Partnership Formation

Sherwin B. Santos, CPA

Learning Objectives
• Differentiate between the accounting for partnerships, sole
proprietorships and corporations
• State the valuation of contributions of partners
• Account for the initial investments of the partners to the partnership
• State the peculiar accounts used in a partnership and identify the
transactions that affect these accounts
Introduction
• Partnership – an unincorporated association of two or more
individuals to carry on, as co-owners, a business, with the intention of
dividing the profits among themselves.
• A partnership is owned by 2 or more individuals while a sole
proprietorship is owned by only one individual
• A partnership is created by agreement between the partners while a
corporation or cooperative is created by operation of law
• A partnership is formed for a business undertaking that is normally of
continuing nature, while a joint venture may be formed for a limited
purpose and ends when its goals are achieved.
Characteristics of Partnership
• Ease of formation – less formality compared to corporations
• Separate legal personality –juridical personality
• Mutual agency –partners are agents of the partnership
• Co-ownership of property
• Co-ownership of profits
• Limited life
• Transfer of ownership –requires the approval of the partners
• Unlimited liability
Limited life
A partnership is easily dissolved:
a) by the express will of any partner
b) by the termination of a definite term stipulated in the contract
c) by any event which makes it unlawful to carry out the partnership
d) when a specific thing which a partner had promised to contribute
to the partnership perishes before the delivery (Art. 1830 (4))
e) expulsion, death, insolvency or civil interdiction of a partner
Unlimited liability
Each partner including industrial ones, may be held personally liable for
partnership debt after all partnership assets have been exhausted. If a
partner is personally insolvent, his share in the partnership debt shall
be assumed by the other solvent partners.
 a partnership in which all partners are individually liable is called a general
partnership
 a partnership in which at least one partner is personally liable is called a
limited partnership. A limited liability partnership usually has “LLP” in its
name
Advantages and Disadvantages of a partnership
Advantage Disadvantage

• Ease of formation • Limited life / easily dissolved

• Shared responsibility of running the • Unlimited liability

business
• Flexibility in decision making • Conflict among partners

• Greater capital compared to sole • Lesser capital compared to a corporation

proprietorship
• Relative lack of regulation by the • A partnership (other than a general
government as compared to corporations professional partnership) is taxed like a
corporation
Accounting for partnerships
 the Conceptual Framework for Financial Reporting and the PFRSs are
applicable to all reporting entities regardless of the type of
organization.
 the main distinction lies on the accounting for equity
 should comply with relevant provisions of the Civil Code of the
Philippines
Accounting for Equity of partnerships
The major considerations in accounting for equity of partnerships are:
a) Formation – accounting for initial investments to the partnership
b) Operations – division of profits or losses
c) Dissolution – admission of new partner and withdrawal, retirement
or death of a partner
d) Liquidation – winding-up of affairs
Formation
• A contract of partnership is consensual. It can be constituted in any form,
such as oral or written.
• However, Articles 1771 and 1772 of the Philippine Civil Code REQUIRE that
a partnership agreement must be made in a public instrument and
recorded with the Securities and Exchange Commission (SEC) when:
i. Immovable property or real rights are contributed to the partnership OR
ii. The partnership has a capital of P3,000 or more.
• Art. 1773 further requires an inventory of any immovable property
contributed to the partnership, signed by the parties and attached to the
public instrument, otherwise the partnership is deemed void.
• A partnership’s legal existence begins from the execution of the contract,
unless otherwise stipulated.
 Valuation of contribution of partners
• Art. 1787 of the Civil Code states that “when the capital or 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 the according to current prices, the subsequent changes thereof being for the account
of the partnership.”
• The term “appraisal” as used in the Civil Code suggests valuation of capital contribution at fair
value.
• Moreover, the provision of PFRS 2 Share-based Payments that equity instruments issued for non-
cash items should be valued at the fair value of the non-cash items received parallels that of Art.
1787
• Accordingly, all assets contributed to (and related liabilities assumed by) the partnership are initially
measured at fair value.
• An equity instrument is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities
• Fair value is “the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date” (PFRS 13)
Valuation of contribution of partners
• When measuring the contributions of partners, the following additional
guidance from the PFRSs shall be observed:
Type of contribution Measurement
Cash and cash equivalents Face amount (PAS 7)
Inventory Lower of cost and net realizable value (PAS 2)

• Each partner’s capital account is credited for the fair value of his net
contribution (i.e. asset contribution less any liability assumed by the
partnership). No contribution shall be valued at an amount that exceeds
the contribution’s recoverable amount. Each partner’s contribution shall
be adjusted accordingly before recognition in the partnership’s books.
Recoverable amount – is the “higher between an asset’s fair value less cost to sell
and value in use.” (PAS 36. Appendix A)
Valuation of contribution of partners
• A partner’s subsequent share in profits (losses) shall also be credited
(debited) to his capital account.
• Likewise, permanent withdrawals of capital are debited to the
partner’s capital account. Temporary withdrawals may be debited to
the partner’s drawings account. The sum of the balances in the
partner’s individual capital accounts represents the total equity of the
partnership.
Partners’ ledger accounts
The partners’ ledger accounts are:
a) Capital accounts
b) Drawings accounts
c) Receivable from / Payable to a partner

*separate capital and drawings accounts are established for each

partner, e.g. “Juan Bayan, Capital” and “Juan Bayan, Drawings”
 The partner’s capital
Capital Accounts account is a real account
and has a normal credit
balance.
Juan Bayan, Capital
Dr. Cr.
Permanent
withdrawals of
xxx Initial Investment
capital xxx Additional
Investments
xxx
Share in losses
xxx xxx Share in profits
Debit balance of
drawings account xxx
 Drawings Accounts The drawings account is a
nominal account that is closed
to the related capital account
Juan Bayan, Drawings at the end of the period. This
account is a contra equity
account and has a normal
Dr. Cr. debit balance.
Temporary
withdrawals xxx xxx
during the period
Recurring
Temporary funds xxx reimbursable costs
held to be remitted by the partner
to the partnership
Receivable from/ Payable to a partner
• The partnership may enter into a loan transaction with a partner. A
loan extended by the partnership to a partner is recorded as a
receivable from the partner, while a loan obtained by the partnership
from a partner is recorded as a payable to the partner.
Proceed to Partnership Formation part3 &4