MODULE 5-Part 2
MODULE 5-Part 2
MODULE 5-Part 2
LESSON OBJECTIVES
At the end of this module, you will be able to:
1. Know the order of priority in the settlement of claims in cases of liquidation
2. Account for the liquidation of the partnership
OVERVIEW
In the preceding module, it discussed about the dissolution of the partnership in which the
business operations were continued without interruption. In this module, we will consider
dissolutions in which the partnership is terminated. The phase of partnership operations which
begins after dissolution and ends with the termination of partnership activities is referred to as
“winding up of the affairs”. These events may occur over relatively short period of time (lump-sum
liquidation), or over a period of several years (installment liquidation).
ABSTRACTION
Marshalling of Assets
As mentioned, one of the characteristics of a partnership is “unlimited liability”. This is because
the personal assets of the general partners are subject to the claims of partnership’s creditors ub
case of partnership insolvency.
The legal doctrine of marshalling assets is applied when the partnership and some of the partners
are insolvent. The following are the rules when applying this doctrine:
1. Any available assets of the partnership are used to settle the partnership’s liabilities
2. In case the assets of the partnership are insufficient to pay all liabilities, the solvent general
partners are required to provide additional funds from their personal assets.
The claims to the personal assets of a partner are ranked in the following order:
a. Those owing to personal creditors
b. Those owing to partnership creditors
c. Those owing to partners by way of contribution
3. In case some partners are insolvent or limited partners, their capital deficiency is offset
to the capital balances of the other partners. If after allocating the capital deficiency of an
insolvent or limited partner, a solvent partner’s capital balance results to a negative
amount, the solvent partner is required to provide additional contribution. (See application)
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MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
The preparation of this schedule requires the application of the same concepts as those we have
applied earlier, namely:
a) Unsold non-cash assets are treated as loss; and
b) Expected future liquidation costs and potential unrecorded liabilities are recognized
immediately as losses.
An additional procedure when preparing a cash priority program is to rank the partners to their
maximum loss absorption capacity. The partner with the highest maximum loss absorption
capacity shall be paid first. The partner with the lowest maximum loss absorption capacity shall
be paid last. The maximum loss absorption capacity is computed as follows:
APPLICATION
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MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
Requirement: determine the amounts of cash distributed to the partners in the final settlement of
their interests.
Solution:
STEP 1: Compute for gain or loss
a. Collection of A/R P10,000
b. Sale of Inventory 5,000
c. Sale of Equipment 53,000
d. Actual liquidation expense (2,000)
Net Proceeds P66,000
Less: Carrying Amounts of all NCA (480,000)
Total Loss (P414,000)
STEP 2: Allocate the gain or loss to the partner’s capital balances (include their right of offset)
A (20%) B (30%) C (50%) Total
Capital Balances 100,000 150,000 200,000 450,000
Payable to B 20,000 _
Total 100,000 170,000 200,000 450,000
Allocation of Loss
[414K * (20%;30%;50%)] (82,800) (124.200) (207,000) (414,000)
Totals 17,200 45,800 (7,000) 56,000
Additional Contribution by C 7,000 __
Amts Received by Each Partners 17,200 45,800 NONE 63,000
Requirement: determine the amounts of cash distributed to the partners in the final settlement of
their interests.
Solution:
STEP 2: Allocate the gain or loss to the partner’s capital balances (include their right of offset)
A B C Total
Capital Balances 100,000 150,000 200,000 450,000
Payable to B 20,000 _
Total 100,000 170,000 200,000 450,000
Allocation of Loss
[414K * (20%;30%;50%)] (82,800) (124.200) (207,000) (414,000)
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MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
Since C is personally insolvent, his capital deficiency is allocated to the other partners with positive
with positive capital balances. The allocation is based on the solvent partners’ P/L Ratio.
(20%/50%) and (30%/50%)
The net proceeds from the sale of non-cash assets amounted to P40,000. The personal assets
and personal liabilities of the partners are as follows:
Requirements:
A. How much additional contributions shall be made by the partners in order to settle all of the
partnership liabilities?
Solution:
Cash 20,000
Proceeds 40,000
Payments of Liabilities (150,000)
Additional Contributions Needed to Settle Liabilities (90,000)
B. Determine the amounts of cash distributed to the partners in the final settlement of their capital
accounts.
Solution:
Net Proceeds 40,000
Carrying Amount (480,000)
Total Loss (440,000)
Then determine which partners are solvent and which are insolvent, we shall apply “marshalling
of assets”.
X Y Z
Personal Assets 300,000 260,000 200,000
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MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
✓ Notice that A and B are solvent up to 80,000 and 40,000, respectively, while C is insolvent.
Now let us determine how the capital balances of ye partners are settled:
X Y Z Total
Capital Balances before
liquidation 50,000 100,000 200,000 350,000
Allocation of Loss
[440K * (20%;30%;50%)] (88,000) (132,000) (220,000) (440,000)
TOTALS (38,000) (32,000) (20,000) (90,000)
NOTE:
✓ Since Z is personally insolvent, his capital deficiency is allocated to the other partners with
positive capital balances.
✓ X and Y are solvent. Therefore, they are required to provide additional contributions
necessary to cover their capital deficiencies. However, since Y is solvent only up to
P40,000, he is required to contribute only up to that amount.
✓ The remaining capital deficiency of Y is allocated to X.
✓ X is required to provide additional contribution necessary to cover the capital deficiency of
Y.
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MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
The partnership will be liquidated on an installment basis. Distributions to owners will be made as
cash becomes available. The following transactions occurred in January 2019.
a. 75% of the accounts receivable was collected for only P30,000
b. Half of the inventory was sold for P40,000
c. Equipment with the carrying amount of P200,000 was sold for P120,000
d. P2,000 liquidation expenses were paid. Estimated future liquidation expenses totaled
P1,000
e. P9,000 cash was retained in the business for potential unrecorded liabilities and
anticipated expenses.
Solution:
1st Step: determine the actual loss on realization
ABC Partnership
Safe Payment Schedule
January 31, 2019
6
MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
✓ Notice that when preparing a safe schedule, the actual and estimated expenses losses are
computed separately. The computations presented earlier, where we did not compute for
these losses separately, are just a simplification of the computation for distributions to the
partners. If you use the simplified method, you should be able to come up with the same
amounts for distributions to the partners.
The partnership will be liquidated on an installment basis. Distributions to owners will be made as
cash becomes available
✓ Even prior to the sale of any asset, we can determine the amount of minimum safe payments
to the partners (when or as cash becomes available) by preparing a cash priority program.
1st step: Determine the Maximum loss absorption capacities (MLAC). This will be the basis in
ranking the partners according to their priority over cash payments.
2nd Step: the partners’ MLAC are equalized. This will be the basis in preparing the Cash Priority
Program.
7
MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
3rd Step: the cash priorities are computed by multiplying the differences above by the respective
partners’ P/L ratio
The cash priority program above means that when cash becomes available:
1. B is paid P20,000 first.
2. Next, A and B are paid P20,000 and P30,000, respectively; and
3. Any remaining cash will be distributed to all partners based on their P/L ratio
APPLICATION OF CPP
Requirement: Prepare the cash payments to the partners on January 31, 2019 using a CPP.
Solution:
The amount of cash available for distribution to the partners on January 31, 2019 is computed as
follows:
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MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY
Using the cash priority program, the amounts of distribution to the partners on January 31, 2019
are determined as follows:
A (20%) B (30%) C (50%) Total
Available Cash – Jan. 31, 2019 168,000
Allocation:
1st Priority 20,000 (20,000)
2nd Priority 20,000 30,000 (50,000)
Balance 20,000 50,000 98,000
Payment after priorities
[98k * (20%;30%;50%) 19,600 29,400 49,000 (98,000)
1st Installment Payment 39,600 79,400 49,000
NOTE:
✓ After A and B are allocated their cash priorities, any balance is allocated to the partners based
on their respective profit or loss ratios,
✓ The amounts computed above are equal to the amounts computed in the previous illustration
for “safe payment schedule”
REFERENCES
Dayag, A. J. (2015). Advanced Accounting 1. Manila: Lajara Publishing House.
MILLAN, Z. V. (2018). Accounting for Special Transactions. Baguio City: Bandolin Enterprise.