Partnership: Introduction to Formation 3.

Unlimited liability
- owner's personal wealth can be seized to
Civil Code of the Philippines cover the balance owed. (General
partner/partnership)
- law governing partnerships in the Philippines.
4. Legal entity/Juridical Personality
Accounting for partnership - separate and distinct from owners
5. Consensual
- provisions of IFRS and CCP. - consensual of money, property, or
- more on application of the provisions of law industry into common fund.
rather than accounting standards. - Exception: 3k or more capital, real
Partnership property = must have public instrument.
6. Co-ownership of Property
- Art. 1767 contract of partnership; two or more - any contribution, all are co-owners.
persons bind themselves to contribute money, 7. Mutual participation in profits
property, or industry to a common fund, w/ - equal in profits/losses.
the intention of dividing the profits among - EX: Industrial Partner (no part on loss)
themselves.
 two or more persons may also form a Advantages and Disadvantages of a Partnership
partnership for exercise of profession
Advantages Disadvantages
(not a business). Ease of formation Unlimited liability of
- Art 1768 partnership has a judicial personality partners
even in case of failure to comply w/requirements More capital avl. for Risk of disagreements
of Art 1772. business among the partners
- Art 1772 contract of partnership having 3k Greater borrowing Can easily be dissolved
pesos or more, in money or property shall appear capacity.
in a public instrument, must be recorded in SEC. Fewer government Transfer of ownership
- Art 1770 partnership must have lawful object regulations. requires the consent of
or purpose and must established for common all partners.
benefit or interest of the partners.
 void if has unlawful object or purpose.
Classifications of Partnerships
- Art 1784 partnership begins from the execution
of contract, unless otherwise stipulated. 1. As to purpose
- Art 1785 when partnership w/fixed term  Trading or Commercial partnership
continued after termination w/out any express - engaged in merchandising and
agreement, rights and duties of partners remain manufacturing business.
the same, consistent w/partnership at will.  Non-trading or Professional
 continuation of business w/out any partnership
settlement or liquidation is prima facie - engaged in servicing business.
evidence (first view) of a continuation 2. As to object
of the partnership.  Universal partnership
Characteristics of a Partnership - Art 1777 all present property
and all profits.
1. Limited life/Indefinite Life - Art 1778 all present property
- dissolve if there’s any change in which the partners contribute
composition of partners. all the property belongs to
2. Mutual agency them to a common fund.
- every partner is an agent.
- delectus personae (the right of partners Art As to its object, a partnership is either
to exercise their choice as to admission 1776 universal or particular. As regards the liability
of partners, a partnership may be general or
of any new members to the partnership)
limited.
Art A UP of profits – the partners may acquire by
1780 their industry or work during the existence of
 partnership. - if continued after expiration or
 Movable or Immovable property completion it will be converted
- each partner may possess at the time of to partnership at will.
celebration of the contract shall continue
to pertain exclusively to each, only the 5. As to legality of existence
usufruct (or use) passing to the  De jure partnership – complied w/all
partnership. legal requirements for its existence.
 usufruct (right to enjoy the property of  De facto partnership – failed to comply
another w/obligation of preserving its w/one or more legal requirements.
form and substance, unless the title 6. As to representation to others
constituting it or the law provides.)  Ordinary or real partnership
- actually exists among the
Art Articles of UP, entered w/out specification of
1781 its nature, only constitute a universal partners as to third persons.
partnership of profits.  Ostensible partnership or partnership
Universal Partnership of profits by estoppel
- not a partnership but considered
- less obligations on partners since they preserve in relation to precluded to deny
ownership of their separate property. or disprove its existence (Art
 Particular partnership 1825)
- formed only to carry out one 7. As to publicity
business.  Secret partnership
3. As to the liability of the partners - existence of certain partners is
 General partnership no made known to the public.
- consists of only general partners  Open partnership
(liable to partnership debt in - existence is made known to the
case of asset< fulfillment of public.
liabilities)
 Limited partnership Kind of Partners (1 under the civil code)
- consisting at least one general 1. Capitalist partner – cash/property contribution.
partner and limited partner 2. Industrial partner – labor/service contribution.
(not personally liable for 3. Capitalist-industrial partner – cash, property,
obligations of partnership Art and service contribution.
1843) 4. General partner – liability to third persons
extends to his personal assets.
4. As to duration of the partnership 5. Limited partner – liability is limited to his
 Partnership at will (Art 1785) capital contributions.
- no specified term, not formed - does not participate in the
for a particular undertaking. management.
- may be terminated by will of - may contribute cash and/or property but
any one partner or one for a not services.
fixed term or continued after 6. Managing partner – manages partnership
termination of term or particular affairs (general or real partner)
undertaking w/out agreement. 7. Liquidating partner – takes charge of
 Partnership w/a fixed term partnership affairs upon dissolution.
- exist is agreed upon and formed 8. Nominal partner or Partner by estoppel – not
for a particular undertaking. really a partner but is made liable as a partner
- dissolved after expiration of for protection of innocent third persons.
term or completion of 9. Continuing partner – continues partnership
undertaking unless continued after dissolution.
by partners. 10. Surviving partner – remains after partner’s
death.
(2) Others
 if industry/service is contributed, only a
1. Ostensible partner – participates and publicly known
memorandum entry is required.
2. Secret partner – active but unknown to public.  partnership may assume the business liabilities
of a partner. (deducted from net assets to
3. Silent partner – not active but publicly known. determine net investment of partner)
4. Dormant partner – not active and unknown.  when re-valuing acc receivables and property,
adjustments are made through their related
5. Original partner – member from its formation. contra-accounts. (increase = debit contra
accounts, decrease = credit contra accounts)
6. Incoming partner – about to be taken as a partner.
 adjustments on re-valuation of assets (1) books
7. Retiring partner – withdrawn from the partnership. of sole proprietorship then transfer (2)
partnership books w/revalued amounts.
 no one can become a partner in a partnership
w/out consent of all the partners. Transferring assets and liabilities to partnership books

Form of Partnership Contract  Accumulated depreciation accounts are netted

against the related asset accounts.
- partnership contract: orally or written.  Allowance for bad debts is not netted against
- partner may contribute to any form accounts receivable. Allowance only reflects
(real/immovable or personal/movable). accounts that are estimated to be uncollectible.
- if partner contributes real property (regardless
of the amount) should be executed in public Pro-forma entries:
instrument (or written) otherwise, partnership
 Investment by capitalist partner
is void and will not acquire juridical personality.
- failure to comply w/requirements of Art 1772 Cash
shall not affect the liability of the partnership
and members to third persons. Partnership Non-cash assets
contract is still valid and acquires juridical X, Capital
personality.
 Liabilities assumed by the partnership
Articles of Co-Partnership
X, Capital
- written agreement between or among the
partners governing the formation, operation, and Liabilities
dissolution of partnership.
 Transfer of capital (Bonus)
 number of capital and drawing accounts as many X, Capital
as number of partners. (one partner = one
Y, Capital
capital, one drawing account)
 all properties brought into or acquired by the  Cash withdrawal of a partner
partnership are partnership property.
X, Capital
Accounting for the Organization of a Partnership
Cash
 partner may contribute cash, property, or
industry/service to the partnership.  Additional investment of a partner

If the asset contributed is in the form of: Cash

1. Cash – recorded in books of account at face X, Capital

value since (face value = fair market value) Additional
2. Non-cash asset – recorded at:
(1) Agreed value generally acceptable number of partners = 2 to 20
(2) Fair market value
in some = 2 to 50, or (Ex: bank) = 2-10
(3) Carrying value
Partnership: Operations
 accounting for partnership operations is the same As to…
as accounting for sole proprietorship. Division Capitalist Industrial Cap-indus
of absence of absence of absence of
Art A stipulation which excludes one or more Profits agreement = agreement agreement, =
1799 partners from any share in profits/losses is void. accordance = receive equitable share as
w/capital just and industrial and
contributions equitable accordance
Partner Drawings and Withdrawals . share. w/capital
contributions as
 Non-cash asset drawings shall be valued at
capitalist.
their fair market value at withdrawal date.
In accordance w/the partner’s agreement.
 Partners normally withdraw regular amounts if
Division only division Absence both character in
cash on a weekly/monthly basis (drawings). of of profits of loss accordance
Charged to the partner’s drawing accounts. Losses agreed = agreement w/capitalist and
Two classes of withdrawals agreement of = no share industrial.
division of in losses.
1. Permanent withdrawals – directly affect profits.
capital account balances (debit to capital) absence of
2. Temporary withdrawals – charged to drawing agreement =
accounts (drawings from share in net income) accordance
 partner’s withdrawal is limited to his share w/capital
contributions
in net income realized by the partnership.
.
beg +end
average capital=
2
Pro-forma entries:
 for the purposes of computing ending capital ratio
Net income Net Loss
and average capital balances of partners to divide
Closing of Revenues Revenues
profits and losses, only the additional revenues and Expenses Income s.
investments and permanent withdrawals are expenses to Income s. Expenses
considered in the computation. income
summary
Rules on Dividing Profits and Losses
account
Art (1) losses and profits shall be distributed
1797 in conformity w/agreements. Closing of Income s. X, Drawing
(2) if no loss sharing agreement = same income X, Drawing Y, Drawing
proportion w/profit agreement summary Y, Drawing Income s.
(3) absence of agreement = proportion in account to
profits and losses (original capital), drawing
ex: industrial partner not liable for accounts
losses, but equitable w/profit sharing.
If he also contributed capital, beside Closing of X, Drawing X, Capital
his service, shall also receive share in drawing Y, Drawing Y, Capital
profits in proportion to his capital. accounts to X, Capital X, Drawing
capital Y, Capital Y, Drawing
 Profit and loss ratio should be established at the accounts
time of formation. Original capital is the only
available capital balance at the time of formation.
 Partners agree to divide profits only = losses are Other Considerations in the Division of Profits and
divided in the same manner. Losses
 Partners agree to divide losses only = profits shall
be divided according to their capital contributions. 1. Interest on capital balances
 - incentives given to partners to the
differences in capital contributions.
- does not take into account the time and
effort partner devoted in business.
2. Salary allowances to partners
- compensation given in proportion to Partnership: Dissolution
time devoted to business.
- does not take into consideration the Dissolution
differences in capital contributions. - occurs if there is a change in ownership of the
3. Bonus business.
- incentive given to managing partner in - partnership nor its operation is not terminated.
recognition of their managerial skills. - may precede to liquidation.
- usually a percentage of profit.
- profit operations = bonus may/not given. Cause of Dissolution
- loss operations = bonus is not allowed. 1. Admission of new partner
2. Withdrawal or retirement of a partner.
 Interest on capital balances and salaries 3. Death of partner
are provided even when losses are incurred. 4. Incorporation of partnership
 Interest, Salaries and Bonus are not
expenses of the firm but as a manner of Accounting considerations before accepting a new
distribution of profits and losses. partner:

Order of Priority Provision 1. Asset Revaluation

- increase/decrease in value of partnership
 partners may agree not to use a residual sharing assets.
ratio in the event profits did not exceed total of 2. Distribution of P/L to Existing Partners
salary and interest allowances. - IS to be prepared to determine P/L to be
Correction of Errors distributed to existing partners.
3. Close Partner’s Drawing Accounts After
1. Counterbalancing errors – not detected, Distribution of Profit or Loss.
automatically corrected in the next accounting - should be closed to partner’s capital.
period.
2. Non-counterbalancing errors – if not detected, Admission of New Partner
not automatically corrected in the next 1. Purchase of Capital Interests from Existing
accounting period. Partners.
Taxes Applicable to Partnerships - transaction between new partner and
existing partner.
NIRC - “corporation” shall include partnership. - does not affect the total capital of
SEC - Exc: general professional partnership partnership difference between
22 (B) (exempt from income tax). goodwill and bonus.
- commercial partnerships (30% income - based on interest purchased not on
tax rate)
payment partnership.
- Change in PL ratio but not with asset.
Capital Balances Adjusted to Profit and Loss Ratio 2. Investment in the Partnership Business.
- investment will increase Assets and
 usually, capital ratios do not equal profit and loss Partner’s Equity
ratios, yet partners may bring capital balances - Change in the structure of partner’s
into their profit and loss ratio through: equity and P/L ratio of all partners.
- NP’s interest: based on agreed capital,
(1) payments outside of the partnership could be lower or higher than
(2) lowest possible additional cash investment contributed capital.
(3) lowest possible cash withdrawal
CC = AC no transfer of capital
 CC > AC bonus to old partner - business may continue w/a substitute.
- business may continue w/the interest of the
CC < AC bonus to new partner.
deceased partner purchased by remaining
partner(s), or partnership.

Terminologies Accounting Considerations for the Settlement of the

Capital of the Deceased Partner
1. Total Contributed Capital (TCC)
- total capital balances of OP + actual 1. Close drawing and capital accounts to liability
amount of investment of NP. account “Payable to Partner’s Estate”
2. Total Agreed Capital (TAC) 2. Compute partner’s share on the asset revaluation
- total capital of partnership based on CC or profit to increase payable.
of partners (OP and NP). 3. Update Payable for any accrued interest.
- TAC = TCC under BONUS method 4. Payment of Payable at the settlement date.
- NP or OP will receive a bonus.
- TAC = CC/% NP interest Partnership: Liquidation
3. Capital Credit (CC) of new partner Liquidation
- amount of capital interest of NP.
- CC = % interest x TAC - winding up affairs of the business towards
termination.
Asset Revaluation: Comparison of TCC and TAC
Types of Partnership Liquidation
TCC = TAC no asset revaluation
1. Simple Liquidation (lump sum)
TCC > TAC - all non-cash assets are sold before any
- assumption: overstatement of assets cash is disbursed to creditors and
- decrease in asset and capital of OP partners.
2. Installment Liquidation
TCC < TAC - non-cash assets are sold in installment
and cash is disbursed to all equity
- assumption: understatement of assets
interests as the cash becomes available.
- increase in asset and capital of OP
Three Steps in Liquidation
Bonus – diff. between NP contributed capital and CC.
1. Sell/convert to cash all remaining properties and
Retirement or Withdrawal of Partner
non-cash assets of business.
- partner may leave the partnership in accordance  gain/loss allocate to partner’s capital
w/the partnership agreement. account on P/L ratio.
- partner can be sued for damages if retired not in 2. Pay liquidation expenses and liabilities.
accordance w/the agreement. 3. Distribute remaining cash in payment of
partner’s interest:
Actions a. Loan from partner
1. Selling equity to remaining partners b. Capital balances including profit share.
2. Selling equity to outsider Legal Provisions on Liquidation
3. Selling equity interest to partnership
1. Payment to creditors & partners on the ff. order:
Accounting Considerations on Dissolution a. Outside creditors
1. Record asset revaluation, if any b. Partners
2. Distribute P/L c. Partner’s capital
3. Close Partner’s Drawing Accounts after d. Partner’s share on profit
Distribution of P/L 2. Insolvent partner, the claim against his
separate properties shall be rank in the ff. order:
Death or Incapacity of a Partner a. Personal creditors
b. Partnership creditors
- dissolves original association of partnership
c. Other partners for contributions made
 3. Partnership creditors have priority over
partnership properties; partner’s personal
creditors have priority over partner’s personal
creditors.
4. Insolvent Partnership, general partners
(including industrial) are liable to pay
partnership creditors from personal properties.
5. Deficient partner, right of offset to a loan
balance owed by the partnership.
6. Limited partner, liable only to extent of
contribution, and shall receive any part of his
contribution if liabilities of firm have been paid.
Terminologies

 Realization – process of selling/converting non-

cash assets to cash.
 Gain/Loss on Realization
 Gain = Cash > NBV of Assets
 Loss = Cash < NBV of Assets
 Capital Deficiency (Deficient Partner) – partner’s
capital < realization on the liquidation of assets.
 Right of Offset – legal right to apply a part or all
amount owed to partner against capital deficiency.
 Partner’s Interest = Sum of Loan Payable to
Partner + Partner’s Capital
 Net worth = Assets – Liabilities
 Positive NW – solvent partner
 Negative NW – insolvent partner