PARTNERSHIP FORMATION

There are no authoritative pronouncements concerning the accounting for partnership. The
principles described have evolved through accounting practice.

Partnership Formation
The partnership is a separate accounting entity (not to be confused with a separate
legal entity), and therefore its assets and liabilities should remain separate and distinct from the
individual partner’s personal assets and liabilities.
All assets contributed to the partnership are recorded by the partnership at their fair
market values. All liabilities assumed by the partnership are recorded at their present
values.
Upon formation, the amount credited to each partner’s capital account must be equal to
the amount of cash contributed or equal to the fair market value of the noncash contributed or
equal to the difference between the fair market value of the assets (including goodwill, if any)
contributed and the present value of the liabilities assumed from the partner. The capital
accounts represent the residual equity of the partnership. The capital account of each partner
reflects all of the activity of an individual partner; contributions, withdrawals, and the
distributive share of net income (loss). In some cases, a drawing account is used as a clearing
account for each partner’ transactions with only the net effect of each period’s activity shown in
the capital account.

Example: Partnership Formation

A and B form a partnership. A contributes cash of P50,000, while B contributed land with a fair
market value of P50,000 and the partnership assumes a liability on the land of P25,000.
The entry to record the formation of the partnership is
Cash P50,000
Land 50,000
Liabilities P25,000
A, capital 50,000
B, capital 25,000
Sometimes, a partner will contribute intangible benefit to the partnership like good
management skills, good business reputation, business connections, or anything that will bring
in higher income to the business. The partners may agree to quantify this in the form of either
goodwill or bonus.

Example: C and D agreed to form a partnership, with C contributing P100,000 cash and D
contributing P150,000 cash. The partners agreed that C will also contribute an intangible
benefit to the business for C to have an initial equal interest in the partnership.

If the bonus method is to be used, the entry in the partnership books must be:
(1) To record the initial contribution of partners:
Cash P250,000
C, Capital P100,000
D. Capital 150,000

(2) To record the bonus recognized:

D, Capital P25,000
C, Capital P25,000

If the goodwill method is to be used, the entry in the partnership books must be:
(1) To record the initial contribution of partners:
Cash P250,000
C, Capital P100,000
D. Capital 150,000
(2) To record the goodwill recognized:
Goodwill P50,000
C, Capital P50,000

The use of either method must be explicitly stated in the problem, otherwise the use of bonus
method is preferable over goodwill method.

Sometimes, two or more single proprietorships may wish to combine their businesses and agree
to form a partnership. In this case, the assets and liabilities of the sole proprietors are normally
restated or revalued to their fair values in order to adjust their capital accounts prior to
recording their contributions in the partnership books. The restated or revalued capitals are now
the partners’ initial contribution.

Example: Mr. T and Mr. D decided to form a partnership on January 3, 20x8, to be called the
TD Merchandising. The following are their respective balance sheets immediately before the
formation:
T Store
Balance Sheet
December 31, 20x7
Assets Liabilities and Capital
Cash P130,000 Accounts Payable P125,000
Accts. Receivable 100,000 T, Capital 355,000
Merchandise Inventory 200,000
Furniture 50,000_ _______
Total P 480,000 Total P480,000

D Store
Balance Sheet
December 31, 2017
Assets Liabilities and Capital
Cash P 15,000 Accounts Payable P 15,000
A/R P40,000 Notes Payable 20,000
Less: ADA 4,000 36,000 D, Capital 79,500
Merchandise Inventory 50,000
Furniture P15,000
Less: A/D 1,500 13,500 ________
Total P114,500 P114,500

The two partners agree to the following adjustments:

1. That P20,000 of Mr. Trump’s accounts receivable be written off.

2. That Mr. T’s furniture has a market value of P40,000.

3. That accrued expenses of P25,000 be recognized on Mr. T’s books.
4. Mr. D’s estimated uncollectible accounts should be 5% of the outstanding accounts
receivable.
5. The fair value of Mr. D’s furniture is P12,000.
6. Total partners’ equity should be P400,000 with Mr. T’s interest
representing 75%.
The most likely question will be how much capital must be recorded in the partnership
books. Then your answer must be P300,000 for Mr. T and P100,000 for Mr. D. The
partnership balance sheet immediately after its formation will be presented as follows:

TD Merchandising
Balance Sheet
January 3, 20x8

Assets Liabilities and Capital

Cash P145,000 Accounts Payable P140,000
Accts. Rec. 120,000 Notes Payable 20,000
Less: ADA 2,000 118,000 Accrued Expenses 25,000
Merchandise Inventory 250,000 T, Capital 300,000
Furniture 52,000 D, Capital 100,000
Goodwill 20,000 _
Total P585,000 P585,000

DISCUSSION PROBLEMS

Problem 1
On March 1, 2020, JM and KK formed a partnership with each contributing the following assets:
JM KK
Cash P300,000 P700,000
Machinery and Equipment 250,000 750,000
Building - 2,250,000
Furniture and Fixtures 100,000 -

The building is subject to mortgage loan of P800,000, which is to be assumed by the partnership
agreement provides that JM and KK share profits and losses 30% and 70%, respectively.
On March 1, 2020 the balance in KK's capital account should be:
A. 3,700,000 C. 2,900,000
B. 3,045,000 D. 2,485,000

Assume that the mortgage loan is not assumed by the partnership and the partners agree to withdraw or
contribute additional cash to make their capital balances agree with their profit and loss ratio.
On March 1, how much cash should be invested/(withdrawn) by KK?
A. (1,215,000) C. (655,000)
B. (415,000) D. 655,000

Problem 2
On October 1, 2020, Jack and Jill pooled their assets to form a partnership, with the firm to take over the
business assets and assume the liabilities. The partners capital are to be based on the net assets
transferred after the following adjustments.

Jill’s invenory is to be increased by P40,000; an allowance for doubtful account of P10,000 and P15,000
are to be set up in the books of Jack and Jill respectively; and asccrued expenses of P40,000 is to be
recognized in Jack’s Books. The partners agree to allocate profits and losses equally.

The individual trial balances on October 1, before adjustment follow:

Jack Jill
Assets 750,000 1,130,000
Liabilities 50,000 345,000

What is the capital of Jack and Jill after the above adjustments?
Jack Jill Jack Jill
A. 650,000 760,000 C. 687,500 772,500
B. 650,000 810,000 D. 750,000 810,000

What is the total assets of the partnership after the formation?

A. 1,460,000 C. 1,895,000
B. 1,855,000 D. 2,000,000

Problem 3
The business assets of Cee and Dee appear below:
Cee Dee
Cash 11,000 22,354
Accounts receivable 234,536 567,890
Inventories 120,035 260,102
Land 603,000 -
Building - 428,267
Furniture and fixtures 50,345 34,789
Other assets 2,000 3,600
Total 1,020,916 1,317,002

Accounts payable 178,940 243,650

Notes payable 200,000 345,000
Cee, Capital 641,976
Dee, Capital 728,352
Total 1,020,916 1,317,002

Cee and Dee agreed to form a partnership by contributing their respective assets and equities subject to
the following adjustments:
a. Accounts receivable of P20,000 in Cee’s books and P35,000 in Dee’s books are uncollectible.
b. Inventories of P5,500 and P6,700 are worthless in Cee’s and Dee’s respective books.
c. Other assets of P2,000 and P3,600 in Cee’s and Dee’s respective books are to be written off.

What are the capital accounts of the partners after the adjustments?
Cee Dee Cee Dee
A. 614,476 683,052 C. 640,876 683,052

B. 615,942 717,894 D. 640,876 712,345

How much total assets does the partnership have after the formation?
A. 2,237,918 C. 2,265,118
B. 2,337,918 D. 2,365,218

Problem 4
On March 1, 2020, EE and FF decided to combine their business and form a partnership. Their balance
sheets onMarch 1 before adjustments showed the following:
EE FF
Cash 90,000 37,500
Accounts receivable 185,000 135,000
Inventories 300,000 195,000
Furniture and fixtures 350,000 100,000
Accumulated depreciation 50,000 10,000
Office equipment 115,000 27,500
Prepaid expenses 63,750 30,000
Total 1,053,750 515,000

Accounts payable 457,500 180,000

EE, Capital 596,250
FF, Capital 335,000
Total 1,053,750 515,000

They agreed to have the following items recorded in their books:

1. Provide 2% allowance for doubtful accounts.
2. EE’s furniture and fixtures should be P310,000, while FF’s office equipment is under-
depreciated by P2,500.
3. Rent expense incurred previously by EE was not yet recorded amounting to P10,000, while
salary expenses incurred by FF amounting to P8,000 was also not recorded.
4. The fair value of EE’s anf FF’s inventory amounted to P295,000 and P210,000 each
respectively.

Compute the net (debit)/credit adjustment for EE anf FF.

EE FF EE FF
A. 28,700 28,200 C. (8,700) 1,800
B. (28,700) (28,200) D. 8,700 (1,800)

Compute the total assets after the formation.

A. 1,607,650 C. 1,579,850
B. 1,570,850 D. 1,568,750

If the partners are to share profits and losses in the ratio of 6:4 and their capital is top reflect this
relationship, what is the capital of FF after the formation?
A. 400,000 C. 369,740
B. 391,700 D. 391,700

If If the partners are to share profits and losses in the ratio of 6:4 and their capital is top reflect this
relationship with EE’s capital to be used as basis, what is the capital of FF after the formation?
A. 400,000 C. 369,740

B. 391,700 D. 391,700

Problem 5
As of July 1, 2020, MM and AA decided to form a partnership. Their balance sheets on this date are:
MM AA
Cash P 15,000 P 38,000
Accounts Receivable 680,000 255,000
Allowance for doubtful accounts (140,000) (30,000)
Merchandise Inventory - 202,000
Machinery and Equipment 150,000 270,000
Total P705,000 P735,000

Accounts Payable 135,000 240,000

MM, capital 570,000
AA, capital - 495,000
Total P705,000 P735,000

The partners agreed that the machinery and equipment of MM is under depreciated by P15,000 and that of
AA by P45,000. Allowances for doubtful accounts is to be set up amounting to P120,000 for MM and
P40,000 for AA. The partnership agreement provides for the profit and loss ratio and capital interest of
60% to MM and 40% to AA with AA’s capital as base. How much cash must MM invest to bring the
partner's capital balances proportionate to their profit and loss ratio?

Problem 6
Z admits A as a partner in business. Accounts in the ledger for Z on November 20, 2018, just before the
admission of A, show the following balances:

Cash P 6,800
Accounts Receivable 14,200
Merchandise Inventory 20,000
Prepaid expense 1,000
Accounts Payable 9,000
Z, Capital 33,000

It is agreed that the purposes of establishing Z's interest the following adjustments shall be made:
a) An allowance for doubtful accounts of 3% of accounts receivable is to be established
b) The merchandise inventory is to be valued at P23,000.
c) Prepaid salary expenses of P600 and accrued rent expense of P800 are to be recognized.
A is to invest sufficient cash to obtain a 1/3 interest in the partnership.

(1) Z's adjusted capital before the admission of A; and (2) the amount cash investment by A:

Problem 7
On March 1, 2018, X and Y formed a partnership. The partners contributed the following:
X Y
Cash P500,000 P400,000
Accounts Receivable 300,000 200,000
Allowance for doubtful accounts 50,000 20,000
Inventory 150,000 100,000
Equipment 500,000 200,000

Accumulated depreciation 100,000 25,000

Accounts Payable 50,000 400,000
Note Payable 200,000
The partners agree on the following:
a. P10,000 of the accounts receivable of X is to be written-off.
b. An allowance for doubtful accounts of 15% is to be established on the remaining receivables of X
and Y.
c. The inventory of Y is to be valued at P140,000.
d. The equipment of X is under depreciated by P20,000 and the equipment of Y has a fair value of
P190,000.
e. The note of X is dated December 1, 2017 and is subject to a 12% interest . Interest had not yet
been accrued.
f. The partners agree on a 2:1 profit and loss ratio.
g. The partners agree to bring their capital balance proportionate to their profit and loss ratio.

If Y's Capital is to be used as basis, how much is the adjusted capital of X after the formation?

What is the total assets of the partnership immediately after the formation?

If the goodwill method is to be used in determining the capital of each partner, how much is the
adjusted capital of Y after the formation?

Problem 8
April, May and June decided to form a partnership on January 1, 2018 to operate a retail store. April and
May both owned a retail store with the following account balances:

APRIL MAY
Cash 5,000,000 10,000,000
Receivables 10,000,000 15,000,000
Inventories 35,000,000 20,000,000
PPE 25,000,000 5,000,000
Accounts Payable 20,000,000 10,000,000
Notes Payable 15,000,000 25,000,000
(10%) (5%)
Capital 40,000,000 15,000,000

The following are to be taken up by the partnership:

a. April and May will contibute all their assets and liabilities in the newly formed partnership.
b. The parties agree to provide a 10% and 20% allowance for bad debts on the receivables of April
and May.
c. The inventories of April and May have fair values of P30,000,000 and P22,500,000, respectively.
d. The PPE of April and May have never been depreciated and should be depreciated by 40% and
30%, respectively.
e. The interest payable on both notes payable were unrecorded and unpaid since the date of contract.
April’s note payable is dated April 1, 2017 while May’s note payable is dated June 30, 2017.
f. June shall have a 20% interest in the partnership upon contribution of sufficient cash.

What is the amount of cash to be contributed by June on January 1, 2018?