Partnership Formation
Fair Value Concept
Fair value in the perspective of partnership
accounting pertains to the value agreed upon by the
partners with regards to their investments and the
liabilities assumed by the partnership as a result of the
creation of the partnership.
In considering this concept, always look for fair
value indications or the agreement of the partnership
and use such in the valuation of investments and
liabilities.
In the absence of any agreement and other
information, the book values or cost of certain assets
may be used as the fair value.
Formation Scenarios
 Two or more individuals form a partnership
 A sole proprietorship and an individual form a
partnership
 Two sole proprietorships form a partnership
Scenario 1
The basic concept to be remembered here is to
always be careful with the valuation of investments.
Always remember the fair value concept.
Cash investments are valued at face value.
Property investments are valued at fair value. Liabilities
assumed are also valued at fair value.
Investment of services or skills is recorded using
a memorandum entry.
***Note that there are certain problems where a liability
is attached or related to a particular asset invested just
like mortgages. As a general rule, such liabilities will be
assumed by the partnership unless otherwise stated.
Thus, if the problem is silent, it is safe to assume that
such liabilities will be assumed by the partnership.
Furthermore, if the problem stated that such liabilities will
not be assumed, the liability will be netted off to the
value of the investment.
Scenario 2
The treatment of the investment of the individual
in this scenario will be the same in scenario 1.
With regard to the sole proprietorship, three
steps should be followed.
Step 1 is to close the nominal accounts just in
case nominal accounts still exist in the books of the sole
proprietorship.
Step 2 is to adjust the books of the sole
proprietorship. In doing this, certain guidelines must be
followed. First, the allowance method should be used in
adjusting accounts receivable, unless the direct write off
method was stated to be used. Second, adjustments to
PPE may be done by directly adjusting the asset or by
adjusting the contra-asset. Third, adjustments to
inventory are directly made to the inventory account.
Finally, information should be read carefully so that
correct adjustments will be made.
Step 3 is to close the books of the sole
proprietorship, meaning eliminating the values of all
accounts. In this step, all accounts with credit balances
will be debited and all accounts with debit balances will
be credited in the closing entry. It is to be noted that the
effects of the adjustments in step 2 should be reflected
to the balances of all accounts affected before step 3 is
done.
Step 4 is to record the investment of the
partners to the books of the partnership. In doing this
step, certain guidelines must be followed. First, accounts
receivable and allowance for doubtful accounts will be
recorded separately not unless direct write off was used
during the adjustments in step 2. Second, PPE will be
recorded net of accumulated depreciation. This is
because on the point of view of the partnership, it has
received a new property and therefore, no accumulated
depreciation should be recognized yet even if on the
point of view of the partner it is already an old property.
Finally, in recording the investments, the actual
investment method should be used unless bonus
method was stated to be used.
***Step 1 and 2 may be done interchangeable. However,
it is more advisable to follow the steps provided so that
procedures and analysis would be less complicated.
***For step 2, it is advisable for adjustment to be done
on a per item basis as to avoid complicated analysis.
However, compound adjustments may also be done.
***For step 3, it is suggested that an adjusted trial
balance should be prepared before proceeding with
closing entries as to assure that all adjustments will be
reflected in affected accounts.
***After step 4, the preparation of the Statement of
Financial Position may be prepared just to assure that
everything is balance after all entries.
Scenario 3
Steps for scenario 3 will be the same with steps
in scenario 2. The only difference is that in this scenario,
more adjustments will be required considering that two
or more sole proprietorships will be forming a
partnership, thus, more adjustments and entries will be
required.
Bonus Method
This happens when the capital balance of a
partner is not equal to his actual contribution as a result
of certain adjustment. This method is used if partners
want their capital balances to be in proportion to a
desired ratio, usually the profit/loss ratio.
It should be noted that in using this method,
careful analysis should be done as to correctly analyze
bonus to and from partners. It should also be noted that
careful analysis should be done in using the ratio
provided so that the correct capital balance or credit will
be satisfied, especially in cases where there are more
than two partners involved.