Liquidation of a Partnership
Liquidation refers to the process of winding down the operations of a business and bringing it to an end. This can occur through the mutual agreement of the partners to sell the business, the death of a partner, or bankruptcy. In contrast to the dissolution of a partnership, which only ends the legal relationship between the partners, liquidation also terminates the economic life of the partnership and brings the business to a close.
The Partnership Liquidation Process
The process of liquidating a partnership involves four steps:
Adjust and close accounts and prepare a trial balance. When the ordinary business activities are discontinued, the accounts should be adjusted and closed in accordance with the customary procedures for summarizing financial activity. A post-closing trial balance is then prepared, containing only assets, liabilities, and owner's equity.
Sale of non-cash assets and allocation of gain/loss on realization. Once the operation of the business is terminated, the non-cash assets must be converted to cash through sale. This process, known as realization, can occur in a single transaction or on a piecemeal basis. If the cash proceeds from the sale are greater than the book value of the assets, the difference is a gain on realization. This gain is then allocated among the partners according to their income-sharing ratios.
Payment of partnership liabilities. After the non-cash assets are sold, the available cash is used to pay the partnership's creditors before any cash is distributed to the partners. The accounting entry for this process debits the liability accounts and credits cash.
Distribution of remaining cash to partners. After all debt claims have been settled, the remaining cash is distributed to the partners according to their capital balances. Note that this distribution is not based on the partners' income-sharing ratios.
It is important to follow these steps in order, as creditors must be paid before the partners receive any cash distributions. Each step should also be recorded with an accounting entry.