PARTNERSHIP FORMATION

A partnership may be formed in any of the following ways:

1. Individual with no existing business formed a partnership.
2. A sole proprietor and an individual without existing business form a partnership.
3. Two or more sole proprietorship formed a partnership.
4. Admission or retirement of a partner.

Step by step:
Books of Proprietor Books of Partnership
1. Adjust the asset and liability 1. Open the books of the partnership
2. Close the books
NOTE: GAINS, LOSSES, INCOME, and EXPENSE adjustment will be reflected directly to CAPITAL ACCOUNT

ILLUSTRATION: INDIVIDUALS WITH NO EXISTING BUSINESS FORMED A PARTNERSHIP

On July 1, 2019, Gerry Fernando and Joanne Java agreed to form a partnership. The partnership agreement specified
that Fernando is to invest cash of ₱700,000 and Java is to contribute land with a fair value of ₱1,300,000 with
₱300,000 mortgage to be assumed by the partnership.

Required: Prepare the journal entries to record the formation of the partnership.
7/1/19 Cash 700,000
G. Fernando, Capital 700,000
#
Land 1,300,000
Mortgage payable 300,000
J. Java, Capital 1,000,000
#
ILLUSTRATION: A SOLE PROPRIETOR AND AN INDIVIDUAL WITHOUT EXISTING BUSINESS FORM A
PARTNERSHIP
The statement of financial position of Leopoldo Medina on October 1, 2019, before accepting Challoner Materi as
partners is shown below?
Leopoldo Medina
Statement of Financial Position
October 1, 2019
Assets Allowance for doubtful accts. (10,000)
Cash 60,000 Merchandise inventory 80,000
Notes Receivable 30,000 Furniture and Fixtures 60,000
Accounts Receivable 240,000 Accum. Depreciation (6,000)
Total Assets 454,000 Medina, Capital 314,000

Liabilities and Equity

Noted Payable 40,000 . .
Accounts Payable 100,000 454,000

Challoner Matero offered to invest cash to get a capital credit equal to one-half of Leopoldo Medina’s capital after giving
effect to the adjustment below. Medina accepted the offer.
1. Merchandise inventory is to be valued at 74,000
2. The accounts receivable is 95% collectible
3. Interest accrued on the notes receivable will be recognized: 10,000, 12% dated July 1, 2019 and 20,000,
12% dated August 1, 2019.
4. Interest in notes payable to be accrued at 14% annually from April 1, 2019.
5. The furniture and fixtures are to be valued at 46,000
6. Office supplies on hand that have been charged to expense in the past amounted to 4,000. These will be used
by the partnership.
Required: Prepare the journal entries to record the formation of the partnership.
1. Medina, Capital 6,000
Inventory (80,000-74,000) 6,000
2. Medina, Capital 2,000
Allowance for uncollectible accounts 2,000*
* AFUA (240,000 x 5%) - required 12,000
AFUA per SFP 10,000
Adjustment 2,000
3. Interest receivable 700
Medina, Capital 700*
* Interest (10,000 x 12% x 3/12) - Jul. to Oct. 300
(20,000 x 12% x 2/12) - Aug. to Oct. 400
Interest receivable 700
4. Medina, Capital 2,800
Interest payable 2,800*
* Interest (40,000 x 14% x 6/12) - Apr. to Oct. 2,800
5. Medina, Capital 8,000
Accum. Dep. - Furniture & Fixtures 8,000*
* Carrying amount - F&F (60,000 - 6,000) 54,000
Value agreed 46,000
 Adjustment 8,000
6. Office supplies 4,000
Medina, Capital 4,000

ILLUSTRATION: TWO OR MORE SOLE PRORIETORSHIP FORM A PARTNERSHIP

On October 1, 2021, Eren and Floch decided to pool their assets and form a partnership. They allocate profit and loss
in the ratio of 44:56 for Eren and Floch, respectively.
The firm is to take over business assets and
EREN FLOCH assume business liabilities, and capitals are to be
Cash 90,000 54,000 based on net assets after the following
Accounts receivable 216,000 180,000 adjustments.
a. Eren’s inventory amounting to 12,000 is
Allowance for doubtful accounts (4,800) (6,000)
worthless, while Floch’s agreed value of
Notes receivable 60,000 inventory amounted to 150,000.
Merchandise inventory 192,000 144,000 b. Uncollectible account of 7,200 for Eren is to
Office supplies 32,400 be provided; a 5% allowance is to be
recognized in the books of Floch.
Equipment 120,000
c. Accrued rent income of 12,000 on Eren, and
Accum. Depreciation - equipment (54,000) accrued salaries of 9,600 on Floch should be
Furniture and fixtures 144,000 recognized on their respective books.
d. Interest of16% in notes receivable fate
Accum. Depreciation - F&F (24,000)
August 17, 2021 should be accrued.
Total Assets 591,600 552,000 e. The office supplies unused amounted to
24,000.
f. The equipment’s agreed value amounted to
60,000
Accounts payable 159,600 120,000
g. The furniture and fixtures has a fair value of
Notes payable 60,000 108,000.
Capitals 372,000 432,000 h. Interest at 12% on notes payable dated July
Total Liabilities & Equity 591,600 552,000 1, 2021 should be accrued.
i. Floch has an unrecorded patent amounting
to 48,000 and is to invest the additional cash
Prepare the following: necessary to have a 60% interest in the new
1. Adjusting and closing entries in the books of Eren & Floch. firm.
2. Entries in the new set of books
In case, wherein days are considered, use 360
3. Balance sheet after the formations of the partnership. days as the basis.

Mer. Inventory 12,000

b. Eren, Capital 7,200
Allow. Doubtful accts. 7,200
EREN
a. Eren, Capital 12,000
 b. Floch, Capital 3,000
Allow. Doubtful accts. 3,000*
c. Rent receivable 12,000
Eren, Capital 12,000 * AFUA (180,000 x 5%) - required 9,000
d. AFUA per SFP 6,000
Adjustment 3,000
c. Floch, Capital 9,600
Salaries payable 9,600
d. Interest receivable 1,200*
Floch, Capital 1,200
e. Eren, Capital (32.4K- 24K) 8,400
Office Supplies 8,400 * Interest (60,000 x 16% x 45/360) 12,000
f. Eren, Capital 6,000 August 17-31; September 1-30; October 1
All. For doubtful 6,000 14 + 30 + 1 = 45
g. e.

f.

g. Floch, capital 12,000

Acc. dep - F&F 12,000

h. Eren, Capital 1,840 * F&F 144,000 144,000

Interest Payable 1,840 A/D 24,000 36,000 = 12,000
(60,000 x 12% x 92/360) 120,000 108,000
* July =30 Sept. = 30
August =31 Oct. = 1 92 h.

FLOCH
a. Mer. Inventory 6,000 i. Patent 48,000
Floch Capital 6,000 Floch, capital 48,000

ADJUSTMENTS Unadjusted Inc. (Dec.) Adjusted Unadjusted Inc.(Dec.) Adjusted

Cash 90,000 90,000 54,000 54,000

Accounts receivable 216,000 216,000 180,000 180,000
All. doubtful accounts (4,800) (7,200) (12,000) (6,000) (3,000) (9,000)
Notes receivable 60,000 60,000
Merchandise inventory 192,000 (12,000) 180,000 144,000 6,000 150,000
Office supplies 32,400 (8,400) 24,000
Equipment 120,000 120,000
Accum. Dep. - equipment (54,000) (6,000) (60,000)
Furniture and fixtures 144,000 144,000
Accum. Depreciation - F&F (24,000) (12,000) (36,000)
Rent receivable 12,000 12,000
Interest receivable 1,200 1,200
Patent 40,000 48,000
Total Assets 591,600 570,000 552,000 592,200

Accounts payable 159,600 159,600 120,000 120,000

Notes payable 60,000 60,000
Interest Payable 1,840 1,840
Salaries payable 9,600 9,600
* **
Capitals 372,000 348,560 432,000 462,600
Total Liabilities & Equity 591,600 570,000 552,000 592,200

*Eren, capital (unadjusted) 372,000 ** Floch, capital (unadjusted) 432,000

Mer. Inventory (12,000) Mer. Inventory 6,000
All. Doubtful acct. (7,200) All. Doubtful acct. (3,000)
Rent receivable 12,000 Salaries payable (9,600)
Office supplies (8,400) Interest receivable 1,200
All. Doubtful acct. (6,000) All. Doubtful acct. (12,000)
Interest payable (1,840) Patent 48,000
Eren, capital (adjusted) 348,560 Floch, capital (unadjusted) 462,600

CLOSING ENTRIES

Eren: Floch:
Accounts payable 159,600 Accounts payable 120,000
Note payable 60,000 Salaries payable 9,600
Interest payable 1,840 AFDA 9,000
AFDA 12,000 A/D 36,000
A/D 60,000 Floch, capital 462,600
Eren, capital 348,560 Cash 54,000
Cash 90,000 Accounts receivable 180,000
Accounts receivable 216,000 Note receivable 60,000
Mer. Inventory 180,000 Mer. Inventory 150,000
Office supplies 24,000 Fur. & Fixtures 144,000
Equipment 120,000 Interest receivable 1,200
Rent receivable 12,000 Patent 48,000

RECORDS OF PARTNERSHIP

To record Eren’s Investment To record Eren’s Investment

Cash 90,000 Cash 54,000

Accounts receivable 216,000 Accounts receivable 180,000
Mer. Inventory 180,000 Note receivable 60,000
Office supplies 24,000 Mer. Inventory 150,000
Equipment, net 60,000 Fur. & Fixtures, net 108,000
Rent receivable 12,000 Interest receiv able 1,200
Accounts payable 159,600 Patent 48,000
Note payable 60,000 Accounts payable 120,000
Interest payable 1,840 Salaries payable 9,600
AFDA 12,000 AFDA 9,000
Eren, capital 348,560 Floch, capital
462,600

Eren 348,560 Eren 348,560 40% Eren, capital 348,560

Floch 462,600 57% Floch ? 60% Divided by 40%
Total Capital 811,160 Total Capital 871,400 100% Total Capital 871,400
Multiply by 60%
Floch, capital 522,840

Additional investment: Entry:

Eren, capital 462,600 Cash 60,240
Required 522,840 Floch, Capital 60,240
Additional 60,240

PARTNERSHIP OPERATION

Possible Methods of Dividing Net Income/Loss:

 1. Equally
2. Unequal / Arbitrary Ratio
3. Ratio of Capital Balances:
a. Original Capital Balances
b. Beginning Capital Balances
c. Ending Capital Balances
d. Average Capital Balances
4. Allowing Interest on Capital Balances and
Dividing the remaining Income/Loss
5. Allowing Salaries to Partners and Dividing the
remaining Income/Loss
6. Bonus to Managing Partner

Assume that on January 1, 2018, Siy and Tiu formed a partnership with an investment of 30,000 by Siy and
60,000 by Tiu. On December 31, 2019, after closing all income and expense accounts, the Income summary
account shows a credit balance of 60,000, representing profit for the year 2019. Changes in the capital
accounts during 2019 are summarized as follows:

SIY TIU
Original Capital Balances - Jan. 1, 2018 30,000 60,000

Capital balances, Jan. 1, 2019 40,000 60,000

Additional investments, March 1 20,000 50,000
Additional investments, August 1 20,000 40,000
Withdrawal, October 1 (20,000)
Withdrawal, November 1 (50,000)
Capital balances, December 31, 2019 60,000 100,000

Prepare journal entry to record division of net income for 2019 under the following independent cases.

1. The partnership agreement is to divide profit and loss equally.

2. The partnership agreement is to divide profit and loss in an arbitrary (unequal) ratio. Agreed to divide
profit and loss in the ratio of 60% to Siy and 40% to Tiu.

3. The partnership agreement is to divide profit and loss based on the ratio of original capital
contributions.

4. The partnership agreement is to divide profit and loss based on the ratio of beginning capital
balances.
 5. The partnership agreement is to divide profit and loss based on the ratio of ending capital balances.

6. The partnership agreement is to divide profit and loss based on the ratio of average capital balances
(PESO-MONTH/ PESO-DAY)

PESO-MONTH / PESO-DAY METHHOD

1. What withdrawals / drawings are to be considered?
2. Only withdrawals Above a Certain Limit are to be viewed as Reduction against capital balances.
Permanent Withdrawals - Made with the intention of ‘permanently’ deceasing the capital
Temporary Withdrawals - Regular advances made by the partners in anticipation of their share in profit.
3. What withdrawals / Drawings are to be recognized?
 Permanent Withdrawals
 Temporary Withdrawals in excess of Allowable amount
Illustration: Allowed temporary Withdrawal, 10,000.
Actual Temporary Withdrawal Made
Case 1 9,000
Case 2 10,000
Case 3 11,000

7. The partnership agreement is to divide profit and loss based on the ratio of average capital balances
(Simple Average)
 8. The partnership agreement allows interest in partners’ average (PES-MONTH/ PESO-DAY Method)
capital balances at 12%, with any remaining net income or loss to be divided equally.

NOTE:
Interest on Capital Balances:
 Gives recognition to difference on capital contributions by partners
 Not an expense of the partnership
 Must be enforced regardless of whether operations are profitable or unprofitable.


9. Assume that the partnership operation results at a loss of 10,000. The partnership agreement allows
interest on partners’ average (PESO-MONTH/ PESO-DAY Method) capital balances as 12%, with
any remaining net income or loss to be divided equally.

10. The partnership agreement provides for an annual salary of 30,000 to Siy and 20,000 to Tiu, with the
resultant net income or loss to be divided equally.

SIY TIU TOTAL

Salaries 30K 20K 50K
Balance (50:50) 5K 5K 10K (balancing figure)
 Totals 35K 25K 60K

Entry: Income Summary 60K

Siy Drawing 35K
Tiu Drawing 25K

11. Assume that the partnership operation results at a loss of 20,000. The partnership agreement provides
for an annual salary of 30,000 to Siy and 20,000 to Tiu, with the resultant net income or loss to be
divided equally.

SIY TIU TOTAL

Salaries 30K 20K 50K
Balance (50:50) (35K) (35K) (70K) (balancing figure)
Totals (5K) (15K) (20K)

Entry: Siy Drawing 5K

Tiu Drawing 15K
Income Summary 20K

NOTE:
Salary Allowances

 To achieve fair division of income based on the time and talents devoted to business
 Salaries are EXPENSES in determination of net income
 Salary allocation MUST BE MADE eve though profit is inadequate/ there is a loss

12. Assume that the partnership operation results at a loss of 30,000. The partnership agreement provides
for an annual salaries are allowed to the extent of earnings only, then no salaries are allowed when
a loss occurs. The partnership agreement provides for an annual salary of 24,000 to Siy and 36,000 to
Tiu.

13. Assume that the partnership of Siy and Tiu has a net income of 190,200 before salaries, interest and
bonus to partners. The partnership contract provides the following:
a. Salaries to Siy and Tiu, 30,000 each.
b. Interest on capital account balances: Siy 7,000:Tiu, 3,200.
c. Bonus to Siy, 20% of net income, bonus is based on net income before allowances for
salaries, interest and bonus.
d. Remaining profit or losses after salaries, interest and bonus, equally.

14. Assume information on question number 13, except that bonus is based on net income before
allowances for salaries and interest, but after deduction of bonus.
15. Assume information on question number 13, except that bonus is based on net income after
allowances for salaries and interest, but before bonus.

16. Assume information on question number 13, except that bonus is based on net income after
allowances for salaries, interest and bonus.