DEFINITION OF A PARTNERSHIP

The Partnership Law is the general governing authority for partnerships.

 Accountants advising partnerships must be familiar with this law because it describes many of
the rights of each partner and of creditors during creation, operation, and liquidation of the
partnership.

 Article 1767 of the Partnership Law embodies the definition of partnership.

 It states that “by the contract of partnership, two or more persons bind themselves to contribute
money, property, or industry to a common fund with the intention of dividing the profits among
themselves.”

This definition encompasses three distinct factors:

1. Association of Two or More Persons – The “persons” are usually individuals. Any natural
person who possesses the right to enter into a contract can become a partner.
2. To Carry On as Co-Owners – A partnership is an aggregation of partners’ individual rights.
This means that all partners are co-owners of partnership property and are co-owners of the
profits or losses of the partnership.
3. Business for Profit – A partnership may be formed to perform any legal business, trade or
profession, or other service. However, the partnership must attempt to make a profit; therefore,
non-profit organizations may not be partnerships.

CHARACTERISTICS OF A PARTNERSHIP

Before taking up the accounting problems encountered in partnerships, it is helpful to know the
important characteristics of the partnership form of organization.

Separate Legal Personality – Article 1768 of the Partnership Law states that the partnership has a
juridical personality separate and distinct from that of each of the partners. A partnership may,
therefore, acquire property in its own name and may enter into contracts.

Ease of Formation – The formation of a partnership does not require as many formalities as a
corporation. The partnership may be created by oral or written agreement between two or more
persons, or merely by inferences from the implication of their conduct.

Capital Limitations – Partnerships are limited in their ability to raise capital. These funds are
usually raised through personal resources or borrowing.

Co-ownership of Partnership Property and Profits – All assets invested in the partnership may
become the property of the partnership. The right of each partner to possess partnership property
for partnership purposes is equal to the right of each of the other partners. Each partner has a
proprietary interest in the partnership. This interest refers to each partner’s share in the earnings
and in the capital.
Limited Life – Any change in the agreement of the partners terminates the partnership contract.
A partnership may also expire any time when there is a change in the relationship of the partners
due to the death, withdrawal, bankruptcy or incapacity of a partner. No one can be forced against
his will to continue as a partner regardless of the agreed terms of operations. Other factors which
may bring a partnership to an end are the expiration of the period specified in the partnership
contract and the admission of a new partner.

Mutual Agency – Each partner has an equal right to act for the partnership and to enter into
contracts binding upon it, as long as he acts within the normal scope of business operations. Each
partner is a principal as well as an agent of the partnership.

Unlimited Liability – Each partner may be held personally liable for all the debts of the
partnership. All of his business and personal properties may be used for the settlement of
partnership liabilities. There is, however, a special type of partnership, called limited partnership,
wherein certain partners are allowed to limit their personal liabilities to the extent of their capital
contributions only.

ENTITY VERSUS PROPRIETORSHIP THEORIES

 The proprietorship theory views the assets of a business as belonging to the proprietor, the
liabilities as debts of the proprietor, and the income of the business as an increase in the
proprietor’s net worth (capital).

 In practice, however, proprietorship assets and liabilities are treated separately from the
personal assets, and liabilities of the proprietor.

 Thus, in practice, proprietorship are treated as separate entities, even though, in theory, they are
not.

 On the other hand, small partnerships are usually viewed as a combination of two or more
proprietorships, and the “proprietorship” theory would be the pertinent one for firms this size.

 The death of one partner would usually cause dissolution especially if there are only two
partners.

 Despite the many similarities between partnerships and proprietorships (i.e. unlimited liability,
dissolution upon death), partnerships are generally viewed as entities separate and apart from the
individual partners.

 Assets are viewed as belonging to the partnership and not to the individual partners.

 Income earned by the partnership is usually viewed as income to the “entity” with each partner
entitled to a distributive share of the income.

ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP

A partnership offers certain advantages over a sole proprietorship and a corporation. It also has a
number of disadvantages. They are as follows:

Advantages versus Proprietorships

1. Brings greater financial capability to the business.
2. Combines special skills, expertise and experience of the partners.
3. Offers relative freedom and flexibility of action in decision-making.

Advantages versus Corporation

1. Easier and less expensive to organize
2. More personal and informal

Disadvantages
1. Easily dissolved and thus unstable compared to a corporation.
2. Mutual agency and unlimited liability may create personal obligations to partners.
3. Less effective than a corporation in raising large amounts of capital.

PARTNERSHIP DISTINGUISHED FROM CORPORATION

Manner of Creation. A partnership is created by mere agreement of the partners while a

corporation is created by operation of law.

Number of Persons. Two or more persons may form a partnership, in a corporation, at least five
persons, not exceeding fifteen.

Commencement of Juridical Personality. In a partnership, juridical personality commences from

the execution of the articles of partnership, in a corporation, from the issuance of certificate of
incorporation by the SEC.

Management. In a partnership, every partner is an agent of the partnership if the partners did not
appoint a managing partner, in a corporation, management is vested on the Board of Directors.

Extent of Liability. In a partnership, each of the partners except a limited partner is liable to the
extent of his personal assets, in a corporation, stockholders are liable only to the extent of their
interest or investment in the corporation.

Right of Succession. In a partnership, there is no right of succession; in a corporation there is

right of succession. A corporation has the capacity of continued existence regardless of the death,
withdrawal, insolvency or incapacity of its directors or stockholders.

Terms of Existence. In a partnership, for any period of time stipulated by the partners, in a
corporation, not to exceed fifty years but subject to extension.

KINDS OF PARTNERS

General Partner
Limited partner – capital contribution 10,000
Capitalist Partner
Industrial Partner
Managing partner
Liquidating partner
Dormant partner – not known as a partner, does not take active part in the partnership
Silent partner – known as a partner, but does not take active in the partnership
Secret partner - not known as a partner, but does take active in the partnership
Nominal partner or partner by estoppel