MODULE 2

ACCOUNTING FOR PARTNERSHIPS

Introduction
In Basic Accounting, generally accepted accounting principles were discussed in the context of a
sole proprietorship. These accounting principles also apply to partnership. Thus, the recording of assets,
liabilities, income and expenses is consistent for both proprietorships and partnerships. Comparing two
businesses of the same nature, one organized as a sole proprietorship and another as a partnership, there
will be no marked difference in their operations.

Learning Outcomes
At the end of this module, students should be able to:

1. Comprehend the different ways of forming a Partnerships

2. Comprehend the recording of partner’s initial investments
3. Comprehend the valuation of partner’s investments
4. Prepare adjustment of accounts prior to formation.
5. Prepare opening entries of a partnership upon formation.

Lesson 1. The Partner’s Capital Account (Ballada, 2019)

For a proprietorship, there is only a single owner. Therefore, there is only on capital account and one
drawing account. On the other hand, since a partnership has two or more owners, separate capital and
drawing accounts are established for each partner.

A partner's capital account is credited for his initial and additional net investment (assets contributed
less liabilities assumed by the partnership), and credit balance of the drawing account at the end of the
period. It is debited for his permanent withdrawal and debit balance of the drawing account at the end
of the period.

Typically, partners do not wait until the end of the year to determine how much of the profits they wish
to withdraw from the partnership. To meet personal living expense partners customarily withdraw
money on a periodic basis throughout the year. A partner's drawing account is debited to reflect assets
temporarily withdrawn by him from the partnership. At the end of each accounting period, the balances
in the drawing accounts are closed to the related capital accounts.

Partner's Capital
Debit
1. Permanent withdrawal 1. Original investments
2.Debit balance of the drawing 2. additional investments
account at the end of the 1 3.Debit balance of the drawing
period account at the end of the
period
 Partner's Drawing Account
Debit Credit
1. Temporary withdrawals 1. Share in profit ( this may be
2. Share in loss ( this may be credited directly to Capital
directly debited to Capital ) account)

Permanent withdrawals are made with the intention of permanently decreasing the partner's capital
while temporary withdrawals are regular advances made by the partners in anticipation of their share in
profit.

The use of drawing accounts for temporary withdrawals provides a record of each partner's drawings
during an accounting period. Hence, drawings in excess of the allowed amounts as stated in the
partnership agreement may be controlled.

Notice that profit (or loss) is credited (or debited) either to the drawing account or to the capital
account. The choice of the account to credit or debit depends on the intention of the partners. If they
wish to maintain their capital accounts for investments and permanent withdrawals, then profit or loss
should be entered in the drawing account.

On the other hand, if the purpose of the partners is to make profit or loss part of their capital, then the
capital account should be used. In either case, the resulting partners' ending capital balances will be the
same.

Lesson 2. Partnership Formation

The books of the partnership are opened with entries reflecting the net contributions the partners to
the firm. Asset accounts are debited for assets contributed to the partnership, liability accounts are
credited for any liabilities assumed by the Partnership and separate capital accounts are credited for the
amount of each partner's net investment (assets less liabilities),

Partners may invest cash or non-cash assets in the partnership. When a partner invests non-cash assets,
they are to be recorded at values agreed upon by the partners. In the absence of any agreement, the
contributions will be recognized at their fair market values at the date of transfer to the partnership.

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The fair market value of an asset is the estimated amount that a willing seller would receive from a
financially capable buyer for the sale of the asset in a free market. Per International Financial
Reporting Standards (IFRS) No. 3, fair value is the price at which an asset or liability could be exchanged
in a current transaction between knowledgeable, unrelated willing parties.

Adjustment of Accounts Prior to Formation

In cases when the prospective partners have existing businesses, their respective books will have to be
adjusted to reflect the fair market values of their assets or to correct misstatements in the accounts. If
the adjustments will not be made, the initial capital balances of the partners may be inequitable.

Illustration. A reconditioned printing equipment invested by Luz Un was recorded incorrectly in the
partnership books at P730,000—its book value from the proprietorship's records. If the partnership
immediately sold the printing equipment for its fair market value of P800,000, the resulting P70,000 gain
would increase the capital balances of both Partners Luz Un and Dennis Sandoval. The printing
equipment should have been recorded at P800,000 and Un's capital credited with P800,000. Simply
stated, increases in asset values accruing before formation should be for the benefit of the contributing
partner.

The adjustments of the assets and liabilities prior to formation will be similar to the adjustments that we
are already familiar with. However, when the adjustment involves a debit or credit to a nominal
account, the Capital account would instead be debited or credited. This is so because the business has
ceased to be a going concern. A business is not viewed as a going concern if liquidation appears
imminent.

Lesson 3. Ways of Forming a Partnership

A partnership is formed in a number of ways:

1. Two or more persons may form a partnership for the first time. In this type of formation, the partners
may contribute cash, property or services.

2. Two or more persons may form a partnership where one of them is already engaged in business.

3. Admission of a new partner in an existing partnership;

a. by purchase of a certain fraction of interest of one of the partners or both;

b. by investment or by contributing cash or other tangible assets to the firm.

Illustrative Problems

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I — Formation of Partnership for the First Time

A. Partners Contribute Cash Only

On Feb. 14, 2018 Rey Co and May Tan formed a partnership named Rema Trading with initial
contributions of and 250,000, respectively.

The opening entry in the books of the partnership is:

Cash 500,000
Co, Capital 250,000
Tan, Capital 250,000
ro record partner's initial investments

B. Partners Contribute Cash and Other Property

On June 4, 2020 J. Co and B. Chua formed a partnership. Their contributions are as follows:
J.Co

Cash 100,000
Offi ce equipment 50,000
150,000

B. Chua

Cash 50,000
Merchandise 50,000
Furniture and Fixtures 100,000
200,000

The opening entry in the book of the partnership are as follows:

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 Cash 100,000
Offi ce equipment 50,000
J. Co, Capital 150,000
Initial investment of Co

Cash 50,000
Merchandise 50,000
Furniture and Fixtures 100,000
B. Chua, Capital 200,000
Initial investment of Chua

A compound entry may also be prepared to record their initial contributions as follows:
Cash 150,000
Offi ce equipment 50,000
Merchandise 50,000
Furniture and Fixtures 100,000
J. Co, Capital 150,000
B. Chua, Capital 200,000
Initial investments of the partners

C. Capitalist and industrial partners forming a partnership

Suppose as in case B , J. Co and B. Chua agreed to form a partnership wherein

J.Co contributes cash and office equipment while B. Chua is to act as an industrial partner

With a 40% share in the profits.

The entry to record the partner’s investments will be:

Cash 100,000
Offi ce equipment 50,000
J. Co, Capital 150,000
Initial investment of Co

A memorandum entry for B. Chua, the industrial partner would appear in the partnership book as
follows:

June 4 - B. Chua is to act as industrial partner with 40% share in the net profit. (memo entry)

Presentation in the general ledger:

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 B. Chua, Capital
Industrial partner with 40% share in the net profit

II. Formation of Partnership Where One of the Partners Is Already in Business

Where one of the partners is already engaged in business, before the partnership is organized, both of
them may agree that certain corrections or are to be made in the books of accounts. Hence, asset values
are adjusted through the owner's capital account.

There are certain rules in the correction of asset values, as follows:

To increase the value of asset:

Debit: Appropriate Asset Account

Credit: Capital

To decrease the value of asset.

Debit: Capital

Credit: Appropriate Asset Account

These two rules are applicable if the assets have no valuation account.

To illustrate, assume that the value of merchandise inventory recorded in the books of Mr. A is P8,000.
Before the formation of the partnership, Mr. A and Mr. B agreed that this value be increased to
P12,000.

The entry to be made in the books of Mr. A is as follows:

Merchandise inventory P 4,000

A, Capital P 4,000

To increase the value of inventory

After posting the adjusting entry made in the books of Mr. A, the merchandise inventory will become
P12,000 as follows:

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 Merchandise inventory
8,000
4,000
12,000

3) To adjust the values of fixed assets which have a valuation account such as accumulated
depreciation account, corrections of said fixed are made through this valuation account:

a) To increase the net amount of a fixed asset:

Debit: Accumulated depreciation - FA

Credit: Capital

To illustrate, assume the following data in the books of A:

Furniture and Fixtures P 40,000

Less: Accumulated Depreciation 6.000

Net amount or Net book value P 34,000

Assume further that partners A and B agreed to increase the net amount of the Furniture and Fixtures
to P38,000. To adjust the value, correction of said fixed asset is made through the valuation account,
Accumulated Depreciation - Furniture and Fixture as follows:

Accumulated Depreciation - Fum. and Fixt. 4,000

A, Capital 4,000

To increase the value of the furniture and fixtures.

After posting the adjusting entry to the Accumulated Depreciation account, it has now a balance of
P2,000 as shown below:
Accumulated Dep.-F&F
4,000 6,000

2,000 balance

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The net amount of furniture and fixtures as has been agreed upon is now P 38,000 as follows:
Before After
Adjustment Adjustment
Furniture and Fixtures 40,000 40,000
Less: accumulated depreciation 6,000 2,000
Net book value 34,000 38,000

b) To decrease the net amount of a fixed asset:

Debit: Capital

Credit: Accumulated depreciation FA

Illustration:

Assume the same data as in 3.a except that partners A and B agreed to decrease the net amount of the
furniture and fixtures to P25,000. To achieve the desired net amount, the entry is:

A, Capital P 9,000

Accumulated Depreciation - Furniture and Fixtures 9,000

Note: The Capital Account of A is decreased by P9,000 while the Accumulated Depreciation Account has
now a balance of P15,000 (6,000 + P9,000). The Accumulated Depreciation — Furniture and Fixture T-
account will now appear, as follows:
Accumulated Dep.-F&F
6,000
9,000 adjustment
15,000 balance

After adjustment, the furniture and fixtures has now a balance of P25,000 as follows:
Before After
Adjustment Adjustment
Furniture and Fixtures 40,000 40,000
Less: accumulated depreciation 6,000 15,000
Net book value 34,000 25,000

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4) To adjust the value of accounts receivable, corrections are made through the allowance for bad
debts account.

a) To increase the net amount of accounts receivable:

Debit: Allowance for Bad Debts

Credit: Capital

Illustration:

The Accounts Receivable as shown in the books of account is as follows:

Accounts Receivable P 50,000

Less: Allowance for Bad Debts 4.000

Net amount P 46,000

A and B agreed that the net amount of the Accounts Receivable be increased to P48,000. Since the net
amount recorded in the books is only P46,000, the allowance for bad debt should be decreased by
P2,000

Allowance for Bad Debts 2,000

A, Capital 2,000

To increase the net amount of Accounts Receivable to P48,000

After posting the above entry, the Allowance for Bad Debts would have a credit balance of P2,000 as
follows:
Allowance for Bad Debts
4,000
adjustment 2,000 -
2,000 balance

Hence, the net amount, of Accounts Receivable is now P48,000 as shown below:

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 Before After
Adjustment Adjustment
Accounts Receivable 50,000 50,000
Less: Allowance for Bad Debt 4,000 2,000
Net book value 46,000 48,000

b) To decrease the net amount of accounts receivables:

Debit: Capital

Credit: Allowance for Bad Debts

Illustration:

Assume the same data as in 4.a, except that the agreement of A and B is to decrease the net amount of
the Accounts Receivable to P40,000. This may be done by increasing the Allowance for Bad Debts from
P4,000 to P10,000 The entry to record the adjustment would be:

A, Capital 6,000

Allowance for Bad Debts 6,000

To decrease the net amount of Accounts Receivable to P40,000,

After this entry is posted, the Allowance for Bad Debts account would have a credit balance of P10,000
as follows:
Allowance for Bad Debts
4,000
6,000 adjustment
10,000 balance

Hence, the net amount of Accounts Receivable of P40,000 as agreed upon has been achieved as shown
below:

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 Before After
Adjustment Adjustment
Accounts Receivable 50,000 50,000
Less: Allowance for Bad Debt 4,000 10,000
Net book value 46,000 40,000

Illustration:

Assume that Leni is currently operating a business, and on June 1, 2022 invited Kiko to join him in that
business. They agreed that Kiko is to contribute an amount which is equal to 50% of Leni’s interest after
adjustment. Before the admission of Kiko, ledger balances of Leni are as follows:
Debit Credit

Cash 50,000
Accounts receivable 30,000
Allowance for bad debts 6,000
Notes receivable 25,000
Merchandise inventory 90,000
Furniture and fixtures 45,000
Accumulated depreciation -F&F 9,000
Accounts payable 70,000
Notes payable 42,000
Leni, Capital 113,000
240,000 240,000

Leni and Kiko further agreed on the following conditions:

1. Allowance for bad debts should be increased to 25% of the accounts receivable.
2. Merchandise inventory should be valued at P 110,000.
3. The furniture and fixtures is under depreciated by P 2,250.
4. Interest of P210 has accrued on the Notes Payable.
5. All the liabilities will be assumed by the partnership.

Required: Prepare journal entries to record the formation of the partnership: New set of books will be
opened for the partnership

Solution:

Adjusting Entries in the books of Leni

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 Debits Credits

1 Leni, Capital 1,500

Allowance for Bad Debt 1,500
(30,000 X 25%-7,500 - 6,000= P1,500)

2 Merchandise Inventory 20,000

Leni. Capital 20,000
( 110,000 - 90,000)

3 Leni, Capital 2,250

Accumulated Dep.-F& F 2,250

4 Leni, Capital 210

Accrued Interest Payable 210

5 No entry

To determine the adjusted capital balance of Leni, as well as the other accounts found in her books, T-
accounts must be prepared as follows:

Cash Accum. Dep. - F&F

50,000 9,000
2,250
11,250

Accounts Receivable Accounts Payable

30,000 70,000

Allowance for Bad Debts Notes Payable

6,000 42,000
1,500
7,500

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 Notes Receivable Accrued Interest Payable
25,000 210

Merchandise Inventory Leni, Capital

90,000 1,500 113,000
20,000 2,250 20,000
110,000 210
3,960 133,000
Furniture and Fixtures 129,040
45,000

Journal Entries in the New set of of books of LK Partnership to record the investment of the partners.
Debits Credits
Cash 50,000
Accounts Receivable 30,000
Notes Receivable 25,000
Merchandise Inventory 110,000
Furniture and Fixtures 33,750
Allowance for bad debts 7,500
Accrued interest Payable 210
Accounts Payable 70,000
Notes Payable 42,000
Leni, Capital 129,040
Initial investments of the partner Leni

Cash (129,040,X 50%) 64,520

Kiko. Capital 64,520
Initial investment of Kiko

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III. Two Sole Proprietors Forming a Partnership

Assume that on Jan 1, 2021, Diokno and Trillanes formed a partnership out of their existing businesses.
They agreed to divide the profits equally. On this date , their statement of financial position appear as
follows:

C. Diokno
Statement of Financial Position
December 31, 2020

Assets
Current Assets:
Cash 60,000
Accounts Receivable 40,000
Less Allowance for bad debts 2,000 38,000
Merchandise Inventory 12,000
Total Current Assets 110,000

Non-Currents Assets
Offi ce Equipment 40,000
Less: Accumulated depreciation 8,000 32,000
Total Assets 142,000

Liabilities and Equity

Current Liabilities
Accounts Payable 30,000
Notes Payable 13,000
Total Current Liabilities 43,000

Owner's Equity
Diokno, Capital 99,000
Total Liabilities and Owner's Equity 142,000

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 R. Trillanes
Statement of Financial Position
December 31, 2020

Assets
Current Assets:
Cash 100,000
Accounts Receivable 28,000
Less Allowance for bad debts 5,000 23,000
Total Current Assets 123,000

Non-Currents Assets
Offi ce Furniture 50,000
Less: Accumulated depreciation 10,000 40,000
Total Assets 163,000

Liabilities and Equity

Current Liabilities
Accounts Payable 27,000
Notes Payable 18,000
Total Current Liabilities 45,000

Owner's Equity
Trillanes, Capital 118,000
Total Liabilities and Owner's Equity 163,000

Diokno and Trillanes further agreed on the following conditions to adjust their non-cash assets before
the formation of the partnership:

1. Merchandise inventory should be recorded at its market amount of PI0.000

2. The allowance for bad debts is to be increased to 20% receivables.
3. The net amount of fixed assets of both must be valued at the following amounts.
Office equipment P 37,000
Office furniture 44,000
4. Diokno must contribute additional cash to make his capital investment equal to the capital of
Trillanes after adjustments

SOLUTION

The following entries must be prepared to adjust the values of the non-cash assets:

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 Book of Diokno Book of Trillanes
Debit Credit Debit Credit
Diokno, Capital 2,000 No entry
Merchandise Inventory 2,000
To decrease ethe value of mdse.

Diokno, Capital 6,000 Trillanes, Capital 600

Allowance for bad debts 6,000 Allowance for bad debts 600
(20% X P40,000= P8,000 -2000) (20% X P28,000= 5,600 - 5,000)

Acc. Depreciation - O.E. 5,000 Acc. Depreciation - O.F. 4,000

Diokno , Capital 5,000 Trillanes , Capital 4,000
(P37,000-32,000 = 5,000 ) ( P44,000- 40,000 = 4,000)

Computation

Before After
Adjustment Adjustment
Offi ce Equipment 40,000 40,000
Less: Accumulated depreciation 8,000 3,000
32,000 37,000

Offi ce Furniture 50,000 50,000

Less: Accumulated depreciation 10,000 6,000
40,000 44,000

The accumulated depreciation accounts in the books of Diokno and Trillanes, after posting #3 adjusting
entry will be shown as follows:
Accumulated Dep. - O.E.
8,000
adjustment 5,000
3,000 balance

Accumulated Dep. - O.F.

10,000
adjustment 4,000
6,000 balance

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Note that the net amount of fixed assets were adjusted through the accumulated depreciation account.

After posting the foregoing adjusting entries in the books of Diokno and Trillanes, their capital accounts
will appear as follows:
Diokno, Capital
Adj #1 2,000 99,000
Adj #2 6,000 5,000 Adj #3
8,000 104,000
96,000 Balance

Trillanes, Capital
118,000
Adj #2 600 4,000 Adj #3
600 122,000
121,400 Balance

Note: C. Diokno must invest an additional capital of P25,400 (P121,400 – 96,000) to make his capital
balance equal to that of Trillanes.

Journal Entries in the Books of the Partnership

1 Cash 25,400
Diokno, Capital 25,400
To record the additional contribution
of partner Diokno

2 Cash 60,000
Accounts Receivable 40,000
Merchandise Inventory 10,000
Offi ce Equipment 37,000
Allowance for bad debts 8,000
Accounts Payable 30,000
Notes Payable 13,000
Diokno, Capital 96,000
To record the initial investment of
Diokno

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 3 Cash 100,000
Accounts Receivable 28,000
Offi ce Furniture 44,000
Allowance for bad debts 5,600
Accounts Payable 27,000
Notes Payable 18,000
Trillanes , Capital 121,400
To record the initial investment of
Trillanes

Journal Entry to Close the Books of Diokno

Allowance for bad debts 8,000
Accumulated Depreciation- O.E. 3,000
Accounts Payable 30,000
Notes Payable 13,000
Diokno, Capital 96,000
Cash 60,000
Accounts Receivable 40,000
Merchandise Inventory 10,000
Offi ce Equipment 40,000
To close the books of Diokno

Journal Entry to Close the Books of Trillanes

Allowance for bad debts 5,600
Accumulated Depreciation - O.F. 6,000
Accounts Payable 27,000
Notes Payable 18,000
Trillanes, Capital 121,400
Cash 100,000
Accounts Receivable 28,000
Offi ce Equipment 50,000
To close the books of Trillanes

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Assessment Tasks
Problem#1 Partner’s Original Investment

P Lacson and T. Sotto formed a partnership for the first time on January 15, 2022. Lacson contributed
P500,000 and Sotto contributed the following:

Land (fair market value, P600,000.)

Building (fair market value, P500,000)

Required: Give the opening entry in the books of the partnership.

Problem #2

On June 1, 20 S. Roces, A. Fuentes and C. Solis agreed to organize partnership known as RFS Partnership.
S. Roces and A. Fuentes contributed P150,000.00 each. C. Solis will act as industrial part with a 30%
share in the net income.

Required: Prepare entries to record the formation of RFS Partnership

Problem #3

A, B and C decided to establish a store. A agreed to give P 100,000 and merchandise worth P50,000; B
will contribute the store equipment which cost him P 75,000 and merchandise worth P100,000 and C
will managed the store for a 20% share in profit .

Required: Journal entries in the books of the partnership.

Problem#4

X and Y formed a partnership for the first time, X contributed cash of P 46,800 while Y invested cash of
P27,000 and merchandise worth P 9,000. At the time of partnership formation, Y has an outstanding
payable account to Bank B amounting to P 15,000. X and Y agreed that this will be assumed by the
partnership.

Required: Record the initial investment of X and Y.

Problem #5 A Sole Proprietor and an individual with no business form a Partnership

KD operated a specialty shop that sold fishing equipment and accessories. His post-closing trial
balance on December 31,2021 is as follows:

KD

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 KD
Post-Closing Trial Balance
December 31, 2021

Debits Credits
Cash 36,000
Accounts Receivable 150,000
Allowance for Bad Debt 16,000
Merchandise inventory 440,000
Furniture and fixtures 135,000
Accumulated depreciation -F&F 75,000
Accounts payable 30,000
KD, Capital 640,000
761,000 761,000

KD plans to enter into a partnership with trusted associate, Alex, effective Jan. 1, 2022. Profits or
losses will be shared equally. KD is to transfer all assets and liabilities of his shop to the partnership
after revaluation.

Alex will invest cash equal to KD's investment after revaluation. The agreed values are as follows:
accounts receivable (net), P140,000; inventory, P460,000; and equipment (net), P124,000. The
partnership will operate under the business name of Fish R' Us.

Required:

1. Prepare the opening journal entries in the books of the partnership.

References
Ballada,W., Ballada, S. (2019).Partnership and Corporation Accounting. Manila. DomDane Publishers &
Made Easy Books

Herrero, C., et al (2010) Accounting Principles 3 Textbook/Workbook, Fourth Edition

Prepared by :

ROSALIE DE CELLO–TIU, CPA, MBA

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