PARTNERSHIP BASIC

CONSIDERATION AND FORMATION

ACCOUNTING FOR SPECIAL TRANSACTIONS
LEARNING OBJECTIVES

 Define a partnership and explain its characteristics.

 Identify and explain the advantages and disadvantages of
organizing a partnership as compared to a corporation
 Identify and differentiate the different types of partnership
 Recognize and measure initial investment of partners
PARTNERSHIP FORMATION AND
OPERATIONS

• BASIC CONSIDERATIONS
• PARTNERSHIP FORMATION
DEFINITION
 Article 1767 of the Civil Code of the Philippines
 A partnership is a contract whereby two or more persons
bind themselves to contribute money, property and industry
into a common fund with the intention of dividing profits
among themselves
CHARACTERISTICS OF A PARTNERSHIP

 Co-ownership of contributed assets

 Income Tax
 Limited Life
 Legal Entity – Entity vs Proprietorship Theory
 Mutual Agency
 Mutual Participation in Profits
 Unlimited Liability
ADVANTAGES OF A PARTNERSHIP
 Easy and inexpensive to organize compared to corporation
 Unlimited liability makes it reliable to creditors
 Combined personal credit offers better opportunity for
obtaining capital compared to sole proprietor
 Participation in business by more than one person
 Direct gain to partners gives incentive for close attention to
business
 Personal element in the character of the partner is retained
DISADVANTAGES OF A PARTNERSHIP
 Personal liability of a partner for partnership debts deters many from
investing capital in a partnership
 Partner may be subject to a personal liability for the wrongful acts or
omissions of his associates
 Less stable because it can be easily dissolved
 Divided authority among partners
 Constant likelihood of dissension and disagreement when each of the
partners has the same authority in the management
 Difficulty in disposing of interest since no formal established marketplace
exist for sale of partnership interest
KINDS OF PARTNERSHIP
 As to Activity
 Trading Partnership
 One whose main activity is the manufacture or the purchase and
sale of goods.
 Non trading Partnership
 One organized for purpose of rendering service
KINDS OF PARTNERSHIP
 As to Object
 Universal Partnership of All Present Property
 Partners contribute all properties which belongs to each of them, at the
time of constitution of partnership, to a common fund with the
intention of dividing the same among themselves as well as the profits
 Universal Partnership of All Profits
 Comprise all that partners may acquire by their industry or work during the
existence of the partnership and the usufruct of movable property or
immovable property which each of the partners may possess at the time of the
institution of the contract
KINDS OF PARTNERSHIP
 As to Liability of Partners
 General Co-Partnership
 One consisting of general partners who are liable prorate and
sometimes solidarily with their separate property for partnership debts
 Limited Partnership
 Formed by two or more persons having as members one or more
general partners and one or more limited partners, who as such are not
bound by the obligations of the partnership. “LIMITED” or “LTD” is
added to the name of a partnership to inform the public
KINDS OF PARTNERSHIP
 As to Duration
 Partnership at Will
 No time is specified and is not formed for a particular undertaking or
venture and may be terminated by mutual agreement of the partners
or by the will of one alone
 Partnership with a Fixed Term
 Term or period to exist is agreed upon or those formed for a particular
undertaking and upon expiration of that term or completion for the
particular undertaking, partnership is dissolved unless continued
KINDS OF PARTNERSHIP
 As to Representation to Others
 Ordinary Partnership
 One which actually exists among the partners and also as to third
persons
 Partnership by Estoppel
 One which in reality is not a partnership but is considered a
partnership only in relation to those who by their conduct or
omission are precluded to deny or disprove the partnership’s
existence
KINDS OF PARTNERSHIP
 As to Legality of Existence
 De Jure Partnership
 One which has complied with all the requirements for its
establishment
 De Facto Partnership
 One which has failed to comply with one or more of the legal
requirements for its establishment
KINDS OF PARTNERSHIP
 As to Publicity
 Secret Partnership
 Existence of certain persons as partners is not made known to the
public by any of the partners
 Open Partnership
 One wherein the existence of certain persons as partners is made
known to the public by the members of the firm
CLASSES OF PARTNERS
 As to Contribution
 Capitalist Partner
 Contributes capital in the form of money or property
 Industrial Partner
 Contributes industry, labor, talent, skills or service
 Capitalist Industrial Partner
 Contributes money, property and industry
CLASSES OF PARTNERS
 As to Liability
 General Partner
 Liability to third persons extends to his separate (private) property
 Limited Partner
 Liability to third persons is limited only to the extent of his capital
contributions into the partnership
CLASSES OF PARTNERS
 As to Management
 Managing Partner
 Manages actively the business of the partnership
 Silent Partner
 Does not participate in the management of partnership affairs
CLASSES OF PARTNERS
 Other Classifications
 Liquidating Partner
 Takes Charge of the winding up of partnership affairs upon dissolution
 Nominal Partner
 Not really a partner and party to the agreement, but is made liable as a
partner for the protection of innocent third persons
 Ostensible Partner
 Takes active part in the management of the firm and is known to the
public as partner in the business
CLASSES OF PARTNERS
 Other Classifications
 Secret Partner
 Takes active part in the management of business but whose
connection is unknown to the public
 Dormant Partner
 Does not take active part in the management and is not known to
the public as a partner; both silent and secret
PARTNERSHIP AGREEMENT
 Framework within which the partners are to operate
 Partnership may be conceived through oral or written
agreement, as a contract
 Securities and Exchange Commission requires registrations
ARTICLES OF CO-PARTNERSHIP
 Names and addresses of the partners, and the name and nature of the partnership
 Date on which partnership contract takes effect and the duration of the contract
 Capital to be invested by each partner
 Authority, rights and duties of each partner
 Accounting period to be used, nature of accounting records, preparation of
financial statements and auditing of partnership books
 Method of sharing profits and losses including the frequency of income
measurement and distribution to partners
 Drawings or salaries to be allowed to each partner and the disposition of partner’s
salary and drawing accounts including the penalties for excessive withdrawal
 Provision of the arbitration of disputes and the liquidation of the partnership at the
termination of the agreed time including those concerning the contingency of a
partner’s death
ADVICE OF AN ACCOUNTANT
 Determination of current fair values to be assigned to
noncash assets initially invested to the partnership
 Assessment of the individual partner’s initial interest in the
partnership capital
 Formulation of plan for sharing in the profits and losses
 Determination of methods to compute the interest of a
withdrawing partner as a result of his retirement or death.
 Determination of the closing procedures, whether or not
income and withdrawals are to be closed to the capital
account at the end of the accounting period
PARTNERSHIP FORMATION AND
OPERATIONS

• BASIC CONSIDERATIONS
• PARTNERSHIP FORMATION
PARTNER’S LEDGER ACCOUNTS
 (Plurality of Capital and Drawing Accounts)
 Capital Accounts
 Drawing or personal accounts
 Account for loans to or from partners
PARTNER’S LEDGER ACCOUNTS

CAPITAL ACCOUNT
 Permanent withdrawal of  Original Investment
capital  Additional Investment
 Debit balance of drawing  Share in Profit
account
 Share in losses
PARTNER’S LEDGER ACCOUNTS

DRAWING ACCOUNT
 Temporary withdrawal in  Partnership obligation
anticipation of profit assumed by the partner
 Personal indebtedness  Personal funds collected by
assumed by the partnership partnership
 Funds or claims of  Periodic salaries
partnership collected or  Salaries in Profits
retained by the partner
PARTNER’S LEDGER ACCOUNTS
 Account for loans to or from partners
 Loan to/Receivable from Partner/Loan Receivable
 Withdrawal by a partner of a substantial amount with the
assumption of its repayment to the firm may be debited to a
Receivable from partner account rather than to the partner’s
drawing accounts.
 Loan From/Payable to Partner/Loan Payable
 Advances to the partnership by a partner with the assumption of its
ultimate repayment by the partnership is viewed as a loan rather
than as an increase in the capital account.
PARTNER’S FORMATION
 Partnership may be formed when:
I. Two or More Individuals Form a Partnership for the First
Time (All Partners are New in the Business)
II. Individual and Sole Proprietor
III. Two or More Sole Proprietors
PARTNER’S FORMATION
 Partners may contribute cash, property or industry to the
partnership.
 Asset contributions are debited to the appropriate asset
accounts and credited to the capital accounts of the partners.
 Measurement:

CONTRIBUTION RECOGNIZED AMOUNT

Cash Face Value
Non-Cash Asset Agreed Value, or
Fair Market value
Services Only memorandum entry
TWO OR MORE INDIVIDUALS FORM A PARTNERSHIP
FOR THE FIRST TIME (ALL PARTNERS ARE NEW IN THE
BUSINESS)

Acosta and Beltran agreed to form a partnership to be known as

AB ENTERPRISES. The entries to record the formation of the
partnership under three independent assumptions are as
follows.
Assumption 1 – Cash Contributions. Each partner invested cash
of P250,000 for an equal interest in the partnership.
Cash 500,000
Acosta, Capital 250,000
Beltran, Capital 250,000
To record initial investment of Acosta and Beltran
TWO OR MORE INDIVIDUALS FORM A PARTNERSHIP
FOR THE FIRST TIME (ALL PARTNERS ARE NEW IN THE
BUSINESS)

Acosta and Beltran agreed to form a partnership to be known as

AB ENTERPRISES. The entries to record the formation of the
partnership under three independent assumptions are as
follows.
Assumption 2 – Cash and Non-Cash Contributions. Acosta
contributed cash P160,000 and inventories costing P130,000
and with agreed value of P140,000. Beltran contributed
equipment, costing P170,000 with accumulated depreciation of
P25,000 and agreed value of P150,000, for one-third interest.
TWO OR MORE INDIVIDUALS FORM A PARTNERSHIP
FOR THE FIRST TIME (ALL PARTNERS ARE NEW IN THE
BUSINESS)

Assumption 2 – Cash and Non-Cash Contributions. Acosta contributed

cash P160,000 and inventories costing P130,000 and with agreed value
of P140,000. Beltran contributed equipment, costing P170,000 with
accumulated depreciation of P25,000 and agreed value of P150,000, for
one-third interest.
Cash 160,000
Inventories140,000
Equipment 150,000
Acosta, Capital 300,000
Beltran, Capital 150,000
To record initial investment of Acosta and Beltran
TWO OR MORE INDIVIDUALS FORM A PARTNERSHIP
FOR THE FIRST TIME (ALL PARTNERS ARE NEW IN THE
BUSINESS)

Acosta and Beltran agreed to form a partnership to be known as

AB ENTERPRISES. The entries to record the formation of the
partnership under three independent assumptions are as
follows.
Assumption 3 – Cash, Non-Cash and Industry. Acosta
contributed cash of P100,000; Accounts Receivable of
P150,000 with Allowance for Uncollectible Accounts of
P50,000; and Equipment valued at P400,000. Beltran is an
industrial partner to contribute his special skills and talents to
the partnership for a one-third interest.
TWO OR MORE INDIVIDUALS FORM A PARTNERSHIP
FOR THE FIRST TIME (ALL PARTNERS ARE NEW IN THE
BUSINESS)

Assumption 3 – Cash, Non-Cash and Industry. Acosta contributed cash of

P100,000; Accounts Receivable of P150,000 with Allowance for Uncollectible
Accounts of P50,000; and Equipment valued at P400,000. Beltran is an
industrial partner to contribute his special skills and talents to the partnership for
a one-third interest.
Cash 100,000
Accounts Receivable 150,000
Equipment 400,000
Allowance for Uncollectible Accounts 50,000
Acosta, Capital 600,000
To record initial investment of Acosta
Memo Entry: Beltran is to contribute his services to the partnership for a one-
third interest.
INDIVIDUAL AND A SOLE PROPRIETOR FORM A
PARTNERSHIP

I. Sole Proprietorship’s Books are Retained for Partnership

I. Adjust the assets and liabilities of proprietor to agreed value, or fair
market value. Adjustments are to be made to the capital account
II. Record the investment of the individual
II. New Books are Opened for the Partnership
I. Adjust the assets and liabilities of proprietor according to agreed
value or fair market value. Adjustments are to be made to the capital
account.
II. Close the books.
III. Record the investment of the proprietor.
IV. Record the investment of the individual.
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

I. One Sole Proprietorship’s Books are Retained for Partnership

I. Adjust the assets and liabilities of proprietors to agreed value, or fair
market value. Adjustments are to be made to the capital accounts.
II. Close the book of the other proprietor
III. Record the investment of the other proprietor.
II. New Books are Opened for the Partnership
I. Adjust the assets and liabilities of proprietor according to agreed
value or fair market value. Adjustments are to be made to the capital
accounts.
II. Close the books of both proprietor.
III. Record the investment of both proprietor.
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

To adjust balances to agreed values, the following rules will be

helpful in making the necessary adjusting entries.
Debit asset and credit capital for increases in asset values
Debit capital and credit asset for decreases in asset values
Debit capital and credit liabilities for increases in liability balances
Debit liabilities and credit capital for decreases in liability balances
In case of contra asset accounts, the following shall apply:
Debit contra asset account and credit capital for increases in asset
values
Debit capital and credit contra asset account for decreases in asset
values
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

Acosta and Beltran, both sole proprietors. Agreed to form a

partnership. Account balances per ledger and the respective
agreed values upon formation are shown below.
Acosta Beltran
Per Books As Agreed Per Books As Agreed
Cash 150,000.00 150,000.00 140,000.00 140,000.00
Accounts Receivable 140,000.00 140,000.00 135,000.00 135,000.00
Allowance for Uncollectible Accounts (50,000.00) (40,000.00) (30,000.00) (40,000.00)
Inventories 135,000.00 137,000.00 128,000.00 130,000.00
Equipment, Cost 300,000.00 150,000.00 200,000.00 175,000.00
Accumulated Depreciation (60,000.00) (20,000.00)
Accounts Payable 100,000.00 100,000.00 150,000.00 150,000.00
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

New Sets of Books will be used by the New Partnership

Cash 150,000
Accounts Receivable 140,000
Inventories 137,000
Equipment 150,000
Allowance for Uncollectible Accounts 40,000
Accounts Payable 100,000
Acosta, Capital 437,000
To record the contribution of Acosta
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

New Sets of Books will be used by the New Partnership

Cash 140,000
Accounts Receivable 135,000
Inventories 130,000
Equipment 175,000
Allowance for Uncollectible Accounts 40,000
Accounts Payable 150,000
Beltran, Capital 390,000
To record the contribution of Beltran
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

Books of Acosta will be used by the New Partnership

Allowance for Uncollectible Accounts 10,000
Inventories 2,000
Accumulated Depreciation 60,000
Acosta, Capital 78,000
Equipment 150,000
To record adjustment on the books of Acosta in order to bring the
ledger balances to agreed values
TWO OR MORE SOLE PROPRIETOR FORM A
PARTNERSHIP

Books of Acosta will be used by the New Partnership

Cash 140,000
Accounts Receivable 135,000
Inventory 130,000
Equipment 175,000
Allowance for Uncollectible Accounts 40,000
Accounts Payable 150,000
Beltran, Capital 390,000
To record the investment of Beltran
BONUS OR GOODWILL ON INITIAL
INVESTMENT

 Not only the valuation of net asset contribution is agreed, but

also the capital share. Capital share is the percentage of
equity that each of them will have in the net assets of the
newly formed partnership
 Valuation problem arises when partners agree on capital
share or capital interests that are not equal to the net assets
invested.
 To meet this condition, capital accounts are adjusted or
recorded using two methods – bonus method or the goodwill
method.
BONUS METHOD

 Generally capital share is proportionate to capital

contribution, but provisions are given in recognition of
intangible factors such as partners’ expertise, established
clientele or necessary business connections – that is, they
may agree to a division of capital not proportionate to their
capital contribution. This gives rise to bonus on initial
investment
BONUS METHOD

 Example. Alfonso and Afable formed a partnership by

contributing P500,000 and P600,000, respectively. Journal
entries to record the investment of the partners under two
approaches are as follows:
 Full investment approach
Cash 1,100,000
Alfonso, Capital 500,000
Afable, Capital 600,000
BONUS METHOD

 Assuming the partners agreed to have equal capital in the

partnership it is presumed that part of the contribution of
Afable is given as bonus to Alfonso in exchange for
intangible advantage that Alfonso will be bringing to the
partnership
 Bonus Approach (Direct recording)
Cash 1,100,000
Alfonso, Capital 550,000
Afable, Capital 550,000
(P500,000 + P600,000) / 2 = P550,000
BONUS METHOD

 Assuming the partners agreed to have equal capital in the

partnership it is presumed that part of the contribution of
Afable is given as bonus to Alfonso in exchange for
intangible advantage that Alfonso will be bringing to the
partnership
 Bonus Approach (Recorded as adjustment)
Afable, Capital 50,000
Alfonso, Capital 50,000
To accomplish equal capital interests by recording P50,000
bonus from Afable to Alfonso
GOODWILL METHOD

 Formation of partnership involving a sole proprietor may

involve recognition of goodwill.
 Goodwill results when the capital credit > agreed value or
fair value of the net assets acquired by the sole proprietor.
 Adjustment for goodwill increases the capital of the sole
proprietor.
 PRFS 3 does not allow the amortization of goodwill acquired
in a combination; instead requires it to be tested annually for
impairment or more frequently if events or changes in
circumstances indicate that it might be impaired.
GOODWILL METHOD

 Example. Alfonso and Afable formed a partnership by

contributing P500,000 and P600,000, respectively. Journal
entries to record the investment of the partners under two
approaches are as follows:
 Full investment approach
Cash 1,100,000
Alfonso, Capital 500,000
Afable, Capital 600,000
GOODWILL METHOD

 Assuming the partners agreed to have equal capital in the

partnership where they are to account the implied value of
the intangible contribution made by Alfonso
 Goodwill method
Goodwill 100,000
Alfonso, Capital 100,000
P600,000 – P 500,000 = P100,000
COMPARISON OF THE METHODS

 A decision to use one method over the other will depend on the partner’s
agreement.
 In the absence of agreement, the bonus method is preferable over the
goodwill method.
 Goodwill method impose certain theoretical values.