AFAR 1 – Accounting for Special Transactions

Chapter 1 – Partnerships: Basic Considerations and Formation

LEARNING OBJECTIVES:

• Define partnership.
• Identify the characteristics of a partnership.
• Explain the advantages and disadvantages of a partnership.
• Distinguish between partnership and corporation.
• Identify and describe the different classifications of partnerships and the different
kinds of partners.
• Outline the essential contents of the articles of co-partnership.

DEFINITION

In a contract of partnership, two or more persons bind themselves to contribute money,

property, or industry to a common fund, with the intention of dividing profits among
themselves. Two or more persons may also form a partnership for the exercise of a
profession (Civil Code of the Philippines, Article 1767).

CHARACTERISTICS OF A PARTNERSHIP

1. Mutual Contribution. There cannot be a partnership without contribution of

money, property or industry (i.e., work or services) to a common fund. 2. Division of
profits or losses. The essence of partnership is that each partner must share in the
profits or losses of the venture.
3. Co-ownership of Contributed Assets. All assets contributed into partnership are
owned by the partnership by virtue of its separate and distinct juridical personality. 4.
Mutual Agency. Any partner can bind the other partners to a contract if he is acting
within his express or implied authority.
5. Limited Life. A partnership has a limited life. It may be dissolved by the admission,
death, insolvency, incapacity, withdrawal of a partner or expiration of the term
specified in the partnership agreement.
6. Unlimited Liability. All partners (except limited partners), including industrial
partners, are personally liable for all debts incurred by the partnership. 7. Partners’
Equity Accounts. Accounting for partnerships are much like accounting for sole
proprietorships. The difference lies in the number of partners’ equity accounts. Each
partner has a capital account and a withdrawal account that serves similar
functions as the related accounts for sole proprietorships.
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ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP

A partnership offers certain advantages over a sole proprietorship and a corporation. It

also has a number of disadvantages. They are as follows:
Advantages versus Proprietorships Advantages versus Corporations

1. Brings greater financial capability to the 1. Easier and less expensive to organize.
business

2. Combines special skills, expertise and 2. More personal and informal.

experience of the partners.

3. Offers relative freedom and flexibility of

action in decision-making.

Disadvantages

1. Easily dissolved and thus unstable compared to a corporation.

2. Mutual agency and unlimited liability may create personal obligations to
partners. 3. Less effective than a corporation in raising large amounts of capital.

PARTNERSHIP DISTINGUISHED FROM CORPORATION

Manner of Creation A partnership is created by mere agreement of the partners while
corporation is created by operation of law.

Number of persons Two or more persons may form a partnership, in a corporation, not
exceeding fifteen (15).

Commencement In a partnership, juridical personality commences from the

of Juridical execution of the articles of partnership; in a corporation, from the
Personality issuance of certificate of incorporation by the Securities and
Exchange Commission.

Management In a partnership, every partner is an agent of the partnership if the

partners did not appoint a managing partner; in a corporation,
management is vested on the Board of Directors.
 Extent of Liability In a partnership, each of the partners except limited partner is
liable to the extent of his personal assets; in a corporation,
stockholders are liable only to the extent of their interest or
investment in the corporation.

Right of Succession In a partnership, there is no right of succession; in a corporation,

there is right of succession.

Terms of Existence In a partnership, for any period of time stipulated by the partners;
in a corporation, shall have perpetual existence unless its articles
of incorporation provide otherwise.

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CLASSIFICATIONS OF PARTNERSHIPS

I. According to Object
a) Universal partnership of all present property. All contributions become
part of the partnership fund.
b) Universal partnership of profits. All that the partners may acquire by their
industry or work during the existence of the partnership and the use of
whatever the partners contributed at the time of the institution of the
contract belong to the partnership.
c) Particular partnership. The object of the partnership is determinate – its
use or fruit, specific undertaking, or the exercise of a profession or
vocation.
II. According to Liability
a) General. All partners are liable to the extent of their separate
properties. b) Limited. The limited partners are liable only to the extent of
their personal contributions.
III. According to Duration
a) Partnership with a fixed term or a particular undertaking.
b) Partnership at will. One in which no term is specified and is not formed
for any particular undertaking.
IV. According to Purpose
a) Commercial or trading partnership. One formed for the transaction of
business.
b) Professional or non-trading partnership. One formed for the exercise of
profession.
V. According to Legality of Existence
a) De jure partnership. One which has complied with all the legal
requirements for its establishment.
b) De facto partnership. One which has failed to comply with all the legal
 requirements for its establishment.

KINDS OF PARTNERS

• General partner - One who is liable to the extent of his separate property after all
the assets of the partnership are exhausted.
• Limited partner - One who is liable only to the extent of his capital contribution. •
Capitalist partner - One who is contributes money or property to the common fund
of the partnership.
• Industrial partner - One who contributes his knowledge or personal service to the
partnership.

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• Managing partner - One whom the partners has appointed as manager of the
partnership.
• Liquidating partner - One who is designated to wind up or settle the affairs of the
partnership after dissolution.
• Dormant partner - One who does not take active part in the business of the
partnership and is not known as a partner.
• Silent partner - One who does not take active part in the business of the
partnership though may be known as a partner.
• Secret partner - One who takes active part in the business but is not known to be a
partner by outside parties.
• Nominal partner or partner by estoppel - One who is actually not a partner but
who represents himself as one.

ARTICLES OF CO-PARTNERSHIP

A partnership may be constituted orally or in writing. In the latter case, partnership

agreements are embodied in the Articles of Co-Partnership. The following essential
provisions may be contained in the agreement:

1. The partnership name, nature, purpose and location;

2. The names, citizenship and residences of the partners;
3. The date of formation and the duration of the partnership;
4. The capital contribution of each partner, the procedures for valuing non-cash
investments, treatment of excess contribution (as capital or as loan) and the
penalties for a partner’s failure to invest and maintain the agreed capital; 5. The
rights and duties of each partner;
 6. The accounting period to be adopted, the nature of accounting records,
financial statements and audits by independent public accountants; 7. The method
of sharing profit or loss, frequency of income measurement and distribution,
including any provisions for the recognition of differences in contributions;
8. The drawing or salaries to be allowed to partners;
9. The provision for arbitration of disputes, dissolution, and liquidation.

A contract of partnership is void whenever immovable property or real rights are

contributed and a signed inventory of the said property is not made and attached to a
public instrument.

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Underlying Equity Theories

1. Proprietary Theory – looks at the entity through the eyes of the owner. It views the
assets of a business as belonging to the proprietor, the liabilities s debt of the
proprietor, and the income of the business as an increase in the proprietor’s net
worth (capital).
2. Entity Theory – views the business as a separate and distinct entity possessing its
own existence apart from the individual partners. Profits earned by the
partnership are usually viewed as profit to the “entity” with each partner entitled
to a distributive share of the profit.

Accounting and Financial Reporting Requirements for Partnership

A partnership has much more flexibility to select specific accounting measurement and
recognition methods and specific financial reporting formats. If a partnership wishes to
issue general-purpose financial statements, then it should use generally accepted
accounting principles (GAAP) as promulgated by IASB and other standard-setting
bodies.

Accounting for Partnership Activities

Accounting for partnerships differs from accounting for sole proprietor or corporation as
far as sharing of profit and loss and the maintenance of the partner’s ledger accounts.

1. Capital Accounts
Following are the items that affect capital account:
 Capital Accounts
account)
• Permanent or Capital • Closing of a net debit
withdrawal balance in the partner’s
• Drawings in excess of a drawing account
specified amount • Initial / Original investment
• Withdrawal of large and • Additional investment
irregular accounts • Share in Net Income (this may
• Share in net losses (this may also be credited to drawing
also be debited to drawing account)

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2. Drawings or Personal Accounts
Drawing Accounts provide a record of each partner’s drawings during an
accounting period. Following are the items that affect the drawing account:

Drawing Accounts

• Personal Withdrawals in
anticipation of profits
• Periodic withdrawals

Two classes of withdrawals:

a. Capital withdrawal or permanent withdrawal – they directly affect the capital

account balance because they arise mostly from withdrawals of investment
be it original or additional.
b. Personal withdrawal or temporary withdrawal or drawing accounts – these are
initially recorded in a drawing account. More often these are drawings from
share of profits which will eventually be closed to capital accounts.

3. Loan Accounts
 Loan receivable from partners are displayed as assets in the partnership balance
sheet and loans payable to partners are displayed as liabilities.

Capital Interest vs. Profit Interest

A partner’s capital interest is a claim against the net assets of the partnership as shown
by the balance in the partner’s capital accounts; an interest in profit and loss
determines how the partner’s capital interest will increase or decrease as a result of
subsequent operations.

Accounting for Partnership Formation

All properties brought into the partnership or acquired by the partnership are
partnership properties.

• Cash investments – recorded at fair value (most often known as face value). Cash
denominated in foreign currency is valued at the current exchange rate, while

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cash under bank receivership should be shown at its estimated recoverable
amount.
• Non-Cash Investment – recorded at fair value at the time of investment. • Services
– memorandum entry if there’s no value agreed upon, otherwise, a journal entry
would be required

A partnership may be formed in numerous ways, to wit:

1. For the first time:
• Individuals (two or more persons)
2. Conversion of a sole proprietor to a partnership
• Individual and a Sole Proprietor
• 2 sole proprietors
3. Conversion of an old partnership to a new partnership
• Partnership and a sole proprietor
• 2 partnerships

Guidelines regarding formation:

 1. Two individuals form a partnership
Books of Individual Partnership
Books

Adjusting Entries n/a Yes

………………………………… Closing n/a Yes
Entries (real accounts) ………………
Investments
……………………………………… Balance
Sheet …………………………………..

2. Sole Proprietor and another individual (New set of books is used)

Books of Books of New Set
Individual Sole of Books
Proprietor

Adjusting Entries n/a Yes Yes

………………………. Closing n/a Yes Yes
Entries (real accounts) ……..
Investments
……………………………. Balance
Sheet ………………………..

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3. Sole Proprietor and another individual (Old set of books is used; retain books of
Sole Proprietor)
Books of Books of
Individual Sole
Proprietor

Adjusting Entries n/a Yes

………………………. Closing n/a No
Entries (real accounts) …….. Yes
Investments Yes
……………………………. Balance
Sheet ………………………..

4. Sole Proprietor and Sole Proprietor (Old set of books is used; retain books of one of
 the Sole Proprietor)
Books of Books of
Sole Sole
Proprietor Proprietor

Adjusting Entries Yes Yes

………………………. Closing Yes No
Entries (real accounts) …….. Yes
Investments Yes
……………………………. Balance
Sheet ………………………..

5. Sole Proprietor and Sole Proprietor (New set of books is used)

Books of Sole Books of New Set
Proprietor Sole of Books
Proprietor

Adjusting Entries Yes Yes Yes

………………………. Closing Yes Yes Yes
Entries (real accounts) ……..
Investments
……………………………. Balance
Sheet ………………………..

6. Partnership and Sole Proprietor (Old set of books is used; retain books of
partnership)
Books of Books of
Sole Partnership
Proprietor

Adjusting Entries Yes Yes

………………………. Closing Yes No
Entries (real accounts) …….. Yes
Investments Yes
……………………………. Balance
Sheet ………………………..

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7. Partnership and Sole Proprietor (New set of Books)
 Books of Sole Books New Set of
Proprietor Partnership Books

Adjusting Entries Yes Yes Yes

………………………. Closing Yes Yes Yes
Entries (real accounts) ……..
Investments
……………………………. Balance
Sheet ………………………..

8. Two Partnerships (Old set of books is used; retain books of one of the Partnerships)
Books of Books of
Partnership Partnership

Adjusting Entries Yes Yes

………………………. Closing Yes No
Entries (real accounts) …….. Yes
Investments Yes
……………………………. Balance
Sheet ………………………..

9. Two Partnerships (Old set of books is used; retain books of one of the Partnerships)
Books of Books New Set of
Partnership Partnership Books

Adjusting Entries Yes Yes Yes

………………………. Closing Yes Yes Yes
Entries (real accounts) ……..
Investments
……………………………. Balance
Sheet ………………………..

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Illustration 1: Two Individuals form a Partnership

The following items are being invested in AC Partnership:

Agreed Values

Investment by A Investment by C
 Cash Php 100,000 Php 100,000
……………………………………………………………… 150,000 -
Inventory - 250,000
………………………………………………………… Land - 450,000
……………………………………………………………… 200,000 -
Building Php 450,000 Php 800,00
………………………………………………………….. 200,000
Equipment Php450,000 Php600,000
………………………………………………………
Totals
……………………………………………………………..
Mortgage on building assumed by the Partnership
……

Assumption 1: Assuming that A and C agree that each partner is to receive a capital
credit equal to the agreed values of the net assets each partner invested.

To record Investments – Partnership Books

Cash 100,000
Inventory 150,000
Equipment 200,000
A. Capital 450,000

Initial Investment of A

Cash 100,000
Land 250,000
Building 450,000
Mortgage Payable 200,000
C. Capital 600,000

Initial Investment of C
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Assumption 2: Assuming that A and C agree that each partner is to receive an equal
capital interest.

To record Investments – Partnership Books

Bonus Approach

Cash 100,000
Inventory 150,000
Equipment 200,000
A. Capital 450,000

Initial Investment of A

Cash 100,000
Land 250,000
Building 450,000
Mortgage Payable 200,000
C. Capital 600,000

Initial Investment of C

C. Capital 75,000
A. Capital 75,000

Bonus to A

Total Agreed Capital (450,000+600,000) Php 1,050,000

Multiplied by Capital Interest (Equal) ½
Partner’s Individual Capital interest Php 525,000
Less: A’s Capital 450,000
Bonus to A Php 75,000
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Revaluation (Goodwill Approach)

Cash 100,000
Inventory 150,000
Equipment 200,000
B. Capital 450,000 Initial Investment of A

Cash 100,000
Land 250,000
Building 450,000
Mortgage Payable 200,000 D. Capital 600,000

Initial Investment of C

Asset (Goodwill or Intangible asset) 150,000 A. Capital 150,000

Total Agreed Capital (600,000 / ½) Php 1,200,000 Less:

Total Contributed Capital 1,050,000 Assets (Goodwill or
Intangible Asset) Php 150,000
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Illustration 2: Sole Proprietor and Another Individual form a Partnership
J Company
Statement of Financial Position
September 1, 2021

Assets
Cash Php60,000
Accounts Receivable Php50,000
Inventory Php70,000
Equipment (Net) Php36,000
Total Assets Php216,000

Liabilities and Equity

Accounts Payable Php 86,000
J Capital Php130,000
Total Liabilities and equity Php 216,000

The audit and appraisal show the following:

• Allowance for bad debts amounting to Php5,000 is to be provided. •
Inventory is to be recorded at market value of Php80,000.
 • The equipment has a fair value of Php35,000
• Php2,000 of accounts payable has not been recorded.

P will contribute Php100,000 cash for a one third capital interest. JP partnership is to
acquire all of J’s business and assume its liabilities.

Assumption 1: Sole Proprietorship’s Books are retained for the partnership.

Books of J (New Partnership Book)

Inventory 10,000
Equipment 1,000
Allowance for Bad Debts 5,000
Accounts Payable 2,000
J Capital 2,000

Cash 100,000
P Capital 100,000

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JP Partnership
Statement of Financial Position
September 1, 2021

Assets
Cash Php160,000
Accounts Receivable Php50,000
Allowance for Bad Debts 5,000 45,000
Inventory 80,000
Equipment 35,000
Total Assets Php320,000

Liabilities and Equity

Accounts Payable Php 88,000
J Capital 132,000
P Capital 100,000
Total Liabilities and equity Php 320,000

Assumption 2: New Books are Opened for the Partnership

Books of J (Sole Proprietorship)
 Inventory 10,000
Equipment 1,000
Allowance for Bad Debts 5,000
Accounts Payable 2,000
J Capital 2,000
To adjust assets and liabilities of J

Accounts Payable 88,000

Allowance for Bad debts 5,000
J Capital 132,000
Cash 60,000
Accounts Receivable 50,000
Inventory 80,000
Equipment 35,000
To close all the adjusted balance of the accounts

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New books of JP Partnership

Cash 60,000
Accounts Receivable 50,000
Inventory 80,000
Equipment 35,000
Accounts Payable 88,000
Allowance for Bad debts 5,000
J Capital 132,000
To record investments of J

Cash 100,000
P Capital 100,000
To record investment of P

Illustration 3: Two Proprietors form a Partnership

Gary Company Harry Company
Statement of Financial Position Statement of Financial Position
June 30, 2021 June 30, 2021
 Assets Assets
Cash Php5,000 Accounts Cash Php4,000 Accounts
receivable 10,000 Inventory 8,000 receivable 8,000 Inventory 10,000
Furnitures and Fixtures 6,000 Total Furnitures and Fixtures 9,000
Assets Php29,000 Total Assets Php31,000

Liabilities and Equity Liabilities and Equity

Accounts Payable Php 3,000 Gary Accounts Payable Php 6,000
capital 26,000 Total Liabilities and Harry capital 25,000 Total Liabilities
Equity Php29,000 and Equity Php31,000

The conditions agreed by the partners for purposes of determining their interests in the
partnership are:
• 10% of accounts receivable is to be set up as uncollectible in each book. •
Inventory of Harry is to be decreased by php1,000.
• The furniture and fixtures of Gary and Harry are to be depreciated by Php600 and
Php900 respectively,

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Assumption 1. Books of Harry are used as the Partnership Books
Books of Gary

Gary Capital 1,600

Allowance for Bad Debts 1,000
Accum. Dep’n. – Furniture & Fixture 600
To record adjustments

Accounts Payable 3,000

Allowance for Bad Debts 1,000
Accum. Dep’n. – Furniture & Fixture 600
Gary Capital 24,400
Cash 5,000
Accounts Receivable 10,000
Inventory 8,000
Furniture & Fixture 6,000
To close Gary’s books
 Books of Harry (Partnership Books)

Inventory 1,000
Harry Capital 700
Allowance for Bad Debts 800
Accum. Dep’n. – Furniture & Fixture 900
To record adjustments of Harry’s assets

Cash 5,000
Accounts Receivable 10,000
Inventory 8,000
Furniture & Fixture 5,400
Accounts Payable 3,000
Allowance for Bad Debts 1,000
Gary Capital 24,400
To record Gary’s investments

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Assumption 2: New book of Partnership will be used.
Books of Gary

Gary Capital 1,600

Allowance for Bad Debts 1,000
Accum. Dep’n. – Furniture & Fixture 600
To record adjustments

Accounts Payable 3,000

Allowance for Bad Debts 1,000
Accum. Dep’n. – Furniture & Fixture 600
Gary Capital 24,400
Cash 5,000
Accounts Receivable 10,000
Inventory 8,000
Furniture & Fixture 6,000
To close Gary’s books

Books of Harry
Inventory 1,000
Harry Capital 700
Allowance for Bad Debts 800
Accum. Dep’n. – Furniture & Fixture 900
To record adjustments of Harry’s assets

Accounts Payable 6,000

Allowance for Bad Debts 800
Accum. Dep’n. – Furniture & Fixture 900
Harry Capital 24,300
Cash 4,000
Accounts Receivable 8,000
Inventory 11,000
Furniture & Fixture 9,000
To close Harry’s books

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New Book of the Partnership

Cash 5,000
Accounts Receivable 10,000
Inventory 8,000
Furniture & Fixture 5,400
Accounts Payable 3,000
Allowance for Bad Debts 1,000
Gary Capital 24,400
To record Gary’s investments

Cash 4,000
Accounts Receivable 8,000
Inventory 11,000
Furniture & Fixture 8,100
Accounts Payable 6,000
Allowance for Bad Debts 800
Harry Capital 24,300
To record Harry’s investments

GH Partnership
Statement of Financial Position
June 30, 2021
Assets
Cash Php 9,000 Accounts Receivable Php18,000
Allowance for Bad Debts 1,800 16,200 Inventory 19,000
Furniture and Fixture 13,500 Total Assets Php57,700

Liabilities and Equity

Accounts Payable Php 9,000 Garry Capital 24,400 Harry
Capital 24,300 Total Liabilities and equity Php 57,700

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