
in th e ca pita l deficien cy of E n dra da (2,000) 2,000
Ba la n ces 31,200 - 3,200 10,800 (1,200) 18,400
Addition a l in vestm en t by E n dra da 1,200 1,200
Ba la n ces 32,400 - 3,200 10,800 - 18,400
P a ym en t to pa rtn ers (32,400) - (3,200) (10,800) - (18,400)

Pship Liquidation

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Pship Liquidation

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Partnership Liquidation

Assets Liabilities and Equity

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Endrada, Capital 1,600

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Encina, Endrada and Elina

Other Loan Capital

Oth er Loa n Ca pita l

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