ALFONSO T.

YUCHENGCO COLLEGE OF BUSINESS

MODULE 2

Topic 5: PARTNERSHIP: ITS NATURE &

ACCOUNTING FOR ITS FORMATION

5.1 Nature of Partnership Business

Definition of Partnership:

“By 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.”
- Civil Code of the Philippines

Major Characteristics of a Partnership:

a. Based on contract
b. Association of individuals
c. Ease of formation
d. Co-ownership of partnership property
e. Assignment of partner’s interest
f. Mutual agency
g. Income participation
h. Unlimited liability
i. Limited life

Requisites of a Partnership:

a. A voluntary and valid agreement among the parties

b. A lawful purpose for which the partnership is organized
c. Contributions of money, property or industry
d. As association for a profit to be divided among the partners
e. Mutual agency among the partners
f. A practice of transparency on the records and transactions of the partnership

Advantages and Disadvantages of a Partnership:

Advantages Disadvantages
Easy formation Unlimited liability
Joint resources Mutual agency
Tax exemption Consensual
Less government supervision Limited life
 ALFONSO T. YUCHENGCO COLLEGE OF BUSINESS

Comparison of Sole Proprietorship and Partnership:

Sole Proprietorship Partnership

Formation
Very easy to form because only one owner Easy to form because a mere oral
decides when to engage in business agreement between partners
organizes a partnership
Capital and Withdrawal Accounts
Only one capital account and one drawing Several capital accounts and drawing
account accounts
Capitalization
Limited by the investment of owner More than one source of capital
Agency
Simple agency Mutual agency
Legal liability
Unlimited Unlimited
Taxation
The owner is taxed for the amount of General professional partnership is
income earned by business taxed exempt
Life Expectancy
Limited within the desire or death of Limited within the desire of partners,
owner or by the death, acceptance
withdrawal or incapacity of any
partners

Kinds of Partnerships:

a. As to nature of business
1. Trading partnership – involves buy and sell of merchandise or manufacture of
goods.
2. Non-trading partnership – involves service business activity.

b. As to purpose
1. Commercial partnership – is engaged in trading, merchandising, or
manufacturing of goods for a profit.
2. General professional partnership – is organized for the exercise of a common
profession.

c. As to liability
1. General partnership – is comprised of general partners or a combination of
general and industrial partners.
2. Limited partnership – is comprised both limited and general partners. Limited
partners shall be liable to the extent of his/ her contribution to the partnership.

d. As to legality of existence:
1. De jure partnership – is organized in accordance with all the legal requirements
for its existence.
2. De facto partnership – is organized without complying with the legal
requirements for its existence.
 ALFONSO T. YUCHENGCO COLLEGE OF BUSINESS

Kinds of Partners:

a. As to contribution
1. Capitalist partner – contributes money or property to the partnership
2. Industrial partner – contributes only his/ her skills, knowledge, industry or
personal service to the partnership
3. Capitalist-industrial partner – contributes money, property and industry to the
partnership

b. As to liability
1. General partner – assumes unlimited liability (i.e. liable for the partnership
debts to the extent of his/ her personal assets)
2. Limited partner – liable to the extent of his/ her capital contribution to the
partnership

c. As to participation
1. Managing partner – appointed to run the business of the partnership
2. Silent partner – known as partner but does not take active participation in
running the affairs of the partnership
3. Liquidating partner – appointed to liquidate partnership assets and settle
unfinished transactions of the partnership after dissolution

d. As to third persons
1. Secret partner – not known as partner but takes active part in running the
partnership business
2. Dormant partner – not known as partner and inactive in the partnership
3. Nominal (or Ostensible) partner – a partner in name only by permitting the use
of his name either for accommodation or for consideration

5.2 Accounting for Partnership Formation

1. Individual persons without existing business form a partnership

a. Amount of individual contribution based on agreement

Illustration 1: A and B form a partnership with an agreed capitalization of

P300,000 to be contributed in cash of 30% and 70% by A and B, respectively.

Cash P300,000
A, Capital P 90,000
B, Capital 210,000
To record initial investments of A and B.

Illustration 2: A, B and C form a partnership with an agreed capitalization of

P300,000 to be contributed equally by A and B in terms of their assets. C is to be
designated as the managing partner with a share of 20% from partnership
profits. A and B contribute the following:
At cost At fair values
Partner A contributions:
Land P50,000 P110,000
Equipment 70,000 60,000
Notes payable (assumed by partnership) 20,000 20,000
Partner B contributions:
Cash P100,000 P100,000
Equipment 70,000 50,000
 ALFONSO T. YUCHENGCO COLLEGE OF BUSINESS

Cash P100,000
Land 110,000
Equipment 110,000
Notes Payable P 20,000
A, Capital 150,000
B, Capital 150,000
To record initial investments of A and B.

To record the contribution of C (an industrial partner), the memorandum entry in

the books of accounts would be as follows:

“C is an industrial partner to share 20% from partnership profits.”

b. Amount of individual contribution is without agreement

Illustration: A and B form a partnership with an agreed capitalization of P300,000

to be contributed in cash.

Cash P300,000
A, Capital P150,000
B, Capital 150,000
To record initial investments of A and B.

In the absence of any partners’ agreement, the amount of contributions of

partners shall be equally divided.

2. Conversion of a Sole Proprietorship to a Partnership

The conversion of sole proprietorship is accounted for using the following

procedures:
a. Close the nominal accounts of the sole proprietorship business
b. Record the adjustments (based on agreed valuation or fair value) of the assets
and liabilities directly to the sole proprietor’s capital account.
c. Close the books of the sole proprietorship (real accounts).
d. Open the new set of partnership books by recording the partners’ contributions.

Illustration: A is the owner of an existing sole proprietorship. A, together with B

and C, decides to form a partnership with an agreed capitalization of P150,000
to be contributed equally by the partners. B and C are to be contribute cash. A
shall also contribute cash if the net assets of his business after agreed valuation
will not be enough to cover his contribution requirement.

A’s sole proprietorship trial balance is as follows:

A’s Proprietorship
Trial Balance
September 30, 2021
Debit Credit
Cash P 5,000
Accounts Receivable 19,800
Merchandise Inventory 8,000
Notes Payable P10,000
A, Capital 20,000
Sales 8,900
Operating Expenses 6,100 ___ ___
Totals P38,900 P38,900
 ALFONSO T. YUCHENGCO COLLEGE OF BUSINESS

Close the nominal accounts of A Proprietorship in its books –

Sales P 8,900
Operating Expenses P 6,100
Income and Expense Summary 2,800
To record closing of nominal accounts.

Income and Expense Summary P 2,800

A, Capital 2,800
To record closing of net profit to capital.

The post-closing trial balance of A’s sole proprietorship is presented below:

A’s Proprietorship
Trial Balance
September 30, 2021
Debit Credit
Cash P 5,000
Accounts Receivable 19,800
Merchandise Inventory 8,000
Notes Payable P10,000
A, Capital 22,800
Totals P32,800 P32,800

Assume that, based on the post-closing trial balance, the following valuation
adjustments were agreed upon:
1. Accounts receivable is to be reduced by P800 due to uncollectibility.
2. Merchandise inventory is to be valued at P9,000.

Adjust the books of A Proprietorship –

A, Capital P 800
Allowance for Bad Debts P 800
To record provision for bad debts.

Merchandise Inventory P 1,000

A, Capital P 1,000
To record adjustment to inventory.

After agreed adjustments, the trial balance of A is shown below:

A’s Proprietorship
Trial Balance
September 30, 2021
Debit Credit
Cash P 5,000
Accounts Receivable 19,800
Allowance for Bad Debts P 800
Merchandise Inventory 9,000
Notes Payable 10,000
A, Capital 23,000
Totals P33,800 P33,800
 ALFONSO T. YUCHENGCO COLLEGE OF BUSINESS

Close the books of A Proprietorship –

Allowance for Bad Debts P 800

Notes Payable 10,000
A, Capital 23,000
Cash P 5,000
Accounts Receivable 19,800
Merchandise Inventory 9,000
To record closing of books of A Proprietorship.

Record the partners contributions in the new set of books of the partnership –

Cash* (5,000 + 27,000) P 32,000

Accounts Receivable 19,800
Merchandise Inventory 9,000
Allowance for Bad Debts P 800
Notes Payable 10,000
A, Capital 50,000
To record the contribution of A.

* Agreed capital contribution of A P50,000

Less: Adjusted capital of A 23,000
Additional cash contribution of A P27,000
Add: Cash of A from sole proprietorship 5,000
Total cash contribution of A P32,000

Cash P100,000
B, Capital P 50,000
C, Capital 50,000
To record the contributions of B and C.

The trial balance after partnership formation in its new set of books is:

ABC Partnership
Trial Balance
September 30, 2021
Debit Credit
Cash P132,000
Accounts Receivable 19,800
Merchandise Inventory 9,000
Allowance for Bad Debts P 800
Notes Payable 10,000
A, Capital 50,000
B, Capital 50,000
C, Capital _ 50,000
Totals P160,800 P160,800

3. Two or More Sole Proprietors Form a Partnership

This formation will not be considered as a business combination but rather as

putting together of resources of two or more existing businesses into common fund.
Therefore, there is no goodwill to be recognized. The accounting procedures in
converting sole proprietorships into a partnership are the same as when a sole
proprietorship is converted into a partnership.