ACCOUNTING FOR SPECIAL TRANSACTIONS

Handout 01: Partnership Formation Instructor: J. Cayetano

Partnership

Is defined in Article 1767 of the Civil Code of the Philippines as “a contract whereby two or more persons bind
themselves to contribute money, property, or industry into a common fund with the intention of dividing profits
among themselves”.

Characteristics of Partnership:
1. Mutual agency – Any partner may act as agent of the partnership in conducting its affairs.
2. Unlimited liability – The personal assets (assets not contributed to the partnership) of any partner may be
used to pay the partnership creditor’s claim if the assets of partnership are not enough to settle them.
3. Limited life – A partnership may be dissolved by: (1) express will of any partner; (2) termination of definite
term stipulated in the contract; (3) event which makes it unlawful to carry out the partnership; or (4)
expulsion, death, insolvency or civil interdiction of a partner.
4. Legal entity – A partnership has legal personality separate and distinct from that of each of the partners.
5. Co-ownership of contributed capital – Property contributed to the partnership are owned by the partnership
by virtue of its separate legal personality.
6. Difficulty of transferring of ownership – In case of dissolution, the transfer of ownership, whether to new or
existing partner, requires the approval of the remaining partners.

Accounting for Partnership Formation

Step 1 Determine the Total Contributed Capital (TCC) – This is the actual contribution of the partners
in the business.

a. Valuation of contribution – The contributed money and property should be initially valued
in the partnership books using the level of priority. While the cash contribution is easily
valued at face amount, the non-cash asset however will be valued using the following level
of priority:

1st – Agreed value

2nd – Fair value
3rd – Book value

b. Adjustment to book value - If one or all partner has an existing business (sole proprietor),
its records should be adjusted prior to formation. These adjustments may include the
following:
• Additional uncollectible accounts
• Impairment of inventories
• Recognition of unrecorded accruals or deferrals
• Adjustment for over or understatement of depreciation

c. Transferred liabilities – Existing liabilities of partner should be accounted as follows:

• Assumed by the partnership – Deduction to the contribution
• Not assumed by the partnership – Ignore
• In absence of information, it is presumed that partnership will assume the liabilities

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Step 2 Determine the Total Agreed Capital (TAC) – This is the desired amount of total equity of the
partnership based on the desired proportion of ownership per partner. To arrive at the desired
amount of capital, the TCC will be adjusted using either: (1) bonus method; or (2) invest or
withdraw method.

Bonus method:
One or more partner will give bonus (transfer capital) to another partner. The TCC will be equal
to TAC. To use the bonus method, the following sub step should be followed:

a. Prepare a five-column formula:

Partners TCC Adjustment/bonus TAC Percentage

Partner A
Partner B

b. Copy the TAC from Step 1 to the second column:

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX
Partner B XX
XX

c. Copy the TAC to the TCC (note, in bonus method TAC = TCC):

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX
Partner B XX
XX XX

d. Place 100% to the total percentage and the percentage of ownership per partner based on
their agreement (e.g., 40:60).

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX 40%
Partner B XX 60%
XX XX 100%

e. Compute the Agreed capital per partner by multiplying TAC to their respective percentage
per partner

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX XX XX 40%
Partner B XX (XX) XX 60%
XX - XX 100%

f. Compute the difference of contributed capital per partner and agreed capital per partner.
The difference it the bonus to (addition) or bonus from (deduction).

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX XX XX 40%
Partner B XX (XX) XX 60%
XX - XX 100%

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Invest or withdraw method:
One or more partner will adjust his/her capital account by adding investment or by withdrawing
portion of investment to come up with the agreed percentage of ownership. While the other
partner(s) referred to as the “base partner” will have his/her agreed capital equal to his/her
contributed capital (no adjustment).

Unlike in the bonus method, the TCC will not equal the TAC in invest or withdraw method. To
use this method, the following sub step should be followed:

a. Prepare a five-column formula:

Partners TCC Adjustment/bonus TAC Percentage

Partner A
Partner B

b. Copy the TAC from Step 1 to the second column:

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX
Partner B XX XX
XX

c. Place 100% to the total percentage and the percentage of ownership per partner based on
their agreement (e.g., 40:60).

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX 40%
Partner B XX XX 60%
XX 100%

d. Compute the TAC by dividing the Agreed capital of the base partner by his percentage of
ownership. Then, compute the agreed capital of the partner that will adjust (invest or
withdraw, here Partner A) by multiplying the TAC by his percentage of ownership.

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX XX 40%
Partner B XX XX 60%
XX XX 100%

e. Compute the difference of contributed capital and agreed capital of the partner that will
adjust. The difference it the amount that he/she will invest or withdraw.

Partners TCC Adjustment/bonus TAC Percentage

Partner A XX XX (XX) XX 40%
Partner B XX - XX 60%
XX XX (XX) XX 100%

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ILLUSTRATION 01 (Bonus Method)

Thor and Loki formed a partnership and contributed the following assets with their respective fair values:

Thor Loki
Cash P 180,000
Land - P220,000
Building - 300,000
Equipment 100,000 -

Per partnership agreement, the equipment is to be valued at P120,000. Loki’s land and building is subject to a
P100,000 real estate mortgage which is assumed by the partnership. The mortgage has P10,000 interest accrued
which is to be assumed by Loki. The fair value of the land and building is agreed to be equal to their respective
book values.
Solution Thor Loki
1. How much is the final capital credit to Thor? Cash 180,000
A. 288,000 C. 300,000 Land - 220,000
B. 420,000 D. 432,000 Building - 300,000

Equipment 120,000 -
2. How much is the final capital credit to Loki? Mortgage-
A. 288,000 C. 300,000 Real Estate (100,000)

B. 420,000 D. 432,000 Total Capital 300,000 420,000

Assuming instead that Thor and Loki decided to divide capital in the ratio of 40:60, respectively and uses the Bonus METHOD

bonus method, answer the following: Partner TCC ADJUSMENT

Solution Thor Loki Thor 12,000

3. How much is the final capital credit to Thor? 300,000

A. 288,000 C. 300,000 Cash 180,000

Loki 420,000 (12,000)
B. 420,000 D. 432,000 Land - 220,000
TOTAL 720,000
Building
- 300,000

4. How much is the final capital credit to Loki? Equipment 120,000 - TAC PERCENTAGE
Mortgage-
A. 288,000 C. 300,000 Real Estate (100,000)

B. 420,000 D. 432,000 Total Capital 300,000 420,000 288,000 40%

432,000 60%
5. The 40:60 agreement would
100%
A. Give bonus to Loki in the amount of P12,000 720,000
B. Give bonus to Loki in the amount of P32,000
C. Give bonus to Thor in the amount of P12,000
D. Give bonus to Thor in the amount of P144,000

ILLUSTRATION 02 (Bonus Method and Invest or Withdraw Method)

On January 1, 2023, Thanos and Helga formed a partnership with each contributing the following assets:

Thanos Hela
Cash 300,000 700,000
Machinery and equipment 250,000 750,000
Building 2,250,000
Furniture and fixtures 100,000

The building is subject to a mortgage loan of P800,000, which is to be assumed by the partnership. The
partnership agreement provides that Thanos and Hela share profits and losses in a 30:70 ratio:

6. How much is the capital balance of Thanos and Hela, respectively? Solution: Thanos Hela

Thanos Hela Cash 300,000 700,000

A. 650,000 2,900,000 Machinery and 250,000 750,000

B. 2,900,000 650,000 equipment

C. 650,000 3,700,000
Building 2,2250,000
Furnitures 100,000
D. 650,000 1,516,667 and Fixtures
Mortgage
(800,000)
(Assumed)
Total
Capital Balances 650,000 2,900,000

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7. Assuming that the mortgage loan is not assumed by the partnership, how much is the capital balance
Hela
of Thanos and Hela, respectively? Solution Thanos

Thanos Hela Cash

Machinery
300,000 700,000

A. 650,000 3,700,000
250,000 750,000
and Equipment

B. 650,000 1,516,667 Building 2,250,000

Furnitures
C. 605,000 1,516,667 and Fixtures
100,000

D. 1,065,000 2,485,000 Mortgage is not assumed

Total Capital Balances 650,000 3,700,00

8. Disregarding the second question and assuming that the partnership agreement states that the capital
credit of Thanos and Hela shall be in accordance with the profit and loss ratio, how much is the capital
balance of Thanos and Hela, respectively using the bonus method?
Thanos Hela Partner TCC ADJUST TAC PERCENTAGE
A. 1,065,000 2,485,000 Thanos 650,000 415,000 1,065,000 30%
B. 650,000 3,700,000 Hela 2,900,000 (415,000) 2,485,000 70%
C. 605,000 1,516,667 Total 3,550,000 0 3,550,000 100%
D. 1,065,000 2,485,000

9. Assuming that the partnership agreement states that the capital credit of Thanos and Hela shall be in
accordance with the profit and loss ratio and that Hela will invest (withdraw) additional cash, how
much is the capital balance of Thanos and Hela, respectively?
Thanos Hela Partner TCC ADJUST TAC PERCENTAGE
A. 1,065,000 2,485,000 Thanos 0 650,000
650,000 30%
B. 650,000 3,700,000
Hela 2,900,000
C. 650,000 1,516,667 1,383,333 1,516,667 70%
Total
D. 1,065,000 2,485,000 3,550,000 0 2,166,667 100%

10. Continuing the previous question, what is the amount of investment or withdrawal by Hela?
A. 1,383,333 B. 605,000 Partner TCC ADJUST TAC PERCENTAGE
C. 2,485,000 D. 1,666,667 Thanos 650,000 0 650,000 30%
Hela 2,900,000 1,383,333 1,516,667 70%
Total 3,550,000 0 2,166,667 100%
ILLUSTRATION 03 (Invest or Withdraw Method)

On July 1, AA and BB decided to form a partnership. Balance sheet items for AA and BB on July 1 before
adjustment are given below:

AA BB AA BB
Cash P 31,000 P 50,000 Cash 31,000 50,000
Accounts receivable 26,000 20,000 Account Receivable 24,000 19,000
Inventory 32,000 24,000 31,000
Inventory 22,000
Office supplies - 5,000
Equipment 20,000 24,000 Office Supplies 5,000 1,500

Accumulated depreciation (9,000) (3,000) Property Plant 11,000 21,000

Equipment
Total assets P 100,000 P 120,000
Account Payable (28,000) (20,000)
Accounts payable P 28,000 P 20,000 Salaries Payable (4,000) (5,000)
Capital 72,000 100,000
Prepaid Rent 7,000 4,500
Total liabilities and capital P 100,000 P 120,000
Total Contributed
Capital 77,000 93,000
AA and BB agreed to the following adjustments:
(a) AA and BB’s inventory is to be valued at P31,000 and P22,000, respectively;
(b) Accounts receivable of P2,000 in AA’s book and P1,000 in BB’s books are uncollectible;
(c) Accrued salaries of P4,000 for AA and P5,000 for BB are still to be recognized in the books;
(d) Unused office supplies of AA amounted to P5,000 while that of BB amounted to P1,500;
(e) Prepaid rent of P7,000 and P4,500 are to be recognized in the books of AA and BB, respectively; and
(f) AA is to invest or withdraw cash necessary to have a 40% interest in the firm
Partner TCC ADJUSTMENT TAC PERCENTAGE

11. How much is the additional investment (withdrawal) made by AA? AA 77,000 (15,000) 62,000 40%

A. 15,000 withdraw B. 6,667 withdraw BB 93,000 0 93,000 60%

C. 3,000 invest D. 8,333 invest Total 170,000 (15,000) 155,000 100%

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 12. How much is the capital balances of AA and BB after all necessary adjustment in the partnership’s interest?
A. AA – 81,250 B. AA – 81,250 Partner TCC ADJUSTMENT TAC PERCENTAGE
BB – 72,000 BB – 75,000
AA 77,000 (15,000) 62,000 40%

C. AA – 100,000 D. AA – 62,000 BB 93,000 0 93,000 60%

BB – 75,000 BB – 93,000 Total 170,000 (15,000) 155,000 100%

ILLUSTRATION 04 (Three Partners)

13. Rey, Sam and Tim formed a partnership on May 31, 2020., with the following assets, measured at their fair
market values contributed by each partner: REY SAM TIM
Cash 60,000 72,000 180,000
Rey Sam Tim Delievery 900,000
Cash 60,000 72,000 180,000 Equipment
Computer 51,000
Delivery equipment 900,000 Equipment
29,600 15,000

Computer equipment 51,000 29,600 15,000 Mortgage Payable 540,000

Total Contributed Capital 471,000 101,600 195,000
Tim will personally settle the loan from his share in the profits of the partnership. The delivery equipment
contributed by Rey has a mortgage of P540,000 and the partnership is to assume the responsibility for the
loan. The partners agree to divided profits and losses 40% to Rey; 40% to Sam, and 20% to Tim.

The partners further agreed to bring their respective capital interest in proportion to their profit and loss
ratio. In this agreement, there shall be a:
A. Bonus from Rey, P163,960 Partner TCC ADJUSTMENT TAC PERCENTAGE
B. Bonus from Tim, P41,480 Rey 471,000 (163,960) 307,040 40%
C. Bonus to Sam, P205,440
Sam
D. All of the above 101,600 205,440 307,040 40%

Tim 195,000 (41,400) 153,520 20%

Total 767,600 767,600 100%
ILLUSTRATION 05 (Unclear Base Partner)

14. MM and NN agreed to form a partnership. The partnership agreement stipulates the following:
• Initial capital of P300,000.
• A 25:75 interest in the equity of the partnership.

MM contributed P100,000 cash while NN contributed P200,000 cash. Which partner should provide
additional investment (or withdraw part of investment) in order to bring the partner’s capital credit equal
to their respective interests in the equity of the partnership?
A. MM shall provide additional capital of P25,000.
B. NN shall withdraw capital of P25,000.
C. NN shall make an additional investment of P25,000.
D. No additional contribution or withdrawal shall be made.

Names TCC Adjustment TAC PERCENTAGE

MM Based (33%) 100,000 100,000 25%

200,000 100,000 300,000 75%

NN (67%)
300,000 100,000 400,000 100%
Total

Names TCC ADJUSTMENT TAC PERCENTAGE

MM(33%) 100,000 (33,333) 66,667 25%

NN(67%) 200,000 0 200,000 75%

Total 300,000 266,667 100%

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SELF-TEST

1. RR and SS drafted a partnership agreement that list the following assets contributed at the partnership’s
formation:

RR SS
Cash P 20,000 P 30,000
Inventory - 15,000
Building - 40,000
Furniture and equipment 15,000 -

The building is subject to a mortgage of P10,000, which the partnership has assumed. The partnership
agreement also specifies that profits and losses are to be distributed evenly. What amounts should be
recorded as capital for RR and SS at the formation of the partnership?

RR SS Solution: RR SS
A. 35,000 85,000 Cash
20,000 30,000
B. 35,000 75,000 Inventory
- 15,000
C. 55,000 55,000 Building
- 40,000
D. 60,000 60,000 Furniture
and Equipment 15,000
Mortgage (10,000)
Numbers 2-3 Total Contributed Capital 35,000 75,000
On April 30, 2021, AA, BB, and CC formed a partnership by combining their separate business proprietorships.
AA contributed cash of P50,000. BB contributed property with a P36,000 carrying amount, a P40,000 original
cost, and P80,000 fair value. The partnership accepted responsibility for the P35,000 mortgage attached to the
property. CC contributed equipment with a P30,000 carrying amount, a P75,000 original cost, and P55,000 fair
value. The partnership agreement specifies that profits and losses are to be shared equally but is silent regarding
capital contributions. AA BB CC

2. Which partner has the largest April 30, 2021 capital account balance? Cash 50,000 0 0
A. Partner AA C. Partner CC Property 0 80,000 0
B. Partner BB D. All capital account balances are equal Equipment 0 0 55,000

Mortgage 0 (35,000) 0
3. Which partner has the smallest April 30, 2021 capital account balance?
Total
A. Partner AA C. Partner CC Contributed 50,000 3.)45,000 2.)55,000
B. Partner BB D. All capital account balances are equal Capital

4. DD and EE formed a partnership and agreed to divide initial capital equally, even though DD contributed
P100,000 and EE contributed P84,000 in assets. Under the bonus approach to adjust the capital accounts,
EE’s capital should be debited for DD EE Total
A. 46,000 C. 8,000 Asset 100,000 84,000 184,000
B. 16,000 D. 0 Bonus Method (8,000) 8,000 0
Total Contribution 92,000 92,000 184,000
Capital
5. JJ, KK, and LL formed a partnership. Their contributions are as follows:

JJ KK LL JJ KK LL
Cash P 50,000 P 40,000 P 140,000 Cash 50,000 40,000 140,000
Equipment - 150,000 - Equipment - 150,000 -
Borrowed 70,000 (70,000)
Total P 50,000 P190,000 P 140,000 Total 120,000 120,000 140,000
Contribution
Additional information: Capital

• Although LL has contributed the most cash to the partnership, he did not have the full amount of
P140,000 available and was forced to borrow P40,000. The partners agreed that half of the amount
borrowed shall be assumed by the partnership.
• The equipment contributed by KK has an unpaid mortgage of P20,000, the repayment of which is not
assumed by the partnership.
• The partners agreed to equalize their interest.

Which partner(s) shall receive bonus from the other partner(s)?

A. KK shall receive P70,000 bonus from LL
B. JJ shall receive P70,000 bonus from LL
C. JJ shall receive P70,000 bonus from KK
D. KK shall receive P70,000 bonus from JJ

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Numbers 6-7
FF and GG formed a partnership. The following are their contributions: FF GG

FF GG Cash 200,000 -
Cash P 200,000 - Account 120,000 -
Receivable
Accounts receivable 150,000 - 90,000
Inventory
Inventory 100,000 - 500,000
Land
Land - P 500,000 Building 620,000
Building - 620,000 Overstated 30,000
Total P 450,000 P 1,120,000 Mortgage(assumed) (550,000)
Notes Payable (210,000)
Note payable P 210,000 - Total
200,000
FF, Capital 240,000 P 1,120,000 Contribution 600,000
Capital
Total P 450,000 P 1,120,000

Additional information:
• The accounts receivable has a recoverable amount of P120,000.
• The inventory has an estimated selling price of P110,000 and estimated costs to sell of P20,000.
• The land has a fair value of P500,000 an unpaid mortgage of P120,000.
• The partners agreed that GG shall settle the mortgage using his personal funds.
• The building is over-depreciated by P30,000. The building also has an unpaid mortgage amounting to
P550,000. The partners agreed that the partnership shall assume repayment of the mortgage.
• FF and GG shall share in profits and losses 40% and 60%, respectively.

6. How much are the adjusted capital balances of FF and GG?

FF GG
A. 200,000 600,000
B. 200,000 1,030,000
C. 230,000 480,000
D. 230,000 600,000

7. Using the invest method, which partner shall make an additional investment and how much?
TAC PERCENTAGE
A. FF, P200,000 C. FF, P120,000 Partner TCC
200,000
ADJUSTMENT
(120,000) 320,000 40%
B. GG, P300,000 D. GG, P240,000 FF
GG 600,000 120,000 480,000 60%
800,000 100%
800,000 0
Total
8. HH and II agreed to form a partnership. HH shall contribute P60,000 cash while II shall contribute P120,000
cash. However, due to the expertise that HH will be bringing to the partnership, the partners agreed that
they should initially have an equal interest in the partnership capital. Under the bonus method, how much
is the adjusted capital balance of II immediately after the formation of the partnership?
HH II Total
A. 60,000 C. 120,000 60,000
Asset 120,000 180,000
B. 90,000 D. 66,667 Bonus Method 60,000 (60,000) 0
Total Contribution Capital 120,000 60,000 180,000
9. Jones and Smith formed a partnership with each partner contributing the following items:

Jones Smith Jones Smith

Cash 80,000 40,000 Cash 80,000 40,000

Building (cost to Jones) 300,000 - Building (Fair Value) 400,000 -
Building (fair value) 400,000 - Inventory(Fair Value) 280,000
Inventory (cost to Smith) - 200,000 Mortgage Payable (120,000)
Inventory (fair value) - 280,000 (60,000)
Account Payable
Mortgage payable 120,000 -
Total Contribution 360,000 260,000
Accounts payable - 60,000 Capital

What is the balance in each partner’s capital account?

Jones Smith
A. 350,000 270,000
B. 260,000 180,000
C. 360,000 260,000
D. 500,000 300,000

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10. On April 1, 2020, Sak and Gin formed a partnership with each contributing the following assets:

Sak Gin
Cash 600,000 280,000
Machinery 440,000
Building 800,000
Furniture and fixtures 120,000

The building is subject to mortgage loan of P320,000 which is not assumed by the partnership. The
partnership agreement provides that Sak and Gin share income and loss of 25% and 75% respectively.
Assuming the partnership agreement provides that the partners initially should have and equal interest in
the partnership capital. Gin capital should be:
A. 960,000 B. 1,120,000
C. 720,000 D. 1,200,000

Solution: Sak Gin

Cash 600,000 280,000

Machinery 440,000
Building 800,000
Furnitures 120,000
and Fixtures
Mortgage(not assummed) (ignore)

Total Contribution Capital 720,000 1,520,000

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