CMPC 131 Accounting for Special Transactions Accounting for the Equity of a Partnership

 Formation – for initial investments to the partnership

CHAPTER 1 PARTNERSHIP FORMATION  Operations – division of profits or losses
Partnership – an unincorporated association of two or more individuals to  Dissolution – admission of a new partner and withdrawal. Retirement or
carry on, as co-owners, a business, with the intention of dividing the death of partner
PROFITS among themselves.  Liquidation – winding-up of affairs
General Partnership – all partners are individually liable
Limited Partnership – at least one partner is personally liable PARTNERSHIP FORMATION
Partnership Sole Corporation Joint Venture - It is created by the agreement of the partners (consensual) which may
Proprietorship be constituted in any form (oral or written). It will be made in a public
- Owned by two or - Owned by - Created by the - May or may instrument and recorded in the Securities and Exchange Commission in
more individuals only one operation of law not be formed instances of: 1) immovable or real rights are contributed to the
- Created by individual for an partnership; 2) the partnership has a capital of 3,000 pesos or more.
agreement between undertaking - The inventory of any immovable property contributed to the
the parties that is to be partnership should be made, signed by the parties and attached to the
- Formed for a continued public instrument. Otherwise, the partnership shall be deemed void.
business undertaking over several - A partnership’s legal existence begins from the moment the contract is
normally of years. executed, unless it is otherwise stipulated.
continuing nature
Valuation of Contribution of Partners
Characteristics of Partnership - All assets contributed to (and related liabilities assumed by) the
a. Ease of formation partnership are initially measured at fair value.
b. Separate legal responsibility
c. Mutual agency Type of contribution Measurement
d. Co-ownership of property
Cash and cash equivalents Face amount
e. Co-ownership of profit
Inventory Net Realizable Value (estimated
f. Limited life
selling price less costs to complete
g. Transfer of ownership
and sell), if lower than cost
h. Unlimited Liability
Non-cash assets a. Agreed Value
b. Fair Value
Advantages Disadvantages
Industry Memo entry is prepared
Ease of formation Easily dissolved/limited life
- A partner’s subsequent share in profits (losses) shall also be credited
Shared responsibility of running the Unlimited liability
(debited) to his capital account.
business
Flexibility in decision making Conflict among partners
- PERMANENT WITHDRAWALS of capital are debited to the partner’s
capital account. TEMPORARY WITHDRAWALS may be debited to the
Greater capital than sole Lesser capital than corporation
partner’s drawings account.
proprietorship
Relative lack of regulation by the Taxed like a corporation - The sum of the balances in the partner’s individual capital accounts
government than corporation represents the total equity of the partnership.
 Juan Dela Cruz, Capital (Real account) CHAPTER 2 PARTNERSHIP OPERATIONS
Debit Credit (normal balance) - Profit and Loss shall be shared according to:
Permanent withdrawals of capital Initial investment 1. Agreed Ratio
Share in losses Additional investments 2. If there is no agreement of distribution of loss but there is
Debit balance of drawings account Share in profits agreement of ratio of profit, same with profit.
3. If there is no stipulation, it shall be proportionate of they have
Juan Dela Cruz, Drawings (Nominal account) contributed.
Debit (normal balance) Credit - Industrial partners do not absorb loss.
Temporary withdrawals during the Recurring reimbursable costs paid
period by the partner
Salaries
Temporary funds held to be
remitted to the partnership
- This could be in fractional year.
- Always given to partners, regardless of the result of operation.
Receivable from/Payable to a partner Interest
- RECEIVABLE is recorded as the loan extended by the partnership TO a - This could be in fractional year.
partner. PAYABLE is recorded as the loan obtained by the partnership - Always given to partners, regardless of the result of operation.
FROM the partner. Bonus
- Given if there is profit only.
Bonus on initial investments - If profit after salaries and interest is a loss, it is not given.
- BONUS is the excess or deficiency if the partner’s capital balance is
credited for an amount greater than or less than the fair value of his net B = Bonus
contribution. Under the bonus method, any increase or decrease in the P = Profit
capital credit of a partner is deducted from or added to the capital I = Interest
credits of the other partners. The total partnership capital remains
S = Salaries
equal to the fair value of the partners’ net contributions to the
Br = Bonus Rate
partnership.

Variations to the bonus method Bonus after bonus

- A partnership agreement may stipulate a certain ratio to be maintained P
B=P−
by the partners representing their specific interests in the equity of the 1+ Br
partnership. Technically, there will be no “bonus” given to a certain Bonus based on Profit after Interest, Salaries, and Bonus
partner. Any increase or decrease to the capital credit of a partner is not P−I −S
B=( P−I −S)−
deducted from his co-partners’ capital accounts. The adjustment is 1+ Br
accounted for as either:
o Cash settlement among the partners;
Bonus based on Profit after Interest and Salaries
o Additional investment or withdrawal of investment of partner
B=( P−I −S)
- The cash settlement among the partners is not recorded in the
partnership’s books because this is not a transaction of the partnership
but rather a transaction among the partners themselves.
CHAPTER 3 PARTNERSHIP DISSOLUTION  Total capital remains the same.
Major Considerations in Partnership Dissolution  There is no gain or loss.
1. Admission of a partner
2. Withdrawal, retirement or death of a partner RETIREMENT/DEATH OF A PARTNER
3. Incorporation of a partnership Purchase of interest by partnership:
 Adjust the capital(e.g. Profit/Loss, Revaluation, Withdrawals)
ADMISSION OF A PARTNER before retirement.
By purchase:  If the settlement is greater than the capital of retiring partner,
 There is no gain or loss. there is bonus to retiring partner.
 Transfer between capital accounts only.  If the settlement is lower than the capital of retiring partner,
 Payment happened between the partners and is not recorded in there is bonus to retiring partner.
the books of the partnership.  The settlement is recorded in the books of partnership.
 The amount of the capital before admission is the same after  Partnership capital is decreased.
admission.  There is no gain or loss.
 If there is a revaluation, only the old partners receive gain on  In a situation of a death of a partner, a liability account should be
their capital. credited with the amount of settlement.

By investment: INCORPORATION OF A PARTNERSHIP

 Any payment is recorded in the partnership books.
 Transaction is between new partner and partnership.
 No gain or loss.
 The amount of total capital is changed (agreed capital).
 If the credited amount of capital of new partner is greater than
his investment, there is a bonus. The excess will be debited to old
partners’ capital accounts according to P/L ratio.
 If the credited amount of capital of new partner is lower than his
investment, there is a bonus to the old partners. The excess will
be credited to old partners’ capital accounts according to P/L
ratio.
 Partners’ capital balances are adjusted because of revaluation and
profit or loss.
 Determine the par value of a share and then determine the
number of shares to distributed to each partners who will become
stockholders.
If the adjusted capital is greater than the total par value of shares
issued, there will be share premium credited.

WITHDRAWAL OF A PARTNER
Purchase of interest by remaining partners:
 The debited amount of withdrawing partner will be distributed
and credited to remaining partners according to P/L Ratio.
 The consideration given to the withdrawing partner is ignored and
not recorded in partnership books.
CHAPTER 4 PARTNERSHIP LIQUIDATION after the full settlement of the
LIQUIDATION liabilities to outside creditors.
- The termination of business operations or the winding-up of affairs. It is 6. Any remaining cash is 6. If both the liabilities to outside
the process by which: distributed to the owners in full and inside creditors are fully settled,
o Assets are converted into cash settlement of their interests. any remaining cash less cash set
o Liabilities are settled aside for future liquidation expenses
o Any remaining amount is distributed to the owners is distributed to the owners as
- May either be voluntary (e.g., agreement of the partners) or involuntary partial settlement of their interests.
(e.g., bankruptcy).
Doctrine of marshalling of assets
Methods of Liquidation - Applied when the partnership and some of the partners are insolvent.
1. Lump-sum liquidation 1. Available assets of the partnership are used to settle the
2. Installment Liquidation partnership’s liabilities.
2. In case the assets of the partnership are insufficient to pay all
Settlement of claims in order of priority liabilities, the solvent general partners are required to provide
1. Outside creditors additional funds from their personal assets (only up to the excess of
2. Inside creditors (e.g., payable to partners) their personal assets and personal liabilities).
3. Owner’s capital balances 3. In case some partners are insolvent, their capital deficiency is offset
*Right to offset to the capital balances of the other partners. If after allocating the
- Allows a deficit in a partner’s capital account to be offset by a loan capital deficiency of an insolvent partner, a solvent partner’s capital
payable to that partner. balance results to a negative amount, the solvent partner is
required to provide additional contribution.
Procedure of Liquidation
Lump-sum Installment Non-cash asset used as payment for claim
1. ALL of the non-cash assets are 1. Some of the non-cash assets are - If a creditor or a partner agrees to receive non-cash assets as settlement
converted to cash. converted into cash. of his claim, the non-cash assets is considered sold at the amount
2. The total gain or loss on the sale 2. The carrying amount of any agreed to be debited to the creditor’s or partner’s claim.
is allocated to the partner’s unsold non-cash asset is considered - The difference between the carrying amount of the non-cash asset and
capital balances based on their as a loss. This is allocated to the the agreed settlement amount is treated as either gain or loss to be
P/L ratios. partners’ capital balances based on apportioned to all of the partner’s capital balances.
their P/L ratios.
3. Actual liquidation expenses are 3. Actual and estimated future Safe Payment Schedule
allocated to the partners’ capital liquidation expenses are allocated to - May be used as supporting information in the Statement of Liquidation
balances based on their P/L the partners’ capital balances based that shows how much cash can be “safely” paid to the partners during
ratios. on their P/L ratios. installment liquidation, which avoids overpayment.
4. The liabilities to outside 4. The liabilities to outside creditors - Maximum loss possible is the sum of:
creditors are fully settled. are partially or fully settled. o Unsold non-cash assets
5. The liabilities to inside creditors 5. The liabilities to inside creditors o Expected future liquidation costs and potential unrecorded
are fully settled. are partially or fully settled but only liabilities

Cash priority program (Cash distribution program)
- Determines which partner shall be paid first and which partner shall be
paid last, after all the liabilities are settled.
- Ranking the partners in accordance with their Maximum Loss
Absorption Capacity (MLAC). The partner with the highest MLAC shall be
paid first and the lowest shall be paid last.
- When all of the priorities are paid, any remaining cash distribution is
allocated to the partners based on their respective P/L ratios.
MLAC = Total partner’s interest in the partnership ÷ Partners P/L percentage
CHAPTER 5 CORPORATE LIQUIDATION AND REORGANIZATION
- There is financial difficulty (A<L) because of insolvency.
- VOLUNTARY INSOLVENCY – the insolvent corporation voluntarily applies
a petition to a court of law to be discharged from its liabilities.
- INVOLUNTARY INSOLVENCY – three or more creditors of the insolvent
corporation file a petition to a court of law for the adjudication of the
corporation as insolvent.
- Measurement is based on realizable value.
o Assets – estimated selling price less estimated costs to sell
o Liabilities – expected net settlement amount
Liquidation Financial Reports
1. Statement of Affairs
- In lieu of Balance Sheet
- Assets and liabilities are restated at their realizable values
- ASSETS:
o Assets pledged to fully secured creditors – assets with realizable
values equal to or greater than the realizable values of the
related liability for which they have been pledged as security.
o Assets pledged to partially secured creditors – assets with
realizable values less than the realizable values of the related
liability for which they have been pledged as security.
o Free assets – assets that have not been pledged as security of
liabilities. Also include the excess of realizable values of assets
pledged to fully secured creditors over the realizable values of
the related liabilities for which they have been pledged.
- LIABILITIES:
o Unsecured liabilities with priority – liabilities that although not
secured by any asset, are mandated by law to be paid first
before any other unsecured liabilities.
o Fully secured creditors – liabilities secured by assets with
realizable values equal to or greater than the realizable values
of such liabilities
o Partially secured creditors – liabilities secured by assets with
realizable values less than the realizable values of such liabilities
o Unsecured liabilities without priority – all other liabilities not
classified in the items above
2. Statement of Realization and Liquidation
- Summarizes assets (realization) and obligations (liquidation)
Debits Credits
Assets to be realized, excluding cash Assets realized
Assets acquired Assets not realized
Liabilities liquidated Liabilities to be liquidated
Liabilities not liquidated Liabilities assumed
Supplementary expenses Supplementary income
REORGANIZATION
- The implementation of a business plan to restructure or rehabilitate a
corporation with the hopes of increasing company value.
- Involves changing the entity’s capital structure
1. Group Reorganization – ownership within a group of companies changes
due to new acquisitions, buyouts, takeovers and other forms of changes
2. Recapitalization – change in the capital structure of an entity by the
cancellation of old shares and issuance of new shares as replacement.
a. Change from par to no-par or vice-versa
b. Reduction of par value or stated value
c. Share splits or reverse splits
3. Quasi-reorganization – financially troubled corporation with favourable
future prospects is permitted but not required, to revalue its assets and
liabilities, and realign its equity, subject to the provisions of relevant
regulations
4. Corporate Rehabilitation – the entity is administered by another party in
order to bring back the entity to its former financial condition and
solvency
5. Troubled Debt Restructuring – the creditor grants the debtor
concession. Effected through (a) asset swap, (b) equity swap, or (c)
substantial modification of the terms of debt.