College of Accountancy and Business Administration

Modular Learning
ACC13 – Financial Accounting and Reporting

MODULE 13 – Partnership Dissolution

I. Introduction
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 busines and accounting entity. Such
change in ownership is termed as dissolution. Partnership dissolution is defined as “the change in
the relation of the partners caused by any partner ceasing to be associated in the carrying on as
distinguished from the winding up of the business.” Dissolution ends the association of partners for
their original purpose.

II. Instructions
1. In addition to this module, read your textbook..
2. Review the chapter objectives. Their aim is to give you some idea of what you need to pay
attention to in the chapter. The objectives help to give your study focus and direct you to what
is of particular importance in the chapter.
3. Read each section and pay particular attention to the emphasized terms and their meanings.
4. Respond to all activities, quizzes and exams and submit them on-time to your instructor.
5. Keep in touch.

III. Objectives/Contents
1. Account for the admission of a new partner
2. Account for a partner’s withdrawal from the firm

IV. Lecture
DISSOLUTION

Limited life is one of the characteristics of a partnership. Any change in the membership of this form
of business organization will result to dissolution. Dissolution of the partnership does not
necessarily imply that business operations will come to an end. Most changes in the ownership of a
partnership are accomplished without interruption of its normal operations.

Dissolution should be distinguished from liquidation of partnership. A partnership is said to be

liquidated when the business is terminated; a partnership may be dissolved without being
terminated but liquidation is always preceded by dissolution.

When partnership dissolution occurs, a new accounting entity is formed. The old partnership should
first adjust its books so that all accounts are properly stated at the date dissolution.

Partnership dissolution due to changes in ownership interest 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 Partner
Admitting a new partner dissolves the old partnership and begins a new one. Anytime the
partner mix changes, the old partnership ceases to exist and a new partnership begins. Often, the
new partnership continues the original partnership’s type of business. Let’s look at the ways a new
owner can be added to a partnership.

Admission by Purchasing an Existing Partner’s Interest

A person can become an owner by purchasing an existing partner’s interest. First, however, the new
person must gain the approval of the other partners.

The Bright & Gonzalez partnership has these balances at December 21, 2013:

Exhibit 13-1
BRIGHT & GONZALEZ
Balance Sheet
December 31, 2019

ASSETS Liabilities and Owners’ equity

Cash ₱ 40,000 Accounts payable ₱ 70,000
Inventory 76,000 Bright, capital 48,100
Computer equipment, net 44,000 Gonzalez, capital 53,900
Total liabilities and owners’ equity ₱172,000
Computer software, net 12,000
Total assets ₱172,000

Suppose Bright wants out and Barry Holt, an outside party, buys Bright’s interest on January 1,
2020. Gonzalez accepts Holt as a partner, and Bright agrees to accept ₱50,000. The partnership
records the transfer of capital interest with the following entry:

Jan. 1 Bright, capital 48,100

Holt, capital 48,100
To transfer Bright’s equity to Holt.

The debit closes Bright’s capital account, and the credit sets up Holt’s capital. The entry amount is
Bright’s capital balance of ₱48,100 and not the ₱50,000 that Holt paid Bright. Why ₱48,100?

In this example, the partnership receives no cash because the transaction was between Holt and
Bright, not between Holt and the partnership. The full ₱50,000 went to Bright. Suppose Holt pays
Bright less than her capital balance—say, ₱40,000. The entry on the partnership books is not
affected. Bright’s equity is transferred to Holt at book value of ₱48,100.

The old partnership of Bright & Gonzalez has dissolved. Gonzalez and Holt draw up a new
agreement with a new profit-and-loss-sharing method and continue in business.
Admission by Investing in the Partnership

A person can enter a partnership by investing directly in the business. (This is different from buying
out an existing partner, as in the preceding example.) Here the new partner invests assets—for
example, cash or equipment—in the business. Refer back to Exhibit 13-1, the balance sheet of
Bright & Gonzalez on December 31, 2019 (before the Holt transaction).

Let’s consider several possible alternate ways to add a new partner.

Admission by Investing in the Partnership at Book Value—No Bonus to Any Partner

Cheryl Kaska wants into the Bright & Gonzalez partnership on January 1, 2020. Kaska can invest land
with a market value of ₱51,000. Bright and Gonzalez agree to dissolve their partnership and start up
a new one, giving Kaska a 1/3 interest in the new partnership for her ₱51,000 investment, as
follows:

Partnership capital before Kaska is admitted (₱48,100 + ₱53,900)........ ₱102,000

Kaska’s investment in the partnership.................................................... 51,000
Partnership capital after Kaska is admitted............................................ ₱153,000
Kaska’s capital in the new partnership (₱153,000 x 1/3) ...................... ₱ 51,000

Notice that Kaska is buying into the partnership at book value because her 1/3 investment of
₱51,000 equals 1/3 of the new partnership’s total capital of ₱153,000.

The partnership’s entry to record Kaska’s investment is as follows:

Jan 1 Land 51,000

Kaska, capital 51,000
To admit Kaska as a partner.

Kaska’s 1/3 interest does not necessarily entitle her to 1/3 of the profits. Remember: The
sharing of profits and losses is a separate element from the creation of the partnership agreement.

Admission by Investing in the Partnership—Bonus to the Old Partners

A successful partnership may require a higher payment from a new partner. The old partners may
demand a bonus, which will increase their capital accounts.

Refer back to Exhibit 13-1, the balance sheet of Bright & Gonzalez on December 31, 2019.
Assume instead that Bright and Gonzalez admit Nancy Fry to a 1/4 interest in the new partnership
for Fry’s cash investment of ₱98,000. Fry’s capital balance on the new partnership books is only
₱48,000, computed as follows:

Partnership capital before Fry is admitted (₱48,100 + ₱53,900) ............ ₱102,000

Fry’s investment in the partnership ........................................................ 98,000
Partnership capital after Fry is admitted ................................................ ₱200,000
Fry’s capital in the partnership (₱200,000 x 1/4) .................................. ₱ 50,000
Bonus to the old partners (₱98,000 - ₱50,000) .................................... ₱ 48,000
In effect, Fry had to buy into the partnership at a price (₱98,000) above the book value of her 1/4
interest (₱50,000). Fry’s higher-than-book-value investment creates a bonus for Bright and
Gonzalez. Assuming Bright and Gonzalez’s original partnership agreement had them sharing profits
and losses equally, the partnership entry to record the receipt of Fry’s investment is as follows:

Jan 1 Cash 98,000

Fry, capital 50,000
Bright, capital (₱48,000 x 1/2) 24,000
Gonzalez, capital (₱48,000 x 1/2) 24,000
To admit Fry as a partner.

Fry’s capital account got credited for her 1/4 interest in the new partnership. The bonus was
allocated to Bright and Gonzalez based on their original profit-and-loss-sharing ratio (equally).

Admission by Investing in the Partnership—Bonus to the New Partner

A new partner may be so valuable that the old partners offer a partnership share that includes a
bonus to the new person.

Let’s go back to our Fry partner admission. On January 2, 2020, Fry gives Bright and Gonzalez
₱98,000 but instead, gets a 60% interest in the new partnership. The computation of Fry’s 60%
equity in the new partnership is as follows:

Partnership capital before Fry is admitted (₱48,100 + ₱53,900)............. ₱102,000

Fry’s investment in the partnership ......................................................... 98,000
Partnership capital after Fry is admitted................................................. ₱200,000
Fry’s capital in the partnership (₱200,000 x 60%)................................. ₱120,000
Bonus to the new partner (₱120,000 x ₱98,000)................................... ₱ 22,000

In this case, Fry entered the partnership at a price less than the book value of her equity of
₱120,000. The bonus of ₱22,000 went to Fry from the other partners so their capital accounts are
debited (reduced) for the bonus. The old partners share this decrease in capital as though it were a
loss, on the basis of their profit-and-loss-sharing ratio (equally). The entry to record Fry’s
investment is as follows:

Jan. 1 Cash 98,000

Bright, capital ₱22,000 x 1/2) 11,000
Gonzalez, capital (₱22,000 x 1/2) 11,000
Fry, capital 120,000
To admit Fry as a partner.

Withdrawal of a Partner
A partner may leave the business for many reasons, including retirement, death, or a dispute. The
withdrawal of a partner dissolves the old partnership. The agreement should specify how to settle
up with a withdrawing partner. Any time the partner mix changes, the old partnership ceases to
exist and a new partnership begins.

In the simplest case, a partner may sell his or her interest to another party in a personal transaction.
This is the same as admitting a new person who purchases an existing partner’s interest, as we saw
earlier. The journal entry simply debits the withdrawing partner’s capital account and credits the
new partner’s capital.
For a partner to withdraw or retire from the partnership, the total interest of a partner should be
properly determined which includes the following:
1. Share in the profit and loss of the partnership.
2. Adjustments in assets and liabilities to reflect fair market values.
3. Loans to and from partnership
4. Drawing accounts
5. Capital interest / accounts

Withdrawal or retirement from the partnership may either be

1. Selling or an interest to an outsider. This is similar to admission by purchase.
2. Selling of an interest to an existing partner. The interest of the retiring partner will be
purchased with the personal assets of existing partners rather than with the assets of the
partnership.
3. Selling of an interest to the partnership/payment from partnership fund. Under this
approach, the withdrawal of a partner maybe treated as:
a. Payment at book value
b. Payment at less than book value – bonus method
c. Payment at more than book value – bonus method

Revaluation of Assets

The withdrawing partner may receive assets other than cash. The settlement procedure often
specifies an independent appraisal to determine fair value. If fair values are different than book
values, the partnership must revalue its assets. The partners share any fair-value changes in their
profit-and-loss-sharing ratio.

Let’s revisit the latest partnership balance sheet for Bright, Gonzalez, and Fry, assuming Fry was
admitted with a bonus from the old partners (the ₱120,000 Fry, capital) on January 2, 2019.

Before any asset appraisal, the partnership balance sheet reports the following:

Exhibit 12-2 Partnership Balance Sheet—After Admitting Fry with a Bonus from the Existing Partners

BRIGHT, GONZALEZ, & FRY

Balance Sheet
January 2, 2019

ASSETS Liabilities and Owners’ equity

Cash (40,000 + 98,000) ₱ 138,000 Accounts payable ₱ 70,000
Inventory 76,000 Bright, capital (48,100 – 11,000) 37,100
Computer equipment, net 44,000 Gonzalez, capital (53,900 – 11,000) 42,900
Fry, capital 120,000
Computer software, net 12,000
Total liabilities and owners’ equity ₱270,000
Total assets ₱270,000

On January 31, 2014 an independent appraiser revalues the inventory at ₱70,000

(down from ₱76,000) and the computer equipment at ₱45,200 (up from ₱44,000). The
partners share the differences between market value and book value on the basis of their
profit-and-loss-sharing ratio.
The partnership agreement allocates 1/6 to Bright, 2/6 to Gonzalez, and 3/6 (or 1/2) to Fry.
(This ratio may be written 1:2:3.) For each share that Bright has, Gonzalez gets two and Fry
gets three. The entries to record the revaluation of the inventory and computer equipment
are as follows:

Jan 31 Bright, capital (₱6,000 x 1/6) 1,000

Gonzalez, capital (₱6,000 x 2/6) 2,000
Fry, capital (₱6,000 x 3/6) 3,000
Inventory (₱76,000 x ₱70,000) 6,000
To revalue the inventory.

31 Computer equipment (₱45,200 - ₱44,000) 1,200

Bright, capital (₱1,200 x 1/6) 200
Gonzalez, capital (₱1,200 x 2/6) 400
Fry, capital (₱1,200 ₱ 3/6) 600
To revalue the computer equipment.

After the revaluations, the partnership balance sheet reports the following:

BRIGHT, GONZALEZ, & FRY

Balance Sheet
January 2, 2019

ASSETS Liabilities and Owners’ equity

Cash ₱ 138,000 Accounts payable ₱ 70,000
Inventory (76,000-6000) 70,000 Bright, capital (37,100 -1,000 + 200) 36,300
Computer equipment, net (44,000 + 1,200) 45,200 Gonzalez, capital (42,900 -2,000 + 400) 41,300
Fry, capital (120,000 – 3,000 + 600) 117,600
Computer software, net 12,000
Total liabilities and owners’ equity ₱265,200
Total assets ₱265,200

The books now carry the assets at fair value, which becomes the new book value, and the
capital accounts are up-to-date. As the balance sheet shows, Bright has a claim to ₱36,300
in partnership assets. Now we can account for Bright’s withdrawal from the business.

Withdrawal at Book Value

If Bright withdraws by receiving cash for her book value, the entry will be as follows:

Jan 31 Bright, capital 36,300

Cash 36,300
To record withdrawal of Bright from the partnership.

Withdrawal at Less than the Book Value

The withdrawing partner may be so eager to depart that she will take less than her full
equity interest (capital balance). Assume that Bright withdraws from the business and
agrees to receive cash of ₱10,000 and the new partnership’s ₱20,000 note payable. This
₱30,000 settlement is ₱6,300 less than Bright’s ₱36,300 equity. The remaining partners
share this ₱6,300 difference—a bonus to them—according to their existing profit-and-loss-
sharing ratio. This means the former 1:2:3 ratio is now 2:3 (Gonzalez’s and Fry’s parts
only).

The entry to record Bright’s withdrawal at less than his book value is as follows:

Jan 31 Bright, capital 36,300

Cash 10,000
 Note payable 20,000
Gonzalez, capital (6,300 x 2/5) 2,520
Fry, capital (6,300 x 3/5) 3,780
To record withdrawal of Bright from the partnership.

Bright’s capital account is closed, and Gonzalez and Fry may or may not continue in the
new partnership of Gonzalez & Fry. If they continue, they will need to draft a new
partnership agreement and determine a new profit-and-loss-sharing ratio.

NOTE: The treatment of a partner withdrawal is similar to the treatment of admitting a new partner. First, the
partners can agree to a revaluation. Then, the withdrawing partner can be withdrawn at an amount either
exactly equal to his or her capital balance or another amount, higher or lower than his or her capital balance.
If the withdrawing partner is given an amount different than his or her capital balance, a bonus to either the
remaining or the withdrawing partner occurs.

Withdrawal at More than the Book Value

A withdrawing partner may receive assets worth more than the book value of his or her
equity. This situation creates the following:
• A bonus to the withdrawing partner
• A decrease in the remaining partners’ capital accounts, shared in their profit-and-
loss-sharing ratio

Let’s assume instead that Bright is given cash of ₱20,000 and a note payable of ₱20,000,
the total of which is ₱3,700 (₱40,000 – ₱36,300) more than Bright’s capital account of
₱36,300. The entry for Bright to withdraw under these new assumptions is as follows:

Jan 31 Bright, capital 36,300

Gonzalez, capital (3,700 x 2/5) 1,480
Fry, capital (3,700 x 3/5) 2,220
Cash 20,000
Note payable 20,000
To record withdrawal of Bright from the partnership.

PROBLEM 2: FOR CLASSROOM DISCUSSION

Admission of a new partner

1. Carrot joins the partnership of Apple and Banana. The partnership’s statement of
financial position before Carrot’s admission is as follows:

Cash 30,000 Accounts payable 80,000

Accounts receivable 140,000 Apple, Capital (60%) 515,000
Inventory 200,000 Banana, Capital (40) 275,000
Equipment 500,000 _______
Total assets 870,000 Total liabilities and equity 870,000

The following adjustments are determined:

a. The recoverable adjustable amount of the accounts receivable is ₱120,000
b. The inventory has a net realizable value of ₱160,000
c. The equipment has a fair value of ₱450,000.
d. Unrecorded liabilities amount to ₱20,000.
 Case 1: Purchase of interest from one partner:
Carrot acquires half of Banana’s capital interest for ₱800,000.

Requirements: Provide the entry and determine the capital balances and P/L ratio of the
partners after Carrot’s admission.

1. Solutions:

Case 1:

Carrying amts. Fair values Increase (Decrease)

Cash 30,000 30,000 -
Accounts receivable 140,000 120,000 (20,000)
Inventory 200,000 160,000 (40,000)
Equipment 500,000 450,000 (50,000)
Accounts payable (80,000) (80,000) -
Accrued liabilities (20,000) (20,000)
Net assets 790,000 660,000 (130,000)

Apple Banana Carrot Total

Capital, beg. 515,000 275,000 790,000
Revaluation decrease (78,000) (52,000) (130,000)
Adjusted, before admission 437,000 223,000 660,000
Sale from Banana to Carrot (111,500) 111,500 -
Capital after admission 437,000 111,500 111,500 660,000

Date Banana, Capital (223,00 x 1/2) 111,500

Carrot, Capital (223,00 x 1/2) 111,500

Partner Before admission Admission of Carrot After admission

Apple 60% 60%
Banana 40% -20% 20%
Carrot 20% 20%
100% 100%
 Case 2: Purchase of interest from more than one partner
Carrot purchases 20% of Apple’s and Banana’s capital interests for ₱800,000.

Requirements: Provide the entry and determine the capital balances of the partners
after Carrot’s admission.

Solution - Case 2:
Date Apple, Capital (437K adj. cap. see above x 20%) 87,400
Banana, Capital (223K adj. cap. x 20%) 44,600
Carrot, Capital 132,000

Apple Banana Carrot Totals

Adjusted cap. 437,000 223,000 660,000
(Debit) Credit (87,400) (44,600) 132,000 -
Capital, end. 349,600 178,400 132,000 660,000

Case 3: Amount of investment:

Carrot wants to invest for 20% in the net asset and profits of the partnership.

Requirements: If no bonus is allowed, how much should Carrot invest, and what would
be the new P/L ratio of the partners after Carrot’s admission.

Solution - Case 3:
Adjusted capital before admission 660,000
Divide by: (100% - 20%) 80%
Grossed-up amount 825,000
Multiply by: 20%
Amount of investment 165,000

Partner Before admission Admission of Carrot After admission

A 60% (100% - 20%) x 60% 48%
B 40% (100% - 20%) x 40% 32%
C 20% 20%
100% 100%

Case 4: Investment in the partnership – Bonus to new partner

Carrot invests P100,000 for a 20% interest in the net assets and profits of the
partnership. No goodwill is recognized.

Requirements: Provide the entry and compute for the capital balances of the partners
after Carrot’s admission.
Case 4:
Adjusted net assets before admission 660,000
Investment of Carrot 100,000
Net assets after admission 760,000
Carrot's interest in net assets 20%
Carrot’s capital credit 152,000
Investment of Carrot 100,000
Bonus to Carrot 52,000

Date Cash 100,000

Apple, Capital (152K – 100K) x 60% 31,200
Banana, Capital (152K – 100K) x 40% 20,800
Carrot, Capital (660K + 100K) x 20% 152,000

Apple Banana Carrot Total

Adj. cap., before admission 437,000 223,000 660,000
Investment of Carrot 100,000 100,000
Bonus to Carrot (31,200) (20,800) 52,000 -
Capital, after admission 405,800 202,200 152,000 760,000
 Case 5: Investment in the partnership – Bonus to old partners
Carrot invests ₱180,000 for a 20% interest in the net assets and profits of the
partnership. No goodwill is recognized.

Requirements: Provide the entry and compute for the capital balances of the partners
after Carrot’s admission.

Case 5:

Adjusted net assets before admission 660,000

Investment of Carrot 180,000
Net assets after admission 840,000
Carrot's interest in net assets 20%
Carrot’s capital credit 168,000
Investment of Carrot 180,000
Bonus to Apple and Banana (12,000)

Date Cash 180,000

Carrot, Capital (660K + 180K) x 20% 168,000
Apple, Capital (12K x 60%) 7,200
Banana, Capital (12K x 40%) 4,800

Apple Banana Carrot Total

Adj. cap., before admission 437,000 223,000 660,000
Investment of Carrot 180,000 180,000
Bonus to old partners 7,200 4,800 (12,000) -
Capital, after admission 444,200 227,800 168,000 840,000

Withdrawal, retirement or death of a partner

2. Partners A, B and C had the following balances on Jan 1,20x1; A, Capital (50%) ₱320,000;
B, Capital (30%) ₱192,000; and C, Capital (20%) ₱128,000. Partner A decided to retire on
Sept. 1, 20x1. The partnership earned profit of ₱800,000 from Jan 1 to Aug 31, 20x1 and the
partners had the following capital withdrawals during that period: A, ₱40,000; B ₱60,000; and
C, ₱30,000

Case 1: Purchase of interest by remaining partner

Partner B purchases Partner A’s interest for P700,000.
Requirements: Provide the entry and compute for the capital balances and P/L ratio of the
partners after A’s retirement.

2. Solutions:
Case 1:

A B C Total
Capital - Jan. 1, 20x1 320,000 192,000 128,000 640,000
Profit 400,000 240,000 160,000 800,000
Drawings (40,000) (60,000) (30,000) (130,000)
Capital - before retirement 680,000 372,000 258,000 1,310,000
 Sept. 1, A, Capital 680,000
20x1
B, Capital 680,000

A B C Total
Capital - before retirement 680,000 372,000 258,000 1,310,000
Sale from A to B (680,000) 680,000 - -
Capital - after retirement - 1,052,000 258,000 1,310,000

P/L ratio after A’s retirement:

Partner Before retirement Retirement of A After retirement
A 50% -50% -
B 30% 30% + 50% 80%
C 20% - 20%
100% 100%

Case 2: Settlement of interest by partnership

The partnership pays Partner A ₱700,000 for his interest.

Requirements: Provide the entry and compute for the capital balances and P/L ratio of
the partners after A’s retirement.

Solution - Case 2:
Sept. 1, A, Capital 680,000
20x1
B, Capital (700K – 680K) x 30%/50% 12,000
C, Capital (700K – 680K) x 20%/50% 8,000
Cash 700,000

A B C Total
Capital - before retirement 680,000 372,000 258,000 1,310,000
Payment to A (700,000) (700,000)
Bonus to A 20,000 (12,000) (8,000) -
Capital - after retirement - 360,000 250,000 610,000

Partner P/L ratio

A -
B 30% / (30% + 20%) 60%
C 20% / (30% + 20%) 40%
100%
 Case 3. Settlement of interest by partnership
The partnership pays Partner A P650,000 for his capital.

Requirements: Provide the entry and compute for the capital balances of the partners
after A’s retirement.

Case 3:
Sept. 1, A, Capital 680,000
20x1
Cash 650,000
B, Capital (680K – 650K) x 30%/50% 18,000
C, Capital (680K – 650K) x 20%/50% 12,000
to record the retirement of A from the partnership

A B C Total
Capital - before retirement 680,000 372,000 258,000 1,310,000
Payment to A (650,000) (650,000)
Bonus to B and C (30,000) 18,000 12,000 -
Capital - after retirement - 390,000 270,000 660,000
V. Assessment