Module 3 - Partnership Dissolution PDF

Preview

Summary

DETAILED LEARNING MODULETitle: Partnership Dissolution Module No. 3I. Introduction This module will discuss what is dissolution and its causes. This will also discuss on how to account the admission of new partner by purchase of interest and investment of asset including withdrawal and death of part...

Description

DETAILED LEARNING MODULE Title: Partnership Dissolution Module No. 3 I. Introduction This module will discuss what is dissolution and its causes. This will also discuss on how to account the admission of new partner by purchase of interest and investment of asset including withdrawal and death of partner. II. Learning Objectives After studying this module, you should be able to: 1. Define dissolution and identify its causes. 2. Account for admission of new partner by purchase of interest and investment of asset and withdrawal and death of partner. III.

Topics and Key Concepts

Definition of 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. Causes of Dissolution 1. Admission of a partner 2. Withdrawals or retirement of a partner 3. Death of a partner 4. Incorporation of a partnership Admission of a Partner • A new partner can only be admitted into a partnership with the consent of all the continuing partner. • Delectus Personae: No one becomes a member of the partnership without the consent of all the members. • 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. Purchase of an Interest from Existing Partner • 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 who the interest is obtained resulting to mere transfers among the capital balances. • 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. Illustration: Ang and Ong are partners with capital balance of P400,000 and P200,000, respectively. They share profits in the ratio of 3:1. Case 1. Payment to old partners is equal to interest purchased. Partners Ang and Ong received an offer from Chang to purchase directly one-fourth of each of their interest in the partnership for P150,000. The partners agreed to admit Chang into the firm. Ang, Capital

100,000

Ong, Capital

50,000

Chang, Capital Computation: Ang: P400,000 x 1/4

150,000

P100,000

Ong: P200,000 x 1/4 Interest transferred to Chang

50,000 P 150,000

Case 2. Payment to old partners is less than the interest purchased. Assumed that Chang directly purchased 40% interest in the business. Chang paid P160,000 for 40% of each partners’ capital Ang, Capital 160,000 Ong, Capital 80,000 Chang, Capital 240,000 Computation: Ang: P400,000 x 40% Ong: P200,000 x 40% Interest transferred to Chang

P160,000 80,000 P 240,000

Case 3. Payment to old partners is more than the interest purchased. Partners Ang and Ong received an offer from Chang to purchase directly 30% of each of their interest in the partnership for P200,000. The partners agreed to admit Chang as a member of the firm. Ang, Capital 120,000 Ong, Capital 60,000 Chang, Capital 180,000 Computation: Ang: P400,000 x 30% Ong: P200,000 x 30% Interest transferred to Chang

P120,000 60,000 P 180,000

New Partner Invests in Partnership • A person may be admitted into a partnership by investing cash or other assets in the business invested into the partnership and not given to the individual partners. • The investment will increase the total assets and the total partners’ equity.

The assets are

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 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. Illustration: AB Partnership has a book value of P300,000 and profit percentages on Jan 1, 2021, as follows: Capital Balances P/L Ratio Andy 200,000 60% Bony 100,000 40% Total 300,000 100% On Jan 2, Cody is to invest cash into the partnership. Cody will have a one-fourth interest and a 25% share of profits. Andy and Bony will share the remaining 75 percent of profits in the ratio of 60:40 resulting in Andy a 45% share of ant profits and Bony having 30%.

Case 1. Investment Equals Proportion of the Partnership’s book value (agreed capital). Cody invests P100,000. After the investment, the difference between the new partner’s investment and his agreed capital is computed as follows:

Andy Bony Total Cody 1/4 Total

Contributed 200,000

Bonus -

Agreed 200,000 100,000 -

300,000 100,000

-

400,000

-

100,000

300,000 100,000* of Total Agreed Capital 400,000

*P400,000 x 1/4 = P100,000

The entry on the partnership’s books is: Cash

100,000

Cody, Capital

100,000

To record admission of Cody for 1/4 interest upon investment of P100,000 Case 2. New Partner’s Investment More Than Proportion of the Partnership Book Value (agreed capital). Cody invests P110,000 for a one-fourth capital interest in the partnership. The difference between the new partner’s investment and the new partner’s proportionate book value is computed as follows: Andy Bony Total Cody 1/4 of Total

Contributed 200,000

Bonus 4,500

300,000 110,000

7,500 (7,500)

410,000

-

Agreed 204,500 100,000

3,000

103,000

307,500 102,500* Total Agreed Capital 410,000

*P410,000 x 1/4 = P102,500 The entry to record the admission of Cody is as follows: Cash 110,000 Andy, Capital 4,500 Bony, Capital 3,000 Cody, Capital 102,500 To record the admission of Cody with bonus to Andy and Bony • •

The capital credit for Cody of P102,500 is P7,500 less than his actual investment. The difference represented the bonus allocated to the old partners using their profit and loss ratio.

Case 3. New Partner’s Investment Less Than Proportion of the Partnership Book Value (agreed capital). Assume that Cody invests P80,000 for one-fourth capital interest in the partnership. The difference between the new partner’s investment and the partner’s proportionate book value (agreed capital) is as follows: Contributed Bonus Agreed Andy 200,000 (9,000) 191,000 Bony 100,000 (6,000) 94,000

Total Cody

300,000 80,000

(15,000) 15,000

285,000 95,000*

Total

380,000

-

380,000

*P380,000 x 1/4 = P95,000 The entry to record the admission of Cody is as follows: Cash 80,000 Andy, Capital 9,000 Bony, Capital 6,000 Cody, Capital To record the admission of Cody. • •

95,000

The capital credit to Cody is more than his actual investment. The equities of Andy and Bony are decreased by P15,000 in their profit and loss ratio.

Withdrawal or Retirement of a Partner This type of dissolution may be accomplished by either of the following ways: a. By selling his equity interest to one or more of the remaining partners. b. By selling his equity interest to an outsider c. By selling his equity interest to the partnership. Sale of Interest to a Partner or an Outsider • 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. • If the partner withdraws in the middle of the accounting period, the books of the partnership should be updated to determine the retiring partner’s capital balance. Profits or losses should be measured from the last closing of the books to the date of withdrawal and distributed according to their profit or loss sharing agreement. Sale of Interest to the Partnership • If the partnership acquires the interest of the retiring/withdrawing partner, the partnership must pay the retiring partner an amount equal to his interest, more than his interest, or less than his interest. • The interest of the retiring/withdrawing partner is usually measured by his capital balance, increased or decreased by his share in the following adjustment: 1. Profit or loss from partnership operations from the last closing date to the date of his/her retirement. 2. Changes in the valuation of all assets and liabilities (book values to fair values). If the net income or loss of prior years were improperly computed. There should likewise be corrected before determining the interest of the retiring/withdrawing partner.

Illustration. On Jan 2, 2020, the capital balances and profit and loss ratio of Bee, Cee and Dee are as follows: Partners Capital Balances P/L Ratio Bee 10,000 50% Cee 15,000 30% Dee 20,000 20% On April 30, 2020, Bee withdraws from the partnership. The net income of the partnership for the four months ended April 30, 2020 is P14,000. It is agreed that the inventory costing P5,000 has market value of P7,000 on April 30, 2020.

Case 1. Settlement equals withdrawing partner’s interest. Assume that Bee agrees to accept payment equal to his interest. The entries to record the adjustments and the settlement with Bee on April 30, 2020 are as follows: Income Summary 14,000 Bee, Capital

7,000

Cee, Capital

4,200

Dee, Capital To record distribution of profit Inventory

2,800

2,000

Bee, Capital

1,000

Cee, Capital

600

Dee, Capital

400

To adjust inventory

Bee, Capital

18,000

Cash To record settlement to Bee

18,000

Case 2. Settlement more than withdrawing partner’s interest. If the settlement price of the withdrawing partner exceeds his capital account, the excess payment will be treated as a bonus to the retiring partner from the continuing partners. Using the data in the preceding illustration and assuming that Bee is paid P 19,500, the entries to record the settlement with Bee is as follows: Bee, Capital 18,000 Cee, Capital (3/5 x P1,500) 900 Dee, Capital (2/5 x P1,500) 600 Cash 19,500 To record settlement to Bee Case 3. Settlement less than withdrawing partner’s interest. If the settlement price of withdrawing partner is less than his capital balance, the amount of bonus is credit to the capital accounts of the continuing partners in their profit and loss ratio. Using the same data and assuming that Bee is paid P17,000 for this interest, the entry will be as follows: Bee, Capital 18,000 Cash 17,000 Cee, Capital (3/5 x P1,000) 600 Dee, Capital (2/5 x P1,000) 400 To record settlement to Bee and to divide the resulting bonus between Cee and Dee in the ratio of 3:2 Death of a Partner When the death of a partner does not result to liquidation, the accounting procedures to be followed are similar to those discussed in the withdrawal of a partner. IV.

Teaching and Learning Materials and Resources 1. Partnership and Corporation Accounting by Ballada

V. 1. 2. 3. 4.

Learning Task Problem 3-1 (True or False) Partnership dissolution is synonymous with partnership liquidation. A new partner cannot be admitted into a partnership without the consent of all the partners. The withdrawal of a partner from a partnership is a type of dissolution. Edward Santos directly purchased Ferdinand Ramos’ P250,000 partnership interest for P300,000. The entry to record the transaction is for P300,000. 5. When a bonus is allowed to a new partner, part of the entry to record his admission to a business reduces the capital accounts of the old partners. 6. If a partner withdraws by selling his equity interest to the partnership in exchange for an amount greater than the balance in his capital account, the excess payment will be treated as a bonus to the continuing partners. 7. In admission by purchase, payment is personally made to the partner from whom the interest is obtained resulting to mere transfers among capital accounts. 8. When a partner withdraws from a partnership, an audit might be performed and the assets reappraised. 9. Capital credit is the equity of a partner in the new partnership and is obtained by multiplying the total agreed capital by the corresponding percentage interest of the partner. 10. The assets invested into the partnership and not given to the individual partners increase the total assets of the partnership. Problem 3-2 (Admission by Purchase of Interest or Investment of Assets) Castro and Falceso are partners who share profits and losses in a ratio of 2:3, respectively, and have the following capital balances on Sept 30, 2020: Castro, Capital, P100,000 Cr. and Falceso, Capital, P150,000 Cr. The partners agreed to admit Garachico to the partnership. Required: Calculate the capital balances of each partner after the admission of Garachico, assuming that bonuses are recorded when appropriate for each of the following assumptions: 1. Garachico paid Castro P50,000 for 40% of his interest. 2. Garachico invested P50,000 for one-sixth interest in the partnership. 3. Garachico invested P50,000 for a 25% interest in the partnership. 4. Garachico invested P50,000 for a 15% interest in the partnership. Problem 3-3 (Admission by Purchase of Interest or Investment of Assets) Aguilar, Sustrina and Bigalbal are partners in Cavite Realty Company. Their capital balances as at July 31, 2020, are as follows: Aguilar, Capital

450,000 cr

Sustrina, Capital

150,000 cr

Bigalbal, Capital

300,000 cr

Each partner has agreed to admit Pascual to the partnership. Required: Prepare the entries to record Pascual’s admission to or Aguilar’s withdrawal from the partnership under each of the following conditions: a. Pascual paid Aguilar P125,000 for 20% of Aguilar’s interest in the partnership. b. Pascual invested P200,000 cash in the partnership and received an interest equal to her investment. c. Pascual invested P300,000 cash in the partnership for a 20% interest in the business. A bonus is to be recorded for the original partners on the basis of their capital balances. d. Pascual invested P300,000 cash in the partnership for a 40% interest in the business. The original partners gave Pascual a bonus according to the ratio of their capital balances on July 31, 2020. e. Aguilar withdrew from the partnership, taking P525,000. The excess of withdrawn assets over Aguilar’s partnership interest is distributed according to the balances of the Capital accounts. f. Aguilar withdrew by selling her interest directly to Pascual for P600,000.

Problem 3-4 (Admission of a New Partner) Detoya and Gevera have operated a successful partnership for many years, sharing profit and losses equally. Madelo is to be admitted to the partnership on June 1 of the current year, in accordance with the following agreement: a. Assets and liabilities of the old partnership are to be valued at their book values as of May 31, except for the following: • Accounts receivable amounting to P20,000 are to be written off, and the allowance for doubtful accounts is to be increased to 5% of the remaining accounts. • Merchandise inventory is to be valued at P638,700. • Equipment is to be valued at P900,000. b. Madelo is to purchase P300,000 of the ownership interest of Gevera for P375,000 cash and to contribute P350,000 cash to the partnership for a total ownership equity of P650.000. c. The income sharing ratio of Detoya and Gevera and Madelo is to be 2:1:1. The post-closing trial balance of Detoya and Gevera as of May 31 follows: Detoya and Gevera Post-Closing Trial Balance May 31, 2020 Cash

95,000

Accounts Receivable

214,000

Allowance for Doubtful Accounts Merchandise Inventory Prepaid Insurance Equipment

5,000 586,000 35,000 950,000

Acc Depreciation

257,000

Notes Payable

120,000

Accounts Payable

148,000

Detoya, Capital

750,000

Gevera, Capital

600,000 1,880,000

1,880,000

Required: Prepare the balance sheet for the new partnership as at June 1, 2020. Problem 3-5 (Determining a New Partner’s Investment Cost) The following adjusted trial balance is presented for the partnership of Morales, Gamino and Quito, who share profits and losses in the ratio of 4:3:3, respectively. Cash 40,000 Other Assets

710,000

Accounts Payable

150,000

Morales, Capital

260,000

Gamino, Capital

180,000

Quito, Capital 750,000 750,000 Assume that the partnership decided to admit Abello as a new partner with one-fourth interest.

Required: For each of the following independent cases, determine the amount that Abello must contribute in cash or other assets: 1. No goodwill or bonus will be recorded. 2. A bonus of P24,000 is to be paid by Abello and allocated to the prior partners. 3. The partners agreed that total resulting capital should be P820,000 and no goodwill should be recognized. 4. Other assets are written down by P20,000 and a bonus of P40,000 is paid to Abello at the time of admission. Problem 3-6 (Withdrawal and Admission of Partners) The partners’ capital (income-sharing ratio in parentheses) of Rivadelo, Del Mundo, Galvan and Samson on May 31, 2020, was as follows: Rivadelo (20%) 60,000 Del Mundo (20%) 80,000 Galvan (20%) 70,000 Samson (40%) 40,000 Total Partners' Equity 250,000 On May 31, 2020, with the consent of Rivadelo, Del Mundo and Samson: a. Galvan retired from the partnership and was paid P50,000 cash in full settlement of his interest in the partnership. b. Mamitag was admitted to the partnership with a P20,000 cash investment for a 10% interest in the net assets of the partnership. No goodwill will be recognized. Required: Prepare journal entries to record the foregoing events. VI.

Reference

Ballada, W. & Ballada S. (2016). Partnership and Corporation Accounting (20th ed.). DomDane Publishers & Made Easy Books Guerrero, P. & Peralta, J. (2013). Advanced Accounting Principles and Procedural Applications (2013 ed.). Cunanan Educational Supply...