SPECTRANS- MODULE 1 A Partnership, as a form of the business organization, offers

several advantages and disadvantages as delineated

below:
3. INTRODUCTION TO PARTNERSHIP
Definitions of Partnership
3. INTRODUCTION TO PARTNERSHIP
3.1. PARTNERSHIP ACCOUNTING
Partnership has been defined variously, as follows:

1. “By the contract of partnership, two or more persons The following are the major considerations in the

bind themselves to contribute money, property, or industry accounting for the equity of a partnership:

to a common fund with the intention of dividing the profits

a. Formation – accounting for initial investments to the
among themselves. Two or more persons may also form a
partnership
partnership for the exercise of a profession.

2. “An association of two or more persons to carry on as

co-owners of a business for profit.

3. “A joint undertaking to share in the profit and loss.

4. “A joint undertaking to share in the profit and loss.

5. “A legal relation based upon the express or implied

agreement of two or more competent persons whereby they
unite their property, labor or skill in carrying on some lawful
business as principles for their joint profit.

The law provides that the minimum number of owners

composing a partnership must be at least two persons. b. Operations – division of profits or losses
However, it does not specify the maximum number of
persons composing a partnership because of the words c. Dissolution – admission of a new partner and

“…two or more persons.” withdrawal, retirement or death of a partner

Characteristics of Partnership d. Liquidation – winding up of affairs

1. Ease of formation • Owner’s equity accounts. Partnership has two or

more owners, separate capital and drawing
2. Separate legal personality accounts are established for each partner.
• A partner’s capital account is credited for his initial
3. Mutual agency and additional net investments (assets contributed
less liabilities assumed by the partnership), and a
4. Co-ownership of property
credit balance of the drawing account at the end of
the period. It is debited for his permanent
5. Co-ownership of Profits
withdrawals and debit balance of the drawing

6. Limited Life account at the end of the period.

• To meet personal living expenses, partners
7. Transfer of Ownership customarily withdraw money on a periodic basis
throughout the year. A partner’s drawing account is
8. Unlimited Liability debited to reflect assets temporarily withdrawn by
him from the partnership. At the end of each
accounting period, the balances in the drawing

Advantages and Disadvantages of a Partnership

 accounts are closed to the related capital accounts the association. The corporation’s equity section, however,
does not contain the capital and drawings accounts of
individual stockholders. Instead, it contains the capital stock
and retained earnings accounts. Accordingly, the
Permanent withdrawals are made with the intention of
partnership assets, liabilities, revenues and expenses are
permanently decreasing the partner’s capital while
all recorded in accordance with the GAAP in the same
temporary withdrawals are regular advances made by the
manner as in the single proprietorships or corporations,
partners in anticipation of their share in profit.
except for the accounting elements under the equity section
of the statement of financial position.
The use of drawing accounts for temporary withdrawals
provides a record of each partner’s drawings during an
4. PARTNERSHIP FORMATION
accounting period. Hence, drawings in excess of the
It refers to the perfection of the partnership contract by the
allowed amounts as stated in the partnership agreement
partners. When a partnership is formed, partners commonly
may be controlled.
observe the following to effect fair and honest business:

If the partners wish to maintain their capital accounts for

1. Execution of partners’ agreement.
investments and permanent withdrawals, then profit or loss
should be entered in the drawing account. On the other 2. Valuation of partners’ investments.
hand, if the purpose of the partners is to make profit or loss
part of their capital, then the capital account should be 3. Adjustments of accounts.
used.
If there is an existing sole proprietor’s business that would
be converted as a partnership, all accounts that are being
revalued according to the partnership agreement would

Loans Receivable from or Payable to Partners increase or decrease the contributing partner's capital. The
adjustments of the accounts are very important because
▪ If a partner withdraws a substantial they reflect the fair and equitable value of the prospective
amount of money with the intention partner’s contributions to the partnership.
of repaying it, the debit should be
to loans receivable-partner account The following rules shall then be observed when capital

instead of to partner’s drawing contribution issues arise:

account. This account should be

1. Amount of contribution. The amount of contribution
classified separately from other
shall be based on the partners’ agreement. In the absence
receivables of the partnership.
of any agreement, it shall be contributed equally.
▪ A partner may lend amounts to the
partnership in excess of his
intended permanent investment,
these advances should be credited
to loans-payable account and not
to partner’s capital account
classified among the liabilities but
separate from liabilities from
outsiders. 2. Valuation of partners' contribution. If cash contribution
is made, the face value of cash is the amount to be
In general, the accounting principles and procedures used recognized. If a noncash contribution is to be made, it shall
in recording partnership transactions with outside parties be
are the same as those of sole proprietorships and
corporations. The difference, however, lies in the owners’
equity accounts. In sole proprietorship, there is one capital
account and one withdrawal account because there is only
one owner of the business. On the other hand, the capital
accounts and drawing accounts of a partnership business
are more than one depending on the number of partners in
recorded at agreed value; otherwise, it will be recorded at is so because the business has
the fair value of the property to effect fair and equitable ceased to be a going concern.
valuation.

Notes:

1. If there is no agreed value, the investment of capital Opening entries of a partnership upon formation
in a partnership should be measured at the fair value of all
tangible and intangible assets contributed at the time of ▪ A partnership may be formed in
their transfer to the partnership. An individual partner’s any of the following ways:
liabilities that have been assumed by the partnership should
also be recorded at fair market value. 1. Individuals with no existing business form a
partnership.
2. The fair value or fair market value represents the
estimated amount in which the seller and buyer would be 2. Conversion of a sole proprietorship to a partnership.

willing to exchange value in an open market. In other words,

a. A sole proprietor and an individual without existing
fair market value suggests the approximate cash equivalent
business form a partnership
of an asset.

b. Two or more sole proprietors form a partnership.

3. Admission or retirement of a partner

Valuation of contributions of partners

▪ Accordingly, all assets contributed

to (and related liabilities assumed
Individuals with no existing business form a partnership
by) partnership are initially
measured at fair value. ▪ The opening entry to
▪ When measuring the contributions recognize the contributions
of partners, the following additional of each partner into the
guidance from the PFRSs shall be partnership is simply to
observed: debit the assets
▪ Cash and Cash equivalents – Face contributed and to credit
amount the liabilities assumed and
▪ Inventory – lower of cost and net the capital account of each
realizable value partner.

Adjustment of accounts prior to the formation

Illustration:
▪ In cases when the prospective
partners have existing businesses, On July 1, 2020, Arnold Quinto and Lovilet Ruiz agreed to
their respective books will have to form a partnership. The partnership agreement specified
be adjusted to reflect the fair that Quinto is to invest cash of P700,000 and Ruiz is to
market values of their assets or to contribute land with a fair market value of P1,300,000 with
correct misstatements in the P300,000 mortgage to be assumed by the partnership. The
accounts. entries are as follows:
▪ The adjustments of the assets and
liabilities prior to formation will be Cash 700,000
similar to the adjustments we do
but, when the adjustment involves Land 1,300,000

a debit or credit to a nominal

Mortgage Payable
account, the capital account would
300,000
instead be debited or credited. This
 Arnold Quinto, Capital
700,000

Lovilet Ruiz, Capital

1,000,000 Two or more sole proprietor form a partnership

▪ The following procedures may be

used in recording the formation of
After formation, the statement of financial position of the the partnership:
partnership is: ▪ Books of the sole proprietor:

1. Adjust the assets and liabilities in accordance with

agreement. Adjustments are to be made to his capital
account.

2. Close the books.

▪ Books of the partnership

1. Record investment of the sole proprietor

A sole proprietor and another individual form a SPECTRANS- MODULE 2

partnership
3. PARTNERSHIP OPERATIONS

▪ A sole proprietor may consider The accounting for partnership operation is concerned with

forming a partnership with an the following activities:

individual who has no existing

1. Accounting treatment of profit and loss
business. Under this type of
formation, the assets and the
2. Proper distribution of profit and loss
liabilities of the proprietorship will
be transferred to the newly formed 3. Preparation of financial statements such as:
partnership at values agreed upon
by all the partners or at their a. Income statement (Statement of Recognized Income
current fair prices. and Expenses)
▪ The following procedures may be
used in recording the formation of b. Statement of Financial Position (formerly Balance

the partnership: Sheet)

▪ Books of the sole proprietor:

c. Partners’ capital statement (Statement of Changes in

1. Adjust the assets and liabilities in accordance with the Partners’ Equity)

agreement. Adjustments are to be made to his capital

3. PARTNERSHIP OPERATIONS
account.
3.1. Accounting Treatment of Partnership’s Profit and

2. Close the books. Loss

The determination of proper income or loss is made through
▪ Books of the partnership the preparation of income statement with the following basic
formula:
1. Record investment of the sole proprietor

2. Record investment of the individual without an existing

business.

In the journal entry, there is net income if the income

summary account has a credit balance. There is net loss if
the income summary account has a debit balance. The b. If there is no agreement as to the distribution of losses
profit or loss is subsequently distributed to the partners by but there is an agreement as to profits, the losses shall be
closing the income summary account to the respective distributed according to the profit-sharing ratio.
partners’ capital accounts.
c. In the absence of agreement:
3. PARTNERSHIP OPERATIONS
3.2. Rules for developing distribution of profits or - As to capitalist partners, the losses shall be divided

losses according to their capital contributions (according to the

ratio of original capital investments or in its absence, the
• The profits or losses shall be distributed in ratio of capital balances at the beginning of the year).
conformity with the agreement. If only the share of
each partner in the profits has been agreed upon, - As to purely industrial partners (if there’s any), shall

the share of each in the losses shall be in the same not be liable for any losses.

proportion.
▪ The industrial partner is not liable for losses because
• In the absence of stipulation, the share of each
he cannot withdraw the work or labor already done by
partner in profits or losses shall be in proportion to
him.
what he may have contributed.
• A stipulation which excludes one or more partners
3. PARTNERSHIP OPERATIONS
from any share in the profits or losses is void.
3.4. Distribution of profits or loss based on partner’s
• The designation of losses and profits cannot be agreement
entrusted to one of the partners (Art 1798). A • In general, profits or losses shall be divided in
stipulation which excludes one or more partners accordance with the agreement of the partners. The ratio in
from any share in the profits or losses is void (Art. which profit or losses from partnership operations are
1799) distributed is recognized as the profit and loss ratio.

3. PARTNERSHIP OPERATIONS • The partners may agree on any of the following

3.3. Summary of legal provision of profit and loss scheme in distributing profits or losses.
distribution
Profits

a. The profits will be divided according to the partner’s 1. Equally or in other agreed ratio
agreement.
2. Based on partner’s capital contributions
b. If there is no agreement:
a. ratio of original capital investments
- As to capitalist partners, the profits shall be divided
according to their capital contributions (according to the b. ratio of capital balances at the beginning of the
ratio of original capital investments or in its absence, the year.
ratio of capital balances at the beginning of the year
c. ratio of capital balances at the end of the year
- As to industrial partners (if any), such share as may be
just and equitable under the circumstances, provided, that d. ratio of average capital balances

the industrial partner shall receive such share before the

3. By allowing interest on partner’s capital and the
capitalist partners shall divide the profits.
balance in agreed ratio

4. By allowing salaries to partners and the balance in

Losses agreed ratio

a. The losses will be divided according to the partner’s 5. By allowing bonus to the managing partner based on
profit and the balance in an agreed ratio.
agreement
6. By allowing salaries, interest on partner’s capital, step in the division of profit, they should specify in
bonus to the managing partner and the balance in agreed the interest rate to be used. It should state whether
ratio. interest is to be computed on capital balances on
specific dates or on average capital balances
during the year.
• Interest on the partner’s capital is considered as a
mere technique to share partnership profit and

Entry on distribution of profit and loss losses and not as expenses of the partnership.
• On the other hand, the interest on loans from
• Profit partners is recognized as an expense and a factor
in the measurement of profit or loss of the
Income Summary partnership.
xx • If the partnership agreement provided for interest
on capital accounts, this provision must be honored
Partner’s
regardless of whether operations yielded profits or
Drawing xx
not.

• Loss

Partner’s Drawing xx
By allowing salaries to partners and the balance in an
agreed ratio
Income
Summary xx
• The sharing agreement may provide for variations
in compensating the personal services contributed
by partners. Even among partners who devote
equal service time, one partner’s superior
experience and knowledge may command a
Based on the partner’s capital contribution greater share of the profit. To acknowledge the
harder working or more valuable partner, the profit-
• Division of partnership profits in proportion to the
sharing plan may provide for salary allowances.
capital invested by each partner is most likely to be
• In the absence of an agreement to govern this
found in partnerships in which substantial
situation, salary allowances will be provided even
investments is the principal ingredient for success.
when operations yielded losses.
• Division of profits or losses on the basis of the three
• Partners are the partnership’s owners, they are not
capital concepts- the original capital investments,
employees of the business. When the partners
capital balances at the beginning of the year, or
calculate the profit of the partnership, salaries to the
capital balances at the end of the year- may prove
partners are not deducted as expenses in the
inequitable if there is material changes in the capital
statement of recognized income and expense.
accounts during the year.

By allowing bonus to the managing partner based on

By allowing interest on capital and the balance in an
profit and the balance in an agreed ratio
agreed ratio

• A partnership contract may provide for a special

• Partnerships may choose to allocate a portion of
compensation in the form of bonus to the managing
the total profits in the capital ratio and balance
partner when the results of operations of the
equally or in other agreed ratio after due
partnership are favorable.
consideration of the partner’s other contributions.
• This allowance is given in order to encourage the
• To allow interest on partner’s capital account
partner to maximize the profit potentials of the
balances is almost similar to dividing part of profits
partnership. A bonus is not being considered in the
in the ratio of partner’s capital balances. If the
computation of profit, rather it is a mere technique
partners agree to allow interest on capital as a first
to distribute profits.