CHAPTER 1 PARTNERSHIP FORMATION

Basic Considerations

Partnership is: A contract, which requires consent of the contracting parties, object certain which is the
subject matter of the contract and cause of the obligation which is established: Upon such contract,
partners are bound to contribute money, property, or industry to a common fund; With the intention of
the profit among themselves.

Generally, partnership may be made in any form, except where immovable property or real rights are
contributed thereto, in which case a public instrument shall be necessary and attached therein an
inventory of the said property.

Every contract of partnership having a capital of 3,000 pesos or more, in money or property, shall
appear in public instrument, which must be recorded in the Office of the Securities and Exchange
Commission. However, failure to with this requirement does not prevent the formation of the
partnership or affect its liabilities and that of the partners to third persons.

A partnership begins from the moment of the execution of the contract, unless it is otherwise stipulated.

Unless there is a stipulation to the contrary, the partners shall contribute equal shares to the capital of
the partnership.

Every partnership shall operate under a firm name, which may or may not include the name of one or
more of the partners. Those who, not being members of the partnership, include their names in the firm
name shall be subject to the liability of a partner.

A partnership could be a stockholder in a corporation but a corporation is not allowed by law to be a

partner in a partnership.

Characteristic elements of partnership:

1. Consensual, because it is perfected by mere consent, that is, upon the express or implied
agreement of two or more persons;
2. Nominate, because it has a special name or designation in our law,
3. Bilateral, because it is entered into two or more persons and the rights and obligations arising
therefrom are always reciprocal;
4. Onerous, because each of the parties aspires to procure for himself a benefit through the giving
of something;
5. Commutative, because the undertaking of each of the partner is considered as the equivalent of
that of the others;
6. Principal, because it does not depend for its existence or validity upon some other contract,
7. Preparatory, because it is entered into as a means to an end, i.e. putting up a business in
preparation to gain profits.
Classifications of Partnership:

1. According to subject matter

A. Universal Partnership of all present property. All contributions become part of the
partnership fund.
B. Universal partnership of profits. All that the partners may acquire by the industry or
work during the existence of the partnership and the use of whatever the partners
contributed from the perfection of the contract.
2. According to Liability
A. General. All partners are liable to the extent of their personal or separate properties.
B. Limited. Limited partners are liable only to the extent of their contribution to the
partnership: In a limited partnership, it is mandated by law that there is one (1) general
partner

3. According to duration

A. Partnership with a fixed term or for a particular undertaking

B. Partnership at will. One in which no time is specified and is not formed for any particular
undertaking

4. According to legality of existence

A. De Jure partnership or one which has complied with all the legal requirements for it
establishments . It exist both in fact and in law.
B. De Facto partnership or one which has failed to comply with all the legal requirements
for its establishment. It exists in fact but not in law. Like de jure, it also has juridical
personality.
5. According to representation
A. Ordinary or real partnership or one which actually exists among. The partners and also
as to third persons.
B. Partnership by estoppel or ostensible partnership or one which in reality is not a
partnership, but is considered a partnership only in relation to those who, by their
actions, are precluded to deny or disprove its existence.
8. According to purpose
A. Commercial or Trading partnership or one formed for the transaction of business.
B. Professional or non-trading partnership or one formed for the exercise of a profession.

Kinds of Partners:

1. General partner – liable to the extent of his separate property after all the partnership
assets are exhausted.
2. Limited partner – liable only to the extent of his capital contribution.

The surname of a limited partner shall not appear in the partnership name unless it is also the surname
of a general partner, or before he entered the partnership the business had already been carried on
under a name, which his surname appeared. A limited partner violating this statement will be liable as a
general partner to partnership creditors. Of course, the limited partner will not be liable to third persons
that have actual knowledge that he is only a limited partner.

A limited partner should not be involved in the management of the partnerships operation. If he does
so, he will be liable as a general partner

3. Capitalist partner-contributes money or property to the common fund of the

partnership.
4. Industrial partner-contributes his knowledge or personal service/talent to the
partnership.
5. Managing partner-appointed by the other partners to be the manager of the
partnership.
6. Liquidating partner designated to wind up or settle the affairs of the partnership after
dissolution
7. Dormant partner does not participate in the business and not known as a partner to the
public.
8. Silent partner does not participate in the business but known as a partner to the public.
9. Secret partner participates in the business but not known as partner to the public.
10. Ostensible partner-participates in the business and known as a partner to the public.
11. Nominal partner or partner by estoppel-one who is not really a partner but who
represents himself as one.

Partnership distinguished from a corporation

1. Creation. Partnership is created by mere agreement of the partners while corporation is

created by operation of law.
2. Composition. Partnership may be formed by two or more persons. But in a corporation,
it may be organized by not more than fifteen (15) persons.
3. Life. Partnership has no limitation upon its duration to perform its activities, same with
a corporation that shall have a perpetual existence.
4. Extent of liability Partners except a limited partner is liable to the extent of his personal
assets while stockholders are limited only to the extent of their interest or investment in
the corporation
5. Management. Every partner is an agent of the partnership if the partners have no
agreement of who will be the managing partner, in a corporation, management is the
responsibility of the board of directors
6. Right of Succession. Partnership has no right of succession while in corporation, it can
exist notwithstanding death, withdrawal, insolvency or incapacity of its directors or
stockholders. Simply stated, position as a partner in a partnership cannot be inherited
while in corporation ownership can be passed to an heir.
7. Effectivity of Juridical existence. Partnership starts from the time the articles of
partnership are executed. Corporation commences its life upon the issuance by
Securities and Exchange Commission (SEC) of certificate of incorporation.
8. Governing Law. Partnership is governed by Civil Law while corporation is governed by
the Revised Corporation Code of the Philippines. (RA No. 11232)
ACCOUNTING FOR PARTNERSHIP

The only difference of partnership accounting with basic accounting is the treatment of capital and
drawing accounts. The focus of basic accounting is sole proprietorship or entity with a single owner. This
time, instead of having one capital account, we will create as many capital accounts in proportion. To
the number of partners. So, if there are three (3) partners, there will be 3 capital accounts.

Thus, any other entries pertaining to assets, liabilities and income are treated the same.

A partner’s capital account is credited for his initial and additional net investments (assets contributed
less liabilities assumed by the partnership). And credit balance of the drawing account at the end of the
period. It is debited for his permanent withdrawals and debit balance of the drawing account at the end
of the period.

Drawings are withdrawals by partners from the partnership to meet their personal living expenses or
cash outlay unrelated to the partnership operation. A drawing account is debited for assets temporarily
withdrawn by him from the partnership. The balances in the drawing accounts are closed to the related
capital accounts at the end of the period.

The logic why the drawing account was made is to avoid mixing the partner’s personal expenses with
the partnership’s business expenses, the partnership’s presentation of financial position more objective.

The partner’s shares in the partnership profits or losses is usually closed temporarily to the partner’s
drawing account that shall be closed finally to the capital accounts: For convenience, in subsequent
topics, profits and losses can be directly charged to the partner’s capital accounts. The result for
computation purposes will be the same.

The balance sheet of the partnership should present only the capital account which means net of
drawings.

Loans receivable from partners and Loans payable to partners

Loans receivable from, also termed “due from partner” is an asset account in the partnership books. It is
a substantial amount of withdrawal of a partner with the intention of repaving it. This account is
separately classified form other receivables of the partnership.

Loans payable to, also termed “loans to partner” is a liability account in the partnership books. This
account represents substantial amounts lent to the partnership by the partner, which the partnership is
obliged to pay.

These accounts are significant during liquidation. Loans payable to partner must be settled after the
outside creditors have been paid in full but with priority over the partner’s equity.
Partnership formation

A partnership can be created in any of the following ways:

1. Individual – Individual; Individuals with no existing business form partnership

2. Change from sole proprietorship to a partnership
A. Sole proprietor – Individual; Sole proprietor and an individual without a business form a
partnership
B. Sole proprietor-Sole proprietor; Two or more sole proprietors form a partnership

3. Admission or Retirement of a partner (to be discussed in Partnership dissolution)

Any contribution by the partners will be recorded in the amount according to their agreement (agreed
value)

In the absence of any agreement, contributions are to be recorded at their fair market value (FMV),
which means the estimated amount that a willing seller would receive from a financially capable buyer
for the sale of the asset in a free market Based on PFRS 3. Fair market value is the price at which an
asset or liability could be exchanged in a current transaction between knowledgeable, unrelated willing
parties:

In case one of the partners is an industrial partner or one who contributes his knowledge or personal
service to the partnership, only a memorandum entry in the general journal is prepared.

The National Internal Revenue Code provided that upon formation of the partnership, a new set of
books for the partnership shall be made. Thus, the books of the sole proprietor will follow these
accounting procedures (ACIC);

1. Adjust the books of the Sole-Proprietor Assets and liabilities need adjustments to reflect the
current fair market values of each account in the absence of any agreement.
2. Close the books of the Sole Proprietor

After closing the books of the sole proprietor, the partnership books will be opened with corresponding
entries of the partner’s initial investments.

3. Invest in the Partnership

4. Combine similar Accounts in the statement of financial position