Chapter Fifteen

Partnerships:
Termination and
Liquidation

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 Termination and Liquidation

The liquidation of a partnership generally involves three

important steps:
1. Non‐cash partnership assets are sold for cash, and gains
and loss on the sales are allocated to the capital accounts of
individual partners on the basis of the profit and loss ratios.
2. Partnership liabilities and expenses incurred during the
liquidation are paid out of the partnership’s available cash.
3. Any partnership cash remaining after paying liabilities
and liquidation expenses is distributed to the individual
partners on the basis of their respective capital balances.

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 Termination & Liquidation

The accountant summarizes and keeps track of the process

in a statement of partnership liquidation.
The liquidation of a partnership becomes complicated if:
• One or more partners have a negative (deficit) capital
balance.
• The liquidation takes place over an extended period of
time.
The accountant can facilitate distribution of cash in
installments by calculating the safe payments.
The accountant might prepare a cash predistribution plan.

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 Learning Objective 15-1

Determine amounts to be paid

to partners in a liquidation.

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 Termination & Liquidation

Morgan & Houseman want to liquidate their

partnership. The process calls for
1) Assets are converted into cash to pay
business obligations and liquidation expenses.
2) Remaining assets are distributed to
partners based on their final capital balances.
3) Partnership books are closed.

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 Termination & Liquidation -
Example
Morgan and Houseman allocate all profits and losses on a
6:4 basis. The partnership has $75,000 of noncash assets
to be liquidated as seen on the 2015 Balance Sheet.

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 Learning Objective 15-2

Prepare journal entries to

record the transactions
incurred in the liquidation of
a partnership.

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 Termination & Liquidation -
Example
On 6/1, the inventory is sold for $15,000.
Note the loss on the sale of inventory of $7,000 is assigned
$4,200 ($7,000 x 60%) to Morgan and $2,800 ($7,000 x
40%) to Houseman.

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 Termination & Liquidation -
Example
Assume that $9,000 of the Accounts Receivable are collected.
The remaining accounts receivables are written off, and the
loss is allocated between Morgan & Houseman.
$3,000 x 60% = $1,800
$3,000 x 40% = $1,200

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 Termination & Liquidation -
Example
The fixed assets are sold for $29,000.
The loss on fixed assets of $12,000 is allocated to
Morgan & Houseman.
$12,000 x 60% = $7,200
$12,000 x 40% = $4,800

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 Termination & Liquidation -
Example
Once all the assets are sold, accounts payable are
paid off. Morgan & Houseman incur an additional
$3,000 in liquidation expenses.

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 Termination & Liquidation -
Example
This schedule is used to determine the partners’ ending
capital account balances and, thus, the appropriate
distribution of the cash balance.

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 Termination & Liquidation -
Example
After the ending capital balances have been
calculated, the remaining cash can be
distributed to the partners to close out the
financial records of the partnership.

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 Statement of Liquidation

A report can be prepared to disclose the progress of the

liquidation to various interested parties.

Transactions to Property still

date. being held by the
partnership.
Liabilities
remaining to be
Current cash and
paid.
capital balances.

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 Statement of Liquidation

The process of liquidation can last over months,

even years.
Partners may experience deficit balances during
the liquidation period.
Partners may want cash distributions prior to
the completion of the liquidation.
Accountants distribute statements at each
important juncture of the process.

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Learning Objective 15-3

Determine the distribution of

available cash when one or
more partners have a deficit
capital balance or become
personally insolvent.

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 Deficit Capital Balance
Deficit balances can be resolved two ways:
 Deficit partner can make a contribution to cover deficit.
 Remaining partners can absorb the deficit. (Deficit
partner may pay later or can be sued for the amount.)

Holland, Dozier, and Ross balances just prior to liquidation.

Cash . . . . . . . . . .$20,000 Holland, Capital . . . . . . . . . $ (6,000)
Dozier, Capital . . . . . . . . . . . .15,000
Ross, Capital . . . . . . . . . . . . . 11,000
Total . . . . . . . . . . . . . . . . . . $ 20,000

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 Deficit Capital Balance --
Contribution by Deficit Partner
Holland legally is required to convey an additional $6,000 to
the partnership to eliminate the deficit balance. This
contribution raises the cash balance to $26,000, which allows
a complete distribution to be made to Dozier ($15,000) and
Ross ($11,000) in line with their capital accounts.

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 Deficit Capital Balance -
Remaining Partners Absorb Deficit
If the partner resists, the loss will be written off against the capital
accounts of Dozier and Ross.

Allocation of Potential $6,000 Loss

Dozier . . . . . . . . . . . . . 2⁄3 of $(6,000) $(4,000)
Ross . . . . . . . . . . . . . . .1⁄3 of $(6,000) $(2,000)

Allocation of the loss is based on the relative profit and loss ratio
specified in the articles of partnership. Dozier and Ross are credited
with 40 percent and 20 percent of partnership income, respectively.
The 40:20 ratio equates to a 2:1 relationship (or 2⁄3:1⁄3) between the
two.

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 Deficit Capital Balance -
Remaining Partners Absorb Deficit

Capital balances after distribution of Holland’s loss:

Holland Dozier Ross
Capital Balances $ (6,000) $ 15,000 $ 11,000
Allocation of Holland’s deficit balance 6,000 (4,000) (2,000)
Capital Balances $ - $ 11,000 $ 9,000

A safe payment of $11,000 may be made to Dozier that reduces

that partner’s capital account from $15,000 to the minimum
$4,000 level. A $9,000 payment to Ross decreases the $11,000
capital balance to the $2,000 limit. Thus, $11,000 and $9,000 are
the safe payments that can be distributed to the partners without
creating new deficits.

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 Schedule of Liquidation -
Interim Cash Distributions

Prior to making interim cash distributions to the

partners, assume:
1. All noncash assets will be complete losses.
2. All liabilities will be paid.
3. All deficit partners will be written off.

Even though assumptions #1 and #3 may be unrealistic,

they allow the computation of “safe” balances.

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 Schedule of Liquidation -
Interim Cash Distributions
Transactions in the partnership liquidation summarized

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 Learning Objective 15-4

Prepare a proposed schedule of liquidation

from safe capital balances to determine an
equitable preliminary distribution of
available partnership assets.

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 Preliminary Distribution of Assets

Under the Uniform Partnership Act, a priority ranking

of creditors having claims against individual partners is
recognized:

Debts owed to
partnership Debts owed to
creditors. the other
partners.
Debts owed to
personal
creditors.
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 Claims Against the Partnership

 Individual partner’s creditors can make a claim

against the assets of the partnership.
 All partnership creditors must be satisfied first.
 The creditors can only assert claims to the extent of
the specific partner’s positive capital balance.
 Each partner is liable for ALL the debts of the
partnership.
 Partners are NEVER liable for the personal debts of
the other partners.

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 Learning Objective 15-5

Develop a predistribution plan to guide the

distribution of assets in a partnership
liquidation.

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 Predistribution Plan

At the start of a liquidation, accountants produce a

single predistribution plan to serve as a guide for all
future payments.
Whenever cash becomes available, the plan indicates
the appropriate recipient(s) without drawing up ever-
changing proposed schedules of liquidation.
The plan is developed by simulating a series of losses,
each of which is just large enough to eliminate, one at
a time, all of the partners’ claims to partnership
property.
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 Predistribution Plan
Assume the following partnership is to be liquidated
Assume the income sharing percentage is Rubens 50%,
Smith 20%, and Trice 30%.

Partnership capital reported totals $121,000. Differing

losses would reduce each partner’s current capital balance
to zero. As a prerequisite to developing a predistribution
plan, the sensitivity to losses exhibited by each of these
capital accounts must be measured.
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 Predistribution Plan

First, determine the maximum loss that each partner

can absorb. Divide each partner’s capital balance by
their respective income sharing percent.

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 Predistribution Plan
Since Rubens can ONLY absorb a partnership loss of
$60,000, new balances are computed assuming that
the partnership has a $60,000 loss.

With Rubens wiped out, continue calculating

maximum absorbable losses using income sharing
percentages of Smith, 20% (2/5) and Trice 30% (3/5).
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 Predistribution Plan

According to the schedule, a total loss of $115,000

($60,000 from Step 1 plus $55,000 from Step 2) leaves
capital of only $6,000, a balance attributed entirely to
Smith.
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 Predistribution Plan
To inform all parties of the pattern by which available
cash will be disbursed, the predistribution plan should be
formally prepared in a schedule format prior to beginning
liquidation. Liquidation expenses have been estimated.

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