Accounting for
partnerships
1
PARTNERSHIP FORM OF ENTITY
A partnership is defined as …
–Is a contract whereby 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
2
Characteristics of partnerships
3
Characteristics of partnerships
1. Association of individuals
– Voluntary association
– May be based on handshake or written
agreement
– Partnership not a legal entity, so is not taxed
– Individual partners pay tax on their share of
profit
4
Characteristics of partnerships
continued
2. Mutual agency
– Each partner acts on behalf of the partnership
when engaging in partnership business
– Act of any partner is binding on all other partners
3. Limited life
– May be ended voluntarily at any time through the
acceptance of a new partner or withdrawal of a
partner
– May be ended by involuntarily by death of
incapacity of a partner
5
Characteristics of partnerships
continued
4. Unlimited liability
– Each partner is personally and individually liable
for all partnership liabilities
5. Co-ownership of property
– Partnership assets are owned jointly by the
partners
– If partnership is dissolved, assets do not legally
revert to original contributor
– Partners have a claim on total assets equal to the
balance in individual capital account
– Partnership profit or loss is co-owned
6
Advantages and disadvantages of
partnerships
•
•
•
•
•
Advantages
Combining skills and resources of 2 or
more individuals
Ease of formation
Not subject to as much government
regulation as companies
Ease of decision making
No taxation on partnership profits
•
•
•
•
Disadvantages
Mutual agency
Limited life
Unlimited liability
Partners must be
able to work
together
7
Kinds of partner
• As to contribution
– Capitalist partner contributes money or property
– Industrial partner contributes skills, knowledge,
industry or service
– Capitalist-industrial partner contributes money or
property and industry
• As to liability
₋ General partners have unlimited liability
₋ Limited partners have limited liability
8
Kinds of partnership
• General Partnership
₋ Partners are all general partner
• Limited Partnership
₋ Composed of one or more general
partner and one or more limited partner
9
Articles of Partnership
• A written contract made by the partners specifying
such details as …
–
–
–
–
–
–
–
Names and contributions of the partners
Rights and duties of partners
Basis for sharing net income or loss
Provision for withdrawals of assets
Procedures for settling disputes
Procedures for withdrawal or addition of a partner
Rights and duties of surviving partners in the event of a
partner’s death
10
Review question 1
A.
B.
C.
D.
Which of the following is not a characteristic of a
partnership?
Taxable entity
Co-ownership of property
Mutual agency
Limited life
11
Review question 2
A.
B.
C.
D.
Statement 1: A lawyer and doctor may formed a
partnership as business partners to practice their
profession.
Statement 2: A limited partner must pay first his
personal creditors before paying the partnership
creditors.
Only 1st is true
Only 2nd is true
Both true
Both false
12
BASIC PARTNERSHIP ACCOUNTING
• Major accounting issues in relation to
partnerships are
– Forming a partnership
– Dividing profit or loss
– Preparing financial statements
– Dissolution of partnership
– Liquidation of partnership
13
Forming a partnership
• Initial investment
– Rules to be observed:
The amount of contribution shall be based on the
partner’s agreement. In the absence of any
agreement, it shall be contributed equally.
₋ Sample problem1:
A and B form a partnership with the total agreed
capitalization of P150, 000 to be contributed in cash of
40% and 60% by A and B, respectively, through the
issuance of their personal checks. The amount
contributed and capital credited to be recorded per
agreement would be:
14
Forming a partnership cont.
– Sample problem2
A and B form a partnership with the total agreed
capitalization of P150, 000 to be contributed in cash
through the issuance of their personal checks. The
amount contributed and capital credited to be
recorded per agreement would be
15
Forming a partnership cont.
• Valuation of partners’ contribution
₋ If cash contribution – based on face value
₋ If non cash – based on agreed value, in the
absence of agreed value it shall be based on fair
value.
*Fair value or fair market value – represents the estimated
amount in which the seller and buyer would be willing to
exchange value in an open market.
• Once partnership has been formed
– Accounting is similar to accounting for transactions of any
other type of business organisation
16
Forming a partnership continued
• Example 1
– Carrying amount and fair value of assets invested
Carrying amt
Fair value
A.Gibson T.Jones A.Gibson T.Jones
Cash
P 8 000 P 9 000
P 8 000 P 9 000
Office equipment
5 000
4 000
Accum. depreciation
(2 000)
Accounts receivable
4 000
4 000
Allow. for doubtful debts
(700)
(1 000)
P11 000 P12 300 P12 000 P12 000
17
Forming a partnership continued
– Journal entries to record investments
Cash
Office Equipment
A. Gibson, Capital
(To record investment of Gibson)
8 000
4 000
Cash
Accounts Receivable
Allowance for Doubtful Debts
T. Jones, Capital
(To record investment of Jones)
9 000
4 000
12 000
1 000
12 000
18
Forming a partnership continued
• Example 2
C, D and E formed a partnership with agreed total
capitalization of P30, 000 which should be contributed equally by C
and D. Meanwhile, E was designated to manage the operation of the
partnership as industrial partner with a share of 20% from
partnership profits. C and D contribute the following assets:
Cash
Land
Office equipment
Supplies
Notes Payable
(assumed by the partners)
Fair Value
Agreed Value
Partner C Partner D Partner C Partner D
P 10 000
P 10 000
P 5 000
11 000
7 000
5 000
6 000
4 000
2 000
1 000
2 000
2 000
.
P 10 000
P 17 000 P 15 000 P 15 000
19
Review question 3
A.
B.
C.
D.
In accounting for the formation of a partnership,
each partner’s initial investment is recorded at …
the carrying amount of assets invested
the fair value of assets invested
the historical cost of assets invested
the book value of assets invested
20
Dividing profit or loss
• Art. 1799 of the New Civil Code provides that any
stipulation that excludes one or more partners from
any share in the profits or losses is null and void.
• Art. 1797 provides the following guidelines on how
partnership profits and losses shall be distributed
among the partners:
21
Dividing profit or loss
As to Capitalist Partner
1. Division of profits
a. In accordance with agreement
b. In the absence of an agreement, in
accordance with capital contributions.
2. Division of losses
a. In accordance with agreement
b. If only the division of profits is agreed
upon, the division of losses will be the same as the
agreement on the division of profit
c. In the absence of agreement, based on capital contribution
Dividing profit or loss
II. As to Industrial Partner
1. Division of profits
a. In accordance with agreement
b. In the absence of an agreement, industrial partner shall
receive a just and equitable share of the profits.
2. Division of losses
a. In accordance with agreement
b. In the absence of agreement, industrial partner shall
have no share in the losses
Dividing profit or loss continued
Closing entries:
1. DR each revenue account for its balance and CR Profit and
Loss Summary for total revenue
2. DR Profit and Loss Summary for total expenses and CR each
expense account for its balance
3. DR (CR) Profit and Loss Summary for its balance and CR (DR)
each partner’s capital account for their share of profit (loss)
4. DR each partner’s capital account for the balance in that
partner's drawing account and CR each partner’s drawing
account for the same amount
24
Dividing profit or loss continued
– Example
• Partnership profit for year is P32 000
• Partners share profit and loss equally
Profit and Loss Summary
L. Cooke, Capital (P32 000 x 50%)
D. Kam, Capital (P32 000 x 50%)
(To transfer profit to partners’
current accounts)
32 000
L. Cooke, Capital
8 000
D. Kam, Capital
6 000
L. Cooke, Drawings
D. Kam, Drawings
(To close drawings accounts to current
PowerPoint presentation by Dr Anne
accounts) Abraham,
University of Western Sydney
16 000
16 000
8 000
6 000
25
Dividing profit or loss continued
Example2:
Assume that Adam and Eve formed a partnership
with original capital contributions of P60,000 and
P30,000 respectively. The profit agreement is 60% and
40% respectively. During the year, the partnership
generated an income of P100,000.
a) Give the closing entry for the above problem.
b) Assuming instead of profit, it was P100,000 loss.
c) Assuming no agreement was made, give the closing
entry under assumption (a) and (b)
26
Dividing profit or loss continued
Profit-and-loss ratios
Typical profit-and loss ratios include:
1 A specified ratio
– expressed as a proportion (6:4), a percentage (70% and
30%), or a fraction (2/3 and 1/3)
2 A ratio based on either:
– capital balances at beginning of year or
– ending capital balances
27
Dividing profit or loss continued
3 Interest on partners’ capital balances and the
remainder on a agreed ratio
4 Salaries or Bonus allowed for partner’s
services, the remainder to be divided in an
agreed ratio
5 Multiple base of allocation
 Salaries to partners, interest on partners’
capitals, and the remainder on a fixed ratio)
28
Dividing profit or loss continued
Sample Problem :
Assume that Adam and Eve formed a partnership with
original capital contributions of P60,000 and P30,000
respectively. General ledger for their capital accounts before
closing entries are shown below:
29
Dividing profit or loss continued
During the year Net Income of P100,000 was earned by the partnership. They agreed
that profit will be divided:
1. 60% to Adam and 40% to Eve
2. Based on capital ratio: (a.) Beginning capital (b.) Ending capital
3. 10% Interest on beginning capital and the balance will be
distributed equally
4. Salary to Eve for P10,000 and the balance distributed 60% for Adam
and 40% to Eve.
5. 10% interest on ending capital, salary to Eve for 10,000, 10% bonus
based on Net Income before salaries and interest for Adam. The
balance will be divided equally.
6. 10% interest on ending capital, salary to Eve for 10,000, 10% bonus
based on Net Income after salaries and interest for Adam. The 30
balance will be divided equally
Dividing profit or loss continued
INSUFFICIENT INCOME
As a rule. The prescribed allocation for
salaries and/or interest should still be given in
spite of the insufficiency of partnership’s net
income to cover them. The earnings deficiency
resulted for giving salaries and/or interest shall be
allocated among the partners based on their
profit and loss sharing.
31
Dividing profit or loss continued
Insufficient Income
• Sample Problem:
– M. Kings and S. Lee agree on
• Salary allowances of P8400 to Kings and P6000 to Lee
• Interest allowances of 10% on beginning capital
balances
• 10% Bonus to S. Lee
• Remainder shared equally
– Beginning capital balances
• Kings P28 000 and Lee P24 000
– Profit for the year is P5,000
32
Dividing profit or loss continued
Division of profit
Net Profit to be distributed
Salary allowance
Interest allowance
Kings (P28 000 x 10%)
Lee (P24 000 x 10%)
Balance: (50:50)
Kings (P14,600 x 50%)
Lee (P14,600 x 50%)
Total division of profit
Kings
Running bal.
P 5,000
P 8,400 P 6,000 (9,400)
2,800
(7,300)
Lee
2,400
(12,200)
(14,600)
(7,300)
(7,300)
0
P 3,900 P 1,100
33
Dividing profit or loss continued
– Entry to record division of profit
Profit and Loss Summary
M. Kings, Capital
S. Lee, Capital
(To close profit to partners’ capital
accounts)
5 000
3 900
1 100
34
Review question 4
A.
B.
C.
D.
NBC reports net income of P60 000. If partners N,
B, and C have an income ratio of 50%, 30%, and
20%, respectively, C’s share of net income is …
P30 000
P12 000
P18 000
P20 000
35
Review question 5
A.
B.
C.
D.
XYZ reports net loss of P60 000. X initial
contributions amounting to P50,000, Y contributes
P30,000 and Z contributes his time and service in
the business. There is no agreement on how profit
and loss will be distributed. How much is the share
in the loss of each partner?
P37,500, 22,500, 0
P20,000, 20,000, 20,000
P30,000, 30,000, 0
P27,272, 16,364, 16,364
36
Partnership financial statements
• Income statement
– Identical to proprietorship except for division of profit
• Statement of financial position
– Identical to proprietorship except for owners’ equity
section
• Partnership statement of changes in equity
– Used to explain the changes in each partner’s capital
account and in total partnership equity during the year
37
Partnership financial statements
KINGSLEE
Statement of Changes in Partners’ Equity
For the year ended 31 December 2013
Max Kings Steven Lee Total .
Capital, 1 January
P 28,000
P 24,000
P 52,000
Add: Share on Profit
12,400
9,600
22,000
Total
40,400
33,600
74,000
Less: Drawings
7,000
5,000
12,000
Capital, 31 December P 33,400 p 28,600 P 62,000
38
Partnership financial statements
KINGSLEE
Statement of Financial Position (partial)
As at 31 December 2013
Total Liabilities(assumed amount)
P 115,000
Owners’ Equity
Max Kings, Capital
P 33,400
Steven Lee, Capital
28,600
Total Owners’ Equity
62,000
TOTAL LIABILITIES AND OWNERS’ EQUITY
P 177,000
39
Review question 5
A.
B.
C.
D.
Which of the following statements about the partnership
financial statements is not true?
The capital balances of each partner are shown on the
statement of financial position
Changes in each partner’s capital account is shown on
statement of changes in equity
Each partner’s drawings is shown on the statement of
financial position
Distribution of profit is shown in income statement
40
Partnership dissolution


The dissolution of a partnership is the
change in the relation of the partners
caused by any partner ceasing to be
associated in the carrying on of the
business.
The change of partners in the partnership
ends their original agreement, thus
terminating the partnership.
41
ADMISSION OF A PARTNER
• The admission of a new partner results in legal
dissolution of the existing partnership and the
beginning of a new one
• To recognise economic effects it is necessary only to
open a capital account for each new partner
• A new partner may be admitted either by:
– Purchasing the interest of an existing partner or
– Investing assets in a partnership
42
ADMISSION OF A PARTNER
continued
PowerPoint presentation by Dr Anne
Abraham, University of Western Sydney
43
Purchase of a partner’s interest
• The admission of a partner by purchase of an interest
in the firm is a personal transaction between one or
more existing partners and the new partner
• Price paid is negotiated and determined by the
individuals involved
• The price may be equal to or different from the
capital equity acquired
• Any money or other consideration exchanged is the
personal property of the participants and not the
property of the partnership
44
Purchase of a partner’s interest
continued
• Example
– Cox agrees to pay P10 000 cash to Adler and
Barker each for 1/3 of their interest in the
Adler-Barker partnership
– At the time of admission of Cox, each
partner has a P30 000 capital balance
45
Purchase of a partner’s interest
continued
– Entry to record admission of Cox
• Each partner will give up P10 000
(1/3 x P30 000)
C. Adler, Capital
10 000
D. Barker, Capital
10 000
L. Cox, Capital
20 000
(To record admission of Cox by purchase)
46
Purchase of a partner’s interest
continued
– Ledger balances after purchase of partners’
interest
C. Adler, Capital
10 000
30 000
Bal. 20 000
D. Barker, Capital
10 000
30 000
Bal. 20 000
L. Cox, Capital
20 000
– Total partnership capital before and after
admission of Cox is P60,000
47
Purchase of a partner’s interest
continued
Sample Problem2:
The capital balances and agreed profit and loss
distribution of Eric and Vincent partnership prior to
dissolution are as follows:
Partners Capital Balances P&L Ratio
Vincent
250,000
25%
Eric
750,000
75%
Lally wants to buy 50% of the interest of Eric to give her
interest of 37.5% in the partnership’s asset and in the
partnership’s profit and loss.
48
Purchase of a partner’s interest
continued
Sample Problem2 cont’d...
Case 1: Purchase at Book Value: Assume that Lally paid
P375,000 directly to Eric.
Case 2: Purchase Lesser than Book Value: Assume that
Lally paid P350,000 directly to Eric.
Case 3: Purchase More than Book Value: Assume that Lally
paid P400,000 directly to Eric.
What is the journal entry for the admission and what is the
49
new profit and loss ratio of new partnership?
Purchase of a partner’s interest
continued
– Entry to record admission of Lally under case1,2 and 3
• Eric will give up 50% of his share
(50% x 750,000)
Eric, Capital
375 000
Lally, Capital
375 000
(To record admission of Lally by purchase)
Note:
1. Gain or loss in the purchase of interest transaction is a personal
gain or loss of the partner/s involved.
2. Total capital before and after admission of Lally is P1,000,000
3. New P&L ratio after admission of Lally: Vincent-25%, Eric50
37.5%, Lally-37.5%
Purchase of a partner’s interest
continued
Sample Problem3:
The capital balances and agreed profit and loss
distribution of Pat and Sponge partnership prior to
dissolution are as follows:
Partners Capital Balances P&L Ratio
Pat
150,000
30%
Sponge
350,000
70%
Mr. Crab wants to buy 20% of the interest in the
partnership’s asset and profit by paying directly to each
of the existing partners.
51
Purchase of a partner’s interest
continued
Sample Problem3 cont’d...
Case 1: Purchase at Book Value: Assume that Mr. Crab paid
P100,000 directly to the partners.
Case 2: Purchase Lesser than Book Value: Assume that Mr.
Crab paid P60,000 directly to the partners.
Case 3: Purchase More than Book Value: Assume that Mr.
Crab paid P150,000 directly to the partners.
What is the journal entry for the admission and what is the
52
new profit and loss ratio of new partnership?
Investment of assets in a partnership
• When a partner is admitted by investment, both the
total assets and the total partnership capital change
• When the new partner’s investment differs from the
capital equity acquired, the difference is considered a
bonus either to:
1. The existing (old) partners or
2. The new partner
53
Investment of assets in a partnership
continued
• Example
– Cox invests P30 000 cash in the Adler-Barker partnership
for a 1/3 capital balance
– Journal entry to record admission
Cash
30 000
L. Cox, Capital
30 000
(To record admission of Cox by investment)
54
Investment of assets in a partnership
continued
– Ledger balances after investment of assets
C. Adler, Capital
30 000
D. Barker, Capital
30 000
L. Cox, Capital
30 000
Total Partnership ‘s Capital
60 000
30 000
Bal. 90 000
55
Investment of assets in a partnership
continued
Bonus to old partners
• Results when new partner’s investment in the firm is
greater than the capital credit on the date of
admittance
• Sample Problem 1:
– Boyd and Chan with total capital of P120 000 agree to admit
Dante to the partnership
– Dante acquires a 25% ownership interest by making a cash
investment of P80 000
– Current profit sharing ratio is Boyd 60% and Chan 40%
56
Investment of assets in a partnership
continued
• Steps in determining bonus
1 Determine the total contributed capital of the new
partnership
• New partner’s investment + capital of the old partnership
• P120 000 + P80 000 = P200 000
2 Determine the new partner’s agreed capital
• Multiply the total capital of the new partnership by the new
partner’s ownership interest
• P200 000 x 25% = P50 000
57
Investment of assets in a partnership
continued
3 Determine the amount of bonus
• Subtract the new partner’s capital credit from the new partner’s
investment
• P80 000 - P50 000 = P30 000
4 Allocate the bonus to the old partners on the basis of their
original income ratios
• Boyd: P30 000 x 60% = P18 000
• Chan: P30 000 x 40% = P12 000
58
Investment of assets in a partnership
continued
– Entry to record admission of Dante
Cash
80 000
S. Boyd, Capital
18 000
T. Chan, Capital
12 000
L. Dante, Capital
50 000
(To record admission of Dante and bonus
to old partners)
59
Investment of assets in a partnership
continued
Bonus to new partner
• Results when the new partner’s investment is less
than his or her capital credit in the firm
• Capital balances of the old partners are decreased
based on their income ratios before the admission of
the new partner
60
Investment of assets in a partnership
continued
Bonus to new partner
• Sample Problem2:
– Boyd and Chan with total capital of P120 000 agree to admit
Dante to the partnership
– Dante acquires a 25% ownership interest by investing cash
of P20 000
– Current profit sharing ratio is Boyd 60% and Chan 40%
61
Investment of assets in a partnership
continued
– Entry to record admission of Dante
Cash
20 000
S. Boyd, Capital
9 000
T. Chan, Capital
6 000
L. Dante, Capital
35 000
(To record admission of Dante and bonus)
62
Investment of assets in a partnership
continued
Sample Problem 3:
The capital balances and agreed profit and loss distribution
ratio of the partners before admitting Judy are as follows:
Job
Capital
Balances
Profit &
Loss Ratio
John
120,000
20%
Jun
Total
240,000 240,000
40%
40%
600,000
100%
Judy admitted by investing cash of P200,000 for 30% interest
63
in the partnership assets and profits
Investment of assets in a partnership
continued
Sample Problem 3 cont’d…
Required:
1.) Journalized admission of new partner Judy
2.) What is the new profit and loss sharing of the partners?
3.) Assume that Judy admitted by investing cash of
P200,000 for 20% interest in the partnership.
64
Review question 6
A.
B.
C.
D.
Yen purchases 50% of Baht’s capital interest in the
Euro-Baht Partnership for
P12 000. If the capital balance of Euro and Baht
are P20 000 and P36 000 respectively, Yen’s capital
balance following the purchase is …
P12 000
P28 000
P10 000
P18 000
65
LIQUIDATION OF A PARTNERSHIP
• The liquidation of a partnership terminates the
business
• In a liquidation, it is necessary to:
1 Sell noncash assets for cash and recognise a gain or loss on
realisation
2 Allocate gain/loss on realisation to the partners based on
their profit-and-loss ratios
3 Pay partnership liabilities in cash
4 Distribute remaining cash to partners on the basis of their
capital balances
66
LIQUIDATION OF A PARTNERSHIP
continued
• Creditors must be paid before partners receive any
cash distributions
• Each step must be recorded by an accounting entry
• No capital deficiency means that all partners have
credit balances in their capital accounts
• Capital deficiency means at least one partner’s
account has a debit balance
67