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C4 Partnership - Review - Questions

Yes, there is a situation where the profit and loss ratio may be used as the basis of cash payments to partners during liquidation. Specifically, if all partnership assets are realized without any losses, and all liabilities are paid off, then the profit and loss ratio can be used to distribute any remaining cash among the partners. This is because in this scenario, where no losses occurred, using the profit and loss ratio to distribute cash would be consistent with the partners' agreed-upon sharing of profits and losses during the normal operations of the partnership.

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666 views3 pages

C4 Partnership - Review - Questions

Yes, there is a situation where the profit and loss ratio may be used as the basis of cash payments to partners during liquidation. Specifically, if all partnership assets are realized without any losses, and all liabilities are paid off, then the profit and loss ratio can be used to distribute any remaining cash among the partners. This is because in this scenario, where no losses occurred, using the profit and loss ratio to distribute cash would be consistent with the partners' agreed-upon sharing of profits and losses during the normal operations of the partnership.

Uploaded by

Jizelle Biana
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Jizelle A.

Biana

2098 Fundamentals of Accountancy Prof. Aileen Mendoza

REVIEW QUESTIONS

1. Define liquidation.
- Liquidation is the winding up of its business activities characterized by sale of all non-cash assets, settlement
of all liabilities and distribution of the remaining cash to the partners.
2. Differentiate dissolution from liquidation.
- Dissolution is the change in the relation of the partners caused by any partner ceasing to be associated in
the carrying on as distinguished from the winding up of the business of the partnership while liquidation is
the winding up of its business activities characterized by sale of all non-cash assets, settlement of all
liabilities and distribution of the remaining cash to the partners.
3. What does the term “realization” mean? “Capital deficiency”?
- Realization means the conversion of non-cash assets into cash; it is also a result by either a gain or loss on
realization and shall be divided in the profit and loss ratio of the partners. Capital deficiency is the excess of
a partner’s share in losses over the partner’s capital credit balance.
4. What is the order of preference in the liquidation of a partnership?
The order of preference in the liquidation of a partnership follows:
 First, those owing to outside creditors,
 Second, those owing to inside creditors in the form of loans or advances for business expenses by
the partners,
 Third, those owing to the partners with respect to their capital contributions,
 Lastly, those owing to the partners with respect to their share of the profits.
5. Explain the “right of offset” as applied in the liquidation of a partnership.
- Right of offset is a privilege that is the legal right of a partner to apply part or all his loan account balance
against his capital deficiency resulting from losses in the realization of the partnership assets.
6. Differentiate lump-sum method from installment method of liquidation.
- Lump-sum method is all non-cash assets are realized and the related gains or losses distributed, and all
liabilities are paid before a single final cash distribution is made to the partners while installment method is
a realization of non-cash assets is accomplished over an extended period. This method persists until all the
non-cash assets are sold.
7. List the pro-forma entries used in recording the steps in liquidation.
i) Sale of Non-Cash Assets
ii) Distribution of Gain or Loss on Realization based on Partners’ P/L Ratio
iii) Payment of Liabilities
iv) Exercise of Right of Offset
v) Additional Investment by Deficient Partner
vi) Deficiency Absorbed by Solvent Partner
vii) Distribution of Cash to Partners
8. State the procedures in lump-sum liquidation.
i) Realization of non-cash assets and distribution of gain or loss on realization among the partners based on
their profit and loss ratio.
ii) Payments of liabilities
iii) Elimination of partners’ capital deficiencies. If after the distribution of loss on realization a partner incurs a
capital deficiency, 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, then exercise the right of offset.
(b) If the deficient partner is solvent, then he should invest cash to eliminate his deficiency.
(c) If the deficient partner is insolvent, then the other partners should absorb his deficiency.
iv) Payments to partners, in the order of priority:
(a) Loan accounts
(b) Capital accounts
9. What is the basis for distributing gain or loss on realization?
- The basis for distributing gain or loss on realization is based on their profit and loss ratio.
10. In case of a partner’s capital deficiency, what is the order of priority to be followed to eliminate it?
(a) If the deficient partner has a loan balance, then exercise the right of offset.
(b) If the deficient partner is solvent, then he should invest cash to eliminate his deficiency.
(c) If the deficient partner is insolvent, then the other partners should absorb his deficiency.
11. Who is preferred as to partnership assets? As to the partners’ separate assets?

12. State the procedures in installment liquidation.


i. Realization of non-cash assets and distribution of gain or loss on realization among the partners based
on their profit and loss ratio.
ii. Payment of liquidation expenses and adjustment for unrecorded liabilities; both items will be distributed
among the partners in their profit and loss ratio.
iii. Payment of liabilities to outsiders.
iv. Distribution of available cash based on a schedule of safe payments which assumes possible losses due
to inability of partnership to dispose of part or all the remaining non-cash assets and failure of the
partners with capital deficiencies to make additional contributions. Payments to partners can also be
made based on a cash priority program.
13. Differentiate restricted from free interest.
- Restricted interest represents the portion of a partner’s interest which should remain available to absorb
possible future losses. Restricted interest is also provided for assumed non-sale of remaining non-cash
assets and for assumed insolvency of deficient partners while free interest is the resulting balances that is
satisfied from all the restricted interest. Free interest is also the simple amounts to be paid to the partners.
14. What is a cash priority program? How does one go about preparing one?
- Cash priority program is a program by which is prepared at the start of the liquidation process that helps the
partners project when they can expect to be included in the cash distribution. When cash priority program is
prepared, any amount of cash received from the realization of partnership assets may be paid immediately
to partnership creditors and later, the partners as specified in the program.
15. What is a loss absorption balance? What does it indicate?
- Loss absorption balance represents the maximum loss that the partners can absorb without reducing their
equity below zero. The partners with the biggest capital exposure or loss absorption balance should be
prioritized in a cash distribution. A partner with a relatively low loss absorption balance can be wiped out by
a material realization loss.
16. Is there any situation wherein the profit and loss ratio may be used as the basis of cash payments to partners?
Explain.

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