LESSON 4 PARTNERSHIP DISSOLUTION (3

Hours)
As mentioned earlier, one of the characteristics of a partnership is that it has a
“limited life” in the sense that the partnership agreement can be easily
dissolved.

Dissolution is the change in the relation of the partners caused by any partner
being disassociated from the business Dissolution is different from
liquidation. Liquidation is the termination of business operations or
the winding up of affairs. Partnership dissolution does not necessarily
terminate the business. The business continues until the remaining partners
decide to liquidate the business. If the business is continued after
dissolution new articles of partnership should be drawn up.

The following are major considerations in for partnership dissolutions:

a. Admission of a partner

b. Withdrawal, retirement or death of a partner

The admission of a new partner or the withdrawal retirement or death of an

existing partner dissolves the original partnership agreement because it
creates a change in the relation of the partners (e.g., a change in the number of
the partners t partnership).

It should be noted that the admission of a new party requires the core of all
the existing partners.

Admission of partner

The admission of a new partner may be effected either through;

a. Purchase of interest in the partnership, or

b. Investment in the partnership

PURCHASE OF INTEREST
A new partner may be admitted when he purchases part or all of the interest of
one or more of the existing partners.

This transaction is a personal transaction between and among the partners. As

such, any consideration paid or received is not recorded in the partnership
books. The only entry to be made in the partnership books is a transfer within
equity. A new capital account is established for the new partner and a
corresponding decrease is made on the capital account(s) of the selling
partner(s). No gain or loss is recognized in the partnership books.

Illustration: Purchase of interest

The following are the capital account balances and profit and loss ratios of the
partners in AB Partnership as of July 1, 20x1:

Capital accounts P/L ratios

A, Capital 150,000 40%
B, Capital 250,000 60%
400,000

Case 1: Purchase of interest from one partner

On July 1, 2021, C was admitted to the partnership when he purchased 20%

interest in the net assets and profits of the firm from A (or one-half of A’s
interest in the partnership) for ₱100,000. The net assets of the firm as of this
date approximate their fair values.

Requirement: Provide the journal entry to record the transaction

Solution:

July 1, A, Capital 75,000

2021
C, Capital (150,000 x 20%/40%) 75,000

to record the admission of C to the

partnership

Notice that the consideration paid by C to A (i.e., ₱100,000) is not recorded in

the partnership books. Moreover, no gain or loss is recognized in the
partnership books.
Case 2: Purchase of interest from more than one partner

On July 1, 2021, C was admitted to the partnership when he purchased

a proportionate interest from A and B representing 20% interest in the net
assets and profits of the firm for ₱100,000. The net assets of the firm as of this
date approximate their fair values

Requirements:

a. Provide the journal entry to record the transaction

b. How much are the capital balances of the partners after the admission of C?

c. How much is the gain or loss to be recognized in the partnership books?

d. How much are the personal gains or losses recognized by A no B

Respectively?

Solution:

Requirement (a):

July 1, A, Capital (400,000 x 20% x 40%) 32,000

2021
B, Capital (400,000 x 20% x 60%) 48,000

C, Capital (400,000 x 20%) 80,000

to record the admission of C to the

partnership

Note that since C purchased a proportionate interest from A and B, the

amount credited to C is allocated to A and B based on their old profit or loss
ratio.

Requirement (b):

A B C Totals
Capital, beg. 150,000 250,000 - 400,000
Credit - - 80,000 80,000
Debit (32,000) (48,000) - (80,000)
Capital, end. 118,000 202,000 80,000 400,000
Notice that when a new partner is admitted through “purchase of interest,” the
total capital of the partnership does not change (i.e., the total capital before
and after the admission of C remains at ₱400,000)

Requirement (c):

Zero. No gain or loss is recognized in the partnership books whim a new

partner is admitted.

Requirement (d):

A B Totals
Consideration received
(100,000 x 40%); (100,000 x 60%) 40,000 60,000 100,000
Amount debited to capital account (32,000) (48,000) (80,000)
Capital, end. 8,000 12,000 20,000

The gains computed above are personal gains of the selling partners. These
are not recorded in the partnership books.

REVALUATION OF ASSETS

When a partnership is dissolved, but not liquidated, a new partnership is

created. The assets and liabilities carried over to the new partnership are
restated to fair values.

The adjustment to the assets and liabilities is allocated first to the existing
partners before recording the admission of the new partner.
Illustration: Purchase of interest - Revaluation

On July 1, 2021, C was admitted to the partnership when he purchased a

proportionate interest from A and B representing 20% interest in the net assets
and profits of the firm for ₱100,000. On this date, the carrying amounts and fair
values of the assets and liabilities of the partnership are as follows:

Carrying Amount Fair Value Increased (Decreased)

Cash 20,000 20,000 -
Equipment 340,000 390,000 50,000
Accounts payable 10,000 10,000 -
A, Capital (40%) 130,000 N/A
B, Capital (60%) 220,000 N/A

Requirements:

a. Provide the journal entries to be made on July 1, 2021.

b. How much are the capital balances of the partners after admission of C?

Solutions:

Requirement (a):

The capital balances of the existing partners before recording the admission of
Care first adjusted for the revaluation increase follows:

July 1, Equipment 50,000

2021
A, Capital (50,000 x 40%) 20,000

B, Capital (50,000 x 60%) 30,000

to record the admission of C to the

partnership

Notice that the evaluation increase is allocated only existing partners. No

allocation is made to C, the incoming partner.
After recording the entry above the capital accounts will have the following
balances:

A B Totals
Capital, unadjusted. 130,000 220,000 350,000
Share in revaluation 20,000 20,000 50,000
Capital, adjusted 118,000 202,000 400,000
After the net assets are properly revalued, the admission of Cis recorded as
follows:

A B C Totals
Capital, beg. 130,000 220,000 - 350,000
Share in revaluation 20,000 30,000 - 50,000
Credit - - 80,000 80,000
Debit (32,000) (48,000) - (80,000)
Capital, end. 118,000 202,000 80,000 400,000

INVESTMENT IN THE PARTNERSHIP

Instead of purchasing interest from the existing partners, a new partner may be
admitted by investing directly in the business. This transaction is a transaction
between the new partner the partnership. As such, any consideration paid by
the incoming partner is recorded in the partnership books. However, because
this is a transaction with an owner, no gain or loss is recognized.

Two things may happen when a new partner invests in a partnership:

1. The new partner's capital account is credited at an amount equal to the fair
value of his investment, or

2. The new partner's capital account is credited at an amount greater

than or less than the fair value of his investment.

The second scenario is accounted for under the "bonus method," similar to
what we have already discussed under partnership formation. That is, any
increase (or decrease) in capital of the new partner is a reduction (or addition)
to the capital of the existing partners. The corresponding debit to the asset
account must still be equal to the fair value of the contribution.

The second scenario may occur, for example, when:

a. the credit to the new partner's capital account is greater than his
contribution because he is bringing in expertise to the business (i.e., bonus to
new partner); or
b. the credit to the new partner's capital account is less than his contribution in
order to compensate for the past efforts of the existing partners in establishing
the business (i.e., bonus to old partners).

ILLUSTRATION 1: Investment in the partnership

The following are the capital account balances and profit and loss ratios of the
partners in AB Partnership as of July 1, 2021:

Capital accounts P/L ratios

A, Capital 150,000 40%
B, Capital 250,000 60%
400,000 100%

On July 1, 2021, C was admitted to the partnership when he acquired 20%

interest in the net assets and profits of the firm for ₱100,000 investment. The
net assets of the firm as of this dale approximate their fair values.

Case 1: Credit to capital equal to investment

C’s capital is credited at an amount equal to his contribution. What is the

journal entry to record the transaction?

Solution:

July 1, Cash 100,000

2021
C, Capital 100,000

to record the admission of C to the

partnership

TEACHER’S INSIGHT

Ø Under investment in the partnership, the consideration paid by the new partner is
recorded in the partnership books. This results to an increase in the partnership
capital.

Ø After the admission of C, the total capital of the partnership is increased to

₱500,000 (i.e., 400,000 partnership capital before admission of new partner + 100,000
investment by new partner).
* A comparison between purchase of interest and investment in the
partnership is provided below:

Purchase of interest Investment in the partnership

· The incoming partner's contribution · The incoming partner's contribution
is not recorded in the partnership books. is recorded in the partnership books.
· Partnership capital remains the · Partnership capital is increased by
same before and after the admission of the the incoming partner's contribution.
incoming partner.

· No gain or loss is recognized in the · No gain or loss is recognized in the

partnership books partnership books

Case 2: Credit to capital is less than the investment

C’s capital is credited for ₱80,000. What is the journal entry to record the
transaction?

Solution:

July 1, Cash 100,000

2021
C, Capital 80,000

A, Capital [(100,000-80,000) x 40%]* 8,000

B, Capital [(100,000-80,000) x 60%]* 12,000

to record the admission of C to the

partnership

*Under the "bonus method," any decrease (or increase) in the capital of the
new partner is treated as an addition (or deduction) to the capital of the
existing partners, allocated based on their profit or loss sharing ratio.

In this case, the ₱20,000 reduction in the capital credit of (100,000 - investment
80,000 capital credit) is allocated as increases in the capital balances of A and
B.

Case 3: Credit to capital is greater than the investment

C’s capital was credited for ₱130,000. What is the journal entry to record the
transaction?

Solution:

July 1, Cash 100,000

2021
A, Capital [(130,000-100,000) x 40%]* 12,000

B, Capital [(130,000-100,000) x 60%]* 18,000

C, Capital 80,000

to record the admission of C to the

partnership

The equity structure of the new partnership after the admission of Cis analyzed
as follows:

Reqmt. (a) Reqmt. (a) Reqmt. (a)

A, Capital 150,000 258,000 138,000
B, Capital 250,000 262,000 232,000
C, Capital 100,000 80,000 130,000
Total 500,000 500,000 500,000

Notice that whether or not an entity uses the "bonus method,” the total capital
remains the same after the admission of a new partner. That is the total capital
is equal to the net assets before the admission plus the fair value of new
partner's contribution.

ILLUSTRATION 2: Amount of investment

The statement of financial position of AB Partnership shows following

information as of July 1,202.

Cash 12,000

Receivable from A 8,000

Equipment 390,000

Total 410,000
Payable to B 10,000

A Capital (40%) 150,000

B, Capital (60%) 250,000

Total 410,000

On July 1, 20x1, the partners decide to admit Cas a new partner with a 20%
interest. The net assets of the firm as of this date approximate their fair values.

Requirement: If no bonus shall be allowed, how much should invest in the

partnership?

Solution:

A, Capital 150,000

B, Capital 250,000

Total capital of existing partnership 400,000

Divide by: (100% less 20% interest of C) 80%

Total capital of new partnership 500,000

Multiply by: Interest of C 20%

Investment of C 100,000

Notice that the receivable and payable accounts to the partners do not affect
the computations above. This is because the business is continued ever after
the partnership dissolution. The accounts are carried over to the books of the
new partnership.

ILLUSTRATION 3: Bonus method

The following are the capital account balances and profit and loss ratios of the
partners In AB Partnership as of July 1, 2021.
 Capital accounts P/L ratios
A, Capital 150,000 40%
B, Capital 250,000 60%
400,000 100%

On July 1, 2021, C was admitted to the partnership when he invested

equipment with a historical cost of ₱100,000 and fair value of ₱80,000 to the
partnership for a 20% interest. The net assets of the firm as of this date
approximate their fair values.

Requirements:

a. If the bones method is used to record the admission of C into the

relationship, how much is the credit to C's capital account?

b. What are the capital balances of the partners after the admission of C?

c. What are the relative profit or loss ratios of the partners after the admission
of C?

Solutions:

Requirement (a): Credit to C's capital account

Total capital of existing partnership 400,000

Divide by: (100% less 20% interest of C) 80,000

Total capital of new partnership 480,000

Multiply by: Interest of C 20%

Credit to C’s capital 96,000

The entry to record the admission of C’s as follows:

July 1, Equipment 80,000

2021
A, Capital [(96,000-80,000) x 40%]* 6,400

B, Capital [(96,000-80,000) x 60%]* 9,600

C, Capital 96,000

to record the admission of C to the

 partnership

Requirement (b): Capital balances after admission of C

A, Capital (150,000 - 6,400) 143,600

B, Capital (250,00 – 9,600) 240,400
C, Capital 96,000
Total capital of new partnership 480,000

Note again that a bonus granted to one partner is accounted for as reduction
in the capital of the other partners.

Requirement (c): New profit or loss ratios

Profit or loss ratios

A, Capital (100% - 20%) x 40% 32%
B, Capital (250,00 – 9,600) 48%
C, Capital 20%
100%

WITHDRAWAL, RETIREMENT OR DEATH OF A PARTNER

When a partner withdraws, retires or dies, his interest may be purchased by (a)
one or all of the remaining partners or (b) the partnership. In case of death, the
deceased partner's estate is entitled to the value of the partner's interest at the
date of his sheath

The interest of the withdrawing retiring or deceased Partner is adjusted for the
following:

a. his share of any profit or loss during the period up to the date of his
withdrawal, retirement or death; and

b. his share of revaluation gains or losses as at the date of his withdrawal,

retirement, or death,

Purchase by one or all of the remaining partners

One or all of the remaining partners may purchase the interest of the retiring,
withdrawing, or deceased partner. This is transaction between and among the
partners (or deceased partner's estate). As such, the settlement amount is not
recorded the partnership books. The only entry to be made is a transfer
within equity. However, the above-mentioned adjustments (i.e., shares in
profits or losses and revaluation gains or losses) are recorded first before the
settlement.

Purchase by the partnership

The partnership may purchase the interest of the retiring withdrawing, or

deceased partner. This is a transaction between the retiring or withdrawing
partner (or deceased partner's estate) and the partnership. As such, the
settlement amount is recorded in the partnership books, alongside any other
necessary adjustments.

Bonus method

When the retiring withdrawing, or deceased partner's interest is settled at an

amount greater than or less than the value of his interest, the bonus method is
used. Under the bonus method, excess (or deficiency) in the payment is
accounted for deduction (or addition) to the remaining partners’ capital
accounts.

Illustration: Withdrawal of a partner

Use the following information for the next four independent cases:

The capital account balances of the partners in ABC Partnership on July 1, 2021
before any necessary adjustments are as follows:

Capital accounts P/L ratios

A, Capital 150,000 20%
B, Capital 250,000 30%
C, Capital 250,000 50%
500,000 100%

The partnership reported profit of ₱900,000 for the six months ended July 1,
2021.
Case #1: Purchase of interest by remaining partners

On July 1, 2021, C withdraws from the partnership when he was bought-out by

his co-partners for ₱620,000 cash. The net assets of the firm as of this date
approximate their fair values.

Requirement: Provide the journal entries.

Solution:

The capital balances of all of the partners are adjusted for their respective
shares in the profit accruing as of the date of withdrawal.

A B C Totals
Unadjusted balance 150,000 250,000 100,000 500,000
Share in profits

[900K x 180,000 270,000 450,000 900,000

(20%;30%;50%)]
Capital, end. 330,000 520,000 550,000 1,400,000

The entry to adjust the capital balances of the partners on C's withdrawal date
is as follows:

July 1, Income summary 900,000

2021
A, Capital 180,000

B, Capital 270,000

C, Capital 450,000

The entry to record the withdrawal of C’s as follows:

July 1, C, Capital 550,000

2021
A, Capital (550,000 x 20%/50%*) 220,000

B, Capital (550,000 x 30%/50%*) 330,000

*Partner's old P/L ratio divided by the sum of remaining partner old P/L ratios
(i.e., A's 20% +B's 30%=50%)

The capital structure of the new partnership is as follows:

 A B Total
Adjusted balance- July 1, 2021 330,000 520,000 850,000
Credit from withdrawal of C 220,000 330,000 550,000
New capital balances 550,000 850,000 1,400,000

TEACHER’S INSIGHT

Ø The settlement amount (i.e., ₱620,000) paid by the remaining partners to C’s not
recorded in the books.

Ø The capital balance of C is allocated to the purchasing partners using their relative
old profit or loss ratio.

Ø The adjusted total capital of the partnership remains the same before and after the
withdrawal of C.

Casa #2: Purchase of interest by partnership

C retires on July 1, 2021. It was agreed that C shall receive ₱620,000 cash from
the partnership in settlement of his interest.

Requirement: Provide the journal entries.

Solution:

The capital balances of all of the partners are adjusted for respective shares in
the profit accruing as of date of withdrawal.

A B C Totals
Unadjusted balance 150,000 250,000 100,000 500,000
Share in profits

[900K x 180,000 270,000 450,000 900,000

(20%;30%;50%)]
Capital, end. 330,000 520,000 550,000 1,400,000

The entry to record the withdrawal of C’s as follows.

 July 1, A, Capital 550,000
2021
B, Capital 28,000

C, Capital 42,000

Cash 620,000

TEACHER’S INSIGHT

Ø The retirement of resulted to a bonus of ₱70,000 (₱620,000 settlement - ₱550,000

capital balance). The bonus is deducted from the capital balances of the remaining
partners.

Ø The payment to C is recorded in the books because the interest of C is purchased

by the partnership, rather than by the remaining partners.

The capital structure of the new partnership is as follows:

A B Total
Adjusted balance- July 1, 2021 330,000 520,000 850,000
Debit for the bonus to C (28,000) (42,000) (70,000)
New capital balances 302,000 478,000 780,000
Notice that the total capital of the partnership is reduced by the payment for
the withdrawing partner's capital balance, as analyzed below:

Adjusted capital before withdrawal of C 1,400,000

Total capital after withdrawal of C 780,000
Decrease in total capital equal to amount paid to C 620,000

A comparison between purchase of interest by remaining

partners and purchase of interest by the partnership is provided below:

Purchase by remaining partners Purchase by partnership

· The payment to the outgoing partner · The payment to the outgoing partner
is not recorded in the partnership books. is recorded in the partnership books.
· Partnership capital remains the same · Partnership capital is decreased by
before and after the withdrawal, retirement the payment for the outgoing partner's
or death of the outgoing partner. capital balance.
· No gain or loss is recognized in the · No gain or loss is recognized in the
partnership books. partnership books.
Incorporation of a partnership

Another instance that causes partnership dissolution is the incorporation of a

partnership. When a partnership is converted into a corporation, the partners'
relation changes - they cease to be partners (i.e., agents of the business) and
become stockholders Corporate accounting

TEACHER’S INSIGHTs

· Dissolution is the change in the relation of the partners caused by any partner
being disassociated from the business.

· Examples of events that result to partnership dissolution: (a) Admission of a

partner, (b) Withdrawal, retirement or death of a partner, and (c) Incorporation of a
partnership.

· In all cases of dissolution, the partnership assets and liabilities

at date of dissolution may need to be revalued to their fair values. Any revaluation
increase or decrease is allocated to all of the existing partners' capital accounts as at
the date of dissolution.