CHANGES IN PARTNERSHIP

Partnership Dissolution (Changes in Ownership)

Partnership dissolution occurs whenever there is a change in ownership (e.g., the

addition of a new partner, or the retirement, withdrawal or death of an existing partner).
This is not to be confused with partnership liquidation which is the winding up of
partnership affairs and termination of the business. Under dissolution the partnership
business continues, but under different ownership.

When partnership dissolution occurs, a new accounting entity results. The

partnership should first adjust its records so that all accounts are properly stated at the
date of dissolution. After the income (loss) has been properly allocated to the existing
partner’s capital accounts, all assets and liabilities should be adjusted to their fair
market value and their present values, respectively. The latter step is performed because
the dissolution results in a new accounting entity.

After all adjustments have been made, the accounting for dissolution depends on the
type of transaction that caused the dissolution.

These transactions can be broken down into two types:

 Transactions between the partnership and a partner (e.g., a new partner
contributes assets, or a retiring partner withdraws assets).
 Transactions between partners (e.g., a new partner purchases an interest form
one or more existing partners, or a retiring partner sells his/her interest to one or
more existing partners).

a. Transactions Between a Partner and the Partnership

1. Admission of a New Partner

When a new partner is admitted to the partnership essentially three cases can
result. The new partner can invest assets into the partnership and receive a
capital balance.
a. Equal to his/her purchase price
b. Greater than his/her purchase price
c. Less than his/her purchase price

If the new partner’s capital balance is equal to the assets invested, then the
entity debits the asset(s) contributed and credits the new partner’s capital
account for the fair value of the asset(s) contributed.

If the new partner’s capital balance is not equal to the assets invested (as in
situation (b) and (c) above), then either the bonus or goodwill method must be
used to account for the difference.

Bonus method – The old partnership capital plus the new partner’s asset
contribution is equal to the new partnership capital. The new partner’s capital is
allocated his purchase share (e.g., 40%) and the old partner’s capital accounts are
adjusted as if they had been paid (or as if they paid) a bonus. The adjustment to
the old partners’ capital accounts is made in accordance with their profit (loss)
sharing ratio.
 The bonus method implies that the old partners either received a bonus form
the new partner, or they paid a bonus to the new partner. As a result the old
partners’ capital accounts are either debited to reflect a bonus paid, or credited to
reflect a bonus received. The new partner’s capital account is never equal to the
amount of assets contributed in a case where the bonus method is used.

Goodwill method – The old partnership capital plus the new partner’s capital
asset contribution is not equal to the new partnership capital. This is because
goodwill is recorded on the partnership books for the difference between the total
identifiable assets of the partnership (not including goodwill) and the deemed
value of the partnership entity (which includes goodwill). An adjustment is made
to the capital accounts of the existing partners to reflect the goodwill (whether
acquired or given) in their profit (loss) sharing ratio. Under the goodwill method,
valuation of the partnership is the objective.

How the value of the partnership is determined depends on whether the book
value acquired is greater or less than the asset(s) invested. If the book value
acquired is less than the asset(s) invested, the value is determined based upon
the new partner’s contribution, and goodwill is allocated to the old partner’s
accounts. If the book value acquired is greater than the asset(s) contributed, the
value is based upon the existing capital accounts, and goodwill is attributed to
the new partner.

The decision as to whether the bonus or goodwill method should be used rests
with partners involved. In other words, the bonus and goodwill methods are
alternative solutions to the same problem.

Example: Admission of a New Partner – Bonus Method

Total old capital for ABC Partnership is P600,000.

Partner A B C
Capital balance P100,000 P200,000 P300,000
P&L ratio 40% 40% 20%

Case I

D is admitted to the partnership and is given a 20% interest in the capital

in return for a cash contribution of P300,000. The entry to record the admission
of D should be
Cash P300,000
D, capital P180,000
A, capital 48,000
B, capital 48,000
C, capital 24,000

The total partnership capital to be shown on the books is P900,000 (P600,000 +

P300,000) of which D is entitled to a 20% interest, or a capital balance of
P180,000. The remaining P120,000 is treated as a bonus to the old partners and
is allocated to their capital accounts in accordance with their P&L ratio.

Case II

D is admitted to the partnership and is given a 20% interest in the capital

in return for a cash contribution of P100,000. The entry to record the admission
of D in this case should be
 Cash P100,000
A, capital 16,000
B, capital 16,000
C, capital 8,000
D, capital P140,000

The total partnership capital to be shown on the books is P700,000

(P600,000 + P100,000) of which D is admitted to a 20% interest, or a capital
balance of P140,000. The difference of P40,000 (P100,000 – P140,000) is allocated
to the old partners’ capital accounts as if they had paid a bonus to the new
partner.

Example: Admission of a New Partner – Goodwill Method

Use the same original data as given above.

Case I

D is admitted to the partnership and is given a 20% interest in the capital

in return for a cash contribution of P200,000. The partners elect to record
goodwill. The book value acquired (P600,000 + P200,000) x 20% = P160,000 is
less than the asset contributed.

The value of the partnership is determined based upon the contribution of

the new partner. In this case it is assumed that the partnership value is
P1,000,000 (P200,000/20%). The resulting goodwill is P200,000 (P100,000 –
P800,000). The P800,000 represents the total current capital exclusive of
goodwill, P600,000 of which is attributable to the old partners and P200,000 of
which is attributable to the new partner. The entry to record the admission of D
should be:

Goodwill P200,000 Cash P200,000

A, capital P80,000 D, capital P200,000
B, capital 80,000
C, capital 40,000

Goodwill was allocated to the old partners in their P&L ratio. Also note
that the capital balance of D represents 20% of the total capital of the
partnership.

Case II

D is admitted to the partnership and is given a 20% interest in the capital

in return for a cash contribution of P100,000. The partners elect to record
goodwill. The book value acquired (P600,000 + P100,000) x 20% = P140,000 is
greater than the asset contributed.

The partnership value is based upon the capital accounts of the existing
partners. Because D is entitled to a 20% interest, the P600,000 capital of the old
partners must represent 80% of the capital. This means that the total value of the
partnership is P750,000 (P600,000/80%). D’s total contribution consists of the
P100,000 in cash and P50,000 of goodwill. The goodwill is determined as the
difference between the cash contribution and the 20% of the partnership capital.
Cash P100,000
Goodwill 50,000
D, capital P150,000
 Note that in this last case no adjustment is made to the capital accounts
of partners A, B, and C.

To summarize the above explanations, under the goodwill method,

goodwill can be determined by simply dividing the capital contributions of either
the new partner or the old partners, to get an amount higher than the total
contributed capital. The higher amount is now called
the total implied capital after goodwill or otherwise known as total agreed capital.
The total agreed capital is then compared to the total contributed capital to get
the total amount of implied goodwill that should be recognized in the books. If the
new partner’s contribution was used to get the total agreed capita, then goodwill
should be credited to the old partner’s capital in accordance with their P&L ratio.
But if the old partners’ capital was used to get the agreed capital then goodwill
should be credited to the new partner’s capital.

The table below summarizes the bonus and goodwill situations discussed
above:

When to Apply Bonus Method

New partnership Capital = Old Partners Capital + New Partner’s Asset
Investment

Which Partner(s) Receive Bonus

New Partner
New Partner’s Capital Credit > New Partner’s Asset Investment
Old Partners
New Partner’s Capital Credit < New Partner’s Asset Investment
(The difference represents the bonus allocated to old partners in their P&L
ratio.)

When to Apply Goodwill Method

New Partnership Capital > Old Partners Capital + New Partner’s Asset
Investment

Which Partner’s Goodwill is Recognized

New Partner’s Goodwill

New Partner’s Capital Credit > New Partner’s Asset Investment
(The difference represents goodwill.)

Old Partners’ Goodwill

New Partner’s Capital Credit = New Partner’s Asset Investment
(Goodwill is allocated to old partners in their P&L ratio)

Total Capital Agreed After Admission

Sometimes partners agreed as to the total capital of the partnership after the
admission of a new partner that might either result in:
a. Goodwill to old partners only or new partner only or both, or
b. Bonus to old partners only or new partner only but it can never
be both, or
c. Goodwill and bonus to either old partners or new partner.
 Situations wherein goodwill to old partners only or new partners only and
bonus to old partners only or new partner only were already discussed above
except that the total agreed capital was not specified in the example. It was
assumed using the bonus method or goodwill method. Cases explained below
pertain to situations wherein goodwill and at the same time bonus were either to
old partners’ capital based on their P&L ratio or to new partner’s capital.

Case I
Using the previous example for ABC Partnership, wherein D invested
P300,000, but this time all partners agreed that the total capital after D’s
admission should be P1,000,000 and D’s interest in the partnership net assets is
20%.

The partnership should therefore recognized goodwill of P100,000

(P1,000,000 agreed capital minus P900,000 contributed capital; P600,000
attributable to old partners and P30,0000 attributable to new partner). D should
be credited for P200,000 (P1,000,000 x 20%) only, in spite of his contribution of
P300,000. Therefore, the old partners in this case should receive the goodwill of
P100,000 and the bonus from the new partner of P100,000 distributed based on
their P&L ratio. The entry to record the admission of D should be:
Goodwill P100,000 Cash P300,000
A, capital P40,000 D, capital P200,000
B, capital 40,000 A, capital 40,000
C, capital 20,000 B, capital 40,000
C, capital 20,000

Case II

Using the previous example in case I above, except, this time D invested
P250,000, and all partners agreed that the total capital after D’s admission
should be P900,000 and D’s interest in the partnership’s net assets is 40%.

The partnership should recognized goodwill of P50,000 (P900,000 agreed

capital minus P850,000 contributed capital). D should be credited for P360,000
(40% x P900,000).

If the capital credit to D is P360,000 but his capital contribution is just

P250,000, then the goodwill of P50,000 should be credited to him as well as a
bonus of P60,000 from the old partners
( to make the total capital of P360,000) deducted from them based on their P&L
ratio. The entry to record the admission of D should be:
Goodwill P50,000 A, capital P24,000
D, capital P50,000 B, capital 24,000
Cash P250,000 C, capital 12,000
D, capital P250,000 D, capital P60,000

Case III

Using again the above example in case I and this time D invested
P200,000 but he should be credited for P250,000 a 25% interest in the
partnership net assets. The partners also agreed that the total capital should be
P1,000,000 after D’s admission.
 The goodwill therefore in this case is P200,000 (P1,000,000 agreed capital
minus P800,000 contributed capital ), and D should be credited for P250,000
(25% x P1,000,000). Inasmuch as the amount of identifiable assets contributed by
D is just P200,000, but he should be credited for P250,000 then it is implied that
D is bringing in goodwill of P150,000, is the implied goodwill of the business
prior to D’s admission and should be credited to old partners based on their P&L
ratio. The entry to record D’s admission should be
Goodwill P200,000 Cash P200,000
A, capital P60,000 D, capital P200,000
B, capital 60,000
C, capital 30,000
D, capital 50,000

Partner’s Interest Different From P&L Sharing Ratio

Normally, the partner’s interest in the partnership’s net assets is equal to

his or her P&L ratio. If in case, the interest in net assets differs from the share in
the profit or loss of the partnership, then the use of either bonus method or the
goodwill method might be advantageous to the new partner in recording his or her
admission.

Example: Interest Greater than P&L Ratio

Case I

Using the same information of ABC Partnership above except that D was
admitted into the partnership for a 25% interest and D’s P&L ratio is only 20%,
after investing P300,000.

Using the bonus method D should be credited for P225,000 (P900,000 x

25%) and based on this you can now say that D, the new partner is giving bonus
to old partners of P75,000 (P300,000 – P225,000), distributed to A, B, & C based
on their P&L ratio.

Using the goodwill method, D’s capital contribution will be the basis of
computing the agreed capital of P1,200,000 (P300,000/25%). The goodwill of
P300,000 (P1,200,000 – P900,000) will determined is normally recorded in the
books. The goodwill once recorded in the books should be written off for a period
of not exceeding 40 years (GAAP rule) and thus the effect is reduction in the
capital of all partners. Since D’s P&L ratio is just 20%, D’s share on the goodwill
amortization would be P60,000 (20% x P300,000), and D’s capital will reduce to
P240,000. Therefore, it will be advantageous for D to use the goodwill method
because the capital is still P240,000, rather than the bonus method where in the
capital is only P225,000, and the advantage will be P15,000 or to simplify the
computation, just get the difference between the interest and P&L share, then
multiply by the amount of goodwill, (25% - 20 %) = 5% of P300,000 goodwill.

To summarize the above explanations the following computations were made.

Bonus method:
Capital credit to D (25% x P900,000 agreed capital) P225,000
Goodwill method:
Capital credit to D initially (25% x P300,000
P1,200,000) equal to his capital
contribution
Less: Share on the goodwill amortization
 (20% x P300,000) 60,000 240,000
Advantage of goodwill method over bonus method P 15,000

OR simply the difference between the interest and P&L multiply by the goodwill
recognized under the goodwill method. (5% x P300,000) = P15,000.

Example: Interest Less Than P&L Ratio

Case II

Using the same information, but this time the interest is 20% and D’s P&L
ratio is 25%.

Bonus method:
Capital credit to D (20% x P900,000) P180,000
Goodwill method:
Capital credit to D (20% x P1,500,000) P300,000
Less: Share on the goodwill amortization
(25% x P600,000) 150,000 150,000
Advantage of bonus method over goodwill method P 30,000

OR simply the difference between the interest and P&L multiply by the goodwill
recognized under the goodwill method (5% x P600,000) = P30,000.

The table below summarizes the situations discussed above.

Bonus method advantageous and the amount of advantage.
Partner’s interest in the net assets < Partner’s P&L ratio, difference
x Goodwill.
Goodwill method advantageous and the amount of advantage
Partner’s interest in the net assets > Partner’s P&L ratio, difference
x Goodwill
Neither bonus nor goodwill advantageous (general rule)
Partner’s interest in the net assets = Partner’s P&L ratio, difference
x Goodwill

2. Partner Death or Withdrawal or Retirement

The death or withdrawal or retirement of a partner is treated in much the

same manner as the admission of a new partner. However, there is no new capital
account to be recorded; we are dealing only with the capital accounts of the
original partners. Either the bonus or goodwill method may be used. The key
thing to remember in regard to a partner’s withdrawal from the partnership is
that the withdrawing partner’s capital account must be adjusted to the amount
that the withdrawing partner is expected to receive.

Example: Partner Withdrawal

Assume the same partnership data as given for the ABC partnership earlier.

Case I

Assume that A withdraws from the partnership after reaching an

agreement with partners B & C that would pay him P160,000. The remaining
partners elect not to record goodwill. The entry to record the withdrawal of A
should be:
B, capital P40,000 A, capital P160,000
 C, capital 20,000 Cash P160,000
A, capital P60,000

The P60,000 bonus is determined as the difference between the current

balance of A’s capital account and the amount of his buyout agreement. This
“bonus” is then allocated between the remaining partners’ capital accounts in
proportion to their P&L ratios.

Case II

Assume again that A withdraws from the partnership pursuant to the

same agreement except that this time the partners elect to record goodwill.

The first step is to determine the amount of goodwill to be recorded. In this

case we know that A’s capital account must have a balance of P160,000, the
agreed buyout payment A is to receive. In order to accomplish this the total
partnership assets must be increased by some amount of which P60,000
represents 40%, A’s P&L ratio. Therefore, the amount of goodwill to be recorded is
P150,000 (P60,000/40%). The entry therefore, to record A’s withdrawal should be:
Goodwill P150,000 A, capital P160,000
A, capital P60,000 Cash P160,000
B, capital 60,000
C, capital 30,000

Note that in this case all of the partners’ capital accounts are adjusted to record
the goodwill in accordance with their P&L ratios.

Case III

Sometimes partners wish to record only the goodwill paid to A and not the
total goodwill, which is known as the “alternative goodwill method”. In this case,
using the information in case II above, the entry to record A’s withdrawal should
be:
Goodwill P60,000 A, capital P160,000
A, capital P60,000 Cash P160,000

b. Transactions between Partners

The sale of a partnership interest is a transaction only between the partners.

Thus, the treatment accorded the transaction is determined by the partners involved.

There are two means of dealing with such a transaction. The first is to simply
transfer a portion of the existing partner’s capital to a new capital account for the
buying partner.

Example: Sale of a Partnership Interest – No Goodwill Recorded

Assume the following for the AB partnership:
Partner A B
Capital P500,000 P500,000
P&L ratio 60% 40%
Case I

Assume that C wishes to enter the partnership by buying 50% of the partnership
interest from both A and B for a total of P800,000. It is important to note that the
P800,000 is being paid to the individual partners and not to the partnership. Thus,
we are only concerned with the proper adjustment between the capital accounts, not
the recording of the cash. This approach ignores the price that C paid for the
partnership interest. The entry to record C’s capital should be:

A, capital P250,000
B, capital 250,000
C, capital P500,000

The other method available for recording a transaction between partners is the
recording of implied goodwill.

Example: Sale of Partnership Interest – Recording Goodwill

Assume the same facts presented above for the sale of the partnership interest
except that in this case partners elect to record goodwill.

Case II

Assuming that C paid P800,000 for a 50% interest in the partnership, the implied
value of the partnership assets is P1,600,000 (P800,000/50%). Because total capital
prior to the purchase is only P1,000,000, the amount of goodwill that must be
recorded is P600,000. The goodwill is allocated to the partner’s capital accounts in
proportion to their P&L ratios. Note that this entry is made before an adjustment is
made to reflect C’s admission to the partnership.
Goodwill P600,000
A, capital P360,000
B, capital 240,000

Now we can record the sale of the partnership interest to C. The capital balance of
A is now P860,000 (P500,000 + P360,000) while the capital balance of B is P740,000
(P500,000 + P240,000). Recall that C is to receive 50% of each balance.
A, capital P430,000
B, capital 370,000
C, capital P800,000

Notice that in this situation the capital balance of C after the purchase is equal to
the amount of the purchase price. Again no entry is made to record the receipt of
cash because the cash goes directly to the individual partners, A and B.