First of all let us understand the liquidation of partnership. Liquidation means from the sale of the business by mutual agreement of the partners, from the death of a partner, or from bankruptcy. It ends both the legal and economic life of the entity.

In this process of liquidation sale of noncash assets for cash is called realization. Any difference between book value and the cash proceeds is called the gain or loss on realization

in the process of liquidation ,partner should do following step by step

1 First step is to Sell noncash assets for cash and recognize a gain or loss on realization

2Second step is to allocate gain/loss on realization to the partners based on their income ratios

3 third step is to pay partnership liabilities in cash

4 Now whatever remaining is to pay to partners on the basis of their capital balances.

From the above discussion we could see that partnership must pay creditors before partners receive any cash distributions

We could highlight the example as follow

Assume that XYZ Company is liquidated when its ledger shows the following balances

Assets
 
Liability and Equity
 

Cash
10,000
Notes Payable
30,000

Accounts Receivable
30,000
Accounts Payable
32000

Inventory
36000
X Capital
30000

Equipment
70000
y Capital
35600

Accumulated Depr. On Equipment
-16000
Z Capital
2400

 
130,000
 
130,000

 

Now partnership will sell its noncash assets to Jackson Enterprises for $150,000 cash. (2) The partnership will pay its partnership liabilities. The income ratios of the partners are 3 : 2 : 1, respectively. The steps in the liquidation process are as follow

Xyz sells the noncash assets (accounts receivable, inventory, and equipment) for $150,000. The book value of these assets is $120,000 ($30,000 + $36,000 + $70,000 – $16,000). Thus Ace realizes a gain of $30,000 on the sale

Accounting entry for these transaction is as follow

Cash
150000
 

Accumulated Depreciation–Equipment
16000
 

Accounts Receivable
 
30,000

Inventory
 
36000

Equipment
 
70000

Gain on Realization
 
30,000

 

From the cash received they should pay the  creditor first and the accounting entry will be as follow

Partnership liabilities consist of Notes Payable $,30000 and Accounts Payable $32,000. Ace pays creditors in full by a cash payment of $30,000.

entry is:

Notes Payable
30,000
 

Accounts Payable
32000
 

Cash
 
62000

In this way we could see that creditor of the partnership would receive their money