Accounting for PartnershipsBasic Considerations and FormationChapter 1

Accounting for Partnerships

After studying this chapter, you should be able to:

• Know the meaning of partnership, its basic features,

contract, and articles of co-partnership.

• Know the advantages and disadvantages of the

partnership.

• Identify the different kinds of partnership and classes of

partners.

• Make entries to record the partners’ investment.

Partnership

• Two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profit among themselves.

• Two or more persons may also form a partnership for the exercise of profession.

• An association of two or more persons to carry on, as co-owners, a business for profit.

• Has a juridical personality separate and distinct from that of each of the partners

Partnership

• Each owner is called a partner.

• Often formed to bring together various talents and knowledge.

• Provide a means of obtaining more equity capital than a single individual can obtain and allow the sharing of risks for rapidly growing business.

General Professional Partnerships

• Partnership associated with the practice of profession.

For example: the practice of law, public accounting, medicine and other professions.

Characteristics of a Partnership

1. Mutual Contribution – contribution of money, property or industry to a common fund

2. Division of Profits or Losses – each partner must share in the profits or losses of the venture

3. Co-Ownership of Contributed Assets – all assets contributed into the partnership are owned by the partnership

4. Mutual Agency – any partner can bind the other partners to a contract if he is acting within his express or implied authority

Characteristics of a Partnership

5. Limited Life – it may be dissolved by the admission, death, insolvency, incapacity, withdrawal of a partner or expiration of the term specified in the partnership agreement.

6. Unlimited Liability – all partners (except limited partners), including industrial partners, are personally liable for all the debts incurred by the partnership

7. Income Taxes – Partnerships, except general professional partnerships, are subject to tax at the rate of 30% of taxable income

8. Partner’s Equity Accounts – each partner has a capital account and a withdrawal account

Advantages of a Partnership

Advantages vs. Proprietorships

1. Brings greater financial capability to the business

2. Combines special skills, expertise and experience of the partners

3. Offers relative freedom and flexibility of action in decision-making.

Advantages vs. Corporations

4. Easier and less expensive to organize

5. More personal and informal

Disadvantages of a Partnership

1. Easily dissolved and thus unstable compared to a corporation.

2. Mutual agency and unlimited liability may create personal obligations to partners.

3. Less effective than a corporation in raising large amounts of capital.

Partnership Distinguished from Corporation

Partnership Corporation

Manner of Creation Created y mere agreement of partners

Created by operation of law

Number of Persons Two or more persons At least 5 not exceeding 15

Commencement of Juridical Personality

From the execution of the articles of partnership

From the issuance of certificate of incorporation by the SEC

Management If there is no managing partner, every partner is an agent of the partnership

Board of Directors

Partnership Distinguished from Corporation

Partnership Corporation

Extent of Liability Each partner except a limited partner is liable to the extent of his personal assets

Stockholders are liable only to the extent of their interest or investment in the corporation

Right of Succession

No right of succession Right of Succession

Terms of Existence

Any period of time stipulated by the partners

Not to exceed 50 yrs. but subject to extension

Classifications of Partnerships

1. According to object:a. Universal partnership of all present property

- All contributions become part of the partnership fund.b. Universal partnership of profits

- All that the partners may acquire by their industry or work during the existence of the partnership and the use of whatever the partners contributed at the time of the institution of the contract belong to the partnership

c. Particular partnership- The object of the partnership is determinate – its use or fruit, specific undertaking, or the exercise of a profession or vocation

Classifications of Partnerships

2. According to liability:a. General – All partners are liable to the extent of

their separate propertiesb. Limited – the limited partners are liable only to the

extent of their personal contributions. In a limited partnership, the law states that there shall be at least one general partner

3. According to duration:a. Partnership with a fixed term or for a particular

undertaking.b. Partnership at will (no term is specified and is not

formed for any particular undertaking

Classifications of Partnerships

4. According to purpose:a. Commercial or trading partnership – formed for the

transaction of businessb. Professional or non-trading partnership – formed

for the exercise of profession5. According 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 as failed to comply with all the legal requirements for its establishment.

Kinds of Partners

1. General Partner – one who is liable to the extent of his separate property after all the assets of the partnership are exhausted

2. Limited Partner – one who is liable only to the extent of his capital contribution

3. Capitalist Partner – one who contributes money or property to the common fund of the partnership

4. Industrial Partner – one who contributes his knowledge or personal service to the partnership

5. Managing Partner – one whom the partners has appointed as manager of the partnership

Kinds of Partners

6. Liquidating Partner – one who is designated to wind up or settle the affairs of the partnership after dissolution.

7. Dormant Partner – one who does not take active part in the business of the partnership and is not known as a partner.

8. Silent Partner – one who does not take active part in the business of the partnership though may be known as a partner.

9. Secret Partner – one who takes active part in the business but is not known to be a partner by outside parties.

10. Nominal partner or partner by estoppel – one who is actually not a partner but represents himself as one.

Limited Liability Partnerships

• Have features of both general partnerships and professional corporations.• Individual partners are personally responsible for their

own actions and for the actions of partnership employees under their supervision.• They are not responsible for the actions of other

partners.• The LLPs as a whole, like a general partnership, is

responsible for the actions of all partners and employees.

Articles of Partnership

• A partnership may be constituted orally or in writing. However, a good business practice requires the partnership contract in writing.

• Partnership agreements are embodied in the Articles of Partnership.

SEC Registration

When the partnership capital is P3,000 or more, in money or property, the public instrument must be recorded with the Securities and Exchange Commission (SEC).

Even if it is not registered, the partnership having a capital of P3,000 or more is still valid and therefore has legal personality.

Assignment: Nov. 13, 2015

(By Group)

1. Get a sample of a partnership agreement (Articles of Partnership)

2. Determine the essential provisions that may be contained in the agreement.

3. Basic steps to register a partnership with the SEC

Seatwork (by pair)

Answer the ff. questions (1whole):1. Define partnership.2. Angel and Rik are partners in a drilling operation. Angel

purchased a drilling rig to be used in the entity’s operations. Is this purchase binding on Rik even though he was not involved in it? Explain.

3. What are the advantages of a partnership form of business organization?

4. What are the disadvantages of a partnership form of business organization?

Accounting for Partnerships

• Recording of assets, liabilities, income and expenses is consistent for both proprietorships and partnerships.• Differences only arise between proprietorship and

partnership concerning owner’s equity.• In a partnership, separate capital and drawing accounts

are established for each partner.

Owner’s Equity Accounts

Partner’s Capital Account

Owner’s Equity Accounts

Partner’s Drawing Account

Note: 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.

Loans Receivable from or Payable to PartnersLoans Receivable from Partners – the account debited wen a partner withdraws a substantial amount of money with the intention of repaying it. This account is classified separately from the other receivables of the partnership.

Loans Payable to Partners – the account credited when a partner lends amounts to the partnership in excess of his intended permanent investment. This must be paid after the claims of outside creditors have been paid in full.

Partnership Formation

A partnership may be formed in any of the following ways:

1. Individuals with no existing business form a partnership

2. Conversion of a sole proprietorship to a partnership

a. A sole proprietor and an individual without an existing business form a partnership

b. Two or more sole proprietors form a partnership

3. Admission or retirement of a partner (to be covered in chapter 3)

Partnership Formation

• Partners can invest both assets and liabilities in the partnership.• Assets and liabilities are recorded at an agreed-upon

value.• In the absence of any agreement, the contributions will

be recognized at their fair market values at the date of transfer to the partnership.

Partnership Formation

Fair market value – 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.

Individuals with no existing business form a partnershipIllustration:

On July 1, 2015, Jane Docto and Therese Revilla agreed to form a partnership. The agreement specified that Docto is to invest cash of P700,000 and Revilla is to contribute land with a fair market value of P1,300,000 with P300,000 mortgage to be assumed by the partnership.

Journal EntriesJuly 1 Cash 700,000

Land 1,300,000

Mortgage Payable 300,000

Jane Docto, Capital 700,000

Therese Revilla, Capital 1,000,000

To record the initial investment of partners

Cash P700,000Land 1,300,000Total Assets P2,000,000

Mortgage Payable P300,000Jane Docto, Capital 700,000Therese Revilla Capital 1,000,000Total Liabilities and Owner's Equity P2,000,000

Liabilities and Owner's Equity

Assets

Docto and RevillaStatement of Financial Position

July 01, 2015

Individuals with no existing business form a partnershipSuppose that Docto and Revilla formed another partnership with Rose Baylon. Docto and Revilla considered Baylon who has a vast business network in Southern Mindanao as an industrial partner. The partnership did not receive any asset from Baylon.

In this case, only a memorandum entry in the general journal will be made.

For example:July 1 Rose Baylon is considered as an industrial partner

contributed his skills and knowledge in managing the partnership business.

Another Example

Illustration:

On January 1, 2015, Rubi, Kim and Aly agreed to form Rukia Partnership. The agreement specified that Rubi is to invest cash of P500,000 and Kim is to contribute building with a fair market value of P900,000 with P90,000 mortgage which will not be assumed by the partnership. Aly is to contribute computer equipment worth P400,000.

Journal Entries

Jan 1 Cash 500,000

Building 900,000

Computer Equipment 400,000

Rubi, Capital 500,000

Kim, Capital 900,000

Aly, Capital 400,000

To record the initial investment of partners

Cash 500,000Computer Equipment 400,000Building 900,000Total Assets 1,800,000

Rubi, Capital 500000Kim, Capital 900,000Aly, Capital 400,000Total Liabilities and Owner's Equity 1,800,000

Liabilities and Owner's Equity

Assets

Rukia PartnershipStatement of Financial Position

January 01, 2015

Seatwork (by pair)Prepare journal entries to record partner’s investment and prepare Statement of Financial Position. (Name the partnership)

1. On August 2, 2015, Tommy, Miho and Alden agree to form a partnership. The agreement specified that Tommy is to invest cash of P650,000 and Miho is to contribute land with a fair market value of P850,000 with P100,000 mortgage to be assumed by the partnership. Alden is an industrial partner.

2. On December 8, 2015, Byuti and Dabist agree to form a partnership to sell imported clothes. The agreement specified that Byuti is to invest cash of P150,000 and Dabist is to contribute merchandise inventory with a fair market value of P300,000. They agreed that the inventory is worth P250,000.

Seatwork (individual)Prepare journal entries to record partner’s investment and prepare Statement of Financial Position. (Name the partnership)

1. Amor and Claudia agree to form a partnership named VistaPowers on Dec. 15, 2015. Amor is to invest a building worth P1,000,000 and Claudia is to contribute cash of P600,000 and computer equipment worth P350,000.

2. Fourtris Motorcycle Parts is formed by partners Four and Tris on Nov. 13, 2015. The agreement specified that Four is to invest inventory and Tris is to contribute cash equal to Four’s investment. The inventory that Four contributed costs P345,000 when he purchased it last month. The fair market value of the inventory today is P350,000. They agreed to value the inventory at P330,000.

Conversion of a Sole Proprietorship to Partnership

• Under this type of formation, the assets and the liabilities of the proprietorship will be transferred to the newly formed partnership at values agreed upon by all the partners or at their current fair prices.

Adjustment of Accounts Prior to Formation• Applicable to prospective partners with existing businesses.• The respective books of the prospective partners will have to

be adjusted to reflect the fair market values of their asset or to correct misstatements in the accounts.

• If the adjustments will not be made, the initial capital balances of the partners may be inequitable.

• 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 of has ceased to be going concern.