Competency Appraisal

Advanced Financial Accounting and Reporting (AFAR)

Partnership Accounting
March 4, 2023

Based on BOA Syllabi effective October 2022

1. Nature, scope and objectives

1.1 Describe the nature, scope and objectives of partnership accounting and conceptually differentiate it
from sole proprietorship and corporation accounting.
1.2 Describe the concepts, principles, rules, practices, and procedures applicable in partnership
accounting.
2. Formation of Partnership
2.1 Compute and account for the initial capital contribution of the partners in the partnership.
3. Operation
4. Dissolutions and/or changes in ownership interest
Compute, account and allocate the changes in the capital balances of the partners as a result of:
4.1 Admission of a new partner
4.1.1 By purchase of interest
4.1.2 By investment
4.2 By withdrawal, retirement, or death of a partner
4.3 Incorporation of a partnership
5. Liquidation of Partnership
Compute the amount of settlement to the partners after liquidating the partnership under:
5.1 Lump-sum liquidation
5.2 Installment method
 Definition
In a 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 profit among themselves.
Two or more persons may also form a partnership for the exercise of a profession (Civil Code of the
Philippines, Article 1767).
An association of two or more persons to carry on, as co-owners, a business for profit (Uniform
Partnership Act, Section 6).
The partnership has a juridical personality separate and distinct from that of each partners.
(Civil Code of the Philippines, Article 1768).
Each owner in a partnership is called a partner.

Characteristics of Partnership

1. Mutual Contribution. There cannot be a partnership without contribution of money, property or industry
(i.e. work or services which may either be personal manual efforts or intellectual) to a common fund.
2. Division of Profits or Losses. The essence of partnership is that each partner must share in the profits or
losses of the venture.
3. Co-Ownership of Contributed Assets. All assets contributed into the partnership are owned by the
partnership by virtue of its separate and distinct juridical personality.
4. Mutual Agency. Any partner can bind the other partners to a contract if he is acting within his express or
implied authority.
5. Limited Life. A partnership has a limited life. It may be dissolved by the admission, death, insolvency,
incapacity, withdrawal of a partner or expiration of the term specified in the partnership agreement.
6. Unlimited Liability. All partners (except limited partners), including industrial partners are personally
liable for all debts incurred by the partnership. If the partnership can not settle its obligations, creditors’
claims will be satisfied from the personal assets of the partners without prejudice to the rights of the
separate creditors of the partners.
7. Income Taxes. Partnerships, except general professional partnerships, are subject to tax at the rate of 30%
(per R.A. No. 9337) of taxable income.
8. Partners’ Equity Accounts. Accounting for partnerships are much like accounting for sole
proprietorships. The difference lies in the number of partners’ equity accounts. Each partner has a capital
account and a withdrawal account that serves similar functions as the related accounts for sole
proprietorships.

Advantages of Partnerships Versus Sole Proprietorships

1. Brings greater financial capability to the business.
2. Combines special skills, expertise and experience of the partners.
3. Offers relative freedom and flexibility of action in decision-making.
Advantages of Partnerships Versus Corporations
1. Easier and less expensive to organize.
2. More personal and informal.

Disadvantages of Partnerships
1. Easily dissolved and thus unstable compared to a corporation.
2. Mutual agency and unlimited liability may create personal obligations to partners.
3. Less effective than a corporation in raising large amounts of capital.

Partnership Distinguished from Corporation

1. Manner of Creation. A partnership is created by mere agreement of the partners while a corporation is
created by operation of law.
2. Number of Persons. Two or more persons may form a partnership; in a corporation, at least five (5)
persons, not exceeding fifteen (15).
3. Commencement of Juridical Personality. In a partnership, juridical personality commences from the
execution of the articles of partnership; in a corporation, from the issuance of certificate of incorporation
by the Securities and Exchange Commission.
4. Management. In a partnership, every partner is an agent of the partnership if the partners did not appoint a
managing partner; in a corporation, management is vested on the Board of Directors.
5. Extent of Liability. In a partnership, each of the partners except a limited partner is liable to the extent of
his personal assets; in a corporation, stockholders are liable only to the extent of their interest or
investment in the corporation.
6. Right of Succession. In a partnership, there is no right of succession, in a corporation, there is right of
succession. A corporation has the capacity of continued existence regardless of the death, withdrawal,
insolvency or incapacity of its directors or stockholders.
7. Terms of Existence. In a partnership, for any period of time stipulated by the partners; in a corporation,
not to exceed fifty (50) years but subject to extension.

Classifications of Partnerships

A. According to Object:
1. Universal partnership of all present property. All contributions become part of the partnership
fund.
2. 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 be considered a universal partnership of profits.
3. Particular partnership. The object of the partnership is determinate – its use or fruit; specific
undertaking, or the exercise of a profession or vocation.
B. According to Liability:
1. General. All partners are liable to the extent of their separate properties.
2. 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.

C. According to Duration:
1. Partnership with a fixed term or for a particular undertaking.
2. Partnership at will. One in which no term is specified and is not formed for any particular
undertaking.
D. According to Purpose:
1. Commercial or trading partnership. One formed for the transaction of business.
2. Professional or non-trading partnership. One formed for the exercise of profession.
E. According to Legality of Existence:
1. De jure partnership. One which has complied with all the legal requirements for its establish.
2. 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 though may be
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 a partner by outside
parties.
10. Nominal Partner or Partner by Estoppel. One who is actually not a partner but who represents himself
as one.

Articles of Partnership
A partnership may be constituted orally or in writing. In the latter case, partnership
agreements are embodied in the Articles of Partnership. The following essential provisions may be
contained in the agreement:

1. The partnership name, nature, purpose and location;

2. The names, citizenship and residences of the partners;
3. The date of formation and duration of the partnership;
4. The capital contribution of each partner, the procedure for valuing non-cash investments, treatment of
excess contribution (as capital or as loan) and the penalties for a partner’s failure to invest and maintain
the agreed capital;
5. The rights and duties of each partner;
6. The accounting period to be adopted, the nature of accounting records, financial statements and
audits by independent public accountants;
7. The method of sharing profit or loss, frequency of income measurement and distribution, including any
provisions for the recognition of differences in contributions;
8. The drawings or salaries to be allowed to partners;
9. The provision for arbitration of disputes, dissolution, and liquidation.

A contract of partnership is void whenever immovable property or real rights are contributed and
a signed inventory of the said property is not made and attached to a public instrument.

Accounting for Partnerships

Generally Accepted Accounting Principles were discussed in Basic Accounting in the

context of sole proprietorship. These accounting principles also apply to a partnership. Thus, the
recording of assets, liabilities, income and expenses is consistent for both sole proprietorships
and partnerships.
Briefly, the following are the Fundamental Concepts
1. Entity Concept. An accounting entity is an organization or section of an organization that stands
apart from other organizations and individuals as a separate economic unit. Simply put, the
transactions of different entities should not be accounted for together. Each entity should
be evaluated separately.
2. Periodicity Concept. An entity’s life can be meaningfully subdivided into equal time periods for
reporting purposes. This concept allows the users to obtain timely information to serve as a basis on
making decisions about future activities. For the purpose of reporting to outsiders, one year is the
usual accounting period.
3. Stable Monetary Unit Concept. The Philippine peso is a reasonable unit of measure and that its
purchasing power is relatively stable.
4. Going Concern. Financial statements are normally prepared on the assumption that the reporting
entity is a going concern and will continue in operation for the foreseeable future.

Basic Principles
1. Objectivity Principle. Accounting records and statements are based on the most reliable data
available so that they will be as accurate and as useful as possible. Reliable data are verifiable when
they can be confirmed by independent observers.
2. Historical Cost. This principle states that acquired assets should be recorded at their actual cost and
not at what management thinks they are worth as at reporting date.
3. Revenue Recognition Principle. Revenue is to be recognized in the accounting period when goods
are delivered or services are rendered or performed.
4. Expense Recognition Principle. Expenses should be recognized in the accounting period in
which goods and services are used up to produce revenue and not when the entity pays for those goods
and services.
5. Adequate Disclosure. Requires that all relevant information that would affect the user’s
understanding and assessment of the accounting entity be disclosed in the financial statements.
6. Materiality. Financial reporting is only concerned with the information that is significant enough to
affect evaluations and decisions. Materiality depends on the size and nature of the item judged in the
particular circumstances of its omission. In deciding whether an item or an aggregate of items is
material, the nature and size of the item are evaluated together.
7. Consistency Principle. The firms should use the same accounting method from period to period to
achieve comparability over time within a single enterprise. However, changes are permitted if
justifiable and disclosed in the financial statements.

However, differences arise between the two forms of business concerning owners’ equity. For a
sole proprietorship, 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.

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.
 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.

Profit (or loss) is credited (or debited) to the capital account.

On September 6, 2007, the International Accounting Standards Board (IASB) issued a revised
International Accounting Standards (IAS) No. 1, Presentation of Financial Statements. This
standard supersedes the 2003 version of IAS 1 as amended in 2005. It’s common to encounter
“profit or loss” rather than usual “net income or net loss” as the descriptive term used in the
Statement of Comprehensive Income (the new title of the income statement per revised IAS No.
1). The balance sheet is called the Statement of Financial Position.

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 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.

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 by 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.
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 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.

(Partnership Dissolution)
March 4, 2023

Rules for the distribution of profits:

1) The profits will be divided according to partners’ agreement.

2) If there is no agreement:
a) As to capitalist partners, the profit shall be divided according to their capital contributions
(according to the ratio of original capital investments or in its absence, the ratio of capital balances at
the beginning of the year).

b) As to industrial partner (if any), such share as may be just and equitable under the
circumstances, provided that the industrial partner shall receive such share before the capitalist partners
shall divide the profits.

Rules for the distribution of losses:

1) The losses will be divided according to partners’ agreement.

2) If there is no agreement as to the distribution of losses but there is an agreement as to profits, the
losses shall be distributed according to the profit-sharing ratio.
3) In the absence of any agreement:
a) As to capitalist partners, the losses shall be divided according to their capital contributions
(according to the ratio of original capital investments or in its absence, the ratio of capital balances at
the beginning of the year).
 b) As to purely industrial partner (if there’s any), shall not be liable for any losses.

The industrial partner is not liable for losses because he cannot withdraw the work or labor
already done by him, unlike the capitalist partners who can withdraw their capital.

IMPORTANT NOTES:

1) In the absence of an agreement, salary allowances will be provided, even when operations yielded
losses.
2) A partnership contract may provide for a special compensation in the form of bonus to the managing
partner when the results of operations of the partnership are favorable.
3) If the partnership agreement provided for interest on capital accounts, this provision must be
honored regardless of whether operations yielded profit or not.
Problem 1
On April 30, 2022, Aira, Angelica and Angeline formed a partnership by combining their separate
business proprietorships. Aira contributed cash of P50,000. Angelica contributed property with a
P36,000 carrying amount, a P40,000 original cost, and P80,000 fair value. The partnership accepted
responsibility for the P35,000 mortgaged attached to the property. Angeline contributed equipment
with a P30,000 carrying amount, a P75,000 original cost, and P55,000 fair value. The partnership
agreement specifies that profits and losses are to be shared equally but is silent regarding capital
contributions. Which partner has the largest capital account balance at April 30, 2022?
A. Aira
B. Angelica
C. Angeline
D. All capital balances are equal.
Problem 2
Christian, Diana and Ericka formed a partnership. Christian will contribute cash of P50,000 and his
store equipment that originally cost P60,000 with a second-hand value of P25,000. Diana will
contribute P80,000 in cash. Ericka, whose family sells computers, will contribute P25,000 cash and a
brandnew computer that cost his family’s computer dealership P50,000 but with a regular selling price
of P60,000. They agreed to share profits and losses equally. Upon formation, what are the capital
balances of the partners?
Christian Diana Ericka
a. 75,000 80,000 85,000
b. 80,000 80,000 80,000
c. 88,333 88,333 88,334
d. 110,000 80,000 75,000
Problem 3
On January 1, 2023, James and Jay agreed to form a partnership contributing their respective
assets and equities subject to adjustments. On that date, the following were provided:
James Jay
Cash 28,000 62,000
Accounts Receivable 200,000 600,000
Inventories 120,000 200,000
Land 600,000
Building 500,000
Furniture and Fixtures 50,000 35,000
Intangible Assets 2,000 3,000
Accounts Payable 180,000 250,000
Other Liabilities 200,000 350,000
Capital 620,000 800,000

The following adjustments were agreed upon:

a. Accounts receivable of P20,000 and P40,000 are uncollectible in James and Jay’s respective books.
b. Inventories of P6,000 and P7,000 are worthless in James and Jay’s respective books.
c. Intangible assets are to be written off in both books.

What will be the capital balances of the partners after adjustments?

 James Jay
a. 592,000 750,000
b. 600,000 700,000
c. 592,000 756,300
d. 600,000 750,000
Problem 4
Mary admits Jane as a partner in the business. Balance sheet accounts of Mary just before the
admission of Jane show: Cash – P26,000; Accounts Receivable – P120,000; Merchandise Inventory –
P180,000; and Accounts Payable – P62,000. It was agreed that for purposes of establishing Mary’s
interest, the following adjustments be made: 1) an allowance for doubtful accounts of 3% of
accounts receivable is to be established; 2) merchandise inventory is to be adjusted upward by
P25,000; and 3) prepaid expenses of P3,600 and accrued liabilities of P4,000 are to be recognized.

If Jane is to invest sufficient cash to obtain 2/5 interest in the partnership, how much would Jane
contribute to the new partnership?
a. 176,000
b. 190,000
c. 95,000
d. 113,980
Problem 5
A, B, and C decided to form ABC Partnership. It was agreed that A will contribute an
equipment with assessed value of P100,000 with historical cost of P800,000 and accumulated
depreciation of P600,000. B will contribute a land and building with book value of P1,200,000 and fair
market value of P1,500,000. The land and building is subject to a mortgage payable amounting to
P300,000 to be assumed by the partnership.
The partners agreed that B will have 60% capital interest in the partnership. They agreed that
C will contribute sufficient cash to the partnership. A day after the partnership formation, the
equipment was sold for P300,000.
A. What is the total agreed capitalization of the ABC Partnership?
a. 1,500,000
b. 2,000,000
c. 2,500,000
d. 3,000,000
B. What is the capital credit of A in the ABC Partnership after the formation?
a. 100,000
b. 200,000
c. 300,000
d. 400,000
C. What is the capital credit of B in the ABC Partnership after the formation?
a. 900,000
b. 1,500,000
c. 1,400,000
d. 1,200,000

D. What is the cash to be contributed by C in the ABC Partnership?

a. 500,000
b. 600,000
 c. 700,000
d. 800,000

(Partnership’s Operations)

Problem 1
In the calendar year 2022, the partnership of Arquero and Langit realized a net profit of
P240,000. The capital accounts of the partners show the following postings:

Arquero, Capital Langit, Capital

Debit Credit Debit Credit
January 1 P 120,000 P 80,000
May 1 P 20,000 P 10,000
July 1 20,000
August 1 10,000
October 1 10,000 5,000

If the profits are to be divided, how much will Arquero and Langit received based on the
capital balances ratio:
a. ratio of capital balances at the beginning of the year;
b. ratio of capital balances at the end of the year;
c. ratio of average capital balances.

Problem 2
Perado and Mapalo formed a partnership in 2022. The partnership agreement provides for
annual salary allowances of P55,000 for Perado and P45,000 for Mapalo. The partners share
profits equally and losses in a 60:40 ratio. The partnership had earnings of P80,000 for 2022
before any allowance to partners.

What amount of these earnings should be credited to each partner’s capital account?

Problem 3
Ambrocio, Hilar and Millares are partners with average capital balances during 2022 of
P120,000, P60,000 and P40,000, respectively. Partners receive 10% interest on their average
capital balances. After deducting salaries of P30,000 to Ambrocio, and P20,000 to Millares,
the residual profit and loss is divided equally. In 2022, the partnership sustained a P33,000
loss before interest and salaries to partners. By what amount should Ambrocio’s capital
account change?

Problem 4
If a partnership has net income of P44,000 and Partner Gabriel is to be allocated a bonus of
10% of income after the bonus. What is the amount of bonus Partner Gabriel will receive?
Problem 5
Partners Ellamil and Vinluan have profit and loss agreement with the following provisions:
salaries of P30,000 and P45,000 for Ellamil and Vinluan, respectively; a bonus to Ellamil of
10% of net income after salaries and bonus; and interest of 10% on average capital balances
of P20,000 and P35.000 for Ellamil and Vinluan, respectively. One-third of any remaining
profits will be allocated to Ellamil and the balance to Vinluan.

1) If the partnership had a net income of P22,000, how much should be allocated to Ellamil
and Vinluan, assuming that the provisions of the profit and loss agreement are ranked by
order of priority starting with salaries?
2) If the partnership had a net income of P200,000, how much should be allocated to Ellamil
and Vinluan?
3) If the partnership had a net loss of P22,000, how much should be allocated to Ellamil and
Vinluan?

Problem 6
On October 31, 2022, Manlongat and Siapno formed a partnership by investing cash of
P300,000 and P200,000, respectively. The partners agreed to receive an annual salary
allowance of P360,000, and to give Manlongat a bonus of 20% of the net income after
partners’ salaries.
If the profits after salaries and bonus are divided equally, the profits on December 31, 2022
after partners’ salaries but before bonus of Manlongat isP360,000, how much is the share of
Manlongat in the profit?

Problem 7
Evangelista is trying to decide whether to accept a salary of P40,000 or salary of P25,000
plus a bonus of 10% of net income after salaries and bonus as a means of allocating profit
among partners. Salaries traceable to the other partners are estimated to be P100,000. What
amount of income would be necessary so that Evangelista would consider choices to be
equal?

Problem 8
Distor, Pit and Vino are capitalist partners and Bergonia, an industrial partner. The
partnership reported a net loss of P100,000. How much is the share of Bergonia in the
reported net loss?