CPAORS-AFAR PARTNERSHIP DISSOLUTION

ADVANCED FINANCIAL ACCOUNTING AND REPORTING

PARTNERSHIP DISSOLUTION
Partnership dissolution refers to the termination of a partnership as well as the
cessation of its various business activities. Partnerships can dissolve for various
reasons and under many circumstances.

Partnership dissolution due to changes in ownership interests occurs for variety of

reasons. These can be summarized as follows:

1. Admission of a partner
2. Retirement of a partner
3. Death of a Partner
4. Incorporation of a partnership

ADMISSION OF A NEW PARTNER

An existing partnership may admit a new partner with the consent of all the
partners. When a new partner is admitted, the partnership is dissolved and a new
partnership is formed.

The admission of a new partner may occur in either two ways, namely:
1. Purchase of all or part of the interest of one or more of the existing partners.
2. Investment of assets in the partnership by the incoming partner.

Purchase of interest from one partner or more partners

The partner in making the transfer of ownership can actually convey the following
rights:
1. The rights of co-ownership in the business property. This right justifies the
partnership drawings from the business as well as the settlement paid at
liquidation or at the time of partners’ withdrawal.
2. The rights to share in profits or losses
3. The rights to participate in the management of the business

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When an incoming partner purchases a portion or all of the interests of one or more
of the original partners, the partnership assets remain unchanged and no cash or
other assets flow from the new partner to the partnership. This transaction is
recorded by opening a capital account for the new partner and decreasing the
capital accounts of the selling partners by the same amount. The cash paid by the
buyer is not recorded in the books of the partnership for this is a personal
transaction between the selling and the buying partners. The gain or loss arising
from the sale of interest is not to be recorded in the partnership books.

ILLUSTRATION:
Assume the following data for Liz, Mer, and Nam (LMN) Partnership on December
31, 2020.

PARTNERS CAPITALS P/L RATIO

Liz 20,000 20%
Mer 20,000 30%
Nam 30,000 50%

On this date, Olive is admitted to the partnership.

CASE 1: Purchase from one partner

Assume Olive purchases one-half of the interest of Liz. Regardless of the amount
paid to Liz, The only entry required in the partnership books is:
Liz, Capital 10,000
Olive, Capital 10,000

CASE 2: Purchase from all partners

1. Assume Olive is admitted to the partnership for 50% interest in the p/l of the
partnership
2. The old partners are to retain their original capital and profit sharing
relationships to each other and are to transfer sufficient amount (50%) of
their own capital accounts to Olive in order to accomplish his admission as
planned.

If Olive agreed to pay total of P50,000 to Liz, Mer, and Nam, the entry to record the
transaction will appear as follows:

Liz, Capital 10,000

Mer, Capital 10,000
Nam, Capital 15,000
Olive, Capital 35,000

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There is no definite rule as to how the P50,000 cash will be divided among the
individual partners. The following procedures are recommended for fair and
equitable division of cash among the existing partners.
1. Determine the amounts of capital balances to be transferred by the existing
partners
2. Apportion any excess (or deficiency) in the original partners’ profit or loss
ratio
Using the above procedures, the P50m000 paid by Olive shall be distributed to old
partners as follows:

TOTAL LIZ MER NAM

Amounts of capital
transferred 35,000 10,000 10,000 15,000
Excess of P15,000 (50K -
35K) 15,000 3,000 4,500 7,500

Total cash distribution 50,000 13,000 14,500 22,500

ALTERNATIVE METHOD:
The net assets of the partnership may be revalued when the purchase of interest
from all the partners is for an amount more than the interest acquired. Thus, if
Olive buys 50% interest in LMN Partnership for P50,000 as in the preceding
example, and it is agreed that the net assets should be revalued, the computation
would be:

Implied book value of the partnership (50,000 / 50%) P100,000

Book value of the partnership (total capital) 70,000
Undervaluation of identifiable assets (goodwill) 30,000

The entries to record the admission of Olive into the partnership would then be:
1)
Identifiable assets (goodwill) 30,000
Liz, Capital 6,000
Mer, Capital 9,000
Nam, Capital 15,000
#to record the revaluation of net assets among the old partners using their
P/L ratio.
2)
Liz, Captal 13,000
Mer, Capital 14,500
Nam, Capital 22,500
Olive, Capital 50,000
#to record admission of Olive into the partnership

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NOTE: Goodwill should not be recorded until all identifiable assets have been
adjusted to their fair value.

New Partner Invests in Partnership

A new partner may acquire interest in the partnership by investing in the business.
In this case, the partnership receives the cash or other assets, thereby increasing
its total assets as well as the total capital. This method of admission is a transaction
between the partnership and the incoming partner. Three cases may exist when a
new partner invests in a partnership:

Case 1: the new partner’s investment (contributed capital) equals the new partner’s
proportion of the partnership’s book value (agreed capital).

Case 2: the new partner’s investment is more than the new partner’s agreed
capital. This indicates that the partnership’s prior net assets are undervalued on the
books or that unrecorded goodwill exists.

Case 3: the new partner’s investment is less than the new partner’s agreed capital.
This suggests that the partnership’s prior net assets are overvalued on its books or
that the new partner may be contributing goodwill in addition to the assets
invested.

The following steps or procedures may be used in determining how to account for
the admission of new partners:
1. compute the new partner’s proportion of the partnership’s book value (agreed
capital ) as follows:

Prior capital Investment Percentage of

Agreed Capital = of old + of the new X capital to new
partners partners partner

2. Compare the new partner’s contributed capital with his or her agreed capital to
determine the procedures to be followed in accounting for his admission.

3. Determine the specific admission method. Three different methods may be used:
a. revalue net assets, b. recognize goodwill, or c. bonus method.

Overview of Accounting for Admission of a New Partner

Case 1:
Investment cost = Agreed capital 1. No revaluation, goodwill, or bonus.

Case 2:
Investment Cost > Agreed Capital 1. Revalue net assets up to fair value
and allocate to old partners

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2. Record unrecognized goodwill and

allocate to old partners
3. Allocate bonus to old partners

Case 3:
Investment cost < Agreed Capital 1. Revalue assets down to their fair
value and allocate to old partners
2. Recognize goodwilll brought in by
new partner
3. Assign bonus to new partner
ILLUSTRATION:
Assume that after operations during 2020, AB Partnership has a book value of
P300,000 and profit percentages on January 1 as follows:

Capital P/L
Balance Ratio
Andy 200,000 60%
Bony 100,000 40%
Total 300,000 100%
On January 2, 2021, Coby invest cash into the partnership. Coby will have one-
fourth interest and a 25% share in the profits. Andy and Bony will share the
remaining 75% of profits in the ratio of 60:40, resulting in Andy 45% share on any
profits, and Bony having 30%.

CASE 1: INVESTMENT EQUALS PROPORTION OF THE PARTNERSHIP’S BOOK

VALUE (AGREED CAPITAL)
Coby invests P100,000. After the investment, the difference between the new
partner’s investment and is agreed capital is computed as follows:

Investment in partnership 100,000

New partner’s proportionate book value
(agreed capital) (300K + 100K ) x 25% 100,000
Difference -0-

Journal entry:
Cash 100,000
Cody, capital 100,000

CASE 2: NEW PARTNER’S INVESTMENT ID MORE THAN THE PROPORTION

OF THE PARTNERSHIP BOOK VALUE (AGREED CAPITAL)

Coby invests P110,000. After the investment, the difference between the new
partner’s investment and is agreed capital is computed as follows:

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Investment in partnership 110,000

New partner’s proportionate book value
(agreed capital) (300K + 110K ) x 25% 102,500
Difference 7,500

Coby has invested P110,000 for an interest with a book value of P102,500, thus
paying excess of P7,500 over the present book value.

Generally, an excess of investment over the book value of interest acquired

indicates that the partnership’s prior net assets are undervalued or that the
partnership has some unrecorded goodwill. Three alternative accounting treatments
exist in this case.

1. REVALUE ASSETS UPWARD

Under this alternative:
a. asset book values are increased to their fair values
b. the old partners’ capital accounts are increased for their respective shares of
increase in the book values of assets
c. the partnership’s total resulting capital reflects the prior capital balances plus the
amount of asset revaluation plus the new partner’s investment

example:
assuming Coby paid a 7,500 excess over the proportionate book value because the
partnership owns a land with book value of P40,000 but appraised at P70,000.
Before recording the admission of Coby the land must be revalued by the ff
adjusting Journal entry:
Land 30,000
Andy, Capital 18,000
Bony, Capital 12,000
#to revalue partnership and to market value

Coby’s investment is P110,000 brings the partnership’s total resulting capital to

P440,000.
The entry to record admission of Coby is

Cash 110,000
Coby, Capital 110,000
#to record admission of Coby for one-fourth capital interest.

2. RECORD UNRECOGNIZED GOODWILL

With this method:
a. unrecognized goodwill is recorded
b. the old partners’ capital accounts are increased for their respective shares of the
goodwill.

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c. the partnership’s total resulting capital is now equal the prior capital balances
plus the goodwill recognized plus the new partner’s investment

example:
Unrecognized goodwill may be computed from the amount of new partner’s
investment. For example, in this case, Coby is investing P110,000 for a one-fourth
interest, the GW is computed as follows:
Estimated total resulting capital (110,000/25%) 440,000
Total net assets (300,000 + 110,000) 410,000
Goodwill 30,000

The entries to record goodwill and the admission of Cody are as follows:
1)
Goodwill 30,000
Andy, Capital 18,000
Bony, Capital 12,000

2)
Cash 110,000
Coby, Capital 110,000

3. USEBONUS METHOD
Basically, the bonus method is a transfer of capital balances among the partners.
This method is used when the partners do not wish to record adjustments in asset
accounts or recognize goodwill. Under this method:
a. The old partners’ capital accounts are increased for their respective shares of the
bonus paid by the new partner.
b. The partnership’s total resulting capital equals the prior capital balances plus the
new partner’s investment.

Example:
New partner’s investment 110,000
New partners proportionate book value
(agreed capital) (300k+ 110k) x 25% 102,500
Bonus to old partners 7,500

Journal Entry:
Cash 110,000
Andy, capital 4,500
Bony ,Capital 3,000
Coby, Capital 102,500

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The following schedule presents the summary of approaches for Case 2

Total New Partner's

Old partners New partner's New partners resulting Share
Agreed
Capital Capital Capital Capital of total resulting
capital (25%)
New partner's investment
more
thank her proportionate
book
value (agreed capital) 300,000 110,000 102,500

1. revalue assets by increasing land, 440,000 110,000

P30,000

2. Recognize P30,000
goodwill to 440,000 110,000
old partners

3. Bous of P7,500 o old

partners 410,000 102,500

CASE 3: NEW PARTNER’S INVESTMENT LESS THAN PROPORTION OF THE

PARTNERSHIP BOOK VALUE (AGREED CAPITAL)

Assume that Coby invests P80,000 for a one-fourth capital inters tint he
partnership. The difference between the new partner’s investment and the partner’s
proportionate book value (agreed capital) is as follows:

Investment in partnership 80,000

New Partner's proportionate

book value (agreed capital) (95,000)

Difference (15,000)

*There are three alternative approaches to account or the difference when the
investment is less than the book value acquired. The three approaches are as
follows:

1. REVALUE ASSETS DOWNWARD

Under this approach:

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a. Asset book values are decreased to their fair values

b. The old partners’ capital accounts are decreased for their respective shares of
the decrease in the values of the assets
c. The partnership’s total resulting capital reflects the old partner’s capital balances
less the amount of the asset valuation write-down plus the new partner’s
investment

ILLUSTRATION:
Assume that the inventory of the partnership which is currently reported at book
value P140,000 has a fair market value of P80,000 because some items are
obsolete. The partners agree to write-down the inventory to its FMV before
admission of new partner. The write-down is divided among the partners’ capital
using their P/L ratio.

Journal entry:
Andy, Capital 36,000
Bony, Capital 24,000
Inventory 60,000
#to revalue inventory to its fair value

Cash 80,000
Coby, Capital 80,000
#to record admission of Coby

Coby’s share to the total resulting capital of the partnership is computed as:
(240,000 + 80,000) x 25%

2. RECOGNIZE GOODWILL BROUGHT BY NEW PARTNER

Under this approach:
a. Goodwill brought in by the new partner is recorded and included in the new
partner’s capital account
b. The old partners’ capital account remain unchanged
c. the partnership’s total resulting capital reflects the old partners’ capital balances
plus the new goodwill brought in plus the new partner’s cash investment

ILLUSTRATION:
Using the previous illustration, if goodwill method will be used, the estimated
goodwill brought in by Coby in the partnership is computed as follows:

Total resulting capital (P300,000 / 75%) P400,000

Total net assets excluding goodwill
(300,000 + 80,000) 380,000

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Goodwill 20,000

*Use new partner’s investment to estimate goodwill to old partners, use old
partners’ capital to estimate goodwill to new partner.

Journal Entry:

Cash 80,000
Goodwill 20,000
Coby, Capital 100,000
#to record the admission of Coby.

The total resulting capital of the ABC partnership is now P400,000, with Andy amd
Bony together having 75% interest and Coby having 25% interest.

3. USE BONUS METHOD

Under this approach:
a. The new partner is assigned a bonus from old partners’ capital accounts which
are decreased for their respective shares of the bonus paid to the new partner.
b. The partnership’s total resulting capital is equal to the old parners’ capital
balances plus the new partner’s investment.

ILLUSTRATION:
Coby’s investment of only P80,000 for a one-fourth interest in the ABC Partnership
may be accounted for by recognizing a bonus given to Coby from the old partners.
The bonus is computed as follows:
New partner’s investment P80,000
New partner’s proportionate book
value (agreed capital) 95,000
Bonus to new Partner 15,000

The old partners’ capital will be reduced b 15,000 in their p/l ratio of 60% for Andy
and 40% for Bony, and Coby’s Capital account will be credited for 95,000.

Cash 80,000
Andy, Capita l 9,000
Bony, Capital 6,000
Caby, Capital 95,000
#to record admission of Coby

Note that Coby’s capital credit is his share of the total resulting capital as shown
below:
(300,000 + 80,000 ) x 25% = 95,000

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The following schedule presents the summary of approaches for Case 3

Old New Total New Partner's
partners partner's New partners resulting Share
Agreed
Capital Capital Capital Capital of total resulting
capital (25%)
New partner's investment more
thank her proportionate book
value (agreed capital) 300,000 80,000 9,500

1. revalue assets by increasing

land, 320,000 80,000
P60,000

2. Recognize P20,000 goodwill to 400,000 100,000

new partners

3. Bous of P15,000 to new partner 380,000 95,000

WITHDRAWAL OF A PARTNER
When a partner retires or withdraws from a partnership, the partnership is
dissolved, but the remaining partners may continue operating the business. The
existing partners may buy out the retiring partner either by making a direct
acquisition or by having the partnership acquire the retiring partner’s interest. If
present partner acquire retiring partner’s interest, the only entry is the transfer of
capital from the retiring partner to the remaining partner. If the partnership
acquires the interest of the retiring partner, the partnership may pay the retiring
partner an amount equal to his interest, more than his interest, or less than his
interest.

The interest of the retiring partner is usually measured by his capital balance,
increased or decreased by his share in the following adjustments:
a. profit or loss from partnership operations from the last closing date to the date of
his/her retirement.
b. Changes in the valuation of all assets and liabilities (book value to fair values)

Any prior period errors must be corrected and adjusted to partner’s capital before
the retirement.

ILLUSTRATION:

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On January 2, 2020, the capital balances and P/L ratio of Bry, Cj, and Dan are as
follows:
CAPITAL P/L
PARTNERS
BALANCES RATIO
Bry 10,000 50%
Cj 15,000 30%
Dan 20,000 20%

On April 30, 2020, Bry withdraws from the partnership. The net income of the
partnership for the four months ended April 30 is P14,000. It is agreed that the
inventory costing P5,000 has market value of P7,000 on April 30.

CASE 1: SETTLEMENT EQUALS WITHDRAWING PARTNER’S INTEREST

Assume that Bry agreed to accept payment equal to his interest.

Journal entry:
April 30:
Income summary 14,000
Bry, Capital 7,000
Cj, Capital 4,200
Dan, Capital 2,800
#to record distribution of profits

Inventory 2,000
Bry, Capital 1,000
Cj, Capital 600
Dan, Capital 400
#to record adjustment on inventory

Bry, Capital 18,000

Cash 18,000
#to record settlement to Bry equal to his adjusted capital balance

CASE 2: SETTLEMENT MORE THAN WITHDRAWING PARTNER’S INTEREST

When the withdrawing partners is paid an amount more than his interest, three
approaches can be used, namely:

1. Record goodwill equal to the excess payment made to the retiring partner
(partial goodwill method)
2. Record total implied goodwill of the partnership computed by dividing the excess
payment with the retiring partner’s profit/loss sharing percentage (total goodwill
method)

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3. Threat the excess payment as bonus from the remaining partners. This is
accomplished by decreasing the remaining partners’ capital accounts by the excess
using their profit/loss sharing percentage.

Using the same data for Bry, Cj, and Dan partnership, assume Bry is paid P19,500,
the entries to record the settlement under the three approaches are as follows:

1. Partial Goodwill Method

Goodwill 1,500
Bry, Capital 18,000
Cash 19,500

2. Total Goodwill Method

Goodwill 3,000
Bry, Capital 18,000
Cj, Capital 900
Dan, Capital 600
Cash 19,500

3. Bonus Method
Bry, capital 18,000
Cj, Capital 900
Dan, Capital 600
Cash 19,500

CASE 3: SETTLEMET LESS THAN WITHDRAWING PARTNER’S INTEREST

Using the same data, assume that Bry is paid P17,000 for his interest, the entry will
be as follows:

Bry, Capital 18,000

Cash 17,000
Identifiable assets 1,000

If the causes of the difference are not determinable or assignable to specific assets,
then the bonus method should be used. The entry to record the settlement is:
Bry, Capital 18,000
Cash 17,000
Cj, Capital(3/5x 1,000) 600
Dan, Capital(2/5 x 1,000) 400
#to record the retirement of Bry and to dovide the resulting bonus between Cj and
Dan.

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DEATH OF A PARTNER
In the event of the death of a partner, the estate of the deceased partner is entitled
to receive the amount of his interest in the partnership at the date of his death. The
deceased partner’s capital is adjusted using his profit and loss share percentage for
the changes in the net asset, and for the profit accruing from the previous reporting
date until the partner’s death. The balance of his capital account after considering
the necessary adjustments should be transferred to a liability account pending
settlement.

INCORPORATION OF A PARTNERSHIP
This is the conversion of a partnership into a corporation. The accounting
procedures in recording the incorporation of a partnership will depend on whether
the original books of the partnership will be continued by the corporation or new
books will be opened.

PARTNERSHIP BOOKS RETAINED: If the partnership books are retained, the steps
to be taken are as follows:
1. Revalue the assets and recognize goodwill if any,
2. Close the partners’ capital accounts to the corporate capital accounts.

NEW BOOKS OPENED FOR THE CORPORATION: if new books are to be opened, the
old partnership books must be closed. The accounting procedures may be outlined
as follows:

In the Books of Partnership:

1. Revalue the assets ( and any other items agreed on) in accordance with the
agreed transfer values
2. Record the transfer of assets and liabilities to the corporation and the receipt of
capital stock by the partnership
3. Record the distribution of stocks to the partners in settlement of the balances of
their capital accounts.

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REVIEW PROBLEMS
PROBLEM 1
Red, White, and Blue are partners with a profit and loss ratio of 2:4:4 and credit
balances of P60,000, P80,000, and P60,000 respectively. Green is to be admitted
into the partnership with an investment of P75,000 for a 25% interest in the
capital, profit, and losses of the firm.

Required:
a. Prepare Journal entries to record the admission of Green, using:
1. Revaluation of assets
2. Bonus approach

b. Prepare Journal entries to record the admission of Green if, instead of investing
into the partnership, he purchases his interest from the partners at the same
P75,000 and :
1. Implicit goodwill is to be recorded
2. Bonus method is used

PROBLEM 2
Bruno and Mario are partners with a profit and loss ratio of 6:2 and credit capital
balances of P200,000 and P300,000, respectively. Tomas is to be admitted into the
partnership by investing P140,000 for a 20% interest in the capital, profits, and
losses.
Required:
a. Prepare schedule of partners’ capital balances after the admission of Tomas, if
1. Goodwill is not recorded
2. Goodwill is to be recorded
3. Goodwill is recorded and then written off

b. Prepare schedule of partners’ capital balances after the admission of Tomas.

Goodwill is to be recorded and then written off but the new profit and loss ratio is
4:4:2 for Bruno, Mario, and Tomas instead of 6:2:2 in (a3) above.

PROBLEM 3
Rodel And Jerry who share profit and losses in the ratio of 4:6 are partners with
credit capital balances of P60,000 and P80,000 respectively. Barry is to be
admitted to the partnership for a 25% interest in the capital of the firm.
Required:
a. calculate the cash payment by Barry is, after the cash payment is recorded, the
capital balances of Rodel and Jerry are P76,000 and P104,000 and goodwill was
recorded.

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b. calculate the cash payment by Barry is after the cash payment is recorded, the
capital balances of Rodel and Jerry are P52,000 and P68,000 and goodwill was not
recorded.

PROBLEM 4
Helen and Cathy are partners with a profit and loss ratio of 70:30. Their credit
capital accounts on January 2013 are P70,000 and P50,000. They have agreed to
admit Cherry as a new partner in their firm.

Required: For each of the following cases, prepare journal entries to admit Cherry.

a. Cherry invests an amount of P40,000 cash for a 25% interest in profits, losses,
and capital.
b. Cherry invests P50,000 for a 25% interests in profits, losses, and capital.
c. Cherry invests P25, 000 for a 25% interest in the capital of the firm and goodwill
is not to be recorded.
d. Cherry invests P50,000 for a 25% interest in the capital of the firm and goodwill
is to be recorded.
e. Cherry invests P25, 000 for a 25% interest in the capital of the firm and goodwill
is to be recorded.

PROBLEM 5
In the ABC partnership, Andy’s capital is P50,000. Benny’s is P30,000, and Conny’s
is P40,000. They share income in a 3:1:1 ratio. Conny is retiring from the
partnership.

Required: Prepare the journal entries to record Conny’s withdrawal according to

each of the following independent assumptions:

a. Conny is paid P48,000 and no goodwill is recorded

b. Conny is paid P50,000 and only his share of the goodwill is recorded
c. Conny is paid P45,000 and implied goodwill is recorded

PROBLEM 6
Subas and Tony sell electronic equipment and supplies through their partnership.
They wish to expand their computer lines and decided to admit Noel to the
partnership. Subas’ capital is P100,000, Tony’s capital is P80,000, and they share
income in a ratio of 3:2.

Required:
a. Noel directly purchases half of Tony’s investment in the partnership for P46,500

b. Noel invests the amount needed to give him a one-third interests in the capital of
the partnership if no goodwill or bonus is recorded.

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c. Noel invests P56,000 for a one-fourth interests. Goodwill is to be recorded

d. Subas and Tony agree that some of the inventories are obsolete. The inventory
account is decreased before Noel is admitted. Noel invests P52,000 for a ¼ interest.

e. Noel directly purchases a ¼ interest by paying Subas P32, 000 and Tony
P36,000. The land account is increased before Noel is admitted

f. Noel invests P40,000 for a one-fifth interest in the total capital P220,000

g. Noel invests P60,000 for one-fifth interest, Goodwill is to be recorded.

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