Definition of a Partnership c.

Book values

A partnership is “a contract whereby two or more Capital Contribution vs. Capital Credit
persons bind themselves to contribute money, property, Capital contributions represent the net assets invested by
or industry to a common fund, with the intention of a partner whereas capital credit represents the agreed
dividing the profits among themselves.” capital for a partner. An accounting issue will arise when
the two do not equal. Such differential is accounted for
Two or more persons may also form a partnership for by either:
the exercise of a profession. Article 1767, Civil Code of
the Philippines 1. Bonus method – an increase (decrease) in any
partner’s contributed capital is treated as a reduction
Characteristics of a Partnership (addition) to other’s capital contribution.
(SECMULI) 2. Goodwill method – the increase in any partner’s
1. Separate legal personality contributed capital is treated as an unidentifiable
2. Ease of formation However, goodwill method is not allowed under PFRS.
3. Co-ownership of contributed assets 3. Revaluation method – the increase in any partner’s
4. Mutual Agency, Mutual participation in the profits contributed capital is treated as an identifiable
5. Unlimited liability 4. Additional investment – an increase in any partner’s
6. Limited life contributed capital as a result of additional investment
7. Income tax 5. Withdrawal - a decrease in any partner’s contributed
capital as a result of withdrawal
Stages in the Life of the Partnership:
1. Formation – the first-time creation of the partnership PARTNERSHIP OPERATION
2. Operation – this is the reason why a partnership is
formed, to operate and earn “profit” Primary accounting issues include:
3. Dissolution – changes in the partnership agreement or 1. Profit or loss allocation
relations among the partners 2. Periodic adjustment of capital after operation
4. Liquidation – realization of the assets of the
partnership and settlement of partnership liabilities. Profit Division:
1 .Profit sharing agreement
PARTNERSHIP FORMATION 2. Original capital
Primary formation issues include:
1. Valuation of contribution Loss Division:
2. Re-alignment of contribution with partnership 1. Loss sharing agreement.
agreement 2. How profit is divided.

Valuation of Contribution Arbitrary Allocation:

The partners may provide for the following methods of
1. Assets – assets contributed by the partners to the profit or loss distribution:
partnership should be valued in the following order of
priority: 1. Salary – compensation for services; provided for
a. Agreed values (Art. 1787 Civil Code) regardless of the existence of profit because the
b. Fair values (Art. 1787 Civil Code & PFRS 2) provision of services by a partner is independent from
c. Book values earning a profit.
2. Liabilities – liabilities attached to assets contributed 2. Interest – compensation for use of partner’s capital;
by the partners are recognized only in the partnership provided for regardless of the existence of profit because
books to the extent that they are assumed by the the use of the partner’s capital is independent from
partnership. When assumed by the partnership, earning a profit.
contributed liabilities operate to decrease the contributed 3. Bonus – compensation for good performance;
capital of the contributing partner; otherwise, the provided only when the partnership has profit and if
liabilities remain to be personal liabilities of the there is a positive balance in net income after deducting
contributing partner. Liabilities assumed by the any salaries and interest.
partnership is valued in the following order of priority:
a.Agreed values (Art. 1787 Civil Code) Bonus bases:
b. Fair value or Present value (Art. 1787 Civil Code & A. Before bonus: Bonus = Bonus rate x bonus factor
PFRS 2)
B. After bonus: Bonus = Bonus rate x [bonus factor/ e. Additional investment – additional investment as a
(100% + bonus rate)] result of re-alignment

Special Allocation Retirement/Withdrawal

1. Distribution of profit in order of priority
2. Minimum profit sharing Procedures:
3. Bonus, interest or salaries are regarded as expense
1. Adjust the capital for share in profit or loss during the
Statement of Partner’s Capital period up to the date of withdrawal or retirement
2. Adjust the capital for share in revaluation as at the
Beginning / Original Capital xx date of withdrawal or retirement
Add: Additional investment xx
Less: Withdrawals (xx) Scenarios:
Less: Drawings (xx)
Add: Share in net income xx Retiring or withdrawing partner’s interest is sold to
Less: Share in net loss (xx)
Ending Capital xx 1. One or more of the remaining partners
a. No adjustment or book value method – assets
PARTNERSHIP DISSOLUTION are not adjusted regardless of the amount paid to the
retiring/withdrawing partner
Dissolution is the change in the relation of the partners b. With adjustment or revaluation method –
caused by any partner being disassociated from the assets of the existing partnership are adjusted based on
business or by change in agreements of the partners. the amount paid to the retiring/withdrawing partner
This may include: 2. Outside party (with the consent of all partners)
a. No adjustment or book value method – assets
1. Admission of a new partner are not adjusted regardless of the amount paid to the
2.Retirement of a partner Incorporation of the retiring/withdrawing partner
partnership b. With adjustment or revaluation method –
3. Death of a partner assets of the existing partnership are adjusted based on
4. Assignment of interest by a partner the amount paid to the retiring/withdrawing partner
5. Incorporation of the partnership 3. Partnership
a. Settlement > Net interest
Admission of New Partner 1. Bonus to retiring partner
2.Goodwill to retiring partner
1.Admission by purchase – this is a personal a. Total goodwill approach
transaction between the new and existing partner(s) b. Partial goodwill approach
3.Revaluation (upwards) of the
Methods: partnership
a. No adjustment or book value method – assets are not b. Settlement < Net interest
adjusted regardless of the amount paid by the new 1. bonus to remaining partners
partner 2. Revaluation (downward) or write-
b. With adjustment or revaluation method – assets of the down of assets of the partnership
existing partnership are adjusted based on the amount c. Settlement = net interest
paid by the new partner.
The death of a partner results in automatic dissolution of
2. Admission by investment – this is a transaction the partnership at the point of death.
between the new partner and the partnership
Procedures:
Methods:
a. Bonus method – bonus to old or new partner(s) 1. Adjust the capital of deceased partner for share in
b. Revaluation method – revaluation of existing profit or loss during the period up to the date of death
partnership 2. Adjust the capital for share in revaluation (if any) as
c. Goodwill method – goodwill to new or existing at the date of death
partners 3. The adjusted capital of the deceased partner shall be
d. Withdrawal – withdrawal of assets as a result of re- transferred to a liability account.
alignment
 4. Interest payable to the estate is a real expense on the to the partners’ capital account on the basis of their P&L
books of the continuing partners. ratio.
3. Any creditors’ claims, including liquidation expenses
Incorporation or anticipated future claims, are satisfied through the
payment or reserve of cash.
Procedures: 4. The remaining unreserved cash is distributed to the
remaining partners in accordance with the balance in
1. Adjust the capital the partners for share in profit or their capital accounts. Note that this is not necessarily
loss during the period up to the date of incorporation the P&L ratio.
2. Adjust the capital the partners for share in revaluation
(if any) as at the date of incorporation Methods of Partnership Liquidation
3. The adjusted capital shall be transferred to share When the partnership is to be liquidated by the sale of
capital. Excess of the aggregate capital accounts over the assets, the following methods may be used:
par value or stated value of shares of stocks issued to the
partners is treated as share premium. 1. Lump-Sum Liquidation / Total Liquidation /
Single Distribution
Assignment of interest -All non-cash assets are realized into cash and one-time
cash distributions to the part
A partner’s interest may be assigned to: a. Realization of assets and distribution of gain
1. Partnership – rules of retirement applies or loss on realization among partners based on
2. Other partners – reclassification of capital the profit and loss ratio.
3. Third party b. Payment of liquidation expenses
a. With consent of other partners – rules on c. Payment of liabilities
formation apply d. Elimination of partner’s capital deficiencies.
b. Without consent of other partners – no If after the distribution of loss on realization, a
accounting issue partner incurs a capital deficiency (ie. partner’s
share of realization loss exceeds his capital
PARTNERSHIP LIQUIDATION credit), this deficiency must be eliminated by
Liquidation is the winding up of the partnership using one of the following methods, in the order
business. This involves: of priority.

1. Converting non-cash assets into cash (i.e. realization) a. If the deficient partner has a loan balance,
2. Settlement of liabilities (i.e. liquidation) exercise the right of offset.
3. Distribution of any remaining amount to the partners b. If the deficient partner is solvent, make him
invest cash to eliminate his deficiency
Basic Concepts on Partnership Liquidation c. If the deficient partner is insolvent, let the
other partners absorb his deficiency.
1. Unlimited Liability – partners have unlimited liability e. Payment of partners (in order of priority):
hence external creditors can run after their separate 1. Loan accounts
personal property in case the partnership asset is 2. Capital accounts
insufficient to satisfy their claims. The personal
creditors; however, of a partner is preferred over 2. Installment Liquidation / Installment Distribution
partnership creditors with respect to the personal assets -Cash distributions to partners are made once cash
of a partner. When a partner is personally insolvent and becomes available from the realization of non-cash
has capital deficiency, the other solvent partners absorbs assets Procedures:
his capital deficiency. a. Record the realization of assets and distribute
2. Right of offset – the right of a partner to set-off his the realized gains or losses among the partners
loan to the partnership against his capital deficiency using the profit and loss ratio.
b. Pay liquidation expenses and unrecorded
Steps to a partnership’s liquidation liabilities, if there are any, and distribute these
among the partners using the profit and loss
1. Any operating income or loss up to the date of the ratio.
liquidation should be computed and allocated to the c.Pay the outside creditors.
partner’s capital accounts on the basis of their P&L ratio. d.Distribute cash to the partners
2. All noncash assets are sold and converted to cash. The
gain (loss) realized on the sale of such assets is allocated Methods of Installment Liquidation
1. Safe Payments Schedule
1. This schedule shows how much cash can be
“safely” distributed to the partners by
determining the amount of loss (assumed loss)
required to eliminate each partner’s capital
Insolvency
account. Any positive balance in the partners’
The financial condition of a debtor that is generally
capital balances represents the safe payments.
unable to pay its or his liabilities as they fall due in the
o Theoretical loss or assumed loss
ordinary course of business or has liabilities that are
a. All of the remaining noncash assets
greater than its or his assets.
b .Cash withheld for contingent expense (future
liquidation expense and possible unrecorded
Kinds of Insolvency
liabilities)
2. Cash Priority Program
1. Voluntary insolvency - an insolvent debtor owing
o This schedule determines the order of priority of
debts exceeding in amount in the sum of P1,000, may
cash distribution to partners. apply to be discharged from his debts and liabilities by
o Steps: petition to the RTC of the province or city in which he
a. Compute for the total interest or partners’ equity has resided for 6 months next preceding the filing of the
b. Computer for the Loss Absorption Potential petition
(LAP)* of each partner 2. Involuntary insolvency - an adjudication of
c. Determine the priority of payments to partners insolvency may be made by the petition of 3 or more
d. Compute the amount of cash to be paid to the creditors, residents of the Philippines, whose credits or
partners under each priority by multiplying the demands accrued in the Philippines, for the amount of
incremental differences in the partner’s LAP and which credits or demands are in the aggregate of not less
respective P&L than P1,000
*Loss Absorption Potential = Net interest/Profit sharing
ratio Possible Recourse of Insolvent Corporation
1. Liquidation
Assumptions in Installment Liquidation 2.Reorganization (such as recapitalization, quasi-
reorganization, corporate rehabilitation and troubled debt
1. The individual partners are assumed to be personally restructuring)
insolvent,
2. The remaining noncash assets are deemed to be Corporate Liquidation
worthless (thus creating a maximum possible amount of Liquidation is the termination of business operations or
loss). the winding up of the affairs. It is a process by which:
Statement of Partnership Liquidation 1. Noncash assets are converted to cash (i.e. realization)
The partnership liquidation schedule shows in detail all 2. Liabilities of the business are settled (i.e. liquidation)
of the transactions associated with the liquidation of the 3. Any remaining amount is distributed to shareholders
partnership. Partners’ equity (Partner’s interest)
Financial Reports
Partners’ capital balance X
1. Statement of Affairs – it is the initial report prepared
Less: Drawing accounts (if not yet closed) (X) that emphasizes liquidation values and provides relevant
information for the trustee in liquidating the debtor
Add: Payable to partner X corporation. Unrecorded asset or liabilities are included.
a. Assets
Less: Receivable from partner (X) -Assets pledged to fully secured creditors –
these are assets with realizable values equal to or
Partners’ equity (Partner’s interest) X greater than the liquidation value (i.e. book
value plus accrued interest) of the related
liabilities
-Assets pledged to partially secured creditors -
these are assets with realizable values less than
the liquidation value of the related liabilities
 -Free assets - assets not used as collateral for an 1. Estimated recovery percentage of unsecured creditors
obligation = (net free assets ÷ total unsecured creditors)
b. Liabilities 2. Recovery of priority liabilities = liquidation value of
1. Fully secured creditors – these are liabilities claims
secured by assets with realizable values equal to 3. Recovery of fully secured creditors = liquidation
or greater than the liquidation value of such value of claims
liabilities 4. Recovery of partially secured creditors = [(fair value
2. Partially secured creditors - these are of partially secured assets) + (recovery % x excess of
liabilities secured by assets with realizable partially secured liabilities over the fair value of
values less than the liquidation value of such collateral assets)]
liabilities 5. Recovery of unsecured creditors = recovery % x
3. Unsecured liabilities with priority - liabilities liquidation value of unsecured creditors without priority
without collateral but are designated by the law
to be paid before any other debts of the DECENTRALIZED OPERATION
corporation.
a. Administration expenses (e.g. Multinationals do business in various countries using
administration fee of trustee or receiver, multiple operational structures, both formally and
liquidation cost, etc.) informally. To increase its sales and income, a company
b. Unpaid employee salaries and wages and may establish a branch or sales outlet, may transact
benefit plans using a consignee and may franchise the business. In this
c. Taxes and assessments (i.e. income taxes, section, we will focus on the following:
business taxes, excise taxes)
4. Unsecured creditors without priority – all 1. Branch – a branch is an extension of the home office.
other liabilities Under PAS 21, this can be included as part of a foreign
2. Statement of Realization and Liquidation – it is an operation if it is based or conducted in a country or
activity statement that is intended to show progress currency other than those of the reporting entity.
toward the liquidation of a debtor’s estate. It is depicted 2. Sales agency – a business unit that performs only a
like a T-account. It contains small portion of the functions traditionally associated
a. Debit side with a branch.
1. Asset to be realized, excluding cash – 3. Consignee – a consignee is a person or party to whom
beginning balance of noncash asset something, usually merchandise, is consigned.
2. Asset acquired – new assets or additional
assets recorded during the period
3. Liabilities liquidated – liabilities paid during
the period
4. Liabilities not liquidated – ending balance of
liabilities
5. Supplementary debits/charges – items of
expense or loss incurred during the period
b. Credit side
1. Assets not realized – ending balance of
noncash assets
2. Assets realized – non-cash assets converted
into cash during the current period
3. Liabilities to be liquidated – beginning
balance of liabilities
4. Liabilities incurred or assumed – new or
additional liabilities during the period
5. Supplementary credits – gains realized during
the period
3. Statement of Receipts and Disbursement – it is a
statement showing the beginning and ending balance of
cash as well as receipts and disbursements.

Computation of Recovery
Home Office and Branch Accounting
The accounting issues related to home office and branch
accounting may be subdivided as follows:

1. General procedures – shipments billed at cost

2. Special procedures – shipments billed above cost
3. Special procedures- interbranch transfers of cash
4. Special procedures – interbranch transfers of
merchandise
5. Reconciliation of reciprocal accounts

Reconciliation of accounts
The “investment in branch” account in the home office
books and the “home office account” in the branch
books are reciprocal accounts and theoretically, should
have an equal balance at the end of the accounting
period. However, the condition seldom exists because of
the following:

1. Bookkeeping or mechanical errors

2. Transposition errors
3. Timing difference