business in order not to impair the independence of
Nature and Definition of a Partnership
Basic Considerations
What are the common classification of business
organizations?
Definition of Partnership
By the contract of partnership, TWO or MORE persons
bind themselves to CONTRIBUTE money, property or
industry, to a COMMON FUND with the intention of
DIVIDING the PROFITS among themselves
Requisites of Partnership
According to the New Civil Code of the Philippines, the
Essential Elements of the formation of partnership are
the following;
Voluntary & Valid AGREEMENT between partiesLAWFUL
purposes for which partnership is
organizedCONTRIBUTIONS: Money, property and/or
IndustryObjective to earn PROFIT that is to DIVIDED
among the partnersMUTUAL AGENCY among
partnersPractice of TRANSPARENCY on the records &
transactions.
Major Characteristics of a Partnership
Based on the Definition and Essential Elements of
Partnership, the following characteristics where derived
therein;
1. Based on Contract
The relation of partners arises from contract NOT
Statute or Operation of LAW or InheritanceThe
agreement of partnership - whether in oral from or in
writing - becomes a contract that is binding to all
partners.
What is written inside a Partnership Contract?
Below are itemized details inside a partnership but not
limited to the following;
Names of partners
Name and Nature or Business
Location of the Business
Start Date of the Partnership
Contribution/Description of each partner
Amount of Investment or Can Withdraw for each
partner
Profit and Loss Sharing
Stipulation for the termination of Agreement
2. Association of Individuals
In order to constitute a partnership, it is necessary that
there are at least two persons, having reciprocal and
obligations towards each other
The Law provides the minimum of TWO but it did not
specify the maximum number of persons
In Business however, it is considered sound practice to
organize a corporation when there are five or more
persons desiring to form a business
HOWEVER, This is not applicable when a business is a
professional partnership of CPA’s to form a corporate
CPA’s
3. Mutual Agency
A Partnership is formed based on the “Trust and
Confidence” of the individuals to each othe
Trust and confidence is the "CORD" that binds the
partnership
A Partnership is VOLUNTARY FORMED by each partner,
and has the RIGHT TO CHOOSE the people with whom
he/she would like to associate
Every partner is assume an agent of the partnership
meaning, any partner can legally bind all the partners by
an action that is part of the usual conduct of the
partnership business
3. Ease of Formation
Partnership is perfected by the mere CONSENT of the
parties
Formation can be;
Informal – Hand Shake or Oral Agreement
Formal – Articles of Co-Partnership
Partners does not need SEC or BIR Permission, UNLESS ;
the partnership’s capitalization is P3,000 or more
investment that involves real property
Partners are still strongly advised to have a formal
agreement to avoid potential problems that arise during
the operation of the business
4. Co-ownership of Partnership Property
Assets invest by any of the partners become the
property of the partners because they co-own the
partnership
The Partner Investing an asset no longer retains
personal right to it.
If the partnership is terminated, the individual partners
may not receive back the same assets the invested,
EXCEPT there is an agreement
5. Income Participation
Partnerships business objective is carried on sharing the
Profit or Loss (P/L) among the partners
Sharing of profit is arrived by mutual consent and is
specified in the articles of the partnership
If no agreement, partners will share P/L base on
CAPITAL CONTRIBUTION
6. Assignment of Partner's Interest
A partner can assign his interest to an Assignee partner
can be assignor
The Assignee has no right to Participate in MANAGING
the AFFAIRS of the business
The Assignee’s rights are limited to receiving the share
of P/L or proceeds in case the partnership is dissolved
7. Unlimited Liability
Under the "Separate Entity Concept" of accounting
Business is viewed as existing separately from owners,
HOWEVER, Partners are NOT considered separate from
the partnership when involves to 3rd party creditors
Each partner whether general or industrial is at risk of
his/her personal assets for partnership debts in the
event the partnership becomes INSOLVENT
Limited partners risk only for their investment Provided
they do not perform any task of a general partner
8. Limited Life
A partnership is automatically DISSOLVED when there is
a Change in Relationship within the partners such as;
–Admission of New Partner
–Withdrawal of a Partner
–Death of a Partner
–Personal Bankruptcy
–Incapacitated of a partner

Advantages & Disadvantages

The characteristics of a Partnership as a business
organization offers several advantages and
disadvantages as shown below:

Difference from other Business Organizations

It is important for entities that has entrepreneurial Partnership Classifications and Kind of Partners
plans to choose which business organization is more
applicable to their purposes and economic business- Kinds of Partnerships
setting, below are some attributes to be compared to As to NATURE of Business
other business organization; Trading Partnership - Also known as "Business co-
Sole Proprietorship VS Partnership partnership"
Buying & Selling of Finished Merchandise or
Manufacturing of Goods
Non-Trading Partnership
Renders Services Only for a Fee

As to PURPOSE
Commercial Partnership
Engages in trading, merchandising, or manufacturing of
goods for a profitService Industry may be classified as
commercial IF it is not engaged in the Practice of a
common Profession
General Professional Partnership (GPP)
Engaged in the exercise of a COMMON profession and
renders services based on their profession. (Ex. CPA's,
Corporation VS Partnership Doctors & Lawyers)NOTE: A group of professionals can
be in a commercial partnership if it not related to their
Professional Practice

As to OBJECT
Universal Partnership
of all present PROPERTIES
ALL present property is contributed into a common
fund.All profit will be divided among themselves.
of Profits
Partners RETAIN OWNERSHIP placed into the common
fund. Only profits from their industry will be distributed.
Particular Partnership
Partnership which has a specific undertaking or
exercises of a profession or vocation
Co-Ownership VS Partnership
As to LIABILITY
General Partnership
Comprised of a General or a combination of General +
Industrial PartnersPersonally Liable for the partnership's
debts after the exhaustion of its assets
Limited Partnership
Comprised of Limited + General PartnersOnly Limited
partner shall be liable to the extend of his contributions
to the partnershipAt Least 1 General Partner to protect
the 3rd party liabilities

As to DURATION
Partnership at will
May be terminated any time at willNo fixed period of
existence
Partnership with a Fixed Term
Formed with a specific period of existencePeriod could
be a time, target profit or event.
As to Legality of EXISTENCE
De jure partnership
Established & organized in accordance with all the
LEGAL requirements
De facto partnership
Established & organized without complying with the
legal requirement
Kinds of Partners
As to CONTRIBUTION
Capitalist Partner - Contributes money and/or property
to the Partnership
Industrial Partner - Contributes only his skills,
knowledge; industry or personal service to the
partnership
Capitalist-Industrial Partnership - Contributes money,
property and industry
As to LIABILITY
General Partner - Assumes unlimited liability (liable for
partnership debt up to his personal assets)
Limited Partner - Liable only up to his Capital
Contribution
As to PARTICIPATION
Managing Partner - Appointed to run the business
(Appointment may be either in the Articles or after the
formation of partnership)
Silent Partner - Known as partner but NOT ACTIVE in
business Operations (can be a limited partner)
Liquidating Partner - Appointed to liquidate
partnership assets and settle unfinished transactions of
the partnership after dissolution
As to Third Persons
Secret Partner - NOT KNOWN as partner but takes
ACTIVE in business operations
Dormant Partner - NOT KNOWN & INACTIVE in business
operations
Nominal / Ostensible Partner - Partner in name only
for accommodation or consideration
Rights of a Partner
A Partner has a right over;
1. Specific partnership property
2. Share in the Profits resulting from business
operation
3. Share in the remaining assets upon partnership
liquidation after the partnership creditors have
been paid
4. To co-manage the partnership
5. To ask that the books be kept in the principal
place of business subject to inspection at a
reasonable time
Articles of Co-Partnership
An agreement concerning formation, operation
dissolution and liquidation of the partnership is
embodied in a contract called "Articles of Co-
Partnership". Although a verbal agreement is valid, it is
advisable to put it writing as conflicts and disagreement
may arise because of the number of persons involved.
The "Articles of Co-Partnership" is a written contract
made by the partners that will act as a form of
governance of partnership activities and will clearly
reflect the relationships of the partners among each
other and with third parties.
It is need to appear in a PUBLIC INSTRUMENT and to
registered with the SEC if partners contributed REAL
PROPERTY (land or building) or REAL RIGHTS or if the
total partnership capital amounted to P3,000 or more.
If a partnership fails to register with the SEC, it cannot
acquire legal personality to maintain an action against
third persons, but the partners may file a suit jointly
against third party persons.
Failure to comply with the registration requirement
does not affect the liability of the partnership and its
partners to the third party persons.
The partnership agreement commonly contains the
following information:
• Name of the partnership
• Names and address of the partners
• Kinds of partners
• Principal place and purpose of business
• Manner of Management of the Partnership
• Duration of the contract (date of effectiveness
and life of the partnership)
• Contributions of the partners
• Duties and rights of each partner
• Conditions for withdrawals
• Salary and the profit and loss agreement
• Dissolution and Liquidation Procedures
• Arbitration of disputes
Partnership Formation
This refers to the PERFECTION of the partnership
contract by the partners. When a partnership is formed,
partners commonly observe the following to effect fair
and honest business:
Execution of partners' agreement (See Articles of Co-
Partnership)
Valuation of partners' investment
Adjustments of accounts
Valuation of Partners' investment
The accounting issues regarding initial investments and
other capital contribution are;
How much the contribution to be made by the
partners? and
What amount the capital contribution shall be
recognized?
The answers to the issues above depend on the
following:
Is there an agreement? and
what was contributed? Cash or Non cash?
The following rules shall then be observed when capital
contribution issues arise:
1st Rule:
The amount of contribution shall based on partner's
agreement, in absence of agreement contribute equally

Illustration for the 1st Rule: (YES) - With Agreement on
Individual Contribution
Alpha and Bravo formed a partnership with a TOTAL
AGREED CAPITAL of Php 150,000 to be contributed as
cash of 40% and 60% by Alpha and Bravo, respectively,
through a issuance of personal checks. (below is the
journal entry for the formation)
Notes:
The journal entries of their respective investments are a
single journal entry because of two (2) separate source
documents (individual checks).
As per previous notes, each partner will have a separate
capital account
Illustration for the 1st Rule: (NO) - Without Agreement
on Individual Contribution
Alpha and Bravo formed a partnership with a TOTAL
AGREED CAPITAL of Php 150,000 to be contributed as
cash. (below is the journal entry of the formation)
2nd Rule:
The valuation of partners' non-cash investment is based
on the partner's AGREED VALUE, in the absence of any
agreement, use FAIR VALUE of the property on the
investment date.
If cash contribution is made, it is valued at FACE
AMOUNT
Partnership Accounting
Accounting for Partnership
In general, the accounting principles, process and
procedures used in recording partnership transactions
are the SAME as Sole Proprietorship & Corporations
The DIFFERENCE, however, lies in the owner's equity
accounts.
Partners' Equity
The rights of the partners over the net assets of the
business is called Partners' Equity.
Each partner's equity is represented by two (2)
accounts:
1. Partner's Capital
2. Partner's Drawing
Partner's Capital Account
The capital account represent original investment which
becomes its permanent or fixed interest. Each partner
has his own capital account which has a normal credit
balance. The balance in the capital account represents
the partner's share in the net asset of the partnership.
The partner's capital account gives information on the
increase or decrease in his interest in the partnership.
Specifically, the transactions affecting the partner's
capital account are summarized as follows:
Investment - contribution made are credited to each
partner's capital account to increase the partner's
equity
Permanent Withdrawal- represents partner's decrease
in its interest into the partnership which is debited to its
capital account.
Income Summary Account - this is the accounting
device used to close the temporary accounts in its
capital account for the period ended:
Net Debit Balance = Loss,
Net Credit Balance = Income,
Notes:
A debit balance in the partner's capital account is called
a deficiency or partner's deficit.
Deficit - partner's share in losses and/or withdrawals
exceeds (>) his capital contribution and share of profits
Partner's Drawing Account
This is the account title used to reflect temporary
decrease in the interest of a partner and is periodically
closed to the partner's capital account.
Each partner has his own drawing account to reflect
temporary withdrawals and other minor amounts taken
by the partner from the partnership in anticipation of
his profit share.
The transactions affecting the partner's drawing
account are as follows:

Share in P/L - The agreement as to the manner of
distribution provided in the Articles of Co-Partnership
Profit - Credited to Drawing Account
Loss - Debited to Drawing Account
Personal Drawings
Often Called salaries, but are in fact withdrawals from
profit
Informal or irregular withdrawals may also be made
when the needs of partners arises (with the consent of
all partners)
The ending balance of the drawing account is closed to
the capital account:
Profit > Withdrawals = Increase in Capital Account
Profit < Withdrawals = Decrease in Capital Account
Other Partnership Accounts (Loans)
Loans Receivable from Partners
Also called “loans to partner” or “due from partner” or
“loans receivable from partners” or (Utang o Bale ng
Kasosyo)
Represent ADVANCES of the Partners with the intention
of repayment
Generally presented and classified as part of the
CURRENT ASSETS except when collection period is
beyond one-year. (Non-current Asset)
Do not be confused between loans and withdrawals,
because the intention of the loan is a "creditor-debtor
relationship", wherein the Partner = Debtor; Partnership
= Creditor
Loans Payable to Partners
Also called “loans from partner” or “due to partner” or
(Utang ng Partnership sa Kasosyo)
Represent SUBSTANTIAL amount LENT by the partners
to the Partnership
Generally presented and classified as part of the
CURRENT LIABILITIES except when payment or due date
is beyond 1 year
"creditor-debtor relationship", wherein the Partnership
= Debtor; Partners = Creditor
Loans to and from Partners
This account title is the COMBINATION of loans
receivable from partner and loans payable to partner
accounts
Represents both a claim and obligation (asset and
liability, respectively),
If ending balance is found at;
Debit Side - Claims
Credit Side - Obligation/Liability
IMPORTANT NOTE: It is emphasized at this point that
"Loans to and from Partners" are either ASSET or
LIABILITY, and therefor shall not be considered in
determining the balances of partner's equity
Methods for Accounting the Initial Contribution
1. Actual Investment Method
When the agreed partner’s capital shares are credited
with the same value as their actual net contributed
Assets. Our previous illustrations from 8.1 are all
examples of the Actual Investment Method.
TOTAL CONTRIBUTED CAPITAL (TCC) = TOTAL AGREED
CAPITAL (TAC) & Partner's CONTRIBUTED CAPITAL =
Partner's AGREED CAPITAL
2. Bonus Method
When the agreed partner’s capital shares is not the
same value as their actual net contributed Assets
TOTAL CONTRIBUTED CAPITAL (TCC) = TOTAL AGREED
CAPITAL (TAC) & Partner's CONTRIBUTED CAPITAL ≠≠
Partner's AGREED CAPITAL
There is a bonus to a partner when his capital credit is
more than hid actual contributed capital and the total
net assets contributed by partners are equal to toal
capital of the partnership.
Illustration
Kappa, a sole proprietor, allows Gamma, decided to
pool their net assets to form a partnership, provided
that the latter would contribute cash amounting to
P70,000. Kappa's contributions comprised of the
following:
P 10,000 Cash
P 30,000 Accounts Receivable
P 20,000 Merchandise
P 8,000 Accounts Payable to be assumed by the
partnership
They agreed that their initial capital balances would be
of equal amount upon formation of the partnership.
Assume that Kappa & Gamma agreed that the
partnership capital would be P122,000.
To record the investments of the partners using the
bonus approach, the following journal entries shall be
made:
*To equalize the capital credits of partners
(P122,000/2), P9,000 has to be transferred from
Gamma's capital as bonus to Kappa
Stages from which Partnership are Formed
The complexity of accounting for partnership formation
depends on the stage from which a partnership is
formed. The stages would be:
• First time in business
• Conversion of a single proprietorship to a
partnership
• Admission of a new partner to an existing
partnership ( to be discussed in Module 4 )
First time in business
The stage wherein individual persons without an
existing business, decided to form a partnership. The
formation of such partnership is accounted by recording
the individual contribution and the valuation of the
contributions of each partner.
The rules on the amount of contribution and its
valuation shall be used (see previous tab), therefor, no
accounts are to be adjusted at the time of formation.
Illustration
Charlie, Delta and Epsilon formed CDE partnership with
an agreed total capitalization of Php 300,000, which
shall be contributed equally by Charlie & Delta.
Meanwhile Epsilon was to manage the operations of the
partnership business as an industrial partner with a
share of 20% from the profits.
Charlie & Delta's contribution is as follows:
To record the contributions, the journal entries would
be
Notes:
The fair value or FMV or Appraised Value was used for
the valuation of the non-cash contribution because this
supports the Cost Principle stated in IAS 16
Liabilities attached to invested properties may be
assumed by the partnership in which case the capital
partner will be credited only for the net amount of the
assets contribution. (Asset - Liability)
Q: What if there is no agreement for the partnership to
assume the liability attached to the property?
A: The Liability will not be recorded, therefor, there will
be no effect on the interest of the investing partner and
the asset is will still recorded at FMV.
For the recording of the contribution of Epsilon
(industrial partner), the memorandum entry in the
general ledger would be as follows:
Conversion of proprietorship to a partnership
This could be made when:
A sole proprietor admits into his business another
individual who has no business of his own
Two or more sole proprietorship joined together and
formed a partnership.
The conversion of sole proprietorship(s) to partnership
is accounted for by the following procedures:
Close the nominal accounts (temporary accounts) of the
sole proprietorship business
Record the adjustments (based on the agreed or fair
value) of the assets and liabilities directly to the sole
proprietor's capital account
Close the books of the sole proprietorship
Open the new set of partnership books by recording the
partner's contributions.
Note: The books of the sole proprietor are not
applicable for use by the newly formed partnership
Why??
A partnership is a legal entity (artificial person)
SEPARATE & DISTINCT from its owners . As a
consequence, a partnership should maintain its own
books of account under its registered name as provided
by law.
As per Section 236A to 236J of the National Internal
Revenue Code (NIRC), every person subject to any
internal revenue tax is required to register once with
the appropriate Revenue District Officer (RDO).
It shall therefor acquire its own Tax Identification
Number (TIN) separately from the TIN of the partners.
Illustration:
Omega is the owner of an existing single proprietorship.
Omega, together with Rho and Tau, decides to convert
his single proprietorship into a partnership.
They agree to start the partnership with total
capitalization of Php 150,000 to be contributed equally
by the partners.
Rho and Tau are to contribute cash.
Omega shall also contribute additional cash if the net
assets of his business after the agreed valuation will not
be enough to cover his contribution requirement.
Omega's single proprietorship trial balance shows the
following:

Step 1: Closing the Nominal Accounts
Prior to the formation, the sole proprietorship's nominal
accounts should first be closed to effect the correct
balance on his capital. The nominal accounts of A should
then be closed as follows:
The post-closing trial balance of A's single
proprietorship is presented below:
Step 2: Record the Adjustment
Adjustments are necessary to effect the proper value of
assets and liabilities in accordance with the valuation
agreement or FMV
The following valuation adjustments were agreed upon
based on the post-closing balances:
a) Accounts Receivable is 98% realizable
b) Merchandise inventory is to be valued at Php 9,000|
c) Interest of Php 600 on note payable should be
recognized
To record the agreed adjustments would require the
following entry in the Omega's books:
Notes:
Adjustments are made directly to capital account and
NOT the nominal accounts because the business is now
in its liquidating concern.
Adjustments are made before the partnership
formation to comply the principles of fairness &
objectivity. Any increase or decrease in the value of the
assets should accrue to the benefit or expense of the
sole owner and not the partnership
The adjusting entries must be posted to show the
updated balance of the capital account of the sole.
Step 3: Close the Proprietor's Accounts
Since the single proprietorship is dissolved, it follows
that the books should be closed, or all the accounts
(nominal or real) are to be brought to ZERO BALANCE.
The closing of the sole proprietorship's books will
require the following journal entry:
Step 4: Recording the Partners' Contribution
The initial investments of the partners will be recorded
in the new set of partnership's books as follows:
Contribution of Omega
Contribution of Rho & Tau

2 or more Sole Proprietorship Form a Partnership

The new accounting standards mention only one
instance when goodwill would be recognized, that is , in
a BUSINESS COMBINATION, applying the purchase
method.

The forming of two (2) single proprietorship into a

partnership will NOT be considered as a business
combination. Instead, this could be considered more as
putting together of resources of two or more existing
business into a common fund, which is more of
POOLING OF INTEREST rather than purchase.

The accounting procedures & steps in converting 2 or

more existing sole proprietorship into a partnership are
the SAME as when a single proprietorship is converted
into a partnership.

However, there are more books that needs to be

adjusted and closed before the formation.
SHARING OF PARTNERSHIP PROFITS AND LOSSES
The primary objective of the accounting for partnership
operations is the determination of periodic net income
and its distribution to the partners.
The determination of net income is calculated in a
traditional manner-that is, by relating the partnership's
periodic revenues and expenses
In measuring partnership income for the period, the
expenses should be scrutinized to make sure that
personal expenses are not included among the
partnership's expenses
Rules of Profit and Loss Sharing
Article 1799 of the New Civil Code provides that any
STIPULATION that EXCLUDES one or more partners from
any share in the profits or losses is VOID. The reason for
this is that partnership must exist for the common
benefit and interest of the partners.
Article 1797 of the New Civil Code provides the
following guidelines on how partnership profits and
losses shall be distributed among the partners:
Rules on Profit Sharing
1. Profit sharing based on partner's agreement
Profits of the partnership shall be divided among the
partners in accordance with their profit-sharing ratio
agreement
Note: The capital contributions of the partners have no
bearing in the profit distribution because their profit
ratio agreement should be followed.
2. Profit sharing based on Capital Contribution
In the ABSENCE of a Profit-sharing agreement, profits
shall be divided among the partners in proportion to
their respective capital contributions
3. Profit sharing Based on Capital Contribution and on
Service
3.1. If there is a industrial partner:
The industrial partner first gets a just and equitable
share for his services (industry), before the capitalist
partners divide the balance of the profits in proportion
to their capital contributions or P/L Agreement
3.2 If there is no specified profit sharing for an
industrial partner
If there is no specified profit sharing for an industrial
partner, he shall receive a share equal to the share of
the CAPITALIST PARTNER having the SMALLEST share
3.3 If there is a partner which is both a Capital and
Industrial partner
The partner gets just and equitable share as an
industrial partner and another share as a capitalist
partner according to agreement or his capital
contributions.
Rules on Losses Sharing
1. Loss sharing based on partner's agreement
1.1 Loss of the partnership shall be divided among the
partners in accordance with their Loss-sharing ratio
agreement
1.2 In the absence of a Loss-Sharing ratio, the profit-
sharing ratio shall be used.
2. Loss sharing based on Capital Contribution
In the ABSENCE of a Profit-sharing agreement, losses
shall be divided among the partners in proportion to
their respective capital contributions
3. Loss Sharing for a "pure" Industrial Partner (no
capital contribution)
3.1. if there is no agreed loss or profit sharing ratio,
The industrial partner is totally EXEMPT from sharing
the losses. The Purely industrial partner is exempt
because he already rendered his service in vain
3.2 if there is a profit and loss agreement wherein he is
included in the P/L sharing.
The industrial partner is bound to respect the contract
between the co-partners. He shall therefor share in the
loss equivalent to his agreed loss ratio even if he is an
industrial partner.
3.3 if there is only a profit agreement
The industrial is not bound in the share of the
partnership losses because he did not give consent to
have his share in partnership losses.
4. Loss sharing for industrial-capitalist partner
If there is no loss sharing agreement but there is profit
sharing agreement, he shall be liable in the same
proportion as his profit sharing ratio.
An industrial partner is no longer exempt from loss
sharing once he become a capitalist partner
Arbitrary Agreement in Computing Profits and Losses
Partners may share the partnership profits and losses in
any manner they wish. The profit and losses agreement
should contain specific and complete provisions to
avoid misunderstanding and disputes among the
partners
The agreement on partnership's profit and losses may
be divided into one of the following ways:
1. Equally
2. Specified ratio or percentage
3. Capital Ratio
4. Interest allowed on partner's capital, the
remainder to be divided in an agreed ratio
5. Salaries or Bonus allowed for services, the
remainder to be divided in an agreed ratio
6. Multiple bases of allocation
To Illustrate the methods:
Assume Eva and Ren formed "EVAREN" partnership
with original capital contributions of P60,000 and
P30,000 respectively. In the second year of the
partnership operations, the capital and drawing
balances of partner's Eva and Ren are trance fro the
general ledger as follows:
During the year, the partnership generated an income
of P 200,000.
Note: Unless otherwise stated, the data above shall be
used as the basis for illustrations in the succeeding
discussions
1. Equally
The partners may mutually agree that the partnership
profit shall be equally divided between them. In case of
losses, and in the absence of a specific agreement
regarding division of losses, the existing equal division
of profit agreement is to be followed by the partners
If Eva and Ren Agreed to divide the partnership equally,
the distribution of P200,000 profit would be:
Eva = P100,000
Ren = P100,000
It is to be observed that Eva and Ren shared on the
partnership profit equally regardless of the unequal
balances of their capital contributions.
2. Specified Ratio or Percentage
Whenever the presence of one of the partners is
perceived more vital to the success of the business due
to experience, ability and reputation the partnership
may stipulate an unequal sharing expressed in agreed
ratio or percentage, otherwise known called arbitrary
ratio.
In specified ratio, the difference in the partner's capital
balances has NO BEARING in the P/L sharing. The
agreed profit and loss ratio may be based on the
partners' better capability or influenceover the other
To illustrate assume that Eva is perceived more vital
than Ren for the success of the partnership business, so
much that they agreed to share in the P/L of 60% and
40%, respectively.
Ren = (P200,000 x 40%) = P 80,000
Eva = (P 200,000 x 60%) = P 120,000
3. Relative Capital Balances
When money or properties invested by the partners
represent the vital contribution to the success of the
partnership business, partners may agree that their
respective capital balances shall be the basis of the P/L
Sharing.
This manner of dividing P/L is different from a arbitrary
ratio P/L Sharing, since there is NO P/L sharing
agreement at all. This is so for the allocation of P/L
distribution is NOT FIXED due to fluctuation of the
capital balances of the partners
However, there is an accounting issue to be addressed
by the partnership on what amount of the partner's
capital shall be considered in the computation of P/L
distribution. For this reason, the agreement should
indicate specifically whether the ratio is to be defined in
terms of:
Original Capital Contribution
Beginning Capital Balance of the Accounting Year
Ending Capital Balance of the Accounting Year
Average Capital Balance of the Year
3.1 Original Capital Contribution
To distribute the P200,000 net income the following
computation should be made
Total Original Capital = P60,000 + P 30,000 = P 90,000
(6:3)
Ren = (P200,000 x 6/9) = P133,333.33
Eva = (P200,000 x 3/9) = P 66,666.67
3.2 Beginning Capital Balance of the Accounting Year
The opening partners' capital balances of the current
year shall be the basis
Total Beginning Capital Balances = P 60,000 + P 50,000 =
P 110,000 (6:5)
Ren = (P200,000 x 6/11) = P 109, 091
Eva = (P200,000 x 5/11) = P 90,909
3.3 Ending Capital Balance of the Accounting Year
All capital transaction affecting the capital accounts
shall be considered to get the ending balances of the
partners
The ending capital balances of each partner is should
first to determine:
Ren = (P60,000 + P40,000+ P110,000 - P60,000) = P
150,000 (15/25)
Eva = (P50,000 + P30,000 + P80,000 - P 60,000) = P
100,000 (10/25)
Total Ending Capital Balances
P250,000 (25/25)
Ren = (P200,000 x 15/25) = P 120,000
Eva = (P200,000 x 10/25) = P 80,000
3.4 Average Capital Balances of the Accounting Year
When partners agreed to divide profits to recognize
CAPITAL CHANGES during the current period, the use of
partners' average capital balances shall be employed.
This method also encourages partners' to contribute
during the year additional investments to the
partnership
3.4.1 Simple Average Capital Method
This method is computed by simply dividing the sum of
the beginning and ending capital by 2.
The simple average capital balances of EVEREN
partnership are computed as follows:
Ren = (P60,000 +P 150,000) / 2 = P 105,000 (105/180)
Eva = (P50,000 + P 100,000) / 2 = P 75,000 ( 75/180) _
Totals P180,000
Ren = (P200,000 x 105/180) = P116,666.67
Eva = (P200,000 x 75/180) = P 33,333.33
3.4.2 Weighted Average Capital Method
This method is also known as "peso-month" or "peso-
day" average capital method. Under this method, the
computation of the average capital considers the period
in which capital contributions have been used in a given
accounting period.
The weighted average capital base on peso months is
computed as follows:
Ren = (P200,000 x 875/1400) = P125,000
Eva = (P200,000 x 525/1400) = P 75,000
Notes:
1. The weighted average capital method should be
assumed in the absences of evidence to the contrary.
Average capital means weighted average unless another
interpretation of average capital is specified in the
agreement
2. The average method is the best alternative compared
to beginning and ending capital methods, because it
provides the most equitable basis for allocating
partnership income.
4. Allowance of Interest on Partner's Capitals
This agreement provides that the cost of money on the
capital contributions ff partners will be added as a profit
sharing device in addition to the P/L ratio agreement
It is based on the philosophy that if the capital
contributions have been invested in other earning
activities such as trading securities the partner should
have realized additional revenue.
The allowance for interest may be computed on the
following bases:
4.1 Interest on Capital Balances
This method allocated first a portion of profit equivalent
to a certain interest rate of the partner's capital
balances. Accordingly, the capital balances should
clearly be defined in the agreement. The remaining
balance of the profit shall be distributed in accordance
with the agreed arbitrary ratio.
4.2 Interest on Excess Investments
This method allows interest in the excess capital
balance of one partner over that of another
5. Salaries or Bonus Allowed for partners' Services
An equitable division of profits and losses frequently
requires that financial consideration be given to the
skills, talents, efforts, and work hours that active
partners devote to the partnership business in addition
to their capital investment. Consequently, salaries
and/or bonus may be given to a partner before the
agreed P/L sharing are to be made.
5.1 Salaries
To recognize personal contribution by the partner to the
business, they may agree to receive salary, and divide
the remaining profit among themselves by the agreed
specified ratio. Except when stated otherwise, salary
allowance are part of the net income/loss allocation to
the partners
5.2 Bonus
A partnership agreement nay provide that a managing
partner be allowed a bonus on the earnings of the
business to encourage PROFIT MAXIMIZATION. The
bonus may computed as follows:
BONUS = Bonus rate % x Base net Income
FINANCIAL REPORTS OF PARTNERSHIPS
Financial statements are a structured representation
with the objective of providing information about the
financial position, financial performance and cash flows
of an entity that is useful to a wide range of users in
making economic decisions. Financial statements also
show the results of the management's stewardship of
the resources entrusted to it.
Overall Considerations
In the same way the financial statements of a sole
proprietorship is prepared, the below are also
considered:
1. Fair Presentation and Compliance with International
Financial Reporting Standards
2. Going Concern Assumption
3. Accrual Basis of Accounting
4. Materiality and Aggregation
5. Offsetting
6. Frequency of Reporting and Comparative Information
7. Consistency of Presentation
8. Identification of the Financial Statements.
Complete Set of Financial Statements
A complete set of financial statements for a partnership
business comprise of the following:
1. Statement of Financial Position
2. Statement of Comprehensive Income
3. Statement of Changes in Partner's Equity (Showing
the total amounts attributable to partIncom
4. Statement of Cash Flows
5. Notes to the Financial Statements
Partnership Dissolution
The dissolution of a partnership is the change in the
relation of the partners caused by any partner ceasing
to be associated in the carrying on of the business.
The change of partners in the partnerships ends their
original agreement, thus terminating the partnership. In
this topic, we will be discussing the causes of dissolution
as follows:
• Admission of New Partner
• Withdrawal, Retirement or death of a Partner
• Insolvency of a partnership or insolvency of
Partner and
• Conversion of the partnership into a
corporation
Admission of a New Partner
Giving due regard to the mutual agency any admission
of a new partner is possible only with the CONSENT OF
ALL the partners.
Technically, the admission of a new partner brings
about a new association of individuals even if the
partnership will not undergo the liquidation process.
Accordingly, the original association has been dissolved
by the common consent resulting n the formation of a
new partnership.
The admission of a new partner can be alternatively
accomplished by two (2) methods, namely:
1. By purchases of Interest of existing partner(s), or
2. By direct investment to partnership
The newly formed partnership may continue to use
either the books of the old partnership or an entirely
new set of books.
Admission by Purchasing a Partner's Interest
An incoming partner may buy a partnership interest
directly from one (1) or more of the current partners.
In this method, a personal transaction is engaged
between the (withdrawing) partner who is selling his
interest and the buying partner (admitted partner). As
such, any gain or loss in the purchase of interest
transaction is a PERSONAL gain or loss of the partner/s
involved.
The selling partner could sell his interest in the
partnership at a amount:
Equal to book value of his interest being sold
Less than the book value of his interest being sold or
More than the book value of his interest being sold
The purchase of interest of existing partner may be a:
Purchase of interest of just one partner or
Purchase of partial interest if all partners
Admission of additional partner(s) by purchase of
interest of existing partner(s) DOES NOT FALL under the
description of a business combination applying the
purchase method as contemplated in IAS/PAS 38
Admission by Direct Investment to the Partnership
This manner of admitting a new partner is a transaction
between the incoming partner and the partnership.
To acquire interest in the partnership, the incoming
partner directly invests cash and.or other non-cash
assets to the partnership, thereby increasing the total
assets of the partnership
The accounting concern in the acquisition of an
incoming partner's interest in the partnership by
investment may be classified in the following situations:
Investment = Capital Credits (interest)
Bonus Method
New Partners' Investment Equals Partner's Individual
Capital Credits
There is no accounting problem in this method of
admitting a new part because all partners will be given a
capital credit exactly the same as their respective asset
contributions to the partnership. The total capital
contributions of the partners are the same as the total
agreed capital of the new partnership.
Bonus Method
Under the bonus method, the TOTAL CONTRIBUTED
CAPITAL is equal to the TOTAL PARTNERSHIP AGREED
CAPITAL BUT some INDIVIDUAL PARTNER's
CONTRIBUTION is not equal to their respective capital
credit because there is a transfer of capital from one
partner to another.
Accordingly, the admission of a new partner will
increase the partnership's total assets with the same
amount of the incoming partner's contribution. The
capital credit to the incoming partner is not equal to his
net assets contribution
Bonus to New Partner
This shows that the new partner's agreed capital credit
is greater than his actual capital contribution
Credit > Contribution
Bonus to Old Partner
This shows that the new partner's agreed capital credit
is lesser than his actual capital contribution. The
difference will be added to the capital credits of the old
partners based on their respective P/L ratio or capital
balances.
Credit < Contribution
Cause for Dissolution - Withdrawal, Retirement or
Death of a Partner
Withdrawal or Retirement of a Partner
By reason of insolvency or incapacity, a partner may
voluntary withdraw or retire from the partnership. He
must obtain the consent of his fellow partners and
determine among them the amount of his capital
refund in the absence of a stipulated amount in the
partnership agreement.
Whenever dissolution is made due to the withdrawal or
retirement of a partner, he may sell his interest to the:
Outside Party,Remaining Partner(s), orPartnership.
Interest is Sold to Outside Party
The withdrawing or retiring partner could sell his
interest to an outsider with the mutual consent of the
remaining partners.
This change in partnership ownership is to be accounted
in the same manner as that of an admission of a new
partner by purchase if interest of an existing partner.
Interest is Sold to Remaining Partners
Instead of selling interest to an outsider, one of the
partners or the remaining partners agree to buy the
interest of the outgoing partner.
Again, this is a personal transaction between a
withdrawing partner and the remaining partner(s). The
personal loss (or gain) of a withdrawing partner in the
transaction should not be recorded in the parnetship's
books. The only concern of the partnership is to transfer
the capital of outgoing partner to the remaining partner
who is interested to buy the outgoing partner's interest.
Interest is Sold to the Partnership
When the capital interest of the withdrawing partner is
purchased by the partnership, it results in the reduction
of the firm's assets (cash or non-cash) accompanied by
cancelllation of the withdrawing partner's capital. n
incoming partner may buy a partnership interest
directly from one (1) or more of the current partners.
The withdrawing partner may receive payment at
• Equal to book value
• Less than the book value
• More than the book value
The accounting procedures commonly used when the
partnership purchased the interest of withdrawing
partner would be;
Adjust the assets of the partnership to their current
FAIR MARKET VALUE (FMV) before accounting for the
retirement of the partner. and
Record the retirement
Dissolution Due to the Death of a Partner
Death is an involuntary termination of one's
participation in the partnership which automatically
dissolves the partnership.
The business activities of the partnership may continue
with the remaining partners and an heir to serve in lieu
of a deceased partner as provided in the partnership
contract
In the absence of an heir to take the deceased partner's
place, the remaining partner may still continue the
business and the deceased partner's equity shall be paid
by the partnership.
The accounting procedures to be used in death of a
partner are basically similar to those of the withdrawal
of a partner. However, if the partnership cannot effect
immediate payment, the following accounting
procedures may be observed:
Determine the deceased partner's profit and loss share
from the beginning of accounting period to the date of
death.
Adjust the capital accounts (include the P/L and asst
valuation as of the time of death)
Close the adjusted capital account of the deceased
partner to the liability account
Accrue the interest on the said recognized liability from
the date of death to the settlement date
Close the liability account at the settlement date.
Insurance on Partner's Lives
In order not to severely impair the working capital and
operation of the business, the partnership may insure
the lives of its partners with the partnership or the
individual partner's heir as the beneficiary.
If the partnership is the beneficiary, the proceeds of life
insurance may be used to pay the estate or heirs of the
deceased partner.
Insolvency of Partnership or a Partner
Insolveny arises when a business (or individual) cannot
pay outstanding debts as they mature.
A person is deemed insolvent when the aggregate of his
property at a far valuation is less in amount that his
total liabilities.
Assets< Liabilities
Common reasons for insolvency are the result of the
following:
Excessive losses from operations
Over-extension of credit customers, or
Excessive investment in inventories or in plant assets
that does generate revenue.
The insolvency of a partner practically dissolves the
partnership because it impairs the mutual agency
principle. The law provides that an insolvent partner
shall have no legal authority to act on behalf of the
partnership and the other partners have no authority to
act for him.
When a partnership becomes insolvent, its remaining
assets are confined to the settlement of its obligations
resulting in its inability to continue normal operations.
Dissolution Procedures when Partnership is Insolvent
The partnership must answer if "Are all general partners
Solvent"?:
if Yes: The General partners must invest additional
amount to pay the outside creditors
if No: The solvent general partner will absorb the
required payment to outside creditors and will have
existing claim against the other general partners.
As a rule, the personal assets of the partners shall first
be applied to their respective personal creditors.
The personal creditors of the general partners have
priority in the claim against the personal assets of the
partners over those of the claims of the partnership
creditors. Therefor, the partnership creditors could run
after the assets of the general partner to the extent of
the latter's remaining assets after his personal creditors
are paid.
Incorporation of a Partnership
As the partnership continues to grow, the partners may
decide to incorporate the business to obtain more
capitalization from public and get hold of other
advantages found in a corporate form of business
organization
If a partnership is incorporated, the partners will
become the stockholders of the corporation. The
corporation then takes over the assets and assumes the
liabilities of the partnership. As a result, the partnership
is dissolved.
At the time of corporation, the assets and liabilities
should be revalued at their fair market values. The
adjustments are allocated to the partner's capital
account based on their P/L ratio.
Partnership Liquidation.
Overview
Nature of Partnership Liquidation
Liquidation is the process of converting all assets of the
business into cash (realization), followed by the final
payments of the creditors' claims and the partners'
capital balances in the Partnership.
This process is usually called the "winding up of
business activities".
It usually happens once the partners decide to end or
terminate business operations after the partnership has
been dissolved.
The dissolution and liquidation of a partnership are not
the same. Dissolution stops the partner's original
association while liquidation converts all non-cash
assets into cash.
Dissolution does not always lead to liquidation while
liquidation is always a result of dissolution.
The liquidation of the partnership must observe the
"principle of equitable distribution of the assets," which
requires the protection of the creditors' and partners'
legal rights.

Accordingly, gains or losses and liquidation expenses, if
any, must be allocated to the partners before actual
cash payments are made to the individual partners.
Failure to consider these factors may result in improper
distribution of assets to partners, which makes the
authorizing partner liable for such distributions.
Further discussion of liquidation will be outlined by the
following subtopics:
Methods of Liquidation
Installment Liquidation
Rules in Settling Accounts After Dissolution
Payment of Partnership Liabilities
This legal doctrine refers to the segregation of assets
owned by the partnership and the personal assets
owned by the several partners. It defines the priority
claims against the assets of the partnership and of the
partners when the partnership and/or one or more of
the partners are insolvent
The partnership's assets are first applies for paying the
debits of the partnership; the excess will be available to
satisfy the claims of the partners over the partnership.
The personal assets of a partner are applied in the
following order of priority:
realization of non-cash assets should be accounted as
follows:
If the partner incurring capital deficiency has loans
receivable from the partnership, he is allowed to
exercise the right of offset.
Under this procedure, the capital deficiency of the
partner would be charged against his receivable from
the partnership.
If, after the exercise of right of offset, there is still
capital deficiency, then the following steps should
follow:
If the partner incurring capital deficiency is a solvent
general partner, he is required to make additional
investment to close his capital deficiencyIf the partner
incurring capital deficiency is a limited partner or
insolvent partner, the other partners would absorb his
capital deficiency
based on their existing P/L ratiosThe available cash of
the partnership undergoing liquidation proceeding
would be distributed according to the following priority:
1) Payment to creditors other than partners
2) Payment of payable to partners
3) Payment of partners' capital

Settlement of debts to personal creditorsSettlement of

debts to partnership creditorsSettlement of obligations
to other partners by way of contribution
Notes:

In accordance with the unlimited liability principle,

general partners are liable to the extent of their
personal assets in satisfying third party creditors
The personal assets of the partners are used first to
settle their personal obligations before these are used
to satisfy the claims of the partnership.

Methods of Liquidation
Lump Sum Liquidation
Under this method, all non-cash assets of the
partnership are first converted into cash before
payments are made to the creditors, the to the
partners.
The payment to the partners is made only once in a
lump sum amount after all the outside creditors has
been paid.
This method is also called "Total Liquidation" or "Simple
Distribution"
Statement of Liquidation
The statement of liquidation is a report that shows the
summary of winding up the affairs of the partnership
including the priority of cash distributions.
It is prepared as the basis of the journal entries which
are needed in recording the liquidation process.
The statement of liquidation would have the following
basic format:

Process observed in Lump Sum Liquidation

The following processes are usually observed in winding

up and recording the lump sum liquidation of the
partnership assets:

Adjustments of accounts and closing of nominal

accountsThe non-cash assets of the partnership are
either:
Sold to 3rd parties orDistributed to the interested
partner at an agreed price to offset his capital
balance.Any gain or loss in the realization process would
be distributed to the partners' capital balances based on
the existing P/L agreement.Any capital deficiency
resulting from the distribution of loss from the
Gain on Realization
There is gain on realization when the non-cash assets of
the partnership are sold at a price more than their
recorded value.
The excess cash received over the recorded value of the
assets is closed to partners' capital according to profit
and loss ratio agreement.
Loss on Realization
There is loss on realization when the non-cash assets of
the partnership are sold at a price lesser than their
recorded value .
The deficit of cash received over the recorded value of
the assets is closed to the partners' capital according to
profit and loss ratio agreement.
A loss on realization usually happens because buyers
are generally willing to buy the partnership's non-cash
assets only if sold at
a price less than its book value since the partnership is
already in its liquidating concern.
Installment Liquidation
This method involves payments to creditors and
partners as proceeds of sale of non-cash assets are
made. Consequently, cash payments to creditors and
partners are on installment basis cash becomes
available.
This method is also called "Piecemeal liquidation"
To guarantee that premature cash distribution to
partners would not result in overpayment, the following
tools are available to direct accurate premature cash
distribution:
1. Safe Payments Schedule
2. Cash Priority Program
Safe Payment Schedule
This statement shows a conservative approach to
liquidation. It is prepared when there is availability of
cash after payment to outside creditors was made. It
indicates how the availability cash should be distributed
to partners.
The preparation of safe payments schedule assumes the
following as possible losses:
Anticipation of all possible liabilities and expected losses
/ expenses to be incurred in the process of liquidation
All unsold non-cash assets will be worthless
The assumed losses are allocated to the partners'
capital balances based on the profit and loss
agreements. This may result in an assumed partner
debit capital balance. The assumed debit capital balance
of a partner is allocated to those partners with credit
balances according to their profit and loss ratio.
The amount of safe payments is the remaining credit
capital balances of partners after allocating the
assumed debit capital balance.
The basic format of the safe payments schedule would
appear as:
*The maximum loss possible may be comprised of the
following items:
Unsold non-cash assets
Estimated liabilities
Expected liquidation expenses
Cash Priority Program
In lieu of safe payment schedule, the other tool to
guarantee that no overpayment will happen in making
premature payments under installment liquidation is
the Predistribution Plan or Cash Priority Program.
The cash priority program will determine the partner to
whom and how much available cash (after payment to
creditors and liquidation expenses are made) shall be
distributed even prior to the total actual realization.
Like the safety payments schedule, the predistribution
plan
Combines the partners' loan balances with their
respective capital
Anticipates all possible liabilities, losses on realization
and liquidation expenses.
In addition, it recognizes that the partner with the
highest rank or ability to absorb anticipated losses will
be the first partner to received safe payments.
It is determined by computing the partner's respective
maximum loss absorption capacity.
The formula in computing the maximum loss absorption
capacity is as follows:
Steps in completing the cash priority program
1. Equalize the absorption capacity of all the partners by
deducting the difference of first priority and second
priority and so on.
2. Determine the amount of priority cash payments by
multiplying the difference with the P/L ratio of the
partner having the highest capacity.
3. When the absorption capacity for all partners
becomes equal to each other, then any succeeding cash
for distribution will be shared based on P/L ratio at this
stage.
In other words, after steps 1 and 2 cash distribution
priority are satisfied, the remaining cash available shall
be distributed according to the partner's profit and loss
ratio. It is because the ratio of the partner's capital
balances becomes equal to their respective profit and
loss ratio.
4. Compute the cash available for distributions
5. Distribute the cash available according to cash
priority program. The balance shall be distributed based
on the P/L ratio.