Module 1 - Introduction to Partnership & Partnership Formation PDF

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Module 1 - Introduction to Partnership & Partnership Formation...

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DETAILED LEARNING MODULE Title: Introduction to Partnership and Accounting for Partnership Formation Module No. 1 I. Introduction In this module, you will learn what is partnership and its classification including its advantages and disadvantages over sole proprietorship and corporation. You will also the accounting rules and procedures in forming a partnership. II. Learning Objectives After studying this module, you should be able to: 1. Define partnership and its classifications. 2. Differentiate partnership with sole proprietorship and corporation. 3. Prepare journal entries for partnership formation III. Topics and Key Concepts Definition of Partnership In a contract of partnership, two or more persons bind themselves to contribute money, property and industry to a common fund, with the intention of dividing the profits among themselves. Two or more persons may also form a partnership for the exercise of a profession. (Civil Code of the Philippines, Article 1767). Characteristics of Partnership 1. Mutual Contribution 2. Division of Profits or Losses 3. Co-owner of Contributed Assets 4. Mutual Agency 5. Limited Life 6. Unlimited Liability Advantages and Disadvantages of a Partnership Advantages vs. Sole Proprietorship 1. Bring greater financial capability to the business 2. Combines special skills, expertise and experience of the partners. 3. Offers relative freedom and flexibility of action in decision making. Advantages vs. Corporation 1. Easier and less expensive to organize 2. More personal and informal Disadvantages 1. Easily dissolved and thus unstable compared to a corporation 2. Mutual agency and unlimited liability may create personal obligations to partners 3. Less effective than a corporation in raising large amounts of capital. Classification of Partnership 1. According to object: a. Universal partnership of all present property b. Universal partnership of profits c. Particular Partnership 2.

According to liability: a. General. All partners are liable to the extent of their separate properties. b. Limited. The limited partners are liable only to the extent of their personal contributions. In a limited partnership, the law states that there shall be at least one general partner.

3.

According to duration:

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a. Partnership with a fixed term or for a particular undertaking. b. Partnership at will. One in which no term is specified and is not form for any particular undertaking. 4.

According to partner: a. Commercial or trading partnership b. Professional or non-trading partnership

5.

According to legality of existence: a. De jure partnership. One which has complied with all the legal requirements for its establishment. b. De facto partnership. One which has failed to complied with all the legal requirements for its establishment.

Kind of Partners 1. General Partner. One who is liable to the extent of his separate property after all the assets of the partnership are exhausted. 2. Limited partnership. One who is liable only to the extent of his capital contribution. He is not allowed to contribute industry or services only. 3. Capitalist partner. One who contributes money or property to the common fund of the partnership. 4. Industrial partner. One who contributes his knowledge or personal service to the partnership. 5. Managing partner. One whom the partners has appointed manager of the partnership. 6. Liquidating partner. One who is designated to wind up or settle the affairs of the partnership after liquidation. 7. Dormant partner. One who does not take active part in the business of the partnership and is not known as a partner. 8. Silent partner. One who does not take active part in the business of the partnership though may be known as a partner. 9. Secret partner. One who takes active part in the business but is not known to be a partner bu outside parties. 10. Nominal partner or partner by estoppel. One who is actually not a partner but who represents himself as one. Articles of Partnership The Articles of Partnership define the obligations, responsibilities and roles of each partner and how the profits and losses will be shared and states who the general and limited partners are. It sets forth all the terms and conditions mutually agreed by the partners thereto.

A contract of partnership is void whenever immovable property or real rights are contributed and signed inventory of the said property is not made and attached to a public instrument. SEC Registration When the partnership capital is P 3000, or more, in money or property, the public instrument must be recorded with the Securities and Exchange Commission (SEC). Even if not registered, the partnership having a capital of P 3,000 or more is still valid and therefore has legal personality. Accounting for Partnership Owner’s Equity Accounts • There are separate capital and drawing accounts that should be established for each partner. • A partner’s capital account is credited for his initial and additional net investments (assets contributed less liabilities assumed by partnerships) and credit balance of the drawing account at the end of the period. • Partner’s capital account is debited for his permanent withdrawals and debit balance of the drawing account at the end of the period. • A partner’s drawing account is debited to reflect assets temporarily withdrawn by him from the partnership. • At the end of each accounting period, the balances in the drawing accounts are closed to the related capital accounts. Partnership Formation Valuation of Investments by Partners • Partners may invest cash or non-cash assets in the partnership. • When a partner invests non-cash assets, they are to be recorded at values agreed upon by the parties. In the absence of any agreement, the contribution will be recognized at their fair market values at the date of transfer to the partnership. • The fair market value of an asset is the estimated amount that a willing seller would receive from a financially capable buyer for the sale of the asset in a free market.

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Opening Entries of a Partnership upon Formation A partnership may be formed in any of the following ways: 1. Individuals with no existing business form a partnership 2. Conversion of a sole proprietorship to a partnership. a. A sole proprietor and an individual without an existing business form a partnership. b. Two or more sole proprietorships form a partnership. 3. Admission or retirement of a partner (to be covered in Module 3)

Individuals with No Existing Form a Partnership • Initial cash investments are in recorded in the capital accounts maintained for each partner. • •

The non-cash properties are recorded at the current fair value of the property at the time of the investment. Liabilities assumed by the partnership are credited

Illustration: On Nov 5, 2020, J. Pascua and K. Mendigorin agreed to form a partnership. The agreement specified that Pascua is to invest cash of P 700,000 and Mendigorin is to contribute land with a fair market value of P 1,300,000 with P 300,000 mortgage assumed by the partnership. The entries are as follows: Cash

700,000

Land

1,300,000 Mortgage Payable

300,000

J. Pascua, Capital K. Mendigorin, Capital

700,000 1,000,000

A Sole Proprietor and Another Individual Form a Partnership 1. Both assets and liabilities of the sole proprietor are transferred to the newly formed partnership. 2. Normally, the partners agree on the revaluation of some of the assets before the transfer. 3. The journal entries to record this type of newly formed partnership or new books are to be opened. Illustration: Assume that J. Pascua has been operating a retail store for a number of years. A statement of financial position on July 1, 2020 is prepared for J. Pascua Company as follows: J. Pascua Company Statement of Financial Position July 1, 2020 Assets Cash Accounts Receivables

60,000 50,000

Inventory

70,000

Equipment Less: Accumulated Depreciation Total Assets

40,000 4,000

36,000 216,000

Liabilities and Equity Accounts Payable J. Pascua, Capital

86,000 130,000

Total Liabilities and Equity

216,000

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J. Pascua needs additional capital to meet the increasing sales and offers K. Mendigorin an interest in the business. Pascua and Mendigorin agree to form a partnership to be known as JK Partnership. Pascua’s business is audited and its net assets are appraised. The audit and appraisal shows the following: 1. Allowance for bad debts of P 5,000 is to be provided. 2. Inventory is to be recorded at its market value of P 80,000. 3. The equipment has a fair value of P 35,000. 4. P 2,000 of accounts payable has not been recorded. Pascua and Mendigorin prepare and sign articles of co-partnership that include all significant operating policies. On July 1, 2020, Mendigorin contributes P 100,000 cash for a one-third capital interest. The JK Partnership is to acquire all Pascua’s business and assume its liabilities. Sole Proprietorship’s Books are Retained for the Partnership. 1. Adjust the assets and liabilities of Pascua to their fair market values as agreed by the partners. Adjustments are to be made to his capital account. 2. Record the investment of Pedro. Books of J. Pascua (Now the Partnership Books) 2020 July 1

Inventory

10,000

Acc. Depreciation-Equipment 4,000 Equipment 5,000 Allowance for bad debts 5,000 Accounts Payable 2,000 J. Pascua, Capital 2,000 July 1

Cash

100,000

K. Mendigorin, Capital

100,000

After the formation, the statement of financial position of the newly formed partnership is

JK Partnership Statement of Financial Position July 1, 2020

Assets Cash Accounts Receivables Less: Allow for doubtful accounts

160,000 50,000 5,000

Inventory Equipment Total Assets

Liabilities and Equity Accounts Payable J. Pascua, Capital

88,000 132,000

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K. Mendigorin, Capital

100,000

Total Liabilities and Equity

320,000

New Books are Opened for the Partnership. Books of J. Pascua: 1. Adjust the assets and liabilities of J. Pascua according to the agreement. Adjustment are made to his capital 2. Close the books. New Books of the Partnership 1. Record the investments of J. Pascua, his assets and liabilities. 2. Record the cash investment of K. Mendigorin. Journal entries to record the formation of the partnership are: Books of Pascua (Sole Proprietorship): 2020 July 1

Inventory

10,000

Acc. Depreciation-Equipment 4,000 Equipment 5,000 Allowance for bad debts 5,000 Accounts Payable 2,000 J. Pascua, Capital 2,000 To adjust assets and liabilities of J. Pascua

Accounts Payable 88,000 Allowance for bad debts 5,000 J. Pascua, Capital 132,000 Cash 60,000 Accounts Receivable 50,000 Inventory 80,000 Equipment 35,000 To close all the adjusted balances of the accounts New Books of Partnership 2020 July 1

Cash

60,000

Accounts Receivable

50,000

Inventory

80,000

Equipment

35,000

Accounts Payable

88,000

Allowance for bad debts

5,000

J. Pascua, Capital

132,000

To record investment of J. Pascua

Cash

100,000

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K. Mendigorin, Capital

100,000

To record cash investment of K. Mendigorin Two or More Proprietors Form a Partnership The accounting procedures described in the preceding section are also applicable when two or more proprietorships join together to form a partnership. Illustrations. Assume that on June 30, 2020, Pascua and Mendigorin, competitors in business, decide to consolidate their business to form a partnership to called KJ Partnership. The statement of financial position of Pascua and Mendigorin on this date are presented below: Pascua Company Statement of Financial Position June 30, 2020 Assets Cash Accounts Receivables Inventory Furnitures & Fixtures Total Assets

5,000 10,000 8,000 6,000 29,000

Liabilities and Equity Accounts Payable Pascua, Capital Total Liabilities and Equity

3,000 26,000 29,000

Mendigorin Company Statement of Financial Position June 30, 2020 Assets Cash Accounts Receivables Inventory Furnitures & Fixtures Total Assets

4,000 8,000 10,000 9,000 31,000

Liabilities and Equity Accounts Payable Mendigorin, Capital Total Liabilities and Equity

6,000 25,000 31,000

The conditions agreed by the partners for purposes of determining their interests in the partnership are presented below: a. 10% of accounts receivable is to be set up as uncollectible in each book. b. Inventory of Mendigorin is to be increased by P 1,000. c. The furnitures and fixtures of Pascua and Mendigorin are to be depreciated by P 600 and P 900, respectively. New Partnership Books will be used. Books of Pascua and Mendigorin

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1. Adjust the accounts of Pascua and Mendigorin according to their agreement. Adjustments are to be made to their capital accounts. 2. Close the books. New Book of the Partnership 1. Record the investments of Pascua, his adjusted assets and liabilities. 2. Record the investments of Mendigorin, his adjusted assets and liabilities. Books of Pascua 2020 June 30

Pascua, Capital

1,600

Allowance for bad debts

1,000

Acc. Depreciation - F&F

600

To record adjustments of assets

Accounts Payable

3,000

Allowance for bad debts

1,000

Acc. Depreciation - F&F

600

J. Pascua, Capital

24,400

Cash

5,000

Accounts Receivable

10,000

Inventory

8,000

Furnitures and Fixtures

6,000

To close the books Books of Mendigorin 2020 June 30

Inventory Mendigorin, Capital

1,000 700

Allowance for bad debts

800

Acc. Depreciation - F&F

900

To record adjustments of assets

Accounts Payable

6,000

Allowance for Bad Debts

800

Acc. Depreciation - F&F

900

Mendigorin, Capital

24,300

Cash

4,000

Accounts Receivable

8,000

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Inventory

11,000

Furnitures and Fixtures

9,000

To close the books

New Books of Partnership 2020 June 30

Cash

5,000

Accounts Receivable

10,000

Inventory

8,000

Furnitures and Fixtures Accounts Payable

5,400 3,000

Allowance for Bad Debts

1,000

Pascua, Capital

24,400

To record investments of Pascua Cash

4,000

Accounts Receivable

8,000

Inventory Furnitures and Fixtures

11,000 8,100

Accounts Payable

6,000

Allowance for Bad Debts

800

Mendorin, Capital 24,300 To record the investments of Mendigorin. The statement of financial position of the partnership after formation is as follows: KJ Partnership Statement of Financial Position June 30, 2020

Assets Cash Accounts Receivables Less: Allow for Bad Debts Inventory Furnitures & Fixtures

9,000 18,000 1,800

Total Assets

Key observations from the illustrations: 1. Assets invested areLiabilities and Equity recorded at their current fair market value at the time 9,000 of the formation. Accounts Payable 24,400 2. No accumulatedPascua, Capital depreciation is carried forward to the partnership. Mendigorin, Capital 24,300 3. All liabilities are Total Liabilities and Equity 57,700 recognized and recorded IV. Teaching and Learning Materials and Resources 1. Partnership and Corporation Accounting by Ballada

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V. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Learning Task Problem 1-1 (Theories True or False) A partnership must always have at least two owners. A dormant partner is one who does not take active part in the partnership business and is not known as a partner. Partners’ drawing accounts have normal credit balances. A partnership should always be constituted in writing. Mutual agency means that each partner has the right to bind the partnership to contracts. Two or more persons may form a partnership for the exercise of a profession. The limited partners are liable only to the extent of their personal contributions. The basis of valuation for non-cash investments should be fair market value. A partnership may be established for charity. A de jure partnership is one which has complied with all the legal requirements for its establishment.

Problem 1-2 (Partner’s Original Investment) Torres contributed land, inventory and P280,000 cash to a partnership. The land has a book value of 650,000 and a market value of P1,350,000. The inventory has a book value of P600,000 and a market value of P510,000. The partnership assumed a P350,000 note payable owed by Torres that was used to purchase the land. Santos agreed to put up cash equivalent to Torres’ net investment. Required: Prepare journal entry to record Torres’ and Santos’ investment in the partnership. Problem 1-3 (Formation of a Partnership) John & Peter have just formed a partnership. John contributed cash of P 1,260,000 and computer equipment that cost P 540,000. The fair value of the computer is P 360,000. John has notes payable on the computer of P 120,000 to be assumed by the partnership. John is to have 60% capital interest in the partnership. Peter contributed cash of P 900,000. The partners agreed to share profit and loss equally. Required: 1. Compute for the additional investment or withdrawal to be made by John.

Problem 1-4 (A Sole Proprietor and an Individual with no Business Form a Partnership) On Apr 8, 2021, Tan who has her own retail business and Tiu, decided to form a partnership wherein they will divide the profits in the ratio of 40:60, respectively. The statement of financial position of Tan is as follows: Tan Company

Statement of Financial Position

Apr 8, 2021

Assets Cash

4,000

Accounts Receivables

160,000

Less: Allow for Bad Debts

16,000

Inventory

200,000

Equipment Less: Acc. Depreciation

144,000

50,000 10,000

Total Assets Liabilities and Equity

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Accounts Payable Tan, Capital

36,000 352,000

388,000 Conditions agreed upon before the formation of the partnership: a. The accounts receivable of Tan is estimated to be 70% realizable. b. The accumulated depreciation of the equipment will be increased by P 10,000. c. The accounts payable will be assumed by the partnership. d. The capital of the partnership is based on the adjusted capital balance of Tan. Tiu is to contribute cash in order to make the partner’s capital balances proportionate to the profit and loss ratio. Required: 1. Prepare the necessary journal entries in all the books to record the formation of the partnership if a new set of books will be used. 2. Prepare the statement of financial position of the partnership. Problem 1-5 (Two Sole Proprietors Form a Partnership) Dy and Sy are fierce competitors who sell hunting equipment. They finally decided to join fo...