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PARTNERSHIP FORMATION
ADVANCED FINANCIAL ACCOUNTING AND REPORTING
PARTNERSHIP FORMATION
Definition of a Partnership
The Partnership Law, Article 1767 states that “ by the article of partnership, two or
more persons bind themselves together to contribute money, property, or industry
to a common fund with the intention of dividing profits among themselves.”
Three distinct factors of a partnership
1. ASSOCIATION OF TWO OR MORE PERSONS
2. TO CARRY ON AS CO-OWNERS
3. BUSINESS PROFIT
CHARACTERISTICS OF A PARTNERSHIP
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Separate legal entity – partnership has a juridical personality separate and
distinct from that of each of the partners
Ease of formation – partnership may be created by oral or written agreement
between two or more persons
Co-ownership of partnership property and profits – all assets invested in a
partnership becomes the property of the partnership. The right of each
partners to possess/use each asset are equal
Limited life – any change in the agreement of the partners terminates the
partnership contract. A partnership may also expire anytime when there is
change in the relationship of the partners
Mutual agency –each partner has an equal right to act for the partnership
and to enter into contracts binding upon it, as long as he acts within the
normal scope of business operations.
Unlimited liability – each partner may be held liable for all the debts of the
partnership.
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PARTNERSHIP AGREEMENT
The formation of a partnership agreement must be done at the inception of the
organization of the partnership. Among the significant points covered by the
partnership agreements are:
1. Names of the partners, and the name and nature of the partnership;
2. The date on which the partnership contract takes effect and the duration of
the contract;
3. The capital to be invested by each partner, the procedure for valuing noncash
contributions, the treatment of any contributions in excess of the agreed
amounts, and the penalties for failure to contribute and maintain the agreed
amount of capital;
4. The authority, the rights, and duties of each partner
5. The accounting period to be used, nature of accounting records, preparation
of FS, and auditing of partnership books
6. The method of sharing profit and losses including the frequency of income
measurement and distribution to partners;
7. The drawings or salaries to be allowed to each partner;
8. Provision of the arbitration of disputes and the liquidation of the partnership.
The Partner’s Ledger Accounts
1. Capital Accounts
2. Drawing or personal accounts
3. Account for loans to or from partners
The transactions that are usually debited and credited to partner’s capital and
drawing accounts may be summarized as follows:
The capital account is credited for
a. Original investment
b. Additional investment
c. Partner’s share in profits
The capital account is debited for
a. Permanent withdrawal of capital
b. Debit balance of the drawing account at the end of the period
c. Partner’s share in losses
The drawing account is credited for
a. Partnership obligations assumed or paid by the partner
b. Personal funds or claims of partner collected and retained by the partnership
c. Periodic partner’s salaries depending on the accounting and disbursement
procedures agreed upon
The drawing account is debited for:
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a. Withdrawal of assets by the partners in anticipation of net income
b. Partner’s personal indebtedness paid or assumed by the partnership
c. Funds or claims of partnership collected and retained by the partners
ACCOUNTING FOR THE FORMATION OF PARTNERSHIP
A partnership may be formed in several ways, namely:
1. Formation of a partnership for the first time
2. Conversion of sole proprietorship into partnership
- A sole proprietor allows another individual, who has no business of his
own to join business
- Two or more sole proprietors form a partnership
3. Admission of a new partner
Partnership Formation for the First Time
Initial Investment in a partnership are recorded in the capital accounts maintained
for each partner.
Cash/Non cash asset
Partner, Capital
#to record the initial investment of the partners
*when a property other than cash is invested in a partnership, the non-cash
property is recorded at Current Fair Market Value of the property at the time of the
investment.
ILLUSTRATION 1:
Assume Carlo and Patrick form a partnership for the first time and their
investments are as follows:
Carlo
Cash
Merchandise
Inventory
Machineries
Computer
Equipment
OCTOBER 2020
Book value
25,000
72,000
Fair value
-063,000
125,000
-
132,000
-
Patrick
Book value
Fair value
60,000
-022,000
35,000
110,000
140,000
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The journal entry to record their investments are as follows:
Cash
25,000
Merchandise Inventory
63,000
Machineries
132,000
Carlo, Capital
220,000
#To record initial investment of Carlo.
Cash
60,000
Merchandise Inventory
35,000
Computer Equipment
140,000
Patrick, Capital
235,000
#to record initial investment of Patrick
BONUS OF GOODWILL ON INITIAL INVESTMENT
Bonus or goodwill on initial investment arises when the total contributed capital is
different from the total agreed capital. The valuation problem arises when partners
agree on capital interests that are not equal to their net assets invested.
Total Contributed Capital (TCC) – total actual amount of partners’ contribution to
the partnership
Total Agreed Capital (TAC) – total agreed amount or proportion of each partners’
initial investment in the partnership. This amount may be equal, less or more than
the total actual contributed capital of each partner.
For example, if each partner agree to receive equal interest, even though Carlo and
Patrick has contributed 220,000 and 235,000 each, they have to adjust their capital
accounts in order to meet the agreed condition. To meet the condition, their capital
will be adjusted either the Bonus or the Goodwill Method.
Under the BONUS Method, No assets will be additionally recorded. To equalize their
capital balances, 7,500 will be transferred to Carlo’s capital.
Patrick, Capital
7,500
Carlo, Capital
OCTOBER 2020
7,500
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 235,000 + 220,000 = 455,000 / 2 = 227,500 must be the capital balance of
each partner after the formation.
Under the GOODWILL Method, the equalization of capital assets is accomplished by
recording goodwill of Php 15,000 with the corresponding increase in Carlo’s capital
account.
Journal Entry:
Goodwill
15,000
Carlo, Capital
15,000
ILLUSTRATION 2:
Will and Adam agreed to form a partnership with the following contributions at their
fair values:
Will:
Cash
25,000
Machinery
120,000
Accounts Payable
10,000
Adam:
Cash
45,000
Furniture and Fixture
140,000
Loans Payable
15,000
Case 1: The partners agreed to have a 60:40 ratio of interest on the partnership
upon formation. What is the total capital balance of each partners? What is the TCC
and TAC?
Journal entry upon investment of Will and Adam are as follows:
Cash
25,000
Mach
120,000
AP
10,000
Will, Capital
135,000
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Cash
45,000
F&F
140,000
LP
15,000
Adam, Capital
170,000
TCC is equal to the total actual capital invested, Php 305,000
TAC is also equal to Php 305,000
But the capital balances of each partner will be adjusted to meet the condition of
60:40 initial interest ratio.
Php305,000 x 60% = 183,000 (should be) capital balance of Will.
Php305,000 x 40% = 122,000 (should be) capital balance of Adam.
JE:
Adam, Capital
48,000
Will, Capital
48,000
#to record accomplish adjustment of 60:40 capital interest by recording 48,000
bonus to Will from Adam.
Case 2: The partners agreed to have a total capital of 350,000 with 60:40 ratio of
interest on the partnership. What is the total capital balance of each partners? What
is the TCC and TAC?
Journal entry upon investment of Will and Adam are as follows:
Cash
25,000
Mach
120,000
AP
10,000
Will, Capital
135,000
Cash
45,000
F&F
140,000
LP
15,000
Adam, Capital
170,000
TCC is equal to the total actual capital invested, Php 305,000
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TAC will be the total amount of capital that the partners agreed upon, Php 350,000.
Partners have to adjust their capital balances too meet the 60:40 initial capital ratio
with total capital balance of Php 350,000.
Php 350,000 x 60% = 210,000 capital to Will
Php 350,000 x 40% = 140,000 capital to Adam
Goodwill
45,000
Adam,Capital
30,000
Will, Capital
75,000
#to record GW and the accomplishment of the 60:40 capital interest of the
partners.
Case 3: The partners agreed to have a 60:40 initial capital interest on the
partnership on the basis of Adam’s capital. What is the total capital balance of each
partners? What is the TCC and TAC? What is the additional capital needed to be
invested or withdrawn by either partner?
Will (60%)
Adam (40%)
TOTAL
TCC
135,000
170,000
305,000
Adjustment
120,000
-0120,000
TAC
255,000
170,000
425,000
TAC is computed as 170,000 / 40% = 425,000
JE:
Cash
120,000
Will, Capital
120,000
Adjusted capital of the partners are P255,000 (Will) and P170,000 (Adam).
Case 4: The partners agreed to have a 60:40 initial capital interest on the
partnership on the basis of Will’s capital. What is the total capital balance of each
partners? What is the TCC and TAC? What is the additional capital needed to be
invested or withdrawn by either partner?
TCC
Adjustment
Will (60%)
135,000
-0Adam (40%)
170,000
(80,000)
TOTAL
305,000
(80,000)
TAC is computed as 135,000 / 60% = 225,000
OCTOBER 2020
TAC
135,000
90,000
225,000
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JE:
Adam, Capital
80,000
Cash
45,000
F&F
35,000
#entry to record Adam’s withdrawal of excess capital invested.
Case 5: The partners agreed to have a 50:50 initial capital interest on the
partnership on the basis of Adam’s capital. What is the total capital balance of each
partners? What is the TCC and TAC? What is the additional capital needed to be
invested or withdrawn by either partner?
TCC
135,000
170,000
305,000
Will (50%)
Adam (50%)
TOTAL
Adjustment
35,000
-035,000
TAC
170,000
170,000
340,000
TAC is computed as 170,000 / 50% = 340,000
JE:
Cash
35,000
Will, Capital
35,000
#entry to record Will’s additional investment to meet the 50:50 capital
requirements
Sole Proprietor and Another Individual Form a Partnership
Under this formation, the assets and the liabilities of the sole proprietor are
transferred to the newly formed partnership. Normally, the partners agree on the
revaluation of some of the assets before the transfer. The journal entry will depend
on whether the books of the sole proprietorship are to be used for the newly formed
partnership or new books are to be opened.
Sole Proprietorship’s books are retained for the partnership:
The following accounting procedures are used to record the formation of the
partnership:
1. Adjust the assets and liabilities to their fair market values as agreed by the
partners. Adjustments are to be made to his (sole proprietor) capital
account.
2. Record the investment of the new partner.
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New books are opened for the partnership:
If new books are to be used for the partnership, the following accounting
procedures may be used to record the formation of the partnership:
1. Adjust the assets and liabilities of the sole proprietor according to the
agreement. Adjustment are made on his capital account.
2. Close the books
3. Record the investment of the former proprietor to the new books of the
partnership.
4. Record the investment of the new partner to the partnership.
ILLUSTRATION:
Josh Company
Statement of Financial Position
June 30, 2020
ASSETS
Cash
Accounts Receivable
Inventory
Equipment
Less: Accumulated Dep’n
Total Assets
LIABILITIES AND EQUITY
Account Payable
Josh, Capital
Total Liabilities and Equity
Php 60,000
50,000
70,000
40,000
(4,000)
36,000
216,000
86,000
130,000
216,000
Peter was interested to form partnership with Josh Co. and the later agreed in order
to meet the increasing demand and sales as well. They agreed to Form JP
Partnership, and had the assets and liabilities of Josh Co. appraised showing the
following:
1.
2.
3.
4.
Allowance for Doubtful accounts of P5,000 to be provided
Inventory is to be recorded at its market value of P80,000
The equipment has a fair value of Php 35,000
Php 2,000 of accounts payable has not been recorded
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Josh and peter prepared and signed the articles of partnership that include all
significant operating policies. On June 30, 2020, Peter contributed Php 100,000
cash for 1/3 capital interest.
Case 1: Sole proprietor’s book will be retained for the partnership
Journal Entries:
Books of Josh (now the partnership books)
1)
Inventory
10,000
Accum. Dep’n
4,000
Equipment
5,000
Allow. For D.A.
5,000
Accounts Payable
2,000
Josh, Capital
2,000
#To adjust assets and liabilities of Josh
2)
Cash
100,000
Peter, Capital
100,000
#to record investment of Peter
Case 2: New books will be used for the partnership
Journal Entries:
Books of Josh:
1)
Inventory
10,000
Accum. Dep’n
4,000
Equipment
5,000
Allow. For D.A.
5,000
Accounts Payable
2,000
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Josh, Capital
2,000
#to adjust assets and liabilities of the Josh
2)
Accounts payable
88,000
Allowance for D.A.
5,000
Josh, Capital
132,000
Cash
60,000
Accounts Receivable
50,000
Inventory
80,000
Equipment
35,000
#to close all the adjusted balances of the accounts
New Books of the Partnership:
1)
Cash
60,000
Accounts Receivable
50,000
Inventory
80,000
Equipment
35,000
Accounts Payable
88,000
Allowance for D.A.
5,000
Josh, Capital
132,000
#to record investment of Josh
2)
Cash
100,000
Peter, Capital
100,000
#to record investment of Peter
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Two Proprietors Form a Partnership
The accounting procedure described in the preceding section are also applicable
when two or more proprietors form a partnership. There should be an agreement
on the determination of the partners’ interest on the partnership. It is also
important to agree on the values of the assets and liabilities to be assigned and
assumed by the new partnership. The books of one of the sole proprietors may be
used for the newly formed partnership, or a new set of partnership books may be
used.
REVIEW QUESTIONS:
1. A partner’s withdrawal of assets from a partnership that is considered
permanent reduction in the partner’s equity is debited to the partner’s:
a. Drawing account
b. Retained earnings account
c. Capital account
d. Loan receivable account
2. The partner’s drawing accounts are used:
a. To record the partners salaries
b. To reduce the partner’s capital account balances at the end of the period
c. In the same manner as the partner’s loan accounts
d. To record the partner’s share of net income or loss for an accounting
period
3. A partner’s drawing account is
a. An expense account
b. A capital account
c. A contra-capital account
d. A liability account
4. A partnership is an association of two or more persons who carry on as coowners of a business for profit. The persons who form the partnership may
be:
I.
Individuals
II.
Corporations
III.
Fraternal Non-profit organization
a. I only
b. I and III
c. I,II, and III
d. I and II
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5. Partnership is a(an):
I.
Accounting entity
II.
Taxable entity
a. I only
b. I and II
c. Neither I nor II
d. II only
6. Partner X Contributed equipment to the XYZ partnership. The equipment cost
Php60,000 with Accumulated depreciation of Php10,000 but had a fair value
of Php70,000 at the date of the partnership formation. At what amount
should the equipment be reported?
a. Php 50,000
b. Php 60,000
c. Php 70,000
d. Php 10,000
7. The partner’s interest in a partnership is generally equal to:
a. The unamortized cost of the assets of the partners
b. The sum of the fair values of the assets the partners contributed to the
firm, increased by any liabilities of other partners assumed and decreased
by any personal liabilities that are assumed by other partners
c. The fair value of net assets at the date of formation
d. The sum of the bases of the individual assets the partner contributed to
the firm, decreased by the partner’s share in partnership liabilities
8. Which of the following statements about a partnership is true?
a. A partnership is a legal entity separate and distinct from the individual
partners
b. Individual partners are jointly liable for the debts and obligations of a
partnership
c. Income tax is levied on the individual partners’ share of the net income of
the partnership and is reported in their personal tax returns
d. All of the above are true
9. Partners Olive, Marie, and Grace formed OMG Partnership with the following
initial cash investment: Php 150,000; Php 220,000, and Php 180,000. They
agreed to have a 3:5:2 initial interest in the partnership.
What is the total contributed capital?
a. 500,000
b. 520,000
c. 440,000
d. 900,000
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10.Using OMG Partnership, if the partners agreed on a 3:5:2 initial interest in
the partnership using the Olive’s capital as the basis, that is the total agreed
capital?
a. 520,000
b. 500,000
c. 440,000
d. 750,000
11.Refer to # 10, what is the adjusted capital of Grace?
a. 150,000
b. 180,000
c. 100,000
d. 250,000
Trisha, Lizz, and Chin formed TLC Partnership and had the following cash
investments: Php 80,000, Php 120,000, Php 100,000.
12.What is the total agreed capital if the partners agree on an equal interest in
the partnership capital?
a. 240,000
b. 300,000
c. 320,000
d. 360,000
13.What is the total agreed capital if the partners agreed on a 4:3:3 initial
capital interest on the partnership using Chin’s capital as the basis?
a. 400,000
b. 200,000
c. 300,000
d. 333,333
14.What is the adjusted capital of Trisha if the partners agreed on a 4:3:3 initial
capital interest on the partnership using Lizz’s capital as the basis?
a. 120,000
b. 160,000
c. 80,000
d. 133,333
15. What is the adjusted capital of Lizz if the partners agreed on a 4:3:3 initial
capital interest on the partnership using Lizz’s capital as the basis?
a. 120,000
b. 100,000
c. 110,000
d. 80,000
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Ingrid, May, and Gaye formed IMG Partnership and invested the following:
Cash
Machineries
Inventory
Accounts Payable
Ingrid
15,000
50,000
20,000
5,000
May
30,000
30,000
0
10,000
Gaye
10,000
60,000
30,000
0
16. What is the total contributed capital?
a. 215,000
b. 200,000
c. 230,000
d. 250,000
17.What is the total agreed capital if the partners agreed on an equal initial
capital interest in the partnership?
a. 215,000
b. 200,000
c. 230,000
d. 250,000
18. What is the total agreed capital if the partners agreed on a 3:2:5 initial
capital interest using May capital as the basis?
a. 250,000
b. 266,667
c. 200,000
d. 230,000
19. Using number 18 assumption, what is the adjusted capital of Ingrid?
a. 80,000
b. 90,000
c. 75,000
d. 60,000
20.James and Dave agreed to form a partnership and they invested Php 75,000
and Php 125, 000. Both agreed that ¾ of the total partnership interest goes
to Dave.
What is the adjusted capital of James and the bonus received by Dave?
a. 150,000 ; none
b. 150,000 ; 25,000
c. 75,000 ; 25,000
d. 50,000 ; 25,000
OCTOBER 2020
ARS.CPA.CMA