1 Lecture Notes Dissolution
1 Lecture Notes Dissolution
1. Admission of a partner
2. Retirement of a partner
3. Death of a Partner
4. Incorporation of a partnership
The admission of a new partner may occur in either two ways, namely:
1. Purchase of all or part of the interest of one or more of the existing partners.
2. Investment of assets in the partnership by the incoming partner.
When an incoming partner purchases a portion or all of the interests of one or more
of the original partners, the partnership assets remain unchanged and no cash or
other assets flow from the new partner to the partnership. This transaction is
recorded by opening a capital account for the new partner and decreasing the
capital accounts of the selling partners by the same amount. The cash paid by the
buyer is not recorded in the books of the partnership for this is a personal
transaction between the selling and the buying partners. The gain or loss arising
from the sale of interest is not to be recorded in the partnership books.
ILLUSTRATION:
Assume the following data for Liz, Mer, and Nam (LMN) Partnership on December
31, 2020.
If Olive agreed to pay total of P50,000 to Liz, Mer, and Nam, the entry to record the
transaction will appear as follows:
There is no definite rule as to how the P50,000 cash will be divided among the
individual partners. The following procedures are recommended for fair and
equitable division of cash among the existing partners.
1. Determine the amounts of capital balances to be transferred by the existing
partners
2. Apportion any excess (or deficiency) in the original partners’ profit or loss
ratio
Using the above procedures, the P50m000 paid by Olive shall be distributed to old
partners as follows:
ALTERNATIVE METHOD:
The net assets of the partnership may be revalued when the purchase of interest
from all the partners is for an amount more than the interest acquired. Thus, if
Olive buys 50% interest in LMN Partnership for P50,000 as in the preceding
example, and it is agreed that the net assets should be revalued, the computation
would be:
The entries to record the admission of Olive into the partnership would then be:
1)
Identifiable assets (goodwill) 30,000
Liz, Capital 6,000
Mer, Capital 9,000
Nam, Capital 15,000
#to record the revaluation of net assets among the old partners using their
P/L ratio.
2)
Liz, Captal 13,000
Mer, Capital 14,500
Nam, Capital 22,500
Olive, Capital 50,000
#to record admission of Olive into the partnership
NOTE: Goodwill should not be recorded until all identifiable assets have been
adjusted to their fair value.
Case 1: the new partner’s investment (contributed capital) equals the new partner’s
proportion of the partnership’s book value (agreed capital).
Case 2: the new partner’s investment is more than the new partner’s agreed
capital. This indicates that the partnership’s prior net assets are undervalued on the
books or that unrecorded goodwill exists.
Case 3: the new partner’s investment is less than the new partner’s agreed capital.
This suggests that the partnership’s prior net assets are overvalued on its books or
that the new partner may be contributing goodwill in addition to the assets
invested.
The following steps or procedures may be used in determining how to account for
the admission of new partners:
1. compute the new partner’s proportion of the partnership’s book value (agreed
capital ) as follows:
2. Compare the new partner’s contributed capital with his or her agreed capital to
determine the procedures to be followed in accounting for his admission.
3. Determine the specific admission method. Three different methods may be used:
a. revalue net assets, b. recognize goodwill, or c. bonus method.
Case 2:
Investment Cost > Agreed Capital 1. Revalue net assets up to fair value
and allocate to old partners
Case 3:
Investment cost < Agreed Capital 1. Revalue assets down to their fair
value and allocate to old partners
2. Recognize goodwilll brought in by
new partner
3. Assign bonus to new partner
ILLUSTRATION:
Assume that after operations during 2020, AB Partnership has a book value of
P300,000 and profit percentages on January 1 as follows:
Capital P/L
Balance Ratio
Andy 200,000 60%
Bony 100,000 40%
Total 300,000 100%
On January 2, 2021, Coby invest cash into the partnership. Coby will have one-
fourth interest and a 25% share in the profits. Andy and Bony will share the
remaining 75% of profits in the ratio of 60:40, resulting in Andy 45% share on any
profits, and Bony having 30%.
Journal entry:
Cash 100,000
Cody, capital 100,000
Coby invests P110,000. After the investment, the difference between the new
partner’s investment and is agreed capital is computed as follows:
Coby has invested P110,000 for an interest with a book value of P102,500, thus
paying excess of P7,500 over the present book value.
example:
assuming Coby paid a 7,500 excess over the proportionate book value because the
partnership owns a land with book value of P40,000 but appraised at P70,000.
Before recording the admission of Coby the land must be revalued by the ff
adjusting Journal entry:
Land 30,000
Andy, Capital 18,000
Bony, Capital 12,000
#to revalue partnership and to market value
Cash 110,000
Coby, Capital 110,000
#to record admission of Coby for one-fourth capital interest.
c. the partnership’s total resulting capital is now equal the prior capital balances
plus the goodwill recognized plus the new partner’s investment
example:
Unrecognized goodwill may be computed from the amount of new partner’s
investment. For example, in this case, Coby is investing P110,000 for a one-fourth
interest, the GW is computed as follows:
Estimated total resulting capital (110,000/25%) 440,000
Total net assets (300,000 + 110,000) 410,000
Goodwill 30,000
The entries to record goodwill and the admission of Cody are as follows:
1)
Goodwill 30,000
Andy, Capital 18,000
Bony, Capital 12,000
2)
Cash 110,000
Coby, Capital 110,000
3. USEBONUS METHOD
Basically, the bonus method is a transfer of capital balances among the partners.
This method is used when the partners do not wish to record adjustments in asset
accounts or recognize goodwill. Under this method:
a. The old partners’ capital accounts are increased for their respective shares of the
bonus paid by the new partner.
b. The partnership’s total resulting capital equals the prior capital balances plus the
new partner’s investment.
Example:
New partner’s investment 110,000
New partners proportionate book value
(agreed capital) (300k+ 110k) x 25% 102,500
Bonus to old partners 7,500
Journal Entry:
Cash 110,000
Andy, capital 4,500
Bony ,Capital 3,000
Coby, Capital 102,500
2. Recognize P30,000
goodwill to 440,000 110,000
old partners
Assume that Coby invests P80,000 for a one-fourth capital inters tint he
partnership. The difference between the new partner’s investment and the partner’s
proportionate book value (agreed capital) is as follows:
Difference (15,000)
*There are three alternative approaches to account or the difference when the
investment is less than the book value acquired. The three approaches are as
follows:
ILLUSTRATION:
Assume that the inventory of the partnership which is currently reported at book
value P140,000 has a fair market value of P80,000 because some items are
obsolete. The partners agree to write-down the inventory to its FMV before
admission of new partner. The write-down is divided among the partners’ capital
using their P/L ratio.
Journal entry:
Andy, Capital 36,000
Bony, Capital 24,000
Inventory 60,000
#to revalue inventory to its fair value
Cash 80,000
Coby, Capital 80,000
#to record admission of Coby
Coby’s share to the total resulting capital of the partnership is computed as:
(240,000 + 80,000) x 25%
ILLUSTRATION:
Using the previous illustration, if goodwill method will be used, the estimated
goodwill brought in by Coby in the partnership is computed as follows:
Goodwill 20,000
*Use new partner’s investment to estimate goodwill to old partners, use old
partners’ capital to estimate goodwill to new partner.
Journal Entry:
Cash 80,000
Goodwill 20,000
Coby, Capital 100,000
#to record the admission of Coby.
The total resulting capital of the ABC partnership is now P400,000, with Andy amd
Bony together having 75% interest and Coby having 25% interest.
ILLUSTRATION:
Coby’s investment of only P80,000 for a one-fourth interest in the ABC Partnership
may be accounted for by recognizing a bonus given to Coby from the old partners.
The bonus is computed as follows:
New partner’s investment P80,000
New partner’s proportionate book
value (agreed capital) 95,000
Bonus to new Partner 15,000
The old partners’ capital will be reduced b 15,000 in their p/l ratio of 60% for Andy
and 40% for Bony, and Coby’s Capital account will be credited for 95,000.
Cash 80,000
Andy, Capita l 9,000
Bony, Capital 6,000
Caby, Capital 95,000
#to record admission of Coby
Note that Coby’s capital credit is his share of the total resulting capital as shown
below:
(300,000 + 80,000 ) x 25% = 95,000
WITHDRAWAL OF A PARTNER
When a partner retires or withdraws from a partnership, the partnership is
dissolved, but the remaining partners may continue operating the business. The
existing partners may buy out the retiring partner either by making a direct
acquisition or by having the partnership acquire the retiring partner’s interest. If
present partner acquire retiring partner’s interest, the only entry is the transfer of
capital from the retiring partner to the remaining partner. If the partnership
acquires the interest of the retiring partner, the partnership may pay the retiring
partner an amount equal to his interest, more than his interest, or less than his
interest.
The interest of the retiring partner is usually measured by his capital balance,
increased or decreased by his share in the following adjustments:
a. profit or loss from partnership operations from the last closing date to the date of
his/her retirement.
b. Changes in the valuation of all assets and liabilities (book value to fair values)
Any prior period errors must be corrected and adjusted to partner’s capital before
the retirement.
ILLUSTRATION:
On January 2, 2020, the capital balances and P/L ratio of Bry, Cj, and Dan are as
follows:
CAPITAL P/L
PARTNERS
BALANCES RATIO
Bry 10,000 50%
Cj 15,000 30%
Dan 20,000 20%
On April 30, 2020, Bry withdraws from the partnership. The net income of the
partnership for the four months ended April 30 is P14,000. It is agreed that the
inventory costing P5,000 has market value of P7,000 on April 30.
Journal entry:
April 30:
Income summary 14,000
Bry, Capital 7,000
Cj, Capital 4,200
Dan, Capital 2,800
#to record distribution of profits
Inventory 2,000
Bry, Capital 1,000
Cj, Capital 600
Dan, Capital 400
#to record adjustment on inventory
1. Record goodwill equal to the excess payment made to the retiring partner
(partial goodwill method)
2. Record total implied goodwill of the partnership computed by dividing the excess
payment with the retiring partner’s profit/loss sharing percentage (total goodwill
method)
3. Threat the excess payment as bonus from the remaining partners. This is
accomplished by decreasing the remaining partners’ capital accounts by the excess
using their profit/loss sharing percentage.
Using the same data for Bry, Cj, and Dan partnership, assume Bry is paid P19,500,
the entries to record the settlement under the three approaches are as follows:
3. Bonus Method
Bry, capital 18,000
Cj, Capital 900
Dan, Capital 600
Cash 19,500
Using the same data, assume that Bry is paid P17,000 for his interest, the entry will
be as follows:
If the causes of the difference are not determinable or assignable to specific assets,
then the bonus method should be used. The entry to record the settlement is:
Bry, Capital 18,000
Cash 17,000
Cj, Capital(3/5x 1,000) 600
Dan, Capital(2/5 x 1,000) 400
#to record the retirement of Bry and to dovide the resulting bonus between Cj and
Dan.
DEATH OF A PARTNER
In the event of the death of a partner, the estate of the deceased partner is entitled
to receive the amount of his interest in the partnership at the date of his death. The
deceased partner’s capital is adjusted using his profit and loss share percentage for
the changes in the net asset, and for the profit accruing from the previous reporting
date until the partner’s death. The balance of his capital account after considering
the necessary adjustments should be transferred to a liability account pending
settlement.
INCORPORATION OF A PARTNERSHIP
This is the conversion of a partnership into a corporation. The accounting
procedures in recording the incorporation of a partnership will depend on whether
the original books of the partnership will be continued by the corporation or new
books will be opened.
PARTNERSHIP BOOKS RETAINED: If the partnership books are retained, the steps
to be taken are as follows:
1. Revalue the assets and recognize goodwill if any,
2. Close the partners’ capital accounts to the corporate capital accounts.
NEW BOOKS OPENED FOR THE CORPORATION: if new books are to be opened, the
old partnership books must be closed. The accounting procedures may be outlined
as follows:
REVIEW PROBLEMS
PROBLEM 1
Red, White, and Blue are partners with a profit and loss ratio of 2:4:4 and credit
balances of P60,000, P80,000, and P60,000 respectively. Green is to be admitted
into the partnership with an investment of P75,000 for a 25% interest in the
capital, profit, and losses of the firm.
Required:
a. Prepare Journal entries to record the admission of Green, using:
1. Revaluation of assets
2. Bonus approach
b. Prepare Journal entries to record the admission of Green if, instead of investing
into the partnership, he purchases his interest from the partners at the same
P75,000 and :
1. Implicit goodwill is to be recorded
2. Bonus method is used
PROBLEM 2
Bruno and Mario are partners with a profit and loss ratio of 6:2 and credit capital
balances of P200,000 and P300,000, respectively. Tomas is to be admitted into the
partnership by investing P140,000 for a 20% interest in the capital, profits, and
losses.
Required:
a. Prepare schedule of partners’ capital balances after the admission of Tomas, if
1. Goodwill is not recorded
2. Goodwill is to be recorded
3. Goodwill is recorded and then written off
PROBLEM 3
Rodel And Jerry who share profit and losses in the ratio of 4:6 are partners with
credit capital balances of P60,000 and P80,000 respectively. Barry is to be
admitted to the partnership for a 25% interest in the capital of the firm.
Required:
a. calculate the cash payment by Barry is, after the cash payment is recorded, the
capital balances of Rodel and Jerry are P76,000 and P104,000 and goodwill was
recorded.
b. calculate the cash payment by Barry is after the cash payment is recorded, the
capital balances of Rodel and Jerry are P52,000 and P68,000 and goodwill was not
recorded.
PROBLEM 4
Helen and Cathy are partners with a profit and loss ratio of 70:30. Their credit
capital accounts on January 2013 are P70,000 and P50,000. They have agreed to
admit Cherry as a new partner in their firm.
Required: For each of the following cases, prepare journal entries to admit Cherry.
a. Cherry invests an amount of P40,000 cash for a 25% interest in profits, losses,
and capital.
b. Cherry invests P50,000 for a 25% interests in profits, losses, and capital.
c. Cherry invests P25, 000 for a 25% interest in the capital of the firm and goodwill
is not to be recorded.
d. Cherry invests P50,000 for a 25% interest in the capital of the firm and goodwill
is to be recorded.
e. Cherry invests P25, 000 for a 25% interest in the capital of the firm and goodwill
is to be recorded.
PROBLEM 5
In the ABC partnership, Andy’s capital is P50,000. Benny’s is P30,000, and Conny’s
is P40,000. They share income in a 3:1:1 ratio. Conny is retiring from the
partnership.
PROBLEM 6
Subas and Tony sell electronic equipment and supplies through their partnership.
They wish to expand their computer lines and decided to admit Noel to the
partnership. Subas’ capital is P100,000, Tony’s capital is P80,000, and they share
income in a ratio of 3:2.
Required:
a. Noel directly purchases half of Tony’s investment in the partnership for P46,500
b. Noel invests the amount needed to give him a one-third interests in the capital of
the partnership if no goodwill or bonus is recorded.
d. Subas and Tony agree that some of the inventories are obsolete. The inventory
account is decreased before Noel is admitted. Noel invests P52,000 for a ¼ interest.
e. Noel directly purchases a ¼ interest by paying Subas P32, 000 and Tony
P36,000. The land account is increased before Noel is admitted
f. Noel invests P40,000 for a one-fifth interest in the total capital P220,000