PARTNERSHIP FORMATION

Kian Barredo
 DEFINITION OF PARTNERSHIP

Article 1767, Civil Code of the Philippines. By the contract of

Partnership, two or more persons bind themselves to contribute
money, property, or industry into a common fund, with an
intention of dividing the profits among themselves. Two or more
persons may also form a partnership for the exercise of a
profession.
 TYPES OF PARTNERSHIPS
General Partnership – those in which each partner is personally liable to
the partnership’s creditors if the partnership assets are not sufficient to pay
such creditors. Such partners are called GENERAL PARTNERS.
Limited Partnership – Only one partner needs to be a general partner. The
remaining partners are limited. Which means that their obligations to
creditors are limited to their capital contributions.
 CAPITAL ACCOUNTS
The initial investment of each partner is recorded by debiting the assets contributed, creating
any liabilities assumed by the firm, and creating the partner’s capital account at the fair value
of net assets (Assets – Liabilities) contributed.

Capital Accounts
Permanent or Capital Withdrawal Original Investment
Drawings in excess of a specified amount Additional Investment
Share in net losses Share in Net income
Closing of a net debit balance in the partners
drawing account

*When a partners capital account has a debit balance, it is called DEFICIENCY.

 DRAWINGS VS. CAPITAL WITHDRAWALS
Partners commonly withdraw regular amounts of money on a weekly or monthly
basis. Such withdrawals are called drawings, sometimes called salary allowances and
they are usually charged to partner’s drawing accounts. For instance, if B and C
withdraw P10,000 from the partnership, they would record the monthly withdrawals as
follows:
B, Drawing 10,000
C, Drawing 10,000
Cash 20,000

B, Capital 10,000
C, Capital 10,000
B, Drawing 10,000
C, Drawing 10,000
 DRAWINGS VS. CAPITAL WITHDRAWALS
Capital withdrawal or permanent withdrawal directly affect capital account balance
because they arise mostly from withdrawals of investment be it original or additional.
Drawings or temporary withdrawal are usually recorded in a drawing account.
Normally, these are drawings from share of profit which will eventually be closed to
capital accounts.
 LOAN ACCOUNTS
A partner may receive cash from the partnership with the intention of repaying such amount.
Such transaction may be debited to Loans Receivable from partners rather than to partners
drawing. Unless all partners agree otherwise, these loans should bear interest and the interest
income is recognized on the partnership’s income statement.
A partner may also make a cash payment to the partnership that is considered loan rather than
increase in the partners’ capital account balance. This transaction is recorded by a credit to
Loans Payable to partners and normally accompanied by a promissory note. The partnership
records interest on loans as an operating expense.
 LOAN ACCOUNTS
Loans Receivable from partners are displayed as Assets while Loans Payable to partners are
displayed in Liabilities. This is a Related Party Transaction which requires a separate footnote
disclosure and must be reported as separate balance sheet item.

Cash 50,000
Loan Payable to C 50,000

Loan Receivable from C 50,000

Cash 50,000
 CAPITAL INTEREST VS. PROFIT
INTEREST
Partners Capital interest is claimed against the net assets of the
partnership as shown by the balance in the partner’s capital
accounts.
Partners Profit and Loss determines how the partner’s capital
will increase or decrease as a result of subsequent operation.
 ACCOUNTING FOR FORMATION
Cash investments are recorded at fair value, most often known as the FACE VALUE.
Non Cash investments are recorded at the following order of priority:
1. Agreed Value
2. Fair Market Value
3. Book Value/Carrying Amount

Fair Value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants and at a measurement date. (PFRS
13)
Fair Value is the amount for which an asset could be exchanged or a liability settled between
knowledgeable, willing parties in an arms length transaction. (AASB 13)
 ACCOUNTING FOR FORMATION
Once services are contributed to the partnership, a memorandum entry is essential if it were no
value agreed upon. Unless a journal entry is required (Bonus Method)
Liabilities assumed by the partnership should be valued at present value (fair value) of the
remaining cash flows.

Ways to form a partnership

1. Individual to Individual
2. Sole proprietor to Individual
3. Sole proprietor to Sole proprietor
4. Admission of a new partner
 INDIVIDUAL TO INDIVIDUAL
Año and Duque formed a partnership that each partner is to receive a capital credit equal to the
agreed values of the net assets each partner invested. The following items are being invested to
form a AD Partnership:
Agreed Values
Accounts
Investment by Año Investment by Duque

Cash P100,000 P100,000

Inventory 100,000 -
Land - 200,000
Building - 400,000
Equipment 200,000 -
Totals 400,000 700,000
Mortgage Assumed by Partnership - 200,000
400,000 500,000
 TO RECORD INVESTMENT
Cash 100,000
Inventory 100,000
Equipment 200,000
Ano Capital400,000

Cash 100,000
Land 200,000
Building 400,000
Mortgage Payable 200,000
Duque, Capital 500,000
 BONUS METHOD
Assume that each partner is to receive an equal capital interest:

Same Entry for the Investment of Assets Above

Additional Entry for the transfer of Capital

Duque, Capital 50,000
Ano, Capital 50,000
Total Agreed Capital (400,000 + 500,000) 900,000
Divide by: Capital Interest(50%) 50%
Partners individual Capital Interest 450,000
Less: Ano’s Capital Interest 400,000
Bonus to Ano 50,000
 GOODWILL METHOD
Assume that each partner is to receive an equal capital interest:

Same Entry for the Investment of Assets Above

Additional Entry for the Revaluation of Assets

Goodwill 100,000
Ano, Capital 100,000

Total Agreed Capital (500,000/ ½) 1,000,000

Less: Total Invested Capital (400,000 +500,000) 900,000
Goodwill 100,000
 BONUS VS. GOODWILL
Under the bonus method, there is a capital transfer of capital to equalize the capital balances.
That journal entry recognizes a partner that is contributing something to the partnership other
than tangible assets, but not to recognize an intangible assets or a value that could not be
determined.
Under the Goodwill approach, if capital interest are given to the partners, the partners will
recognize an intangible assets. One partner’s capital account balances will be used as a basis to
determine total agreed capital recognizing that the other partner already contributing
something of value in the partnership that is intangible in value that is specifically identifiable.
*Goodwill approach are to be removed as a basis for initial investments due to the PFRS 3
provision with regard to the recognition of goodwill only on acquisition method in business
combination.