MODULE 1

PARTNERSHIP FORMATION
Week 1-3

INTRODUCTION

A business partnership is a way of organizing a company that is owned and sometimes

run by two or more people or entities. The partners share in the profits or losses. Before
you establish a business partnership, you should investigate the various types of
partnerships that are available and how each of them works.1

One of the major advantages of a partnership is the tax treatment it enjoys. A partnership
doesn't pay tax on its income but "passes through" any profits or losses to the individual
partners. At tax time, the partnership must file a tax return (BIR Form 1702-Ex) that
reports its income and loss to the BIR. In addition, each partner reports his or her share
of income and loss on his individual annual income tax returns.

According to Article 1767 of the Civil Code of the Philippines, a 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 the profit among themselves.

1
https://www.thebalancesmb.com/what-is-a-business-partnership-398402
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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
CHARACTERISTICS OF A PARTNERSHIP

1. Mutual agency – any partner may act as an agent of the partnership in conducting
its affairs. Each partner has an equal right to act for the partnership and to enter
into contracts binding upon it, as long as he acts within the normal scope of
business operations.

2. Limited life – a partnership may be dissolved at any time by action of the partners
or by operation of law. The withdrawal, death, retirement, bankruptcy, incapacity
of a partner and the admission of a new partner dissolves the partnership.

3. Unlimited liability – the personal assets of a general partner may be used to

satisfy the claims of the creditors of the partnership if the partnership assets are
not enough to settle the liabilities to outsiders upon liquidation.

4. Co-ownership of property – properties contributed to the partnership are owned

by the partnership. Properties invested by a partner cease to be his own personal
property.

5. Co-ownership of profit – a partner has the right to share in partnership profits.

The partners are entitled to share in the firm’s profits as a return on their
investment.

6. Legal entity – a partnership has a legal personality separate and distinct from that
of each of the partners. A partnership may, therefore, acquire property in its own
name and may enter into contracts.

ADVANTAGES OF A PARTNERSHIP

1. It is easy to form and to dissolve. A partnership is ended whenever there are

changes in the ownership structure such as withdrawal of a partner or admission
of a new partner.

2. Greater amount of capital may be raised compared to a sole proprietorship. The

source of capital investment comes from 2 or more persons.

3. There is relative freedom and flexibility in decision-making compared to a

corporation. Decisions are effected simply by agreement among the partners
without the formalities necessary under a corporation.

4. It is better managed because business affairs are supervised by more than one
person. Better management results from the combined experience and ability of
several individuals.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 5. The unlimited liability of a general partner makes it reliable from the point of view
of creditors.

DISADVANTAGES OF A PARTNERSHIP

1. The unlimited liability of a partnership deters many from investing in a partnership.

2. There is lack of business continuity because it can be easily dissolved.

3. There is difficulty in transferring ownership interest because ownership interest in

the partnership cannot be transferred without the consent of all the partners.

4. Limited amount of capital may be raised compared to a corporation.

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

KINDS OF PARTNERSHIPS

1. According to activity

a. Service – main activity is the rendering of services

b. Merchandising or Trading – main activity is the purchase or sale of goods
c. Manufacturing – main activity is the production of goods

2. According to liability

a. General Partnership – one consisting of general partners who are liable

prorate and sometimes solidarily with their separate property for partnership
liabilities.
b. Limited Partnership – one consisting of one or more general partners and
one or more limited partners. “LTD” is added to the name of the partnership.
c. Limited Liability partnership – extends legal protection from liability to all
partners, including general partners. An LLP is often formed by partners in
the same professional category, such as accountants, architects, and
lawyers. The partnership protects partners from liability from the actions of
other partners.

3. According to object

a. Universal partnership of all present property – one in which the partners

contribute all the property which actually belong to each of them, at the time
of the constitution of the partnership, to a common fund with the intention of
dividing the same among them as well as the profits which they may acquire

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 therewith. All assets contributed to the partnership and subsequent
acquisitions become common partnership assets.

b. Universal partnership of profits – one which comprises all that the

partners may acquire by their industry or work during the existence of the
partnership and the usufruct of movable or immovable property which each
of the partners may possess at the time of the institution of the contract.
The original movable or immovable property contributed do not become
common partnership assets.

c. Particular partnership – one which has for its object determinate things,
their use or fruits or a specific undertaking or the exercise of a profession of
vocation.

4. According to Duration

a. W/ fixed term
b. Partnership at will – no term specified

5. According to Purpose

a. Commercial/trading – for business transaction, subject to income tax

b. Professional/non-trading – exercise of profession, not subject to income tax
(GPP)
6. According to Legality

a. De jure – complied all legal requirements

b. De facto – failed to comply all legal requirements

KINDS OF PARTNERS

a. According to Investment

1. Capitalist – one who contributes capital in money or property.

2. Industrial – one who contributes industry, labor, skill or service.
3. Capitalist-Industrial – one who contributes money, property and industry

b. According to Liability

1. General – one whose liability to third persons extends to his private property
2. Limited – one whose liability to third persons is limited only to the extent of his
capital contribution to the partnership.

c. According to Participation

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 1. Nominal- a partner in name only.
2. Secret – one who takes active part in the business but whose connection with the
partnership is concealed or unknown to the public.
3. Silent – one who does not participate actively in the management of partnership
affairs.
4. Managing – one who manages actively the business of the partnership.
5. Dormant – one who is a participant in the profits of a firm, but his name being
concealed, his interest is not apparent.

Partners may be individuals, groups of individuals, companies, and

corporations. Depending on the type of partnership and the levels of partnership
hierarchy, a partnership can have different levels of partners. For example, there may
be junior and senior partners. These partnership types may have different duties,
responsibilities, and levels of input and investment requirements.

FEATURES OF PARTNERSHIP ACCOUNTING

1. Plurality of capital and drawing accounts – there will be as many capital

accounts and as many drawing accounts as there are partners

2. Partner’s loans – partners may advance money to the partnership in the form of
loans when the business is in need of additional funds.

3. Partner’s borrowings – the partnership may advance money to partners other

than withdrawals in the form of loans.

4. Partner’s salaries – partners are paid salaries for services rendered in the
conduct of partnership business.

5. Interest on investment – interest is allowed to earn on the asset investment of

the partners.

6. Division of profit and losses – net profit or net loss is to be divided among the
partners based on their agreement.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 INTENDED LEARNING OUTCOMES

1. To define and explain the nature of partnership

2. To know how it is formed
3. To identify its characteristics and various advantages &
disadvantages.
4. To learn how to account for initial investments of the partners
5. To know the valuation of their contributions

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 PARTNERSHIP FORMATION

PARTNERSHIP AS DISTINGUISHED FROM CORPORATION

PARTNERSHIP CORPORATION
Manner of Creation mere agreement of the created by operation of law
partners
No. of persons two or more one person can create
corporation, (revised from “at
least 5 persons, not exceeding
15”)
Commencement of execution of Articles of issuance of certificate of
Juridical Partnership incorporation by SEC
Personality
Management every partner is an agent of vested in the Board of
the partnership if no managing directors
partner was appointed
Extent of Liability up to personal assets only up to extent of interest
excluding limited partner and investment
Right of no right of succession (One there is right of succession, it
Succession partner died, the “P” will will continue even if one died
dissolve)
Terms of Existence based on contract agreed unlimited, revised from being
50 years

Partnerships are usually registered with the state in which they do business. Partnerships
use a partnership agreement to clarify the relationship between the partners; what
contributions, including cash, they will make to the partnership; the roles and
responsibilities of the partners; and each partner's distributive share in profits and losses.
This agreement is often just between the partners; it's not generally registered with a
state.

ARTICLES OF CO-PARTNERSHIP

An agreement in writing among the partners governing the nature and terms of the
partnership contract. This agreement is the framework within which the partners are to
operate or conduct partnership business – from formation to operations then to the
eventual dissolution and liquidation of the partnership. Observations of these details will
help minimize, if not eliminate, the confusion and disputes that may arise between or
among the partners.

The written agreement among the partners governs the formation, operation and
dissolution of the partnership and is required to be registered with Securities and
Exchange Commission (SEC). It contains the following information:

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 1. The name of the partnership;
2. The names, addresses of the partners, classes of partners stating whether the
partner is a general or a limited partner;
3. The effective date of the contract;
4. The purpose and principal place of business of the business;
5. The capital of the partnership stating the contributions of each of the partners;
6. The rights and duties of each of the partners;
7. The manner of dividing profit or loss among the partners;
8. The conditions under which the partners may withdraw money or other assets;
9. The manner of keeping the books of accounts;
10. The causes for dissolution and the provision for arbitration in settling disputes.

RECORDING PARTNERSHIP FORMATION

Accounting entries to record the formation of a partnership will depend upon how the
partnership is formed. A partnership may be formed in the following ways, namely:

1. Formation of a partnership for the first time by individuals.

2. Conversion of a sole proprietorship to a partnership
a. A sole proprietor allows another individual who has no business of his own
to join the business.
b. Two or more sole proprietors form a partnership.

GENERAL GUIDELINES

1. Cash investments are recorded using their face values.

2. Non-cash asset investment is recorded at the current fair value of the property at
the time of investment. Independent professional appraisals should be made to
determine the fair value. Fair value is the amount to be obtained when the asset
is sold at the present time in its present condition.

3. Accounts receivable are recorded in the books of the partnership at gross amount.
Allowance for bad debts is carried forward to the partnership.

4. Depreciable property assets are recorded in the books of the partnership at

carrying value. Accumulated depreciation is not carried forward to the partnership.

5. When a sole proprietorship is converted into a partnership, the following books

may be used:

a. Books of the sole proprietorship may be used as books of the partnership.

b. Books of the sole proprietorship will be closed and a new set of books will
be used for the partnership.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
Two Kinds of Partnership Formation

1. Formed by individuals

Cash Cash xxx

investment X, Capital xxx

Non-cash Asset xxx

asset X, Capital xxx
investment
Note: Use the fair market value of
the asset.

Non-cash Asset xxx

asset Liability xxx
investment X, Capital xxx
with assumption
of liability
Note: Debit the asset account using its fair
market value; credit the liability account
using the loan balance to be assumed by the
partnership; and credit the capital account of
the partner using the net amount.

Service or Memo Entry

Industry Mr. X is admitted as an industrial partner
with a ____ share in profits.

2. Sole proprietorship(s) converted into a partnership – accounting procedures

are as follows:

a. Adjust the books of the sole proprietorship(s).]

Increase in value Asset xxx

of an asset X, Capital xxx
without a contra-
asset account

Decrease in value X, Capital xxx

of an asset Asset xxx
without a contra
asset account

Increase in value Contra- asset xxx

of an asset X, Capital xxx
with a contra
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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 asset account

Decrease in value X, Capital xxx

of an asset Contra- asset xxx
with a contra
asset account

Increase in value X, Capital xxx

of a liability Liability xxx

Decrease in value Liability xxx

of a liability X, Capital xxx

Note: These adjustments are similar to the year-end

adjusting entries. Only, replace the nominal
accounts with the Owner, Capital account.

b. Close the books of the sole proprietorship(s).

Closing entry Contra-asset xxx

Liabilities xxx
X, Capital xxx
Assets xxx

c. Record the investment of the partners in the books of the partnership

– assume new set of books.

Opening entry Assets xxx

To record Allowance for Bad Debts xxx
investment of Liabilities xxx
sole proprietor X, Capital xxx

Notes:
1. Accounts receivable is taken at gross
amount; allowance for bad debts is carried
over in the books of the partnership.
2. Depreciable property assets are
recorded at carrying value; accumulated
depreciation is not carried over in the books
of the partnership.

EQUITY THEORIES IN PARTNERSHIP

1. ENTITY THEORY holds that the business is separate and distinct from the
owners of the business. The business is the entity.
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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 2. PROPRIETARY THEORY holds that the owners are the entity

PROPRIETARY ENTITY
The entity is viewed as the The business unit is separate and
individual owners distinct from its owners
Salaries to partners are Partnership enters contracts in its
distributions of income (not own name
expenses)
Unlimited liability extends to Partnership give up title to their
personal assets of owners contribution
Original partnership is dissolved
with the admission or withdrawal of
a partner

ACCOUNTING FORMATION

Partnership may be formed in several ways:

a. Formation of the partnership for the first time
b. Conversion of sole proprietorship to a partnership
c. Admission of a new partner

VALUATION OF INVETSMENTS

1. Bonus approach – retains historical cost

2. Revaluation approach – depart from historical cost, non-GAAP believed not in
accordance with substance over form (Goodwill Method)

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
ACTIVITY 1: TWO NEW INDIVIDUAL FORM A PARTNERSHIP (FIRST TIMERS)
On July 1 2016, Pholdz and JC agreed to form a partnership. The partnership
agreement specified that Pholdz is to invest cash of 50,000 and JC is to contribute land
with FMV of P100,000 with 20,000 mortgage liability in the bank to be assumed by the
partnership.

REQUIRED:
Prepare the journal entry and financial position of the partnership. (10pts)

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
ACTIVITY 2: SOLE PROPRIETORSHIP TO PARTNERSHIP
Assume that AA and BB form a partnership. AA has been operating a business that is to
be carried on by the new partnership. BB is to invest cash of P250,000 and equipment
with a fair value of 125,000 encumbered by a mortgage note payable of P25,000. Just
before the partnership is formed, a statement of financial position is drawn up for AA’s
business as follows:

AA
Statement of Financial Position
As of January 31, 2016

Assets Liabilities and Capital

Cash 162,000 Trade and other payables 240,000
Trade Receivables 200,000 AA’s Capital 404,000
Less: ABD 12, 000
188,000
Inventory 214,000
Other CA 16,000
Equipment 120,000
Less: Accum. Dep 56,000
64,000
Total Assets 644,000 Total Liabilities and Capital 644,000

The following adjustments must be made in establishing AA’s interest.

a. Trade receivable - Doubtful accounts of 10,000 are to be written off; a 4%
allowance for doubtful accounts is to be recognized on the remaining accounts.
b. Inventory- this should be written up to P266,000 fair value
c. Equipment- This is over depreciated by P11,000
d. Accrued expenses of P10,000 was unrecorded (credit to this trade and other
payables)
REQUIRED:
Prepare the adjusting entries and financial position of the partnership
1. If AA’s books will be used as the partnership books (10 pts)
2. If New partnership books will be used (10 pts)
Note: You will have 2 set of answers: (1) one is when the partners agreed to continue the
books of AA for the partnership formation and (2) the other is when the partners agreed
to create new books for the formation.

END

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit