Partnership: Basic

Considerations and
Formation

Advance Accounting
Partnership Definition
- A contract whereby two or more persons bind
themselves to contribute money, property, or industry
to a common fund, with the intention of dividing the
profit among themselves

- A contract is a meeting of minds between two

persons whereby one binds himself, with respect to the
other, to give something or to render some service.
3 Distinct Factors in
Partnership Definition
1. Association of two or more persons
- The persons are usually individuals
- Any natural person who possesses the right to enter
into a contract can become a partner
2. To carry on as co-owners
- A partnership is an aggregation of partners’
individual rights
- All partners are co-owners of partnership property
and are co-owners of the profits or losses of the
partnership
3 Distinct Factors in
Partnership Definition
3. Business for profit
- A partnership may be formed to perform any legal
business, trade or profession or other service
- The partnership must attempt to make a profit,
therefore, non-profit organizations may not be
partnerships
Characteristics of a Partnership
1. Separate Legal Personality
- Partnership has a judicial personality separate and
distinct from that of each of the partners

2. Ease of Formation
- The formation of a partnership does not require as
many formalities as a corporation
- The partnership may be created by oral or written
agreement
Characteristics of a Partnership
3. Co-ownership of Partnership Property and Profits
- All assets invested in the partnership become the
property of the partnership
- The right of each partner to possess partnership
property for partnership purposes is equal to the right
of each partner
- Each partner has a proprietary interest in the
partnership; this interest refers to each partner’s share
in the earnings and in the capital
Characteristics of a Partnership
4. Limited Life
- Any change in the agreement of the partners
terminates the partnership contract
- A partnership may also expire any time when there is
a change in the relationship of the partners due to the
death, withdrawal, bankruptcy or incapacity of a
partner
Characteristics of a Partnership
5. Mutual Agency
- 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
- Each partner is a principal as well as an agent of the
partnership
Characteristics of a Partnership
6. Unlimited Liability
- Each partner may be held personally liable for all the
debts of the partnership
- All of his business and personal properties may be
used for the settlement of partnership liabilities
- Exception to this is the limited partnership, wherein
certain partners are allowed to limit their personal
liabilities to the extent of their capital contributions
only
Partnership Agreement
Significant Points
1. Names of the partners, and the name and nature of
the partnership
2. The date on which the partnership contract takes
effect and the duration of the contract
3. The capital to be invested by each partner, the
procedure for valuing noncash contributions, the
treatment of any contribution (whether as capital or as
loan) in excess of agreed amounts, and the penalties
for failure to contribute and maintain the agreed
amount of capital
Partnership Agreement
Significant Points
4. The authority, the rights and duties of each partner
5. The accounting period to be used, the nature of
accounting records, preparation of financial statements
and auditing of partnership books
6. The method of sharing profits and losses including
the frequency of income measurement and distribution
to partners
Partnership Agreement
Significant Points
7. The drawings or salaries to be allowed to each
partner and the disposition of partner’s salary and
drawing accounts including the penalties, if any, for
excessive withdrawals
8. Provision of the arbitration of disputes and the
liquidation of the partnership at the termination of the
agreed time including those concerning the
contingency of partner’s death

* Contents in Articles of Co-Partnership

Advantages of a Partnership
- It is easy and inexpensive to organize compared with
a corporation.
- The unlimited liability of the partners makes it
reliable from the point of view of the creditors.
- The combined personal credit of the partners offers
better opportunity for obtaining additional capital than
does a sole proprietorship.
Advantages of a Partnership
- The participation in the business by more than one
person makes possible for a closer supervision of all
its activities.
- The direct gain to the partners is an incentive to give
close attention to the business.
- The personal element in the character of the partners
is retained.
Disadvantages of a Partnership
- The personal liability of a partner for partnership
debts deters many from investing capital in a
partnership.
- A partner may be subject to a personal liability for
the wrongful acts or omissions of his associates.
- It is less stable because it can be easily dissolved.
- There is divided authority among the partners.
Disadvantages of a Partnership
- There is a constant likelihood of dissension and
disagreement when each of the partners has the same
authority in the management of the partnership.
- There is difficulty in disposing of interest since no
formal established marketplace exists for the sale of
partnership interest.
Kinds of Partnerships
1. As to Activity
a. Trading partnership
- One whose main activity is the manufacture or the
purchase and sale of goods

b. Non trading partnership

- One organized for the purpose of rendering services
Kinds of Partnerships
2. As to Object
a. Universal partnership of all present property
- All contribution becomes part of the partnership fund
b. Universal partnership of profits
- All that the partners may acquire by their industry or
work during the existence of the partnership and the
use of whatever partners contributed belongs to the
partnership
c. Particular partnership
- The object is determinate
Kinds of Partnerships
3. As to Liability
a. General
- All partners are liable to the extent of their separate
properties

b. Limited
- The limited partners are liable only to the extent of
their personal contributions
Kinds of Partnerships
4. As to Duration
a. Partnership with fixed term or for particular
undertaking

b. Partnership at will
- No term specified
Kinds of Partnerships
5. As to Representation to Others
a. Ordinary partnership
- One which actually exists among the partners and
also as to third persons

b. Partnership by estoppel
- One which in reality is not a partnership but is
considered a partnership only in relation to those who
by their conduct or omission are precluded to deny or
disprove the partnership’s existence
Kinds of Partnerships
6. As to Legality of Existence
a. De Jure Partnership
- Complied with all legal requirements

b. De Facto Partnership
- Failed to comply with all legal requirements
Kinds of Partnerships
7. As to Publicity
a. Secret partnership
- One wherein the existence of certain persons as
partners is not made known to the public by any of the
partners

b. Open partnership
- One wherein the existence of certain persons as
partners is made known to the public by the members
of the firm
Kinds of Partners
1. General - one who is liable to the extent of his
separate property after all the assets of the partnership
are exhausted
2. Limited - liable only to the extent of their capital
contributions
3. Capitalist - contributes money or property to the
common fund of partnership
4. Industrial - contributes his knowledge or personal
service
Kinds of Partners
5. Managing partner - whom the partners appointed as
manager
6. Liquidating - one who is designed to wind up or
settle the affairs of the partnership after dissolution
7. Dormant - who does not take active part in the
business and is not known as partner
8. Silent - does not take active part in the business
though known as partner
Kinds of Partners
9. Secret - takes active part in the business but is not
known by outside parties
10. Nominal or Partner by estoppel - not actually a
partner but who represents himself as one
11. Capitalist industrial partner - one who contributes
money, property and industry
Partner’s Ledger Accounts
- In a partnership, although it is possible to operate
with only one equity account for each partner, it is
desirable that the following partner’s accounts be
maintained:
1. Capital accounts
2. Drawing or personal accounts
3. Account for loans to or from partners
Capital Account Credit
1. Original investment

2. Additional investment

3. Partner’s share in the profits

(Sometimes this is closed to the drawing account)
Capital Account Debit
1. Permanent withdrawal of capital

2. Debit balance of the drawing account at the end of

the period

3. Partner’s share in the losses

(Sometimes this is closed to the drawing account)
Drawing Account Credit
1. Partnership obligations assumed or paid by the
partner

2. Personal funds or claims of partner collected and

retained by the partnership

3. Periodic partner’s salaries depending on the

accounting and disbursement procedures agreed upon
Drawing Account Debit
1. Withdrawal of assets by the partners in anticipation
of net income

2. Partner’s personal indebtedness paid or assumed by

the partnership

3. Funds or claims of partnership collected and

retained by the partner
Permanent/Temporary Withdrawals
- Normally, increases or decreases in capital that are
interpreted as permanent capital changes are recorded
directly in the capital account. Withdrawals which are
considered equivalent to salaries made by the partner
in anticipation of profits and other increases or
decreases of relatively minor amounts are recorded in
the drawing account.
Loans To and From Partners
- A withdrawal by a partner of a substantial amount
with the assumption of its repayment to the firm may
be debited to a Receivable from Partner account rather
than to the partner’s drawing account. On the other
hand, an advance to the partnership by a partner with
the assumption of its ultimate repayment by the
partnership is viewed as a loan rather than as an
increase in the capital account.
Formation of Partnership
1. Two individuals form a partnership

2. One individual and a sole proprietor form a

partnership
a. Use the books of the sole proprietor
- Adjust the books of sole to their fair values to his
capital as agreed by the partners.
- Record the investment of individual.
Formation of Partnership
b. New books for the partnership is opened
- Adjust the books of sole to their fair values to his
capital as agreed by the partners.
- Close the books of sole.
- Record the investment of sole, his assets and
liabilities from the books previously closed.
- Record the investment of individual.
Formation of Partnership
3. Two sole proprietors form a partnership
a. Use the books of one of the sole proprietors
- Adjust the books of each sole to their fair values as
agreed by the partners.
- Close the books of the sole that will not be used by
the partnership.
- Record the investment of the sole that was
previously closed, his assets and liabilities.
Formation of Partnership
b. New books for the partnership is opened
- Adjust the books of each sole to their fair values as
agreed by the partners.
- Close the books of each sole.
- Record the investment of each sole, their respective
assets and liabilities from the books previously closed.
Formation of Partnership
Notes
1. Assets / net assets contributed by the partners are
recorded in the books of partnership at their agreed
values or fair values at the time of contribution.

2. No accumulated depreciation is recorded in the

partnership books relative to non-cash contributions
that were previously depreciated. The agreed value or
fair value represents the cost as basis for future
depreciation by the partnership.
Formation of Partnership
3. When a partner’s contributions include accounts
receivable with corresponding allowance for
uncollectible accounts, both accounts are recorded in
the partnership books. The allowance for uncollectible
accounts is carried in the partnership books because of
the possibility of collection. However, if there are
specific accounts receivable which are deemed
worthless such must be written off and removed
permanently from the accounts receivable in the
partnership books.