ADVANCED FINANCIAL ACCOUNTING AND REPORTING

Partnership Accounting: Partnership Formation and Operations (PART I)

COMPREHENSIVE PROBLEM FOR DISCUSSION

Partnership Formation and Operation
Assume that on June 30, 2022, Gerry and Henry, competitors in business decide to consolidate their business to form a partnership to be called
GH Partnership. The statement of financial position of Gerry and Henry on this date are presented below:

Gerry Company
Statement of Financial Position
June 30, 2022

Assets
Cash P5,000,000
Accounts receivable 10,000,000
Merchandise inventory 8,000,000
Furniture and fixtures 6,000,000
Total assets P29,000,000

Liabilities and Equity

Accounts payable P3,000,000
Gerry, capital 26,000,000
Total liabilities and equity P29,000,000

Henry Company
Statement of Financial Position
June 30, 2022

Assets
Cash P4,000,000
Accounts receivable 8,000,000
Merchandise inventory 10,000,000
Furniture and fixtures 9,000,000
Total assets P31,000,000

Liabilities and Equity

Accounts payable P6,000,000
Henry, capital 25,000,000
Total liabilities and equity P31,000,000

The conditions agreed by partners for purposes of determining their interests in the partnership are presented below:
a. 10% of accounts receivable is to be set up as uncollectible in each book
b. Merchandise inventory of Henry is to be increased by P1,000,000
c. The furniture and fixtures of Gerry and Henry are to be depreciated by P600,000 and P900,000, respectively.
d. Prepaid expenses of P550,000 and P250,000 are to be recognized in the books of Gerry and Henry, respectively
a. Accrued expenses of P425,000 and P225,000 are to be recognized in the books of Gerry and Henry, respectively.

The partnership agreement requires that profits and losses be divided as follows:

Gerry Henry
Annual salaries P120,000 P180,000
Interest on average capital balances 9% 12%

Bonus 25% of net income before salaries 10% of net income before
but after interest on capital and interest but after salaries
bonuses and bonuses
Remainder 25% 75%

Net loss for the 2022 amounted to P532,000 while net income for 2023 amounted to P7,436,000. On September 1, 2022, Gerry contributed
additional P300,000 cash for the partnership while Henry made a direct withdrawal of P36,000 (in excess of the specified amount of
withdrawals) on October 1, 2022. On April 1, 2023, Gerry contributed P30,000 worth of inventory while Henry contributed additional cash of
P461,000 on August 1, 2023. Gerry is allowed monthly withdrawal of P2,000 from the business while Henry is allowed P1,000 monthly
withdrawal.

Questions:

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 1. What is the total assets of GH partnership upon formation?
2. What is the total capital of GH partnership upon formation?
3. How much is the interest of Gerry and Henry in 2022?
4. How much is the bonus of Gerry and Henry in 2022?
5. What is the corresponding share in net loss of Gerry and Henry in 2022?
6. How much is the total capital of Gerry and Henry as of December 31, 2022?
7. How much is the interest of Gerry in 2023? Henry’s interest?
8. How much is the bonus of Gerry and Henry in 2023?
9. How much is the share in profits of Gerry and Henry in 2023?
10. How much is the total capital of Gerry and Henry as of December 31, 2023?

Change in Profit and Loss Ratio

Assume that B and C, sharing profits and losses 10% and 90%, respectively, decided to change their ratio to 25% to B and 75% to C. Assume also
that on the date of change, the partnership held land that was carried at cost of P50,000 but had a fair value of P350,000.

Questions:
1. What entry should be made using the first approach?
2. What entry should be made using the second approach?

Assuming the land was sold for P400,000.

3. How will the gain be divided using the first approach?

4. How will the gain be divided using the second approach?

Correction of Prior Period Error

Assume that in 2021, the reported net income of D and E was P100,000 and that partners divide profits and losses, equally. In the year 2022,
they changed the ratio to 60% for D and 40% for E.
During 2022, the following errors in computing the 2012 net income were discovered:
a. Depreciation is understated by P20,000
b. Prepaid expenses of P15,000 was omitted
c. Accrued expenses of P5,000 was omitted
Questions:

1. What is the share of D and E in the 2021 net income before corrections?
2. What is the correct share of D and E in the 2021 net income?
3. How much is the adjustment to D and E capital?
4. What is the adjusting entry to be made in 2022 in relation to the error

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Net loss for the 2022 amounted to P532,000 while net income for 2023 amounted to P7,436,000. On September 1, 2022,
Gerry contributed additional P300,000 cash for the partnership while Henry made a direct withdrawal of P36,000 (in excess
of the specified amount of withdrawals) on October 1, 2022. On April 1, 2023, Gerry contributed P30,000 worth of inventory
while Henry contributed additional cash of P461,000 on August 1, 2023. Gerry is allowed monthly withdrawal of P2,000 from
the business while Henry is allowed P1,000 monthly withdrawal.

Questions:
11. What is the total assets of GH partnership upon formation?
12. What is the total capital of GH partnership upon formation?
13. How much is the interest of Gerry and Henry in 2022?
14. How much is the bonus of Gerry and Henry in 2022?
15. What is the corresponding share in net loss of Gerry and Henry in 2022?
16. How much is the total capital of Gerry and Henry as of December 31, 2022?
17. How much is the interest of Gerry in 2023? Henry’s interest?
18. How much is the bonus of Gerry and Henry in 2023?
19. How much is the share in profits of Gerry and Henry in 2023?
20. How much is the total capital of Gerry and Henry as of December 31, 2023?

Change in Profit and Loss Ratio

Assume that B and C, sharing profits and losses 10% and 90%, respectively, decided to change their ratio to 25% to B and 75%
to C. Assume also that on the date of change, the partnership held land that was carried at cost of P50,000 but had a fair
value of P350,000.

Questions:
5. What entry should be made using the first approach?
6. What entry should be made using the second approach?

Assuming the land was sold for P400,000.

7. How will the gain be divided using the first approach?

8. How will the gain be divided using the second approach?

Correction of Prior Period Error

Assume that in 2021, the reported net income of D and E was P100,000 and that partners divide profits and losses, equally. In
the year 2022, they changed the ratio to 60% for D and 40% for E.
During 2022, the following errors in computing the 2012 net income were discovered:
d. Depreciation is understated by P20,000
e. Prepaid expenses of P15,000 was omitted
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f. Accrued expenses of P5,000 was omitted

Questions:
5. What is the share of D and E in the 2021 net income before corrections?
6. What is the correct share of D and E in the 2021 net income?
7. How much is the adjustment to D and E capital?
8. What is the adjusting entry to be made in 2022 in relation to the error?
MULTIPLE CHOICE QUESTIONS
A. THEORIES
1. A partner’s withdrawal of assets from a partnership that is considered a permanent reduction in the partner’s equity
is debited to the partner’s:
a. Drawing account
b. Retained earnings account
c. Capital account
d. Loan receivable account
2. The partner’s drawing accounts are used:
a. To record the partner’s salaries
b. To reduce the partner’s capital account balances at the end of the period
c. In the same manner as the partners’ loan accounts
d. To record the partners’ share of net income or loss for an accounting period
3. A partner’s drawing account is
a. An expense account
b. A capital account
c. A contra-capital account
d. A liability account
4. A partnership is an association of two or more persons who carry on as owners of a business for profit. The persons
who form the partnership may be:
I. Individuals
II. Corporations
III. Fraternal nonprofit organization
a. I only
b. I and III
c. I, II and III
d. I and II
5. A partnership is a (an): I. Accounting entity
II. Taxable entity

a. I only
b. II only
c. Neither I or II
d. Both I and II
6. Partner X contributed equipment to the XYZ partnership. The equipment cost, P60,000 with accumulated
depreciation of P10,000 but had a fair value of P70,000 at the date the partnership received it. At what amount
should the equipment be reported?
a. P70,000
b. P60,000
c. P10,000
d. P50,000
7. Which of the following accounts can be found in the MN partnerships’ general ledger?
I. Receivable from M
II. M drawing
III. M loan

a. I only
b. I and II
c. I, II and III

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 d. II and III
8. Which of the following statement about partnership accounts is true?
a. Two accounts are generally maintained for each partner, a drawing account and a capital account
b. The drawing account is credited with the partner’s withdrawals of cash or other assets during the period
c. Answer (a) is correct but (b) is false.
d. Answer (a), (b) and (c) are all correct.
9. Partner’s interest in a partnership is generally equal to:
a. The fair value of net assets at date of contribution
b. The sum of the fair values of the assets the partner contributes to the firm, increased by any liabilities of
other partners assumed and decreased by any personal liabilities that are assumed by other partners
c. The sum of the bases of the individual assets the partner contributes to the firm, decreased by the partner’s
share of partnership liabilities.
d. The unamortized cost of the assets to the partner
10. Which of the following statements, concerning partnership is true?
a. A partnership is a legal entity, separate and distinct from the individual partners
b. Individual partners are jointly liable for the debts and obligations of a partnership
c. Income tax is levied on the individual partners’ shares of the net income of a partnership and is reported in
their personal tax returns.
d. All of the above is true.
11. On July 1, 2012, Long and Short formed a partnership. Long contributed cash. Short, previously a sole proprietor,
contributed property other than cash, including realty subject to a mortgage, which the partnership assumed. Short’s
capital account of July 1, 2012, should be recorded at:
a. Short’s book value of the property at July 1, 2012
b. Short’s book value of the property less mortgage payable at July 1, 2012
c. The fair value of the property less the mortgage payable at July 1, 2012
d. The fair value of the property at July 1, 2022
12. A partnership is formed by two individuals who were previously sole proprietors. Property other than cash that is part
of the initial investment in the partnership is recorded for financial accounting purposes at the:
a. Proprietor’s book values or the fair value of the property at the date of the investment, whichever is higher.
b. Proprietor’s book values or the fair value of the property at the date of the investment, whichever is lower.
c. Proprietor’s book values of the property at the date of investment.
d. Fair value of the property at the date of the investment.
13. On April 30, 2022, A, B and C formed a partnership by combining their separate business proprietorships. A
contributed P50,000 cash, B contributed property with a P36,000 book value, a P40,000 original cost, and P80,000 fair
value. The partnership assumed the P35,000 mortgage attached to the property. C contributed equipment with a
P30,000 carrying amount, a P75,000
original cost, and P55,000 fair value. The partnership agreement specifies that profits and losses are to be shared
equally but is silent regarding capital contributions.

Which partner has the largest April 30, 2022, capital account balance?
a. A
b. B
c. C
d. All capital account balances are equal
14. The partnership contract provides that “net income or losses are to be distributed in the ratio of partner’s capital
account balances.” The appropriate interpretation of this provision is that net income or losses should be distributed
in:
a. The ratio of beginning capital account balances
b. The ratio of average capital account balances
c. The ratio of ending capital account balances
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 d. The ratio of original capital account balances
15. Salaries to partners of a partnership typically should be accounted for as:
a. A device for sharing net income
b. An operating expense of the partnership
c. Drawings by the partners from the partnership
d. Reductions of the partners’ capital account balances 16. Which of the following is an expense of a
partnership?
a. Interest on partners’ capital account balances
b. Interest on loans from partners to the partnership
c. Both a and b
d. Neither a nor b
17. A partners’ withdrawal of assets from a partnership that is considered a permanent reduction in that partners’ equity
is debited to the partners’:
a. Drawing accounts
b. Retained earnings account
c. Capital account
d. Loan receivable account
18. The partners’ drawing accounts are used:
a. To record the partners’ salaries
b. To reduce the partners’ capital account balances at the end of an accounting period
c. In the same manner as the partners’ loan accounts
d. To record the partners’ share of net income or loss for an accounting period
19. The allocation of an error should be based on the profit and loss ratio in effect when:
a. The error was made
b. The error was corrected
c. The error was discovered
d. The allocation should always be made equally
20. If there is a provision for division of profits but not losses in the partnership agreement, it is concluded that:
a. Losses should not be divided to the capital accounts, but matched against future earnings
b. Losses should be divided using the same approach as division of profits
c. Losses should be divided equally
d. Losses should be allocated according to the ratio of capital account balances
21. Partners X and Y share profit in a 2:1 ratio, respectively. Each partner receives an annual salary allowance of P60,000. If the salaries
are recorded in the accounts as a partnership expense
rather than treated as a division of net income, the total amount allocated to each partner for salaries and net income would be:
a. Less for both X and Y
b. Unchanged for both X and Y
c. More for X and less for Y
d. More for Y and less for X
22. Under what circumstance can the closing of the income summary account result in a debit to one partners’ capital account and
credits to the other partners’ capital accounts?
a. The results of operations divided in a profit and loss ratio and the partnership sustained a loss for the period
b. The result of operations are allocated in a profit or loss ratio and the partnership’s net income was very low
c. The results of operations are divided in the average capital ratio and one partner had a low capital balance
d. The partnership agreement provides for interest on capital and salary allowances and net income is less than the sum of
the interest and salary allowances.
23. If the partnership agreement provides for the division of losses only. Profits should be divided: a. Equally
b. According to beginning capital ratio
c. According to ending capital ratio
d. According to average capital ratio

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B. COMPUTATIONAL
For numbers 1-2
1. Charles and Henry decided to combine their businesses and form a partnership. Below are their statements of financial
position before the formation:

Charles Henry
Cash P2,048,400 P1,098,360
Accounts receivable 1,031,960 2,498,716
Inventories 528,160 1,144,448
Property and equipment – net 613,380 852,224
Other assets 8,800 15,840
TOTAL ASSETS P4,230,700 P5,609,588

Accounts payable P787,336 P1,072,600

Notes payable 1,000,000 –
Mortgage payable – 1,440,000
Charles, capital 2,443,364 –
Henry, capital – 3,097,528
TOTAL LIABILITIES AND EQUITY P4,230,700 P5,609,588

The partners agreed that the property and equipment of Charles is under-depreciated by P80,000 and that of Henry is
over-depreciated by P200,000. Accounts receivable of P108,000 in Charles’ book and P140,000 in Henry’s book are
uncollectible. The partnership decided to assume the mortgage liability of Henry. The partnership’s agreement
provides for a profit and loss ratio and capital interest of 60% to Charles and 40% to Henty. Henry is willing to invest
or withdraw cash from the partnership to comply with the agreement.

What are the capital balances of Charles and Henry after the formation? a. P2,255,353
and P1,503,576, respectively
b. P2,255,364 and P3,157,528, respectively
c. P6,896,292 and P4,597,528, respectively
d. P6,896,292 and P3,157,528, respectively

2. Using the data in number 1, what is the total assets of the partnership after the formation: a. P8,058,336
b. P5,618,336
c. P6,618,336
d. P9,840,288

3. Cielo and Nova sole proprietorships decided to form a partnership on June 1, 2022. The partnership will take over
their assets and assume their liabilities. As of June 1, 2022, the net assets of Cielo and Nova are P220,000 and
P309,375, respectively. The partners agreed on a 25:75 profit and loss ratio. Furthermore, the partners arrive on
the following agreements to revalue their assets and liabilities:
a. Cielo’s inventory is undervalued by P11,000
b. An allowance for doubtful account is to be set up in the books of Cielo and Nova in the amount of P2,750
and P4,125, respectively.
c. Accrued expenses of P20,250 was not recognized in Nova’s books.

How much cash should Cielo invest (withdraw) so that their capital interest would be equal to their profit and loss
ratio?
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a. (P133,250)
b. (P95,000)
c. P133,250
d. P95,000

For numbers 4-5

4. On June 30, 2022, Kenvi and Roe formed a partnership with each contributing the following assets:
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 Kenvi Roe
Book value Fair value Book value Fair value
Cash P375,000 P375,000 P875,000 P875,000
Office Equipment 350,000 312,000 872,500 937,500
Building – net – – 3,262,500 2,812,500
Furniture and Fixtures 95,000 125,000 – –

The building is subject to a mortgage loan of P1,125,000 which is to be assumed by the partnership. The partnership
agreement provides that Kenvi and Roe share profits and losses in the ratio of 30% and 70%, respectively. Assuming
that the partners agreed to bring their respective capital in proportion to their profit and loss ratio, and using Roe
capital as the base:

What is the capital account of Roe on June 30, 2022? a. P3,500,000

b. P4,000,000
c. P3,937,500
d. P3,837,500

5. How much is the additional cash to be invested by Eden?

a. P2,687,500
b. P2,587,000
c. P688,000
d. P680,000

6. C admits D for a partnership interest in his business. The statement of financial position of Cortez on November 30,
2022 prior to admission of D show the following:

Debit Credit
Cash P?
Accounts receivable 96,000
Merchandise inventory 144,000 Accounts payable P49,600
C, capital ?

It is agreed that for purposes of establishing C’s interest, the following adjustments should be made:
a. An allowance for doubtful accounts of 2% of accounts receivable is to be established.
b. The merchandise inventory is to be valued at P160,000
c. Prepaid expenses of P5,200 and accrued expenses of P3,200 are to be recognized.

D invested cash of P113,640 to give him a one-third interest in the total capital of the form. What is the capital
balance of C before the admission of D?
a. P227,280
b. P230,120
c. P211,200
d. P250,500

7. On September 30, 2022, Sheila admits Mendez for an interest in her business. On this date Sheila’s capital account
shows a balance of P158,400. The following were agreed upon before the formation of the partnership:

a. Prepaid expenses of P17,500 and accrued expenses of P5,000 are to be recognized

b. 5% of the outstanding accounts receivable of Sheila amounting to P100,000 is to be recognized as
uncollectibles
c. Mendez is to be credited a one-third interest in the partnership and is to invest cash aside from the P50,000
worth of merchandise.

The amount of cash to be invested by Mendez and the total capital of the partnership are: a. P32,950 and
P248,850, respectively

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 b. P55,300 and P221,200, respectively
c. P82,950 and P248,850, respectively
d. P32,950 and P171,200, respectively

8. As of July 1, 2022, Peter and Patrick decided to form a partnership. Their statement of financial position on this date
are:

Peter Patrick
Cash P1,500 P3,750
Accounts receivable 54,000 22,500
Merchandise inventory – 20,250
Machinery and equipment 15,000 27,000

TOTAL P70,500 P73,500

Accounts payable P13,500 P24,000

Peter, capital 57,000 –
Patrick, capital – 49,500
TOTAL P70,500 P73,500

The partners agreed that the machinery and equipment of Peter is under-depreciated by P1,500 and that of Patrick
by P4,500. Allowance for doubtful accounts is to be set up amounting to P12,000 for Peter and P4,500 for Patrick.
The partnership agreement provides for a profit and loss ratio and capital interest of 60% to Peter and 40% to
Patrick. How much cash must Peter invest to bring the partner’s capital balances proportionate to their profit and
loss ratio? a. P14,250
b. P5,250
c. P17,250
d. P10,250

9. Claire and Ciara are partners operating a grocery store. Their partnership agreement requires that profits and losses be
divided as follows:

Claire Ciara
Salaries P20,000 None
Commission on gross sales None 2%
Interest on average capital balances 8% 8%

Bonus 20% of net income before None

commission, and interest but after
salaries and bonus
Remainder 60% 40%

Gross sales for 2013 were P1,250,000. Income before deducting amounts for salary, commission, interest, and bonus
were P200,000. Average capital balances of Claire and Ciara are P400,000 and P420,000, respectively. What are the
profit share of Claire and Ciara, respectively?

a. P117,640 and P82,360

b. P35,460 and P23,760
c. P110,640 and P89,360
d. P117,460 and P82,540

For numbers 10-11

10. Tiger and Woods are partners operating a chain of retail stores. The partnership agreement in dividing profits and
losses provides for the following:
 S, Capital P110,000
T, Capital 80,000
U, Capital 110,000
Tiger Woods
Salaries P64,000 P100,000
Interest on average capital balances 10% 10%

Bonus 25% of net income before salaries None

and bonus but after interest on
capital
Remainder 30% 70%

The Income Summary account for the year 2022 shows a credit balance of P360,000 before any allocations. Average
capital balances for Tiger and Woods are P240,000 and P300,000, respectively. Capital balances before closing of the
profit for the period amounted to P225,000 and P295,000 for Tiger and Woods, respectively. How much profit share
would Tiger be entitled to receive?

a. P184,150
b. P181,300
c. P175,850
d. P42,700

11. After the allocation and closing of profit share, how much is the capital balance of Woods? a. P470,850
b. P479,150
c. P409,150
d. P400,850

For numbers 12-13

12. S and T formed a partnership in 2022 to operate a bookstore. Susan contributed the initial capital while T managed
the business. With the assistance of their accountant, they wrote an Articles of Partnership agreement that contains
the following provisions:

a. Each partner is allowed to draw P1,000 in cash from the business every month. Any withdrawal in excess of that
figure will be accounted for as a direct reduction to the partners’ capital balance.
b. Partnership profits and losses will be allocated each year according to the following plan:
i. Interest of 15% will be accrued by each partner based on the monthly average capital balance for
the year (computed without regard for normal drawings or current income)
ii. As the managing partner, T is to receive credit for a bonus equal to 20% of the year’s net income.
iii. Any remaining profit or loss will be divided equally between the two partners.

S and T begin the year 2022 with capital balances of P150,000 and P30,000, respectively. On April 1, of that year, S
invests an additional P8,000 cash in the business, while on July 1, T withdraws P6,000 in excess of the specified
drawing allowance. The partnership reports net income of P30,000 for 2022.

The capital balances of the partners as of December 31, 2022 for S and T, respectively are: a. P167,675 and
P20,325
b. P155,675 and P26,325
c. P179,675 and P32,325
d. P159,675 and P22,325

13. How much is the share of S and T, respectively in the net income for the year?
a. P27,675 and P1,325
b. P21,675 and P8,325
c. P22,050 and P7,950
d. P28,050 and P1,950

For number 14-21

14. A partnership begins its first year of operations with the following capital balances:

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 According to the partnership agreement, all profits will be distributed as follows:
• S will be allowed an annual salary of P20,000 with P10,000 assigned to U.
• The partners will be allocated with interest equal to 10% of the capital balances as of the first day of the year.
• The remainder will be divided on a 5:2:3 basis, respectively.
• Each partner is allowed to withdraw up to 10,000 per year.

Assume that the net loss for the first year of operations is P20,000 with net income of P40,000 in the subsequent
year. Assume further that each partner withdraws the maximum amount from the business each period. What is the
balance in S’s capital account at the end of the second year? a. P102,600
b. P104,400
c. P108,600
d. P109,200

15. What is the share of each partner in the net loss of the first year?
a. S: P10,000, T: P9,000, U: P1,000
b. S: P9,000, T: P8,000, U: P3,000
c. S: P8,000, T: P9,000, U: P3,000
d. S: P9,000, T, P10,000, U: P1,000

16. How much is the capital of the partners as of the end of the first year?
a. S: P101,000, T: P72,000, U: P107,000
b. S: P92,000, T: P72,000, U: P109,000
c. S: P91,000, T: P62,000, U: P97,000
d. S: P62,000, T, P101,000, U: P107,000

17. How much is the share of each partner in the net income of the second year?
a. S: P26,100, T: P2,300, U: P11,600
b. S: P22,600, T: P4,200, U: P13,200
c. S: P20,000, T: P8,000, U: P12,000
d. S: P21,600, T, P3,200, U: P15,200

18. How much is the capital of T at the end of second year?

a. P102,600
b. P55,200
c. P102,200
d. P65,200

19. Assuming that bonus is being provided to T computed at 10% of net income after salaries, interest and bonus. Net
loss before allocation in the first year is P20,000 while net income before allocations in the second year is P90,000.
What is the share in loss of T in the first year? a. P10,000
b. P9,000
c. P8,000
d. P3,000

20. Continuing assumptions in number 19, how much is the share in profit of T in the second year? a. P45,009
b. P15,746
c. P29,245
d. P8,000

21. Continuing assumptions in number 19, how much is the capital of T in the first and second year, respectively?
a. P91,000 and P126,009
b. P97,000 and P116,245
c. P62,000 and P67,747
d. P62,000 and P69,747