 In this presentation, we will take a look at a partnership liquidation in which one partner will end up with a negative capital count and have to pay back the partnership within the liquidation process. So here's going to be our data. The profit sharing split is a 3-2-1 split. That means that we're going to have to use a ratio in order to see what the split will be, the ratio will be, or the percent will be, between K's capital C's capital and M's capital, our three owners. The way we do this is we take the 3 plus the 2 plus the 1, adding up to 6, and then we just compare each to the 6. So the 3 belongs to K, the 2 belongs to C, and the 1M. Therefore we just take the 3 over the total 6, and we get the 50% capital distribution or capital sharing for K. If we take the 2 over 6, we get the 0.333 on forever, just being the reason why we can't use a percent, but must use a fraction. And then we'll take the 1 over 6, and that'll give us the 0.1666 on forever once again. That being the reason we need a fraction rather than a percent. Need to understand how to calculate those, because if we don't understand that, can't move forward with many partnership problems. So that's going to mean that we have a 50%, about a 33.33 for C, and about a 16.67 profit sharing that we'll be using throughout the liquidation process. Then we have basically our trial balance here listed out in a table format. We will also see the trial balance in terms of a trial balance format, but it's useful to see in a table format because often presented in practice and in book problems in table format. When we see it in a table, they're also often going to condense numbers and call everything assets, accounts, and liability accounts rather than having the account names. It's useful to have the account names, so we're just going to make a very small actual example of accounts here so we can see the actual accounts and not just generic names of assets and then liabilities. So what we have is we've got cash at the 182.500, we've got inventory, the other asset, 530,000 liability accounts payable, 240,000, and then the capital accounts for K, C, and M at 93,000, 212,500, and 167,000 respectively. We can see that this is in essence the accounting equation. Assets minus liabilities equals equity or assets equal liabilities plus equity. So the assets here are 182.5 plus the 530 gives us 712.500 for the cash and inventory. That should be equivalent to the liabilities and equity who we owe that to as the company. 240,000 liability and then the capital accounts at 93,000 and 225 plus the 167 giving us that 712.500. So when we use a table format we're basically just doing an accounting equation format. Then we're going to say we're going to sell the assets. Remember we always have to do this in order, meaning we're going to sell the assets, we're going to apply the gain or loss on sale to the capital accounts in accordance with their profit sharing. Then we'll check if there's any problem with negative capital accounts, which here there will be, and then we'll deal with that problem. Then we'll pay off the liabilities with the cash that we get. Then we will pay the partners. We really have to go in that order because that will cause the least amount of problems, problems such as negative capital accounts, which even going in this order will not always remove all those problems. But if there is a negative capital account we want it to be as a result of just the process and not our fault. And that means that we're not going to pay the owners before we sell the inventory because that will just make things worse if we don't sell the inventory or the assets at book value. So if we go through this then we're going to sell the assets. We're going to say that we're selling them for $320,000 and they're on the books for $530,000. Clearly we have a loss here. So we're going to take them off the books and take the inventory off the books. Then we're going to split the difference between the partners in accordance with their profit sharing agreement. So if we pull out the calculator here, we're going to say that we had the $530,000 that we sold or that's what the assets were on the books for the inventory, minus $320,000, which is all we can get for them during this clearance sale, gives us a loss of $210,000. 50% of that's going to go to K. So I'm going to say times 0.5, that'll give us the $105,000. If I do that same thing, $530,000 minus $320,000, $210,000. If I multiply it times 0.3333 times 0.3333, it's close, not exact. That's the problem with the percentage here. We can use a fraction, however, and that would be the same $210,000 times, remember what it was, 2, I can say times 2 over the 6, 2 over 6. So that'll give us the more exact $70,000. So remember what we're talking about, 2 sixths. So I'm taking the $210,000 times 2 sixths, 2 over 10, $210,000 times 2 divided by 6. So that's going to give us the $70,000, and then one more time. We're going to do this one more time. We've got the $210,000, then again if I say times 0.1667, close, not exact. If I was to say $210,000 times the ratio of 1 divided by 6, we get $35,000 more exact. So there's the $35,000 more exact number. Then we're going to bring down the balances, the cash that we received, $502,500. Then toy then going down to zero. Accounts payable just being pulled down. Capital accounts is $93,000 minus $105,000, bringing us to a negative capital account. That's the problem. And then C is having a capital account of $212,500 minus $70,000 or $142,500. M's capital account, $167,000 minus $35,000 or $132,000. Here is our problem. K has a negative capital account. So this could happen. We did everything properly and we still ended up in negative capital accounts. Why? Because we sold the assets and we didn't get as much for them as was reported on the books for those assets. Therefore resulting in a loss, that loss being allocated, bringing a positive capital account, flipping it to negative. So now we got to go to K and say, hey K, we're closing the company. We did everything we could and your capital account went negative. Would you pay the partnership so we can go through the closing process properly? And hopefully they should because that's part of the closing process. So they owe the company. So we're going to say that K pays the company $12,000. That would be the nice thing to happen because it's a closing process where liquidating partnerships are closing everything, not always the nicest time in practice. It may be an issue to get that $12,000 and we'll take a look at a case of what would happen if we don't get the $12,000, at least from an accounting standpoint. And then we're going to reduce the $12,000 for capital for K, bringing it to zero. So our new balance is going to be the $502,500 plus $12,000 for cash bringing us to $514,500. We bring down the accounts payable at the $240,000. The K's capital is going to zero. And then we're just going to bring down the other two capitals for C and M at $142,500 and $132,000 respectively. Then we're going to say we're going to pay off the liability. That's going to be the next step we want to do. We of course will pay it with cash. Liabilities on the books for $240,000. We're taking it off the books for $240,000. That's how much cash we will be paying. So we're going to pay out the $240,000 cash. To the $514,500 minus the $240,000, we're going to pay off two accounts payable, whoever we owe leads us with a balance in cash of $274,500. The accounts payable going from $240,000 down by $240,000 to zero. Then the capital accounts we're just going to bring down at $142,500 and the $132,000 for C and M respectively. Now we finally have this last step that we've been looking forward to, which we can finally pay out the partnership and be done with the partnership. So we have the $274,500 which will be equivalent to the $142,500 and the $132,000. So our accounting equation has always been in balance here as we go through this process. So now we can just pay it out in accordance with their capital accounts. As we do this, that these two are not in the same ratio as the 321, of course. And so don't get in the thought process that they have to be in that same ratio because that's only profit sharing, doesn't account for draws, doesn't account for investments. So the capital accounts will almost never be in alignment with the same kind of profit sharing percentages. So then that'll give us our zero balances that we've been looking for. We'll do that same process now with journal entries. It's very helpful to do this in both kind of ways. A lot of book problems will show this format here and in practice when you're working with lawyers and whatnot, they tend to like to see a table more than a trial balance. When we work on the accounting side of things, of course, I tend to see a trial balance better. It's easier for me to work through this with a trial balance and actually work through the journal entries to see what would happen. If we go through this closing process, and of course, when we actually record this, we will need to do so. We'll need to see the journal entries and actually record them in a journal entry type format, typically. So here's our trial balance. It's got the debits in non-bracketed numbers, the credits in bracketed numbers. Debits minus the credits equals zero, meaning debits do equal the credits. Assets in green, liabilities in orange, equity is in the light blue. The income statement accounts of revenue and expenses in dark blue. Note that there are no revenue and expenses in this problem. In essence, we have a post-closing trial balance. That means that we must have the revenue and expenses closed out to the capital accounts. Otherwise, the capital accounts will not be properly valued when we start the problem. So we're going to go through this now and go through the same steps as the table we did above. We're going to say that the cash is what we're going to receive when we sell the inventory. We only got 320. We're going to increase cash by the 320 in our journal entry. The credit's going to be for the 530 to take inventory completely off the books. The debit minus the credit is not in balance. We're going to put that as we normally would when it wasn't in a closing process to a gain or loss, in this case loss. So we had a loss on the sale of the 210,000. Now in the table, we just allocated those directly to the owners. But typically when we do a journal entry in practice, that would be going to a gain or loss. So this probably looks more normal in a journal entry format. So let's do this in a two-step process. We'll record the loss and then we'll close out the loss to the capital accounts in accordance with their profit sharing agreement, taking us to that same format we had prior to this. So if we post this out then, we're going to say that the cash here is going to go to the cash here. It started at $182,500. It's going to go up by $320,000 to a balance of $502,500. Then we have the inventory in our journal entry here going to the trial balance here starting at $530,000 going down with a credit by $530,000 to $0. And then we've got the gain or loss down here on the income statement going from zero up in the debit direction similar to an expense bringing down net income by $210,000 to $210,000. So if we look at everything now, we've zeroed out our inventory. That's our first step. And we received the cash that we could get for that. And we put now this loss on the books though. And remember we said that we have to close out all income statement accounts in order to move forward with the closing process. That will then be our next step just like to move forward with the liquidation process. So that will be our next step similar to a closing process. So we're just going to close out this gain or loss to, which is a loss in this case, to the capital accounts in accordance with their profit sharing agreement. So we're just going to take this $210,000, close it out in accordance with the profit sharing. So we're going to credit the $210,000. So we'll put that on the bottom. And we're going to debit K, C, and M capital accounts in accordance with profit sharing. So we're going to say that we had the $210,000. We're taking this $210,000 times the .33. Again that's an estimate and that was for C. So it's not quite exact because it's really .3333. It should be $70,000. But we should use the ratio to get more exact, same as we did with the table. And then we take the $210,000 times .5 and that'll give us the amount that's going to go to K. And then we'll take the $210,000 times the .17 and that'll give us close to the amount that would go to M. So again that would be the $70,000 to $35,000 that would go to K, C, and M, $105,000, the $70,000, and the $35,000. So then just remember that we did use the rounding here. If we use the fraction it would be exact just as we did with the table. If we post this out then we're going to post this. We're going to say that the capital account started at $93,000 for K in the credit side. Then we debited it doing the opposite thing to it bringing it down not only to zero but beyond zero to a negative capital account. This is the most confusing thing to look at when we look at the trial balance because we typically think of the capital accounts as having a normal credit balance which they typically do. So if you ever see a capital account that has a debit balance it's a problem typically. It means that the owner owes the business money or the partnership money and that's basically what this means in this case. Then we're going to say the $70,000 here is going to be posted to this area. So the $212,500 C's capital goes down in the debit direction by $70,000 to $142,500. Then the $35,000 here is going to be posted to the capital account here on the trial balance. The $167,000 going down by $35,000 to $132,000. Then we've got the loss that's going to be taken care of or removed. This adds $210,000 debit. We're going to credit it $210,000 bringing it to zero. So if we see our trial balance now here is our problem. We've got this negative capital we're back to all zeros on our trial balance so we can move forward but now we have to say hold we have to stop here and go hmm there's a negative capital we got to take care of that somehow. Talk to Katie and see if he wants to repay it if he does great then we can move forward that's what we're going to do here. So now we're going to say we got to take care of this negative capital how he's going to pay us or he or she is going to pay us $12,000 and that will bring the capital account back to zero and so basically investing money into the company and the partnership even though it's closing as part of the liquidation process. So if we post that then the cash is going to go back up to $514,500 and that's basically because of course this $12,000 is owed to the other two partners or to some liability that hasn't yet been paid so that's the case responsibility to pay that back. So then we're going to reduce the capital account back down to zero again we can you can kind of think of it as we're bringing it back up to zero because this is a negative capital account so it's a debit balance we're going to take the debit balance the normal unusual debit balance down to zero by doing the opposite thing to it. So there we have it and we're left then with cash the accounts payable and the two capital accounts for C and M. Now we're going to pay off the liabilities as we did in the table. We've got the accounts payable on the books at $240,000 it's a credit therefore we're going to debit it to make it go down. We're going to then credit cash because that's we're going to use to pay off the account payable liability. If we post this out then we've got the $240,000 credit for accounts payable which we will then debit bringing it down to zero. We've got the cash here that's going to be posted to the trial balance starting at $514,500 going down by $240,000 credit to $574,500. We're left with just cash and then the two capital accounts for C and M. So now of course the two capital accounts are equivalent to the cash and we could just pay it off and be done with this partnership. So the way we're going to do that will of course be just doing whatever we need to do to make these go down to zero. So this has a credit balance of $142,500 we then will do the opposite thing to it debit it $142,500. This has a credit of $132,000 we will do the opposite thing to it debit it $132,000. Then the cash has a debit of $174,500. We will do the opposite thing to it credit $274,500, hope I said that right. But there we have it and of course the two debits will equal the credits. If we post this out then cash is going to go down to zero, capital accounts down to zero, M's capital account down to zero and we've zeroed everything out. I can just keep in mind that I always get mixed up or people always I used to get mixed up a lot that these two capital accounts should be somehow in alignment with the profit sharing doesn't have to be in alignment with profit sharing. We're just going to close everything out. Whatever's in there will be closed out. What should happen is the two capital accounts should be equivalent to whatever cash is left at this point, which it must be if we are in balance.