Accounting for Partnerships

PARTNERSHIP, Definition and Introduction

Art. 1767. By the contract of partnership two or more persons bind themselves to contribute money,
property, or industry to a common fund, with the intention of dividing the profits among themselves.
Two or more persons may also form a partnership for the exercise of a profession. (1665a)

Art. 1771. A partnership may be constituted in any form, except where immovable property or real rights
are contributed thereto, in which case a public instrument shall be necessary. (1667a)

Art. 1772. Every contract of partnership having a capital of three thousand pesos or more, in money or
property, shall appear in a public instrument, which must be recorded in the Office of the Securities and
Exchange Commission.

TYPES OF PARTNERS

• Capitalist Partner – contributes money/property

• Industrial Partner – contributes his/her industry
• General Partner – liable up to the extent of his personal property; may be active in the
management of a partnership, and can either be a capitalist or an industrial partner.
• Limited Partner – liable only up to the extent of his/her investment in the partnership; can only
be a capitalist partner and cannot participate in the management of the partnership.

TYPES OF PARTNERSHIPS

• Universal vs. Particular partnership

o Art. 1777. A universal partnership may refer to all the present property or to all the
profits. (1672)
o Art. 1778. A partnership of all present property is that in which the partners contribute
all the property which actually belongs to them to a common fund, with the intention of
dividing the same among themselves, as well as all the profits which they may acquire
therewith. (1673)
o Art. 1779. In a universal partnership of all present property, the property which belongs
to each of the partners at the time of the constitution of the partnership, becomes the
common property of all the partners, as well as all the profits which they may acquire
therewith.
o A particular partnership only has a specific undertaking, and does not include ventures of
the partners outside the partnership.
• General vs. Limited partnership
o If partners are all general partners, then the partnership is a general partnership.
o A limited partnership must have at least one general and one limited partner.
• Limited liability partnership (LLP) – is designed to protect innocent partners from malpractice or
negligence claims resulting from the acts of another partner.

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

 • Limited liability companies (LLC) – same as a limited partnership but the owners, who are called
members, are allowed to be part of management.
• General professional partnership (GPP) – established for the exercise of a profession.

CHARACTERISTICS OF PARTNERSHIPS

• Association of Individuals - A partnership is a legal entity because it can own property and can sue
or be sued. A partnership is also an accounting entity because the personal transactions of the
partners are not included in the accounting books of the partnership (also known as the economic
entity assumption, which also applies to a sole proprietorship). The net income of a partnership
(like a sole proprietorship’s) is not taxed as a separate entity (income tax expense is not recorded
in the company’s income statement). A partner’s share in net income of the partnership is taxable
at personal tax rate.
• Mutual Agency - The act of any partner is binding on all partners so long as the act appears to be
appropriate for the partnership (within the scope of business).
• Limited Life - Partnership dissolution occurs whenever there is death or incapacity of a partner,
withdrawal by a partner, or admission of a new partner. If the remaining partners agree to
continue operations, then they must form a new partnership.
• Unlimited Liability - Each partner is personally and individually liable for all partnership liabilities.
If partnership assets are insufficient to satisfy creditors’ claims, then the claims attach to the
personal resources of any partner, regardless of the extent of his/her equity in the partnership.
• Co-ownership of Property - Partners jointly own partnership assets. If the partnership is dissolved,
then a partner cannot claim the specific asset he/she contributed to the partnership. Partnership
net income/net loss is also shared by the partners.

ADVANTAGES/DISADVANTAGES OF A PARTNERSHIP

• Advantages
o Combining skills and resources of two or more individual
o Ease of formation
o Freedom from governmental regulations and restrictions
o Ease of decision making

• Disadvantages
o Mutual agency
o Limited life
o Unlimited liability

PARTNERSHIP FORMATION

Art. 1784. A partnership begins from the moment of the execution of the contract, unless it is otherwise
stipulated. (1679)

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

Articles of Partnership

• Contains (as a minimum) the following:

o Name of the partnership
o Principal office
o Name, Citizenship, Residence and Amount contributed
o Term of existence
o Purpose
o Basis of sharing of net income or net loss
o Identity of the general manager

• Others that may be included:

o Rights and duties of partners
o Provisions for withdrawals of assets
o Procedures for submitting disputes to arbitration
o Procedures for the withdrawal or addition of a partner
o Rights and duties of surviving partners in the event of a partner’s death

Source: SEC website www.sec.gov.ph/download/Forms/otherforms/AP_template.pdf

Art. 1787. When the capital or a part thereof which a partner is bound to contribute consists of goods,
their appraisal must be made in the manner prescribed in the contract of partnership, and in the absence
of stipulation, it shall be made by experts chosen by the partners, and according to current prices, the
subsequent changes thereof being for account of the partnership. (n)

Art. 1790. Unless there is a stipulation to the contrary, the partners shall contribute equal shares to the
capital of the partnership. (n)

Example:

C and M entered into a partnership contract to undertake the selling and distribution of native Philippine
mangoes. Their asset contributions are as follows:

C’s Contribution M’s Contribution

Book Value Fair Value Book Value Fair Value
Cash 50,000 125,000
Inventory 375,000 375,000
Land 300,000 ?
Delivery Equipment 175,000 200,000
Bank Loan 100,000

According to the partnership articles, they shall be equal partners, hence, contribute equal amounts of
assets to the partnership. Journalize the transactions at partnership formation. Determine the fair value
of the land contributed by C.

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

PARTNERSHIP NET INCOME OR LOSS

Art. 1797. The losses and profits shall be distributed in conformity with the agreement. If only the share
of each partner in the profits has been agreed upon, the share of each in the losses shall be in the same
proportion.

In the absence of stipulation, the share of each partner in the profits and losses shall be in proportion to
what he may have contributed, but the industrial partner shall not be liable for the losses. As for the
profits, the industrial partner shall receive such share as may be just and equitable under the
circumstances. If besides his services he has contributed capital, he shall also receive a share in the profits
in proportion to his capital. (1689a)

Typical income allocation basis:

• Fixed ratio/percentage
• Salaries to partners
• Interest on partners’ capital balances (beginning, average, ending)
• Bonus to partners
• Combination of any of the above

Example:

In Year 1 of CM Partnership (example above), net income from operations is 100,000. Determine how
much should be allocated to C and to M based on the following independent scenarios:

1. No agreement on net income allocation.

2. C and M shares 60% and 40%, respectively.
3. C gets an annual salary of 35,000, and M gets 25,000. The remainder is shared equally.
4. C gets an annual salary of 35,000, and M gets 25,000. Partners receives 10% interest each on
contributed capital. The remainder is shared equally.
5. C gets an annual salary of 35,000, and M gets 25,000. Partners receives 2% interest each on
contributed capital. As the managing partner, C gets 25% bonus on net income before salaries,
interest, and any bonuses. The remainder is shared equally.
6. C gets an annual salary of 35,000, and M gets 25,000. Partners receives 2% interest each on
contributed capital. As the managing partner, C gets 25% bonus on net income after deducting
salaries and interest. The remainder is shared equally.
7. C gets an annual salary of 35,000, and M gets 25,000. Partners receives 5% interest each on
contributed capital. As the managing partner, C gets 25% bonus on net income after deducting
salaries and interest. The remainder is shared equally.

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

PARTNERSHIP CAPITAL STATEMENT

C withdrew 18,000, while M withdrew 12,000 during the year.

CM Partnership
Partner's Capital Statement
For the Year Ended 20X1

C M Total
Capital, January 1 0 0 0
Add: Additional investment 500,000 500,000 1,000,000
Net income allocation 55,000 45,000 100,000
555,000 545,000 1,100,000
Less: Drawings 18,000 12,000 30,000
Capital, December 31 537,000 533,000 1,070,000

What are the entries to close the partnership books?

ADMISSION OF A NEW PARTNER

Admission of a new partner into an existing partnership causes the legal dissolution of the existing
partnership. Upon admission of a new partner, the new partnership shall be registered and the previous
partnership will cease to exist. There are two ways in which a partner may be admitted, either by acquiring
the capital interest, in whole or in part, of one or more of the old partners, or by contributing cash or
other non-cash assets to the partnership.

Acquisition of Existing Capital Interest

In this particular transaction, the negotiation is between the partners (acting for themselves, not on behalf
the partnership) and the new partner. Cash payments, or any compensation, in exchange for an existing
partner’s capital interest does not go to the partnership; it goes directly to the personal account of the
partners.

Example:

The capital balances of C and M are 750,000 and 450,000 respectively. L, a friend of C and M, is interested
to be part of the partnership. Before the admission of L, C and M share net income on a 60% to 40% basis.
Upon admission, L shall have a 25% interest in the partnership.

The following are independent scenarios:

1. C agrees to sell half of his partnership interest. L pays him 500,000.
2. C agrees to sell half of his partnership interest. L pays him 300,000.
a. Does the purchase price matter?

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

 3. Both C and M agree to sell a quarter of their partnership interest.
a. What is the new net income allocation of the partnership?

Investment of Assets into the Partnership

New partners contribute cash or non-cash assets in the partnership. Unlike the previous type of
transaction, the negotiation in this case is between the new partner and the existing partners who are
acting on behalf of the partnership.

Example:

The capital balances of C and M are 750,000 and 450,000 respectively. L, a friend of C and M, is interested
to be part of the partnership. Before the admission of L, C and M share net income on a 60% to 40% basis.
Upon admission, L shall have a 25% interest in the partnership.

The following are independent scenarios:

1. L contributes 400,000 worth of assets into the partnership.
2. L contributes 500,000 worth of assets into the partnership.
3. L contributes 300,000 worth of assets into the partnership.
a. What is the new net income allocation of the partnership?

WITHDRAWAL/RETIREMENT OF A PARTNER

Just like in the admission of a new partner, both the withdrawal and retirement of an existing partner also
causes the legal dissolution of an existing partnership. Furthermore, just like in the admission of a new
partner, this transaction can be carried out by the partners either by acting personally or acting behalf of
the partnership.

Example:

C, M, and L have capital balances of 800,000, 600,000 and 450,000, respectively. Furthermore, they share
in the profits and losses as follows: C – 45%, M – 30%, L – 25%.

The following are independent scenarios:

1. M purchases L’s capital interest for 600,000.
a. Does the purchase price matter?
b. Why would M want to pay for more than the actual capital balance of L?
2. C and M agrees to pay for L’s capital interest equally by paying 250,000 each.
a. What is then new net income allocation?
3. L is bought out using partnership assets amounting to:
a. 450,000
b. 600,000
c. 300,000

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

DISSOLUTION OF THE PARTNERSHIP

Art. 1839. In settling accounts between the partners after dissolution, the following rules shall be
observed, subject to any agreement to the contrary:

(1) The assets of the partnership are:

(a) The partnership property,

(b) The contributions of the partners necessary for the payment of all the liabilities specified in No. 2.

(2) The liabilities of the partnership shall rank in order of payment, as follows:

(a) Those owing to creditors other than partners,

(b) Those owing to partners other than for capital and profits,
(c) Those owing to partners in respect of capital,
(d) Those owing to partners in respect of profits.

(3) The assets shall be applied in the order of their declaration in No. 1 of this article to the satisfaction of
the liabilities.

(4) The partners shall contribute, as provided by article 1797, the amount necessary to satisfy the
liabilities.

(5) An assignee for the benefit of creditors or any person appointed by the court shall have the right to
enforce the contributions specified in the preceding number.

(6) Any partner or his legal representative shall have the right to enforce the contributions specified in
No. 4, to the extent of the amount which he has paid in excess of his share of the liability.

(7) The individual property of a deceased partner shall be liable for the contributions specified in No. 4.

(8) When partnership property and the individual properties of the partners are in possession of a court
for distribution, partnership creditors shall have priority on partnership property and separate creditors
on individual property, saving the rights of lien or secured creditors.

(9) Where a partner has become insolvent or his estate is insolvent, the claims against his separate
property shall rank in the following order:

(a) Those owing to separate creditors;

(b) Those owing to partnership creditors;
(c) Those owing to partners by way of contribution. (n)

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana

Example:

The following is the balance sheet of CML company at the end of the year:
Cash 100,000 Advances by M 100,000
Advances to C 100,000 Payable to 3rd parties 350,000

Other Non-Cash Assets 800,000 C, Capital 250,000

M, Capital 200,000
L, Capital 100,000

Net income/loss is allocated as follows: C – 45%, M – 30%, L – 25%. They then decide to dissolve the
partnership.

Prepare the schedule of cash payments with the following independent scenarios:
1. Other non-cash assets are sold for:
a. 800,000
b. 1,000,000
c. 600,000
2. Other non-cash assets are sold for 200,000:
a. All partners are solvent.
b. L has personal assets amounting to 100,000 and liabilities amounting to 50,000.
c. L has personal assets amounting to 100,000 and liabilities amounting to 70,000.

Course Notes BA 99.2 – 2nd Semester 2019-2020 mbmagana