Statement of Liquidation (Fundamentals of Accounting, Pt.2).pptx

Notes for Statement of Liquidation

1. STATEMENT OF LIQUIDATON Members: Conti, Patricia Isabel Fernandez, Aaron Hulleza , Miah Joy

2. The liquidation of a partnership is the winding up of its business activities characterized by sale of all non-cash assets, settlement of all liabilities, and distribution of the remaining cash to the partners. The conversion of non-cash assets into cash is referred to as realization . This may either result to a gain or loss on realization and shall be divided in the profit and loss ratio of the partners. In some cases, a substantial loss on realization may yield for a partner a capital deficiency , which is the excess of a partner’s share, in losses over the partner’s capital credit balance. This deficiency will certainly affect the partner’s interest —the sum of his capital and loan accounts—in the partnership.

3. RULES IN SETTLING ACCOUNTS AFTER DISSOLUTION Assets of the Partnership The assets of the partnership consist of the following: Partnership property Additional contributions of the partners needed for the payment of all liabilities consistent with the discussions below. Order of Preference The assets of a general partnership shall be applied in the following order: Those owing to outside creditors Those owing to inside creditors in the form of loans or advances for business expenses by the partners Those owing to the partners with respect to their capital contributions Those owing to the partners with respect to their share of the profit

4. The second preference above gives the partner with the loan account the option to exercise his right of offset . This privilege is the legal right of a partner to apply part or all of his loan account balance against his capital deficiency resulting from losses in the realization of the partnership assets. Illustration. Niel Andrade, Ronalyn Salaver , and Shielo Fril are partners in a prawn export business. Initially, Andrade contributed P300,000; Salaver , P200,000 and Fril P100,000. On the date of dissolution, the remaining assets of the partnership amounted to P1,000,000. The partnership has outstanding obligations with Kristelle Andales , P140,000; Elliana Torralba , P100,000 and loans payable to Niel Andrade, P40,000. The accounts of the Andrade, Salaver , and Fril partnership shall be settled as follows:

5. Kristelle Andales and Elliana Torralba who are outside creditors shall be paid the total sum of P240,000; thus, leaving a balance of P760,000 (P1,000,000 – P240,000) in partnership assets; Niel Andrade who is inside creditor shall be paid his loan to the partnership of P40,000; balance at P720,000 (P760,000 – P40,000); The total contributions of Andrade, Salaver , and Fril to the initial partnership capital in the amount of P600,000 will be paid; balance of assets at P120,000 (P720,000 – P600,000); The balance of P120,000 shall be distributed to the partners in the ratio of their capital contributions since there was no mention of an agreement governing the division of profits or losses. Therefore, Niel Andrade shall be entitled to 3/6 of P120,000 or P60,000; Ronalyn Salaver , 2/6 or P40,000 and Shielo Fril , 1/6 or P20,000.

6. INSUFFICIENT PARTNERSHIP ASSETS In cases when the partnership assets are insufficient to settle all outside liabilities, the partners should make additional contributions in the partnership. Any partner who contributed in excess of his share in this liability has a right to collect the supposed additional contributions from the other partners. Illustration. Assume in the illustration above that the outstanding obligations of the partnership, all accruing to outside creditors, amounted to P1,120,000. The partnership assets of P1,000,000 will be insufficient to fully settle these liabilities. The unpaid balance will be P120,000. Therefore, the partners should contribute sufficient assets to cover the deficiency or loss. In the absence of an agreement, the basis of the additional contributions shall be the ratio of their capital contributions.

7. As a result, Niel Andrade is still liable from his separate properties in the amount of P60,000; Ronalyn Salaver , P40,000, and Shielo Fril , P20,000; these contributions will be used to settle the remaining liabilities of P120,000. This sum of money is properly considered as partnership assets. In the event of payment by Shielo Fril of the full amount P120,000, she will have the right to recover the amount that she has paid in excess of her share of the liability from Niel Andrade, P60,000 and from Ronalyn Salaver , P40,000.

8. PREFERENCE OF PARTNERSHIP CREDITORS AND PARTNERS’ SEPARATE CREDITORS The creditors of the partnership shall have priority in payments over those of the partners’ separate creditors as regards the partnership properties. On the other hand, the creditors of the partners are preferred with respect to the separate or personal properties of the partners. DISTRIBUTION OF SEPARATE PROPERTIES OF AN INSOLVENT PARTNER If a partner is insolvent, his personal properties shall be distributed as follows: Those owing to separate creditors, Those owing to partnership creditors, Those owing to the partners by way of additional contributions when the assets of the partnership were insufficient to settle all obligations.

9. Illustration. Assuming that because of the total partnership liabilities amounting to P1,120,000, Shielo Fril is still personally liable to partnership creditors in the amount of P20,000. Her separate properties in the amount of P90,000 shall first be applied to settle her personal obligations of P80,000 to Irene Alano and the balance of P10,000 to pay one-half of her liability of P20,000 to the creditors of the partnership. This is in consonance with the rule that separate creditors are preferred over partnership creditors as regards separate properties of a partner. The procedures in liquidation after the adjustment and closing of books will be dependent on the above rules. It will be advisable to have a mastery of these principles to be able to fully understand the liquidation of partnerships.

The use of a statement of liquidation will greatly aid the liquidating partner summarize the events and transactions associated with the liquidation of the partnership.

10. METHODS OF PARTNERSHIP LIQUIDATION The following methods may be used when a partnership is liquidated: Lump-sum method – Under this method, all non-cash assets are realized and the related gains or losses distributed and all liabilities are paid before a single final cash distribution is made to the partners. Installment method – Under this method, realization of non-cash assets is accomplished over an extended period of time. When cash is available, creditors may be partially or fully paid. Any excess may be distributed to the partners in accordance with a program of safe payments or a cash priority program. This process persists until all the non-cash assets are sold.

11. ENTRIES RELATED TO LIQUIDATION The steps in liquidation of a partnership will need the following pro-forma entries:

12. LUMP-SUM LIQUIDATION Under this method, all non-cash assets are realized and all liabilities are settled before a single final cash distribution is made to the partners. The procedures below may be followed in lump-sum liquidation: Realization of non-cash assets and distribution of gain or loss on realization among the partners based on their profit and loss ratio.
Payment of Liabilities.
Elimination of partners’ capital deficiencies. If after the distribution of loss on realization a partner incurs a capital deficiency (i.e., partners’ share of realization loss exceeds his capital credit), this deficiency must be eliminated by using one of the following methods, in the order of priority a. If the deficient partner has a loan balance, then exercise the right of offset. b. If the deficient partner is solvent, then he should invest cash to eliminate his deficiency.

13. c. If the deficient partner is insolvent, then the other partners should absorb his deficiency. 4. Payments to partners, in the order of priority:
a. Loan accounts
b. Capital accounts Illustration. Mich Calinao , Kate Tiansay , and Robemie Mabate are partners in a public relations firm and share profits and losses in the ratio of 2:2:1, respectively. They decided to liquidate their business on Dec. 31, 2014. The following is the condensed statement of financial position prepared prior to liquidation:

14. Case 1. Loss on Realization Fully Absorbed by Partners’ Capital Balances Assume that the non-cash assets are sold at P2,500,000 with a resulting loss on realization of P900,000 which was distributed in the ratio 4:4:2. The capital balance of each partner was sufficient to fully absorb the share in the loss. The payment of cash to partnership creditors and the final distribution of the remaining cash to the partners presented no problem. A statement of liquidation will summarize the steps involved in the liquidation.

The entries pertinent to this case follow:

15. Case 2. Loss on Realization Resulting to a Capital Deficiency with Right of Offset Assume that the non-cash assets are sold at P1,850,000 with a resulting loss on realization of P1,550,000, which was distributed in the ratio 4:4:2. The capital balance of partner Kate Tiansay was insufficient to fully absorb her share in the loss and thus, incurred a capital deficiency of P20,000. Instead of making an additional investment, Tiansay opted to exercise her right of offset. A portion of her loan to the partnership was applied to her deficient capital. Outside creditors were paid and a final distribution of the remaining cash to the partners was made. A statement of liquidation will summarize the steps involved in the liquidation.

The entries are shown below:

16. Case 3. Loss on Realization Resulting to a Capital Deficiency to a Personally Solvent Partner Assume that the non-cash assets are sold at P1,700,000 with a resulting loss on realization of P1,700,000 which was distributed in the ratio 4:4:2. The capital balance of partner Kate Tiansay was again insufficient to fully absorb her share in the loss and thus, incurred a capital deficiency of P80,000. Tiansay exercised her right of offset but it was not enough to cover her losses; she has no recourse but to invest additional cash of P30,000 to fully eliminate her deficiency. A statement of liquidation will summarize the steps involved in the liquidation.

The entries to illustrate the steps in liquidation are given below:

17. Case 4. Loss on Realization Resulting to a Capital Deficiency to a Personally Insolvent Partner Assume the same facts as in case 3 except that Kate Tiansay is personally insolvent and is unable to make additional investments for her remaining deficiency of P30,000. In this case, Mich Calinao and Robemie Mabate have to absorb this deficiency as additional loss to them in the ratio of 4:2. A statement of liquidation will summarize the steps involved in the liquidation.

18. The entries to summarize the results of the liquidation process follow:

Entry nos. 1 to 3 is the same as those in Case 3.

19. Case 5. Partnership Insolvent but Partners Personally Solvent Assume that the non-cash assets are sold at P900,000 with a resulting loss on realization of P2,500,000 distributed in the ratio 4:4:2. The cash balance after full realization of the non-cash assets in the amount of P1,100,000 was not enough to settle all the liabilities to outsiders. Also, the capital balances of Mich Calinao and Kate Tiansay were insufficient to fully absorb their share in the loss and thus, incurred capital deficiencies of P50,000 and P400,000, respectively.

20. Tiansay exercised her right of offset but it was not enough to cover her losses; she has no recourse but to invest additional cash of P350,000 to fully eliminate her deficiency. Calinao also invested P50,000. From these investments, the partnership was able to pay in full the outside creditors. The balance of P380,000 is paid to Mabate for her loan and capital account balances of P80,000 and P300,000, respectively. A statement of liquidation will summarize the steps involved in the liquidation. The pertinent entries for this case illustration are shown below:

21. Case 6. Partnership Insolvent and Partners Personally Insolvent Kia Cabiloque , Beah Grijaldo , and Stephan Borja are partners who are sharing profits or losses in the ratio of 4:3:2, respectively. They decided to liquidate their business on Nov. 1, 2014, because of constant credit problems. The partnership and partners Grijaldo and Borja are currently unable to meet their financial obligations. The partnership’s condensed balance sheet and the personal status of the partners are as follows:

22. The non-cash assets are sold for P335,000, resulting to a loss on realization of P270,000. The cash generated from the realization of all non-cash assets is inadequate for the full payment of the liabilities. The partnership is insolvent and will depend on its solvent partners for relief.

23. After the distribution of loss on realization, Beah Grijaldo is deficient by P30,000. She can not make additional investments since she is personally insolvent—her current personal deficit is P24,500 (P94,500 – P119,000). The two other partners absorbed the deficiency, even if Cabiloque has her own deficiency. This is possible because Cabiloque is still personally solvent. In the case of Borja, she is made to share in the loss due to insolvency of Grijaldo though she is already personally insolvent because in the partnership her capital balance is still a positive P20,000. In the meantime, an additional investment of P40,000 is necessary from the solvent Cabiloque to be used to pay the remaining liabilities and the P10,000 balance in Borja’s capital account. The P10,000 that Borja received can now be used to pay off her personal creditors. Cabiloque and Borja can later claim from Grijaldo her supposed additional investment due to capital deficiency after she has satisfied her personal liabilities. This is if Grijaldo becomes solvent in the future.

24. The statement of liquidation is as follows:

25. The statement of liquidation is as follows:

26. INSTALLMENT LIQUIDATION Realization of non-cash assets is accomplished over an extended period of time. It is a process of selling some assets, paying the creditors, paying the remaining cash to the partners, realizing additional assets and making additional payments to the partners. The liquidation will continue until all the non-cash assets have been realized and all available cash distributed to partnership creditors and partners. Installment payments to partners are appropriate if necessary safeguards are used to ensure that all partnership creditors are paid in full and that no partner is paid more than the amount to which he would be entitled after all losses on realization of assets are known. Procedures to be followed in installment liquidation:

27. Realization of non-cash assets and distribution of gain or loss on realization among the partners based on their profit and loss ratio. Payment of liquidation expenses and adjustment for unrecorded liabilities; both of these items will be distributed among the partners in their profit and loss ratio.
Payment of liabilities to outsiders.
Distribution of available cash based on a schedule of safe payments which assumes possible losses due to inability of the partnership to dispose of part or all the remaining non-cash assets and failure of the partners with capital deficiencies to make additional contributions. Payments to partners can also be made based on a cash priority program .

28. Illustration: The balance sheet for Hilery Dimson , Haylee Regala , and Kenneth Talite , partners sharing profits in the ratio of 4:3:3 respectively, showed the following balances on April 30, 2014, just before liquidation:

29. In May, part of the assets are sold at book value, P300,000. In June, the remaining assets are sold for P210,000. Assume that available cash is distributed to the proper parties at the end of May and at the end of June. Assume further that partners are solvent and that any partner who is deficient made appropriate payment to the partnership on July 31. Schedule A:

30. Schedule B:

31. It can be observed that the total partners’ interests are continuously restricted for possible losses. A partner’s restricted interest represents the portion of a partners’ interest which should remain available to absorb possible future losses. Restricted interests are provided for assumed non-sale of remaining non-cash assets and for assumed insolvency of deficient partners. When all of these restricted interests are satisfied, the resulting balances will be referred to as free interests which are simply the amounts to be paid to the partners. This payment should first be applied to loan then to capital in accordance with the rules on the order of preference in liquidation.

32. CASH PRIORITY PROGRAM The use of safe of safe payment schedules is a reliable method of computing the amount of safe payments to partners for it prevents excessive payments to any partner. However, the approach is inefficient if numerous installment distributions are to be made to partners. In the previous illustration, the partnership made two payments and for each, a schedule of safe payments is made. The procedure of preparing safe payment schedules will go on as long as there is cash to be distributed and until the capital balances are aligned with the P/L ratio.

33. This repetitious procedure can be avoided with the introduction of an alternative device called the cash priority program. This program which is prepared at the start of the liquidation process will help the partners project when they can expect to be included in the cash distribution. If the program is prepared, any amount of cash received from the realization of partnership assets may be paid immediately to partnership creditors and later, the partners as specified in the program. Illustration. Jaymee Huelar , Miah Hulleza , and Keren Tabujara divide profits 60%, 25%, and 15% respectively. A balance sheet on June 30, 2014, just before partnership liquidation, showed the following balances:

34. Certain assets are sold in July at book value of P500,000 and available cash is distributed to appropriate parties. Remaining assets are sold in August for P150,000 and cash is distributed in final settlement.

35. Loss absorption balances represent the maximum loss that the partners can absorb without reducing their equity below zero. The partner with the biggest capital exposure or loss absorption balance should be prioritized in a cash distribution. A partner with a relatively low loss absorption balance can be wiped out by a material realization loss.

Looking at Figure 4-8, Hulleza has the lowest loss absorption balance and this means that she is most vulnerable or susceptible to losses. Assume that a loss on realization amounted to P400,000, Hulleza’s capital balance will become zero because her share in the loss will be P100,000 (400,000 × 25%) which is equivalent to her capital interest. Huelar will be prioritized in a cash distribution because of her higher loss absorption balance brought about by a larger capital interest and a higher profit and loss sharing ratio. This is being done to be fair with her since she has the biggest capital exposure.

36. The next step in the preparation of the program would be to make the highest loss absorption balance equal to the next highest. The difference will be the basis for the computation of the cash priority payments to the partners. The cash priority payments can be obtained by multiplying the excess or the difference in the loss absorption balances by the profit and loss ratio of the respective partner. The above procedure is continued until the loss absorption balances of all the partners are equal. If the loss absorption balances are already equal, cash may be distributed to the partners in their profit and loss ratio. The entries related to this illustration follow:

37. The initial cash balance is P50,000 and this is increased by the P500,000 proceeds from the sale of non-cash assets. The balance after settlement of liabilities of P350,000 is P200,000. This amount is now available for distribution. Based on the cash priority program, Huelar should be given P150,000 being the first priority. The total cash for allocation in priority II is P75,000. For this month, only P50,000 is available after the P150,000 allocation to Huelar .

When cash is insufficient to fully satisfy the cash requirements in a particular priority, then the available cash will be distributed in the ratio of the supposed allocation in that priority. In this instant case, the P50,000 will be allocated in the ratio of the supposed allocation in priority II—P60,000 and P15,000 for a total of P75,000. The ratio is 60/75 for Huelar and 15/75 for Tabujara . The ratio only considered the two partners since they are the only ones included in priority II. Meanwhile, the balance of P25,000 in priority II will be allocated next month.

38. Last month, the balance in priority II is P25,000. This will be satisfied since there is sufficient cash for distribution this month. After satisfaction of the first two priorities, any excess cash will be distributed in the profit and loss ratio of the partners since there is no more priority to satisfy other than the last priority.

Cash payments may be made in the profit and loss ratio only when installment payments have caused the ratio of the partners’ capital account balances to be the same as the profit and loss ratio. The mathematical basis for payments in accordance with the previous statement—profit and loss ratio, will be proven by using the figures in the Huelar , Hulleza , and Tabujara partnership.

39. First, subtract the July payments to the partners, the distribution of loss on realization and the August payments to the partners to fully satisfy priority II, from the capital balances before liquidation. The result of these series of subtractions will be the capital balances after the satisfaction of the first two priorities in the amounts of P75,000; P31,250 and P18,750 for Huelar , Hulleza , and Tabujara in that order. The total of these balances is P125,000. The ratio of each capital balance to the total capital balances will then be computed— Huelar , P75,000/P125,000 or 60%, Hulleza , P31,250/P125,000 or 25% and Tabujara , P18,750/P125,000 or 15%. Observe that the capital ratio yielded the same ratio as that in priority III of the cash priority program. This piece of information may prove very useful in handling cash priority programs.