POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

ACCO 30103 – Integrated Review in Advanced Financial Accounting and Reporting

CHAPTER 1.1.: PARTNERSHIP FORMATION

PARTNERSHIP – is a contract whereby two or more persons bind themselves to contribute money, property or industry
into a common fund with the intention of dividing profits among themselves.

Characteristics of a Partnership
• Co-ownership of contributed capital – Assets contributed to the partnership become assets of the partnership by
virtue of its separate legal personality.
• Income Tax – Partnership except General Professional Partnership (like CPAs, lawyers, etc.) are subject to income tax
rate of 30% based on net income.
• Limited Life – A partnership may be dissolved at any time by action of the partners or by operation of law.
• Legal Entity – A partnership has a legal personality separate and distinct from that each of the partners.
• Mutual Agency – Any partner may act as an agent of the partnership in conducting its affairs.
• Mutual Participation in Profit – A partner has the right to share in partnership profits.
• Unlimited Liability – The personal assets of any partner may be used to satisfy the creditors’ claims in the partnership
if the firm’s assets are not enough to settle the liabilities to outsiders.

Advantages of a Partnership
1. It is easy and inexpensive to organize compared with a corporation.
2. The unlimited liability of the partners makes it reliable from the point of view of the creditors.
3. The combined personal credit of the partners offers better opportunity for obtaining additional capital than a sole
proprietorship.
4. The participation in the business by more than one person makes possible for a closer supervision of all its activities.
5. The direct gain to the partners is an incentive to give close attention to the business.
6. The personal element in the character of the partners is retained.

Disadvantages of a Partnership
1. The personal liability of a partner for partnership debts deters many from investing capital in a partnership.
2. A partner may be subject to a personal liability for the wrongful acts or omissions of his associates.
3. It is less stable because it can be easily dissolved.
4. There is divided authority among partners.
5. There is a constant likelihood of dissension and disagreement when each of the partners has the same authority in the
management of the partnership.
6. There is difficulty in disposing of interest since no formal established marketplace exists for the sale of partnership
interest.

Kinds of Partnerships

1. As to Activity
a. Trading Partnership – one whose main activity is the manufacture or the purchase and sale of goods.
b. Non-Trading Partnership – one organized for the purpose of rendering services.

2. As to Object
a. Universal Partnership
• Universal Partnership of all Present Property – one in which the partners contribute all the properties which
actually belong to each of them at the time of formation. All assets contributed to the partnership and
subsequent acquisitions become common partnership assets.
• Universal Partnership of all Profit – one which comprises all that the partners may acquire by their industry
or work during the existence of the partnership and the usufruct of movable property or immovable property
which each of the partners may possess at the time of formation. Partnership assets consist of assets acquired
during the life of the partnership and only the usufruct or use of the assets contributed at the time of formation.
The original movable or immovable property contributed do not become common partnership assets.
b. Particular Partnership – one which has for its object determinate things, their use or fruits, or a specific
undertaking or the exercise of a profession or vocation.

3. As to Liability of Partners
a. General Partnership – one consisting of general partners who are liable prorata and sometimes solidarily with
their separate property for partnership debts.

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 b. Limited Partnership – one formed by two or more persons having as members one or more general partners and
one or more limited partners who as such are not bound by the obligations of the partners.
4. As to Duration
a. Partnership at Will – one for which no time is specified and is not formed for a particular undertaking or venture
and which may be terminated any time by mutual agreement of the partners or by the will of one alone.
b. Partnership with a Fixed Term – one in which the term or period for which the partnership is to exist is agreed
upon or one formed for a particular undertaking and upon the expiration of that term or completion of the
particular undertaking, the partnership is dissolved unless continued by the partners.

5. As to Representation to Others
a. Ordinary Partnership – one which actually exists among the partners and also as to third persons.
b. Partnership by Estoppel – one which in reality is not a partnership but is considered partnership only in relation to
those who by their conduct or omission are precluded to deny or disprove the partnership’s existence.

6. As to Legality of Existence
a. De Jure Partnership – one which has complied with all the requirements for its establishment.
b. De Facto Partnership – one which has failed to comply with one or more of the legal requirements for its
establishment.

7. As to Publicity
a. Secret Partnership – one wherein the existence of certain persons as partners is not made known to the public by
any of the partners.
b. Open Partnership – one wherein the existence of certain persons as partners is made known to the public by the
members of the firm.

Classes of Partners

1. As to Contribution
a. Capitalist Partner – one who contributes capital in the form of money or property.
b. Industrial Partner – one who contributes industry, labor, talent, skills or service.
c. Capitalist Industrial Partner – one who contributes money, property and industry.

2. As to Liability
a. General Partner – one whose liability to third persons extends to his separate (private) property.
b. Limited Partner – one whose liability to third persons is limited only to the extent of his capital contribution into
the partnership.

3. As to Management
a. Managing Partner – one who manages actively the business of the partnership.
b. Silent Partner – one who does not participate in the management of the partnership affairs.

4. Other Classifications
a. Liquidating Partner – one who takes charge of the winding up of partnership affairs upon dissolution.
b. Nominal Partner – one who is not really a partner, not being a party to the partnership agreement but is made
liable as a partner for the protection of innocent third persons.
c. Ostensible Partner – one who takes active part in the management of the partnership and is known to the public as
a partner in the business.
d. Secret Partner – one who takes active part in the management of the business but whose connection with the
partnership in concealed or unknown to the public.
e. Dormant Partner – one who does not take active part in the management of the business and is not known to the
public as a partner. He is both a silent and a secret partner.

Articles of Co-Partnership

A partnership is created by an oral or a written agreement. Since partnerships are required to be registered with the
Securities and Exchange Commissions (SEC), it is necessary that the agreement be in writing. In this case,
misunderstanding and disputes among partners relative to the nature and terms of the contract may be avoided or
minimized. The written agreement between or among partners which governs the formation, operation and dissolution
of the partnership is referred to as the “Articles of Co-Partnership”.

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 Accounting for Partnership

As compared to other forms of business organization, accounting for partnership differs with regard to capital accounts.
In a partnership, there should be as many capital accounts and as many drawing accounts as there are partners. Example:
In JoLiBi Partnerships, the partners are Jo, Li and Bi. The capital accounts are: Jo Capital, Li Capital and Bi Capital. The
drawing accounts are: Jo Drawing, Li Drawing and Bi Drawing.

The transactions affecting the capital and drawing accounts of each partner are:

CAPITAL
Permanent withdrawal (decrease) of capital Original investment by a partner
Share In the partnership loss from operations Share in the partnership profit from operations
Debit balance of drawing account closed to capital Additional investment by a partner

DRAWING
Personal withdrawal by a partner in anticipation of profits Share in partnership profit from operation (this may be
(temporary withdrawal of capital) credited directly to capital)
Share in partnership loss from operation (this may be
debited directly to capital)

Aside from the contributions, the partnership may acquire additional financing from its present partners. Any loan
between a partner and the partnership is always accompanied by a proper loan documentation such as promissory note.
A loan from partner is shown as “Loan Payable, Advances from Partner, Due to Partner” on the partnership books
similar to any other loan. Unless all partners agree otherwise, the partnership is obligated to pay the individual partner
interest on the loan and such interest is reported in the Income Statement of the partnership as an “Expense”.

On the other hand, the partnership may also lend money to a partner. In this case, the partnership records a “Loan
Receivable, Advances to Partner, Due from Partner”. Again, unless otherwise agree by the partners, the loan bears
interest and such interest is reported in the Income Statement of the partnership as “Income”.

Partnership Formation

Partnership can be formed by (at least):

1. One individual and one individual
2. One individual and one sole proprietorship
3. One sole proprietorship and one sole proprietorship

Partners may contribute cash, property or industry to the partnership. Assets contributions are debited to the appropriate
asset accounts and credited to the capital accounts of the partners. Below are the rules:
• If the asset contributed is cash, it is recorded in the partnership books at face value.
• If the assets contributed are in the form of properties or non-cash assets, such are recorded at agreed values. In the
absence of an agreement, such are recorded at fair market values.
• If the contribution is service, a memorandum entry is prepared.

In some instances, one or two or all of the partners are former sole proprietors who decide to unite their assets and
liabilities to form a stronger enterprise. In such situation, the new partnership may open a new set of books or may
continue using the books of one of the sole proprietors. If a new set of books will be used, entries are prepared to record
the contributions. However, if the books of one of the sole proprietors are used, the following procedures shall be
followed:
1. Adjust the books of the sole proprietor which shall be used as partnership books.
2. Record the investment of the other partners.

Capital Credit is Different from Capital Contribution

Prior to recording partners’ initial contributions to the partnership, the individual partners first agree not only on the
valuation of asset contributions but also on their capital credit. The “capital credit” 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 capital contribution. However, in recognition of intangible
factors such as a partner’s special expertise, established clientele or necessary business connections, partners may agree to
a division of capital that is not proportionate to their capital contributions. This will give rise to allowing “BONUS” on
initial investments.
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 PROBLEM SOLVING

Problem 1
The partnership of A and B was formed on January 1, 2021. On this date, A invested PHP200,000 cash and office equipment
with a fair value of PHP80,000. B invested PHP220,000 cash, merchandise valued at PHP150,000, and furniture valued at
PhHP150,000 subject to a note payable of PHP100,000, which the partnership assumes. The partnership provides that A
and B share profits and losses 30:70, respectively. The agreement further provides that the partners should have a 70:30
capital ratio.
How much is the capital credited to A and B upon formation?

Problem 2
On August 01, 2021, A and B decided to combine their businesses to form a partnership. Their balance sheets on this date
before adjustments follow:
A B

Cash PHP18,000 PHP7,500

Accounts Receivable 37,000 27,000
Inventories 60,000 39,000
Furniture & Fixtures (net) 60,000 18,000
Office equipment (net) 23,000 5,500
Prepaid Expenses 12,750 6,000
TOTAL PHP210,750 PHP103,000

Accounts Payable PHP91,500 PHP36,000

Capital 119,250 67,000
TOTAL PHP210,750 PHP103,000

The parties agreed that profits and loss be shared 40:60, and that the following adjustments should be considered
prior to formation.
A. Provide 5% allowance for doubtful accounts on each Accounts Receivable.
B. Inventories should be recognized only at 80% of their book values.
C. Furniture and fixtures of A is undervalued by PHP25,000 while the Equipment of B is undervalued by
PHP3,500.
D. Prepaid expenses of PHP6,000 for A and PHP2,000 for B is to be recognized.
E. Accrued expenses of PHP3,000 for A and PHP1,000 for B is to be recognized.

What is the adjusted capital of A and B upon formation?

Problem 3
On July 01, 2021, A, B, and C formed a business partnership to be operated as an advertising agency. A contributed
PHP100,000 cash while B shall have capital credit of PHP60,000 upon receipt of bonus of PHP10,000 from A based on the
provision in Articles of Co-Partnership. The terms of the agreement provide that A and B shall have a combined 40% capital
interest in the newly formed partnership.

What is the capital contribution made by C to the partnership?

Problem 4
On January 1, 2021, A, B, and C formed ABC & Co., a general professional partnership for the exercise of their common
profession. A contributed a building with cost of PHP500,000 and accumulated depreciation of PHP400,000. Based on the
city assessor’s records, the building has an assessed value of PHP200,000. The building has an annotated mortgage payable
amount of PHP50,000 to be assumed by the Partnership.

On the other hand, B contributed 10,000 shares of stocks with par value of PHP20/share and prevailing quoted price of
PHP30/share. On January 2, 2021, the building contributed by A was sold for PHP550,000.

If C wants to have a 30% capital interest in the newly formed partnership, how much cash shall be contributed by C?

Problem 5
MN and OP decided to form a partnership on June 01, 2020. The partnership will take over their assets as well as assume
their liabilities. As of June 01, 2020, the net assets of MN and OP are P220,000 and P309,375 respectively. Liabilities of MN
are 55% less than book value of its net assets while liabilities of OP are 40% more than the book value of its net assets. The
partners agreed on a 25:75 profit and loss ratio. Furthermore, the partners arrived on the following agreements: MN’s
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 inventory is undervalued by P11,000. An allowance for doubtful accounts is to be set-up in the books of MN and OP at 10%
of the accounts receivable balances (Accounts Receivable balances: MN, P27,500; OP, P41,250). Accrued salary of P20,250
was not recognized in OP’s books.

What is the total asset of the partnership immediately after formation if partner’s capital interest should be equal to their
profit and loss ratio through withdrawal of excess cash investment by one of the partners?

Problem 6
Happy and New Year are partners in Happy New Year Partnership sharing profits and losses 25% and 75%, respectively.
On January 1, 2021, the partners revised their profits and loss sharing ratio into 40% to Happy and 60% to New Year. On
the date of change, the partnership’s land with a carrying value of P500,000 was appraised to have a fair value of P1,000,000.
On August 1, 2021, the land was sold for P1,500,000.

The total increase in the capital of Happy and New Year as a result of the above was:

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