ACCT 1103 (Accounting for Specialized Transactions)

Lesson 1: Partnership – Basic Consideration, Formation and Operation

Topics: a. Partnership Definition

b. Characteristics of Partnership
c. Valuation of Partners Contributions
d. Accounting for Partnership Formation
i. Contributed Capital
ii. Capital Credit
iii. Bonus Method
iv. Variations to Bonus Method
e. Partnership Operations
i. Items that can affect the division of a partnership’s profits or
losses among the partners.
ii. Partnership’s profit or loss distribution.

Learning Outcomes: At the end of this module, you are expected to:
a. State how to value the contributions made by each partner.
b. Account for the initial investments of the partners to the partnership.
c. State the items that affect the division of a partnership’s profits or losses
among the partners.
d. Compute for the share of a partner in the partnership’s profit or loss.

LEARNING CONTENT:

Under the Civil Code of the Philippines Art. 1767, a partnership is defined as, ‘by the contract of
partnership, two or more persons bind themselves to contribute money, property or industry to a common fund
with intention of dividing profits among themselves. Two or more persons may also form partnership for the
exercise of profession.’

A contract of partnership is consensual. So, how it becomes a consensual contract? Simply because it
is created by the agreement of the partners which may be constitute in any form, it can be oral or written but
subject to the provisions of Philippine Civil Code Art. 1771 and 1772. Its legal existence begins from the
moment the contract is executed, unless otherwise stipulated.

The following distinguish a partnership from other types of entities:

a. A partnership is owned by two or more individuals while a sole proprietorship is owned by only one
individual.
b. A partnership is created by agreement between partners while a corporation or cooperative is created
by the operation of law.
c. A partnership is formed for a business undertaking that is normally of continuing nature while a joint
venture may or may not be formed for an undertaking that is to be continued over several years.

Now, let’s have a quick review what you have learned before in your Financial Accounting and Reporting when
you are in first year about the characteristics of a partnership and the different class or kinds of partners.

Characteristics of Partnership

1. Ease of formation
2. Separate legal personality
3. Mutual agency
4. Co-ownership of property
5. Co-ownership of profits
6. Limited life
ACCT 1103: Partnership Formation and Operations 1
 7. Transfer of ownership
8. Unlimited liability (this is applicable to a general partnership)

CLASSES OF PARTNERS

1. As to Contribution
a. Capitalist Partner – one who contributes capital in money or property
b. Industrial Partner – one who contributes industry, labor, skill 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 to 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
b. Nominal Partner
c. Ostensible Partner
d. Secret Partner
e. Dormant Partner

Partnership Formation

From the definition of partnership, formation happens when the partners bind themselves to contribute
money, property or industry to a common fund. So the main issue in accounting for partnership formation is
on how we are going value the contributions made by each partner.

So, to deal with the issue, we are going to value the contributions made by each partner in order of priority:

1. All contributed assets MUST be valued at the AGREED VALUE.

2. In the absence of agreed value, use FMV/APPRAISED VALUE (* NOT assessed value)
Note: Add’l guidance from PFRS: a. Cash & C.E = Face Amount
b. Inventory = LCNRV

Then any liability assumed by the partnership will be included in the partnership books.
(* if the problem is SILENT: Liabilities are NOT assumed)

Contributed Capital vs. Capital Credit

Contributed Capital
 These are the contributions made by each partner to the partnerships.
 So here is how you are going to get the contributed capital of each partner:

Contributed Asset (Agreed/FMV/Appraised) xxx

Less: Liabilities assumed by the partnership (xx)
Contributed Capital (CC) xxx

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 Capital Credit/Agreed Capital
 Initial capital of a partner to be recorded in the book of the partnership
 Always based on agreed capital and to compute the capital credit:

Total agreed capital

X Cap. Interest ratio
Agreed Capital (AC)

Note: (*If the problem is SILENT: Contributed capital is equal to capital credit)
Now, problem arises again when the contributed capital is not equal to the capital credit. So, how we are going
to account the difference?

If such is the case, the difference between the capital credit and contributed capital shall be accounted
using the BONUS METHOD.

BONUS METHOD
-any increase or decrease from the contributed capital to correspond with the capital credit or agreed
capital shall be deducted/added to the capital of the other partners.
-Under the bonus method, total agreed capital is equal to total contributed capital (TAC=TCC)

Illustration Problem
A and B agreed to form a partnership. A shall contribute P40,000 cash while B contribute P100,000
cash. However, due to the expertise that A will be bringing to the partnership, the partners agreed that they
should initially have an equal interest in the partnership capital.
Solution:
Contributed Capital Agreed Capital Bonus Method
A 40,000 70,000 30,000
B 100,000 70,000 (30,000)
Total 140,000 = 140,000 0

As you can see above, Total Contributed Capital is equal to Total Agreed Capital and also you can
see how the contributed capital balances of each partner changes to correspond to the agreed capital.

Journal Entries:
Contribution of A
Cash 40,000
A, Capital 40,000

#
Contribution of B
Cash 100,000
B, Capital 100,000
#
Bonus to Partner
B, Capital 30,000
A, Capital 30,000

ACCT 1103: Partnership Formation and Operations 3

Variation to the Bonus Method
-Instead of deduction/addition to the capital of the other partners of the increase or decrease in the
contributed capital to correspond with the capital credit or agreed capital, the capital adjustment is
accounted for as either:
a. Cash settlement among the partners; or
b. Additional investment or withdrawal of a partner

Illustration Problem: Cash settlement among the partners

A, B, and C formed a partnership. Their contributions are as follows:

A B C

Cash 40,000 10,000 100,000

Equipment 80,000

Total 40,000 90,000 100,000

Additional information:
a. C was forced to borrow P40,000 just to have the full amount of P100,000 contribution made to
the partnership.
b. The equipment contributed by B has an unpaid mortgage of P20,000 which assumed by the
partnership.
c. They agreed to have equal initial interest. Cash settlement are to be made among the partners
outside the partnership.
Solution:
A B C Partnership

Cash 40,000 10,000 100,000 150,000

Equipment 80,000 80,000

Mortgage Payable (20,000) (20,000)

Contributed Capital 40,000 70,000 100,000 210,000

Agreed Capital 70,000 70,000 70,000 210,000

Cash receipt(payment) (30,000) 0 30,000

 C shall receive P30,000 from A.

 This cash settlement among partners are not recorded in the partnership books because it is a
personal transaction between partners only.
 The personal loan of C is ignored because it is not assumed by the partnership (Silent).

Journal Entry:
Cash 150,000

Equipment 80,000

Mortgage Payable 20,000

A, Capital 70,000

B, Capital 70,000

C, Capital 70,000

ACCT 1103: Partnership Formation and Operations 4

Illustration: Additional investment or withdrawal of a partner
A and B agreed to form a partnership. The partnership agreement stipulates the following:
 Initial Capital of P140,000.
 A 60:40 interest in the equity of the partnership.

A contributed P100,000 cash while B contributed P40,000 cash. The partners agreed to provide
additional investment or withdraw part of investment in order to bring the partners’ capital credits equal
to their respective interest in the partnership.

Solution: Total Agreed Capital 140,000

A’s required capital balance (140,000 x 60%) 84,000
B’s required capital balance (140,000 x 40%) 56,000

A B Total
Contributed capital 100,000 40,000 140,000
Agreed capital 84,000 56,000 140,000
Add’l Investment (Withdrawal) (16,000) 16,000 -

 A shall withdraw from initial contribution of P16,000 and B shall make an additional investment
of 16,000.

Partnership Operations

In this topic, we are going to deal on how profit and loss will be distributed depending on the agreement or
allocation tool agreed by all of the partners. Given below the rules on how profits or loss will be divided among
the partners.

Division of profits and losses

 First priority, partners shall share in the profits or losses of a partnership in accordance with
the partnership 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. (Art. 1797 of the Philippine Civil Code)
 The designation of losses and profits cannot be entrusted to one of the partners (Art. 1798).
 A stipulation which excludes one or more partners from any share in the profits or losses is
void (Art. 1799).

Other stipulations that affect division of P/L

a. Salaries – normally, an industrial partner shall receive salary, in addition to his share in the
partnership’s profits, as compensation for his services to the partnership.
b. Bonuses – the partnership agreement may stipulate a bonus to be given to a managing
partner to encourage excellent management performance. Unlike for salaries though, a
partner is entitled to a bonus only if the partnership earns profit.
c. Interest on capital contributions – the partnership agreement may stipulate that each partner
may be entitled to a per annum interest computed on his capital contributions.
d. The above-mentioned items are normally provided first to the respective partners and any
remaining amount of the profit or loss is shared based on the stipulated profit or loss ratio.

ACCT 1103: Partnership Formation and Operations 5

 Changes in Capital

Capital beginning xxx

Additional investment xxx
Drawings (permanent/temporary) (xx)
Share in NI (NL) x(x)
Capital ending xxx

Drawings

1. Permanent capital drawings

- Directly affects capital balance
2. Regular/Temporary drawings
- For anticipation for share in share in net income
- Yearly withdrawal

*If net loss is generated, regular/temporary withdrawal is considered as permanent withdrawal.

*If silent, it is permanent.

*** END of LESSON 1***

Note: Assessment is given in the Prelim Assessment folder in this course, kindly answer and solve it
honestly.

REFERENCES

Textbooks

 Millan, Z. V. (2018). Accounting for Special Transactions. Baguio City: Bandolin Enterprise.
 Dayag, A. (2019), Advanced Financial Accounting and Reporting: GIC Enterprises & Co., Inc.

ACCT 1103: Partnership Formation and Operations 6