Partnership Dissolution

(Accounting For Special Transactions)

2nd Trimester, AY 2023-2024
 Partnership Dissolution
Learning Objectives:

1. State the causes of partnership dissolution.

2. Account for the effects of partnership dissolution on the

partnership equity.
 Dissolution
• Dissolution is the change in the relation of the partners
caused by any partner being disassociated from the
business.
• While Liquidation is the termination of business
operations or the winding up of affairs.
• Partnership dissolution does not necessarily terminate
the business because the business continues until the
remaining partners decide to liquidate the business.
• New articles of partnership should be prepared if the
business is continued after the dissolution.
 Causes of Partnership Dissolution
The following are major considerations in the accounting for
partnership dissolutions:
1. Admission of a partner
2. Withdrawal, retirement or death of a partner
3. Incorporation of a partnership
These major considerations creates a change in the relation
of the partners (ex. Change of number of the partners in a
partnership).
In the admission of a new partner, there should be consent
of all the existing partners.
Admission of New Partner
1. Purchase of interest in the partnership
2. Investment in the partnership
 Purchase of Interest
• A new partner maybe admitted when he purchases part
or all of the interest of one or more of the existing
partners.
• Any consideration paid or received by a partner is not
recorded in the partnership books as this is a personal
transaction.
• Only a transfer within equity is made to establish the
capital account of the new partner and decrease the
capital account(s) of the selling partner(s).
• No gain or loss shall is recognized in the partnership
books.
Illustration: Purchase of Interest
The capital balances and profits and loss ratios of the partners in ABC
Co., are as follows:

Case 1: Purchase of interest from one partner

D purchases one-half of C’s capital interest for P48,000
Requirement: Provide the journal entry to record the transaction

The P48,000 payment of D to C is not recorded in the partnership

books.
Case 2: Purchase of interest from more than one partner
D purchases 25% of A’s, B’s and C’s capital interests for P60,000
Requirements:
a. Provide the journal entry to record the transaction

b. How much are the capital balances of the partners after the
admission of D?
Requirements:
c. How much is the gain or loss recognized in the partnership’s
books when a new partner is admitted?
Answer: Zero, no gain or loss is recognized in the partnership’s
books when a new partner is admitted.
d. How much is the payment of D divided between the old
partners and how much are the old partners’ respective
personal gains?
Answer: The old partners divide the payment of D based on whatever
they have agreed upon or as follows:
Case 3: Purchase of interest – Book value Method
D purchases 20% interest from A and B for P50,000. The partners
agreed to account for the sale at the book values of A’s and B’s
capital accounts (rather than the total partnership capital).
Requirement: Provide the journal entry to record the transaction

Case 4: Purchase of interest – Proportionate share

D purchases 20% interest in the net assets and profits of the
partnership firm A and B for P50,000. A and B agreed to share
proportionately on the 20% interest sold to D. The partnership’s net
assets are fairly valued on D’s admission date.
Requirement: How much is the combined gain of A and B from
the sale?
Case 4: Purchase of interest – Proportionate share (continued)
 Revaluation of Assets
• When a partnership is dissolved but not liquidated, a
new partnership is created. The assets and liabilities
carried over to the new partnership are restated to fair
values.

• Any adjustment to the assets and liabilities is allocated

first to the existing partners before recording the
admission of the new partner.
Illustration:
C purchases 20% of A’s and B’s capital interests for P100,000. The
carrying amounts and fair values of the partnership’s net identifiable
assets immediately before C’s admission are as follows:

Requirements: a. Provide the journal entries:

The adjusted capital balances are as follows:

C’s admission is recorded as follows:

b. Compute for the partners’ capital balances after C’s admission

 Investment in the Partnership
The following scenarios may occur when a new partner invests
in a partnership:
1. The incoming partner’s investments is equal to his/her capital
credit which may be determined by multiplying the incoming
partner’s net assets after the admission. Entry: Debit to the
invested asset, and a credit to the incoming partner’s capital.
2. The incoming partner’s investments is greater than his/her
capital credit. The excess contribution is treated as a bonus to
the old partners to compensate for their past efforts in
establishing the business. The bonus is accounted for as an
increase in the old partners’ capital and a decrease in the new
partner’s capital.
3. The incoming partner’s investments is less than his/her capital
credit. The deficiency is treated as a bonus to the new partner.
The bonus is accounted for as an increase in the new partner’s
capital and a decrease in the old partners’ capital.
Illustration: Investment in the partnership
The capital balances of the partners in ABC Co., are as follows:

The carrying amount of the net assets approximates fair value:

Case 1: Investment equal to Capital credit
D invests P60,000 cash for a 25% interest in the partnership’s net
assets and profits.
Requirement: Provide the journal entry to record the transaction.
Case 1: Investment equal to Capital credit
Supporting computation of D’s capital credit

Case 2: Bonus to old partners

D invests P80,000 cash for a 25% interest in the partnership’s net
assets and profits.
Requirement: Provide the journal entry to record the transaction
and determine the capital balances and profit and loss sharing
ratio of the partners after the admission of D.
Case 2: Bonus to old partners
Solution:

The bonus is allocated to the old partners based on their old P/L ratio.
Case 2: Bonus to old partners
The capital balances of the partners after the admission of D are
determined as follows:

The new P/L ratios after D's admission are as follows:

Case 3: Bonus to new partner
D invests P52,000 cash for a 25% interest in the partnership’s net
assets and profits.
Requirement: Provide the journal entry to record the transaction
and determine the capital balances of the partners after the
admission of D.
Case 3: Bonus to new partner
Capital balances after admission of D

Case 4.1: Amount of investment

D wants to join the partnership through direct investment. D asks the
existing partners how much should he invests for a 20% interest in the
partnership’s net assets and profits. The partnership’s books include
a receivable from A of P8,000 and a loan payable to B of P10,000.
Requirement: If no bonus is allowed, how much should D invest?
Case 4.2: Adjustment to capital and Cash settlement
After D’s admission in Case 4.1, the partners agreed to adjust their
capital balances to reflect their proportionate shares in the
partnership’s net assets based on their new profit and loss ratio.
Cash settlement will be made among the partners.
Requirement: Determine how the cash settlement is to be made.
Case 4.2: Adjustment to capital and Cash settlement
In the cash settlement, A pay B P6,000 and C, P26,000

Case 4.3: Correction of errors

In Year 3, two years after D’s admission in Case 4.1, the partnership
earned profit of P1,000,000. However, it was discovered that the
following items were omitted in the partnership’s books.

Requirement: How much is the share of A in the Year 3 profit?

Case 4.3: Correction of errors
Recall the concepts on correction of prior period errors:
Ø If an asset-related account is understated, profit is also
understated (direct relationship). The opposite applies to a liability
related account.
Ø Counterbalancing errors automatically reverse in the immediately
following period if not corrected.
 Goodwill Method
• Goodwill method is used to recognize an implied value from
a partner’s contribution during admission (and payment to a
partner during withdrawal). This method, however has been
outlawed by PFRS 3 Business Combinations.
Illustration: Goodwill method

Case 1: Purchase of interest – Goodwill to old partners

C purchase 20% from A and B for P100,000. The partners
agreed to recognize an implied goodwill from C’s payment.
 Goodwill Method
Case 1: Purchase of interest – Goodwill to old partners
 Goodwill Method
Case 2: Investment – Goodwill to old partners
C invests P120,000 to the partnership for a 20% interest. The
partners agreed to recognize an implied goodwill from C’s
investment.
 Goodwill Method
Case 3: Investment – Goodwill to new partner
C invests P90,000 to the partnership for a 20% interest. The
partners agreed to have a total capital of P500,000.

The equity structure of the new partnership after the admission

of C is analyzed as follows:
 Withdrawal, Retirement or
Death of a Partner
• When a partner withdraws, retires or dies, his interest
may be purchased (a) by one or all of the remaining
partners or (b) settled 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 this death.
• The interest of the withdrawing, retiring, or deceased
partner shall be 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, retirement, or death.
 Withdrawal, Retirement or
Death of a Partner
Purchase by One or All of the Remaining Partners
This is a transaction between and among the partners (or deceased
partner’s estate). As such, the settlement amount is not recorded in
the books. The only entry to be made in the partnership books is a
transfer within equity.
Settlement by the Partnership
This is a transaction between the retiring or withdrawing partner (or
deceased partner’s estate) and the partnership. As such, the
settlement amount is recorded in the books.
Deferral Settlement
Pending settlement, the outgoing partner’s interest is transferred to a
liability account, which is considered an ordinary claim, subordinate to
the claims of other outside creditors. May also agree that interest shall
accrue on the outgoing partner’s unpaid balance from the date of his
disassociation up to the date of settlement.
Illustration 1: Withdrawal, retirement or death of a partner
Fact pattern:
The capital account balances of the partners in ABC Partnership on
July 1, 20x1 before any necessary adjustments are as follows:

The partnership reported profit of P900,000 for the six months ended
June 30, 20x1.
Case1: Withdrawal – Purchase of interest by remaining partners
On July 1, 20x1, C withdraws 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 fair values.
Illustration 1: Withdrawal, retirement or death of a partner
Requirement: Provide the journal entries
The capital balances of all of the partners are adjusted for their
respective shares in the profit accruing as of the date of C’s withdrawal.

The adjusting entry is as follows:

Illustration 1: Withdrawal, retirement or death of a partner
Requirement: Provide the journal entries
The entry to record the withdrawal of C is as follows:

Partnership capital after C’s withdrawal:

Illustration 1: Withdrawal, retirement or death of a partner
Case 2: Retirement – Settlement of interest by partnership
C retires on July 1, 20x1. The partnership settles C’s interest for
P620,000 cash.
Requirement: Provide the journal entries
The partners’ capital accounts are adjusted for the P900,000 profit.
After the adjustment, the balance of C’s capital account is P550,000.
(see computations in Case 1)
The entry to record the retirement of C is as follows:

Ø C is given a bonus of P70,000 (P620k payment minus P550k capital

balance). The bonus is deducted from the capital balances of the
remaining partners.
Ø The payment of C is recorded in the books because the interest of C
is settled by the partnership, rather than by the remaining partners.
Illustration 1: Withdrawal, retirement or death of a partner
Case 2: Retirement – Settlement of interest by partnership
Partnership capital after C’s retirement:

Case 3: Retirement – payment in the form of non-cash asset

C retires on July 1, 20x1 and receives cash of P500,000 and land with
carrying amount of P100,000 and fair value of P300,000 from the
partnership as settlement for his interest.
Requirement: Provide the journal entries
Illustration 1: Withdrawal, retirement or death of a partner
Case 3: Retirement – payment in the form of non-cash asset
The partners’ capital balances are adjusted for their respective shares
in the P900,000 profit and the revaluation of the land.

The entry to adjust the capital balances of the partners are as follows:
Illustration 1: Withdrawal, retirement or death of a partner
Case 3: Retirement – payment in the form of non-cash asset
The entry to record the settlement of C’s interest is as follows:

Partnership capital after C’s settlement:

Ø The total partnership capital is reduced by the P800,000 payment for

C’s capital balance.
Illustration 1: Withdrawal, retirement or death of a partner
Case 3: Retirement – payment in the form of non-cash asset
Ø The net effect of C’s taking the non-cash asset is a net decrease of
P200,000 on his capital as analyzed below:

Case 4: Death of a partner – settlement of interest by partnership

Use the same information in Case 3, except that C dies on July 1, 20x1.
Requirement: Provide the journal entries
Pending settlement, C’s adjusted capital balance is transferred to a
liability account.
Illustration 1: Withdrawal, retirement or death of a partner
Case 4: Death of a partner – settlement of interest by partnership
The entry on settlement date is as follows:

Case 5: Withdrawal – fully depreciated asset

C withdraws on July 1, 20x1 and receive cash of P250,000 and fully
depreciated equipment with fair value of P300,000 from the partnership,
as settlement for his interest.
Requirement: Provide the entry to record the withdrawal of C
Illustration 1: Withdrawal, retirement or death of a partner
Case 5: Withdrawal – fully depreciated asset
The balances of the partners are adjusted as follows:

Partnership capital after C’s withdrawal

 Goodwill Method (Traditional
Accounting Based on US GAAP)
Illustration:
C withdraws from ABC Partnership. The adjusted capital balances
are as follows:

Case 1: Partial goodwill

The partner’s settles C’s capital for P620,000. The partners agreed to
recognize whatever goodwill the settlement would generate.
 Goodwill Method (Traditional
Accounting Based on US GAAP)
Case 2: Total goodwill
The partner’s settles C’s capital for P620,000. The partners agreed to
recognize total goodwill from C’s settlement.
Additional Illustration: Retirement – Personal accounts

C retires on December 31, 20x1. The net assets approximate their fair
values except for the equipment which has a fair value of P450,000.
Case 1: Settlement amount includes payment of loan
The partnership pays P140,000 as settlement for his interest including
his loan.
Requirement: Compute for the capital balances after C’s retirement
Additional Illustration: Retirement – Personal accounts
Case 1: Settlement amount includes payment for loan

Note: The partnership capital is reduced by the payment for C’s

capital balance excluding his loan: (140k total payment including
payment for loan – 10k payment for loan = 130k payment for capital)
Additional Illustration: Retirement – Personal accounts
Case 2: Settlement amount excludes payment for loan
The partnership pays C P140,000 as settlement for his interest, excluding
his loan which is to be repaid in full.
Requirement: Compute for the capital balances after C’s retirement.
The capital balances of the partners are adjusted first for the revaluation,
similar to Case 1.
 Incorporation of a Partnership
Incorporation of a partnership causes partnership dissolution.
When a partnership is converted into a corporation, the
partners’ relation changes – they cease to be partners (agents
of business) and become stockholders.
Reasons for Incorporating a Partnership:
a. Limited liability of shareholders
b. Ease of raising additional capital
c. Privacy and confidentiality
d. Dispersion of risk
e. Unlimited life
f. Transferability of ownership
g. Better public relations
 Incorporation of a Partnership
When a partnership is converted to a corporation, the
corporation acquires the assets and assumes the liabilities of
the partnership, and in return issues shares of stocks to the
owners.
On the 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 set-up for the corporation.
Illustration:
ABC Partnership is converted into a corporation on January 1, 20x1.
Relevant information follows:

The corporation’s authorized capitalization is P2,000,000 divided into

200,000 ordinary shares with par value of P10 per share.
Case 1: Number of shares issued
Assume that the shares to be issued to the partners are based on their
respective adjusted capital balances.
Requirement:
a. Compute the number of shares to be issued to each of the
partners
Case 1: Number of shares issued
b. Journal entries in the partnership’s books:
Case 1: Number of shares issued
b. Journal entries in the corporation’s books:

Case 2: Share premium

Assume that A, B, and C agreed to be issued 14,000; 12,000 and 35,000
shares respectively.
Requirement: How much is credited to the share premium account?
Case 2: Share premium
Journal entry in the corporation’s books to record the initial investments:

Case 3: Preference share

Assume that the corporation was authorized to issue P100 par
preference shares and P10 par ordinary shares. The partners agreed to
receive 1,000 ordinary shares each and even multiples of preference
shares for their remaining interest.
Requirement: How many ordinary and preference shares did each
partner receive?
OPEN FORUM

•QUESTIONS????
•REACTIONS!!!!!
END OF PRESENTATION