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1) Separate Legal Personality – Partnership Law states that the partnership has a juridical DRAWING ACCOUNT
personality separate and distinct form that of each of the partners. Withdrawal of assets by the partners in Partnership obligations assumed or paid
2) Ease of Formation – the partnership may be created by oral or written agreement anticipation of the net income by the partner
between two or more persons, or merely by inferences from the implication of their Partner’s personal indebtedness paid or Personal funds or claims of partner
conduct. assumed by the partnership collected and retained by the
3) Co-ownership of Partnership Property and Profits – the right of each partner to possess Funds of claims of partnership collected partnership
partnership property for partnership purposes is equal to the right of each of the other and retained by the partner Periodic partner’s salaries depending on
partners. the accounting and disbursement
4) Limited Life – any change in the agreement and relationship of the partners terminates procedures agreed upon
the partnership contract. Such as:
a. Death of a partner
b. Withdrawal of a partner LOANS TO PARTNERS/RECEIVABLE FROM PARTNER/DUE FROM PARTNERS
c. Bankruptcy of a partner
A withdrawal by a partner of a substantial amount with the assumption of its
d. Incapacity of a partner
repayment to the firm. (w/ interest)
e. Admission of a new partner
f. Expiration of the period specified in the partnership contract LOANS FROM PARTNERS/LOANS PAYABLE TO PARTNERS/NOTES PAYABLE/DUE TO PARTNERS
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 An advance to the partnership by a partner with the assumption of its ultimate
operations. repayment by the partnership is viewed as a loan rather than as an increase in the
6) Unlimited Liability – each partner may be held personally liable for all the debts of the capital account. (w/ interest)
partnership. Except in Limited Partnership, wherein certain partners are allowed to limit
their personal liabilities to the to the extent of their capital contributions only.
Partnership Agreement
Partnership Formation for the First Time – Initial Investments Use the Books of one of the Sole Proprietors (SP1)
Books of SP2
Cash Investment
1) Adjusts the assets and liabilities of the proprietor to their agreed value (or FMV if
Recorded at face value of the investment. there is no agreed value) by the partners. Adjustments are to be made to his capital
account.
Cash xxx 2) Close the books.
Partner, Capital xxx
Books of SP1 (New partnership books)
Property or Noncash Investment 1) Adjusts the assets and liabilities of the proprietor to their agreed value (or FMV if
The fair value of the noncash asset is determined by the agreement of the partners. there is no agreed value) by the partners. Adjustments are to be made to his capital
If there is no agreement, the fair value of the noncash asset at the time of the account.
investment shall prevail. 2) Record the investment of the other partner.
Recording partners’ noncash investment at their current fair value ensures that any
gains and losses on the subsequent sale of the property will be equitably distributed in New Books are Opened for the Partnership
accordance with the partnership agreement. Books of Both Partners
1) Adjusts the assets and liabilities of the proprietor to their agreed value (or FMV if
Industry there is no agreed value) by the partners. Adjustments are to be made to his capital
A memorandum entry is prepared. account.
2) Close the books.
A partner is admitted into the partnership as an industrial partner to share a certain
portion in the partnership profit. New Book of the Partnership
1) Record the investment of both partners.
Valuation
Cash Face Value on the date of formation Bonus Method vs. Goodwill Method
Property or Noncash Agreed Value/FMV/Book Value/Carrying Value
Valuation problem arises when partners agree in capital interests that are not equal to
Industry or Services Memorandum Entry
their net asset invested.
Liability Present Value/Book Value
Note:
Sole Proprietor and Another Individual Form a Partnership
The recognition of goodwill method poses definite theoretical problems.
Sole Proprietorship’s Books are Retained for the Partnerships Because the business recognized asset even though no funds have been spent.
1) Adjusts the assets and liabilities of the proprietor to their agreed value (or FMV if
Thus, although partnership goodwill is sometimes encountered in actual practice, the
there is no agreed value) by the partners. Adjustments are to be made to his capital
authors believe that this asset should be viewed with skepticism.
account.
A decision to use one method over the other will depend on the partner’s agreement.
2) Record the investment of the other partner.
In the absence of any agreement, the bonus method is preferable over the goodwill
method.
New Books are Opened for the Partnership
Books of the Sole Proprietor
Bonus Method
1) Adjusts the assets and liabilities of the proprietor to their agreed value (or FMV if
No assets is recorded in the partnership books.
there is no agreed value) by the partners. Adjustments are to be made to his capital
This approach recognizes only the assets that are physically contributed to the
account.
business.
2) Close the books.
Example: Pedro capital = 70,000; Jose capital = 50,000
New Book of the Partnership
Pedro capital 10,000
1) Record the investments of the sole proprietor.
Jose capital 10,000
2) Record the investment of the other partner.
Goodwill Method
This approach is based on the assumption that an implied value can be estimated
mathematically and recorded for any intangible contribution made by a partner.
Example: Pedro capital = 70,000; Jose capital = 50,000
Goodwill 20,000
Jose capital 20,000
Note:
Division of Profit and Losses When the services rendered by the individual partners to the partnership are not
Capitalist Partner Industrial Partner equal, due to differing abilities of partners or differences in time spent on partnership
Profits Agreement Agreement business, it is not proper to provide for such differences through the use of profit and
Original Capital Contribution Just/Equitable loss sharing ratios.
Losses Agreement Agreement The best way to provide for these differences is to allow salaries to a partner who
Profit Ratio (if there is no agreement) No share (if there is no agreement) devotes time to the partnership business.
Original Capital Contribution (if there
is no agreement in profit a Salary Allowances
Partner salary allowances like interest allowances on capital account balances are not
In using the capital balances as a basis in determining the share in profit or loss, the an expense in the determination of partnership net income.
use of average capital balances is preferable because it reflects the capital actually The salaries are debited in the drawing account if it is distributed monthly and closed
available for use by the partnership during the year. to the capital account at the end of the period.
In the absence of an agreement, salaries are automatically allowed even when losses
Division of Profit and Loss in the Ratio of Partners’ Capital Account Balances are incurred. But if partnership agreement provides that salaries are allowed to the
extent of the earnings only, then no salaries are allowed when a loss occurs.
1. Ratio of Original Capital Contributions
Bonus Allowances
2. Ratio of Beginning Capital Balances
3. Ratio of Ending Capital Balances When bonuses are to be allowed, the agreement must clearly specify the basis of the
4. Ratio of Average Capital Balances (use if the problem is silent) bonus.
a. Simple Average Method
- average of the beginning and ending capital balances Financial Statements for a Partnership
Reasons for Dissolution - The partnership receives cash or other assets, thereby increasing its total
1. Admission of a partner assets as well as the total capital.
2. Retirement/Withdrawal of a partner - It is a transaction between the partnership and the incoming partner.
3. Death/Incapacity of a partner - Cases
4. Incorporation of a partnership
CC = AC 1. No revaluation but there might be bonus.
Admission of a Partner CC > AC 1. Revalue net assets up to fair value and allocate to old
Upon the admission of a new partner, a new agreement covering partners’ interests, (negative partners.
profit and loss sharing and other consideration should be drawn because the revaluation) 2. Record unrecognized goodwill and allocate to old
dissolution of the original partnership cancels the old agreement. partners.
3. Allocate bonus to old partners.
a. By purchase (sells, pays, bought, sold, and transferred) CC < AC 1. Revalue net assets down to fair value and allocate to
old partners.
- The partnership assets and capital remain unchanged because no cash or
2. Recognize goodwill brought in by new partner.
other assets flow from the new partner to the partnership.
3. Assign bonus to new partner.
- A personal transaction between the old partner and the incoming partner
- Rights conveyed:
Methods in accounting for the difference in the CC and AC
the right of co-ownership in the business property
the right to share in profits and losses
the right to participate in the management in the business Method
- No gain and loss arising from the sale of interest is to be recorded in the Revaluation Method The historical cost bases of the partnership’s
partnership books. (personal transaction) net assets are adjusted during the admission of
- The net assets of the partnership may be revalued when the purchase of the new partner.
interest from all the partners is for the amount more than the interest Bonus Method Involves the capital transfer among the
acquired. partners to align the total resulting capital of
- Goodwill should not be recorded until all identifiable assets have been the partnership.
adjusted to their fair values.
- Asset Revaluation procedures Bonus Method (used if the problem is silent)
a. Bonus to the old partners – a reduction in the capital of the new partner and an
1st. Compute the new partnership capital using as basis the amount to increase in the capital of the old partners.
b. Bonus to the new partner – a reduction in the capital of the old partners and an
increase in the capital of the new partner.
Cases
Sales of interest to outsider
Like admission of a new partner by purchase
Procedures Sales of interest to remaining partners
1st. Multiply the agreed capital by the fraction of interest of the new partner. The Sales of interest to the partnership Total assets & total capital decreases
result is the capital credit of the new partner in the new partnership.
2nd. Compare the capital credit with the investment of the new partner. Sales of Interest to a New Partner/ Sale of Interest to Continuing Partners
a. If the credit capital is more than the investment of the new partner, the The partnership recognizes only the transfer of capital interest from the retiring
difference is bonus to the new partner. partner to the new or acquiring partner/partners.
b. If the credit capital is less than the investment of the new partner, the Any gain or loss from the sale is a personal gain or loss of the retiring partner.
difference is bonus to the old partners.
(personal transaction)
Asset Revaluation
Sale of Interest to the Partnership
The adjustment in assets may be determined as the difference between the agreed
A retiring partner may sell his capital interest to the continuing partners through the
capital and the total contributed capital.
partnership.
Generally, asset revaluations upon partnership formation relate only to the partners
The purchase price or amount of settlement may be:
of the old partnership.
a. at book value
Capital Credit – it is the interest or equity of a partner in the firm. (Agreed Capital x
b. at less than book value
fraction of interest = Capital Credit)
c. at more than book value
The balances of the partnership assets and the partners’ capital must be adjusted
When the payment to the retiring partner is less than or more than his capital
prior to the admission of a new partner.
interest, the difference between the purchase price and the capital interest may be
2 kinds of asset revaluation accounted for using:
Negative Asset Revaluation (Asset Overvalued assets a. bonus method (used if the problem is silent) – the difference between the
Revaluation Decrease) CC > AC payment and the total interest is the total bonus
Positive Asset Revaluation (Asset Undervalued assets b. asset revaluation method – the difference between the payment and the total
Revaluation Increase) CC < AC interest is only a portion of the asset revaluation
Death/Incapacity of a Partner
The death or incapacity of a partner legally dissolves the old partnership.
The remaining partners may continue operations based on a new contract or Articles
of Co-Partnership.
The interest of the deceased or incapacitated partner must be determined by the
partnership in order to make necessary settlement with his legal representatives.
In case the business is continued without immediate settlement, the legal
representative of the deceased is considered as an ordinary creditor and is to receive
an amount equal to the interest and profits attributable to this interest.
Accounting for settlement to the deceased or incapacitated partner is the same as
that of withdrawal or retirement.
PARTNERSHIP (LUMP-SUM LIQUIDATION) - The loan payable to a partner has a higher priority in liquidation than a partner’s
capital balance but a lower priority than liabilities to outside creditors.
In liquidation, the association of the partners for purposes of carrying on activities in
the usual manner is considered ended. Procedures in Lump-Sum Liquidation
Partners can only engage in activities leading to final settlement of business affairs.
Lump-sum Liquidation or Liquidation by Totals – this is a type of liquidation whereby the Initial Procedures
distribution of cash to the partners is done only after all the non-cash assets have been 1st. Adjust the books
realized, the total amount of gain or loss on realization is known, and all liabilities have 2nd. Close the nominal accounts
3rd. Transfer the resulting profit or loss to the partners’ capital account
been paid.
4th. Close the advances and withdrawals to the partners’ capital account
Causes of Partnership Liquidation
1. The accomplishment of the purpose for which the partnership was organized. Liquidation Process
2. The termination of the term/period covered by the partnership contract. 1st. Realization of non-cash assets and distributions of gains and losses
3. The bankruptcy of the firm. 2nd. Payment of liquidation expenses & unrecorded liabilities
4. The mutual agreement among the partners to close the business. 3rd. Payment of liabilities
4th. Eliminate capital deficiency
Marshalling of Assets a. Right of offset
- it involves the order of the creditors’ rights against the partnership’s assets and the b. Solvent (PA > PL)
personal assets of the individual partners. c. Insolvent (PA < PL , PA = PL)
- The order in which claims against the partnership’s asset will be marshaled is as 5th. Payment to partners
a. Inside liabilities
follows:
b. Capital
1. Partnership creditors other than partners;
2. Partners’ claims other than capital and profit, such as loans payable and accrued
Cash can be distributed to partners before or after the elimination of the deficiency.
interest payable; and
In the elimination of capital deficiency, if after the distribution of loss on realization, a
3. Partners’ claim to capital or profits, to the extent of credit balances in capital
partner incurs a capital deficiency, this deficiency must be eliminated by using one of
accounts.
the ff. methods, in the order of priority.
a. If the deficient partner has a loan balance, exercise the right of offset.
Note:
b. If the deficient partner is solvent, make him invest cash to eliminate his
The rule indicating priority of partner’s capital is supported by an established
deficiency.
legal doctrine called the right of offset.
c. If the deficient partner is insolvent, let the other partners absorb his deficiency.
- The order of claims against the personal assets of the individual partners is as follows:
Cash is distributed after the elimination of the deficiency
1. Personal creditors of individual partners; and
1. Capital deficiency is eliminated by
2. Partnership creditors on unpaid partnership liabilities regardless of a partner’s
a. Making additional cash investment, if the deficient partner is solvent.
capital balance in the partnership.
b. Charging the deficiency as additional loss to the remaining partners, if the
deficient partner is insolvent.
Right of Offset
2. Cash available for distribution is then paid to partners to apply first on loan then on
- The legal right to apply part or all of the amount owing to a partner on a loan balance
capital.
against deficiency in his capital account resulting from losses in the process of
liquidation.
Note:
- it involves offsetting a deficit in a partner’s capital (debit balance in the capital
The final distribution of cash to partners is made based on partners’ capital balances and
account of a partner) against the loan payable to that partner.
not on any ratio.
- The amount to be offset shall be the lower of the amount of the loan or the amount
of the deficiency.
Cash is distributed before the elimination of the deficiency
1. Cash available for distribution is paid to partners based on an accompanying schedule
to determine amounts to be paid to partners.
2. Deficient partners may
a. If solvent, make additional cash investment; to be paid to partners as second
cash distribution, or the deficient partner may make direct cash settlement to
the other partners.
b. If insolvent, the deficiency shall be absorbed by the other partners as additional
loss according to their profit and loss ratio.
Note:
There may be instances when the cash realized from the sale of other assets is not
sufficient to pay partnership liabilities. In such cases, remaining liabilities are satisfied by:
a. The additional cash investment by deficient solvent partners.
b. Direct collection by the partnership creditors from any one of the partners and the
latter making cash settlement among themselves.
Partners loan account is not close to partners capital account. But partner capital
balances before realization should be after closing the following account, if any:
a. Partner’s drawing
b. Partnership goodwill
c. Receivable from partners
d. Payable to partners (question: hindi ba ang loan to partners and payable to partner
ay iisa?)
According to the Partnership Law, the assets of the partnership are first available to
creditors of the partnership, and that the personal assets of the partners are first
available to his personal creditors.
If after the debts of the partnership have been paid in full and some assets still remain in
the partnership, the creditors of a partner have a claim against the assets of the
partnership only to the extent of his share.
After the creditors of a partner have been paid in full from his personal assets, any
remaining asset is available to partnership creditors regardless of whether the partner’s
capital account shows a credit or a debit balance.
The claims of creditors of the partnership on the separate property of a partner are
permitted only when these creditors are unable to obtain payment from the partnership.
Format
Partner A Partner B
Total Interest xxx xxx
Actual Losses
Gain/Loss on realized assets xxx
Liquidation expense and unrecorded liabilities xxx
Total xxx (xxx) (xxx)
Balance before payment xxx xxx
Restricted Interest/Theoretical Loss:
Unsold assets xxx
Restricted for expenses xxx
Total xxx (xxx) (xxx)
Balances xxx xxx
Less: Additional loss to other partners (from Deficient
partner) (xxx) (xxx)
Balances - for payment xxx xxx