Forms of Business Organization 8.

Rights, powers, and duties of the

partners
Sole Proprietorship – Form of organization 9. Accounting period
where there is only one owner, the 10. Manner of dividing profits and losses
proprietor. 11. Liabilities of the partners for
Partnership – two or more persons who partnership debts
binds themselves to contribute money, 12. Compensation for services offered
property, or industry to a common fund, by partners
with the intention of dividing the profit 13. Treatment of partners’ additional
among themselves. investments and withdrawals
Corporation – an artificial being created by 14. Procedure for settlement of partners’
the operation of law, having the right of interest upon dissolution of
succession and the powers, attributes and partnership
properties expressly authorized by law 15. Provision for settlement of disputes
or incident to its existence.
Characteristics
Partnerships
1. Mutual Contribution
Procedure in Organizing a Partnership 2. Division of Profit and Loss
3. Co-Ownership of Contributed Assets
- Register the business name with the 4. Mutual Agency
Bureau of Domestic Trade. 5. Limited Life
- Have the partnership agreement be 6. Unlimited Liability
notarized.
- Obtain a tax account number for the Classification of Partnerships
partnership from the BIR.
- Register with SEC. As to object
- Obtain the municipal licenses from
local government. a. Universal Partnership
- Apply for VAT or non-VAT. b. Particular Partnership
- Register with the BIR the books of
accounts and the business forms to As to liability
be used.
a. General Partnership
Partnership Contract / Articles of Co- b. Limited Partnership
Partnership
As to legality of existence
1. Name of the partnership
2. Names of the partners a. De Facto Partnership
3. Place of business b. De Jure Partnership
4. Effective date of the partnership
5. Nature of business As to duration
6. Investment of each partner and
corresponding capital credit a. Partnership at Will
7. Duration of the contract b. Partnership with a Fixed Term
Classes of Partners

As to contributions

a. Capitalist Partner
b. Industrial Partner
c. Capitalist-industrial Partner

As to liability

a. General Partner
b. Limited Partner

As to management

a. Managing Partner
b. Silent Partner

Other classes of partners

a. Secret Partner
b. Nominal Partner
c. Liquidating Partner

Advantages

1. It is easy to form. (compared to

Corporation)
2. Suited to the practice of profession.
3. Flexibility of operation.
4. More capital and better decision
arrived at. (Compared to Sole
Propietorship)
5. Good credit standing

Disadvantages

1. Unlimited liability of the partners.

2. Limited life.
3. Limited ability to raise capital

PARTNERSHIP FORMATION
 The partnership is a separate accounting entity (not to be confused with a separate legal entity), and
therefore its assets and liabilities should remain separate and distinct from the individual partner’s
personal assets and liabilities.
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.
Upon formation, the amount credited to each partner’s capital account is the difference between the
fair market value of the assets (including goodwill, if any) contributed and the present value of the
liabilities assumed from the partner. The capital accounts represent the residual equity of the partnership.
The capital account of each partner reflects all of the activity of an individual partner; contributions,
withdrawals, and the distributive share of net income (loss). In some cases, a drawing account is used as a
clearing account for each partner’s transactions with only the net effect of each period’s activity shown in
the capital account.

Example: 1

A and B form a partnership. A contributes cash of P50,000, while B contributed land with a fair
market value of P50,000 and the partnership assumes a liability on the land of P25,000.
The entry to record the formation of the partnership is
Cash P50,000
Land 50,000
Liabilities P25,000
A, capital 50,000
B, capital 25,000

Example: 2

On June 1 20x9, S and T pooled their assets to form a partnership, with the firm to take over their
business assets and assume the liabilities. Partners capitals are to be based on the assets transferred after
the following adjustments:

a) T’s inventory is to be increased by P3,000.

b) An allowance for bad debts of P1,000 and P1,500 are be set up on the books of S and T,
respectively.
c) Accounts payable of P4,000 is to be recognized in S’s books.
d) An amount of cash must be contributed by any one of the partners in order to establish equal
amount of interest.

The following balances appear on S and T’s individual books on June 1, before adjustments:
Assets Liabilities
S P 75,000 P 5,000
T 113,000 34,500

How much capital must be credited to S?

Answer:
 S T Total
Assets of S P75,000 P113,000 P188,000
Less: Liabilities of S ( 5,000) ( 34,500) ( 39,500)
Unadjusted capital of S P70,000 P 78,500 P148,500
Adjustment:
a. Inventory increase 3,000 3,000
b. Allowance for bad debts ( 1,000) ( 1,500) ( 2,500)
c. Accounts payable recognized ( 4,000) _____ ( 4,000)
Capital before cash contribution P65,000 P 80,000 P145,000
Cash contribution by S 15,000 _______ _ 15,000
Equal interest P80,000 P 80,000 P160,000

Example: 3

The balance sheet as of July 31, 20x4, for the business owned by Sexy, shows the following assets and
liabilities:

Cash P 50,000 Furniture & Fixtures P164,000

Accounts receivable 134,000 Accounts payable 28,800
Merchandise inventory 220,000

It is estimated that 5% of the receivables will prove uncollectible. The cash balance includes a 1,000
shares marketable equity securities recorded at its cost, P4,000. The stock last sold on the market at
P17.50 per share. Merchandise inventory includes obsolete items costing P18,000 that will probably
realized only P4,000. Depreciation has never been recorded; however, the furniture and fixtures are two
years old, have an estimated total life of 10 years, and would cost P240,000 if purchased new. Prepaid
items amount to P5,000. Pogi is to be admitted as a partner upon investing P200,000 cash and P100,000
merchandise. How much capital is to be credited to Sexy upon formation of partnership?

Answer:
Assets contributed by Sexy:
Cash P 50,000
Accounts receivable 134,000
Merchandise inventory 220,000
Furniture and fixtures 164,000 P568,000
Less: Accounts payable ( 28,800)
Unadjusted capital contributed P539,200
Adjustments:
Allowance for bad debts (5% x 134,000) ( 6,700)
Marketable securities (17,500 – 4,000) 13,500
Merchandise inventory (18,000 – 4,000) ( 14,000)
Furniture and fixtures (240,000 x 80% - 164,000) 28,000
Prepaid items 5,000
Adjusted capital of Sexy P565,000

1. On May 1, 2008, Jose and Pedro formed a partnership and agreed to share profits and losses in
the ratio of 3:7, respectively. Jose contributed a computer that cost him P50,000.Pedro
 contributed P200,000 cash. The computer was sold for P55,000 on May 1, 2008 immediately
after the formation of the partnership. What amount should be recorded in Jose's capital account
on formation of the partnership?

2. Red, White, and Blue form a partnership on May 1, 2008. They agree that Red will contribute
office equipment with a total fair value of P40,000; White will contribute delivery equipment
with a fair value of P80,000; and Blue will contribute cash. If Blue want a one-third interest in the
capital and profits, how much should he contribute?

3. Scooby admits Scrappy as a partner in the business. Balance sheet accounts of Scooby on
September 30, just before the admission of Scrappy show:
Cash P 2,600
Accounts receivable 12,000
Merchandise inventory 18,000
Accounts payable P 6,200
Scooby, capital 26,400

It is agreed that for purposes of establishing Scooby’s interest, the following adjustments shall be
made:

a. An allowance for doubtful accounts of 2% is to be established.

b. Merchandise inventory is to be valued at P20,200.
c. Prepaid expenses of P350 and accrued expenses of P400 are to be recognized.

Scrappy is to invest sufficient cash to obtain a 1/3 interest in the partnership. How much is
Scrappy’s investment to the partnership?

4. Minipao and Siopao formed a partnership with each contributing the following assets at the
indicating market value:
Minipao Siopao
Cash P20,000 40,000
Machinery and equipment 30,000
Land 200,000
Building 60,000
Office furniture 30,000

The partners agree to share profits in the ratio of one-fourth to Minipao and three-fourths to
Siopao. Assume that Siopao’s land and building are subject to a mortgage loan of P120,000 that
the partnership will assume, the partner’s capital accounts should have the following initial
balances:
 PARTNERSHIP OPERATION

Allocation of Partnership Income (Loss)

The partners should have a written agreement, called articles of co-partnership, specifying
the manner in which partnership income (loss) is to be distributed. Note that in the absence of
a predetermined agreement, the profit and loss (P&L) is divided according to original capital
contributed by partners.

A number of issues arise which complicate the allocation of partnership income (loss).
1. Partners may receive interest on their capital balances. If so, it must be determined
what constitute the capital balance (e.g., the year-end amount of some type of weighted-
average).
2. Some of the partners may receive a salary.
3. Some of the partners may receive a bonus on distributable net income. If so, you need
to determine if the bonus should be computed before or after salary, interest and bonus
allocations.
4. A formula needs to be determined for allocating the remaining income. The formula
agreed upon is usually termed the residual, remainder, or profit (loss) sharing ratio.

Finally, the partners should decide upon how income is to be allocated if net income is
insufficient to cover partner’s salaries, bonuses, and interest allocations. These allocations are
usually made even if the effect is to create a negative remainder. This is important to note that
partners may choose the allocate losses (or a negative remainder) in a different manner than
income.

Example: Partnership P & L Distribution

The following are the capital balances and net income of ABC Partnership:

A, Capital – 300,000
B, Capital – 200,000
C, Capital – 100,000
Net Income – 150,000

Give the entry for the division of profit under each of the independent assumptions:

1. Profit is divided equally.

2. Profit is divided in the ratio 3:4:5 for A, B and C respectively.
3. Profit is divided in the following percentages: A – 50%; B – 30%; C – 20%
4. Profit is divided in the following fractions: A – 1/2; B – 1/3; C – 1/6
5. Interest of 10% on the capital and the balance in the ratio of 3:1:1 for A, B and C
respectively.
6. Salaries of 45,000 to A and 30,000 to B and the balance equally.
7. 20% bonus on income to C and the balance in the ratio of 4:3:3 for A, B and C
respectively.
8. Interest of 30% on capital and the balance equally.
9. Interest of 10% on capital, salaries of 30,000 each to A and B, 20% bonus to C on
income after interest and salaries, and the balance in the ratio of 3:1:1 for A, B and C
respectively.
10. Interest of 10% on capital to A, salaries of 30,000 each to A and B, 20% bonus to C on
income after interest and salaries, and the balance in the ratio of capital balances.
 11. 20% bonus after bonus to A, allowances of 80,000 each for A and B, and the balance
equally.
CHANGES IN PARTNERSHIP

Partnership Dissolution (Changes in Ownership)

Partnership dissolution occurs whenever there is a change in ownership (e.g., the addition
of a new partner, or the retirement, withdrawal or death of an existing partner). This is not to
be confused with partnership liquidation which is the winding up of partnership affairs and
termination of the business. Under dissolution the partnership business continues, but under
different ownership.

When partnership dissolution occurs, a new accounting entity results. The partnership
should first adjust its records so that all accounts are properly stated at the date of dissolution.
After the income (loss) has been properly allocated to the existing partner’s capital accounts, all
assets and liabilities should be adjusted to their fair market value and their present values,
respectively. The latter step is performed because the dissolution results in a new accounting
entity.

After all adjustments have been made, the accounting for dissolution depends on the type
of transaction that caused the dissolution.

These transactions can be broken down into two types:

 Transactions between the partnership and a partner (e.g., a new partner contributes
assets, or a retiring partner withdraws assets).
 Transactions between partners (e.g., a new partner purchases an interest form one or
more existing partners, or a retiring partner sells his/her interest to one or more
existing partners).

When a new partner is admitted to the partnership essentially three cases can result. The
new partner can invest assets into the partnership and receive a capital balance.
a. Equal to his/her purchase price
b. Greater than his/her purchase price
c. Less than his/her purchase price

When an existing partner withdrew from a partnership, the result will also be one from
these three cases. The old partner can get assets
a. Equal to his/her capital balance
b. Greater than his/her capital balance
c. Less than his/her capital balance

Example:

The ABC Partnership’s capital balances and profit and loss ratio is shown below:

A, Capital 120,000 50%

B, Capital 100,000 30%
C, Capital 80,000 20%

Record the following independent situations regarding dissolution:

1. D is to be admitted in the partnership by purchasing 1/3 interest of the

partnership for P100,000.
2. D is to be admitted in the partnership by purchasing ½ interest of B for
80,000.
 3. D is to be admitted in the partnership by investing 100,000 for 25%
interest.
4. D is to be admitted in the partnership by investing 100,000 for 20%
interest.
5. D is to be admitted in the partnership by investing 200,000 for 25%
interest. The land owned by the partnership will be revalued and will be increased by
100,000 before admission.
6. D will invest sufficient cash that will give him 20% interest.
7. C withdrew from the partnership and received 100,000 from A as
payment of his capital.
8. C withdrew from the partnership and received 60,000 as payment of his
capital.
PARTNERSHIP LIQUIDATION

Liquidation is the winding up of the partnership business. That is, it sells all of its non- cash
assets, pays its liabilities, and makes final liquidating distribution to the partners. There are
two cases of liquidation. These are 1) Lump sum liquidation, and 2) Installment liquidation.
Whether the liquidation is lump sum or installment, the partnership should prepare a
statement of liquidation, which is a summary of the transactions that happened in the course
of the liquidation.

1. LUMP SUM LIQUIDATION

Under the lump sum liquidation, the partnership sells all of its non- cash assets in bulk,
and all of the creditors’ claims are satisfied before a single liquidating distribution is made
to the partners. There are four basic steps to partnership lump sum liquidation, and these
are the following:
1. Any operating income or loss up to the date of the liquidation should be computed and
allocated to the partners’ capital accounts on the basis of their profit and loss ratio.
2. Gains or losses on sale of non- cash assets are allocated to the partners’ capital
accounts on the basis of their profit and loss ratio.
3. All outside creditors’ claims are satisfied through the payment or reservation of cash.
4. The remaining unreserved cash is distributed to the partners, first applying to their
loan accounts, and then, to their capital accounts. The distribution to the partners is
made based on their capital balances, and not on their profit and loss ratio.

Two factors that may complicate the liquidation process are the existence of loans or
advances between the partnership and one or more of the partners, and the existence of a
deficiency in a partner’s capital account. If there is a loan payable by the partnership to
the partner, this loan is shown separately from the capital account, since it has a different
priority in payment. If the partnership has a receivable from a partner, this receivable is
offset outright from the capital account of the partner. If a deficiency exists in a partner’s
capital account, the following are the possible remedies:
1. If the deficient partner has a loan account, offset the deficiency from the loan account.
2. If the deficient partner has no loan account, or the loan account is not enough, then the
partner is required to infuse cash into the partnership at an amount equal to his capital
deficiency (if he is solvent).
3. If the deficient partner does not have cash to infuse (insolvent), then the partner’s
capital deficiency is to be absorbed by the remaining solvent partners on the basis of
the remaining solvent partners’ profit and loss ratio.
Illustrative Problem:

ABC Partnership Balance Sheet as of December 31, 2018 is shown below. On this date, the
partners decide to liquidate the partnership.

ABC Partnership
Balance Sheet
December 31, 2018

Cash 150,000 Accounts Payable 100,000

Non-Cash Assets 600,000 Loans from B 150,000
A, Capital (50%) 200,000
B, Capital (30%) 100,000
C, Capital (20%) 200,000
Total Assets 750,000 Total Liabilities and Capital 750,000

Give the journal entries under each of the following independent assumptions:

1. Non-cash assets were sold for 800,000. All partners are solvent.
2. Non-cash assets were sold for 450,000. All partners are solvent.
3. Non-cash assets were sold for 100,000. All partners are solvent.
4. Non-cash assets were sold for 100,000. All partners are insolvent.

(no. 1 liquidation table)

Cash Non- Accounts Loan A,Capital B, C,

Cash Payable from B Capital Capital
Assets
Balances before liquidation 150,000 600,000 100,000 150,000 200,000 100,000 200,000
Realization 800,000 (600,000) 100,000 60,000 40,0000
Balances 950,000 - 100,000 150,000 300,000 160.000 240,000
Payment of liabilities (100,000) (100,000)
Balances 850,000 - - 150,000 300,000 160.000 240,000
Payment to partners (850.000) (150,000) (300,000) (160,000) (240,000)
Balances 0 0 0 0 0 0 0