Partnership Formation

(Accounting For Special Transactions)

2nd Trimester, AY 2023-2024
 Partnership Formation
Learning Objectives:
1. Differentiate between the accounting for partnerships,
sole proprietorships, and corporations.
2. State the valuation of contributions of partners.
3. Account for the initial investments of the partners to the
partnership.
4. State the peculiar accounts used in a partnership and
identify the transactions that affect these accounts
 Definition of Partnership
• A partnership is an unincorporated association of two
or more individuals to carry on, as co-owners, a
business, with the intention of dividing the profits among
themselves.
• The following distinguish a partnership from other types
of entities:
a. A partnership is owned by two or more individuals, while a sole
proprietorship is owned by only one individual.
b. A partnership is created by agreement between the partners,
while a corporation or cooperative is created by the operation of
law.
c. A partnership is formed for a business undertaking that is
normally of continuing nature, while a joint venture maybe forced
for a limited purpose and ends when its goal is achieved.
 Characteristics of a Partnership
1. Ease of formation
2. Separate legal personality
3. Mutual agency
4. Co-ownership of property
5. Co-ownership of profits
6. Limited life
7. Transfer of ownership
8. Unlimited liability (this is applicable to a general
partnership)
 Advantages and Disadvantages
of a Partnership
Advantage Disadvantage
• Ease of formation • Limited life/easily dissolved
• Shared responsibility of • Unlimited liability
running the business
• Flexibility in decision • Conflict among partners
making
• Greater capital compared to • Lesser capital compared to
sole proprietorship a corporation
• Relative lack of regulation • A partnership (other than a
by the government as general professional
compared to corporations partnership) is taxed like a
corporation
 Accounting for Partnerships
• The following are the major considerations in the
accounting for the equity of a partnership:
1. Formation – accounting for initial investments to the
partnership
2. Operation – division of profits or losses
3. Dissolution – admission of a new partner and withdrawal,
retirement or death of a partner
4. Liquidation – winding-up of affairs
 Partnership Formation Requirements
• A contract of partnership is consensual. It is created by agreement
of the partners which may be constituted in any form, such as oral
or written.
• However, per Articles 1771 and 1772 of the Philippine Civil Code
require that a partnership agreement must be made in a public
instrument and recorded with the Securities and Exchange
Commission (SEC) when:
a. Immovable property or real rights are contributed to the
partnership (e.g., PPE) or
b. The partnership has a capital of P3,000 or more.
• Art. 1773 requires further an inventory of any immovable property
contributed to the partnership, signed by the parties and attached
to the public instrument, otherwise the partnership is deemed void.
• A partnership’s legal existence begins from the execution of the
contract, unless otherwise stipulated.
Valuation of Contributions of Partners
• The term “appraisal” as used in the Civil Code suggests
valuation of capital contribution at fair value.
• The provision of PFRS 2 Share-based Payments that
equity instruments issued for non-cash items should be
valued at the fair value of the non-cash items received
parallels that of Art. 1787.
• As such, all assets contributed to (and related liabilities
assumed by) the partnership shall be measured at fair
value.
Valuation of Contributions of Partners
Ø An equity instrument is any contract that evidences a
residual interest in the assets of an entity after deducting all
of its liabilities.
Ø Fair value is “the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

When measuring the contributions of partners, the following

additional guidance from the PFRS shall be observed:

Type of Contribution Measurement

Cash and cash equivalents Face Amount (PAS 7)
Inventory Lower of Cost and Net realizable
value (PAS 2)
Valuation of Contributions of Partners
Each partner’s capital account is credited for the fair value of
his net contribution (i.e., asset contribution less any liability
assumed by the partnership).
No contribution shall be valued at an amount that exceeds the
contribution’s recoverable amount. Each partner’s contribution
shall be adjusted accordingly before recognition in the
partnership’s books.
Ø Recoverable amount – is “the higher between an asset’s
fair value less cost to sell and value in use.
A partner’s share in profits (losses) shall be credited (debited)
to his capital account.
Permanent withdrawals of capital are debited to the partner’s
capital account.
 Partner’s Ledger Accounts

The partners’ ledger accounts are as follows:

a. Capital accounts
b. Drawings accounts
c. Receivable from/Payable to a Partner
 Partner’s Ledger Accounts
Capital and Drawings accounts:
 Partner’s Ledger Accounts
Receivable from/Payable to a Partner:
• The partnership may enter into a loan transaction with a
partner.
• A loan extended by the partnership is recorded as a
receivable from the partner, while a loan obtained by
the partnership from a partner is recorded as a payable
to the partner.
 Illustration: Formation of Partnership – Valuation of Capital
A and B formed a partnership. The following are their contributions:
Additional Information:
• Included in accounts receivable is an
account amounting to P20,000 which is
deemed uncollectible.
• The inventory has an estimated selling
price of P100,000 and estimated costs
to sell of P10,000.
• The partnership assumed a P10,000
unpaid mortgage on the land.
• The building is under depreciated by
P25,000.
• There is an unpaid mortgage of
P15,000 on the building which B
agreed to settle using his personal
Requirement: funds.
(a) Compute for the adjusted balances of • The note payable is stated at face
the partner’s capital accounts amount. A proper valuation requires
the recognition of a P15,000 discount
on note payable.
• A and B shall share in profits and
losses on a 60:40 ratio, respectively.
(a) Compute for the adjusted balances of the partner’s capital accounts

The unpaid mortgage on the building is not included because it is not assumed by the
partnership.
(b) Assume that a partner’s capital shall be increased accordingly by
contributing additional cash to bring the partners’ capital balances
proportionate to their profit and loss ratio. Which partner should
provide additional cash and how much is the additional cash
contribution?

Conclusion: B’s contribution has no deficiency.

Conclusion: Partner A shall contribute additional cash of
P37,500 to make his contribution proportionate to his
profit-sharing ratio.
 Bonus on Initial Investments
• A partnership agreement may allow a certain partner
who is bringing expertise or special skill to the
partnership, to have a capital credit greater than the fair
value of his contributions.
• A bonus exists when the capital account of a partner is
credited for an amount greater than or less than the fair
value of his contributions.
• Under the bonus method, the bonus is treated as a
deduction to the capital accounts of the other partners.
Illustration:
A and B agreed to form a partnership. A contributed P40,000 cash
while B contributed equipment with fair value of P100,000. However,
due to the expertise that A will be bringing to the partnership, the
partners agreed that they should initially have an equal interest in the
partnership capital.
Requirement: Provide the journal entry to record the initial
investment of the partners.
 Variations to the Bonus Method
• A partnership agreement may stipulate a certain ratio to be
maintained by the partners representing their specific interests in
the equity of the partnership. This stipulation may give rise to the
adjustments to the initial contributions of the partners.
• Since technically, there is no bonus being given to a certain
partners, any increase or decrease to the capital credit of a partner
is not deducted from his co-partners’ capital accounts.
• Instead the capital adjustment is accounted for as either:
a. Cash settlement among the partners; or
b. Additional investment or withdrawal of investment of a
partner.
The following illustrations are variations to the bonus method:
1. Cash settlement between partners
2. Additional investment (withdrawal of investment)
Illustration 1: Cash settlement
between partners
Illustration 2: Additional investment
(withdrawal of investment)
OPEN FORUM

•QUESTIONS????
•REACTIONS!!!!!
END OF PRESENTATION