AE 112-

MODULE 8
INSERT RELATED PICTURE HERE (PARTNERSHIP
LIQUIDATION-
LUMP-SUM)

COURSE LEARNING OUTCOMES

At the end of the module, you should
be able to:
1. define partnership liquidation and
identify its causes;
2. know the various problems
encountered in partnership
liquidation; and
3. understand the accounting
procedures under lump-sum
liquidation.

FINANCIAL
ACCOUNTING AND
REPORTING

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 Many people are afraid of the dark, but the real tragedy is those
who are afraid of the light.

Plato

COURSE INTRODUCTION
This course provides an introduction to accounting, within the context of business
and business decisions. Students explore the role of accounting information in the
decision-making process and learn how to use various types of accounting information
found in financial statements and annual reports. This course starts with a discussion of
accounting thought and the theoretical background of accounting and the accounting
profession. The next topic is the accounting cycle - recording, handling, and summarizing
accounting data, including the preparation and presentation of financial statements for
merchandising and service companies. Moreover, it continues with transactions, financial
statements, and problems peculiar to the operations of partnerships and corporations as
distinguished from sole proprietorships. Topics include accounting for partnership formation
and operations; share capital issuances, treasury shares, other related transactions
affecting accumulated profits. Emphasis is placed on understanding the reasons
underlying basic accounting concepts and providing students with an adequate
background on the recording, classification, and summarization functions of accounting to
enable them to appreciate the varied uses of accounting data.

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 When the partnership is dissolved and the partners do not wish to continue business
operations, the dissolved partnership is liquidated. Liquidation is the process of winding up
business affairs; that is, conversion of non-cash assets into cash, paying the liabilities and
distributing the remaining cash to the partners.

Partnership dissolution with liquidation may be caused by any of the following:

a. Accomplishment of the purpose for which the partnership was organized

b. Ending or the termination of the period covered by the partnership contract
c. Bankruptcy of the firm
d. Mutual agreement among the partners to close the business.
e. By court decree

One of the partners or an outsider may be assigned to take care of the liquidation of the
firm. This person, called the liquidator or receiver, will take an inventory of the partnership
assets, all partners being furnished with a copy of such inventory. Then from time to time
he will submit to the partners a report of the progress of the liquidation.

The liquidation process may take a considerable period of time, with the partners seeking
the best possible prices for partnership assets and considering a forced sales price like in a
public auction, as secondary option. As such, certain costs and expenses may be incurred
during the liquidation process to effect the best realization of noncash assets. Such costs
and expenses include cost to complete inventory, sales commissions, shipping costs and
other costs related to disposal of assets. Such costs shall be deducted from the sales
proceeds to get the net cash realized from the sale of noncash assets. The partnership
agreement should specify if a special ratio shall be used in distributing gains and losses in
liquidation. Otherwise, the normal profit and loss sharing ratio shall be applied.

The liquidation process must observe the principle of “equitable distribution of assets”
which requires the protection of creditors’ and partners’ legal rights. As such proper
accounting and observance of applicable laws should be enforced regarding the
activities of the entire liquidation process. Article 1839 of the Partnership Law provides
the following rules on the settlement of claims of creditors and partners:

1. The assets of the partnership are

a. the partnership property
b. the contributions of the partners necessary for the payment of all the liabilities
specified in No. 2

2. The liabilities of the partnership shall rank in the order of payment, as follows:
a. those owing to creditors other than partners
b. those owing to partners other than capital and profits (like loans and salaries).

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 c. those owing to partners in respect of capital
d. those owing to partners in respect of profits (based on profit and loss sharing
ratio)

3. The assets shall be applied in the order of their declaration in No. 1 of this article to
the satisfaction of the liabilities.

4. The partners shall contribute, as provided by article 1797 the amount necessary to
satisfy the liabilities.

5. An assignee for the benefit of creditors or any person appointed by the court shall
have the right to enforce the contributions specified in the preceding number.

6. Any partner or his legal representative shall have the right to enforce the
contributions specified in No. 4, to the extent of the amount which he has paid in
excess of his share of the liability.

7. The individual property of a deceased partner shall be liable for the contributions
specified in No. 4.

8. When partnership property and the individual properties of the partners are in
possession of a court for distribution, partnership creditors shall have priority on
partnership property and separate creditors on individual property, saving the rights
of lien of secured creditors.

9. Where a partner has become insolvent or his estate is insolvent, the claims against
his separate property shall rank in the following order:
a. those owing to separate creditors
b. those owing to partnership creditors
c. those owing to partners by way of contribution

Nos. 2, 8 and 9, known as the Doctrine of Marshaling of Assets, shall be applied whenever
the partnership and/or one of the partners are insolvent. Amounts owed to partners by way
of contribution refers to amounts owed the partnership as represented by the partner's
debit capital balance. To reiterate, the doctrine states that:

1. The order of claims against partnership assets shall be as follows:

a. Partnership creditors other than partners
b. Partners’ claims other than capital and profits
c. Partners’ claims as to capital and profits

2. The order of claims against personal assets of individual partners shall be as follows:
a. Personal creditors of individual partners
b. Partnership creditors for unpaid partnership liabilities

Hence, if personal creditors are not satisfied from personal assets, they have a claim
against the partner's interest in the partnership. If partnership creditors are not fully paid
out of partnership assets they have claim against the personal assets of any partner who

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 has personal assets remaining after satisfying his personal creditors. It must be noted,
however, that the partners, including industrial partners, are liable pro-rata with all their
separate property to pay partnership obligation after all assets of the firm have been
exhausted (See Art. 1816 of the Civil Code of the Philippines). Pro-rata has been legally
interpreted to mean equally in this particular case. (See Co-Pitco vs. Yulo,8 Phil. 544; Island
Sales, Inc. vs. United Pioneers General Construction Company,L-22493, July 31, 1975.)

To illustrate, assume that the partnership is insolvent, with total assets of P46,000 and total
liabilities of P50,000. Information relating to each partner is as follows:

Happy Joy
Partnership Capital Balances P1,000 (P5,000)

Total Personal Assets P20,000 P16,000

Less: Total Personal Liabilities 12,000 14,000
Assets available for payment to partnership P8,000 P2,000
creditors

Unpaid partnership creditors, P4,000 (P50,000 - 46,000) may seek recourse from the
individual partners in a pro-rata basis, meaning partner contributes P2,000 each.

To illustrate the recourse of unpaid creditors if the partnership and a

partner become insolvent, let us assume the following information for the partnership:

Total Assets P 40,000

Less: Total Liabilities 50,000
Unpaid liabilities P 10,000

Happy Joy
Partnership Capital Balances (P14,000) P4,000

Total Personal Assets P26,000 P24,000

Less: Total Personal Liabilities 20,000 30,000
Assets available for payment to partnership P6,000 (P6,000)
creditors

The partnership creditors claim P 5,000 each from the partners. Happy is under no
obligation to pay more than this share of unpaid partnership liabilities. The remaining
partnership creditors cannot claim from Joy because she is personally insolvent and
likewise the personal creditors of Joy cannot claim Joy's interest in the partnership because
the partnership itself is insolvent.

METHODS OF PARTNERSHIP LIQUIDATION

1. Lump-sum Method or Total Liquidation or Single Distribution

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 Under this method, all assets are converted into cash and all liabilities to outsiders are
settled, after which the remaining cash is distributed to the partners based on their
capital balances. This method provides an assurance of recording all gains and losses
before distribution to partners.

2. Installment Method
Under this method, a periodic distribution of cash may be agreed upon by the
partners if it would take a considerable period of time to convert the non-cash
assets into cash. The non-cash assets are realized on a piecemeal basis. Payments to
partners are made in installment after the partnership creditors have been paid. In as
much as there are still non-cash assets not yet realized, the total loss on realization
cannot be ascertained yet at the time the installment payments are made to the
partners.

This method necessitates the preparation of a schedule of safe payments which

assumes possible losses due to 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. This method is discussed in detail in an advanced accounting course.

I. LUMP-SUM LIQUIDATION

The following procedures may be followed in a lump-sum liquidation:

1. Realization and distribution of gain or loss

Realization is the conversion of non-cash assets into cash. Gains or loss on realization
must be distributed among the partners based on agreed profit or loss ratio. If the
amount realized or amount received for the non-cash asset is:

A. More than the book value of the assets, then there is a GAIN.
Cash xx
Contra-asset accounts (itemized) xx
Non-cash assets (itemized) xx
Partners, Capital (P&L ratio) xx
To record realization of non-cash assets and distribution of gain.

B. Less than the book value of the assets, then there is a LOSS.
Cash xx
Contra-asset accounts (itemized) xx
Partners, Capital (P&L ratio) xx
Non-cash assets (itemized) xx
To record realization of non-cash assets and distribution of loss.

Liquidation expenses may be incurred to facilitate the immediate realization of non-

cash assets. Payment of liquidation expenses reduces cash and is recorded as
deductions from partner’s capital based on the partners’ profit and loss ratios. Or it

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 can be deducted in the sales proceeds in determining the gain or loss on
realization.

2. Elimination of any deficiency in a partner’s capital account.

Capital deficiency refers to a debit (or negative) capital balance of a partner that
usually occurs when a partner's share of the loss on realization exceeds his capital
credit. Such deficiency is collectible by the partnership from the deficient partner. The
following procedure is suggested to eliminate the capital deficit, in the order of priority:

A. Exercise of the Right of Offset

Right of Offset is the legal right to apply part or all of an amount owing to a partner
on a loan balance against his capital deficiency. The amount of offset would be
the loan balance or capital deficiency whichever is lower.
Legally, partners’ loan accounts have a higher priority than partner’s capital accounts.
However, the doctrine of right of offset sets aside this ranking in order to facilitate the
liquidation process. Thus, a partners’ claim on partnership assets shall be represented
by the credit balance of his total interest in the partnership, which is the sum of his loan
and capital account. The entry to record exercise of offset is:

Partner, Loan xx
Partner, Capital xx

However, the right of offset cannot be exercised in the following instances:

i. The deficient partner is a limited partner.
ii. The deficient partner is a general partner but he is personally insolvent by an
amount greater than his loan balance.

(Please refer to cases 8 and 9 for the explanations of the above instances)

If the partner has no loan account or his loan account balance is not sufficient to
cover his capital deficiency, then the remaining capital deficiency shall be settled
depending on the personal financial status of the deficient partner.

B. Additional Investment – applied if the deficient partner is solvent (personal assets

exceeds personal liabilities). The deficient partner should invest cash equivalent to
his deficit or extent of solvency, whichever is lower. The entry would be::

Cash xx
Partner, Capital xx
To record the additional investment of deficient partner.

However, since a limited partner is liable only up to his capital contribution, he is

exempted from making additional investment even if he is personally solvent. In
case the deficient partner is a general partner but who is insolvent (personal assets

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 is less than personal liabilities), the burden of loss is passed to the other partners
since he cannot make additional investment.

C. Absorption – applied when the first two remedies are not applicable or are not
enough to cover the capital deficiency. In such case, the deficiency balance will
be viewed as realization loss to be absorbed by the other partners based on their
profit and loss ratio. The entry would be:

Partner, Capital (partner with credit xx

balance)
Partner, Capital (partner with deficit) xx
To record absorption of partners’ capital deficiency.

3. Payment of Liabilities

Partnership creditors shall be preferred to those of each partner as regards the

partnership property. Payment to outside creditors shall be made in the following order:

a. Preferred claims are those claims which must be satisfied before all other creditors.
These claims are enumerated by law like Taxes Payable, Accrued Salaries Payable,
etc.
b. Secured creditors are those whose claims are secured by specific assets of the
partnership. If not satisfied, these creditors may sell the securities they hold, and
from the proceeds, they may retain their claims. If there is any excess proceeds,
such amounts should be turned over to the partnership. If the proceeds are not
enough, in most cases, the deficiency becomes an unsecured credit.

c. Unsecured creditors are those whose claims are not secured by any asset of the
partnership. They are the last priority in the payment to creditors.
The entry should be:

Liabilities (Itemized) xx
Cash xx
To record payment of liabilities.

Again, if there are unpaid creditors after the partnership assets have been exhausted,
the partners (except the limited partner) shall be liable pro rata with all their property.

4. Payment to Partners

As a general rule, cash distribution shall be made to the partners only after elimination of
any capital deficiency and after partnership creditors are fully paid This is in accordance
with the doctrine of marshalling of assets and right of offset. The settlement to the
partners shall be equal to the remaining credit balances of their loan and capital
accounts.
The entry should be:

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 Partner, Loan xx
Partner, Capital xx
Cash xx
To record settlement of partner’s
interest.

STATEMENT OF LIQUIDATION

The Statement of Liquidation is an accounting statement summarizing the winding up of

the affairs of the partnership. It shows the balances of assets, liabilities and capital
accounts before realization of non-cash assets, the division of net gain or loss on
realization, the elimination of capital deficit, if any, the payment of liabilities and the
distribution of the remaining cash to the partners.

To illustrate, the post-closing trial balance of ABC Partnership on January 1, 2020, after
they have ceased business operations and adjusted and closed the accounts of the
general ledger, shows the following account balances (The partners share profits and
losses equally):
Cash P 100,000
Accounts Receivable 400,000
Merchandise Inventory 150,000
Accounts Payable 430,000
C, Loan 20,000
A, Capital 90,000
B, Capital 70,000
C, Capital 40,000
Case 1: Gain on Realization of Assets.

ABC Partnership is able to sell its non-cash assets for P 604,000. The transaction results to a
gain of P54,000 which is distributed to the partners at P18,000 each. Since there is no
capital deficiency to eliminate, the next step is to pay the liabilities to creditors, after which
payment to partners' loan and capital balances. The journal entries to record these
transactions and the Statement of Liquidation are shown below:

 Realization of assets & distribution of gain

Cash 604,000
Accounts receivable 400,000
Merchandise inventory 150,000
A, Capital 18,000
B, Capital 18,000
C, Capital 18,000

 Payment of liabilities
Accounts payable 430,000
Cash 430,000

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  Payment to partners
C, Loan 20,000
A, Capital 108,000
B, Capital 88,000
C, Capital 58,000
Cash 274,000

ABC Partnership
Statement of Liquidation
January 1, 2020

Case 2: Loss on Realization of Assets, No Capital Deficiency

ABC Partnership is able to sell its non-cash assets for P 490,000. The transaction results to a
loss of P60,000 which is distributed to the partners at P20,000 each. Since the loss on
realization is fully absorbed by the partner’s capital, the next step is to pay the liabilities to
creditors then payment of partners' loan and capital balances. The journal entries to
record these transactions and the Statement of Liquidation are shown below:

 Realization of assets & distribution of loss

Cash 490,000
A, Capital 20,000
B, Capital 20,000
C, Capital 20,000
Accounts receivable 400,000
Merchandise Inventory 150,000
 Payment of liabilities
Accounts payable 430,000
Cash 430,000

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  Payment to partners
C, Loan 20,000
A, Capital 70,000
B, Capital 50,000
C, Capital 20,000
Cash 160,000

ABC Partnership
Statement of Liquidation
January 1, 2020

Case 3: Loss on Realization of Assets, Deficient Partner Exercises His Right of Offset

ABC Partnership is able to sell its non-cash assets for P 424,000. The transaction results to a
loss of P126,000 which is distributed to the partners at P42,000 each. C's share in the loss of
P424,000 results in his capital deficiency of P2,000. Since the partnership is liable to C for
P20,000 loan, P2,000 of the loan is offset against the capital deficiency. The next step is to
pay the liabilities to creditors after which payment to partners' loan and capital
balances. The journal entries to record these transactions and the Statement of
Liquidation are shown below:
 Realization of assets & distribution of loss
Cash 424,000
A, Capital 42,000
B, Capital 42,000
C, Capital 42,000
Accounts receivable 400,000
Merchandise Inventory 150,000

 Exercise right of offset

C, Loan 2,000
C, Capital 2,000

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  Payment of liabilities
Accounts payable 430,000
Cash 430,000

 Payment to partners
C, Loan 18,000
A, Capital 48,000
B, Capital 28,000
Cash 94,000

ABC Partnership
Statement of Liquidation
January 1, 2020

Case 4: Loss on Realization of Assets, Deficient Partner is Solvent

ABC Partnership is able to sell its non-cash assets for P 355,000. The transaction results to a
loss of P195,000 which is distributed to the partners at P65,000 each. C's share of
P65,000 results in his capital deficiency of P25,000. Since C has a loan from the
partnership, he can offset it against his capital deficit. The offset of the P20,000 loan due to
C leaves a capital deficiency of P5,000. If C is solvent, then he makes an additional
investment of cash to cover up his remaining capital deficit. The next step is to pay the
liabilities to creditors then payment of capital balances to partners A and B only. The
journal entries to record these transactions and the Statement of Liquidation are :
 Realization of assets & distribution of loss
Cash 355,000
A, Capital 65,000
B, Capital 65,000
C, Capital 65,000
Accounts receivable 400,000
Merchandise Inventory 150,000

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  Elimination of capital deficit
C, Loan 20,000
Cash 5,000
C, Capital 25,000
 Payment of liabilities
Accounts payable 430,000
Cash 430,000
 Payment to partners
A, Capital 25,000
B, Capital 5,000
Cash 30,000

ABC Partnership
Statement of Liquidation
January 1, 2020

Case 5: Loss on Realization of Assets, Deficient Partner is Insolvent

ABC Partnership is able to sell its non-cash assets for P 355,000. The transaction results to a
loss of P195,000 which is distributed to the partners at P65,000 each. C's share of
P65,000 results in his capital deficiency of P25,000. The loan due to C is offset against his
capital but this is not sufficient to eliminate C's capital deficit. Assume further that he is
insolvent and therefore unable to pay for his capital deficiency. The debit balance in the
capital account of C is absorbed by A and B at P 2,500 each, based on their profit and loss
sharing ratio which is equally. The next step is to pay the liabilities to creditors and capital
balances to partners A and B only. The journal entries to record these transactions and the
Statement of Liquidation are shown below:
 Realization of assets & distribution of loss
Cash 355,000
A, Capital 65,000
B, Capital 65,000
C, Capital 65,000
Accounts receivable 400,000
Merchandise Inventory 150,000

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  Offset of loan & absorption of deficit by other partners
C, Loan 20,000
A, Capital 2,500
B, Capital 2,500
C, Capital 25,000

 Payment of liabilities
Accounts payable 430,000
Cash 430,000

 Payment to partners
A, Capital 22,500
B, Capital 2,500
Cash 25,000
ABC Partnership
Statement of Liquidation
January 1, 2020

Case 6: Partnership is Insolvent, Partners are Solvent

ABC Partnership is able to sell its non-cash assets for P 310,000. The transaction results
to a loss of P240,000 which is distributed to the partners at P80,000 each. B and C's share
of P80,000 results in their capital deficiencies of P10,000 and P40,000 respectively. The
offset of the P20,000 loan due to C leaves a capital deficiency of P20,000 deficit. If B and
C are solvent, then they make additional investment of P30,000 cash to cover up their
capital deficit. The next step is to pay the liabilities to creditors then payment of capital
balances to partner A only. The journal entries to record these transactions and the
Statement of Liquidation are shown below:
 Realization of assets & distribution of loss
Cash 310,000
A, Capital 80,000
B, Capital 80,000
C, Capital 80,000
Accounts receivable 400,000
Merchandise Inventory 150,000

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  Offset of loan & additional investment of other partners
C, Loan 20,000
Cash 30,000
B, Capital 10,000
C, Capital 40,000

 Payment of liabilities
Accounts payable 430,000
Cash 430,000

 Payment to partners
A, Capital 10,000
Cash 10,000
ABC Partnership
Statement of Liquidation
January 1, 2020
ASSETS LIABILITIES CAPITAL
Accounts Accounts A B C
Cash Receivable Mdse. Payable C, Loan (1/3) (1/3) (1/3)
Bal. Before Realization 100,000 400,000 150,000 430,000 20,000 90,000 70,000 40,000
Real. & Dist. Of Loss 310,000 (400,000) (150,000) (80,000) (80,000) (80,000)
Balances 410,000 430,000 20,000 10,000 (10,000) (40,000)
Right of Offset (20,000) 20,000
Investment of Cash 30,000 10,000 20,000
Balances 440,000 430,000 10,000
Payment to Creditors (430,000) (430,000)
Payment to Partners
Capital (10,000) (10,000)

Case 7: Partnership is Insolvent, Partners are Insolvent

ABC Partnership is able to sell its non-cash assets for P 310,000. The transaction results to a
loss of P240,000 which is distributed to the partners at P80,000 each. B and C's share of
P80,000 results in their capital deficiencies of P10,000 and P40,000 respectively. The offset
of the P20,000 loan due to C leaves a capital deficiency of P20,000 deficit. Assume further
that all of the partners are insolvent and unable to pay their capital deficiencies. The debit
balances of P 10,000 and P20,000 in the capital accounts of B and C respectively are
absorbed by A to the extent of P10,000. The amounts absorbed are:
B: (10,000 / 30,000) x P10,000 = 3,333
C: (20,000 / 30,000) x P10,000 = 6,667
P10,000

The available cash of P410,000 is paid to creditors at the rate of P0.9535 (410,000 /
430,000). Since the partners and the partnership are insolvent, the creditors suffer bad
debts of P20,000. The creditors may collect later from the personal assets of the three
partners. A may also recover later from B and C if the financial position of the latter

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 improve. The journal entries to record these transactions and the Statement of Liquidation
are shown below:

 Realization of assets & distribution of loss

Cash 310,000
A, Capital 80,000
B, Capital 80,000
C, Capital 80,000
Accounts receivable 400,000
Merchandise Inventory 150,000

 Offset of loan & absorption of deficit by other partners

C, Loan 20,000
A, Capital 10,000
B, Capital 3,333
C, Capital 26,667

 Payment of liabilities
Accounts payable 410,000
Cash 410,000

ABC Partnership
Statement of Liquidation
January 1, 2020

. A S S E T S . LIABILITIES . C A P I T A L .
Cash Accounts Mdse. Accounts C, Loan A B C
Receivable Payable (1/3) (1/3) (1/3)
Bal. b4 100,000 400,000
150,000 430,000 20,000 90,000 70,000 40,000
Realization
Real & Dist. 310,000 (400,000) (150,000) (80,000) (80,000) (80,000)
of Loss
Balances 410,000 430,000 20,000 10,000 (10,000) (40,000)
Right of (20,000) 20,000
Offset
Absorption (10,000) 3.333 6,667
of A
Balances 410,000 430,000 (6,667) (13,333)
Payment (410,000) (410,000)
to
Creditors
Balances 20,000 (6,667) (13,333)
Offset of Unpaid liability to third parties
Against uncollectible capital (20,000) 6,667 13,333
deficiency

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 Case 8: Loss on Realization of Assets, Deficient Partner is Solvent but is Limited Partner

Let us use the same facts as Case 4 except that C is a limited partner. In here, the right of
offset cannot be applied against C since C’s loan account is technically not part of his
invested capital. If C did not lend his money to the partnership that money should have
become part of his personal assets which cannot be claimed by the partnership since his
liability as a limited partner is limited to his invested capital. C should not suffer a loss as a
consequence of doing a favor to the partnership by granting a loan when the partnership
needed funds to operate prior to liquidation. Such fund is a claim of C as a creditor, not
partner, of the partnership. Otherwise, if his intention is to make it part of his invested
capital, it should have just been credited to his capital balance, and not placed on a
separate loan account. This is supported by the Partnership Law provision numbers 2, 8 and
9 as reiterated in the discussion of Doctrine of Marshalling of Assets (pages 152 and 153). It
can also be reflected as the reason why we exclude loan balance in the computation of
weighted average capital which is used as basis in distributing operating profits or losses.

Therefore, the journal entries to be made are shown on the below:

 Realization of assets & distribution of loss

Cash 355,000
A, Capital 65,000
B, Capital 65,000
C, Capital 65,000
Accounts receivable 400,000
Merchandise Inventory 150,000

 Absorption of deficit by other partners

A, Capital 12,500
B, Capital 12,500
C, Capital 25,000
 Elimination of Capital deficit
Cash 7,500
B, Capital 7,500

 Payment of liabilities
Accounts payable 430,000
Cash 430,000

 Payment to partners
C, Capital 20,000
A, Capital 12,500
Cash 32,500

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 The Statement of Liquidation for this case is shown below:

ABC Partnership
Statement of Liquidation
January 1, 2020

ASSETS LIABILITIES CAPITAL

Accounts Accounts A B C
Cash Receivable Mdse. Payable C, Loan (1/3) (1/3) (1/3)
Bal. b4 100,000 400,000 150,000 430,000 20,000 90,000 70,000 40,000
realization
Real. & dist. 355,000 (400,000) (150,00) (65,000) (65,000) (65,000)
of loss
Balances 455,000 430,000 20,000 25,000 5,000 (25,000)
Absorption (12,500) (12,500) 25,000
Investment 7,500 7,500
of Cash
Balances 462,500 430,000 20,000 12,500
Payment to (430,000) (430,000)
creditors
Payment to
partners
Loans (20,000) (20,000)
Capital (12,500) (12,500)

Case 9: Loss on Realization of Assets, Deficient Partner is Insolvent

Let us use the same facts as Case 5 except that C is personally insolvent by more than P
20,000. In here, the right of offset cannot be applied against C since C’s loan account is
technically not part of his invested capital. If C did not lend his money to the partnership,
that money should have become part of his personal assets and which must be used to
satisfy first C’s personal creditors before it can be claimed by the partnership creditors and
partners. C has the right to claim his loan balance and use it to pay first his personal
creditors. Again, he should not suffer a loss as a consequence of doing a favor to the
partnership by granting a loan when the partnership needed funds to operate prior to
liquidation. However, since C is a general partner and is liable to the extent of his personal
assets, he should reimburse the partners by the time he becomes personally solvent. If C’s
loan balance is more than his capital deficit, the excess can be claimed by the partnership
by exercising the right of offset. Just like in Case 8, the loan is a claim of C as a creditor, not
partner, of the partnership. Otherwise, if his intention is to make it part of his invested
capital, it should have just been credited to his capital balance, and not placed on a
separate loan account. Again, this is supported by the Partnership Law provision numbers
2, 8 and 9 as reiterated in the discussion of Doctrine of Marshalling of Assets (pages 152 and
153). It can also be reflected as the reason why we exclude loan balance in the
computation of weighted average capital which is used as basis in distributing operating
profits or losses.

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 Therefore, the journal entries as well as the Statement of Liquidation to be made will be the
same as in Case 8.

KEY POINT
If the problem is silent, the basic assumption is that the partners are
INSOLVENT, for purposes of conservatism. In the event that a partner cannot pay for
his capital deficiency, the additional loss has already been considered in the
statement of liquidation. Of course, this does not limit the right of the other
partners to collect from the deficient partner, especially if he is a general partner.

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 Practice Exercise 8-1: MULTIPLE CHOICE - CONCEPTUAL

Select the letter of the best possible answer to each of the following items.

_____1. The process of terminating the business, selling the assets, paying the liabilities
and disbursing the remaining cash to the partners is called
A. Dissolution
B. Formation of the partnership
C. Withdrawal
D. liquidation
E. None of the above

_____2. What is the rule of offset?

A. Loans from partners should be offset against their debit capital
balances before they receive any cash distribution.
B. Receivables from partners should be offset against their debit capital
balances before they receive any cash distribution.
C. Loans to partners should be offset against their debit capital balances
before they receive any cash distribution.
D. Loans from partners should be offset against their credit capital
balances before they receive any cash distribution.
E. None of the above

_____3. During liquidation, a partner’s capital balance drops below zero. What should
happen?
A. The other partners should file a legal suit against the partner with the
deficit capital balance.
B. The partner with the highest capital balance should contribute
sufficient assets to eliminate the deficit.
C. The deficit balance should be removed from the accounting records
with only the remaining partners sharing in future gains and losses.
D. The partner with a deficit should contribute enough assets to offset the
deficit balance.
E. None of the above

_____4. If all the liabilities have been recorded, and no additional expenses are
expected, the maximum loss a partnership can realize is the
A. Fair market value of the non-cash assets.
B. Book value of the non-cash assets.
C. Book value of the non-cash assets plus the recorded liabilities.
D. Fair market value or the book value of the noncash assets, whichever
is larger.
E. None of the above

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 _____5. The following partnership accounts represent a liability of a partner to the
partnership except:
A. Receivable from partner
B. Loan to partner
C. Loan from partner
D. Due from partner
E. None of the above

_____6. The loss on realization is distributed to the partners in accordance to their:

A. Capital balances at the time of realization
B. Profit and loss sharing agreement
C. Distributed equally among the partners
D. Ending capital balances at the beginning of the year
E. None of the above

_____7. A partner who administers the realization and distribution of partnership assets
after dissolution.
A. Industrial partner
B. Liquidating partner
C. Managing partner
D. General partner
E. None of the above

_____8. The conversion of non-cash assets into cash.

A. Liquidation
B. Dissolution
C. Realization
D. Marshaling of assets
E. None of the above

_____9. When is a partnership legally insolvent?

A. When the partnership assets are insufficient to meet the partnership
obligations and at least one partner is legally insolvent.
B. When the partnership assets are insufficient to meet the partnership
obligations.
C. When the partnership assets plus the assets of all the partners are
insufficient to meet the partnership plus the individual partners’
liabilities.
D. When all the partners are personally insolvent.
E. None of the above

_____10. In the liquidation of a partnership, a loan payable to a partner:

A. Must be closed to that partner’s drawing account.
B. Has the same priority as amounts payable to outside creditors of the
partnership.

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 C. Will not advance the time of payment to that partner during the
liquidation.
D. May be offset against that partner’s capital account balance before
liquidation commences.
E. None of the above

Practice Exercise 8-2: (Statement of Liquidation and Journal Entries)

Anita, Banana and Carla are partners in the ABC partnership decided to liquidate.
The condensed statement of financial position of the partnership as of December 31, 2020
is presented below:

Assets Liabilities and Capital

Cash P 40,000 Liabilities P 140,000
Non-cash Assets 360,000 Carla, Loan 20,000
Anita, Capital 140,000
Banana, Capital 80,000
Carla, Capital 20,000
Total Assets P 400,000 Total Liabilities and Capital P 400,000

Anita, Banana and Carla share profits and losses in the ratio of 5:3:2, respectively.

Instruction: Prepare liquidation statements and journal entries to record the liquidation
under each of the following independent cases.

Case 1 - Other assets are sold for P200,000.

Case 2 - Other assets are sold for P140,000. All partners are solvent and any partner
with a capital deficit makes good
his deficit by contributing additional cash to the partnership.
Case 3 - Other assets are sold for P140,000. All partners are insolvent and unable to
make good any capital deficit.
Case 4 - Other assets are sold for P104,000. The personal assets and liabilities of the
partners are as follows:

Personal Assets Personal

Liabilities
Anita P200,000 P160,000
Banana 100,000 90,000
Carla 60,000 50,000

Case 5 - Other assets are sold for P104,000. The personal assets and liabilities of the
partners are as follows:

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 Personal Assets Personal
Liabilities
Anita P160,000 P130,000
Banana 80,000 84,000
Carla 60,000 70,000

Case 1 - Other assets are sold for P200,000.

ABC Partnership
Statement of Liquidation
December 31, 2020
Non- Carla, Anita, Banana, Carla,
Particulars Cash cash Liabilities Loan Capital Capital Capital
Assets

GENERAL JOURNAL
POST
DATE PARTICULARS DEBIT CREDIT
REF
1 1

2 2

3 3

4 4

5 5

6 6

7 7

8 8

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Case 2 - Other assets are sold for P140,000. All partners are solvent.

ABC Partnership
Statement of Liquidation
December 31, 2020
Non- Carla, Anita, Banana, Carla,
Particulars Cash cash Liabilities Loan Capital Capital Capital
Assets

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Case 3 - Other assets are sold for P140,000. All partners are insolvent.

ABC Partnership
Statement of Liquidation
December 31, 2020
Non- Carla, Anita, Banana, Carla,
Particulars Cash cash Liabilities Loan Capital Capital Capital
Assets

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Case 4 - Other assets are sold for P104,000. Personal assets and liabilities are to be
considered.

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 ABC Partnership
Statement of Liquidation
December 31, 2020
Non- Carla, Anita, Banana, Carla,
Particulars Cash cash Liabilities Loan Capital Capital Capital
Assets

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REF
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8 8

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14 14

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 15 15

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17 17

Case 5 - Other assets are sold for P104,000. Personal assets and liabilities are to be
considered.

ABC Partnership
Statement of Liquidation
December 31, 2020
Non- Carla, Anita, Banana, Carla,
Particulars Cash cash Liabilities Loan Capital Capital Capital
Assets

GENERAL JOURNAL
POST
DATE PARTICULARS DEBIT CREDIT
REF
1 1

2 2

3 3

4 4

5 5

6 6

7 7

8 8

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Practice Exercise 8-3: (Book value of Non-cash assets and loss from realization)

Ethel, Elaine, Elinore and Edna are partners sharing profits in to ratio 2:4:6:8, respectively.
The balances of their capital accounts are as follows: Ethel – P40,000; Elaine – P760,000;
Elinore – P760,000; and Edna – P280,000. The partners decided to liquidate and they
accordingly converted the noncash assets into P699,000 cash. After paying the liabilities
amounting to P90,000, they have P666,000 cash to divide. Assume that a debit balance of
any partner’s capital is uncollectible.

Instructions: Compute for the book value of the non-cash assets and loss from realization
and determine the share of each partner in the loss from realization.

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 Practice Exercise 8-4: (Cash Realized)

Mattie, Nicole, Alonzo and Joey are partners sharing profits and loss in the ratio of 3:4:5:6
and having capital balances of P60,000, P80,000, P70,000 and P90,000, respectively. The
partners decided to liquidate and used the partnership cash of P15,000 to facilitate the
liquidation process. After converting all non-cash assets into cash and paying partnership

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 liabilities of P50,000, they have P115,000 to divide. Assume that a debit balance of any
partner’s capital is uncollectible.

Instruction: Compute for the net cash realized from the sale of noncash assets.

Practice Exercise 8-5: (Computation of Loss on realization)

Carl, Carlos and Ceasar, partners of CCC Partnership who share profits and losses in the
ratio of 4:3:3, have the following related account balances as of October 31, 2014:

Debit Credit
Carl, Loan P 5,000 Ceasar, Loan P 8,000
Carlos, Drawing 15,000 Carl, Drawing 10,000
Carl, Capital 65,000
Carlos, Capital 70,000
Ceasar, Capital 52,000

On November 1, 2014, the partnership underwent liquidation. Carl received P 15,000 as

final settlement of his claims in the partnership.

Instruction: Compute for the loss on realization of assets.

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 SUMMATIVE ASSESSMENT (GRADED ACTIVITY) – PARTNERSHIP LUMP-SUM LIQUIDATION
The 3G Company decided to liquidate on December 1, 2020. Statement of financial position of
the company on such date is as follows:
3G Company
Statement of Financial Position
December 1, 2020

Assets
Cash P 23,000
Non-cash assets 198,000
Total P 221,000
Liabilities and Capital
Accounts Payable P 66,000
Gary, Loan 3,600
Gala, Capital 61,000
Gary, Capital 37,400
Gaston, Capital 53,000
Total Liability and Equities P 221,000

Gala, Gary and Gaston share profits and losses in the ratio of 2:2:1, respectively.

Instruction: Prepare journal entries to record the liquidation transactions and a Statement of
Liquidation for each of the independent cases shown below:

Case 1 - Non-cash assets were sold for P205,500

3G Company
Statement of Liquidation
December 31, 2020
Non-cash Accounts Gary, Gala, Gary, Gaston,
Particulars Cash Assets Payable Loan Capital Capital Capital

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Case 2 - Non-cash assets were sold for P138,000

3G Company
Statement of Liquidation
December 31, 2020
Non-cash Accounts Gary, Gala, Gary, Gaston,
Particulars Cash Assets Payable Loan Capital Capital Capital

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Case 3 - Non-cash assets were sold for P105,000

3G Company
Statement of Liquidation
December 31, 2020
Non-cash Accounts Gary, Gala, Gary, Gaston,
Particulars Cash Assets Payable Loan Capital Capital Capital

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Case 4 - Non-cash assets were sold for P90,000, deficient partner is solvent.

3G Company
Statement of Liquidation
December 31, 2020
Non-cash Accounts Gary, Gala, Gary, Gaston,
Particulars Cash Assets Payable Loan Capital Capital Capital

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Case 5 - Non-cash assets were sold for P90,000, deficient partner is insolvent.

3G Company
Statement of Liquidation
December 31, 2020
Non-cash Accounts Gary, Gala, Gary, Gaston,
Particulars Cash Assets Payable Loan Capital Capital Capital

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End of Module 8

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