 Oh, and welcome to the session. This is Professor Farhad. In the session, we would look at a withdrawal of a partner. This topic is covered in financial accounting as well as an advanced accounting course. Also covered on the CPA FAR section. As always, I would like to remind you to connect with me only then, if you haven't done so. YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax and finance lectures as well as Excel tutorial. If you like my lessons, please like them, share them, subscribe to the channel. If they benefit you, it means they might benefit other people. Share the wealth, connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources to supplement your accounting education. And if you are looking to pass your CPA exam at those 10 to 15 points, check out my website. In this session, we're gonna be looking at a withdrawal of a partner in contrast to the prior session where we looked at an admission. So a partner can withdraw basically, say goodbye to the partnership in one of two ways. The partner can sell his or her partnership interest to another partner, I'm sorry, to another person. Could be another partner. Or the partner can distribute cash and other assets to the withdrawing partner. Or simply put, the partner says, look, I'm getting out of this business. Give me my share of the business and I'm leaving. So that's how you can get out. Either sell it to another person, including another partner or to someone else, or get out. Now, is the partnership dissolved? That's a legal question. I will not try to answer in this recording because the rules are changing recently. So when a partner withdraws, there's always either no bonus or a bonus. So in this situation, we're gonna work an example where the partners withdraw and they get no bonus. Now, here's what you need to know. We have a capital account. For example, far hat capital, okay? And let's assume my partnership interest in a certain partnership is 75,000. When I get out of this partnership, the balance has to be zero. So I have to zero out my balance. So when a partner leaves, they have to zero out their balance. So keep that in mind. So let's take a look at an example. At the date of the withdrawal of Peraz, the partners have the following partner's basis. Peraz 38, Zain 84, Rashid 38. The partners share income and losses equally. Peraz is to receive 38. That's excellent. That's easy. That's easy for everyone. Peraz's balance is 38 and Peraz is getting 38. Their balance is 38 and they're receiving 38. So pretty straightforward. We debit Peraz's capital 38 because that's their balance. So Peraz capital was 38 and now it's going to go down to zero. And we'll give them cash. So that's easy. No bonus. Now let's assume at the end of the withdrawal of Peraz, Peraz's balance was 38, Zain 84, Rashid 38. And now we're going to give Peraz 34. It seems Peraz wants to get out real bad and that's not a good time to get out. And we're going to tell Peraz, look, if you want to withdraw, that's your call, but we can only give you 34,000. Peraz says, I need to get out. What does that mean? What it means, Peraz got less than their partner's capital. Now here's what's going to happen. Peraz's capital is 38. And what do we have to do? We have to debit this account 38 to bring it down to zero, but we're only going to give them 34,000. So what happened to the other 4,000? Well, the other 4,000, it's going to be given to Zain and Rashid 50-50. So here's what's going to happen. Peraz's get out with EBITDA account 38, we give them only 34,000. The remaining balance, which is 4,000, we increase Zain's capital by 2,000 and Rashid's capital by 2,000, okay? They want to get out. Well, that's what you do. Now what's going to happen? We're going to give bonus to the withdrawing partner. Same fact, Peraz balance is 38, but Peraz is going to get 40. So notice Peraz is getting a little bit more than their capital balance. What's going to happen? That $2,000 will be taken away from the other two partners. Therefore we have to debit Peraz's capital 38 to bring them down to zero, but Peraz is getting 40,000. So what happened to the other 2,000? It's taking from Zain's capital 1,000 and Rashid's capital 1,000. They have to absorb the losses of the other partner. Not the losses, but basically they have, yeah, they have to absorb the loss basically. They absorb the loss of 2,000 that goes to Peraz. Maybe they want to get rid of Peraz. It's like, look, we're going to give you 2,000 more. Just get out, okay? Another situation that happens in partnership, death of a partner, what happened in case of a partner dies, a partner's death, generally speaking, generally speaking, because the partners, they have a lot of state laws, generally speaking, dissolve a partnership. If deceased partner's estate is entitled to receive his or her equity. So the state of that partner would receive their equity. The partnership agreement usually contain a provision for the settlement, what should they do? And usually what happens is this, first you close the books to determine income or loss since the end of the previous period. Because basically once that partner's die, the profit and the loss stops there. Then we have to determine the fair market value of both assets and liabilities. Because basically in a sense, we're liquidating. And we have to settle the deceased partner's estate, which can involve either selling the remaining partner, selling to the remaining partner. So one way to do it is to sell whatever the deceased partner have to the partners that left, or we can sell it to an outsider, somebody else, or we could just get the money out and leave the partnership. So those are the three options that the estate would have. Either sell it to another partner, sell it to an outsider, or get the cash out once the partner dies. Now the best way to illustrate all these concepts is to work an example. So we have Fluffy, Angela, and Lopez are partners and they share income and loss in the ratio of two, three, and five. Again, don't let those ratio intimidate you. Two to three to five, what you do is you do two, plus three, plus five equal to 10. It means Fluffy to 10th, which is 20%, Angela three 10th, and Lopez five 10th. So basically 20%, 30%, and 50%. Whatever ratio they're given, you add them up and you find the relative for each proportion. So it's pretty straightforward. And this is gonna become useful when we do liquidation. The partner's capital balances are as follow, Fluffy 300, Angela 270, Lopez 400. Lopez decides to withdraw from the partnership and the partners agree to reevaluate the assets upon Lopez's retirement. Prepare the journal entry to record Lopez may first withdraw from the partnership under each of the following three separate situations. Lopez sells his interest to Monica for 500 after Fluffy and Angela approves the entry of Monica into the partnership. So the first thing is Lopez sold his interest to Monica for 500. Lopez has a 400 balance, sold it for 500. Guess what? The partnership did not get anything, okay? All that happened is Monica joined the partnership. So under those circumstances, the partnership don't debit cash. The partnership will have to remove Lopez at 400 and replace Monica for 400. Although Monica paid 500, that's irrelevant for the partnership. All what the partnership is considering, Lopez is leaving, Monica is joining, replacing Lopez. So here's what's gonna happen as far as the journal entry is concerned, the really the partnership don't get any penny out of this transaction. The partnership don't get any penny. Lopez balance was 400, they're gonna go down to zero and it's gonna 400, it's gonna go to Monica. And now what happened, the balance of the partnership is a thousand before and a thousand after, nothing really happened. All what we did is Lopez gave up some of their capital, not some, all of it to Monica. Now the journal entry would remove Lopez at 400 because we need to zero Lopez's account at 400 and we're gonna replace Lopez account with Monica's capital for 400. Notice there is no bonus, no cash, none like that. Let's look at another scenario. Now Lopez gives his interest to a son-in-law, Madrigal and thereafter Fluffy and Angela accept Madrigal as a partner. Now all what they did is they gave it, they just simply gave their interest to another person. That's fine, it doesn't matter as far as the partnership is concerned, they did not receive a penny. All what we have to do is replace Lopez with Madrigal. So as far as the entry is concerned and the total balance and equity before and after, it's technically the same because nothing really happened as far as the partnership is concerned. So we're reducing Lopez down to zero and we are giving his cousin or his son-in-law, his son-in-law the interest of 400. So before and after. So notice whether Lopez gave money, received money for his interest or did not receive money, it's irrelevant as far as the partnership is concerned because Lopez sold his partnership or her partnership to a third party. So it has nothing to do with the partnership. Let's look at a different scenario. So the entry is remove Lopez and replace Lopez with his son-in-law. So it doesn't, nothing really happened as far as the partnership. Now Lopez is paid $400 for his interest, easy. If he's paid $400 and he's worth $400, no one's getting anything. So now notice what's gonna happen is we have Fluffy, Angela and Lopez and Lopez is gonna be gone, okay? Lopez gonna be gone, what's left is $600. And the entry is debit, Lopez account, $400, credit, cash $400 because the partnership did pay cash of $400 and Lopez is technically gone. So again, there is no bonus for Lopez, no bonus for the remaining partner. Now it seems we need to get rid of Lopez. We're gonna pay him $600 to convince him to leave. Lopez interest is $400, we're gonna pay them $600. Therefore what's gonna happen, the other two partners will have to absorb the $200 in the respective ratios. What is the respective ratios? Well, Lopez has a ratio of five. So once Lopez is out, what's remaining is two and three. And the ratio of two and three, two and three equal two plus three equal to five, two-fifth and three-fifth. This is how we distribute the 200. So let's take a look at it. So notice, now what's left notice, we had two, three and five, five is gone. What's left is two and three. We distribute them in the ratio of two-fifth and three-fifth. So the remaining ratio is two-fifth and three-fifth, okay? So the entry would involve now, so notice their balance. So if we take, now what's gonna happen? It's gonna be 200 times two-fifth and that's how much, which is $80 and this is how much Fluffy's capital will go down by and it's gonna go down to 250. Angela's gonna go down by 200 times three-fifth by 120 and it's gonna be 150. So notice the capital of the business went down to 400 because we gave out $600 in cash. So the entry would debit the capital account 400 for Lopez but the credit to cash is 600 and the remaining two partners would reduce their balance by 80 and by 120. So they absorbed the loss. Basically Lopez got a bonus of $200. Now let's take a look at this. Lopez has paid $70 in partnership plus equipment recorded on the partnership books for $40, less accumulated depreciation of 10, which is less accumulated depreciation. It means it's gonna give us the book value. So notice here, so it's $70 plus the equipment. Let's see what's gonna happen now. This is their balance as before and what's gonna happen is the partnership asset decreased by 100, which is $70 and the cash, it's $70, the equipment is 40 minus the 10. The book value is equal to $30. So basically we gave Lopez how much? $100 for their interest that's worth 400. It means Lopez needs the money so bad they want to get out. Say, okay, if you want to get out we can only give you 100. Well, if we give them 100, it means the remaining balance, the 300, it's gonna be left to the other two partners in the ratio of two-fifth and three-fifth because Lopez is gone. So here's what's gonna happen. The ratio is two, three to five, the five is gone. So what we left is two and three, which is equal to five, two-fifth for Fluffy, three-fifth for Angela. So now what's gonna happen? The remaining ratio, the remaining bonus times two-fifth will give us 120. That's gonna go to Fluffy and Fluffy's capital balance will increase and 300 times three-fifth is 180 and Angela's balance will increase. Therefore, their balance after is 450 and 450, respectively. Lopez is gone. And now we only gave up 100 from the partnership to get root of Lopez. The entry will be Lopez debited their capital account 400 because that's how much we need to debit their capital account. We need to get root of it fully, 400. Notice, let's see, let's look at the journal entry overall. So now, Lopez account is 400 to remove Lopez's account. We gave them $70 cash, that's easy. We're gonna credit equipment 40 debit it's accumulated depreciation 10 because we got root of the equipment. Credit the equipment debit accumulated depreciation and the two partners capital account will increase one by 120 and the other one by 180. If you like this recording, please like it and share it. If you're looking for additional resources to supplement your accounting education or pass your CPA exam, check out my website farhatlectures.com. You invest once in your lifetime for your education and your CPA exam. It's a lifetime investment. I strongly suggest you check out my website. In the next session, we would look at liquidation of partnership. Stay safe during those coronavirus days and study hard.