Basics of partnership accounting (Part II)
In the last article, we discussed partner capital accounts, contributions, and withdrawals, as well as the allocation of periodic income. Now we’ll look at how to account for the termination of a partnership.
1. Accounting for partnership termination
For the first part of this article series, refer to Basics of partnership accounting, part I.
All good things eventually come to an end, and partnerships are usually no different. Perhaps the business is not performing well, but even if it is, the partners may need to liquidate the investment or just want to go their separate ways. No matter the reason, the goal of partnership dissolution is to turn all assets into cash or other assets the partners are willing to accept and pay off all creditors. Anything left over goes to the partners in a manner that depends on their capital account balances. Let’s continue our example from Part 1 of the partnership started by Jerry, Tom, and Billy. Throughout the dissolution examples, keep in mind the fact that Jerry has a 50% interest, Tom has a 30% interest, and Billy has a 20% interest. Also note that the partners split up profits and losses based on ownership percentage. These two pieces of information become critically important during the dissolution process.
2. Dissolving a partnership - No capital deficits
We’ll first look at what happens when a partnership has performed well and everyone ends up with a positive capital balance. After 10 years of business, the JTB partners decide to end the partnership. The company’s final balance sheet is shown below.
JTB Final Balance Sheet |
||
Assets |
||
Cash |
$40,000 |
|
Accounts Receivable |
$25,000 |
|
Office Equipment and Furnishings (net of depreciation)* |
$40,000 |
|
Building (net of depreciation) |
$300,000 |
|
Total Assets |
$405,000 |
|
Total Liabilities* |
$60,000 |
|
Equity |
||
Partner Capital – Jerry |
$190,000 |
|
Partner Capital – Tom |
$105,000 |
|
Partner Capital – Bill |
$50,000 |
|
(*) Multiple accounts combined for simplicity
When a partnership ends and assets are liquidated, the company often cannot fully recover the book value of noncash assets. For example, let’s say that the partnership collects the full amount of receivables but can only sell the office equipment and furnishings for $30,000 and the building for $270,000. Whenever the partnership receives less (more) than book value for an asset during the dissolution process, the difference is treated the same as a loss (profit). We discussed how to allocate profit and losses in Part 1. The partnership will now make the following three journal entries related to the liquidation of assets:
Account Names |
Debits |
Credits |
Cash |
25,000 |
|
Accounts Receivable |
25,000 |
|
Cash |
30,000 |
|
Partner Capital – Jerry |
5,000 (10,000 x 50%) |
|
Partner Capital – Tom |
3,000 (10,000 x 30%) |
|
Partner Capital – Bill |
2,000 (10,000 x 20%) |
|
Office Furnishings/Equipment |
40,000 |
|
Cash |
270,000 |
|
Partner Capital – Jerry |
15,000 (30,000 x 50%) |
|
Partner Capital – Tom |
9,000 (30,000 x 30%) |
|
Partner Capital – Bill |
6,000 (30,000 x 20%) |
|
Building |
300,000 |
The amounts debited to partner accounts represent losses on the sale of equipment and building allocated based on partnership ownership percentages.
The partnership now has $365,000 (i.e., $40,000 + $25,000 + $30,000 + $270,000) in cash and liabilities totaling $60,000. Partner capital balances are as follows:
- Jerry’s capital balance is $170,000 = $190,000 - $5,000 - $15,000.
- Tom’s capital balance is $93,000 = $105,000 - $3,000 - $9,000.
- Bill’s capital balance is $42,000 = $50,000 - $2,000 - $6,000.
The partnership can now close its books by paying off all liabilities and distributing the remaining cash to the partners:
Account Names |
Debits |
Credits |
Accounts Payable |
60,000 |
|
Cash |
60,000 |
|
Partner Capital – Jerry |
170,000 |
|
Partner Capital – Tom |
93,000 |
|
Partner Capital – Bill |
42,000 |
|
Cash |
305,000 |
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