NORTHERN LUZON ADVENTIST COLLEGE

DEPARTMENT OF BUSINESS EDUCATION

COURSE: ACCOUNTING FOR SPECIAL TRANSACTION

LESSON 4: ACCOUNTING FOR PARTNERSHIP DISSOLUTION

I. Introduction

A partnership rests upon a contractual foundation, therefore, the life span

of a partnership may be somewhat uncertain since it depends on the moods
and relationships of the partners.

II. Learning Outcomes

After reading this chapter, the students should be able to:

 Define partnership dissolution and identify the conditions giving rise to it.
 Understand the accounting procedures to record the admission of a new
partner by purchase and by investment
 Understand the accounting procedures to record the withdrawals of partners

III. Integration of Faith:

"He changes times and seasons; he deposes kings and raises up others.

He gives wisdom to the wise and knowledge to the discerning.” Daniel 2:21

IV. Topics for Reading:

Book: Fundamentals of Accounting / Advanced Accounting 1

Additional Readings:
Introduction to accounting
https://bit.ly/34McCUF
https://bit.ly/31yB2ik
https://bit.ly/3b2pzKS

References:
1. Accounting for Partnership and Corporation (Tolentino-Baysa &
Lupisan, 2018)
2. Financial Accounting and Reporting (Cabrera & Cabrera, 2019)
3. Advanced Accounting 1 (Guerrero & Peralta, 2017)
4. Partnership and Corporation Accounting (Aduana, 2016)
5. Financial Accounting and Reporting (Millan, 2019)
 ACCOUNTING FOR 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.

Dissolution refers to the termination of the life of an existing partnership. The

dissolution of an old partnership may be followed by:

1. 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.

2. Liquidation. This refers to the termination of the business activities carried on by

the partnership and the winding up of partnership affairs preparatory to going
out of business.

Dissolution, therefore, does not always result to liquidation although liquidation is

always preceded by dissolution.

CONDITIONS RESULTING TO PARTNERSHIP DISSOLUTION

The following conditions will result to partnership dissolution by a change in
ownership structure:

1. Admission of a new partner

2. Retirement or withdrawal of a partner
3. Death, incapacity or bankruptcy of a partner
4. Incorporation of a partnership

1. 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.

TYPES OF ADMISSION OF A NEW PARTNER

A new partner may be admitted into a partnership by:

a) Purchase of interest from one or more of the original (old) partners; or
b) 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 form one or more of the
old partners.
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 book 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-forma entry is:

Seller, Capital xxx

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 personal gain or loss of the selling partner and not of the partnership.
Therefore, no gain or loss is recognized in the partnership books.

Illustrative Problem A: Alpha and Bravo are partners with capital balances of
P100,000 and P50,000, respectively. They share profits and losses equally. Charlie is a
new partner.

Case 1a – Purchase at book value from one partner only. Charlie purchases a 1/5
interest from Alpha by paying P20,000.

Alpha, Capital 20,000

Charlie, Capital 20,000
(P100,000 x 1/5 = P20,000)

The P20,000 paid by the new partner Charlie to the old partner Alpha should not be
reflected in the partnership books because the said amount goes directly to Alpha.
What is recorded in the partnership books is the transfer of 1/5 of the capital of
Alpha to Charlie. 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 Alpha.
Case 1b – Purchase at book value from more than one partner. Charlie purchases
1/5 interest from the old partners by paying P30,000.
Alpha, Capital 20,000
Bravo, Capital 30,000
Charlie, Capital 30,000
(P100,000 x 1/5 = P20,000 )
(P50,000 x 1/5 = 10,000)
The P30,000 paid by Charlie to Alpha and Bravo should not be reflected in the
partnership books because the said amount goes directly to Alpha and Bravo.
What is recorded in the partnership books is the transfer of 1/5 of the capital of the
old partners. Alpha and Bravo (P20,000 and P10,000 respectively) to the new
partner Charlie. 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 – Purchased at less than book value. Charlie purchases 1/5 interest from the
old partners by paying P25,000.

Alpha, Capital 20,000

Bravo, Capital 10,000
Charlie, Capital 30,000
(P100,000 x 1/5 = P20,000)
(P50,000 x 1/5 = P10,000)

The P25,000 paid by Charlie to Alpha and Bravo 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 a personal loss of the selling (old) partners.

Case 3 – Purchase at more than book value. Charlie pays P40,000 for a 1/5 interest
of the old partners.

Alpha, Capital 20,000

Bravo Capital 10,000
Charlie Capital 30,000

The P40,000 payment made by Charlie to Alpha and Bravo 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 Alpha and Bravo.

KEYPOINTS: 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 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 P150,000 before the admission
of Charlie is also the total partnership capital after his admission.
Therefore, the admission of a new partner by purchase will not
affect the total asset and the total capital of the partnership.
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:

Total Contributed Capital (TCC) – it is the investment of all the partners, both old
and new, to the partnership. It is the sum of the capital balances of the old partners
(net asset investment) and the contribution of the new partner.

Total Agreed Capital (TAC) – it is the amount of a 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.

Bonus – it is the transfer of capital from one partner to another. A bonus to the old
partner is given by the new partner. And a bonus to new partner is given by the old
partners.

Asset Revaluation – necessary adjustment in asset values upon admission of a new

partner. The adjustment in assets may be determine as the difference between the
agreed capital and the total contributed capital.

PROBLEMS RELATING TO ADMISSION OF A NEW PARTNER BY INVESTMENT

Situations relating to admission of a new partner by investment may fall under any
of the following:

1. 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:

a. No Bonus, No Asset Revaluation

b. Bonus to old partners, no Asset Revaluation
c. Bonus to new partners, no Asset Revaluation
d. Asset Revaluation, no Bonus

2. Agreed capital is not given. When agreed capital is not given, the problem calls
for two alternative solutions.

a. Bonus method
b. Asset revaluation method
The following are the illustrations of the various problems involving admission of a
new partner.

AGREED CAPITAL IS GIVEN

Illustrative Problem B: Alpha and Bravo are partners with capital balances of
P200,000 and P100,000, and who share profit/loss 60% and 40% respectively. Charlie
is to be admitted in the partnership.

Case 1 – No Bonus, no Asset Revaluation. Charlie invest P100,000 for a 1/4 interest in
the agreed capital of P400,000.

Cash 100,000
Charlie, Capital 100,000

Solution:
Use a table to aide you in analyzing the transaction.

TAC TCC
Old Partner P300,000 P300,000
New Partner 100,000 100,000
Total P400,000 P400,000

Conclusion based on the table:

i. TAC = TCC, 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.

Case 2 – Bonus to the old partners, no Asset Revaluation. Charlie invests P100,000 for
a 1/5 interest in the new firm capitalization of P400,000.

Cash 100,000
Charlie, Capital 100,000
#
Charlie, Capital 20,000
Alpha, Capital 12,000
Bravo, Capital 8,000
Solution:
TAC TCC Bonus
Old Partner P320,000 P300,000 P20,000
New Partner 80,000 100,000 (20,000)
Total P400,000 P400,000 - .

Conclusion based on the table:

i. TAC = TCC, therefore, there is no asset revaluation.
ii. New partner: AC < CC, therefore, he gives the bonus.
iii. Old partners: AC > CC, therefore, the old partner receive the
bonus shared according to their profit and loss ratio.
Case 3 – Bonus to new partner, no Asset Revaluation. Charlie invests P60,000 for a
1/4 interest in the total capitalization of P360,000.

Cash 60,000
Charlie, Capital 60,000
#
Alpha, Capital 18,000
Bravo, Capital 12,000
Charlie, Capital 30,000

Solution:

TAC TCC Bonus

Old Partner P270,000 P300,000 P(30,000)
New Partner 90,000 60,000 30,000
Total P360,000 P360,000 - .

Conclusion based on the table:

i. TCC = TAC, therefore, there is no asset revaluation.
ii. New partner: AC > CC, therefore, he receives the bonus.
iii. Old partners: AC < CC, therefore, the old partner give the bonus
shared according to their profit and loss ratio.

Case 4 – Positive Asset Revaluation, no Bonus. Charlie invests P100,000 for a 1/5
interest in the agreed capital of P500,000.
Cash 100,000
Charlie, Capital 100,000
#
Other Assets 100,000
Alpha, Capital 60,000
Bravo, Capital 40,000
Solution:
TAC TCC Asset Revaluation
Old Partner P400,000 P300,000 P100,000
New Partner 100,000 100,000 - .
Total P500,000 P400,000 P100,000.

Conclusion based on the table:

i. TAC > TCC, 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.
Case 5 – Negative Asset Revaluation, no Bonus. Charlie invests P60,000 for a 1/5
interest in the agreed capital of P300,000.
Cash 60,000
Charlie, Capital 60,000
#
Alpha, Capital 36,000
Bravo, Capital 24,000
Other Assets 60,000

Solution:
TCC TAC Asset Revaluation
Old Partner P240,000 P300,000 (P60,000)
New Partner 60,000 60,000 - .
Total P300,000 P360,000 (P60,000)

Conclusion based on the table:

i. TAC > TCC, therefore, there is a negative asset revaluation.
ii. New partner: AC = CC, therefore, there is no bonus.
iii. Old partners: AC < CC, therefore, they are charged for the asset
revaluation shared according to their profit and loss ratio.
AGREED CAPITAL IS NOT GIVEN

There are cases when the contribution and the fraction of interest of the new
partner are given, but the agreed capitalization of the new firm is not specified.
When such a situation exists, the admission of the new partner is recorded using any
of these two methods:

1. Bonus method
2. Asset revaluation method

Bonus Method
Under this method, the agreed capitalization of the new partnership is
equal to the total amount of contribution of all the partners, both old and
new.

Asset Revaluation Method

An asset revaluation is made to properly value the assets of the
partnership prior to admission of a partner. This method will divide old
partners’ capital by its interest or divide new partner’s capital by its
interest, whichever is higher.

a. Positive Asset Revaluation Method

Under this method, the agreed capitalization is computed
as follows:

Total Agreed Capital = New partner’s CC ÷ new partner’s interest

b. Negative Asset Revaluation Method

A negative asset revaluation decreases the old partnership
assets and the capital accounts of the old partners. The decrease
is shared by the old partners based on their profit and loss sharing
ratio.
The total agreed capital is computed under this method in
the same manner as in positive asset revaluation.

Illustrative Problem C. Charlie invests P100,000 for a 1/5 interest in the partnership of
Alpha and Bravo. The contributions of Alpha and Bravo are P200,000 and P100,000
respectively, and they share profits and losses in the ratio of 3:1. After the admission
of Charlie, profits and losses will be divided equally.

1. Bonus Method

Cash 100,000
Charlie, Capital 100,000
#
Charlie, Capital 20,000
Alpha, Capital 15,000
Bravo, Capital 5,000
Solution:
TAC TCC Bonus
Old Partner P320,000 P300,000 P20,000
New Partner 80,000 100,000 (20,000)
Total P400,000 P400,000 - .

2. Positive Asset Revaluation Method

Cash 100,000
Charlie, Capital 100,000
#
Other Asset 100,000
Alpha, Capital 75,000
Bravo, Capital 25,000

Solution:
TAC TCC Asset Revaluation
Old Partner P400,000 P300,000 P100,000
New Partner 100,000 100,000 - .
Total P500,000 P400,000 P100,000.

To determine the Total Agreed Capital:

TAC = 100,000 / 20% = 500,000

Illustrative Problem D. Charlie invests P80,000 for a 1/4 interest in the partnership of
Alpha and Bravo. The contributions of Alpha and Bravo are P200,000 and P100,000
respectively, and they share profits and losses in the ratio of 3:1. After the admission
of Charlie, profits and losses will be divided equally.

1. Bonus Method

Cash 80,000
Charlie, Capital 80,000
#
Alpha, Capital 11,250
Bravo, Capital 3,750
Charlie, Capital 15,000

Solution:
TAC TCC Bonus
Old Partner P285,000 P300,000 (P15,000)
New Partner 95,000 80,000 15,000
Total P380,000 P380,000 - .
2. Negative Asset Revaluation Method

Cash 80,000
Charlie, Capital 80,000
#
Alpha, Capital 45,000
Bravo, Capital 15,000
Other Assets 60,000

Solution:
TAC TCC Asset Revaluation
Old Partner P240,000 P300,000 (P60,000)
New Partner 80,000 80,000 - .
Total P320,000 P380,000 (P60,000)

To determine the Total Agreed Capital:

TAC = 80,000 / 25% = 320,000

NOTE:
1. If the problem is silent, use bonus method.
2. If the “Other asset” in the revaluation method is “Unidentifiable
intangible asset” then it is a goodwill.
2. RETIREMENT OR WITHDRAWAL OF A PARTNER

The partnership may allow any of its partners to withdraw or retire from the firm. The
business may continue after such withdrawals; on the other hand, the interest of the
retiring or withdrawing partner may be:

1. Sold to a new partner (Outsider)

2. Sold to the continuing (remaining) partners
3. Sold to the partnership

Illustrative Problem A: The statement of financial position of the partnership of Sy, Peter
and Diaz on December 31, 2019 shows the following capital balances:

Diaz, Capital P82,000

Sy, Capital 40,000
Peter, Capital 46,000

The partners share in profits and losses in the ratio of 4:2:4. On January 1, 2020, Diaz
asked to be allowed to withdraw from the partnership.

Assumption 1 – Sale of interest to a new partner. Diaz sold his interest to Duque for
P100,000.

Diaz, Capital 82,000

Duque, Capital 82,000

The gain of P18,000 (P100,000 – P82,000) is a personal gain of Diaz since the sale of
the interest to an outsider is a personal transaction between the buying partner
and Diaz.

Assumption 2 – Sale of interest to the continuing partners. Diaz sold his interest to Sy
and Peter for P75,000; the interest being divided equally by the remaining partners.
Profits and losses after the retirement of Diaz will be divided equally.

Diaz, Capital 82,000

Sy, Capital 41,000
Peter, Capital 41,000

The loss of P7,000 (P75,000 – P82,000) is a personal loss of Diaz since the sale of the
interest to Sy and Peter is a personal transaction among the partners.
Assumption 3 – Sale of interest to the partnership. Diaz sold his interest to the
partnership. The partners agreed to make immediate cash settlement to the retiring
partner. Profits and losses after the retirement of Diaz will be divided equally.

Case A – Settlement to retiring partner is equal to his capital interest. The

partnership paid Diaz P82,000.

Diaz, Capital 82,000

Cash 82,000

The settlement involves no bonus nor asset revaluation.

Case B – Settlement is less than the capital interest of the retiring partner (at
less than book value.) The partnership paid Diaz P76,000 which is P6,000 less
than his capital interest of P82,000.

The difference between the amount payment and the capital interest of
Diaz may now be considered as:
1. Bonus to the remaining partners (Bonus Method)
2. Asset Revaluation reducing the capital accounts of all the partners
(Asset Revaluation Method)

Bonus Method

Diaz, Capital 82,000

Cash 76,000
Sy, Capital 4,000
Peter, Capital 2,000
(P6,000 x 4/6 = P4,000)
(P6,000 x 2/6 = P2,000)

The bonus of P6,000 is shared by the remaining partners in accordance with

their original profit and loss ratio of 4:2.

Asset Revaluation Method

The difference of P6,000 is only a portion of the asset revaluation. The total
amount of asset revaluation is calculated by the difference of P6,000 by the
retiring partner’s fraction of interest or (P6,000 ÷ 4/10 = P15,000). Thus, the
reduction from the capital balances of the partners will be computed as
follows: (Sy P15,000 x 4/10 = P6,000, Peter P15,000 x 2/10 = P3,000,
Diaz P15,000 x 4/10 = P6,000)

Sy, Capital 6,000

Peter, Capital 3,000
Diaz, Capital 6,000
Other Assets 15,000
 Case C – Settlement is more than the capital interest of the retiring partner
(at more than the book value). The partnership paid Diaz P85,000 which is
P3,000 or more than his capital interest of P82,000.

The difference between the amount of payment and the capital interest of
Diaz may now be considered as:
1. Bonus from the remaining partners (Bonus Method)
2. Asset Revaluation increasing the capital accounts of all the partners
(Asset Revaluation Method)

Bonus Method

Diaz, Capital 82,000

Sy, Capital 2,000
Peter, Capital 1,000
Cash 85,000

The bonus of P3,000 is shared by the remaining partners in accordance with

their original profit and loss ratio of 4:2.

Asset Revaluation Method

The difference of P3,000 is only a portion of the asset revaluation of the
partnership. The total amount of asset revaluation is calculated by dividing
the difference of P3,000 by the retiring partner’s fraction of interest or
P3,000 ÷ 4/10 = P7,500. Thus, the increase in the capital balances of the
partners will be computed as follows: (Sy P7,500 x 4/10 = P3,000, Peter
P7,500 x 2/10 = P1,500, Diaz P7,500 x 4/10 = P3,000)

Other Assets 7,500

Diaz, Capital 82,000
Cash 85,000
Sy, Capital 3,000
Peter, Capital 1,500

3. DEATH OR INCAPACITY OF A PARTNER

The death or incapacity of a partner legally dissolves the old partnership since a
partner ceases to be associated in the carrying on of the business. The remaining
partners may continue operations based on a new contract or Articles of Co-
Partnership. The interest of the deceased or incapacitated partner must be determined
by the partnership in order to make necessary settlement with his legal representative.
Cases of distribution are similar to withdrawal or retirement of a partner.

4. INCORPORATION OF A NEW PARTNERSHIP

Partnership can be turned into a distinct business entity by forming a corporation.
Incorporating a partnership firm protects the owners from the liabilities of the business. It
also makes it much easier to raise funds from outside investors.