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Liquidation

e process of winding up a business normally consists of the conversion of a portion or all of the
assets into cash, settlement with creditors, and the distribution of remaining assets to the partners.

e conversion of assets into cash is referred to as realization. e payment of liabilities is referred to


as liquidation; however, it is also used in a broader sense to refer to the complete winding up process.

Procedure in Liquidation

When a partnership is to be liquidated, the books should be adjusted and closed and the net income or
loss for the period should be carried to the partners’ capital accounts. e partnership is then ready to
proceed with liquidation.

As assets are converted into cash, any differences between the book values and the amounts realized
represent gains or losses to be divided among partners in the profit and loss ratio. Such gains and
losses are carried to the capital accounts, which will become the basis for settlement.

In the course of liquidation, when a partner’s capital account reports a debit balance and such partner
has a loan balance, the law permits exercise of the right of offset, that is, the offset of a part or the entire
loan against the capital deficiency. A debit balance in the capital account in the absence of a loan
balance or aer offset of a loan balance indicates the need for a contribution by the deficient partner.
e inability of a partnership to recover a capital deficiency will mean the remaining partners will have
to absorb such amount.

As cash becomes available for distribution, it is first applied to the payment of outside creditors. It may
then be applied in settlement of partner’s loan and capital balances. It may be observed that the
Philippine Partnership Law provides that partners’ loan shall rank ahead of partners’ capital in order of
payment.

Procedure in summarized form:

1. Realization of assets and distribution of gain or loss on realization among the partners based on
the profit and loss ratio.

2. Payments of expenses – During the liquidation process, expenses are usually incurred, such as
legal and accounting expenses and advertising cost of selling the assets. e expenses are
allocated to partners’ capital accounts in their profit and loss ratio.

3. Payment of liabilities

4. Elimination of partner’s capital deficiencies. If aer the distribution of loss on realization, a


partner incurs a capital deficiency (i.e., partner’s 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, exercise the right of offset.

b. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.