Partnership and Corporation Accounting

by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Chapter 2
Accounting for Partnerships and Partnership Formation

Learning Objectives:

After studying this chapter, you should be able to:

1. Explain the differences between partner’s capital and drawing accounts;

2. Distinguish between partner’s capital and drawing accounts;
3. Discuss the fair value concept; and
4. Prepare and explain the entries for partnership formation.

ACCOUNTING FOR PARTNERSHIPS

Owners' Equity Accounts

In Basic Accounting, generally accepted accounting principles were discussed in the context of a
sole proprietorship. These accounting principles also apply to a partnership. Thus, the recording of
assets, liabilities, income and expenses is consistent for both proprietorships and partnerships.
Comparing two businesses of the same nature, one organized as a sole proprietorship and another as a
partnership, there will be no marked difference in their operations.

However, differences arise between the two forms of business concerning owners' equity. For a
proprietorship, there is only a single owner. Therefore, there is only one capital account and one drawing
account. On the other hand, since a partnership has two or more owners, separate capital and drawing
accounts are established for each partner.

Partner’s Capital Account

Debit Credit
1. Permanent withdrawals 1. Original investment
2. Debit balance of the drawing account at 2. Additional investment
the end of the period 3. Credit balance of the drawing account at
the end of the period

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.

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Partner’s Drawing Account

Debit Credit
1. Temporary withdrawals 1. Share in profit (this may be credited
2. Share in loss (this may be debited directly directly to Capital)
to Capital)

Typically, partners do not wait until the end of the year to determine how much of the profits
they wish to withdraw from the partnership. To meet personal living expenses, partners customarily
withdraw money on a periodic basis throughout the year. 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.

Permanent withdrawals are made with the intention of permanently decreasing the partner’s
capital while temporary withdrawals are regular advances made by the partners in anticipation of their
share in profit.

The use of drawing accounts for temporary withdrawals provides a record of each partner’s
drawings during an accounting period. Hence, drawings in excess of the allowed amounts as stated in
the partnership agreement may be controlled.

Notice that profit (or loss) is credited (or debited) either to the drawing account or to the capital
account. The choice of the account to credit or debit depends on the intention of the partners. If they
wish to maintain their capital accounts for investments and permanent withdrawals, then profit or loss
should be entered in the drawing account.

On the other hand, if the purpose of the partners is to make profit or loss part of their capital,
then the capital account should be used. In either case, the resulting partners ending capital balances will
be the same.

Loans Receivable from or Payable to Partners

If a partner withdraws a substantial amount of money with the intention of repaying it. The debit
should be to Loans Receivable-Partner account instead of to Partner’s Drawing account. This account
should be classified separately from the other receivables of the partnership.

A partner may lend amounts to the partnership in excess of his intended permanent investment.
These advances should be credited to Loans Payable-Partner account and not to Partner’s Capital
account classified among the liabilities but separate from liabilities to outsiders. This distinction is
important in case of liquidation. Loans payable to partners must be paid after the claims of outside
creditors have been paid in full. These loans have priority over partners’ equity.

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

PARTNERSHIP FORMATION

Valuation of Investments by Partners

The books of the partnership are opened with entries reflecting the net contributions of the
partners to the firm. Asset accounts are debited for assets contributed to the partnership, liability
accounts are credited for any liabilities assumed by the partnership and separate capital accounts are
credited for the amount of each partner’s net investment (assets less liabilities).

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 the partners. In the absence of any agreement, the
contributions 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. Per International Financial
Reporting Standards (IFRS) No. 3, fair value is the price at which an asset or liability could be
exchanged in a current transaction between knowledgeable, unrelated willing parties.

Adjustment of Accounts Prior to Formation

In cases when the prospective partners have existing businesses, their respective books will have
to be adjusted to reflect the fair market values of their assets or to correct misstatements in the accounts.
If the adjustments will not be made, the initial capital balances of the partners may be inequitable.

Illustration: A reconditioned printing equipment invested by Agapito Rubio was recorded

incorrectly in the partnership books at P730,000 - its book value from the proprietorship’s records. If the
partnership immediately sold the printing equipment for its fair market value of P800,000, the resulting
P70,000 gain would increase the capital balances of both Partners Agapito Rubio and Nora Bisana. The
printing equipment should have been recorded at P800,000 and Rubio ‘s capital credited with P800,000.
Simply stated, increases in asset values accruing before formation should be for the benefit of the
contributing partner.

The adjustments of the assets and liabilities prior to formation will be similar to the adjustments
that we are already familiar with. However, when the adjustment involves a debit or credit to a nominal
account, the Capital account would instead be debited or credited. This is so because the business has
ceased to be a going concern. A business is not viewed as a going concern if liquidation appears
imminent. For example, two sole proprietorships will cease operations because of their agreement to
enter into a partnership. Both proprietorships have ceased to be going concerns.

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

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 proprietors form a partnership.
3. Admission or retirement of a partner

Individuals with No Existing Business Form a Partnership

The opening entry to recognize the contributions of each partner into the partnership is simply to
debit the assets contributed, and to credit the liabilities assumed and the capital account of each partner.

Illustration. On July 1, 2015, Nilo Burgos and Helenita Ruiz agreed to form a partnership. The
partnership agreement specified that Burgos is to invest cash of P700,000 and Ruiz is to contribute land
with a fair market value of P1,300,000 with P300,000 mortgage to be assumed by the partnership. The
entries are as follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 July
1 Cash P 700,000 1
2 Land 1,300,000 2
3 Mortgage Payable P 300,000 3
4 Nilo Burgos, Capital 700,000 4
5 Helenita Ruiz, Capital 1,000,000 5
To record the initial investment of
6 6
Burgos and Ruiz

Date Account Titles and Explanation P.R. Debit Credit

2015
1 July
1 Cash P 700,000 1
2 Nilo Burgos, Capital P 700,000 2
3 To record the initial investment of Burgos 3
4 4
5 1 Land 1,300,000 5
6 Mortgage Payable 300,000 6
7 Helenita Ruiz, Capital 1,000,000 7
8 To record the initial investment of Ruiz 8

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

After the formation, the statement of financial position of the partnership is:

Burgos and Ruiz Company

Statement of Financial Position
July 1, 2015

Assets
Cash P 700,000
Land 1,300,000
Total Assets P 2,000,000

Liabilities and Owner’s Equity

Mortgage Payable P 300,000
Nilo Burgos, Capital 700,000
Helenita Ruiz, Capital 1,000,000
Total Liabilities and Owner’s Equity P 2,000,000

Illustration. Suppose that Burgos and Ruiz formed another partnership with Nora Elizabeth
Maniquiz. Burgos and Ruiz considered Maniquiz who has a vast business network in Bicol as an
industrial partner. The partnership did not receive any asset from Maniquiz. In this case, only a
memorandum entry in the general journal will be made.

LIMITED LIABILITY COMPANY

A limited liability company (LLC) is a hybrid form of business for it combines the best features
of a partnership and a corporation. LLC is a form of legal entity that provides limited liability to its
owners. In 1988, the Internal Revenue Service (IRS) of the United States of America ruled that LLC
may be treated as a partnership for tax purposes subject to conditions. As a result of this ruling, all 50
U.S. states allow LLCs.

The owners of an LLC are called members. These owners may be individuals, partnerships,
corporations or other entities. Many states even allow one-person LLCS. The members have limited
liability even if they are active in the company.

This type of entity is attractive for professional service firms because the owners will not have
personal liability for the other owners’ malpractice.

A limited liability partnership (LLP) is very similar to an LLC except that investment in LLP is
restricted to professionals. The four major international accounting firms KPMG, Ernst & Young,
PricewaterhouseCoopers and Deloitte Touche started as partnerships. As they grew and the risk
increased, these firms were allowed to change, by operation of law, to LLPs, The LLP concept is
different from that of a limited partnership.

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

The accounting for LLCS is the similar to partnerships. The terms “member” and “member’s
equity” are used instead of “partner” and “partner’s equity.”

A Sole Proprietor and another Individual Form a Partnership

A sole proprietor may consider forming a partnership with an individual who has no existing
business. Under this type of formation, the assets and the liabilities of the proprietorship will be
transferred to the newly formed partnership at values agreed upon by all the partners or at their current
fair prices.
Illustration. The statement of financial position of Galicano Del Mundo on Oct. 1, 2015, before
accepting Christine Resultay as partner is shown as follows:

Galicano Del Mundo

Statement of Financial Position
October 1, 2015

Assets

Cash P 60,000 60,000 C

Notes Receivable 30,000 30,000 C
Interest Receivable 700 C
Accounts Receivable P 240,000 240,000 C
Less: Allowance for Uncollectible Accounts 10,000 230,000 12,000 228,000 D
Merchandise Inventory 80,000 74,000 C
Furniture and Fixtures P 60,000 60,000 C
Less: Accumulated Depreciation 6,000 54,000 14,000 46,000 D
Total Assets P 454,000

Liabilities and Owner’s Equity

Notes Payable P 40,000 40,000 D

Interest Payable 2,800 D
Accounts Payable 100,000 100,000 D
Galciano Del Mundo, Capital 314,000 299,900 D
Total Liabilities and Owner’s Equity P 454,000

Christine Resultay offered to invest cash to get a capital credit equal to one-half of Galicano Del
Mundo’s capital after giving effect to the adjustments below. Del Mundo accepted the offer.
1. The merchandise is to be valued at P74,000.
2. The accounts receivable is estimated to be 95% collectible.
3. Interest accrued on the notes receivable will be recognized P10,000, 12% dated July 1, 2015 and
P20,000, 12% dated August 1, 2015.
4. Interest on notes payable to be accrued at 14% annually from Apr. 1, 2015.
5. The furniture and fixtures are to be valued at P46,000.

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

6. Office supplies on hand that have been charged to expense in the past amounted to P4,000. These
will be used by the partnership.

New books for the Partnership (required per National Internal Revenue Code)

The following procedures may be used in recording the formation of the partnership:
Books of Galicano Del Mundo:
1. Adjust the assets and liabilities of Galicano Del Mundo in accordance with the
agreement. Adjustments are to be made to his capital account.
2. Close the books.

Books of the Partnership:

1. Record the investment of Galicano Del Mundo.
2. Record the investment of Christine Resultay.

Following the procedures, the entries are:

Books of Galicano Del Mundo

1.
Date Account Titles and Explanation P.R. Debit Credit
1
2015
October 1 Galicano Del Mundo, Capital 6 14,100 1
2 Office Supplies 4,000 2
3 Interest Receivable 3 700 3
4 Merchandise Inventory 1 6,000 4
5 Allowance for Uncollectible Accounts 2 2,000 5
4
6 Interest Payable 2,800 6
7 Accumulated Depreciation 5 8,000 7
To record adjustments to
8 8
restate Del Mundo’s Capital
2.
Date Account Titles and Explanation P.R. Debit Credit
2015
1 October 1 Notes Payable 40,000 1
2 Accounts Payable 100,000 2
3 Interest Payable 2,800 3
4 Allowance for Uncollectible Accounts 12,000 4
5 Accumulated Depreciation 14,000 5
6 Galicano Del Mundo, Capital 299,900 6
7 Cash 60,000 7
8 Notes Receivable 30,000 8
9 Accounts Receivable 240,000 9
10 Interest Receivable 700 10

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

11 Merchandise Inventory 74,000 11

12 Office Supplies 4,000 12
13 Furniture and Fixtures 60,000 13
14 To close the books of Del Mundo 14

Books of the Partnership

Date Account Titles and Explanation P.R. Debit Credit
2015
1 October 1 Cash 60,000 1
2 Notes Receivable 30,000 2
3 Accounts Receivable 240,000 3
4 Interest Receivable 700 4
5 Merchandise Inventory 74,000 5
6 Office Supplies 4,000 6
7 Furniture and Fixtures 7 46,000 7
8 Notes Payable 40,000 8
9 Accounts Payable 100,000 9
10 Interest Payable 2,800 10
11 Allowance for Uncollectible Accounts 12,000 11
12 Galicano Del Mundo, Capital 299,900 12
13 To record the investment of Del Mundo 13
14 14
15 8 15
1 Cash 149,950
16 Christine Resultay, Capital 149,950 16
17 To record the investment of Resultay 17

Computations: On P40,000: P40,000 x 14% x 6/12 P 2,800

1. Merchandise Inventory, per ledger P 80,000

Merchandise Inventory, as agreed 74,000 5. Furniture and Fixtures, net per ledger P 54,000
Decrease in Merchandise Inventory P 6,000 Furniture and Fixtures, net as agreed 46,000
Increase in Accumulated Depreciation P 8,000

2. Accounts Receivable, net per ledger P 230,000

Accounts Receivable, net as agreed
(240,000 x 95%) 228,000 6. Net effect of adjustments on Capital:
Increase in Allowance P 2,000
Decrease in Merchandise Inventory P (6,000)
Increase in Allowance for Uncollectible (2,000)
3. Interests accrued on Notes Receivable: P x r x t Increase in Interest Receivables 700
Increase in Interest Payable (2,800)
On P10,000: P10,000 x 12% x 3/12 P 300 Increase in Accumulated Depreciation (8,000)
On P20,000: P20,000 x 12% x 2/12 400 Increase in Office Supplies 4,000_
700 Decrease in Capital P (14,100)

4. Interest accrued on Notes Payable: 7. Furniture and Fixtures, cost per books P 60,000

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Furniture and Fixtures, cost as agreed 46,000

Writedown of Furniture and Fixtures P 14,000

8. Galicano Del Mundo, Capital

before adjustments P 314,000
Net Adjustments to Capital 14,100
Galicano Del Mundo, Capital
after adjustments P 299,900
Agreed Capital Credit for Christine Resultay 50%
Cash Investment of Christine Resultay P 149,950

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

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

Del Mundo and Resultay Company

Statement of Financial Position
October 1, 2015

Assets

Cash P 209,950
Notes Receivable 30,000
Accounts Receivable P 240,000
Less: Allowance for Uncollectible Accounts 12,000 228,000
Interest Receivable 700
Merchandise Inventory 74,000
Office Supplies 4,000
Furniture and Fixtures 46,000
Total Assets P 592,650

Liabilities and Owner’s Equity

Notes Payable P 40,000

Accounts Payable 100,000
Interest Payable 2,800
Galciano Del Mundo, Capital 299,900
Christine Resultay, Capital 149,950
Total Liabilities and Owner’s Equity P 592,650

Note that furniture and fixtures are now recorded in the partnership books at the agreed amount
of P46,000 which represented the cost of the asset to the partnership. On the other hand, the accounts
receivable is still recorded at gross amount of P240,000 with a related allowance for uncollectible
accounts of P12,000. The 12,000 is only a provision for possible uncollectibles.

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Two or More Sole Proprietors Form a Partnership

Illustration. On June 30, 2015, Deogracia Corpuz and Esterlina Gevera, friendly competitors in a
certain line of business decided to combine their talents and capital to form a partnership. Their
statements of financial position are as follows:

Deogracia Corpuz
Statement of Financial Position
June 30, 2015

Assets

Cash P 50,000 46,500 C

Accounts Receivable 100,000 100,000 C
Less: Allowance for Uncollectible Accounts 10,000 D
Merchandise Inventory 80,000 80,000 C
Furniture and Fixtures 60,000 60,000 C
Less: Accumulated Depreciation 6,000 D
Total Assets P 290,000

Liabilities and Owner’s Equity

Accounts Payable P 30,000 P 30,000 D

Deogracia Corpuz, Capital 260,000 240,500 D
Total Liabilities and Owner’s Equity P 290,000

Esterlina Gevera
Statement of Financial Position
June 30, 2015

Assets

Cash P 40,000 P 40,000 C

Accounts Receivable 80,000 80,000 C
Less: Allowance for Uncollectible Accounts 8,000 D
Merchandise Inventory 100,000 110,000 C
Delivery Equipment 90,000 90,000 C
Less: Accumulated Depreciation 9,000 D
Total Assets P 310,000

Liabilities and Owner’s Equity

Accounts Payable P 60,000 60,000 D

Esterlina Gevera, Capital 250,000 243,000 D
Total Liabilities and Owner’s Equity P 310,000

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

The conditions and adjustments agreed upon by the partners for purposes of determining their
interests in the partnership are:
1. Actual count and bank reconciliation on Corpuz proprietorship’s cash account revealed cash
short and unrecorded expenses of P3,500.
2. Establishment of a 10% allowance for uncollectible accounts in each book
3. The merchandise inventory of Gevera is to be increased by P10,000.
4. The furniture and fixtures of Corpuz are to be depreciated by P6,000.
5. The delivery equipment of Gevera is to be depreciated by P9,000.

New books for the Partnership (required per National Internal Revenue Code)

The following procedures may be used in recording the formation of the partnership:
Books of Deogracia Corpuz and Esterlina Gevera:
1. Adjust the accounts of both parties in accordance with the agreement.
Adjustments are to be made to their respective capital accounts.
2. Close the books.

Books of the Partnership:

1. Record the investment of Deogracia Corpuz.
2. Record the investment of Esterlina Gevera.

Following the procedures, the entries are:

Books of Deogracia Corpuz

1.
Date Account Titles and Explanation P.R. Debit Credit
1 2015
June 30 Deogracia Corpuz, Capital 19,500 1
2 Cash 3,500 2
3 Allowance for Uncollectible Accounts 10,000 3
4 Accumulated Depreciation 6,000 4
5 To record adjustments to restate Corpuz’s capital. 5

2.
Date Account Titles and Explanation P.R. Debit Credit
1 2015
June 30 Accounts Payable 30,000 1
2 Allowance for Uncollectible Accounts 10,000 2
3 Accumulated Depreciation 6,000 3
4 Deogracia Corpuz, Capital 240,500 4
5 Cash 46,500 5
6 Accounts Receivable 100,000 6
7 Merchandise Inventory 80,000 7
8 Furniture and Fixtures 60,000 8

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

9 To close the books of Corpuz. 9

Books of Esterlina Gevera
1.
Date Account Titles and Explanation P.R. Debit Credit
1 2015
June 30 Merchandise Inventory 10,000 1
2 Esterlina Gevera, Capital 7,000 2
3 Allowance for Uncollectible Accounts 8,000 3
4 Accumulated Depreciation 9,000 4
5 To record adjustments to restate Gevera’s capital. 5

2.
Date Account Titles and Explanation P.R. Debit Credit
1 2015
June 30 Accounts Payable 60,000 1
2 Allowance for Uncollectible Accounts 8,000 2
3 Accumulated Depreciation 9,000 3
4 Esterlina Gevera, Capital 243,000 4
5 Cash 40,000 5
6 Accounts Receivable 80,000 6
7 Merchandise Inventory 110,000 7
8 Delivery Equipment 90,000 8
9 To close the books of Gevera. 9

Books of the Partnership

Date Account Titles and Explanation P.R. Debit Credit
1 2015
June 30 Cash 46,500 1
2 Accounts Receivable 100,000 2
3 Merchandise Inventory 80,000 3
4 Furniture and Fixtures 54,000 4
5 Accounts Payable 30,000 5
6 Allowance for Uncollectible Accounts 10,000 6
7 Deogracia Corpuz, Capital 240,500 7
8 To record the investment of Corpuz. 8
9 9
10 30 Cash 40,000 10
11 Accounts Receivable 80,000 11
12 Merchandise Inventory 110,000 12
13 Delivery Equipment 81,000 13
14 Accounts Payable 60,000 14
15 Allowance for Uncollectible Accounts 8,000 15
16 Esterlina Gevera, Capital 243,000 16

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 Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

17 To record the investment of Gevera 17

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

Corpuz and Gevera Company

Statement of Financial Position
June 30, 2015

Assets

Cash P 86,500
Accounts Receivable P 180,000
Less: Allowance for Uncollectible Accounts 18,000 162,000
Merchandise Inventory 190,000
Furniture and Fixtures 54,000
Delivery Equipment 81,000
Total Assets P 573,500

Liabilities and Owner’s Equity

Accounts Payable 90,000

Deogracia Corpuz, Capital 240,500
Esterlina Gevera, Capital 243,000
Total Liabilities and Owner’s Equity P 573,500

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