Ridgeline Bike Co. is a partnership of R. Chen, S. Dubois and T. Nakamura, who share income 5:3:2. After a few hard years they agree to close the business. Liquidation means ending the business by turning everything into cash, paying everyone the business owes, and giving what is left to the partners. The order matters. Creditors must be paid before the partners get anything, and the partners do not get their cash in the income ratio: they get whatever their capital accounts say they own after the gains and losses from selling the assets have been shared. Doing these steps in the wrong order is how partners end up paid twice or creditors end up unpaid.
The four steps of liquidation
- Sell the non-cash assets for cash and record the gain or loss on realization (the difference between cash received and book value).
- Allocate the gain or loss on realization to the partners in their income ratio.
- Pay the liabilities in cash.
- Distribute the remaining cash to the partners according to their capital balances.
| Ridgeline Bike Co., June 30, 2029 | Amount |
|---|---|
| Cash | $15,000 |
| Accounts Receivable | $25,000 |
| Merchandise Inventory | $40,000 |
| Equipment $70,000 less Accumulated Amortization $20,000 | $50,000 |
| Total assets | $130,000 |
| Accounts Payable | $30,000 |
| R. Chen, Capital | $50,000 |
| S. Dubois, Capital | $38,000 |
| T. Nakamura, Capital | $12,000 |
| Total liabilities and partners' equity | $130,000 |
On July 15, 2029, the partners sell all the non-cash assets for $125,000, a gain of The gain is shared 5:3:2: Chen $5,000, Dubois $3,000, Nakamura $2,000. Cash is now after the $30,000 of payables is paid, $110,000 remains. The capital balances are Chen $55,000, Dubois $41,000 and Nakamura $14,000, which total exactly $110,000, so the cash is distributed by those balances.
| Date | Account | Debit | Credit |
|---|---|---|---|
| July 15, 2029 | Cash | $125,000 | |
| Accumulated Amortization — Equipment | $20,000 | ||
| Accounts Receivable | $25,000 | ||
| Merchandise Inventory | $40,000 | ||
| Equipment | $70,000 | ||
| Gain on Realization | $10,000 | ||
| Step 1: sell the non-cash assets | |||
| July 15, 2029 | Gain on Realization | $10,000 | |
| R. Chen, Capital | $5,000 | ||
| S. Dubois, Capital | $3,000 | ||
| T. Nakamura, Capital | $2,000 | ||
| Step 2: share the gain 5:3:2 | |||
| July 16, 2029 | Accounts Payable | $30,000 | |
| Cash | $30,000 | ||
| Step 3: pay the creditors | |||
| July 17, 2029 | R. Chen, Capital | $55,000 | |
| S. Dubois, Capital | $41,000 | ||
| T. Nakamura, Capital | $14,000 | ||
| Cash | $110,000 | ||
| Step 4: distribute the remaining cash by capital balances |
Now suppose the assets sell for only $75,000, a loss of $40,000 (Chen $20,000, Dubois $12,000, Nakamura $8,000). Capital becomes $30,000, $26,000 and $4,000; cash after paying creditors is and the capitals still total $60,000. The steps never change, only the sign of the result.
When a partner's capital goes negative
If the loss is big enough, a partner's share of it can exceed that partner's capital, leaving a debit balance called a capital deficiency. Suppose Ridgeline's assets sell for only $35,000, a loss of $80,000. Chen absorbs $40,000, Dubois $24,000 and Nakamura $16,000. Nakamura had only $12,000 of capital, so his account now has a $4,000 debit balance. Cash after paying creditors is and capital is Chen $10,000 + Dubois $14,000 − Nakamura $4,000 = $20,000. A debit balance means Nakamura owes the partnership $4,000. There are two outcomes.
- Dr Cash $4,000; Cr T. Nakamura, Capital $4,000
- Nakamura's capital is now zero
- Cash is now $24,000
- Pay Chen $10,000 and Dubois $14,000
- Chen and Dubois absorb the $4,000 in their ratio, 5:3
- Dr R. Chen, Capital $2,500; Dr S. Dubois, Capital $1,500; Cr T. Nakamura, Capital $4,000
- Capitals: Chen $7,500, Dubois $12,500 (total $20,000)
- Pay Chen $7,500 and Dubois $12,500; they may still have a legal claim against Nakamura
The statement of partners' equity and the balance sheet
For a partnership that is continuing, the statement of partners' equity (also called the statement of partners' capital) explains how each partner's capital changed during the year. It has one column per partner and a total column. Each column starts with the beginning capital, adds new investments and the partner's share of net income (or subtracts the share of a net loss), and subtracts drawings to reach ending capital. The shares come straight from the division-of-income table, and the ending balances go to the balance sheet. Here is Singh & Tremblay Landscaping's first year.
| Year ended Dec. 31, 2026 | P. Singh | L. Tremblay | Total |
|---|---|---|---|
| Capital, Jan. 1, 2026 | $0 | $0 | $0 |
| Add: Investments | $50,000 | $30,000 | $80,000 |
| Add: Share of net income | $44,600 | $45,400 | $90,000 |
| Total | $94,600 | $75,400 | $170,000 |
| Less: Drawings | $24,600 | $25,400 | $50,000 |
| Capital, Dec. 31, 2026 | $70,000 | $50,000 | $120,000 |
| Balance sheet (partial), Dec. 31, 2026 | ||
|---|---|---|
| Partners' Equity | ||
| P. Singh, Capital | $70,000 | |
| L. Tremblay, Capital | $50,000 | |
| Total partners' equity | $120,000 |