AFAR Review
Rema Chan
Partnership Formation and Capital
Accounts
All assets contributed to the partnership are recorded by the
partnership at their agreed value (or fair market values) in the
absence of agreed values. All liabilities that the partnership assumes
are recorded at their net present values. Thus, if a partner contributes
a non-cash asset to the partnership subject to mortgage, the capital
account is credited for the agreed value or fair value of the non-cash
asset less the mortgage of liability assumed by the partnership
Partnership Operation – Division of
Profits and Losses
Methods
1. Equally
2. Arbitrary Ratio (2:3:5) (50:50) (30:70)
3. Capital Contrbution ratio
Original capital or initial investments
Beginning capital balance of each year
Average capital balance
Ending capital balance of each year
Partnership Operation – Division of
Profits and Losses
Methods
4. Interest on capital balance/ or loan balance and the balance on
agreed ratio.
5. Salaries to partners and the balance on agreed ratio
6. Bonus to partners and the balance on agreed ratio
a. Bonus as an “expense” in computing the bonus amount, Here,
bonus is computed based on net income after the bonus
b. Bonus as a distribution of profit. Here the bonus is computed
based on net income before deducting the bonus
Partnership Operation – Division of
Profits and Losses
Methods
7. Interest on capital and/or loan balances, salaries to partners, and
bonus to partner and the balance on agreed ratio.
The method of division to be used in any given situation is genellary the
method specified in the partnership agreement.
Partnership Dissolution
A. Admission of a new partner
Purchase of interest from existing partner
Admission by investment of additional asset
Bonus method
No bonus is recognized – when an incoming partner’s capital is equal to his purchase price,
the partnership merely debit asset and credit capital of the new partner.
Bonus granted to old partners – when the FMV of the assets contributed by an incoming
partner exceeds the amount of ownership interest to be credited. The old partners gets the
excess and divide it based on income allocation agreement of ratio by the old partnership.
Bonus granted to new partner – FMW of contributed assets is less than the partnership
interest granted to the incoming partner. The capital balances of the old partner are
reduced based on PL ratio.
Partnership Dissolution
B. Withdrawal of a Partner or Retirement from partnership
• The total interest of the partner should be properly determined which includes the
following
1. Share in the profit and loss of the partnership
2. adjustment in assets and liabilities to reflect the fair market
values.
3. Loans to and the partnership
4. Drawing accounts, and
5. capital interest /accounts
Partnership Dissolution
Withdrawal or retirement from the partnership may either be
1. Selling of an interest to an outsider. This is similar to admission by purchase
2. Selling of an interest to an existing partner. The interest of the retiring partner
will be purchased with the personal assets of an existing partner rather than
with the assets of the partnership.
3. Selling of interest to the partnership/payment from partnership fund. Under
this approach, the withdrawal of the partner maybe treated as:
a. payment at book value
b. payment at less than book value –bonus method (to existing
partners)
c. payment at more than book value – bonus method (to retiring partner)
Partnership Dissolution
C. Incorporation of the Partnership
Two approaches are in general use.
1. Retain the books of the partnership and to record the all assets and
liabilities at fair market value concomitant with the closing of the partners
capital accounts and the opening of common stocks accounts.
2. Close out the partnership books completely and to open a new set of
books for the corporation. The FMV are used as the basis for recording all
assets and liabilities with the balancing amount credited to common
stock
Occasionally, additional cash or other assets may be invested in the
corporation.
Partnership Liquidation
Liquidation is the process of converting partnership assets into cash and
distributing the cash to creditors and partners.
Frequently, the sale of assets will not provide sufficient cash to pay both
the creditors and partners.
Creditors have priority in any cash distribution
The basic rule is that no distribution is made to any partner until all
possible losses and liquidation expenses have been paid or provided for.
Premature cash distribution to partners which may result to deficit holds
the responsible partner personally liable if the insolvent partner is
unable to repay such distribution.
Partnership Liquidation
A. Lump sum Distribution
Step 1 – sell all non-cash assets and allocate the resulting gain or loss to the capital
accounts of the partners according to P/L ratio.
Step 2 – Satisfy the liabilities owing to creditors other than partners.
Step 3 – satisfy liabilities owing to partners other than for capital and profits.
Step 4 – Distribute any cash remaining to the partners for capital and finally for profits.
Any deficiency (debit balance of capital) in a solvent’s partner will require that partner
to contribute cash equal to the debit balance. If the deficient partner is insolvent, the
debit balance will be absorbed by the remaining partners usually in accordance with P/L
ratio.
The right of offset doctrine – a partner’s loan to the partnership will have distribution
priority only to the extent it exceeds a debit balance in the partner’s capital account.
Partnership Liquidation
B. Installment Distributions – The liquidation may take place over a period
of several months. Installment distributions may be made to partners on
the basis of
a. Schedule of Safe Payments
b. Cash Priority Program
in conjunction with
c. Liquidation Schedule similar to one used for lump sum liquidation.
The schedule of sale payments takes a conservative to the distribution by
assuming that noncash assets are worthless; thus distribution maybe made
to partners on the basis of partnership assets until the assets are sold.
Partnership Problem
•Problem 1: A and B formed a partnership on March 1, 2024. A contributed cash for 1M,
land with an acquisition cost of 500,000 and fair market value of 700,000.
B contributed equipment acquired through bank financing for 500,000 having fair
market value of P300,000 and unpaid amortization of 100,000. The partners agreed
to assume the obligation with the bank.
The partnership agreement stipulates the following:
Monthly salary allowances of ₱10,000 for A and ₱6,000 for B. Salary allowances are
to be withdrawn by the partners throughout the period and are to be debited to their
respective drawings accounts.
The partners share profits equally and losses on a 60:40 ratio.
On June 30, 2024, C was admitted with in investment of 500,000 with an agreed
interest of 25% and new profit and loss ratio of 50:25:25 for A, B and C respectively
providing same salary allowances of the old partners. Prior to the admission of C, the
partnership determined an undivided profit of P 200,000 after provisions for salaries
of the old partners.
At year end the partnership realized net profit of P300,000 from July 1 2024.
• Required: Determine the capital balances of the partners on December 31, 2024.
Partners A B C Total
Cash 1,000,000.00 1,000,000.00
Land 700,000.00 700,000.00
Equipment 300,000.00 300,000.00
Total 1,700,000.00 300,000.00 2,000,000.00
Bank Loan 100,000.00 100,000.00
Net Initial Investments 1,700,000.00 200,000.00 1,900,000.00
June 30 Profit after salary provisions 200,000.00
Add Salaries 40,000.00 24,000.00 64,000.00
Total income 264,000.00
Salary provisions 40,000.00 24,000.00 64,000.00
Balance 120,000.00 80,000.00 200,000.00
Total Profit Sharing 160,000.00 104,000.00 - 264,000.00
Withdrawals 40,000.00 24,000.00 64,000.00
Net Profit share after withdrawals 120,000.00 80,000.00 - 200,000.00
Capital Balance, June 30 2024 1,820,000.00 280,000.00 - 2,100,000.00
Admission of C 500,000.00 500,000.00
Total Capital after the investment of C 1,820,000.00 280,000.00 500,000.00 2,600,000.00
Capital Interest of C (25% of 2,600,000) 650,000.00
Bonus to C - 90,000.00 - 60,000.00 150,000.00 -
Capital Balance, June 30 2024 1,730,000.00 220,000.00 650,000.00 2,600,000.00
Net Profit 300,000.00
Salary Allowance 60,000.00 36,000.00 96,000.00
Remaining income for Distribution 102,000.00 51,000.00 51,000.00 204,000.00
Less Salary Drawings - 60,000.00 - 36,000.00 -
Capital after profit distribution 1,832,000.00 271,000.00 701,000.00 2,804,000.00
Partnership Liquidation
Problem : On January 1, 2024, the partners of ABC Co. decided to liquidate their partnership. The
following information was made available:
Cash 180,000
Accounts receivable 340,000
Inventory 680,000
Equipment 1,600,000
Total 2,800,000
Accounts payable 180,000
Payable to B 120,000
A, Capital (20%) 700,000
B, Capital (30%) 800,000
C, Capital (50%) 1,000,000
Total 2,800,000
Information on the conversion of non-cash assets is as follows:
80% was collected on accounts receivable; the balance is uncollectible.
40% was received for the entire inventory.
The equipment was sold for ₱1,200,000.
₱20,000 liquidation expenses were paid.
₱168,000 was paid to outside creditors, after offset of a ₱12,000 credit memorandum received on
January 2, 2024.
Assume that if there is a partner with capital deficiency, the deficient partner is also personally
insolvent.
Requirements:
1. Prepare the statement of liquidation under lump sum liquidation
2. Assume that all non-cash assets (except for equipment which was sold on the 3rd month for
1,000,000) were realized by installment 40% in January, 40% in February and the remaining 20% in
March 2025 at 50% recovery rate per month. Liquidation expenses is paid @5,000 per month for 3
month liquidation process. Prepare the schedule of safe payments, cash priority program and
liquidation schedule.
