Module 3  Start Date of the Partnership

 Contribution/Description of each partner

 Amount of Investment or Can Withdraw for each
7.0 -- Overview of Partnership partner
 Profit and Loss Sharing
It is important to note that Partnership Business is supported  Stipulation for the termination of Agreement
by the Partnership Law or The Civil Code of The Philippines
Articles: 1767 - 1783. 2.  Association of Individuals
 In order to constitute a partnership, it is necessary
Nature of Partnership Business that there are at least two persons, having
reciprocal and obligations towards each other
Basic Considerations
 The Law provides the minimum of TWO but
What are the common classification of business
it did not specify the maximum number of
organizations?
persons
 In Business however, it is considered sound
practice to organize a corporation when there are
five or more persons desiring to form a business
 HOWEVER, This is not applicable when a
business is a professional partnership of CPA’s to
form a corporate business in order not to impair
the independence of CPA’s

3. Mutual Agency
Definition of Partnership
 A Partnership is formed based on the “Trust and
By the contract of partnership, TWO or MORE persons bind Confidence” of the individuals to each other
themselves to CONTRIBUTE money, property or industry,  Trust and confidence is the "CORD" that binds
to a COMMON FUND with the intention the partnership
of DIVIDING the PROFITS among themselves  A Partnership is  VOLUNTARY FORMED by
each partner, and has the RIGHT TO CHOOSE
Requisites of Partnership the people with whom he/she would like to
associate
According to the New Civil Code of the Philippines,  Every partner is assume an agent of the
the Essential Elements of the formation of partnership are partnership meaning, any partner can legally bind
the following; all the partners by an action that is part of the
1. Voluntary & Valid AGREEMENT between usual conduct of the partnership business
parties
2. LAWFUL purposes for which partnership is 3. Ease of Formation
organized  Partnership is perfected by the
3. CONTRIBUTIONS: Money, property and/or mere CONSENT of the parties
Industry  Formation can be;
4. Objective to earn PROFIT that is o Informal – Hand Shake or Oral Agreement
to DIVIDED among the partners o Formal – Articles of Co-Partnership
5. MUTUAL AGENCY among partners  Partners does not need SEC or BIR Permission,
Practice of TRANSPARENCY on the records UNLESS ;
& transactions. o the partnership’s capitalization is P3,000 or more
o investment that involves real property
Characteristics of Partnership  Partners are still strongly advised to have a
formal agreement to avoid potential problems
Based on the Definition and Essential Elements of
that arise during the operation of the business
Partnership, the following characteristics where derived
therein;
4. Co-ownership of Partnership Property
 Assets invest by any of the partners become the
1. Based on Contract
property of the partners because they co-own the
 The relation of partners arises from
partnership
contract  NOT Statute or Operation of LAW or
 The Partner Investing an asset no longer retains
Inheritance
personal right to it.
 The agreement of partnership - whether in oral
 If the partnership is terminated, the individual
from or in writing - becomes a contract that is
partners may not receive back the same assets the
binding to all partners.
invested, EXCEPT there is an agreement
What is written inside a Partnership Contract?
5. Income Participation
Below are itemized details inside a partnership but not  Partnerships business objective is carried on
limited to the following; sharing the Profit or Loss (P/L) among the
partners
 Names of partners  Sharing of profit is arrived by mutual consent and
 Name and Nature or Business is specified in the articles of the partnership
 Location of the Business
  If no agreement, partners will share P/L base
on CAPITAL CONTRIBUTION

6. Assignment of Partner's Interest

 A partner can assign his interest to an Assignee
partner can be assignor
 The Assignee has no right to Participate in
MANAGING the AFFAIRS of the business
 The Assignee’s rights are limited to receiving the
share of P/L or proceeds in case the partnership is
dissolved.

7. Unlimited Liability
 Under the "Separate Entity Concept" of
accounting Business is viewed as existing
separately from owners, HOWEVER, Partners
are NOT considered separate from the Corporation VS Partnership
partnership when involves to 3rd party creditors
 Each partner whether general or industrial is at
risk of his/her personal assets for partnership
debts in the event the partnership
becomes INSOLVENT
 Limited partners risk only for their
investment Provided they do not perform any
task of a general partner

8. Limited Life

A partnership is automatically DISSOLVED  when there is

a Change in Relationship within the partners such as;
–Admission of New Partner Co-Ownership VS Partnership
–Withdrawal of a Partner
–Death of a Partner
–Personal Bankruptcy
–Incapacitated of a partner

7.2 -- Partnership VS other business structures

Partnership Vs Other  Business Organization

Advantages & Disadvantages

The characteristics of a Partnership as a business

organization offers several advantages and disadvantages as
shown below:

7.3 -- Partnership Concepts

Partnership Concepts

Kinds of Partners

1. As to CONTRIBUTION

Difference from other Business Organizations o Capitalist Partner - Contributes money and/or

property to the Partnership
It is important for entities that has entrepreneurial plans to o Industrial Partner - Contributes only his skills,
choose which business organization is more applicable to knowledge; industry or personal service to the
their purposes and economic business-setting, below are partnership
some attributes to be compared to other business o Capitalist-Industrial Partnership - Contributes
organization; money, property and industry

Sole Proprietorship VS Partnership 2. As to LIABILITY

o General Partner - Assumes unlimited liability

(liable for partnership debt up to his personal
assets)
 o Limited Partner - Liable only up to his Capital  ALL present property is contributed into a
Contribution common fund.
 All profit will be divided among themselves.
3. As to PARTICIPATION 2. of Profits
 Partners RETAIN OWNERSHIP placed into the
o Managing Partner - Appointed to run the common fund.
business (Appointment may be either in the  Only profits from their industry will be
Articles or after the formation of partnership) distributed.
o Silent Partner - Known as partner but NOT o Particular Partnership
ACTIVE in business Operations (can be a limited  Partnership which has a specific undertaking or
partner) exercises of a profession or vocation
o Liquidating Partner - Appointed to liquidate
partnership assets and settle unfinished 4.As to LIABILITY
transactions of the partnership after dissolution
o General Partnership
4. As to Third Persons  Comprised of a General or a combination of
General + Industrial Partners
o Secret Partner - NOT KNOWN as partner but  Personally Liable for the partnership's debts after
takes ACTIVE in business operations the exhaustion of its assets
o Dormant Partner - NOT KNOWN & o Limited Partnership
INACTIVE in business operations  Comprised of Limited + General Partners
o Nominal / Ostensible Partner - Partner in name  Only Limited partner shall be liable to the extend
only for accommodation or consideration of his contributions to the partnership
 At Least 1 General Partner to protect the 3rd
Rights of a Partner party liabilities

A Partner has a right over; 5. As to DURATION

1. Specific partnership property o Partnership at will

2. Share in the Profits resulting from business operation  May be terminated any time at will
3.Share in the remaining assets upon partnership  No fixed period of existence
liquidation after the partnership creditors have been paid o Partnership with a Fixed Term
4.To co-manage the partnership  Formed with a specific period of existence
5.To ask that the books be kept in the principal place of  Period could be a time, target profit or event.
business subject to inspection at a reasonable time
6. As to Legality of EXISTENCE
Kinds of Partnerships
o De jure partnership
1.As to NATURE of Business  Established & organized in accordance with all
the LEGAL requirements
o Trading Partnership - Also known as o De facto partnership
"Business co-partnership"  Established & organized without complying with
 Buying & Selling of Finished Merchandise or the legal requirements
 Manufacturing of Goods
o Non-Trading Partnership 7.4 -- Partnership Accounting
 Renders Services Only for a Fee
Accounting for Partnership
2. As to PURPOSE
In general, the accounting principles, process and
o Commercial Partnership procedures  used in recording partnership  transactions are
 Engages in trading, merchandising, or the SAME as Sole Proprietorship & Corporations
manufacturing of goods for a profit
 Service Industry may be classified as commercial The DIFFERENCE, however, lies in the owner’s equity
IF it is not engaged in the Practice of a common accounts.
Profession
o General Professional Partnership (GPP) Partners' Equity
 Engaged in the exercise of a COMMON The rights of the partners over the net assets of the
profession and renders services based on their business is called  Partners' Equity.
profession. (Ex. CPA's, Doctors & Lawyers)
 NOTE: A group of professionals can be in a
commercial partnership if it not related to their Each partner's equity is represented by two (2) accounts:
Professional Practice 1. Partner's Capital
2. Partner's Drawing
3. As to OBJECT
Partner's Capital Account
o Universal Partnership
The capital account represent original investment which
1. of all present PROPERTIES becomes its permanent or fixed interest. Each partner has his
own capital account which has a normal credit balance.
The balance in the capital account represents the partner's o Loss - Debited to Drawing Account
share in the net asset of the partnership.   Personal Drawings
o Often Called salaries, but are in fact
The partner's capital account gives information on withdrawals from profit
the increase or decrease in his interest in the partnership. o Informal or  irregular withdrawals may also
Specifically, the transactions affecting the partner's capital be made when the needs of partners
account are summarized as follows: arises (with the consent of all partners)

The ending balance of the drawing account is closed to the

capital account:

Profit > Withdrawals = Increase in Capital Account

Profit < Withdrawals = Decrease in Capital Account

Other Partnership Accounts (Loans)

1. Loans Receivable from Partners

 Investment - contribution made are credited to
o Also called “loans to partner” or “due from
each partner's capital account to increase the
partner” or “loans receivable from partners”
partner's equity
or (Utang o Bale ng Kasosyo)
 Permanent Withdrawal- represents partner's
o Represent ADVANCES of the Partners with the
decrease in its interest into the partnership which
is debited to its capital account. intention of repayment
o Generally presented and classified as part of
 Income Summary Account - this is the
accounting device used to close the temporary the CURRENT ASSETS except when collection
accounts in its capital account for the period period is beyond one-year. (Non-current Asset)
ended: o Do not be confused between loans and
o Net Debit Balance =  Loss, withdrawals, because the intention of the loan is
o Net Credit Balance = Income, a "creditor-debtor relationship", wherein the
Partner = Debtor; Partnership = Creditor

Notes: 2. Loans Payable to Partners

 A debit balance in the partner's capital account is o Also called “loans from partner” or “due to
called a deficiency or partner's deficit. partner” or (Utang ng Partnership sa Kasosyo)
 Deficit  - partner's share in losses and/or o Represent SUBSTANTIAL amount LENT by
withdrawals exceeds (>) his capital contribution the partners to the Partnership
and share of profits o Generally presented and classified as part of
Partner's Drawing Account the CURRENT LIABILITIES except when
payment or due date is beyond 1 year
This is the account title used to reflect temporary decrease in o "creditor-debtor relationship", wherein the
the interest of a partner and is periodically closed to the Partnership = Debtor; Partners = Creditor
partner's capital account.
3. Loans to and from Partners
Each partner has his own drawing account to reflect o This account title is the COMBINATION of
temporary withdrawals and other minor amounts taken by loans receivable from partner and loans payable
the partner from the partnership in anticipation of his profit  to partner accounts
share. o Represents both a claim and obligation (asset and
liability, respectively),
The transactions affecting the partner's drawing account are o If ending balance is found at;
as follows:  Debit Side – Claims
 Credit Side - Obligation/Liability

IMPORTANT NOTE: It is emphasized at this point that

"Loans to and from Partners" are either ASSET
or LIABILITY, and therefor shall not be considered in
determining the balances of partner's equity

8.0 -- Partnership Formation

Partnership Formation
This refers to the PERFECTION of the partnership
 Share in P/L - The agreement as to the manner contract by the partners. When a partnership is formed,
of distribution provided in the Articles of Co- partners commonly observe the following to effect fair and
Partnership honest business:
o Profit - Credited to Drawing Account 1. Execution of partners' agreement (See Articles of
Co-Partnership)
 2. Valuation of partners' investment 2nd Rule:
3. Adjustments of accounts The valuation of partners' non-cash investment is based on
the partner's AGREED VALUE,  in the absence of any
Valuation of Partners' investment agreement, use FAIR VALUE of the property on the
investment date.
The accounting issues regarding initial investments and
other capital contribution are; If cash contribution is made, it is valued at FACE
 How much the contribution to be made by the AMOUNT
partners? And
 What amount the capital contribution shall be
recognized?

The answers to the issues above depend on the following:

 Is there an agreement? And
 what was contributed? Cash or Non cash?

The following rules shall then be observed when capital

contribution issues arise:

1st Rule: 8.1 -- Articles of Co-Partnership

The amount of contribution shall based on partner's
agreement, in absence of agreement contribute equally Articles of Co-Partnership

An agreement concerning formation, operation dissolution

and liquidation of the partnership is embodied in a contract
called "Articles of Co-Partnership". Although a verbal
agreement is valid, it is advisable to put it writing as
conflicts and disagreement may arise because of the number
of persons involved.

Illustration for the 1st Rule: (YES) - With Agreement on The "Articles of Co-Partnership" is a written contract made
Individual Contribution by the partners that  will act as a form of governance of
partnership activities and will clearly reflect the
Alpha and Bravo formed a partnership with a TOTAL relationships of the partners among each other and with third
AGREED CAPITAL of Php 150,000 to be contributed as parties.
cash of 40% and 60% by Alpha and Bravo, respectively,
through a issuance of personal checks. (below is the journal It is need to appear in a PUBLIC INSTRUMENT and to
entry for the formation) registered with the SEC if partners contributed REAL
PROPERTY (land or building) or REAL RIGHTS or if the
total partnership capital amounted to P3,000 or more.

If a partnership fails to register with the SEC, it cannot

acquire legal personality to maintain an action against third
persons, but the partners may file a suit jointly against third
party persons.

Failure to comply with the registration requirement does not

Notes: affect the liability of the partnership and its partners to the
third party persons.
1. The journal entries of their respective The partnership agreement commonly contains the following
investments are a single journal entry information:
because of two (2) separate source
documents (individual checks).
2. As per previous notes, each partner will 1. Name of the partnership
have a separate capital account 2. Names and address of the partners
3. Kinds of partners
4. Principal place and purpose of business
Illustration for the 1st Rule: (NO) - Without Agreement 5. Manner of Management of the Partnership
on Individual Contribution 6. Duration of the contract (date of
effectiveness and life of the partnership)
Alpha and Bravo formed a partnership with a TOTAL 7. Contributions of the partners
AGREED CAPITAL  of Php 150,000 to be contributed as 8. Duties and rights of each partner
cash. (below is the journal entry of  the formation) 9. Conditions for withdrawals
10. Salary and the profit and loss agreement
11. Dissolution and Liquidation Procedures
12. Arbitration of disputes
8.2 -- Stages from which Partnership are Formed - First no effect on the interest of the investing partner and the asset
Time in Business is will still recorded at FMV.

 Stages from which Partnership are Formed 3. For the recording of the contribution of Epsilon
(industrial partner), the memorandum entry in the
The complexity of accounting for partnership formation general ledger would be as follows:
depends on the stage from which a partnership is formed.
The stages would be:
1. First time in business
2. Conversion of a single proprietorship to a
partnership
3. Admission of a new partner to an
existing partnership ( to be discussed in Module 4
)
8.3 -- Conversion of proprietorship to a partnership
First time in business
Conversion of proprietorship to a partnership
The stage wherein individual persons without an existing
business, decided to form a partnership. The formation of This could be made when:
such partnership is accounted by recording the individual  A sole proprietor admits into his business another
contribution and the valuation of the contributions of each individual who has no business of his own
partner.  Two or more sole proprietorship joined together
and formed a partnership.
The rules on the amount of contribution and its valuation
shall be used (see previous tab), therefor, no accounts are to The conversion of sole proprietorship(s) to
be adjusted at the time of formation. partnership is accounted for by the following procedures:
1. Close the nominal accounts (temporary accounts)
Illustration of the sole proprietorship business

Charlie, Delta and Epsilon formed CDE

partnership with an agreed total capitalization of
Php 300,000, which shall be 
contributed equally by Charlie & Delta.

Meanwhile Epsilon was to manage the operations

of the partnership business as an industrial partner
with a share of 20% from the profits.

Charlie & Delta's contribution is as follows:

To record the contributions, the journal entries would be

2. Record the adjustments (based on the agreed or
fair value) of the assets and liabilities directly to
the sole proprietor's capital account
3. Close the books of the sole proprietorship
4. Open the new set of partnership books by
recording the partner's contributions.

Note: The books of the sole proprietor are not applicable

for use by the newly formed partnership

Notes: Why??

1. The fair value or FMV  or Appraised A partnership is a legal entity (artificial

Value was used for the valuation of the non-cash person)  SEPARATE & DISTINCT from its owners . As a
contribution because this supports the Cost consequence, a partnership should maintain its own books
Principle stated in IAS 16 of account under its registered name as provided by law.

2. Liabilities attached to invested properties may be As per Section 236A to 236J of the National Internal
assumed by the partnership in which case the Revenue Code (NIRC), every person subject to any internal
capital partner will be credited only for the net revenue tax is required to register once with the appropriate
amount of the assets contribution. (Asset - Revenue District Officer  (RDO).
Liability)
It shall therefor acquire its own Tax Identification Number 
Q: What if there is no agreement for the partnership to (TIN) separately from the TIN of the partners.
assume the liability attached to the property? 
A: The Liability will not be recorded, therefor, there will be
Illustration:
  Omega is the owner of an existing single
proprietorship.
 Omega, together
with Rho and Tau, decides to convert his
single proprietorship into a partnership.
 They agree to start the partnership with
total capitalization of Php 150,000 to be
contributed equally by the partners.
 Rho and Tau are to contribute cash.
 Omega shall also contribute additional
cash if the net assets of his business after
the agreed valuation will not be enough
to cover his contribution requirement.
Step 1: Closing the Nominal Accounts

Prior to the formation, the sole proprietorship's nominal Omega's single proprietorship trial balance shows the
accounts should first be closed to  effect the correct balance following:
on his capital. The nominal accounts of A should then be
closed as follows:

Notes:
The post-closing trial balance of A's single proprietorship is
presented below: 1. Adjustments are made directly to capital
account and NOT the nominal accounts because
the business is now in its liquidating concern.
2. Adjustments are made before the partnership
formation to comply the principles of fairness
&  objectivity.  Any increase or decrease in the
value of the assets should accrue to the benefit or
expense of the sole owner and not the partnership
3. The adjusting entries must be posted to show the
updated balance of the capital account of the sole.

Step 2: Record the Adjustment

Adjustments are necessary to effect the proper value of

assets and liabilities in accordance with the valuation
agreement or FMV

The following valuation adjustments were agreed upon

based on the post-closing balances: Step 3: Close the Proprietor's Accounts

a) Accounts Receivable is 98% realizable Since the single proprietorship is dissolved, it follows that
b) Merchandise inventory is to be valued at Php 9,000| the books should be closed, or all the accounts (nominal or
c) Interest of Php 600 on note payable should be recognized real) are to be brought to ZERO BALANCE.

To record the agreed adjustments would require the The closing of the sole proprietorship's books will require
following entry in the Omega's books: the following journal entry:
 Partner's CONTRIBUTED CAPITAL = Partner's
AGREED CAPITAL

2. Bonus Method

When the agreed partner’s capital shares is not the same

value as their actual net contributed Assets

Step 4: Recording the Partners' Contribution TOTAL CONTRIBUTED CAPITAL (TCC) = TOTAL
AGREED CAPITAL (TAC)
The initial investments of the partners will be recorded in &
the new set of partnership's books as follows: Partner's CONTRIBUTED CAPITAL  ≠≠ Partner's
AGREED CAPITAL
Contribution of Omega
There is a bonus to a partner when his capital credit is more
than hid actual contributed capital and the total net assets
contributed by partners are equal to total capital of the
partnership.

Illustration

Kappa, a sole proprietor, allows Gamma, decided to pool

their net assets to form a partnership, provided that the
latter would contribute cash amounting to P70,000.
Kappa's contributions comprised of the following:
 P 10,000 Cash
 P 30,000 Accounts Receivable
 P 20,000 Merchandise
Contribution of Rhio & Tau  P 8,000    Accounts Payable to be assumed by the
partnership

They agreed that their initial capital balances would be

of equal amount upon formation of the partnership.
2 or more Sole Proprietorship Form a Partnership
Assume that Kappa & Gamma agreed that the partnership
The new accounting standards mention only one instance capital would be P122,000.
when goodwill  would be recognized, that is , in
a  BUSINESS COMBINATION, applying the purchase To record the investments of the partners using the bonus
method. approach, the following journal entries shall be made:

The forming of two (2) single proprietorship into a

partnership will NOT be considered as a business
combination. Instead, this could be considered more as
putting together of resources of two or more existing
business into a common fund, which is more of POOLING
OF INTEREST rather than purchase.

The accounting procedures & steps in converting 2 or more

existing sole proprietorship into a partnership are the SAME
as when a single proprietorship is converted into a
partnership.

However, there are more books that needs to be adjusted and

closed before the formation.

8.4 -- Methods For Accounting the Initial Contribution *To equalize the capital credits of partners (P122,000/2),
P9,000 has to be transferred from Gamma's capital as bonus
Methods for Accounting the Initial Contribution to Kappa

1. Actual Investment Method

When the agreed partner’s capital shares are credited with

the same value as their actual net contributed Assets. Our
previous illustrations from 8.1 are all examples of the Actual
Investment Method.

 TOTAL CONTRIBUTED CAPITAL (TCC) = TOTAL MODULE 4

AGREED CAPITAL (TAC)
& 9.0 -- Partnership Operation
Overview 3.2 If there is no specified profit sharing for an industrial
partner
A business partnership operates like any other forms of
profit oriented business. It manufactures, sells products or
If there is no specified profit sharing for an industrial
provides services for a profit.
partner, he shall receive a share equal to the share of the
The Accounting Process of a partnership's transactions is CAPITALIST PARTNER having the SMALLEST share
basically similar to the accounting process for sole
proprietorships or corporations. Their differences lie in the 3.3 If there is a partner which is both a Capital and
following items to be discussed in this topic: Industrial partner
 Rules of Profit and Loss Sharing
 Arbitrary Agreements if Computing Profits and The partner gets just and equitable share as an industrial
Losses partner and another share as a capitalist partner according to
agreement or his capital contributions.
9.1 -- Rules for Profit and Loss Sharing
Rules on Losses Sharing
SHARING OF PARTNERSHIP PROFITS AND
LOSSES 1. Loss sharing based on partner's agreement
The primary objective of the accounting for partnership 1.1 Loss of the partnership shall be divided among the
operations is the determination of periodic net income and partners in accordance with their Loss-sharing ratio
its distribution to the partners. agreement
The determination of net income is calculated in a traditional 1.2 In the absence of a Loss-Sharing ratio, the profit-sharing
manner-that is, by relating the partnership's periodic ratio shall be used.
revenues and expenses
2. Loss sharing based on Capital Contribution
In measuring partnership income for the period, the
expenses should be scrutinized to make sure that personal In the ABSENCE of a Profit-sharing agreement, losses shall
expenses are not included among the partnership's expenses. be divided among the partners in proportion to their
respective capital contributions
Rules of Profit and Loss Sharing
3. Loss Sharing for a "pure" Industrial Partner (no
Article 1799 of the New Civil Code provides that capital contribution)
any STIPULATION that EXCLUDES one or more
partners from any share in the profits or losses is VOID. The 3.1. if there is no agreed loss or profit sharing ratio,
reason for this is that partnership must exist for the common
benefit and interest of the partners. The industrial partner is totally EXEMPT from sharing the
losses. The Purely industrial partner is exempt because he
Article 1797 of the New Civil Code provides the following already rendered his service in vain
guidelines on how partnership profits and losses shall be
distributed among the partners: 3.2 if there is a profit and loss agreement wherein he is
included in the P/L sharing.
Rules on Profit Sharing
The industrial partner is bound to respect the contract
1. Profit sharing based on partner's agreement between the co-partners. He shall therefor share in the loss
equivalent to his agreed loss ratio even if he is an industrial
Profits of the partnership shall be divided among the partner.
partners in accordance with their profit-sharing ratio
agreement 3.3  if there is only a profit agreement

Note: The capital contributions of the partners have no The industrial is not bound in the share of the partnership
bearing in the profit distribution because their profit ratio losses because he did not give consent to have his share in
agreement should be followed. partnership losses.

2. Profit sharing based on Capital Contribution 4. Loss sharing for industrial-capitalist partner

In the ABSENCE of a Profit-sharing agreement, profits shall If there is no loss sharing agreement but there is profit
be divided among the partners in proportion to their sharing agreement, he shall be liable in the same proportion
respective capital contributions as his profit sharing ratio.

3. Profit sharing Based on Capital Contribution and An industrial partner is no longer exempt from loss sharing
on Service once he become a capitalist partner

3.1. If there is a industrial partner: 9.2 -- Arbitrary Agreement in Computing Profits and Losses

The industrial partner first gets a just and equitable Arbitrary Agreement in Computing Profits and Losses
share for his services (industry), before the capitalist
partners divide the balance of the profits in proportion to Partners may share the partnership profits and losses in any
their capital contributions or P/L Agreement manner they wish. The profit and losses agreement should
contain specific and complete provisions to avoid ability and reputation the partnership may stipulate an
misunderstanding and disputes among the partners unequal sharing expressed in agreed ratio or percentage,
otherwise known called arbitrary ratio.
The agreement on partnership's profit and losses may be
divided into one of the following ways: In specified ratio, the difference in the partner's capital
balances has NO BEARING in the P/L sharing. The agreed
1. Equally profit and loss ratio may be based on the partners' better
2. Specified ratio or percentage capability or influenceover the other
3. Capital Ratio
4. Interest allowed on partner's capital, the To illustrate assume that Eva is perceived more vital than
remainder to be divided in an agreed ratio Ren for the success of the partnership business, so much that
5. Salaries or Bonus allowed for services, the they agreed to share in the P/L of 60% and 40%,
remainder to be divided in an agreed ratio respectively.
6. Multiple bases of allocation
Ren = (P200,000 x 40%) =  P 80,000
To Illustrate the methods: Eva = (P 200,000 x 60%) =  P 120,000

Assume Eva and Ren formed "EVAREN" partnership with 3. Relative Capital Balances
original capital contributions of P60,000 and P30,000
respectively. In the second year of the partnership When money or properties invested by the partners represent
operations, the capital and drawing balances of partner's Eva the vital contribution to the success of the partnership
and Ren are trance fro the general ledger as follows: business, partners may agree that their respective capital
balances shall be the basis of the P/L Sharing.

This manner of dividing P/L is different from a arbitrary

ratio P/L Sharing, since there is NO P/L sharing agreement
at all. This is so for the allocation of P/L distribution is NOT
FIXED due to fluctuation of the capital balances of the
partners

However, there is an accounting issue to be addressed by the

partnership on what amount of the partner's capital shall be
considered in the computation of P/L distribution. For this
reason, the agreement should indicate specifically whether
the ratio is to be defined in terms of:

1. Original Capital Contribution

2. Beginning Capital Balance of the
Accounting Year
3. Ending Capital Balance of the Accounting
Year
During the year, the partnership generated an income of P 4. Average Capital Balance of the Year
200,000.

Note: Unless otherwise stated, the data above shall be used 3.1 Original Capital Contribution
as the basis for illustrations in the succeeding discussions
To distribute the P200,000 net income the following
1. Equally computation should be made

The partners may mutually agree that the partnership profit Total Original Capital = P60,000 + P 30,000 = P 90,000
shall be equally divided between them. In case of losses, and (6:3)
in the absence of a specific agreement regarding division of
losses, the existing equal division of profit agreement is to Ren = (P200,000 x 6/9) = P133,333.33
be followed by the partners Eva = (P200,000 x 3/9) = P    66,666.67

If Eva and Ren Agreed to divide the partnership equally, the 3.2 Beginning Capital Balance of the Accounting Year
distribution of P200,000 profit would be:
The opening partners' capital balances of the current year
Eva=P100,000 shall be the basis
Ren = P100,000
Total Beginning Capital Balances = P 60,000 + P 50,000 = P
It is to be observed that Eva and Ren shared on the 110,000 (6:5)
partnership profit equally regardless of the unequal balances
Ren = (P200,000 x 6/11) = P 109, 091
of their capital contributions.
Eva = (P200,000 x 5/11) = P     90,909
2. Specified Ratio or Percentage
3.3 Ending Capital Balance of the Accounting Year
Whenever the presence of one of the partners is perceived
more vital to the success of the business due to experience,
All capital transaction affecting the capital accounts shall be Notes:
considered to get the ending balances of the partners
1. The weighted average capital method should be assumed
The ending capital balances of each partner is should first to in the absences of evidence to the contrary. Average capital
determine: means weighted average unless another interpretation of
average capital is specified in the agreement
Ren = (P60,000 + P40,000+ P110,000 - P60,000) = P
150,000 (15/25) 2. The average method is the best alternative compared to
Eva = (P50,000 + P30,000 + P80,000 - P 60,000) =  P beginning and ending capital methods, because it provides
100,000 (10/25) the most equitable basis for allocating partnership income.
Total Ending Capital Balances                                                   
P250,000   (25/25) 4. Allowance of Interest on Partner's Capitals

This agreement provides that the cost of money on the

 Ren = (P200,000 x 15/25) = P 120,000 capital contributions ff partners will be added as a profit
 Eva = (P200,000 x 10/25) = P 80,000  sharing device in addition to the P/L ratio agreement

3.4 Average Capital Balances of the Accounting Year It is based on the philosophy that if the capital contributions
have been invested in other earning activities such as trading
When partners agreed to divide profits to recognize securities the partner should have realized additional
CAPITAL CHANGES during the current period, the use of revenue.
partners' average capital balances shall be employed. This
method also encourages partners' to contribute during the The allowance for interest may be computed on the
year additional investments to the partnership following bases:

3.4.1 Simple Average Capital Method 4.1 Interest on Capital Balances

This method is computed by simply dividing the sum of the This method allocated first a portion of profit equivalent to a
beginning and ending capital by 2. certain interest rate of the partner's capital balances.
Accordingly, the capital balances should clearly be defined
The simple average capital balances of EVEREN partnership in the agreement. The remaining balance of the profit shall
are computed as follows: be distributed in accordance with the agreed arbitrary ratio.

Ren = (P60,000 +P 150,000) / 2 = P 105,000 (105/180) 4.2 Interest on Excess Investments

Eva = (P50,000 + P 100,000) / 2 = P     75,000 (  75/180) _
Totals                                                              P180,000  This method allows interest in the excess capital balance of
one partner over that of another
 Ren = (P200,000 x 105/180) = P116,666.67 5. Salaries or Bonus Allowed for partners' Services
 Eva = (P200,000 x  75/180) =   P    33,333.33
An equitable division of profits and losses frequently
3.4.2 Weighted Average Capital Method requires that financial consideration be given to the skills,
talents, efforts, and work hours that active partners devote to
This method is also known as "peso-month" or "peso-day" the partnership business in addition to their capital
average capital method. Under this method, the computation investment. Consequently, salaries and/or bonus may be
of the average capital considers the period in which capital given to a partner before the agreed P/L sharing are to be
contributions have been used in a given accounting period. made.

The weighted average capital base on peso months is 5.1 Salaries

computed as follows:
To recognize personal contribution by the partner to the
business, they may agree to receive salary, and divide the
remaining profit among themselves by the agreed specified
ratio. Except when stated otherwise, salary allowance are
part of the net income/loss allocation to the partners

5.2 Bonus

A partnership agreement nay provide that a managing

partner be allowed a bonus on the earnings of the business to
encourage PROFIT MAXIMIZATION. The bonus may
computed as follows:

BONUS = Bonus rate % x Base net Income

10.0 -- Partnership Dissolution 

 Ren = (P200,000 x 875/1400) = P125,000 Partnership Dissolution

 Eva = (P200,000 x  525/1400) = P 75,000
The dissolution of a partnership is the change in the 1. By purchases of Interest of existing
relation of the partners caused by any partner ceasing to be partner(s), or
associated in the carrying on of the business. 2. By direct investment to partnership
The change of partners in the partnerships ends their
The newly formed partnership may continue to use either the
original agreement, thus terminating the partnership. In
books of the old partnership or an entirely new set of books.
this topic, we will be discussing the causes of dissolution
as follows:
Admission by Purchasing a Partner's Interest
 Admission of New Partner
 Withdrawal, Retirement or death of a Partner An incoming partner may buy a partnership interest directly
 Insolvency of a partnership or insolvency of from one (1) or more of the current partners.
Partner and
 Conversion of the partnership into a corporation In this method, a personal transaction is engaged between
the (withdrawing) partner who is selling his interest and the
10.1 -- Asset Revaluation buying partner (admitted partner). As such, any gain or loss
Asset Revaluation in the purchase of interest transaction is a PERSONAL gain
or loss of the partner/s involved.
The accounting process for partnership dissolution requires
that the existing partners' capital accounts be updated first The selling partner could sell his interest in the partnership
before dissolution. at a amount:
1. Equal to book value of his interest being sold
Accordingly, assets and liabilities of the partnership should 2. Less than the book value of his interest being
be restated at their fair market values to determine the fair sold or
equitable capital balances of the existing partners. The 3. More than the book value of his interest being
increase ir decrease of assets is allocated among them based sold
on their P/L rations or capital ratios
The purchase of interest of existing partner may be a:
Negative Asset Revaluation  Purchase of interest of just one partner or
 Purchase of partial interest if all partners
Negative Asset Revaluation decreases the old partners'
capital balances as an effect of decreasing the value of the Admission of additional partner(s) by purchase of interest of
old partnership's existing assets(s) existing partner(s) DOES NOT FALL under the description
of a business combination applying the purchase method as
The decrease in the value of the partnership's assets is contemplated in IAS/PAS 38
allocated among the partners based on their P/L ratios or
capital ratios. Admission by Direct Investment to the Partnership

Positive Asset Revaluation This manner of admitting a new partner is a transaction

between the incoming partner and the partnership.
Positive Asset Revaluation increases the old partners' capital
balances as an effect of increasing the value of the old To acquire interest in the partnership, the incoming partner
partnership's existing assets directly invests cash and.or other non-cash assets to the
partnership, thereby increasing the total assets of the
The increase in the value pf the partnership's assets is partnership
allocated among the partners based on their P/L ratios. In
case the P/L ratios are not available, their capital ratios shall The accounting concern in the acquisition of an incoming
be used  partner's interest in the partnership by investment may be
classified in the following situations:
Note: It must be observed from your FINACRE samples that  Investment = Capital Credits (interest)
the revaluation of assets only affect the capital balances of  Bonus Method
the old partners.
New Partners' Investment Equals Partner's Individual
10.2 -- Cause for Dissolution - Admission of a New Partner Capital Credits
Admission of a New Partner There is no accounting problem in this method of admitting
Giving due regard to the mutual agency any admission of a a new part because all partners will be given a capital credit
new partner is possible only with the CONSENT OF ALL exactly the same as their respective asset contributions to the
the partners. partnership. The total capital contributions of the partners
are the same as the total agreed capital of the new
Technically, the admission of a new partner brings about a partnership.
new association of individuals even if the partnership will
not undergo the liquidation process. Accordingly, the Bonus Method
original association has been dissolved by the common
consent resulting n the formation of a new partnership. Under the bonus method, the TOTAL CONTRIBUTED
CAPITAL is equal to the TOTAL PARTNERSHIP
The admission of a new partner can be alternatively AGREED CAPITAL BUT some INDIVIDUAL
accomplished by two (2) methods, namely: PARTNER's CONTRIBUTION is not equal to their
respective capital credit because there is a transfer of capital
from one partner to another.
Accordingly, the admission of a new partner will increase cancellation of the withdrawing partner's capital. n incoming
the partnership's total assets with the same amount of the partner may buy a partnership interest directly from one (1)
incoming partner's contribution. The capital credit to the or more of the current partners.
incoming partner is not equal to his net assets contribution
The withdrawing partner may receive payment at
 Bonus to New Partner
1. Equal to book value 
This shows that the new partner's agreed capital credit is
2. Less than the book value 
greater than his actual capital contribution
3. More than the book value 
Credit > Contribution 
The accounting procedures commonly used when the
 Bonus to Old Partner partnership purchased the interest of withdrawing partner
would be;
This shows that the new partner's agreed capital credit is 1. Adjust the assets of the partnership to their
lesser than his actual capital contribution. The difference current FAIR MARKET VALUE (FMV) before
will be added to the capital credits of the old partners based accounting for the retirement of the partner. And
on their respective P/L ratio or capital balances. 2. Record the retirement

Credit < Contribution 10.4 -- Cause for Dissolution - Insolvency of Partnership or

Partner 
10.3 -- Cause for Dissolution - Withdrawal or Retirement of
a Partner Insolvency of Partnership or a Partner

Withdrawal or Retirement of a Partner Insolvency arises when a business (or individual) cannot
pay outstanding debts as they mature.
Withdrawal or Retirement of a Partner A person is deemed insolvent when the aggregate of his
property at a  far valuation is less in amount that his total
By reason of insolvency or incapacity, a partner may
liabilities.
voluntary withdraw or retire from the partnership. He must
obtain the consent of his fellow partners and determine Assets< Liabilities
among them the amount of his capital refund in the
Common reasons for insolvency are the result of the
absence of a stipulated amount in the partnership
following:
agreement.
 Excessive losses from operations
Whenever dissolution is made due to the withdrawal or  Over-extension of credit customers, or
retirement of a partner, he may sell his interest to the:  Excessive investment in inventories or in plant
 Outside Party, assets that does generate revenue.
 Remaining Partner(s), or
 Partnership. The insolvency of a partner practically dissolves the
partnership because it impairs the mutual agency principle.
Interest is Sold to Outside Party The law provides that an insolvent partner shall have no
legal authority to act on behalf of the partnership and the
The withdrawing or retiring partner could sell his interest to other partners have no authority to act for him.
an outsider with the mutual consent of the remaining
partners. When a partnership becomes insolvent, its remaining assets
are confined to the settlement of its obligations resulting in
This change in partnership ownership is to be accounted in its inability to continue normal operations.
the same manner as that of an admission of a new partner by
purchase if interest of an existing partner. Dissolution Procedures when Partnership is Insolvent

Interest is Sold to Remaining Partners The partnership must answer if "Are all general partners
Solvent"?:
Instead of selling interest to an outsider, one of the partners
or the remaining partners agree to buy the interest of the if Yes: The General partners must invest additional amount
outgoing partner. to pay the outside creditors

Again, this is a personal transaction between a withdrawing if No: The solvent general partner will absorb the required
partner and the remaining partner(s). The personal loss (or payment to outside creditors and will have existing claim
gain) of a withdrawing partner in the transaction should not against the other general partners.
be recorded in the parentship’s books. The only concern of
the partnership is to transfer the capital of outgoing partner As a rule, the personal assets of the partners shall first be
to the remaining partner who is interested to buy the applied to their respective personal creditors. 
outgoing partner's interest.
The personal creditors of the general partners have priority
Interest is Sold to the Partnership in the claim against the personal assets of the partners over
those of the claims of the partnership creditors. Therefore,
When the capital interest of the withdrawing partner is the partnership creditors could run after the assets of the
purchased by the partnership, it results in the reduction of general partner to the extent of the latter's remaining assets
the firm's assets (cash or non-cash) accompanied by after his personal creditors are paid.
10.5 -- Cause for Dissolution - Death of a Partner Liquidation is the process of converting all assets of the
business into cash (realization), followed by the final
Dissolution Due to the Death of a Partner
payments of the creditors' claims and the partners' capital
Death is an involuntary termination of one's participation balances in the Partnership.
in the partnership which automatically dissolves the
partnership. This process is usually called the "winding up of business
activities".
The business activities of the partnership may continue
with the remaining partners and an heir to serve in lieu of a It usually happens once the partners decide to end or
deceased partner as provided in the partnership contract terminate business operations after the partnership has been
In the absence of an heir to take the deceased partner's dissolved.
place, the remaining partner may still continue the business
and the deceased partner's equity shall be paid by the The dissolution and liquidation of a partnership are not the
partnership. same. Dissolution stops the partner's original association
while liquidation converts all non-cash assets into cash.
The accounting procedures to be used in death of a partner
are basically similar to those of the withdrawal of a partner. Dissolution does not always lead to liquidation while
However, if the partnership cannot effect immediate liquidation is always a result of  dissolution.
payment, the following accounting procedures may be
observed: The liquidation of the partnership must observe
the "principle of equitable distribution of the
assets," which requires the protection of the creditors' and
1. Determine the deceased partner's profit and partners' legal rights.
loss share from the beginning of accounting
period to the date of death. Accordingly, gains or losses and liquidation expenses, if
2. Adjust the capital accounts (include the P/L any, must be allocated to the partners before actual cash
and asst valuation as of the time of death) payments are made to the individual partners.
3. Close the adjusted capital account of the
deceased partner to the liability account Failure to consider these factors may result in improper
4. Accrue the interest on the said recognized distribution of assets to partners, which makes the
liability from the date of death to the authorizing partner liable for such distributions.
settlement date
5. Close the liability account at the settlement Payment of Partnership Liabilities
date.
This legal doctrine refers to the segregation of assets owned
Insurance on Partner's Lives by the partnership and the personal assets owned by the
several partners. It defines the priority claims against the
In order not to severely impair the working capital and assets of the partnership and of the partners when the
operation of the business, the partnership may insure  the partnership and/or one or more of the partners are insolvent
lives of its partners with the partnership or the individual
partner's heir as the beneficiary. The partnership's assets are first applies for paying the
debits of the partnership; the excess will be available to
If the partnership is the beneficiary, the proceeds of life satisfy the claims of the partners over the partnership. The
insurance may be used to pay the estate or heirs of the personal assets of a partner are applied in the following
deceased partner. order of priority:
1. Settlement of debts to personal creditors
2. Settlement of debts to partnership creditors
10.6 -- Cause for Dissolution - Incorporation of a 3. Settlement of obligations to other partners by
Partnership way of contribution

Incorporation of a Partnership Notes:

As the partnership continues to grow, the partners may
decide to incorporate the business to obtain more 1. In accordance with the  unlimited liability
capitalization from public and get hold of other advantages principle, general partners are liable to the
found in a corporate form of business organization extent of their personal assets in satisfying third
party creditors
If a partnership is incorporated, the partners will become the 2. The personal assets of the partners are used first
stockholders of the corporation. The corporation then takes to settle their personal obligations before these
over the assets and assumes the liabilities of the partnership. are used to satisfy the claims of the partnership.
As a result, the partnership is dissolved.

At the time of corporation, the assets and liabilities should Further discussion of liquidation will be outlined by the
be revalued at their fair market values. The adjustments are following subtopics:
allocated to the partner's capital account based on their P/L  Methods of Liquidation
ratio.  Installment Liquidation

11.0 -- Partnership Liquidation 11.1 -- Method of Liquidation - Lump Sum Liquidation

Nature of Partnership Liquidation Lump Sum Liquidation
The liquidation process is usually accomplished by using 1) Payment to creditors other than partners
either of the two (2) common methods: 2) Payment of payable to partners
3) Payment of partners' capital
1. Lump Sum and
2. Installment

On this page we will be first talking about lump sum

liquidation Statement of Liquidation

Lump Sum Liquidation

Under this method, all non-cash assets of the partnership are

first converted into cash before payments are made to the
creditors, the to the partners. The payment to the partners is
made only once in a lump sum amount after all the outside
creditors has been paid.

This method is also called "Total Liquidation" or "Simple

Distribution"

Process observed in Lump Sum Liquidation

The following processes are usually observed in winding up

and recording the lump sum liquidation of the partnership
assets:

1. Adjustments of accounts and closing of

nominal accounts
2. The non-cash assets of the partnership are
either:
o Sold to 3rd parties or
The statement of liquidation is a report that shows the
o Distributed to the
summary of winding up the affairs of the partnership
interested partner at an including the priority of cash distributions.
agreed price to offset his
capital balance. It is prepared as the basis of the journal entries which are
3. Any gain or loss in the realization process needed in recording the liquidation process.
would be distributed to the partners' capital
balances based on the existing P/L The statement of liquidation would have the following basic
agreement. format:
4. Any capital deficiency resulting from the
distribution of loss from the realization of
non-cash assets should be accounted as
follows:

o If the partner incurring  capital deficiency has

loans receivable from the  partnership, he is
allowed to exercise the right of offset. Under this
procedure, the capital deficiency of the partner
would be charged against his receivable from the
partnership.
If, after the exercise of right of offset, there is
still capital deficiency, then the following steps
should follow:
 If the partner incurring capital deficiency is
a solvent general partner, he is required to make
additional investment to close his capital
deficiency
 If the partner incurring capital deficiency is
a limited partner or insolvent partner, the other Gain on Realization
partners would absorb his capital deficiency
based on their existing P/L ratios There is gain on realization when the non-cash assets of the
 The available cash of the partnership undergoing partnership are sold at a price more than their recorded
liquidation proceeding would be distributed value. The excess cash received over the recorded value of
according to the following priority: the assets is closed to partners' capital according to profit
and loss ratio agreement.

Loss on Realization
There is loss on realization when the non-cash assets of the *The maximum loss possible may be comprised of the
partnership are sold at a price lesser than their recorded following items:
value . The deficit of cash received over the recorded value
of the assets is closed to the partners' capital according to
1. Unsold non-cash assets
profit and loss ratio agreement.
2. Estimated liabilities
3. Expected liquidation expenses
A loss on realization usually happens because buyers are
generally willing to buy the partnership's non-cash assets
only if sold at a price less than its book value since the Cash Priority Program
partnership is already in its liquidating concern.
In lieu of safe payment schedule, the other tool to  guarantee
11.2 -- Method of Liquidation - Installment Liquidation that no overpayment will happen in making premature
payments under installment liquidation is the Pre-
Installment Liquidation distribution Plan or Cash Priority Program.

This method involves payments to creditors and partners as The cash priority program will determine the partner to
proceeds of sale of non-cash assets are made. Consequently, whom and how much available cash (after payment to
cash payments to creditors and partners are on installment creditors and liquidation expenses are made) shall be
basis cash becomes available. distributed even prior to the total actual realization.

This method is also called "Piecemeal liquidation" Like the safety payments schedule, the pre-distribution plan

To guarantee that premature cash distribution to partners

1. Combines the partners' loan balances with their
would not result in overpayment, the following tools are
respective capital
available to direct accurate premature cash distribution:
2. Anticipates all possible liabilities, losses on
realization and liquidation expenses.
1. Safe Payments Schedule
2. Cash Priority Program
In addition, it recognizes that the partner with the highest
Safe Payment Schedule rank or ability to absorb anticipated losses will be the first
partner to received safe payments.
This statement shows a conservative approach to liquidation.
It is prepared when there is availability of cash after It is determined by computing the partner's
payment to outside creditors was made. It indicates how the respective maximum loss absorption capacity.
availability cash should be distributed to partners.
The formula in computing the maximum loss absorption
The preparation of safe payments schedule assumes the capacity is as follows:
following as possible losses:

1. Anticipation of all possible liabilities and

expected losses / expenses to be incurred in the
process of liquidation
2. All unsold non-cash assets will be worthless Steps in completing the cash priority program

1. Equalize the absorption capacity of all the partners by

The assumed losses are allocated to the partners' capital
deducting the difference of first priority and second priority
balances based on the profit and loss agreements. This may
and so on.
result in an assumed partner debit capital balance. The
assumed debit capital balance of a partner is allocated to 2. Determine the amount of priority cash payments by
those partners with credit balances according to their profit multiplying the difference with the P/L ratio of the partner
and loss ratio. having the highest capacity.
The amount of safe payments is the remaining credit capital 3. When the absorption capacity for all partners becomes
balances of partners after allocating the assumed debit equal to each other, then any succeeding cash for
capital balance. distribution will be shared based on P/L ratio at this stage.
The basic format of the safe payments schedule would In other words, after steps 1 and 2 cash distribution priority
appear as: are satisfied, the remaining cash available shall be
distributed according to the partner's profit and loss ratio. It
is because the ratio of the partner's capital balances becomes
equal to their respective profit and loss ratio.

4. Compute the cash available for distributions

5. Distribute the cash available according to cash priority

program. The balance shall be distributed based on the P/L
ratio.