1.

0 Partnership Accounting

Partnership

Partnerships are a popular form of business because they are easy to form and because they allow several individuals to combine their talents and skills in a
particular business venture. In addition, partnerships provide a means of obtaining more capital than a single individual can obtain and allow the sharing of risks
for rapidly growing businesses. Partnerships are particularly common in the service professions, especially law, medicine and accounting.

Partner's Ledger Accounts

In a partnership, although it is possible to operate with one equity account for each partner, it is desirable that the following partner's accounts be maintained:

1) Capital accounts

2) Drawing or personal accounts

3) Account for loans to or from partners

Capital and Drawing accounts

The original investment of each partner is recorded by debiting the fair value of the assets invested, crediting the liabilities assumed by the firm and crediting the
partner's capital account for the net assets contributed. Subsequent to the original investments, transactions between the partnership and the partners will result
to changes in the respective partner's ownership interest. These changes are summarized in the respective partner's capital and drawing accounts.

A partner's equity is increased by the additional investment of cash or other property and by a share in the partnership profit. A partner's equity is decreased by
the withdrawal of cash or other assets and by a share in the partnership loss.

Normally, increases or decreases in capital that are interpreted as permanent capital changes are recorded directly in the capital account. Withdrawals, which
are considered equivalent to salaries, made by the partner in anticipation of profits and other increases or decreases of relatively minor amounts are recorded in
the drawing account. At the end of the accounting period, the debit and credit balances in the drawing account are then closed to the respective partner's capital
account. Also, during this period, the profit or loss as shown by the Income Summary account is distributed in accordance with the profit and loss sharing
agreement, The share of each partner in the profit or loss is recorded in their respective capital account. Individual partner's capital and drawing balances are
combined to reporting each partner's interest in the statement of financial position.

The Capital account is credited for:

a) Original Investment

b) Additional Investment

c) Partner's share in the profits

The Capital account is debited for:

a) Permanent withdrawal of capital

b) Debit balance of the drawing account at the end of the period

c) Partner's share in the losses

The Drawing account is credited for:

a) Partnership obligations assumed or paid by the partner

b) Personal funds or claims of partner collected and retained by the partnership

c) Periodic partner's salaries depending on the accounting and disbursement procedures agreed upon.

 
The Drawing account is debited for:

a) Withdrawal of assets by the partners in anticipation of net income

b) Partner's personal indebtedness paid or assumed by the partnership

c) Funds or claims of partnership collected and retained by the partner

Loan to and Loan from partners

A withdrawal by a partner of a substantial amount with the assumption of its repayment to the firm may be debited to a Receivable from partner account rather
than to the partner's drawing account. On the other hand, an advance to the partnership by a partner with the assumption of its ultimate repayment by the
partnership is viewed as a loan rather than as an increase in the capital account. This type of transaction is credited to the Loan's payable or Notes payable if the
loan is evidence by a note duly signed in the name of the partnership

1.1 Formation

Accounting for the Formation of a Partnership

A partnership maybe formed in several ways namely:

1. Formation of a partnership for the first time

2. Conversion of a sole proprietorship to a partnership

     a. A sole proprietor allows an individual, who has no business of his own to join his business.

     b. Two or more sole proprietors form a partnership

3. Admission of a new partner

Partnership formation for the First Time

Cash Investments

Initial cash investments in a partnership are recorded in the capital accounts maintained for each partner. For example Aldous and Baxia each invests P100,000
cash in a new partnership. The entry to record the investments would be:

Cash                   200,000

           Aldous, capital              100,000

           Baxia, capital                  100,000

Non-cash investments

When property other than cash is invested in a partnership, the non-cash property is recorded at the current fair value of the property at the time of the
investment. The fair value on non-cash asset is determined by agreement of the partners. The amounts involved should be specified in the written partnership
agreement.

1.2 Operation

Accounting for Partnership Operations

Net income is computed in the usual manner that is matching revenues and expenses then credited to the individual capital accounts. However, the treatment
becomes more complex because of the differences in capital contributions, abilities and talents of individual partners, and in time spent on partnership duties by
the individual partners,

Division of Profits and Losses

The partnership law provides that profits and losses of the partnership are to be divided in accordance with the partners agreement. If no agreement is made
between and among the partners, profits and losses are to be divided according to their original capital contributions. Should the partners agree to divide the
profits only, losses, if any are to be divided in the same manner as that of dividing profits. However, should the partners agree to divide losses only,  profits, if any
shall be divided by the partners according to capital contributions.
The ratio in which the partnership profits and losses are divided is known as the profit and loss ratio. The many possible methods of dividing net income or loss
among partners can be summarized as follows:

1. Equally

2. In an unequal or arbitrary ratio

3. In the ratio of partners capital account balances on a particular date, or in the ratio of average capital account balances during the year.

4. Allowing interest on partners' capital account balances and dividing the remaining net income or loss in a specified ratio.

5. Allowing salaries to partners and dividing the remaining net income or loss in a specified ratio

6. Bonus to managing partner based on net income.

1.3 Dissolution/Changes in ownership interest

Partnership Dissolution/Changes in Ownership Interest

A partnership rests upon a contractual foundation, therefore, the life span of a partnership may be somewhat uncertain since it depends on the moods and
relationships of the partners. Any circumstances which cause the technical termination of a partnership may lead to the the partnership's permanent dissolution
and liquidation, if the partners so agree, Dissolution and liquidation in relation to the partnership are not synonymous. A partnership is said to be dissolved when
the original association for the purposes of carrying on activities has ended. A partnership is said to be liquidated when the business is terminated. Thus, a
partnership may be dissolved without being liquidated. While dissolution may result to liquidation of a partnership, liquidation always results to dissolution.

Partnership dissolution due to changes in ownership interests occurs for variety of reasons. These can be summarized as follows:

1. Admission of a partner

2. Retirement of a partner

3. Death of a partner

4. Incorporation of a partnership

In most cases, when a change in ownership occurs, the market values of individual partnership assets and liabilities are different from their book values. These
differences can be accounted for by recording them on the partnership books either by adjusting the assets and liabilities - in may cases, by adjusting the
partners' capital accounts.

1.3.1 Admission of a new partner

Admission of a new partner

An existing partnership may admit a new partner with the consent of all the partners. When a new partner is admitted, the partnership is dissolved and a new
partnership is formed. Upon the admission of a new partner, a new agreement covering partners' interests, profit and loss sharing and other consideration should
be drawn because the dissolution of the original partnership cancel the original agreement.

The admission of a new partner may occur in either of two ways, namely:

1. Purchase of all or part of the interest of one or more of the existing partners.

2. Investment of assets in the partnership by the incoming partner.

1.3.1.1 By purchase of interest

Purchase of Interest from One or More Partners

One or more partners may sell their portion of the business to an outside party. This type of transaction is common in operations that rely primarily on monetary
capital rather than on the business expertise of the partners.

The partner in making the transfer of ownership can actually convey the following rights:

1. The right of co-ownership in the business property. This right justifies the partnership drawings from the business as well as the settlement paid at liquidation
or at the time of partners' withdrawal.

2. The right to share in profits and losses.

3. The right to participate in the management of the business.

When an incoming partner purchases a portion or all of the interests of one or more of the original partners, the partnership assets remain unchanged and no
cash or other assets flow from the new partner to the partnership. This transaction is recorded by opening a capital account for the new partner and decreasing
the capital accounts of the selling partners by the same amount. The cash paid by the buyer is not recorded in the books of the partnership for this is a personal
transaction between the selling partners and the buyer. The gain or loss arising from the sale of interest is not to be recorded in the partnership books.

1.3.1.2 By investment

New partner invests in partnership

A new partner may acquire interest in the partnership by investing in the business. In this case, the partnership receives the cash or other assets, thereby
increasing its total assets as well as the total capital. This method of admission is a transaction between the partnership and the incoming partner. Three cases
may exist when a new partner invests in partnership:

Case 1: The new partner's investment (contributed capital) equals the new partner's proportion of the partnership's book value (agreed value)

Case 2: The new partner's investment is more than the new partner's agreed capital. This indicates that the partnership's prior net assets are undervalued on the
books.

Case 3: The new partner's investment is less than the new partner's agreed capital. This suggests that the partnership's prior net assets are overvalued on its
books.

The following steps/procedures may be used in determining how to account for the admission of a new partner:

1. Compute the new partner's proportion of the partnership's book value (agreed capital) as follows:

Agreed capital = Prior capital of old partners  +  Investment of the new partner  X  % of capital to new partner

2. Compare the new partner's contributed capital with his or her agreed capital to determine the procedures to be followed in accounting for his or her admission.

Case 1: Investment = Agreed Capital

 No revaluation or bonus

Case 2: Investment cost > Agreed Capital

 Revalue net assets up to fair value and allocate to old partners.

 Allocate bonus to old partners.

Case 3: Investment cost < Agreed Capital

 Revalue net assets down to fair value and allocate to old partners.
 Assign bonus to new partner

3. Determine the specific admission method.

1.3.2 Withdrawal, retirement or death of a new partner

Withdrawal or Retirement of a partner

When a partner retires or withdraws from the partnership, the partnership is dissolved but the remaining partners may continue operating the business. The
existing partners may buy out the retiring partner either by making a direct acquisition or by having the partnership acquire the retiring partner's interest. If the
present partner directly acquire the retiring partner's interest, the only entry on the partnership's books is to record the transfer of capital from the retiring partner
to the remaining partner. If the partnership acquires the interest of the retiring partner, the partnership must pay the retiring partner an amount equal to his
interest, more than his interest or less than his interest.

The interest of the retiring partner is usually measured by his capital balance, increased or decreased by his share in the following adjustment:

1. Profit or loss from the partnership operations from the last closing date to the date of his/her retirement.

2. Changes in the valuation of all assets and liabilities (book values to fair values)

Death of a partner
In the event of the death of a partner, the estate of the deceased partner is entitled to receive the amount of his interest in the partnership at the date of his
death, The deceased partner's capital is adjusted using his profit and loss share percentage for changes in asset values arising from revaluation of assets and for
the profit from the date the books were last closed. The balance of his capital account after considering the necessary adjustments should be transferred to a
liability account pending settlement.

1.3.3 Incorporation of a Partnership

Incorporation of a Partnership

When a partnership is converted into a corporation, the corporation takes over the assets and assume the liabilities of the partnership in exchange for shares of
stocks. The stocks received by the partnership are distributed in settlement of their interest. The partners now become stockholders of the newly formed
corporation.

The accounting procedures in recording the incorporation of the partnership will depend on whether the original books of the partnership will be continued by the
corporation or new books will be opened.

Partnership Books Retained. If the partnership book are retained, the steps to be taken are as follows:

1. Revalue the assets

2. Close the partner's capital accounts to the corporate capital accounts

New Books Opened for the Corporation. If new books are to e opened, the old partnership books must be closed. The accounting procedures may be outlined as
follows:

In the books of the partnership:

1. Revalue the assets (and any other items agreed on) in accordance with the agreed transfer values.

2 Record the transfer of assets and liabilities to the corporation and the receipt of capital stocks by the partnership.

3. Record the distribution of stocks to the partners in settlement of the balances of their capital accounts.

1.4 Liquidation

Liquidation

The basic objectives of a partnership during the liquidation process are to convert the partnership assets to cash (called realization of assets), to pay off
partnership obligations and to distribute cash and any unrealized assets to the individual partners. The purpose of accounting during this period is to have an
equitable distribution of partnership cash to creditors and partners. Hence, it is no longer income determination that is the focus of accounting but rather, the
computation of gains or losses on realization of assets which are to be subsequently allocated among the partners, the payment of liabilities in accordance with
law and the final distribution of cash to partners.

There are certain rules that should be followed in the liquidation of the partnership namely:

1. Always allocate and close gains or losses to the partners' capital accounts prior to distribution any cash to partners.

2. When the business is liquidated, the partner is entitled to an amount depending upon his capital contribution, his drawing, his share in the net income or loss
from operations before liquidation, gains and losses on realization and the balance of his loan account, if any.

Each partner will receive in the final settlement the amount of his equity in the business, The amount of a partner's equity is increased by the positive factors
such as investment of capital and share in the profits. It is decreased by the negative factors such as withdrawals and share in the losses. If the negative factors
are greater than positive factors, the partners will have a deficiency (debit balance) and he must pay the partnership the amount of such deficiency, Failure to do
so would mean that his fellow partners would bear more than their contractual share in losses and they will consequently receive less than their equities in the
business.

As a general rule, the cash should be distributed as follows:

1. First, to outside creditors

2. Second, to partners for loan accounts.

3. Third, to partners for capital accounts.

A debit balance in the partner's capital account may be caused by losses incurred in the realization of assets or by prorata absorption of an uncollectible deficit of
a partner whose combined capital and loan accounts is not enough to absorb the partner's share of total losses.

Methods of Partnership Liquidation

When a partnership is to be liquidated by the sale os assets, the following methods may be used:

1. Lump-Sum Liquidation, otherwise called Total Liquidation or Single Distribution.

2. Installment Liquidation, otherwise called Installment Distribution.

1.4.1 Lump-sum method

Lump-sum Liquidation

A lump-sum liquidation of a partnership is one in which all the assets are converted into cash within a very short time, outside creditors are paid, and single lump-
sum payment is made to the partners for their total interests.

Realization of Assets. Typically a partnership will experience losses on the sale of its assets. A partnership may have a "Going Out of Business" sale in which its
inventory is marked down well below normal selling price to encourage immediate sale. The partnership's fixed assets may also be offered at a reduced price.
The accounts receivable are actually collected by the partnership. Sometimes the partnership offers a large cash discount for prompt payment of any remaining
receivables whose collection may otherwise delay the termination of the partnership. Alternatively, the receivables may be sold to a factor. A factor is a business
that specializes in acquiring accounts receivables and immediately paying cash to the seller of the receivables. The partnership records the sale of the
receivables, as it would any other asset.

Before any distribution may be made to the partners, either liabilities to outside creditors must be paid in full or the necessary funds may be placed in an escrow
account. The escrow agent, usually a bank, uses the funds only for payment of the partnership liabilities.

Expenses of Liquidation. During the liquidation process, expenses are usually incurred, such as legal and accounting expenses and advertising cost of selling the
assets. These expenses are allocated to partners' capital accounts in their profit and loss ratio.

Liquidation Procedures. The following procedure may be used in lump-sum liquidation.

1. Realization of assets and distribution of gain or loss on realization among the partners based on the profit and loss ratio.

2. Payment of expenses

3. Payment of liabilities

4. Elimination of partner's capital deficiencies. If after the distribution of loss on realization, a partner incurs a capital deficiency (i.e. partner's share of realization
loss exceeds his capital credit) this deficiency must be eliminated by using one of the following methods, in order of priority.

    a. If the deficient partner has a loan balance, exercise the right of offset,

    b. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.

    c. If the deficient partner is insolvent, let the other partners absorb his deficiency

5. Payment to partners (in order of priority)

     a. Loan accounts

     b. Capital accounts

1.4.2 Installment method

Installment Liquidation

Involves the selling of some assets, paying liabilities of the partnership, dividing the available cash to the partners, selling additional assets and making further
payments to partners. This process continues until all the assets have been sold and all cash has been distributed to the creditors and to partners.

Procedures for Liquidation by Installment

The following are the accounting procedures that may be followed in liquidating a partnership by installments.

1. Record the realization of assets and distribute the realized gains or losses among the partners using profit and loss ratio.

2. Pay liquidation expense and unrecorded liabilities, if there are any and distribute these among the partners using the profit and loss ratio.

3. Pay the liabilities to outsiders.

4, Distribute cash to partners after possible future losses have been apportioned to partners or in accordance with a cash distribution program.
*Eliminate any capital deficiency only before final payments to partners.

Periodic Computation of Safe Payments to partners

The Statement of partnership liquidation is usually supported by a schedule of safe installment payments to partners, simply called Schedule of Safe Payments,
prepared periodically. According to the schedule, each installment of cash is distributed as if no more cash is forthcoming, either from sale of assets or from
collection of deficiencies from partners. Cash is therefore, distributed to a partner only if he has an excess credit balance in his partnership interest (i.e. capital
account or capital and loan account combined) after absorption of his share of the maximum possible loss that may occur. The possible loss (hypothetical loss)
consists of the following:

1. Total value of remaining non-cash assets. These assets are assumed unrealizable (they cannot be sold), hence, they are considered loss chargeable to the
partners.

2. Cash withheld to pay for anticipated liquidation expenses and unrecorded liabilities that may arise. The said expenses and liabilities represent possible loss to
the partners because upon their payment, the amount paid is to be correspondingly absorbed by the partners.

Additional loss may also accrue to the partners when a debit balance in any of the capital accounts results from the foregoing allocations of possible loss. The
deficiency of any of the partners is absorbed by the other partners as additional possible loss to them because he is presumed unable to pay anything to the firm.

Cash Withheld

The cash set aside in a separate fund is not a factor in computing possible loss. It is the cash set aside to insure payments of potential liquidation expenses,
which may be incurred and unrecorded liabilities may be discovered. This cash withheld is added to the total remaining non-cash assets to obtain the maximum
possible loss needed in the computation of safe installment payment. Also cash available for distribution to the partners for the period is net of the cash withheld.

Unrecorded liabilities are obligations which are discovered or incurred during the liquidation. These are allocable to the partners according to their profit and loss
sharing agreement.

Summary: Module 1

Capital interest vs. Profit and Loss Interest

Capital Interest is a claim against the net assets of the partnership as shown by the balance in the partner’s capital account, while Interest in Profit or
Loss determines how the partner’s capital interest will increase or decrease as a result of subsequent operations.

Assignment of an interest to a Third Party

A. Revaluation Approach

--- The use of fair values provides an equitable measure of each partner’s capital interest in the partnership.

--- Basis of valuation is fair value

--- Results in a marked departure from the historical principle

B. Absence of Revaluation

--- This approach would retain the historical cost/changing value (BOOK VALUE APPROACH).

Admission of a New Partner

1. Admission by Purchase Interest

Case 1: Purchase of interest for one partner

A, Capital       xx

        B, Capital                xx

Case 2: Purchase of interest from all partners

 
Assumption 1 Purchase at Book Value

Assumption 2 Purchase at more than Book Value

        
         Alternative 1: BOOK VALUE APPROACH

          Amount paid                                       xx

          Less: BV of interest acquires    xx

          Excess                                                    xx
          

          Alternative 2: REVALUATION APPROACH

                   Goodwill          xx

                       A, Capital               xx

                       B, Capital                xx

        

                Amount paid  -------------------------- xx

                Less: BV interest Acquired ---------(xx)

                Excess ---------------------------------- xx

                Divided by: Interest Acquired ------xx

                Revaluation of Asset Upward ------xx

                                              
A, Capital (old+goodwill*interest acquires)    xx

B, Capital (old+goodwill*interest acquires)    xx

                         F, Capital                                                                   xx

Assumption 3: Purchase at less than Book Value

In Book Value approach, same format but it is a loss, while, in Revaluation approach, same format but it is downward.

 Prefer Book Value if Profit and Loss interest > capital interest, otherwise, use revaluation approach.

2. Admission by Investment

Any gain or loss are recognized on sales subsequent to recording the admission will be allocated on the basis of the new profit and loss ratio.

TCC=TAC- No Adjustment

TCC>TAC- overstatement of the asset or diminution in partner’s capital

TCC<TAC- unrecorded net assets or the required additional investment in partner’s capital

CC=AC- No transfer of capital

CC>AC- Capital transfer or bonus to old partners

CC<AC- Additional Capital credit (either bonus or goodwill) from the old partners.

TOTAL AGREED CAPITAL                                              XX

LESS: TOTAL CONTRIBUTED CAPITAL                 XX

DIFFERENCE                                                                         XX                    

In bonus, if there’s a revaluation of assets, they cannot recognized. But if revaluation method is used, they affected the partner’s capital account.

In the absence of approach to be used, bonus approach should applied.

Incorporation of a Partnership

Partnership books are retained

1. Change in assets and liability values in the partner’s interest prior to corporation
2. The change in the form of proprietorship. A revaluation account may be debited to losses and credited with gains from revaluation, and the balance
may subsequently be closed into the capital accounts in the Profit and Loss Ratio.

New books for the corporation.

In accounting record of partnership

1. Prepare J.E. for revaluation of assets, including recognition of goodwill.

2. Record any cash withdrawal necessary to adjust parties capital account balances to round amounts
3. Record the transfer of assets and liabilities to the corporation, the receipt of the corporation’s common stock by partnership, and the distribution of
the common stock to the partners in settlement of the balances of their capital accounts.

In the accounting records of the corporation

1. Record the acquisition of assets and liabilities from the partnership at current fair values.
2. Record the issuance of common stock at current fair value in payment of the obligation to the partnership.

Partnership Liquidation

The phase of partnership operations which begins after dissolution and ends with the termination of a partnership activities referred to as "winding up the affairs."

Basic Procedures in Liquidation

Procedures for minimizing inequities among partners.

1. Sharing Gains and Losses. When a partnership is liquidated, the books should be adjusted and have closed the net profit or loss for the period in the
manner they have agreed in the partnership agreement.
2. Advance planning when the partnership is formed.
3. Rules on setoff- Partnership Loans (Receivable) to the partners
4. Rules on set off- Partner (Payable) loans to the partnership—depends upon the situation.

-Legal doctrine of setoff- whereby a deficit balance in partner’s capital account may be set off against any balance existing in his/her loan account.

5. Liquidation expenses. Certain cost incurred during the liquidation process should be treated as a reduction of the proceeds from the sale of non-cash
asset. Other liquidation costs should be treated as expenses.
6. Marshalling of assets. This doctrine is applied when the partnership and/or one or more of the partners are insolvent.
7. Distribution of cash or other assets to partners.

Lump-sum Liquidation

Is one in which all assets are converted into cash within a very short time, creditors are paid, and a single, lump-sum payment is made the partner’s for their
capital interest.

1. Realization and distribution of gain or loss to all partners on the basis of profit and loss ratio.
2. Payment of liquidation expenses, if any.
3. Payment of liabilities to third parties.
4. Elimination of capital deficiencies.
5. Payment to partners(in order)

a. loan accounts

b. capital accounts

Installment Liquidation

Is a process of realizing some assets, paying creditors, paying the remaining available cash to partners, realizing additional assets, and making additional cash
payment to partners.

A. Schedule of Safe Payments

     A.1. Assume total loss on all remaining non-cash assets. Provide all possible losses, including potential liquidation cost and unrecorded liabilities.

Possible Loss= amount of unrealized non-cash assets + amount of cash withheld (i.e. unrecorded unpaid expenses, and anticipated liquidation expenses)

    A.2. Assume that partners with a potential capital deficit will be unable to pay anything to the partnership (assume to be personally insolvent)    

 Hypothetical or assumed deficit balance is allocated to the partners who have credit balances using profit and loss ratio. This portion is the maximum
potential loss on non-cash assets.
 Any capital deficiencies that may result in other partners as a result of a maximum loss on non-cash assets.

 Schedule of Safe Payments is effective method of computing the amount of safe payments to partners and preventing excessive payments on any
partners.
 It is inefficient, if numerous installment distributions are made to partners.
 It is deficient as a planning device because it does provide information, but it can be overcome by preparing cash distribution plan at the start of the
liquidation process.

B. Cash Priority Program

1. Ranking the Partners

2. Total interest(equity) account=balance of the capital account + loan receivable(-)/loan payable (+) to the partner
3. Loss Absorption Power/Abilities/Potential/Maximum Loss Absorbable= Total interest account/Profit and Loss assigned ratio

   Vulnerability Rankings

Lowest absorption abilities is the most vulnerable to partnership losses.

   Limitation of Cash Priority Program

1. The program is operable only after outside creditors have been paid in full.
2. Reflects only the order in which cash distribution to partners will be made if cash is available to distribute
3. The sequence of distribution of cash in the program coincides with the sequence that would result if cash were distributed using the schedule of safe
payments