Partnership Formation and Operation

PARTNERSHIP
FORMATION AND
OPERATION
Youth on the Rock | Partnership Accounting
Objectives of this lecture
PARTNERSHIP
Its definition,
characteristics, kinds,
and classes of partners.

Definition of Partnership
PARTNERSHIP is a contract whereby two or more

persons bind themselves to contribute money,
property, or industry into a common fund with the
intention of dividing profits among themselves.
(Article 1767 of the Civil Code of the Philippines)

Characteristics of Partnership
Legal Entity Income Tax Mutual Agency Limited Time
Co-ownership of Unlimited Mutual

contributed assets Liability Participation in
Profits
Kinds of Partnership
As to Activity As to Publicity
Secret Partnership
Trading
Open Partnership
Non-Trading
As to Liability As to Duration
General Co-partnership Partneship at Will
Limited Partnership Partnership with A Fixed Term

Kinds of Partnership
As to Legality
As to Object
of Existence
Universal Partnership of All Present Properties
De Jure Partnership
Universal Partnership of All Profit
De Facto Partnership
Particular Partnership
As to representation to others
Ordinary Partnership
Partnership by Estoppel

Classes of Partners
As to Contribution As to Management
Managing partners
Capitalist partner
Silent partners
Industrial partner
Capitalist-Industrialist partner
As to Liability
General partners
Limited partners

Classes of Partners
Other
Classifications
Liquidating partner
Nominal partner
Ostensible partner
Secret partner
Dormant partner

PARTNERSHIP
How to form a partnership?

Partnership Formation
Money Property Industry

Recorded at Recorded at Memorandum
Face Value Agreed Value or at Entry
Fair Market Value
(FMV)

Application Time!
Different Scenarios of the Partnership Formation

Scenarios 1:
Two or more partners form a partnership for the first time.
Asta and Yuno agreed to form a partnership to be

known as Black Clover Co. The entries to record the
transactions are as follows:

Assumption 1 – Cash Contributions
A. Each partner invested P500,000 cash for an equal interest in the partnership.
Cash 1,000,000
Asta Capital 500,000
Yuno Capital 500,000
B. Asta invested P250,000 cash for one-fourth interest in the partnership.

Cash 1,000,000
Total Capital; 250,000/1*4 = 1,000,000

Total Capital (1,000,000) – Asta Capital (250,000) = Yuno Capital (750,000)

Assumption 2 – Cash and Non-cash Contributions
Asta contributed Cash of P140,000 and Inventories costing P150,000 with agreed
value of P160,000. Yuno contributed Machinery costing P200,000 with
Accumulated Depreciation of P55,000 and agreed value of P150,000, for one-third
interest.
Cash 140,000
Inventories 160,000
Machinery 150,000
Total Capital = 450,000
Yuno Capital; 150,000/450,000 = 1/3 interest

Assumption 3 – Cash, Non-cash Assets and Industry
Asta contributed Cash of P50,000; Accounts Receivable of P225,000 with Allowance for
Uncollectible Accounts of P75,000 and Machinery costing P230,000 with Accumulated
Depreciation of P40,000 and agreed value of P200,000. Yuno is an industrial partner to
contribute his special skills and talents to the partnership for a one-third interest.
Cash 50,000
Accounts Receivable 225,000
Machinery 200,000
Allowance for Uncollectible Accounts 75,000
Yuno is to contribute his services to the partnership for one third interest.

Important Points:
1. Non-cash assets contributed are recorded in the books at

their agreed values or fair market value at the time of
contribution.
2. No Accumulated Depreciation is recorded in the
partnership books.
3. The Allowance for Uncollectible Accounts is carried in the
partnership because of the possibility of collection.

Important Points:
If one or two or all partners are former sole proprietors..
1. Open new set of books; or

2. Continue using the books of one of the sole proprietors, noting
the following:
a. Adjust the books of the sole proprietor which will be used
as partnership books, and
b. Record the investment of the new partner(s).

Scenarios 2:
An individual or a sole proprietor or two or more sole proprietors
form a partnership.
Akaashi and Bokuto, both sole proprietors agreed

to form a partnership to be known as Fukurodani
Co. Account balances per ledger and the respective
agreed balances are as follows:

Assumption 1 – New set of books

a. To record the contribution of Akaashi
Cash 150,000
Inventories 137,000
Equipment 150,000
Accounts Payable 100,000
Akaashi Capital 437,000
b. To record the contribution of Bokuto

Cash 140,000
Inventories 130,000
Equipment 175,000
Bokuto Capital 390,000

Assumption 2 – Books of Akaashi will be used by the new partnership

a. To record the adjustments on the books of Akaashi
Inventories 2,000
Accumulated Depreciation 60,000
Akaashi Capital 78,000
Equipment 150,000
b. To record the investment of Bokuto

Cash 140,000
Inventories 130,000
Equipment 175,000
Bokuto Capital 390,000

Important Points:
1. The capital account is debited or credited for any increase

or decrease in the value of assets.
2. The sole proprietors can contribute their assets and

liabilities to the newly formed partnership upon formation
and recording the contributions at agreed values or fair
market values.

CAPITAL SHARE
DIFFERENT FROM
CAPITAL CONTRIBUTION
Capital share is the percentage of
equity that each partner will have in
the net assets of the newly formed
partnership.
Approaches on recording capital share:
Full Investment Approach or Bonus Approach
Oikawa and Iwaizumi agreed to divide initial

partnership capital equally even though Oikawa
contributed P300,000 while Iwaizumi contributed
P200,000 cash into the partnership. Journal entries
to record the investment of the partners under two
approaches are as follows:

a. Full investment approach
Cash 500,000
Oikawa Capital 300,000
Iwaizumi Capital 200,000
b. Bonus approach
Cash 500,000
Oikawa Capital 250,000
Iwaizumi Capital 250,000
PARTNERSHIP
Operations, part 1
Closing entries and the division
of profits and losses
Reminders:
1. Non-cash assets contributed are recorded in the books at
their agreed values or fair market value at the time of
contribution.
2. Upon formation, no Accumulated Depreciation is recorded

in the partnership books.
3. The Allowance for Uncollectible Accounts is carried in the

partnership because of the possibility of collection.

Reminders:
4. The capital account is debited or credited for any increase

or decrease in the value of assets.
5. The sole proprietors can contribute their assets and

liabilities to the newly formed partnership upon formation
and recording the contributions at agreed values or fair
market values.

Closing Entries of a Partnership
Partnership Profit
Income Summary XXX
Juan, Drawing XXX
Cruz, Drawing XXX
Partnership Loss
Juan, Drawing XXX
Cruz, Drawing XXX
Income Summary XXX

Closing Entries of a Partnership
Partnership Profit
Income Summary 480,000
Juan, Capital 240,000
Cruz, Capital 240,000
Partnership Loss

Division of Profits and Losses
Services rendered Amount of Capital Entrepreneurial

by the partners Contributed Ability
Salaries are given to partners Interest on capital Bonus is allowed to
proportionate to time contribution is allowed to partners when the
devoted to the organization. each partner. partnership realizes profits.

Division of Profits and Lossess
The profit or loss division of the partners may be expressed in
terms of Percentages, Fractions, Decimals, or even Ratio,
Chan and Cristine are partners sharing profits and losses based on
their capital contributions of P600,000 and P400,000, respectively.
Their profit and loss sharing can be expressed as follows:
Partner Percentage Fraction Decimal Ratio

Chan 60% 6/10 0.60 6:10
Cristine 40% 4/10 0.40 4:10

Rules for Dividing Profits and Losses
As to Capitalist Partners
Division of Profits Division of Losses

1. In accordance with agreement 1. In accordance with agreement
2. In accordance with capital 2. If only the division of profits is
contribution agreed upon, division of losses
will follow the same proportion
3. In accordance with capital
contribution

Rules for Dividing Profits and Losses
As to Industrial Partners
Division of Profits Division of Losses

1. In accordance with agreement 1. In accordance with agreement
2. In the absence of agreement: 2. In the absence of agreement
a. Industrial partner – Just for Capitalist-industrial partner:
and equitable share of the a. No share in losses as an
profits industrial partner
b. Capitalist partner – In b. Share in proportion to
accordance with capital capital contribution as a
contribution capitalist partner.

PARTNERSHIP
Operations, part 2
Methods of distributing profits based on
partners’ agreement
Methods of Distributing Profits based on the
Partners’ Agreement
Equally Arbitrary Ratio Capital Ratios
Things to consider before the Distribution of Profits and Losses
Interest on Capital Salary Allowances Bonus to

to partners managing partners

Application Time!
Different Scenarios of the Partnership Distribution of Profits and Losses

Illustration
JC Enterprises realized a profit of P480,000 for the year. Changes in capital
accounts of the partners during the year are as follows:
Juan, Capital Jan. 1 Balance P1,000,000

Apr 1 Additional Investment 100,000
May 1 Withdrawal 40,000
Oct. 1 Additional investment 200,000
Cruz, Capital Jan. 1 Balance P600,000

June 1 Withdrawal 60,000
Sept. 1 Additional investment 200,000
Dec. 1 Withdrawal 20,000

Assumption 1 – Profit is divided equally
Computation: P480,000/2 = P240,000
Assumption 2 – Profit is divided in the ratio of 3:2

Computation: P480,000 x 3/5 = P288,000
P480,000 x 2/5 = P192,000

Assumption 3 – Profit is divided 55% to Juan and 45% to Cruz
Computation: P480,000 X 55% = P264,000
P480,000 X 45% = P216,000
Assumption 4 – Profit is divided according to beginning capital ratio

Computation: P480,000 x 1M/1.6M= P300,000
P480,000 x 600k/1.6M = P180,000

Assumption 5 – Profit is divided according to average capital ratio
Computation: P480,000 X 1,098,333/1,728,333 = P305,034
P480,000 X 630,000/1,728,333 = P174,966
Juan, Capital Cruz, Capital

Jan. 1 – Mar. 31 (P1,000,000 x 3) P3,000,000 Jan. 1 – May 31 (P600,000 x 3) P3,000,000
Apr. 1 – Apr. 30 (P1,100,000 x 1) 1,100,000 Jun. 1 – Aug. 31 (P540,000 x 3) 1,620,000
May 1 – Sept. 30 (P1,060,000 x 5) 5,300,000 Sept. 1 – Nov. 30 (P740,000 x 3) 2,220,000
Oct .1 – Dec. 31 (P1,260,000 x 3) 3,780,000 Dec. 1 – Dec. 31 (P720,000 x 1) 720,000
Total P13,180,000 Total P7,560,000
Average capital (Total ÷ 12) 1,098,333 Average capital (Total ÷ 12) 630,000

Interest on Capital
Interest shall be provided whether the profit is sufficient
or insufficient or there is net loss unless otherwise
agreed upon by the partners.

Assumption 6 – Each partner is allowed 10% interest on ending capital and
the remaining profit is divided equally.
Juan Cruz Total

Interest on ending capital:
P1,260,000 x 10% P126,000
P720,000 x 10% P72,000 P198,000
Remainder equally (P282,000/2) 141,000 141,000 282,000
Net Profit P267,000 P213,000 P480,000

Salaries
Salaries shall be provided whether there is profit or loss
or in case of profit, whether it is sufficient or not, unless
otherwise agreed upon by the partners.

Assumption 7 – Cruz is allowed salaries of P300,000 and the remaining profit
is divided in the ratio 4:1
Juan Cruz Total

Salaries to Cruz P300,000 P300,000
Remainder – 4:1
P180,000 x 4/5 P144,000
P180,000 x 1/5 36,000
Net Profit P144,000 P336,000 P480,000

Bonus
Bonus based on profit before deducting bonus and income tax.
Bonus based on profit after deducting bonus but before deducting income tax.
Bonus based on profit before deducting bonus but after deducting income tax.
Bonus based on profit after deducting bonus and income tax.

Assumption 8 – Cruz, the managing partner, is allowed a bonus of 20% of
profit BEFORE bonus and income tax. The remainder divided equally.
Juan Cruz Total

Bonus to Cruz
P685,714 x 20% P137,142 P137,142
(P480,000 ÷ 70%)
Remainder - equally 171,429 171,429 342,858
Net Profit P171,429 P308,571 P480,000

Other assumptions on the computation of bonus (using Assumption 8
-Cruz, the managing partner, is allowed a bonus of 20% of profit)
a. The bonus is based on profit AFTER deduction for bonus but BEFORE
deduction of income tax
B = 0.20 (P 685,714 – B)
B = P 137,143–0.20B
B + 0.20B = P 137,143
1.20B = P 137,143
B = P 137,143 ÷ 1.20
B = P 114,286

-Cruz, the managing partner, is allowed a bonus of 20% of profit
b. The bonus is based on profit BEFORE deduction for bonus but AFTER
deduction of income tax
B = 0.20 (P 685,714 – T) T = 0.30 (P 685,714)

B = 0.20 (P 685,714 – P 205,714) T = P 205,714
B = 0.20 (P 480,000)
B = P 96,000

-Cruz, the managing partner, is allowed a bonus of 20% of profit
c. The bonus is based on profit AFTER deduction for bonus and

income tax
B = 0.20 (P 685,714 – B - T)
B = 0.20 (P 685,714 – B – P 205,714) B + 0.20B = P 96,000
B = 0.20 (P 480,000 – B) 1.2B = P 96,000
B = P 96,000 – 0.20B B = P 96,000 ÷ 1.20
B = P 80,000

Order of
Profit Sharing Provision

Assumption 9 – The partnership agreement provides salaries of P200,000 and
P100,000 to Juan and Cruz, respectively; 10% interest on ending capital; 20%
bonus to managing partner Cruz if the net profit is sufficient; and the balance
will be divided equally.
Juan Cruz Total

Interest on ending capital 126,000 72,000 198,000
Salaries 200,000 100,000 300,000
Bonus to Cruz - -
Remainder – equally (9,000) (9,000) (18,000)
Net Profit P317,000 P163,000 P480,000

Order of
Priority Provision

Assumption 10 – The partnership agreement provides salaries of P200,000 and
P100,000 to Juan and Cruz, respectively; 10% interest on ending capital; and the
balance will be divided equally. Profit is to be allocated by first giving priority to
interest on invested capital and then on salary allowance.
Juan Cruz Total
Interest on ending capital 126,000 72,000 198,000
Salaries (ratio of 2:1) 188,000 94,000 282,000
Net Profit P317,000 P163,000 P480,000

Reminders:
1. Interest allowed to partners is proportionate to the period
the capital is invested into the business.
2. Salaries allowed to partners is proportionate to the period

the partners’ rendered service to the firm.
3. Bonus is computed on the basis of “partnership net profit”. In

such case, no bonus is allowed if there is insufficient profit
after the distribution of interest and salaries.

PARTNERSHIP
Operations, part 3
Corrections in net profit prior to
distribution
Capital Ratio Adjusted to Profit
or Loss Ratio

Correction in Net Profit prior to distribution
Errors Omissions

Corrections to profit of the current
year for errors made in
Prior year Current year
1. Unrecorded prepaid expenses - +
2. Unrecorded accrued expenses + -
3. Unrecorded accrued income - +
4. Unrecorded unearned income + -
5. Overstatement of inventories + -
6. Understatement of inventories - +
7. Overstatement of purchases - +
8. Understatement of purchases + -
9. Overstatement of depreciation none +
10. Understatement of depreciation none -

Illustration
Sun Woo, Jung Hwan and Choi Taek are partners sharing profits on a 2:3:5 ratio. On
January 1, 1988, Deok Sun was admitted with 20% share in profits. The old partners shall
continue to participate in profits in proportion to their original ratios.
For the year 1988, the partnership books showed profit of P1,592,000. However, the
following errors were made.
1. Accrued expenses not recorded in 1987 20,000
2. Overstatement of 1988 ending inventory 192,000
3. Goods received and inventoried in 1988 but the related
purchases were not recorded 80,000
4. Income received in advance, not recorded at the end of 1987 40,000
5. Prepaid expenses not recorded at the end of 1987 12,000

Accrued expenses not recorded in 1987 20,000
Income received in advance, not recorded
at the end of 1987 40,000 P 60,000
Unrecorded purchases of 1988 80,000
Unrecorded prepaid expenses of 1987 12,000
Overstatement of 1988 ending inventory 192,000 (284,000)
(P224,000)
X 70%
Net adjustment after tax (P156,800)
Reported profit 1,592,000
Corrected profit P1,435,200

New profit and loss ratios:
Sun Woo 20% x 80% 16%
Jung Hwan 30% x 80% 24%
Choi Taek 50% x 80% 40%
Deok Sun 20%
100%
Corrected profit divided among the partners:

Sun Woo P1,435,200 x 16% P229,632
Jung Hwan P1,435,200 x 24% 344,448
Choi Taek P1,435,200 x 40% 574,080
Deok Sun P1,435,200 x 20% 287,040
P1,435,200

Capital Ratio Adjusted to Profit and Loss Ratio
1. By payments outside of the firm among the partners and
where the total partnership capital will remain the same.
2. By the lowest possible additional cash investment in the

firm by the partners.
3. By the lowest possible additional cash investment or cash

withdrawal from the firm by the partners.

Illustration
X, Y and Z are partners with original capital contribution as of

December 31, 2020 as follows:
Partner Capital P/L ratio
X 400,000 20%
Y 200,000 35%
Z 400,000 45%

By payments outside of the firm among the partners and where the total partnership
capital will remain the same.
X Y Z Total
Capital balances 400,000 200,000 400,000 1,000,000
Required balances 200,000 350,000 450,000 1,000,000
Cash received (paid) (200,000) 150,000 50,000 -
Journal Entry:
Y, Capital 150,000
Z, Capital 50,000
X, Capital 200,000

By the lowest possible additional cash investment in the firm by the partners.
X Y Z Total
Required balances 400,000 600,000 1,000,000 2,000,000
Additional investment - 400,000 600,000 1,000,000
Journal Entry:
Cash 1,000,000
Y, Capital 400,000
Z, Capital 600,000

By the lowest possible additional cash investment or cash withdrawal from the firm
by the partners.
X Y Z Total
Required balances 160,000 240,000 400,000 800,000
Additional investment (240,000) 40,000 - (200,000)
(withdrawal)
Journal Entry:
X, Capital 240,000
Cash 200,000
Y, Capital 40,000

Thanks!
Does anyone have any questions?
berejercitodelacruz@gmail.com
FB: Ber Ejercito Dela Cruz
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PARTNERSHIP

Youth on the Rock | Partnership Accounting

PARTNERSHIP is a contract whereby two or more

(Article 1767 of the Civil Code of the Philippines)

Youth on the Rock | Partnership Accounting

Legal Entity Income Tax Mutual Agency Limited Time

Co-ownership of Unlimited Mutual

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Money Property Industry

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Asta and Yuno agreed to form a partnership to be

Youth on the Rock | Partnership Accounting

B. Asta invested P250,000 cash for one-fourth interest in the partnership.

Total Capital; 250,000/1*4 = 1,000,000

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

1. Non-cash assets contributed are recorded in the books at

Youth on the Rock | Partnership Accounting

If one or two or all partners are former sole proprietors..

1. Open new set of books; or

Youth on the Rock | Partnership Accounting

Akaashi and Bokuto, both sole proprietors agreed

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

b. To record the contribution of Bokuto

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

b. To record the investment of Bokuto

Youth on the Rock | Partnership Accounting

1. The capital account is debited or credited for any increase

2. The sole proprietors can contribute their assets and

Youth on the Rock | Partnership Accounting

Oikawa and Iwaizumi agreed to divide initial

Youth on the Rock | Partnership Accounting

2. Upon formation, no Accumulated Depreciation is recorded

3. The Allowance for Uncollectible Accounts is carried in the

Youth on the Rock | Partnership Accounting

4. The capital account is debited or credited for any increase

5. The sole proprietors can contribute their assets and

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Services rendered Amount of Capital Entrepreneurial

Youth on the Rock | Partnership Accounting

Partner Percentage Fraction Decimal Ratio

Youth on the Rock | Partnership Accounting

Division of Proﬁts Division of Losses

Youth on the Rock | Partnership Accounting

Division of Proﬁts Division of Losses

Youth on the Rock | Partnership Accounting

Equally Arbitrary Ratio Capital Ratios

Things to consider before the Distribution of Proﬁts and Losses

Interest on Capital Salary Allowances Bonus to

Youth on the Rock | Partnership Accounting

Youth on the Rock | Partnership Accounting

Juan, Capital Jan. 1 Balance P1,000,000

Cruz, Capital Jan. 1 Balance P600,000