Basic Financial Accounting and Reporting

1. Chapter 6: Accounting for Partnerships

2. Introduction

In this chapter, we will discuss reasons why businesses select the partnership form of organization. We
also will explain the major issues in accounting for partnerships. The content and organization of this
chapter are as follows.

3. Learning Outcome

a. Identify the characteristics of the partnership form of business organization.

b. Explain the accounting entries for the formation of a partnership.
c. Identify the bases for dividing net income or net loss.
d. Describe the form and content of partnership financial statements.
e. Explain the effects of the entries to record the liquidation of a partnership.

4. Learning Content

a. Partnership Form of Organization

The Philippine Civil Code provides for a definition of a partnership as follows:

By the contract of partnership two or more persons bind themselves to contribute money, property, or
industry to a common fund, with the intention of dividing the profits among themselves.

Two or more persons may also form a partnership for the exercise of a profession.

Characteristics of Partnerships

Partnerships are fairly easy to form. People form partnerships simply by a verbal agreement, or more
formally, by written agreement. We explain the principal characteristics of partnerships in the following
sections.

• ASSOCIATION OF INDIVIDUALS. A partnership is a legal entity. A partnership can own

property (land, buildings, equipment), and can sue or be sued. A partnership also is an
accounting entity. Thus, the personal assets, liabilities, and transactions of the partners are
excluded from the accounting records of the partnership, just as they are in a proprietorship.

The net income of a partnership is not taxed as a separate entity. But, a partnership must file a
tax return showing partnership net income and each partner’s share of that net income. Each
partner’s share is taxable at personal tax rates, regardless of the amount of net income each
withdraws from the business during the year.

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Chapter 6 | Accounting for Partnerships
• MUTUAL AGENCY. Mutual agency means that each partner acts on behalf of the partnership
when engaging in partnership business. The act of any partner is binding on all other partners.
This is true even when partners act beyond the scope of their authority, so long as the act appears
to be appropriate for the partnership.

For example, a partner of a grocery store who purchases a delivery truck creates a binding
contract in the name of the partnership, even if the partnership agreement denies this authority.
On the other hand, if a partner in a law firm purchased a snowmobile for the partnership, such an
act would not be binding on the partnership. The purchase is clearly outside the scope of
partnership business.

• LIMITED LIFE. Corporations have unlimited life. Partnerships do not. A partnership may be
ended voluntarily at any time through the acceptance of a new partner or the withdrawal of a
partner. It may be ended involuntarily by the death or incapacity of a partner. Partnership
dissolution occurs whenever a partner withdraws or a new partner is admitted. Dissolution does
not necessarily mean that the business ends. If the continuing partners agree, operations can
continue without interruption by forming a new partnership.

• UNLIMITED LIABILITY. Each partner is personally and individually liable for all partnership
liabilities. Creditors’ claims attach first to partnership assets. If these are insufficient, the claims
then attach to the personal resources of any partner, irrespective of that partner’s equity in the
partnership. Because each partner is responsible for all the debts of the partnership, each partner
is said to have unlimited liability.

• CO-OWNERSHIP OF PROPERTY. Partners jointly own partnership assets. If the partnership is

dissolved, each partner has a claim on total assets equal to the balance in his or her respective
capital account. This claim does not attach to specific assets that an individual partner
contributed to the fi rm. Similarly, if a partner invests a building in the partnership valued at
P100,000 and the building is later sold at a gain of P20,000, the partners all share in the gain.

Partnership net income (or net loss) is also co-owned. If the partnership contract does not
specify to the contrary, all net income or net loss is shared equally by the partners. As you
will see later, though, partners may agree to unequal sharing of net income or net loss.

CLASSIFICATIONS OF PARTNERSHIPS

1. According to a. Universal partnership of all present property. All contributions become

object part of the partnership fund.
b. Universal partnership of profits. All that the partners may acquire by their
industry or work during the existence of the partnership and the use of
whatever the partners contributed at the time of the institution of the contract
belong to the partnership. If the articles of universal partnership did not
specify its nature, it will considered a universal partnership of profits.
c. Particular partnership. The object of the partnership is determinate--its use
or fruit, specific undertaking, or the exercise of a profession or vocation.
2. According to a. General. All partners are liable to the extent of their separate properties.
liability b. Limited. The limited partners are liable only to the extent of their personal
contributions. In a limited partnership, the law states that there shall be at
least one general partner.
3. According to a. Partnership with a fixed term or for a particular undertaking.
duration b. Partnership at will. One in which no term is specified and is not formed for
any particular undertaking.
4. According to a. Commercial or trading partnership. One formed for the transaction of
purpose business.
b. Professional or non-trading partnership. One formed for the exercise of
profession.

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Chapter 6 | Accounting for Partnerships
5. According to a. De jure partnership. One which has complied with all the legal requirements
legality of for its establishment.
existence b. De facto partnership. One which has failed to comply with all the legal
requirements for its establishment.

KINDS OF PARTNERS

1. General partner. One who is liable to the extent of his separate property after all the assets of
the partnership are exhausted.
2. Limited partner. One who is liable only to the extent of his capital contribution. He is not allowed
to contribute industry or services only.
3. Capitalist partner. One who contributes money or property to the common fund of the
partnership.
4. Industrial partner. One who contributes his knowledge or personal service to the partnership.
5. Managing partner. One whom the partners has appointed as manager of the partnership.
6. Liquidating partner. One who is designated to wind up or settle the affairs of the partnership
after dissolution.
7. Dormant partner. One who does not take active part in the business of the partnership and is not
known as a partner.
8. Silent partner. One who does not take active part in the business of the partnership though may
be known as a partner.
9. Secret partner. One who takes active part in the business but is not known to be 3 partner by
outside parties.
10. Nominal partner or partner by estoppel. One who is actually not a partner but who represents
himself as one.

Organizations with Partnership Characteristics

If you are starting a business with a friend and each of you has little capital and your business is not
risky, you probably want to use a partnership. As indicated above, the partnership is easy to establish
and its cost is minimal. These types of partnerships are often called regular partnerships. However
if your business is risky—say, roof repair or providing some type of professional service—you will
want to limit your liability and not use a regular partnership. As a result, special forms of business
organizations with partnership characteristics are now often used to provide protection from unlimited
liability for people who wish to work together in some activity.

The special partnership forms are:

1. limited partnerships,
2. limited liability partnerships, and
3. limited liability companies.

These special forms use the same accounting procedures as those described for a regular
partnership. In addition, for taxation purposes, all the profits and losses pass through these
organizations (similar to the regular partnership) to the owners, who report their share of partnership
net income or losses on their tax returns.

1. LIMITED PARTNERSHIPS. In a limited partnership, one or more partners have unlimited

liability and one or more partners have limited liability for the debts of the fi rm. Those with
unlimited liability are general partners. Those with limited liability are limited partners. Limited
partners are responsible for the debts of the partnership up to the limit of their investment in the fi
rm.

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Chapter 6 | Accounting for Partnerships
 The words “Limited Partnership,” or “Ltd.,” or “LP” identify this type of organization. For the
privilege of limited liability, the limited partner usually accepts less compensation than a general
partner and exercises less influence in the affairs of the firm. If the limited partners get involved in
management, they risk their liability protection.

2. LIMITED LIABILITY PARTNERSHIP. Limited liability partnership or “LLP” is designed to

protect innocent partners from malpractice or negligence claims resulting from the acts of another
partner. LLPs generally carry large insurance policies as protection against malpractice suits.
These professional partnerships vary in size from a medical partnership of three to five doctors,
to 150 to 200 partners in a large law firm, to more than 2,000 partners in an international
accounting fi rm.

3. LIMITED LIABILITY COMPANIES. A hybrid form of business organization with certain features
like a corporation and others like a limited partnership is the limited liability company, or “LLC.”
An LLC usually has a limited life. The owners, called members, have limited liability like owners
of a corporation. Whereas limited partners do not actively participate in the management of a
limited partnership (LP), the members of a limited liability company (LLC) can assume an active
management role.

Advantages and Disadvantages of Partnerships

Why do people choose partnerships? One major advantage of a partnership is to combine the skills
and resources of two or more individuals. In addition, partnerships are easily formed and are relatively
free from government regulations and restrictions. A partnership does not have to contend with the
“red tape” that a corporation must face. Also, partners generally can make decisions quickly on
substantive business matters without having to consult a board of directors.

On the other hand, partnerships also have some major disadvantages. Unlimited liability is
particularly troublesome. Many individuals fear they may lose not only their initial investment but also
their personal assets, if those assets are needed to pay partnership creditors.

The illustration below summarizes the advantages and disadvantages of the regular partnership form
of business organization. As indicated in the previous section, different types of partnership forms
have evolved to reduce some of the disadvantages.

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Chapter 6 | Accounting for Partnerships
Different forms of organizations with partnership characteristics

The Partnership Agreement

Ideally, the agreement of two or more individuals to form a partnership should be expressed in a
written contract, called the partnership agreement or articles of co-partnership. The partnership
agreement contains such basic information as the name and principal location of the firm, the purpose
of the business, and date of inception. In addition, it should specify relationships among the partners,
such as:
1. Names and capital contributions of partners.
2. Rights and duties of partners.
3. Basis for sharing net income or net loss.
4. Provision for withdrawals of assets.
5. Procedures for submitting disputes to arbitration.
6. Procedures for the withdrawal or addition of a partner.
7. Rights and duties of surviving partners in the event of a partner’s death.

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Chapter 6 | Accounting for Partnerships
 We cannot overemphasize the importance of a written contract. The agreement should attempt to
anticipate all possible situations, contingencies, and disagreements. The help of a lawyer is highly
desirable in preparing the agreement.

b. Basic Partnership Accounting

We now turn to the basic accounting for partnerships. The major accounting issues relate to forming
the partnership, dividing income or loss, and preparing financial statements.

Forming a Partnership

Each partner’s initial investment in a partnership is entered in the partnership records. The partnership
should record these investments at the fair value of the assets at the date of their transfer to the
partnership. All partners must agree to the values assigned.

To illustrate, assume that A. Rolfe and T. Shea combine their proprietorships to start a partnership
named U.S. Software. The firm will specialize in developing financial modeling software packages.
Rolfe and Shea have the following assets prior to the formation of the partnership.

The partnership records the investments as follows.

Note that the partnership records neither the original cost of the office equipment (P5,000) nor its
book value (P5,000 2 P2,000). It records the equipment at its fair value, P4,000. The partnership does
not carry forward any accumulated depreciation from the books of previous entities (in this case, the
two proprietorships).

In contrast, the gross claims on customers (P4,000) are carried forward to the partnership. The
partnership adjusts the allowance for doubtful accounts to P1,000, to arrive at a cash (net) realizable
value of P3,000. A partnership may start with an allowance for doubtful accounts because it will
continue to collect existing accounts receivable, some of which are expected to be uncollectible. In
addition, this procedure maintains the control and subsidiary relationship between Accounts
Receivable and the accounts receivable subsidiary ledger.

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Chapter 6 | Accounting for Partnerships
After formation of the partnership, the accounting for transactions is similar to any other type of
business organization. For example, the partners record all transactions with outside parties, such as
the purchase or sale of merchandise inventory and the payment or receipt of cash, the same as would
a sole proprietor.

The steps in the accounting cycle described in Chapter 4 for a proprietorship also apply to a
partnership. For example, the partnership prepares a trial balance and journalizes and posts
adjusting entries. A worksheet may be used. There are minor differences in journalizing and posting
closing entries and in preparing financial statements, as we explain in the following sections. The
differences occur because there is more than one owner.

Dividing Net Income or Net Loss

Partners equally share partnership net income or net loss unless the partnership contract
indicates otherwise. The same basis of division usually applies to both net income and net loss. It
is customary to refer to this basis as the income ratio, the income and loss ratio, or the profit and
loss (P&L) ratio.

Because of its wide acceptance, we will use the term income ratio to identify the basis for dividing
net income and net loss. The partnership recognizes a partner’s share of net income or net loss in
the accounts through closing entries.

• CLOSING ENTRIES. As in the case of a proprietorship, a partnership must make four entries in
preparing closing entries. The entries are:
1. Debit each revenue account for its balance, and credit Income Summary for total revenues.
2. Debit Income Summary for total expenses, and credit each expense account for its balance.
3. Debit Income Summary for its balance, and credit each partner’s capital account for his or her
share of net income. Or, credit Income Summary, and debit each partner’s capital account for
his or her share of net loss.
4. Debit each partner’s capital account for the balance in that partner’s drawing account, and
credit each partner’s drawing account for the same amount.

The first two entries are the same as in a proprietorship. The last two entries are different because
1. there are two or more owners’ capital and drawing accounts, and
2. it is necessary to divide net income (or net loss) among the partners.

To illustrate the last two closing entries, assume that AB Company has net income of P32,000 for
2012. The partners, L. Arbor and D. Barnett, share net income and net loss equally. Drawings for
the year were Arbor P8,000 and Barnett P6,000. The last two closing entries are:

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Chapter 6 | Accounting for Partnerships
 Assume that the beginning capital balance is P47,000 for Arbor and P36,000 for Barnett. After
posting the closing entries, the capital and drawing accounts will appear as shown below.

As in a proprietorship, the partners’ capital accounts are permanent accounts; their drawing
accounts are temporary accounts. Normally, the capital accounts will have credit balances, and
the drawing accounts will have debit balances. Drawing accounts are debited when partners
withdraw cash or other assets from the partnership for personal use.

c. INCOME RATIOS

The partnership agreement should specify the basis for sharing net income or net loss. The following
are typical income ratios.
1. A fixed ratio, expressed as a proportion (6:4), a percentage (70% and 30%), or a fraction (2/3 and
1/3).
2. A ratio based either on capital balances at the beginning of the year or on average capital balances
during the year.
3. Salaries to partners and the remainder on a fixed ratio.
4. Interest on partners’ capital balances and the remainder on a fixed ratio.
5. Salaries to partners, interest on partners’ capital, and the remainder on a fixed ratio.

The objective is to settle on a basis that will equitably reflect the partners’ capital investment and
service to the partnership.

• A fixed ratio is easy to apply, and it may be an equitable basis in some circumstances. Assume,
for example, that Hughes and Lane are partners. Each contributes the same amount of capital,
but Hughes expects to work full-time in the partnership and Lane expects to work only half-time.
Accordingly, the partners agree to a fixed ratio of 2/3 to Hughes and 1/3 to Lane.

• A ratio based on capital balances may be appropriate when the funds invested in the
partnership are considered the critical factor. Capital ratios may also be equitable when the
partners hire a manager to run the business and do not plan to take an active role in daily
operations.

The three remaining ratios (items 3, 4, and 5) give specific recognition to differences among
partners. These ratios provide salary allowances for time worked and interest allowances for
capital invested. Then, the partnership allocates any remaining net income or net loss on a fixed
ratio.

Salaries to partners and interest on partners’ capital are not expenses of the partnership.
Therefore, these items do not enter into the matching of expenses with revenues and the
determination of net income or net loss. For a partnership, as for other entities, salaries and wages
expense pertains to the cost of services performed by employees. Likewise, interest expense
relates to the cost of borrowing from creditors. But partners, as owners, are not considered either
employees or creditors. When the partnership agreement permits the partners to make monthly
withdrawals of cash based on their “salary,” the partnership debits these withdrawals to the
partner’s drawing account.

• SALARIES, INTEREST, AND REMAINDER ON A FIXED RATIO. Under income ratio (5) in the
list on the previous page, the partnership must apply salaries and interest before it allocates the
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Chapter 6 | Accounting for Partnerships
remainder on the specified fixed ratio. This is true even if the provisions exceed net income. It is
also true even if the partnership has suffered a net loss for the year. The partnership’s income
statement should show, below net income, detailed information concerning the division of net
income or net loss.

To illustrate, assume that King and Lee are co-partners in the Kingslee Company. The partnership
agreement provides for:
1. salary allowances of P8,400 to King and P6,000 to Lee,
2. interest allowances of 10% on capital balances at the beginning of the year, and
3. the remainder equally.

Capital balances on January 1 were King P28,000, and Lee P24,000. In 2020, partnership net
income is P22,000. The division of net income is as follows.

Kingslee Company
Division of Net Income
For the Year Ended December 31, 2020

Kingslee records the division of net income as follows.

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Chapter 6 | Accounting for Partnerships
 Now let’s look at a situation in which the salary and interest allowances exceed net income.
Assume that Kingslee Company’s net income is only P18,000. In this case, the salary and interest
allowances will create a deficiency of P1,600 (P19,600 2 P18,000). The computations of the
allowances are the same as those in the preceding example. Beginning with total salaries and
interest, we complete the division of net income as shown below.

d. Partnership Financial Statements

The financial statements of a partnership are similar to those of a proprietorship. The differences are
due to the number of owners involved. The income statement for a partnership is identical to the
income statement for a proprietorship except for the division of net income, as shown earlier.

The owners’ equity statement for a partnership is called the partners’ capital statement. It explains
the changes in each partner’s capital account and in total partnership capital during the year.

The illustration below shows the partners’ capital statement for Kingslee Company. It is based on the
division of P22,000 of net income in on page 9 (see first illustration). The statement includes assumed
data for the additional investment and drawings. The partnership prepares the partners’ capital
statement from the income statement and the partners’ capital and drawing accounts.

Kingslee Company
Partners’ Capital Statement
For the Year Ended December 31, 2020

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Chapter 6 | Accounting for Partnerships
 The balance sheet for a partnership is the same as for a proprietorship except for the owner’s equity
section. For a partnership, the balance sheet shows the capital balances of each partner. The owners’
equity section for Kingslee Company would show the following.

Kingslee Company
Balance Sheet (partial)
December 31, 2020

e. Liquidation of a Partnership

Liquidation of a business involves selling the assets of the firm, paying liabilities, and distributing any
remaining assets. Liquidation may result from the sale of the business by mutual agreement of the
partners, from the death of a partner, or from bankruptcy. Partnership liquidation ends both the
legal and economic life of the entity.

From an accounting standpoint, the partnership should complete the accounting cycle for the final
operating period prior to liquidation. This includes preparing adjusting entries and financial
statements. It also involves preparing closing entries and a post-closing trial balance. Thus, only
balance sheet accounts should be open as the liquidation process begins.

In liquidation, the sale of noncash assets for cash is called realization. Any difference between book
value and the cash proceeds is called the gain or loss on realization. To liquidate a partnership, it is
necessary to:
1. Sell noncash assets for cash and recognize a gain or loss on realization.
2. Allocate gain/loss on realization to the partners based on their income ratios.
3. Pay partnership liabilities in cash.
4. Distribute remaining cash to partners on the basis of their capital balances.

Each of the steps must be performed in sequence. The partnership must pay creditors before
partners receive any cash distributions. Also, an accounting entry must record each step.

When a partnership is liquidated, all partners may have credit balances in their capital accounts. This
situation is called no capital deficiency. Or, one or more partners may have a debit balance in the
capital account. This situation is termed a capital deficiency. To illustrate each of these conditions,
assume that Ace Company is liquidated when its ledger shows the following assets, liabilities, and
owners’ equity accounts.

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Chapter 6 | Accounting for Partnerships
No Capital Deficiency

The partners of Ace Company agree to liquidate the partnership on the following terms:
1. The partnership will sell its noncash assets to Jackson Enterprises for P75,000 cash.
2. The partnership will pay its partnership liabilities.

The income ratios of the partners are 3: 2: 1, respectively. The steps in the liquidation process are as
follows.

1. Ace sells the noncash assets (accounts receivable, inventory, and equipment) for P75,000. The
book value of these assets is P60,000 (P15,000 + P18,000 + P35,000 -- P8,000). Thus, Ace
realizes a gain of P15,000 on the sale. The entry is:

(1)

2. Ace allocates the P15,000 gain on realization to the partners based on their income ratios, which
are 3:2:1. The entry is:

(2)

3. Partnership liabilities consist of Notes Payable P15,000 and Accounts Payable P16,000. Ace pays
creditors in full by a cash payment of P31,000. The entry is:

(3)

4. Ace distributes the remaining cash to the partners on the basis of their capital balances. After
posting the entries in the fi rst three steps, all partnership accounts, including Gain on Realization,
will have zero balances except for four accounts: Cash P49,000; R. Arnet, Capital P22,500; P.
Carey, Capital P22,800; and W. Eaton, Capital P3,700, as shown below.

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Chapter 6 | Accounting for Partnerships
 Ace records the distribution of cash as follows.

After posting this entry, all partnership accounts will have zero balances.

A word of caution: Partnerships should not distribute remaining cash to partners on the basis of their
income-sharing ratios. On this basis, Arnet would receive three-sixths, or P24,500, which would
produce an erroneous debit balance of P2,000. The income ratio is the proper basis for allocating net
income or loss. It is not a proper basis for making the fi nal distribution of cash to the partners.

SCHEDULE OF CASH PAYMENTS

The schedule of cash payments shows the distribution of cash to the partners in a partnership
liquidation. A cash payments schedule is sometimes prepared to determine the distribution of cash to
the partners in the liquidation of a partnership. The schedule of cash payments is organized around
the basic accounting equation.

The illustration below shows the schedule for Ace Company. The numbers in parentheses refer to the
four required steps in the liquidation of a partnership. They also identify the accounting entries that
Ace must make. The cash payments schedule is especially useful when the liquidation process
extends over a period of time.

Capital Deficiency

A capital deficiency may result from recurring net losses, excessive drawings, or losses from
realization suffered during liquidation.

To illustrate, assume that Ace Company is on the brink of bankruptcy. The partners decide to liquidate
by having a “going-out-of-business” sale. They sell merchandise at substantial discounts, and sell the
equipment at auction. Cash proceeds from these sales and collections from customers total only
P42,000. Thus, the loss from liquidation is P18,000 (P60,000 -- P42,000).

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Chapter 6 | Accounting for Partnerships
The steps in the liquidation process are as follows.

1. The entry for the realization of noncash assets is:

(1)

2. Ace allocates the loss on realization to the partners on the basis of their income ratios. The entry
is:

(2)

3. Ace pays the partnership liabilities. This entry is the same as the previous one.

(3)

4. After posting the three entries, two accounts will have debit balances—Cash P16,000, and W.
Eaton, Capital P1,800. Two accounts will have credit balances— R. Arnet, Capital P6,000, and
P. Carey, Capital P11,800. All four accounts are shown below.

Eaton has a capital deficiency of P1,800, and so owes the partnership P1,800. Arnet and Carey
have a legally enforceable claim for that amount against Eaton’s personal assets. Note that the
distribution of cash is still made on the basis of capital balances. But the amount will vary
depending on how Eaton settles the deficiency. Two alternatives are presented in the following
sections.

• PAYMENT OF DEFICIENCY. If the partner with the capital deficiency pays the amount owed the
partnership, the deficiency is eliminated.

To illustrate, assume that Eaton pays P1,800 to the partnership. The entry is:
(a)

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Chapter 6 | Accounting for Partnerships
 After posting this entry, account balances are as follows.

The cash balance of P17,800 is now equal to the credit balances in the capital accounts (Arnet
P6,000 + Carey P11,800). Ace now distributes cash on the basis of these balances. The entry is:

After posting this entry, all accounts will have zero balances.

• NONPAYMENT OF DEFICIENCY. If a partner with a capital deficiency is unable to pay the

amount owed to the partnership, the partners with credit balances must absorb the loss. The
partnership allocates the loss on the basis of the income ratios that exist between the partners
with credit balances.

The income ratios of Arnet and Carey are 3: 2, or 3/5 and 2/5, respectively. Thus, Ace would make
the following entry to remove Eaton’s capital deficiency.
(a)

After posting this entry, the cash and capital accounts will have the following balances.

The cash balance (P16,000) now equals the sum of the credit balances in the capital accounts
(Arnet P4,920 1 Carey P11,080). Ace records the distribution of cash as:

After posting this entry, all accounts will have zero balances.

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Chapter 6 | Accounting for Partnerships
5. Teaching and Learning Activities

Activity 1 Partnership Organization.

Indicate whether each of the following statements is true or false.
______ 1. Partnerships have unlimited life. Corporations do not.
______ 2. Partners jointly own partnership assets. A partner’s claim on partnership assets does not attach
to specific assets.
______ 3. In a limited partnership, the general partners have unlimited liability.
______ 4. The members of a limited liability company have limited liability, like shareholders of a
corporation, and they are taxed like corporate shareholders.
______ 5. Because of mutual agency, the act of any partner is binding on all other partners.

action plan
✔ When forming a business, carefully consider what type of organization would best suit the needs of
the business.
✔ Keep in mind the new, “hybrid” organizational forms that have many of the best characteristics of
partnerships and corporations.

Activity 2 Division of Net Income.

LeeMay Company reports net income of P57,000. The partnership agreement provides for salaries of
P15,000 to L. Lee and P12,000 to R. May. They will share the remainder on a 60:40 basis (60% to Lee).
L. Lee asks your help to divide the net income between the partners and to prepare the closing entry.

action plan
✔ Compute net income exclusive of any salaries to partners and interest on partners’ capital.
✔ Deduct salaries to partners from net income.
✔ Apply the partners’ income ratios to the remaining net income.
✔ Prepare the closing entry distributing net income or net loss among the partners’ capital accounts.

Activity 3 Partnership Liquidation.

The partners of Grafton Company have decided to liquidate their business. Noncash assets were sold for
P115,000. The income ratios of the partners Kale D., Croix D., and Marais K. are 2:3:3, respectively.
Complete the following schedule of cash payments for Grafton Company.

action plan
✔ First, sell the noncash assets and determine the gain.
✔ Allocate the gain to the partners based on their income ratios.
✔ Use cash to pay off liabilities.
✔ Distribute remaining cash on the basis of their capital balances.

Actitivity 4 Partnership Liquidation.

Kessington Company wishes to liquidate the firm by distributing the company’s cash to the three partners.
Prior to the distribution of cash, the company’s balances are: Cash P45,000; Rollings, Capital (Cr.)
P28,000; Havens, Capital (Dr.) P12,000; and Ostergard, Capital (Cr.) P29,000. The income ratios of the
three partners are 4:4:2, respectively. Prepare the entry to record the absorption of Havens’ capital
deficiency by the other partners and the distribution of cash to the partners with credit balances.

action plan
✔ Allocate any unpaid capital deficiency to the partners with credit balances, based on their income
ratios.
✔ After distribution of the deficiency, distribute cash to the remaining partners, based on their capital
balances.

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Chapter 6 | Accounting for Partnerships
6. Assessment Task

Problem 1 Multiple Choice. Choose the best possible answer.

1. Which of the following is not a c. P18,000.

characteristic of a partnership? d. No correct answer is given.
a. Taxable entity.
b. Co-ownership of property. 7. Using the data in (6) above, what is B’s
c. Mutual agency. share of net income if the percentages are
d. Limited life. applicable after each partner receives a
P10,000 salary allowance?
2. A partnership agreement should include a. P12,000.
each of the following except: b. P20,000.
a. names and capital contributions of c. P19,000.
partners. d. P21,000.
b. rights and duties of partners as well as
basis for sharing net income or loss. 8. To close a partner’s drawing account, an
c. basis for splitting partnership income entry must be made that:
taxes. a. debits that partner’s drawing account
d. provision for withdrawal of assets. and credits Income Summary.
b. debits that partner’s drawing account
3. The advantages of a partnership do not and credits that partner’s capital
include: account.
a. ease of formation. c. credits that partner’s drawing account
b. unlimited liability. and debits that partner’s capital
c. freedom from government regulation. account.
d. ease of decision making. d. credits that partner’s drawing account
and debits the firm’s dividend account.
4. Upon formation of a partnership, each
partner’s initial investment of assets should 9. Which of the following statements about
be recorded at their: partnership financial statements is true?
a. book values. a. Details of the distribution of net income
b. cost. are shown in the owners’ equity
c. fair values. statement.
d. appraised values. b. The distribution of net income is shown
on the balance sheet.
5. Ben and Sam Jenkins formed a c. Only the total of all partner capital
partnership. Ben contributed P8,000 cash balances is shown in the balance
and a used truck that originally cost sheet.
P35,000 and had accumulated d. The owners’ equity statement is called
depreciation of P15,000. The truck’s fair the partners’ capital statement.
value was P16,000. Sam, a builder,
contributed a new storage garage. His cost 10. In the liquidation of a partnership, it is
of construction was P40,000. The garage necessary to (1) distribute cash to the
has a fair value of P55,000. What is the partners, (2) sell noncash assets, (3)
combined total capital that would be allocate any gain or loss on realization to
recorded on the partnership books for the the partners, and (4) pay liabilities. These
two partners? steps should be performed in the following
a. P79,000. order:
b. P60,000. a. (2), (3), (4), (1).
c. P75,000. b. (2), (3), (1), (4).
d. P90,000. c. (3), (2), (1), (4).
d. (3), (2), (4), (1).
6. The NBC Company reports net income of
P60,000. If partners N, B, and C have an
income ratio of 50%, 30%, and 20%,
respectively, C’s share of the net income is:
a. P30,000.
b. P12,000.
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Chapter 6 | Accounting for Partnerships
Use the following account balance information balance of Kate Kildare and Leo Lemon are
for Creekville Partnership to answer questions P40,000 and P30,000, respectively,
11 and 12. Income ratios are 2 : 4 : 4 for Santiago’s capital balance following the
Harriet, Mike, and Elly, respectively. purchase is:
a. P22,000.
b. P35,000.
c. P20,000.
d. P15,000.

14. Capital balances in the MEM partnership

are Mary, Capital P60,000; Ellen, Capital
11. Assume that, as part of liquidation P50,000; and Mills, Capital P40,000, and
proceedings, Creekville sells its noncash income ratios are 5 : 3 : 2, respectively. The
assets for P85,000. The amount of cash MEMO partnership is formed by admitting
that would ultimately be distributed to Elly Oleg to the firm with a cash investment of
would be: P60,000 for a 25% capital interest. The
a. P52,000. bonus to be credited to Mills, Capital in
b. P48,000. admitting Oleg is:
c. P34,000. a. P10,000.
d. P86,000. b. P7,500.
c. P3,750.
12. Assume that, as part of liquidation d. P1,500.
proceedings, Creekville sells its noncash
assets for P60,000. As a result, one of the 15. Capital balances in the MURF partnership
partners has a capital defi ciency which that are Molly, Capital P50,000; Ursula, Capital
partner decides not to repay. The amount P40,000; Ray, Capital P30,000; and Fred,
of cash that would ultimately be distributed Capital P20,000, and income ratios are 4 :
to Elly would be: 3 : 2 : 1, respectively. Fred withdraws from
a. P52,000. the firm following payment of P29,000 in
b. P38,000. cash from the partnership. Ursula’s capital
c. P24,000. balance after recording the withdrawal of
d. P34,000. Fred is:
a. P36,000.
13. Louisa Santiago purchases 50% of Leo b. P37,000.
Lemon’s capital interest in the K & L c. P38,000.
partnership for P22,000. If the capital d. P40,000.

Problem 2 Comprehensive.
On January 1, 2020, the capital balances in Hollingsworth Company are Lois Holly P26,000, and Jim
Worth P24,000. In 2020 the partnership reports net income of P30,000. The income ratio provides for
salary allowances of P12,000 for Holly and P10,000 to Worth and the remainder equally. Neither partner
had any drawings in 2020.

Instructions
1. Prepare a schedule showing the distribution of net income in 2020.
2. Journalize the division of 2020 net income to the partners.

Problem 3 Identify characteristics of partnership.

Sarah David has prepared the following list of statements about partnerships.
1. ______ A partnership is an association of three or more persons to carry on as co-owners of a
business for profit.
2. ______ The legal requirements for forming a partnership can be quite burdensome.
3. ______ A partnership is not an entity for financial reporting purposes.
4. ______ The net income of a partnership is taxed as a separate entity.
5. ______ The act of any partner is binding on all other partners, even when partners perform business
acts beyond the scope of their authority.

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Chapter 6 | Accounting for Partnerships
6. ______ Each partner is personally and individually liable for all partnership liabilities.
7. ______ When a partnership is dissolved, the assets legally revert to the original contributor.
8. ______ In a limited partnership, one or more partners have unlimited liability and one or more partners
have limited liability for the debts of the firm.
9. ______ Mutual agency is a major advantage of the partnership form of business.

Instructions: Identify each statement as true or false. If false, indicate how to correct the statement.

Problem 4 Journalize entry for formation of a partnership.

Juan Hernandez has owned and operated a proprietorship for several years. On January 1, he decides
to terminate this business and become a partner in the firm of Hernandez and Cortez. Hernandez’s
investment in the partnership consists of P12,000 in cash, and the following assets of the proprietorship:
accounts receivable P14,000 less allowance for doubtful accounts of P2,000, and equipment P20,000
less accumulated depreciation of P4,000. It is agreed that the allowance for doubtful accounts should be
P3,000 for the partnership. The fair market value of the equipment is P13,500.

Instructions: Journalize Hernandez’s admission to the firm of Cortez and Hernandez.

Problem 5 Prepare journal entries to record allocation of net income.

O. Gomez (beginning capital, P60,000) and K. Guillermo (beginning capital P90,000) are partners. During
2020, the partnership earned net income of P70,000, and Gomez made drawings of P18,000 while
Guillermo made drawings of P24,000.

Instructions
a. Assume the partnership income-sharing agreement calls for income to be divided 45% to Gomez and
55% to Guillermo. Prepare the journal entry to record the allocation of net income.
b. Assume the partnership income-sharing agreement calls for income to be divided with a salary of
P30,000 to Gomez and P25,000 to Guillermo, with the remainder divided 45% to Gomez and 55% to
Guillermo. Prepare the journal entry to record the allocation of net income.
c. Assume the partnership income-sharing agreement calls for income to be divided with a salary of
P40,000 to Gomez and P35,000 to Guillermo, interest of 10% on beginning capital, and the remainder
divided 50%–50%. Prepare the journal entry to record the allocation of net income.
d. Compute the partners’ ending capital balances under the assumption in part (c).

Problem 6 Prepare entries for formation of a partnership and a balance sheet.

The post-closing trial balances of two proprietorships on January 1, 2020, are presented below.

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Chapter 6 | Accounting for Partnerships
 Patrick and Samuelson decide to form a partnership, Pasa Company, with the following agreed upon
valuations for noncash assets.

All cash will be transferred to the partnership, and the partnership will assume all the liabilities of the two
proprietorships. Further, it is agreed that Patrick will invest an additional P5,000 in cash, and Samuelson
will invest an additional P19,000 in cash.

Instructions
a. Prepare separate journal entries to record the transfer of each proprietorship’s assets and liabilities
to the partnership.
b. Journalize the additional cash investment by each partner.
c. Prepare a classified balance sheet for the partnership on January 1, 2020.

Problem 7 Journalize divisions of net income and prepare a partners’ capital statement.
At the end of its first year of operations on December 31, 2020, Caneru Company’s accounts show the
following.

Partner Drawings Capital

Risa Cam P23,000 P48,000
Pipoy Neri 14,000 30,000
Bea Ugalde 10,000 25,000

The capital balance represents each partner’s initial capital investment. Therefore, net income or net loss
for 2020 has not been closed to the partners’ capital accounts.

Instructions
a. Journalize the entry to record the division of net income for the year 2020 under each of the following
independent assumptions.
1. Net income is P30,000. Income is shared 6 : 3 : 1.
2. Net income is P37,000. Cam and Neri are given salary allowances of P15,000 and P10,000,
respectively. The remainder is shared equally.
3. Net income is P19,000. Each partner is allowed interest of 10% on beginning capital balances.
Cam is given a P12,000 salary allowance. The remainder is shared equally.
b. Prepare a schedule showing the division of net income under assumption (3) above.
c. Prepare a partners’ capital statement for the year under assumption (3) above.

7. References

Ballada, W. et al 2019. Basic Financial Accounting and Reporting. DomDane Publishers

Millan, Z. 2019. Intermediate Accounting. Bandolin Enterprises

Weygandt, J. et al 2019. Accounting Principles 13E. John Wiley & Sons, Inc.

ISUE__ __ Syl ___

Revision: 02
Effectivity: August 1, 2020
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Chapter 6 | Accounting for Partnerships