FORMATION: accounting for initial investments

OPERATIONS: accounting for division of profits/losses

DISSOLUTION: accounting for admission/withdrawal/retirement/death
LIQUIDATION: accounting for safe payments of cash as a return of capital to partners

PARTNERSHIP FORMATION
Article 1767- By the contract of partnership 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.
1. VALUATION OF CONTRIBUTIONS
TYPE MEASUREMENT
Cash and cash equivalents Face Value
Inventories LCNRV: Lower of Cost and Net Realizable Value*
*NRV = Estimated Selling Price – Costs to Complete
and Sell
Other assets not mentioned above Fair Value

2. WHEN TO USE THE BONUS METHOD

When a partner’s capital balance is credited for an amount greater than or less than the fair value of his net
contribution.
Under the bonus method, no additional or withdrawal in the initial investment is made, nor is there a cash
settlement between the partners.
For example: Partners A and B each contributed P50,000 cash. The partnership has a total capital balance of
P100,000 (P50k x 2), but because partner A is also providing his expertise to their partnership, he will be given a
capital credit of P60,000.
Notice that the Face Value of A’s contribution = P50,000 but his Capital Credit = P60,000
A bonus of P10,000 (P60k-P50k) has been granted to A. The same bonus was taken from the Capital Credit of B.
Therefore:
Contributions Bonus to (from) Capital Balance
A P50,000 +P10,000 =P60,000
B P50,000 (P10,000) =P40,000
3. VARIATIONS TO THE BONUS METHOD
Technically, there is no bonus being given to a certain partner because any increase or decrease in his capital
credit is not added to/deducted from another partner’s capital account.
Under variations to the bonus method:
a. a cash settlement among the partners are made
b. additional or withdrawal in the initial investment is made
For example: Partners A, B, and C contributed the following to the Partnership:
A B C Partnership
Cash 500,000 200,000 100,000 800,000
Accounts receivable 700,000 700,000
Inventories 900,000 900,000
Equipment 2,000,000 2,000,000
Mortgage payable (800,000) (800,000)
Net contribution 1,200,000 1,400,000 1,000,000 3,600,000
Equal interest (3.6 ÷ 3) 1,200,000 1,200,000 1,200,000 3,600,000
Cash receipt (payment) - 200,000 (200,000) -

FUNDAMENTALS OF FINANCIAL ACCOUNTING AND REPORTING JCFA

Notice that the partners’ initial contributions totaled to P3,600,000. They decided to equalize their interests to
P1,200,000 each, so any excess contribution will be withdrawn or treated as cash receipt from a co-partner (from
C), and any deficiency will be contributed by the partner or treated as cash payment (to B).

PARTNERSHIP OPERATIONS
After the partners have successfully formed their partnership, it will have to operate, earn profit or incur a loss
for the entire period. Thus, the partnership's profit/loss ratio (P/L ratio) is substantially used in this stage.
P/L ratio may be based on agreement by the partners. If not, each partners' capital contributions shall be the basis
for division of P/L.
-each partner's share in the profit increases his capital balance. (capital credited)
-each partner's share in the loss decreases his capital balance. (capital debited)
1. Partners' Additional Stipulations
-these are items that the partners may agree upon so that they have additional basis for division of P/L.
Stipulations may come in the form of Bonuses, Interest, and Salaries.
1. Bonuses- usually received by the Managing partner (either Capitalist or Industrial). If the managing partner
successfully managed the business, the partnership will earn profits. To compensate for good
management, the managing partner is given a bonus. So, if the partnership incurs a loss, no bonus is given.
Since bonuses are given only if there is an agreement, bonuses may take on different forms and
statements. For example:
 "before salaries, before interest, before bonus" OR
 "after salaries, before interest, before bonus" OR
 "after salaries, after interest, before bonus" OR even
 "after salaries, after interest, after bonus" and so on…
What You Need To Remember:
As long as it says "after" salaries/interest/bonus, that means such salaries/interest/bonus have to be
deducted first before you can compute for the bonus.

The following illustrations are given with this fact pattern:

Profit = P1,000
Bonus = 10%
Salaries = 50 per partner (2 partners)
Interest = 8% on P 1,000 beginning capital balance of each partner
Illustration #1:
Bonus is 10% "before salaries, before interest, before bonus"
Analysis: Bonus is just 10% of profit. No deduction for salaries, interest, nor bonus yet.
Computation: Bonus = 10% x 1,000 = P100
Illustration #2:
Bonus is 10% "after salaries, before interest, before bonus"
Analysis: Bonus is 10% of profit after deducting salaries of 100 50 x 2 partners =100. No deduction for
interest, nor bonus yet.
Computation: Bonus = 1,000-100 = 900 x 10% = 90
Illustration #3:
Bonus is 10% "after salaries, after interest, before bonus"
Analysis: Bonus is 10% of profit after deducting salaries of 100 50 x 2 partners =100 and interest of 160
1,000 beginning capital x 8% interest x 2 partners. No deduction for bonus yet.
Computation: Bonus = 1,000-100-160 = 740 x 10% = 74
Illustration #4:
Bonus is 10% "after salaries, after interest, after bonus"

FUNDAMENTALS OF FINANCIAL ACCOUNTING AND REPORTING JCFA

 Analysis: Bonus is 10% of profit after deducting salaries of 100 50 x 2 partners =100 and interest of 160
1,000 beginning capital x 8% interest x 2 partners, and bonus. Notice that bonus has to be deducted first
in order to get the bonus. That is, Bonus = 10% of Profit less Salaries, less Interest, less Bonus.
Computation: B = .10(P - S - I - B)
B = .10(1,000 - 100 - 160 -B)
B = 100 - 10 - 16 - 0.10B
B = 74 - 0.10B
B + 0.1B = 74
1.1B = 74
1.1B/1,1 = 74/1.1
B = 67

2. Interest- usually received by a Capitalist partner, to compensate for the passage of time in contributing
cash and cash equivalents. Interest is usually given in the form of a percentage, and could be multiplied
to the receiving partner's Weighted Ave. Capital Balance, OR Beginning Capital Balance, OR even the
Ending Capital Balance, depending on agreement. Partners may receive interest despite incurring a loss.
What you need to remember: weighted-average capital balances and average investments are the same
– drawings are considered in the computations.
3. Salaries- usually received by an Industrial partner, to compensate for his services/skills/expertise. Partners
must be compensated with salaries despite incurring a loss.
*Minor complication: take note that Income-Expenses=Profit or Loss
If the problem treats salaries as expenses (that means that it is treated as Salaries and Wages expense
rather than as a means for division of P/L), it has already been deducted to compute for the profit or loss.
So salaries should be added back to profit or loss to compute for the right amount to be divided among
the partners, unless the problem says "profit or loss before salaries".

PARTNERSHIP DISSOLUTION
Dissolution happens when there is a change in relation among the partners. It does not necessarily mean
the liquidation and winding-up of the business affairs. Dissolution may lead back to operations (whether
in a similar or different business organization such as a sole proprietorship or corporation) or it may lead
to liquidation.
What is dissolved in the partnership: the old partnership contract and relations.
Dissolution may occur due to:
 Admission of a new partner
 Withdrawal of a partner
 Retirement of a partner
 Death of a partner
 Incorporation
1. Admission of a new partner
Key points to remember:
- “interest in the partnership” = “P/L share” or “P/L ratio”
- capital ratio or capital credit = amount of partner’s capital shown on the balance sheet
-bonus method: when partner’s capital credit is not equal to partner’s contribution
-revalue all assets and liabilities to Fair Value before admission; distribute the gain or loss in revaluation to the
old partners; and distribute the profit or loss to the old partners up to the date of admission of a new one
PURCHASE OF INTEREST INVESTMENT IN THE PARTNERSHIP
Partner to partner transaction (transaction within Partner to Partnership transaction
equity only)
Contribution is not recorded in the books Contributions are recorded in the books
FUNDAMENTALS OF FINANCIAL ACCOUNTING AND REPORTING JCFA
 Total partnership capital remains the same Total partnership capital is increased by the fair value
of the incoming partner’s contributions
Bonus method is not used Bonus method may be used
P/L ratios of the partner(s) whose interests are sold P/L ratios of all the existing partners change
also changes. The unaffected partner will have an
unaffected P/L ratio

2. Withdrawal/Retirement/Death of a partner
Key points to remember:
-revalue all assets and liabilities to Fair Value at the date of death; distribute the gain or loss in revaluation to
the old partners; and distribute the profit or loss to the old partners up to the date of dissolution
PURCHASE BY ONE OR ALL OF THE REMAINING PURCHASE BY THE PARTNERSHIP
PARTNERS
Partner to partner transaction (transaction within Partner to Partnership transaction
equity only)
Settlement is not recorded in the books Settlement are recorded in the books
Total partnership capital remains the same Total partnership capital is decreased by the fair
value of the outgoing partner’s capital balance
Bonus method is not used Bonus method may be used

PARTNERSHIP LIQUIDATION
1. Realization (converting non-cash assets into cash)
2. Dividing gain/loss on realization among the partners
3. Settlement of Liabilities
1. Outside creditors
2. Inside creditors
4. Settlement of Equity
In case the partnership’s assets are insufficient, in which case the
partnership becomes insolvent, the solvent general partners shall
prioritize:
1. personal creditors
MARSHALLING OF ASSETS 2. partnership creditors
3. those owed to co-partners
In case the partnership is insolvent, and some partners have capital
deficiency:
1. offset the capital deficiency to the capital balance of other partners
(solvent)
2. if after offsetting the deficiency, the solvent general partner’s capital
balance results to a negative amount, he is required to provide additional
contribution (because he has unlimited liability)
TO SIMPLIFY, remember that:
-when there is a limited partner (whether solvent or insolvent), he shall not be required to provide additional
contribution even if he incurs a negative capital balance (because a limited partner is liable only up to his capital
contributions)
- when a partner is a SOLVENT general partner, he shall be required to:

FUNDAMENTALS OF FINANCIAL ACCOUNTING AND REPORTING JCFA

1. absorb the capital deficiency (or negative balance) of a co-partner.
2. if he incurs a negative capital balance after absorbing another partner’s deficiency, he shall be required to
provide additional contribution
Example on how insolvent general partners shall divide the capital deficiency of a co-partner:
A (30%) B (40%) C (30%)
Total 10,000 8,000 (5,000)
C has a P5,000 capital deficiency. If A and B are both solvent general partners, they shall be required to absorb
C’s deficiency proportionately through: A (30%) + B (40%) = 70% so A’s proportion shall be 30/70 and B’s shall
be 40/70
Total 10,000 8,000 (5,000)
Absorption: (2,143) (2,857) 5,000
Ending: 7,857 5,143 0

Lump-sum liquidation occurs when all of the non-cash assets are sold simultaneously or within a short period of
time. All proceeds from the sale are first used to pay up the partnership’s liabilities, and any remaining cash is
divided among the partners.
Installment liquidation occurs when non-cash assets take a longer period of time before they are all converted
to cash. Available cash are distributed to partners after all partnership liabilities are settled. To facilitate with
cash distributions, accountants use the Schedule of Safe Payments (SSP) or the Cash Priority Program (CPP).
Major assumptions in using the SSP and CPP:
Carrying amount of unsold non-cash assets
+ Estimated future liquidation costs
+ Cash set aside (usually for potential unrecorded liabilities)
Theoretical loss a.k.a. Maximum Loss Possible (treated as if they are already losses to the partnership)
We have to differentiate theoretical loss from actual loss on realization computed as follows:
Carrying amount of non-cash assets sold
- Cash proceeds from sale
Loss on sale + Actual liquidation expenses = Actual loss on realization

In using the schedule of safe payments:

 In the first installment:
1. compute first the total interests of the partners (take into account +payable to partners and –receivable
from partners)
2. allocate the actual loss on realization to the partners based on their P/L ratios
3. allocate the theoretical loss to the partners based on their P/L ratios
4. Subtract step 1, 2, and 3 to get the first installment payment to the partners.
ANALYSIS: as long as there are still non-cash assets left unsold, there shall also be a theoretical loss. Hence,
when all non-cash assets are sold, there shall be no theoretical losses left, and that signifies the last
installment.
 In the second until the last installment:
1. compute first the total interests of the partners (take into account +payable to partners and –
receivable from partners)
2. allocate the CUMULATIVE actual loss on realization to the partners based on their P/L ratios
3. allocate the NEW theoretical loss to the partners based on their P/L ratios
4. Subtract step 1, 2, 3, and the preceding installment payments to get the current payment.

FUNDAMENTALS OF FINANCIAL ACCOUNTING AND REPORTING JCFA

 The CPP may also be used in lieu of the SSP. To use the CPP, you have to compute for the Maximum Loss
Absorption Potential of each partner in order to determine the order of priority in which partners shall
be paid.
Note: The first priority amount shall be settled in full first before proceeding to distribution for the
second priority, and so on. After all priority amounts are fully settled, any remaining cash shall be
divided in accordance with the partners’ P/L ratio.

FUNDAMENTALS OF FINANCIAL ACCOUNTING AND REPORTING JCFA