— Kishore V, SME and ACW at Edumarz
Deficiency of creditors occurs when a company is unable to pay its creditors after selling all of its assets and using the private assets of its partners. There are two steps that must be followed in such a situation:
1. Transferring the shortfall to the Partners’ Capital Account:
- In this approach, creditors are paid from the firm’s cash reserves, which include each partner’s individual contribution.
- The deficit is moved to the Partners’ capital account and is therefore managed by all partners in accordance with their profit sharing ratio.
- If one of the partners goes insolvent, the business suffers a capital loss.
- According to the Garner vs. Murray case, if the partnership agreement does not contain a clause for such a circumstance, the capital loss must be paid by partners who are insolvent and in proportion to their capital percentage in the business.
2. Deficiency Transfer to Deficiency Account:
- During this step, a separate account is created for creditors.
- A cash account is then created to determine the cash gained from the sale of enterprises and the private assets of partners.
- Then, after assessing the amount of cash on hand, creditors and external liabilities are paid in part, but not entirely.
- The deficit account is subsequently used to transfer the remaining creditors or the deficiency.