PARTNERSHIP FORMATION

Partnership
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.
Characteristics of a partnership
1. Ease of formation
2. Separate legal personality
3. Mutual agency
4. Co-ownership of property
5. Co-ownership of profit
6. Limited life
7. Transfer of ownership
8. Unlimited liability (this is applicable to a general partnership)

Accounting for partnerships

 The following are the major considerations in the accounting for the equity of a partnership:

1. Formation – accounting for initial investments to the partnership

2. Operation – division of profits or losses
3. Dissolution – admission of a new partner and withdrawal, retirement or death of a partner
4. Liquidation – winding-up of affairs
Valuation of contributions of partners

 All assets contributed to (and related liabilities assumed by) the partnership shall be measured at fair
value.
Partners’ ledger accounts
1. Capital accounts
2. Drawing accounts
3. Receivable from/ Payable to a partner
Bonus on initial investments

 A bonus exists when the capital account of a partner is credited for an amount greater than or less than
the fair value of his contributions.
 The bonus is treated as adjustment to the capital accounts of the other partners.

PARTNERSHIP OPERATIONS
Division of profits and losses

 The partners shall share in the profits or losses of a partnership in accordance with the partnership agreement.
 If only the share of each partner in the profits has been agreed upon, the share of each in the losses shall be in
the same proportion.
 In the absence of stipulation, the share of each partner in the profits and losses shall be in proportion to what
he may have contributed, but the industrial partner shall not be liable for the losses. (Art. 1797 of the
Philippine Civil Code)
 The designation of losses and profits cannot be entrusted to one of the partners (Art. 1798).
 A stipulation which excludes one or more partners from any share in the profits or losses is void (Art. 1799).

Other stipulations that affect division of P/L

 1. Salaries – normally, an industrial partner shall receive salary, in addition to his share in the partnership’s
profits, as compensation for his services to the partnership.
2. Bonuses – the partnership agreement may stipulate a bonus to be given to a managing partner to encourage
excellent management performance. Unlike for salaries though, a partner is entitled to a bonus only if the
partnership earns profit.
3. Interest on capital contributions – the partnership agreement may stipulate that each partner may be entitled
to a per annum interest computed on his capital contributions.

 The above-mentioned items are normally provided first to the respective partners and any remaining amount
of the profit or loss is shared based on the stipulated profit or loss ratio.

PARTNERSHIP DISSOLUTION
Dissolution

 Dissolution is the change in the relation of the partners caused by any partner ceasing to be associated in the
carrying on of the business.
Causes of partnership dissolution
1. Admission of a partner
2. Withdrawal, retirement or death of a partner
3. Incorporation of a partnership

Admission of partner

 The admission of a new partner may be effected either through:

1. Purchase of interest in the partnership, or
2. Investment in the partnership
Purchase of interest

 A personal transaction between and among the partners

 Any consideration paid or received is not recorded in the partnership books
 Only a transfer within equity is made to establish the capital account of the new partner and decrease the
capital account(s) of the selling partner(s).
 No gain or loss shall is recognized in the partnership books.
Revaluation of assets

 When a partnership is dissolved but not liquidated, a new partnership is created. The assets and liabilities
carried over to the new partnership are restated to fair values.
 Any adjustment to the assets and liabilities is allocated first to the existing partners before recording the
admission of the new partner.
Investment in the partnership

 The incoming partner invests directly to the partnership instead of purchasing interest from an existing
partner(s).
 This is a transaction between the new partner and the partnership. Any consideration paid by the incoming
partner is recorded in the partnership books.
 No gain or loss shall be recognized

Withdrawal, retirement or death of a partner

 When a partner withdraws, retires or dies, his interest may be purchased (a) by one or all of the remaining
partners or (b) by the partnership.
 The interest of the withdrawing, retiring, or deceased partner shall be adjusted for the following:
 a. his share of any profit or loss during the period up to the date of his withdrawal, retirement or death; and
b. his share of any revaluation gains or losses as at the date of his withdrawal, retirement, or death.
 Purchase by one or all of the remaining partners
This is a transaction between and among the partners (or deceased partner’s estate). As such, the settlement
amount is not recorded in the books. The only entry to be made in the partnership books is a transfer within
equity.
 Purchase by the partnership
This is a transaction between the retiring or withdrawing partner (or deceased partner’s estate) and the
partnership. As such, the settlement amount is recorded in the books.

Incorporation of a partnership

 On date of incorporation:
a. The partners’ capital balances are adjusted for their respective shares in any profit or loss and revaluation
gains or losses as at the date of incorporation. The adjusted capital balances may be used in determining the
number of shares to be issued to each partner.
b. Normally, the books of the partnership are closed and new books are set-up for the corporation.

PARTNERSHIP LIQUIDATION

 Liquidation is the termination of business operations or the winding up of affairs. It is a process by which
a. the assets of the business are converted into cash,
b. the liabilities of the business are settled, and
c. any remaining amount is distributed to the owners.
Methods of liquidation
1. Lump-sum liquidation – the partners’ claims are settled in a single, lump-sum payment after all non-cash
assets are realized and after all liabilities are settled.
2. Installment liquidation – the partners’ claims are settled on an installment basis as non-cash assets are
realized and as cash becomes available, but only after all liabilities are fully settled.
Settlement of claims

 The available cash of the partnership is used to settle claims in the following descending order:
1. First, to outside creditors;
2. Second, to inside creditors (e.g., payables to partners);
3. Third, to owners’ interests

Lump-sum vs. Installment liquidation

The following procedures shall be observed when accounting for lump-sum liquidation or installment liquidation:

Marshalling of assets
  A partner who is solvent, shall be required to make additional contributions to settle any deficiency in his
capital balance, subject to the following order of priority over his personal assets:

1. The partner’s separate creditors

2. The partnership creditors
3. To the other partners by way of contribution

 The capital deficiency of an insolvent partner shall be offset to the capital credits of the other partners.
Chapter 5
Corporate Liquidation and Reorganization