1.

0 Partnership Accounting
1.1 Nature, Scope, and Objectives

 Nature
- Association of two or more persons (individuals)
- To carry on as co-workers – contribute money, property, and service
- Business for profit
- Characteristics:
 Separate legal entity
 Ease of formation
- Mere agreement
- No signing of contract
 Unlimited liability
- Up to personal assets
 Limited life
- Dissolution
- Liquidation

“Two or more persons bind themselves to contribute money, property or industry to a common fund with the intention of dividing the profits
among themselves.” – Article 1767

 Scope – matter of partner’s intention under the normal scope of business

 Objectives – to turn a profit at a maximum level

1.1.1 Differentiate

 Sole Proprietorship
 has a single owner who generally is also the manager
 small-service type of business and retail establishments
 the owner receives all profits, absorbs all losses, and is solely responsible for all debts of the business
 distinct from its owner
 the accounting records do not include the proprietor’s personal financial record
 Partnership
 created by mere agreement
 two or more persons may form a partnership
 juridical personality commences from the execution of the articles of partnership
 every partner is an agent of the partnership if the partners did not appoint a managing partner
 each of the partners except a limited partner is liable to the extent of his personal assets
 there is no right of succession
 term of existence is for any period of time stipulated by the partners
 Corporation
 created by operations of law
 at least 5 persons, not exceeding 15
 from the issuance of certificate of incorporation by the sec
 management is vested on the board of directors
 stockholders are liable only to the extent of their interest or investment
 has the capacity of continued existence regardless of the death, withdrawal, insolvency or incapacity of its directors or stockholder
 not to exceed 50 years but subject to extension

1.1.2 Concepts, Principles, Rules, Practices, and Procedures

Partnership Agreement
 Framework: agreement
1) Formation
2) Operation
3) Dissolution or liquidation
 Help minimize, if not eliminate, the confusion and disputes that may arise
 Formulation of agreement must be done at the inception
 May be oral, implied or written
 Significant points in the agreement
1) Names – partners and the partnership
2) Date – take effect and duration
3) Capital to be invested
 Procedure of valuing noncash
 Treatment of any contribution – capital or loan
 Penalties for failure to contribute
4) Authority, rights, and duties
5) Accounting period to be used
 Nature of accounting records
 Preparation of FS
 Auditing
6) Methods of sharing profits and losses
 Frequency of income measurements
 Contributions to partners
7) Drawings or salaries to be allowed
8) Provision of the arbitration of disputes
 Consultation of Lawyers and CPAs
 1) Determination of current FV
2) Ascertainment of partner’s initial investment
3) Plan for sharing in profits or loss
4) Methods to compute interest
5) Closing procedures to be followed

Partner’s Ledger Account

 Capital accounts
- Original investments
- Additional investments
- Partner’s share in profit
 Drawing account (end of month) credit
 Obligations assumed/paid
 Funds/claims of partner (partnership)
 salaries
- Permanent withdrawal
- Debit balance of drawing account
- Partner’s share in losses
 Drawing account (end of month)
 Temporary withdrawal debit
 Partner’s indebtedness assumed
 Funds/claims of partner (partner)
*drawings account
- reduce the partner’s capital account
- a liability

 Loans to and from partners

- Withdrawal to repay – debit: loans receivable – partner
- Lend amounts to the partnership – credit: loans payable - partner

1.2 Formation
1.2.1 Initial Capital Contribution

Hierarchy
1) Agreed value
2) Fair value
3) Book value – appraised
4) If none, Market value (sold)
- assumed liability is deducted
- if silent, not assumed

Partnership Formation for the First Time

 Cash investment:
Cash xx
A, Capital xx
B, Capital xx

 Non cash investment: current FV

- Independent appraisal
- Agreement of the partners

Asset xx
A, Capital xx
B, Capital xx

 Bonus method
1) Interests are not equal to investment
2) Receive equal interest
3) Allocation: transfer of capital
4) If silent, use bonus method

A contribution > B Contribution

*equalize the capital balance of B

A 70,000
B 50,000
120,000 ÷ 2 = 60,000

A 70,000 – 10,000 = 60,000

B 50,000 + 10,000 = 60,000

A, Capital 10,000
B, Capital 10,000

 Goodwill Method
 1) Equalization of capital is accomplished
2) Capitalize (intangible asset)

A 70,000 = 70,000
B 50,000 + 20,000 = 70,000

Goodwill 20,000
B, Capital 20,000

Sole Proprietor and another individual form a partnership

 Sole proprietorship’s books are retained for the partnership
1) Adjust assets and liabilities to FMV (agreed: capital account)
2) Record the investment

 New books are opened for the partnership

1) Books of the sole proprietor
a. Adjust assets and liabilities
b. Close the books
2) New books of the partnership
a. Record investments
b. Record cash investments

Two proprietors form a partnership

 Books of sole proprietor
1) Adjust assets and liabilities to FMV (agreed: capital account)
2) Close the books
 Books of the other sole proprietor
- Now the new partnership book
1) Adjust assets and liabilities to FMV (agreed: capital account)
2) Record the investment of the other sole proprietor

 New books are opened for the partnership

1) Books of both sole proprietor
a. Adjust the assets and liabilities
b. Close the book
2) New book of the partnership
a. Record both the investment (net of adjustments)
b. Record both the investment (PPE)

Contributed assets (agreed/FMV/appraised) xx

Liabilities assumed by the partnership (xx)
Contributed capital xx

Total agreed capital xx

Capital interest ratio agreement %
Capital credit xx

*capital of each partner after formation is always based on agreed capital

*if silent, contributed capital = capital credit
*assets – current FMV
*no accumulated depreciation is carried forward into the partnership
*individual partner’s total capital = partner’s net asset

Techniques:

“how much should *** contribute” or additional cash investment

B (70%) J (30%)
920,000 525,000÷30%×70% 1,750,000
295,000 (525,000)
(87,000) 1,225,000
1,128,000 (1,128,000)
97,000

Or
 R(1/3) W(1/3) B(1/3)
40,000 80,000 ?

40,000
80,000
120,000 120,000÷2/3×1/3 60,000

Or

P(40%) E (60%)
70,000 300,000÷60%×40% 200,000
90,000 (120,000)
(40,000) 80,000
120,000

In bonus method, if partners agree in P&L ratio

R(40%) S(40%) T(20%)

471,000 291,000 195,000 957,000

9,750,000 × 40% 382,800 Agreed capital

(471,000) 250,000
× 40% 382,800 (291,000)200,000
× 20% 191,400 Individual capital
(195,000) 252,000
198,000
(2,000) 2,000 –
excess: goodwill

*obsolete inventory – deduct

*under depreciated – deduct from asset
*over depreciated – added to asset
*accrued expenses – liability
*prepaid expenses – asset

1.3 Operation/ Dissolution/ Changes in Ownership Interest

 Operation

 Division of Profit and Losses

1) Partner’s agreement
2) If no agreement, capital contribution
3) Profit: (credit balance)
 Agreement
 Capital Contribution
4) Losses: (debit balance)
 Agreement
 Profit ratio
 Capital contribution

1) Equally
2) Unequal: arbitrary ratio
3) Capital account balances ratio
a. Original
b. Beginning
c. Ending
4) Average capital account balances ratio (preferable)
a. Simple average method

beginning + ending
A (40,000 + 60,000) ÷ 2 = 50,000
B (60,000 + 100,000) ÷ 2 = 80,000
130,000

A 60,000 × 5/13 = 23,077

B 60,000 × 8/13 = 36,923

b. Peso month/peso day

- drawing account balances up to the amounts specified in the agreement would not be deducted
 A
1/1/2021 40,000 40,000 2/12 6,667
3/1/2021 20,000 60,000 5/12 25,000
8/1/2021 20,000 80,000 2/12 13,333
10/1/2021 (20,000) 60,000 3/12 15,000
60,000
B
1/1/2021 60,000 60,000 2/12 10,000
3/1/2021 50,000 110,000 5/12 45,833
8/1/2021 40,000 150,000 3/12 37,500
11/1/2021 (50,000) 100,000 2/12 16,667
110,000

A 60,000 × 60/117 = 21,117

B 60,000 × 110/117 = 38,823

5) Interest – allocation of net profit/loss

A (60,000) B (110,000)
interest (12%) 7,200 13,200 20,400
remainder 19,800 19,800 39,600
total 27,000 33,000 60,000

A (60,000) B (110,000)
interest (12%) 7,200 13,200 20,400
remainder (15,200) (15,200) (30,400)
total (8,000) (2,000) (10,000)

6) Salaries – not expense but for sharing net income (same format with interest
7) Bonus (example: 20%)
a. Net income before salaries, interest and bonus
- Net income × Bonus %

b. Net income before salaries, interest but after bonus

- Bonus + Income after bonus = Net income
- (Net income ÷ 120% × 20% = Bonus) – net income after bonus

c. Net income after salaries, interest but before bonus

- (Net income – Salaries – Interest) × Bonus %
- If amount is negative, no bonus

d. Net income after salaries, interest, bonus

- (Net income – Salaries – Interest) ÷ 120% × 20% = Bonus
- If negative, no bonus

*net loss, no bonus

Capital account - incurred loss
A debit - one partner contributed substantially more capital
B credit than the other partner
Techniques:

L J
salaries 120,000 80,000 200,000
remainder (1,000) (10,000) (20,000) *equally work back
income 110,000 70,000 180,000 *given

Credited to partners
(distributed)
Changes in Capital:

Capital, beginning xx
Additional investment xx
Drawings (xx)
Share in net income (loss) xx
Capital, ending xx
Net income: 250,000

 To receive 10% of net income up to 100,000 and 20% over 100,000

- 100,000 × 10% = 10,000
- (250,000 – 100,000) × 20% = 30,000

 To receive 5% of the remaining income over 150,000

- (10,000 + 30,000 ) – 250,000 = 210,000
- (210,000 – 150,000) × 5% = 3,000

*inventor y overstatement – deduct from net income

*inventory understatement – add back to net income

1.3.1 Admission of a New Partner

- Old partnership is dissolved and new partnership is formed
- New agreement should be drawn because the dissolution cancels the old agreement
 Dissolution
1) Admission of a partner
2) Retirement of a partner
3) Death of a partner
 Withdrawal concerns:
 Payment using partner’s separate cash
 Payment using partner’s asset
o Below interest
o Above interest
4) Incorporation of a partnership

Dissolution vs. Liquidation

- Dissolution – when the original association for purposes of carrying on activities has ended
- Liquidation – when the business is terminated
- Partnership:
 Dissolution may or may not result to liquidation
 Liquidation always results to dissolution

1.3.1.1 By Purchase of Interest

 Case 1: Purchase of interest from one partner

- opening a capital account for the new partner and decreasing the capital accounts of the selling (original) partners by the same
amount

 Case 2: Purchase of interest from one or more partners

- total capital of the partnership does not change
- no gain or loss is recognized in the partnership

 Case 3: Purchase of interest: book value method

- book values of the old partners rather than the total partnership capital

 Case 4: Purchase of interest: proportionate share

- net asset and profit = payment of new partner less capital credit

o Procedure for fair and equitable division of cash among the existing partner:
 Determine the amounts of capital balances to be transferred by the existing partner
 Apportion any excess/deficiency in the original partner’s profit/loss ratio

 Revaluation of Assets
- assets and liabilities restated to fair value
- adjustment: allocate first to the existing partners before admission of the new partner

1.3.1.2 By Investment

- Acquire interest by investing

- Receives cash/other assets
 Increase total assets
 Increase total capital

 For the new partner:

 Case 1: New Partner’s Investment (contributed capital) = New Partner’s Proportion (agreed capital)
 Investment of the new partner is added to the net asset of the old partners before multiplying the interest of the new
partner (increase in the partnership’s capital)

Purchase of interest Investment in the

partnership
Incoming partner’s Incoming partner’s
contribution not contribution is
included included in the
 partnership’s book
Partnership’s capital Partnership’s capital
remains the same increased by the
incoming partner’s
contribution
No gain or loss is No gain or loss is
recognized recognized

 Case 2: New Partner’s Proportion < New Partner’s Investment = NEGATIVE

 Undervalued prior net assets
 Unrecorded goodwill
 Allocate bonus to old partners

 Case 3: New Partner’s Proportion > New Partner’s Investment = POSITIVE

 Overvalued prior net assets
 New partner may be contributing goodwill
 Assign bonus to new partner

 Case 4.1: Amount of investment (if no bonus is allowed)

 Net asset before admission divided by 100% less the % of the new partner multiplied by the % of the new partner

 Case 4.2: Adjustment to capital and cash settlement

 New P/L ratio: (100% - % of the new partner) x % of the old partner

 Case 4.1: Correction of error

Steps:
1) Compute the new partner’s proportion
Agreed Capital = [Old Partner’s Capital + New Partner’s Capital (investment)] × % of Capital to New Partner
2) Compare contributed capital with agreed capital
3) Determine admission method (may use any)
 Revalue net asset upward/downward
 Record unrecognized goodwill/recognized goodwill brought in by the new partner (case 3)
 Bonus method (case 2)

 Goodwill method
o Case 1: Purchase of interest – Goodwill to old partners
 Implied goodwill to new partner’s payment
o Case 2: Investment – Goodwill to old partners
 Implied goodwill to new partner’s investment
o Case 3: Investment – Goodwill to new partners
 Implied goodwill to agreed capital

1.3.2 Withdrawal, Retirement, or Death of a Partner

 Withdrawal/ retirement of a partner

- Partnership is dissolve, but remaining partners may continue operating
- Existing partners may buy out the retiring partner’s interest
 Direct acquisition
 Record the transfer of capital from retiring to remaining partner (entry)
- Have the partnership acquire the retiring partner’s interest
 Pay the retiring partner equal amount to his interest (more or less)

o Purchased by one/all of the remaining partner

 Adjust capital balances from profit earned using capital ratio
 Record withdrawal using remaining partner’s ratio based on adjusted balance of the exiting partner
 Total capital balance remains the same

o Settlement by the partnership

 Remaining partners deducts the partnership for the bonus of the exiting partner (capital account – interest settlement)
o Bonus method
o Deferred settlement
o Retirement – payment in the form of noncash asset (by the partnership)
 Adjust capital balance: unadjusted + profit + revaluation (FV)
 Record the settlement, payment to outgoing partner (cash + FV)
o Death of a partner – settlement of interest by partnership
 Outgoing partner’s capital is transferred to a liability account