Chapter 2

NATURE AND FORMATION OF A PARTNERSHIP

Learning objectives
1. Define and discuss the nature of a partnership - its characteristics,
advantages and disadvantages
2. Identify the different kinds of partnerships and the classes of partners.
3. Discuss the requirements in the formation of a partnership.
4. Discuss accounting for partners initial investments in a partnership
PARTNERSHIP
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 A PARTNERSHIP
● Mutual Agency
● Unlimited liability
● Limited life
● Mutual participation in profits
● Legal entity
● Co-ownership of contributed assets
● Income tax
ADVANTAGES OF PARTNERSHIP
● It is easy and inexpensive to organize
● The unlimited liability
● Better opportunity for obtaining additional capital
● Closer supervision of all the partnership activities
● Direct gain to the partners
● The personal element in the characters of the partners is retained
DISADVANTAGES OF A PARTNERSHIP
● Personal liability of a partner
● A partner may be subject to personal liability
● Less stable
● Divided authority among the partners
● Constant likelihood of dissension and disagreement
KINDS OF PARTNERSHIP
1. As to Activity 3. As to liability of partners
● Trading Partnership ● General co-partnership
● Non-trading partnership ● Limited partnership

2. As to object
● Universal partnership of all
present property
● Universal partnership of all profit
● Particular partnership
4. As to duration
● Partnership at will
● Partnership with a fixed term
KINDS OF PARTNERSHIP
5. As to representation to others 7. As to publicity

● Ordinary Partnership ● Secret partnership

● Partnership by estoppel ● Open partnership

6. As to legality of existence

● De jure partnership
● De facto partnership
CLASSES OF PARTNERS
1. As to Contribution
● Capitalist partner
● Industrial partner
● Capitalist-industrial partner
2. As to liability
● General partner
● Limited partner
3. As to management
● Managing partner
● Silent partner
4. Other classifications
● Liquidating partner
● Nominal partner
● Ostensible partner
● Secret partner
● Dormant partner
PARTNERSHIP CONTRACT
● Created by an oral or a written agreement
● Registered with the Office of the Securities and Exchange Commissions
● The agreement be in writing
The Articles of Co-partnership contains the following information:

● The name of the partnership ● The conditions under which

● The names and addresses of the partners may withdraw money
partners ● The manner of keeping the
● The effective date of the contract books of accounts
● The purpose or purposes and ● The causes for dissolution
principal office of the business
● The provision for arbitration in
● The capital of the partnership
● The rights and duties of each
settling disputes
partner
● Dividing net income or loss
among partners
 ACCOUNTS FOR PARTNERSHIPS
CAPITAL ACCOUNT
● Permanent withdrawal ● Original investment by a partner
(decrease) of capital ● Additional investment by a
● Share in partnership loss from partner
operations ● Share in partnership profits
● Debit balance of drawing from operations to be added to
account closed to capital capital
 ACCOUNTS FOR PARTNERSHIPS
DRAWING ACCOUNT
● Personal withdrawal by partner ● Share in partnership profits
● Share in partnership loss from from operations (this may be
operations (this may be debited credited directly to the partner’s
directly to the partner’s capital capital account)
account)
OPENING ENTRIES
● Partners may contribute cash, property, or industry to the partnership
● Asset contributed in the form of cash
● Recorded in the partnership books at face value
● If the asset contributed is in the form of property of non-cash asset
● It is recorded at agreed value
● In the absence of an agreement, at fair market value
● When industry is contributed into the partnership, a memorandum entry is
prepared
PARTNERSHIP FORMATION
FORMATION A: TWO OR MORE PERSONS FORM A PARTNERSHIP FOR THE FIRST TIME ALL PARTNERS ARE NEW IN THE BUSINESS.

1. Cash Contributions only (Capitalist Partners)

Cash 200,000

Abad, Capital 600,000

Alba, Capital 600,000

2. Cash and Non-cash Contributions (Capitalist Partners)

Abdon Anton

Cash P600,000 P200,000

Inventories 300,000

Equipment 500,000
The entry to record the contributions of the partners follows:
Cash 800,000
Inventories 300,000
Equipment 500,000
Abdon, Capital 900,000
Anton, Capital 700,000
3. Contributions in the form of Cash. Non-cash Assets and Industry
(Capitalist and Industrial Partners)
The entry record the contributions of partners follows:
Cash 900,000
Equipment 450,000
Alma Capital 600,000
Anna, Capital 350,000
FORMATION B: A SOLE PROPRIETOR AND AN INDIVIDUAL FORM A PARTNERSHIP

The partnership may either:

● Use the books of the sole proprietor

● Open a new set of books

However, it is a common practice that a new set of books are opened for any new business
undertaking.
Assumption I - The partnership will use the books of the sole proprietor

The following procedures should be followed in accounting for this type of formation:

1. Adjust the books of the sole proprietor to bring account balances to agreed values,
2. Record the investment of the other partner.
The following rules will be helpful in making the necessary adjusting entries:

● Debit asset and credit capital for increases in asset values

● Debit capital and credit asset for decreases in asset values
● Debit capital and credit liabilities for increases in liability balances
● Debit liabilities and credit capital for decreases in liability balances
In the case of contra asset accounts, the following rules shall apply:

● Debit contra asset account and credit capital for increases in asset values
● Debit capital and credit contra asset account for decreases in asset values
Assumption 2 - The partnership will open a new set of books

The entry required on the new books of the firms is the recording of the
investment of the partners at agreed values.
FORMATION C: TWO OR MORE SOLE PROPRIETORS FORM A PARTNERSHIP

● They may decide to transfer their asset and liabilities (net assets) to the
partnership at values agreed upon or at fair market values.
● The partnership may either:
○ Use the books of one of the sole proprietors
○ Open a new set of books for the partnership
CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION

● The Capital share of each partner is the percentage of equity that each of
them will have in the net assets of the newly formed partnership. Generally,
the capital share of a partner is proportionate to his/her capital contribution.
LOAN RECEIVABLE AND LOAN PAYABLE
● Loans made by partners to the partnership, which are payable immediately
by the Partnership and are usually with interest, are recorded in the account.
● The partnership may advance money to partners, other than withdrawals, in
the form of loans.