PARTNERSHIP STUDY GUIDE SBU-MANILA JTCHIO one which has for its object determinate things, their use or
fruits, or a specific undertaking or the exercise of a
As per Art. 1767 of the New Civil Code of the Philippines profession or vocation.
A contract whereby two or more persons bind themselves to As to liability
contribute money, property or industry into a common fund with the General co-partnership – consist of purely all general partners
intention of dividing the profits among themselves. Limited partnership – consist of one or more limited partners
Characteristics As per the law, majority of the partners should be general
Mutual agency As to duration
Unlimited liability – in general, except if a partner is a limited partner At will
Limited life one that has unlimited term of existence.
Mutual participation in profits With a fixed term
Legal entity one that has a specific period or term of existence and
Co-ownership of contributed assets expiration thereof dissolves the partnership.
Subject to income tax As to representation to others
Ordinary
Kinds of Partnership one which actually exists among the partners and also to
As to activity third party.
Trading Partnership by estoppel
Nontrading one which is not actually a partnership but is considered as
As to object one only in relation to those who, by their act or omission
Universal partnership are precluded to deny or disprove the partnership’s
Of all present property existence.
one whereby property contributed by the partners As to legality of existence
belongs to the partnership and the profits thereof De jure – has complied with all requirements
also belongs or owned by the partnership De facto – failed to comply with one or more of the legal
Of all profits requirements
one whereby property contributed by the partners As to publicity
belongs to the partners, only the usufruct (right to Secret
use) is given to the partnership, and only the profits Open
thereof belongs or owned by the partnership. Kinds of partners
Particular As to contribution
Capitalist – contributes money or property
Industrial – contributes industry each partner’ transactions with only the net effect of each period’s activity shown in
Capitalist – Industrial the capital account.
Contributes both money and industry
As to liability Partnership operation
General
Limited The partners should have a written agreement, called articles of co-partnership,
As to management specifying the manner in which partnership income (loss) is to be distributed. Note
Managing that in the absence of a predetermined agreement, the profit and loss (P&L) is divided
Silent according to original capital contributed by partners.
Other classifications A number of issues arise which complicate the allocation of partnership income
Liquidating (loss).
Nominal
Ostensible 1. Partners may receive interest on their capital balances. If so, it must be
Secret determined what constitute the capital balance (e.g., the year-end amount of
Dormant some type of weighted-average).
Formation 2. Some of the partners may receive a salary.
3. Some of the partners may receive a bonus on distributable net income. If so,
The partnership is a separate accounting entity (not to be confused with a separate
you need to determine if the bonus should be computed before or after salary,
legal entity), and therefore its assets and liabilities should remain separate and interest and bonus allocations.
distinct from the individual partner’s personal assets and liabilities. 4. A formula needs to be determined for allocating the remaining income. The
formula agreed upon is usually termed the residual, remainder, or profit
All assets contributed to the partnership are recorded by the partnership at their fair (loss) sharing ratio.
market values. All liabilities assumed by the partnership are recorded at their
present values. Finally, the partners should decide upon how income is to be allocated if net
income is insufficient to cover partner’s salaries, bonuses, and interest allocations.
Upon formation, the amount credited to each partner’s capital account must be equal
These allocations are usually made even if the effect is to create a negative
to the amount of cash contributed or equal to the fair market value of the noncash
remainder. This is important to note that partners may choose to allocate losses (or a
contributed or equal to the difference between the fair market value of the assets
negative remainder) in a different manner than income.
(including goodwill, if any) contributed and the present value of the liabilities
assumed from the partner. The capital accounts represent the residual equity of the If the interest, salary, and bonus allocation had exceeded net income, the excess
partnership. The capital account of each partner reflects all of the activity of an would have been deducted on the distribution schedule in the P&L ratio.
individual partner; contributions, withdrawals, and the distributive share of net
income (loss). In some cases, a drawing account is used as a clearing account for
Partnership dissolution Personal transaction between the selling partner and the buying
partner
Partnership dissolution occurs whenever there is a change in ownership (e.g., the The amount paid does not go to the partnership but instead goes to
addition of a new partner, or the retirement, withdrawal or death of an existing the selling partner directly.
partner). We will also include in this handout the incorporation of a partnership, that The buying partner will be credited the percentage of partnership
is, change from a partnership form of organization to a coporation. Partnership interest he has purchased from the selling partner.
dissolution should not be confused with partnership liquidation which is the winding Any gain or loss from the sale of interest in the partnership is a
up of partnership affairs and termination of the business. Under dissolution the personal gain or loss for the selling partner.
partnership business continues, but under different ownership. 2. Investment
When partnership dissolution occurs, a new accounting entity exists. The partnership When a new partner is admitted to the partnership essentially three cases can
should first adjust its records so that all accounts are properly stated at the date of result. The new partner can invest assets into the partnership and receive a
dissolution. After the income (loss) has been properly allocated to the existing capital balance.
partners’ capital accounts, all assets and liabilities should be adjusted to their fair (a) Equal to his/her purchase price.
market value and their present values, respectively. The latter step is performed (b) Greater than his/her purchase price.
because the dissolution results in a new accounting entity. (c) Less than his/her purchase price.
After all adjustments have been made, the accounting for dissolution depends on the If the new partner’s capital balance is equal to the assets invested, then the entry
type of transaction that caused the dissolution. debits the asset(s) contributed and credits the new partner’s capital account for
the fair value of the asset(s) contributed.
These transactions can be broken down into two types:
If the new partner’s capital balance is not equal to the assets invested (as in
* Transactions between the partnership and a partner (e.g., a new partner situation (b) and (c) above), then either the bonus or asset revaluation or even
contributes assets, or a retiring partner withdraws assets). both must be used to account for the difference.
* Transactions between partners (e.g., a new partner purchases an interest from Bonus method
one or more existing partners, or a retiring partner sells his/her interest to one or more i. The old partnership capital plus the new partner’s asset
existing partners). contribution is equal to the new partnership capital. The new
partner’s capital is allocated his purchase share (e.g., 40%)
Admission of new partners
and the old partner’s capital accounts are adjusted as if they
1. Purchase had been paid (or as if they paid) a bonus. The adjustment to
Sale to a new partner of an old existing partner’s interest in the the old partners’ capital accounts is made in accordance with
partnership. their profit (loss) sharing ratio.
ii. The bonus method implies that the old partners either of the original partners. Either the bonus or asset revaluation method may be
received a bonus from the new partner, or they paid a bonus used. The key thing to remember in regard to a partner’s withdrawal from the
to the new partner. As a result the old partners’ capital partnership is that the withdrawing partner’s capital account must be adjusted
accounts are either debited to reflect a bonus paid, or to the amount that the withdrawing partner is expected to receive.
credited to reflect a bonus received. The new partner’s o Retirement
capital account is never equal to the amount of assets Bonus method
contributed in a case where the bonus method is used. If settlement is greater than the capital of the retiring
Asset revaluation method partner, the difference, which will be divided using
i. Necessary adjustment in values of assets upon admission of the profit and loss (PL ratio) of the remaining
a partner. partners, will be treated as bonus given by the
ii. The adjustment in asset values may be determined as the remaining partners to the retiring partner and hence
difference between the agreed capital and total contributed be treated as a reduction to the capital balance of the
capital remaining partners.
When is it bonus or asset revaluation or both? If the settlement is less than the capital of the
i. When the total Agreed Capital (AC) is equal to total retiring partner, the difference will be treated as a
contributed capital (CC), but the old and new partners AC bonus given by the latter to the remaining partners.
differs from its CC, bonus method is used. Hence, the bonus will result as an addition to the
ii. When the total AC is not equal to the total CC, capital of the remaining partners.
Normally the difference would be the asset Asset revaluation method
revaluation to be done to the old partners’ assets. If If settlement is different than the capital of the
upon adjustment using the difference in values, and retiring partner, the difference in amount is the share
the old partners’ AC would be equal to its CC, asset of the retiring partner in the asset revaluation.
revaluation alone is used. Hence, adjust all the partners’ asset values and
However, if upon adjustment after revaluation and capital first to make the settlement amount equal to
the AC of the old partners is not equal to the CC, the retiring partner’s capital balance.
then bonus is recognized to adjust the remaining
difference. Partnership liquidation
o Occurs when the partnership sells its assets, pays its liabilities, and
Withdrawal of partners
distributes remaining assets to partners
The death or withdrawal or retirement of a partner is treated in much the o Process of terminating the business or winding up its affairs. It will
same manner as the admission of a new partner. However, there is no new normally deal with these steps:
capital account to be recorded; we are dealing only with the capital accounts
Convert partnership assets or non-cash assets into cash with A deficient partner may exercise the right of offset to a loan balance owing to
gain or loss on realization be distributed to the partners him or her by the partnership.
Pay partnership liabilities (both internal and external) and Creditor claims does not mean that partnership creditors must be fully paid
liquidation expense before partners can receive any distribution
Distribute cash to partners in payment for their interest Creditor claims means that the accountant has the duty to ensure that
o May occur due to sufficient funds will be available for creditors if partners receive any
Partnership fulfilling its business purpose distribution
Partners desire to not continue the business
Partnership is in financial difficulty LIQUIDATION PROCESS
o May be Adjust books and close all nominal accounts and allocate profit or loss to
Voluntary – the partners may choose to liquidate capital accounts
Involuntary – creditors force the partnership to liquidate Liquidate noncash assets, allocate gains and losses directly to capital
o Partnership creditors’ claims accounts using residual profit and loss ratios
By partnership creditors Pay liabilities
By personal creditors if claim not fully paid from partner If there is a deficient capital, eliminate it by
personal assets (limited to partner’s capital balance) Applying the right of offset when there is a loan payable to the
By personal creditors deficient partner
By partnership creditors if claim not fully paid from Require additional from solvent but deficient partner
partnership assets (not limited to partner’s capital balance) If deficient partner is insolvent or a limited partner, deficiency is
By other partners if partner capital account has a deficit absorbed by other partners
capital balance If deficient partner is a limited partner, right of offset cannot be
applied.
Partnership liabilities shall rank in the following order
o Creditors other than partners
o Partners other than for capital and profits
o Partners in respect of capital
o Partners in respect of profits
In case the partnership is insolvent, an industrial partner is also considered a
general partner and is liable to pay the partnership creditors from his/her
personal assets.
A limited partner is liable only to the extent of his/her contribution to the
partnership.
