Republic of the Philippines

City of Caloocan
St. Vincent de Ferrer College of Camaranin, Inc.
SVFC Compound, San Vicente de Ferrer Rd. Area D, Brgy. 179, Caloocan City

COURSE TITLE: Accounting for Special Transactions Professor: Orland L. Adrigado, CPA

LESSON 2: PARTNERSHIP FORMATION

Partnership is a consensual contract. It is created by the agreement of the partners which may
be constitute in any form, such as oral or written. However, articles 1771 and 1772 of the
Philippine Civil Code requires partnership agreement must be in public instrument and be
registered to Securities and Exchange Commission (SEC) when:
a. Immovable property or real rights are contributed to the partnership
b. Partnership capital amounting to P3,000 or more

PARTNER’S LEDGER ACCOUNT

• Capital accounts
• Drawing accounts
• Receivable from/Payable to a partner

CAPITAL ACCOUNTS
REUNO M, CAPITAL
Debit Credit
*Permanent withdrawals xxx Initial investment*
of capital xxx xxx Additional investment*
*Share in losses xxx xxx Share in profit*
* Debit balance of
drawing account xxx

Note: Partner’s capital account is a real account and has a normal credit balance

DRAWING ACCOUNTS
REUNO M, DRAWINGS
Debit Credit
*Temporary withdrawals
during the period xxx xxx recurring reimbursable cost
*Temporary Funds held to paid by the partner*
be remitted to the partnership xxx

Note: Partner’s drawing account is a nominal account that is closed to capital account at the
end of the period. This is a contra equity account and has a normal debit balance.
RECEIVABLE FROM / PAYABLE TO a partner

The partnership may enter into a loan agreement with a partner. A loan given to a partner is
recorded as ‘receivable from’ and loan obtain by the partnership to any of the partners is
recorded as ‘payable to’

FORMATION OF PARTNERSHIP – VALUATION OF CAPITAL

ILLUSTRATIVE EXAMPLE:

Problem 1: Reuno and Clyde form a partnership with the following balances on their
contribution;
REUNO CLYDE
CASH 100,000.00
ACCOUNTS RECEIVABLE 50,000.00
INVENTORY 80,000.00
LAND 50,000.00
BUILDING 120,000.00
Total Assets 230,000.00 170,000.00

Note Payable 60,000.00

Reuno, capital 170,000.00
Clyde, capital 170,000.00
Total Liabilities and capital 230,000.00 170,000.00

Additional information
▪ Accounts receivable includes 20,000 which is deemed uncollectible
▪ The inventory has an estimated selling price of 100,000 and estimated cost to sell of
10,000
▪ The partnership assumed a 10,000 unpaid mortgage on the land.
▪ The building is under-depreciated by 25,000
▪ There is an unpaid mortgage of 15,000 on the building which Clyde agreed to settle using
his personal funds.
▪ The note payable is stated at face amount. A proper valuation requires the recognition of
15,000 discount on note payable
▪ Reuno and Clyde has a 60:40 ratio on their profit or loss sharing respectively.

Requirement 1: compute for the adjusted balances.

Solution:
REUNO CLYDE PARTNERSHIP
CASH 100,000.00 100,000.00
ACCOUNTS RECEIVABLE ( 50K-20K) 30,000.00 30,000.00
INVENTORY (lower of cost over NRV) 80,000.00 80,000.00
LAND 50,000.00 50,000.00
BUILDING (120k-25k) 95,000.00 95,000.00
Total Assets 210,000.00 145,000.00 355,000.00

Note Payable (60k-15k) (45,000) (45,000)

Mortgage payable - land (10,000) (10,000)
-
ADJUSTED CAPITAL 165,000.00 135,000.00 300,000.00

Journal Entry

Cash 100,000.00
Accounts receivable 30,000.00
Inventory 80,000.00
Land 50,000.00
Building 95,000.00
Discount on NP 15,000.00
Note payable 60,000.00
Mortgage payable 10,000.00
Reuno, Capital 165,000.00
Clyde, Capital 135,000.00
to record adjusted capital contribution

Requirement 2: Assume that the partner’s capital shall be increased accordingly by contributing
cash to bring the partners’ capital balances proportionate to their P&L ratio.

Solution:
A. using Reuno capital, determine if Clyde contribution has any deficiency.

Reuno, Capital 165,000

Divide P&L ratio (share of reuno) 60%
Total 275,000
Multiply by Clyde, P&L ratio 40%
Minimum capital Required for Clyde 110,000
Versus Clyde Actual Capital 135,000
Deficiency none
 B. Using Clyde Capital

Clyde, Capital 135,000

Divide P&L ratio (share of clyde) 40%
Total 337,500
Multiply by Reuno, P&L ratio 60%
Minimum capital Required for Reuno 202,500
Versus Reuno Actual Capital 165,000
Deficiency 37,500
Therefore, Reuno must contribute additional cash of 37,500 to make his contribution equal to
his P&L sharing ratio.

Reconciliation:
Reuno capital (165k + 37.5K) 202,500
Clyde capital 135,000
Adjusted Total Contribution 337,500

BONUS ON INITIAL CONTRIBUTION

If the partner’s capital credit is greater than the Fair value of his contribution, such additional
credit to the partner’s capital is accounted for as a deduction from the capital of other partners
using the Bonus Method.

Illustration:
ZJ and Mark agreed to form a partnership with the following contribution, ZJ – cash 40,000,
Mark- Equipment @FV 100,000. However, due to ZJ’s expertise, partners agreed that they
should initially have an equal interest in the partnership capital.

Solution: Using bonus method

Actual Bonus method
ZJ 40,000 (140,000*50%) 70,000
Mark 100,000 (140,000*50%) 70,000
Total 140,000 140,000

Journal entries:
Cash 40,000
Equipment 100,000
ZJ, Capital 70,000
Mark, Capital 70,000
VARIATIONS TO THE BONUS METHOD

a. Cash Settlement Between Partners

b. Additional investment or withdrawal of investment of the Partner

Illustration: Cash Settlement Between Partners

Annabelle, Desiree and Ria form a partnership with the following contributions
Annabelle Desiree Ria
Cash 40,000 10,000 100,000
Equipment 80,000
Total 40,000 90,000 100,000
Additional info:
• The equipment has an unpaid mortgage of 20,000 which the partnership assumes to repay
• The partners agreed to equalized their interest. Cash settlements among the partners are
to be made outside the partnership.
Requirements:
a. Which partner(s) shall receive cash payment from the other partner(s)
b. Provide the entries

Annabelle Desiree Ria Partnership

Cash 40,000 10,000 100,000 150,000
Equipment 80,000 80,000
Mortgage (20,000) (20,000)
Net Contribution 40,000 70,000 100,000 210,000
Equal Interest (210/3) 70,000 70,000 70,000 210,000
Cash receipt (payment) (30,000) 0 30,000
*therefore Ria receives 30,000 from Annabelle

Entries:
Cash 150,000
Equipment 80,000
Mortgage Payable 20,000
Annabelle Capital 70,000
Desiree Capital 70,000
Ria Capital 70,000

Illustration 2: Additional investment or withdrawal of investment of the Partner

Michelle and Nicole form a partnership. The partnership agreements are:

✓Initial capital of 140,000
✓60:40 interest in equity of the partnership
✓Cash contribution for Nicole 100,000 while Nicole 40,000

Requirement: which partner shall provide additional investment/withdraw in order to bring the
partnership capital credits equal to their respective interest in the equity.
Solution:
Agreed Initial capital 140,000

Michelle, required capital balance (140k x 60%) 84,000

Nicole, requires capital balance (140k x 40%) 56,000

Michelle Nicole Partnership

Actual contributions 100,000 40,000 140,000
Required capital bal. 84,000 56,000 140,000
Additional (withdraw) (16,000) 16,000