Partnership Formation and Accounting - Prof. Diaz | Summaries Business Accounting

BAFACR1X – FINANCIAL ACCOUNTING AND REPORTING

MODULE 2: PARTNERSHIP FORMATION

I. NOTES

Definition of Partnership

A partnership is defined in Article 1767 of the Civil Code of the Philippines as contract whereby two or more persons bind

themselves to contribute money, property industry into a common fund with the intention of dividing profits among

themselves.

Characteristics of a Partnership

1. Mutual agency. Any partner may act as agent of the partnership in conducting affairs.

2. Unlimited liability. The personal assets (assets not contributed to the partnership) any partner may be used to

satisfy the partnership creditors' claims upon liquidation if partnership assets are not enough to settle the

liabilities to outsiders.

3. Limited life. A partnership may be dissolved at any time by action of the partners or by operation of law.

4. Mutual participation in profits. A partner has the right to share in partnership profits.

5. Legal entity. A partnership has legal personality separate and distinct from that of each of the partners.

6. Co-ownership of contributed assets. Property contributed to the partnership are owned by the partnership

by virtue of its separate legal personality

7. Income tax. Partnerships, except general professional partnerships (i.e., those organized for the exercise of

professions like CPAs, lawyers, engineers, etc.) are subject to the 30% income tax.

Advantages of a Partnership

1. It is easy and inexpensive to organize, as it is formed by a simple contract between two or more persons.

2. The unlimited liability of the partners makes it reliable from the point of view creditors

3. The combined personal credit of the partners offers better opportunity for obtaining additional capital than does

a sole proprietorship

4. The participation in the business by more than one person makes it possible for a closer supervision of all the

partnership activities

5. The direct gain to the partners is an incentive to give close attention to the business

6. The personal element in the characteristics of the partners is retained

Disadvantage of a Partnership

1. The personal liability of a partner for firm debts deters many from investing capital in a partnership.

2. A partner may be subject to personal liability for the wrongful acts or omissions of his/her associates.

3. It is less stable because it can easily be dissolved.

4. There is divided authority among the partners

5. There is constant likelihood of dissension and disagreement when each of the partners has the same authority in

the management of the firm.

Kinds of Partnerships

1. As to activity

a. Trading partnership - one whose main activity is the manufacture and sale or the purchase and sale of

goods.

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BAFACR1X – FINANCIAL ACCOUNTING AND REPORTING

MODULE 2 : PARTNERSHIP FORMATION

I. NOTES

Definition of Partnership A partnership is defined in Article 1767 of the Civil Code of the Philippines as contract whereby two or more persons bind themselves to contribute money, property industry into a common fund with the intention of dividing profits among themselves. Characteristics of a Partnership

Mutual agency. Any partner may act as agent of the partnership in conducting affairs.
Unlimited liability. The personal assets (assets not contributed to the partnership) any partner may be used to satisfy the partnership creditors' claims upon liquidation if partnership assets are not enough to settle the liabilities to outsiders.
Limited life. A partnership may be dissolved at any time by action of the partners or by operation of law.
Mutual participation in profits. A partner has the right to share in partnership profits.
Legal entity. A partnership has legal personality separate and distinct from that of each of the partners.
Co-ownership of contributed assets. Property contributed to the partnership are owned by the partnership by virtue of its separate legal personality
Income tax. Partnerships, except general professional partnerships (i.e., those organized for the exercise of professions like CPAs, lawyers, engineers, etc.) are subject to the 30% income tax. Advantages of a Partnership
It is easy and inexpensive to organize, as it is formed by a simple contract between two or more persons.
The unlimited liability of the partners makes it reliable from the point of view creditors
The combined personal credit of the partners offers better opportunity for obtaining additional capital than does a sole proprietorship
The participation in the business by more than one person makes it possible for a closer supervision of all the partnership activities
The direct gain to the partners is an incentive to give close attention to the business
The personal element in the characteristics of the partners is retained Disadvantage of a Partnership
The personal liability of a partner for firm debts deters many from investing capital in a partnership.
A partner may be subject to personal liability for the wrongful acts or omissions of his/her associates.
It is less stable because it can easily be dissolved.
There is divided authority among the partners
There is constant likelihood of dissension and disagreement when each of the partners has the same authority in the management of the firm. Kinds of Partnerships
As to activity a. Trading partnership - one whose main activity is the manufacture and sale or the purchase and sale of goods.

b. Non-trading partnership - one which is organized for the purpose of rendering services.

As to object a. Universal partnership of all present property - one in which the partners contribute, at the time of the constitution of the partnership, all the properties which actually belong to each of them into a common fund with the intention of dividing the same among themselves as well as the profits which they may acquire therewith. All assets contributed to the partnership and subsequent acquisitions become common partnership assets. b. Universal partnership of all profit - one which comprises all that the partners may acquire by their industry or work during the existence of the partnership and the usufruct of movable or immovable property which each of the partners may possess at the time of the institution of the contract. Partnership assets consist of assets acquired during the life of the partnership and only the usufruct or use of assets contributed at the time of partnership formation. The original movable or immovable property contributed do not become common partnership assets. c. Particular partnership - one which has for its object determinate things, the use or fruits, or a specific undertaking or the exercise of a profession or vocation.
As to liability of partners a. General co-partnership - one consisting of general partners who are liable prorata and sometimes solidarily with their separate property for partnership liabilities. b. Limited partnership - one formed by two or more persons having as member one or more general partners and one or more limited partners not bound by the obligations of the partnership. The word "LIMITED” or “LTD” is added to the name of the partnership to inform the public that it is limited partnership.
As to duration a. Partnership at will - one for which no term is specified and is not formed for a particular undertaking per venture and which may be terminated any time by mutual agreement of fe partners or the will of one partner alone b. Partnership with a fixed term - one in which the term or period for which the partnership is to exist is agreed upon. It may also refer to a partnership formed for a particular undertaking and upon the expiration of that term or completion of the particular undertaking the partnership is dissolved, unless continued by the partners.
As to representation to others a. Ordinary partnership - one which actually exists among the partners and also as to third persons b. Partnership by estoppel - one which in reality is not a partnership be considered as one only in relation to those who, by their conduct or emission an precluded to deny or disprove the partnership's existence.
As to legality of existence a. De jure partnership - one which has complied with all the requirements for its establishment b. De facto partnership - one which failed to comply with one ore more of the legal requirements for its establishment
As to publicity a. Secret partnership – one wherein the existence of certain partners as partners is not made known to the public by any of the partners. b. Open partnership - one wherein the existence of certain partners as partners is made known to the public by the members of the firm. Classes of Partners
As to contribution a. Capitalist partner - one who contributes capital in cash (money) or property

Among the usual procedure in recording partnership formation is to adjust the amounts to the agreed amounts or at its fair value from its initial costs. A suggested approach is to use the accounting equation to reflect the effects of adjustments to the elements of the financial statements, mainly assets, liabilities and equity.
There are two main situations in recording the partnership formation that involve contribution of non-cash assets: First, the net assets contributed by the partner will be based on the fair value of assets and liabilities. Second, the net assets contributed by each partner will be further be adjusted in accordance to agreement as to capital ratio. The latter give rise to the bonus approach and to the revaluation or goodwill approach.
Bonus approach is based on the assumption that pursuant to the agreement as to the arbitrary capital ratio, each of the partners will credited more and the other partner will be credited less than its actual contributions. In this case there will be transfer of bonus capital from one partner to another. This method is also used when an intangible contribution of a partner (ex. Artistic abilities) does not constitute a recordable partnership asset with a measurable cost. It recognizes only the assets that are physically transferred to the business (such as cash, inventory, patents)
Goodwill approach is based on the assumption that the partners are not amenable to be credited less than their actual capital contributions to the partnership. Instead, they will either revalue their assets or recognize goodwill as an intangible asset. It also assumes that any intangible contribution of a partner can be measured impliedly.
Revaluation of assets is accepted under GAAP. Recognition of goodwill in partnership formation is not accepted under GAAP as it is not similar to business combination. However, due to business practice and invaluable service and expertise of one of the partners goodwill is recognized. Difference of sole proprietorship, partnership and corporation accounting Partnership Sole Proprietor Corporation Ownership Two or more owners (account used: Owners capital, withdrawals for each partner) A single owner (account used: Owners capital, withdrawals) 1 or more owner (account used: contributed capital, retained earnings) Profits or losses Profits are divided according to agreement (closed to each partner’s capital) All profits go to sole owner (closed to owner’s capital) Profits are retained by the corporation and only distributed as dividends upon declaration of board of directors (closed to retained earnings) Investment A partner may contribute cash, non-cash assets and his own services (industry) An owner may invest cash and non-cash assets but not his own services A shareholder may contribute cash, non-cash assets and his own services (industry) Withdrawals Has withdrawal accounts Has withdrawal account No withdrawal account II. STRAIGHT PROBLEMS PROBLEM 1 ( Adjustments of Assets to Fair Value). The balance sheet of A on November 30, 20x4 before accepting B as his partner to form AB Partnership is presented below: Assets Liabilities and Capital Cash P120,000 Accounts payable P12,

Accounts receivable P48,000 Notes payable 60, Less: Allowance for bad debts P3,000 45,000 A, Capital 246, Notes receivable 60, Merchandise inventory 27, Equipment P72, Less: Accumulated depreciation 6, Total assets P318,000 Total liabilities and capital P318, It is agreed that for purposes of establishing A’s interest the following adjustments shall be made: a. The accounts receivable is estimated to be 90% realizable b. Interest at 8% on notes receivable dated March 1, 20x4 is to be accrued. c. The merchandise inventory is to be valued at P21, d. The equipment is under-depreciated by P4, e. Prepaid expenses of P2,400 and accrued expenses of P7,200 are to be recognized. B is to invests cash to obtain one-third interest in the partnership Required:

Prepare the following entries in the books of A, as to: a. Adjustments b. Closing c. Investments
Prepare the balance sheet after the formation of the partnership. PROBLEM 2 ( Capital Interest Under Three Approaches). The following items are being invested by A and B to form AB Partnership: Particulars Agreed values Accounts Investment by A Investment by B Cash P120,000 P120, Inventory 120,000 -- Land -- 240, Building -- 480, Equipment 240, Totals P480,000 P840, Mortgage on building (assumed by partnership) -- 240, Totals P480,000 P600, Required:
Prepare entries to record the formation of partnership assuming A and B agree that each partner is to receive a capital credit equal to agreed values of net assets each partner invested. (Net Assets Approach)
Prepare entries to record the formation of partnership assuming that A and B agree that each partner is to receive an equal capital interest. (Bonus and Asset Revaluation/Goodwill Approach)

Abel and Carr formed a partnership and agreed to divide initial capital equally, even though Abel contributed P100,000 and Carr contributed P84,000 in identifiable assets. Under the bonus approach to adjust the capital accounts, Carr’s unidentifiable asset should be debited for a. P46,000 b. P16,000 c. P8,000 d. P 0 On March 1, 20x4, Evan and Helen decide to combine their business and form a partnership. The balance sheets of Evan and Helen on March 1, 20x4 before adjustments Accounts Evan Helen Cash P9,000 P3, Accounts receivable 18,500 13, Inventories 30,000 19, Furniture and Fixtures (net) 30,000 9, Office equipment (net) 11,500 2, Prepaid expenses 6,375 3, Total P105,375 P51, Accounts payable P45,750 P18, Evan, Capital 59, Helen, Capital 33, Total P105,375 P105, They agree to provide 3% for allowance for doubtful accounts of their accounts receivable and found Helen’s furniture and fixtures to be under-depreciated by P900.
If each partner’s share in equity is equal to the net assets invested, the capital accounts of Evan and Helen would be a. P58,170 and P33,095, respectively c. P59,070 and P32,195, respectively b. P58,320 and P32,495, respectively d. P104,820 and P50,195, respectively
Biil and Ken enter into partnership agreement in which Biil is to have a 60% interest in capital and profits and Ken is to have a 40% interest in capital and profits. Biil contributes the following: Particulars Cost Fair value Land P10,000 P20, Building P100,000 P60, Equipment P20,000 P15, There is a P30,000 mortgage on the building that the partnership agrees to assume. Ken contributes p50, cash to the partnership. Bill and Ken agree that Ken’s capital account should equal Ken’s P50,000 cash contribution and that goodwill (revaluation of asset) should be recorded. Goodwill (revaluation of asset) should be recorded in the amount of a. P10,000 b. P15,000 c. P16,667 d. P20, Use the following information for question 8 and 9 As of July 1, 20x4, FF and GG decided to form a partnership. Their balance sheets on this date: Particulars FF GG Cash P1,500 P3, Accounts receivable 54,000 22, Merchandise inventory - 20, Machinery and equipment 15,000 27,

Total P70,500 P73, Accounts payable P13,500 P24, FF, capital 57, GG, capital 49, Total P70,500 P73, The partners agreed that the machinery and equipment of FF is under depreciated by P1,500 and that of GG by P4,500. Allowance for doubtful accounts is to be set up amounting to P12,000 for FF and P4,500 for GG.

If the capital contribution of each partner is the net amount of his assets and liabilities taken over by the partnership, the capital accounts of FF and GG would be: a. P43,500 and P40,500 c. P57,000 and P49, b. P46,500 and P49,500 d. None of the above
Assume that the partnership agreement provides for profit and loss sharing of 60% to FF and 40% to GG, and that the new capital of the partnership is to be based on the adjusted capital of GG. How much additional cash must be invested by FF in order to bring the partner’s capital balances proportionate to the profit and loss ratio? a. P14,250 b. P5,250 c. P17,250 d. None of the choices END

Partnership Formation and Accounting - Prof. Diaz, Summaries of Business Accounting

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BAFACR1X – FINANCIAL ACCOUNTING AND REPORTING

MODULE 2 : PARTNERSHIP FORMATION

I. NOTES