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CHAPTER 1 (PARTNERSHIP FORMATION AND OPERATION) ▲ Partnership Formation

▲ Structure of Partnership • Two or more sole proprietors form a partnership
• Two or more persons form a partnership for the first time Tori and Mavy, decided to form a partnership on October 1 of the current
• A person already in business may invite an individual to form a year. Their statement of financial position on this date were:
partnership
• Two or more sole proprietors may form a partnership Tori Mavy
Cash 65,625 164,063
▲ Articles of Co-Partnership – a voluntary contract between/ among two Accounts receivable 1,487,500 896,875
or more persons to place their capital, labor, and skills into business with
the understanding that there will be a sharing of the profits and losses Merchandise inventory 875,000 885,937
between/ among partners Equipment 656,250 1,268,750
• Name of the partnership Total 3,084,375 3,215,625
• Name and address of the partners
• Rights and responsibilities of each partner
Accounts payable 459,375 1,159,375
• The purpose for which the partnership is formed
Tori, Capital 2,625,000
• The initial investment and additional investments to be made by each of
the partner Mavy, Capital 2,056,250

• The withdrawals that maybe made by partners and the limitations, if any Total 3,084,375 3,215,625

• The profit and loss ratio

• Procedures on dissolving the partnership
▲ Recording the Contributions of the Partners
• Cash contributions
- Valued at its face value (fair value)
- Foreign currency denominated cash contributions are valued based on
exchange rates on the date of contribution
- Cash deposited in a bankrupt or closed bank is valued at its estimated
recoverable amount (net realizable value)
• Noncash contributions
- Valued at its fair market value
They agreed to the following adjustments:
- Equipment of Tori is under depreciated by P87,500 and that Mavy is over
depreciated by P131,250
- Allowance for doubtful accounts is to be set up amounting to P297,500
for Tori and P196,875 for Mavy
- Inventories of P21,875 and P15,320 are worthless in the books of Tori
and Mavy, respectively
- The profit and loss ratio for Tori and Mavy is 6:4
Required:
1. Adjusted capital of Tori and Mavy using the net investment method
2. Adjusted capital of Tori and Mavy using the bonus method, assuming
their capital ratio is the same as the profit and loss ratio

• Accounts receivables transferred to the partnership

1. Net Investment Method
- Recorded at gross amount accompanied by corresponding allowance for
bad debts Tori Mavy
Unadjusted capital 2,625,000 2,625,000
• Fixed assets transferred to the partnership Under/Over depreciated
(87,500) 131,250
- Recorded at fair market value equipment
Allowance for bad debts (297,500) (196,875)

▲ Accounting for Initial Investment Write down of

(21,875) (15,320)
inventories
• Net investment method (Transfer of Capital Method) – the
partnership credited for the amount of net assets invested (FV of assets Adjusted capital 2,218,125 1,975,305
minus FV of liabilities)
- This will happen if the contributions ratio is equal to capital ratio 2. Bonus Method
Tori, adjusted capital 2,218,125
• Bonus method – partner’s capital is credited based on their agreed ratio Mavy, adjusted capital 1,975,305
which may be different from their contribution
Total contributed capital 4,193,430
- The difference between the amount contributed and amount credited to
the capital is the bonus
Tori Mavy
Contributed capital 2,218,125 1,975,305
Capital credit per 2,516,058 1,677,372
agreement
Bonus 297,933 (297,933)

Pagatpat, Aischelle Mhae R.

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• A sole proprietor and two individuals form a partnership 2. Layla as the base (595,000/35% = 1,700,000
On December 1 of the current year, Mikee, the sole proprietor of the Mikee Layla Roma
Victory Company, expands the company and establish a partnership with Contributed capital 905,200 595,000 687,000
Layla and Roma. The partners plan to share profits and losses as follows:
Agreed capital 680,000 595,000 425,000
Mikee, 40%; Layla, 35% and Roma, 25%. Mikee asked Layla to join the
partnership because his image and reputation are expected to be valuable Withdrawal (225,200) 0 (262,000)
during formation. Layla is also contributing P105,000 cash and the
building that was acquired for P1,010,000, with carrying amount of
P870,000 and fair value of P490,000. The building is subject to mortgage 3. Using net investment method
P198,000 that the partnership did not assume. Roma is contributing Mikee Layla Roma
P212,000 cash and marketable securities costing P336,000 to Roma but are Contributed capital 905,200 595,000 687,000
currently worth P475,000. Mikee's investment in the partnership is the
Agreed capital 874,8880 765,520 546,800
Victory Company.
Withdrawal (30,320) 170,520 (140,200)
Assets Liabilities and Capital
Cash Accounts
390,000 437,000 ▲ Partnership Operations
Payable
Accounts Notes Payable • Factors in Profit and Loss Sharing Agreement
456,000 592,000
Receivable ■ Single ratio
Merchandise
394,000
Capital
829,000
- If the partners agree on the manner of profit distribution but not loss
Inventory distribution, then loss will be distributed using the profit ratio
Equipment, net 618,000 829,000 - If the partners agree on the manner of loss distribution but not profit
Total 1,858,000 Total 1,858,000 distribution, then profit will be distributed using the capital ratio
- If there is no provision for the distribution of profit and losses, then it will
be divided on the basis of capital ratio
The partners agreed that 35% of inventory is considered worthless, the
equipment is 75% of its carrying amount, in 15% of accounts receivable is
uncollectible. Mikee plans to pay off the accounts payable with his ■ Provision for Salaries – part of profit distribution given to the partners
personal assets. The other partners have agreed a partnership will assume that devote time in the management of the partnership
the notes payable. The partners agreed that their capital balances upon
formation will be in conformity with their profit and loss ratio. ■ Provision for Interest – part of profit distribution which allowed
partners interest on capital to give recognition to the differences in the
Required: capital given to the partnership
1. Assuming the partners will either invest or withdraw cash, using Roma
as the base, Mikee and Layla will both invest cash with total amount of ■ Provision for Bonus – part of profit distribution give it to the partners
2. Show me the partners that either investor withdraw cash, using Layla as who contribute skills or expertise to the partnership
the base, Mikee and Roma will both withdraw cash with total amount of
3. If the net investment method is used, the capital account of Mikee and ◊ Computation of Bonus
Roma will change by  Based on profit before deducting bonus income tax
 Based on profit after deducting bonus but before deducting income tax
Mikee (40%) Layla (35%) Roma (25%) Total  Based on profit before deducting bonus but after deducting income tax
Unadjusted capital 829,000  Based on profit after deducting bonus and income tax
Write-down of
(137,900)
inventory
ILLUSTRATION 1: Single Method of Allocation
Write-down or
(154,500)
PPE James and Howard are partners and have capital balance at the end of 2017
Provision for as follows: James – P 60,000; Howard – P 30,000. The results of its 2017
(68,400)
uncollectible operations is a net income after tax of P 120,000.
Payables not
437,000
assumed by firm
Required
Cash contribution 105,000 212,000
1. Profit is divided equally
Fair value of
490,000 2. Profit is divided in the ratio of 3:1
building

Marketable 3. No agreement on profit distribution

475,000
securities

Net asset
contribution
905,200 595,000 687,000 2,187,200 1. Equally
James Howard

1. Roma as the base (687,000/25% = 2,748,000) 120,000*50% 60,000

Mikee Layla Roma 120,000*50% 60,000

Contributed capital 905,200 595,000 687,000 Share in profit 60,000 60,000

Agreed capital 1,099,200 961,800 687,000

Additional
194,000 961,800 0
investment

Pagatpat, Aischelle Mhae R.

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2. Ratio of 3:1 Joseph
James Howard Beginning capital 300,000 * 12/12 300,000
120,000*3/4 90,000
May 31 50,000 * 8/12 33,333
120,000*1/4 30,000
Aug 1 35,000 * 5/12 (14,583)
Share in profit 60,000 60,000
Dec 1 30,000 * 1/12 2,500
Average capital 321,250
3. No agreement
James Howard
2. Profit Distribution
120,000*6/9 80,000
Ezekiel Joseph Total
120,000*3/9 40,000
Salary 50,000 50,000
Share in profit 60,000 60,000
Interest 55,500 32,125 87,625

ILLUSTRATION 2: Multiple Bases of Allocation Bonus 10,000 10,000

On January 1, 2021, partners Ezekiel and Joseph formed Meow Balance 20,950 31,425 52,375
Partnership with Ezekiel contributing P500,000 and Joseph contributing
Total 136,450 63,550 200,000
P300,000. Partnership realized a profit of P200,000 for the year 2021.
Below is the summary of additional investments and withdrawals from
partners during the year ▲ Accounting for Errors
• Counterbalancing errors – this error if on detected or corrected will
Ezekiel Additional Investment Withdrawal offset or correct them after two reporting period

Feb 1 60,000 - A correcting journal entry is necessary for any counterbalancing error
that is detected before it has counterbalanced
Mar 31 30,000
- If the error is discovered after it has counterbalanced, no correcting
Jul 1 50,000 journal entry is necessary, that the financial statements should be restated
so that they are not misleading
Nov 1 15,000

■ Effects of Common Counterbalancing Errors

Joseph Additional Investment Withdrawal
Type of adjustment Income (current year) Income (next year)
May 31 50,000
Ending inventory
Over Under
Aug 1 35,000 overstated

Dec 1 30,000 Ending inventory

Under Over
understated
Failure to accrue
Profit is distributed to the partners according to the following provisions: Over Under
expenses at year end
- Annual salary to Ezekiel, managing partner in the amount of P50,000 Overstatement of
- Interest of 10% each based on average capital balances accrued expenses at year Under Over
end
- Bonus to Ezekiel off 5% of net income before bonus and income tax
Failure to accrue earned
- Balance 4:6 revenue at year end
Under Over

Overstatement of
Required accrued revenue at year Over Under
1. Compute the average capital end

2. Distribute the profit to partners Failure to expense

Over Under
prepayments at year end
Understatement of year-
1. Average Capital Under Over
end prepaid expense
Understatement of year
2. Profit distribution end liabilities for
Over Under
revenues received in
Ezekiel advance
Beginning capital 500,000 *12/12 500,000 Overstatement of near
and liability for revenue Under Over
Feb 1 60,000 * 11/12 55,000 received in advance
Mar 31 30,000 * 9/12 (22,500)
Jul 1 50,000 * 6/12 25,000 • Non-counterbalancing errors – are areas that will not be automatically
offset in the next accounting period
Nov 1 15,000 * 2/12 (2,500)
- A correcting journal entry is necessary for a non-counterbalancing error
Average capital 555,000 and any applicable financial statements must be restated

Pagatpat, Aischelle Mhae R.

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ILLUSTRATION 3: Correction of Errors
Teddy, Kyla and Poe are partners who share profits on a 5:3:2 ratio. For
the year 2019, the net income of the partnership was reported at P250,000.
However, it is discovered that the following items were omitted in the
partnership's books:

Unrecorded at year
2018 2019
end
Prepaid expense 16,000
Accrued expense 12,000
Unearned income 14,000
Accrued income 10,000

Required: Compute the correct net income for 2019

Reported net income, 2019 250,000

Prepaid expense (16,000)
Accrued expense (12,000)
Unearned income 14,000
Accrued income 10,000
Adjusted net income, 2019 246,000

Pagatpat, Aischelle Mhae R.