Accounting 12

Partnership Formation

Accounting for Partnership Formation

 Based on Law and Practice
All properties brought into the partnership or acquired by the partnership are partnership
property. Partners may contribute cash, property, or industry to the partnership
 Cash Investments - recorded in partnership books at fair value (fair value is
normally equal to face value).
 Cash is dominated in foreign currency – exchange rate at the date of
contribution/investment; current exchange rate
 Noncash Investments - recorded at the agreed value which is normally the fair value
of the property at the time of investment. In case of conflict between agreed value
and fair value agreed value prevails.
 Services - memorandum entry is prepared if no agreed upon value, otherwise
journal entry would be required (which is a rare case).
Expense xx
Capital xx
 Liabilities Assumed - valued at the present value (fair value) of the remaining cash
flows.
Note:
 A partner that contributes cash and non-cash asset – capitalist partner
 A partner that contributes industry – industrial partner
 A partner that contributes cash or non-cash asset plus industry – capitalist
industrial partner
Example: Acosta contributed cash of 100,000; Accounts Receivable of P150, 000 with
Allowance for Uncollectible Accounts of P50, 000; and Equipment valued at P400, 000 with
cost of 770,000 and accumulated depreciation of 150,000. Beltran is an industrial partner
to contribute his special skills and talents to the partnership for a one third interest.
Journal Entry:
Cash 100, 000
Accounts Receivable 150, 000
Equipment 400, 000
Allowance for Uncollectible Accounts 50, 000*
Acosta, Capital 600, 000
*There is a chance that you can collect the 50, 000, otherwise if proven worthless, eliminate
the amount to the gross amount of the Accounts Receivable.
Memo Entry: Beltran is to contribute his service to the partnership for 1/3 interest.
Individual and a Sole Proprietor or Two or More Proprietors form a Partnership.
Recording can be done through either:
A. Opening a new set of books (normal practice); or
B. Continue using the books of one of the sole proprietors.
1. Adjust the books of the sole proprietor which will be used as partnership
books. Adjustments are made through capital account. Capital account is
credited for the increases in the value of the net asset and decreases for the
value of the net assets.
2. Record the investment of other partners.
Example: James admits Dani as a partner in business. Accounts in the ledger of James on
June 1, 2018, just before the admission of Dani, show the following balances:
Cash 26,000 Accounts Payable 264,000
Accounts Receivable 120,000 James, Capital 62,000
Merchandise Inventory 180,000
It is agreed that for purposes of establishing James's interest, the following adjustments
should be made:
a. An allowance for doubtful accounts of 2% of accounts receivable is to be
established.
b. The merchandise inventory is to be valued at P202, 000.
c. Prepaid expenses of P6, 500 and accrued expenses of P4, 000 are to be established.
Dani is to invest sufficient funds in order to receive a 1/3 interest in the partnership.
Answer the following:
a. How much is the adjusted capital of James?
b. How much cash should Dani invest?
c. Journal entries if 1.) New set of books will be used 2.) Books of James will be used by
the partnership.
Answer:
a. How much is the adjusted capital of James?
ANSWER: 62,000 — 2,400 + 22,000 + 6,500 - 4,000 = 84,100
b. How much cash should Dani invest?
ANSWER: 84,100 divided by 2/3 = 126,150 Total Capital
126, 150 x 1/3 = 42,050 Dani's investment
c. (1) Journal entries if new set of books will be used.
Cash 26, 000
Accounts Receivable 120, 000
Merchandise Inventory 202, 000
Prepaid Expenses 6, 500
Accounts Payable 264, 000
Accrued Expenses 4, 000
Allowance for Doubtful Accounts 2, 400
James, Capital 84, 100
 Cash 42, 050
Dani, Capital 42, 050
Note:
 Books of James (Closing Entries) – ADJUST – CLOSE – TRANSFER TO THE NEW SET
OF BOOKS
o The balance of the Books of James before closing entries will be the same
amounts above.
(2) Journal entries if books of James will be used by the partnership. (ADJUSTMENTS on
the books of James)
Merchandise Inventory 22, 000
Prepaid Expenses 6, 500
Accrued Expenses 4, 000
Allowance for Doubtful Accounts 2, 400
James, Capital 22, 100
Cash 42, 050
Dani, Capital 42, 050
Note:
 If the partnership did not assume the liability: 84, 100 + 264, 000 = 348, 200
(Capital of James)
o Accounts payable should be eliminated in the c.1 journal entry; Accounts
payable will be debited and James, Capital will be credited in c.2.
Capital Share Different from Capital Contribution
Capital share (capital interest) — claim against the net assets of the partnership as shown
by the balance in the partners’ capital account.
Generally, the capital share of a partner is proportionate to his/her capital contribution.
However, partners may agree to a division of capital that is not proportionate to their
capital contributions.
 Reason (difference between capital share and capital contribution) NOTE:
DIFFERENT FROM PARTNERSHIP ADMISSION
i. Intangible factor in the partnership (e.g. skills) – capital credit increase
Capital Share Different from Capital Contribution can be accounted using:
1. Bonus Method - a transfer of capital from one partner to another partner is made.
Total Partnership Capital/Agreed Capital is equal to the Total Contribution of
partners.
Example:
Contribution of Partners Capital Ratio Capital credit
A = 100, 000 50% 150, 000
B = 200, 000 50% 150, 000
 Total Contribution of 100% Partnership Capital =
Partners = 300, 000 300, 000

2. Revaluation Method/Goodwill Method - the new partnership should recognize an

intangible asset at the date of formation due to the assumption that partner/s are
contributing something of value to the partnership that is intangible in nature.
 Partnership Capital is not equal to the Total Contribution of partners.
Normally, Agreed Capital is higher than the Total Contribution of partners.
Example: C and D agreed to form a partnership, with C contributing P100, 000 cash and D
contributing P150, 000 cash. The partners agreed that C will also contribute an intangible
benefit to the business for C to have an initial equal interest in the partnership.
If the bonus method is to be used, the entry in the partnership books must be:
1) To record the initial contribution of partners:
Cash P250, 000
C, Capital P100, 000
D, Capital P150, 000
2) To record the bonus recognized:
D, Capital P25, 000
C, Capital P25, 000
If there is no specification as to what approach may be used, the bonus approach would be
preferred.
If the revaluation method is to be used, the entry in the partnership books must be:
1) To record the initial contribution of partners:
Cash P250, 000
C, Capital P100, 000
D, Capital P150, 000
2) To record the intangible recognized:
Intangible Asset P25, 000
(What Intangible Asset? Depends on the agreement of the partners)
C, Capital P25, 000
Note:
 Total Agreed Capital:
D, Capital (150, 000/50% = 300, 000)
C, Capital (100, 000/50% = 200, 000) – X INTANGIBLE ASSET MUST BE RECOGNIZED;
AGREED CAPITAL IS HIGHER THAN TOTAL CONTRIBUTION OF PARTNERS
 If unequal, C is 1/3 and D is 2/3:
D, Capital (150, 000/2/3 = 225, 000) - X
C, Capital (100, 000/1/3 = 300, 000)