Dissolution - Admission by Purchase
Partnership dissolution happens when the ownership structure or composition changes. Examples are:
Admission of a new partner – there is an additional partner
Retirement/Death of a partner – there is a reduction in the number of partners
Incorporation of a partnership – the partnership is ended, a different company in the form of a corporation is created
In the case of incorporation, the partnership is dissolved and liquidated.
Dissolution pertains to a change in ownership, but not necessarily the end or closure of the partnership.
Liquidation pertains to closing or end of the partnership. This is also called winding up of business.
Let’s focus now on the different cases of partnership dissolution.
Alright, so there are two types of Partnership Admission. A new partner may join an existing partnership by 1) Purchasing interest from the partners, or 2) Investing in the partnership. It’s also possible to Purchase interest AND Invest to be admitted as a partner.
Let’s go over these one by one.
Let’s have a simple example for the above statements.
Lily and Daisy are partners of FLOWERS PARTNERSHIP. Lily has 40% interest ownership for P120,000, while Daisy has 60% interest ownership for P180,000.
Rose wanted to join the partnership by having 20% interest. She is willing to give P100,000. Lily and Daisy agreed to let her purchase the 20% from Daisy. After admission, ownership interest would be 40% to Lily, 40% to Daisy and 20% to Rose.
Her capital credit would be computed as:
180,,000 / 60% x 20% = P60,000
Her interest purchase is from Daisy, so our basis was Daisy’s capital of 180,000, which is currently 60%. After getting the partnership capital (180,000 / 60%), we multiply that by 20%, which is the interest purchased by Rose.
The difference between the payment (P100,000) and the capital credit (recorded capital of P60,000) is a personal gain of Daisy, and a personal loss of Rose.
Entry to record the purchase is:
Debit Daisy, Capital 60,000
Credit Rose, Capital 60,000
Notice that the payment (in cash or in kind) is not reflected on the books of the partnership. Again, this is because admission by purchase is a personal transaction between the selling partner and the person to be admitted. Also, the total capital of the partnership remains the same at P300,000 even after the admission.
After admission of Rose, the capital balances of the partners are as follows:
Lily – 40% at P120,000
Daisy – 40% at P120,000 (This is computed as P180,000 – P60,000 purchased by Rose.)
Rose – 20% at P60,000
Let’s have another example. Purchase can also be made from more than one partner.
Say, Lily and Daisy agreed to let Rose purchase 10% interest from Lily and 10% interest from Daisy, for a total payment of P100,000.
This would be computed as follows:
From Lily = P120,000 / 40% x 10% = P30,000
From Daisy = P180,000 / 60% x 10% = P30,000
The capital credit to Rose is P60,000.
The capital balances of Lily and Daisy are as follows:
Lily – P120,000 – P30,000 = P90,000
Daisy – P180,000 – P30,000 = P150,000
To record the admission,
Debit Lily, Capital 30,000
Debit Daisy, Capital 30,000
Credit Rose, Capital 60,000
The payment of Rose is distributed between Lily and Daisy based on the following: (Please note that there is no established rule, this one is the suggested method for fair distribution.)
- The amount of capital credit transferred to the new partner
- The excess is allocated using the P/L ratio of the selling partners
That would mean, P30,000 to Lily, P30,000 to Daisy, and the excess of P40,000 is to be allocated using their P/L ratio. Suppose the P/L agreement is 40:60 to Lily and Daisy, respectively, the P40,000 excess is distributed as follows:
To Lily – P40,000 x 40% = 16,000
To Daisy – P40,000 x 60% = 24,000
The total distribution of Rose’s payment amounting to P100,000 is:
To Lily – P30,000 + P16,000 = P46,000
To Daisy – P30,000 + P24,000 = P54,000
Got them? Alright, this one is the simplest. Moving on…
There is another method, wherein the new partner’s contribution is perceived and taken as the basis of his interest purchase. Any difference is considered an asset revaluation. Practically, the existing partnership capital is NOT EQUAL to partnership capital AFTER ADMISSION of a new partner.
Example: Rose is to purchase 20% interest in the partnership, from both Lily and Daisy, for P80,000.
We compute first for the TOTAL CAPITAL of the Partnership after admission by using Rose’s purchase of interest and payment as basis.
P80,000 / 20% = P400,000
Before the admission, the total capital is [Lily P120,000 + Daisy P180,000 = P300,000]
Here we have a positive asset revaluation of P100,000. The asset revaluation is relative to the assets of the company. It may be that the PPE are undervalued, so the adjustment of P100,000 may be applied to those accounts.
Also, this revaluation is only applicable to the existing/old partners (before the admission), and allocated using their P/L ratio.
To record that,
Debit to Asset accounts 100,000
Credit to Lily, Capital 40,000
Credit to Daisy, Capital 60,000
And then, the admission of Rose:
Debit to Lily, Capital P32,000 (P120,000 + P40,000) x 20%
Debit to Daisy, Capital P48,000 (P180,000 + P60,000) x 20%
Credit to Rose, Capital P80,000 (As is the payment)
After the admission of Rose, capital balances of the partners are:
Lily - P120,000 + P40,000 – P32,000 = P128,000
Daisy – P180,000 + P60,000 – P48,000 = P192,000
Rose = P80,000
Total capital is P128,000 + P192,000 + P80,000 = P400,000.
Still following?
There are a lot of possible questions for Partnership Dissolution. (I’m talking about exam questions, by the way.)
- Purchased capital from each partner (if more than one)
- Distribution of payment to selling partners
- Recording of transactions (some asks how much is the debit to a partner’s account)
- Capital balances after admission (of old partners or new partner)
- Total capital of the partnership after admission
The most difficult one is when all of the above are involved, in “which of the following statements is true?” questions. The choicees are: A provides the total capital of partnership after admission, B provides the capital balance of a partner after admission, C provides the distribution of payment to a partner, and D provides the debited amount to one of the partners.
I reviewed in CPAR, and it’s true that the items from the actual board are nothing like the ones on the handouts (except for the theories), but the logic was this (and I’m a believer of this, too):
IF YOU CAN ANSWER DIFFICULT QUESTIONS THAT REQUIRE THE BASICS AND THE UNDERSTANDING OF CONCEPTS, ONES THAT ARE SUPPOSED TO TRICK YOU, THEN YOU CAN PROBABLY ANSWER ANY TYPE OF QUESTION IN THE ACTUAL BOARD.
The point was: If you’ve been practicing and answering difficult questions, and you’ve been able to, without getting tricked, you’ll definitely feel like SOME or MOST of the questions in the actual board are easy. You might find yourself smiling while taking the exams. And again, that takes A LOT of practice, which requires HARD WORK AND DILIGENT EFFORT on your part.
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