CHAPTER 15
PARTNERSHIPS: TERMINATION AND LIQUIDATION
Chapter Outline
I. The termination of a partnership and liquidation of its property may take place for a number
of reasons.
A. The death, withdrawal, or retirement of a partner can lead to cessation of business
activity.
B. The bankruptcy of either an individual partner or the partnership as a whole can
necessitate termination and liquidation.
II. Because of the importance of liquidating and distributing assets fairly, all parties look to the
accountant to play an important role in the process.
A. The accountant provides timely financial information.
B. The accountant works to ensure an equitable settlement of all claims.
III. The statement of liquidation
A. The liquidation process usually involves the disposal of noncash assets, payment of
liabilities and liquidation expenses, and distribution of any remaining cash to the partners
based on their final capital balances.
B. A statement of liquidation should be produced periodically by the accountant to disclose
losses and gains that have been incurred, remaining assets and liabilities, and current
capital balances.
IV. Deficit capital balances
A. By the end of, or even during, the liquidation process, one or more partners may have a
negative (or deficit) capital balance often as a result of losses incurred in disposing of
assets.
B. The Uniform Partnership Act indicates that any deficit capital balance should be
eliminated by having that partner contribute enough additional assets to offset the
negative balance.
C. If this contribution is not immediately received, the remaining partners may request a
preliminary distribution of any partnership cash that is available.
1. Safe payments of cash to individual partners are determined based on safe capital
balances, the amounts that will remain in the individual capital accounts even if all
deficits and other assets prove to be complete losses that must be absorbed by the
remaining partners.
2. If a portion (or all) of a deficit is subsequently recovered from a partner, a further
distribution to the other partners is made based on newly computed safe capital
balances.
3. Any deficit that is not recovered from a partner must be charged to the remaining
partners based on their relative profit and loss ratio.
V. Treatment of partner’s loan to partnership
A. The Uniform Partnership Act states that, in a liquidation, partnership assets should be
used to first settle claims of partnership creditors, including claims of partners who are
creditors.
1. This implies that the partnership would first repay partners’ loans before distributing
any cash to partners based on their capital balances.
B. However, in practice, to avoid making a cash distribution to a partner who subsequently
develops a deficit capital balance, partners’ loan accounts typically are combined with
partners’ capital accounts and funds are distributed accordingly. This text uses this
practice.
Vl. Preliminary distribution of assets to the partners
A. The liquidation process can extend over a lengthy period of time as business activities
wind down and property is sold.
B. When the partnership terminates activity, or during the course of the liquidation, more
cash may be available than the amount needed to extinguish all potential liabilities and
liquidation expenses.
C. If possible, the distribution of excess cash amounts should be made as quickly as
possible to enable the partners to make use of their funds.
1. The accountant may choose to produce a proposed schedule of liquidation at such
times to determine the equitable distribution of cash amounts that become available.
2. The proposed schedule of liquidation is developed based upon simulating the
accounting recognition that would be required by a possible series of transactions:
assets are sold, expenses are paid, etc.
a. These events are simulated with the anticipation of maximum losses in each
case.
b. Noncash assets are assumed to have no resale value; maximum possible
liquidation expenses are included; all partners are considered personally
insolvent; etc.
3. Ending potential capital balances that remain on a proposed schedule of liquidation
are safe capital balances, the amounts that could be immediately paid to each
partner without jeopardizing future payments. Safe capital balances indicate that the
partner will still have a sufficient interest in the partnership to absorb all potential
losses even after a preliminary distribution.
Vll. Predistribution plan
A. The proposed schedule of liquidation (described above) can be used to determine safe
payments based on safe capital balances but a newly revised schedule must be
prepared each time a distribution of cash to partners is contemplated.
B. Accountants often prefer to produce a single predistribution plan at the start of a
liquidation to provide guidance for all payments made to the partners throughout this
process.
C. Information for the predistribution plan is generated by assuming the occurrence of a
series of losses, each just large enough to eliminate one partner’s claim to any
partnership property.
D. Once a series of losses has been simulated that would eliminate the capital balances of
all partners, the actual plan is developed by measuring the effects that occur if the
losses do not materialize.
E. By working backwards through this series of possible losses, a predistribution plan can
be produced that serves as a guide for all payments made during the liquidation.
Answer to Discussion Question: What Happens if a Partner Becomes Insolvent?
This case demonstrates one of the nightmares of a partnership: the apparent insolvency of a
partner is threatening the future of a successful business. The problem is especially acute to
Wilkinson and Walker since this partnership was created solely for convenience; the partners
share the facilities but do not actually work together. Therefore, the presence of Rogers is not
essential to the other partners except that he pays a portion of the business’s expenses.
However, the claim that has been filed could lead to the actual liquidation of the entire business.
Obviously, the partners should take no immediate action until they have spoken with Rogers.
The entire issue may prove to be a mistake. Conversely, numerous other claims against Rogers
may also be outstanding with the initial claim simply being the first to be filed. Because of the
Walker would have a building that was apparently larger than their needs. Unless they could
utilize the space in some manner, they might have no way of recouping their additional
investment.
As a second possibility, a new dentist could be brought in to acquire Rogers’ interest in the
partnership. Again, the money is conveyed to Rogers but now the original partners are not
forced to make the payment. The building would continue to be fully utilized so that the partners’
expenses would not escalate. In this case, though, a new partner may have to be identified in a
Although Wilkinson and Walker have several possible actions that can be taken, none of these
is without problems. Therefore, partners should always include agreements within their Articles
of Partnership to specify actions that will be taken in such cases. The insolvency of a partner is
not a particularly unusual event. Hence, the partners (or their attorneys and accountants) should
have the forethought to arrange the resolution of the business if insolvency of a partner does
occur.
Answers to Questions
1. A dissolution refers to the cessation of a partnership. In many cases, this process is simply a
preliminary step in the transfer of business property to a newly formed partnership.
2. Many reasons can exist that would lead to the termination and liquidation of a partnership.
The business might simply have failed to generate sufficient profits or the partners may elect
3. During the liquidation process, monitoring the balance of the partners’ capital accounts
becomes of paramount importance. That amount will eventually indicate either the cash to
4. Final distributions made to the various partners are based solely on their ending capital
account balances unless the partners have agreed otherwise. If any partner has a deficit
balance, that partner should make an additional contribution to the partnership to offset the
5. A statement of liquidation summarizes the financial effect of the liquidation process as it has
progressed to date. Information to be presented includes the balances of all remaining
6. From a legal viewpoint, any partner who incurs a negative (or deficit) capital balance is
obligated to make an additional contribution to offset that amount.
7. A safe capital balance is the amount of a partner’s capital account that exceeds all possible
needs of a partnership as it goes through liquidation. A partner should, therefore, be able to
receive this balance immediately without endangering the future amount to be received by
8. Although the Uniform Partnership Act states that loans from partners rank ahead of the
partners’ capital balances in the distribution of partnership assets, in practice a partner’s
9. A proposed schedule of liquidation is prepared by the accountant to determine the allocation
of any cash available in the early stages of a liquidation that exceeds the amount needed to
pay all liabilities and estimated liquidation expenses. The schedule is based on anticipating
10. A predistribution plan is produced based on an assumed series of losses. Each loss is
calculated to eliminate in turn the capital balance of one of the partners. In this manner, the
accountant can determine the vulnerability to losses exhibited by each capital account.
Answers to Problems
4. B (Partner with deficit capital balance)
Angela, Capital Woodrow, Capital Cassidy, Capital
Reported balances $19,000 $18,000 $(12,000)
Potential loss from
5. B (Insolvent partner)
Bell Hardy Dennard Suddath
Reported balances $50,000 $56,000 $14,000 $80,000
Adjusted balances $ 6,000 $23,000 $(8,000)$69,000
Potential loss from Dennard
6. A (Predistribution plan)
7. A (Proposed schedule of liquidation to determine safe payments before the
liquidation begins; partner has deficit)
Art Raymond Darby
Reported balances ………………………….…... $18,000 $25,000 $26,000
Loss on sale of assets ($22,000) split
on a 4:3:3 basis …………..……….…..….….… (8 ,800) (6 ,600) (6 ,600)
Adjusted balances ……………….…..….….….. $ 9,200 $18,400 $19,400
Anticipated liquidation expenses ($12,000)
Since the partnership currently has total capital of $400,000, the $30,000
that is available would indicate maximum potential losses of $370,000.
A B C
Reported balances $100,000 $120,000 $180,000
Anticipated loss ($370,000) split on
Potential loss from C’s deficit (split 2:3) (2 ,000) (3 ,000) 5 ,000
Current cash distribution $ 24 ,000 $ 6 ,000 $ -0-
9. C (Predistribution plan)
To solve this problem a predistribution plan should be created.
Maximum Losses That Can Be Absorbed
Kevin $59,000/40% $147,500
The assumption is made that a $130,000 loss occurs:
Kevin Michael Brendan Jonathan
Reported balances …………….….….….$59,000 $39,000 $34,000 $34,000
Assumed loss ($130,000) split
Maximum Losses That Now Can Be Absorbed
Kevin $7,000 / 4/7 $12,250 (most vulnerable to losses)
The assumption is made that a $12,250 loss occurs:
Kevin Brendan Jonathan
Reported balances ………………………….….…...$7,000 $21,000 $8,000
Assumed loss ($12,250) split
Maximum Losses That Now Can Be Absorbed
Brendan $19,250/1/3 $57,750
Jonathan $4,500/2/3 6,750 (most vulnerable to losses)
The assumption is made that a $6,750 loss occurs:
Brendan Jonathan
Reported balances……………………..…..….….….… $19,250 $4,500
Brendan will receive a $17,000 distribution from the partnership before any
of the other partners collect any cash.
Carney Pierce Menton Hoehn
Beginning balances $60,000 $27,000 $43,000 $20,000
Assumed loss of $90,000 (see
Schedule 1) (4:3:2:1 basis) (36 ,000) (27 ,000) (18 ,000) (9 ,000)
Schedule 1
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Carney $60,000/40% $150,000
Schedule 2
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
Carney $24,000/(4/7) $ 42,000 (most vulnerable)
Schedule 3
Maximum Loss
Capital Balance/ That Can
Partner Loss Allocation Be Absorbed
11.C (Partners with deficit capital balances; proposed schedule of liquidation;
safe capital balances)
The $16,000 available cash can be distributed but should be done under the
assumption that all deficit balances will be total losses. After offsetting
can be immediately distributed.
Wayman Jones Fuller Rogers
(30%) (20%) (30%) (20%)
Reported balances $(2,000) $(2,000) $13,000 $7,000
Potential losses from Wayman
12.(8 minutes) (Determine safe payments; partner has deficit)
Nixon Cleveland Pierce
Reported balances …………………..….… $170,000 $110,000 $70,000
Anticipated loss ($342,000) split
13. (20 minutes) (Final settlement of a partnership being liquidated; various
amounts of loss on sale of assets)
Part a. Brown gets $21,000, Fish gets $12,000, and Stone gets $2,000.
Brown Fish Stone
Reported balances …………………….…..….…. $25,000 $15,000 $5,000
Part b. Brown gets $16,429 and Fish gets $8,571
Brown Fish Stone
Reported balances …………………….…..….…. $25,000 $15,000 $5,000
Loss on sale of land ($20,000) split on
Part c. Brown gets $10,714 and Fish gets $4,286
Brown Fish Stone
Reported balances …………………….…..….…. $25,000 $15,000 $5,000
Loss on sale of land ($30,000) split on
a 4:3:3 basis…………………..….….….…..…. (12 ,000) (9 ,000) (9 ,000)
14.(10 minutes) (Distribute cash contributed by partner with deficit balance)
The entire $20,000 goes to Atkinson.
Atkinson Kaporale Dennsmore Rasputin
Reported balances $70,000 $30,000 $(42,000) $(58,000)
Capital contribution -0- -0- -0- 20 ,000
Adjusted balances $70,000 $30,000 $(42,000) $(38,000)
Potential loss from Dennsmore
15. (8 minutes) (Determine safe payments)
Ball gets $143, Eaton gets $1,429, and Lake gets $3,428.
Ace Ball Eaton Lake
Reported balances …….…..….….... $25,000 $28,000 $20,000 $22,000
Maximum losses on land and building
($85,000) split on a 3:3:2:2 basis (25,500) (25,500) (17,000)
(17,000)
Estimated liquidation expenses
16. (15 minutes) (Prepare a proposed schedule of liquidation)
HARDWICK, SAUNDERS, AND FERRIS
Proposed Schedule of Liquidation
Hardwick, Ferris,
Other Accounts Loan and Saunders, Loan &
Cash Assets Payable Capital Capital Capital
Beginning
balances 90,000 820,000 (210,000) (270,000) (200,000)
(230,000)
(44,000)
Of the available $80,000 in cash, $22,000 can be paid safely to Hardwick, $14,000
to Saunders, and $44,000 to Ferris.
17.(7 minutes) (Determine amount of cash needed to assure payments to all
partners)
Watson is the partner most vulnerable to a loss. A loss of only $100,000 would
completely eliminate Watson’s capital balance:
18.(5 minutes) (Determine safe capital balances and safe payments)
Maximum potential losses are $128,000: $8,000 in liquidation expenses and a
complete $120,000 loss on the noncash assets. Such a loss would reduce the