Chapter Ten

Partnerships:
Termination and
Liquidation
McGraw-Hill/I rwin Copyright 2011 by The McGraw-Hill Companies, I nc. All rights reserved.
10-2
Reasons for Termination
Personality disputes between partners
Retirement
Death
Changed business environment
Other opportunities
Low profits
Bankruptcy (either of the
business or an individual
partner)
10-3
Termination & Liquidation
When the partners wish
to terminate the
business:
Convert all assets to
cash.
Allocate all gains or
losses to the partner
capital balances.
Pay all liabilities.
Distribute remaining
cash to partners.
10-4
Morgan & Houseman want to
liquidate their partnership.
Balances at 5/1/11 are:
Morgan & Houseman
Balance Sheet
5/1/2011
Assets Liabilities and Capital
Cash 45,000 $ Liabilities 32,000 $
A/R 12,000 Morgan,Capital 50,000
Inventory 22,000 Houseman,Capital 38,000
Land, Bldg, & Equip. 41,000
Total 120,000 $ Total 120,000 $
Termination & Liquidation -
Example
10-5
Termination & Liquidation -
Example
Date Description Debit Credit
Cash 15,000
Morgan, Capital 4,200
Houseman, Capital 2,800
Inventory 22,000
According to their agreement, Morgan &
Houseman divide profits 6:4 respectively.
On 6/1, the inventory is sold for $15,000.
Note that the loss on the sale of inventory of $7,000
is assigned $4,200 ($7,000 x 60%) Morgan and
$2,800 ($7,000 x 40%) to Houseman.

10-6
Morgan & Houseman
Balance Sheet
6/1/2011
Assets Liabilities and Capital
Cash 60,000 $ Liabilities 32,000 $
A/R 12,000 Morgan,Cap. 45,800
Land, Bldg, & Equip. 41,000 Houseman,Cap. 35,200
Total 113,000 $ Total 113,000 $
The balances after selling the inventory were:
Termination & Liquidation -
Example
10-7
Termination & Liquidation -
Example
Assume that $9,000 of the Accounts
Receivable are collected.
The remaining accounts receivables are
written off, and the loss is allocated
between Morgan & Houseman.
$3,000 x 60% = $1,800
$3,000 x 40% = $1,200
Date Description Debit Credit
Cash 9,000
Morgan, Capital 1,800
Houseman, Capital 1,200
Accounts Receivable 12,000
10-8
Termination & Liquidation -
Example
The fixed assets are sold for $29,000.
The loss on fixed assets of $12,000 is
allocated to Morgan & Houseman.
$12,000 x 60% = $7,200
$12,000 x 40% = $4,800

Date Description Debit Credit
Cash 29,000
Morgan, Capital 7,200
Houseman, Capital 4,800
Land, Bldg & Equip.(net) 41,000
10-9
Date Description Debit Credit
Accounts Payable 32,000
Cash 32,000
Morgan, Capital 1,800
Houseman, Capital 1,200
Cash 3,000
Termination & Liquidation -
Example
Once all the assets are sold, the
accounts payable are paid off.
Morgan & Houseman incur an
additional $3,000 in liquidation
expenses.
10-10
Morgan & Houseman
Balance Sheet
10/15/2011
Assets Liabilities and Capital
Cash 63,000 $ Morgan, Cap. 35,000 $
Houseman,Cap 28,000
Total 63,000 $ Total 63,000 $
The pre-distribution balances are:
Termination & Liquidation -
Example
10-11
Date Description Debit Credit
Morgan, Capital 35,000
Houseman, Capital 28,000
Cash 63,000
Once the remaining cash is
distributed, the partnership
is considered terminated.
Termination & Liquidation -
Example
10-12
Schedule of Liquidation
Transactions
to date.
Property still
being held by
the partnership.
Liabilities
remaining to
be paid.
Current cash
and capital
balances.
Because the various parties want to be
updated on the progress of the liquidation,
a report can be prepared to disclose:
10-13
Schedule of Liquidation
The process of
liquidation can take
time.
Partners may
experience deficit
balances during the
liquidation period.
Partners may want
cash distributions
prior to the
completion of the
liquidation.
10-14
Deficit balances can be
resolved two ways:
The deficit partner can
make a contribution to
make up the deficit.
The remaining partners
can absorb the deficit.
(The deficit partner may pay
later or can be sued for
the deficit amount.)
Deficit Capital Balance
10-15
Partner
Capital
Balance
Profit & Loss
Ratio
Loup $ 100,000 40%
Lobo $ 86,000 10%
Sabaka
$ (25,000) 50%
Any
payments by
Sabaka will
be split 4/5 to
Loup and
1/5 to
Lobo.
Contributions made by the deficit
partner(s) are distributed to the non-
deficit partners based on their relative
profit sharing percentages.
Deficit Capital Balance --
Contribution by Deficit Partner
10-16
Hund, Chien and Cano have the following
balances just prior to liquidation.
Hund, Chien & Cano
Balance Sheet
6/30/2008
Assets Liabilities and Capital
Cash 30,000 $ Accts. Payable 35,000 $
Inventory 75,000 Hund, Capital 25,000
Chien, Capital 40,000
Cano, Capital 5,000
Total 105,000 $ Total 105,000 $
Deficit Capital Balance -
Remaining Partners Absorb Deficit
10-17
Date Description Debit Credit
Cash 25,000
Hund, Capital 17,500
Chien, Capital 12,500
Cano, Capital 20,000
Inventory 75,000
Hund, Chien and Cano share profits
35:25:40. On 7/5/08, the inventory is
sold for $25,000, a $50,000 loss.
Prepare the entry.
Deficit Capital Balance -
Remaining Partners Absorb Deficit
10-18
With a 40% share of the
$50,000 loss, Canos capital
account moves to a deficit
balance of $(15,000).
5,000
20,000
(15,000)
Cano Capital
Date Description Debit Credit
Cash 25,000
Hund, Capital 17,500
Chien, Capital 12,500
Cano, Capital 20,000
Inventory 75,000
Deficit Capital Balance -
Remaining Partners Absorb Deficit
10-19
The $25,000 for the inventory sale,
increases the cash balance to
$55,000. $35,000 must be kept to
pay off the accounts payable.
How will the
remaining
$20,000 be
distributed?
Date Description Debit Credit
Cash 25,000
Hund, Capital 17,500
Chien, Capital 12,500
Cano, Capital 20,000
Inventory 75,000
Deficit Capital Balance -
Remaining Partners Absorb Deficit
10-20
Hund Chien Cano
Capital Balances 7,500 $ 27,500 $ (15,000) $
Allocation of Cano's
deficit balance (8,750) (6,250) 15,000
Capital Balances (1,250) $ 21,250 $ - $
Allocation of Hund's
deficit balance 1,250 (1,250)
Capital Balances - $ 20,000 $
Notice that, after Canos deficit has been
allocated on the basis of 35:25, there is now
a deficit balance in Hunds account!
Deficit Capital Balance -
Remaining Partners Absorb Deficit
10-21
Hund Chien Cano
Capital Balances 7,500 $ 27,500 $ (15,000) $
Allocation of Cano's
deficit balance (8,750) (6,250) 15,000
Capital Balances (1,250) $ 21,250 $ - $
Allocation of Hund's
deficit balance 1,250 (1,250)
Capital Balances - $ 20,000 $
After allocating Hunds deficit to Chien, the
$20,000 can be distributed to Chien.
Deficit Capital Balance -
Remaining Partners Absorb Deficit
10-22
Schedule of Liquidation -
Interim Cash Distributions
Prior to making an interim
cash distribution to the
partners, assume:
1. All noncash assets will be
complete losses.
2. All liabilities will be paid.
3. All deficit partners will be
written off.
Even though
assumptions #1
and #3 may be
unrealistic, they
allow the
computation of
safe balances.
10-23
Marshaling of Assets
Debts owed to
separate
creditors.
Debts owed to
partnership
creditors.
Debts owed to
the other
partners.
Under the Uniform Partnership Act, a
Marshaling of Assets is a priority ranking
of creditors having claims against
individual partners:
10-24
Individual partners creditors
can make a claim against
the assets of the
partnership.
All partnership creditors
must be satisfied first.
The creditors can only
assert claims to the extent
of the specific partners
positive capital balance.
Claims Against the Partnership
Each partner is
liable for ALL
the debts of the
partnership.
Partners are
NEVER liable for
the personal
debts of the
other partners.
10-25
Hund, Chien & Cano
Balance Sheet
6/30/2008
Assets Liabilities and Capital
Cash 30,000 $ Accts. Payable 35,000 $
Inventory 75,000 Hund, Capital 25,000
Chien, Capital 40,000
Cano, Capital 5,000
Total 105,000 $ Total 105,000 $
Predistribution Plan
Used by accountants to guide the
distribution of cash resulting from the
liquidation process.
Examine the Balance Sheet below.
Assume the income sharing % is Hund
10%, Chien 40%, and Cano 50%.
10-26
Predistribution Plan
First, determine the maximum loss that
each partner can absorb. Divide each
partners capital balance by their
respective income sharing %.
Partner
Capital
Balance
Income
Sharing %
Maximum
Loss That
Can Be
Absorbed
Hund 25,000 $ 10% 250,000 $
Chien 40,000 40% 100,000 $
Cano 5,000 50% 10,000 $
10-27
Predistribution Plan
Since Cano can ONLY absorb a
partnership loss of $10,000, we will first
compute new balances assuming that
the partnership has a $10,000 loss.
Partner
Capital
Balance
Income
Sharing %
Maximum
Loss That
Can Be
Absorbed
Hund 25,000 $ 10% 250,000 $
Chien 40,000 40% 100,000 $
Cano 5,000 50% 10,000 $
10-28
Predistribution Plan
With Cano wiped out, we will proceed
with determining maximum absorbable
losses using income sharing
percentages of Hund 20% (1/5) and
Chien 80% (4/5).
Hund,
Capital
(10%)
Chien,
Capital (40%)
Cano,
Capital
(50%)
Beginning Balances 25,000 $ 40,000 $ 5,000 $
Assume a $10,000 loss (1,000) (4,000) (5,000)
Remaining Balances
24,000 $ 36,000 $ - $
10-29
Predistribution Plan
As earlier, we will compute the maximum
absorbable loss by dividing the capital
balances by the relative income sharing %.
Partner
Capital
Balance
Income
Sharing %
Maximum
Loss That
Can Be
Absorbed
Hund 24,000 $ 20% 120,000 $
Chien 36,000 80% 45,000 $
10-30
Predistribution Plan
As we can see above, Chien can only
absorb a loss of $45,000.
Lets determine new capital balances for
a loss of $45,000.
Partner
Capital
Balance
Income
Sharing %
Maximum
Loss That
Can Be
Absorbed
Hund 24,000 $ 20% 120,000 $
Chien 36,000 80% 45,000 $
10-31
Predistribution Plan
With Cano and Chien both wiped out,
and Hund remaining as the only partner,
we can now determine the
predistribution plan.
Hund,
Capital
(20%)
Chien,
Capital (80%)
Cano,
Capital
(50%)
Beginning Balances 24,000 $ 36,000 $ N/A
Assume a $45,000 loss (9,000) (36,000) N/A
Remaining Balances
15,000 $ - $ N/A
10-32
Predistribution Plan
Available Cash Recipient
First $35,000 Creditors
Next $15,000 Hund
Next $45,000 Hund(20%) and Chien(80%)
All other cash
benefits
Hund(10%), Chien(40%) and
Cano(50%)
Hund, Chien & Cano
Predistribution Plan
10-33
Summary
Partnerships may be terminated for a
variety of reasons.
When terminated, partnership assets
must be systematically liquidated.
Actual liquidation can require an
extended period to accomplish. This
promotes the use of proposed
schedules of liquidation.
Marshaling of assets may be
necessary when one or more partners
have negative capital balances.
10-34
Possible Criticisms
WHAT DO YOU THINK???
Development of predistribution plans
and schedules of liquidation may
involve speculation. Some critics feel
that this violates the traditionally
conservative role of accountants.