PARTNERSHIP DISSOLUTION 1

Dissolution refers to the termination of the life of an existing partnership. The dissolution of an old partnership may be followed by:

a. The formation of a new partnership. This is known as dissolution by change in ownership structure. The new partnership
continues the business activities of the dissolved partnership without interruption.

b. Liquidation. This refers to the termination of business activities carried on by the partnership and the winding up of
partnership affairs preparatory to going out of business. This involves the sale or conversion of assets into cash, paying
creditors, and distributing the remaining cash to the partners.

Thus, a partnership may be dissolved without being liquidated. While dissolution may result to the liquidation of a partnership,
liquidation always results to dissolution. Accounting problems are usually encountered in the following:
1. Admission of a partner
2. Withdrawal or Retirement of a partner
3. Death of a partner
4. Incorporation of a Partnership (Chapter 6)

ADMISSION OF A PARTNER
A partner may be admitted in a partnership only with the consent of all the partners, for reasons such as: (a) the need for additional
capital; or (b) the need for skills or expertise of a particular person; or (c) present partners may want to reduce interest. Upon
admission of a new partner, a new partnership agreement covering the partners' interest, sharing of profit and loss and other
considerations should be drawn because the dissolution of the original partnership cancels the old agreement. New partners may be
admitted either by any of the following:
A. Purchase of an interest from present partners; or
B. Investment of assets in the partnership.

Regardless of the method of recording the admission of a new partner, an equitable relationship in the new partnership ordinarily
requires that the assets in the existing partnership be adjusted to fair market value before admission of the new partner. The change
in asset values should be reflected in the existing partners' capital accounts according to their profit and loss sharing ratio.

A. ADMISSION BY PURCHASE OF AN INTEREST

Illustrative Problem:
On June 30 of the current year, Dexter and Timothy have capital balances of P 120,000 and P 180,000 and divide profits and losses in
the ratio 60% and 40% respectively. JM is admitted as a new partner under the following independent cases:

Case 1: JM purchased one-half of the interest of Dexter for P60,000.

Case 2: JM purchased one-half interest in the partnership for P150,000.
Case 3: JM purchased one-half of the interest of Dexter for P72,000.
Case 4: JM purchased one-half interest in the partnership for P175,000.
Case 5: JM purchased one-half of the interest of Dexter for P54,000.
Case 6: JM purchased one-half interest in the partnership for P140,000.

The entry to record the admission of JM and the resulting capital balances and profit and loss ratio of the partners immediately after
the admission of JM, under the independent cases above is presented below.

Case 1: Purchase of interest from one partner at book value

Dexter, Capital 60,000

JM, Capital 60,000
To record JM's admission.
 PARTNERSHIP DISSOLUTION 2

The resulting capital balances and profit and loss ratio of the partners will be:
Old Capital New Capital Old New
Transfer P/L Ratio Transfer P/L Ratio
Dexter P 120,000 (60,000) P 60,000 60% (30%) 30%
Timothy 180,000 180,000 40% 40%
JM 60,000* 60,000 30%* 30%
Total P 300,000 P 300,000 100% 100%

* Since JM purchased one-half of the interest of Dexter, he gets one-half of both the capital and profit share of Dexter.

Case 2: Purchase of interest from all partners at book value

Dexter, Capital 60,000

Timothy, Capita 90,000
JM, Capital 150,000
To record JM's admission.

The resulting capital balances and profit and loss ratio of the partners will be:
Old Capital New Capital Old P/L New P/L
Transfer Ratio Transfer Ratio
Dexter P 120,000 (60,000) P 60,000 60% (30%) 30%
Timothy 180,000 (90,000) 90,000 40% (20%) 20%
JM 150,000 150,000 50% 50%
Total P 300,000 P 300,000 100% 100%

* Since JM purchased one-half of the interest of both partners, he gets one-half of both the capital and profit shares of both
partners.

Case 3: Purchase of interest from one partner at greater than book value

The journal entry to record the admission of JM as well as the new capital balances and profit and loss ratio of the partners will be the
same as in Case 1. Dexter shall enjoy the gain of P 12,000 since this is a personal transaction between Dexter and JM. Only the transfer
of capital is to be reflected in partnership books.

Case 4: Purchase of interest from all partners at greater than book value

The journal entry to record the admission of JM as well as the new capital balances and profit and loss ratio of the partners will be the
same as in Case 2. The difference of P 25,000, between the purchase price of P 175,000 and book value of interest purchased of P
150,000, is considered a personal profit to Dexter and Timothy, and therefore not recognized by the partnership. Only the transfer of
capital is to be reflected in partnership books.

The purchase price of P 175,000 is to be divided between Dexter and Timothy based on the ratio of the interest sold to JM, computed
as follows:

Dexter Timothy Total

Interest sold P 60,000 P 90,000 P 150,000
Excess (6:4) 15,000 10,000 25,000
Total Payment P 75,000 P 100,000 P 175,000

Case 5: Purchase of interest from one partner at less than book value

The journal entry to record the admission of JM as well as the new capital balances and profit and loss ratio of the partners will be the
same as in Case 1. Dexter shall bear the loss of P 6,000 since this is a personal transaction between Dexter and JM. Only the transfer
of capital is to be reflected in partnership books.
 PARTNERSHIP DISSOLUTION 3

Case 6: Purchase of interest from all partner at less than book value

The journal entry to record the admission of JM as well as the new capital balances and profit and loss ratio of the partners will be the
same as in Case 2. The loss amounting to P 10,000, is considered a personal loss to Dexter and Timothy and therefore not recognized
by the partnership. Only the transfer of capital is to be reflected in partnership books.

The purchase price of P 140,000 is to be divided between Dexter and Timothy based on the ratio of the interest sold to JM, computed
as follows:

Dexter Timothy Total

Interest sold P 60,000 P 90,000 P 150,000
Deficit (6:4) (6,000) (4,000) (10,000)
Total Payment P 54,000 P 86,000 P 140,000

In all the above cases, the transfer of capital from the old partners to the new partner is recorded at book value regardless of the
amount paid. Payment at “less than” and at “more than” book value is recorded as if they were made at book value. In addition, all
cases show that the total partnership capital before and after admission of a new partner remains at P 300,000.

PURCHASE OF INTEREST ACCOUNTED AT OTHER THAN BOOK VALUE:

In actual practice however, in as much as the will of the partners may prevail, the partnership may choose to ignore the standard
(Accounting at Book Value Approach) and apply other traditional methods.

Partnership assets may be adjusted using the price paid by the buyer (new partner) as the implied value of the partnership. Thus,
when the purchase price is greater than book value of interest purchased, it is accounted for as either an undervaluation of existing
partnership assets or an implied goodwill to the old partners. However, goodwill is no longer acceptable under PFRS No. 3. In the same
manner, when the interest of partner/s is purchased at a price lower than book value, it shall be accounted for as if the existing
partnership assets are overvalued. The amount of asset revaluation shall be adjusted to the old partners’ capital accounts in
accordance with their old profit and loss ratio.

Using the same (preceding) problem, the accounting for purchase of interest under the Revaluation Method is shown below:

Purchase at more than book value

Case 3: Purchase of interest from one partner at greater than book value

Assets 40,000
Dexter, Capital (60%) 24,000
Timothy, Capital (40%) 16,000
To adjust the value of partnership assets.

Purchase price P 72,000

BV interest purchased (1/2 x P 120,0000) 60,000
Difference P 12,000
% of interest purchased (1/2 x 60%) 30%
Total Undervaluation of Assets P 40,000

Dexter, Capital [(120,000 + 24,000) x ½] 72,000

JM, Capital 72,000
To record JM's admission.
 PARTNERSHIP DISSOLUTION 4

The resulting capital balances of the partners will be:

Old Capital Share in Capital after New Capital
Revaluation Revaluation Transfer
Dexter P 120,000 P 24,000 P 144,000 (72,000) P 72,000
Timothy 180,000 16,000 196,000 196,000
JM 72,000* 72,000
Total P 300,000 P 40,000 P 340,000 P 340,000

The resulting profit and loss ratio of the partners will be:
Old P/L New P/L
Ratio Transfer Ratio
Dexter 60% (30%) 30%
Timothy 40% 40%
JM 30%* 30%
Total 100% 100%

Case 4: Purchase of interest from all partners at greater than book value

Assets 50,000
Dexter, Capital (60%) 30,000
Timothy, Capital (40%) 20,000
To adjust the value of partnership assets.

Purchase price P 175,000

BV interest purchased (1/2 x P 300,000) 150,000
Difference P 25,000
% of interest purchased (1/2 x 100%) 50%
Total Undervaluation of Assets P 50,000

Dexter, Capital [(120,000 + 30,000) x ½] 75,000

Timothy, Capital [(180,000 + 20,000) x ½] 100,000
JM, Capital 175,000
To record JM's admission.

The resulting capital balances of the partners will be:

Old Capital Share in Capital after New Capital
Revaluation Revaluation Transfer
Dexter P 120,000 P 30,000 P 150,000 (75,000) P 75,000
Timothy 180,000 20,000 200,000 (100,000) 100,000
JM 175,000* 175,000
Total P 300,000 P 50,000 P 350,000 P 350,000

The resulting capital balances and profit and loss ratio of the partners will be:
Old P/L New
Ratio Transfer P/L Ratio
Dexter 60% (30%) 30%
Timothy 40% (20%) 20%
JM 50%* 50%
Total 100% 100%

PURCHASE AT LESS THAN BOOK VALUE

Case 5: Purchase of interest from one partner at less than book value
Dexter, Capital (60%) 12,000
Timothy, Capital (40%) 8,000
Assets 20,000
To adjust the value of partnership assets.
 PARTNERSHIP DISSOLUTION 5

Purchase price P 54,000

BV interest purchased (1/2 x P 120,0000) 60,000
Difference (P 6,000)
% of interest purchased (1/2 x 60%) 30%
Total Overvaluation of Assets P 20,000

Dexter, Capital [(120,000 - 12,000) x ½] 54,000

JM, Capital 54,000
To record JM's admission.

The resulting capital balances and profit and loss ratio of the partners will be:
Old Capital Share in Capital after New Capital
Revaluation Revaluation Transfer
Dexter P 120,000 (P 12,000) P 108,000 (54,000) P 54,000
Timothy 180,000 (8,000) 172,000 172,000
JM 54,000* 54,000
Total P 300,000 (P 20,000) P 280,000 P 280,000

The resulting capital balances and profit and loss ratio of the partners will be:
Old P/L New P/L
Ratio Transfer Ratio
Dexter 60% (30%) 30%
Timothy 40% 40%
JM 30%* 30%
Total 100% 100%

Case 6: Purchase of interest from all partners at less than book value

Dexter, Capital (60%) 12,000

Timothy, Capital (40%) 8,000
Assets 20,000
To adjust the value of partnership assets.

Purchase price P 140,000

BV interest purchased (1/2 x P 300,000) 150,000
Difference (P 10,000)
% of interest purchased (1/2 x 100%) 50%
Total Overvaluation of Assets P 20,000

Dexter, Capital [(120,000 - 12,000) x ½] 54,000

Timothy, Capital [(180,000 - 8,000) x ½] 86,000
JM, Capital 140,000
To record JM's admission.

The resulting capital balances of the partners will be:

Old Capital Share in Capital after New Capital
Revaluation Revaluation Transfer
Dexter P 120,000 (P 12,000) P 108,000 (54,000) P 54,000
Timothy 180,000 (8,000) 172,000 (86,000) 86,000
JM 140,000* 140,000
Total P 300,000 (P 20,000) P 280,000 P 280,000
 PARTNERSHIP DISSOLUTION 6

The resulting profit and loss ratio of the partners will be:
Old P/L New
Ratio Transfer P/L Ratio
Dexter 60% (30%) 30%
Timothy 40% (20%) 20%
JM 50%* 50%
Total 100% 100%

A. ADMISSION BY INVESTMENT
When a new partner is admitted by means of an investment of cash or other assets, there is an increase in the partnership tangible
assets. Unlike the admission by purchase, the price paid is relevant because this now becomes a transaction between the
partnership and the incoming or new partner. The investment of the new partner may be:

1. equal to the capital balance acquired (agreed capital)

2. more than the capital balance acquired (bonus to new partner)
3. less than the capital balance acquired (bonus to old partners)

Investment equal to the agreed capital of the new partner

Under this situation, the entry to record the admission of the new partner is simply a debit to cash or other asset and credit to the
new partner's capital account. In the partnership of Dexter and Timothy, the present capital is P 300,000 with balances of P 120,000
for Dexter and P 180,000 for Timothy. JM is admitted into the partnership and contributes enough cash for a one-fifth interest in
the new firm's capital. If the interest of the new partner is one-fifth (1/5), then the interest of the old partners is equivalent to
four-fifths (4/5). The total capital of the new partnership is P 375,000 [(P 300,000 /(4/5)]. JM, therefore, contributes P 75,000 (1/5 of
P 375,000). The entry will be:

Cash 75,000
JM, Capital 75,000
To record JM's admission.

The resulting capital balances of the partners will be:

Agreed Capital Contributed Difference
Computation Capital
Dexter P 120,000 P 120,000
Timothy 180,000 180,000
JM 75,000 (2) P 375,500 x 1/5 75,000
Total P 375,000 (1) P 300,000 ¸ 4/5 P 375,000 -

The resulting profit and loss ratio of the partners will be:
Old P/L New P/L
Ratio Computation Ratio
Dexter 50% 4/5 x 50% 40%
Timothy 50% 4/5 x 50% 40%
JM 1/5 or 20% 20%
Total 100% 100%

Investment more/less than the agreed capital of the new partner

If a partner has special skills or expertise, this skill is frequently recognized by crediting his capital account with a bonus or crediting
his account with the amount of goodwill established as an asset. The admission of the new partner and contribution of assets may be
recorded on the basis of any of the following methods: the goodwill method or the bonus method. However, since goodwill method
is no longer acceptable under PFRS 3, only the bonus method shall be accepted.

The BONUS METHOD is based upon the historical cost principle. Admission of a new partner involves debiting cash or
other assets at the FMV of the asses contributed and crediting the new partner’s capital for the agreed percentage of
total capital. Total capital
PARTNERSHIP DISSOLUTION 7
 PARTNERSHIP DISSOLUTION 8

Case 1: No bonus (New Partner’s AC = New Partner’s CC)

JM invests P 150,000 and is to be credited for the same amount given to him with a one-third (1/3) interest in the partnership. The
entry to record the admission of JM is:

Cash 150,000
JM, Capital 150,000

Computation:
AC CC1 Difference4
Old partners P 300,0003 450,000 – 150,000 = 300,000 P 300,000 -
New Partner 150,000 150,000 -
Total P 450,000 2 150,000 ¸ ⅓ = 450,000 P 450,000 -

Case 2: Bonus to old partners (New Partner’s AC < New Partner’s CC)

JM invests P 180,000 for a one-third interest in the partnership. The new total agreed capital of the firm is P 480,000. The
following entries are made:

Cash 180,000
JM, Capital 180,000
To record JM's investment.

JM, Capital 20,000

Dexter, Capital (60%) 12,000
Timothy, Capital (40%) 8,000
To record bonus to old partners.

Computation:
AC CC1 Difference4
Old partners P 320,0003 480,000 – 160,000 = 320,000 P 300,000 P 20,000
New Partner 160,0002 480,000 x ⅓ = 160,000 180,000 (20,000)
Total P 480,000 P 480,000 -

Case 3: Bonus to new partner (New Partner’s AC > New Partner’s CC)

JM invests P 120,000 for a one-third interest in the partnership. The new total agreed capital is P 420,000. The following entries are
made:

Cash 120,000
JM, Capital 120,000
To record JM's investment.

Dexter, Capital (60%) 12,000

Timothy, Capital (40%) 8,000
JM, Capital 20,000
To record bonus to new partner.

Computation:
AC CC1 Difference4
Old partners P 280,0003 420,000 – 140,000 = 280,000 P 300,000 (P 20,000)
New Partner 140,0002 420,000 x ⅓ = 140,000 120,000 20,000
Total P 420,000 P 420,000 -
 PARTNERSHIP DISSOLUTION 9

Under all of the cases above, a new profit and loss sharing ratio is to be computed after the admission of JM, as follows:

Old P/L Computation New P/L

Dexter 50% ⅔ x 50% 33⅓ %
Timothy 50% ⅔ x 50% 33⅓ %
JM ⅓ or 33⅓ % 33⅓%
Total 100% 100 %

RETIREMENT / WITHDRAWAL OF A PARTNER

The withdrawing or retiring partner is entitled to the value of his interest in the partnership as of the date of withdrawal or retirement.
To arrive at the fair amount of what is due to the retiree, adjustments may be made on the books such as:
1. correction of accounting errors affecting income,
2. revaluation of assets to market value, and
3. recognition of partnership goodwill.

A withdrawing/retiring partner may sell his interest to any of the following:

1. An outsider
2. Another partner
3. Partnership

To illustrate, assume the following balances on December 31 of the current year:

Dexter Timothy JM
Capital Balances P 120,000 P 180,000 P 50,000
Profit and loss ratio 50% 30% 20%

On December 31, Dexter withdraws from the partnership. The net income of the partnership for the six months ended December 31
is P 120,000. It was discovered that depreciation in the amount of P 6,000 has not been recorded last year (when JM is not yet admitted
as partner and Dexter and Timothy share Profits and Losses in the ratio 6:4) and that the inventories are undervalued by P 14,000.
The following entries are made:

Case 1: Settlement Equal to withdrawing partner's interest

Income Summary 120,000

Dexter, Capital (50%) 60,000
Timothy, Capital (30%) 36,000
JM, Capital (20%) 24,000
To close the income summary account.

Inventories 14,000
Dexter, Capital (50%) 7,000
Timothy, Capital (30%) 4,200
JM, Capital (20%) 2,800
To adjust the value of partnership asset.

Dexter, Capital (60%) 3,600

Timothy, Capital (40%) 2,400
Accumulated Depreciation 6,000
To record prior period adjustment.

Dexter, Capital 183,400

Cash 183,400
To record the retirement of Dexter.
 PARTNERSHIP DISSOLUTION 10

Computation:
Capital -Unadjusted P 120,000
Adjustments:
Share in Net Income P 60,000
Adjustment of assets 7,000
Prior period adjustment (3,600) 63,400
Capital – adjusted P 183,400

Case 2: Settlement More than the withdrawing partner's interest

When the withdrawing partner is paid an amount more than his interest, the excess payment can be viewed as follows:

a. Bonus from the remaining partners (Bonus Method).

b. Undervaluation of partnership assets (Revaluation Method)
c. Goodwill to the withdrawing partner only
d. Total implied goodwill of the partnership computed by dividing the excess payment with the withdrawing partner's profit and
loss sharing ratio.

When the problem is silent regarding any indication for revaluation of assets, then the bonus method shall be applied. Otherwise, use
the revaluation method to the extent of revaluation and then apply bonus method for the balance. Thus, if Dexter is paid P 185,000
for her interest, the related entries under the abovementioned approaRIPs shall be as follows:

a. Record Bonus From the Remaining Partners (Bonus Method)

Dexter, Capital 183,400
Timothy, Capital (3/5 x 1,600) 960
JM, Capital (2/5 x 1,600) 640
Cash 185,000
To record the settlement with Dexter.

b. Adjust Understated Assets (Revaluation Method)

If the difference is attributable to undervaluation of the partnership’s fixed assets, the related entries would be:
Accumulated depreciation (1,600 / 50%) 3,200
Dexter, Capital (50%) 1,600
Timothy, Capital (30%) 960
JM, Capital (20%) 640
To adjust the value of partnership asset.

Dexter, Capital 185,000

Cash 185,000
To record the settlement with Dexter.

(See Appendix on the application of Goodwill Method on Withdrawal of a Partner)

Case 3: Settlement less than withdrawing partners' interest

In cases where the withdrawal of a partner requires payment for less than the partner's interest, the difference may be attributed as:
a. Bonus to the remaining partners (Bonus Method)
b. Overvaluation of partnership assets (Revaluation Method)
Again, the bonus method shall be applied if there is no indication for adjustment on the value of partnership assets. Otherwise, use
the revaluation method to the extent of revaluation and then apply bonus method for any balance.

On the other hand, if Dexter is paid P 180,000 for her interest, the related entries under each of the foregoing approaRIPs are as
follows:
a. Record Bonus to Remaining Partners (Bonus Method)
Dexter, Capital 183,400
Cash 180,000
Timothy, Capital (3/5 x 3,400) 2,040
 PARTNERSHIP DISSOLUTION 11

JM, Capital (2/5 x 3,400) 1,360

To record the settlement with Dexter.

a. Adjust Overstated Assets (Revaluation Method)

If the difference is attributable to overvaluation of the partnership’s fixed assets, the related entries would be:

Dexter, Capital (50%) 3,400

Timothy, Capital (30%) 2,040
JM, Capital (20%) 1,360
Accumulated depreciation (3,400 / 50%) 6,800
To adjust the value of partnership asset.

Dexter, Capital 180,000

Cash 180,000
To record the settlement with Dexter.

DEATH OF A PARTNER
The following agreement should be provided for between the partners, in case of death of a partner:

1. Closing of the Books

2. Amount of profits on which the dead partner may share
3. Valuation of assets
4. Terms of payment
5. Insurance on Partners’ Lives

To illustrate, assume that Miller, Ryan, Dexter and RIP are partners sharing profits and losses in the ratio of 5:3:2:5 respectively. On
January 1 of the current year, their capital balances showed:
Miller P 440,000 Dexter P 288,400
Ryan 344,000 RIP 200,000

RIP, the managing partner, died on September 1. The books were closed on this date and net profits for the eight-month
period amounted to P135,864. After negotiations with the remaining partners, the estate of the deceased partner agreed to accept
as full settlement a one-year 12% note for P200,000 and the balance in cash.

Assuming an immediate settlement of the estate is desired, the following entries are prepared:

Revenue and Expense Summary 135,864

Miller, Capital (5/15) 45,288
Ryan, Capital (3/15) 27,173
Dexter, Capital (2/15) 18,115
RIP, Capital (5/15) 45,288
To close net income.

RIP, Capital 245,448

Cash 45,448
Notes Payable 200,000
To record settlement with estate of RIP.

Assuming that the firm continued operations until December 31 which is the end of the fiscal period and realized a net profit of
P207,000, the following entries are prepared:

Revenue and Expense Summary 138,000

Miller, Capital (5/15) 46,000
Ryan, Capital (3/15) 27,600
Dexter, Capital (2/15) 18,400
RIP, Capital (5/15) 46,000
To record distribution of profit prior to death RIP.
 PARTNERSHIP DISSOLUTION 12

Computation:
Total net profit P 207,000
x Fraction of year (Jan 1 – Sept 1) 8/12
Net profit prior to death P 138,000

Revenue and Expense Summary 69,000

Miller, Capital (5/10) 34,500
Ryan, Capital (3/10) 20,700
Dexter, Capital (2/10) 13,800
To record distribution of profit after the death RIP.

Computation:
Total net profit P 207,000
Net profit prior to death (138,000)
Net profit after death P 69,000

RIP, Capital 246,000

Cash 46,000
Notes Payable 200,000
To record settlement with estate of RIP.