Partnership Dissolution

(Article 1828 Civil Code of the Philippines)

It is the change in the relationship between partners due to a partner ceasing to be associated in the carrying on as
distinguished from the winding up of the business of the partnership.

(Article 1829)Here, the partnership is not terminated but continues until the winding up of the affairs in the partnership
is liquidated.

Note: Liquidation happens when business is terminated, always preceded by dissolution. However, dissolution may
happen without being terminated.

Causes of dissolution:

1. Admission of a partner
2. Withdrawal or retirement of a partner
3. Death of a Partner
4. Incorporation of a partner

Admission of a Partner

-is based on the principle of “delectus personae” meaning no one becomes a member of a partnership without
the consent of all the members. It is because a partnership is built on mutual trust and confidence in all
partners.

To become a partner in a partnership a person may:

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

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

Note: A person admitted to the partnership is liable for all obligations of the partnership incurred before his admission
though he’s not a partner when obligations were incurred. Liability is limited to his capital contribution unless there’s
another agreement made.

1. Purchase of an interest from existing partners

A person may be admitted into an existing partnership by purchasing an interest directly from one or more of the
existing partners. It results in mere transfers among capital accounts where payment is made personally or direct to
the partner from whom the interest is obtained.

This will result in a debit to the capital account of the selling partner for the sold interest and a credit to the capital
account of the buying partner for the purchased interest.

Note: The debited and credited amount doesn’t affect the actual price of the partnership capital. Total assets,
liabilities, and owner’s equity of the partnership are not affected upon admission.

Case 1: Payment to old partners is equal to interest purchased

Case 2: Payment to old partners is less than the interest purchased

Case 3: Payment to old partners is more than the interest purchased

Investment of assets in a partnership

By investing cash or other assets in the business a person may be admitted into a partnership. The investment
will increase the total assets and the total partner’s equity.

Definition of terms:

Total Contributed Capital is the sum of total capital balances of old partners and the actual investment of the new
partner.

Total Agreed Capital is the total capital of the partnership after considering the capital credits given to each partner.
Bonus is the amount of capital or equity transferred by a partner to another partner.

Capital credit is the capital of a partner in the new partnership and is acquired by multiplying the total agreed capital by
the applicable percentage interest of the partner.

Bonus to Old Partners

A partnership may be extremely attractive due to the superior earning records that partners may demand a
premium from a new partner. This premium increases the old partner’s capital interest and is affected 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. There will be a debit to cash or the investment and
credit to the capital account of the new partner for his investment. The second entry would be a debit to the new
partner’s equity and credit to the old partners’ equity for their bonus.

Case 1: Total agreed capital is stated

Case 2: Total agreed capital is not explicitly stated

Example problem

Assume that Uno invested P260, 000 for a one-fourth interest in the business. The total agreed capital is P860, 000. The
old partners' Dos and Tres, who contributed P400,000 and P200,000 respectively, share profits in a ratio of 3:1. The
investment of Uno resulted in a bonus as shown in the ff. table:

P860, 000x1/4= P215, 000

Bonus to New Partner

Because of his vast financial resources, extensive business network, distinctive reputation, unique management, and/ or
technical skills a new partner may be admitted into the partnership. Because of all these exceptional qualifications, the
partners may be willing to give a premium by allowing a capital credit greater than the new partner’s investment just to
ensure his association with the partnership. This capital will be treated as a bonus from the equities of the old partners
and credited to the new partner. There will be a debit to cash or the investment and credit to the capital account of the
new partner for his investment. The second entry would be a debit to the old partners’ equity and credit to the new
partner’s equity for his bonus.

Example problem

Assume that Uno invested P210, 000 for a one-third interest in the business. The total agreed capital is P810, 000. The
old partner Dos and Tres, who contributed P400,000 and P200,000 respectively, share profits in a ratio of 3:1. The
investment of Uno resulted in a bonus as shown in the ff. table:

P810,000 x 1/3= P270,00

Case 1: Total agreed capital is stated

Case 2: total agreed ratio is not explicitly stated

Withdrawal or retirement of a partner

A partner may withdraw or retire from a partnership for some reasons. These reasons include disputes with other
partners, old age, and the pursuit of better opportunities. The withdrawal of a partner dissolves the old partnership.

1. By selling his equity interest to one or more of the remaining partners

2. By selling his equity interest to an outsider
3. By selling his equity interest to the partnership
Sale of Interest to a Partner or an outsider

Here, the withdrawing partner is paid from the personal assets of the buyer and adopts the same accounting to
the admission by the purchase of interest. The total assets of the partnership are not affected by the consideration
involved. The entry would be debit to the seller’s capital account for his capital balance and credit to buyer’s capital
account fro the same amount.

Note: There are situations that partners withdraw in the middle of the period, so, the books of the partnership should be
updated to determine the retiring capital balance of the partner. Profits or losses should be measured from the last
closing of books to the date of withdrawal and distributed according to their profit and loss sharing agreement.

Sale of Interest to the Partnership

A partner is paid from the assets of the partnership when a withdrawing partner sells his interest to the
partnership. He may receive an equal, less than, or greater than the amount of the balance of his capital account. This
withdrawal will lead to a reduction of asset and owner’s equity of the partnership.

Asset Revaluation problem for Adjusting

Example: Suppose that Uno is retiring midyear from the partnership of Uno, Dos, and Tres because of his health
problem. His active performance and work in the partnership may worsen his health condition. The books needs to be
adjusted for the mid- year profits but before revaluation , their capital balances are as follows:

Uno, Capital P450,000

Dos, Capital P450,000

Tres Capital P300,000

During the midyear, they discovered that the merchandise inventory was understated by P 100,00 and their land
increased to P60,000. The profit ratio of the partners is 2:2:1.

Note: Withdrawing partner may receive his share of the business in partnership assets rather than cash.

Case 1: Withdrawal at book value

This will result to debit to selling partner’s interest and credit to buying partner’s capital with the same amount
as the selling partner’s capital.

Case 2: Withdrawal at more than book value

This will result to debit to selling partner’s interest and credit to cash. Since more than book value it will create
bonus from the continuing partner so more credit capital for the withdrawing partner.

Case 3: Withdrawal art less than book value

This will result to debit to selling partner’s interest and credit to cash of the partnership. Since less than book
value it will create a bonus to the continuing partner so more credit capital for the continuing partners.

3.Death of a Partner

When the death of a partner doesn’t result to liquidation, accounting procedures should follow the same of the
discussed 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
After evaluating the various advantages of having a corporate form of business, a partnership may
decide to incorporate it. After the necessary adjusting and closing entries in the books of the partnership, the
assets and liabilities of the partnership will be transferred to the corporation in exchange for shares of stock. The
 shares received by partners are distributed 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.

Note: There are 3 steps to incorporation of a partnership. First, adjust the books of the partnership to the current date.
Second, close the books. Third, transfer the assets and liabilities to the books of the corporation to also establish the
equity of the corporation.
Partnership Liquidation

-is the winding up of its business activities in three steps. First, sale of all non- cash assets. Then, settlement of all
liabilities and last, distribution of the remaining cash to the partners.

Realization- conversion of non- cash assets into cash. This may result to gain or loss on realization and shall be divided in
the profit and loss ratio of the partners.

Capital Deficiency- a partner may yield substantial loss on realization which is the excess of a partner’s share in losses
over the partner’s capital credit balance. This deficiency will certainly affect the partner’s interest- the sum of his capital
and loan accounts- in the partnership.