ACCOUNTING FOR SPECIAL TRANSACTIONS AND BUSINESS COMBINATIONS

Prepared by Gabrielle Antonette M. Rubio

MODULE 4
Partnership Liquidation
Part 1

IINTRODUCTION
This module tackles the partnership share in partnership profits and losses, and its
division to each partner. This also deeply discussed different proportions when sharing losses
and even profit and its allocation.

INTENDED LEARNING OUTCOMES

ILO 1 State the order of priority in the settlement of claims in cases of liquidation.
ILO 2 Account for the liquidation of a partnership.

LIQUIDATION
Liquidation is the termination of business operations or the winding up of affairs.  It is a process
by which assets are converted into cash, liabilities are settled,  and any remaining amount is
distributed to the owners. Liquidation may either be voluntary or involuntary.
conversion of non-cash assets into cash
The conversion of assets into cash is referred to as realization settlement of claims of creditors
and owners is referred to as liquidation.  However, the term liquidation is used in a broader
sense to include the entire winding-up process. The winding up process starts with the
Conversion of non-cash assets into cash . As such, the timing of the realization of non-cash
assets determines the manner on which the liquidation is carried out.

 Methods of Liquidation
 Liquidation may be accomplished through:
1. Lump sum liquidation -  all the non-cash assets of the partnerships are sold
simultaneously or within a very short period of time, and the proceeds are used to settle 
first all the liabilities and any remaining amount is paid to the partners under a lump sum
payment.  Lump sum liquidation is possible when there is a contracted buyer of all non-
cash assets or the assets are sold on a package deal basis.
2.  Installment liquidation -  in most cases , it would take some time before all the assets of a
business are converted into cash . In such cases, the partners' claims are settled on an
installment basis as cash becomes available , but only after all partnership liabilities are
fully settled.
When financial statements are prepared during the liquidation process, all the
assets of the partnership are restated to the realizable values and all liabilities to their
expected settlement amounts.  the use of historical cost, fair value, present value, or other
measurement basis is appropriate only when the entity is a going concern.

Settlement of Claims 
The available cash of the partnership is used to settle claims in the following order of priority:
 1. Side creditors 
2. Inside creditors 
3. Owner's capital balances 
Right of Offset
As shown above, a loan payable to a partner has a higher priority over the partner's capital
balance. However, the legal right of offset allows a deficit in a partner's capital account to be
offset by a loan payable to that partner. 

Lump-sum Liquidation vs. Installment Liquidation

The following are the procedures in the accounting for lump sum liquidation and installment
liquidation:

Lump-sum Installment

All of the non-cash assets are Some of the non-cash assets are converted into cash.
converted into cash.

The total gain or loss on the sale The carrying amount of any unsold non-cash assets is
is allocated to the partners’ considered as a loss. This is allocated to the partners’
capital balances based on their capital balances based on their P/L ratio.
P/L ratio.

Actual liquidation expenses are Actual and estimated future liquidation expenses are
allocated to the partners' capital allocated to the partners’ capital balances based on their
balances based on their P/L ratio. P/L ratio.

The liabilities outside creditors The liabilities to outside creditors are partially or fully
are fully settled. settled.

The liabilities to inside creditors The liabilities to inside creditors are partially or fully
are fully settled. settled but only after the full settlement of the liabilities to
outside creditors.

Any remaining cash is If both the liabilities to outside and inside creditors are
distributed to the owners in full fully settled, any remaining cash less cash set aside for
settlement of their interests. future liquidation expenses is distributed to the owners as
partial settlement to their interests.

ILLUSTRATION 1: LUMP-SUM VS. INSTALLMENT LIQUIDATION

Fact pattern:
On January 1, 20x1, the partners of ABC Co. decided to liquidate their partnership. The
following information was made available:

Cash 20,000
Accounts Receivable 60,000
 Inventory 120,000
Equipment, net 300,000
Total 500,000
Accounts Payable 30,000
Payable to B 20,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
Total 500,000

Case 1: Lump-sum Liquidation

Information on the conversion of non-cash asset is as follows:
a.  50,000 was collected on the accounts receivable;  the balance is uncollectible.
b.  70,000 was received for the entire inventory.
c.  The equipment was sold for 250,000.
d.  2000 edition expenses were paid

Requirement:  determine the amounts of cash distributed to the partners in the  final settlement of
their interest.

Solution:

Step 1:  Compute for the gain or loss on the sale.

Collection on accounts receivable 50,000

Sale of inventory 70,000
Sale of equipment 250,000
Liquidation expenses ( 2,000)
Net Cash Proceeds 368,000
Less: Carrying amount of non-cash asset
(60k accounts receivable+120k (480,000)
inventory+300k equipment)
Total loss (112,000)

Step 2:  Allocate the gain or loss to the partners’ capital balances ( include the right of
offset).

A (20%) B (30%) C (50%) Total

Capital balances 100,000 150,000 200,000 450,000
Payable to B (right of offset) 20,000 20,000
Total 100,000 170,000 200,000 470,000
Allocation of loss (112k*.20,.30,.50) (22,400) (33,600) (56,000) (112,000)
Amounts received by the partners 77,600 136,400 144,000 358,000
To check the accuracy of our answer, let us identify if the total amount distributed to the
partners is equal to the amount of cash available for distribution to owners:
Beginning balance of cash 20,000
Net proceeds from the sale of non-cash assets 368,000
Less: Payment to outside creditors (accounts (30,000)
payable)
Cash available for distribution to partners 358,000

Notice that the cash available for distribution to partners of P358,000 is equal to the total amount
received by the partners.

01.01.x1 Cash 368,000

Loss on sale (inclusive of liquidation expenses) 112,000
Receivables 60,000
Inventory 120,000
Equipment 300,000
To record the realization of non-cash
assets.
01.01.x1 A, Capital 22,400
B, Capital 33,600
C, Capital 56,000
Loss on sale 112,000
To close the loss on sale to the
partners’ respective capital accounts.
01.01.x1 Accounts Payable 30,000
Cash 30,000
To record the settle of liability to outside
creditors
01.01.x1 Payable to B 20,000
Cash 20,000
To record the settle of liability to outside
creditors
01.01.x1 A, Capital 77,600
B, Capital (136.4k-20k) 116,400
C, Capital 144,000
Cash (358k-20k loan) 338,000
To record the settlement of the
partners’ capital balances.

To check the accuracy of our answer, let us identify if the total amount distributed to the
partners is equal to the amount of cash available for distribution to owners.
We can prepare a formal report on the liquidation through the statement of liquidation. A
statement of liquidation  is a financial report that highlights the realization (receipt from asset
disposal) and the liquidation (settlement of creditors and partners claims) of a partnership.
Case 2:  Installment Liquidation
Use the fact pattern above but assume that the partnership will be liquidated over a
prolonged period of time. Distributions to the partners will be made as cash becomes available. 
Information  on the conversion of non-cash assets is as follows:
 75% of the  accounts receivable was collected for only 30,000.
 Half of the inventory was sold for 40,000
 Equipment with carrying amount of 200,000 was sold for 120,000
 Actual liquidation expenses of 2,000 were paid
 Estimated future liquidation expenses totaled 1,000
 P9,000 cash was retained in the business for potential and recorded liabilities and
anticipated expenses.

Requirement: Determine  the amounts of cash distributed to the partners from the partial
realization of partnership assets.

Solution:

Step 1:  Compute for the gain or loss.

Collection on accounts receivable 30,000

Sale of inventory 40,000
Sale of equipment 120,000
Actual liquidation expenses (2,000)
Estimated liquidation expenses (1,000)
Cash retained for future expenses (9,000)
Net Cash Proceeds 178,000
Less: Carrying amount of non-cash asset
(60k accounts receivable+120k (480,000)
inventory+300k equipment)
Total loss (302,000)

Notes:
 The procedure above is similar to the procedure used in lump-sum liquidation,  with the
following additional concepts:
Expected future expenses are recognized immediately as losses to be allocated to the
partners’ capital balances.
Unsold non-cash assets are considered as losses to be allocated also to the partners’
capital balances.
To simplify our solution,  the total gain or loss to be allocated to the partners capital balances is
computed simply by comparing the net proceeds and the carrying amount of all non-cash assets,
whether sold or not.

Step 2:  Allocate the gain or loss to the partners’ capital balances ( include the right of
offset).
 A (20%) B (30%) C (50%) Total
Capital balances 100,000 150,000 200,000 450,000
Payable to B (right of offset) 20,000 20,000
Total 100,000 170,000 200,000 470,000
Allocation of loss (303k*.20,.30,&.50) (60,400) (90,600) (151,000) (302,000)
Amounts received by the partners 39,600 79,400 49,000 168,000

Checking:
Beginning balance of cash 20,000
Net proceeds from the sale of non-cash assets 178,000
Less: Payment to outside creditors (accounts (30,000)
payable)
Cash available for distribution to partners 168,000

Summary: Lump-sum and Install Liquidation:

Step 1: Compute for the net proceeds. Deduct all expenses,  whether paid or not, as well as any
cash retention for future cost.
Step 2: Compute for the gain or loss by comparing the net  proceeds with the total carrying
amount of non-cash assets, whether sold or not.
Step 3: Allocate the gain or loss to the partner's interests.  Any residual amount in a partner's
capital balance, including his right of offset,  represents the settlement of his interest in the
partnership.

Step 1: Compute for the net proceeds. Deduct all expenses,  whether paid or not, as well as any
cash retention for future cost.
Step 2: Compute for the gain or loss by comparing the net  proceeds with the total carrying
amount of non-cash assets, whether sold or not.
Step 3: Allocate the gain or loss to the partner's interests.  Any residual amount in a partner's
capital balance, including his right of offset,  represents the settlement of his interest in the
partnership.

ILLUSTRATION 2: LUMP-SUM LIQUIDATION

On January 1, 20x1, the partners of ABC Co. decided to liquidate their partnership. The
following information was made available:
Cash 20,000
Accounts Receivable 60,000
Inventory 120,000
Equipment, net 300,000
Total 500,000
Accounts Payable 50,000
A, Capital (20%) 100,000
B, Capital (30%) 150,000
C, Capital (50%) 200,000
Total 500,000
A third part offered to by for P480,000 the partnership assets, including liabilities but excluding
cash but after the following assets are revalued to their fair values:
Accounts receivable 45,000
Inventory 75,000
Equipment 320,000

Requirement: Determine the amounts of cash distributed to the partners.

Solution:

Net proceeds from the sale of assets 480,000

Carrying amount of net assets sold (430,000)
(60k A/R+120k Invty. + 300k equipt. -30k
AP)
Gain on Sale 50,000

To simplify the solution,  simply ignored the revaluation of the assets.  Instead, we
compared directly the net selling price of 480,000 with the carrying amount of the net assets
sold,  excluding the 20,000 cash on hand which was not sold. The difference represents the gain
to be closed to the partner's capital balances.

A (20%) B (30%) C (50%) Total

Capital balances 100,000 150,000 200,000 450,000
Allocation of gain (50k*.20,.30,&.50) 10,000 15,000 25,000 50,000
Amounts received by the partners 110,000 165,000 225,000 500,000

Checking:
Beginning balance of cash 20,000
Net proceeds from the sale of assets and 480,000
liabilities
Cash available for distribution to partners 500,000

ILLUSTRATION 3: INSTALLMENT LIQUIDATION

On, January 1, 20x1, partners A and B, who share profits and losses on a 3:1 ratio, decided to
liquidate their business. As of this date, the following information has been detertmined:

Cash 20,000
Other Assets 480,000
Liabilities 50,000
A, Capital 250,000
B, Capital 200,000

In the first month of liquidation,  180,000 were received on the sale of some assets,  liquidation
expenses of 5,000 were paid,  and additional liquidation expenses of 2,000 were anticipated
before the liquidation was completed.  Creditors were paid 28,000.  Available cash was
distributed to the partners.
Requirement: Determine the amounts of cash distributed to the partners.

Solution:

Sale of certain non-cash assets 180,000

Actual liquidation expenses (5,000)
Estimated future liquidation expenses (2,000)
Net Cash Proceeds 173,000
Less: Carrying amount of all non-cash assets (480,000)
Total loss (307,000)

Notes: Remember the following concepts:

 Expected future expenses are recognized immediately as losses.
 It doesn't matter whether or not  all the non-cash assets were sold. Any unsold asset is
considered as loss.

A (3/4) B (1/4) Totals

Capital balances before liquidation 250,000 200,000 450,000
Allocation of loss (307k*3/4 and 2/4) (230,250) (76,750) (307,000)
Amounts received by the partners 19,750 123,250 143,000

Checking:
Beginning balance of cash 20,000
Net cash proceeds (net liquidation expenses) 173,000
Partial payment of liabilities* (28,000)
Cash set aside for the unpaid balance of (22,000)
liabilities (50k-28k)*
Cash available for distribution to partners 143,000
* Before payment can be made to the partners,  all the liabilities must be settled first or
sufficient funds must be set aside to settle any unpaid liabilities.

Resource:

Millan, Zeus Vernon B. (2020). Accounting for Special Transactions. Baguio City: Bandolin
Enterprise Publishing ang Printing.