Chapter Ten
Partnerships:
Termination and
Liquidation
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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.
10-2
Termination & 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 prepares a cash predistribution plan.
10-3
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.)
 Profit / loss ratio: Holland 40%; Dozier 40%; Ross 20%
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
10-4
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.
10-5
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.
10-6
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.
10-7
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
creditors.
Debts owed to
the other
partners.
Debts owed to
personal
creditors.
10-8
Claims Against the Partnership
 Individual partner’s creditors can make a claim
against the assets of the partnership.
 All partnership creditors must be satisfied.
 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.
10-9
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 everchanging 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.
10-10
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.
10-11
Predistribution Plan
First, determine the maximum loss that each partner
can absorb. Divide each partner’s capital balance by
their respective income sharing percent.
10-12
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).
10-13
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.
10-14
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.
10-15