LIQUIDATION OF A PARTNERSHIP
Liquidation refers to the process of winding-up the operation of the business. Liquidation may result form the sale of the business by mutual agreement of the partners, from the death of a partner, or from bankruptcy. In contrast to the dissolution of a partnership, liquidation ends both the legal and economic life of the entity. The liquidation of a partnership terminates the business.
6.2 The Partnership Liquidation Process
The liquidation process involves four steps. These are:
- Adjust and close accounts and prepare trial balance. When the ordinary business activities are discontinued, as the partnership goes out of the business, the accounts should be adjusted and closed according to the customary procedures of the periodic summary. Then a post closing trial balance is prepared that contains only assets, liabilities, and owner’s equity.
- Sale of the non-cash assets and allocation of gain/loss on realization
Once the operation of the business is terminated, the non-cash assets should be converted to cash through sale. The sale of non-cash assets for cash is called realization. The non-cash assets may be sold in a single transaction, or on piecemeal basis. When assets are sold on piecemeal basis, the liquidation process may extend over a considerable period of time.
If the cash proceed from sale is greater than book value, the difference is gain on realization. After recording the sale of the non-cash assts, gain or loss on realization is allocated between/among partners according to their income sharing ratios.
3. Payment of partnership Liabilities
After the non-cash assets are sold, the available cash is used to pay the partnership creditors before any cash is distributed to partners. The accounting entry debits liabilities (or liability account) and credit cash.
4. Distribute the Remaining Cash to Partners
After all debt claims are settled, the remaining cash will be distributed to the partners according to their capital balances. Note that the remaining cash is not distributed to the partners on the basis of their income-sharing ratio.
Each of the above step must be performed in sequence because creditors must be paid before partners receive any cash distributions. Each step also must be recorded by an accounting entry.
Partnership dissolution may be followed by liquidation. Liquidation involves termination of the operation of the partnership. When a partnership is liquidated accounts should be adjusted and closed; non-cash assets are converted to cash; all creditors are paid; and the remaining cash should b e distributed to the partners.
The sale of non-cash assets (realization) may result in gain or loss. Any gain or loss arising from realization is divided between/among partners according to their income sharing agreement. Gain on realization increase’s the partners’ capital accounts while loss on realization reduces the accounts.
After all creditors are paid the remaining cash is distributed to the partners according to their capital balances.