04 Partnership Liquidation

PARTNERSHIP LIQUIDATION
Partnership liquidation refers to either a voluntary or involuntary discontinuance of a business resulting in the required
sale of partnership assets and payment of partnership liabilities. It is also called “winding up of affairs”. The purpose of
partnership liquidation is to aid in the termination of the partnership’s business. It can also serve as the documentation or
proof of the business termination.
The partnership liquidation generally has the following procedures (in order of priority):
1. Realization of non-cash assets or the conversion of non-cash assets into cash.
2. Payment of partnership liabilities.
3. Distribution of the remaining cash to the partners.
Two (2) Methods in Partnership Liquidation

a. Lump-sum Liquidation -This is used when all the partnership non-cash assets are converted into cash
simultaneously.
b. Installment Liquidation - This is used when the partnership non-cash assets are partially converted into cash
over a certain period until all the non-cash assets are converted into cash.
LUMPSUM LIQUIDATION
Procedures in Lump-Sum Liquidation (in order)
1. Realize or sell the non-cash assets. Allocate the gain or loss on sale to the partners using the profit or loss ratio.
2. Pay liquidation expenses.
3. Pay partnership liabilities to outside creditors.
4. Eliminate any capital deficiencies among the partners’ capital accounts. (Capital deficiency is the negative
amount in the capital account balance of the partner) The capital deficiency should be eliminated by applying one
of the following, in order of priority:
a. If the deficient partner has an existing loan balance (payable to partner account), exercise the right of
offset against his capital only up to the extent of his deficiency.
b. If the deficient partner is personally solvent, the deficient partner should invest cash to eliminate the
deficiency.
c. If the deficient partner is personally insolvent, the other partners should absorb the capital deficiency.
Note: If the problem is silent or no indication regarding the personal status of the partner, it is assumed that the
deficient partner is insolvent.
5. Distribute cash to the partners (in order of priority)
a. Loan accounts (payable to partner account)
b. Capital accounts
Illustration 1: Lump-sum Liquidation

On March 31, 20X1, the partners of XYZ Co. decided to discontinue operating their business. The following are the
account balances in the partnership’s balance sheet:
Cash ₱30,000
Other assets 570,000
Total Assets ₱600,000
Accounts payable ₱40,000

Payable to Y 20,000
X, Capital (20%) 162,000
Y, Capital (30%) 195,000
Z, Capital (50%) 183,000
Total Liabilities and Capital ₱600,000
The other assets are all sold for ₱370,000. Liquidation expenses amounting to ₱2,000 were paid.
Required: Prepare a liquidation statement and journal entries.

Other Accounts
Cash Assets Payable Payable to Y X, Capital Y, Capital Z, Capital
Balances before liquidation ₱30,000 ₱570,000 ₱40,000 ₱20,000 ₱162,000 ₱195,000 ₱183,000
Sale of other assets 368,000 (570,000) - - (40,400) (60,600) (101,000)
Balances 398,000 - 40,000 20,000 121,600 134,400 82,000
Payment of liabilities (40,000 - (40,000) - - - -
Balances 358,000 - - 20,000 121,600 134,400 82,000
Payment of loan to partners (20,000) - - (20,000) - - -
Balances 338,000 - - - 121,600 134,400 82,000
Distribution of remaining cash to the partners (338,000) - - - (121,600) (134,400) (82,000)
Balances after liquidation ₱- ₱- ₱- ₱- ₱- ₱- ₱-
JOURNAL ENTRIES:
Sale of other assets:

Cash 370,000
Loss on realization 200,000
Payment of liquidation expenses:

Cash 2,000
Distribution of loss to partners:

X, Capital 40,400
Y, Capital 60,600
Z, Capital 101,000
Payment of liabilities:
Accounts payable 40,000
Cash 40,000
Payment of loan:
Payable to Y 20,000
Cash 20,000
Distribution of cash to partners:

X, Capital 121,600
Y, Capital 134,400
Z, Capital 82,000
Cash 338,000
The other assets were sold for ₱370,000. Since there are liquidation expenses amounting to ₱2,000 that need to be paid,
the net cash proceeds are ₱368,000. The liquidation expenses are expenses normally incurred to conduct the sale of other
assets.
The amount of ₱368,000 will then be compared to the book value of the other assets that were sold, which is ₱570,000.
The difference will be a gain or loss on realization. Since the net cash proceeds are lower than the book value of other
assets, a loss is incurred amounting to ₱202,000. This amount of loss will then have to be allocated to the partners’ capital
account balances using their profit or loss ratios. As seen in the balance sheet, their profit or loss ratios is 20%, 30%, and
50%, respectively, for X, Y, and Z.
After the sale of other assets and allocation of loss to the partners, the liabilities of the partnership should then be settled.
The amount of liabilities pertains to the accounts payable, which is ₱40,000. This amount is deducted in the column of
accounts payable and cash since the accounts payable is already paid and the cash is used.
After the settlement of liabilities, the loan account of Partner Y should be paid. This loan account is a liability account of
the partnership and is payable to the partner. The loan amount of ₱20,000 is then paid.
After the settlement of liabilities and the partner’s loan account, the remaining cash amounting to ₱338,000 may now be
distributed to the partners.
Illustration 2: Lumpsum Liquidation (Loss on realization with capital deficiency; loan is sufficient)
Using the same information in Illustration 1 except that the assets are sold for ₱190,000, and the loan account belongs to
Z. Liquidation expenses are also paid amounting to ₱2,000.
Other Accounts
Cash Assets Payable Payable to Z X, Capital Y, Capital Z, Capital
Balances 218,000 - 40,000 20,000 85,600 80,400 (8,000)
Payment of liabilities (40,000) - (40,000) - - - -
Balances 178,000 - - 20,000 85,600 80,400 (8,000)
Offsetting capital deficiency - - - (8,000) - - 8,000
Balances 178,000 - - 12,000 85,600 80,400 -
Payment of loan to partners (12,000) - - (12,000) - - -
Balances 166,000 - - - 85,600 80,400 -
Distribution of remaining cash to the partners (166,000) - - - (85,600) (80,400) -
JOURNAL ENTRIES:

Cash 190,000

Cash 2,000

X, Capital 76,400
Y, Capital 114,600
Z, Capital 191,000
Cash 40,000
Offsetting capital deficiency:

Payable to Z 8,000
Z, Capital 8,000
Payment of loan:
Payable to Z 12,000
Cash 12,000

X, Capital 85,600
Y, Capital 80,400
Cash 166,000
Illustration 3: Lumpsum Liquidation (Loss on realization with capital deficiency; loan is insufficient, but partner is
personally solvent)
Using the same given information in Illustration 1, except that the other assets were sold for ₱100,000 and that the loan
account belongs to Z. Same amount of liquidation expenses was paid.

Other Accounts
Balances 128,000 - 40,000 20,000 67,600 53,400 (53,000)
Balances 88,000 - - 20,000 67,600 53,400 (53,000)
Balances 88,000 - - - 67,600 53,400 (33,000)
Required cash investment 33,000 - - - - - 33,000
Balances 121,000 - - - 67,600 53,400 -
JOURNAL ENTRIES:

Cash 100,000

Cash 2,000

X, Capital 94,400
Y, Capital 141,600
Z, Capital 236,000
Cash 40,000

Payable to Z 20,000
Z, Capital 20,000
Required cash investment:

Cash 33,000
Z, capital 33,000

X, Capital 67,600
Y, Capital 53,400
Cash 121,000
Illustration 4: Lumpsum Liquidation (Loss on realization with capital deficiency; loan is insufficient, and partner is
personally insolvent)
Using the same given information and assumptions in Illustration 3, except that the partner is personally insolvent.
Other Accounts
Balances 128,000 - 40,000 20,000 67,600 53,400 (53,000)
Balances 88,000 - - 20,000 67,600 53,400 (53,000)
Balances 88,000 - - - 67,600 53,400 (33,000)
Absorption of capital deficiency - - - - (13,200) (19,800) 33,000
Balances 88,000 - - - 54,400 33,600 -
JOURNAL ENTRIES:

Cash 100,000

Cash 2,000

X, Capital 94,400
Y, Capital 141,600
Z, Capital 236,000
Cash 40,000

Payable to Z 20,000
Z, Capital 20,000
Absorption of capital deficiency:

X, Capital 13,200
Y, Capital 19,800
Z, capital 33,000

X, Capital 54,400
Y, Capital 33,600
Cash 88,000
INSTALLMENT LIQUIDATION
There are instances when liquidation of partnership is done over a series of installments. This occurs when the other
assets are being sold partially over a period of time. In this case, each partial sale of the other assets will need a
liquidation statement to determine how much of the available cash as of an installment period can be distributed to the
partners.
Two Methods of Installment Liquidation

a. Safe Payment Schedule - This method is used to determine the safest amount of cash that can be distributed to
the partners as of an installment period. This method prevents the overpayment of cash to the partners.
b. Cash Priority Program - This method is used to determine who among the partners should be paid first using the
available cash as of an installment period.
Illustration 5: Safe Payment Schedule

On January 1, 20x1, XYZ Company decides to liquidate their partnership on an installment basis on the month of January
and ending on February 28, 20x1. The following are the account balances in the balance sheet of XYZ Company on Jan. 1,
20x1:
Cash ₱20,000

Payable to Y 20,000
X, Capital (30%) 110,000
Y, Capital (50%) 140,000
Z, Capital (20%) 100,000
Total Liabilities and Capital ₱400,000
During the month of January, a portion of other assets worth ₱310,000 are sold for only ₱180,000. Liquidation expenses
amounting to ₱3,000 were paid to sell the assets. Estimated future liquidation expenses is ₱2,000. Cash amounting to
₱10,000 was reserved for any incidental expenses.
During the month of February, the remaining other assets were sold for ₱50,000. Liquidation expenses of ₱15,000 resulting
from the sale of remaining assets are paid.
Required: Determine the safe amounts of cash to be paid to partners on the 1st and 2nd installment.
Solution:
The actual loss on realization of assets from 1st installment and the maximum possible loss as of 1st installment should be
computed first before preparing the safe payment schedule as seen below:
Loss on partial sale of other assets ₱130,000

Actual liquidation expenses 3,000
Total actual loss on 1st installment ₱133,000
Carrying amount of unsold assets ₱70,000

Estimated future liquidation expenses 2,000
Reserved or retained cash for incidental expenses 10,000
Total maximum possible loss ₱82,000
1st SAFE PAYMENT SCHEDULE:

X Y Z Total
Loan account (if any) ₱- ₱20,000 ₱- ₱20,000
Capital balance before liquidation 110,000 140,000 100,000 350,000
Total interest on January 1 110,000 160,000 100,000 370,000
Allocation of gain or loss on partial sale of assets (39,900) (66,500) (26,600) (133,000)
Balance before payment 70,100 93,500 73,400 237,000
Allocation of maximum possible loss (24,600) (41,000) (16,400) (82,000)
1st installment - January ₱45,500 ₱52,500 ₱57,000 ₱155,000
The safe payment schedule should start with the computation of the total interest of the partners at the beginning of an
installment period (i.e., beginning of January or beginning of February). The total interest of a partner is composed of the
loan balance (the payable to partner account) and the capital account balance.
The gain or loss on realization of non-cash assets should then be allocated to each of the partners’ total interest using the
P/L ratio. The maximum possible loss will then be deducted from the balance after the allocation of gain or loss on
realization.
After the allocation of maximum possible loss, the first installment payments to the partners are determined. This means
that the partnership can safely pay the partners X, Y, and Z with the amounts of ₱45,500, ₱52,500, and ₱57,000,
respectively, as of the first installment.
Computation of Actual Loss on Realization of Assets (2nd Installment)

Loss on partial sale of remaining assets ₱20,000
Actual liquidation expenses 15,000
Total actual loss on 2nd installment ₱35,000
2nd SAFE PAYMENT SCHEDULE:

X Y Z Total
Loan account (if any) ₱- ₱20,000 ₱- ₱20,000
Capital balance before liquidation 110,000 140,000 100,000 350,000
Total interest on January 1 110,000 160,000 100,000 370,000
Allocation of gain or loss on partial sale of assets (39,900) (66,500) (26,600) (133,000)
Balances 70,100 93,500 73,400 237,000
First installment safe payments (45,500) (52,500) (57,000) (155,000)
Total interest on February 1 24,600 41,000 16,400 82,000
Allocation of actual loss on sale of remaining assets (10,400) (17,500) (7,000) (35,000)
Final installment ₱14,100 ₱23,500 ₱9,400 ₱47,000
The second installment in the given problem is also the last installment since all the remaining assets are sold in this
installment as stated in the problem. In all cases, when the final installment arrives, only the total actual loss on
realization during the last installment should be computed. The maximum possible loss is no longer required to be
computed in the final installment.
The 2nd safe payment schedule is a continuation of the 1st safe payment schedule. The balances of the partners’ interests
after the distribution of the first installment payments will now be the beginning total interests of the partners for the
second installment. Then the loss on sale of remaining assets at the second installment will be allocated to the partners
using the P/L ratio. Afterwards, the final installment payments will be determined.
Illustration 6: Cash Priority Program (The same given problem will be used)
The very first thing that needs to be done when using the cash priority program is the computation of the Maximum Loss
Absorption Capacity (MLAC) of the partners. The MLAC is used to determine who among the partners should be paid first.
MAXIMUM LOSS ABSORPTION CAPACITY (MLAC)

X Y Z
Loan account ₱- ₱20,000 ₱-
Capital balance before liquidation 110,000 140,000 100,000
Total interest on January 1 110,000 160,000 100,000
Divide by: P/L ratio 0.30 0.50 0.20
MLAC ₱366,667 ₱320,000 ₱500,000
Order of priority 2 3 1
EQUALIZATION OF MLAC CASH PRIORITY PROGRAM

X Y Z X (30% Y (50%) Z (20%)
MLAC ₱366,667 ₱320,000 ₱500,000
Priority 1 - - (133,333) - - 26,667
Balance 366,667 320,000 366,667
Priority 2 (46,667) - (46,667) 14,000 - 9,333
Equalized MLAC ₱320,000 ₱320,000 ₱320,000
The equalization of MLAC is performed to determine the specific amounts of cash that needs to be distributed first to the
priority partners. Looking at the table of Cash Priority Program at the right side of the equalization, the specific amounts of
cash are plotted. These specific amounts are computed by multiplying the P/L ratio of the priority partner to the
differences that are computed in the equalization table. These specific amounts will be applied in the actual distribution
of the available cash.
Computation of available cash as of 1st installment
Initial balance of cash ₱20,000

Cash proceeds from the partial sale 180,000
Liquidation expenses paid (3,000)
Cash set aside for future expenses (12,000)
Payment of liabilities (10,000)
Available cash as of 1st installment ₱155,000
Distribution of available cash from 1st installment according to Cash Priority Program
X Y Z Total
Available cash ₱155,000
1st payment ₱- ₱- ₱26,667 (26,667)

2nd payment 14,000 - 9,333 (23,334)
Remaining cash is allocated through P/L ratio 31,500 52,500 21,000 (105,000)
Distributable cash to partners in 1st installment ₱45,500 ₱52,500 ₱57,000 ₱-
The first and second payments in the cash distribution table for first installment are derived from the cash priority program
that was made.
Distribution of available cash from 2nd installment according to Cash Priority Program
X Y Z Total
Available cash ₱155,000
Distributable cash to partners using P/L ratio ₱45,500 ₱52,500 ₱57,000 ₱-
In the 2nd installment, the available cash is entirely allocated to the partners using the P/L ratios of the partners because
the priority payments have already been made in the first installment. If the available cash in the first installment is not
enough to satisfy the priority payments, the undistributed priority payments will be distributed in the succeeding
installments when cash becomes available again.
References:
Dayag, A. (2024). Advanced Financial Accounting. Good Dreams Publishing.
Millan, Z. (2023). Accounting for Special Transactions. Bandolin Enterprise.
De Jesus, P. (2023). Accounting for Special Transactions. Omori and Sons Corp.
Rante, G., Liz, M., Ruado, E., & Binaluyo, J. (2020). Accounting for Special Transactions. Millenium Books, Inc.
EXERCISES
CASE 1
XYZ Co.’s statement of financial position shows the following account balances before liquidation:
Cash ₱60,000

Payable to Y 40,000
X, capital (20%) 160,000
Y, capital (30%) 260,000
Z, capital (50%) 410,000
Total Liabilities and Equity ₱930,000
All the other assets were sold for only ₱680,000. Liquidation expenses amounting to ₱6,000 were paid.
Required: Compute the amount of cash distributed to each partner.
CASE 2
XYZ Co.’s statement of financial position shows the following account balances before liquidation:
Cash ₱60,000

Payable to Y 40,000
X, capital (20%) 160,000
Y, capital (30%) 260,000
Z, capital (50%) 410,000
In the first installment, a portion of the other assets with a carrying amount of ₱540,000 was sold for only ₱390,000.
Liquidation expenses amounting to ₱6,000 were paid.
Required:
a. Prepare a safe payment schedule for the first installment showing the total and the amounts of safe cash
payments distributed to partners X, Y, and Z.
b. Using the cash priority program, what are the loss absorption capacity of partners X, Y, and Z, respectively?
c. Prepare a cash priority program for the first installment showing the priority cash payments to each partner.
d. What is the amount of available cash as of first installment?
e. Show how the available cash in the first installment will be distributed to partners X, Y, and Z according to cash
priority program.
CASE 3
Read and analyze the following problem and answer the questions asked. Show your computations.
Cash ₱-
Non-cash assets 85,000
Liabilities ₱25,000
Loan payable to Partner F 11,000
Loan payable to Partner G 16,000
F, capital (60% in P/L) 21,000
G, capital (40% in P/L) 12,000
Required:
a. All the non-cash assets are sold for ₱53,000.
i. How much is the amount distributable to F?
ii. How much is the amount distributable to G?
b. The non-cash assets are sold in installments. Settlement of partners' claims shall be made in installments as
cash becomes available. In the first sale, three-fourths (3/4) of the non-cash assets are sold for ₱46,000.
i. How much is the amount distributable to F after the first sale?
ii. How much is the amount distributable to G after the first sale?
c. The non-cash assets are sold in installments. Settlement of partners' claims shall be made in installments as
cash becomes available. In the first sale, 90% of the non-cash assets are sold for ₱60,000.
i. How much is the amount distributable to F after the first sale?
ii. How much is the amount distributable to G after the first sale?
CASE 4
On December 31, the accounting records of Tito, Vic and Joey Partnership included the following information:
Tito, drawings (debit balance) (₱48,000)

Joey, drawings (debit balance) (18,000)
Vic, loan 60,000
Tito, capital 246,000
Vic, capital 201,000
Joey, capital 216,000
Total assets amounted to ₱957,000, including ₱105,000 cash and liabilities totaled ₱300,000. The partnership was
liquidated on December 31 and Joey received ₱166,500 cash pursuant to the liquidation. Tito, Vic, and Joey share net
income and losses in a 5:3:2 ratio, respectively.
Required: Compute the following:

a. Loss on realization
b. The cash balance after payment of liabilities
c. The amount realized from sale of noncash assets
d. Cash distributed to Tito

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PARTNERSHIP LIQUIDATION

Two (2) Methods in Partnership Liquidation

Illustration 1: Lump-sum Liquidation

Accounts payable ₱40,000

Required: Prepare a liquidation statement and journal entries.

Sale of other assets:

Payment of liquidation expenses:

Distribution of loss to partners:

Distribution of cash to partners:

Required: Prepare a liquidation statement and journal entries.

Sale of other assets:

Payment of liquidation expenses:

Distribution of loss to partners:

Offsetting capital deficiency:

Distribution of cash to partners:

Required: Prepare a liquidation statement and journal entries.

Sale of other assets:

Payment of liquidation expenses:

Distribution of loss to partners:

Offsetting capital deficiency:

Required cash investment:

Distribution of cash to partners:

Required: Prepare a liquidation statement and journal entries.

Sale of other assets:

Payment of liquidation expenses:

Distribution of loss to partners:

Offsetting capital deficiency:

Absorption of capital deficiency:

Distribution of cash to partners:

Two Methods of Installment Liquidation

Illustration 5: Safe Payment Schedule

Accounts payable ₱30,000

Loss on partial sale of other assets ₱130,000

Carrying amount of unsold assets ₱70,000

1st SAFE PAYMENT SCHEDULE:

Computation of Actual Loss on Realization of Assets (2nd Installment)

2nd SAFE PAYMENT SCHEDULE:

MAXIMUM LOSS ABSORPTION CAPACITY (MLAC)

EQUALIZATION OF MLAC CASH PRIORITY PROGRAM

Computation of available cash as of 1st installment

Initial balance of cash ₱20,000

1st payment ₱- ₱- ₱26,667 (26,667)

Accounts payable ₱60,000

Required: Compute the amount of cash distributed to each partner.

Accounts payable ₱60,000

Tito, drawings (debit balance) (₱48,000)

Required: Compute the following:

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