Chapter 12

Formation of a partnership

• Introduction
• Cash investment
• Non - cash investment
• Assets and liabilities
 Introduction
Each partner must have a separate capital account. The capital account
shows the following:
- Beginning capital or initial investment made by a partner.
- Additional investment or sub-sequent capital contribution.
- Withdrawals of assets.
- Reduction of capital.
- Profits (or losses) for the year.
- Ending capital balance.

Dr. Aly, Capital Cr.

- +
Withdrawals … Beginning capital balance …

Reduction of capital … Additional investment …

losses … profits …

Ending capital balance …

 The journal entries related to capital account transactions:

Account title and explanation Dr. Cr.

1) Beginning. Investment Cash ...

Aly, Capital …
To record the owner’s beginning investment

2) Additional investment Cash …

Aly, Capital …
To record the owner’s additional investment

3) Reduction of capital Aly, Capital

Cash
To record the reduction of capital
4) Closing the profits for Income summary …
the year into capital
Aly, Capital …
To record the close of profits into capital

5) Closing the losses for Aly, Capital …

the year into capital
Income summary …
To record the close of losses into capital
6) Closing the drawings Aly, Capital …
for the year into capital
Aly, Drawings …
To record the close of drawings into
capital
 The statement of partners, equity

ABC Company
Statement of partners’ equity
For the year ended December 31, 2021

Partner A Partner B Partner C

Beginning Capital Jan.1, 2021 ….. ….. …..
Add:
Additional investment ….. ….. …..
+Net income (or - less net loss) ….. ….. …..
….. ….. …..
Less:
Drawings (…..) (…..) (…..)
Ending Capital Dec. 31, 2021 ….. ….. …..

The balance sheet of a partnership

ABC Company
Balance sheet
December 31, 2021
Assets … Liabilities …

Partners’ equity
Aly, Capital …
Fady, Capital …
Shady, Capital …

Total liabilities and equity …

 Formation of a partnership
Opening the accounts of a new partnership

The initial investments contributed by partners for forming a partnership may

take any of the following forms:

1- Cash investment.
2- Non-cash investment.
3- Assets and liabilities.

1- Cash investment.

Cash investment made by a partner is recoded by debiting the cash

account and crediting the partner’s capital account.
Account title & explanation Dr. Cr.
Cash …………
A, Capital …………
To record A’s investment

The following example illustrates the opening entries for a newly

formed partnership by contributing cash investment:
Example: On January 1, A and B decided to form a partnership. The
following are the cash contributed by each partner:
A, Cash investment $60,000
B, Cash investment $40,000
Required: Record the formation of AB partnership.

Account title & explanation Dr. Cr.

Cash 60,000
A, Capital 60,000
To record A’s cash investment
Cash 40,000
B, Capital 40,000

To record B’s cash investment

By combining the two entries into one entry

Cash 100,000
A, Capital 60,000
B, Capital 40,000

To record A & B cash investment

 2- Non-cash investment

• In forming a partnership partners may contribute assets other

than cash, such as supplies, inventory, land, building, and
equipment.
• The GAAP stated that non-cash assets should be valued at their fair
market value at the date of formation of a partnership.
• Some assets could have market values the same as their book values
such as, receivables (Accounts receivable & notes receivable),
payables (Accounts payable & notes payable), and cash.
• Non - cash investments are recoded by debiting the assets' accounts
and crediting the partner’s capital account (with the total assets).

Journal
Account title & explanation Dr. Cr.
Land (Market value) ……
Building (Market value) ……
Inventory (Market value) ……
Equipment (Market value) ……
A, Capital ……
To record A’s non - cash investment (market value)

The following example illustrates the opening entries for a newly

formed partnership by contributing non-cash investment:
Example: On January1, 2020 A and B decided to form a partnership. The
following are the assets contributed by each partner:

A: Book Market
value value
Land $ 20,000 $ 30,000
Building 40,000 60,000

B:
Inventory 10,000 15,000
Equipment 45,000 55,000

Required: Give 2 journal entries to record the formation of AB partnership.

Journal
Account title & explanation Dr. Cr.
Land 30,000
Building 60,000
A, Capital 90,000
To record A’s non- cash investment (market value)
Inventory 15,000
Equipment 55,000
B, Capital 70,000
To record B’s non-cash investment (market value)
 3- Assets and liabilities

▪ In forming a partnership partners may contribute assets and

transfer liabilities to the partnership. This may happen when
partners enter a new partnership by consolidating their
previous sole businesses.

▪ Examples of assets: cash, accounts receivable, notes

receivable, office supplies, inventory, land, building, office
equipment, cars, and furniture.

▪ Examples of liabilities: Accounts payable, notes payable,

salaries payable, interest payable, mortgage payable,
allowance for doubtful accounts ADA (contra asset
account), and taxes payable.

▪ The journal entry is recorded by debiting the assets, crediting

the liabilities, and crediting the capital account with the
value of net assets, or (total assets-total liabilities).

The following example illustrates the opening entries for a newly

formed partnership by contributing assets and liabilities:
Example: On January1, 2020 A and B formed a partnership. B decided to
transfer the assets and liabilities of his sole previous business to the new
partnership.
- The following are the items included in partner B's old balance sheet.
Items: Book Market
value value

Cash………………………………... $ 600
Accounts receivable………………. 34,900
Inventory…………………………... 45,000 $ 54,000
Equipment………………………… 21,600 19,000
Accounts payable…………………. 1,800
ADA………………………………. 5,000 6,700
Accumulated depreciation-Equip…. 1,200

Required: Record the net investment made by partner B into the new partnership.
Journal
Dr. Cr.
Cash 600
Accounts receivable 34,900
Inventory 54,000
Equipment 19,000
Accounts payable 1,800
ADA 6,700
B, Capital 100,000

To record the assets and liabilities invested

by partner B (108,500-8,500=100,000)
 Problems on Formation of a partnership
Problem (1)
On Jan.1, 2020 Hassan and Kareem decided to form HK Partnership.
Hassan’s investment in the partnership consists of $50,000 cash, and
inventory has a book value of $200,000, and a market value of $150,000.
Kareem’s contribution into the new partnership includes the following
assets and liabilities of his sole previous business.
Book Market
values values
Cash……………………………… $150,000
Accounts receivable……………… 80,000
Inventory….……………………… 55,000 $50,000
Land..........………………………. 100,000 120,000
Building.......................................... 82,000 100,000
Mortgage payable........................... 30,000
Notes payable……………………. 150,000
Allowance for doubtful accounts… 16,500 20,000
Accumulated depreciation (Building) 12,000

Required:
1. Prepare 2 journal entries to record each partner investment
in the partnership.

2. Prepare the beginning balance sheet of the new partnership

on Jan. 1, 2020.
 Answer

Account title and explanation Debit Credit

(1) Cash 50,000
Inventory 150,000
Hassan, Capital 200,000

(2) Cash 150,000

Accounts receivable 80,000
Inventory 50,000
Land 120,000
Building 100,000
Mortgage payable 30,000
Notes payable 150,000
Allowance for doubtful accounts (ADA) 20,000
Kareem, Capital 300,000

HK Partnership
Balance Sheet
Jan. 1, 2020
Assets Liabilities
Cash (H+K) 200,000 Mortgage payable 30,000
(50,000+150,000) Notes payable 150,000
Accounts receivable 80,000 Total liabilities ……… 180,000
-ADA (20,000)
60,000
Inventory 200,000 Partners' equity
(H+K)150,000+50,000
Land 120,000 Hassan, Capital 200,000
Building 100,000 Kareem, Capital 300,000
Total equity …………. 500,000

Total assets ………. 680,000 Total liabilities & Partners' 680,000

equity
 Problem (2)

On January1, 2020 A, B, & C decided to form ABC partnership, A invested $50,000

cash, and accounts receivable $200,000.

B's investment in the partnership consists of $100,000 cash, accounts receivable

$150,000, and an inventory has a book value of $140,000 and a market value of
$250,000.

C’s contribution consists of the following assets of his previous business along with
the transfer to the partnership of his business liabilities. The market values of the
various items, and their book values on C’s records are listed below:

Book Market
values values
Cash……………………………. $150,000
Accounts receivable………….... 240,000
Inventory ……………………… 270,000 200,000
Equipment ……………………. 250,000 400,000
Allowance for doubtful accounts 40,000 90,000
Notes payable…………………. 100,000
Accounts payable………………. 50,000
Accumulated depreciation (equip) 50,000

Required:
1. Give three journal entries to record the investment made by each partner to form
the partnership.
2. Prepare the beginning balance sheet of the new partnership.
 Answer
Account title and explanation Debit Credit
Cash 50,000
Accounts receivable 200,000
A, Capital 250,000
To record A 's investment in the partnership
Cash 100,000
Accounts receivable 150,000
Inventory 250,000
B, Capital 500,000
To record B's investment in the partnership
Cash 150,000
Accounts receivable 240,000
Inventory 200,000
Equipment 400,000
ADA 90,000
Notes payable 100,000
Accounts payable 50,000
C, Capital 750,000
To record C's investment in the partnership
Balance Sheet

Assets Liabilities
Cash………………………. 300,000 Notes payable……. 100,000
(50,000+100,000+150,000)
Accounts receivable……… 590,000 Accounts payable... 50,000
(200,000+150,000+240,000
- ADA……………………... (90,000) Total liabilities…... 150,000
500,000
Inventory…………………. 450,000 Partners' equity
(250,000+200,000)
Equipment………………… 400,000 A, Capital 250,000
B, Capital 500,000