UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION COMPETENCY APPRAISAL COURSE

PARTNERSHIP ACCOUNTING 3. Taxation

DEFINITION A partnership is taxed like a corporation for business partnerships, and like a proprietorship
for general professional partnerships were partners are taxed based upon their share in the
The Partnership Law is the general governing authority for partnerships. partnership income, not on their withdrawals from the business.

Accountants advising partnerships must be familiar with this law because it describes many of the 4. Limited Life
rights of each partner and of creditors during creation, operation, and liquidation of the
partnership. A partnership is a business carried on by individuals and cannot exist separate and apart from
those individuals. Should something happen to take away the ability of a partner to contract
Article 1767 of the Partnership Law embodies the definition of partnership. (death, bankruptcy or lack of legal capacity), the partnership may be terminated. Also, the life
of a partnership may be limited by terms in the partnership contract, or it may be terminated
• It states that “by the contract of partnership, two or more persons bind themselves to by any one of the partners at will.
contribute money, property, or industry to a common fund with the intention of dividing the
profits among themselves.” 5. Mutual Agency

• This definition encompasses three distinct factors: Mutual agency is the legal ability of each partner, acting as an agent of the business, to enter
o Association of Two or More Persons into and bind it to contracts within the scope of the partnership. For example, LeBron, AD,
o To Carry On as Co-Owners and Kuzma are partners in an accounting firm. AD may bind the partnership by contracting to
o Business for Profit buy a computer for the business, even if the two other partners know nothing of the purchase.
They are bound to the contract because a computer is an expected and necessary piece of
CHARACTERISTICS equipment for an accounting firm. However, the firm would not be bound if AD should
contract to buy land with the expectation that its value would increase because this
1. Voluntary Association transaction is considered to be outside the purpose of an accounting business. Partners may
agree to limit the power of one or more of the partners to negotiate contracts for the
A partnership is a voluntary association of two or more legally competent persons (of who are business. Outsiders are bound by this agreement only if they are aware of it.
age and sound mental capacity) to carry on as co-owners a business for profit. Because a
partnership is based on agreement, no person can be a partner against her or his own will. 6. Unlimited Liability
Doctors, accountants, and lawyers frequently form partnerships, and this form of business
organization is common in small service and retail businesses. Much like a proprietorship, partners have unlimited liability for their business. Unlimited
liability means that each partner is personally liable for the debts of the business. When a
2. Partnership Agreement partnership business is unable to pay its debts, the creditors may satisfy their claims from the
personal assets of any of the partners. If any one partner cannot pay his or her share of the
Two or more legally competent people may form a partnership. It is best if their agreement is debt, creditors may make their claims against any of the other partners.
in writing, but it may be expressed verbally. The partnership contract is prepared by a lawyer,
though an accountant may review it. The contract will stipulate among other things, how
partnership income and losses are to be divided among the partners.

ADVANCED FINANCIAL ACCOUNTING & REPORTING CEDRIC IAN CARLO E. PETALCORIN, CPA, MBA 1
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION COMPETENCY APPRAISAL COURSE
ACCOUNTING TREATMENT their original capital contributions. The method chosen by the partners for dividing the profits or
losses is called the profit-loss ratio.
FORMATION AND OPERATION
The following are the number of methods that may be used to divide profits and losses:
A partnership may be formed in several ways, namely: 1. May be divided equally
1. Formation of a partnership for the first time 2. May be distributed on a fractional basis
2. Conversion of a sole proprietorship to a partnership 3. May be distributed based on amounts invested
1. A sole proprietor allows another individual, who has no business of his own to join 4. May be distributed using a fixed ratio
his business 5. May be distributed using an allowance for salary, interest, and bonuses with any
2. Two or more sole proprietors form a partnership remaining profits divided equally or using a ratio.
3. Admission of a new partner
Accounting for a Deficit When Distributing Net Income
Partnership Formation for the First Time
1. Cash Investments - Initial cash investments in a partnership are recorded in the capital In the event the method used for distribution of net income results in a deficit amount (negative)
accounts maintained for each partner. after interest and salary allowances, the deficit must be subtracted in the calculation rather than
2. Noncash Investments - When property other than cash is invested in a partnership, the added.
noncash property is recorded at the current fair value of the property at the time of the
investment. Distributing a Net Loss
3. Bonus on Initial Investments – Valuation problem arises when partners agree on capital
interests that are not equal to their net assets invested. To meet this condition, the capital Should a loss occur, the procedure for distributing the loss to the partners’ capital accounts is the
accounts should be adjusted using the bonus approach. same as distributing the net income unless the partners agree otherwise. Losses will reduce both
assets and capital.
Sole Proprietor and another Individual Form a Partnership
• An individual who has no business of his own may join another individual who is already PRACTICE PROBLEMS:
operating his own business. Under this type of formation, both the assets and liabilities of the
sole proprietor are transferred to the newly formed partnership. Normally the partners agree LEBRON admits ANTHONY as a partner in business. Just before the partnership’s formation,
on the revaluation of some of the assets before the transfer. LEBRON’s books showed the following:

Two Proprietors Form a Partnership Cash 2,600

• There should be an agreement on the determination of the partners’ interest in the new Accounts Receivable 12,000
partnership. It is also important that the partners agree on the values of the assets to be Merchandise Inventory 18,000
assigned and liabilities to be assumed by the partnership. Books of one of the sole Accounts Payable 6,200
proprietorship may be used for the newly formed partnership or a new set of books may be LEBRON, Capital 26,400
used.
It was agreed that, for purposes of establishing LEBRON’s investment in the firm, the following
Dividing the Net Income adjustments shall be reflected:
• Allowance for bad debts of 2% should be set-up
Partners are owners of the business, not employees, and as such, may divide their net income as • Merchandise inventory should be valued at P 20,200
they choose. The partnership contract, however, must state how the net income or loss is to be • Prepaid expenses of P 350 and accrued expenses of P 400 should be recognized
divided. If there is no contract, the law states that profits and losses will be divided according to

ADVANCED FINANCIAL ACCOUNTING & REPORTING CEDRIC IAN CARLO E. PETALCORIN, CPA, MBA 2
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION COMPETENCY APPRAISAL COURSE
REQUIRED: Withdrawing or Adding a New Partner
1. How much is the adjusted capital of LEBRON prior to admission of ANTHONY?
2. How much cash should ANTHONY invest to secure a one-third interest in the partnership? A partnership is based on a contractual agreement among individuals and ends when a partner
3. If ANTHONY contributed an equipment with carrying value of P 4,000 and fair value of P 4,500, withdraws from the firm or a new partner is added. The business, however, may continue with a
how much cash was contributed for a one-fifth interest in the partnership? new partnership agreement. A partner may withdraw by selling his or her interest in equity in cash
or other assets. If all the partners agree, a new partner may join the firm either by buying the
JOKIC and MURRAY share profits and losses equally after salary and interest allowances. JOKIC and interest of a present partner, by contributing additional assets equal to the equity he or she is
MURRAY receive salary allowances of P 40,000 and P 60,000, respectively, and both partners acquiring, or by investing either more or less than the equity he or she will receive.
receive 10% interest on their average capital balances. Average capital balances are calculated at
the beginning of each month, regardless of when additional capital contributions or permanent The partnership agreement should outline the procedure governing a partner who wishes to
withdrawals are made subsequently within the month. Partners’ drawings of P 3,000 per month withdraw from the business. Withdrawal may occur when a partner wants to retire or does not
are not used in determining the average capital balances. Total net income for 2020 is P 240,000 wish to continue under the present business arrangements. The partnership contract provides
that an audit be performed which includes having all assets appraised to determine market value.
JOKIC MURRAY In addition, a determination must be made of all liabilities of the partnership. Should the audit
January 1 Capital Balances 200,000 240,000 reveal that assets and liabilities are different than reflected on the books of the partnership,
Yearly drawings (P 3,000 per month) 36,000 36,000 adjustments are made to the record to determine the true equities of the partners. Once this is
Permanent withdrawals of capital: accomplished, the contract may provide that assets be distributed to the retiring partner if it does
June 3 24,000 not jeopardize the future profitability of the remaining partners.
May 2 30,000
PRACTICE PROBLEMS:
Additional investments of capital:
July 3 80,000 RAPTORS, CELTICS, and HEAT are partners sharing profits and losses of 40%, 40% and 20%,
October 2 100,000 respectively. The December 31, 2020 balance sheet of the partnership before any profit allocation
was summarized as follows:
REQUIRED:
1. What is the weighted-average capital for JOKIC and MURRAY in 2020? ASSETS LIABILITIES & CAPITAL
2. If the average capital for JOKIC and MURRAY from the above information is P 224,000 and P Cash 90,000 Accounts Payable 7,500
238,000 respectively, what will be the total amount of profit allocated to salary and interest Inventories 60,000 CELTICS, Loan 5,000
distributions? Equipment 75,000 RAPTORS, Capital 100,000
3. If the average capital balances for JOKIC and MURRAY are P 200,000 and P 240,000, what will Trademark 22,500 HEAT, Capital 90,000
be the total partnership profit allocations be for JOKIC and MURRAY in 2020? CELTICS, Capital 45,000
Total Assets 247,500 Total Liabilities & Capital 247,500
DISSOLUTION
The income summary account has a credit balance of P 25,000 for the year 2020. On January 1,
Partnership dissolution may occur due for variety of reasons. These can be summarized as follows: 2021, a partner has decided to retire from the partnership and by mutual agreement among
• Admission of a new partner partners; the following have been arrived at:
• Withdrawal/retirement of a partner • Inventories amounting to P 10,000 is considered obsolete and must be written off
• Death of a partner • Equipment should be adjusted to their current value of P 50,000
• Incorporation of a partnership • Trademarks are to be written-off immediately before the retirement.

ADVANCED FINANCIAL ACCOUNTING & REPORTING CEDRIC IAN CARLO E. PETALCORIN, CPA, MBA 3
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION COMPETENCY APPRAISAL COURSE
It was agreed that the partnership will pay the retiring partner for his interest in the partnership Loan to GAMBIT 7,500 ROGUE, capital (40%) 9,000
inclusive of loan balance. Total P 63,000 Total P 63,000

REQUIRED: The percentages shown are the residual profit and loss sharing ratios. The partners dissolved the
1. If CELTICS retired and received P 38,500 as a retirement price, how much will be the bonus to partnership on January 1, 2017 and began the liquidation process. The partners set the policy of
or (from) HEAT? setting aside P 3,000 cash for contingent expenses every month until prior to the last distribution
2. If CELTICS retired and received P 38,500 as a retirement price, how much will be the adjusted period. The partnership strictly followed the liquidation process mandated by law.
capital of RAPTORS under bonus method?
3. If CELTICS retired and received P 43,500, by how much will the adjusted capital of RAPTORS During January, the following realization of assets and payment of liquidation expenses occurred:
under revaluation of asset method traceable to entire entity (full revaluation)? • Accounts receivable of P 6,000 was collected and the balance is deemed as bad debt
4. If CELTICS retired and received P 41,000, by how much will the adjusted capital of HEAT be • All inventory was sold for P 15,000
higher or (lower) than RAPTORS under specific revaluation of asset method (specific • Liquidation expense of P 1,500 was paid
revaluation)?
5. If CELTICS retired and received P 41,000, by how much will the adjusted capital of RAPTORS During February the following realization of assets and payment of liquidation expenses occurred:
under specific revaluation of asset method (specific revaluation)? • The plant assets was sold for P 15,000
• Liquidation expense of P 2,000 was paid
LIQUIDATION
REQUIRED:
Partners may determine that it is no longer possible to continue in business. This may occur if the 1. Using Cash Priority Program, how much cash would JEAN GRAY receive from the cash that is
partners have unsettled disputes or the business is no longer profitable and liquidation becomes available for distribution on January 30, 2017?
necessary. Liquidation is the total process of going out of business, or the legal process of 2. Using Schedule of Safe Payment, how much cash would GAMBIT receive from the cash that is
converting assets to cash, paying all creditors, and making final distribution of cash to the partners. available for distribution on January 30, 2017?
This legal process also means that each partner is liable to pay the creditors whether or not there 3. Using Cash Priority Program, how much cash would ROGUE receive from the cash that is
is sufficient cash remaining. Although many different circumstances occur in liquidation, only two available for distribution on February 28, 2017?
are discussed here. In each case, there are four steps to be followed. 4. Using Schedule of Safe Payment, how much cash would JEAN GRAY receive from the cash that
1. Convert all noncash assets to cash and record the gain or loss on liquidation is available for distribution on February 28, 2017?
2. Distribute the gains or losses to the partners’ capital accounts according to the profit-loss
ratio. EXERCISES:
3. Pay the liabilities
4. Distribute the remaining cash according to the equities (capital balances) of the partners 1. MAGIC and KAREEM formed a partnership and agreed to divide initial capital equally, even
though Anton contributed P 100,000 and KAREEM contributed P 84,000 in identifiable assets.
PRACTICE PROBLEM: Under the bonus method, to adjust the capital accounts, KAREEM’s intangible assets should
be debited for:
On March 30, 2017, GAMBIT, JEAN GRAY, and ROGUE partnership had the following fiscal year-
end balance sheet: 2. KG, PAUL, and RAY decided to engage in a real estate venture as a partnership. KG invested P
140,000 cash and PAUL provided an office and furnishings valued at P 220,000. (There is a P
Cash P 6,000 Accounts Payable P 10,500 60,000 note payable remaining on the furnishings to be assumed by the partnership).
Accounts Receivable 9,000 Loan from ROGUE 7,500 Although RAY has no tangible assets to invest, both KG and PAUL believe that RAY’s expert
Inventory 21,000 GAMBIT, capital (40%) 21,000 salesmanship provides an adequate investment. The partners agree to receive an equal
Plant Assets, net 19,500 JEAN GRAY, capital (20%) 15,000

ADVANCED FINANCIAL ACCOUNTING & REPORTING CEDRIC IAN CARLO E. PETALCORIN, CPA, MBA 4
UNIVERSITY OF MINDANAO COLLEGE OF ACCOUNTING EDUCATION COMPETENCY APPRAISAL COURSE
capital interest in the partnership. Using the bonus method, what is the capital balance of 8. On December 31, 2020, the accounting records of the ABC partnership included the
RAY? following information:
A, drawing (debit balance) P 24,000 A, capital P 123,000
3. TIM, TONY, and MANU are new CPA’s and are to form a partnership. TIM is to contribute cash B, drawing (debit balance) 9,000 B, capital 100,500
of P 50,000 and his computer originally costing P 60,000 but has a second-hand value of P C, loan 30,000 C, capital 108,000
25,000. TONY is to contribute cash of P 80,000. MANU, whose family is selling computers, is
to contribute cash of P 25,000 and a brand-new computer with a regular selling price of P Total assets amounted to P 478,500, including P 52,500 cash, and liabilities totaled P
60,000 but which cost is P 50,000. Partners agree to share profits equally. The capital balances 150,000. The partnership was liquidated on December 31, 2020, and B received P 83,250
of each partner upon formation are? cash pursuant to the liquidation. A, B, and C share net income and losses in a 5:3:2 ratio
respectively. How much should A and C receive upon liquidation of the partnership?
4. CC, DD, and EE, doctors, agree to form a partnership and to share profits in the ratio of 5:3:2.
They also agreed that EE is to be allowed a salary of P 14,000, and that DD is to be guaranteed 9. A balance sheet for the partnership of A,B, and C, who share profits in the ratio of 2:1:1,
P 10,500 as his share of the profits. During the first year of operation, income from fees are P shows the following balances just before liquidation:
90,000, while expenses total P 48,000. What amount of net income should be credited to each Cash P 12,000 A, capital P 22,000
partners’ capital account? Other Assets 59,500 B, capital 15,500
Liabilities 20,000 C, capital 14,000
5. LL, MM, and PP are partners with capitals of P 40,000, P 25,000, and P 15,000 respectively.
The partnership agreement provides that each partner shall be allowed 5 percent on his On the first month of the liquidation, certain assets are sold for P 32,000. Liquidation
capital, and that LL shall be allowed an annual salary of P 8,500 and that MM shall be entitled expenses of P 1,000 are paid, and additional liquidation expenses are anticipated. Liabilities
to a minimum of P 14,000 per annum including amounts allowed as interest on capital and as are paid amounting to P 5,400, and sufficient cash is retained to insure the payment to
share of profit. Profit after interest and salary allowances is to be divided between LL, MM, creditors before making payments to partners. On the first payment to partner, A receives P
and PP 5:3:2 respectively. What amount must be earned by the partnership during 2020 6,250. How much is the amount of cash withheld for anticipated liquidation expenses and
before charges for interest or salary if LL is to receive an aggregate of P 20,000 to include unpaid liabilities?
interest, salary, and share of profit?
10. A, B, and C share profits in 5:3:2 ratio. Their capital prior to liquidation (which is expected to
6. A and B are partners who share profits and losses in the ratio of 7:3 respectively. Their result in substantial gains) are as follows:
respective capital accounts are as follows: A - P 18,000 B - P 27,000 C - P 3,000
A P 35,000 B P 30,000
The partners wish to distribute cash as it becomes available so that the capital accounts may
They agreed to admit C as a partner with a one-third interest in the capital and profits and be brought into the profit and loss ratio as rapidly as possible. Who is the partner to receive
losses, upon an investment of P 25,000. The new partnership will begin with a total capital of the first available cash and up to how much?
P 90,000. Immediately after C’s admission, what are the capital balances of A, B, and C
respectively?
“The most important thing is you must put everybody on notice that you’re here and you are
7. A, B, and C were partners with capital balances on January 2, 2020 of P 100,000, P 150,000, for real.”
and P 200,000, respectively. Their profit and loss ratio is 5:3:2. On July 1, 2020, A retires from – Kobe Bryant, 1978 - 2020
the partnership on the date of retirement the partnership net income is P 140,000 and the
partners agreed that inventories are to be revalued at P 70,000 from its original cost of P
50,000. The partners agreed further to pay A P 195,000 in settlement of her interest. What
are the capital balances of the remaining partners after the retirement of A?

ADVANCED FINANCIAL ACCOUNTING & REPORTING CEDRIC IAN CARLO E. PETALCORIN, CPA, MBA 5