University of San Jose – Recoletos

School of Business and Management

Accounting 301: Accounting for Special Transactions
Ms. Nathallie Cabaluna, CPA

Module 3: Partnership Dissolution

This module demonstrates an understanding of accounting for the equity of partnership dissolutions.

Partnership Dissolution
The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be
associated in the carrying on as distinguished from the winding up of the business of the partnership. On dissolution,
the partnership is not terminated, but continues until the winding up of partnership affairs is completed.

The dissolution of the partnership does not necessarily imply that business operations will come to an end. Most
changes in ownership of a partnership are accomplished without interruptions of its normal operation. A
partnership dissolution should be distinguished from liquidation. A partnership is said to be liquidated when the
business is terminated; a partnership may be dissolved without being terminated but liquidation is always
preceded by dissolution.
• Winding up is the process of settling the business or partnership affairs after dissolution.
• Termination is the point in time when all partnership affairs are wound up or completed, and is the end of
the partnership life.

Capital interest vs. P/L interest

*Any correlation between a partner’s recorded capital at a particular point in time and the P/L percentage would
probably be coincidental
Capital interest – claim against the net assets of the partnership
P/L interest – how the partner’s capital interest will increase or decrease as a result of subsequent operations

Assignment of an Interest to a Third Party

When a partner assigns his/her interest in the partnership to a third party, a partnership is not dissolved. An
assignee is only entitled to the following:
1. Interest in future partnership profits
2. Partnership assets in the event of liquidation
Journals are limited to capital transfers only. The purchase is irrelevant since it is a personal transaction between
the partner/s and the third party.

Rules on the Valuation of Assets and Liabilities

1. If with agreement, revaluation is allowed

2. If without agreement:
a. Revaluation/Goodwill approach – assets and liabilities @ FV; record goodwill
b. Bonus Procedure – assets and liabilities @ BV unless FV adjustments are GAAP-allowed
i. Recognize decreases in net asset revaluation
ii. Non-recognition of increases in net asset revaluation

Causes of Partnership Dissolution

1. Admission of a new partner
a. By Purchase of Interest
b. By Investment
2. Withdrawal or retirement of a partner
3. Death or incapacity of a partner
4. Incorporation of a partnership
1. Admission of a New Partner
- Can be admitted with the consent of all partners in the business
- New agreement should be drawn up that specifies (1) the partners’ interests upon formation of the
partnership, (2) the distribution of P/L among partners and (3) all of the other considerations relative to
the new association

1.a. Admission by Purchase of an Interest

- this is a personal transaction between the incoming partner and the selling partner(s)
- no additional money or properties are invested in the partnership
➢ Purchase of Interest from One Partner – capital transfer only
➢ Purchase of Interest from All Partners
o At Book Value – capital transfer only
o Book Value/Bonus Approach
▪ Price > Book Value – capital transfer; gain is NOT a partnership transaction
▪ Price < Book Value – capital transfer; loss is NOT a partnership transaction
o Revaluation/Goodwill Approach
▪ Price > Book Value – capital transfer; recognize goodwill/upward revaluation
▪ Price < Book Value – capital transfer; downward revaluation

1.b Admission by Investment

- investment of assets or something of value directly to the partnership
- any gain/loss recognized on sales subsequent to recording the admission will be allocated on the basis of
the new profit and loss ratio

Terms to know:
Total Agreed Capital (TAC) – new capitalization of the newly formed partnership.
Total Contributed Capital (TCC) – total investments of the old and new partners.
Partner’s Agreed Capital (PAC) – new capital of the newly admitted partner
Partner’s Contributed Capital (PCC) – newly admitted partner’s contribution/s
Capital Credit – interest or equity of a partner in the newly formed partnership.
Percentage/Fraction of Interest - interest or equity of a partner expressed in fraction or percentage.
Goodwill – an intangible advantage a business possesses by which it is able to earn more than what is
normal in its business operations.
Bonus – a transfer of portion of the partner’s capital to the credit of another in consideration of the latter’s
business advantage

General Rules:
1. If TCC = TAC – no adjustment
2. If TCC > TAC – drawing/withdrawals needed
3. If TCC < TAC – recognize goodwill or additional investment/s

Specific Rules:
1. If PCC = PAC – no capital transfers between partners
2. If PCC > PAC – bonus to old partners
3. If PCC < PAC – bonus from old partners

Breakdown of TAC:
Bonus Approach – does not directly recognize increases in partnership assets
1. BV of partnership
2. Less partnership asset’s write-downs
3. FV of consideration
 Revaluation (Goodwill) Approach
1. BV of partnership
2. Plus, appreciation/Less depreciation of net assets
3. Revaluation of net assets/ recognition of goodwill
4. FV of consideration

Additional Rules:
1. When valuation approach is silent, use bonus approach
2. Under bonus approach, it is assumed that TCC = TAC
3. Under revaluation approach, if goodwill amount is not specifically stated, gross-up the new partner’s
contribution to get TAC. Goodwill = TAC-TCC

Note: If P&L interest > Capital interest, prefer bonus approach

If P&L interest < Capital interest, prefer revaluation approach

2. Withdrawal or Retirement of a Partner

- A partner may withdraw or retire from a partnership for various reasons. Disputes with other partners, old
age, and pursuit for better opportunities among the possible explanations. The withdrawal of a partner
dissolves the old partnership. This type of dissolution may be accomplished by either of the following ways:
➢ Sell his interest to an outside party (admission by purchase of interest)
➢ Sell his interest to one or more of the remaining partners (admission by purchase of interest)
➢ Partners mutually agree to transfer partnership assets wherein settlement shall either be:
▪ Payment in cash
▪ Payment in non-cash assets
▪ Recognition of liability for the full or remaining balance of the retiring partner’s interest
2.a&b Sale of interest to an outside partner or to one/more of the remaining partners
- When a partner’s interest is sold to another partner or an outsider, the withdrawing partner is paid from
the personal assets of the buyer.
- Accounting for this sale is similar to admission by purchase of interest. The total assets of the partnership
are not affected by the consideration involved.
- The required entry will only be a debit to the seller’s capital account for his capital balance and a credit to
the buyer’s capital account for the same amount.

2.c Sale of interest to the partnership/Transfer of partnership assets as settlement

- When a withdrawing partner sells his interest to the partnership, the partner is paid from the assets of the
partnership. He may receive an amount equal to, greater than or less than the balance of his capital
account. The effect of withdrawal is to reduce the assets and owner’s equity of the partnership.
- The accounting issues to be encountered here will be similar to admission by investment of assets but in a
reverse manner.
- Instead of a new partner joining the partnership by investing assets into the partnership, an old partner is
now leaving the partnership with the business distributing assets to the withdrawing partner.
➢ Payment at Book Value
➢ Payment at More than Book Value (benefit of retiring partner)
➢ Payment at Less than Book Value (benefit of remaining partner/s)
▪ Bonus
▪ Partial Revaluation
▪ Total Revaluation
❖ Wherein:
3. Death of a partner
- The death of a partner dissolves a partnership.
- When the death of a partner does not result to liquidation, the accounting procedures to be followed are
similar in the withdrawal of a partner.
- The deceased partner may be considered to have retired from the partnership and his heirs or estate
can expect to receive the amount of his interest from the business.
- If payment to the estate of the deceased cannot be made immediately, the balance in the capital
account of the deceased partner should be transferred to a liability account, payable to the estate

4. Incorporation of a Partnership
- A partnership may decide to incorporate after evaluating the various advantages of having a corporate
form of business organization.
- After necessary adjusting and closing entries, the assets and liabilities of the partnership are transferred
to the corporation in exchange for shares of stock.
- The shares received by the partnership are distributed to the partners based on their equity interests.
- In the books of the corporation, the receipt of transferred assets and liabilities will be recorded along
with the issuance of share capital to the incorporators, the “former” partners.
➢ Partnership Books Retained
▪ Record changes in assets and liabilities
▪ Close capital accounts and recognize issuance of shares of stock
➢ New Books Opened for the Corporation
▪ In the Partnership books:
• Journalize revaluation of assets (incl. recognition of goodwill)
• Record cash withdrawals
• Record transfer of partnership assets and liabilities
• Record receivable from corporation
• Close receivable and recognize receipt of shares of stock
• Close capital accounts and recognize issuance of shares of stock
▪ In the New Corporation books:
• Record acquisition of partnership assets and liabilities
• Record payable to partnership
• Close payable and recognize issuance of shares of stock
- Note: when assembling the balance sheet of the corporation, the allowance for doubtful accounts is
recognized. However, in contrast, accumulated depreciation is disregarded because the new cost for
depreciable assets the fair value as of incorporation date.
Illustrative Examples:

Problem 1. MariMar Partnership has a book value of P100,000 and P&L ratio on January 1, 2023 as follows:

Mari, Capital (55%) 85,000

Mar, Capital (45%) 65,000

On the very same day, Aww is admitted to the partnership.

Below are different scenarios that are to be answered depending on the additional information given by each
number. Answer them separately.
1. Both Mari and Mar assigns 20% of their interest to Aww and were both paid P35,000
2. Aww purchased ¼ of Mar’s interest in the partnership and paid P20,000 to Mar
3. Aww purchased ¼ of Mari and Mar’s interest in the partnership and paid P37,500
4. Aww purchased ¼ of Mari and Mar’s interest and paid 25,000 and 18,000 respectively. The new partner will
have the same P&L ratio and the old partners continue to use their old P&L ratio
5. Aww invests noncash assets worth P50,000. The total firm capital is set to be P200,000
6. Aww invests noncash assets worth P50,000 for 30% interest in the partnership.
a. Under BV approach, total firm capital is P200,000
b. Under Revaluation approach, the total firm capital is P220,000
7. Aww invests noncash assets worth P30,000 for 15% interest in the partnership.
a. Under BV approach, the total firm capital is P180,000
b. Under Revaluation approach, the total firm capital is P200,000

Problem 2. The partners in MarimarAww Partnershiphave capital balances as follows:

Mari – P70,000; Mar – P70,000; Aww – P105,000

Profits and losses are shared 30%, 20% and 50% respectively. On this date, Aww withdraws and the partners agree
to pay him P140,000 out of partnership cash.

1. Journalize the withdrawal through the following approaches:

a. Bonus
b. Partial-goodwill
c. Total goodwill