MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY

COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY

DEPARTMENT OF ACCOUNTANCY

ACT130: Accounting for Special Transactions

Partnership Dissolution

LESSON OBJECTIVES
At the end of this module, you will be able to:
1. Know the causes of partnership dissolution;
2. Account for the effects of partnership dissolution on the partnership equity.

OVERVIEW
A business conducted as a partnership usually has changes in ownership during its existence. In
this module, we discuss the changes in ownership that do not result in the termination of the
partnership operations or of the partnership as a separate business and accounting entity. Such
change in ownership is termed as dissolution. Unlike corporation, changes in ownership structure
of a partnership are events that require special accounting treatment.

ABSTRACTION

Definition
Dissolution is the change in the relation of the partners caused by any partner being disassociated
from the business. It is different from liquidation (next topic) since liquidation is the termination of
business operations or the winding up of affairs. Partnership dissolution does not necessarily
terminate the business.

The following are major considerations in the accounting for partnership dissolutions:
1. Admission of a partner
2. Withdrawal, retirement or death of a partner
3. Incorporation of a partnership

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. Note that this transaction is personal between and among the partners and
as such, any consideration paid or received is not recorded in the partnership books. A new
capital account will be established for the new partner and a corresponding decrease is made on
the capital account(s) of the selling partner. No gain or loss is recognized in the partnership
books.

Illustration:
The following are the capital account balances and profit and loss ratio of partner in AB
Partnership as of July 1, 2019:
Capital Accounts P/L Ratio
A, capital P150,000 40%
B, capital 250,000 60%
Total P400,000

1
 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

On July 2019, 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 P100,000. The net
assets of the firm as of this date approximate their fair values.

Requirements:
A. Provide for the Journal Entries to record the transaction.

A, Capital (400,000 x 20% x 40%) P32,000

B, Capital (400,000 x 20% x 60%) 48,000
C, Capital P80,000

NOTE: 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 ratio.

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

A, Capital (P150,000 – 32,000) P118,000

B, Capital (P250,000 – 48,000) 202,000 P400,000
C, Capital 80,000

If you notice, the total partnership net assets did not change.

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

ZERO. Since the transaction is personal with the Partners and C. Partnership books will not
recognize personal gain or loss.

D. How much are the personal gains or losses recognized by A and B, respectively?
Partner A Partner B
Consideration Received
(P100,000 x 40%) P40,000
(P100,000 x 60%) P60,000
Capital Debited (32,000) (48,000)
Personal Gain P8,000 P12,000

Investment in the Partnership

Instead of purchasing interest from the existing partners, a new partner may be admitted by
investing directly to the partnership. This is a transaction between the new partner and the
partnership.

Two scenarios may happen when a new partner invests in 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. This is accounted for under the bonus method.

Illustration:
The following are the capital account balances and profit and loss ratio of partner in AB
Partnership as of July 1, 2019:
Capital Accounts P/L Ratio

2
 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

A, capital P150,000 40%

B, capital 250,000 60%
Total P400,000

On July 2019, C was admitted to the partnership when he acquired 20% interest in the net assets
of the firm for P100,000 investment. The net assets of the firm as of this date 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?

Cash P100,000
C, Capital P100,000
To record the admission of C

NOTE: Under the investment method, the investment of the new partner is recorded in the
partnership books. Since the partnership will recognize additional asset (Cash), the new
partnership will have an increase in net assets by P100,000 for a total of P500,000.

CASE 2: Credit to capital is less than the investment

C’s Capital is credited for P80,000. What is the journal entry to record the transaction?

Cash P100,000
C, Capital P80,000
A, Capital [(100K – 80K) x 40%] 8,000
B, Capital [(100K – 80K) x 60%] 12,000
To record the admission of C

NOTE: Under 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 old
profit or loss sharing ratio.

CASE 3: Credit to capital greater than the investment

C’s capital was credited for P130,000. What is the journal entry to record the transaction?

Cash P100,000
A, Capital [(130K – 100k) x 40%] 12,000
B, Capital [(130K – 100K) x 60%] 18,000
C, Capital P130,000
To record the admission of C

NOTE: Under 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 old
profit or loss sharing ratio.

Withdrawal, Retirement, or Death of a Partner

3
 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

When a partner withdraws, retires, or dies, his interest may be purchased by one or all of the
remaining partners or 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 death.

The interest of the leaving partner is adjusted for the following:

a) His share of any profits/loss during the period up to the date of his withdrawal,
retirement, or death;
b) His share of any revaluation gains/losses as at the date of his withdrawal, retirement,
or death.

Purchase by the Remaining Partners Purchase by the Partnership

➢ The payment to the outgoing partner is ➢ The payment to the outgoing partner is
not recorded in the partnership books. recorded in the partnership books.

➢ Partnership capital remains the same ➢ Partnership capital is decreased by the

before and after the withdrawal, payment for the outgoing partner’s
retirement, or death of the outgoing capital balance.
partner

➢ No Gain or Loss is recognized in the ➢ No Gain or Loss is recognized in the

partnership books. partnership books.

Illustration: Purchase by the Remaining Partners

The capital account balances of the partners in ABC Partnership on July 1, 2019 before any
necessary adjustments are as follows:

A, Capital (20%) 150,000

B, Capital (30%) 250,000
C, Capital (50%) 100,000
Total P500,000

The partnership reported net income of P900,000 for the six months ended July 1, 2019. On
the same date, C withdraws from the partnership when he was bought-out by his co-partners
for P620,000 cash. The net asset of the firm as of this date approximate their fair values.
Requirement: Provide the journal entries

Income Summary 900,000

A, Capital (20%) 180,000
B, Capital (30%) 270,000
C, Capital (50%) 450,000
To adjust capital balances

C, Capital 550,000
A, Capital (550K x 20%/50%) 220,000
B, Capital (550k x 30%/50%) 330,000
To record C’s Witdrawal

NOTE:

4
 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

1. The settlement amount paid by the remaining partners was not recorded in the partnership
books;
2. The capital balances of C is allocated to the purchasing partners using their relative old
profit or loss ratio;
3. The adjusted total capital of the partnership remains the same before and after the
withdrawal of C.

Illustration: Purchase of Interest by the Partnership

Using the same figures above, but assuming it was agreed that C shall receive P620,000 cash
from the partnership in settlement of his interest.

Requirement: Provide for the journal entries

Income Summary 900,000

A, Capital (20%) 180,000
B, Capital (30%) 270,000
C, Capital (50%) 450,000
To adjust capital balances

C, Capital 550,000
A, Capital (P620k – 550k) x 20%/50% 28,000
B, Capital (620k-550k) x 30%/50% 42,000
Cash 620,000
To record the withdrawal of C

NOTE:
1. The retirement of C resulted to a bonus of P70,000 (P620,000 – 550,000). The bonus is
deducted from the capital balances of the remaining partners.
2. The payment to C is recorded in the books because the interest of C is purchased by the
partnership.

Bonus Method
When the outgoing 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, any excess/deficiency in the
payment is accounted for as a deduction/addition to the remaining partner’s capital accounts.

Incorporation of Partnership
Another instance that causes partnership dissolution is the incorporation of a partnership. When
a partnership is converted into a corporation, the partner’s relation changes. They cease to be
partners and become stockholders.

The new corporation acquires the assets and assumes the liabilities of the partnership and in
return issues shares of stocks to the partners. On the date of incorporation:
a) The partner’s capital balances are adjusted for their respective shares in any profit or loss
and revaluation gains or losses as at the date of incorporation. The adjusted capital
balances may be used in determining the number of shares to be issued to each partner.
b) Normally, the books of the partnership are closed and new books are established for the
corporation.

ASSESMENT

5
 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

PROBLEM NO. 1

A and B, partners in a consulting business, share profits and losses in the ratio of 3:2,
respectively. Prior to recording the admission of C as a new partner, A has a capital balance of
$80,000, and B has a capital balance of $40,000.

Required:
For each of the following independent cases, prepare the journal entry that was made to record
the admission of C into the partnership.

1) C purchased 20 percent of the respective capital balances of A and B, paying $20,000 cash
directly to each of them.

2) C invested $30,000 cash in the partnership for a 20 percent ownership interest. Total capital
after recording his admission was $150,000.

3) C invested $40,000 cash into the partnership for a 20 percent ownership interest. Total
capital after recording his admission was $160,000.

PROBLEM NO. 2
A summary balance sheet for the A, B, and C partnership on December 31, 2006 is shown
below. Partners A, B, and C allocate profit and loss in their respective ratios of 4:5:7. The
partnership agreed to pay partner C $227,500 for his partnership interest upon his retirement
from the partnership on January 1, 2007. Any payments exceeding C’s capital balance are
treated as a bonus from partners A and B.

Assets
Cash $ 75,000
Inventory 87,500
Marketable securities 60,000
Land 90,000
Building-net 150,000
Total assets $ 462,500

Equities
A, capital $ 212,500
B, capital 112,500
C, capital 137,500
Total equities $ 462,500

Required:
Prepare the journal entry to reflect C’s retirement from the partnership.

REFERENCES
Dayag, A. J. (2015). Advanced Accounting 1. Manila: Lajara Publishing House.

6
 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

MILLAN, Z. V. (2018). Accounting for Special Transactions. Baguio City: Bandolin Enterprise.