ACCOUNTING FOR PARTNERSHIPS

Dissolution - Changes in Ownership

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 (Civil Code
of the Philippines, Article 1828).

On 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. Termination is that point in time when all
partnership affairs are wound up or completed, and is the
end of the partnership life.
Limited life is one of the characteristics of a partnership. Any change
in the membership of this form of business organization will result to
dissolution. Dissolution of the partnership does not necessarily
imply the business operations will come to an end. Most changes in
the ownership of a partnership are accomplished without
interruption of its normal operations.

Dissolution should be distinguished from liquidation of a

partnership. 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.

When partnership dissolution occurs, a new accounting entity is

formed. The old partnership should first adjust its books so that all
accounts are properly stated at the date of dissolution.
CAUSES OF DISSOLUTION
Partnership dissolution due to changes in ownership
occurs for varying reasons and the following are the
more prevalent:
1. Admission of a partner
2. Withdrawal or retirement of a partner
3. Death of a partner
4. Incorporation of the partnership
 ADMISSION OF A PARTNER
A new partner can only be admitted into a partnership
with the consent of all the continuing partnership
partners. This is based on the principle of delectus
personae: no one becomes a member of the
partnership without the consent of all members. This is
because a partnership is based on mutual trust and
confidence of the partners.
By admission of a new partner, the old partnership has been
dissolved and it is important that a new agreement be formulated to
govern the continuing business operations. A person may become a
partner in an existing partnership by either of the following:

1. Purchase of an interest from one or more of the existing

partners.
2. Investment of assets in the partnership by the new partner.

The foregoing situations are similar in the sense that the old
partnership is legally dissolved; the capital, and profit and loss ratio
will be based on a new partnership agreement. But these are
dissimilar in the sense that the partnership receives no new
resources when a third party purchases an interest directly from
existing partners, but it does receive new resources when a third
party becomes a partner by investing in the partnership.
Liability of Incoming Partner for Existing Obligations
A person admitted as a partner into an existing
partnership is liable for all the obligations of the
partnership incurred before his admission as though he
had been a partner when such obligations were
incurred. Such liability is limited to his capital
contribution, unless otherwise agreed.
Illustration
Castro, Pural and Bernal formed a general professional
partnership with a capital of P50,000 each on Feb. 14, 2007. On
Apr. 8, & the partnership incurred an obligation of P200,000 to
Tuy which will be payable on Dec. 16. On June 13, Ruiz was
admitted into the partnership; she contributed P20,000. Even if
the obligation was incurred before Ruiz’s admission into the
partnership, she is still liable to Tuy but only to the extent of her
contribution. Total partnership capital upon admission is
P170,000 leaving a balance of P30,000 (deficit) which will be
shared by the old partners equally.
PURCHASED OF AN INTEREST FROM EXISTING PARTNERS

With the consent of all continuing partners, a person may be

admitted into an existing partnership by purchasing an interest
directly from one or more of the existing partners. Payment is
made personally to the partner from whom the interest is
obtained resulting to mere transfers among capital accounts.

This type of admission will only result to a debit to the capital

account of the selling partner for the interest purchased. The
amount debited and credited is not affected by the actual price
for the equity interest. In this type of admission, the total
assets, total liabilities and total partners’ equity of the
partnership are not affected upon admission.
Illustration

Deogracia Corpuz and Magdalena Solis are partners

with capital balances of P400,000 and P200,000,
respectively. They share profits in the ratio of 3:1. their
business has been very successful. All indications show
that it will continue to be.
Case 1. Payment to old partners is equal to interest
purchased.

Partners Deogracia Corpuz and Magdalena Solis received an offer

from Jose Lacson to purchase directly one-fourth of each of their
interest in the partnership for P150,000. The partners agreed to
admit Jose Lacson as member of the firm.

Case 2. Payment to old partners is less than the interest

purchased.
Assume that Jose Lacson directly purchased one-third of each
partner’s interest in the business. Lacson paid P160,000 for one-
third of each partner’s capital.
Case 3. Payment to old partners is more than the interest
purchased.

Partners Deogracia Corpuz and Magdalena Solis received

an offer from Jose Lacson to purchase directly 30% of
each of their interest in the partnership for P200,000. The
partners agreed to admit Jose Lacson as member of the
firm.
 INVESTMENT OF ASSET IN A PARTNERSHIP

A person may be admitted into a partnership by

investing cash or other assets in the business. The
assets are invested into the partnership and not given
to the individual partners. The investment will increase
the total assets and the total partners’ equity.
Definition of Terms
Total Contributed Capital. It is the sum of the capital balances of the
old partners and the actual investment of the new partner.

Total Agreed Capital. It is the total capital of the partnership after

considering the capital credits given to each of the partners. Under
the bonus method, total agreed capital is equal to the total
contributed capital though the capital credits to each partner may be
equal to, greater than or less than his capital contributions.

Bonus. It is the amount of capital or equity transferred by one partner

to another partner.

Capital Credit. It is the equity of a partner in the new partnership and

is obtained by multiplying the total agreed capital by the applicable
percentage interest of the partner.
Bonus to Old Partners
A partnership may be exceptionally attractive because of
superior earnings record such that the old partners may
demand a premium from a new partner. This premium
increases the old partner’s capital interest. This premium
is effected either by allocating a portion of the investment
of the new partner to the old partners. The capital
accounts of the old partners are credited for the premium
according to their profit and loss ratio.
Illustration
Zenaida Rivadelo and Janet Matuguinas are partners with
capital balances of P400,000 and P200,000, respectively.
They share profits in the ratio of 3:1. the partners agreed
to admit Leopoldo Medina as a member of the firm. The
foregoing information will be the basis of the following
cases.
Case 1. Total agreed capital is stated.
Assume that Leopoldo Medina invested P250,000 for a one-
fourth interest in the business. The partners decided not to
revalue the assets of the partnership and that the total agreed
capital is P850,000.

Case 2. Total agreed capital is not explicitly stated.

Assume that Leopoldo Medina invested P400,000 in the business.
Out of the cash investment, P100,000 is considered as a bonus to
Partners Zenaida Rivadelo and Janet Matuguinas.

The investment of Medina resulted to a bonus as stated. Under

the bonus method, the total contributed capital is equal to the
total agreed capital. It is also clearly specified that the old partners
will receive the bonus.
Bonus to New Partner
A new partner may be admitted into the partnership
because of his vast financial resources, extensive business
network, distinctive reputation, unique management and
/or technical skills. The old partners may be willing to give
a premium for all of these exceptional qualifications by
allowing a capital credit greater than the prospective
partner’s investment just to ensure his association with
the partnership. This premium will be treated as a bonus
from the qualitites of the old partners and created to the
new partner.
Case 1. Total agreed capital is stated
Assume that Leopoldo Medina invested P240,000 for a
one-third interest in the business. The total agreed capital
is P840,000. the investment of Medina resulted to a bonus
as shown by the following table.

Case 2. Total agreed capital is not explicitly stated

Assume that Leopoldo Medina invested P300,000 for a
50% interest in the business. Zenaida Rivadelo and Janet
Matuguinas transferred part of their capital balance to that
of Leopoldo Medina as a bonus. The investment of Medina
resulted to a bonus as stated. Under the bonus method,
the total contributed capital is equal to the total agreed
capital. It is also clearly specified that the new partner will
receive the bonus.