Learning Module 2 Nature and Formation of Partnership PDF

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Copyright © 2020 Marivic Valenzuela-Manalo. All rights reserved. 1No part of this learning module may be used, reproduced, stored, or transmitted in any form or by any means without the writtenLearning Module 2Nature and Formation of PartnershipOverviewBill Gates and Paul Allen of Microsoft. Steve J...

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Learning Module 2

Nature and Formation of Partnership Overview Bill Gates and Paul Allen of Microsoft. Steve Jobs, Steve Wozniak, and Ronald Wayne of Apple. Larry Page and Sergey Brin of Google. Mark Zuckerberg with fellow college students and roommates Andrew McCollum, Eduardo Saverin, Dustin Moskovitz, and Chris Hughes of Facebook. How did all these successful companies come to be? These business ventures started with an innovative idea that needs co-founders or multiple partners. Not all are capable of being a sole proprietor. The partnership venture started either by long-time friends, school mates, or relatives. Not all started in good terms with each other, but they believed in the innovative business idea. And from there, the partnership prospered and even became more than a partnership but a big business venture! Learning Objectives After studying this chapter, the student should be able to acquire the following competencies: 1. Enumerate and describe the different forms of business organizations. 2. Know the definition and special features of a partnership. 3. Identify the different kinds of partnership and partners. 4. Distinguish the advantages and disadvantages of partnership form of business. 5. Account for partnership formation by organizing a new partnership business or by converting sole proprietorship business into partnership. A business owned by two or more individuals is called a partnership. These individual owners are called partners. Similar to a sole proprietorship, starting a partnership business does not involve special legal requirements. The only requirement is for the two or more partners to agree to operate a business together. The agreement can be either oral or written and normally includes how business profits and losses should be divided. Although an oral agreement can bind the partners to form a partnership venture, a written agreement is preferred to help partners avoid or resolve disputes during the operation of the business.

1 Copyright © 2020 Marivic Valenzuela-Manalo. All rights reserved. No part of this learning module may be used, reproduced, stored, or transmitted in any form or by any means without the written consent of the author.

Friendship into Partnership: Charito Couturier Shop Business Case Charito Couturier Shop has been operating for five years now. Business is growing. More and more clients from different walks of life come to her shop which is bigger and currently using state-of-the-art sewing equipment. By the end of the shop’s fifth year, Charito is tinkering on the idea of expanding her operation in the neighboring city. Charito contacted her CPA friend, Luz, who suggested she analyze her latest statement of financial position since her business consistently earns higher net income for the past five years compared to other entities in the same line of business in her locality. Luz explained that the statement of financial position contained the listing of the business’s asset, liabilities and owner’s equity. She has to analyze the assets of the company since these are resources which are owned or controlled by her business. These resources are necessary and good things to have because she could use them for her business expansion plans. Liabilities, on the other hand, are commitments to pay out assets, typically cash, or to render services to creditors. Analyzing the liabilities of the shop is necessary in order to know what other sources of funding are available for the company other than additional investment from Charito if the plans of business expansion will push through. She can decide in borrowing money from a local bank to partly finance the new shop she’s planning to open in the neighboring city. If she is going to expand her business, moving quickly to penetrate the market, she would need a major infusion of capital. This is an important decision partly because Charito wanted Guadalupe, a long-time friend and also a clothes designer, to join her business. Guadalupe is known in her excellent designing and sewing of children and teenager apparels which will complement Charito’s competency in designing and sewing women, men, and professional apparels. On January 2, 2023, Guadalupe accepted the invitation of Charito to become her partner in the Charito couturier business. Aside from the initial cash investment equal to twenty percent (20%) of the total partnership capitalization, Guadalupe will be co-managing the partnership business with Charito. The two partners decided that if they will be involved together in a partnership it is best to put all their agreements in writing to avoid misunderstanding in the future. This written agreement is known as the Articles of Co-Partnership, which is an agreement in writing among the partners governing the nature and terms of the partnership contract. The principal information contained among these agreements are: 1) the name of the partnership, 2) the names, addresses of the partners, classes of partners stating whether the partner is a general or a limited partner, 3) the effective date of the contract, 4) the purpose and principal place of business of the partnership, 5) the investments each partner will make in the business stating the contributions of each of the partners, 2 Copyright © 2020 Marivic Valenzuela-Manalo. All rights reserved. No part of this learning module may be used, reproduced, stored, or transmitted in any form or by any means without the written consent of the author.

6) 7) 8) 9) 10)

the rights and duties of each of the partners, the allocation and distribution of profits (and losses) among the partners, the conditions under which the partners may withdraw money or other assets, the manner of keeping the books of accounts, the method of decision making such as the causes for dissolution and the provision for arbitration in settling disputes, etc.

The following is the post-closing trial balance of Charito Couturier Shop just before the proposed formation of the partnership with her friend Guadalupe on January 2, 2023. Charito Couturier Shop Post-Closing Trial Balance December 31,2022 Account Title Cash in Bank Petty Cash Fund Accounts Receivable Allowance for Bad Debts Notes Receivable Advances to Employees Interest Receivable Sewing Supplies on Hand Land Buildings Accumulated Depreciation-Building Sewing and Designing Equipment Accumulated Depreciation-Sewing and Designing Equipment Shop Equipment Accumulated Depreciation-Shop Equipment Furniture and Fixture Accumulated Depreciation – Furniture and Fixture Accounts Payable Unearned Service Income Utilities Payable Withholding Taxes Payable Notes Payable due in 3 years Charito, Capital Totals

Debit P 281,175 10,000 219,000

Credit

P 21,900 40,000 7,500 400 23,500 700,000 800,000 250,000 550,000 100,000 480,000 281,250 400,000

P 3,511,575

185,000 68,500 105,845 7,200 12,500 120,000 2,359,380 P 3,511,575

3 Copyright © 2020 Marivic Valenzuela-Manalo. All rights reserved. No part of this learning module may be used, reproduced, stored, or transmitted in any form or by any means without the written consent of the author.

To convert Charito Couturier Shop into Charito and Guadalupe Couturier, Ltd., Charito sought again the help of the two partners’ common friend Luz, a CPA. Luz explained to Charito that she will proceed with the task of converting her business into partnership by applying the following three steps: Step 1: Revalue the assets and liabilities of CCS based on Fair Market Value (FMV) to obtain fair valuation of capital of Charito. Step 2: To close the books of accounts of CCS business in order to transfer all these accounts to the partnership that will be formed with Guadalupe. Step 3: To record the investment of both Charito and Guadalupe in the new set of books of Charito and Guadalupe Couturier, Ltd. To proceed with step 1, it was agreed that for the purpose of establishing Guadalupe’s interest, the following revaluations shall be made in the existing books of Charito: 1) The allowance for bad debts shall be increased by P 4,380 making it equal to 12% of the outstanding accounts receivable. 2) The Sewing Supplies on Hand is to be valued at P 18,500. 3) And a professional appraiser estimated that the land’s fair market value is P 850,000 and the rest of the equipment and furniture of CCS were fairly valued. The following are the revaluation entries recorded by Luz for CCS based on the agreement above. P a

DATE 2023

PARTICULARS

Jan. 2 Charito, Capital Allowance for Bad Debts

P/R

D E B I T

g e

1

C R E D I T

4 3 8 0 4 3 8 0

12% of Accounts Receivable 2 Charito, Capital

5 0 0 0

Sewing Supplies on Hand Revalue sewing supplies on its fair valuation. 2 Land

5 0 0 0

1 5 0 0 0 0 Charito, Capital

1 5 0 0 0 0

Revalue asset land based on its appraised value.

The above revaluation entries recorded in the books of CCS were posted on the following Taccounts to show the adjusted balances of the accounts affected. Luz showed the following Taccounts to Charito to explain to her the effect of these revaluations to her capital account. 4 Copyright © 2020 Marivic Valenzuela-Manalo. All rights reserved. No part of this learning module may be used, reproduced, stored, or transmitted in any form or by any means without the written consent of the author.

Sewing Supplies on Hand Dec.3 1 balance

23,500

Allowance for Bad Debts 21,900 Dec. 31 balance

5,000 revaluation No.2

4,380 Jan. 2, 2023 balance

18,500

26,280

Jan. 2, 2023balance

Charito, Capital

Land Dec.3 1 balance

700,000

revaluation No.1

4,380

revaluation No.3

150,000

revaluation No.2

5,000

Jan. 2, 2023 balance

revaluation No. 1

850,000

2,359,380 Dec. 31 balance 150,000 revaluation No.3 2,500,000

Jan.2, 2023 balance

To proceed with step 2, Luz recorded the following entry in closing the business of Charito Couturier Shop. P a g DATE

PARTICULARS

P/R

D

E B

I

T

2 6

2 8

0

e 1

C R E D

I

T

2 8 1 1

7 5

1 0 0

0 0

2 1 9 0

0 0

4 0 0

0 0

7 5

0 0

4

0 0

1 8 5

0 0

Land

8 5 0 0

0 0

Building

8 0 0 0

0 0

Sewing and Designing Equipment

5 5 0 0

0 0

Shop Equipment

4 8 0 0

0 0

Furniture and Fixture

4 0 0 0

0 0

2023 Jan.

2 Allowance for Bad Debts Accumulated Depreciation-Building

2

5 0

0 0

0

Accumulated Depreciation-Sewing & Designing Equipment

1

0 0

0 0

0

Accumulated Depreciation-Shop Equipment

2

8 1

2 5

0

Accumulated Depreciation-Furniture and Fixture

1

8 5

0 0

0

6 8

5 0

0

0 5

8 4

5

1 2

5 0

0

7

2 0

0

1

2 0

0 0

0

5

0 0

0 0

0

Accounts Payable Unearned Service Income

1

Withholding Taxes Payable Utilities Payable Notes Payable due in 3 years Charito, Capital Cash in Bank Petty Cash Fund Accounts Receivable Notes Receivable Advances to Employees Interest Receivable Sewing Supplies on Hand

2

To close the books of existing sole proprietorship business.

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Since Charito and Guadalupe decided to form Charito and Guadalupe Couturier, Ltd., the two agreed that Guadalupe is to invest cash which will give her 20% ownership in the newly formed partnership plus being a co-managing partner of the enterprise with Charito. To proceed with Step 3, Luz explained to her two friends that since the books of accounts of CCS is closed, she recorded the entries to journalize the two partners’ initial investments in the new set of partnership books of Charito and Guadalupe Couturier, Ltd. She also explained to Charito that since they are starting with a new form of business as a partnership, the depreciable assets (i.e., Building, Sewing and Designing Equipment, Shop Equipment, and Furniture and Fixture) to be invested will be recorded at their carrying values, meaning, the difference between the acquisition cost minus the accumulated depreciation as shown in the following entries. DATE

PARTICULARS

P/R

D E

B

I T

C

2 8

1

1 7

5

1

0

0 0

0

2 1

9

0 0

0

4

0

0 0

0

7

5 0

0

4 0

0

P

a g

e

1

R

E D

I

T

2 6 0 1

8 0 4 0 0 0 0

0 0 5 0 0 0 0

0

2023 Jan.

2 Cash in Bank Petty Cash Fund Accounts Receivable Notes Receivable Advances to Employees Interest Receivable Sewing Supplies on Hand

1

8

5 0

0

Land

8 5

0

0 0

0

Building

5 5

0

0 0

0

Sewing and Designing Equipment

4 5

0

0 0

0

Shop Equipment Furniture and Fixture Allowance for Bad Debts Accounts Payable Unearned Service Income Withholding Taxes Payable Utilities Payable Notes Payable due in 3 years Charito, Capital To record initial investment.

1 9 2 1

8 5

7 5 0 0

0 0

2 Cash in Bank Guadalupe, Capital To record initial investment.

1 5

2 0

6 8 5 2 7 0 0

6

2

5 0 0

1

2

6 2

5

0 0

2 5 8 5 2 0 0

0

Luz provided the two partners of the following computation on how the initial cash invested by Guadalupe was derived: Charito,Capital (100% - 20% = 80%) 80% share in the total partnership capitalization Total capitalization of the partnership 20% share in partnership capitalization of Guadalupe Guadalupe,Capital initial cash to be invested

P 2,500,000 80% 3,125,000 x 20% P 625,000

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Luz also prepared the following initial statement of financial position of the newly formed partnership. Charito and Guadalupe Couturier Ltd. Statement of Financial Position January 2, 2023 ASSETS Current Assets Cash (Note 1) Trade and other receivables ( Note 2 ) Sewing Supplies on Hand

P 916,175 240,620 18,500

P 1,175,295

Non-Current Assets Property, Plant and Equipment ( Note 3)

2,263,750 P 3,439,045

Total Assets

Current Liabilities Trade and other payables ( Note 4 ) Non-Current Liabilities

P 194,045

Notes Payable due for 3 years Total Liabilities Partners’ Equity Charito, Capital Guadalupe, Capital

P

P 2,500,000 625,000

3,125,000 P 3,439,045

Total Liabilities and Owner's Equity

Note 1: Cash Cash in Bank Petty Cash Fund Total Cash

120,000 314,045

P P

906,175 10,000 916,175

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Note 2: Trade and Other Receivables Accounts Receivable Allowance for Bad Debts Notes Receivable Advances to Employees Interest Receivable Total Trade and Other Receivables Note 3: Property, Plant and Equipment Land Building Sewing and Designing Equipment Shop Equipment Furniture and Fixture Total Property, Plant, and Equipment Note 4: Trade and Other Payables Accounts Payable Unearned Service Income Withholding Taxes Payable Utilities Payable Total Trade and Other Payables

P 219,000 (26,280)

P

P

P

192,720 40,000 7,500 400 240,620

850,000 550,000 450,000 198,750 215,000

P 2,263,750

P 68,500 105,845 12,500 7,200 P 194,045

Equipped with competence, confidence and trust for each other, the two friends who are now partners are ready to operate their newly formed partnership. Business Case Discussion Questions 1. What are the major advantages of starting a partnership? 2. What is the main difference in the statement of financial position of a partnership compared to that of a sole proprietorship form of business? 3. What is the document needed in forming a partnership, and what should this document contain? 4. What was the total amount of increase in the equity of the business when Charito invited Guadalupe to be her partner in business? 5. Is the action of Charito to form partnership with Guadalupe a good decision for the business? Why? 8 Copyright © 2020 Marivic Valenzuela-Manalo. All rights reserved. No part of this learning module may be used, reproduced, stored, or transmitted in any form or by any means without the written consent of the author.

Forms of Business Organizations A business entity may be formed in various ways. The type of business organization the owners choose will determine how the company will conduct its various business activities. It will also determine the proprietors’ legal liability, the extent of governmental control, and income taxation scheme. The first classification of type of business organization is according to ownership.

Based on Ownership There are three basic types of business organization according to ownership. This classification is based on owner/s investing or putting capital on a business being started. • Sole or single proprietorship - a business which is owned and managed by only one person. Examples of these types include individually owned mini stores, vulcanizing shops, and dress shops owned and operated by one owner. • Partnership - an association of two or more persons who bind themselves together to do business for profit. The persons owning this form of business are called partners. Examples of these are those partnerships organized for the exercise of professions, e.g., CPAs, doctors, lawyers, among others. • Corporation - a body formed and authorized by law to act as a single person although constituted by one or more persons and legally endowed with various rights and duties. This is the more popular ...