Module 1:

Partnership Accounting

Intended Learning Outcomes

This course is under the Advanced Financial Accounting and Reporting (AFAR) in the Certified Public Accountant Licensure Examination
(CPALE).

Always remember to have a paper, pen, and basic calculator while studying every page of this canvas course so you can practice the illustrative
problems. As we all know, practice makes better.

At the end of the topic, the students are expected to be able to:                   

1. Understand the nature of a partnership;

2. Articulate the accounting process of partnership formation, operation, dissolution and liquidation.
3. Prepare and solve the different accounting problems regarding partnership formation, operation, dissolution and liquidation.

1.0 Partnership Accounting

Partnership

Partnerships are a popular form of business because they are easy to form and because they allow several individuals to combine their talents
and skills in a particular business venture. In addition, partnerships provide a means of obtaining more capital than a single individual can obtain
and allow the sharing of risks for rapidly growing businesses. Partnerships are particularly common in the service professions, especially law,
medicine and accounting.

Partner's Ledger Accounts

In a partnership, although it is possible to operate with one equity account for each partner, it is desirable that the following partner's accounts be
maintained:

1) Capital accounts

2) Drawing or personal accounts

3) Account for loans to or from partners

Capital and Drawing accounts

The original investment of each partner is recorded by debiting the fair value of the assets invested, crediting the liabilities assumed by the firm
and crediting the partner's capital account for the net assets contributed. Subsequent to the original investments, transactions between the
partnership and the partners will result to changes in the respective partner's ownership interest. These changes are summarized in the
respective partner's capital and drawing accounts.

A partner's equity is increased by the additional investment of cash or other property and by a share in the partnership profit. A partner's equity is
decreased by the withdrawal of cash or other assets and by a share in the partnership loss.

Normally, increases or decreases in capital that are interpreted as permanent capital changes are recorded directly in the capital account.
Withdrawals, which are considered equivalent to salaries, made by the partner in anticipation of profits and other increases or decreases of
relatively minor amounts are recorded in the drawing account. At the end of the accounting period, the debit and credit balances in the drawing
account are then closed to the respective partner's capital account. Also, during this period, the profit or loss as shown by the Income Summary
account is distributed in accordance with the profit and loss sharing agreement, The share of each partner in the profit or loss is recorded in their
respective capital account. Individual partner's capital and drawing balances are combined to reporting each partner's interest in the statement of
financial position.

The Capital account is credited for:

a) Original Investment
b) Additional Investment

c) Partner's share in the profits

The Capital account is debited for:

a) Permanent withdrawal of capital

b) Debit balance of the drawing account at the end of the period

c) Partner's share in the losses

The Drawing account is credited for:

a) Partnership obligations assumed or paid by the partner

b) Personal funds or claims of partner collected and retained by the partnership

c) Periodic partner's salaries depending on the accounting and disbursement procedures agreed upon.

The Drawing account is debited for:

a) Withdrawal of assets by the partners in anticipation of net income

b) Partner's personal indebtedness paid or assumed by the partnership

c) Funds or claims of partnership collected and retained by the partner

Loan to and Loan from partners

A withdrawal by a partner of a substantial amount with the assumption of its repayment to the firm may be debited to a Receivable from partner
account rather than to the partner's drawing account. On the other hand, an advance to the partnership by a partner with the assumption of its
ultimate repayment by the partnership is viewed as a loan rather than as an increase in the capital account. This type of transaction is credited to
the Loan's payable or Notes payable if the loan is evidence by a note duly signed in the name of the partnership

1.1 Formation

Accounting for the Formation of a Partnership

A partnership maybe formed in several ways namely:

1. Formation of a partnership for the first time

2. Conversion of a sole proprietorship to a partnership

     a. A sole proprietor allows an individual, who has no business of his own to join his business.

     b. Two or more sole proprietors form a partnership

3. Admission of a new partner

Partnership formation for the First Time

Cash Investments

Initial cash investments in a partnership are recorded in the capital accounts maintained for each partner. For example Aldous and Baxia each
invests P100,000 cash in a new partnership. The entry to record the investments would be:

Cash                   200,000
           Aldous, capital              100,000

           Baxia, capital                  100,000

Non-cash investments

When property other than cash is invested in a partnership, the non-cash property is recorded at the current fair value of the property at the time
of the investment. The fair value on non-cash asset is determined by agreement of the partners. The amounts involved should be specified in the
written partnership agreement.

1.2 Operation

Accounting for Partnership Operations

Net income is computed in the usual manner that is matching revenues and expenses then credited to the individual capital accounts. However,
the treatment becomes more complex because of the differences in capital contributions, abilities and talents of individual partners, and in time
spent on partnership duties by the individual partners,

Division of Profits and Losses

The partnership law provides that profits and losses of the partnership are to be divided in accordance with the partners agreement. If no
agreement is made between and among the partners, profits and losses are to be divided according to their original capital contributions. Should
the partners agree to divide the profits only, losses, if any are to be divided in the same manner as that of dividing profits. However, should the
partners agree to divide losses only,  profits, if any shall be divided by the partners according to capital contributions.

The ratio in which the partnership profits and losses are divided is known as the profit and loss ratio. The many possible methods of dividing net
income or loss among partners can be summarized as follows:

1. Equally

2. In an unequal or arbitrary ratio

3. In the ratio of partners capital account balances on a particular date, or in the ratio of average capital account balances during the year.

4. Allowing interest on partners' capital account balances and dividing the remaining net income or loss in a specified ratio.

5. Allowing salaries to partners and dividing the remaining net income or loss in a specified ratio

6. Bonus to managing partner based on net income.

1.3 Dissolution/Changes in ownership interest

Partnership Dissolution/Changes in Ownership Interest

A partnership rests upon a contractual foundation, therefore, the life span of a partnership may be somewhat uncertain since it depends on the
moods and relationships of the partners. Any circumstances which cause the technical termination of a partnership may lead to the the
partnership's permanent dissolution and liquidation, if the partners so agree, Dissolution and liquidation in relation to the partnership are not
synonymous. A partnership is said to be dissolved when the original association for the purposes of carrying on activities has ended. A
partnership is said to be liquidated when the business is terminated. Thus, a partnership may be dissolved without being liquidated. While
dissolution may result to liquidation of a partnership, liquidation always results to dissolution.

Partnership dissolution due to changes in ownership interests occurs for variety of reasons. These can be summarized as follows:

1. Admission of a partner

2. Retirement of a partner

3. Death of a partner
4. Incorporation of a partnership

In most cases, when a change in ownership occurs, the market values of individual partnership assets and liabilities are different from their book
values. These differences can be accounted for by recording them on the partnership books either by adjusting the assets and liabilities - in may
cases, by adjusting the partners' capital accounts.

1.3.1 Admission of a new partner

Admission of a new partner

An existing partnership may admit a new partner with the consent of all the partners. When a new partner is admitted, the partnership is
dissolved and a new partnership is formed. Upon the admission of a new partner, a new agreement covering partners' interests, profit and loss
sharing and other consideration should be drawn because the dissolution of the original partnership cancel the original agreement.

The admission of a new partner may occur in either of two ways, namely:

1. Purchase of all or part of the interest of one or more of the existing partners.

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

1.3.1.1 By purchase of interest

Purchase of Interest from One or More Partners

One or more partners may sell their portion of the business to an outside party. This type of transaction is common in operations that rely
primarily on monetary capital rather than on the business expertise of the partners.

The partner in making the transfer of ownership can actually convey the following rights:

1. The right of co-ownership in the business property. This right justifies the partnership drawings from the business as well as the settlement
paid at liquidation or at the time of partners' withdrawal.

2. The right to share in profits and losses.

3. The right to participate in the management of the business.

When an incoming partner purchases a portion or all of the interests of one or more of the original partners, 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. The cash paid by the buyer is  not recorded
in the books of the partnership for this is a personal transaction between the selling partners and the buyer. The gain or loss arising from the sale
of interest is not to be recorded in the partnership books.

1.3.1.2 By investment

New partner invests in partnership

A new partner may acquire interest in the partnership by investing in the business. In this case, the partnership receives the cash or other
assets, thereby increasing its total assets as well as the total capital. This method of admission is a transaction between the partnership and the
incoming partner. Three cases may exist when a new partner invests in partnership:

Case 1: The new partner's investment (contributed capital) equals the new partner's proportion of the partnership's book value (agreed value)

Case 2: The new partner's investment is more than the new partner's agreed capital. This indicates that the partnership's prior net assets are
undervalued on the books.

Case 3: The new partner's investment is less than the new partner's agreed capital. This suggests that the partnership's prior net assets are
overvalued on its books.

The following steps/procedures may be used in determining how to account for the admission of a new partner:

1. Compute the new partner's proportion of the partnership's book value (agreed capital) as follows:

Agreed capital = Prior capital of old partners  +  Investment of the new partner  X  % of capital to new partner
 

2. Compare the new partner's contributed capital with his or her agreed capital to determine the procedures to be followed in accounting for his
or her admission.

Case 1: Investment = Agreed Capital

 No revaluation or bonus

Case 2: Investment cost > Agreed Capital

 Revalue net assets up to fair value and allocate to old partners.

 Allocate bonus to old partners.

Case 3: Investment cost < Agreed Capital

 Revalue net assets down to fair value and allocate to old partners.
 Assign bonus to new partner

3. Determine the specific admission method.

1.3.2 Withdrawal, retirement or death of a new partner

Withdrawal or Retirement of a partner

When a partner retires or withdraws from the partnership, the partnership is dissolved but the remaining partners may continue operating the
business. The existing partners may buy out the retiring partner either by making a direct acquisition or by having the partnership acquire the
retiring partner's interest. If the present partner directly acquire the retiring partner's interest, the only entry on the partnership's books is to record
the transfer of capital from the retiring partner to the remaining partner. If the partnership acquires the interest of the retiring 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 partner is usually measured by his capital balance, increased or decreased by his share in the following adjustment:

1. Profit or loss from the 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)

Death of a partner

In the event of the death of a partner, the estate of the deceased partner is entitled to receive the amount of his interest in the partnership at the
date of his death, The deceased partner's capital is adjusted using his profit and loss share percentage for changes in asset values arising from
revaluation of assets and for the profit from the date the books were last closed. The balance of his capital account after considering the
necessary adjustments should be transferred to a liability account pending settlement.

1.3.3 Incorporation of a Partnership

Incorporation of a Partnership

When a partnership is converted into a corporation, the corporation takes over the assets and assume the liabilities of the partnership in
exchange for shares of stocks. The stocks received by the partnership are distributed in settlement of their interest. The partners now become
stockholders of the newly formed corporation.

The accounting procedures in recording the incorporation of the partnership will depend on whether the original books of the partnership will be
continued by the corporation or new books will be opened.

Partnership Books Retained. If the partnership book are retained, the steps to be taken are as follows:
1. Revalue the assets

2. Close the partner's capital accounts to the corporate capital accounts

New Books Opened for the Corporation. If new books are to e opened, the old partnership books must be closed. The accounting procedures
may be outlined as follows:

In the books of the partnership:

1. Revalue the assets (and any other items agreed on) in accordance with the agreed transfer values.

2 Record the transfer of assets and liabilities to the corporation and the receipt of capital stocks by the partnership.

3. Record the distribution of stocks to the partners in settlement of the balances of their capital accounts.

1.4 Liquidation

Liquidation

The basic objectives of a partnership during the liquidation process are to convert the partnership assets to cash (called realization of assets), to
pay off partnership obligations and to distribute cash and any unrealized assets to the individual partners. The purpose of accounting during this
period is to have an equitable distribution of partnership cash to creditors and partners. Hence, it is no longer income determination that is the
focus of accounting but rather, the computation of gains or losses on realization of assets which are to be subsequently allocated among the
partners, the payment of liabilities in accordance with law and the final distribution of cash to partners.

There are certain rules that should be followed in the liquidation of the partnership namely:

1. Always allocate and close gains or losses to the partners' capital accounts prior to distribution any cash to partners.

2. When the business is liquidated, the partner is entitled to an amount depending upon his capital contribution, his drawing, his share in the net
income or loss from operations before liquidation, gains and losses on realization and the balance of his loan account, if any.

Each partner will receive in the final settlement the amount of his equity in the business, The amount of a partner's equity is increased by the
positive factors such as investment of capital and share in the profits. It is decreased by the negative factors such as withdrawals and share in
the losses. If the negative factors are greater than positive factors, the partners will have a deficiency (debit balance) and he must pay the
partnership the amount of such deficiency, Failure to do so would mean that his fellow partners would bear more than their contractual share in
losses and they will consequently receive less than their equities in the business.

As a general rule, the cash should be distributed as follows:

1. First, to outside creditors

2. Second, to partners for loan accounts.

3. Third, to partners for capital accounts.

A debit balance in the partner's capital account may be caused by losses incurred in the realization of assets or by prorata absorption of an
uncollectible deficit of a partner whose combined capital and loan accounts is not enough to absorb the partner's share of total losses.

Methods of Partnership Liquidation

When a partnership is to be liquidated by the sale os assets, the following methods may be used:

1. Lump-Sum Liquidation, otherwise called Total Liquidation or Single Distribution.

2. Installment Liquidation, otherwise called Installment Distribution.

1.4.1 Lump-sum method

Lump-sum Liquidation

A lump-sum liquidation of a partnership is one in which all the assets are converted into cash within a very short time, outside creditors are paid,
and single lump-sum payment is made to the partners for their total interests.

Realization of Assets. Typically a partnership will experience losses on the sale of its assets. A partnership may have a "Going Out of Business"
sale in which its inventory is marked down well below normal selling price to encourage immediate sale. The partnership's fixed assets may also
be offered at a reduced price. The accounts receivable are actually collected by the partnership. Sometimes the partnership offers a large cash
discount for prompt payment of any remaining receivables whose collection may otherwise delay the termination of the partnership. Alternatively,
the receivables may be sold to a factor. A factor is a business that specializes in acquiring accounts receivables and immediately paying cash to
the seller of the receivables. The partnership records the sale of the receivables, as it would any other asset.

Before any distribution may be made to the partners, either liabilities to outside creditors must be paid in full or the necessary funds may be
placed in an escrow account. The escrow agent, usually a bank, uses the funds only for payment of the partnership liabilities.

Expenses of Liquidation. During the liquidation process, expenses are usually incurred, such as legal and accounting expenses and advertising
cost of selling the assets. These expenses are allocated to partners' capital accounts in their profit and loss ratio.

Liquidation Procedures. The following procedure may be used in lump-sum liquidation.

1. Realization of assets and distribution of gain or loss on realization among the partners based on the profit and loss ratio.

2. Payment of expenses

3. Payment of liabilities

4. Elimination of partner's capital deficiencies. If after the distribution of loss on realization, a partner incurs a capital deficiency (i.e. partner's
share of realization loss exceeds his capital credit) this deficiency must be eliminated by using one of the following methods, in order of priority.

    a. If the deficient partner has a loan balance, exercise the right of offset,

    b. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.

    c. If the deficient partner is insolvent, let the other partners absorb his deficiency

5. Payment to partners (in order of priority)

     a. Loan accounts

     b. Capital accounts

1.4.2 Installment method

Installment Liquidation

Involves the selling of some assets, paying liabilities of the partnership, dividing the available cash to the partners, selling additional assets and
making further payments to partners. This process continues until all the assets have been sold and all cash has been distributed to the creditors
and to partners.

Procedures for Liquidation by Installment

The following are the accounting procedures that may be followed in liquidating a partnership by installments.

1. Record the realization of assets and distribute the realized gains or losses among the partners using profit and loss ratio.

2. Pay liquidation expense and unrecorded liabilities, if there are any and distribute these among the partners using the profit and loss ratio.

3. Pay the liabilities to outsiders.

4, Distribute cash to partners after possible future losses have been apportioned to partners or in accordance with a cash distribution program.

*Eliminate any capital deficiency only before final payments to partners.

Periodic Computation of Safe Payments to partners

The Statement of partnership liquidation is usually supported by a schedule of safe installment payments to partners, simply called Schedule of
Safe Payments, prepared periodically. According to the schedule, each installment of cash is distributed as if no more cash is forthcoming, either
from sale of assets or from collection of deficiencies from partners. Cash is therefore, distributed to a partner only if he has an excess credit
balance in his partnership interest (i.e. capital account or capital and loan account combined) after absorption of his share of the maximum
possible loss that may occur. The possible loss (hypothetical loss) consists of the following:

1. Total value of remaining non-cash assets. These assets are assumed unrealizable (they cannot be sold), hence, they are considered loss
chargeable to the partners.

2. Cash withheld to pay for anticipated liquidation expenses and unrecorded liabilities that may arise. The said expenses and liabilities represent
possible loss to the partners because upon their payment, the amount paid is to be correspondingly absorbed by the partners.

Additional loss may also accrue to the partners when a debit balance in any of the capital accounts results from the foregoing allocations of
possible loss. The deficiency of any of the partners is absorbed by the other partners as additional possible loss to them because he is
presumed unable to pay anything to the firm.

Cash Withheld

The cash set aside in a separate fund is not a factor in computing possible loss. It is the cash set aside to insure payments of potential liquidation
expenses, which may be incurred and unrecorded liabilities may be discovered. This cash withheld is added to the total remaining non-cash
assets to obtain the maximum possible loss needed in the computation of safe installment payment. Also cash available for distribution to the
partners for the period is net of the cash withheld.

Unrecorded liabilities are obligations which are discovered or incurred during the liquidation. These are allocable to the partners according to
their profit and loss sharing agreement.

Illustrative Problems in Partnership Accounting

Partnership Formation

1. As of July 2, 2011, FF and GG decided to form a partnership. Their balance sheets this date are:                                                                   
FF                                         GG .
Cash...........................................                    P15,000                               P37,500
Accounts Receivable.................                       540,000                               225,000
Merchandise Inventory..............                        -                                       202,500
Machinery and Equipment.........                      150,000                               270,000
Total...............................                                 P705,000                            P735,000
Accounts Payable.......................                P135,000                         P240,000
FF, Capital..................................                       570,000
GG, Capital.................................                                                                  495,000
Total...........................................                    P705,000                            P735,000

The partners agreed that the machinery and equipment of FF is underdepreciated by P15,000 and that of GG by P45,000. Allowance for doubtful
accounts is to be set up amounting to P120,000 for FF and P45,000 for GG. The partnership agreement provides for a profit and loss ratio and
capital interest of 60% to FF and 40% to GG. How much cash must FF invest to bring the partners’ capital balances proportionate to their profit
and loss ratio? 

2. CC admits DD as partner in business. Accounts in the ledger for CC on November 30, 2011 just before the admission of DD, show the
following:
Cash..................................................................... P6,800
Accounts receivable............................................. 14,200
Merchandise Inventory........................................ 20,000
Accounts Payable................................................ 8,000
CC, Capital.......................................................... 33,000
It is agreed that for purposes of establishing CC’s interest, the following shall be made:
a) An allowance fro doubtful accounts of 3% of accounts receivable is to be established
b) The merchandise inventory is to be valued at P23,000
c) Prepaid salary expenses of P600 and accrued rent expense of P800 are to be recognized
DD is to invest sufficient cash to obtain 1/3 interest in the partnership.
Compute for: (1) CC’s adjusted capital before the admission of DD; and (2) the amount of cash investment by DD:

Solution:

1. GG’s adjusted capital*...………………………………………………………………………………. P 405,000

Divided by: GG’s P&L percentage..…………………………………………………………………..…...     40%
Total Agreed Capital………………………………………………………………………………...      P 1,012,500
Multiplied by FF’s P&L percentage………………………………………………………………………....    60%
FF’s agreed capital………………………………………………………………………………..…...      P 607,500
Less: FF’s adjusted contributed capital*………………………………………………………….……….. 435,000
Additional cash to be invested by FF….………………………………………………………….. P 172,500 (Answer)
*Computation of adjusted contributed capital:
                                                                                                              FF          GG
Unadjusted capital……….……………………………………………… P570,000  P495,000
Add (deduct): adjustments:
Accumulated depreciation………………………………………………. ( 15,000)      ( 45,000)
Allowance for doubtful accts. ………………………………………….. ( 120,000)   ( 45,000)
Adjusted contributed capital…………………………………………..…P435,000      P405,000

2. Unadjusted capital of CC……………………………………………………………………..……. P 33,000

Add (deduct): Adjustments:
Allowance for doubtful accounts (3% x P14,200)……………………………………………………..   ( 426)
Increase in merchandise inventory (P23,000 – P20,000)………………………………..…………… 3,000
Prepaid Salary………………………………………………………………………..………..                     600
Accrued rent expense……………………………………………………………………..……...              ( 800)
Adjusted capital balance of CC………………………………………………………………………   P 35,374 (Answer)
Divided by: Capital interest of CC…………………………………………………………..……… ……... 2/3
Total capital of the partnership……………………………………………………………...………… P 53,061
Less: Adjusted capital balance of CC………………………………………………………..……..…... 35,374
Capital balance of DD………………………………………………………………….……...……   ... P 17,687 (Answer)

PARTNERSHIP OPERATIONS

1. The partnership agreement of XX, YY & ZZ provides for the year-end allocation of net income in the following order:
- First, XX is to receive 10% of net income up to P200,000 and 20% over P200,000.

- Second, YY and ZZ each are to receive 5% of the remaining income over P300,000.
-  The balance of income is to be allocated equally among the three partners.

The partnership's 2011 net income was P500,000 before any allocations to partners. What amount should be allocated to XX?

2. AA and DD created a partnership to own and operate a health-food store. The partnership agreement provided that AA receive a salary of
P10,000 and DD a salary of P5,000 to recognize their relative time spent in operating the store. Remaining profits and losses were divided 60:40
to AA and DD, respectively. Income for 2011, the first year of operations of P13,000 was allocated P8,800 to AA and P4,200 to DD.

On January 1, 2012, the partnership agreement was changed to reflect the fact that DD could no longer devote any time to the store's
operations. The new agreement allows AA a salary of P18,000, and the remaining profits and losses are divided equally. In 2012 an error was
discovered such that the 2011 reported income was understated by P4,000. The partnership income of P25,000 for 2012 included the P4,000
related to year 2011.

In the reported net income of P25,000 for the year 2012. AA and DD would have:

SOLUTION:
1. 

                                                                              XX             YY                   ZZ                     Total

XX First P200,000 X 10%.................................. P 20,000                                                    P 20,000
 Over P200,000: (500,000 - P200,000) 20%.. 60,000                                                      60,000
YY and ZZ: 5% of remaining income

over P300,000: (P500,000 - P20,000 -

 P60,000 - P300,000) < 5%                                                 P 6,000           P 6,000            12,000
Balance: Allocate equally……………………… ….136,000      136,000          136,000            408,000
                                                           (Answer) P 216,000  P142,000        P142,000         P500,000 

2.                                                                           AA                     DD                Total

Salary .............................................                    P18,000              -                     P18,000

Balance: Equally ... ………………                           1,500               1,500              3,000
Income for year 2012 only ……….                      19,500              1,500            21,000
Income for year 2011 (60:40) ........                     2,400               1,600             4,000
Reported income for year 2012…..     (Answer)  21,900              3,100               25,000

PARTNERSHIP DISSOLUTION

1. Capital balances and profit and loss sharing ratios of the partners in the BIG Entertainment Gallery are as follows:
Betty, capital (50%)               P140,000
Iggy, capital (30%)                   160,000
Grabby, capital (20%)             100,000
Total                                     P 400.000

Betty needs money and agrees to assign half of her interest in the partnership to Yessir for P90,000 cash. Yessir pays directly to Betty. Yessir
does not become a partner.

What is the total capital of the BIG Partnership immediately after the assignment of the interest to Yessir? 

2. On June 30, 2011, the balance sheet of Western Marketing, a partnership, is a summarized as follows:
Sundry assets ………………………………………………………… P150.000
West, Capital ……………………………………………………..……… 90,000
Tern, Capital .………………………………………………….……….... 60,000
West and Tern share profit and losses at a 60:40 ratio, respectively. They agreed to take in Cuba as a new partner, who purchases 1/8 interest
of West and Tern for P25, 000. What is the amount of Cuba’s capital to be taken up in the partnership books if book value method is used?

3.On June 30, 2011, the statement of financial position for the partnership of CC, MM, and PP, together with their
respective profit and loss ratios, were as follows:
Assets, at cost ……………………………………………………………………………….                   P180,000
CC, loan .............................................................................................................................................. 9,000
CC. capital (20%) .............................................................................................................................. 42,000
MM, capital (20%).............................................................................................................................. 39,000
PP, capital (60%) .............................................................................................................................. 90,000
Total ....................................................................................................................................           P 180,000
CC decided to retire from the partnership. By mutual agreement, the assets are to be adjusted to their fair value of P216,000 at June 30, 2011. It
was agreed that the partnership would pay CC P61,200 cash for CC's partnership interest, including CC's loan which is to be repaid in full. No
goodwill is to be recorded. After CC's retirement, what is the balance of MM's capital account?

SOLUTION:

1.A partnership is not dissolved when a partner assigns his or her interest in the partnership to a third party because such agreement does not in
itself change the relations among partners. Such assignment only entities the assignee to receive the assigning interest partner’s interest in
future partnership profits and in partnership assets in the event of liquidation. The assignee does not become a partner, however, and does not
obtain the right to share in management of the partnership. If the assignee does not become a partner, the only change required on the
partnership books is for transfer of the capital interest of the assignor partner to the assignee. The assignment by Betty to Yessir of his 50%
interest in the BIG Entertainment Company is recorded as follows:
Betty, capital (P140,000 x 50%) ………………………… 70,000
Yessir, capital ………………...............................                         70,000
The amount of the capital have based is equal to the recorded amount of Betty’s capital at the time of the assignment, and it is independent of
the consideration received by Betty for her 50& interest. If the recorded amount of Betty’s is P70,000, then amount of the transfer entry is
P70,000, regardless of whether Yessir pays Betty P70,000 or some other amount. Therefore, the capital of the partnership after the assignment
of interest remains the same at P400,000.

2. Amount paid ……………………………………………………….. P 25,000

Less: Book value of interest acquired:
P150,000 x 1/8 …………………………………………….             18,750 (Answer)

Gain of West and Tern ……………………………………………. P 6,250 

3.  P45,450

PARTNERSHIP LIQUIDATION

1. A local partnership was considering the possibility of liquidation since one of the partners is solvent (Tillman) and the others are insolvent.
Capital balances at that time were as follows. Profits and losses were divided on a 4:2:2:2 basis,
respectively.
Ding, capital……………………………………………………………………………………….. P 60,000
Laurel, capital……………………………………………………………………………………...… 67,000
Ezzard, capital……………………………………………………………………………………..... 17,000
Tillman, capital…………………………………………………………………………………...….. 96,000
Ding’s creditors filed a P25,000 claim against the partnership’s assets. At that time, the partnership held assets reported at P360,000 and
liabilities of P120,000. If the assets could be sold for P228,000, what is the minimum amount that Ding’s creditors would have received?

2. AA, BB and CC are partners in ABC Partnership and share profits and losses 50%, 30% and 20%, respectively. The partners have agreed to
liquidate the partnership and some liquidation expenses to be incurred. Prior to the liquidation, the partnership balance sheet reflects the
following book values:
Cash………………………………………………………………………………………..      P 25,200
Non-cash assets…………………………………………………………………………….… 297,600
Notes payables to CC………………………………………………………………………….. 38,400
Other liabilities…………………………………………………………………………………. 184,800
AA, capital………………………………………………………………………………..……     72,000
BB, capital deficit……………………………………………………………………….………. (12,000)
CC, capital………………………………………………………………………………….….     39,600 

Assuming that the actual liquidation expenses are P16.800 and that the non-cash assets with a book value of P240,000 are sold for P216,000.
How much cash should CC receive? 

3. Arthur, Baker and Carter are partners in textile distribution business, sharing profits and losses equally. On December 31, 2011 the
partnership capital and partners drawings were as follows:
                                                         Arthur                Baker            Carter            Total
Capital.                                           P100,000         P80,000       P300,000      P480,000
Drawing                                            60,000            40,000          20,000        120,000
The partnership was unable to collect on trade receivables and was forced to liquidate. Operating profit in 2011 amounted to P72,000 which was
all exhausted, including the partnership assets. Unsettled creditors' claims at December 31, 2011 totaled P84,000. Baker and Carter have
substantial private resources, but Arthur has no personal assets. The final cash distribution to Carter was: 

ANSWERS:

1. P2,500

2. P39,600

3. P78,000

Summary: Module 1
Capital interest vs. Profit and Loss Interest

Capital Interest is a claim against the net assets of the partnership as shown by the balance in the partner’s capital account, while  Interest in
Profit or Loss determines how the partner’s capital interest will increase or decrease as a result of subsequent operations.

Assignment of an interest to a Third Party

A. Revaluation Approach
--- The use of fair values provides an equitable measure of each partner’s capital interest in the partnership.

--- Basis of valuation is fair value

--- Results in a marked departure from the historical principle

B. Absence of Revaluation
--- This approach would retain the historical cost/changing value (BOOK VALUE APPROACH).

Admission of a New Partner

1. Admission by Purchase Interest

Case 1: Purchase of interest for one partner

A, Capital       xx

        B, Capital                xx

Case 2: Purchase of interest from all partners

Assumption 1 Purchase at Book Value

Assumption 2 Purchase at more than Book Value

        
         Alternative 1: BOOK VALUE APPROACH

          Amount paid                                       xx

          Less: BV of interest acquires    xx

          Excess                                                    xx
          

          Alternative 2: REVALUATION APPROACH

                   Goodwill          xx

                       A, Capital               xx

                       B, Capital                xx

               

                Amount paid  ------------------------------xx

                Less: BV interest Acquired ---------(xx)

                Excess --------------------------------------xx
                Divided by: Interest Acquired ------xx

                Revaluation of Asset Upward ------xx

                                              
A, Capital (old+goodwill*interest acquires)    xx

B, Capital (old+goodwill*interest acquires)    xx

                         F, Capital                                                                   xx

Assumption 3: Purchase at less than Book Value

In Book Value approach, same format but it is a loss, while, in Revaluation approach, same format but it is downward.

 Prefer Book Value if Profit and Loss interest > capital interest, otherwise, use revaluation approach.

2. Admission by Investment
Any gain or loss are recognized on sales subsequent to recording the admission will be allocated on the basis of the new profit and loss ratio.

TCC=TAC- No Adjustment

TCC>TAC- overstatement of the asset or diminution in partner’s capital

TCC<TAC- unrecorded net assets or the required additional investment in partner’s capital

CC=AC- No transfer of capital

CC>AC- Capital transfer or bonus to old partners

CC<AC- Additional Capital credit (either bonus or goodwill) from the old partners.

TOTAL AGREED CAPITAL                                              XX

LESS: TOTAL CONTRIBUTED CAPITAL                 XX

DIFFERENCE                                                                 XX                    

In bonus, if there’s a revaluation of assets, they cannot recognized. But if revaluation method is used, they affected the partner’s capital account.

In the absence of approach to be used, bonus approach should applied.

Incorporation of a Partnership
Partnership books are retained

1. Change in assets and liability values in the partner’s interest prior to corporation
2. The change in the form of proprietorship. A revaluation account may be debited to losses and credited with gains from revaluation, and
the balance may subsequently be closed into the capital accounts in the Profit and Loss Ratio.

New books for the corporation.

In accounting record of partnership

1. Prepare J.E. for revaluation of assets, including recognition of goodwill.

2. Record any cash withdrawal necessary to adjust parties capital account balances to round amounts
3. Record the transfer of assets and liabilities to the corporation, the receipt of the corporation’s common stock by partnership, and the
distribution of the common stock to the partners in settlement of the balances of their capital accounts.

In the accounting records of the corporation

1. Record the acquisition of assets and liabilities from the partnership at current fair values.
2. Record the issuance of common stock at current fair value in payment of the obligation to the partnership.

Partnership Liquidation
The phase of partnership operations which begins after dissolution and ends with the termination of a partnership activities referred to as
"winding up the affairs."

Basic Procedures in Liquidation

Procedures for minimizing inequities among partners.

1. Sharing Gains and Losses. When a partnership is liquidated, the books should be adjusted and have closed the net profit or loss for
the period in the manner they have agreed in the partnership agreement.
2. Advance planning when the partnership is formed.
3. Rules on setoff- Partnership Loans (Receivable) to the partners
4. Rules on set off- Partner (Payable) loans to the partnership—depends upon the situation.

-Legal doctrine of setoff- whereby a deficit balance in partner’s capital account may be set off against any balance existing in his/her loan
account.

5. Liquidation expenses. Certain cost incurred during the liquidation process should be treated as a reduction of the proceeds from the
sale of non-cash asset. Other liquidation costs should be treated as expenses.
6. Marshalling of assets. This doctrine is applied when the partnership and/or one or more of the partners are insolvent.
7. Distribution of cash or other assets to partners.

Lump-sum Liquidation
Is one in which all assets are converted into cash within a very short time, creditors are paid, and a single, lump-sum payment is made the
partner’s for their capital interest.

1. Realization and distribution of gain or loss to all partners on the basis of profit and loss ratio.
2. Payment of liquidation expenses, if any.
3. Payment of liabilities to third parties.
4. Elimination of capital deficiencies.
5. Payment to partners(in order)

a. loan accounts

b. capital accounts

Installment Liquidation
Is a process of realizing some assets, paying creditors, paying the remaining available cash to partners, realizing additional assets, and making
additional cash payment to partners.

 
A. Schedule of Safe Payments

     A.1. Assume total loss on all remaining non-cash assets. Provide all possible losses, including potential liquidation cost and unrecorded
liabilities.

Possible Loss= amount of unrealized non-cash assets + amount of cash withheld (i.e. unrecorded unpaid expenses, and anticipated liquidation
expenses)

    A.2. Assume that partners with a potential capital deficit will be unable to pay anything to the partnership (assume to be personally insolvent)    

 Hypothetical or assumed deficit balance is allocated to the partners who have credit balances using profit and loss ratio. This portion is
the maximum potential loss on non-cash assets.
 Any capital deficiencies that may result in other partners as a result of a maximum loss on non-cash assets.

 Schedule of Safe Payments is effective method of computing the amount of safe payments to partners and preventing excessive
payments on any partners.
 It is inefficient, if numerous installment distributions are made to partners.
 It is deficient as a planning device because it does provide information, but it can be overcome by preparing cash distribution plan at
the start of the liquidation process.

B. Cash Priority Program

1. Ranking the Partners

2. Total interest(equity) account=balance of the capital account + loan receivable(-)/loan payable (+) to the partner
3. Loss Absorption Power/Abilities/Potential/Maximum Loss Absorbable= Total interest account/Profit and Loss assigned ratio

   Vulnerability Rankings
Lowest absorption abilities is the most vulnerable to partnership losses.

   Limitation of Cash Priority Program

1. The program is operable only after outside creditors have been paid in full.
2. Reflects only the order in which cash distribution to partners will be made if cash is available to distribute
3. The sequence of distribution of cash in the program coincides with the sequence that would result if cash were distributed using the
schedule of safe payments