Partnerships and Limited Liability Companies

Partnership Liquidation

Calculations and Journal Entries for Gain on Realization

When a partnership dissolves, the first step is to sell any assets in order to pay off creditors.

A liquidation of a partnership is the process of paying off liabilities, selling assets, and distributing remaining cash and assets to partners during a dissolution of the partnership. A liquidation occurs when a partnership business goes out of business. Upon closure, the day-to-day operations of the business are discontinued, and the accounts should be adjusted and then closed. A realization is the first step in the liquidation of a partnership when the assets of the partnership are sold for cash.

The steps in the liquidation process are:

1. Sale of assets (realization)

2. Division of gains or losses

3. Payment of liabilities

4. Distribution to partners

To illustrate, the noncash assets of ABC Company are carried on the balance sheet at $65,000. Partners Andy, Samantha, and Kim sell these noncash assets for $75,000, creating a gain of $10,000 ($75,000 – $65,000). Andy, Samantha, and Kim's income-sharing ratio is 2:2:1. They each currently have $25,000 in their capital accounts, and the cash balance is $15,000.

Step 1: Sale of Assets—$75,000 including a gain of $10,000 ($65,000 + $10,000)

Step 2: Division of Gains

Andy $4,000 ($10,000 ×\times 40%)
Samantha $4,000 ($10,000 ×\times 40%)
Kim $2,000 ($10,000 ×\times 20%)

Step 3: Payment of Liabilities—$5,000

Step 4: Distribution to Partners—The remaining $85,000 cash is distributed to the partners according to their capital balances.

Distribution of Cash after Gains to Partners

A. Potts S. Stevenson K. Foxx Total
Capital before liquidation $25,000 $25,000 $25,000 $75,000
Distribution of gains $4,000 $4,000 $2,000 $10,000
Capital after gains $29,000 $29,000 $27,000 $85,000

A statement of partnership liquidation is a financial statement that provides a visual summary of the partnership liquidation.

Statement of Partnership Liquidation - Gain

This statement of partnership liquidation provides a visual summary of the partnership liquidation that shows gain realized by the partners. For example, Andy's gain is a 40% share of $29,000.
Several journal entries record the liquidation: sales of assets, division of gain, payment of liabilities, and distribution of cash to partners.

Step 1: Sale of Assets

Sales of Assets in Partnership Journal Entry

Date Description Debit Credit
Jan. 1 Cash $75,000
Noncash Assets $65,000
Gain on Realization $10,000

Step 2: Division of Gain

Division of Gain between Partners Journal Entry

Date Description Debit Credit
Jan. 1 Gain on Realization $10,000
Andy Potts, Capital (Member's Equity) $4,000
Samantha Stevenson, Capital (Member's Equity) $4,000
Kim Foxx, Capital (Member's Equity) $2,000

Step 3: Payment of Liabilities

Payment of Liabilities Journal Entry

Date Description Debit Credit
Jan. 1 Liabilities $5,000
Cash $5,000

Step 4: Distribution of Cash to Partners

Distribution of Cash to Partners Journal Entry

Date Description Debit Credit
Jan. 1 Andy Potts, Capital (or Member's Equity) $29,000
Samantha Stevenson, Capital (Member's Equity) $29,000
Kim Foxx, Capital (Member's Equity) $27,000
Cash $85,000

Calculations and Journal Entries for Loss on Realization

Partners' equity accounts receive whatever gains or losses incurred during a liquidation, based on an agreed-upon ratio.

During the liquidation process, gains and losses are distributed to the partners' individual equity accounts in the income-sharing ratio outlined in the partnership agreement. For example, the partnership has a preexisting cash balance of $15,000. The partnership's noncash assets sell at $50,000, which results in a $15,000 loss realization ($65,000$50,000=$15,000)\left(\$65\text{,}000 - \$50\text {,}000\,=\,\$15\text {,}000\right).

Step 1: Sale of Assets—$50,000 with a loss realization of $15,000

Step 2: Division of Losses

Andy $6,000 ($15,000 ×\times 40%)
Samantha $6,000 ($15,000 ×\times 40%)
Kim $3,000 ($15,000 ×\times 20%)

Step 3: Payment of Liabilities—$5,000

Step 4: Distribution of Cash to Partners—The remaining $60,000 cash is distributed to the partners according to their capital balances.

Distribution of Cash after Losses to Partners

A. Potts S. Stevenson K. Foxx Total
Capital before liquidation $25,000 $25,000 $25,000 $75,000
Distribution of Loss ($6,000) ($6,000) ($3,000) ($15,000)
Capital after Losses $19,000 $19,000 $22,000 $60,000

The statement of partnership liquidation reflects the loss for each partner.

Statement of Partnership Liquidation - Loss

The statement of partnership liquidation provides a visual summary of the partnership liquidation, noting the loss realization for the partners. For example, Andy's share of the loss is $6,000.
Several journal entries are made to record the liquidation: sale of assets, division of loss, payment of liabilities, distribution of cash to partners.

Step 1: Sale of Assets

Sale of Assets Journal Entry

Date Description Debit Credit
Jan. 1 Cash $50,000
Loss on Realization $15,000
Noncash Assets $65,000

Step 2: Division of Loss

Division of Loss Journal Entry

Date Description Debit Credit
Jan. 1 Andy Potts, Capital (Member's Equity) $6,000
Samantha Stevenson, Capital (Member's Equity) $6,000
Kim Foxx, Capital (Member's Equity) $3,000
Loss on Realization $15,000

Step 3: Payment of Liabilities

Payment of Liabilities Journal Entry

Date Description Debit Credit
Jan. 1 Liabilities $5,000
Cash $5,000

Step 4: Distribution of Cash to Partners

Distribution of Cash to Partners Journal Entry

Date Description Debit Credit
Jan. 1 Andy Potts, Capital (Member's Equity) $19,000
Samantha Stevenson, Capital (Member's Equity) $19,000
Kim Foxx, Capital (Member's Equity) $22,000
Cash $60,000

Calculations and Journal Entries for Capital Deficiency

A partnership may have a claim against a partner(s) called a deficiency, which must be calculated and recognized.

By eliminating all the assets and liabilities, the only remaining accounts on the books are equity accounts of the partners and the corresponding cash balance used to distribute cash to the partners. A deficiency is a claim that the partnership has against a partner. The loss and distribution of that loss to the partner(s) results in a debit balance in a partner's capital account.

To illustrate, the partnership has a preexisting cash balance of $15,000. The partnership's noncash assets are $65,000, but they sell for only $2,000, creating a loss of $63,000 ($65,000$2,000=$63,000)\left(\$65\text{,}000 - \$2\text {,}000\,=\,\$63\text {,}000\right).

Step 1: Sale of Assets—$2,000 with a loss of $63,000

Step 2: Division of Loss

Andy $25,200 ($63,000 ×\times 40%)
Samantha $25,200 ($63,000 ×\times 40%)
Kim $12,600 ($63,000 ×\times 20%)

Step 3: Payment of Liabilities—$5,000

Step 4: Distribution of Cash to Partners—The remaining cash of $12,000 is distributed to the partners according to their capital balances.

Distribution of Cash with Deficiencies to Partners

A. Potts S. Stevenson K. Foxx Total
Capital before liquidation $25,000 $25,000 $25,000 $75,000
Distribution of Loss ($25,200) ($25,200) ($12,600) ($63,000)
Capital after Losses ($200) ($200) $12,400 $12,000

Andy's and Samantha's distribution of losses caused their capital balance to go into a deficit. Therefore, they owe the partnership $200 each. Assuming they both pay the deficit, the cash would go up by $400, which would allow the partnership to be able to pay newest partner Kim her entire capital balance.

A statement of partnership liquidation reflects deficiency and provides a visual summary of the partnership liquidation.

Statement of Partnership Liquidation-Deficiency

The statement of partnership liquidation provides a visual summary of the partnership liquidation. Note the deficiency resulting from the distributed loss, leaving a debit balance. For example, the deficiency share for Andy is $200.
There are several journal entries to record the liquidation on the deficiency: sale of assets, division of loss, payment of liabilities, receipt of deficiencies, distribution of cash to partners.

Step 1: Sale of Assets

Sales of Assets Journal Entry

Date Description Debit Credit
Jan. 1 Cash $2,000
Loss on Realization $63,000
Noncash Assets $65,000

Step 2: Division of Loss

Division of Loss Journal Entry

Date Description Debit Credit
Jan. 1 Andy Potts, Capital (Member's Equity) $25,200
Samantha Stevenson, Capital (Member's Equity) $25,200
Kim Foxx, Capital (Member's Equity) $12,600
Loss on Realization $63,000

Step 3: Payment of Liabilities

Payment of Liabilities Journal Entry

Date Description Debit Credit
Jan. 1 Liabilities $5,000
Cash $5,000

Step 4a: Receipt of Deficiencies

Receipt of Deficiencies Journal Entries

Date Description Debit Credit
Jan. 1 Cash $400
Andy Potts, Capital (Member's Equity) $200
Samantha Stevenson, Capital (Member's Equity) $200

Step 4b: Distribution of Cash to Partners

Cash to Partners Journal Entry

Date Description Debit Credit
Jan. 1 Kim Foxx, Capital (Member's Equity) $12,400
Cash $12,400

If the deficient partners do not pay the deficiency, there will not be enough cash on hand to pay the capital accounts of the other partners. If the deficiency is uncollected, the loss will be divided among the remaining partnership accounts based on the income-sharing ratio.

Statement of Partnership Equity

To show changes in the capital account of a partnership business, the statement of partnership equity is used, as it reflects performance during a given period.
The statement of partnership equity is used to illustrate the changes in the partnership capital (equity) accounts during a given period. The statement of members' equity is a statement for an LLC used to illustrate the changes in the member's equity accounts during a given period. The only difference between the two statements is that the columns of the statement represent the member's equity in the LLC instead of the partner's equity.
The statement of partnership equity is used to illustrate the changes in the partner capital (equity) accounts during a given period. Notice that Andy's partnership share of equity increased from $250,000 to $302,500 by year's end.
In addition to these statements, some partnerships and LLCs use various ratios to determine the performance of the organization. One such formula is the revenue per employee, which is a measure of how efficient a business is in generating revenue based on the number of employees. This is calculated by taking the total revenue and dividing it by the number of employees in order to determine financial performance of a company.