POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

College of Accountancy and Finance

PARTNERSHIP FORMATION

PARTNERSHIP – is a contract whereby two or more persons bind themselves to contribute money, property or industry
into a common fund with the intention of dividing profits among themselves.

Characteristics of a Partnership
• Co-ownership of contributed capital – Assets contributed to the partnership become assets of the partnership by
virtue of its separate legal personality.
• Income Tax – Partnership except General Professional Partnership (like CPAs, lawyers, etc.) are subject to income
tax rate of 30% based on net income.
• Limited Life – A partnership may be dissolved at any time by action of the partners or by operation of law.
• Legal Entity – A partnership has a legal personality separate and distinct from that each of the partners.
• Mutual Agency – Any partner may act as an agent of the partnership in conducting its affairs.
• Mutual Participation in Profit – A partner has the right to share in partnership profits.
• Unlimited Liability – The personal assets of any partner may be used to satisfy the creditors’ claims in the
partnership if the firm’s assets are not enough to settle the liabilities to outsiders.

Advantages of a Partnership
1. It is easy and inexpensive to organize compared with a corporation.
2. The unlimited liability of the partners makes it reliable from the point of view of the creditors.
3. The combined personal credit of the partners offers better opportunity for obtaining additional capital than a sole
proprietorship.
4. The participation in the business by more than one person makes possible for a closer supervision of all its
activities.
5. The direct gain to the partners is an incentive to give close attention to the business.
6. The personal element in the character of the partners is retained.

Disadvantages of a Partnership
1. The personal liability of a partner for partnership debts deters many from investing capital in a partnership.
2. A partner may be subject to a personal liability for the wrongful acts or omissions of his associates.
3. It is less stable because it can be easily dissolved.
4. There is divided authority among partners.
5. There is a constant likelihood of dissension and disagreement when each of the partners has the same authority in
the management of the partnership.
6. There is difficulty in disposing of interest since no formal established marketplace exists for the sale of partnership
interest.

Kinds of Partnerships

1. As to Activity
a. Trading Partnership – one whose main activity is the manufacture or the purchase and sale of goods.
b. Non-Trading Partnership – one organized for the purpose of rendering services.

2. As to Object
a. Universal Partnership
• Universal Partnership of all Present Property – one in which the partners contribute all the properties
which actually belong to each of them at the time of formation. All assets contributed to the partnership and
subsequent acquisitions become common partnership assets.
• 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 property or immovable property
which each of the partners may possess at the time of formation. Partnership assets consist of assets
acquired during the life of the partnership and only the usufruct or use of the assets contributed at the time
of formation. The original movable or immovable property contributed do not become common partnership
assets.
b. Particular Partnership – one which has for its object determinate things, their use or fruits, or a specific
undertaking or the exercise of a profession or vocation.

3. As to Liability of Partners
a. General Partnership – one consisting of general partners who are liable prorata and sometimes solidarily with
their separate property for partnership debts.
b. Limited Partnership – one formed by two or more persons having as members one or more general partners and
one or more limited partners who as such are not bound by the obligations of the partners.

4. As to Duration
a. Partnership at Will – one for which no time is specified and is not formed for a particular undertaking or venture
and which may be terminated any time by mutual agreement of the partners or by the will of one alone.
b. Partnership with a Fixed Term – one in which the term or period for which the partnership is to exist is agreed
upon or one 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.
5. 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 but is considered partnership only in relation
to those who by their conduct or omission are precluded to deny or disprove the partnership’s existence.

6. 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 has failed to comply with one or more of the legal requirements for its
establishment.

7. As to Publicity
a. Secret Partnership – one wherein the existence of certain persons as partners is not made known to the public
by any of the partners.
b. Open Partnership – one wherein the existence of certain persons as partners is made known to the public by the
members of the firm.

Classes of Partners

1. As to Contribution
a. Capitalist Partner – one who contributes capital in the form of money or property.
b. Industrial Partner – one who contributes industry, labor, talent, skills or service.
c. Capitalist Industrial Partner – one who contributes money, property and industry.

2. As to Liability
a. General Partner – one whose liability to third persons extends to his separate (private) property.
b. Limited Partner – one whose liability to third persons is limited only to the extent of his capital contribution into
the partnership.

3. As to Management
a. Managing Partner – one who manages actively the business of the partnership.
b. Silent Partner – one who does not participate in the management of the partnership affairs.

4. Other Classifications
a. Liquidating Partner – one who takes charge of the winding up of partnership affairs upon dissolution.
b. Nominal Partner – one who is not really a partner, not being a party to the partnership agreement but is made
liable as a partner for the protection of innocent third persons.
c. Ostensible Partner – one who takes active part in the management of the partnership and is known to the public
as a partner in the business.
d. Secret Partner – one who takes active part in the management of the business but whose connection with the
partnership in concealed or unknown to the public.
e. Dormant Partner – one who does not take active part in the management of the business and is not known to the
public as a partner. He is both a silent and a secret partner.

Articles of Co-Partnership

A partnership is created by an oral or a written agreement. Since partnerships are required to be registered with the
Securities and Exchange Commissions (SEC), it is necessary that the agreement be in writing. In this case,
misunderstanding and disputes among partners relative to the nature and terms of the contract may be avoided or
minimized. The written agreement between or among partners which governs the formation, operation and dissolution
of the partnership is referred to as the “Articles of Co-Partnership”.

Accounting for Partnership

As compared to other forms of business organization, accounting for partnership differs with regard to capital
accounts. In a partnership, there should be as many capital accounts and as many drawing accounts as there are
partners. Example: In JoLiBi Partnerships, the partners are Jo, Li and Bi. The capital accounts are: Jo Capital, Li
Capital and Bi Capital. The drawing accounts are: Jo Drawing, Li Drawing and Bi Drawing.

The transactions affecting the capital and drawing accounts of each partner are:

CAPITAL
Permanent withdrawal (decrease) of capital Original investment by a partner
Share In the partnership loss from operations Share in the partnership profit from operations
Debit balance of drawing account closed to capital Additional investment by a partner

DRAWING
Personal withdrawal by a partner in anticipation of profits Share in partnership profit from operation (this may be
(temporary withdrawal of capital) credited directly to capital)
Share in partnership loss from operation (this may be
debited directly to capital)

Aside from the contributions, the partnership may acquire additional financing from its present partners. Any loan
between a partner and the partnership is always accompanied by a proper loan documentation such as promissory
note. A loan from partner is shown as “Loan Payable, Advances from Partner, Due to Partner” on the partnership
books similar to any other loan. Unless all partners agree otherwise, the partnership is obligated to pay the individual
partner interest on the loan and such interest is reported in the Income Statement of the partnership as an “Expense”.

On the other hand, the partnership may also lend money to a partner. In this case, the partnership records a “Loan
Receivable, Advances to Partner, Due from Partner”. Again, unless otherwise agree by the partners, the loan bears
interest and such interest is reported in the Income Statement of the partnership as “Income”.

Partnership Formation

Partnership can be formed by (at least):

1. One individual and one individual
2. One individual and one sole proprietorship
3. One sole proprietorship and one sole proprietorship

Partners may contribute cash, property or industry to the partnership. Assets contributions are debited to the
appropriate asset accounts and credited to the capital accounts of the partners. Below are the rules:
• If the asset contributed is cash, it is recorded in the partnership books at face value.
• If the assets contributed are in the form of properties or non-cash assets, such are recorded at agreed values. In
the absence of an agreement, such are recorded at fair market values.
• If the contribution is service, a memorandum entry is prepared.

In some instances, one or two or all of the partners are former sole proprietors who decide to unite their assets and
liabilities to form a stronger enterprise. In such situation, the new partnership may open a new set of books or may
continue using the books of one of the sole proprietors. If a new set of books will be used, entries are prepared to
record the contributions. However, if the books of one of the sole proprietors are used, the following procedures shall
be followed:
1. Adjust the books of the sole proprietor which shall be used as partnership books.
2. Record the investment of the other partners.

PROBLEM 1 – Two or more individuals form a partnership for the first time
Jo, Li and Bi agreed to form a partnership to be known as JoLiBi Partnership. What are the entries in the partnership
books under different assumptions?
a. Each partner invested cash of P100,000 for an equal interest in the partnership.
b. Jo contributed cash of P150,000 and inventories costing P130,000 and with agreed values of P150,000. Li
contributed cash of P200,000. Bi contributed equipment costing P170,000 with accumulated depreciation of P25,000
and agreed value of P150,000.
c. Jo contributed cash of P100,000; Accounts Receivable of P150,000 with Allowance for Doubtful Accounts of P50,000.
Li contributed equipment valued at P400,000 while Bi is an industrial partner to contribute his special skills and
talents to the partnership.

PROBLEM 2 – An individual and a Sole Proprietor or Two or More Sole Proprietors from a Partnership
PUP and CAF, both sole proprietors, agreed to form a partnership. Account balances and the respective agreed values
upon formation are:
PUP PUP
Per Books As Agreed Per Books As Agreed
Cash 150,000 150,000 140,000 140,000
Accounts Receivable 140,000 140,000 135,000 135,000
Allowance for Bad Debts (50,000) (40,000) (30,000) (40,000)
Inventory 135,000 137,000 128,000 130,000
Equipment 300,000 150,000 200,000 175,000
Accumulated Depreciation (60,000) 0 (20,000) 0
Accounts Payable 100,000 100,000 150,000 150,000

What are the entries in the partnership books under different assumptions?
a. The partners decided to use a new set of books.
b. The partners decided to use the books of PUP.
c. The partners decided to use the books of CAF.

Capital Credit is Different from Capital Contribution

Prior to recording partners’ initial contributions to the partnership, the individual partners first agree not only on the
valuation of asset contributions but also on their capital credit. The “capital credit” of each partner is the percentage
of equity that each of them will have in the net assets of the newly formed partnership.

Generally, the capital share of a partner is proportionate to his capital contribution. However, in recognition of
intangible factors such as a partner’s special expertise, established clientele or necessary business connections,
partners may agree to a division of capital that is not proportionate to their capital contributions. This will give rise to
allowing “BONUS” on initial investments.
PROBLEM 3 – Capital Contribution is not the same with Capital Credit
Big and Mak agreed to form a partnership. They initially agreed to divide the initial partnership capital equally even
though Big contributed P500,000 while Mac contributed P400,000 cash into the partnership. What are the entries to
record the transactions in the books of the partnership?

PROBLEM 4
On March 1, 2017, Daniel and Kathrine decided to combine their businesses and form a partnership. Their balance
sheet on this date were:

Daniel Kathrine
Cash 180,000 70,500
Accounts Receivable 370,000 270,000
Inventory 600,000 390,000
Furniture and Fixture 600,000 180,000
Office Equipment 230,000 50,500
Prepaid Expenses 12,750 6,000
Total Assets 1,992,750 967,000

Accounts Payable 911,500 360,000

Capital 1,081,250 607,000
Total Liabilities and Capital 1,992,750 967,000

The parties also agreed to have the following adjustments:

• Provide 5% allowance for doubtful accounts on each Accounts Receivable.
• Inventories should be recognized only at 80% of their book values.
• Furniture and Fixture of Daniel is overvalued by P25,000 while the Office Equipment of Kathrine is overvalued by
P11,500.
• Prepaid Expenses of P6,000 for Daniel and P2,000 for Kathrine is to be recognized.
• Accrued Expenses of P3,000 for Daniel and P1,000 for Kathrine is to be recorded.

Determine the following:

a. Entries to record the formation in the books of the partnership (assuming the partners decided to use a new set of
books)
b. Total Assets after formation
c. Total Liabilities after formation
d. Capital Contribution and Capital Credit of Daniel
e. Capital Contribution and Capital Credit of Kathrine

PROBLEM 5
Use the same information in problem 4 except the parties agreed that Kathrine will make additional cash investment to
give her 50% interest in the firm, after making the adjustments.

Determine the following:

a. Entries to record the formation in the books of the partnership (assuming the partners decided to use a new set of
books)
b. Total Assets after formation
c. Total Liabilities after formation
d. Capital Contribution and Capital Credit of Daniel
e. Capital Contribution and Capital Credit of Kathrine

PROBLEM 6
Use the same information in problem 4 except the parties agreed that they will make settlement among themselves to
conform to the 60:40 capital and P&L ratio after making the adjustments.

Determine the following:

a. Entries to record the formation in the books of the partnership (assuming the partners decided to use a new set of
books)
b. Total Assets after formation
c. Total Liabilities after formation
d. Capital Contribution and Capital Credit of Daniel
e. Capital Contribution and Capital Credit of Kathrine