Partnership formation and

operation
Partnership
A partnership is defined as an association of two or more persons who contributes money,
property or industry to a common fund with the intention of dividing the profits among
themselves.

Accounting for partnerships should comply with the legal requirements as set forth by law
as well as complying with the partnership agreement itself.
Characteristics of partnership
A. Ease of formation
B. Separate legal personality
C. Mutual agency
D. Co-ownership of property
E. Co-ownership of profits
F. Limited life
G. Unlimited liability
Advantages and disadvantages
Advantages
Ease of formation
Shared responsibility of running business
Flexibility in decision making
Greater capital compared to sole proprietorship
Relative lack of regulation compared to corporation
Disadvantages
Limited life/Easily dissolved
Unlimited liability
Conflict among partners
Lesser capital compared to a corporation
A partnership is taxed like a corporation (except
general professional partnership)
Kinds of partners
1. CAPITALIST - one who contributes money or property to the common fund
2. INDUSTRIAL - one who contributes only his industry or personal service
3. GENERAL - one whose liability to 3rd persons extends to his separate property
4. LIMITED - one whose liability to 3rd persons is limited to his capital contribution
5. MANAGING - one who manages the affairs or business of the partnership
6. LIQUIDATING - one who takes charge of the winding up of partnership affairs upon
dissolution
7. PARTNER BY ESTOPPEL - one who is not really a partner but is liable as a partner for the
protection of innocent 3rd persons
8. CONTINUING PARTNER - one who continues the business of a partnership after it has
been dissolved by reason of the admission of a new partner, retirement, death or expulsion
of one of the partners
Kinds of partners
9. SURVIVING PARTNER - one who remains after a partnership has been dissolved by death
of any partner
10. OSTENSIBLE - one who takes active part and known to the public as partner in the
business
11 SECRET - one who takes active part in the business but is not known to be a partner by
outside parties
12. SILENT - one who does not take any active part in the business although he may be
known to be a partner
13. DORMANT - one who does not take active part in the business and is not known or
held out as a partner
Stages of partnership
1. Formation
2. Operation
3. Dissolution
4. Liquidation
Formation
Contribution Measurement
Cash Face value
Noncash asset 1. Agreed value
2. Fair value
3. Carrying amount
Liabilities* 1. Net present value

*Liabilities are assumed only when it is specifically stated in the problem.

Formation
On December 1, 2021, EE and FF formed a partnership, agreeing to share for profits or
losses in the ratio of 2:3, respectively. EE invested a parcel of land that cost him P25,000. FF
invested P30,000 cash. The land was sold for P50,000 on the same date, three hours after
formation of the partnership. How much should be the capital balance of EE right after
formation?
EE FF Total
Cash 30,000 30,000
Land 50,000 50,000
Capital 30,000 50,000 80,000
Formation
Cash 30,000
Land 50,000
EE, Capital 30,000
FF, Capital 50,000
Formation
On March 1, 2021, II and JJ formed a partnership with each contributing the following assets:
II JJ
Cash P300,000 P700,000
Machinery and equipment 250,000 750,000
Building – 2,250,000
Furniture and fixtures 100,000 –

The building is subject to mortgage loan of P800,000, which is to be assumed by the partnership,
agreement provides that II and JJ share profits and losses 30% and 70%, respectively. On March 1,
2021 the balance in JJ’s capital account should be:
Formation
II JJ Total
Cash 300,000 700,000 1,000,000
Machinery and equipment 250,000 750,000 1,000,000
Building – 2,250,000 2,250,000
Furniture and fixtures 100,000 – 100,000
Mortgage payable – (800,000) (800,000)
Capital 650,000 2,900,000 3,550,000
Cash 1,000,000
Machinery and equipment 1,000,000
Building 2,250,000
Furniture and fixtures 100,000
Mortgage payable 800,000
II, Capital 650,000
JJ, Capital 2,900,000
Formation
On March 1, 2021, II and JJ formed a partnership with each contributing the following assets:
II JJ
Cash P300,000 P700,000
Machinery and equipment 250,000 750,000
Building – 2,250,000
Furniture and fixtures 100,000 –

The building is subject to mortgage loan of P800,000, which is not to be assumed by the
partnership, agreement provides that II and JJ share profits and losses 30% and 70%, respectively.
On March 1, 2021 the balance in JJ’s capital account should be:
Formation
II JJ Total
Cash 300,000 700,000 1,000,000
Machinery and equipment 250,000 750,000 1,000,000
Building – 2,250,000 2,250,000
Furniture and fixtures 100,000 – 100,000
Capital 650,000 3,700,000 4,350,000

Cash 1,000,000
Machinery and equipment 1,000,000
Building 2,250,000
Furniture and fixtures 100,000
II, Capital 650,000
JJ, Capital 3,700,000
Bonus
Aldo, Bert, and Chris formed a partnership on April 30, with the following assets, measured at their fair values,
contributed by each partner
Aldo Bert Chris
Cash P10,000 P12,000 P30,000
Delivery trucks 150,000 28,000 –
Computers 8,500 5,100 –
Office furniture – 3,500 2,500
Total 168,500 48,600 32,500

Although Chris has contributed the most cash to the partnership, he did not have the full amount of P30,000
available and was forced to borrow P20,000. The delivery truck contributed by Aldo has a mortgage of P90,000
and the partnership is to assume responsibility for the loan. The partners agreed to equalize their interest. How
much is the capital interest of the partners?
Bonus
Aldo Bert Chris Total
Cash P10,000 P12,000 P30,000 P52,000
Delivery trucks 150,000 28,000 – 178,000
Computers 8,500 5,100 – 13,600
Office furniture – 3,500 2,500 6,000
Mortgage payable (90,000) – – (90,000)
Contributed capital 78,500 48,600 32,500 159,600
Bonus (25,300) 4,600 20,700 –
Agreed capital 53,200 53,200 53,200 159,600
Additional investment/withdrawal
On July 1, 2021, Rachel and Ross decided to form a partnership. Their balance sheets on this date are:
Rachel Ross
Cash P15,000 P37,500
Accounts receivable 540,000 225,000
Merchandise inventory – 202,500
Machinery and equipment 150,000 270,000
Total 705,000 735,000

Accounts payable P135,000 P240,000

Rachel, Capital 570,000
Ross, Capital 495,000
Total 705,000 735,000

The partners agreed that the machinery and equipment of Rachel is underdepreciated by P15,000 and that of Ross by
P45,000. Allowance for doubtful accounts is to be set up amounting to P120,000 for Rachel and P45,000 for Ross. The
partnership agreement provides for a profit and loss ratio and capital interest of 60% to Rachel and 40% to Ross. How much
cash must Rachel invest to bring the partners’ capital balances proportionate to their profit and loss ratio?
Additional investment/withdrawal
Rachel Ross Total
Cash P15,000 P37,500 P52,500
Accounts receivable 420,000 180,000 600,000
Merchandise inventory – 202,500 202,500
Machinery and equipment 135,000 225,000 360,000
Accounts payable (135,000) (240,000) (375,000)
Contributed capital 435,000 405,000 840,000
Additional cash 172,500 – 172,500
Agreed capital 607,500* 405,000 1,012,500

Contributed capital, Ross 405,000

Divided by 40%
Total agreed capital 1,012,500
Multiply by 60%
Agreed capital, Rachel 607,500*
Cash settlement between partners
A, B, and C formed partnership. Their contributions are as follows:

A B C
Cash P40,000 P10,000 P100,000
Equipment – 80,000 –
Total 40,000 90,000 100,000

Additional information:
• The equipment has an unpaid mortgage of P20,000, which the partnership assumes to repay.
• The partners agreed to equalize their interests. Cash settlements among the partners are to be made
outside the partnership.
Cash settlement between partners
A B C Total
Cash P40,000 P10,000 P100,000 150,000
Equipment – 80,000 – 80,000
Mortgage payable – (20,000) – (20,000)
Contributed capital 40,000 70,000 100,000 210,000
Bonus 30,000 – (30,000) –
Agreed capital 70,000 70,000 70,000 210,000
Operations
Profits and losses are allocated based on agreement. The computation of the profit (loss)
share of the partners will depend on the method agreed upon by the partners and these
are:

1. Equally or in an agreed ratio

2. Capital contribution ratio
a. Original capital or initial investment
b. Beginning capital of each year
c. Average capital
d. Ending capital of each year
4. By allowing salaries, interests and bonuses to partners (salaries, interests and bonuses
are treated as part of profit distribution not as expenses)
Operations
The method of division to be used in any given situation is generally the method specified
in the partnership agreement.

If no profit and loss sharing agreement is specified in the partnership agreement, the
division of profit and losses is to be shared in the following order of priority:
1. Original capital
2. Beginning capital of each year
If no loss sharing agreement is specified in the partnership agreement, the division of
losses is to be shared in the following order of priority:
1. Profit agreement
2. Original capital
3. Beginning capital of each year
Salaries
In its first year of operations, Luffy and Company, a partnership, made a net income of P20,000 before
providing for salaries of P5,000 and P3,000 per annum for Luffy and Zoro, respectively, as stipulated in the
partnership agreement. Capital contributions are as follows:

Luffy P30,000
Zoro 20,000
Sanji 10,000

Assuming that no profit and loss ratios are provided in the partnership agreement and that there has been no
change in the capital contributions during the year, how much profit share would Luffy be entitled to received?

Luffy (1/2) Zoro (1/3) Sanji (1/6) Total

Salaries 5,000 3,000 – 8,000
Remainder 6,000 4,000 2,000 12,000
Total 11,000 7,000 2,000 20,000
Interest – beginning or ending capital
On January 1, 2021, Salt and Pepper have capital balances of P20,000 and P16,000, respectively. On July 1,
2021, Salt invests an additional P4,000 and Pepper withdraws P1,600. Profits and losses are divided as follows:
Pepper is the managing partner and as such shall receive P16,000 salary and Salt shall receive P7,200; both
partners shall receive interest of 10% on their beginning capital balances to offset whatever difference in
capital investments they have and any remainder shall be divided equally.

Income of the Salt-Pepper partnership for the year 2021 is P9,600. Salt’s share in net income is:

Salt (1/2) Pepper (1/2) Total

Salaries 7,200 16,000 23,200
Interest 2,000 1,600 3,600
Remainder (8,600) (8,600) (17,200)
Total 600 9,000 9,600
Interest – weighted average capital
On January 1, 2021, David and Goliath decided to form a partnership. At the end of the year, the partnership
made a net income of P120,000. The capital accounts of the partnership show the following transactions.

David, Capital Goliath, Capital

Debit Credit Debit Credit
January 1 – 40,000 – 25,000
April 1 5,000 – – –
June 1 – – – 10,000
August 1 – 10,000 – –
September 1 – – 3,000 –
October 1 – 5,000 1,000 –
December 1 – 4,000 – 5,000

Assuming that an interest of 20% per annum is given on average capital and the balance of the profits is
divided equally, the sharing of the profits shall be:
Interest – weighted average capital
David, Captial Goliath, Capital
Month Capital Months Peso Capital Months Peso
balance unchanged months balance unchanged months
January 1 40,000 3 120,000 January 1 25,000 5 125,000
April 1 35,000 4 140,000 June 1 35,000 3 105,000
August 1 45,000 2 90,000 September 1 32,000 1 32,000
October 1 50,000 2 100,000 October 1 31,000 2 62,000
December 1 54,000 1 54,000 December 1 36,000 1 36,000
Total 504,000 Total 360,000
Divided by 12 Divided by 12
Average 42,000 30,000
Interest rate 20% 20%
Interest 8,400 6,000
Interest – weighted average capital
David Goliath Total
Interest 8,400 6,000 14,400
Remainder 52,800 52,800 105,600
Total 61,200 58,800 120,000
Interest – weighted average capital
Popol and Kupa formed a partnership in 2021 and made the following investments and capital withdrawals
during the year:

Popol Kupa
Investments Draws Investments Draws
March 1 P30,000 P20,000
June 1 P10,000 P10,000
August 1 20,000 2,000
December 1 – 5,000

The partnership’s profit and loss agreement provides for a salary of which P30,000 was paid to each partner for
2021. AA is to receive a bonus of 10% on net income after salaries and bonus. The partners are also to receive
interest of 8% on average annual capital balances affected by both investments and drawings. Any remaining
profits are to be allocated equally among the partners.
The interest based on average capital balance is:
Interest – weighted average capital
Popol Kupa
Capital Months Peso months Investments Months Peso months
balance unchanged unchanged
March 1 P30,000 3 P90,000 P20,000 3 P60,000
June 1 20,000 2 40,000 10,000 2 20,000
August 1 40,000 4 160,000 8,000 5 40,000
December 1 35,000 1 35,000
Total 325,000 Total 120,000
Divided by 10 Divided by 10
10 – month average 32,500 10 – month average 12,000

Popol – 32,500 x 8% x 10/12 = 2,167

Kupa – 12,000 x 8% x 10/12 = 800
Interest – weighted average capital
Popol Kupa
Capital Months Peso months Investments Months Peso months
balance unchanged unchanged
March 1 P30,000 3 P90,000 P20,000 3 P60,000
June 1 20,000 2 40,000 10,000 2 20,000
August 1 40,000 4 160,000 8,000 5 40,000
December 1 35,000 1 35,000
Total 325,000 Total 120,000
Divided by 12 Divided by 12
Annual average 27,083 Annual average 10,000

Popol – 27,083 x 8% = 2,167

Kupa – 10,000 x 8% x = 800
Bonus
The partners, Rimuru and Veldora, share profits 3:2. However, Rimuru is to receive a yearly bonus of
20% of the profits, in addition to his profit share. The partnership made a net income for the year of
P24,000 before the bonus. Assuming Rimuru’s bonus is computed on profit after deducting said
bonus, how much profit share will Veldora receive?

Rimuru Veldora Total

Bonus* 4,000 – 4,000
Remainder 12,000 8,000 20,000
Total 16,000 8,000 24,000

B = 20% (24,000 – B)
B = 4,800 - .20B
B = 4,000*
Operations result in net loss
If the partnership operations resulted in net loss the following rules should be followed:

1. Salaries are included in partnership distribution unless stated otherwise

2. Interests are included in partnership distribution unless stated otherwise
3. Bonuses are not included in partnership distribution unless stated otherwise
Operations result in net loss
If the partnership operations resulted in net loss the following rules should be followed:

1. Salaries are included in partnership distribution unless stated otherwise

2. Interests are included in partnership distribution unless stated otherwise
3. Bonuses are not included in partnership distribution unless stated otherwise
Operations result in net loss
Drogon, Rhaegal and Viserion are partners with average capital balances during 2021 of
P472,500, P238,650 and P162,350, respectively. The partners receive 10% interest on their
average capital balances; after deducting salaries of P122,325 to Drogon and P82,625 to
Viserion, the residual profits or loss is divided equally.

In 2021, the partnership had a net loss of P125,624 before the interest and salaries to
partners.

Drogon Rhaegal Viserion Total

Salaries 122,325 82,625 204,950
Interest 47,250 23,865 16,235 87,350
Remainder (139,308) (139,308) (139,308) (417,924)
Total 30,267 (115,443) (40,448) (125,624)
Insufficient net income
In cases where the net income is less than the salaries, interests, and bonuses provided in
the partnership agreement and no agreement was established for such occurrence,
allocate the salaries, interests and bonuses as if sufficient income had been earned.
Insufficient net income
On January 1, 2021, Salt and Pepper have capital balances of P20,000 and P16,000, respectively. On July 1,
2021, Salt invests an additional P4,000 and Pepper withdraws P1,600. Profits and losses are divided as follows:
Pepper is the managing partner and as such shall receive P16,000 salary and Salt shall receive P7,200; both
partners shall receive interest of 10% on their beginning capital balances to offset whatever difference in
capital investments they have and any remainder shall be divided equally.

Income of the Salt-Pepper partnership for the year 2021 is P9,600. Salt’s share in net income is:

Salt (1/2) Pepper (1/2) Total

Salaries 7,200 16,000 23,200
Interest 2,000 1,600 3,600
Remainder (8,600) (8,600) (17,200)
Total 600 9,000 9,600
Order of priority
Partners Samson and Delilah have profit and loss agreement with the following provisions:
salaries of P90,000 and P135,000 for Samson and Delilah, respectively: a bonus to Samson
of 10% of net income after salaries; and interest of 10% on average capital balances of
P60,000 and P105,000 for Samson and Delilah, respectively. One-third of any remaining
profits will be allocated to Samson and the balance to Delilah.

If the partnership had net income of P66,000, how much should be allocated to Partner
Samson, assuming that the provisions of the profit and loss agreement are ranked by order
of priority starting with 1) salaries, 2) interest, 3) bonus and up to the extent of the ranking
only?
 Order of priority
Samson Delilah Total
Salaries 26,400 39,600 66,000
Changes in profit or loss ratio
If the profit or loss ratio changes, any differences between the fair value and book value of
assets and liabilities and any unrecorded assets and liabilities should be allocated using the
old profit or loss ratio.

Difference between the fair value and book value of assets may be addressed either by:
1. Updating the fair value and allocating the difference using the old profit or loss ratio.
2. Not updating the fair value and allocating the gain upon the ultimate disposal of the
asset first to the difference using the old profit or loss ratio and the remaining gain to
the new profit or loss ratio.
Changes in profit or loss ratio
Abe, Bert and Carl are partners sharing profit on a 7:2:1 ratio. On January 1, 2021, Dave
was admitted into the partnership with 15% share in profits. The old partners continue to
participate in profits in their original ratios.

For the year 2021, the partnership showed a profit of P15,000. However, it was discovered
that the following items were omitted in the firm’s book:
Unrecorded at year-end 2020 2021
Accrued expense 1,050
Accrued income 875
Prepaid expenses 1,400
Unearned income 1,225

The share of partner Bert in the 2021 net profit is:

Changes in profit or loss ratio
Net income Under (over)
Prepaid expenses, 2020 1,050
Unearned income, 2020 (1,225)
Net effect (175)

Abe (70%) Bert (20%) Carl (10%) Total

Capital adjustment (122.50) (35) (17.50) (175)
Changes in profit or loss ratio
Unadjusted profit, 2021 15,000
Accrued expense, 2021 (1,050)
Accrued income, 2021 875
Prepaid expenses, 2020 (1,400)
Unearned income, 2020 1,225
Adjusted profit, 2021 14,650

Abe (59.5%) Bert (17%) Carl (8.5%) Dave (15%) Total

Profit distribution 8,716.75 2,490.50 1,245.25 2,197.50 14,650
Capital changes
Capital, beg xx
Additional investments xx
Drawings (xx)
Share in net income (net loss) xx (xx)
Prior period errors xx (xx)
Capital, end xx