PARTNERSHIP

Contents:

Definition of Partnership

Characteristics of a Partnership

Advantages and Disadvantages of a Partnership

Classification of Partnerships

Kinds of Partners

Accounting for Partnerships

Major Considerations in Accounting for a Partnership

Lesson 1.1 Partnership

Partnership is an association of two or more persons to carry on, as co-owners, a business for
profit. In a contract of partnership, two or more persons bind themselves to contribute money, property
or industry into a common fund for purpose of having profit and dividing profit among themselves.

Generally, a partnership can either be a business partnership or general professional

partnership. General professional partnership is a partnership formed by professionals such as doctors,
lawyers, accountants and other professionals for the sole purpose of exercising a common profession
and no part of the income of which is derived from engaging in any trade or business. Business
partnership/general co-partnership refers to all partnerships except general professional partnerships
no matter how created or organized.

*Articles of Partnership

A partnership may be constituted orally or in writing. Articles of Partnership contains the partnership
agreements in case it is constituted in writing.

*SEC Registration

Partnership with capital of P3,000 or more, in money or property, must register with the SEC.

Lesson 1.2 Characteristics of a Partnership

Ease of formation – as compared to corporations, the formation of a partnership requires less formality.
Separate legal personality – the partnership has a judicial personality separate and distinct from the
partners. The partnership can transact and acquire properties in its name.

Mutual agency – the partners are agents of the partnership for the purpose of its business. As such, a
partner may legally bind the partnership to a contract or an agreement that is in line with the
partnership’s operations.

Co-ownership of property – each partner is a co-owner of the properties invested in the partnership and
each has an equal right with his partners to possess specific partnership property for partnership
purposes. However, a partner has no right to possess a partnership property for any purpose without
the consent of his partners.

Co-ownership of profits – a partnership is created as a business (a profit-oriented entity), as such, each

partner is entitled to his share in the partnership profit. A stipulation which excludes one or more
partners from any share in the profits or losses is void.

Limited life – the creation of a partnership is basically consensual. As such, a partnership may be
dissolved:

By express will of any partner;

By the termination of a definite term stipulated in the contract;

By any event which makes it unlawful to carry out the partnership;

When specific thing which a partner had promised to contribute to the partnership perishes before the
delivery; or

Expulsion, death, insolvency or civil interdiction of a partner

Transfer of ownership – in case of dissolution, the transfer of ownership, whether to new or existing
partner, requires the approval of remaining partners.

Unlimited liability – each partner, including industrial ones, may be held personally liable for partnership
debt after all partnership assets have been exhausted. If a partner is personally insolvent, his share in
the partnership debt shall be assumed by the other solvent partners.

Lesson 1.3 Advantages and Disadvantages of a Partnership

Advantages

Disadvantages

Ease of formation

Shared responsibility of running the business

Flexibility in decision making

Greater capital compared to sole proprietorship

Relative lack of regulation by the government as compared to corporations

Easily dissolved/ limited life

Unlimited liability

Conflict among partners

Lesser capital compared to a corporation

A partnership (other than a general professional partnership) is taxed like a corporation

Lesson 1.4 Classification of Partnerships

According to Object:

Universal partnership of all present property – All present (current and existing) properties are
contributed by partners with the intention of dividing the properties as well as the profits among
themselves. Any property acquired by a partner in the future will not form part of the partnership unless
there is a stipulation.

Universal partnership of profits – The properties contributed (if any) are still owned by the individual
partner and not by the partnership. Only the profits resulting from the utilization of the properties will
form part of the partnership and divided among the partners. Also, profits resulting from an individual
partner’s industry will form part of the partnership. This includes salaries and wages, commissions, etc.
Note that these profits must result from a partner’s exertion of work, physical or intellectual. Those that
result from chance (i.e., lotto winnings, raffle) are excluded. Profits from properties acquired after
formation of the partnership are also excluded, unless there is a stipulation stating that future
properties will be included.

Particular partnership - The object of the partnership is determinate – its use or fruit, specific
undertaking, or the exercise of profession or vocation.

According to Liability:

General partnership – all partners are liable to the extent of their separate properties.

Limited partnership – the limited partners are liable only to the extent of their personal contributions. In
a limited partnership, the law states that there shall be at least one general partner.
According to Duration:

Partnership for a fixed term – one that is formed to last only a certain period of time.

Partnership at will – one in which no term is specified and is not formed for a particular undertaking.

According to Purpose:

Commercial or trading partnership – one formed for the transaction of business.

Professional or non-trading partnership – one formed for the exercise of profession.

According to Legality:

De jure partnership – one which has complied with the legal requirements for its establishment.

De facto partnership – one which has failed to comply with all the legal requirements for its
establishment.

Lesson 1.5 Kinds of Partners

As to extent of liability

General Partner – one who is liable to the extent of his separate property after all assets of the
partnership are exhausted.

Limited Partner – one who is liable only to the extent of his capital contribution. He is not allowed to
contribute industry or service only.

As to type of contribution

Capitalist Partner – one who contributes money or property to the common fund of the partnership.

Industrial Partner – one who contributes his knowledge or personal service to the partnership.

As to role in the partnership

Managing Partner – one whom the partners have appointed as manager of the business.

Liquidating Partner – one who is designated to wind up or settle the affairs of the partnership after
dissolution.

As to participation in the operation

Active/Ostensible Partner – one who takes active part in the day-to-day working of the business

Dormant/Sleeping Partner – one who contributes only capital to the business, but does not take part in
its management.
As to the point of view of outsiders

Secret Partner – one who takes active part in the business but is not known to be a partner by outside
parties.

Nominal Partner – one who does not contribute capital and do not take active part in management. His
contribution is limited to allowing the other partners to make use of his name.

Partner by estoppel – one who is not a partner but by his words and conduct he leads the outsiders to
believe that he is also a partner. Usually this arises, when the outgoing partner fails to give notice about
his retirement.

Lesson 1.6 Accounting for Partnerships

The accounting for assets and liabilities remains the same regardless of the form of a business
organization. What changes is the accounting for equity. For proprietorship, there is only one owner.
Therefore, there is only one capital account and one drawing account. On the other hand, since a
partnership has two or more owners, separate capital and drawing accounts are established for each
partner.

Partner’s Capital Account

A partner’s capital account is credited for his initial and additional net investments (assets contributed
less liabilities assumed by the partnership), and credit balance of the drawing account at the end of the
period. It is debited for his permanent withdrawals and debit balance of the drawing account at the end
of the period.

Partner’s Drawing Account

Typically, partners do not wait until the end of the year to determine how much of the profits they wish
to withdraw from the partnership. To meet personal living expenses, partners customarily withdraw
money on a periodic basis throughout the year. At the end of each accounting period, the balance in the
drawing accounts are closed to the related capital accounts.

Mr. A, Capital

Mr. A, Drawings

Debit

Permanent withdrawals
Debit balance of the drawing account at the end of the period

Credit

Original investments

Additional investments

Credit balance of the drawing account at the end of the period

Debit

Temporary withdrawals

Share in loss (this may be debited directly to Capital)

Temporary funds held to be remitted to the partnership

Credit

Share in profit (this may be credited directly to Capital)

Recurring reimbursable costs paid by the partner

Permanent withdrawals are made with the intention of permanently decreasing the partner’s capital
while temporary withdrawals are regular advances made by the partners in anticipation of their share in
profit. The use of drawing accounts for temporary withdrawals provides a record of each partner’s
drawings during an accounting period. Hence, drawings in excess of the allowed amounts as stated in
the partnership agreement may be controlled.

Notice that profit (or loss) is credited (or debited) either to the drawing account or to the capital
account. The choice of the account to credit or debit depends on the intention of the partners. If they
wish to maintain their capital accounts for investment and permanent withdrawals, then profit or loss
should be entered in the drawing account.

On the other hand, if the purpose of the partners is to make profit or loss part of their capital, then
the capital account should be used. In either case, the resulting partner’s ending capital balances will be
the same.

Loans Receivable from or Payable to Partners

If a partner withdraws a substantial amount of money with the intention of repaying it, the debit should
be to the Loans Receivable-Partner account instead of Partner’s Drawing account. This account should
be classified separately from the other receivables of the partnership.

A partner may lend amounts to the partnership in excess of his intended permanent investment.
These advances should be credited to the Loans Payable-Partner account and not to Partner’s Capital
account classified among the liabilities separate from the liabilities to outsiders. This distinction is
important in case of liquidation. Loans payable to partners must be paid after the claims of outside
creditors have been paid in full. These loans have priority over partner’s equity.

Lesson 1.7 Major Considerations in Accounting for a Partnership

Formation – accounting for the initial investments to the partnership

Operation – division of profits and losses

Dissolution – admission of a new partner and withdrawal, retirement or death of a partner

Liquidation – winding-up of affairs