When liquidating a partnership, gains or losses from the sale of assets should be distributed to partners:
The correct answer and explanation is:
Correct Answer:
According to the profit and loss sharing ratio of the partners
Explanation:
In the process of liquidating a partnership, all business operations come to an end and the assets of the partnership are sold off. The proceeds from these asset sales are used to pay any outstanding debts and liabilities. Once creditors are paid, any remaining amount is distributed among the partners. However, before any final distribution to the partners is made, the partnership must recognize and account for any gains or losses that occurred as a result of selling the partnership’s assets.
These gains or losses are not simply split evenly or based on capital contributions unless the partnership agreement specifies so. Instead, they are distributed according to the established profit and loss sharing ratio outlined in the partnership agreement. This ratio determines how the partners normally share profits and absorb losses during the regular course of business. If the partnership agreement does not explicitly state this ratio, most jurisdictions assume an equal sharing among all partners.
The reason for using the profit and loss sharing ratio is based on the principle of fairness. Partners are entitled to receive gains and bear losses in the same way they would if the business were still ongoing. For example, if three partners share profits in a 3:2:1 ratio, then gains from the liquidation sales would be divided accordingly—50%, 33.3%, and 16.7%, respectively. The same rule applies to any losses from the asset sales.
After gains or losses are allocated, the final step is to settle each partner’s capital account. This includes adding any allocated gains or subtracting losses from their existing capital balances. Any resulting positive balances are distributed to the partners, and any deficit must typically be settled by the partners through personal payment into the partnership.