 In this presentation, we will take a look at the liquidation of a partnership and a situation where a partner results in a negative capital account during the liquidation process and does not pay back the partnership for the negative capital account resulting in us having to allocate that capital account to the remaining partners. Here's going to be our data. We're going to put this in a table format and then work it through with journal entries and a trial balance. The first thing we want to do is work out what our rates will be. We're going to have the 2, 3, 1 split here, so just remember how to deal with these. You're just going to add them up, 3 plus 2 plus 1 adds up to 6 and then we'll just take the division, the fraction of 3 to 6, 2 to 6, 1 to 6, or 3 divided by 6 is 50 percent for K's capital. It's not there yet. And then it's 2 over 6 for C's, notice it's not exact here. That's why we need a ratio. And then 1 over 6 and note, again, it's not going to be exact when we write it down. So when we write these down then K's was 50 percent C, about 33.33, not exact. That's why we use ratios. And then we've got 16.67, not exact. That's why we use ratios. And we're going to say that we have the balances. This is kind of like the trial balance, but in table format. We've got assets including cash. We've got inventory. We've got liabilities of accounts payable, 240,000. Then we've got the three capital accounts for our three partners. Note that this is just basically a accounting equation problem when we consider it in table format. It's like the trial balance, but instead of debits and credits we've got the accounting equation, which is assets, 182.5. And 530 for the cash and inventory of 712,500. Then the liabilities and equity of 240,000 accounts payable, 93,000 capital, 212.5 capital and 167,000 capital for 212,500. The assets equal in the liabilities and equity. We're going to go through our normal process through the closing process. First selling the inventory. Then allocating that gain or loss to the capital accounts in accordance with their profit share and agreement. Then we're going to see if there's any negative capital accounts and deal with them then there will be in this problem and we'll have to deal with it. And once dealt with, then we will pay off the liabilities. Then we'll pay off the capital account balances. Has to be in this order, what doesn't have to be, but to avoid any kind of problems or reduce them as much as possible. This is the preferred order to do this in, otherwise we're more likely to have negative capital accounts and not only have them, but then being kind of partially our fault by not going in the proper order. So we're going to go through this, sell the assets. We're going to sell the assets for 320,000 even though they're on the books for 530,000. So we're going to get cash at 320,000. We're going to take them off the books at 530,000. Then we're going to allocate the difference to our three owners in accordance with their profit sharing. So we've got the 530 minus the 320, it means we have a loss of 210 times 50% times .5 is 105. Note we can use the 50% there and be exact, but we can also use the ratio which was 210,000 loss times, I'm going to say 3 over 6 times 3 over 6. 3 divided by 6, 105. Now that's going to be more important for the second one because we have that same loss 210,000. And if I say times .3333, it's not exact. We're off by a few bucks here. So we could do our same ratio analysis, 210,000 times the 2. This is on the 2 divided by 6. That'll give us a more exact number. And the same is true for M here, where we have, and I'm using these ratios. These will come into play later, these other ratios. So then we'll have the 210,000 times, we're going to say 1 over 6, gives us the 35. So that's what our split will be. And that means that our assets still equal our liabilities plus equity with this transaction if we bring down our balances then. Cash goes from 182,500 up by 320,000 to 502,500. Inventory goes down to zero. Capital accounts payables remains the same. The capital account for K goes from 33,000 down by 105,000 to negative 12,000. That's the problem. That's what we will have to deal with. Sees capital account goes from 212,500 down by 70,000 to 142,500. M's capital account goes from 167,000 down by 35,000 to 132,000. Then we're going to allocate this deficit. Now we're going to say here that we went to K and we said, hey, hey, could you pay the capital account because we did everything we're supposed to do? We sold the inventories, but we had this loss. We allocated that loss in accordance with the profit sharing, which means 50% to you. And that brought your capital account balance from a positive to a negative representing the fact that you owe the company money. And K very well may say, I'm not paying the company because it's a liquidation process and I just want out of this partnership and I don't expect to pay anything at this point. I had a $93,000 capital account before the process and whatnot. So we won't get into like the legal scenario between the other partners and K here. We're just going to say, okay, well, if that happens, there might come a point where we have to just allocate that to the other partners and move forward so that we can close out this partnership agreement. So how are we going to do that? We would have to allocate that loss then reducing C and M's capital accounts in some way. So we're going to take that $12,000 and allocate it. Now we can't allocate it using the same ratio, 3 to 1, because the 3 is gone. We can't allocate it to K, he's gone. So we got to allocate it between the other two. One way we can do that is we can say, okay, well, there's 2 and 1 remaining for C and M and 2 plus 1 is 3. So we can take the 2 over 3 and allocate 0.6666 of that $12,000 to C and then, of course, we can take the 1 over 3 for the 0.333. So again, they're not exact, so the ratio would be better to use. So if we took the 12,000, in other words, times 2 over 3, that's going to be 8,000. And if we take that 12,000 times 1 over 3, that's going to give us 36. So we'll apply that 12,000 taking K's capital down to 0, apply it 8,000 to C and 4,002M. So then if we look at our balance then, we're going to say that the cash is still just bringing brought down, the account's payable just bringing it down. The K's capital now going to 0 and the C's capital starting at $142,500 going down by 8,000, his portion of what he's reducing his capital account by due to C not paying back partnership for the negative capital account to $134,500 and then M starting at $132,000 going down by 4,000, same scenario, his portion or her portion of the 12,000 being a reduction to 128,000. Then we're going to pay off the liability accounts. So the liabilities are on the books for $240,000, we're going to pay off the $240,000 and then we're going to reduce the liability by the $240,000. If we bring the balances down then we're going to say the $502,500 cash minus the $240,000 cash brings us to $262,500 accounts payable going from $240,000 down by $242,000. Then we'll just bring down the capital accounts at $134,500 for C and $128,000 for M. Then we have the distribution to the owners all we have remaining being cash and what is owed to the owners and we can just distribute what is owed bringing the balances down to zero. Note that these final distributions and the capital accounts along this whole way will not necessarily match the profit sharing agreement. So remember the profit sharing only has to do with the allocation of net income, not with draws, not with investments, therefore the balance in the capital accounts will not necessarily match the ratios given for the profit sharing. Okay so now we're going to do the same thing in terms of a trial balance in terms of journal entries. When you see this in practice many times you'll work with a lawyer if you actually do this in practice and they will probably most likely and a lot of times they like to see things in table format, obviously when recording the information or just going through it I like to see journal entries as well to visualize this process. So the journal entries will help us to visualize what actually happens and when we actually do it we will need to have the journal entries. So here's our trial balance, our nice little short trial balance, let's give us an example here and we've got the debits in positive numbers, the credits in negative numbers, debits minus the credits equal zero or debits equal the credits. We have the assets in grain, liabilities in orange and the capital in blue. The income statement, revenue and expenses in dark blue, note there are none, they're all zero. No revenue and expense accounts, when we close out the company we need to have those at zero meaning we have in essence a post-closing trial balance with no income statement accounts. That must be the case otherwise the capital accounts will not be properly valued because the net income hasn't been allocated to it. So now we're going to go through the closing process, same thing as we did with our table, journal entry format, first selling the inventory, the only inventory we have selling the assets, the only assets we have being inventory. And obviously cash is an asset but we're not selling cash, we're going to get cash. So cash will be the last thing we're going to sell all other assets. So we're going to say that we sold it for 320,000 and the assets on the book for 530. So we're going to reduce it by 530, 530 minus 320 gives us a difference or a loss of 210. So here's going to be our journal entry. We result in this loss. If we post this out, the cash is going to go from 182,500 up by 320,000 to 502,500. Inventory is going to go from 530,000 down by 530,000 to zero and the loss then going from zero up in the debit direction to by 220, 210 to 210. Now of course you'll note that we have recorded this loss here a little bit different than we did it on the table where we just allocated that difference directly to the capital accounts in accordance with our profit sharing. This loss is probably the way we would see it more likely in practice when we sell an asset, something like this, we would record the loss. So we're doing this in kind of a two step process. We're going to record the loss and then we're going to go back and close it out in essence have a little closing process to close it out to the capital accounts because that's probably more familiar than us doing just allocating that loss in this journal entry. So that's our next step. We're going to have to get rid of this, get back to the post closing trial bounds, close any income statement accounts to the capital accounts before moving forward. To do that we're going to say that this loss is going to be allocated to K, C and M respectively in accordance with 50.33 and 17% profit sharing. Now note that these are not exact again. So they're just going to be rounded because we're not using the actual ratio. So 210,000 times 50%. That one's exact because that's 50% but this one's an estimate. So remember this was 210,000. It's really like 0.3333 and that's pretty close. It should be 70,000 and then 210,000 times 0.16666 is what it really is. And that's pretty close there. So just be aware that if we just used 0.33 we would be fairly substantially off, 0.33. That's why we use ratio. So it should be 70,000. So just be careful with those. So we're going to go through these again. C we're going to have 70,000 and M 35,000 allocated of this 210. So 105, 70, 35 and then we're going to credit the gain or loss. So in other words I would think of it this way. We're going to take the gain or loss off the books with a credit which we put on the bottoms to be proper. And then we're going to debit the capital accounts in accordance with the profit sharing of the 105 to 70 and the 35 which is 50.33 and 0.17% of the 270,000 about 0.3333 really 0.16666 not forever. Okay. If we post this out then we're going to say that the capital account for K it started at 93,000. We're going to make it go down by 105,000. Not only to zero, but past it to negative 12,000. There's our problem. We shouldn't have a negative capital account. We shouldn't have a debit balance in the capital account and that's what we're going to have to deal with. Then we have the 70,000 is going to be posted to this 212,500 goes down by 70 to 142,500. Then we have the 35,000 is going to be posted here to the 167,000 bringing it down by 35 to 132,000. Then we have the 210,000 gain or loss is going to be posted here, bringing that 210 down by 210 to zero. So if we look at our balances now, our problem here is going to be this 12,000 negative capital. Same thing we had on the table. We're going to ask K the partner, hey, you know, we did everything we could. You got a negative capital account. We really should pay the partnership back in the closing process because that 12,000 should be is really kind of owed to the either the liability or the other two partners. And so we really kind of need you to pay the partnership before we can move forward with the partnership closing or liquidation. If they say no, then at some point we might have to say, okay, we're going to move forward anyway. And again, we won't get into the legal ramifications of that, but we'll just move forward in terms of journal entries, which means we're going to have to allocate that 12,000 to C and M in some way. So now we're going to reduce to 12,000 and allocate it. So this is going to go off the books. It's on the books at a debit. We have to make it go to zero doing the opposite thing to it a credit. And then we're going to debit the other two capital accounts C and M's in accordance with their profit sharing. Now we have a problem to do that same problem we had on the table in that the profit sharing was at a 321, which adds up to six, which is 50, 30, and 0.17 about. But we can't allocate here because this person, that's who we're allocating from. We're taking it from Case Capital, who's basically not paying it back to go to C and M. So we can't use the same ratios. We can't use 0.33 or 0.17 because that doesn't add up to 100. So what we can do is that's the same thing we did on tables, take these two. That's a two and a one, by the way. And then the two and the one, which adds up to three. So then we can take the 12,000 times two over three is 8,000. And we can take the 12,000 times one over three, which 12,000 times one over three is 4,000. Or in other words, we're taking two over three is 0.666, which matches here, times 12,000 is 8,000. And we're taking one over three is 0.3333 times 12,000 is the 4,000. OK, so that's going to be our allocation. So we're going to take this off the books, making it go to zero, allocate the debits, which will reduce their capital accounts for C and M in accordance with the profit sharing, which we just reallocated to be this 0.6666 and 0.333333 on forever. OK, so then we're going to post this. So there's the 12,000 first, bringing the 12,000 down by 12,000 to zero. The other two losing or reducing their capital accounts, the 8,000 C started at 142,500, going down by 8,000 debit to 134,500. M starting at 132,000, going down by 4,000 to 128,000. So now we have our balances. We only have our two partners. They're both negative capital accounts, so we are OK to move forward and pay off the liabilities. So we're going to pay off the liabilities now with cash. So the liabilities are on the books for 240,000 credit. We're going to do the opposite thing to it, debit to bring them off the books and credit, of course, cash. That's what we're going to use to pay it. So if we post this out then, this liability is going to be posted here, this 240 bringing it down by 242,000. Then we have the cash here. It's going to be posted to the 502,500 cash debit. We are going to credit it, making it go down to 262,500. Now we're going to be left with just the cash and the two capital accounts. Nice easy ending process here. All we have to do now is pay off the cash in accordance with whatever is in the capital accounts. No ratios, no math here. We're just going to pay it off whatever is there. So that means that this capital accounts on the books for 134,000. It's a credit. We're going to debit it. This capital account for Amazon, the books for 128,000. It's credit. We're going to debit it. Then we're going to credit the cash, which is on the books for 262,000, which also, of course, is equivalent to 134,500 plus the 128,000. If we post this out, then the capital account for C goes from 134,500 down by 134,500 to zero. M's capital account goes from 128,000 down by 128,000 to zero. Cash goes from 262,500 going down by 262,500 to zero. And now we have all zeros and the liquidation process is complete.