Chapter 1 Partnership Formation Learning Objectives 1 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 ‘ A partnership is 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. The following distinguish a partnership from other types of entities: b. A partnership is owned by two 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 the operation of law. 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, 3 Characteristics of a partnership a. Ease of formation — as compared to corporations, the formation of a partnership requires less formality.bb Separate legal personality — the partnership has a judicial personality separate and distinct from the partners. ‘The partnership can transact and acquire properties in its name. © Mutual agency ~ the partners are agents of the partnership for the purpose of its business. As such, a partner may legally bind the partnership to a contract or agreement that is in line with the partnership's operations. 4. Co-ownership of property ~ each partner is a co-owner of the Properties invested in the partnership and each has an equal right with his partners to possess specific partnership property for partnership purposes. However, a partner has no right to possess a partnership property for any other purpose without the consent of his partners. &. Co-ownership of profits — a partnership is created as a business (a protit-oriented entity), as such, each partner is entitled to his share in the partnership profit. A stipulation which excludes one or more partners from any share in the profits or losses is void. (Art. 1799 ofthe Cuil Code ofthe Philippines) . Limited life ~ the creation of a partnership is basically consensual. As such, a partnership may be dissolved: i. _ by the express will of any partner; : ii. by the termination of a definite term stipulated in the contract; a iii, by any event which makes it unlawful to carry ou! partnership; a iv. when a specific thing which a partner had ponitel contribute to the partnership perishes before the delivery tact, 183008));, OF ee v feoulaion, death, insolvency or civil interdiction of partner. ion, the transber of artiner, requires the approval of the remaining partners, Unlimited liability - each partner, induding, industria! ones, may be held personally liable for partnership debt after ali 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 partnership includes at least one general partner who maintains ted > “LLP” in its name. Advantages and disadvantages of a Advantage * Ease of formation . Disadvantage ily dissolved limited a a oe ed * Shared responsibility of | « running the business * Flexibility in decision + Conflict among partners eee eee le ee a * Greater capital compared to | « Lesser capital compared to sole proprietorship a corporation | * Relative lack of regulation | A partnership (other thana | by the government as general professional compared to corporations partnership) is taxed like a corporation.Tee following are the major considerations in the | accounting for the equity of 2 partnership: % Formsciom - accounting for inital investments to the | partnership >. Operatams ~ division of profits or losses © Ossscixttos ~ admission of a new partner and withdrawal, 4. Liquidation - winding-up of affairs Formation A contract of partnership is consensual. It is created by the agreement of the partners which may be constituted in any form, | such as oral or written. However, Articles 1771 and 1772 of the Philippine Civil Code requires that a partnership agreement must be made in a bia: instrament and recorded in the office of the Securities and ‘Exchange Commission (SEC) when: % immovable property or real rights are contributed to the Pattnership (e.g, PPE), or the partnership has a capital of P3,000 or more. SSnnemeneenmee ee A partnersiap’s legal existence begins from the moment the contracts executed, unless itis otherwise stspulated Valuation of contributions of partners Art. 1787 of the Civil Code states that “when the capital or part The term “appraisal” as used in the Civil Code. whether in accordance with the contract of partnership or in the absence thereof, suggests valuation of capital contributions at fair value Although there are no specific financial reporting standards that address the accounting for partnerships, a similar Provision under PFRS.2 Share-based Payments which states that ‘equity instruments issued for non-cash items should be valued at the fair value of the non-cash items received may be construed to be in accordance with the provision of Art. 1787. > An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. The meaning of equity interest is not limited to Corporations. An interest in a partnership or an association of Persons in the nature of ownership interest is an equity instrument. Therefore, all assets contributed to (and related liabilities assumed by) the partnership are initially measured at fair value.' SE ros When measuring the contributions of Partners, the “olloming additional guidance from the PFRSs shall be observed: Capital and Drawings accounts ; fe Seale nae See i [ich partner bas his or her own capital and. drawings 3 Tape of contrition 7 __ Measurement ~~ “Tuan dela Crux. Capital” and Shon dels Crane ies Doxa | te | " snvesements Each parmver's capital account is recited forthe fair value | 7 ee ee awrin f hs wt conembuton (ie, fair value of contribution less amy | drawings account Satie; assumed 2y the partnership}. No contribution shall be *atued st am amount thet exceeds the contribution’s recoverable | sstesne. Each ertner's conenbution shall be adjusted accordingly The partner's capital account is 2 real account and has before recognition in the partnership's books. ormal credit balance. smoxat ~ is “the higher between an asset's fair value ee = fess octind sainete eee (PAS Se Appendte§) = as PS Seco genes oct 4 sarmer's subsequent share in profits (losses) shall also Sonnet pas be coatiied “debmed) to his capital account. Likewise, permanent ‘pe “dcarwais ot capita: are debited to the partner's capital account. remporary funds held ‘Temonrary ~wandeawals may be debited to the partner's drawings be remitted to the qessui’ he sum of che balances in the parmers’ individual capital partnership Mita cecesants the Sota! equity of the partnership. E . The drawings account is a noneinal acvownt that is closed to : | __ the related capital account at the end of the period. This accsunt is Pevemer:” ‘aciger scouts be 2 contra equity ocepunt and has a normal debit balance Fie careers lesiger wcccames ane ge The partners’ capita! and drawings accounts are similar to oe Comatat The bonus given to A, i, 30,000 (P70,000 capital credit - 740,000 actual contribution) is treated as a reduction to the capital credit of B.Requirements: Which partner(s) shall receive cash payment from the other parmer(s)? . Provide the entry to record the contributions of the partners. Variations to the bonus method Pe solutions: A parnership agreement may stipulate a certain ratio i | Requirement a: cies by the panes representing th Specie intr | AEB ETT Pactra to the initial contributions of the partners. Since i 4 e lly there is no “bonus” being given to a certain partner | ease or decrease to the capital credit of a partner is not | from his co-partners’ capital accounts. Instead, th: capital adjustment is accounted for as either: 2. Cash settiement among the partners; or b. Additional investment or withdrawal of investment of < easier C Sel ects 1300 foe perner Requirement (b): The following illustrations are variations to the bonus method: Mortgage payable A, Capital B, Capital C, Capital i Iustration 1: Cash settlement between partners A. B and C formed a partnership. Their contributions are as follows: t § Notes: ‘© 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. © The partnership's capital of 210,000 remains the same after the cash settlement. Again, what varied are only the credits to the partners’ capital accounts. ers agreed to equalize their interests. Cas among the partners are to be made outside thIlustration 2: Additional investment (Withdrawal of investment) A and B agreed to form a partnership. The partnership agreemeny stipulates the following: Initial capital of P140,000. ¢ A.60:40 interest in the equity of the partnership. A cartabuted P100,000 cash while B contributed P40,000 cash, Requirement: Which partner should provide additional investmen (or withdraw part of his investment) in order to bring the partners’ capital credits equal to their respective interests in the equity of the partnership? Solution: Agreed initial capital 140,000 A's required capital balance (140K x 60%) 84,000 B's required capital balance (140K x 40%) 56,000 A B Totals Actual contributions 100,000 40,000 140,000 _Required capital balance 84,000 56,000 140,000_ Additional (Withdrawal) (16,000) 16,000 2 Answer: A shall withdraw P16,000 from his initial contributio" while B shall make an additional investment of P16,000.