Chapter 2 – Partnership: Basic Concepts and Formation

Partnership
– organization or contract where two or more persons bind themselves to contribute money (cash), property
(noncash assets like building, land, inventory, receivable), or industry (skills or talent) into a common fund
with the intention of dividing the profits among themselves (New Civil Code, Article 1767)
– Contract represents agreement which could be either written or oral
– Written contracts are safer
– Oral contracts happens when total capitalization of partnership is less than ₱3,000

Elements of Partnership
1. There must be a valid contract, whether oral or written
2. A partnership must be put up by persons having legal capacity to contract
▪ Should be of legal age
3. Their contributions must be in the form of money, property, or service
▪ Money – cash
▪ Property – noncash assets like building, land, inventory, receivable
▪ Service – skill or talent
4. The purpose of the business is to divide the profits among themselves
▪ Profits are not accumulated thus divided among the partners

Features of Partnership
1. Mutual Agency
▪ All partners are agents of partnerships
▪ Agents mean they can enter into contracts and bind partnership in terms of obligation part of
contract agreed upon
2. Legal Entity
▪ Partnership must be distinct and separate of that owners
▪ It can acquire, sell or dispose properties, incur obligations and transact business in its name
(Article 1768)
3. Co-ownership of Contributed Assets
▪ Whatever the partners have contributed in the partnership, that will be considered assets of the
partnership
▪ Once assets are invested and or acquired by the partnership, these cease to become personal
properties and instead become joint property of all partners
▪ Partners have a claim on all partnership assets
4. Voluntary Association
▪ Individuals, by their own free will, agree to join together and form a partnership
5. Mutual Participation in Profits
▪ All partners will have their own share in the profit and loss
 ▪ Sharing of profits will depend on the agreement of partners
6. Limited Life
▪ Partnership can easily be dissolved
▪ Life pertains to the structure of partnership, wherein changes on it may dissolve the structure and
not the operation
▪ It can easily be dissolved or terminated with the mere withdrawal, incapacity or death of a partner
7. Unlimited Liability
▪ If assets of the partnership are not sufficient to pay its obligations, then creditors may go to
personal properties of partners
8. Taxable Entity
▪ Income of ordinary partnerships are taxed to 20% effective 2021 for taxable income which is not
more than ₱5,000,000
▪ partnership itself is not taxable but whatever the income received by each of the individual as a
share from the partnership is subject to tax
▪ General Professional Partnership – tax exempt, organized for the purpose of exercising their
common profession

Kinds of Partnership
1. As to activity
a. Trading Partnership
▪ Merchandising and manufacturing
▪ Buy and sell
b. Non-trading Partnership
▪ service
2. As to property
a. Universal Partnership of Property
▪ One where all partners contribute all their properties into a common fund
▪ Whatever properties invested in the time of formulation of partnership, that become the
ownership of the property
b. Universal Partnership of Profits
▪ One where the partners contribute all what will receive as a result of their work or service
rendered during the lifetime of the partnership
▪ The partners retain ownership over their present or future property
▪ What becomes property of partnership is those coming from profits
3. As to liability
a. General Partnership
▪ General partners with unlimited liability and are liable to partnership creditors even up to
the extent of their personal properties especially when partnership becomes insolvent
 b. Limited Partnership
▪ Composed of at least one general partner with limited partners who are liable to
partnership creditors only to the extent of their investment in the partnership
4. As to duration
a. Partnership at will
▪ Has indefinite existence
b. Partnership with a fixed term
▪ Written in the articles of partnership up to when the business will exist
5. As to representation to others
a. Ordinary Partnership
▪ Third party recognizes their existence
▪ Complied with all the legal requirements
▪ All partners and outsiders recognize the partnership
b. Partnership by Estoppel
▪ Partnership only by name
6. As to legality of existence
a. De jure Partnership
▪ Complied with all the requirements
b. De facto Partnership
▪ Did not comply with the requirement
7. As to publicity
a. Secret Partnership
▪ Not known to the public
b. Open Partnership
▪ Known to the public

Class of Partners
1. As to contribution
a. Capitalist
• Partner that contributes money or property
b. Industrialist
• Partner that contributes industry, talent, or skill
c. Capitalist-industrialist
• Partner that contributes a combination of property, money, or industry
2. As to liability
a. General
• One who manages the partnership, contributes property, or service and has unlimited
liability
 • Partners liable to the extent of their personal property
b. Limited
• One who invests cash or property, has no unlimited liability, and has no active role in
the management of the partnership
• Partner’s liability is up to how much they have invested
3. As to management
a. Universal
• Participation extends to the entire business
• Partner involved in the management as a whole
b. Particular
• Participation is limited to a unit or part of a business
• Partner is only involved in a department
4. Other Classifications
a. Liquidating
• Partner involved in the liquidation process of the partnership
• The partner responsible for liquidating process
b. Real vs Nominal
• Real – actual partner
• Nominal – partner by name
c. Ostensible vs Secret
• Ostensible – partner active in the business and known to the public
• Secret – active in the management but identity is not known to the public
d. Dormant
• Not active and not known to the public

Articles of Co-Partnership
– Written agreement between or among the partners governing the formation, operations, and dissolution
of the partnership
– Contract act as a form of governance of partnership activities and will clearly reflect the relationships of
the partners among each other and with third parties
– Article 1772 of the New Civil Code – requires that contributions of partners in cash or properties should
be in a public instrument duly registered with the Securities and Exchange Commission (SEC) if it
amounts to three thousand pesos or more

Contents of the Articles of Co-Partnership

1. The name of partnership
2. The names and addresses of the partners, classes of partners, stating whether the partner is a general
or limited partner
 3. The effective date of the contract
4. The purpose/s and principal office of the business
5. The capital of the partnership stating the contributions of individual partners, their description, and agreed
values
6. The rights and duties of each partner
7. The manner of dividing net income or loss among the partners, including salary allowance and interest
on capital
8. The conditions under which the partners may withdraw money or other assets for personal use
9. The manner of keeping the books of accounts
10. The causes of dissolution
11. The provision for arbitration in settling disputes

Comparison between Partnership and Sole Proprietorship

Similarities Differences
▪ Unlimited liability ▪ Taxable entity
▪ Active role in managing the ▪ Legal entity
business ▪ Combination of capital
▪ Limited life resources and skills
▪ Can be easily dissolved

Advantages of Partnership Disadvantages of Partnership

against Sole Proprietorship against Sole Proprietorship
▪ Greater amount of capital ▪ Delay on matters involving
▪ Greater opportunity to expand prompt and immediate attention
the business ▪ Conflicts and disagreement
▪ Better management among partners which may
adversely affect the operation
of the business and may cause
downfall or, at worse, its
termination

Comparison between Partnership and Corporation

Similarities Differences
▪ Taxable ▪ As to existence
▪ Legal entity ▪ As to liability
▪ As to management

Advantages of Partnership Disadvantages of Partnership

against Corporation against Corporation
▪ Ease of formation ▪ Difficulty in transferring
▪ Lesser legal requirements ownership
▪ Active management ▪ Easy to dissolve
▪ Unlimited liability
▪ Limited life
Rights of a Partner
1. Right over specific partnership property
2. Right to share in the profits resulting from business operation
3. Right to share in the remaining assets upon partnership liquidation after the partnership creditors have
been paid
4. Right to co-manage the partnership
5. Right to ask that the books be kept in the principal place of business subject to inspection at a reasonable
time

Organizing the Partnership

Requirements for
Place of Registration Certificates Issued
Registration
Securities and Exchange Articles of Co-Partnership SEC Certificate
Commission Filed SEC Registration form
Department of Trade and Industry Articles of Co-Partnership Certificate of registration of Business
SEC Certificate Name (renewable every 5 years)
City of Municipal Mayor’s Office Certificate of Registration of Mayor’s Permit and License to
Business Name Operate (renewable annually)
Bureau of Internal Revenue SEC Registration BIR Registration No.
Articles of Co-Partnership Partnership’s Tax Identification
Number (TIN)
Registration of books, invoices, and
official receipts
Social Security System Filed SSS Application Form SSS Certificate of Membership
List of employees SSS Employer ID Number
Philippine Health Insurance SEC Registration PhilHealth Employer Number and the
Corporation Employer Data Record or ERI Certificate of Registration
Form PhilHealth Identification Number (PIN)
Business Permit or License and Member Data Record (MDR) for
concerned employees
Home Mutual Development Fund SEC Registration HMDF Certificate of Membership
(PAGIBIG Fund) Articles of Co-Partnership HMDF Employer ID Number
 ACCOUNTING FOR PARTNERSHIP

Partners’ Equity
– the rights of the partners over the net assets of the business
– represented by two accounts: Partner’s Capital and Partner’s Drawing

Transactions affecting the Capital Account

Capital Account – represent original investment which becomes its permanent or fixed interest

CAPITAL
▪ Permanent withdrawal of ▪ Original investment by a
capital partner
▪ Debit balance of drawing ▪ Additional investment by a
account partner

Transactions affecting the Drawing Account

Drawing Account – reflects temporary interest of a partner

– two transactions affecting this account:
o Share in the net profit – credited to the drawing account to increase the partner’s equity and
becomes a source of regular drawings by the partner; or share in net loss – debited to the drawing
account to decrease the partner’s equity as well as decrease the amount that a partner can
withdraw
o Personal drawings – oftentimes called salaries but are in fact withdrawals of profit and are debited
to the drawing account to decrease the partner’s equity

DRAWING
▪ Share in partnership loss from ▪ Share in partnership profits
operations (this may be debited from operations (this may be
directly to the partner’s capital credited directly to the partner’s
account) capital account)
▪ Personal withdrawal by the
partner

Notes:

The balances I the drawing accounts represent unwithdrawn profits. These balances could be left open and
brought forward next accounting period specially if partners intent to withdraw them as per agreement or these
balances could be closed to the capital accounts and made part of their permanent investments.

Partners contributions may be:

▪ Money
▪ Property
▪ Industry
Pro-forma entry for partner’s investment:
Assets xxx
Partner’s Capital xxx

Liability can also be credited if any existing liability of a partner will be assumed by the business. Such liability
will decrease the capital account of the partner.

Other Factors affecting Partner’s Capital

▪ A partnership notes payable to the bank in the amount of ₱5,000 fell due and it was paid by Abd out of
his own personal cash.
Notes Payable 5,000
Abad, Capital 5,000
▪ A personal receivable of Basa in the amount of ₱6,000 was collected and retained by the partnership
Cash 6,000
Basa, Capital 6,000
▪ A personal note of Basa payable to Filinvest in the amount of ₱3,500 was paid out of the partnership
cash.
Basa, Capital 3,500
Cash 3,500
▪ A partnership receivable in the amount of ₱2,000 was collected and retained by Abad.
Abad, Capital 2,000
Accounts Receivable 2,000

Notes:

A contribution in the form of property should be recorded, as of the investment date, at current fair market value
or appraised value. This is support of the Exchange Price or Cost Principle as stated in IAS 16.

Liabilities attached to invested properties may be assumed by the partnership in which case the capital of the
partner will be credited only for the net amount of the asset contributed.
 PARTNERSHIP FORMATION

Formation A: two or more persons new in business form a partnership

Cash Contributions
Abad and Basa agreed to form a partnership by contributing ₱500,000 each

Cash 1,000,000
Abad, Capital 500,000
Basa, Capital 500,000

Cash and Non-cash Contributions

Abad and Basa made the following contributions in the partnership

Abad Basa
Cash 200,000 300,000
Inventories 300,000
Furniture 200,000

Cash 500,000
Inventories 300,000
Furniture 200,000
Abad, Capital 500,000
Basa, Capital 500,000

Note: Fair market value of the non-cash assets should be recognized on the date of partnership formation.

Cash, Non-cash, & Industry Contributions

Santos, Ambros, and Carlos formed a partnership on August 1, 2019. Investment are as follows: Cash of P50,000
from Santos, merchandise from Ambros which she bought last year for P50,000 but which has a current fair
value of 80% of its cost. Carlos is to be admitted as sales Manager for a 10% share in the profits.

Cash 50,000
Merchandise Inventory 40,000
Santos, Capital 50,000
Ambros, Capital 40,000

The entry to record Carlos’ contribution is: (memorandum entry)

Carlos is admitted into the partnership as Sales Manager for a 10% share in the profits of the partnership.

Non-cash Contributions with Assumed Liability

Ambros decided to invest land which cost her P100,000 which was acquired in 2010, but which current appraised
value is P500,000. There is still a mortgage balance of P50,000 on the land which the partnership will assume.
Land 500,000
Mortgage Payable 50,000
Ambros, Capital 450,000

If there was no agreement for the partnership to assume the mortgage balance, the entry will appear as:
Land 500,000
Ambros, Capital 500,000
Formation B: a sole proprietor and an individual form a partnership

Accounting Procedure:
1. Present for review the assets and liabilities of the sole proprietorship business to the other partners for
adjustment or revaluation.
2. In the books of the sole proprietorship business:
a. Update the assets and liabilities for an adjustment/revaluation agreed upon by the partners. Any
revaluation or adjustments coursed through the sole proprietor's capital account.
b. Close the books at the adjusted amounts.
3. Record the assets and liabilities or partner's contribution in the books of the partnership as well as the
contributions of the other partners at the revalued or adjusted amounts.

* If the partners agree to continue using the sole proprietor's books as the partnership books, Step 2.b will
change: record the investment of the other partners. Omit Step 3.

Key Points:
▪ The sole proprietor may transfer his assets and liabilities to the partnership at agreed value or if not
agreed values, at fair market value.
▪ The partnership may (a) use the books of the sole proprietor or (b) open a new set of books (It is a
common practice to use a new set of books)
▪ When individual set of books are kept by each partner or by any one of the partners, entries are made
on the separate books of the partners for adjustments to the recorded values. These adjustments are
made through the capital account. The capital account is credited for increases in the value of net assets
and is debited for decreases in the value of net assets.
▪ Alternatively, a Capital Adjustment Account may also be used. The Balance of this account, after
recording all the necessary adjustments, is transferred to the capital account.

The following rules will be helpful in making the necessary adjustments to the CAPITAL account:
▪ The following rules will be helpful in making the necessary adjusting entries
o Debit asset and credit capital for increases in asset values.
o Debit capital and credit assets for decreases in asset values.
o Debit capital and credit liabilities for increases in liability balances.
o Debit liabilities and credit capital for decreases In liability balances.
▪ In the case of contra asset accounts, the following rules shall apply:
o Debit contra asset account and credit capital for increases in asset values
o Debit capital and credit contra asset account for decreases in asset values.

Peter has a book store along Taft Avenue called Peter Pan's Bookstore which has been operating for five years.
On March 1, 2019, Pilar Garces invites him to put up a partnership within the university belt of Mendiola. Peter
agrees to close his business and invests his net assets in the partnership. Pilar agrees to put cash equal to half
of the contribution of Peter.
 Debit Credit
Cash P12,000
Accounts Receivable 50,000
Allowance for Bad P 5,500
Debts
Merchandise 25,000
Inventory
Furniture & Fixtures 10,000
Accumulated 2,000
Depreciation
Accounts Payable 27,000
Pan, Capital 62,500
Totals P97,000 P97,000

The partners agreed on the following:

1. The allowance for bad debts should be adjusted to 15% of the Accounts Receivable
2. The furniture & fixtures should be 25% depreciated
3. Obsolete merchandise amounting to P3,000 be written off
4. Both partners will act as managing partners and share profits and losses according to their capital
contributions

Assumption 1 – the partnership will use the books of the sole proprietorship
The following procedures should be followed in accounting for this type of formation:
▪ Adjust the books of the sole proprietor to bring account balances to agreed values
▪ Record the investment of the other partner

Step 1: Adjust the books of the sole proprietor Pan to agreed values.

Pan, Capital 2,000

Allowance for Bad Debts 2,000

Pan, Capital 500

Accumulated Depreciation 500

Pan, Capital 3,000

Merchandise Inventory 3,000

The balance of the capital account of Pan after the three adjusting entries are posted is ₱57,000 (62,500
– 2,000 – 500 – 3,000)

Step 2: Record the investment of the other partner, Garces.

Cash 28,500
Garces, Capital 28,500

Note: The Accumulated Depreciation should be closed since this is not carried forward in the new partnership
books

Accumulated Depreciation 2,500

Furniture & Fixtures 2,500
This will now bring the balance of Accumulated Depreciation to PO and the Furniture & Fixture to P7,500

Alternative entry in Step 1, entry 2

Accumulated Depreciation 2,000

Pan, Capital 500
Furniture & Fixture 2,500

Assumption 2 – the partnership will open a new set of books

The following procedures should be followed in accounting for this type of formation:
▪ Adjust the books of the sole proprietor to bring account balances to agreed values
▪ Close the books of the sole proprietor
▪ Record the investments of the partners in the new set of books

Step 1: Adjust the books of the sole proprietor Pan to agreed values.

Pan, Capital 2,000

Allowance for Bad Debts 2,000

Pan, Capital 500

Accumulated Depreciation 500

Pan, Capital 3,000

Merchandise Inventory 3,000

The balance of the capital account of Pan after the three adjusting entries are posted is ₱57,000 (62,500
– 2,000 – 500 – 3,000)

Step 2: Close the books of the sole proprietor Pan.

Accounts Payable 27,000

Allowance for Bad Debts 7,500
Accumulated Depreciation 2,500
Pan, Capital 57,000
Cash 12,000
Accounts Receivable 50,000
Merchandise Inventories 22,000
Furniture & Fixtures 10,000
To close the books of Pan

Step 3: Record the investments of the partners in the new set of books

Cash 12,000
Accounts Receivable 50,000
Merchandise Inventories 22,000
Furniture & Fixtures 7,500
Allowance for Bad Debts 7,500
Accounts Payable 27,000
Pan, Capital 57,000

Cash 28,500
Garces, Capital 28,500
Formation C: two or more sole proprietors form a partnership

When all the prospective partners are already in business, they may decide to transfer their assets and liabilities
(net assets) to the partnership at values agreed upon or at fair market values, in the absence of agreed values.
The partnership may either: (1) use the banks of one of the sole proprietor, or (2) open a new set of books for
the partnership.

James Laredo and Jim Lopez, sole proprietors, operate a novelty shop one in Manila and another in Cubao.
After a year of operation, James invited Jim to form a Lalo Novelty Store. The following are their statements of
financial position as at January 2, 2019

James Novelty Store

Statement of Financial Position
January 2, 2019
Assets
Cash P 13,000
Accounts Receivable 10,000
Merchandise Inventory 20,000
Furniture & Fixtures 5,000
Total Assets P 48,000
Liabilities and Capital
Accounts Payable P 12,500
Laredo, Capital 35,500
Total Liabilities and Capital P 48,000
Jim Novelty Store
Statement of Financial Position
January 2, 2019
Assets
Cash P 15,000
Accounts Receivable P 40,000
Less: Allowance for Bad Debts 4,000 36,000
Merchandise Inventory 50,000
Furniture & Fixtures 15,000
Less: Accumulated Depreciation 1,500 13,500
Total Assets P 114,500
Liabilities and Capital
Accounts Payable P 15,000
Notes Payable 20,000
Laredo, Capital 79,500
Total Liabilities and Capital P 114,500

The partners agreed on the following conditions:

1. James will invest his business subject to the following conditions:
a. That P2,000 of the Accounts Receivable be written off
b. The Furniture be adjusted to its fair market value of P4,000.
c. Accrued expenses of P2,500 be recognized.
2. Jim's net contribution should be adjusted subject to the following:
a. 15% of the Accounts Receivable is estimated to be uncollectible.
b. Furniture and Fixtures should have a net book value of P12,000,
It was further agreed that James and Jim's interest should be the same as their profit and loss ratio of 1:1 so that
one of them must make additional investment to conform to the agreed interest.

Assumption 1 – the partnership will use the books of one of the sole proprietor (Laredo)

Step 1: Adjust the books of Laredo

Laredo, Capital 2,000

Accounts Receivable 2,000

Laredo, Capital 1,000

Furniture & Fixture 1,000

Laredo, Capital 2,500

Accrued Expense 2,500

*After the adjustment, Laredo will have a capital balance of ₱30,000 (35,000 – 2,000 – 1,000 – 2,500)

Step 2: Record the investment of Lopez and additional investment of Laredo

Cash 15,000
Accounts Receivable 40,000
Merchandise Inventory 50,000
Furniture & Fixtures 12,000
Allowance for Bad Debts 6,000
Accounts Payable 15,000
Notes Payable 20,000
Lopez, Capital 76,000

Cash 46,000
Laredo, Capital 46,000

The adjustments on the account balances of Lopez are not taken up on the books of Laredo which are now the
partnership books. Instead, the following adjusting and closing entries are prepared on the separate books of
Lopez.

Lopez, Capital 2,000

Allowance for Bad Debts 2,000

Lopez, Capital 1,500

Accumulated Depreciation 1,500
Furniture & Fixtures 3,000
 Allowance for Bad Debts 6,000
Accounts Payable 15,000
Notes Payable 20,000
Lopez, Capital 76,000
Cash 15,000
Accounts Receivable 40,000
Merchandise Inventory 50,000
Furniture & Fixtures 12,000

Assumption 2 – the partnership will open a new set of books

When a new set of books are opened for the partnership, entries are prepared to record the investment of the
partners at agreed values.

The opening entries on the new partnership books will be:

Cash 59,000
Accounts Receivable 8,000
Merchandise Inventory 20,000
Furniture & Fixture 4,000
Accounts Payable 12,500
Accrued Expenses 2,500
Laredo, Capital 76,000
To record the investment of Laredo

Cash 15,000
Accounts Receivable 40,000
Merchandise Inventory 50,000
Furniture & Fixtures 12,000
Allowance for Bad Debts 6,000
Accounts Payable 15,000
Notes, Payable 20,000
Lopez, Capital 76,000
To record the investment of Lopez

Key Points:

In the opening entry, the plant assets are recorded net of depreciation. The account accumulated depreciation
is not carried on the partnership books. The net amount, being the agreed value, represents the cost of the plant
assets to the partnership and such amount becomes the basis for future depreciation by the partnership. On the
other hand, both accounts receivable and the corresponding allowance for uncollectible accounts is carried on
the partnership books because of the possibility of collection. However, if there are specific accounts receivable
which are deemed worthless, such must be written off and removed permanently from the outstanding accounts
receivable.

Lalo Novelty Store

Statement of Financial Position
January 2, 2019
Assets
 Cash P 74,000
Accounts Receivable P 48,000
Less: Allowance for Bad Debts 6,000 42,000
Merchandise Inventory 70,000
Furniture & Fixtures 16,000
Total Assets P 202,000
Liabilities and Capital
Accounts Payable P 27,500
Notes Payable 20,000
Accrued Expense 2,500
Laredo, Capital 76,000
Lopez, Capital 76,000
Total Liabilities and Capital P 202,000

CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION

Prior to recording partners' initial contributions to the partnership, the individual partners must first agree not only
on the valuation of the net asset contributions but also on their capital share. The capital share of each partner
is the percentage of equity that each of them will have in the net assets of the newly formed partnership.
Generally, the capital share of a partner is proportionate to his/her capital contribution. However, in recognition
of intangible factors such as partners' special expertise, established clientele of necessary business connections,
partners may agree to a division of capital that is not proportionate to their capital contributions. This situation
will give rise to provision of bonus on initial investments.

Gil and Casey formed a partnership by contributing P500,000 and P300,000, respectively. Journal entries to
record the investment of the partners under the following approaches:

Full investment approach

Cash 800,000
Gil, Capital 500,000
Casey, Capital 300,000

Bonus Approach (total agreed capital is equal to total contributed capital)

Cash 800,000
Gil, Capital 400,000
Casey, Capital 400,000

Gil Casey Total

Agreed Capital P 400,000 P 400,000 P 800,000
Contributed 500,000 300,000 800,000
Capital
Bonus (P 100,000) P 100,000 P0
Goodwill Approach (total agreed capital is greater than total contributed capital)

Cash 800,000
Goodwill 200,000
Gil, Capital 500,000
Casey, Capital 500,000

Gil Casey Total

Agreed Capital P 500,000 P 500,000 P 1,000,000
Contributed 500,000 300,000 800,000
Capital
Goodwill P0 P 200,000 P 200,000

Note:

PAS 38 recognizes goodwill only as a result of an acquisition of a business. Partnership goodwill has no related
acquisition cost since no funds have been spent to acquire the goodwill. Partnership goodwill is rare in actual
practice. The bonus capital is the preferable method.