PARTNERSHIP ▪ The capital ratio is a claim against the net asset

of the partnership as shown by the balance in the

PARTNERSHIP FORMATION: partner’s capital account.
• Governed by the Partnership Law [Philippine Civil
Code Articles 1767 to 1867]. ▪ The profit and loss ratio (P&L ratio) determines
how much will the income or loss be distributed
• Article 1767: By the contract of partnership, two or among the partners.
more persons bind themselves to contribute
money, property or industry to a common fund with Accounting for Partnership Formation
the intention of dividing the profits among • Cash investment
themselves. ✓ Local currency is valued at face value.

Characteristics of Partnership ✓ Foreign currency is valued at the current

✓ Ease of formation exchange rate.
✓ Limited life
✓ Mutual agency • Noncash investment
✓ Separate legal entity ✓ Recorded at agreed value which is normally the
✓ Sharing of profit and losses fair value of the properties at the time of
✓ Unlimited liability investment.

Types of Partnership • Liabilities assumed by the partnership should be

• General Partnership value at the present value (fair value) of the
✓ Each partner is personally liable to the remaining cash flows.
partnership’s creditors if the partnership
assets are not enough to pay such creditors. • The difference between the fair value of the assets
contributed by the partners and the liabilities
✓ There is at least one general partner in each assumed by the partnership is credited to the
partnership. partners’ capital accounts.

• Limited Partnership ✓ If the partners’ initial investment is not equal to

✓ Partners are liable only up to the extent of that partner’s agreed capital, the bonus
their capital contributions. approach will be used.

Accounting for Partnership Activities ✓ Under the bonus approach, one partner’s capital
account decreases, while the other partner’s
• Capital Account (normal balance: credit) capital account increases at the same amount.
▪ Increases
✓ Initial investment Bonus Approach Pro-forma Entry
✓ Additional investment
✓ Share in net income A, Capital xx
B, Capital xx
▪ Decreases
✓ Permanent withdrawal Total agreed capital xx
✓ Drawings in excess of a specific amount x Capital interest xx%
✓ Share in net loss Partner’s individual capital interest xx
Less: B, capital interest xx
• Drawing Account (normal balance: debit) Bonus to B xx

▪ Increases PARTNERSHIP OPERATIONS

✓ Regular drawings • Division of Profits and Losses

• Loan Accounts ▪ The Partnership Law provides that profits and

▪ Transactions between the partners and the losses of the partnership are to be divided in
partnership. accordance with the partners’ P&L agreement.

▪ Must be reported as separate balance sheet ▪ If no agreement is made between and among the
items. partners, profits and losses are to be divided
✓ Loan from partners – presented as a according to their original capital contributions.
liability.
▪ Should the partners agree to divide the profits
✓ Loan to partners – presented as other only, losses shall be divided in the same manner
receivable (current asset). as that of dividing profits.

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 ▪ However, should the partners agree to divided ▪ Use of average capital balances is preferable
losses only, profits shall be divided by the because it reflects the capital actually available
partners according to their original capital for use by the partnership during the year.
contributions.
• Interest Allowed on Partners’ Capital
▪ The ratio in which partnership profits and losses ▪ Partnership contract may provide for interest
are divided is known as the profit and loss ratio. allowances on partners’ capital in order to
The possible methods of dividing net income or encourage capital investments. Remaining
loss among partners may be summarized as profits are then divided equally or in any other
follows: specified ratio.
✓ Equally.
▪ Interest allowed to partners may vary from one
✓ In an unequal or arbitrary ratio. partner to another due to the differences of
capital contributions and balances.
✓ In the ratio of partners’ capital account
balances on a particular date, or in the ▪ Partnership contract should therefore provide
ratio of average capital account balances that a specific interest rate shall be allowed to a
during the year. partner based on his beginning, ending or
average capital balances.
✓ Allowing interest on partners’ capital
account balances and dividing the ▪ Interest on partners’ capital accounts is not an
remaining net income or loss in a specified expense of the partnership.
ratio.
• Salary and Bonus Allowances
✓ Allowing salaries to partners and dividing ▪ When the services rendered by the individual
the remaining net income or loss in a partners to the partnership are not equal, due to
specified ratio. differing abilities of partners or differences in
time spent on partnership business, it is not
✓ Bonus to managing partner based on net proper to provide for such differences through
income. the use of profit and loss sharing ratios.

▪ These alternative methods emphasize that the ▪ A partnership contract may provide for a bonus
value of personal services rendered by individual to the managing partner equal to a specified
partners may vary widely, as may the amounts of percentage of income. When bonuses are to be
capital invested by each partner. allowed, the agreement must clearly specify the
basis of the bonus.
▪ Therefore, as a preliminary step, agreements
should be made for salaries to partners and ▪ The computation of the bonus may be based on:
interest on their respective capital account ✓ Net income before allowances for salaries,
balances. Any remaining profit or loss then may interest and bonus.
be divided in a specified ratio.
✓ Net income before allowances for salaries
• Division of Profit and Loss in the Ratio of Partners’ and interest but after deduction of the
Capital bonus.

▪ The capital contributions of partners are usually ✓ Net income after allowances for salaries
considered in the determination of profit and and interest but before bonus.
loss sharing agreement.
✓ Net income after allowances for salaries,
▪ If partners’ capital account is considered in interest and bonus.
allocating partnership income, the agreement
should specify whether the ratio is based on the PARTNERSHIP DISSOLUTION
original capital contributions, beginning capital • Changes in ownership interest.
balances, ending capital balances or average
capital balances. • Capital Interest
▪ Claim against the net assets of the partnership
▪ In addition, several interpretations of average as shown by the balance in the partner’s
capital balances are possible, and capital capital account.
balances may be determined before or after
drawing accounts are closed to the partners’ ▪ Evidenced by the capital ratio.
capital accounts.

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 • Profit and Loss Interest
▪ Determines how the partner’s capital interest ✓ Elimination of capital deficiencies.
will increase or decrease as a result of income
or loss allocation. ✓ Payment to partners (in order):

▪ Evidenced by the profit and loss (P&L) ratio. o Loan accounts

Admission or Withdrawal of a Partner o Capital accounts

• Admission by purchase of interest
▪ Case 1: Purchase of interest for one partner • Installment Liquidation
A, Capital xx ▪ A process of realizing some assets, paying
B, Capital xx creditors, paying the remaining available cash to
partners, realizing additional assets, and making
▪ Case 2: Purchase of interest from all partners additional cash payment to partners.
A, Capital xx
B, Capital xx
C, Capital xx Basic Principles in Installment Liquidation
• Schedule of Safe Payments
• Admission by investment ▪ Method of computing the amount of safe
▪ Observe the following rules: payments and preventing excessive payments to
✓ Contributed capital (CC) any partners.
✓ Agreed capital (AC)
✓ Total contributed capital (TCC) ▪ Assume total loss on all remaining noncash
✓ Total agreed capital (TAC) assets. Provide all possible losses, including
potential liquidation cost and unrecorded
TCC=TAC No Adjustment. liabilities.
TCC>TAC Overstatement of the asset or diminution
in partner’s capital. ✓ Maximum possible loss = amount of
TCC<TAC Unrecorded net assets or the required unrealized noncash assets + amount of
additional investment in partner’s cash withheld (i.e., unrecorded unpaid
capital. expenses, and anticipated liquidation
CC=AC No transfer of capital. expenses)
CC>AC Capital transfer or bonus to old partners. ▪ Assume that partners with a potential capital
CC<AC Additional capital credit (bonus method) deficit will be unable to pay anything to the
from the old partners. partnership (assumed to be personally
insolvent).
Total agreed capital xx
Less: Total contributed capital xx ✓ Hypothetical or assumed deficit
Difference xx balance is allocated to the partners who
have credit balances using profit and loss
• Withdrawal of a partner ratio. This portion is the maximum
▪ Same accounting as admission of a new partner potential loss on noncash assets.
discussed above.
▪ Cash Priority Program (Cash Distribution
Program)
PARTNERSHIP LIQUIDATION
• The termination phase of the partnership’s activities. ✓ Ranking of the partners’ vulnerability level.

BASIC PROCEDURES IN LIQUIDATION ✓ Total interest (equity) account = balance of

the capital account +/- loans from (to) the
• Lump-sum Liquidation
partners
▪ All assets are converted into cash within a very
✓ Loss Absorption Ability = Total interest
short time, creditors are paid, and a single, lump-
account/Profit and Loss assigned ratio
sum payment is made to the partners for their
capital interest.
• Vulnerability Rankings
✓ Realization and distribution of gain or loss ▪ The partner with the lowest absorption ability is
to all partners on the basis of their profit the most vulnerable to partnership losses.
and loss ratio.
- - End - -
✓ Payment of liquidation expenses, if any.

✓ Payment of liabilities to third parties.

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