 Hello and welcome to this session. This is Professor Farhad in which we would look at a liquidation of a partnership. This topic is covered in financial accounting as well as in advanced accounting. Obviously in advanced accounting, it's covered a little bit more in details. It's also covered on the CPA exam, the FAR section. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting auditing tax finance lectures, as well as many CPA questions and Excel tutorial. If you like my lectures, please like them, share them, put them in playlists. If they benefit you, it means they might benefit other people. Subscribe to the channel, connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources to supplement your CPA exam, as well as CMA enrolled agent and all of your accounting courses. If you are looking to improve your score, 10 to 15 points on your professional examination, I strongly suggest you check out my website. So today we're gonna be talking about liquidation of a partnership. And simply put, liquidation is something we're going out of business. I remember when Borders, maybe some of you remember this bookstore, maybe not, went out of business. I used to hang out in this place a lot when I was younger. Actually, I can't do that anymore. It's closed, but I can't do that anymore anyhow. So what do you do when you liquidate? When you go out of business? The first thing you do is you sell everything. Then you pay off your debt, you pay off your employee, you pay off your taxes. Then whatever's left, anything leftover goes to the owners. That's the general idea. So this is the big idea that we're gonna be working with when it comes to a partnership. So let's look at this specific detail. So the partnership requires three steps following the sale of a non-cash asset. You sell everything that's non-cash. You cannot sell the cash. You can try to sell your cash. Somebody will give you exactly $20 for your cash. But if you have land, if you have inventory, like what borders have, if you have stores, you're gonna sell it and you're gonna either record a gain or a loss on liquidation on the sale. What does it mean? It means you sell something, you have a gain. It means you sold it more than its book value or you have a loss. You sell it less than your book value. So first you have the gain or the loss. And here's where students forget. Students skip over this first step. Once you have a gain or a loss, you cannot have both. You net them out. You either have a gain or a loss. That gain or a loss is allocated to the partner. So simply put, if you have a gain, the partner's account will go up. If you have a loss, the partner's account will go down using their income and loss ratio. So depending on what their income and loss ratio is, 50, 50, 70, 30, 60, 40, whatever that loss ratio is, then your liabilities are settled. Your liabilities are paid. You pay off your liabilities and that's obviously logically how things happen. You sell everything. First, you have to pay your obligation. And anything that's after your obligation goes to the partners, goes to the owner of the business. That's basically the logical step of closing the business. Now the best way to illustrate those steps is to actually start to illustrate this in an example. The first thing we want to define by before we illustrate anything is something called no capital deficiency. What does it no capital deficiency mean? Let's assume I am a partner in a partnership and I have a four hat capital account. As long as I have a credit balance of zero or $10, I don't have a capital deficiency. But if I have a balance of $2 debit, if I have a balance of a debit, it means I owe the partnership. Simply put, I took money out more than my capital balance. Okay, so the first thing we're going to assume is there's no capital deficiency. It means all partners, they either have a zero balance. So zero balance means no capital efficiency. It means your balance is zero. Or you have a credit balance, which is good if you have a credit balance. That's basically what it means. So the first example, we're going to be making that assumption. So we have Z, P, and R. Three partners agree to this older partnership. The only outstanding liability is a debt of $20,000. Prior to the dissolution, they have the following balances. So here's where we stand down. They have cash of $178,000. They have a land on the books that's worth 40. They have an account spable of 20. Zane's capital is 70. Perez's capital is 66. And Rashid's capital is 62. So the first thing they do, they're going to have to get rid of the land. They have to sell the land. So let's see how much they sold the land for. So they started the dissolution and they sold the land for $46,000. Well, let me ask you, do we have a gain or do we have a loss? Obviously we have a gain on the land. How much is the gain? The gain is $6,000. We sold the land $6,000 more than the $40,000 book value. So we have a gain and we're going to allocate the gain equally. That's how they distribute things among the partners. And after the sale, they're going to pay off their liability. So first we get rid of the land, then we get rid of the $20,000. Let's take it step by step. So let's first compute, journalize the land. We debit cash $46,000. We get rid of the land and we have a gain of $6,000. Now this gain here will have to be closed out to the various partnership. And it's easy. We said it's equally. Therefore, each one of them get $2,000. So we're going to increase Zane's account by $2,000, Faraz's capital account by $2,000 and Rashid's capital account by $2,000. And we get rid of this gain. So this gain is gone. Notice we debited the gain. So the gain is gone. And their capital, each one of their capital went up by $2K. Plus 2K, plus 2K. Now the next thing we're going to do, the logical step is to pay off the liability. Luckily we only have one liability, which is accounts payable. So we're going to debit accounts payable credit cash. Now what I want you to do just basically, although I did not mention this, notice we had 178,000 in cash to start with. Then we sold the land for 46. So now we have more cash. Then we're going to pay off the liability of 20. So it's very important to keep track of your cash balance. So we're going to pay off the liability, which is 20,000. So this is, we paid off the liability. So after step two, here's what our cash balance would look like in our capital balances. Our capital balances for Zain is 72. It started with 70, then we added two. The Perez, we started with 66, added two. Forty Rashid started with 62, added two. The cash balance started with 178, added 46, subtracted 20. We have 204. Now we are ready to distribute the cash. Each one of them, notice, because we have no capital efficiency, gets exactly their account balances. Therefore, we credit cash. We debit the capital of Zain 72. The H per Az 68. So this is down to zero, down to zero, down to zero. So we debit all these accounts for the amount and everything is down to zero. Now let's look at an example where we have a capital deficiency. And what does a capital deficiency means? It means in your capital account you have a partner with a debit balance. Now why would a partner would have a debit balance? Well, the partner will have a debit balance for two reasons. Either they absorbed a lot of losses because remember net loss is close to capital or they took out a lot of withdrawals. So they kept taking out withdrawals from the business. Therefore, their capital became like negative. We call it the capital deficiency or a debit balance. So either losses or withdrawals. This can arise from liquidation losses, excessive withdrawals before liquidation or reoccurring losses. So it also could be when we liquidate, they had to absorb a large amount of a loss and they don't have enough capital. So a partner with a capital deficiency, usually, if possible, they should cover the deficiency. So if you owe the partnership $10,000, your capital, you have a debit balance, you should come up with $10,000 to kind of cover your capital deficiency. So simply put, if I have a capital deficiency of $10,000, I have to increase my capital by $10,000. So I would credit my capital balance and I will contribute cash of $10,000. So I contribute cash of $10,000, debit cash, credit capital. My capital is up to zero and I'm good. Therefore, I satisfied my obligation. Sometime I can do it, sometime I don't. If I cannot cover my capital deficiency, who's going to cover my capital deficiency? And guess what? The other partner. So let's take a look at an example to look at how capital deficiency work. We have Zayn, Paraz and Rashid. They agree to the soldier partnership prior to the final distribution of cash to the partners. Zayn has a capital balance of $19,000, which is positive, Paraz of $8,000. And Rashid, notice here it's negative $3,000. So simply put, Rashid owes the partnership $3,000. And Rashid here is able to pay it. Well, if Rashid is able to pay it, simply put, here's what Rashid's account look like before the dissolution. So they had a $3,000 debit balance. Now they credit the capital balance $3,000. They satisfied, they can move out, okay? Now what's left? Now what's going to happen is what's left goes to the other partners. So simply put, we have $27,000 left. $19 goes to Paraz, $8 goes to Paraz. So simply put, Rashid was able to cover his deficiency, which is really good news for the other two partners. Now let's take a look at when the partner cannot pay the deficiency. So let's assume you have a deficiency and sometime you cannot pay the deficiency. Simply put, you don't have money to pay the deficiency. Let's assume the same information, except that Rashid don't have $3,000 and assume the profit and loss is shared equally. So remember, Rashid has a deficit of $3,000. Who's gonna absorb the deficit? Well, guess what? The other partners, how are they gonna absorb it in their income and their profit loss ratio, which is 50, 50. Therefore, what's gonna happen? Zayn has a balance of 19, Paraz of eight and Rashid of negative three. So what's gonna happen? Rashid's balance will be added three to make it down to zero. And what's gonna happen? The other partners, Zayn and Paraz will basically absorb it. Notice Zayn balance now 17,500. Paraz's balance is 6,500. And the entry will be to debit Zayn, debit Paraz, reduce their balances, increase Rashid's balance up to zero. Well, why? Because Rashid don't have cash to pay. Therefore, the other two partners will have to absorb the capital balance. And when we look with eight, we have 24,000 left with credit cash and debit their capital remaining balances to close the business. Now, the best way to illustrate this is to actually work another example, a little bit more in details, kind of emphasize this. And by the way, if you want more about this topic, please go to my advanced accounting course where you have advanced partnership situation. This is basically for financial accounting. So we have three partners, D, G and O, begin by investing by the partnership as followed. D, 190, G, 340 and O, 550. D, G and K, share of income, one to one to two. Simply put, one to one to two equal to four, one fourth, one fourth, two fourth. So it's, let me go back down the erase. Let me go down to where I was. See all slides, let me just, I clicked. I went up by mistake. So what does that mean? It means they have the balance of 25%, 25% and 50%. One to one to two, you add them up equal to four and you take one divided by four, one divided by four and two divided by four to find the percentages. The operation did not go well, surprise with the partnership, it didn't go well. And the partners eventually decided to look with a partnership. On July 31st, after all assets were converted to cash and all creditors were paid, only $80 remained in the partnership. So after everything said and done, here they're telling you we liquidated, we sold everything, we paid off the creditors and we have $80 left. Now compute the capital account balances of each partner after the liquidation of the asset and the payment of the creditors. Assume that's first scenario, second scenario, assume that any partner with the deficit agrees to pay to the partnership to cover the deficit, prepare the journal entries, the cash receipts and the final disbursement of cash. Assume that if there's any deficit, the person is not able to pay it and record the entry, how the other partners will absorb it, how the other partners will absorb it. So let's take a look at the first scenario. Before the liquidation, this is what we have. We have three balances, 190, 340 and 550. This is what we have. So total equity, $1080. What we are told that after the liquidation, okay, after the liquidation, it means we have equity of that much. It means we have total asset of $1080. But what we are told after the liquidation, all the assets that's left is $80. It means we sold everything for at a loss. We sold everything at a loss. So simply put, what happened is after the liquidation, we only have $80. After the liquidation, we only have cash of $80. What does that mean? It means we had a loss of $1,000. Although they're not telling you the loss exactly as $1,000, but they're giving you that information indirectly. So the loss is $1,000. What's gonna happen? These partners will have to absorb the loss, 25%, 25% and 50%. So what's gonna happen is each partner will have to absorb 25%, 25% and 50%. 250, 250 and 500. We're gonna have to reduce their balances by that much. So now the NECA reduces their balance. GAGA reduces their balance and opera. Now notice the NECA has a capital deficiency of $60. GAGA still have $90 and opera still have a credit balance of $50. Now let's look at the first thing we said we're gonna assume that they can pay it. The NECA pay the deficiency. That means it's gonna give the partnership $60 in cash, which is good. And that's gonna reduce her balance down to zero, increase her balance, not reduce it, increase their balance down to zero. Therefore, basically the NECA is out because the NECA paid her balance. And the other balances stays the same, but now we have $140 in cash. What we do next is we distribute the cash of the $140, $90 and $50 to the respective partners and we debit their balances and we credit cash to close the partnership. So in this scenario, the person with the deficit was willing and able to pay it, which is good. In the second and third scenario, we're gonna assume that the person cannot pay off. So simply put, this $60 will have to be absorbed by the other two partners. Now remember, it's one to one to two. If we took one out, what we left is one to two. One plus two equal to three. It means it's gonna be distributed one third and two third to the other partners. So simply put, we're gonna absorb it by one third. Once $60, it's absorbed one third by GAGA and two third by APRA, which is 20 and 40 respectively. And now the NECA's out. Therefore, now the NECA's balance, we reduce the balance down to zero. And we also had to reduce the other two partners because they have to absorb basically the loss that the NECA did not cover. Now we still have $80. What we do is we distribute the $80 to the partners by debiting their account and crediting cash. And this is what we did here. Now, as always, I would like to remind you, if you want additional resources, if you want additional lectures, I strongly suggest you visit my website. Please like this recording, share it, put it in playlist. Remember, farhatlectures.com is there to help you pass your CPA exam, to help you improve your performance, to help you in your career. You invest for your certification once in your lifetime. You invest in your education once in your lifetime. It's gonna pay dividend over time. Take it seriously, study hard, good luck, and stay safe, especially during those coronavirus days. Good luck.