LESSON 2 FORMATION OF PARTNERSHIP (2

Hours)
In general, the accounting principles, procedure and accounting cycle used in a
sole proprietorship, partnership and corporation form are basically the same.
Regular business transactions related to purchases and sales of merchandise,
payments of expenses and collections of revenues are given similar accounting
treatment.

The exception however lies in the owners’ equity accounts. In sole

proprietorship, there is one capital account and one withdrawal account
because there is only one owner of the business. On the other hand, the capital
accounts and drawing accounts of a partnership business are more than one
depending on the number of partners in the association.

In addition to the difference in equity account, partnership business involves

special accounting concern for the following:

1. Partners’ capital investments and withdrawals;

2. Distribution of partners’ profit and loss; and

3. Dissolution and liquidation of partnership.

The corporation’s equity section, however, does not contain the capital and
drawings account of individual stockholders. Instead, it contains the share
capital and retained earnings accounts.

SUMMARY OF ACCOUNTING ELEMENTS

ACCOUNTING SOLE PARTNERSHIP CORPORATION

ELEMENTS PROPRIETORSHIP
Assets/ Liabilities Same Same Same
Equity:

Owners’ Proprietor’s Capital Partners’ Capital- Share Capital

Investment one for each partner

Charge to Partners
Charge to owner’s Drawings- one for Not accounted in
Owners’ drawings each partner Corporation’s books
Drawings because the current
stockholder could
transfer or sell his
investment without
notifying the issuing
corporation
Revenue and Finally closed to Finally closed to Finally closed to
Expenses Proprietor’s Capital at individual Partner’s Accumulated
the end of each Capital at the end of Earnings at the end
accounting period each accounting of each accounting
period. period.

The Basic Accounting Equation

The Basic Accounting Equation is a very important tool in analyzing the

elements affected by all business transactions. In Basic Accounting, the
accounting equation takes the following formula:

ASSETS = LIABILITIES + CAPITAL

In the formation of a partnership, the accounting equation is used to

determine the amount of assets to be contribution, the obligations to be
assumed, and the partner’s interest in the partnership. Each capital
account is established for partner.

ILLUSTRATION

Assume that Eye and Bee formed a partnership. They that the total capital of
partnership is ₱120,000, two-thirds of which is to be contributed by Aye. Aye
will contribute ₱80,000 in cash while Bee will contribute cash aside from the
₱30,000 worth of merchandise taken from his business with outstanding
accounts payable for ₱5,000 to be assumed by the partnership. How much
would be the cash contribution of Bee?

Using the accounting equation, Bee’s cash contribution can be computed and
analyzed as follows:

ASSETS = LIABILITY + CAI, CAPITAL

(debit) (credit) (credit)

Cash Merchandise = Accounts Payable + Required Capital
? ₱30,000 ≠ ₱5,000 + ₱40,0000
Since the debit should always be equal to credit, the cash contribution to
be given by Bee would be ₱15,000, determined by getting the equilibrium
of equation.

ASSETS = LIABILITY + CAI, CAPITAL

(debit) (credit) (credit)

Cash Merchandise = Accounts Payable + Required Capital
₱15,000 ₱30,000 ≠ ₱5,000 + ₱40,0000

The total required capital contribution of Bee is computed as follows:

Total agreed partnership capital ₱ 120,000

Less: Aye’s capital contribution (₱ 120,000 x 2/3) 80,000
Bee’s capital contribution (₱ 120,000 x 1/3) ₱ 40,000

The cash contribution of Cain can be computed as follows:

Required capital contribution of Cain (₱ 120,000 x 1/3) ₱ 40,000

Add: Accounts payable assumed by the partnership 80,000
Total Credits ₱ 40,000
Less: Merchandise contribution of Bee 30,000
Cash contribution of Cain ₱ 15,000

partnership accounts

As a rule, the account titles used in the accounting for sole proprietorship’s
operation are also used in the accounting for partnerships. However, some
accounts of a partnership differ from those of a sole proprietorship in the
following ways:

Partners’ Capital Account

A partner’s capital account is a permanent account. Each partner has his own
capital which has a normal credit balance. The balance in the capital account
represents the partner’s share in the net assets of the partnership.

The partner’s capital account gives information on the increase or decrease in

his interest in the partnership. Specially, the transactions affecting the partner’s
capital account are summarized as follows:

PARTNER’S CAPITAL
Debit Credit
1. Permanent withdrawals of 1. Original investment
capital

2. Closing of the net debit

balance of the drawing account 2. Additional Investments

3. Share in the net loss from

operation

3. Share in the net income from

operation

Occasionally, a partner’s capital account may have a debit balance called a

“deficiency” sometimes termed as a “partner’s deficit” which occurs because
the partner’s share in losses and/ or withdrawals exceeds his capital
contribution and share of profits. A deficiency is usually eliminated by
additional capital contributions.

To illustrate, assume that the capital accounts of Sea after closing entries of net
loss and withdrawals to the capital account show a debit balance of P3,000 and
the partnership agreement provides that at least P50,000 of the partner's
capital must be maintained before the start of the new business year.

The journal entry to eliminate deficit and meet the capitalization requirement
would be as follows:

GENERAL JOURNAL
Date Descriptions Debit Credit
12/31 Cash ₱53,000
Sea, Capital ₱53,000
To eliminate Sea’s capital deficiency and
maintain the required capital balance at the start
of the year.

Partner's Drawing Account

A partner's drawing account is a temporary account and is periodically closed

to the partner's capital account.
Each partner has his own drawing account to reflect temporary withdrawals
and other minor amounts taken by the partner from the partnership in
anticipation of his share in the partnership income.

The transactions affecting the partner's drawing account are summarized

below:

PARTNER’S DRAWING
Debit Credit
1. Temporary withdrawals 1. Periodic partner's salaries

2. Partner's personal debts paid or 2. Partnership debts assumed or

assumed by the partnership paid by the partner

3. Funds or claims of partnership

collected and retained by the
partner 3. Personal funds or claims of
partner collected and retained by
the partnership

4. Share in partnership losses

(eventually closed to capital
account) 4. Share in partnership profits
(eventually closed to capital
account)
ILLUSTRATION

Assume that the partnership paid the personal electric bill of partners Dy and
Sea amounting to P500 and P700, respectively. The journal entry in the books
of the partnership would be:

GENERAL JOURNAL
Date Descriptions Debit Credit
07/01 Dy, Drawings ₱500
Sea, Drawings 700
Cash ₱1,200
To record partner’s personal expenses

Loans Receivable from Partners

Also called "loans to partner" or "due from partner, " loans receivable from
partner's account represent the substantial amount borrowed by a partner
from the partnership. Thus, the partner's capital/drawing account is used to
describe the partner's withdrawals because of the creditor-debtor relationship
between the partnership (creditor) and the partner (debtor).

ILLUSTRATION

Assume that Dy, a partner, borrowed money from the partnership amounting
to P20,000 for a money cost of 12% per year. He promised to settle his
obligation within 3 months. The journal entry would be:

GENERAL JOURNAL
Date Descriptions Debit Credit
07/01 Loans receivable from partner- Dy ₱20,000
Cash ₱20,000
To record payment partner’s advances.
The loans receivable from partner account is generally classified as part of the
current assets except when the agreed collection period extends beyond the
one-year period wherein the loans receivable from partner is classified as
noncurrent.

The subsequent payment of Joseph to settle his obligation to the partnership

would be:

GENERAL JOURNAL
Date Descriptions Debit Credit
10/01 Cash ₱20,600
Loans receivable from partner- Dy ₱20,000
Interest income 600
To record collection of loans to partner.
Computation:

Interest income (₱20,000 x 12% x 3/ 12) 600

Loans Payable to Partners

Also called “loan from partner” or “due to partner”, these accounts represent
the substantial amounts lent to the partnership by the partner which the
partnership is obliged to pay.

The partner's capital account is not the appropriate account to describe the
transaction because a creditor debtor relationship has been created when
partner lends money to the partnership, the partner being the creditor and the
partner being the debtor.

ILLUSTRATION
Assume that Sea, a partner, lent money to the partnership amounting to
P50,000 with an interest of 6% per year. The loan agreement provides that the
partnership will pay the entire amount due within 6 months. The related
journal entry would be:

GENERAL JOURNAL
Date Descriptions Debit Credit
07/01 Cash ₱50,000
Loans payable to partner- Sea ₱50,000
To record loans from partner.

The subsequent payment of the partnership to partner Sea is as follows:

GENERAL JOURNAL
Date Descriptions Debit Credit
12/31 Loans payable to partner- Sea ₱180,000
Interest expense 140,000
Cash ₱50,000
To record payment of due from partner.
Computation of interest expense:

(₱50,000 x 6% x 6/ 12) ₱1,500

TEACHER’S INSIGHT

Ø The interest expense shall be treated as other operating expense of the partnership.

Since this account is a payable, it is generally classified as part of the current

liabilities except when the agreed payment period extends beyond the
one-year period.

Loans to and from Partners

This account title is a combination of loans receivable from partner and loans
payable to partner accounts.

If the "loans receivable from partner” account has a credit balance, it means
that the borrowing partner paid more than his advances from the partnership.
In such a case, the partnership becomes a debtor instead of a creditor.

In a similar manner, if the "loans payable to partner” 1 account reflects a debit

balance, there would be an overpayment made by the partnership. Thus, the
partnership becomes a creditor.
Accordingly, accountants use an alternating account, which is usually termed
as "Loans to and from Partners," representing both a claim and obligation. This
account represents a claim when its balance is found on the debit side. If its
balance is found on the credit side, it represents a liability.

LOANS TO AND FROM PARTNERS

Debit Credit
Balance xxx Balance xxx

ASSET LIABILITY

TEACHER’S INSIGHT

Ø Any loans between a partner and the partnership should always be accompanied by
proper loan documentation, such as a promissory note. As in any other loan, a loan
from a partner is shown as payable on the partnership’s books.

PARTNERSHIP FORMATION

A partnership is formed or perfected from the time the partners agreed on the
terms and conditions of the partnership contracts. When a partnership is
formed, partners commonly observe the following to ensure fair and honest
business:

1. Execution of partners' agreement.

2. Valuation of partners' investments.

The valuation of partners' non-cash investment is based on the partners

agreed value. In the absence of any agreement, the fair value of the property is
used as its value to measure the contribution of the partner.

3. Adjustments of accounts.

If there is an existing sole proprietor's business that would be converted as a

partnership, all accounts that are being revalued according to the partnership
agreement would increase or decrease the contributing partner's capital.

The adjustments of the accounts are very important because they reflect the
fair and equitable value of the prospective partner's contributions to the
partnership.

Initial Investments by Partners

The accounting issues regarding initial investments and other capital
contribution are how much the contribution to be made by the partners and at
what amount the capital contribution shall be recognized.

The answers to these issues depend on whether the partners agreed on their
respective individual contribution and whether cash or noncash contributions
are made.

The following rules shall then be observed when capital contribution issues
arise:

1. Amount of contribution. The amount of contribution shall be based on the

partners' agreement. In the absence of any agreement, it shall be contributed
equally.

AMOUNT OF PARTNER'S CONTRIBUTION

Do partners agree upon their respective capital contribution?

▼ ▼
Yes No

▼ ▼
Contribute and record as per To be contributed equally
agreement

ILLUSTRATION - With agreement on individual contribution

Eye and Bee form a partnership with a total agreed capitalization of ₱150,000
to be contributed in cash of 40% and 60% by Eye and Bee, respectively,
through the issuance of their personal checks.

The amount contributed and capital credit to be recorded per agreement

would be:

GENERAL JOURNAL
Date Description Debit Credit
01/01 Cash ₱60,000
Eye, Capital ₱60,000
To record initial investment of Eye.

01/01 Cash ₱90,000

 Bee, Capital ₱90,000
To record initial investment of Bee.
NOTES:

1. The journal entry for the investments of Eye and Bee is a single journal entry
because there are two separate source documents - the individual checks of
each owner It is therefore necessary to have two separate entries.

2. There is a separate capital account (and withdrawal account) for each

partner.

3. The rules of debits and credits should always be observed in recording

transactions in the books of accounts.

ILLUSTRATION - Without agreement on individual partner's capital

contribution

Eye and Bee decided to form a partnership with a total agreed capitalization of
₱150,000 to be contributed in cash.

The above agreement, standing alone, shall mean that equal amount of cash
shall be collected from each partner and to be recorded in the partnership's
books as:

GENERAL JOURNAL
Date Description Debit Credit
01/01 Cash ₱150,000
Eye, Capital ₱75,000
Bee, Capital ₱75,000
To record initial investment of Eye and Bee.

2. Valuation of Partners' Contribution. If cash contribution is made, the face

value of cash is the amount to be recognized.

If noncash contribution is to be made, it shall be recorded at agreed value,

otherwise, it will be recorded at the fair value of the property to effect fair and
equitable valuation.

VALUATION OF PARTNERS' CONTRIBUTION

Is it cash contribution?

▼ ▼
To be recorded at
No Yes ► ACTUAL
 AMOUNT
of cash
▼ contributed.

Is it Property?

▼ ▼
To be recorded at AGREED
No Yes ► VALUE, otherwise at FAIR
VALUE

Industry (skill or labor) ► Recorded in

MEMORANDUM ENTRY
form

TEACHER’S INSIGHT

Ø If there is no agreed value, the investment of capital in a partnership should be

measured at the fair value of all tangible and intangible assets contributed at the time
of their transfer to the partnership. An individual partner's liabilities that have been
assumed by the partnership should also be recorded at fair market value.

Ø The fair value or fair market value represents the estimated amount in which the
seller and buyer would be willing to exchange value in an open market. In other
words, fair market value suggests the approximate cash equivalent of an asset.

Recording Industrial Partner's Contribution

To record the contribution (industry) of an industrial partner, a memorandum

entry in the general ledger is prepared as follows:

Sea, Capital
Sea is an industrial partner to share 8% in the partnership

profit

TEACHER’S INSIGHT

Ø The ledger account is used in recording the memorandum entry for the contribution
of an industrial partner.
Ø When the net income of the partnership has been distributed to the partners, the
capital account of an industrial partner would have a journal entry equivalent to his
share in the profit.

Assets Contribution with Liabilities Assumed

When a partner contributes assets together with liabilities assumed by the

partnership, the assets are to be valued at the agreed value or fair market value,
whichever is applicable. The assets are to be reduced by the fair value of the
liabilities assumed by the partnership. The partner's capital to be credited is
the value of assets reduced by the value of liabilities assumed by the
partnership

ILLUSTRATION

AB Partnership accepted Sea to the partnership. Sea contributed assets and

liabilities agreed to be assumed by the partnership, as follows:

COST AGREED FAIR

VALUE VALUE
Machine ₱200,000 ₱180,000
Furniture and fixture 100,000 ₱140,000
Notes Payable 50,000 50,000
Interest on notes payable 5,000 5,000

The investments of Allan to the partnership are recorded as follows:

GENERAL JOURNAL
Date Description Debit Credit
07/01 Machine ₱180,000
Furniture and Fixtures 140,000
Notes Payable ₱50,000
Accrued interest on notes payable 5,000
Sea, Capital 265,000
To record Allan’s contribution to the partnership

TEACHER’S INSIGHT

Ø The interest income shall be treated as other operating income of the partnership.

Stages from which Partnerships are Formed

The complexity of accounting for partnership formation depends on the stage
from which a partnership is formed. These stages would be:

1. First time in business - individual persons without existing business Soma

partnership.

2. Conversion of a single proprietorship to a partnership - this could be

made when:

a. A sole proprietor admits into his business another individual who has no
business of his own.

b. Two or more sole proprietorship converted into a partnership.

3. Admission of a new partner to an existing partnership (See LESSON 4) -

by nature, this is a form of dissolution of an old partnership which gives rise to
the formation of a new partnership.

Partnership Formation by Individuals without Existing Business (First

Time in Business)

The formation of partnership composing of partners without existing business

is simply accounted for by recording the individual contribution of the partners.
The rules on the amount of contributions and the valuation of contributed
assets are observed. There are no accounts to be adjusted and closed at the
time of formation.

ILLUSTRATION

Eye, Bee and Sea formed a partnership with agreed total capitalization of
P300,000 which should be contributed equally by Eye and Bee. Meanwhile, Sea
was designated to manage the operation of the partnership as an industrial
partner with a share of 20% from partnership profits. Eye and Bee contribute
the following assets:

Contributions of Partner Eye At Cost At Fair Value

Land ₱50,000 ₱110,000
Equipment 70,000 60,000
Unpaid property tax assumed by the partnership 20,000 20,000

Contributions of Partner Bee

Cash ₱100,000 ₱100,000
Equipment 50,000 40,000
Supplies 20,000 10,000
To record the partners' contributions, the journal entries would be:

GENERAL JOURNAL
Date Description Debit Credit
07/01 Cash ₱100,000
Supplies 10,000
Equipment (₱60,000 + ₱40,000) 100,000
Land 110,000
Property tax payable ₱20,000
Eye, Capital 150,000
Bee, Capital 150,000
To record the initial investments by Eye and Bee.

To record the contribution of Sea (an industrial partner), the memorandum

entry in the general ledger would be as follows:

Sea, Capital
Sea is an industrial partner to share 20% in the partnership

profit

Conversion of a Single Proprietorship to a Partnership

The conversion of sole proprietorship) to partnership is accounted for by

following the procedures:

1. Close the nominal accounts of the sole proprietorship business.

2 Record the adjustments (based on the agreed valuation or fair value) of the
assets and liabilities directly to the sole proprietor's capital account.

3. Close the books of the sole proprietorship.

4. Open the new set of partnership books by recording the partners

contribution

As per Section 236A to 236J of the National Internal Revenue Code (NIRC),
every person subject to any internal revenue tax in required to register once
with the appropriate Revenue District Officer (RDO).

A partnership is a legal entity separate and distinct from its owners. It shall
therefore acquire its own Tax Identification Number (TIN) separately from the
TIN of the partners. As a consequence, a partnership should maintain its own
books of account under its registered name as provided by law.2
It follows, therefore, that the books of the sole proprietor are not applicable to
be used by the newly formed partnership because the sole proprietorship is
registered under the name of the single owner, whereas a partnership is
registered in another name with a separate TIN. Inasmuch as partnership exists
as a juridical person like a corporation for income tax purposes, it should
maintain its own separate book as the law requires

ILLUSTRATION

Eye is the owner of existing single proprietorship, Eye, together with Bee and
Sea, decides to convert his single proprietorship into a partnership. They agree
to start the partnership with total capitalization of ₱1,500,000 to be
contributed equally by the partners Bee and Sea are to contribute cash. Partner
Eye shall also contribute additional cash if the net assets of his business after
the agreed valuation will not be enough to cover his contribution requirement.

Eye's single proprietorship trial balance shows the following:

Eye's Proprietorship

Trial Balance

January 1, 2020
Account Title Debit Credit
Cash ₱50,000
Accounts Receivable 200,000
Allowance for bad debts ₱2,000
Merchandise Inventory, end 80,000
Notes Payable 100,000
Eye, Capital 200,000
Sales 89,000
Salaries expense 50,000
Supplies expense 5,000
Miscellaneous expense 6,000
₱391,000 ₱391,000
Closing the Nominal Accounts

Prior to the formation, the sole proprietor's nominal accounts should first be
cloned to effect the correct balance on his capital. The nominal accounts of A
should then be closed as follows:

GENERAL JOURNAL

(Eye’s Proprietorship)
Date Descriptions Debit Credit
01/01 Sales ₱89,000
 Salaries Expense ₱50,000
Supplies Expense 5,000
Miscellaneous Expense 6,000
Income Summary 28,000
To close revenue and expenses.

01/01 Income Summary ₱28,000

Eye, Capital ₱28,000
To close the net profit to capital.

The post-closing trial balance of A single proprietorship is presented below.

Eye's Proprietorship

Post-Closing Trial Balance

January 1, 2020
Account Title Debit Credit
Cash ₱50,000
Accounts Receivable 200,000
Allowance for bad debts ₱2,000
Merchandise Inventory, end 80,000
Notes Payable 100,000
Eye, Capital 228,000
₱330,000 ₱330,000
Suppose that, based on the post-closing balances, the following valuation
adjustments were agreed upon:

a. Accounts receivable is 98% realizable.

b. Merchandise inventory is to be valued at P9,000.

c. Interest of P 600 on note payable should be recognized.

Adjustments of Sole Proprietor's Accounts

Prior to the formation of the partnership, adjustments shall be made in the

books of the prospective sole proprietor Adjustments are necessary to effect
the proper value of assets and liabilities in accordance with the valuation
agreement or fair value.

To record the agreed adjustments would require the following entry in the
books of Eye’s Proprietorship.

GENERAL JOURNAL
 (Eye’s Proprietorship)
Date Descriptions Debit Credit
a)Eye, Capital ₱89,000
Allowance for bad debts ₱50,000
To record adjustments on accounts receivable,
computed as follows:
Required Allowance (₱200,000 x 2%) ₱4000
less: Recorded allowance
2000
Increase in allowance
₱2,000

b)Merchandise inventory ₱10,000

Eye, Capital ₱10,000
To adjust merchandise inventory, computed as
follows:
Required Value of Inventory ₱90,000

less: Recorded Value of Inventory 80,000

Increase in Inventory ₱10,000

c)Eye, Capital ₱6,000
Accrued interest payable ₱6,000
To record accrued interest on notes payable.

TEACHER’S INSIGHT

Ø The nominal accounts in the adjustments are not used anymore instead,
adjustments are made directly to the sole proprietor's capital account because the
business is now in its liquidating concern.

Ø Adjustments are effected prior to the formation of the partnership in accordance

with the disciples of fun and objectivity, Accordingly, any increase or decrease in the
value of the sets belote the formation of the partnership should sent to the benefit or
expense of the sole owner and not to the partnership.

To update the postings on Eye, Capital account would show the following

Eye, Capital
Debit Credit
(a) ₱2,000Post- Closing Balance ₱228,000

(c) 6,000(b) 10,000

8,000
Adjusted Dr. Balance _230,000 ________

Total ₱238,000Total ₱238,000

After the agreed adjustments are posted, the adjusted trial balance of Eye’s
proprietorship can be shown as follows;

Eye's Proprietorship

Adjusted Trial Balance

January 1, 2020
Account Title Debit Credit
Cash ₱50,000
Accounts Receivable 200,000
Allowance for bad debts ₱4,000
Merchandise Inventory, end 90,000
Notes Payable 100,000
Accrued Interest Payable 6,000
Eye, Capital 200,000
₱340,000 ₱340,000

Closing the Sole Proprietor's Accounts

Since the single proprietorship is dissolved, it follows that its books should be
coined, meaning all the accounts (nominal and real) are to be brought to zero
balance.

The closing of the single proprietorship books will require the following journal
entry:

GENERAL JOURNAL

(Eye’s Proprietorship)
Date Descriptions Debit Credit
01/01 Allowance for bad debts ₱4,000
Notes Payable 100,000
Accrued Interest Payable 6,000
Eye, Capital 230,000
Cash ₱50,000
Accounts Receivable 200,000
Merchandise Inventory, end 90,000
To close the books of A's Proprietorship.
Recording the Partners Contributions

The initial investments of the partners will be recorded in the new set of
partnership's books as follows:

GENERAL JOURNAL

(Eye, Bee & Sea Partnership)

Date Descriptions Debit Credit
01/01 Cash *₱320,000
Accounts Receivable 200,000
Merchandise Inventory, end 90,000
Allowance for bad debts ₱4,000
Notes Payable 100,000
Accrued Interest Payable 6,000
Eye, Capital 230,000
To close the books of Eye's Proprietorship.

TEACHER’S INSIGHT

Ø The basic accounting equation of Assets = Liabilities and Capital is used to

compute the amount of cash contribution of Eye, computed as follows:

Agreed Capital contribution of Eye ₱500,000

Less: Adjusted capital based on agreed valuation adjustments 230,000
Additional cash contribution of Eye ₱270,000
Add: Cash from single proprietorship 50,000
Total cash contribution of Eye *₱320,000

The contribution of and would be recorded as follows:

GENERAL JOURNAL

(Eye, Bee & Sea Partnership)

Date Descriptions Debit Credit
01/01 Cash ₱1,000,000
Bee, Capital ₱500,000
Sea, Capital 500,000
To record the contribution of Bee and Sea.

The partnership trial balance right after the formation would be:

Eye, Bee & Sea Partnership

 Trial Balance

January 1, 2020
Account Title Debit Credit
Cash ₱1,320,000
Accounts Receivable 200,000
Allowance for bad debts ₱4,000
Merchandise Inventory, end 90,000
Notes Payable 100,000
Accrued Interest Payable 6,000
Eye, Capital 500,000
Bee, Capital 500,000
Sea, Capital _________ 500,000
₱1,610,000 ₱1,610,000

Two or More Sole Proprietors Form a Partnership

The new accounting standards mention only one instance

when goodwill would be recognized, through business combination applying
the purchase method. Accordingly, there is no goodwill that could be
recognized in forming a partnership which is more a pooling of interest rather
than purchase.

The forming of a single proprietorship into a partnership will not be

considered as a business combination through purchase of an existing entity's
net assets. This could be considered more as putting together of resources of
two or more existing businesses into common fund; otherwise, it is not a
partnership. Any changes in the total value of total capital contribution to the
partnership should be attributed to asset revaluation.

The accounting procedures in converting two or more existing single

proprietorship into a partnership are the same when a single proprietorship is
converted into a partnership. However, in converting two or more
proprietorships into a partnership, there are two or more books that need to
be adjusted and closed before the formation of a partnership.

ILLUSTRATION

Eye and Bee are both owners of an existing single proprietorship business They
agreed to combine their businesses into a partnership. They agreed to start
with a total capitalization of ₱4,000,000 to be contributed equally. They also
agreed to the following valuation of their business’s noncash assets:

a. Their receivables are 95% collectible.

b. The inventory has reliable value of P30,000.

c. The equipment has fair value of P50,000.

They will invest additional cash if needed to complete their agreed

contribution.

The trial balance of the single proprietorship businesses upon formation of Eye
& Bee Partnership is as follows:

Aye Business Bee Business

Cash ₱200,000 Cash ₱50,000
Accounts 600,000 Accounts 450,000
Receivable Receivable
Inventory 250,000 Store Equipment 1,200,000
Eye, Capital ₱500,000Accum. ₱300,000
Depreciation
Eye, Drawing 50,000 Bee, Capital 1,250,000
Accounts Payable 700,000Sales 600,000
Income Summary 100,000 Cost of Expenses 400,000
________ ________Misc. Expenses _ 50,000 ________
₱1,200,000 ₱1,200,000 ₱2,150,000 ₱2,150,000

1. Closing of nominal and temporary accounts

Books of Eye Books of Eye

Eye, Capital ₱150,000 Sales ₱600,000
Eye, Drawing ₱50,000 Cost of Sales ₱400,000
Income Summary 100,000 Misc. Expense 50,000
Income 150,000
Summary

Income Summary 150,000

Bee, Capital 150,000

2. Agreed valuation adjustments

Books of Eye Books of Eye

Inventory ₱50,000 Bee, Capital ₱422,500
Accounts ₱30,000 Accounts ₱2,250
Receivable Receivable
Income Summary 100,000 Accum. 400,000
Depreciation

3. Closing of Eye’s books and Bee's books

 Books of Eye Books of Eye
Eye, Capital ₱370,000 Rio, Capital ₱977,500
Accounts Payable 700,000 Accum. 700,00
Depreciation
Cash ₱200,000 Cash ₱50,000
Accounts 570,000 Accounts 427,500
Receivable Receivable
Inventory 300,000 Store Equipment 1,200,000

4. Opening of Partnership's Books

GENERAL JOURNAL

(Eye & Bee Partnership)

Date Descriptions Debit Credit
(a)Cash ₱1,830,000
Accounts receivable 570,000
Inventory 300,000
Accounts Payable ₱700,000
Eye, Capital 500,000
To record the investments of Eye.
(b)Cash ₱1,072,500
Accounts receivable 427,500
Store Equipment 500,000
Bee, Capital 2,000,000
To record the investments of Bee.

5. Eye & Bee Partnership's Trial Balance upon formation would be:

Eye & Bee Partnership

Trial Balance

January 1, 2020
Account Title Debit Credit
Cash ₱2,902,500
Accounts Receivable 997,500
Inventory 300,000
Store Equipment 500,000
Accounts Payable ₱700,000
Eye, Capital 2,000,000
Bee, Capital 2,000,000
₱4,700,000 ₱4,700,000

Actual Investment Method

When the agreed partners' capital shares are credited with the same value as
their actual net contributed tangible assets, the approach of initial investment
and in called "Actual Investment Method”

ILLUSTRATION

Sea and Dy decided to form Sea & Dy Partnership with an agreed capital
contribution of ₱900,000 and ₱700,000, respectively. The journal entry would
be:

GENERAL JOURNAL

(Sea & Dy Partnership)

Date Descriptions Debit Credit
(a)Cash ₱1,600,000
Sea, Capital 900,000
Dy, Capital 700,000
Initial investments of partners.

Bonus Method

When the actual contribution of individual partner in not the same as the
agreed capital credit to him as recorded in the partnership books, the partner
capital accounts shall be adjusted in the books of the partnership upon
formation by using a "bonus method”.

There is a bonus to a partner when his capital credit is more than his actual
contributed capital and the total net assets contributed by part is equal to total
capital of the partnership. This method does not record intangible asset in the
partnership books at the formation of the partnership.

BONUS METHOD

Partnership’s Total Agreed Capital (TAC) = Partners’ Total Contributed Capital

(TCC)
Is any of the Partner’s
Agreed Capital Credit ► No ► No bonus
GREATER THAN his
Actual Contribution.
► Yes ► There is bonus. The bonus is equal to the
INCREASE of his actual caption
contribution
ILLUSTRATION

Eye, sole proprietor, allows Bee to join his business to form partnership,
provided that the latter would contribute cash mounting to ₱700,000. Eye
contributions comprised the following ₱100,000 cash ₱300,000 accounts
receivable, ₱200,000 merchandise and accounts payable of ₱80,000 to be
assumed by the partnership.

They agreed that their initial capital balances would be of equal amount upon
the formation of the partnership.

Assume that Eye and Bee agreed that the partnership capital would be
₱1,220,000

To record the investments of the partners using the bonus approach, the
following journal entries shall be made:

GENERAL JOURNAL

(Eye & Bee Partnership)

Date Descriptions Debit Credit
01/01Cash ₱100,000
Accounts Receivable 300,000
Merchandise inventory 200,000
Accounts payable 80,000
Eye, Capital 520,000
Initial investments of Eye.

Cash 700,000
Bee, Capital 700,000
Initial investments of Bee.

Bee, Capital 90,000

Eye, Capital 90,000
To establish equal capital interest of ₱ 610,000 by
recording a ₱ 90,000 bonus from Bee to Eye.

TEACHER’S INSIGHT

Ø There is bonus because there is no difference between the total capital contribution
(₱1,220,000) and the total agreed capital (₱1,220,0000, and yet the capital credit Bee
is less than what the actually contributed. The bonus is to be given to Scott to equalize
the capital balances of partners. A tabular analysis would be:

Eye Bee Total

Total tangible assets contributed ₱600,000 ₱700,000 ₱1,300,000
Less: Liabilities assumed (80,000) . (80,000)
Net tangible assets contributed ₱520,000 ₱700,000 ₱1,220,000
Capital credit, equally 610,000 610,000 ₱1,220,00
0
Bonus from Bee to Eye ₱90,000 ₱90,000 ₱ - 0
-

Ø To analyze the capital credits of partners (₱1,200,000/20, ₱90,000 has to be

transferred from Bee's capital as bonus to Eye

Additional Investments and withdrawal

The partnership agreement should include guidelines regarding additional

investments and withdrawals. The additional investment is recorded directly to
the capital account of the investing partner at the fair market value of the asset
at the time of investment. However, the accounting treatment of withdrawals
would depend on whether the withdrawn amount is substantial or irregular.

Withdrawals in Large Amounts. If the withdrawal involved a large amount

and intended to reduce capital investment, it is charged directly to the capital
account of a withdrawing partner.

ILLUSTRATION

Assume that Eye partner of ABC Partnership with an interest of ₱1,000,000,

withdrew cash from the partnership intended to reduce his capital by 40%. The
journal entry would be:

GENERAL JOURNAL

(Eye & Bee Partnership)

Date Descriptions Debit Credit
(a)Eye, Capital ₱400,000
Cash ₱400,000
To record withdrawal of cash by Eye.

Withdrawal of Allowances. The business rewards of partners are not in the

form of a salary as the take-home pay of employees, but in the form of a share
in partnership profits.

Partners working in the partnership usually withdraw regular amounts of

money as allowances or salary allowances in anticipation of their share from
partnership profits Such withdrawals are not charged to the capital accounts.
They are charged to the withdrawing partner's drawing accounts.

Assuming that industrial partner takes his salary allowance for the month of
June amounting to ₱30,000, the related journal entry would be:

GENERAL JOURNAL

(Eye & Bee Partnership)

Date Descriptions Debit Credit
6/30Eye, Drawings ₱30,000
Cash ₱30,000
Salary allowance of Eye for the month.

Partners Interest in the Profits and Losses vs. Partner's Interest in the
Partnership

A partner’s interest in the profits and losses refers to the partner's share when
the meaning of the partnership is divided among the partners. It may be based
on their capital balances or on the arbitrary ratio of profit and loss sharing
agreement.

In contrast, a partner's interest in the partnership represents the partner's

interest in the net assets of the partnership at a particular time. In other words,
it refers to the capital balance of the partner in the partnership.

ILLUSTRATION

On January 1, 2020, Samson and Delilah formed a partnership with contributed

capital of ₱2,000,000 each. They agreed that the profit or loss of the
partnership should be divided into a ratio of 60:40, respectively.

During the year, the partnership has a net income of ₱100,000 and prior to
profit determination and distribution, the partners' allowances were taken in
advance from the partnership as follows:

Samson Delilah
Drawings ₱160,000 ₱40,000

The partner's interest in the profits would be the ratio of 60% for Samson and
40% for Delilah. The profit is then distributed as follows:

Share in the partnership profits Samson Delilah

Samson- 60% of ₱100,000 ₱60,000
 Delilah- 40% of ₱100,000 ₱40,000

The partner's interest in the partnership could be then computed as follows:

Samson Delilah
Capital contribution, January 1, 2020 ₱2,000,000 ₱2,000,000
Add: Share in profits 60,000 40,000
Totals ₱2,060,000 ₱2,040,000
Less: Drawings 160,000 40,000
Capital balances, December 31, 2020 ₱1,900,000 ₱2,000,000

Based on the above, the partners interests in the profits and losses are 60%
and 40%, respectively to Samson and Delilah which is different from their
Respective interest in the partnership which in 48.72% and 51.28% respectively,
computed as follows:

Samson (P190,000/P390,000) 48.72%

Delilah (P200,000/P390,000) 51.28%

TEACHER’S INSIGHTs

· The major considerations in the accounting for the equity of

partnerships are: (a) Formation; (b) Operations; (c) Dissolution; and (d) Liquidation.

· The contributions of the partners to the partnership are measured

at fair value.

· A partner’s capital balance is normally credited for the fair value of

his net contribution to the partnership. If a partner’s capital balance is credited for an
amount greater than or less than the fair value of his net contribution, there is bonus.

· Under the bonus method, any increase (or decreased) in the capital
credit of a partner is deducted from (or added to) the capital credits of the partners.
The total partnership capital remains equal to the fair value of the partner’s net
contributions to the partnership.