partnership formation and operation (better)

Partnership formation

Module 1

ACCOUNTING PRINCIPLES Same accounting procedures and same books are used (general

journal, ledgers and special journals) except that accounting procedures differ in:

Computing and recording the sharing of profit and losses Presenting the Owners’ (Partners’) Equity Computing and recording the liquidation of the business

Ways of Forming a Partnership1. Two or more individuals

a. Two or more capitalist partnersb. A capitalist partner and an industrial partner

2. One sole proprietor and an individual3. Two or more sole proprietorships

REMEMBER: When recording partner’s investment:1. Cash investments are recorded at face value2. Non-cash investments are recorded at the Fair Market Value at the

date of contribution/transfer to the partnership3. The AGREED VALUE prevails over the FAIR MARKET VALUE4. If the a partner is a sole proprietor, only the CAPITAL account is used to

record the adjustment to reflect the investment’s fair market value. (not the Income and Loss Summary account) Capital is credited when the value of the assets increase or the value of the

liabilities assumed decreases Capital is debited when the value of the assets decrease or the value of the

liabilities assumed increases

5. To revalue the Accounts Receivable account, use its contra-asset account: Allowance for Bad Debts/Doubtful account.REMEMBER: Amongst the contra-assets, ONLY the Allowance for Bad Debts is carried in the partnership’s books. WHY?

6. To revalue the Fixed Asset account, use its contra-asset account: Accumulated Depreciation account.

Partnership between two or more individuals

Recording the investment of capitalist partnersPROFORMA:

Assets (at FMV) XXLiabilities (at FMV) XXPartner, Capital XX

Recording the investment of industrial partners PROFORMA:

No JOURNAL entry is required. Only a MEMORANDUM entry.

CASE 1: Both are capitalist partnersOn December 1, 2009, Rody and Lorie formed a partnership. They

agreed on the following contributions:

Prepare the journal entries to record the investment. Assume that the mortgage liability is a) assumed by partnership and b) not assumed by the partnership.

RodyBook Value Fair Value

Cash P 300,000 P 300,000Equipment P 10,000 P 7,500

LorieBook Value Fair Value

Cash P 200,000 P 200,000Land P 100,000 P 150,000** Land is mortgage to a bank for P50,000

CASE 1: JOURNAL ENTRIES

Cash 300,000Equipment 7,500 Rody, Capital 307,500

To record Rody's initial investment.

if liability is assumed by the partnership

Cash 200,000Land 150,000 Mortgage payable 50,000 Lorie, Capital 300,000

To record Lorie's initial investment.

if liability is not assumed by the partnershipCash 200,000Land 150,000 Lorie, Capital 350,000

To record Lorie's initial investment.

CASE 2: One is a capitalist partner and the other is an industrial partner

On December 1, 2009, Rody and Lorie formed a partnership. They agreed that Lorie shall manage the partnership business and shall be given a 10% share in the yearly profits. Rody, on the other hand, shall contribute the following:

Prepare the journal entries to record the partnership formation.

REMEMBER: Generally, Industrial partners share in the profits of the business but NOT in the losses of the business. He/She, however, is liable to share in the losses incurred arising from contractual obligations with 3rd parties.

RodyBook Value Fair Value Agreed Value

Cash P 300,000 P 300,000 P 300,000Equipment P 10,000 P 7,500 P 8,000

CASE 2: JOURNAL ENTRIES

Cash 300,000Equipment 8,000 Rody, Capital 308,000

To record Rody's initial investment.

Memorandum Entry "In accordance with the partnership agreement,Lorie is an industrial partner in this partnershipand shall earn 10% share in the profits of the partneship.

Partnership between individuals and a sole proprietor Opening entries can be made by using:

a new set of books (preferred) or the old set of books of the old sole proprietorship

CASE 1: A new set of books is used. 1. Prepare all capital adjusting entries to state the sole proprietors’ accounts in their agreed/fair

market value.2. Record the investment of the individual partner.

CASE 2: A new set of books is used. I. In the books of the sole proprietor

1. A. Prepare all capital adjusting entries to state the sole proprietors’ accounts in their agreed/fair market value.

2. Prepare adjusted trial balance.3. Prepare closing entries

II. In the books of the partnership1. Record the investment of the sole proprietor and the individual partner.

PROBLEM:The books of Japh’s Sari-sari store presents the

following:ASSETS

Cash P 16,000

Accounts Receivable P 50,000 Allowance for Bad Debts -2,000 48,000 Inventory 18,000 Supplies 2,500 Total current assets 84,500

Land 90,000 Equipment 80,000 Accumulated Depreciation -20,000 60,000 Total noncurrent assets 150,000

Total Assets P 234,500

LIABILITIES and OWNER'S EQUITY Accounts Payable 22,000 Notes Payable 30,000 Total liabilities 52,000

Japh, Capital 182,500

Total Liabilities and Owner's Equity P 234,500

Japh's Sari-sari StoreStatement of Financial Position

30-Nov-10

On December 1, 2010, he agreed to formed a partnership with Jaja to form JJ Merchandising. Jaja agreed to invest cash representing a 30% capital interest in the newly formed business.

Before forming the partnership, Japh and Jaja agreed that 50% of the notes payable will be settled. They also agreed that the following valuation will made with regards to Japh’s contributed assets.

Prepare the journal entries assuming that:a. The old books of the sole proprietor is used.b. A new set of books is used.

Book Value Fair Value Agreed Value

Cash P 16,000 P 16,000 No informationAccounts Receivable 48,000 40,000 42,000Inventory 18,000 20,000 20,000Supplies 2,500 2,500 3,000Land 90,000 100,000 No informationEquipment 60,000 68,000 64,000

CASE 1: OLD SOLE PROPRIETOR’S BOOKS ARE USED

ASSETS Cash P 16,000





Japh, Capital182,500



30-Nov-10

STEP 1: Record capital adjustment in sole proprietor's books.

Notes Payable 15,000 Cash 15,000 To record partial settlement of notes payable.

Inventory 2,000Supplies 500Land 10,000Accumulated Depreciation 4,000 Allowance for Bad Debts 6,000 Japh, Capital 10,500 To adjust the valuation of assets.

193,000 182,500 unadjusted10,500 entry above

193,000 193,000

JAPH's CAPITAL

CASE 1: OLD SOLE PROPRIETOR’S BOOKS ARE USED









30-Nov-10

STEP 2: Record the investment of the individual partner.

Cash 82,714 Jaja, Capital 82,714 To record initial investment of Jaja.

Japh's adjusted capital 193,000Divide by: % of capital interest (100%-30%) 70%Total partnership's capital 275,714Multiply by: Jaja's % interest 30%Cash contribution 82,714

CASE 2: NEW BOOKS ARE USED









30-Nov-10

STEP 1: Record capital adjustment in sole proprietor's books.

Notes Payable 15,000 Cash 15,000 To record partial settlement of notes payable.

Inventory 2,000Supplies 500Land 10,000Accumulated Depreciation 4,000 Allowance for Bad Debts 6,000 Japh, Capital 10,500 To adjust the valuation of assets.

193,000 182,500 unadjusted10,500 entry above

193,000 193,000

JAPH's CAPITAL










30-Nov-10

STEP 2: Prepare the adjusted trial balance.

Accounts

Cash P 16,000 P 15,000 P 1,000 Accounts Receivable 50,000 50,000 Allowance for Bad Debts P 2,000 6,000 P 8,000 Inventory 18,000 P 2,000 20,000 Supplies 2,500 500 3,000 Land 90,000 10,000 100,000 Equipment 80,000 80,000 Accumulated Depreciation 20,000 4,000 16,000 Accounts Payable 22,000 22,000 Notes Payable 30,000 15,000 15,000 Japh, Capital 182,500 10,500 193,000

P 256,500 P 256,500 P 31,500 P 31,500 P 254,000 P 254,000

AdjustmentsUnadjusted Trial Balance Adjusted Trial Balance










30-Nov-10

STEP 3: Close the books of the sole proprietor.

Allowance for Bad Debts 8,000Accumulated Depreciation 16,000Accounts Payable 22,000Notes Payable 15,000

Japh, Capital 193,000 Cash 1,000 Accounts Receivable 50,000 Inventory 20,000

Supplies 3,000 Land 100,000 Equipment 80,000 To record the closing of books of the store.










30-Nov-10

STEP 4: Record initial investment of the partners in the new books.

Cash 1,000 Accounts Receivable 50,000 Inventory 20,000 Supplies 3,000 Land 100,000 Equipment 64,000

Allowance for Bad Debts 8,000 Accounts Payable 22,000

Notes Payable 15,000 Japh, Capital 193,000

To record Japh's initial investment

Cash 82,714 Jaja, Capital 82,714

To record initial investment of Jaja.

Partnership between TWO OR MORE SOLE proprietorships Opening entries can be made by using:

a new set of books (preferred) or the old set of books of the one of the old sole proprietorships

Accounting Procedures:1. Record the capital adjusting entries in the books of the sole

proprietors.2. Prepare the adjusted trial balance of the sole proprietors3. Close the books of the sole proprietors. (No need to close the books

of the one that will be used by the partnership)4. Record the investment of the sole proprietors in the books of the

partnership.5. Prepare the partnership’s initial statement of financial position.

Partnership OPERATION & Profit distribution

Module 2

RULES ON PROFIT SHARING1. With profit and loss agreement

Profit is shared amongst ALL partners in accordance with the stipulations agreed upon by the partners (refer to partnership agreement)

2. No profit and loss agreementIf all are CAPITALIST partners, profits are to be divided in proportion to

their respective (ORIGINAL) capital contributionIf one is an INDUSTRIAL partner, the latter gets a just and equitable

share, and the remaining percentage shall be divided amongst the capitalist partners in accordance with their respective capital contribution

If one is a CAPITALIST-INDUSTRIAL partner, the latter gets a just share as industrial and another share as capitalist partner.

RULES ON LOSS SHARING1. With profit and loss agreement

Loss is shared amongst ALL partners in accordance with the stipulations agreed upon by the partners (refer to partnership agreement)

REMEMBER: The industrial partner is generally exempt in sharing losses but may become liable for losses only if there is a stipulation.

2. No profit and loss agreementIf all are CAPITALIST partners, losses are to be divided in accordance

with their profit sharing agreement.If one is an INDUSTRIAL partner, the latter is exempted and the

capitalist partners share in losses in accordance with their capital contributions.

Sharing of profits and lossesA, B and C formed a partnership. A and B contributed P50,000 each while C served as the managing partner of the business. For the first two years of the business, the partnership incurred net loss of P90,000 in Year 1 and net income of P120,000 in Year 2. How will the results of the operations be distributed amongst the partner if:a. The partnership agreement stipulates equal sharing of

the profits and losses of the business; andb. The partnership does not provide any stipulation on the

division of profits and losses and the managing partner is provided a 10% share in the profits.




A B C=A*BYear 1

P/L Ratio Net Income Share in NI

A 1/3 90,000 30,000B 1/3 90,000 30,000C 1/3 90,000 30,000

A B C=A*BYear 1


A 45% 90,000 40,500B 45% 90,000 40,500C 10% 90,000 9,000

Profit % for A and B

Contribution Fraction Profit % % Share

A 50,000 1/2 90% 45%B 50,000 1/2 90% 45%

100,000




A B C=A*BYear 2

P/L Ratio Net Loss Share in NI

A 1/3 -120,000 -40,000B 1/3 -120,000 -40,000C 1/3 -120,000 -40,000

A B C=A*BYear 2


A 50% -120,000 -60,000B 50% -120,000 -60,000C 0% -120,000 0

Profit % for A and B

Contribution Fraction Profit % % Share

A 50,000 1/2 100% 50%B 50,000 1/2 100% 50%

100,000

Accounting for partnership operations1. CAPITAL ACCOUNT ( Name of Partner, Capital)

> Credited for:a. Initial investments in the form of cash, merchandise or other assetsb. Additional investments in the form of cash, merchandise or other

assetsc. If the partnership has no available fund and the payment of

partnership obligation was made by the partner from his personal funds and such will be considered as an additional investment

d. Closing the credit balance of a partner’s drawing account (Indirect method)

e. Closing the credit balance of income summary account (Direct method)

Accounting for partnership operations1. CAPITAL ACCOUNT ( Name of Partner, Capital)

> Debited for:a. Permanent withdrawals, provided they would not prejudice the

partnership creditorsb. Amount of interest sold with the consent of the other partnersc. Closing the debit balance of a partner’s Drawing account

(Indirect Method)d. Closing the debit balance of Income Summary account (Direct

Method)

Accounting for partnership operations2. DRAWING or WITHDRAWAL ACCOUNT( Name of Partner, Drawing/Withdrawal/Personal)

> Credited for:a. Withdrawals of cash or other partnership assets. These withdrawals are

temporary in nature and to be deducted from the partner’s share in the profit of the partnership

b. Losses from partnership operations c. Closing the credit balance of drawing account to capital account.

> Debited for:d. Allowance for salaries or bonuses not as an expense to the firm but as a

share in the profit or loss of the partnershipe. Interest allowed on their capital balances as per agreementf. Closing the credit balance of income summary account g. Closing the debit balance of drawing account to capital account

Accounting for partnership operationsREMEMBER:

Personal withdrawals of a partner in anticipation of profits is viewed as a transaction of temporary nature

A partner can only withdraw to the extent of his/her share in the profits of the business.

Capital and Drawing account balances are not combined to determine the total interest on the SOFP. Increases and decreases in the accounts are separately presented in the Statement of Partners’ Equity.

Accounting for partnership operations3. LOAN ACCOUNT

If partnership owes a sum of money to a partner:Loan Payable – Name of PartnerNotes Payable – Name of PartnerDue to Partner – Name of Partner

If partner owes a sum of money to the partnership

Due from Partner – Name of PartnerReceivable from Partner – Name of PartnerNotes Receivable – Name of Partner

Journal entries: Recording profit distribution1. Distribution of net income/profit

Income Summary xx Income Summary xxA, Capital xx A, Drawing xxB, Capital xx B, Drawing xx

2. Closing of drawing accounts to capital accounts.

A, Capital xx A, Capital xxB, Capital xx B, Capital

A, Drawing xx A, Drawing xx

B, Drawing xx B, Drawing xx

DIRECT METHOD INDIRECT METHOD


Journal entries: Recording profit distribution1. Distribution of net loss

A, Capital xx A, Drawing xxB, Capital xx B, Drawing xx

Income Summary xx Income Summary xx

2. Closing of drawing accounts to capital accounts.

A, Capital xx A, Capital xxB, Capital xx B, Capital

A, Drawing xx A, Drawing xxB, Drawing xx B, Drawing xx



Profits may be divided using:

1. Arbitrary or agreed ratiosa. Equallyb. Using agreed ratios as follows:

i. Percentage Ratioii. Fractional Ratioiii. Algebraic Ratio

2. In the ratio of Partners’ Capital Balancesa. Beginning Capitalb. Ending Capitalc. Average Capital

3. Allowing interest, salaries, bonuses and the remainder divided according to (1) or (2)

Example

Ki and WangYu are partners in Perennial Partnership. Both have contributed a certain sum of money. However, Ki is tasked to manage the business. During the year, the books of the partnership revealed the following:

The partnership earned a net profit of P140,000 for the year ending 2013.

1-Jul 25,000 1-Jan 110,000 1-Apr 32,000 1-Jan 160,0001-Dec 25,000 1-Apr 20,000 1-Dec 38,000 1-Jun 40,000

1-Nov 55,000 1-Oct 70,000

Ki, Capital WangYu, Capital

• Record the distribution of profit and other items using the following assumptions:

a. Equallyb. 1/3 and 2/3 ratio for Ki and WangYu, respectivelyc. 60% for Ki and 40% for WangYud. 1:5 ratio for Ki and WangYu, respectivelye. Based on beginning capital balancesf. Based on ending capital balancesg. Based on average capital balances

• Work on the following assumptionsa. A 20% interest on the beginning capital is providedb. A salary of P10,000 to the managing partnerc. A 10% bonus based on net income to the managing partner

REMINDERS:

1. The industrial partner does not share in the losses of the partnership unless stipulated.

2. The interest and salary are provided to partners whether it is a net income or net loss.

3. Bonuses are not provided to partners when there is a net loss.

4. Be careful with the basis of computing for the amount of bonus.

5. A net income is the net results of operations after tax.

Case A: EquallyKi WangYu TOTAL

Net income 140,000Interest Ki (110,000*20%) 22,000 WangYu (160,000*20%) 32,000 54,000Salary 10,000 10,000Bonus (140,000*10%) 14,000 14,000Capital before share of profit 46,000 32,000 78,000Remaining income to share 62,000 Ki 31,000 WangYu 31,000 62,000Increase in capital 77,000 63,000

Income Summary 140,000 Ki, Drawing 77,000 Wangyu, Drawing 63,000

Ki, Drawing 77,000Wangyu, Drawing 63,000 Ki, Capital 77,000 Wangyu, Capital 63,000

Case B: 1/3 Ki and 2/3 WangYuKi WangYu TOTAL




Case C: 60% Ki and 40% WangYuKi WangYu TOTAL




Case D: 1:5 for Ki and WangYu, respectivelyKi WangYu TOTAL




Case E: Based on beginning capital balancesKi WangYu TOTAL

Net income 140,000Interest Ki (110,000*20%) 22,000 WangYu (160,000*20%) 32,000 54,000Salary 10,000 10,000Bonus (140,000*10%) 14,000 14,000Capital before share of profit 46,000 32,000 78,000Remaining income to share 62,000 Ki (62*110/270) 25,259 WangYu (62*160/270) 36,741 62,000Increase in capital 71,259 68,741



ENDING CAPITAL BALANCE

1-Jul 25,000 1-Jan 110,000 1-Apr 32,000 1-Jan 160,0001-Dec 25,000 1-Apr 20,000 1-Dec 38,000 1-Jun 40,000

1-Nov 55,000 1-Oct 70,00050,000 185,000 140,000 200,000

Ending 135,000 Ending 60,000

Ki, Capital WangYu, Capital

Case F: Based on ending capital balancesKi WangYu TOTAL

Net income 140,000Interest Ki (110,000*20%) 22,000 WangYu (160,000*20%) 32,000 54,000Salary 10,000 10,000Bonus (140,000*10%) 14,000 14,000Capital before share of profit 46,000 32,000 78,000Remaining income to share 62,000 Ki (62*135/195) 42,923 WangYu (62*60/195) 19,077 62,000Increase in capital 88,923 51,077



AVERAGE CAPITAL BALANCEKi, Capital

Date Inc (Dec) Balance Months Unchanged Average Balance

1-Jan 110,000 110,000 3 330,0001-Apr 20,000 130,000 3 390,0001-Jul -25,000 105,000 4 420,0001-Nov 55,000 160,000 1 160,0001-Dec -25,000 135,000 1 135,000

12 1,435,000119,583

WangYu, Capital

Date Inc (Dec) Balance Months Unchanged Average Balance

1-Jan 160,000 160,000 3 480,0001-Apr -32,000 128,000 2 256,0001-Jun 40,000 168,000 4 672,0001-Oct -70,000 98,000 2 196,0001-Dec -38,000 60,000 1 60,000

12 1,664,000138,667

Case G: Based on average capital balancesKi WangYu TOTAL

Net income 140,000Interest Ki (110,000*20%) 22,000 WangYu (160,000*20%) 32,000 54,000Salary 10,000 10,000Bonus (140,000*10%) 14,000 14,000Capital before share of profit 46,000 32,000 78,000Remaining income to share 62,000 Ki (62*119,583/258,250) 28,709 WangYu (62*138,667/258,250) 33,291 62,000Increase in capital 74,709 65,291



partnership formation and operation (better)

Documents

journal entries partnership

partnership business

capital account

journal entries case

new set of books

contraasset account

partners investment

investments fair market