Partnership Liquidation

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

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.

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 $\left(\$65\text{,}000 - \$50\text {,}000\,=\,\$15\text {,}000\right)$.

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

Step 2: Division of Losses

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.

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 $\left(\$65\text{,}000 - \$2\text {,}000\,=\,\$63\text {,}000\right)$.

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

Step 2: Division of Loss

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.