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    Partnership Dissolution and Change in Capital Structure PDF

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    Partnership Dissolution and Change in Capital Structure PDF

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    CHAPTER 4 PARTNERSHIP DISSOLUTION LEARNING OBJECTIVES 1. Define parmership dissolution and identify the conditions giving rise to it. 2. Understand the accounting procedures to record the admission of a new partner by purchase. 3. Understand the accounting procedures to record the admission of a new partner by investment. PREVIEW OF THE CHAPTER PARTNERSHIP DISSOLUTION I Causes of Admission by Admission by Dissolution Purchase Investment Admission of a new * Sale of interest at = Capital credit equal partner book value to capital Retirement of a = Sale of interest at contribution partner less than book value * Capital credit not Death, incapacity, or | | * Sale of interest at equal to capital bankruptcy of a more than book contribution partner value * Bonus method Incorporation of a = Asset revaluation partnership method PARTNERSHIP DISSOLUTION Dissolution is defined in Article 1825 of the Civil Code of the Philippines as the change in the relation of the partners caused by any partner ceasing to be associated in the carrying out of the business. eter ene Dissolution Dissolution refers to the teminstion of the lie of a” eXstnE PATMESNP. Thy dissolution of an old partnership may be followed by own as dissolution by change jy lL. Th ic i ¢ formation of a new partnership. This is KNOWN Mines activities of thy ownership structure. The new partnership continues the dissolved partnership without interruption. ness activities carried on by 2. Liquidation. This the bust iqi This refers to the termination of ratory to going oy, the partnership and the winding up of partnership affairs PreP: of business. Dissolution, therfore, doesnot always result to lguidation although liquidation is alway, preceded by dissolution, CONDITIONS RESULTING TO PARTNERSHIP DISSOLUTION The following conditions will result to partnership dissolution by a change in ownership ‘structure: . Admission of a new partner . Retirement or withdrawal of a partner . Death, incapacity or bankruptcy of a partner Incorporation of a partnership Ree Accounting for admission of a new partner is discussed in this chapter. Accounting for retirement, withdrawal, incapacity or bankruptcy and death of a partner is discussed in the next chapter. ADMISSION OF A NEW PARTNER ‘A new partner, with the consent of all the partners, may be admitted in an existing partnership. Upon admission of a new partner, the firm is automatically dissolved and a new partnership is formed. All the partners draw a new contract, Articles of Co- Partnership. The admission of a new partner gives rise to the following accounting problems: 1, Determination of the profit or loss from the beginning of the accounting period 0 the date of admission of a new partner and the distribution of such profit or loss to the old partners. 2. Correction of accounting errors in prior periods like overstatement of understatement of inventories, excessive depreciation charges and failure to provide adequately for doubtful accounts Chapter 4 ~ Parmership Dissolution 139 Parmership Disoluion 3. Revaluation of accounts which may call for the restatement of the existing assets Of the partnership to appraised or fair market values and recognition of unrecorded liabilities of the firm. All adjustments to the accounts give rise to Profit or loss; such adjustments are recorded in the partnership books as increase or decrease in capital shared according to partners’ profit and loss ratio. 4. Closing of the partnership books. TYPES OF ADMISSION OF A NEW PARTNER A new partner may be admitted into a partnership by: 1. Purchase of interest from one or more of the original (old) partners; or 2. Investment or asset contributions to the partnership ADMISSION BY PURCHASE With the consent of all the partners, a new partner may be admitted in an existing partnership by purchasing a capital equity interest directly from one or more of the old partners. Terms such as purchases, sells, pays, bought, sold and transferred indicate admission by purchase. The sale to a new partner of an old partner's interest in an existing partnership is a personal transaction between the selling partner and the buying partner. The amount paid by the partner who purchases an interest goes personally to the partner who sells his or her interest; the amount paid does not go to the partnership, The only entry required on the partnership books is the recording of the transfer of capital from the capital account of the selling partner to that of the buying partner. The amount of capital transferred will be equal to the book value of the interest sold regardless of the amount paid. The pro-form entry is: (Name of seller), Capital XXX (Name of buyer), Capital Xxx The purchase price of the interest sold to the new partner may be: 1. equal to the book value of interest sold * 2. less than the book value of interest sold 3. more than the book value of interest sold “The new partner may pay more than or less than the book value of the interest sold by the old partner resulting in a gain or loss in the transaction. This gain or loss, however, is a winership Dissolution Chapter Personal gain or loss of the selling partner and not of the partnership ee oF loss is recognized in the partnership books. Ilustrative Problem A: Coloma and Claudio are partners with capital ce 4 100,000 and P50,000, respectively. ‘They share profits and losses equally. Cordero isa new partner, Case 1a — Purchase at book value from one partner only. Cordero purchases l/s interest from Coloma by paying P20,000. Coloma, Capital 20,000 Cordero, Capital eats P100,000 x 1/5 = P20,000 The P20,000 paid by the new partner Cordero to the old partner Coloma should not be reflected in the partnership books because the said amount goes directly to Coloma. What is recorded in the partnership books is the transfer of 1/5 of the capital of Coloma to Cordero. The amount paid in the purchase is equal to the book value of the acquired 1/5 interest; hence, the sale of interest does not give rise to gain or loss to Coloma. Case 1b — Purchase at book value from more than one partner. Cordero purchases 1/5 interest from the old partners by paying P30,000. Coloma, Capital 20,000 Claudio, Capital 10,000 Cordero, Capital 30,000 P100,000 x 1/5 = P20,000 P 50,000 x 1/5 = P10,000 The P30,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership books because the said amount goes directly to Coloma and Claudio. What is recorded in the partnership books is the transfer of 1/5 of the capital of the old partners Coloma and Claudio (P20,000 and P10,000, respectively) to the new partner Cordero. The admission of the new partner, by purchasing a 1/5 interest from the old partners at book value, does not result in a gain or loss to the old partners. Case 2 Purchase at less than book value. Cordero purchases 1/5 interest from the old partners by paying P25,000. Coloma, Capital 20,000 Claudio, Capital 10,000 . Cordero, Capital 30,000 P100,000 x 1/5 = P20,000 P 50,000 x 1/: uw Chapter 4 Partnership Dissolution The P25,000 paid by Cordero to Coloma and Claudio should not be reflected in the partnership books because the said amount was paid directly to the partners. What is recorded in the partnership books is the transfer of 1/5 of the capital of the old partners (P20,000 and P10,000, respectively) to the new partner. ‘The difference of P5.000 is personal loss of the selling (old) partners. Case 3 - Purchase at more than book value, Cordero pays R40,000 for a 1/5 interest of the old partners. Coloma, Capital 20,000 Claudio, Capital 10,000 Cordero, Capital 30,000 The P40,000 payment made by Cordero to Coloma and Claudio should not be reflected in the partnership books. What is recorded in the books of the partnership is the transfer of 1/5 of the capital of the old partners to the new partner. The P10,000 excess payment is a personal gain of Coloma and Claudio Key Points. In the preceding four cases, 1a, 1b, 2 and 3, the transfer of capital from the old partners to the new partner is recorded at book value regardless of the amount paid. Payments at less than book value and at more than book value are recorded as if they were made at book value. In addition, the four cases show that the total partnership capital before and after the admission of the new partner are the same. Thus, the total partnership capital of 150,000 before the admission of Cordero is also the total partnership capital after his, admission. Therefore, the admission of a new partner by purchase will not affect the total assets and the total capital of the partnership. ASSET REVALUATION UPON ADMISSION OF A NEW PARTNER BY PURCHASE Revaluation of assets of the old partnership, however, is generally undertaken prior to the admission of a new partner. The effect of the asset revaluation is carried to the capital accounts of the old partners. The adjusted capital of the old partners becomes the basis. for the interest transferred to the new partner. The procedures under this approach are as follows Step 1- Compute the new partnership capital using as basis the amount to be paid by the incoming partner and his fraction of interest. Step2- Deduct the capital of the old partnership from the capital of the new partnership. The difference is the asset revaluation. Step 3- Allocate the asset revaluation among the old partners in accordance with their residual profit and loss sharing agreement. 1a per rma Dissolution Ch Step 4~ Add the share ofeach partner on the asset revaluation 10 ht capital balances to get the capital balances after the asset revaluation. Step 5- Compute the amount of interest transferred by the old Pareers 1° the! ney partner based on their capital after the asset revaluation. Step 6- Prepare the entry to record the admission of the new partner ‘A where Coloma and Claudio To illustrate, assume the sami : ¢ data in Illustrative Problem tly. They share are partners with capital balances of P100,000 and P50,000, respect¥ profits and losses equally. Cordero is a new partner who purchases @ 1/5 interest from Coloma and Claudio paying P4000. However, before the admission of Cordero, partnership assets are to be revalued using as basis the amount tobe paid PY Cordero. Solution: Step 1- The new partnership capital is equal to the amount paid by the incomng partner divided by his fraction of interest New partnership capital = P40,000 + 1/5 = P200,000 Step 2- The amount of asset revaluation is equal to the new partnership capital less old partnership capital. ‘Asset revaluation = P200,000 — P150,000 = P50,000 Step 3- The allocation of the amount of the asset revaluation among the old partners is as follows: P50,000 / 2 = P25,000 per partner. Step 4- The capital balances of the old partners after asset revaluation 1s equal to their old capital balances plus their share on asset revaluation. Coloma Claudio Capital balances before revaluation P100,000 50,000 Share on asset revaluation __25,000 _25,000 Capital balances after revaluation 125,000 75,000 step 5- The amount of interest transfered by the old partners fo the new partner is based on the new capital balances (capital balances after asset revaluation). Coloma Claudio Capital balances after revaluation 125,000 P75,000 Interest transferred us 15 Capital transferred to Cordero P.25,000 15,000 Chapter 4 Partership Dissolution 143 Step6- The journal entries to record the revaluation of asset and the admission of Cordero are as follows: Other Assets 50,000 Coloma, Capital 25,000 Claudio, Capital 25,000 pecs Se Coloma, Capital 25,000 L C Claudio, Capital 15,000 Cordero, Capital 40,000 Moen Capital balances after the admission of Cordero shall be: Coloma P100,000 + P25,000 — P25,000 P100,000 x Claudio P50,000 + P25,000 - P15,000 60,000 Cordero 40,000 ADMISSION BY INVESTMENT ‘The admission of a new partner by investment is a transaction between the original partnership and the new partner. The use of the terms like invests and contributes represent admission of a new partner by investment. The investment of the new partner increases the total assets and the total capital of the partnership. The entry to record the admission of the new partner depends upon the capital interest credited to the partners” accounts. DEFINITION OF TERMS Agreed Capital (AC) ~ it is the amount of new capital set by the partners for the partnership. It may be equal to, more than, or less than the total contributions of the partners. Other terms used for agreed capital are: new firm capital, total capital and agreed capitalization. The terms of the admission of a new partner may indicate the agreed capital. If agreed capital is not indicated, it can be computed in either of two ways: 1, Investment of the new partner divided by the new partner’s fraction of interest; or 2. Investment of the old partners (equal to the net assets or capital of the partnership) divided by the old partners’ fraction of interest. Example: Corpus and Carlos are partners with capital balances of 150,000 each. Cabral invests P100,000 for a 2/5 interest in the new partnership. The agreed capital of the new partnership is determined as follows: Computation | - The new partner's investment used as a basis, 100,000 = 2/5 = P250,000 Computation 2 - The old partners’ investment used as a basis 300,000 = 3/5 = P500,000 rinership Dissolution a nate tart SET Total Contributed Capital (CC) - it is the investment of all the partners, both old and the capital balances of the old partners (net asset new, to the partnership. It is the sum of tl investment) and the contribution of the new partner. apital is P400,000, the sn, the total contributed ¢ 0,006 rtner’s contribution of Using the information in the example give (00,000 and the new pat sum of the old partners’ contribution of P3 100,000. Bonus ~ it isthe transfer of capital ffom one partner 9 anothes ‘A bonus to the old partners is given by the new partner. It isa reduction 9 the capital of the new partner and aanrvrease inthe capital ofthe old partners. The capital accounts of the old partners are credited according to their profit and loss ratio. “A bonus to the new partner is given by the old partners It isa reduction inthe capital ofthe old partners and an increase in the capital of the new partner. The capital aocount of the new partner is credited and the capital accounts of the old partners are debited according to their profit and loss ratio. ‘The following procedures will be helpful in the computation and determination of the ownership of bonus: 1. Multiply agreed capital (AC) by the faction of interest of the new partner. The result isthe capital credit of the new partner in the new partnership 2, Compare the capital credit with the investment of the new parinr. a. If the capital coedit is more than the investment of the new parine®, the difference is bonus to the new partner. b. Ifthe capital credit i less than the investment of the new partner, the difference is bonus to the old partners Asset Revaluation necessary adjustment in asset values upon admission of a new partner. The adjustment in assets may be determined as the difference between the oreed capital and the total contributed capital, Generally, asset revaluations upon parinership formation relate only to the partners ofthe old partnership. Capital Credit ~ iti the interest oF equity of parmer in the firm. Its computed by multiplying agreed capital by te faction of interest ofa partner. Chapter 4 ~ Partnership Dissolution “ PROBLEMS RELATING TO : ADMISSION OF A NEW PARTNER BY INVESTMENT fitations relating to admission ofa new partner by investment may fall under any ofthe ing 1 wv 4 & Agreed capital is given. When agreed capital is given, the admission of a new Partner by investment will give rise to any of the following cases: 4 No Bonus, no Asset Revaluation b. Bonus to old partners, no Asset Revaluation ¢. Bonus to new partner, no Asset Revaluation Asset Revaluation, no Bonus Agreed capital is not given. When agreed capital is not given, the problem calls for two altemative solutions. a. Bonus method b. Asset revaluation method Agreed capital is not given but the basis for its computation is indicated in the terms of admission. The amount of contribution of the new partner is not given. No fraction of interest for either the new or old partners is given. The following are the illustrations of the various problems involving admission of a new partner by investment. AGREED CAPITAL IS GIVEN Illustrative Problem B; Calma and Castro are partners with capital balances of 200,000 and P100,000, respectively. They share profits and losses equally. Conde is to be admitted in the partnership Case 1 - Yo Bonus, no Asset Revaluation. Conde invests P100,000 for a % interest in the agreed capital of P400,000. Cash 100,000 Conde, Capital 100,000 srmership Disolu tt Solution: Step 1 Fill in the given data in the table. a. Partners, old and new b. AC column, with the total written fist ec. CCcolumn cc ac p 300,000 Me Sea 00,000 ew __ range, PH. —P400,000- Step2 Compare AC and CC. In this ease, AC = CC uation {P400,000 = P400,000), therefore, there is no asset evaluat Step3 Determine if there is bonus. a. Compute for the capital credit ‘AC x fraction of interest; b. Write this amount in the AC column cc. Compare the new partner's AC with are the same, therefore, there is no bonus: of the new partner 400,000 x Y= P100,000 of the new partner his CC. In this case, AC and CC Step 4 The above table will be completed as follows a, ACor capital credit ofthe old partners ‘AC x fraction of interest (4/4—1/4= 74) 400,000 x % = P300,000 b. Acompleted table appears as follows: AC cc Old P 300,000 P 300,000 New 100,000 P__ 400,000, ¢. Conclusion based on the table: (i) AC=CC, therefore, there is no asset revaluation (ii) New partner: AC = CC, therefore, there is no bonus (iii) Old partners: AC = CC, therefore, there is no bonus either. In actual problem solving, only one table is prepared. The missing items are filled as they are needed. uw Chapter 4 ~ Partnership Dissolution Case 2 ~ Bonus to the old partners, no Asset Revaluation. Conde invests P100,000 for a 1/5 interest in the new firm capitalization of P400,000. Cash 100,000 Conde, Capital 100,000 Conde, Capital 20,000 Calma, Capital 10,000 Castro, Capital 10,000 ‘These entries were made to show clearly the transfer of capital from the new partner to the old partners. However, a compound entry may also be prepared as follows: Cash 100,000 Conde, Capital 80,000 Calma, Capital 10,000 Castro, Capital 10,000 Solution: Step 1 Fill in the table as in Case 1. The completed table after Steps 1 to 4 is shown below: AC cc Bonus Old P 320,000 P 300,000 P 20,000 New 80,000 100,000. (20,000) P_ 400,000, P__ 400,000 : Step 2 Compare AC and CC. Ini this case, AC = CC (P400,000 = P400,000). ‘Therefore, there is no asset revaluation but there may be bonus. Step3 Determine if there is bonus. a. Compute for the capital credit of the new partner. ‘AC x fraction of interest, P400,000 x 1/5 = P80,000. b. Write this amount in the AC column of the new partner. ¢. Compare the new partner's AC with his CC. In this case, his ‘AC CC, therefore, they receive the bonus shared according to their profit and loss ratio. Case 3 — Bonus to new partner, no Asset Revaluation. Conde invests P60,000 for a 1/4 interest in the total capitalization of P360,000. Cash 60,000 Calma, Capital 15,000 Castro, Capital 15,000 Conde, Capital 90,000 Solution: Step Fill in the table as in Cases 1 and 2, The completed table after Steps I to 4 is shown below: AC cc Bonus old P 270,000 P- 300,000 P- (30,000) New 90,000 60,000 30,000 P_360,000. _P 360,000 = Step2 Compare AC and CC. In this case, AC = CC (P360,000 = P360,000). Therefore, there is no asset revaluation but there may be bonus, Step3 Determine if there is bonus. ‘Compute for the capital credit of the new partner. ‘AC x fraction of interest; P360,000 x 1/4 = P90, 000. b. Write this amount in the AC column of the new partner. Compare the new partner’s AC with his CC. In this case, his AC > CC (P90,000 ~ P60,000); therefore, the increase in his contributed capital represents bonus from the old partners a. ¢ Step4 Complete the table by filling in the missing figures. a. AC or capital credit of the old partners ‘AC x fraction of interest 360,000 x 3/4 = P270,000 or CC - Bonus to old partners 300,000 — P30,000 = P270,000 The bonus given to the new partner is shared by the old partners according to their profit and loss sharing ratio. b. A completed table is shown in Step 1 Chapter 4~ Partership Dissolution 19 Conclusion based on the table: (i) AC=CC, therefore, there is no asset revaluation. (ii) New partner: AC> CC, therefore, he receives the bonus. (iii) Old partners: AC < CC, therefore, they give the bonus shared according to their profit and loss ratio. Case 4 ~ Positive Asset Revaluation, no Bonus. Conde invests P100.000 for a 1/5 interest in the agreed capital of P500,000, Other Assets 100,000 Calma, Capital 50,000 Castro, Capital 50,000 e 100,000 Conde, Capital 100,000 Solution: Step | Fill in the table as in Cases | to 3. The completed table after Steps 1 to 4 is shown below: Asset AC cc Revaluation Old P 400,000 P 300,000 P 100,000 New 100,000. 100,000 “ P 4 P 100,000 Step2 Compare AC and CC. In this case, AC > CC (P500,000 > 400,000), Therefore, there is a positive asset revaluation. Step3 Determine if there is bonus. a. Compute for the capital credit of the new partner. ‘AC x fraction of interest; P500,000 x 1/5 = P100,000, b. Write this amount in the AC column of the new partner. c. Compare the new partner’s AC with his CC. In this case, his ‘AC = CC (P100,000 = P100,000); therefore, there is no bonus Step4 Complete the table by filling inthe missing figures a, AC or capital credit of the old partners. ‘AC x fraction of interest 500,000 x 4/5 = P400,000 or CC + Asset Revaluation 300,000 + P100,000 = P400,000 b. Acompleted table is shown in Step 1 c. Conclusion based on the table: (i) AC>CC, therefore, there is a positive asset revaluation (ii) New partner: AC = CC, therefore, there is no bonus. (iii) Old partners: AC > CC, therefore, they are credited for the asset revaluation shared according to their profit and loss ratio. 1 Dissolut Chapter 4 Porters " Case 5 ~ Negative interest in the agreed Calma, Capital Asset Revaluation, No bonus, Conde invests POO! capital of P300,000. 000 for a 1/5 ° 000 Case. Capa 30400 Other Assets ° 60,000 Cash 60,000 Conde, Capital 60,000 Solution: Step 1 Fill in the table as in Cases 1 to 4, The completed table after Steps | t0 4 is shown below: Asset AC cc Revaluation Old P 240,000 P 300,000 (P 60,000) New ____60,000_ 60,000 = P_ 300,000 P_ 360,000 P 60,000) Step2 Compare AC and CC. In this case, AC < CC (P300,000 < P360,000). Therefore, there is a negative asset revaluation. Step3 Determine if there is bonus. a. Compute for the capital credit of the new partner. AC x fraction of interest; P300,000 x 1/5 = P60,000. b. Write this amount in the AC column of the new partner. c. Compare the new partner’s AC with his CC. In this ease, his AC = CC (P60,000 = P60,000); therefore, there is no bonus. Step4 Complete the table by filling in the missing figures. a. AC or capital credit of the old partners. ‘AC x fraction of interest 300,000 x 4/5 = P240,000 or CC - Asset Revaluation 300,000 ~ P60,000 = P240,000 b. A completed table is shown in Step | ¢. Conclusion based on the table: (i) AC CC) A positive asset revaluation increases the old partnership assets and the capital accounts of the old partners. The increase is shared by the old partners based on their profit and loss sharing ratio. Here, the agreed capitalization of the new partnership is more than the total amount of contribution of both the old and new partners. Under this method, the agreed capitalization is computed as follows: ‘AC = New partner's CC + new partner’s fraction of interest NEGATIVE ASSET REVALUATION METHOD (AC

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