Partnership Formation

Usual Questions?
o capital account
o cash: contribution; invested
o adjustment to capital account
o capital balance; upon formation; under bonus method; proportionate to their profit and loss ratio; before new
admission; after adjustment
o goodwill
o total capital after the formation
o total assets; after formation
o value of merchandise
o capital transfer under bonus method
o additional investment (withdrawal)
o unidentified asset

Topics
o Introduction
 Definition of a Partnership
 Characteristics of a Partnership
 Entity versus Proprietary Theories
 Partnership Agreement
 Partner’s Ledger Accounts
 Capital and Drawing Accounts
 Loans To and From Partners
o Accounting for the Formation of a Partnership
 Partnership Formation for the first time – Initial Investments
 Cash Investments
 Noncash Investments
 Bonus or Goodwill on Initial Investments
 Comparison of Methods
 Sole Proprietor and Another Individual Form a Partnership
 Sole Proprietorship’s Books are Retained for the Partnerships
 New Books are Opened for the Partnership
 Two Proprietors Form a Partnership
 Books of a Partner are used as the Partnership Books
 New Partnership Books will be used
 *Key Observation from the Illustrations

Definition of a Partnership
o Partnership Law
o general governing authority
o right of each partner and of creditors
o Art. 1767
 “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”
 Association of Two or More Persons
- individuals; natural persons
 To Carry on as Co-Owners
- aggregation of partner’s individual rights
- co-owners to partnership property and profit/loss
 Business for Profit
- must attempt to make a profit

Characteristics of a Partnership
o Separate Legal Personality
- juridical personality separate and distinct from partners
- acquire property in its own name and enter into contracts
 o Ease of Formation
- does not require as many formalities as a corporation
- oral or written agreement, or inferences
o Co-ownership of Partnership Property and Profits
- assets invested becomes the partnership’s property
- right to possession is equal
- proprietary interest in the earnings and capital
o Limited Life
 change in the agreement
 change in the relationship:
- death
- withdrawal
- bankruptcy
- incapacity
 expiration
 admission of new partner
o Mutual Agency
- act for the partnership and enter into contracts within the normal scope of the business
- principal and agents of the partnership

Entity versus Proprietorship Theories

o Proprietorship Theories
- assets, liabilities, and income belongs to the proprietor
- but in practice, it is viewed as separate from the owner
o Small Partnership
- combination of two or more proprietors
- proprietorship theory applicable
- death will cause dissolution
o Partnership
- assets, liabilities, and income is separate from partners and belongs to the partnership

Partnership Agreement
- done at the inception of the partnership
- framework to operate or conduct partnership formation to liquidation
- minimize the confusion and disputes that may arise
- oral, implied or (best if) written
o composed of:
 names of the partners, and name and nature of the partnership
 effective date of partnership contract and duration
 capital to be invested, valuation of noncash contributions, treatment of excess contribution and
penalties
 authority, rights, and duties of each partner
 accounting period, accounting records, financial statements, and auditing of books
 method of sharing profit/loss such as income measurement and distribution
 drawing or salaries
 provision of the arbitration of disputes and the liquidation
- consult with lawyers and CPAs
o seek advice from accountants with:
 FV of the initially invested noncash assets
 individual partner’s initial interest
 sharing of profit/loss
 method of computing the interest of a withdrawing partner due to retirement or death
 in withdrawal, revaluation of assets and recognizing intangible asset values
 closing procedures (at the end of accounting period)

Partner’s Ledger Accounts

- *possible to operate with only one equity account
o Capital and Drawing Accounts
 - individual partner’s capital and drawing balances are combined to report each partner’s interest in the
SFP
Debited Credited
Original Investment Permanent Withdrawal of Capital
Capital
Additional Investment Debit Bal. of Drawing Account (at the end of reporting period)
Account
Share in the Profits (offset against drawing account) Share in the Losses
Withdrawal of Assets (by the partners for net income) Salaries
Drawing
Partner's Personal Indebtedness (paid or assumed by the partnership) Partnership Obligations (assumed or paid by the partner)
Account
Partnership Funds or Claims (collected and retained by the partner) Personal Funds or Claims of Partner (collected and retained by partnership)

o Loans To and From Partners

- Withdrawal by a partner is a Receivable from partners; Loan to (dr)
- Advance to the Partnership is a Payable to partners; Loan from (Loans/Notes Payable) (cr)

Accounting for the Formation of a Partnership

o Partnership is formed in several ways:
 first time
 conversion from sole proprietorship to partnership
 a sole proprietor allows another individual, who has no business of his own to join his
business
 two or more sole proprietors form a partnership
 admission of a new partner

Partnership Formation for the First Time – Initial Investment

o Cash Investments
- reported in the capital account for each partner
o Noncash Investment
- recorded at FV at the time of investment, and determined by partner’s agreement, and specified in the
written agreement
- to record gain or loss, then equitably distributed through agreement