Getting Started!

“Attitude is a choice and

the choice is always yours.”
1.1 PARNERSHIP FORMATION
Twitter, founded by Evan Williams, Biz Stone, and Jack Dorsey, is an excellent
example of a successful business partnership. In less than 3 years, these
individuals managed to grow Twitter from the sound a bird makes to an
incredible industry where over 63% of the brands in the world signing on to
use it. In accounting, can we consider Twitter as a partnership form of
business?
Do you know that Article
1767 of the Law on You, as an accountant, have a major role in every partnership,
Partnerships says that hence, you should learn the following concepts.
partnership is a contract of
two or more persons A capital account is maintained for each partner and
binding themselves to everytime a partner invests in the business, he receives
contribute money, ownership in the partnership and his capital account is
property, or industry to a credited. An initial/original investment, for example, is
common fund, with the recorded in this account.
intention of dividing the
profits among The accounting procedures on recording the initial investment
themselves? of the partners to the partnership are reflected in the diagram
below: (Valencia, 2005)
Therefore, it may be
formed for the purpose of
engaging in a lawful trade
or business (like Twitter)
or for the practice of a
profession (like your
future accounting firm) to
secure profits and to
divide the same among
partners. Well, Willams,
Stone and Dorsey are
surely earning from
Twitter. By the way, what’s
your latest tweet?

To operate, definitely a
capital is needed, so the
partners (or owners) can
invest cash, other assets or
services. They can even
transfer a note or
mortgage (a liability) to
the business if one is
associated with an asset
the owner is giving the
business. Assets
contributed to the
business are recorded at
their fair market values.
What is fair market value?

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To illustrate, Albert, Remi and Jerome decided to form a partnership. Albert contributes P100,000
cash to the partnership. Remi is going to give P25,000 cash and an automobile with a market value
of P30,000. Remi is also going to transfer the P20,000 note on the automobile to the
business. Jerome will join the partnership as an industrial partner with one-third interest in
profit. The entries would be:

Cash 100,000
Albert, capital 100,000
To record cash contribution by owner.

Cash 25,000
Automobile 30,000
Notes Payable 20,000
Remi, Capital 35,000*

To record assets and notes contribution by owner.

Jerome is admitted in the partnership as an industrial partner with one-

third share on the profit only.

To record the services contributed by owner.

* Remi’s capital will be credited by P 35,000 since he invested assets which totalled P55,000 less
the liability transferred to the partnership of P 20,000.
“Who you are right now is the result
1.1.1 Sole Proprietorship formed into Partnership of your past attitude and choices.”

There are times when an existing sole proprietorship is formed into a partnership, or sole
proprietorships are merged to form a partnership. In such instance, the prospective partners
usually agree on the adjustments of assets to reflect current market values and the correction of
certain accounts the balances of which are either wrong or not up to date. The adjustments of the
assets and liabilities of the sole proprietorship are made directly to the Capital Account instead
of nominal accounts since assets and liabilities affect the capital. In your Basic Accounting, you
learned that a change in an asset account directly affects the capital ( Cash; X, Capital) while
a change in a liability account inversely affects the capital ( Accounts Payable; X, Capital).
Recall that A – L = C.

To illustrate, Kevin invites Dove to be a partner in his business by investing cash of P 150,000.
Accounts in the ledger of Kevin on July 31, 20x9 just before the admission of Dove show the
following balances:

Debit Credit
Cash P 24,000
Accounts Receivable 125,000
Allowance for Doubtful Accounts P 500
Merchandise Inventory 91,000
Furniture & Equipment 120,000
Accumulated Depreciation 20,000
Accounts Payable 66,500
Kevin, Capital 273,000

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 It is agreed that for the purpose of establishing Kevin’s interest, the following adjustments shall
be made:

(1) The allowance for doubtful accounts shall be increased to 2% of accounts receivable.
(2) The merchandise inventory is to be valued at P 120,000.
(3) The furniture & equipment has a current market value of P 125,000.

The entries to record the investment of Kevin and Dove in the partnership books are as follows:
Cash 24,000
Accounts Receivable 125,000
Merchandise Inventory 120,000
Furniture & Equipment 125,000
Allowance for Doubtful Accounts 2,500*
Accounts Payable 66,500
Kevin, capital 325,000**
To record the initial investment of partner Kevin.

Cash 150,000
Dove, capital 150,000
To record the initial investment of partner Dove.

* The credit to Allowance for Doubtful Accounts of P 2,500 is computed as 2% of P125,000

balance of Accounts Receivable.

** The total assets and liabilities contributed by Kevin to the partnership amounted to
P391,500 and P 66,500, respectively. Hence, the amount to be credited to Kevin will be
P325,000.

“Your attitude and choices not only affect your

1.1.2 Bonus on Initial Investment present but also determine your future.”

As an accountant, there are times that you will encounter a valuation problem when partners
agree on relative capital balances that are not aligned with their investments of identifiable assets
or invested capital. The Bonus Approach may be used to adjust the capital accounts.

For example, Cara and Cruz could agree to divide initial partnership capital, equally, even though
Cara contributed P 50,000 cash and Cruz contributed P 42,000 cash. Such an agreement implies
that Cruz is contributing an unidentifiable asset such as individual talent, established clientele,
or banking connections to the partnership. The entry to record the investment of the partners is
as follows:
Cash P 92,000
Cara, capital P 50,000
Cruz, capital 42,000

The amount of the implied unidentifiable asset can be inferred from Cara’s fair value contribution.
Cara invested P 50,000 of assets measured at fair value for a 50 percent interest in the partnership.
One can infer from Cara’s investment that the fair value of the partnership is P100,000 (P50,000
÷ 50%). The implied fair value of the unidentifiable asset contributed by Cruz is P8,000 (FVPartnership
– Invested CapitalCara – Invested CapitalCruz = P100,000 – P50,000 – P42,000) because Cruz also
has a 50 percent interest in the partnership but only contributed identifiable assets with a fair
value of P42,000. The partnership agreement specifies equal capital interests (Agreed InterestCara
: Agreed InterestCruz = 50% : 50%), so we should adjust the capital account balances of Cara and
Cruz to meet the agreement’s conditions.

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Under the bonus approach, the only journal entry necessary to meet the agreement of the partners
to have an equal initial capital follows:
Cara, capital P 4,000
Cruz, capital P 4,000

“Your basic values…influence the quality of your choices.”- Dr. W. Knaus

1.1.3 Partner’s Accounts “I choose to define my values and what matters most to me.”
Traditionally, partnership accounting records contain two accounts for each partner - capital
account and drawing account.

A capital account records the partner’s equity investment at any point in time. It is credited
initially with the fair market value of the assets contributed (called initial or original contribution
or investment) by the partner at the time of the partnership formation; subsequent changes reflect
the partner’s share in net income earned, additional assets invested, and assets withdrawn.

A drawing account is debited to record cash withdrawals in anticipation of yearly profits, i.e.,
a partner who badly needs money may be allowed to withdraw a limited amount from his
investment (this is called temporary withdrawal) and an amount in excess of the limit, shall be
considered as a permanent withdrawal already. Moreover, you may opt to credit this to reflect
the partner’s share in profit instead of crediting the capital account. This account is closed to the
partner’s capital account at the end of the accounting period.

Kindly refer to the ledgers (or T-Accounts) below for the summary of the aforementioned
discussions.

Partner’s Capital Account

Debit Credit
1. Permanent withdrawals. 1. Original investment
2. Debit balance of the drawing account at 2. Additional investment
the end of the period. 3. Credit balance of the drawing account at
the end of the period.

Partner’s Drawing Account

Debit Credit
1. Temporary withdrawals 1. Share in profit(this may be credited
Credit directly to Capital)

Note:
Kindly check out your study planner. To indicate that you have finished grasping the key points at
this part of the module, tick on the checklist for Partnership Formation. This is a form of self -
assessment so you can personally monitor your learning progress. 

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 Self-Check

1. What are the ways of forming a partnership?

2. Explain the basis of valuation of non-cash assets invested in the partnership.
3. As a general rule, when do you credit the capital account and when do you debit a
capital account when preparing capital adjustments for assets to be invested into the
partnership by a sole proprietorship?
4. How do you record the investment of labor of an industrial partner in the partnership
books?
5. Isak Tagasawang was already in trading business a year ago. She offered Osang to join
her in the business for the first time. The general ledger balances of Isak prior to
partnership formation follows:

Cash P 375,000
Accounts Receivable 90,000
Estimated Uncollectible Accounts (1,000)
Merchandise 420,000
Equipment 250,000
Accumulated Depreciation (50,000)
Accounts Payable (75,000)
Tagasawang, Capital ?

Osang will contribute cash equal to one-half of Isak’s capital balance after the
following adjustments are reflected in the sole proprietor’s book of Isak.

a. Accounts Receivable should be an estimated realizable value of P85,000.

b. Merchandise Inventory should have a net realizable value of P390,000 after considering
obsolescence.
c. Equipment should have a carrying value or net book value of P180,000.
d. The omitted accrued utilities of P1,500 should be considered in the adjustment.

Required:

5.1 Capital balance of Isak prior to partnership formation

5.2 Adjusting entry necessary to correct the book of Isak
5.3 Closing entry in the sole proprietorship book of Isak
5.4 Statement of Financial Position after the formation of partnership

Refer to the Answer Key for Number 5’s answers.

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 ANSWERS KEY

Unit 1. Accounting for Partnership

TAGASAWANG & OSANG

1.
Debits:
Cash P375,000
Accounts Receivable 90,000
Merchandise 420,000
Equipment 250,000 P1,135,000

Credits:
Estimated Uncollectible Accounts P1,000
Accumulated Depreciation 50,000
Accounts Payable 75,000 P126,000

Account Balance of Tagasawang P1,009,000

2.
a. Tagasawang, Capital P4,000
Estimated Uncollectible Account P4,000
b. Tagasawang, Capital 30,000
Merchandise 30,000
c. Tagasawang, Capital 20,000
Accumulated Depreciation 20,000
d. Tagasawang. Capital 1,500
Accrued Utilities 1,500

3.
Estimated Uncollectible Accounts P5,000
Accumulated Depreciation 70,000
Accounts Payable 75,000
Accrued Utilities Expense 1,500
Isak, Capital 953,500
Cash P375,000
Accounts Receivable 90,000
Merchandise 390,000
Equipment 250,000

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4.
Tagasawang and Osang
Statement of Financial Position
As of _______
Assets Liabilities
Current Assets
Cash P851,750 Accounts Payable P75,000
Accounts Receivable P90,000 Accrued Utilities Expense 1,500 P76,500
Est. Uncollectible Acct. 5,000 85,000
Merchandise 390,000 Partners’ Equity
Non-Current Assets Tagasawang, Capital P953,500
Equipment (Net) 180,000 Osang, Capital 476,750 1,430,250
Total Assets Total Liabilities & Partner’s Equity
P1,506,750 P1,506,750

(The account Accumulated Depreciation is no longer carried in the book of the partnership.)