Chapter 14: Partnerships - Formation and Operation
Chapter 10: Partnerships - Termination and Liquidation
I. Termination and liquidation defined: Termination of a partnership is the ceasing of its providing services or products to customers. For example, if a CPA partnership terminates, it stops providing audit, tax, and consulting services to clients. Liquidation is the disposal of a company's assets, settlement of its liabilities, and the final distribution of any remaining assets to its owners.
II. Liquidation Process: The process of liquidating a partnership consists of four basic steps.
A. Convert all assets into cash.
B. Allocate to partners, based on their income sharing percentages, any gains or losses recognized on the conversion of assets.
C. Pay all liabilities and liquidation expenses.
D. Distribute any remaining cash to partners based on their capital balances.
III. Process illustrated:
While vacationing in Hawaii on October 13, 2005, Chen and Khan won a PowerBall lottery and split a jackpot of $56,000,000. As a result of their good fortune, they decided to terminate their internet business as of October 31, 2005, and liquidate the partnership as soon as possible.
On November 1, 2005, the Chen and Khan partnership's account balances were as follows.
|Account |Balance |
|Cash |$135,000 |
|Accounts Receivable |36,000 |
|Equipment |189,000 |
|Accounts Payable |(96,000) |
|Chen, Capital |(164,000) |
|Khan, Capital |(100,000) |
In liquidating the partnership, the following events occurred.
November 15: A total of $30,000 accounts receivable was collected from clients. The remaining $6,000 in accounts receivable was judged to be uncollectible. Assuming that Chen and Khan share income on a 50:50 basis, the effects of this event would be as follows.
|Date |Accounts |Debits |Credits |
|11/15 |Cash |30,000 | |
| |Chen, Capital |3,000 | |
| |Khan, Capital |3,000 | |
| |Accounts Receivable | |36,000 |
November 19: The equipment was sold for $144,000.
|Date |Accounts |Debits |Credits |
|11/19 |Cash |144,000 | |
| |Chen, Capital |22,500 | |
| |Khan, Capital |22,500 | |
| |Equipment | |189,000 |
November 24: Accounts payable was paid in full.
|Date |Accounts |Debits |Credits |
|11/24 |Accounts Payable |96,000 | |
| |Cash | |96,000 |
November 30: Liquidation expenses of $3,000 were paid to Strickland, CPA.
|Date |Accounts |Debits |Credits |
|11/30 |Chen, Capital |1,500 | |
| |Khan, Capital |1,500 | |
| |Cash | |3,000 |
November 30: All remaining cash was distributed to the partners. As a result of the liquidation process, the partners' balances on November 30 were as follows.
|Item |Chen |Khan |Total |
|November 1 |($164,000) |($100,000) |($264,000) |
|Accounts receivable collection loss |$3,000 |$3,000 |$6,000 |
|Equipment sale loss |$22,500 |$22,500 |$45,000 |
|Liquidation expense payment |$1,500 |$1,500 |$3,000 |
|November 30 |($137,000) |($73,000) |($210,000) |
The final cash distribution affects the partnership as follows.
|Date |Accounts |Debits |Credits |
|11/30 |Chen, Capital |137,000 | |
| |Khan, Capital |73,000 | |
| |Cash | |210,000 |
IV. Special Liquidation Considerations:
A. Partner deficit balance: If the liquidation process results in a partner having a deficit balance, that partner is legally required to make an additional investment in the partnership to eliminate the deficit balance. Once the additional investment is made, the cash can be distributed to the other partners according to the balances in their capital accounts. If the partner with the deficit balance becomes unable to make the additional investment (insolvent), the deficit balance must be absorbed by the remaining partners based on their income-sharing percentages.
B. Preliminary distribution of partnership assets: If a partnership is solvent, it is not necessary to wait until all liquidation activities are completed before transferring assets to partners. In order to make preliminary distributions to partners, the partnership must assure that the remaining balances in partner capital accounts are large enough to absorb all future partnership losses. For example, if Chen and Khan want to withdraw all available cash on November 10, the following calculations would be made to determine the proper cash withdrawal.
| | |Accounts | |Accounts |Chen, |Khan, |
|Item |Cash |Receivable |Equipment |Payable |Capital |Capital |
|11/1 balance | | | | | | |
| |$135,000 |$36,000 |$189,000 |($96,000) |($164,000) |($100,000) |
|Maximum loss on | | | | | | |
|assets | | | | | | |
| | |($36,000) |($189,000) | |$112,500 |$112,500 |
|Liabilities payment | | | | | | |
| |($96,000) | | |$96,000 | | |
|Liquidation expenses| | | | | | |
| |($3,000) | | | |$1,500 |$1,500 |
|Potential balances | | | | | | |
| |$36,000 |$0 |$0 |$0 |($50,000) |$14,000 |
Based on the above calculations, the $36,000 cash payment would result in the following. Notice that because Khan's capital balance is a deficit, he does not receive any of the $36,000.
|Date |Accounts |Debits |Credits |
|11/10 |Chen, Capital |36,000 | |
| |Cash | |36,000 |
On November 15, when the partnership collects $30,000 of its $36,000 accounts receivable, the partnership would be affected as follows.
|Date |Accounts |Debits |Credits |
|11/15 |Cash |30,000 | |
| |Chen, Capital |3,000 | |
| |Khan, Capital |3,000 | |
| |Accounts Receivable | |36,000 |
If Chen and Khan want to withdraw all available cash on November 16, the following calculations would be made to determine the proper cash withdrawal.
| | |Accounts | |Accounts |Chen, |Khan, |
|Item |Cash |Receivable |Equipment |Payable |Capital |Capital |
|11/1 balance | | | | | | |
| |$135,000 |$36,000 |$189,000 |($96,000) |($164,000) |($100,000) |
|11/10 liquidation | | | | | | |
| |($36,000) | | | |$36,000 | |
|A/R collection | | | | | | |
| |$30,000 |($36,000) | | |$3,000 |$3,000 |
|11/15 balance | | | | | | |
| |$129,000 |$0 |$189,000 |($96,000) |($125,000) |($97,000) |
|Maximum loss on | | | | | | |
|assets | | | | | | |
| | | |($189,000) | |$94,500 |$94,500 |
|Liabilities payment | | | | | | |
| |($96,000) | | |$96,000 | | |
|Liquidation expenses| | | | | | |
| |($3,000) | | | |$1,500 |$1,500 |
|Potential balances | | | | | | |
| |$30,000 |$0 |$0 |$0 |($29,000) |($1,000) |
Based on the above calculations, the $30,000 cash payment would result in the following.
|Date |Accounts |Debits |Credits |
|11/16 |Chen, Capital |29,000 | |
| |Khan, Capital |1,000 | |
| |Cash | |30,000 |
On November 19, when the partnership sells its $189,000 of equipment for $144,000, the partnership would be affected as follows.
|Date |Accounts |Debits |Credits |
|11/19 |Cash |144,000 | |
| |Chen, Capital |22,500 | |
| |Khan, Capital |22,500 | |
| |Equipment | |189,000 |
If Chen and Khan want to withdraw all available cash on November 20, the following calculations would be made to determine the proper cash withdrawal.
| | |Accounts | |Accounts |Chen, |Khan, |
|Item |Cash |Receivable |Equipment |Payable |Capital |Capital |
|11/1 balance | | | | | | |
| |$135,000 |$36,000 |$189,000 |($96,000) |($164,000) |($100,000) |
|11/10 liquidation | | | | | | |
| |($36,000) | | | |$36,000 | |
|A/R collection | | | | | | |
| |$30,000 |($36,000) | | |$3,000 |$3,000 |
|11/16 liquidation | | | | | | |
| |($30,000) | | | |$29,000 |$1,000 |
|Equipment sale | | | | | | |
| |$144,000 | |($189,000) | |$22,500 |$22,500 |
|11/19 balance | | | | | | |
| |$243,000 |$0 |$0 |($96,000) |($73,500) |($73,500) |
|Liabilities payment | | | | | | |
| |($96,000) | | |$96,000 | | |
|Liquidation expenses| | | | | | |
| |($3,000) | | | |$1,500 |$1,500 |
|Potential balances | | | | | | |
| |$144,000 |$0 |$0 |$0 |($72,000) |($72,000) |
Based on the above calculations, the $144,000 cash payment would result in the following.
|Date |Accounts |Debits |Credits |
|11/20 |Chen, Capital |72,000 | |
| |Khan, Capital |72,000 | |
| |Cash | |144,000 |
On November 24, when the partnership pays is accounts payable in full, the partnership would be affected as follows.
|Date |Accounts |Debits |Credits |
|11/24 |Accounts Payable |96,000 | |
| |Cash | |96,000 |
If Chen and Khan want to withdraw all available cash on November 25, the following calculations would be made to determine the proper cash withdrawal.
| | |Accounts | |Accounts |Chen, |Khan, |
|Item |Cash |Receivable |Equipment |Payable |Capital |Capital |
|11/1 balance | | | | | | |
| |$135,000 |$36,000 |$189,000 |($96,000) |($164,000) |($100,000) |
|11/10 liquidation | | | | | | |
| |($36,000) | | | |$36,000 | |
|A/R collection | | | | | | |
| |$30,000 |($36,000) | | |$3,000 |$3,000 |
|11/16 liquidation | | | | | | |
| |($30,000) | | | |$29,000 |$1,000 |
|Equipment sale | | | | | | |
| |$144,000 | |($189,000) | |$22,500 |$22,500 |
|11/20 liquidation | | | | | | |
| |($144,000) | | | |$72,000 |$72,000 |
|Liabilities payment | | | | | | |
| |($96,000) | | |$96,000 | | |
|11/24 balance | | | | | | |
| |$3,000 |$0 |$0 |$0 |($1,500) |($1,500) |
|Liquidation expenses| | | | | | |
| |($3,000) | | | |$1,500 |$1,500 |
|Potential balances | | | | | | |
| |$0 |$0 |$0 |$0 |$0 |$0 |
Based on the above calculations, no additional cash payment would be made to the partners.
On November 30, when the partnership pays liquidation expenses of $3,000 to Strickland, CPA, the partnership would be affected as follows
|Date |Accounts |Debits |Credits |
|11/30 |Chen, Capital |1,500 | |
| |Khan, Capital |1,500 | |
| |Cash | |3,000 |
After the November 30 transaction, the partnership's assets, liabilities, and owners' equity accounts all have zero balances and the liquidation process is complete.
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