Partnerships Capital Deficiency: Pictures with Explanation

Capital Deficiency

Capital deficiency means that at least one partner has a debit balance in his or her capital account at the point of final cash distribution (during step as explained in the prior section). This can arise from liquidation losses, excessive withdrawals before liquidation, or recurring losses in prior periods. A partner with a capital deficiency must, if possible, cover the deficit by paying cash into the partnership.

To illustrate, assume that Zayn, Perez, and Rasheed operate their partnership in BOARDS for several years, sharing income and losses equally. The partners then decide to liquidate. Immediately prior to the final distribution of cash, the partners’ recorded capital balances are Zayn, $19,000; Perez, $8,000; and Rasheed, $(3,000). Rasheed’s capital deficiency means that Rasheed owes the partnership $3,000. Both Zayn and Perez have a legal claim against Rasheed’s personal assets. The final distribution of cash in this case depends on how this capital deficiency is handled. Two possibilities exist: the partner pays the deficiency or the partner cannot pay the deficiency.

Partner Pays Deficiency
Rasheed is obligated to pay $3,000 into the partnership to cover the deficiency. If Rasheed is willing and able to pay, the entry to record receipt of payment from Rasheed follows.




After the $3,000 payment, the partners’ capital balances are Zayn, $19,000; Perez, $8,000; and Rasheed, $0. The entry to record the final cash distributions to partners is




Partner Cannot Pay Deficiency
The remaining partners with credit balances absorb any partner’s unpaid deficiency according to their income-and-loss-sharing ratio. To illustrate, if Rasheed is unable to pay the $3,000 deficiency, Zayn and Perez absorb it. Since they share income and loss equally, Zayn and Perez each absorb $1,500 of the deficiency. This is recorded as follows.




After Zayn and Perez absorb Rasheed’s deficiency, the capital accounts of the partners are Zayn, $17,500; Perez, $6,500; and Rasheed, $0. The entry to record the final cash distribution to the partners is



Rasheed’s inability to cover this deficiency does not relieve Rasheed of the liability. If Rasheed becomes able to pay at a future date, Zayn and Perez can each collect $1,500 from Rasheed.