PARTNERSHIP AND

CORPORATION
Lesson Title: Chapter 1 - Partnership Formation

Lesson Objectives:
At the end of the module, the learners will be able to:
1. Understand the formation of a partnership.
2. Identify the different types of partnerships.
3. Know the accounting for partnership formation.
Lectures and Annotations:

Partnership defined
• A partnership is an association of two or more persons who contribute
money, property, or industry to a common fund with the intention of
dividing the profits among themselves.

Advantages of a Partnership
• It permits the pooling of capital and other resources without the
complexities and formalities of a corporation.
• It is easier and less costly to establish than a corporation
• It is generally not subject to much governmental regulation.
• The partners may be able to operate with more flexibility because they
are not subject to the control of a board of directors.
Types of Partnerships
• General partnerships – are those in which each partner is
personally liable to the partnership’s creditors if partnership
assets are not sufficient to pay such creditors. Such partners
are referred to as general partners.

• Limited partnerships – in this kind of partnerships, only one

partner needs to be a general partner. The remaining partners
can be limited, which means that their obligations to creditors
are limited to their capital contributions.
Features of General Partnerships

• Ease of formation – the partners merely put their agreement into

writing concerning who contributes assets or services, their role and
functions, and how profits and losses are allocated. This written
document is called the partnership agreement. In some cases,
partnership may also be created by oral agreement between two or
more persons or maybe implied by their agreement.
• Limited life – it is possible that the partnership operation could not
continue after the withdrawal or death of a partner.
• Assignment of partner’s interest – the assignee’s right is only limited in
the allocation of profit and loss and the right to receive assignor’s
interest in the event of dissolution.
• Unlimited liability – partners are responsible for liabilities and have all
the authority to act on his behalf.
• Mutual agency – every partner is an agent and has the authority to act
(within the normal scope of business operations) for the partnership.
• Separate legal personality – partnership law provides that partnership
has a juridical personality separate and distinct from that of each
partner.
• Sharing profits and losses – P & L are shared among the partners in any
manner to which they agree.
Underlying Equity Theories
1. Proprietary theory
• It views the assets of a business as belonging to the proprietor.
• The liabilities of a business are debts of the proprietor.
• The profits generated are viewed as an increase in the proprietor’s
capital.

2. Entity theory
• It views the business as a separate and distinct entity possessing its
own existence apart from the individual partners.
• The profits earned by the partnership are usually viewed as profit to
the entity with each partner entitled to a distributive share of the
profit.
Written Partnership Agreements (Articles of Partnership) – provides the following
information:

1. Name of the partnerships

2. The name, addresses of the partners, classes of partners, stating whether the partners are
general or limited.
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 contribution 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 withdraw money or other assets for partnership use.
9. The manner of keeping the books of accounts
10. The causes of dissolution
11. The provision for arbitration in settling disputes.
Accounting and Financial Requirements for Partnership
• The partnership should use the generally accepted accounting principles if a
partnership wishes to issue general-purpose financial statements for
creditors, vendors or other external users.
• For internal users, the partnership may use non-GAAP accounting methods.

Accounting for Partnership Activities

1. Capital accounts
2. Drawings or personal accounts
3. Accounts for loans to and from partners
Capital accounts
• The initial investments by each partner is recorded by debiting the assets
contributed.
• Crediting the liabilities assumed by the firm.
• And crediting the partner’s capital account at the fair value of the net assets
(assets minus liabilities) contributed.
• Partner’s equity is increased by additional investments at fair value at the
time of investment and any share of net income.

• Partner’s equity is decreased by withdrawal of cash or other assets and

share of net losses. Withdrawals of large and irregular accounts are ordinarily
charged directly to the withdrawing partner’s capital account. The entry to
such withdrawal is:

A, Capital xx
Cash xx
Increased in the capital account (by crediting the following transactions to
capital account):
• Initial/original investment
• Additional investment
• Share in net income (this may be credited to drawing accounts)

Decreased in the capital account (by debiting the following transactions to

capital account):
• Permanent or capital withdrawal
• Drawings in excess of a specified amount
• Withdrawal of large and irregular accounts
• Share in net losses (this may be debited to drawing accounts)
• Closing of a net debit balance in the partner’s drawing account
Loan accounts
• A partner may receive cash from the partnership with the intention of
repaying this amount. Such a transaction may be debited to the Loans
Receivable from Partners (partnership asset acct) ledger account
rather than to the partner’s drawing account.

• On the other hand, a partner may make a cash payment to the partnership
that is considered a loan rather than an increase in the partner’s capital
account balance. This transaction is recorded by a credit to Loans
Payable to Partners (partnership liability account) and normally is
accompanied by the issuance of a promissory note.
Capital Interest
• A partner’s capital interest is a claim against the net assets of the
partnership.
• The percentage of equity that each of the partner will have in the net
assets of the partnership.
• It represents his/her ownership or capital in the partnership.

Profit or Loss Interest

• Determines how the partner’s capital interest will increase or decrease as
a result of subsequent operations (net income/loss).
Accounting for Partnership Formation

Cash Investments
• All properties brought into the partnership or acquire by the partnership are
partnership property.
• Recorded at fair value.
• Cash denominated in foreign currency is valued at the current exchange rate.
• Cash in bank under receivership should be shown at its estimated recoverable
amount.

Noncash Investment
• Recorded at the agreed value, normally the fair value of the property at the
time of investment.
Industry or Service
• Services are contributed to the partnership, a memo entry if it has no value
agreed upon, otherwise a journal entry would be required.

Liabilities
• Assumed by the partnership should be valued at the present value (fair value)
of the remaining cash flows.
To illustrate, assume that A, B, and C organized a partnership, with A investing cash of P50,000
and B investing equipment originally costing P120,000 and with accumulated depreciation of
P50,000 at the time of partnership formation. A, B, and C agreed to a fair valuation of this
equipment at P80,000. C is admitted as an industrial partner, with a 20% share in partnership
profits. The entries in the books of the partnership to record the investment of each partner
are as follows:
Cash 50,000
A, Capital 50,000

Equipment 80,000
B, Capital 80,000

Memo: C is admitted as an industrial partner, with a 20% share in profits.

A partnership may be formed in numerous ways as follows:
1. For the first time:
• individual versus individual (two or more persons)
Guidelines on the formation:
Books of Partnership
Individual Books
Adjusting entries N/A
Closing entries (real
N/A
accounts)
Investments Yes
Balance Sheet Yes
A partnership may be formed in numerous ways as follows:
2. Conversion of a sole proprietor to a partnership
• individual versus sole proprietor (new set of books is used )
Guidelines on the formation:
Sole
Individual New Set of
Proprietor
Books Books
Books
Adjusting entries N/A Yes
Closing entries (real
N/A Yes
accounts)
Investments Yes
Balance sheet Yes
A partnership may be formed in numerous ways as follows:
3. Conversion of a sole proprietor to a partnership
• sole proprietor versus sole proprietor (new set of books is used )
Guidelines on the formation:
Sole Sole
New set of
Proprietor Proprietor
Books
Books Books
Adjusting entries Yes Yes
Closing entries (real
Yes Yes
accounts)
Investments Yes

Balance sheet Yes

Illustrative Problem:
A. Cruz and B. Santos, indvidually, have been in the hardware business for several years. On Jan 2, 2022,
they combined their businesses to avoid competition since the two entities operate in a common area.
A. Cruz and B. Santos agreed to the following measurement of assets and liabilities to be assumed by
the partnership.
1) The partnership, at the following valuation, would take over assets invested by the partners:
A. Cruz B. Santos
Accounts receivable 30,000 80,000
Land 300,000 0
Building 200,000 0
Furniture & equipment 24,000 50,000
Inventories 80,000 220,000
2) The partnership shall recognize the unrecorded accrued expenses of P20,000 in the books of A. Cruz.
3) The partnership would assume all other liabilities.
4) The partners would contribute or withdraw cash to make their capital equal to P400,000 each.
Before forming the partnership, A. Cruz and B. Santos had the following account balances in their books.
A. Cruz B. Santos
Cash 100,000 200,000
Accounts receivable 50,000 100,000
Allowance for uncollectible accounts -10,000 0
Inventories 100,000 200,000
Land 200,000 0
Building 400,000 0
Accumulated depreciation-Building -100,000 0
Furniture and equipment 30,000 60,000
Accumulated depreciation- F & E -10,000 -20,000
Total assets 760,000 540,000

Accounts payable 140,000 120,000

Accrued expenses 20,000 40,000
Capital 600,000 380,000
Total liabilities and capital 760,000 540,000
Required:
1) Journal entries to record the formation of the new partnership, AB Merchandising.
2) A statement of financial position immediately after the partnership formation.
Assume that the partnership would use a new set of books (formation #5). The
following are the accounting procedures to be taken up.

• In the individual books of both A. Cruz and B. Santos,

 The respective assets and liabilities shall be adjusted, debiting or crediting
the capital accounts directly; and
 All accounts shall be brought to zero balances.

• In the new set of books of the partnership,

 The assets and liabilities received from A. Cruz and B. Santos shall be
recorded. The PPE accounts are taken up at the agreed fair values,
without transferring the related accumulated depreciation to the
partnership books. The creation of the partnership gives rise to a new
basis of accountability, such that the fair values at the date of
contribution are the cost basis for PPE.
 The cash contributed from the single proprietorships shall be increased or
decreased to bring their respective capital balances to the agreed amount
The following adjusting and closing entries should be made in the books of A. Cruz:
Adjusting entries
Land 100,000
Accumulated depreciation - F & E 4,000
A. Cruz, capital 46,000
Allowance for uncollectible accounts 10,000
Inventories 20,000
Accumulated depreciation-Building 100,000
Accrued expenses 20,000
To adjust assets and liabilities to the agreed values.
Account affected Agreed valuation Carrying value Adjustment
Accounts receivable, net of allowance 30,000 40,000 10,000 decrease
Land 300,000 200,000 100,000 increase
Building, net of accum. depreciation 200,000 300,000 100,000 decrease
Furniture & equipment, net of accu. dep. 24,000 20,000 4,000 increase
Inventories 80,000 100,000 20,000 decrease
Accrued expenses 40,000 20,000 20,000 increase
Closing entries:
Allowance for uncollectible accounts 20,000
Accounts payable 140,000
Accrued expenses 40,000
Accum. Depreciation - Building 200,000
Accum. Depreciation - Furniture & equip. 6,000
A. Cruz, capital 554,000
Cash 100,000
Accounts receivable 50,000
Land 300,000
Building 400,000
Furniture & equipment 30,000
Inventories 80,000
To bring all accounts to zero balances
The following adjusting and closing entries should be made in the books of B. Santos:
Adjusting entries
Inventories 20,000
Accumulated depreciation - F & E 10,000
Allowance for uncollectible accounts 20,000
B. Santos, capital 10,000
To adjust assets and liabilities to the agreed values.

Account affected Agreed valuation Carrying value Adjustment

Accounts receivable, net of allowance 80,000 100,000 20,000 decrease
Inventories 220,000 200,000 20,000 increase
Furniture & equipment, net of accu. dep. 50,000 40,000 10,000 increase
Closing entries:
Allowance for uncollectible accounts 20,000
Accum. Depreciation - Furniture & equip. 10,000
Accounts payable 120,000
Accrued expenses 40,000
B. Santos, capital 390,000
Cash 200,000
Accounts receivable 100,000
Inventories 220,000
Furniture & equipment 60,000
To bring all accounts to zero balances
New Set of Books of the Partnership
(1)
Cash 100,000
Accounts receivable 50,000
Land 300,000
Building 200,000
Furniture and equipment 24,000
Inventories 80,000
Allowance for uncollectible accounts 20,000
Accounts payable 140,000
Accrued expenses 40,000
A. Cruz, capital 554,000
Assets and liabilities from A. Cruz
 (2)
Cash 200,000
Accounts receivable 100,000
Furniture and equipment 50,000
Inventories 220,000
Allowance for uncollectible accounts 20,000
Accounts payable 120,000
Accrued expenses 40,000
B. Santos, capital 390,000
Assets and liabilities from B. Santos
 (3)
A. Cruz, capital 154,000
Cash 154,000
Cash withdrawal by A. Cruz to bring
his total capital to P400,000

(4)
Cash 10,000
B. Santos, capital 10,000
Additional cash investment by B. Santos
to bring his total capital to P400,000
 AB Merchandising
Statement of Financial Position
January 2, 2022
Assets
Current Assets
Cash 156,000
Accounts receivable 150,000
Less: Allowance for uncollectible accounts 40,000 110,000
Inventories 300,000
Total current assets 566,000
Property, Plant and Equipment
Land 300,000
Buildings 200,000
Furniture and Equipment 74,000
Total Property, Plant and Equipment 574,000
Total Assets 1,140,000
 Liabilities
Current Liabilities
Accounts payable 260,000
Accrued expenses 80,000
Total liabilities 340,000
Partner's Equity
Partners' Capital
A. Cruz, capital 400,000
B. Santos, capital 400,000
Total partners' capital 800,000
Total Liabilities and Partners' Capital 1,140,000
Non-cash assets investment in the partnership
• The adjustments should be made thru their related contra-accounts.
 Accounts Receivable (allowance for doubtful account)
 Property, Plant, and Equipment (accumulated depreciation)

• Accounts Receivable – if agreed value of A/R is higher than its recorded amount, the
AJE would be:
Allowance for doubtful accounts xx
X, Capital xx
• Accounts Receivable – if agreed value of A/R is lower than its recorded amount, the
AJE would be:
X, Capital xx
Allowance for doubtful accounts xx
• PPE – if agreed value of PPE is higher than its recorded amount, the
AJE would be:
Accumulated depreciation xx
X, Capital xx

• PPE – if agreed value of PPE is lower than its recorded amount, the AJE
would be:
X, Capital xx
Accumulated depreciation xx
Non-cash Asset Accounts transferred to the partnership books

• Transferring PPE account – the accumulated depreciation account is netted

against the related asset account, the JE would be:
PPE (net of accumulated depreciation) xx
X, Capital
xx
• Transferring A/R – the related allowance for doubtful account is not netted
against the A/R, the JE would be:
Accounts receivable xx
Allowance for doubtful accounts xx
X, Capital xx
Accounting for liabilities attached to a property invested in the
partnership
• If the partnership will assume the liability, the JE would be:
Asset account xx
Mortgage payable xx
X, Capital xx

• If the partnership will not assume the liability, the JE would be:
Asset account xx
X, Capital xx
Establishment of Initial Capital of the Partners

1. Net investment method

2. Bonus method
3. Invest or withdraw method

 Net investment method, the initial capital of a partner is equal to his/her net
capital investment (if the problem is silent, use this method).
 Bonus method, one of the partners will transfer a portion of his/her capital to
the other partner/s.
 Invest or withdraw method, one of the partner’s capital investment will
become the basis for the total partnership capital and the other partner will
invest (or withdraw) assets to (or from) the partnership to conform with their
agreement.
Illustrative example:
A and B formed a partnership by contributing cash of P100,000 and
P150,000, respectively.
• Net investment method,
the JE would be:
Cash 100,000
A, Capital 100,000

Cash 150,000
B, Capital 150,000
Illustrative example:
A and B formed a partnership by contributing cash of P100,000 and P150,000, respectively.
• Bonus method,
Case 1: Assuming the partners agreed to have equal capital interest in the
partnership, the JE would be:
Cash 100,000
A, Capital 100,000

Cash 150,000
B, Capital 150,000

B, Capital 25,000
A, Capital 25,000

A’s initial capital (250,000 x 50%) = 125,000

B’s initial capital (250,000 x 50%) = 125,000
Illustrative example:
A and B formed a partnership by contributing cash of P100,000 and P150,000, respectively.
• Bonus method,
Case 2: Assuming the partners agreed to have a capital interest ratio of 30:70 to A and
B, respectively, the JE would be:
Cash 100,000
A, Capital 100,000

Cash 150,000
B, Capital 150,000

A, Capital 25,000
B, Capital 25,000

A’s initial capital (250,000 x 30%) = 75,000

B’s initial capital (250,000 x 70%) = 175,000
Illustrative example:
A and B formed a partnership by contributing cash of P100,000 and P150,000, respectively.
• Invest or withdraw method,
Case 1: Assuming the partners agreed to share profits and losses equally. B will either
invest or withdraw cash to make his capital interest proportionate to his P/L
ratio, the JE would be:
Cash 100,000
A, Capital 100,000

Cash 150,000
B, Capital 150,000

B, Capital 50,000
Cash 50,000

A’s (100,000 ÷ 50%) = 200,000 (total partnership capital)

B’s (200,000 x 50%) = 100,000 (B’s initial capital)
Illustrative example:
A and B formed a partnership by contributing cash of P100,000 and P150,000, respectively.
• Invest or withdraw method,
Case 2: Assuming the partners agreed to share profits and losses equally. A will
either invest or withdraw cash to make his capital interest proportionate to his
P/L ratio, the JE would be:
Cash 100,000
A, Capital 100,000

Cash 150,000
B, Capital 150,000

Cash 50,000
A, Capital 50,000

B’s (150,000 ÷ 50%) = 300,000 (total partnership capital)

A’s (300,000 x 50%) = 150,000 (A’s initial capital)
References:

Ballada, W., Ballada, S., (2023). Partnership and Corporation. Manila: DomDane
Publishers.

Empleo, P.M., Robles, N.S, German, C.I., (2023). Fundamentals of Accounting Volume 2.
Quezon City: PME Publishing Corp.

Reyno, Jr. F.Z., Reyno, DW. M., (2019). Financial Accounting and Reporting Part Two.
Dagupan City: Reyno Publishing House.

Villaluz, B.C. S., (2024). The Ultimate Partnership Accounting Reviewer. Cainta, Rizal:
BCV Accounting Bookshop.