Chapter 1 Partnership Liquidation PDF

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PARTNERSHIP LIQUIDATION – LUMP SUM LIQUIDATIONPARTNERSHIP LIQUIDATIONAs per defined in the previous discussion on partnership dissolution, it does not necessary meantermination of the business, instead, it refers to the termination of the partnership as a going concern.In some cases, dissolution res...

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PARTNERSHIP LIQUIDATION – LUMP SUM LIQUIDATION PARTNERSHIP LIQUIDATION As per defined in the previous discussion on partnership dissolution, it does not necessary mean termination of the business, instead, it refers to the termination of the partnership as a going concern. In some cases, dissolution results in the reorganization of the partnership as a new unit that will not necessitate the liquidation process. However, if the recognized condition calls for winding up of business affairs, this will require the process of liquidation. The association of the partners for the purpose of carrying on the business activities in the usual manner is considered ended. Termination is that point in time when all partnership affairs are completely ended and finally settled. It signifies the end of the life of an existing partnership. Some of the causes where there is partnership dissolution with liquidation include the accomplishment of the objective for which the partnership was formed, termination of the period covered as stated in the contract and mutual agreement among the partners to dissolve and liquidate the partnership. Partnership liquidation is the process of winding up the business operations/affairs after dissolution. This is the process where non-cash assets are reduced to cash and distributing the proceeds to the proper parties. The following procedures are to be followed in the process of liquidation: 1. 2. 3.

Conversion of non-cash assets into cash Payment of liabilities to creditors other than partners Payment to partners in the following order: a. Loans to the partnership b. Capital contribution c. Share in profits

1. Conversion of non-cash assets into cash The process of converting non-cash assets into cash is called realization. This involves the collection of receivables, selling of inventories, and selling of property and equipment. Realization of non-cash assets may either result in a gain or loss on realization and will be distributed to the partners based on their profit and loss agreement. Gain on realization is the excess of the selling price over the cost or book value of the assets being disposed, otherwise, the result would be a loss on realization. There is not much problem if the result is a gain since there would be enough cash to settle all the outside creditors and the partners. However, problem arises when the realization resulted in a loss since this will be distributed among the partners as a deduction from their capital balance. If the partner’s capital balance resulted in a negative amount (debit balance) after the distribution of the loss, this is known as capital deficiency and must be eliminated and the affected partner will be known as the deficient partner.

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Capital deficiency may be eliminated in the following manner: a) If the deficient partner has a loan to the partnership, he may exercise the right of offset, which is 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 of liquidation. 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. b) If the deficient partner is solvent and has no loan to the partnership, he may make an additional investment equal to the amount of his capital deficiency, and c) If the deficient partner is insolvent, his capital deficiency will be absorbed by the remaining partners as additional loss based on their profit and loss sharing. A partner is considered solvent if his personal assets exceed his personal liabilities while an insolvent partner is one whose personal liabilities exceed his personal assets. Liquidation expenses maybe incurred to facilitate the realization of non-cash assets and will result in reduction to cash and will be distributed to partners as a deduction in their capital balances according to their profit and agreement. 2. Payment of liabilities to creditors other than partners In the distribution of proceeds from realization, the partnership creditors other partners has the top priority. If the cash available is sufficient, liabilities to this group of creditors must first be settled in full before making any payment to the partners in whatever capacity they are entitled into. In case the partnership cannot meet its obligation to outside creditors, the personal assets of the partners will be applied as payment but only if there is an excess over his personal liabilities. In other words, priority is given to the partner’s personal creditors and any excess will be applied as payment to the partnership creditors. Marshalling of assets involves the order of priorities or creditors’ rights against the partnership assets and the personal assets of the individual partners. The order in which claims against the assets of the partnership will be marshaled is as follows: 1) partnership outside creditors; 2) partners’ claims other than capital and profits, such as loan payable; and 3) partners’ claims to capital or profits, to the extent of credit balances in capital accounts

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3. Payment to partners After the settlement of the liabilities to the partnership outside creditors, any capital deficiency resulting from the distribution of loss on realization, must first be eliminated before making payments to the partners. Settlement with the partners follows this order of priority: 1) Loans to the partnership 2) Capital contributed 3) Share in the profits Accounting problems involved in partnership liquidation include the following: 1. Determining the profit or loss from the beginning of the accounting period to the date of liquidation and the distribution of the such profit or loss; 2. Closing of the partnership books; 3. Correction of the discovered accounting errors of prior periods; and 4. Liquidation of the partnership.

TYPES OF LIQUIDATION 1.

Lump-sum liquidation – this is a process whereby the distribution of cash to partners is done only after all the non-cash assets have been realized, the gain or loss is distributed, and the obligation with the partnership outside creditors have been settled.

2. Liquidation by installment or piece-meal liquidation – this is the process whereby assets are realized on a piecemeal basis and cash is distributed to partners on a periodic basis as it becomes available even before all non-cash assets are realized.

STATEMENT OF LIQUIDATION The statement of liquidation is a statement prepared to show the summary of the process of liquidation. It is the basis for the preparation of journal entries to record the liquidation. It presents the realization of non-cash assets and the distribution of the proceeds to the proper parties.

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ILLUSTRATIVE PROBLEM Assume that the statement of financial position of King, Jolly and Donald shows the following account balances before liquidation:

KING, JOLLY and DONALD Statement of Financial Position October 1, 2019

ASSETS Cash Other Assets

Total Assets

P 16,000 272,000

P 288,000

LAIBILITIES AND CAPITAL Liabilities Jolly, Loan Donald, Loan King, Capital Jolly, Capital Donald, Capital Total Liabilities and Capital

P 89,600 4,000 6,400 76,000 48,000 64,000 P 288,000

Profit and loss ratio: 4:4:2 to King, Jolly and Donald, respectively. Required: 1. Prepare a Statement of Liquidation for each case below: Case 1 – The other assets were sold for P 280,000 Case 2 – The other assets were sold for P 200,000 Case 3 – The other assets were sold for P 148,000 Case 4– The other assets were sold for P 136,000. Deficient partner is solvent. Case 5 – The other assets were sold for P 136,000. Deficient partner is insolvent. Case 6 – The other assets were sold for P 136,000. Additional cash investment of deficient partner is considered as second cash distribution to partners requiring a schedule to accompany the statement of liquidation to determine amounts paid to partners. 2. Journal entries to record the liquidation process.

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1.

Other assets were sold for P 280,000. There is a gain on realization King, Jolly and Donald Statement of Liquidation October 1-31, 2019

Profit and loss ratio Balances before liquidation Realization and distribution of gain Balances Payment of liabilities Balances Payment to partners

Cash

Other Assets

Liabilities

16,000 280,000 296,000 89,600 206,400 (206,400)

272,000 (272,000)

Journal entries: a)

Sale of other assets and distribution of gain

Cash Other assets King, capital Jolly, Capital Donald, Capital

280,000 272,000 3,200 3,200 1,600

b) Payment of liabilities Liabilities Cash c)

89,600 89,600

Payment to partners

Jolly, loan Donald, loan King, Capital Jolly, Capital Donald, Capital Cash

4,000 6,400 79,200 51,200 65,600 206,400

5

Loan

6,400

King 4 76,000 3,200 79,200

Capital Jolly 4 48,000 3,200 51,200

Donald 2 64,000 1,600 65,600

6,400 (6,400)

79,200 (79,200)

51,200 (51,200)

65,600 (65,600)

Jolly

Donald

89,600

4,000

6,400

89,600 (89,600)

4,000 4,000 (4,000)

2.

Other assets were sold for P 200,000. There is a loss on realization but no capital deficiency. King, Jolly and Donald Statement of Liquidation October 1-31, 2019

Cash Profit and loss ratio Balances before liquidation Realization and distribution of loss Balances Payment of liabilities Balances Payment to partners

16,000 200,000 216,000 (89,600) 126,400 (126,400)

Other Assets 272,000 (272,000)

Journal entries a) Sale of other assets and distribution of loss Cash King, Capital Jolly Capital Donald, Capital Other Assets

6,400

King 4 76,000 (28,800) 47,200

Capital Jolly 4 48,000 (28,800) 19,200

Donald 2 64,000 (14,400) 49,600

6,400 (6,400)

47,200 (47,200)

19,200 (19,200)

49,600 (49,600)

Jolly

Donald

89,600

4,000

6,400

89,600 (89,600)

4,000 4,000 (4,000)

c) Payment to partners

200,000 28,800 28,800 147,400

Jolly, loan Donald, loan King, Capital Jolly, Capital Donald, Capital Cash

272,000

b) Payment of liabilities Liabilities Cash

Loan Liabilities

89,600 89,600

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4,000 6,400 47,200 19,200 49,600 126,400

3.

Other assets were sold for P 148,000. There is a loss on realization with capital deficiency., right of offset is exercised. King, Jolly and Donald Statement of Liquidation October 1-31, 2019

Cash Profit and loss ratio Balances before liquidation Realization and distribution of loss Balances Payment of liabilities Balances Offset Jolly, loan to Jolly’s capital deficiency Balances Payment to partners

16,000 148,000 164,000 (89,600) 74,400

Other Assets 272,000 (272,000)

74,400 (74,400)

Journal entries a) Sale of other assets and distribution of loss Cash King, Capital Jolly Capital Donald, Capital Other Assets

c)

148,000 49,600 49,600 24,800

Donald

89,600

4,000

6,400

89,600 (89,600)

4,000

6,400

King 4 76,000 (49,600) 26,400

4,000 (1,600) 2,400 (2,400)

6,400

26,400

6,400 (6,400)

26,400 (26,400)

Jolly, loan Donald, loan King, Capital Donald, Capital Cash

272,000

89,600 89,600

Offset loan to capital deficiency Jolly, loan Jolly, Capital

Jolly

d) Payment to partners

b) Payment of liabilities Liabilities Cash

Loan Liabilities

1,600 1,600

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2,400 6,400 26,400 39,200 74,400

Capital Jolly 4 48,000 (49,600) (1,600) (1,600) 1,600

Donald 2 64,000 (24,800) 39,200 39,200 39,200 (39,200)

4.

Other assets were sold for P 136,000. There is a loss on realization with capital deficiency, deficient partner is solvent King, Jolly and Donald Statement of Liquidation October 1-31, 2019

Cash Profit and loss ratio Balances before liquidation Realization and distribution of loss Balances Payment of liabilities Balances Offset Jolly, Loan to Jolly’s capital deficiency Balances Additional investment of Jolly Balances Payment to partners

16,000 136,000 152,000 (89,600) 62,400

Other Assets 272,000 (272,000)

b)

c)

136,000 54,400 54,400 27,200

89,600

4,000

6,400

89,600 (89,600)

4,000

6,400

King 4 76,000 (54,400) 21,600

4,000 (4,000)

6,400

21,600

6,400

21,600

6,400 (6,400)

21,600 (21,600)

Cash Jolly Capital

2,400 2,400

272,000 e) Payment to partners 89,600

Donald, Loan King, Capital Donald, Capital Cash

89,600

Offset loan to capital deficiency Jolly, loan Jolly, Capital

Donald

d) Additional investment of Jolly

Payment of liabilities Liabilities Cash

Jolly

62,400 2,400 64,800 (64,800)

Journal entries a) Sale of other assets and distribution of loss Cash King, Capital Jolly Capital Donald, Capital Other Assets

Loan Liabilities

4,000 4,000

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6,400 21,600 36,800 64,800

Capital Jolly 4 48,000 (54,400) (6,400) (6,400) 4,000 (2,400) 2,400

Donald 2 64,000 (27,200) 36,800 36,800 36,800 36,800 (36,800)

5.

Other assets were sold for P 136,000. There is a loss on realization with capital deficiency, deficient partner is insolvent King, Jolly and Donald Statement of Liquidation October 1-31, 2019

Cash Profit and loss ratio Balances before liquidation Realization and distribution of loss Balances Payment of liabilities Balances Offset Jolly, Loan to Jolly’s capital deficiency Balances Add’l loss to other partners due to Jolly’s insolvency Balances Payment to partners

Other Assets

Jolly

Donald

89,600

4,000

6,400

89,600 (89,600)

4,000

6,400

King 4 76,000 (54,400) 21,600

4,000 (4,000)

6,400

21,600

62,400

6,400

62,400 (62,400)

6,400 (6,400)

21,600 (1,600) 20,000 (20,000)

16,000 136,000 152,000 (89,600) 62,400

272,000 (272,000)

Journal entries a) Sale of other assets and distribution of loss Cash King, Capital Jolly Capital Donald, Capital Other Assets

c)

136,000 54,400 54,400 27,200

King, Capital Donald, Capital Jolly, Capital

1,600 800 2,400

272,000 e) Payment to partners 89,600

Donald, Loan King, Capital Donald, Capital Cash

89,600

Offset loan to capital deficiency Jolly, loan Jolly, Capital

Capital Jolly 4 48,000 (54,400) (6,400) (6,400) 4,000 (2,400) 2,400

d) Additional loss to other partners due to Jolly’s insolvency

b) Payment of liabilities Liabilities Cash

Loan Liabilities

4,000 4,000

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6,400 20,000 36,000 62,400

Donald 2 64,000 (27,200) 36,800 36,800 36,800 (800) 36,000 (36,000)

6.

The other assets were sold for P 136,000. Additional cash investment of deficient partner is considered as second cash distribution to partners requiring a schedule to accompany the statement of liquidation to determine amounts paid to partners. King, Jolly and Donald Statement of Liquidation October 1-31, 2019

Cash Profit and loss ratio Balances before liquidation Realization and distribution of loss Balances Payment of liabilities Balances Offset Jolly, Loan to Jolly’s capital deficiency Balances Payment to partners (see schedule) Balances Additional investment of Jolly Balances Payment to partners

16,000 136,000 152,000 (89,600) 62,400

Other Assets 272,000 (272,000)

62,400 (62,400) 2,400 2,400 (2,400)

Loan Liabilities

Jolly

Donald

89,600

4,000

6,400

89,600 (89,600)

4,000

6,400

King 4 76,000 (54,400) 21,600

4,000 (4,000)

6,400

21,600

6,400 (6,400)

21,600 (20,000) 1,600 1,600 (1,600)

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Capital Jolly 4 48,000 (54,400) (6,400) (6,400) 4,000 (2,400) (2,400) 2,400

Donald 2 64,000 (27,200) 36,800 36,800 36,800 (36,000) 800 800 (800)

Journal entries a)

Sale of other assets and distribution of loss Cash King, Capital Jolly Capital Donald, Capital Other Assets

d) Payment to partners with accompanying schedule

136,000 54,400 54,400 27,200

Donald, loan King, Capital Donald, Capital Cash

c)

e) Additional investment of Jolly 89,600

Cash Jolly, Capital

89,600

Offset loan to capital deficiency Jolly, loan Jolly, Capital

62,400

272,000

b) Payment of liabilities Liabilities Cash

6,400 20,000 36,000

2,400 2,400

f) Final payment to partners 4,000

King, Capital Donald, Capital Cash

4,000

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1,600 800 2,400

The Schedule to Accompany the Statement of Liquidation shows amounts to be paid to the partners. Total partners’ interest will be reduced by the restricted interest for possible losses if the deficient partner fails to pay his capital deficiency. Restricted interest for possible loss will continue until all deficiencies or debit capital balances are eliminated, after which, balances will now be called as Free Interest-amounts to be paid to partners, where payments are applied first t loan, then on capital.

King, Jolly and Donald Schedule To Accompany Statement of Liquidation October 1-31, 2019

Capital balances Add: loan balances Total partners’ Interest Restricted interests – possible loss to P 2,400 to King and Donald in the ratio of 4:2 if Jolly fails to pay his deficiency Free interest – amount to be paid to partner

Payment to apply on: Loan Capital Cash settlement

King P 21,600

Jolly (P 2,400)

P 21,600

(P2,400)

(1,600) P 20,000

2,400

P 20,000 P 20,000

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Donald P 36,800 6,400 P 43,200 (800) P 42,400

P 6,400 36,000 P 42,400

COMPUTATION OF CASH SETTLEMENT TO PARTNERS There are some problems that ask for the computation of cash settlement to partners but do not require the preparation of a statement of liquidation. In such cases, the following must have taken place before computing the cash settlement to partners: a) Non-cash assets must have been realized b) Liabilities to outside creditors are already settled c) Gain or loss on realization have not been distributed to partners’ capital accounts To determine if there is a gain ...