The Professional CPA Review School

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ADVANCED FINANCIAL ACCOUNTING & REPORTING PROF. ROEL E. HERMOSILLA

WEEK 1 - ACCOUNTING FOR PARTNERSHIP

PARTNERSHIP FORMATION

There are no authoritative pronouncements concerning the accounting for partnership. The principles
described have evolved through accounting practice.

Partnership Formation
The partnership is a separate accounting entity (not to be confused with a separate legal
entity), and therefore its assets and liabilities should remain separate and distinct from the individual
partner’s personal assets and liabilities.

All assets contributed to the partnership are recorded by the partnership at their fair market
values. All liabilities assumed by the partnership are recorded at their present values.

Upon formation, the amount credited to each partner’s capital account must be equal to the
amount of cash contributed or equal to the fair market value of the noncash contributed or equal to the
difference between the fair market value of the assets (including goodwill, if any) contributed and the
present value of the liabilities assumed from the partner. The capital accounts represent the residual
equity of the partnership. The capital account of each partner reflects all of the activity of an individual
partner; contributions, withdrawals, and the distributive share of net income (loss). In some cases, a
drawing account is used as a clearing account for each partner’ transactions with only the net effect of
each period’s activity shown in the capital account.

Example: Partnership Formation

A and B form a partnership. A contributes cash of P50,000, while B contributed land with a fair
market value of P50,000 and the partnership assumes a liability on the land of P25,000.

The entry to record the formation of the partnership is

Cash P50,000
Land 50,000
Liabilities P 25,000
A, capital 50,000
B, capital 25,000

Sometimes, a partner will contribute intangible benefit to the partnership like good management skills,
good business reputation, business connections, or anything that will bring in higher income to the
business. The partners may agree to quantify this in the form of either goodwill or bonus.

Example: C and D agreed to form a partnership, with C contributing P100,000 cash and D contributing
P150,000 cash. The partners agreed that C will also contribute an intangible benefit to the business for
C to have an initial equal interest in the partnership.

If the bonus method is to be used, the entry in the partnership books must be:
(1) To record the initial contribution of partners:
Cash P250,000
C, Capital P100,000
D. Capital 150,000

(2) To record the bonus recognized:

D, Capital P25,000
C, Capital P25,000
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If the goodwill method is to be used, the entry in the partnership books must be:
(1) To record the initial contribution of partners:
Cash P250,000
C, Capital P100,000
D. Capital 150,000
(2) To record the goodwill recognized:
Goodwill P 50,000
C, Capital P50,000

The use of either method must be explicitly stated in the problem, otherwise the use of bonus method is
preferable over goodwill method.
Sometimes, two or more single proprietorships may wish to combine their businesses and agree to form
a partnership. In this case, the assets and liabilities of the sole proprietors are normally restated or
revalued to their fair values in order to adjust their capital accounts prior to recording their contributions
in the partnership books. The restated or revalued capitals are now the partners’ initial contribution.

Example: Jackson and Johnson decided to form a partnership on January 3, 202B, to be called the JJ
Merchandising. The following are their respective balance sheets immediately before the formation:
Jackson Store
Balance Sheet
December 31, 202A
Assets Liabilities and Capital
Cash P130,000 Accounts Payable P125,000
Accts. Receivable 100,000 Jackson, Capital 355,000
Merchandise Inventory 200,000
Furniture 50,000 _______
Total P 480,000 Total P480,000

Johnson Store
Balance Sheet
December 31, 202A

Assets Liabilities and Capital

Cash P 15,000 Accounts Payable P 15,000
A/R P40,000 Notes Payable 20,000
Less: ADA 4,000 36,000 Johnson, Capital 79,500
Merchandise Inventory 50,000
Furniture P15,000
Less: A/D 1,500 13,500 _______
Total P114,500 P114,500

The two partners agree to the following adjustments:

1. That P20,000 of Jackson’s accounts receivable be written off.
2. That Jackson’s furniture has a market value of P40,000.
3. That accrued expenses of P25,000 be recognized on Jackson’s books.
4. Johnson’s estimated uncollectible accounts should be 5% of the outstanding accounts
receivable.
5. The fair value of Johnson’s furniture is P12,000.
6. Total partners’ equity should be P400,000 with Jackson’s interest
representing 75%.
The most likely question will be how much capital must be recorded in the partnership books.
Then your answer must be P300,000 for Jackson and P100,000 for Johnson. The partnership
balance sheet immediately after its formation will be presented as follows:
JJ Merchandising
Balance Sheet
January 3, 202B

Assets Liabilities and Capital

Cash P145,000 Accounts Payable P 140,000
Accts. Rec. 120,000 Notes Payable 20,000
Less: ADA 2,000 118,000 Accrued Expenses 25,000
Merchandise Inventory 250,000 Jackson, Capital 300,000
Furniture 52,000 Johnson, Capital 100,000
Goodwill 20,000 ________
Total P 585,000 P 585,000
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PROBLEMS
1. On June 30, 202A MC, the sole proprietor of MC. Inc, expands the company and establishes a
partnership with Tom and Charles. The partners plan to share profits and losses as follows: MC,
50%; Tom, 25% and Charles 25%. They also agree that the beginning capital balances of
partnership will reflect this same relationship.

MC asked Tom to join the partnership because his many business contacts are expected to be
valuable during the expansion. Tom is also contributing P40,000 and a building that has an
original cost of P520,000, book value of P420,000, tax assessment of P310,000 and fair value of
P370,000. The building is subject to a P242,000 mortgage that the partnership will assume.
Charles is contributing P66,000 and marketable securities costing P252,000 but are currently worth
P345,000.

MC’s investment in the partnership is his business. He plans to pay off the notes with his personal
assets. The other partners have agreed that the partnership will assume the accounts payable.
The balance sheet for the MC follows:

Balance Sheet
June 30, 202A
Assets Liabilities and Capital
Cash P60,000 Accounts payable P318,000
Accounts receivable (net) 288,000 Notes payable 372,000
Inventory 432,000 MC, Capital 510,000
Equipment-net (dept’n, P120k) 420,000

The partners agree that the inventory is worth P510,000, and the equipment is worth half its
original cost, and the allowance established for doubtful accounts is correct.

How much is the agreed capital of MC if the partners agree to use the bonus method to record the
formation and if the partners agree to use the goodwill approach to record the formation?
A. P694,500; P810,000
B. P694,500; P822,000
C. P810,000; P694,500
D. P810,000; P822,000

2. Douglas, a sole proprietor, agreed to form a partnership with Johnny in a business. Accounts in
the ledger for Douglas on November 30, 202A, just before the formation show the following
balances:
Cash P 26,000 Accounts payable P 62,000
Accounts receivable 120,000 Douglas, Capital 264,000
Merchandise inventory 180,000

It is agreed that for purposes of establishing Douglas’s interest, the following adjustments should
be made:
1. An allowance for doubtful accounts of 2% of accounts receivable is to be established.
2. The merchandise inventory is to be valued at P202,000.
3. Prepaid expenses of P6,500 and accrued liabilities of P4,000 are to be established.

Johnny is to invest sufficient funds in order to receive a 1/3 interest in the partnership. How much
must Johnny contribute?
A. P 88,000
B. P 95,360
C. P 132,000
D. P 143,050

3. On February 14, 202A, Allan and Paul agreed to invest equal amounts and share profits equally to
form a partnership. Allan invested P780,000 and a piece of equipment. Paul invested some assets
which are shown below:
Accounts receivable P100,000 Machineries, net P560,000
inventory 280,000 Intangibles, net 230,000

The assets invested by Paul are not properly valued. P8,000 of the accounts receivable are proven
uncollectible. Inventories are to be written down to P260,000. Included in the machineries is an
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obsolete apparatus acquired for P96,000 with an accumulated depreciation balance of P84,000.
Part of the intangibles is a patent with a carrying value of P14,000 which was sued upon by a
competitor. Paul unsuccessfully defended the case and the final decision of the court was released
on February 12, 202A.
What is the fair value of the equipment invested by Allan?
A. P242,000
B. P336,000
C. P350,000
D. P390,000

4. Scarlett and Natalie decided to form a partnership on May 1, 202A. The assets to be contributed by
the partners are:
Scarlett Natalie
Book Value Fair Value Book Value Fair Value
Cash P375,000 P375,000 P875,000 P875,000
Merchandise inventory 95,000 125,000
Furniture and fixtures 350,000 312,500 872,500 937,500
Transportation equipment 3,262,500 2,812,500

The transportation equipment is subject to a mortgage loan of P1,125,000, which is to be assumed

by the partnership. The partnership agreement provides that Scarlett and Natalie share profits and
losses of 30% and 70% respectively. Assuming that the partners agreed to bring their respective
capital in proportion to their profit and loss ratio, using Natalie capital as base, how much additional
cash is to be invested (withdrawn) by Scarlet?
A. P687,500
B. P875,000
C. (P987,500)
D. (P687,500)

5. The balance sheet as of July 31, 202A for the business owned by Angelina, shows the following
assets and liabilities:
Cash P 110,000 Fixtures P 360,800
Accounts Receivable 294,800 Accounts Payable 63,360
Merchandise 484,000
It is estimated that 5% of the receivable will prove uncollectible. The cash balance includes 1,000
share certificates of PNB at its cost, P 8,000; the stock last sold on the market at P 70.00 per share.
Merchandise includes obsolete items costing P 36,000 that will probably realize only P 8,000.
Depreciation has never been recorded; the fixtures are 2 years old, have an estimated life of 10
years, and would cost P 480,000 if purchased new currently. Sundry prepaid items amount to P
10,000. Danny is to be admitted as a partner upon investing P 400,000 cash and P 200,000
merchandise.

What will be the total capital after the formation of partnership?

6. Emma and Shailane establish a partnership to operate to a used-furniture business under the name
Amorini Furniture. Emma contributes furniture that cost P 78,000 and has a fair value of P 117,000.
Shailane contributes to P 39,000 cash and delivery equipment that cost P 52,000 and has a fair
value of P 39,000. The partners agree to share profits and losses 60% to Emma and 40% to
Shailane.

Calculate the peso of inequity that will result if the initial noncash contributions of the partners are
recorded at cost rather than fair market value.

7. The balance sheet of the proprietorship of Margot as of June 30, 202A showed the following assets
and liabilities:
Cash P 48,000
Accounts Receivable 64,320
Inventory 105,600
Equipment 78,720
Accounts Payable 76,224

The cash balance included a 200-share certificate of CW Resources common at acquisition cost of
P 1,600; the current market quotation is P 70 per share. Of the accounts receivable, an estimated
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5% is considered to be doubtful of collection. Certain inventory items, booked at cost of P 22,960,

are currently worth P 16,000. Depreciation has not been recorded; the equipment, acquired two
years ago, has a remaining useful life of about eight more years. Prepaid expense of P 12,800 and
accrued expense of P 6,120 have not been properly recognized. Jessica and Kirsten will join Margot
in a partnership. Margot will invest the net assets of her business, after effecting the appropriate
adjustments, and she will be allowed credit for goodwill equal to 10% of her initial capital credit.

Jessica and Kirsten will each contribute cash to secure the respective interests of 1/3 and 1/6,
respectively.
A. Margot’s goodwill credit would be:
B. Jessica’s cash investment would be:

8. Anna and Salve are partners sharing profits 60:40. A balance sheet prepared for the partnership on
April 1, 2018 shows the following:
Cash 48,000 Accounts 89,000
Payable
Accounts Receivable 92,000 Anna, Capital 133,000
Inventory 165,000 Salve, Capital 108,000
Equipment 70,000
Accumulated (45,000)
depreciation
330,000 330,000
On this date, the partners agree to admit Connie as a partner. The terms of the agreement is that
assets and liabilities are to be restated as follows:
a. An allowance for possible uncollectible Salve of P4,500 is to be established
b. Inventories are to be restated at their present replacement values of P170,000
c. Equipment are to be restated at a value of P35,000
d. Accrued expenses of P4,000 are to be recognized

Anna, Salve, and Connie will divide profits in the ratio of 5:3:2. Capital balances for the new partners
are to be in this ratio with Anna and Salve making cash settlement outside of the partnership for the
required capital adjustment between themselves and Connie investing cash in the partnership for her
interest.

Questions: 1. How much cash Connie should contribute?

2. How will you state the settlement between Anna and Salve?
3. Journal Entries to reflect the above transactions.

reh/cde