BALIUAG UNIVERSITY

CPA Review Program

Advanced Financial Accounting and Reporting
Luisito V. Correa Jr., CPA, CAT, MBA
__________________________________________________________________________________________
Module 1: Partnership Accounting: Formation & Operation L. V. CORREA

I. Partnership, Basic Consideration

✓ Law governing partnership in the Philippines
• The Partnership Law in the Philippines is embodied in Title IX of RA 386, also known as The Civil Code of
the Philippines, from Article 1767 to Article 1867.
• Accounting for partnership should comply with the provisions set forth in the Partnership Law. Likewise,
it should adhere to the partnership agreement stipulated in the articles of partnership.
✓ Legal definition of partnership
A contract of two or more persons who bind them to contribute money, property or industry to a common
fund, with the intention of dividing the profits among themselves. Two or more persons may also form a
partnership for the exercise of a profession (Art, 1767).
✓ Characteristics of partnership
• Separate legal personality Mutual agency
• Co-ownership of property Limited life
• Ease of formation Unlimited liability
✓ Partner’s accounts
• Partner’s capital – Credited for investment made and share in profits and debited for share in losses and
closing of partner’s drawing account.
• Partner’s drawing – Partner’s withdrawal of partnership fund.
• Loans to or from partner – Payable to or receivable from a partner.

II. Partnership Formation

✓ Valuation of partner’s contribution
• All assets contributed to the partnership are recorded by the partnership at their fair market values.
• All liabilities assumed by the partnership are recorded at their present values.
✓ Ways to form a partnership
• Two or more individuals formed a partnership
- A partner’s contribution includes assets invested in the partnership and liabilities assumed by the
partnership.
- Partner’s capital equals assets contributed to the partnership minus liabilities assumed by the
partnership.
• Conversion of a sole proprietorship into a partnership
- Revaluation of the assets of the sole proprietorship are usually made before the formation of
partnership in order to reflect current market values.
- Books of the sole proprietorship are adjusted and closed.
- Contributions of the sole proprietor, based on revalued amount, are recorded in the books of the
partnership.
✓ Illustration of partnership formation
On January 01, Year 1, Pirena, who owns an LPG retail store, and Amihan decided to form a partnership that
will sell both LPGs and fire extinguishers. The statement of financial position of Pirena prior to formation of
partnership follows:

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 Module 1: Partnership Accounting: Formation & Operation L. V. CORREA
Cash P 10,000 Accounts payable P 20,000
Accounts Receivable P16,000 Pirena, capital 100,000
Less: Allowance for doubtful accounts 1,000 15,000 Total liabilities and capital P120,000
Merchandise inventory 30,000
Furniture and fixtures P80,000
Less: Accumulated depreciation 15,000 65,000
Total Assets P120,000
Conditions agreed upon by both parties are as follows:
a) The accounts receivable of Pirena is estimated to be 75% realizable.
b) The furniture and fixtures of Pirena is under-depreciated by P7,000.
c) The accounts payable will be assumed by the partnership.
d) Amihan will contribute fire extinguishers costing P40,000 with fair market value of P37,000. She will
also contribute cash in order to obtain 40% interest in the partnership.
Requirements: (1) Record the adjustments and close the books of Pirena.
(2) Record the investment of Pirena in the books of the partnership.
(3) Record the investment of Amihan in the books of the partnership.

Solution: Journal entries

Books of Pirena Books of the Partnership

III. Partnership Operation

✓ Rules on distribution of profit and loss (Art. 1797)
• The losses and profits shall be distributed in conformity with the agreement.
• If only the share of each partner in the profits has been agreed upon, the share of each in the losses
shall be in the same proportion.
• In the absence of stipulation:
- The share of each partner in the profits and losses shall be in proportion to what he may have
contributed.
- The industrial partner shall not be liable for the losses.
- As for the profits, the industrial partner shall receive such share as may be just and equitable under
the circumstances.
- If besides his services, the industrial partner has contributed capital, he shall also receive a share in
the profits in proportion to his capital.
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Module 1: Partnership Accounting: Formation & Operation L. V. CORREA

✓ Methods of distribution of profit and loss

1. Profit and loss ratio
2. Capital ratio
a. Original/beginning capital balances
b. Ending capital balances
c. Average capital
3. Interest on capital balances
4. Salaries to partners
5. Bonus to managing partner
Notes on interest, salaries and bonus:
• Interest and salaries to partners are not accounted as expense but as tools to compute share in the
profits of the partnership.
• Interest and salaries are still allowed to partners even when the partnership incurred losses, unless
otherwise stipulated in the partnership agreement.
• If the profit is insufficient to satisfy the salaries in full, and that salary is first in the order of priority of
profit distribution, then the profit shall be prorated according to the amount of salaries to partners.
• Bonus based on net income before bonus is not accounted as expense. However, if the basis is on net
income after bonus, the bonus is accounted as expense.
• Bonus is not allowed to a partner if the partnership suffered losses.
✓ Illustration of partnership operation
Clinton and Trump formed a partnership that sells election and campaign paraphernalia. For Year 1, their
partnership earned P45,000 net income before any interest, salaries, and bonus.
The changes in partners’ capital for the year are as follows:
Particulars Clinton Trump
Capital balance, Jan 1 P59,000 P 75,000
Additional investment, Mar 1 20,000 30,000
Additional investment, Aug 1 20,000 60,000
Drawing, Oct 1 16,000 -
Drawing, Nov 1 - 30,000
Capital balance, Dec 31 P83,000 P135,000

Requirements: Distribute the income in the following independent cases

1. The partners agreed to give 10% interest on average capital balance and salaries of P10,000 and P5,000
to Clinton and Trump, respectively. Clinton and Trump shall distribute the remaining balance in the ratio
of 1:3, respectively.
2. Clinton being the managing partner shall receive 20% bonus on net income before any interest, salaries
and bonus. Interest shall be 10% interest on average capital balance and salaries for both partners shall
be P15,000 each. Clinton and Trump shall distribute the remaining balance in the ratio of 1:3,
respectively.
3. Clinton being the managing partner shall receive 20% bonus on net income after interest and salaries
but before bonus. Interest shall be 10% interest on average capital balance and salaries for both
partners shall be P5,000 each. Clinton and Trump shall distribute the remaining balance in the ratio of
1:3, respectively.
4. Clinton being the managing partner shall receive 20% bonus on net income before interest and salaries
but after bonus. Interest shall be 5% interest on average capital balance and salaries for both partners
shall be P15,000 each. Clinton and Trump shall distribute the remaining balance in the ratio of 2:3,
respectively.

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Module 1: Partnership Accounting: Formation & Operation L. V. CORREA
5. Clinton being the managing partner shall receive 20% bonus on net income after interest, salaries and
bonus. Interest shall be 5% interest on average capital balance and salaries for both partners shall be
P5,500 each. Clinton and Trump shall distribute the remaining balance equally.
6. Clinton being the managing partner shall receive 20% bonus on net income after interest, salaries and
bonus. Interest shall be 20% interest on average capital balance and salaries of P10,000 and P15,000
shall be given Clinton and Trump, respectively. Clinton and Trump shall distribute the remaining
balance equally.

Solution: Schedules of profit distribution

Case 1 Case 2
Particular Clinton Trump Total Particular Clinton Trump Total
Interest Interest
Salaries Salaries
Bonus Bonus
Remainder Remainder
Total Total
Case 3 Case 4
Particular Clinton Trump Total Particular Clinton Trump Total
Interest Interest
Salaries Salaries
Bonus Bonus
Remainder Remainder
Total Total
Case 5 Case 6
Particular Clinton Trump Total Particular Clinton Trump Total
Interest Interest
Salaries Salaries
Bonus Bonus
Remainder Remainder
Total Total

❖ Multiple Choice Questions

1. Which of the following is not a characteristic of most partnership?
A. Limited liability C. Mutual agency
B. Limited life D. Ease of formation
2. When property other than cash is invested in the partnership, at what amount should the noncash property
be credited to the contributing partner’s capital account?
A. Original cost of the property C. Fair value at the time the property was
aquired
B. Assessed valuation for property tax purposes D. Fair value at the date of contribution
3. Which of the following statement is not true?
A. Industrial partner shall not share in the losses of the partnership.
B. If the there is no stipulation, the industrial partner shall first receive a just and equitable share in the
profit before the capitalist partners divide the profit in accordance to their capital contribution.
C. A limited partner may be a capitalist or an industrial partner.
D. A partner may have a capacity of both an industrial partner and a capitalist partner.
4. Partnership capital and drawing accounts are similar to the corporate
A. Paid-in capital, retained earnings, and dividend accounts
B. Retained earnings account

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Module 1: Partnership Accounting: Formation & Operation L. V. CORREA
C. Paid-in capital and retained earnings accounts
D. Preferred and common stock accounts.
5. On December 1, Year 1, Enemy and Friend formed a partnership, agreeing to share for profits and losses in
the ratio of 2:3, respectively. Enemy invested a parcel of land that cost him P25,000. Friend invested P30,000
cash. The land was sold for P50,000 on the same date, three hours after formation of the partnership. How
much should be the capital balance of Enemy right after formation?
A. 20,000 C. 60,000
B. 30,000 D. 50,000
6. On March 1, Year 1, I and U formed a partnership with each contributing the following assets:
I U____
Cash……………………………………………………………….. P300,000 P700,000
Machinery and Equipment…………………………….. 250,000 750,000
Building………………………………………………………….. --- 2,250,000
Furniture and Fixtures…………………………………….. 100,000 ---
The building is subject to mortgage loan of P800,000, which is to be assumed by the partnership
agreement provides that I and U share profits and losses 30% and 70%, respectively. On March 1, Year 1, the
balance in U’s capital account should be:
A. 3,700,000 C. 3,050,000
B. 3,140,000 D. 2,900,000
7. Xing, Ying and Zhing joined in a business partnership. Xing invested cash of P25,000. Ying invested equipment
costing P35,000, book value of P20,000 and fair value of P27,500. Zhing invested property with initial cost of
P25,000, carrying value of P20,000 and market value of P40,000, and the partnership accepted responsibility
for the mortgage of P17,500 attached to the property. The partnership agreement provides that profits and
losses shall be divided equally, but is silent regarding capital contributions. The partner with the largest initial
capital balance is
A. Xing C. Zhing
B. Ying D. All - equally
8. Ann, Ben and Cid formed a partnership by combining their businesses. Ann gave cash of P50,000. Ben gave
a property with a carrying amount of P30,000, an original cost of P40,000, and fair market value of P80,000.
Ben’s property, however, has a P35,000 mortgage for which the new partnership accepted legal
responsibility. Cid gave a delivery equipment with a book value of P30,000, an acquisition cost of P75,000,
an appraised value of P55,000. It was agreed that profits and losses are to be shared equally. The partner
with the biggest original capital balance is
A. Ann C. Cid
B. Ben D. All - equally
9. Glad, Joy and Fun, new CPAs, are to form a partnership. Glad will contribute cash of P50,000 and his
computer that originally cost P60,000 but with a second-hand value of P25,000. Joy will contribute P80,000
cash. Fun,
whose family sells computers, will contribute P25,000 cash and a brand-new computer with printer that cost
his family’s computer dealership P50,000 but with a regular selling price of P60,000. They agree to share
profits and losses equally. Upon formation, capital balances are
Glad_ Joy_ __Fun_ Glad_ Joy_ __Fun_
A. 75,000 80,000 85,000 C. 83,333 83,333 83,333
B. 80,000 80,000 80,000 D. 110,000 80,000 75,000
10. Al and Dub pooled their resources in a partnership, with the firm taking over their business assets and
assuming their business liabilities. The partners’ capital are to be based on net assets transferred after these
adjustments:
• Dub’s inventory is to be increased by P3,000.
• Allowance for bad debts for P1,000 and P1,500 are to be set up, respectively in the books of Al and Dub.
• Accounts payable of P4,000 is to be recorded in Al’s books.
Their individual trial balances before adjustment, show the following:
Al’s books Dub’s books
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Module 1: Partnership Accounting: Formation & Operation L. V. CORREA
Assets P75,000 Assets P113,000
Liabilities 5,000 Liabilities 34,500
Al’s capital after adjustment would be
A. 65,000 C. 68,500
B. 66,000 D. 70,000
11. Refer to no. 15. Dub’s capital after adjustment would be
A. 77,000 C. 81,500
B. 80,000 D. 88,500
12. Which of the following would be least likely to be used as a means of allocating profits among partners who
are active in the management of the partnership?
A. Salaries
B. Bonus as a percentage of net income before the bonus
C. Bonus as a percentage of sales in excess of a targeted amount
D. Interest on average capital balances
13. Which of the following best describes the use of interest on invested capital as a means of allocating profits?
A. If interest on invested capital is used, it must be used for all partners.
B. Interest is allocated only if there is partnership net profit.
C. Invested capital balances are never affected by drawings of the partnerships.
D. Use of beginning or ending measures of invested capital may be subject to manipulation that distorts
the measure of invested capital.
14. A partnership agreement calls for allocation of profits and losses by salary allocations, a bonus allocation,
interest on capital, with any remainder to be allocated by preset ratios. If a partnership has a loss to allocate,
generally which of the following procedures would be applied?
A. Any loss would be allocated equally to all partners.
B. Any salary allocation criteria would not be used.
C. The bonus criteria would not be used.
D. The loss would be allocated using the profit and loss ratios, only.
15. If the partnership agreement provides a formula for the computation of a bonus to the partners, the bonus
would be computed
A. In any manner agreed to by the partners.
B. Next to last, because the final allocation is the distribution of the profit residual.
C. Before income tax allocations are made.
D. After the salary and interest allocations are made.
16. If the partnership does not specify how income is to be allocated, profit and losses should be allocated
A. Equally.
B. In accordance with partners’ capital contribution.
C. In proportion to the weighted average of capital invested during the period.
D. Equitably so that partners are compensated for the time and effort expended on behalf of the
partnership.
17. Which of the following is not a component of the formula used to distribute income?
A. Salary allocation to those partners working on behalf of the partnership.
B. After all other allocation, the remainder divided according to the profit and loss sharing ratio.
C. Interest on the average capital investments.
D. Interest on notes to partners.
18. Which of the following is not considered a legitimate expense of a partnership?
A. Interest paid to partners based on the amount of invested capital.
B. Depreciation on assets contributed to the partnership by partners.
C. Salaries for management hired to run the partnership.
D. Supplies used in the partners’ offices.
19. The partnership agreement of Xenon, Yttrium & Zirconium provides for the year end allocation of net income
as follows:
• First, Xenon is to receive 10% of net income up to P200,000 and 20% over P200,000
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Module 1: Partnership Accounting: Formation & Operation L. V. CORREA
• Second, Yttrium and Zirconium each are to receive 5% of the remaining income over P300,000.
• The balance of income is to be allocated equally among the three partners.
The partnership’s net income was P500,000 for the year just ended, before any allocations to partners. What
amount should be allocated to Xenon?
A. 202,000 C. 206,000
B. 216,000 D. 220,000
20. The partnership agreement of Rainbow and Sun provides the interest at 10 % per year is to be credited to
each partner on basis of weighted-average capital balances. A summary of Sun capital account for the year
ended December 1, Year 1 is as follows:
Balance, January 1………………………………………… P420,000
Additional investment, July 1………………………... 120,000
Withdrawal, August 1……………………………………. (45,000)
Balance, December 31…………………………………… 495,000
What amount of interest should be credited to Sun’s capital?
A. 45,750 C. 46,125
B. 49,500 D. 51,750
21. Ano, Bakit, and Kailan are partners with average capital balances during Year 1 of P360,000, P180,000, and
P120,000, respectively. Partners receive 10% interest on their average capital balances. After deducting
salaries of P90,000 to Ano and P60,000 to Kailan the residual profit or loss is divided equally. In Year 1, the
partnership sustained a P99,000 loss before interest and salaries to partners. By what amount should Ano’s
capital account change?
A. 21,000 increase C. 105,000 decrease
B. 33,000 decrease D. 126,000 increase
22. In Year 1, the partnership of Alligator and Buwaya realized a net profit of P240,000. The capital accounts of
the partners show the following postings:
Alligator Buwaya
Date Debit Credit Debit Credit
Jan 1 P120,000 P80,000
May 1 P20,000 P10,000
Jul 1 20,000
Aug 1 10,000
Oct 1 10,000 5,000
If the profits are to be divided based on average capital, the share of Alligator and Buwaya, respectively are
A. 129,600 110,400 C. 136,800 103,200
B. 144,000 96,000 D. 136,543 103,457
23. Refer to no. 27. If 20% interest based on the capital at the end of the year is allowed and the balance of the
profit is divided equally, the share of Alligator and Buwaya, respectively are
A. 121,500 118,500 C. 123,000 117,000
B. 124,000 116,000 D. 122,625 117,375
24. In Year 1, Buena and Mano formed a partnership with capital contributions of P175,000 and P25,000,
respectively. They agreed to share profits and losses 80% and 20%, respectively. Mano is the general
manager and works in the partnership full-time. An interest of 5% is allowed on starting capital. Mano is
given a salary of P5,000 a month and a bonus of 15% of net profit before salary, interest, and bonus.
The condensed profit and loss statement of the Buena Mano Partnership for the year ended is as follows:
Net sales P875,000
Cost of sales 700,000
Gross profit P175,000
Expenses (including salary, interest and bonus) 143,000
Net profit P 32,000
The bonus of Mano for the year is
A. 13,304 C. 15,300
B. 18,000 D. 20,700
25. On January 1, Year 1, Zee and Bra have capital balances of P20,000 and P16,000, respectively. On July 1,
Year 1, Zee invested an additional P4,000 while Bra withdrew P1,000. Profits and losses are divided as
follows: Bra is the managing partner and as such shall receive P16,000 as salary, with Zee receiving P7,200;
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Module 1: Partnership Accounting: Formation & Operation L. V. CORREA
both partners shall receive interest of 10% on their beginning capital balances, to offset whatever
difference in capital investments they have; and any remainder shall be divided equally. The net income for
Year 1 was P9,600. What was Zee’s share in the Net income for Year 1?
A. 9,200 C. 880
B. 4,800 D. 600
26. Dulce Amor, a partner in a partnership of The Sweet Shop, has a 30% participation in partnership profit.
Her capital account had a net decrease of P48,000 during the year. In the same year, she withdrew
P104,000 (charged against her capital account) and contributed property valued at P20,000 to the
partnership. The net income of the partnership for the year was
A. 36,000 C. 132,000
B. 120,000 D. 440,000
27. Me, an active partner in the Me-Shell Partnership, receives an annual bonus of 25% of the partnership
income after deducting the bonus. For the year just ended, the partnership income before the bonus
amount to P240,000. The bonus of Me for the year is
A. 45,000 C. 60,000
B. 48,000 D. 80,000
28. Egg and Plant, partners, allow monthly salaries of (P6,000 and P5,000, respectively) and 6% interest on
beginning capital (P300,000 and P230,000, respectively), and then divide any remaining profit equally. On a
net profit of P100,000, the respective shares of Egg and Plant would be
A. 50,000 and 50,000 C. 56,600 and 43,400
B. 54,500 and 45,500 D. 58,100 and 41,900
29. Azul, Bughaw and Blue are partners who had average capital balances, respectively, of P240,000, P120,000
and P80,000 during the year. Partners received 10% interest on their average capital balances. After
deducting salaries of P60,000 for Azul and P40,000 for Blue, the residual profit or loss is divided equally.
For the year just ended, the partnership sustained a P66,000 loss before interest and salaries to partners.
By what amount would the capital account of Azul change?
A. 14,000 increase C. 70,000 decrease
B. 22,000 increase D. 84,000 decrease
30. The partnership agreement of Big and Bang provides that Big is to receive 20% bonus on profits before
bonus. Remaining profits and losses are divided in the respective ratio of 2:3. Which partner has the
greater advantage when the partnership realizes a profit or when it sustains a loss?
Profit Loss Profit Loss
A. Big Big C. Bang Big
B. Bang Big D. Bang Bang
31. The partnership agreement of Ping and Pong provides that Ping is to receive 20% bonus on profits after
bonus. Remaining profits and losses are divided in the respective ratio of 2:3. Which partner has the
greater advantage when the partnership realizes a profit or when it sustains a loss?
A. Profit – Ping C. Profit – Indifferent
32. Mr. Gahaman is trying to decide whether to accept a salary of P40,000 or salary of P25,000 plus a bonus of
10% of profit after salaries and bonus as a means of allocating profit among partners. Salaries of other
partners totaled P100,000. What amount of profit would be necessary so that Mr. Gahaman would
consider the choices to be equal?
A. 165,000 C. 290,000
B. 265,000 D. 305,000
33. The partnership has the following accounting amounts:
Sales P700,000
Cost of sales 400,000
Operating expenses 100,000
Salaries to partners 130,000
Interest paid to banks 20,000
Partner’s drawings 80,000
What is the partnership net income (loss)?
A. 200,000 C. 50,000
B. 180,000 D. (30,000)
34. On January 1, Year 1, Doubleyu, Eks, Why and Zee formed a partnership with their respective capital
contributions as follows: P50,000, P25,000, P25,000, and P20,000. The partnership provided that each
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partner shall receive a 5% interest on contributed capital, and that Doubleyu and Eks shall receive annual
salaries of P5,000 and P3,000, respectively. The contract also provided that Why shall receive a minimum
of P2,500 per annum, and Zee a minimum of P6,000 per annum, which is inclusive of amounts representing
interest and share of remaining profits. The balances of profits shall be divided to Doubleyu, Eks, Why and
Zee in the respective ratio of 3:3:2:2.
What amount must be earned by the partnership, before any charge for interest and salaries, so that
Doubleyu may receive an aggregate of P12,500 including interest, salary and share of remaining profits.
A. 16,667 C. 30,667
B. 30,000 D. 32,333
35. Hu, Arr, Yu and Mi are partners who share profits equally. Mi is an industrial partner who contributed her
professional expertise in the firm. Hu, being the managing partner, shall receive a salary of P20,000. If the
firm reported a net loss of P100,000, how much is the share of Mi?
A. -0- C. ( 30,000)
B. (25,000) D. (100,000)

“Faith is the first step to understanding. Either it's the Word of an infallible God, the fallible words of men,
or faith in what you personally believe. You've got to have faith in something. Believe me.” Ray Comfort

“Wisdom begins in wonder.” Socrates

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