Partnership Liquidation

January 12, 2013

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LIQUIDATION is the process of converting all assets of the business into cash (realization), followed by the final payments of creditors claims and the partners capital balance in the partnership (liquidation). This is usually called the winding up of business activities. The following acts result in dissolution and liquidation: 1. The accomplishment of the purpose for which the partnership was formed. 2. The expiration of the time for which the partnership was formed. 3. Bankruptcy of the partnership. 4. Death or retirement of a partner and the remaining partners decide to discontinue the business. Technically, there are two steps involved in the termination of the business. They are (1) realization and (2) liquidation. MARSHALLING OF ASSETS - a legal doctrine that refers to the segregation of assets owned by the partnership and the personal assets owned by the several partners. It defines the priority of claims against the assets of the partnership and the partners when the partnership and/or one or more of the partners are insolvent. PRIORITY OF CLAIMS Of partnership assets: 1. Those owing to outside creditors. 2. Those owing to inside creditors in the form of advances or loans for business expenses by the partners. 3. Those owing to the partners with respect to their capital contribution. 4. Those owing to partners with respect to their share in the profit. Of individual partners personal assets: 1. Those owing to separate creditors. 2. Those owing to partnership creditors. 3. Those owing to partners by way of additional contributions when the assets of the partnership were insufficient to settle all obligations. LUMP SUM LIQUIDATION Steps 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. a. If the deficient partner has a loan balance, exercise the right of offset. b. If the deficient partner is solvent, he should invest cash to eliminate his deficiency. c. If the deficient partner is insolvent, then the other partners should absorb his deficiency. 4. Payment to partners, in order of priority a. Loan accounts b. Capital accounts INSTALLMENT LIQUIDATION Steps 1. Realization of noncash assets and distributions of gain or loss on realization among the partners based on their profit and loss ratio. 2. Payment of liquidation expenses and adjustment of unrecorded liabilities; both of these items will be distributed among the partners in their profit and loss ratio. 3. Payment of liabilities to outside creditors.

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4. Distribution of available cash based on a schedule of safe payments which assumes possible losses due to inability of the partnership to dispose of part or all the remaining noncash 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. SAFE PAYMENT SCHEDULE a statement which shows a conservative approach to liquidation. It is prepared when there is availability of cash after payment to outside creditors is made. It indicates how much cash should be distributed to partners. CASH DISTRIBUTION PLAN/ CASH PRIORITY PROGRAM a mathematical plan which can be used to effect cash contribution as cash is available. The terminal result is the same as the safe payments schedule. Steps in preparing cash distribution plan/cash priority program: 1. Determine the maximum loss needed to extinguish the combined equity (capital and loans) of each partner. To compute the maximum loss, divide the partners combined equity by his profit and loss ratio. 2. Indicate the sequence in which each partners equity method is extinguished. The partner having the least in maximum loss is extinguished first and so on. 3. Compute, for each partner, a possible loss needed to full extinguish his combined equity following the sequence for extinguishment in Step 2. Then proceed to extinguish each partners account in the sequence suggested. To compute for the required possible loss to extinguish each partners account, divide the remaining equity balance of a partners account to be extinguished by the partners profit and loss ratio, taking into consideration the changes in profit and loss ratios as the number of partner decreases after each extinguishment. 4. Prepare a schedule of cash distribution by accumulating all the possible losses under Step3 used to extinguish each partners account, and the updated profit and loss ratios after each extinguishment. Arrange them by starting from the last line of the calculation in Step 3 and working upward. The partnership liabilities, of course, should be first in priority. ILLUSTRATIVE PROBLEMS Problem 1 Cheim, Jamie and Lee are partners in a public relations firm and share profits and losses in the ratio of 4:4:2, respectively. They decided to liquidate their business on Dec. 31, 2013. The following is the condensed statement of financial position prepared prior to liquidation: Cheim, Jamie and Lee Statement of Financial Position December 31, 2013 LIABILITIES and CAPITAL P 200, 000 Liabilities P1,120,000 3,400,000 Jamie, Loan 50,000 Lee, Loan 80,000 Cheim, Capital 950,000 Jamie, Capital 600,000 Lee, Capital 800,000 P3,600,000 Total Liabilities and Capital P3,600,000

ASSETS Cash Non-cash Assets

Total Assets

Prepare the necessary journal entries and prepare a statement of liquidation in good form using the following assumptions. Case 1. Assume that noncash assets are sold at P 2,500,000. Case 2. Assume that noncash assets are sold at P1, 850,000.

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Case 3. Assume that noncash assets are sold at P 1, 700, 000. Any deficient partner is deemed to be personally solvent. Case 4. Assume the same facts in Case 3 except that the deficient partner is personally insolvent. Case 5. Assume that noncash assets are sold at P 900, 000. Deficient partners are personally solvent. Problem 2 The balance sheet of Chiem, Jamie and Lee, partners sharing profits and losses in the ratio of 4:4:3 respectively, showed the following balances on April 30, 2013, just before liquidation: CJL Partnership Statement of Financial Position April 30, 2013 ASSETS Cash Noncash Assets LIABILITIES and CAPITAL Liabilities P 435, 000 Lee, Loan 30, 000 Cheim, Capital 600, 000 Jamie, Capital 350, 000 Lee, Capital 150, 000 Total Liabilities and Capital P 1,565,000

P 315,000 1, 250,000

Total Assets

P 1,565,000

In May , part of the assets are sold at book value, P 300,000. In June, the remaining assets are sold for P 210, 000. Assume that available cash is distributed to the proper parties at the end of May and at the end of June. Assume further that partners are solvent and that any partner who is deficient made appropriate payment to the partnership on July 31. Prepare statement of liquidation using safe Payment schedule. Problem 3 Bart, Tun and Der divide profits 60%, 25%, and 15%, respectively. A statement of financial position on June 30, 2013, just before partnership liquidation, showed the following balances: BARTUNDER PARTNERSHIP Statement of Financial Position June 30, 2013 ASSETS Cash Noncash Assets LIABILITIES and CAPITAL Liabilities P Bart, Capital Tun, Capital Der, Capital Total Liabilities and Capital P

P 50, 000 925, 000

Total Assets

P 975,000

350,000 450,000 100,000 75,000 975,000

Certain assets were sold in July at a book value of P 500, 000 and available cash is distributed to appropriate parties. Remaining assets are sold in August for P 150, 000 and cash is distributed in final settlement. Prepare statement of liquidation using cash priority program.

Partnership Liquidation

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