Partnership NATURE, FORMATION, OPERATION & FS PREPARATION Definition A 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 the profit among themselves (Article 1767 of the Civil Code of the Philippines). Articles of Co-Partnership An agreement in writing among the partners governing the nature and terms of the partnership contract. A written agreement is required when partnership capital is P 3,000 or more in money or in property. The Article of Copartnership helps in avoid misunderstanding among the partners. The written agreement among the partners governs the formation, operation and dissolution of the partnership and is required to be registered with SEC. Characteristics of a Partnership 1. Based on contract 2. Voluntary association 3. Mutual agency 4. Limited life 5. Unlimited liability 6. Co-ownership of property 7. Co-ownership of profit 8. Legal entity 9. Income tax Advantages of a Partnership 1. It is easy and inexpensive to form and to dissolve 2. Greater amount of capital may be raised compared to a sole proprietorship. 3. There is relative freedom and flexibility in decision-making compared to a corporation. 4. It is better managed because more than one person supervises business affairs. 5. The unlimited liability of general partners makes it reliable from the point of view of creditors. Disadvantages of a Partnership 1. There is lack of business continuity because it can be easily dissolved. 2. Limited amount of capital may be raised compared to a corporation. 3. The unlimited liability of a partnership deters many from joining in a partnership form of business. 4. A general partner may be subjected to a personal liability for erroneous management decisions made by his associates. 5. There is likelihood of dissension and disagreement when each of the partners has the same authority in the management of the firm. 6. There is difficulty in transferring ownership interest because ownership interest in the partnership cannot be transferred without the consent of all the partners. Kinds of Partnerships According to activities ◦ Service – main activity is the rendering of services ◦ Merchandising or Trading – main activity is the purchase or sale of goods ◦ Manufacturing – main activity is the production of goods According to liability ◦ General – one wherein all the partners are general partners who are liable for the partnership debts to the extent of their personal property after all the partnership assets have been exhausted. ◦ Limited – one consisting of one or more general partners and one or more limited partners. Kinds of Partnerships According to object ◦ Universal partnership of all present property – one in which the partners contribute all the property which actually belong to each of them, at the time of the constitution of the partnership, to a common fund with the intention of dividing the same among them as well as the profits which they may acquire therewith. All assets contributed to the partnership and subsequent acquisitions become common partnership assets. ◦ Universal partnership of profits – one which comprises all that the partners may acquire by their industry or work during the existence of the partnership and the usufruct of movable or immovable property which each of the partners may possess at the time of the institution of the contract. The original movable or immovable property contributed do not become common partnership assets. ◦ Particular partnership – one which has for its object determinate things, their use or fruits or a specific undertaking or the exercise of a profession of vocation. Kinds of Partnership According to duration of partnership existence ◦ Partnership at will – one for which no term is specified and is not formed for a particular undertaking or venture and which may be terminated any time by mutual agreement of the partners or the will of one alone. ◦ Partnership with a Fixed Term – one in which the term or period for which the partnership is to exist is agreed upon (Baysa and Lupisan, 2000). Kinds of Partners According to contribution a. Capitalist – one who contributes capital in money or property. b. Industrial – one who contributes industry, labor, skill or service c. Capitalist-Industrial – one who contributes money, property and industry According to Liability a. General – one whose liability to third persons extends to his private property b. Limited – one whose liability to third persons is limited only to the extent of his capital contribution to the partnership. Kinds of Partners According to management a. Managing Partner – one who manages actively the business of the partnership b. Silent – one who does not participate in the management of partnership affairs. Others a. Nominal- a partner in name only. b. Secret – one who takes active part in the business but whose connection with the partnership is concealed or unknown to the public. c. Dormant partner – one who does not take active part in the business and is not known to the public as a partner. Partnership Formation Ways of Partnership Formation 1. formation of a partnership for the first time. 2. conversion of a sole proprietorship to a partnership. ◦ a sole proprietor allows another person, who has no business of his own to join his business. ◦ two or more sole proprietors form a partnership. Illustrative Problem 1 (first time) ABS, GMA and TV5 decided to form the partnership firm. They contributed as follows: ABS – computers $500,000 and cash $300,000 GMA – cash 700,000 and stock 100,000 TV5 – plant 280,000 and cash $520,000 Requirement: 1. Calculate the initial capital of each partner. 2. Prepare journal entries for the above transaction in the books of partnership firm. 3. Prepare the statement of financial position/ balance sheet on the formation of the partnership. Illustrative Problem 2 Kapamilya and Kapuso were the main competitors in the shoe industry. Due to unhealthy competition between them, On May 15, 2018, they decided to form a new partnership entity with the name of Family & Love by merging out their businesses. On 15th May, 2018, their accounts balances are as follows: Kapamilya Kapuso Cash 16,000 24,000 Accounts Receivable 80,000 96,000 Inventory 64,000 40,000 Machinery – Cost 120,000 96,000 Factory Equipment – Cost 56,000 64,000 Accumulated Depreciation – Machinery 64,000 32,000 Accumulated Depreciation – Factory Equipment 24,000 40,000 Allowance for Doubtful Accounts 5,600 3,200 Accounts Payable 64,000 76,000 Illustrative Problem 2 continuation… In order to complete the formation of a new partnership, the following valuations were agreed upon between Kapamilya and Kapuso as follows: Kapamilya: Accounts receivable, net: $ 51,000, inventory at: $ 56,000 & machinery at: 30,000. Kapuso: Accounts receivable, net: $16,000, factory equipment: $10,000 Required: 1. Record the journal entries to form the new partnership. 2. Make initial balance sheet of the newly established firm. Partnership Operations Division of Profit and Loss The Partnership Law provides that if the profit allocation has been agreed upon, the share of each partner in the losses shall be in the same proportion with the net income allocation. It also provides that on the absence of agreement, the share of each partner in the profits and losses shall be in proportion to what they have contributed (based on capital contributions), but the industrial partner shall receive such share as may be just and equitable under the circumstances. Methods of profit and loss allocation 1) Equally 2) Arbitrary ratio 3) In the ratio of partner’s capital account balances and dividing the balance on agreed ratio: ◦ ◦ ◦ ◦ a) Original capital – the initial investment/capital at the time of formation b) Beginning capital of the period c) Ending capital of the period d) Average capital ◦ d1) Simple average ◦ d2) Weighted average 4) Interest on partners’ capital accounts and dividing the balance on agreed ratio 5) Salaries to partners and dividing the balance on agreed ratio 6) Bonus to partners and dividing the balance on agreed ratio 7) Interest on capital account balance, salaries and bonus to partners and dividing the balance on agreed ratio. Illustrative Problem 3 Assume that a net income of P288,000 is determined for X and Y Partnership at the end of 2018. Regular withdrawals by partners in anticipation of net income have been summarized in the drawing accounts; permanent capital changes have been summarized in the capital accounts. Drawing and capital accounts at the end of 2018 appear as follows: X, capital Y, capital 1/1/2018 P300,000 4/1/2018 12/31/2018 3/1/2018 P30,000 1/1/2018 P420,000 60,000 11/1/2018 60,000 P360,000 12/31/2018 P450,000 X, drawing Y, drawing 1/1-12/31 P36,000 1/1–12/31 P114,000 12/31/2018 P36,000 12/31/2018 P114,000 Required: Determine the share of each partner in the net income assuming: 1) Net income would be allocated equally among X and Y. 2) X and Y agree to allocate net income in the ratio of 3:2. 3) Allocation of net income shall be based upon original capitals. 4) Beginning capital balances are used in allocating partnership profit. 5) Allocation of net income shall be based upon partner’s capital at the end of each year. 6) Allocation of net income shall be based upon simple average capitals for the year. 7) Allocation of net income shall be based upon weighted average capitals for the year 8) X and Y agree to allow interest on average capital at 6%; any net income or loss balance is to be allocated at the ratio of 3:7. a) Same interest was allowed but assuming the partnership incurred a net loss of P80,000 and any balance will be allocated into 1:4 ratio. 9) The partners agree to allow interest of 6% on the excess of the average capital of one partner over that of another and the balance in net income would be allocated in 1:2 ratio. 10) X and Y agree to the allowance of monthly salaries of P10,000 and P9,000 respectively; any net income or loss balance is to be allocated in the ratio of beginning capital. Illustrative Problem 4 (Bonus Computation) The net income of A and B Partnership for 2014 amounted to P420,000. A, as the managing partner, is entitled to bonus. Required: Determine the bonus of A assuming it is based on: 1. A bonus of 20% of net income before bonus is deducted. 2. A bonus of 20% of net income after deduction of the bonus. Illustrative Problem 5 Refer to illustrative problem number 4, assume that the partners further agreed on the allocation of net income: • Bonus of 20% to A; • Salaries to A, P40,000 and B, P60,000; • Interest on average capital balances – A, P12,000 and B, P8,000 • Residual balance in net income be allocated to A and B in the ratio of 2:1. Illustrative Problem 5 continuation… Compute the bonus of A assuming: a) Bonus is based on net income after salaries but before bonus and interest. b) Bonus is based on net income after interest but before bonus and salaries. c) Bonus is based on net income before bonus but after income tax (tax rate is 35%). d) Bonus is based on net income, that is after bonus and income tax. Illustrative Problem 5 continuation… Determine the share of each partner in the net income assuming: a) Bonus is based on net income before bonus, salaries, and interest. b) Bonus is based on net income after bonus but before salaries and interest. c) Bonus is based on net income after bonus and salaries but before interest. d) Bonus is based on net income after bonus, salaries and interest. Seatwork Assume that a net income of P345,600 is determined for X and Y Partnership at the end of 2018. Regular withdrawals by partners in anticipation of net income have been summarized in the drawing accounts; permanent capital changes have been summarized in the capital accounts. Drawing and capital accounts at the end of 2018 appear as follows: X, capital Y, capital 1/1/2018 P360,000 4/1/2018 12/31/2015 3/1/2018 1/1/2018 P504,000 72,000 11/1/2018 72,000 P432,000 12/31/2015 P540,000 X, drawing P36,000 Y, drawing 1/1-12/31 P43,200 1/1–12/31 P136,800 12/31/2018 P43,200 12/31/2018 P136,800 Required: Prepare journal entries to allocate net income based on: a) Beginning capital b) Ending capital c) 6 percent interest on excess average capital balance and the balance allocated in the ratio of 1:2.