CHAPTER FOUR

ACCOUNTING FOR PARTNERSHIP FORM OF BUSINESS

A partnership is an association of two or more persons to carry on as co-owners of a business
profit. The partnership form of organization is widely used in relatively small businesses
(service, merchandise and manufacturing) and also in certain professionals such as accountants,
lawyers, engineers, managers, educations, IT experts, marketers and physicians have formed
partnerships to pool their talents and abilities. Partnerships provide a convenient and inexpensive
means of combining the capital, managerial talent and experience of two or more persons. It
pools the skills, abilities and financial resources of two or more individuals. Often partners start a
completely new business (partnership) with initial investments of cash and other assets, or
sometimes two sole proprietors may combine their operations into a partnership.
Significant Characteristics (features) of a partnership
A partnership agreement may be oral or written. However, it is highly desirable
that a written contract of partnership be prepared by an attorney (legal representative) in order to
avoid any future misunderstandings and disagreements. This is the reason why in some
countries, including ETHIPIA, the contents of a memorandum of association or article of
partnership are legally specified. The Ethiopian commercial code, article 286 states that the
memorandum of association to be drawn by partners shall contain the following points:
Name, address and nationality of each partner; Name of the firm, head office and branches (if
any); Date of formation, business activities and business purposes of the firm; The planned
duration (period of time) for which the partnership is established; The managers and agents of
the firm; Assets to be invested by each partner and the procedures for valuing non-cash assets
invested; Penalties for not meeting capital commitments; The accounting period to be used,
accounting method, and financial statements; Authority, rights and duties of each partner; Basis
for sharing net income or losses; Salaries and drawings allowed to partners and any penalties for
excessive withdrawals; Procedures for submitting disputes to negotiation; Procedures for the
withdrawal or addition of a partner; Rights and duties of surviving partners in the event of a
partner’s death; Provisions for arbitration of disputes; Whether an audit is to be performed.

Disputes between partners not referenced in contract can be resolved by ar55bitration, or in

court
1. Ease of formation
It is easy and inexpensive to form as compared with corporation, b/c a partnership can be formed
without any legal complications (formalities).
2. Co-ownership of property
Assets invested in the partnership by a partner are owned jointly by all the partners. A partner
who invests a property in a partnership doesn’t retain any personal right to the assets
contributed.
The partners have claim only on equity ownership interest in net assets of the partnership.

3. Net income of a partnership is not taxed as a separate entity

The partners report their shares of the partnerships’ income or loss on their individual income
tax returns and each partner’s share of income is taxable at personal income tax rates.
4. participation in income
Net income and net loss are distributed among the partners in accordance with their agreement in
the memorandum of association. In the absence of an agreement all partners share equally.
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 5. Mutual agency
Except for the acts that may be considered beyond the normal scope of the business operations,
each partner has the power to act on behalf of the organization and binding the partnership by
those acts. i.e., each partner can act independently on behalf of the partnership.
6. Unlimited liability
Each partner is individually liable to satisfy partnership debts when the partnership
cannot meet its obligations. i.e., if the partnership becomes insolvent (unable to pay) its
creditors Partners may be called on to use their personal assets. If one partner
does not have sufficient assets to meet his/her share of the partnership’s
debt, the other partners can be held individually liable by the creditor
requiring payment. Thus a partner’s personal assets as well as the partnership’s assets
may be required in payment of the firm’s debts. This characteristic enhances the credit standing
of the business, but it can be a danger to the individual partner.
7. Limited life
A partnership is legally dissolved (ceases) and a new partnership is established (if possible),
whenever one of the following occurs.
 an existing partner dies ,withdraws or a new partner is admitted
 A partner or the partnership becomes bankrupt (insolvent).
 A defined period of time has elapsed (expired) or completion of the project for which the
partnership was formed
 A partner requests that the partnership be dissolved
8. Transfer of ownership
Although it is relatively easy to dissolve a partnership, the transfer of
ownership, whether to a new or existing partner, requires approval of the
remaining partners. Upon a transfer of interest, the existing partnership is dissolved and a
new partnership must be formed.

Partnership Accounting
Except for the number of partners’ equity accounts, accounting for a partnership is the same as
accounting for a sole proprietor. In a partnership there are as many capital accounts as the
number of partners representing ownership equity of each partner. Each partner has a separate
capital account for investments and his/her share of net income or loss, and a separate
withdrawal account. A withdrawal account is used to track the amount taken from the business
for personal use. The net income or loss is added to the capital accounts in the closing process.
The withdrawal account is also closed to the capital account in the closing process.

Asset contributions to partnerships

When a partnership is formed or a partner is added and contributes assets
other than cash, the partnership establishes the net realizable or fair market
value for the assets on the transfer date. For example, if the Walking Partners
Company adds a partner who contributes accounts receivable and
equipment from an existing business, the partnership evaluates the
collectability of the accounts receivable and records them at their net
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realizable value. An existing valuation reserve account (usually called
allowance for doubtful accounts) would not be transferred to the partnership
as the partnership would establish its own reserve account. Similarly, any
existing accumulated depreciation accounts are not assumed by the
partnership. The partnership establishes and records the equipment at its
current fair market value and then begins depreciating the equipment over
its useful life to the partnership.
Up on formation of a partnership a separate journal entry is made for the initial investments of
each partner as follows:
 the various assets contributed by a partner are debited to the proper asset accounts
 if liabilities are assumed by the partnership, the appropriate liability accounts are credited
 the partner’s capital account is credited by the net amount(assets - liabilities)
Subsequently partner’s capital account is:
 Increased by Fair value of net asset additionally invested and Share of net income,
 Decreased by Withdrawal of cash or other assets and Share of net loss
Example 1.
The articles of partnership, sighed by Alton Carson and Ptis Bennett when they form a
partnership say that each partner is to invest Br 30,000 in cash. To record the investment of each
partner, the following entries are made in the book of the new partnership.
Cash 60,000
Alton Carson, capital . 30,000
Ptis Bennett, capital 30,000
Example 2
Tom Moore operates a home decorating business. On March 01, 2001, he forms a partnership
with Martha Hillsdale. Mr. Moore invests the assets of his business, and the partnership assumes
the liabilities of his business. He has a net investment of Br 15,000.00 Miss Hillsdale invests Br
10,000.00 in cash.
Mr. Moors Business Asset Liability and Capital are given bellow:

Assets Liability
Cash 1,000.00 Accounts Payable 900.00
Accounts Receivable 3,500.00
Merchandise Inventory 8,000.00 Capital
Supplies 400.00 Tom Moor Capital 15,000.00
Equipment 3,000.00

Total Assets 15,900.00 Total Liability and Capital 15,900.00

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The Journal entry to record the investment (opening entry) is as follows:

Division of net income or net loss

Partners may agree on any type of income sharing plan regardless of the amount of their
respective capital balances. The partnership agreement should include how the net
income or loss will be allocated to the partners. The uniform partnership act requires
equal division of NI or loss, if the partnership contract is silent regarding the plan for sharing NI
or loss; regardless of the differences in amounts of capital contributed, special skills and
experience possessed or time devoted to the business; because it is assumed that partners are
intended to share equally.
As partners are the owners of the business, they do not receive a salary but each has the right to
withdraw assets up to the level of his/her capital account balance. Many partnerships use the
salary allowances for partners and interest on investments to determine how much they will
withdraw in cash from the business during a given year in anticipation of their share of net
income. That is, the income-sharing plans may try to consider two central factors that greatly
affect the success of the partnership.
1. Amount of capital invested by each partner involving both Amount and
Time value of money. If each partner is to contribute equal amount of capital to the
partnership, an equal sharing in a partnership net income would be reasonable. If one partner
is to contribute a larger portion (amount) of capital than the other, provision for unequal
capital contribution may be given in the agreement for division of net income.
2. Value of personal services rendered by individual partners especially with
regard to skill & expert. If each partner is to contribute equal services to the
partnership, an equal sharing in a partnership net income would be fair. If the service of one
partner is much more value able to the partnership than those of the others, provision for
unequal service contribution should be given recognition in the agreement for division of net
income

NB. The salary allowances for partners and interest allowances are not expenses of the
business; they are part of the formula for splitting net income.

The following are among the numerous possible plans that could be applied for sharing earning:

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 1. Equally, or according to agreed upon percentages, for example for three
partners (, 50%, 40%, and 10%), ratios (2:3:1), or fractions (1⁄3, 1⁄3, and
1⁄3).
2. In the ratio of the partners' capital account balances on a specific date, or in the ratio of
average capital account balances during the year.
3. Allowing interest on partners' capital account balances and dividing the remaining net
income or loss in a specified ratio.
4. Allowing salaries to partners and dividing the resultant net income or loss in a stated ratio.
5. Allowing salaries and interest on capital account balances, and dividing the remaining net
income or loss in a stated ratio.
The following 4 end of period closing entries are required for a partnership:
1. Debit each revenue account for its balance and credit Income Summary for total revenues.
2. Debit Income Summary for total expenses and credit each expense account for its
balance.
3. Debit (credit) Income Summary for its balance and credit (debit) each partner’s capital
account for his or her share of net income (net loss).
4. Debit each partner’s capital account for the balance in that partner's drawing account and
credit each partner’s drawing account for the same amount.
The first two entries are the same as a proprietorship, while the last two entries are different
because, there are two or more owners’ capital and drawing accounts and it is necessary to
divide net income or loss among the partners.
In step 3 the business needs to determine the distributive share, which is the amount of net
income or net loss allocated to each partner. Distributive share refers solely to the division of net
income or net loss among partners, not to cash distributions. If the net income is less than the
total of the special allowances, the remaining balance will be a negative figure that must be
divided among the partners as though it were a net loss.
Example 3
Assume that P & Q partnership has earned a net income of Birr 32,000 during its first year of
operation which ended on Dec.31, 2008. Partner Q has invested Br 70,000 and 8,000 in cash on
January 1 and April 1, 2008 respectively. Partner P has invested Br 28,000 and 6,000 in cash on
January 1 and November 1, 2008, respectively and withdrawn Br 12,000 on March 1, 2008. The
partnership also provides for Br 200 withdrawal by each partner at the end of each month and the
drawings are not a means for sharing net income/loss.
 Assuming the following selected independent plans determine the share of NI for each
partner and prepare journal entries to record allocation of NI.

a) NI shared in the ratio of partners' capital account balances

 Under this method the entire NI is divided in the ratio of partners’ capital balances and the
contract should clearly specify whether the ratio is to be applied on the:
i. Original capital investment
ii. Capital balance @beginning of the year
iii. Capital balance @end of the year
iv. Weighted Average capital during each year

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  For the preceding example if we assume that division of NI in the ratio of Weighted
Average capital
Partner Date Increase/decrease in Capital Fraction of Average
capital Balance year Capital
account
balance
P Jan1 - 28,000 2/12 4,667
Mar1 (12,000) 16,000 8/12 10,667
Nov1 6,000 22,000 2/12 3,666
19,000
Q Jan1 - 70,000 3/12 17,500
Apr1 8,000 78,000 9/12 58,500
76,000

 Net income = Br 32,000

 Total average capital(19,000+76,000)= 95,000
 Division of NI:
P= 19,000/95,000 X 32, 000 = Br 6,400
Q= 76,000/95,000 X 32, 000 = 25,600
Journal entry:
Income summary .32, 000
P, capital 6,400
Q, capital .25, 600
b) Allowing salaries to partners and the remaining NI balance divided in a stated
ratio
Assume that the partnership contract provides salary of Br 800 per month to partner P and
divided the remaining NI/loss equally.

P Q Total
NI .Br 32,000
Salary (800x12) .. 9,600 - (9,600)
NI after annual
Salary exp. = 11,200 11,200 (22,400)
Total share of NI ...20,800 11,200

End of year Journal entry to close income summary

Income summary 32,000
P, capital ... 20,800
Q, capital 11,200
c) Allowing salaries and interest on capital account balances, and dividing the remaining
net income or loss in a stated ratio.
Assume that the partnership agreement in the preceding example provides a monthly salary
allowance of Br 800 to partner P (annual salary = 9,600), 10% interest on average monthly
capital balances to each partner, and the remaining to be divided equally
 Interest allowance to:
Partner P Partner Q

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 Br 28,000x2/12x10%= 467 Br 70, 000X3/12x10%=1,750
16,000X8/12X10% = 1,067 78,000X9/12X10%=5,850
22,000X2/12X10% = 666 7,600
2,200

P Q Total
NI ...Br 32,000
Salary allowance 9,600 - (9,600)
Interest allowance .... 2,200 ..7,600..... (9,800)
Remaining Bal. of NI ...6, 300.........6,300 ..12,600
Total share of NI 18100 13,900

Journal entries to record income allocation:

Income summary 32,000
P, capital .....18100
Q, capital 13,900

DISSOLUTION OF A PARTNERSHIP

Although a partnership is formed easily and does not need state approval, its life is limited and it
may be dissolved much more easily than a corporation. Any change in the personnel of the
membership (change in the relation of the partners) results in the dissolution of a partnership.
Therefore, any of the following factors will cause dissolution:
 Admission a new partner
 Withdrawal of a partner
 Death or bankruptcy of a partner.
 Dissolution is the legal termination of a partnership. Dissolution of the partnership may or
may not follow by the winding up of the affairs of the business. That is, up on dissolution the
partnership may Contribute under a new agreement or terminate both as legal and economic
entity.
Admission of a new partner:-
With the consent of all the current partners, an additional person may be admitted to a
partnership through either of the following limited procedures:
1. By buying an interest from one or more of the current partners.
2. By making an investment (contribution of assets) to the partnership.
Admission by purchase of interest:-
When an additional person is admitted to a firm; the new partner may purchase all or part of the
interest of an existing partner by making payment directly to the selling partners. In this case, no
cash or other asset is transferred to the partnership.
 The capital interest of the incoming partner is obtained from the current partners.
 Neither the total assets or liabilities nor the total capital of the business is affected.
 The money or other consideration passes directly from the new partner to the selling
partner not appear in the accounting records of the partnership, because it is a
personal transaction b/n the two individuals.

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  The only change and an entry needed is the transfer of the proper amounts capital
from the capital accounts of the selling’s to the capital account established for the
incoming partner.
Example 4
Assume that MJM and EAM have a capital balance of $ 70,000 and $50,000,
respectively in their partnership. If MJM decides to retire and the partners
agree to have TLM buy out MJM’s partnership interest, the partnership’s
accounting records must simply reflect the change of ownership. The
partnership’s entry to record the transaction is as follows:
MJM, Capital 70,000
TLM, Capital 70,000
The cash that MJM receives from TLM is not recorded on the partnership’s
books as it is an exchange of an investment by individuals with no assets
being given to or taken from the partnership. Therefore, it does not matter
whether TLM pays $50,000, $70,000, or $100,000 for MJM’s partnership
interest, the partnership simply records the change in the partner’s capital
accounts using the current balance in the MJM, capital account.
Admission by contribution of assets:-
Instead of buying an interest from the current partners, the incoming partner may contribute or
invest assets to the partnership. In this case both the total assets and total capital of the business
will increase b/c the payment by the new partner goes to the partnership and not to the partners
as individuals.
 When a new partner is admitted by investing assets in the partnership bonus (good will) to
old partners or to the incoming partner may be recognized. Such factors to recognize bonus
or good will are:
1) If the existing partnership has exceptionally high earnings year after year.
2) If the new partner possesses special talents or may have advantageous business
contacts that will add to the profitability of the partnership
Example 6.
A and B are partners in AB Company with the following Original Capital balances
Existing Capital %Interest in %Interest in
Partners Balances Capital Profit
Partner A 30,000.00 40% 50%
Partner B 45,000.00 60% 50%
Required:
For each independent alternatives below record the journal entry in admission of Partner C
using bonus method and good will method.
a. Assume that Partner C invests Birr 27,000.00 in exchange for 20% interest in capital and
20% interest in profit.
b. Assume that Partner C invests Birr 10,000.00 for a 20% interest in capital and 20%
interest in profit
When Partner C invests Birr 27,000.00 in exchange for 20%
interest in capital and 20% interest in profit.
i. If Bonus to old partners is given:

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 Book value of original partnership Birr 75,000.00
Partner C’s investment 27,000.00
Total Capital of new partnership 102,000.00
Partner C’s % interest x 20%
Interest recorded for C 20,400.00

To calculate bonus
Bonus to A and B = Partner C’s investment - Interest recorded for C
= 27,000.00 - 20,400.00 = Birr 6,600.00
 Journal Entry to record the admission of partner C
Assets 27,000
Capital, A 3,300.00
Capital, B 3,300.00
Capital, C 20,400.00

ii. Goodwill attributed to original partners.

 To calculate goodwill
Total value of New partnership = Partner C’s investment = 27,000.00 = Birr 135,000.00
% Interest in Capital 20%
Total fair value of partnership 135,000.00
Total book value of capital (A + B + C) 102,000.00
Good will 33,000.00
 Journal Entry for admission of C
Assets 27,000.00
Goodwill 33,000.00
A, Capital 16,500.00
B, Capital 16,500.00
C, Capital 27,000.00

When Partner C invests Birr 10,000.00 in exchange for 20%

interest in capital and 20% interest in profit.
I.Bonus to New Partner
Total capital of new partnership = Birr 85,000
Partner C’s capital interest = Total capital of new partnership x partner C’s % Interest
= Birr 85,000 x 20% = Birr 17,000.00
Bonus to C = Birr 17,000 (Capital interest) - Birr 10,000.00 (consideration paid) = Br 7,000.00
Partner C’s bonus is deducted from the capital accounts of A and B.
Journal Entry
Assets 10,000.00
Capital, A 3,500.00
Capital, B 3,500.00
Capital C 17,000
II. Good will method when goodwill is attributed to new partner.
Calculating fair value of new partnership = Book value of original partners’ capital

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 New % Interest of original partners
75,000.00 = Br. 93,750
80%
 Calculating goodwill
Fair value of partnership = C’s & interest x C’s interest in Capital

93,750.00 x 20% = 18,750.00

Goodwill = 18,750.00 - 10,000.00 = 8,750.00
 Journal Entry
Assets 10,000.00
Goodwill 8,750.00
C, Capital 18,750.00

Withdrawal of an existing partner:-

The partnership agreement should contain provisions specifying the procedures to be followed
by the withdrawal of a partner. A partner may withdraw from a partnership through:
 Sale of capital interest to a new or existing partner.
 Transfer of capital interest(assets) from the partnership

Example -6
Partners’ ownership interests and profit percentages for A,B and C partners is are as follows.
A B C
Capital balance 30,000.00 50,000.00 20,000.00
Profit / Loss % 40% 40% 20%
% Interest in Capital 30% 50% 20%
a. Partner A withdraws and partnership funds are used to purchase A’s interest
b. A withdraws partnership cash of Br 36,000.00.

Bonus method – the difference between A’s recorded capital and A’s cash withdrawal is a
bonus to A granted by the remaining partners.
Journal Entry:
A, Capital 30,000.00
B, Capital 4,000.00
C, Capital 6,000.00
Cash 36,000.00
The shares of A’s bonus deducted from B and C’s capital are calculated by the ratio of their
profit/loss percentage.

Goodwill method - There are Two Alternatives, if difference between A’s recorded capital and
A’s cash withdrawal is a goodwill.
(1) Recognize Goodwill traceable to the retiring partner.
Journal Entries
Goodwill 6,000.00

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 A, Capital 6,000.00

A, Capital 36,000.00
Cash 36,000.00
(2) Recognize the amount of goodwill traceable to the entire partnership.

Calculate the total amount of goodwill to be recognized:

Goodwill attributable to A = 6,000.00 = Birr 15,000.00

A’s Profit/Loss % 40%

Journal Entries:
Goodwill 15,000.00
A, Capital 6,000.00
B, Capital 6,000.00
C, Capital 3,000.00
A, Capital 36,000.00
Cash 36, 000.00

LIQUIDATION OF A PARTNERSHIP

 Is the process of breaking-up and discontinuing a partnership business

 Is an end to the business both economically and legally
 Involve four steps:
a. Asset realization-converting non cash assets in to cash
b. Recognizing gains/losses and distributing among each partners based on their profit
or loss sharing ratios
c. Payment of all liabilities
d. Distributing cash to the partners according to the final balances in their capital
accounts
Example7.
Assume that Alebachew, Gashaw and Tewolde share income and losses in the ratio of 5:3:2 (5/10,
3/10, 2/10). On April 9, after discontinuing the ordinary business operations of their partnership
and closing the accounts, the following summary of the general ledger is prepared.
Cash 11,000.00
Non-cash Assets 64,000.00
Liabilities 9,000.00
Alebachew, Capital 22,000.00
Gashaw, Capital 22,000.00
Tewolde, Capital 22,000.00
Total Br. 75,000.00 Br. 75,000.00

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 Based on the above facts, accounting for the liquidation of the partnership will be illustrated
using three different selling prices for the non-cash assets. For the sake of clarity, it will be
assumed for each selling price that all non-cash assets are disposed of in a single transaction, and
all liabilities are paid at one time. In addition, Non cash assets and liabilities will be used as
account titles in place of the various asset, contra asset, and liability accounts that in actual
practice would be affected by the transactions.
1. Gain On Realization
From April 10 to April 30 of the current year, Alebachew, Gashaw and Tewolde sell non-cash
assets for Br. 72,000.00, realizing a gain of Br. 8,000.00 (Br. 72,000 – Br. 64,000). The gain is
divided among the capital accounts in the income-sharing ratio of 5:3:2. The liabilities are paid,
and the remaining cash is distributed to the partners according to partners is determined by
reference to the balances of their respective capital accounts after the gain on realization has
been divided among the partners. Income sharing ratio must not be used as a basis for
distributing the cash. A statement of partnership liquidation, which summaries the liquidation
process follows.

Alebachew, Gashaw and Tewolde

Statement of Partnership liquidation
For the Period April 10-13, 2005

Non- Capital
Cash Cash Liabilities Alebachew Gashaw Tewolde
Assets 50% 30% 20%
Balance Before Realization
11,000 64,000 9,000 22,000 22,000 22,000
Sale of Non-cash assets &
division of gain +72,000 - 64,000 __ + 4,000 + 2,400 + 1,600
Balances after realization 83,000 0 9,000 26,000 24,400 23,600
Payment of liabilities - 9,000 - 9,000
Balance after payment of
liabilities 74,000 0 26,000 24,400 23,600
Distribution of cash to
partners - 74,000 - 26,000 - 24,400 23,600
0 0 0 0
The entries to record the several steps in the liquidation procedure are as follows:
Sales of Cash 72,000.00
Assets Non cash Assets 64,000.00

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 Gain on realization 8,000.00

Division of Loss and Gain on Realization 8,000.00

Gain Alebachew, Capital 4,000.00
Gashaw, Capital 2,400.00
Tewolde, Capital 1,600.00

Payment of Liabilities 9,000.00

Liabilities Cash 9,000.00
Distribution of Alebachew, Capital 26,000.00
Cash to partners Gashaw, Capital 24,400.00
Tewolde, Capital 23,600.00
Cash 74,000.00

2. Loss on Realization; No Capital Deficiencies

Assume that in the foregoing example, Alebachew, Gashaw and Tewolde sell all non-cash assets
for Birr 44,000.00, incurring a loss of Birr 20,000.00 (Br. 64,000.00 – Br. 44,000.00). The
various steps in the liquidation of the partnership are summarized in the following statement:
Alebachew, Gashaw and Tewolde
Statement of Partnership Liquidation
For period April 10-30, 2005

Capital
Cash Non-cash Liabilities Alebachew Gashaw Tewolde
50% 30% 20%
Bal. Before Realization 11,000 64,000 9,000 22,000 22,000 22,000
Sales of Assets & Division
of loss + 44,000 - 64,000 - 10,000 - 6,000 - 4,000
Balance after Realization
55,000 0 9,000 12,000 16,000 18,000
Payment of Liabilities - 9,000 - 9,000
Bal. after payment of Liab.
46,000 0 12,000 16,000 18,000
Distribution of Cash to
Partners - 46,000 - 12,000 -16,000 -18,000
Final Balance 0 0 0 0

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The entries to record the liquidation are as follows:
Cash 44,000.00
Sales of Assets Loss and Gain on Realization 20,000.00
Non-cash Assets 64,000.00

Division of loss Alebachew, Capital 10,000.00

Gashaw, Capital 6,000.00
Tewolde, Capital 4,000.00
Loss and Gain on Realization 20,000.00

Payment of liabilities 9,000.00

Liabilities Cash 9,000.00

Distribution of cash Alebachew, Capital 12,000.00

To Partners Gashaw, Capital 16,000.00
Tewolde, Capital 18,000.00
Cash 46,000.00

3. Loss on Realization; Capital Deficiency

The share of the loss chargeable to a partner may exceed that partner’s ownership equity. The
resulting debit balance in the capital account is called a deficiency, is a claim of the partnership
against the partner. Pending collection from the deficient partner, the partnership cash will not
be sufficient to pay the other partners in full. In such cases, the available cash should be
distributed in such a manner that if the claim against the deficient partner and not be collected,
each of the remaining capital balances will be sufficient to absorb the appropriate share of the
deficiency.
To illustrate a situation of this assume that Alebachew, Gashaw and Tewolde sell all of the non
cash assets for Birr 10,000.00, incurring a loss of Birr 54,000.00 (Br. 64,000.00 – Br.
22,000.00). It is readily apparent that the part of the loss allocable to Alebachew Br. 27,000.00
(50% of 54,000) exceeds the Br. 22,000.00 balance in Alebachew’s capital account. This Br.
5,000.00 deficiency of Alebachew is a potential deficiency to Gashaw and Tewolde and must be
tentatively divided between them in their income-sharing ratio of 3:2 (3/5 and 2/5). The capital
balances remaining represent their claims on the partnership cash. The computation may be
summarized as:
Alebachew, Gashaw, and Tewolde
Statement of Partnership Liquidation
For Period April 10 –30, 2005

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 Non – Capital
Cash
Cash Liabilities Alebachew Gashaw Tewolde
Assets
50% 30% 20%
Balances Before Realization 11,000 64,000 9,000 22,000 22,000 22,000
SaleofAssets&Loss division +10,000 -64,000 -27,000 -16,200 -10,800
Balances After Realization 21,000 0 9,000 5,000 (Dr) 5,800 11,200
Payment of Liabilities -9,000 -9,000
Balances pyt of Liabilities 12,000 0 5,000 (Dr) 5,800 11,200
Distribution of Cash to
Partners -12,000 ________ 2,800 9,200
Final Balances 0 5,000 (Dr) 3,000 2,000

The entries to record the liquidation to this point are as follows:

Sale of assets Cash 10,000.00

Loss on Realization 54,000.00
Non-cash Assets 64,000.00

Division of loss Alebachew, Capital 27,000.00

Gashaw, Capital 16,200.00
Tewolde, Capital 10,800.00
Loss on Realization 54,000.00

Payment of Liabilities 9,000.00

Liabilities Cash 9,000.00

Distribution to Gashaw, Capital 2,800.00

Partners Tewolde, Capital 9,200.00
Cash 12,000.00
The affairs of the partnership are not completely wound up, until the claims among the partners
are settled: payments to the firm by the deficient partner are credited to that partner’s capital

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account. Any uncollectible deficiency becomes a loss to the partnership and is written off
against the capital balances of the remaining partners. Finally, the cash received from the
deficient partner is distributed to other partners according to their ownership claims.

To continue with the preceding illustrating the capital balances remaining after the Birr
12,000.00 cash distribution are as follows: Alebachew, Br. 5,000.00 debit; Gashaw Br. 3,000.00
Credit; Tewolde, Br. 2000.00 credit. The various steps in the final settlement and the entries for
the partnership under three different assumptions as to the final settlement are illustrated in the
following paragraphs.

Assumption 1: Alebachew pays the entire amount of the Br. 5,000.00 deficiency to the
partnership (no loss).

The receipt of the Br. 5,000.00 paid by Alebachew to the partnership and the distribution of the
Br. 5,000 to the partners are indicated in the following statement of partnership liquidation.

Alebachew, Gashaw and Tewolde

Statement of Partnership Liquidation
For period April 10 – 30, 2005

Non- Captal
Cash Cash Liabilities Alebachew Gashaw Tewolde
Assets 50% 30% 20%
Balances 0 0 0 5,000 (Dr) 3,000 2,000
Receipt of Deficiency + 5,000 + 5,0000
Balances 5,000 0 3,000 2,000
Distribution of Cash to
Partners - 5,000 - 3,000 - 3,000
Final Balances 0 0 0

The entries to record the final settlement are as follows:

Receipt of Cash 5,000.00

Deficiency Alebachew, Capital 5,000.00

Distn. of cash Alebachew, Capital 3,000.00

to Partners Tewolde, Capital 2,000.00
Cash 5,000.00

After the transactions above are completed all of the partnership’s assets will have been
distributed, the liabilities paid and the partner’s capital balances reduced to zero.
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 Assumption 2: Alebachew pays Birr 3,000 of the deficiency to the partnership and the
remainder is considered to be uncollectible (Br. 2,000.00 loss)

If the receipt of the Br. 3,000.00 paid by Alebachew to the partnership, the division of the Br.2,
000.00 losses, and the distribution of the Br. 3,000.00 to the partners are indicated in the
following statement of partnership liquidation.

Statement of Partnership Liquidation

For Period April 10 – 30, 2005

Non-Cash Liabilities Alebachew Gashaw Tewolde

Assets
Cash 50% 30% 20%
Balances 0 0 0 5,000 (Dr) 3,000 2,000
Receipt of Part of
Deficiency +3,000 +3,000 ______ ______
Balances 3,000 2,000 (Dr) 3,000 2,000
Division of Loss +2,000 -1,200 -800
Balances 3,000 0 1,800 1,200
Distribution of Cash to
Partners -3,000 -1,800 -1,200
Final Balances 0 0 0

It should be noted that the Br. 2,000.00 loss was divided between Gashaw and Tewolde in their
income-sharing ratio of 3:2(3/5 and 2/5). The entries to record the final settlement are as
follows:

Receipt of part Cash 3,000.00

of deficiency Alebachew, Capital 3,000.00
Division of Gashaw, Capital 1,200.00
Loss Tewolde, Capital 800.00
Alebachew, Capital 2,000.00

Distn of cash Gashaw, Capital 1,800.00

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to partners Tewolde, Capital 1,200.00
Cash 3,000.00
After the three transactions above are completed, all of the partnership’s assets will have
distributed, the liabilities paid, and the partners’ capital balances reduced to zero.

Assumption 3: Alebachew is unable to pay any part of the Br. 5,000.00 deficiency (Br. 5,000.00
loss). The division of the Br. 5,000.00 loss is indicated in the following statement of partnership
equitation:

Alebachew, Gashaw and Tewolde

Statement of Partnership Liquidation
For period April 10 – 30, 2005

Non-Cash Liabilities Alebachew Gashaw Tewolde

Assets
Cash 50% 30% 20%
Balances 0 0 0 5,000 (Dr) 3,000 2,000
Division of Loss + 5,000 -3,000 -2,000
Final Balance 0 0 0

The Birr 5,000.00 loss was divided between Gashaw and Tewolde in their income sharing ratio
3:2 (3/5 and 2/5). The following entry which reduces the partnership account balances to zero,
records that final steep in the liquidation:
Division of loss Gashaw, Capital 3,000.00
Tewolde, Capital 2,000.00
Alebachew, Capital 5,000.00

It should be noted that the type of error most likely to occur in the liquidation of a partnership is
an improper distribution of cash to the partners. Errors of this type results from confusing the
distribution of cash with the division of gain and losses on realization.

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