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.

Upon dissolution, the partnership is not terminated, but continues until the winding up of partnership affairs is completed
(Article 1829). Winding up is the process of settling the business or partnership affairs after dissolution.

The following conditions will result to partnership dissolution by a change in ownership structure:
1. Admission of a new Partner
a. Admission by Purchase
b. Admission by Investment
2. Retirement or withdrawal of a partner
3. Death, incapacity or bankruptcy of a partner
4. Incorporation of a partnership

 ADMISSION OF A NEW PARTNER

A. Admission by Purchase

Under this way of admission, the partner may purchase all or part of the adjusted interest of one or more partners.
There will be no changes on the total partnership capital. The only thing changes here are the individual capital
interest of the partners. No gain or loss shall be accounted by the partnership because it is treated as personal
transaction between the selling partner/s and the outside party (new partner).

Illustration 1. Assume the following data for LMN Partnership on December 31, 2022:

Partners Capital P&L ratio

L 20,000 20%
M 20,000 30%
N 30,000 50%

On the same date, O is admitted to the partnership.

Case 1. Purchase from one partner.

Assume O purchases one-half of the interest of L. Regardless of the amount paid to L, the only journal entry in the
book of partnership is:

L, Capital 10,000
O, Capital 10,000

Regardless if O paid more or less than 10,000, no gain or loss shall be accounted by the partnership because any
amount paid in excess of the capital credit shall personally accounted by the selling partner and not by the
partnership. The entry above only shows the transfer of capital from L to O.

Case 2. Purchase from all the partners

Assume the following:
1. O is admitted into the partnership for a 50% interest in the profit and losses of the partnership.
2. The old partners (L, M, and N) are to retain their original capital and profit sharing relationships to each
other and to transfer sufficient amount (50%) of their own capital accounts to O in order to accomplish
his admission as planned.

If O agrees to pay a total of 50,000 to L, M, and N, the entry necessary to record this transaction will appear as
follows:

L, Capital 10,000
M, Capital 10,000
N, Capital 15,000
O, Capital 35,000

This entry only shows the transfer of capital from the old to new partner. No cash involved and no gain or loss being
accounted in the partnership side because this is treated as personal transaction between the partners.

Thus, the 15,000 in excess of 35,000 as 50% interest will be divided by the old partner based on their P&L ratio.
L M N Total
Capital Transferred 10,000 10,000 15,000 35,000
Excess (50,000-35,000)
15,000 x 20% 3,000 3,000
15,000 x 30% 4,500 4,500
15,000 x 50% 7,500 7,500
Total Cash received by each partner 13,000 14,500 22,500 50,000
 Alternative Method

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.

In the above case, If O buys 50% interest in LMN partnership for 50,000 and it is agreed that the net assets should
be revalued, the computation would be:

Implied value of the partnership (50,000/50%) 100,000

Book value of the partnership (total capital-old partners) 70,000
Undervalued identifiable assets 30,000

The 30,000 asset revaluation shall be allocated to the capitals of the old partners: L = 6,000, M = 9,000, and N =
15,000; making each partners’ capital increased to L = 26,000, M = 29,000, and N = 45,000.

The entry to record the increase in identifiable assets would be:

Other Assets 30,000

L, Capital 6,000
M, Capital 9,000
N, Capital 15,000

Thus, the Journal Entry to record the admission of O would be:

L, Capital 13,000
M, Capital 14,500
N, Capital 22,500
O, Capital 50,000

B. Admission by Investment

The admission of a new partner by investment is a transaction between the partnership and the new partner. The
use of the terms like invests and contributes represents admission of a new partner by investment. The investment
of the new partner increases the total assets and total capital of the partnership.

Total Agreed Capital – 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.

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

Methods in accounting for admission by Investments

1. Bonus – it is the transfer of capital from one partner to another; old to new or vice versa.

2. 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 total agreed capital and the total contributed capital.
Generally. Asset revaluations upon partnership formation relate only to the partners of the old partnership.

Under Asset Revaluation, if the total agreed capital is not given, it can be computed in either of two ways:
A. Investment of the new partner divided by the new partner’s fraction of interest.
B. Investment of the old partner divided by the old partners’ fraction of interest.

CASES METHODS

Total Contributed Capital is Equal to Total Agreed Capital No Bonus, No Revaluation of assets

Total Contributed Capital is Greater Than the Total Agreed

Bonus to old partners Or Positive Asset Revaluation
Capital

Total Contributed Capital is Lesser Than the Total Agreed Capital Bonus to new partner or Negative Asset Revaluation
Illustration 2. For the purpose of this discussion, assume that after operations during 2022, AB partnership has a
book value of 300,000 and profit percentages on January 1, 2023, as follows:

Partners Capital Balance Profit and Loss Ratio

Andy 200,000 60%
Bony 100,000 40%
Total 300,000 100%

On January 2, 2023, Cody is to invest cash into the partnership. Cody will have a one-fourth interest and 25% share
of profits. Andy and Bony will share the remaining 75% of profits in the ration of 60:40, resulting in 45% and 30%,
respectively.

CASE 1. TCC is equal to TAC

Cody invests 100,000. After the investment, the difference between the new partner’s investment and his agreed
capital is computed as follows:

Investment 100,000
Agreed Capital (300,000+100,000) * 25% (100,000)
Difference -0-

Since the investment and the agreed capital is equal, this implies that the partnership net assets are fairly valued.
There would be no bonus and no revaluation to be recognized.

The Journal Entry in the partnership book is:

Cash 100,000
Cody, Capital 100,000

CASE 2. TCC is greater than the TAC

Cody invests 110,000. For one-fourth interest in the partnership. After the investment, the difference between the
new partner’s investment and his agreed capital is computed as follows:

Investment 110,000
Agreed Capital (300,000+110,000) * 25% (102,500)
Difference 7,500

A. Under Bonus method

The Total Contributed Capital must be equal to the total agreed capital. Any difference between the amount of
investment and the capital credit of the admitting partner must be accounted as bonus to new or bonus to old
partners using their original Profit and Loss ratio.

The bonus is computed as follows:

Partners P/L ratio (Orig) TCC Bonus TAC .

Andy 60% 200,000 4,500 204,500
Bony 40% 100,000 3,500 103,000
Total Capital (Old) 300,000
Cody 110,000 (7,500) 102,500
Total Capital (New) 410,000 -0- 410,000

As you can see, Cody contributed 110,000 but his capital credit is only 102,500 (410,000 x 25%), therefore there
Is bonus to old partner of 7,500 that is to be divided based on their original P/L ratio.

The Journal entry to record the admission of Cody is:

Cash 110,000
Andy, Capital 4,500
Bony, Capital 3,500
Cody, Capital 102,500

B. Under Revaluation Method

Assume that Cody paid 7,500 excess over the proportionate book value because the partnership owns land with
a book value of 40,000 but a recent appraisal indicates that the land has a market value of 70,000. Before
recording the admission of Cody, the land must be revalued by the following adjusting entry:
 Land 30,000
Andy, Capital 18,000
Bony, Capital 12,000

The revaluation increase (70,000 – 40,000) must be allocated to old partners based on their original P/L ratio.

Total Capital of Old partnership 300,000

Revaluation increase of Land 30,000
Adjusted Capital of Old partnership 330,000
Cody’s Investment 110,000
Total Capital of new partnership 440,000

After the revaluation of land, Cody’s interest in the partnership will be 110,000 (440,000 x 25%)

The Journal Entry to record his investment:

Cash 110,000
Cody, Capital 110,000

CASE 3. TCC is lesser than the TAC

Assume the Cody invests 80,000 for a one-fourth capital interest in the partnership. The difference between the
new partner’s investment and the partner’s proportionate book value (agreed capital) is as follows:

Investment 80,000
Agreed Capital (300,000+80,000) * 25% (95,000)
Difference (15,000)

Since the investment is not equal to the agreed capital, the partnership may give bonus to old/new partner or
revalue assets of the partnership.

A. Under Bonus Method

Cody’s investment of 80,000 for one-fourth interest in the partnership maybe accounted for by recognizing
bonus to Cody from old partners.

The bonus is computed as follows:

Partners P/L ratio (Orig) TCC Bonus TAC .
Andy 60% 200,000 (9,000) 191,000
Bony 40% 100,000 (6,000) 94,000
Total Capital (Old) 300,000
Cody 80,000 15,000 95,000
Total Capital (New) 380,000 -0- 380,000

As you can see, Cody contributed 80,000 but his capital credit is 95,000 (380,000 x 25%), therefore, there is
bonus to Cody of 15,000 that is to be charged to the old partners’ capital account and allocated based on their
original P/L ratio.

The Journal entry to record the admission of Cody is:

Cash 80,000
Andy, Capital 9,000
Bony, Capital 6,000
Cody, Capital 95,000

B. Under Revaluation Method

Assume that the inventory of the partnership which is currently recorded at book value of 140,000 and has a
fair value of on 80,000 because some items are obsolete. The partners agree to write-down the inventory to its
fair value before admission of new partner.

The write-down is recorded as follows:

Andy, Capital 36,000

Bony, Capital 24,000
Inventory 60,000

The 60,000 (140,000 – 80,000) is allocated to the old partners’ original P/L ratio.

Total Capital of Old partnership 300,000

Revaluation decrease of Inventory (60,000)
 Adjusted Capital of Old partnership 240,000
Cody’s Investment 80,000
Total Capital of new partnership 320,000

After the valuation, Cody’s capital upon admission is 80,000 (320,000 x 25%).

The Journal Entry to record his investment:

Cash 80,000
Cody, Capital 80,000
 CHANGE IN CAPITAL STRUCTURE BY 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 adjusted (recognize any profit or loss during the date of
retirement/withdrawal and recognize any asset revaluation, if there’s any) capital/interest of the retiring or
withdrawing partner may be;

1. Sold to a new partner (outsider) – same treatment as Admission by Purchase

2. Sold to the continuing partner (remaining) – same treatment as Admission by Purchase
3. Sold to the partnership

Sold to Partnership

The partnership has the obligation to make payment to the retiring partner either by payment in cash, transfer of
non-cash assets or recognition of a liability for the full or the balance of the unpaid interest or the retiring partner.

The purchase price or amount of settlement by the partnership to the retiring partner may be:

1. Equal to the capital of the retiring/withdrawing partner (at book value)

2. More than the capital of the retiring/withdrawing partner (at more than book value)
3. Less than the capital of the retiring/withdrawing partner (at less than book value)

Illustration 3. On January 2, 2020, the capital balances and profit and loss ratio of Bee, Cee and Dee are as follows:

Partners Capital Balance Profit and Loss Ratio

Bee 10,000 50%
Cee 15,000 30%
Dee 20,000 20%
Total 45,000 100%

On April 30, 2020, Bee withdraw from the partnership. The net income of partnership for the four month operation
is 14,000. It is agreed that the inventory costing 5,000 has fair market value of 7,000 on April 30, 2020.

CASE 1. At Book Value (No Bonus, No Asset Revaluation)

Assume that Bee agrees to accept payment equal to his interest (Capital). The entries to record the adjustments and
settlement with Bee on April 30, 2020 are as follows:

To record the distribution of profit.

Income Summary 14,000
Bee, Capital 7,000
Cee, Capital 4,200
Dee, Capital 2,800

To record the adjustment of inventory (asset revaluation).

Inventory 2,000
Bee, Capital 1,000
Cee, Capital 600
Dee, Capital 400

To record the settlement of Bee equal to his adjustment capital balance.

Bee, Capital 18,000
Cash 18,000

Capital of Bee:
Capital Balance, January 2, 2020 10,000
Adjustment:
Share of Profit (14,000 x 50%) 7,000
Share in Increase of Inventory (2,000 x 50%) 1,000
Total Adjustment Capital – April 30, 2020 18,000
CASE 2. At more than Book value

Any difference between the amount of settlement and the capital interest of the retiring/withdrawing partner shall
be treated as:
A. Bonus to the retiring/withdrawing partner (Bonus Method)
B. Asset Revaluation increasing the capital accounts of all the partners (Revaluation Method)

A. Under Bonus Method

Assume that Bee is paid 19,500, the entries to record the settlement with Bee on April 20, 2020 should be:

Bee, Capital 18,000

Cee, Capital(1,500 x 3:2) 900
Dee, Capital(1,500 x 2:3) 600
Cash 19,500

Partners P/L ratio (Orig) Adjusted Capital Withdrawal Excess New Capital
Bee 50% 18,000 (18,000) 1,500 -0-
Cee 30% 19,800 (900) 18,900
Dee 20% 23,200 (600) 22,600
Total Capital of the remaining partners 41,500

The 1,500 excess in the capital of Bee shall be absorbed by the remaining partners based on their P/L ratio.

B. Under Revaluation Method

Bee’s Settlement amount 19,500

Bee’s Adjusted Capital 18,000
Increase due to Asset revaluation 1,500

The 1,500 is just a portion of the total increase in Asset Revaluation. The total amount of Asset Revaluation is
calculated by dividing the difference by the retiring partner’s fraction of interest or 1,500 / 50% = 3,000. Thus,
the increase in the capital balances of the partnership will be computed as follows:

Bee = 3,000 x 50% = 1,500

Cee = 3,000 x 30% = 900
Dee = 3,000 x 20% = 600

The compound Journal Entry to record the Increase Asset revaluation and Withdrawal of Bee is:

Other Assets 3,000

Bee Capital 19,500
Cee, Capital (1,500 x 3:2) 900
Dee, Capital (1,500 x 2:3) 600
Bee, Capital 1,500
Cash 19,500

Partners Adjusted Capital Revaluation New Capital Withdrawal Remaining Capital

Bee (50%) 18,000 1,500 19,500 (19,500) -0-
Cee (30%) 19,800 900 20,700 20,700
Dee (20%) 23,200 600 23,600 23,600
Total Capital of the remaining partners 44,300

CASE 3. At less than Book value

Any difference between the amount of settlement and the capital interest of the retiring/withdrawing partner shall
be treated as:
A. Bonus to the remaining partners (Bonus Method)
B. Asset Revaluation decreasing the capital accounts of all the partners (Revaluation Method)

A. Under Bonus Method

Assume that Bee is paid 17,000 for his interest, the entry will be as follows:

Bee, Capital 18,000

Cash 17,000
Cee, Capital (1,000 x 3:2) 600
Dee, Capital (1,000 x 2:3) 400

The 1,000 difference in the capital of Bee shall be given to the remaining partners based on their P/L ratio.
 B. Under Revaluation Method

Bee’s Settlement amount 17,000

Bee’s Adjusted Capital 18,000
Decrease due to Asset revaluation (1,000)

The 1,000 is just a portion of the total decrease in Asset Revaluation. The total amount of Asset Revaluation is
calculated by dividing the difference by the retiring partner’s fraction of interest or 1,000 / 50% = 2,000. Thus,
the decrease in the capital balances of the partnership will be computed as follows:

Bee = 2,000 x 50% = 1,000

Cee = 2,000 x 30% = 600
Dee = 2,000 x 20% = 400

Thus, the compound Journal Entry to record the Decrease Asset revaluation and Withdrawal of Bee is:

Bee Capital 18,000

Cee, Capital (1,000 x 3:2) 600
Dee, Capital (1,000 x 2:3) 400
Cash 17,000
Other Assets 2,000

 DEATH, INCAPACITY, OR BANKRUPTCY OF A PARTNER

If there’s a death of a partner, the existing partnership legally dissolves since the partner ceases to be associated in
the carrying on of the business. The remaining partners may continue the operations based on the new contract or
Articles of Co-Partnership. The deceased partner’s interest must be given to his/her heirs or legal representative
through settlement (payment of cash or non-cash to the heirs or recognizing liability payable to the heir) or
continue to be part of the business with the approval from the remaining partners.

 INCORPORATION OF A PARTNERSHIP

To be discussed in the Corporation topics.

Note:
Most of the problems indicate whether you use Bonus or Revaluation method but if the problem is silent, use the
bonus method.