ACCCOB1 Chapter 5 Partnership Liquidation

What is Partnership Liquidation?

The termination of a partnership as a business entity involves winding up the affairs of the partnership business and is referred to as partnership liquidation. This leads to conversion of non-cash assets into cash (ie, "realization"), settlement of debts to creditors and the distribution of remaining cash, if any to the partners. The partnership is liquidated when the purpose for which it was established has been completed. Other factors for liquidation include bankruptcy, mutual agreement among partners to close the business or term covered by the articles of co-partnership has lapsed.

What is Liquidation?

The process of winding up a business which normally consists of conversion of assets into cash, payment of liabilities and distribution of remaining among the partners.

What is Realization?

The process of converting non-cash assets into cash.

What is Gain on realization?

The excess of the selling price over the carrying amount of the non-cash assets sold through realization.

What is Loss on realization?

The excess of the carrying amount over the selling price of the non-cash assets sold through realization.

What is Capital deficiency?

the excess of a partner's share in loss on realization over his capital balance resulting to a debit balance in the capital account.

What is a Deficient partner?

A partner with a debit balance in his capital account

What is Right of Offset?

The legal right to apply part or all of the amount owning to a partner on a loan balance against his capital-deficient.

What is Partner's Interest?

The sum of a partner's capital, loan balance and advances to the partnership.

What is Solvent Partner?

Personal assets of the partner is greater than his personal liabilities.

What is Insolvent Partner?

Personal assets of the partner are less than his personal liabilities.

What is Statement of Liquidation?

An accounting statement summarizing the winding up of the business affairs of the partnership.

What is Safe payments schedule?

This is used in an installment liquidation to determine what amounts may be safely distributed to partners with positive capital balances.

Types of Liquidation

1.) Lump-sum

2.) Installment

Lump-sum (Type Of Liquidation)

Cash distribution to partners are made only after the complete realization of all assets and all liabilities to third party creditors have been settled.

Installment (Type Of Liquidation)

Cash distribution to partners are made periodically over an extended period of time. Creditors and partners receive cash under a safe payment method which ensures that all creditors are fully protected (i.e., no cash distribution will be made unless there is projected available cash after settlement of partnership external debts).

Steps in Lump Sum Liquidation

1.) Finish the accounting cycle

2.) Realization of non-cash assets and compute gain or loss on realization and distribute among the partners using their P&L (Profit and Loss) Ratio

3.) Payment of Liabilities and Liquidation expense

4.) Elimination of Capital deficiency. This happens when the share in the loss on realization and liquidation expenses exceed the capital balance of a partner

What is Installment Liquidation?

Involves the distribution of cash to partners before complete liquidation of the assets occurs.

Steps in Liquating a partnership by installments

1.) Record the realization of assets and distribute the realized gains or losses among the partners using profit and loss ratio.

2.) Pay liquidation expenses and unrecorded liabilities, if there are any, and distribute these among the partners using the profit and loss ratio.

3.) Pay the liabilities to outsiders.

4.) Distribute cash to partners after possible future losses have been apportioned to partners or in accordance with the computation of safe payments. The possible losses or restricted interest shall consist of unsold assets, cash withheld for possible expenses and absorption of any potential capital deficiency of a partner.

Computation of Safe payments to Partners

In an installment liquidation, cash can be distributed to partners even before all non-cash assets are sold. This requires careful planning to ensure fair distribution and avoid overpaying partners. To manage this, a Schedule of Safe Payments is prepared, assuming no further cash will come from asset sales or partner collections.

Before distributing cash, the following potential losses are considered:
1.) Non-cash assets: Treated as a loss, shared by the partners.
2.) Liquidation expenses and liabilities: Future costs that partners must absorb.
3.) Capital deficiencies: If a partner's capital goes negative, others absorb the loss.

Each partner's total interest (capital and loan balances) is adjusted for these possible losses. Partners with positive balances receive cash, with priority given to repaying loans first, followed by capital distributions. This process ensures safe and equitable cash payouts.

True or False: Lump sum liquidation method requires that all assets are converted into cash, all liabilities are paid, and all profits and losses are charged to the partners, followed by a single distribution of cash.

True

True or False: The process of removing the debit balance of a partner through his existing loan account is called exercising the right of off set.

True

True or False: Dissolution always results to liquidation.

False

Reason: Dissolution does not always result in liquidation. Dissolution refers to the legal ending of a partnership, which can occur for various reasons such as a partner leaving, the expiration of the partnership term, or other circumstances. However, the business may continue operating under a new partnership agreement. Liquidation, on the other hand, specifically refers to the process of selling off assets and settling liabilities, which happens when the business is permanently closing down. So, while liquidation can follow dissolution, dissolution does not always lead to liquidation.

True or False: In liquidation, cash should be distributed first to outside creditors.

True

True or False: Gain or loss on realization is divided among the partners according to their capital contributions.

False

Not CAPITAL CONTRIBUTION but PROFIT & LOSS RATIO

True or False: The loss absorption potential is the maximum loss each partner can absorb and which can eliminate him from any cash distribution.

True

True or False: In the partnership liquidation statement, assets are generally classified as cash and non-cash assets.

True

True or False: Loss on realization and liquidation expense are allocated based on the profit and loss ratio and will decrease the partners' capital accounts.

True

True or False: Under lump sum liquidation, the final cash distribution is made on the basis of the partners' profit and loss sharing agreement.

False

Reason: Not PROFIT AND LOSS SHARING AGREEMENT but the CAPITAL BALANCES, END

True or False: Payment of liabilities would not affect the capital balances of the partners.

True

This refers to the process of converting the non-cash assets of the partnership and distributing the total cash to the creditors and the remainder, if any, to the partners.

a. Dissolution
b. Termination
c. Liquidation
d. Operation

ANSWER: C. Liquidation

Which of the following statements is correct regarding partner's capital deficiency?

a. The partners who absorb another's capital deficiency have the legal claim against the deficient partner.
b. If contributions are not possible, the other partners with credit capital balances will be allocated a portion of the debit balance.
c. The partner should contribute to reduce the debit balance to the extent possible.
d. All of these statements are correct.

ANSWER: d. All of these statements are correct.

The final cash distribution to partners in the event of lump sum partnership liquidation is in accordance with

a. partners' profit and loss ratio
b. ending capital balances
c. capital contributions
d. none of the above

ANSWER: b. ending capital balances

If a partner is solvent but has capital deficiency, his personal cash/fund shall be applied

a. to partnership creditors.
b. to partnership to remove capital deficiency.
c. to deficient partner's own creditors.
d. to partnership and partner's own creditors proportionately.

ANSWER: b. to partnership to remove capital deficiency.

What is the procedure carried out in a situation where the partnership owes a partner his loan balance while the partner owes the partnership the amount of his capital deficiency?

a. Liquidation
b. Dissolution
c. Right of offset
d. Absorption of loss

ANSWER: c. Right of offset

The process of converting non-cash assets into cash:

a. Realization
b. Liquidation
c. Conversion
d. Encashment

ANSWER: a. Realization

A partner whose personal liabilities exceed his personal assets

a. Insolvent partner
b. Deficient partner
c. Nominal partner
d. Bankrupt partner

ANSWER: a. Insolvent partner

A simple partnership liquidation requires

a. periodic payments to creditors and partners as cash becomes available.

b. partnership assets to be converted into cash with full payment made to all outside creditors before remaining cash is distributed to partners in a lump sum payment.

c. only creditors to be paid in an orderly manner.

d. periodic payments to partners as cash becomes available

ANSWER: b. partnership assets to be converted into cash with full payment made to all outside creditors before remaining cash is distributed to partners in a lump sum payment.

If conditions produce a debit balance in a partner's capital account when liquidation losses are allocated

a. the partner receives further allocations of liquidation losses, but not gains.
b. the partner receives no further allocation of liquidation losses and gains
c. the partner is no longer obligated to partnership creditors.
d. solvent partner has the obligation to contribute to the partnership additional cash equivalent to his debit capital balance.

ANSWER: d. solvent partner has the obligation to contribute to the partnership additional cash equivalent to his debit capital balance.

Gains or losses from assets sold during liquidation of a partnership are

a. not recorded.
b. divided according to partners' profit and loss ratio.
c. divided equally among partners.
d. divided according to partner's ending capital balances.

ANSWER: b. divided according to partners' profit and loss ratio.