MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY

COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY

DEPARTMENT OF ACCOUNTANCY

ACT130: Accounting for Special Transactions

Partnership Formation

LESSON OBJECTIVES
At the end of this module, you will be able to:
1. Differentiate between the accounting for partnership, sole proprietorship, and corporations.
2. State the valuation of contributions of partners;
3. Account for initial investments of the partners to the partnership;
4. State the peculiar accounts used in a partnership and identify the transactions that affect
these accounts.

OVERVIEW
Partnerships are a popular form of business because they are easy to form and they allow several
individuals to combine their talents and skills in a particular business venture. In addition,
partnerships provide a means of obtaining more equity capital than a single individual can obtain
and allow a sharing of risks rapidly growing businesses.

ABSTRACTION

DEFINITION
A partnership is an association of two or more persons who can contribute money, property, and
industry to a common fund with the intention of dividing the profits among themselves.

CHARACTERISTICS
1. Ease of Formation
The partners merely put their agreement into writing concerning who contributes assets
or services, their roles and functions, and how profits and losses are allocated.

2. Limited Life
The possibility that the operations of a partnership could not continue after the withdrawal
or death of a partner was considered a major pitfall of this form of business organization.

3. Assignment of Partner’s Interest

Assignment of partner’s interest does not automatically dissolve a partnership.

4. Unlimited Liability
Partnership creditors having difficulty in collecting from the partnership may request
payment from any partner who has personal assets in excess of personal liabilities.

5. Mutual Agency
Every partner is an agent and has the authority to act for the partnership and to enter into
contracts on its behalf.

6. Separate Legal Personality

Partnership law provides that partnership has a juridical personality separate and distinct
from that of each partner.

7. Sharing Profits and Losses

Profit and losses are shared among the partners in any manner to which they agree.

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

ACCOUNTING FOR PARTNERSHIP ACTIVITIES

Accounting for Partnership differs from sole proprietor or a corporation as far as sharing of profit
and loss and the maintenance of the partner’s ledger accounts. To maintain partnership records,
it might be possible to have one ledger account for each partner, and the usual practice is to
maintain three types of accounts. These are:

1. Capital Accounts
The following are the items that affect capital account:

CAPITAL ACCOUNT
Permanent or Capital Withdrawal Initial or Original Investment

Drawings in excess of a specified amount Additional Investment

Withdrawal of large and irregular accounts Share in Net Income

Share in Net Losses

Closing of a net debit balance in the parner's

drawing account

2. Drawings or Personal Accounts

There are two classes of withdrawal:
a. Capital Withdrawal or Permanent Withdrawal – it directly affects the capital account balance
because they arise mostly from withdrawals of investment be it original or additional;

b. Personal Withdrawal or Temporary Withdrawal – These are initially recorded in a drawing

account. More often these are drawings from share of profits which will eventually be closed to
capital account.
Drawing Account
Personal withdrawals in anticipation of Profits

Periodic Withdrawal

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

3. Accounts for Loans to and from Partners

a. Loan Receivable to Partner (Loans to) – a partner may borrow cash from the partnership with
the intention of repaying it in the future. Such transaction is recorded under this title and will be
treated as asset by the partnership. If these loans bear interest, it will be recognized as interest
income that will reflect in the income statement of the partnership.

b. Loan Payable to Partner (Loans from) – the partnership may receive cash from a partner which
will be considered as a Loan rather than as an investment. This transaction is recorded by a credit
to Loans Payable to Partner. Unless agreed otherwise, the partnership may be assessed of
capital interest by which it will be recorded as operating expense.

ACCOUNTING FOR PARTNERSHIP FORMATION

ITEM RECORDED @
1. Cash Investment Fair Value which is its FACE VALUE

2. Cash denominated in Foreign Currency CURRENT Exchange Rate

3. Cash under Receivership Estimated Recoverable Amount

4. Non-Cash Investment Agreed Value which is normally its FAIR

VALUE

5. Liabilities Present Value (Fair Value) of the Remaining

Cash Flows

Note: The individual partners must agree to the percentage of equity that each will have in the net
assets of the partnership. Generally, the capital balance is determined by the proportionate share
of each partner’s capital contribution.

An accounting problem exist when a partner’s capital account is credited for an amount greater
than the fair value of his contributions. This will be treated as BONUS on Initial Investment.

For further discussion, see the PDF File (Chapter 1: Partnership Formation) attached together
with this module.

APPLICATION
On January 1, 2020, Mr. A and Ms. B agreed to form a partnership contributing their respective
assets and equities subject to adjustments. On that date, the following were provided:
Mr. A Ms. B
Cash P28,000 P62,000
Accounts Receivable 200,000 600,000
Inventories 120,000 200,000
Land 600,000
Building 500,000
Furnitures and Fixtures 50,000 35,000
Intangible Assets 2,000 3,000
Accounts Payable 180,000 250,000

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Other Liabilities 200,000 350,000

Capital 620,000 800,000
The following adjustments were agreed upon:
a. Accounts Receivable of P20,000 and P40,000 are uncollectible in A’s and B’s respective
books;
b. Inventories of P6,000 and P7,000 are worthless in A’s and B’s respective books;
c. Intangible assets are to be written off.

REQUIREMENT:
1. Compute for the adjusted capital balances of the partners;
SOLUTION:
Mr. A Mr. B
Unadjusted Capital Balances P620,000 P800,000
Adjustments:
a. Setting up DA (20,000) (40,000)
b. Inventory Adjustments (6,000) (7,000)
c. Written-off Intangibles (2,000) (3,000)
Adjusted Capital Balances P592,000 P750,000

2. Provide the entry in the partnership’s books

To record the Adjustments:
A, Capital 28,000
B, Capital 50,000
Allowance for Doubtful Accounts 60,000
Inventories 13,000
Intangibles 5,000

To record the Partnership Formation:

Cash 90,000
Accounts Receivable 800,000
Inventories 307,000
Land 600,000
Building 500,000
Furnitures and Fixtures 85,000
Allowance for Doubtful Accounts 60,000
Accounts Payables 430,000
Other Liabilities 550,000
A, Capital 592,000
B, Capital 750,000

ASSESSMENT
Provide the correct answer. Prepare the solution in good form and properly labeled.

1. Robert and Smith drafted a partnership agreement that lists the following assets contributed at
the partnership’s formation:
Robert Smith
Cash 20,000 30,000
Inventory 15,000

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

Building 40,000
Furniture and equipment 15,000

The building is subject to a mortgage of P10,000, which the partnership has assumed. The
partnership agreement also specifies that profits and losses are to be distributed equally. What
amounts should be recorded as capital for Roberts and Smith at the formation of Partnership?
Back-up answer with computations.

2. on April 30, 2019, A, B, and C formed a partnership by combining their separate business
proprietorships. A contributed cash of P50,000. B contributed property with a carrying amount of
P36,000, an original cost of P40,000, and P80,000 fair value. The partnership accepted
responsibility for the P35,000 mortgage attached to the property. C contributed equipment with a
P30,000 carrying amount, a P75,000 original cost, and P55,000 fair value. The partnership
agreement specifies that profits and losses are to be shared equally but is silent regarding capital
contributions. Which partner has the largest April 30, 2019 capital balance? Back-up answer with
computations.

3. A and B formed a partnership. The partnership agreement stipulates the following:

• A shall contribute non-cash assets with carrying amount of P60,000 and Fair Value of
P100,000
• B shall contribute cash of P200,000
• A and B shall have interests of 80% and 20%, respectively, on both initial partnership
capital and in subsequent partnership profits and losses
• No outside cash settlements shall be made between and among the partners
Question:
1. The total partnership capital after the formation is?
2. The adjusted capital account of B after the formation is?
3. The entry to record the contribution of B is?

4. Consider the following information for Partner 1 and Partner 2:

Partner 1 Partner 2
Cash 250,000 1,800,000
Accounts Receivable 430,000 1,000,000
Land 1,250,000
Building 2,000,000
Accounts Payable 330,000 400,000
Notes Payable 500,000
Capital 3,600,000 1,900,000

Additional Information:
➢ The cash contribution of Partner 1 as listed above is the peso equivalent of 6,250 foreign
currency units. The current exchange rate is P45: FCU1
➢ Partner 2’s account receivable should be written down by P200,000.
➢ The land has an appraised value of P1,500,000.
➢ The building has an appraised value of P1,400,000.
➢ Attached to the building is an unpaid mortgage of P800,000 Partner 1 agrees to settle this
immediately using his/her personal funds.
➢ There is a pending lawsuit over Partner 1’s contributed properties – a claim by a third
party. A discussion with partner 1’s legal counsel reveals that it is probable that the plaintiff

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 MINDANAO STATE UNIVERSITY - GENERAL SANTOS CITY
COLLEGE OF BUSINESS ADMINISTRATION AND ACCOUNTANCY
DEPARTMENT OF ACCOUNTANCY

will accept an out of court order settlement of not less than P300,000. The partnership
shall assume the obligation of paying the plaintiff.
➢ There are unpaid real property taxes on the properties contributed by Partner 1 amounting
to P40,000. The partners agreed that the partnership shall assume those obligations.
➢ The notes payable above is stated at face amount. An inspection of the related promissory
note reveals that the note is a 5-year non-interest-bearing note issued 2 years ago and
requires a lump-sum payment at maturity date. The appropriate discount rate is 10%.

Requirements:
a. Compute for the adjusted balances of your capital accounts.
b. Provide the entries to record contributions in the partnership books

REFERENCES
Dayag, A. J. (2015). Advanced Accounting 1. Manila: Lajara Publishing House.
MILLAN, Z. V. (2018). Accounting for Special Transactions. Baguio City: Bandolin Enterprise.