PARTIAL TOPICS

1. PARTNERSHIP FORMATION

a. CHARACTERISTICS OF A PARTNERSHIP

B. ACCOUNTING FOR PARTNERSHIP

C. FORMATION

D. VALUATION OF CONTRIBUTIONS OF PARTNERS

1. PARTNERSHIP OPERATION

2. PARTNERSHIP DISSOLUTION

3. PARTNERSHIP LIQUIDATION

ADVACC1
Accounting for Special Transactions
(Advanced Accounting 1)
 Topic-3
Partnership Dissolution

A partnership rest upon a contractual foundation, therefore, the life span of a partnership may be somewhat
uncertain since it depends on the moods and relationship of the partners.

One of the characteristics of a partnership is that it has a “limited life”, in the sense that a partnership agreement
can be easily dissolved.

The dissolution of a partnership is the change in the relationship caused by any partner ceasing to be
associated in the carrying on as distinguished from the winding up of the business of the partnership (Civil code,
Art.1828)

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 a new articles of partnership
should be drawn up.
 The following are major consideration in the accounting for partnership dissolution:
a. Admission of a partner
b. Withdrawal, retirement and death of a partner
c. Incorporation of a partnership
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 relationship of the partners.

Admission of a partner
The admission of a new partner may be effected either through:
1. Purchase of interest in the partnership
2. Investment in the partnership
Purchase of interest

A new partner may 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 the
transfer within equity.

Example 1. The following are the capital account balances and profit and loss ratios of the partners in ALBAR
Partnership as of July 1, 2019

Capital accounts P/L ratios

Alfonso, capital 150,000 40%

Barrios, capital 250,000 60%

a. Assume that on July 1, 2019 , Canlas was admitted to the partnership when he purchased 20% interest in the
net assets and profits of the firm from Alfonso for P100,000. Prepare journal entry to record the transaction.

Ans. Alfonso, Capital 75,000

Canlas, capital (150,000 x 20% /40%) 75,000
To record the admission of Canlas

b. Assume that on July 1, 2019, Canlas was admitted to the partnership when he purchased a proportionate
interest from Alfonso and Barrios representing 20% interest in the net assets and profits of the firm
for P100,000.

Required: prepare the journal entry to record the admission of Canlas.

Ans. Alfonso, Capital (400,000x 20% x 40%) 32,000

Barrios, Capital (400,000 x 20% x 60%) 48,000
Canlas, Capital (400,000 x 20%) 80,000
To record the admission of Canlas
Purchase of interest – Revaluation
On July 1, 2019, Canlas was admitted to the partnership when he purchased a proportionate interest from Alfonso and
Barrios representing 20% interest in the net assets and profits of the firm for P100,000. On this date, the carrying amounts
and fair values of the assets and liabilities of the partnership are as follows:
Carrying amount Fair value
Cash 20,000 20,000
Equipment 340,000 390,000
Accounts payable 10,000 10,000
Alfonso, capital 130,000 N/A
Barrios, capital 220,000 N/A
Required : Journal entries to be made on July 1, 2019

Ans. 1st Equipment 50,000

Alfonso, Capital (50,000 x 40%) 20,000
Barrios, Capital (50,000 x 60%) 30,000
To record the revaluation of equipment
2nd Alfonso, Capital (400,000 x 20% x 40%) 32,000
Barrios, Capital (400,000 x 20% x 60%) 48,000
Canlas, Capital (400,000 x 20%) 80,000
To record the admission of Canlas
The capital balances of the partners after the admission of Canlas

Alfonso Barrios Canlas Total

Capital, beginning 130,000 220,000 - 350,000
Share in revaluation 20,000 30,000 _ 50,000
Credit to Canlas 80,000 80,000
Debit to Alfonso and Barrios (32,000) (48,000) (80,000)
Capital, ending 118,000 202,000 80,000 400,000
Investment in the partnership

A new partner may be admitted by investing directly in the business. This transaction is a transaction
between the new partner and the partnership. As such, any consideration paid by the incoming partner
is recorded in the partnership books.

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
2. The new partner’s capital account is credited at a an amount greater than or less than the fair
value of his investment

The second scenario is accounted for under bonus method, this may occur 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
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.
 Problem 1 : The following are the capital accounts balances and profit and loss ratios in ALBAR Partnership as

July 1, 2019

Capital accounts P/L ratios

Alfonso, capital 150,000 40%

Barrios, capital 250,000 60%

On July 1, 2019, Canlas was admitted to the partnership when he acquired 20% interest in the net assets and
profits of the firm for a P100,000 investment. The net assets of the firm as of this date approximate their fair values.
Required: Journal entry if Canlas’s capital is credited at an amount equal to his contribution.

Ans. Cash 100,000

Canlas, Capital 100,000
To record the admission of Canlas to the partnership
 Comparison between purchase of interest and investment in the partnership

Purchase of interest Investment in the partnership

 The incoming partner’s contribution - The incoming partner’s contribution is recorded in the
is not recorded in the partnership books partnership books.

 Partnership capital remains the same
before and after the admission of the
of the incoming partner.
 No gain or loss is recognized in the
partnership books.
- Partnership capital is increased by the incoming partner’s
contribution.
- No gains or loss is recognized in the partnership books.
Problem 2- The following are the capital accounts balances and profit and loss ratios:
Capital accounts P/L ratios
Alfonso, Capital 150,000 40%
Barrios, Capital 250,000 60%
Canlas was admitted to the partnership when he acquired 20% interest in the net assets and profits of the
firm for a P100,000 investment. The net assets of the firm as of this date approximate their fair values.

a. Assume Canlas’s capital is credited for P80,000. what is the journal entry to record the transaction?

Ans. Cash 100,000

Canlas, Capital 80,000
Alfonso, Capital (100,000-80,000 x 40%) 8,000
Barrios, Capital (1000,000-80,000 X 60%) 12,000
To record the admission of Canlas

Note: 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 partner, allocated based on their old P/L sharing ratio.

b. Assume Canlas capital was credited for P130,000. What is the journal entry to record the transaction.
Ans. Cash 100,000
Alfonso, Capital (130,000-100,000 x 40%) 12,000
Barrios, Capital (130,000 -100,000 x 60%) 18,000
Canlas, Capital 130,000
To record the admission of Canlas
 Problem 3 :The flowing are the capital account balances and P/L ratios :

Capital accounts P/L ratios

Alfonso, Capital 150,000 40%

Barrios, Capital 250,000 60%

Canlas was admitted to the partnership when he invested equipment with historical cost of P100,000 and fair value of P80,000 to the partnership of this date
approximate their fair values.
Required:. a. If the bonus method is used to record the admission of Canlas in to the partnership, how much is the credit to
Canlas’s capital account?
b. What are the capital balances of the partners after the admission of Canlas?
c. What are the relative profit and loss ratios of the partners after the admission of Canlas?

Solution . a. Total capital before the admission of Canlas 400,000

Fair value of contribution of Canlas 80,000
Total capital after the admission of Canlas 480,000
Multiply by Canlas’s interest 20%
Credit to Canlas’s capital account 96,000

Journal entry – Equipment 80,000

Alfonso, Capital (96,000 – 80,000) x (40%) 6,400
Barrios, Capital (96,000 – 80,000) x (60%) 9,600
Canlas, Capital 96,000
To record the admission of Canlas

b. Alfonso, Capital (150,000 – 6400) 143,600

Barrios, Capital (250,000 – 9,600) 240,400
Canlas, Capital 96,000
Total capital of new partnership 480,000
c. P/L ratios
Alfonso (100% - 20%) x 40% 32%
Barrios (100% - 20%) x 60% 48%
Canlas 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) by 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 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 any revaluation gains or losses as at the date of his withdrawal, or death,

Purchase by one or all of the remaining partners

This is a transaction between and among the partners, as such, the settlement amount is not
recorded in the partnership books. The only entry to be made is a transfer within equity.

The above-mentioned adjustments are recorded first before the settlement (i.e. share in profits and losses and revaluation gains and losses).

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 and the partnership.

The settlement amount is recorded in the partnership books, alongside any other necessary adjustment.

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, any excess (or deficiency) in the payment is accounted for as a deduction (or addition)
to the remaining partners’ capital account.

Differed settlement
Pending settlement, provided all necessary adjustments were made , the withdrawing, retiring or deceased partner’s
is transferred to a liability account.
Illustration 1 : Withdrawal, retirement or death of a partner

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

A, Capital (20%) 150,000

B, Capital (30%) 250,000
C, Capital (50%) 100,000
500,000

The partnership profit is P900,000 for the six moths ended July 1, 2019.

a. Withdrawal - Purchase on interest by remaining partners.

On July 1,2019 , C withdrawals from the partnership when he was bought out by his co-partners for P620,000 cash.
The net assets of the firm as of this date approximate their values. Required journal entries.

Solution: Adjustment for the profit sharing

A (20%) B (30%) C (50%) Total
Unadjusted balance 150,000 250,000 100,000 500,000
Share in profit
(900K x (20%; 30%; 50%) 180,000 270,000 450,000 900,000
Adjusted balance 330,000 520,000 550,000 1,400,000

Journal entries
Income summary 900,000
A, Capital 180,000
B, Capital 270,000
C, Capital 450,000
To adjust the capital balances due profit sharing

C, Capital 550,000
A, Capital (550,000 x 20%/50%) 220,000
B, Capital (550,000 x 30%/50%) 330,000
To record the withdrawal of C
b. Retirement – Purchase of interest by partnership

The capital account balances of the partners on July 1, 2019 before any adjustments are as follows:
A, Capital (20%) 150,000
B, Capital (30%) 250,000
C, Capital (50%) 100,000
500,000

The partnership profit is P900,000 for the six moths ended July 1, 2019.

On July1, 2019 C retires. It was agreed that C shall receive P620,000 cash from the partnership in settlement of his
investment. Required journal entries.

Solution: Adjustment for the profit sharing

A (20%) B (30%) C (50%) Total

Unadjusted balance 150,000 250,000 100,000 500,000
Share in profit
(900K x (20%; 30%; 50%) 180,000 270,000 450,000 900,000
Adjusted balance 330,000 520,000 550,000 1,400,000

Journal entry – C, Capital 550,000

A, Capital ( 620,000-550,000) x 20%/50%) 28,000
B, Capital ( 620,000-550,000) x 30%/50%) 42,000
Cash 620,000
To record the withdrawal of C
c. Retirement – payment in the form of non-cash asset
The capital account balances of the partners on July 1, 2019 before any adjustments are as follows:
A, Capital (20%) 150,000
B, Capital (30%) 250,000
C, Capital (50%) 100,000
500,000
The partnership profit is P900,000 for the six moths ended July 1, 2019.
On July1, 2019 C retires. It was agreed that C shall receive P500,000 and equipment with carrying amount of P100,00
and fair value of P300,000 in settlement of his interest in the partnership. Required journal entries.
Solution: Profit shares and revaluation of the asset
A (20%) B (30%) C (50%) Total
Unadjusted balance 150,000 250,000 100,000 500,000
Share in profit
(900K x (20%; 30%; 50%) 180,000 270,000 450,000 900,000
Share in revaluation
gain (300,000-100,000) x
20%,30% & 50%) 40,000 60,000 100,000 200,000

Adjusted balance 370,000 580,000 650,000 1,600,000

Journal entries: 1st – Income summary 900,000

A, Capital 180,000 3 rd - C, Capita[ 650,000
B, Capital 270,000 A, Capital 60,000*
C, Capital 450,000 B, Capital 90,000
To record distribution of profit Cash 500,000

2nd – Equipment (300,000-100,000) 200,000 Equipment 300,000

A, Capital 40,000 To record settlement of C
B, Capital 60,000
C, Capital 100,000 ( 500,000+3000 – 800,000-650,000=150,000
To record the revaluation increase in equipment 150,000 x 20%/50%= 60,000* )
 d. Death of a partner – purchase of interest by partnership
The capital account balances of the partners on July 1, 2019 before any adjustments are as follows:

A, Capital (20%) 150,000

B, Capital (30%) 250,000
C, Capital (50%) 100,000
500,000

The partnership profit is P900,000 for the six moths ended July 1, 2019.

On July1, 2019, C dies. It was agreed that C shall receive P500,000 and equipment with carrying amount of P100,00
and fair value of P300,000 in settlement of his interest in the partnership. Required journal entries.

Journal entries

July1, 2019 – C, Capital 650,000

A, Capital (150,000 x 20%/50%) 60,000
B, Capital ( 150,000 x 30%/50%) 90,000
Liability to the estate of C 800,000
To record the transfer of C’s interest to a liability account
Illustration 2: Retirement of a partner- Personal accounts

The balance sheet of ABC Co. as of December 2019, shows the following information:
Cash 112,000
Receivable from A 8,000
Equipment 390,000
Total 510,000

Payable to C 10,000
A, Capital (20%) 150,000
B, Capital (30%) 250,00
C, Capital (50%) 100,000

On December 31, 2019 , C decided to retire from the partnership. The partnership net assets approximate their
Values except for the equipment which has a fair value of P450,000.

It was agreed that the partnership would pay C for P140,000for his partnership interest, including C’s loan which is to be repaid in full.
Required: What are the balances of A and B’s capital accounts after the retirement of C?

Solution: Adjustment of capital balances

A (20%) B (30%) C (50%) Total
Unadjusted balance 150,000 250,000 100,000 500,000
Share in revaluation
(450,000-390,000) x20%,30%&50%) 12,000 18,000 30,000 60,000
Adjusted balance 162,000 268,000 130,000 560,000

Journal entry - Payable to C 10,000

C, Capital 130,000
Cash 140,000
To record the settlement to C
 Incorporation of a partnership
Another instance that causes partnership dissolution is the incorporation of a partnership. When a partnership is converted
into corporation, the partners’ relation changes – they cease to be partners and become stockholder.

When a partnership is converted into a corporation, the corporation acquires the assets and assumes the liabilities of the
partnership and in return issues shares of stocks to the partners.

On date of incorporation:

a. The partners’ 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.
Illustration Incorporation of a partnership
On January 1, 2019 , the partners of ABC Partnership decide to admit other investors. As a result the partnership
shall be converted to a corporation. The following information was determined: Increase
Carrying amounts Fair values (Decrease)
Cash 20,000 20,000
Accounts receivable 60,000 40,000 (20,000)
Inventory 80,000 70,000 (10,000)
Equipment 540,000 670,000 130,000
Payables 50,000 50,000 -
A, Capital (20%) 150,000 N/A
B, Capital (30%) 200,000 N/A
C, Capital (50%) 300,000 N/A

The corporation has an authorized capitalization of P2,000,000 divided into 200,000 ordinary shares with par value of P10
per shares. Assume that the adjusted capital balances of the partners are used in determining the number of shares to be
issued to each partner.

Required: a. What is the aggregate par value of the shares issued to A,B and C, respectively?
b. How many shares are issued to each of the partners?
c. Journal entries.

Solution: a. A (20%) B (30%) C (50%) Total

Unadjusted balance 150,000 200,000 300,000 650,000
Share in revaluation
(100,000 x 20%; 30%&50%) 20,000 30,000 50,000 100,000
Adjusted balances 170,000 230,000 350,000 750,000

Ans. The total par value of the shares issued to the partner is P750,000 the adjusted net assets
b. The number of shares issued to each partner
A B C Total
Adjusted capital balances 170,000 230,000 350,000 750,000
Divided by: Par value per share 10/share 10/share 10/share 10/share
Number of shares issued 17,000 23,000 35,000 75,000
Journal entries:
1st - Equipment 130,000
A/R 20,000
Inventory 10,000
A, Capital 20,000
B, Capital 30,000
C, Capital 50,000
To adjust the net assets of the partnership

2nd - A, Capital 170,000

B, Capital 230,000
C, Capital 350,000
Payables 50,000
Cash 20,000
A/R 40,000
Inventory 70,000
Equipment 670,000
To close the books of partnership
3rd - Cash 20,000
A/R 40,000
Inventory 70,000
Equipment 670,000
Payables 50,000
Share capital 750,000
To record initial investments
 Summary

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

 Example of events that result to partnership dissolution:

1. Admission of a partner
2. Withdrawal, retirement or death of a partner
3. 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 value.

 Any revaluation increase or decrease is allocated to all of the existing partners’ capital accounts
as at the date of dissolution.

End of presentation