1

XPARCOAC MIDTERMS REVIEWER by Kirsten

CHAPTER 4: LIQUIDATION
- winding up of its business activities characterized by sale of all non-cash assets, settlement of all
liabilities and distributions of the remaining cash to partners
- may be caused by:
Liquidation of a Partnership a. Termination of the term/period covered by the partnership contract.
b. Bankruptcy of the firm
c. The accomplishment of the purpose from which the partnership was organized.
d. Mutual agreement of the partners to close the business.
Liquidation Dissolution
 Business is terminated  Changes in ownership interest/capital structure
 Conversion of assets into cash  Business may not be necessarily terminated
 Settlement of liabilities
 Distribution of cash to partners
- conversion of non-cash assets into cash
- may either result to a gain or loss on realization and shall be divided in the profit and loss ratio of the
partners
Realization (Sale of Assets)
1. Gain on realization – excess of the selling price over the cost or book value of the asset sold.
2. Loss on realization – the excess of the cost or book value over the selling price of the asset
sold.
 Legal and accounting expenses
Expenses of Liquidation  Advertising cost of selling the assets
 It reduces cash
(Both are allocated to partner’s capital accounts based on P/L ratio.)
- in some cases, a substantial loss on realization may yield for a partner a ____ which is the excess of a
Capital Deficiency partner’s share in losses over the partner’s capital credit balance
- the excess of a partner’s share on losses over his capital.
- a capital deficiency will affect this
Partner’s Interest - the sum of his capital and loan accounts in the partnership
- the sum of the partner’s capital, loan balance, and advances to the partnership.
Rules in Settling Accounts after Dissolution
1. Partnership property
Assets of the Partnership 2. Additional contributions of the partners needed for the payment of all liabilities consistent with
the discussions below
- the assets of a general partnership shall be applied in the following order:
1. First, those owing to outside creditors
2. Second, those owing to inside creditors in the form of loans or advances for business expenses
Order of Preference
by the partners
3. Third, those owing to the partners with respect to their capital contributions
4. Lastly, those owing to partners with respect to their share of the profits
General rule in cash distribution or the
1. To outside creditors (partnership creditors other than partners)
order in which claims against the
2. To partners for loan accounts (partner’s claim other than capital & profits)
partnership’s assets will be marshalled is
3. To partners for capital accounts (partner’s claim to capital & profits)
as follows:
- involves the order of creditor's rights against the partnership’s assets and the personal assets of the
Marshaling of Assets
individual partners.
- the second preference above gives the partner with the loan account the option to exercise his right of
____
- this privilege is the legal right of a partner to apply part of all of his loan account balance against his
Right of Offset
capital deficiency resulting from losses in the realization of the partnership assets
- 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 losses in the process of liquidation.
Insufficient Partnership Assets
- in cases when the partnership assets are insufficient to settle all of their liabilities, the partners should
make ____ in the partnership
Additional contributions - any partner who contributed in excess of his share in this liability has has a right to collect the
supposed additional contributions from the other partners

Preference of Partnership Creditors and Partners’ Separate Creditors

- shall have priority in payments over those of the partners’ separate creditors as regards the
partnership properties
Creditors of the Partnership
- on the other hand, the creditors of the partners are preferred with respect to the separate or personal
properties of the partners
The order of claims against the personal  Personal creditors of individual partners
 2
XPARCOAC MIDTERMS REVIEWER by Kirsten
assets of the individual partners is as  Partnership creditors ( partnership liabilities regardless of a partner’s capital balance in the
follows: partnership)
Solvent Partner - the personal assets of the partner exceeds personal liabilities.
Insolvent Partner - the personal assets are less than personal liabilities.
- a partner has debit balance in his/her capital accounts resulting from losses in the process of
Deficient Partner
liquidation.
Distribution of Separate Properties of an Insolvent Partner
1. First, those owing to separate creditors
If a partner is insolvent, his personal
2. Second, those owing to partnership creditors
properties shall be distributed as
3. Lastly, those owing to the partners by way of additional contributions when the assets of the
follows:
partnership were insufficient to settle all obligations
- will greatly aid in the liquidating partner summarize the events and transactions associated with the
liquidation of the partnership
- NOTE: SINCE THERE IS NO STANDARD THAT DISCUSSES THE STEPS IN THE
Statement of Liquidation
PREPARATION OF THE LIQUIDATION STATEMENT, THE NEXT SLIDE CONTAINS THE
SUGGESTED STEPS THAT WE WILL FOLLOW SO THAT WE WILL HAVE THE SAME
SOLUTION ON OUR LIQUIDATION STATEMENT.
Methods of Partnership Liquidation
- under this method, all non-cash assets are realized and the related gains or losses distributed and all
Lump-Sum Method
liabilities are paid before a single final cash distribution is made to the partners
- under this method, realization of non-cash assets is accomplished over an extended period of time
- when cash is available, creditors may be partially or fully paid
Installment Method - any excess may be distributed to the partners in accordance with a program of safe payments or a
cash priority program
- this process persists until all the non-cash assets are sold
Lump-Sum Liquidation Installment Liquidation
 All assets are sold/ converted into cash  Assets are sold on a piecemeal basis.
 Outside creditors are paid  Outside creditors are paid
 Single payment is made to the partners for their total  Series of installments are made to the partners
interests.
Entries Related to Liquidation
a. At book value
Cash xxx
Non-Cash Assets xxx
b. Above book value
Cash xxx
Sale of Non-Cash Asset Non-Cash Assets xxx
Gain on Realization xxx
c. Below book value
Cash xxx
Loss on Realization xxx
Non-Cash Assets xxx
a. Distribution of Gain on Realization
Gain on Realization xxx
A, Capital xxx
B, Capital xxx
Distribution of Gain or Loss on
C, Capital xxx
Realization based on Partners’ P/L
b. Distribution of Loss on Realization
Ratio
A, Capital xxx
B, Capital xxx
C, Capital xxx
Loss on Realization xxx
Liabilities xxx
Payment of Liabilities
Cash xxx
A, Loan xxx
Exercise of Right of Offset
A, Capital xxx
Additional Investment by Deficient Cash xxx
Partner A, Capital xxx
B, Capital xxx
Deficiency Absorbed by Solvent Partner
A, Capital xxx
A, Capital xxx
B, Capital xxx
Distribution of Cash to Partners
C, Capital xxx
Cash xxx
 3
XPARCOAC MIDTERMS REVIEWER by Kirsten
Lump-Sum Liquidation
- under this method, all non-cash assets are realized and all liabilities are settled before a single final
Lump-Sum Liquidation
cash distribution is made to the partners
1. Realization of non-cash assets and distribution of gain or loss on realization among the partners
based on their profit and loss ratio
2. Payment of liabilities
3. Elimination of partners’ capital deficiencies. If after the distribution of loss on realization a partner
incurs a capital deficiency (i.e. partner’s share of realization loss exceeds his capital credit), this
deficiency must be eliminated by using one of the following methods, in the order of priority:
Procedures
a. If the deficient partner has a loan balance, then exercise the right of offset
b. If the deficient partner is solvent, then he should invest cash to eliminate his deficiency
c. If the deficient partner is insolvent, then the other partners should absorb his deficiency
4. Payments to partners, in the order of priority:
a. Loan accounts
b. Capital accounts
1. Realization of assets and distribution of gain or loss on realization among the partners based on
P/L ratio.
2. Payment of expenses.
3. Payment of liabilities.
4. Elimination of capital deficiencies
Procedure in Lump-sum Liquidation  Exercise the right of offset.
 Deficient partner will invest cash to eliminate deficiency (if solvent)
 Solvent partners absorb the deficiency (if deficient partner is insolvent)
5. Payments to partners, in the order of priority:
a. Loan accounts
b. Capital accounts
Installment Liquidation
- under this method, realization of non-cash assets is accomplished over an extended period of time
- it is a process of selling some assets, paying the creditors, paying the remaining cash to the partners,
realizing additional assets, and making additional payments to the partners
- liquid division will continue until all the non-cash assets have been realized and all available cash
distributed to partnership creditors and partners
- installment payments to partners are appropriate if necessary safeguards are used to ensure that all
partnership creditors are paid in full and that no partner is paid more than the amount to which he
Installment Liquidation
would be entitled after all losses in realization of assets are known
- non-cash assets are sold on a piece-meal basis over an extended period of time
- cash realized is immediately distributed to partners after fully satisfying creditors’ claims or after
setting aside sufficient cash for these liabilities
- it is necessary that each cash distribution to partners be considered as if it were the last; remaining
unsold assets, therefore, must be treated as a complete loss assuming that nothing is realized on them.
Also, debit balances in capital and potential capital deficiencies are assumed uncollectible.
1. Realization of non-cash assets and distribution of gain or loss on realization among the partners
based on their profit and loss ratio.
2. Payment of liquidation expenses and adjustment for unrecorded liabilities; both of these items will
be distributed among the partners in their profit and loss ratio.
Procedure in Installment Liquidation 3. Payment of liabilities to outsiders.
4. Distribution of available cash based on a schedule of safe payments which assumes possible
losses due to the inability of the partnership to dispose of part or all the remaining non-cash assets
and failure of the partners with capital deficiencies to make additional contributions. Payments to
partners can also be made based on a cash priority program.
- is inefficient if numerous installment distributions are to be made to partners
Schedule of Safe Payments - will go on as long as there is cash to be distributed and until the capital balances are aligned with the
P&L ratio
- represent the portion of a partners’ interest which should remain available to absorb possible future
losses
- are provided for assumed non sale of remaining non-cash assets and for assumed insolvency of
deficient partners
Restricted Interest
- shall consist of:
a. Remaining unsold assets
b. Cash withheld (for possible expenses)
c. Debit balances in capital
Free Interest - when all of these restricted interests are satisfied, the resulting balances will be referred to as this
which are simply the amounts to be paid to the partners
- this payment should first be applied to the loan then to capital in accordance with the rules on the
 4
XPARCOAC MIDTERMS REVIEWER by Kirsten
order of preference in liquidation
Cash Priority Program
- alternative device prepared at the start of the liquidation process which will help the partners project
when they can expect to be included in the cash distribution
- prepared prior to liquidation, that is, before cash becomes available for distribution
Cash Priority Program - there may be instances wherein the gain or loss related to the sale of individual assets during the
Cash Predistribution Plan course of liquidation is difficult to determine. In such cases, no gain or loss is recognized on realization
Program of Priorities and cash is recorded equal in amount of the book value of the assets sold.
- the total gain or loss on realization is recognized in the final realization of assets and it is the
difference between the cash realized and the book value of the remaining assets sold. Such gain or
loss is then carried to capital
1. Determine total partners’ interest; that is, capital balances before liquidation plus loans by
partners to the partnership less advances by the partnership to the partners.
2. Divide total partners interest by their profit and loss ratio to get each partners’ loss
absorption capacity. The loss absorption capacity is the maximum amount of loss that a partner
may absorb and may eliminate any partner in any cash distribution. A partner, therefore, with the
Steps in Preparing a Cash Priority highest loss absorption balance has the first priority on cash distributions
Program 3. Once the loss absorption balances are determined, allocations may now be made, starting
with Allocation I wherein the highest loss absorption balance is reduced to the next highest.
Each reduction in the loss absorption balance requires payment to partners computed by
multiplying the amount of reduction by the partners profit and loss ratio.
4. After the partners’ loss absorption balances are made equal, cash distributions are made in the
profit and loss ratio.
- represent the maximum loss that the partners can absorb without reducing their equity below zero
Loss Absorption Balances - the partner with the biggest capital exposure or loss absorption balance should be prioritized in a cash
distribution
- may be made only when installment payments have caused the ratio of the partners’ capital account
Cash Payments made in the P&L ratio
balances to be the same as the profit and loss ratio

CHAPTER 5: Accounting for Corporations

 5
XPARCOAC MIDTERMS REVIEWER by Kirsten