A. Partnership Formation And Dissolution.docx

ADVANCED FINANCIAL REPORTING: ACCOUNTING FOR PARTNERSHIP DEFINITION OF PARTNERSHIP -A contract where two or more persons bind themselves to contribute money, property or industry to a common fund with the intention of dividing profits among themselves. Two or more persons may also form a partnership for the practice of profession or what we call GENERAL PROFESSIONAL PARTNERSHIP (Art. 1767, Civil Code of the Philippines)

CHARACTERISTICS OF A PARTNERSHIP Some characteristics of a partnership that distinguish it from other forms of business organization (Sole and Corporation) are the following:  

 

Voluntary Association A partnership is created by voluntary agreement of individual rather than operation of law. Limited life Partnership is created by a contract and anything that ends the contract of the partnership dissolves it (admission of new partner, withdrawal, death/retirement, liquidation). Unlimited Liability A partner’s liability extends beyond his/her capital contribution (except limited partners). Mutual Agency Each partner is an agent of the partnership within the scope of the business.

PARTNERSHIP AS DISTINGUISHED FROM CORPORATION 1. Manner of Creation 2.

No. of persons

3.

Commencement of Juridical Personality

4.

Management

5.

Extent of Liability

6.

Right of Succession

7.

Terms of Existence

P- mere agreement of the partners C- created by operation of law P- 2 or more C- at least 5 persons, not exceeding 15 P-execution of articles of “P” C- issuance of certificate of incorporation by SEC P- every partner is an agent of the “P” if no managing partner was appointed C- Management is vested in the Board of directors P- up to personal assets excluding limited partner C-only up to extent of interest and investment P- no right of succession (One partner died, the “P” will dissolve) C- there is right of succession, it will continue even if one died P- based on contract agreed C- 50 years subject to extension

CLASSIFICATION OF PARTNERSHIP 1. According to Liability a. General – up to separate assets b. Limited – up to contribution 2. According to Duration a. W/ fixed term b. Partnership at will – no term specified 3. According to Purpose a. Commercial/trading – for business transaction b. Professional/non-trading – exercise of profession 4. According to Legality a. De jure – complied all legal requirements b. De facto – failed to comply all legal requirements 5. According to Subject a. Universal “P” of all present properties – all contribution becomes part of the “P” fund b. Universal “P” of all profits – if the problem is silent it is assumed to be letter B KINDS OF PARTNERS 1. General partner 2. Limited Partner 3. Capitalist 4. Industrial 5. Managing partner 6. Liquidating 7. Dormant 8. Silent 9. Secret 10. Nominal or partner by estoffel EQUITY THEORIES IN PARTNERSHIP 1. 2.

ENTITY THEORY holds that the business is separate and distinct from the owners of the business. The business is the entity. PROPRIETARY THEORY holds that the owners are the entity

PROPRIETARY The entity is viewed as the individual owners Salaries to partners are distributions of income (not expenses) Unlimited liability extends to personal assets of owners Original partnership is dissolved with the admission or withdrawal of a partner

ENTITY The business unit is separate and distinct from its owners Partnership enters contracts in its own name Partnership give up title to their contribution

ACCOUNTING FORMATION Partnership may be formed in several ways: a. Formation of the partnership for the first time b. Conversion of sole proprietorship to a partnership c. Admission of a new partner ACCOUNTING FOR PARTNERSHIP FORMATION Cash investments – recorded at face value as far as cash valuation is concerned (agreed value) Non-cash investment – agreed value or FV or the price at which assets and liabilities can be exchanged in an arm length transactions between knowledgeable, unrelated, willing parties (IFRS 3). In case there is conflict between agreed value and FV, the former prevails. Liabilities – PV or remaining cash flows Services – memo entry

VALUATION OF INVETSMENTS 1. Bonus approach – retains historical cost 2. Revaluation approach – depart from HC, non-GAAP believed not in accordance with substance over form (GW Method) ILLUSTRATION 1: TWO NEW INDIVIDUAL FORM A PARTNERSHIP (FIRST TIMERS)

On July 1 2016, Pholdz and JC agreed to form a partnership. The partnership agreement specified that Pholdz is to invest cash of 50,000 and JC is to contribute land with FMV of P100,000 with 20,000 mortgage liability in the bank to be assumed by the partnership. ILLUSTRATION 2: SOLE PROPRIETORSHIP TO PARTNERSHIP Assume that AA and BS form a partnership. AA has been operating a business that is to be carried on by the new partnership. B is to invest cash of P250,000 and equipment with a fair value of 125,000 encumbered by a mortgage note payable of P25,000. Just before the partnership is formed, a statement of financial position is drawn up for AA’s business as follows: AA Statement of Financial Position As of January 31, 2016 Assets Cash Trade Receivables Less: Allowance for Bad debts Inventory Other current assets Equipment Less: Accum. Depreciation Total Assets

162,000 200,000 12, 000

120,000 56,000

188,000 214,000 16,000

Liabilities and Capital Trade and other payables AA’s Capital Total Liabilities and Capital

240,000 404,000 644,000

64,000 644,000

The following adjustments must be made in establishing AA’s interest. a. Trade receivable - Doubtful accounts of 10,000 are to be written off; a 4% allowance for doubtful accounts is to be recognized on the remaining accounts. b. Inventory- this should be written up to P266,000 fair value c. Equipment- This is over depreciated by P11,000 d. Accrued expenses of P10,000 was unrecorded (credit to this trade and other payables) Prepare the adjusting entries and financial position of the partnership  AA’s books will be used as the partnership books  New partnership books will be used

AA and BS PARTNERSHIP Statement of Financial Position As of January 31, 2016 Assets Cash Trade Receivables Less: Allowance for Bad debts Inventory Other current assets Equipment Total Assets

412,000 190,000 7, 600

182,400 266,000 16,000 200,000 1,076,400

Liabilities and Capital Trade and other payables Mortgage Payable AA, Capital BS, Capital Total Liabilities and Capital

250,000 25,000 451,400 350,000

275,000 801,400 1,076,400

A new set of books will used for the partnership If new books will be opened, the books of AA after adjustment of assets and liabilities must be closed. Hence the following entries are required to close the books of AA: Trade and other payables AA, Capital Allowance for doubtful accounts Accumulated depreciation Cash Trade and other receivables Inventory Other current assets Equipment

250,000 451,400 7,600 45,000 162,000 190,000 266,000 16,000 120,000

IF TWO OR MORE SOLE PROPRIETORSHIPS JOINED TO FORM A NEW PARTNERSHIP A. IF NEW BOOKS WILL BE OPENED -Adjust and close the books of each sole proprietorship -Open the new books of the partnership by transferring the partners’ contributed assets and liabilities and their respective amount of capital. B. IF OLD BOOKS WILL BE USED (BOOKS OF ONE OF THE PROPRIETORS) -Adjust and close the books of each sole prop whose books will not be used -Adjust the proprietor’s books to be used as the partnership books (including closing of accumulated depreciation of account) - In the books to be used as partnership books, record the other partner’s contributed assets and liabilities and their respective amount of capital. Then draw up a statement of financial position with the procedures taken in the first illustration. REALIGNING PARTNER’S CAPITAL IN THE PARTNERSHIP FORMATION RULE 1: IF THERE IS NO AGREEMENT AS TO THE INITIAL CAPITAL CREDIT OF THE PARTNERS UPON FORMATION, WHATEVER IS THE NET ASSETS INVESTED BY THE PARTNERS BECOMES THEIR INITIAL CAPITAL CREDIT. RULE 2: IN SOME CASES WHERE PARTNERS MAY AGREE TO HAVE A CAPITAL CREDIT DIFFERENT FROM THEIR NET ASSETS CONTRIBUTIONS, GOODWILL OR BONUS METHOD WILL BE USED. ILLUSTRATION A: GOOD WILL METHOD Assume that in the AA and BS Partnership, it is agreed further that AA should have 60% interest in the net assets of the newly formed partnership and that BS capital of P350, 000 equals 40%. If goodwill is recognized, it will be measured and recorded as follows: ILLUSTRATION B: BONUS METHOD Assuming now that AA and BS must have 60% and 40% capital credit respectively upon the partnership formation and goodwill will not be recognized, the entry to record the bonus is as follows: EXERCISES:

PROBLEM 1: On July 1, 2013, HB and KM decided to form a partnership. The firm is to take over business assets and assume liabilities, and capitals are to be based on net assets transferred after the following adjustments: a. b. c. d. e. f.

HB and KM’s inventory is to be valued at 31K and 22K respectively. AR of 2K in HB’s books and 1K in KM’s books are uncollectible Accrued salaries of 4,000 for HB and 5,000 for KM are still to be recognized in the books. Unused office supplies of HB amounted to 5,000 while that of KM amounted to 1,500. Prepaid rent of 7,000 and 4,500 are to be recognized in the books of HB and KM respectively. HB is to invest or withdrew cash necessary to have 40% interest in the firm.

Balance sheet for HB and KM on July 1 before adjustments are given below:

Cash AR Inventory Supplies Equipment

HB 31,000 26,000 32,000 20,000

KM 50,000 20,000 24,000 5,000 24,000

Accum. Depr’n. PREPAID RENT Total Assets

(9,000)

(3,000)

100,000

120,000

AP Capital Total liabilities and Capital

28,000 72,000 100,000

20,000 100,000 120,000

Determine the following: 1. The net adjustment – capital in the books of HB and KM 2. The adjusted capital of HB and KM in their respective books 3. The additional investment (withdrawal) made by HB 4. The total assets of the partnership after formation 5. The total liabilities of the partnership after formation 6. The total capital of the partnership after formation 7. The capital balances of HB and KM in the combined balance sheet

.

Problem 2: On December 1, 2011, Arjay and Homarr formed a partnership with each contributing the following assets at fair market values: Arjay Homarr Cash 9,000 18,000 Machinery 13,500 ----Land -----90,000 Building -----27,000 Office Furniture 13,500 -----The land and building are subject to a mortgage loan of P54,000 that the partnership will assume. The partnership agreement provides that Arjay and Homarr share profits and losses, 40% and 60% respectively and partners agreed to bring their capital balances in proportion to the profit and loss ratio and using capital balance of Homarr as the basis. The additional cash investment made by Arjay should be . Problem 3: JR and BS are joining their separate business to form a partnership. Cash and non-cash assets are to be contributed for a total capital of 300,000. The non-cash assets to be contributed and liabilities to be assumed are: JR BS BV FV BV FV AR 22,500 22,500 Inventory 22,500 33,750 60,000 67,500 Equipment 37,500 30,000 67,500 71,250 AP

11,250

11,250

7,500

7,500

The partner’s capital accounts are to be equal after all contributions of assets and assumptions of liabilities. 1. 2.

The total assets of the partnership is The amount of cash that each partner must contribute:

Problem 4: On April 30, 2012, XX, YY and ZZ formed a partnership by combining their separate business proprietorships. XX contributed cash f 75,000. YY contributed property with a 54,000 carrying amount, a 60,000 original cost and 120,000 fair value. The partnership accepted responsibility for the 52,500 mortgage attached to the property. ZZ contributed equipment with a 45,000 carrying amount, a 112,500 originalcost and 82,500 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 April 30, 2012 capital balance? PARTNERSHIP OPERATIONS

PARTNER’S LEDGER 1. 2. 3.

Capital Accounts Drawings Account Account for loans to or from partner

CAPITAL ACCOUNT Permanent withdrawal Debit balance of the drawing account Share in Losses

DRAWINGS Original Investment Additional Investment Partner’s share in profit

Partnership Withdrawals Partner’s personal indebtedness Funds or claims of “P” collected and Retained by partner

Obligations of “P assumed or paid by partner personal funds of partner collected or retained by “P Partner’s salaries Depending on the Agreement

DIVISION OF PROFITS AND LOSSES RULE 1: The losses and profits shall be distributed in conformity with the agreement. RULE 2: If ONLY the share of each partner in the profits has been agreed upon, the share of each in the losses shall be in the same proportion RULE3: In the absence of stipulation, the share of each partner in the profits and losses shall be in proportion to what they have contributed (original capital contribution) but the industrial partner shall not be liable for the losses. As for the profits, the industrial partner shall receive such share as may be just and equitable under the circumstances. RULE 4: If beside his services, he also contributed capital, he shall also receive a share in the profits in proportion to his capital. (Law on Partnership, Civil code of the Philippines, article 1797) METHODS OF DIVIDING PROFITS AND LOSSES Partners may agree on the distribution of profits and losses in any manner they choose as long as the provisions of the law are not violated. The agreement on this matter should be specific and complete to avoid misunderstanding and dispute. 1. 2. 3.

4.

Equally In an arbitrary or agreed ratio In the ratio of partners’ capital a. Original capital b. Beginning of the year capital c. End of the year capital d. Simple average during the year e. Weighted average during the year Interest, salaries and bonus are to be allowed, the balance to be divided based on some arbitrary basis as agreed upon.

EQUALLY  Assume that A, B, C are partners in ABC partnership. Profit for the period is P120,000. Entry: IN AN ARTBITRARY OR AGREED RATIO  Assume that in the ABC partnership, income is divided 40%, 30%, 30% to ABC respectively. Entry: IN THE RATIO OF PARTNERS’CAPITAL Using the ratio of partners’ capital in dividing profits, the following are the methods: a. Based on Original capital b. Based on beginning capital c. Based on ending capital d. Based on simple average e. Based on weighted average capital 

Assume that the ABC partnership was organized two years ago with each partner contributing the following: A- P180, 000 B- 120,000 C- 300,000

Transactions between the partners and the partnership during the current year are as follows: PARTNER A: January 1 Balance March 1 Additional Investment June 30 Withdrawal October 31 Additional Investment December 31 Balance (before division of income)

200,000 50,000 30,000 20,000 240,000

PARTNER B: January 1 Balance August 1 Additional Investment November 1 Additional Investment December 31 Balance (before division of income)

150,000 20,000 70,000 200,000

PARTNER C: January 1 Balance February 1 additional Investment May 31 Additional investment October 31 Additional investment December 31 Balance (before division of income)

400,000 50,000 60,000 20,000 530,000

Assume that the profit for the period is P120,000 SALARY, INTEREST AND BONUS TO PARTNERS Assume that AA and BS are partners in a travel agency, Their capital account balances on January 1, 2010 are 40,000 and 20,000 respectively. They agree that partnership are to be distributed as follows: AA BS Salary 3,000 9,000 Interest on beginning capital 5% 5% Bonus 25% of NI after -0Salaries and bonus But before interest Residual Profit or loss 70% 30% Calculate the distribution of profits if the partnership net income before salary, interest and bonus is 60,000. AA

BB

TOTAL

SALARY INTEREST BONUS* TOTAL RESIDUAL PROFIT

TOTAL EXERCISES 401-2

PROBLEM 1-A: Medina and Detoya Partnership which had a profit of 300,000 for the year ended December 31, 2013, the first year of operations. The partnership contract provided that each partner may withdraw 5,000 on the last day of each month; both partners did so during the year. The drawings are recorded by debits to the partner’s drawing accounts and shall not be considered in the division of profits and losses. It is the intention of the partners that each partner’s share in the profit or loss be either credited or debited to the drawing account. Medina invested 400,000 on January 1, 2013 and an additional 100,000 on April 1. Detoya invested P800,000 on Jan. 1 and withdrew 50,000 on July 1.     

1.aEqually or in other agreed ratio 1.b Based on partner’s Original Capital contributions 1.c Ratio of capital balances at the beginning of the year 1.d Ratio of capital balances at the end of the year 1.e Ratio of Average capital balances

PROBLEM 1-B: Assume that the profit for the year is 400,000 and partnership agreement is to give (1) bonus to medina of 25% of profit after salaries and interest but before bonus; (2) Annual salaries of 100,000 to Medina and 60,000 to Detoya; (3) Interest on average capital balances of P71,250 and 116,250 to medina and Detoya, respectively; (4) Balance to be divided in a ratio of 40:60. PARTNERSHIP DISSOLUTION DISSOLUTION refers to the change in the relation of the partners. It does not necessarily mean termination of the business. After dissolution of old partnership, a new partnership may be forged or the business may cease to operate. The winding up or terminating partnership affairs is known in accounting as LIQUIDATION. CAUSES OF DISSOLUTION -Admission of new partner -Withdrawal of partner -Death or incapacity -Incorporation

ILLUSTRATIONS Problem 1: Assets

Liabilities and Capital

Cash …………………………………………. Php 5,000.00 Noncash assets …………………….…………. 65,000.00

Liabilities ……………………..…..………..Php15,000.00 XX, capital (80%) ……………..……..…….... 40,000.00

XX, load ……………………………………………. 5,000.00 Total…………….……………………….. Php75,000.00

YY, capital (20%) …………….…………...…..20,000.00 Total…………….……………………….. Php75,000.00

The percentage in the parentheses after the partner’s capital balances represents their respective interest in the profits and losses. The partners agree to admit ZZ as a member of the firm. Required:Prepare the required entries on the partnership books to record the admission of ZZ under each of the following assumptions: Situation 1: ZZ purchases a ¼ interest in the firm. One-fourth of each partner’s capital is to be transferred to the new partner. ZZ pays the partners Php15,000 which is divided between them in the proportion to the equities given up. 1. The entry to admit ZZ as a new partner should be: 2. The capital balance of XX, YY, and ZZ after the admission should be:

Situation 2:ZZ invests Php20,000 in the cash for ¼ ownership interest. The money goes to the original partners. 1. The entry to admit ZZ as a new partner should be if the book value method (no adjustments/ no revaluation) is used: 2. Using the same information in No. 1 the capital balances of XX, YY, and ZZ after the admission should be: 3. Using the same information in No. 1 compute the partnership gain (or gain to be recognized in partnership books). 4. Using the same information in No. 1, compute the gain to be recognized by XX, and YY. 5. If revaluation/ adjustments in assets are recognized, the entry to admit ZZ should be: 6. Using the same information in the No. 5, the capital balances of XX, YY, and ZZ after the admission should be:

Situation 3: ZZ purchases a ¼ interest in the firm. One-fourth of each partner’s capital is to be transferred to the new partner. ZZ pays partners Php12,000, which is divided between them in proportion to the equities given up. 1. The entry to admit ZZ as a new partner should be if book value method (no adjustments/ no revaluation) is used: 2. Using the same information in No. 1the capital balances of XX, YY, and ZZ after the admission should be: 3. Using the same information in No. 1, compute the partnership loss (for loss to be recognized in partnership books). 4. Using the same information in No. 1, compute the loss to be recognized by XX, and YY. 5. If revaluation/ adjustments in assets are recognized, the entry to admit ZZ should be: 6. Using the same information No. 5, the capital balances of XX, YY, and ZZ after the admission should be:

Situation 4: ZZ invest Php25,000 for a ¼ interest in the firm. The total agreed capital is Php85,000. 1. The entry to admit ZZ as a new partner should be: 2. The capital balances of XX, YY, and ZZ after the admission should be: 3. The new profit and loss of all partners after ZZ’s admission should be:

Situation 5: New partner ZZ conveyed a tangible assets with a fair value of Php32,000 with and assumed mortgage of Php5,000 in exchange for a 35% interest in capital, keeping in mind that ZZ would be acquiring a ¼ interest in profits. 1. What is the journal entry to admit ZZ if bonus method is used? 2. The capital balances of XX, YY and ZZ after the admission should be:

Situation 6 : New partner ZZ conveyed non-cash assets with a fair value of Php15,000 in exchange for a 30% interest I a capital and a 1/5 interest in profits. The total agreed capital after admission is Php80,000. 1. The entry to admit ZZ as a new partner should be: 2. The capital balances of XX, YY, and ZZ after the admission should be: 3. The new profit and loss of all partners ZZ’s admission should be: Situation 7: ZZ invests Php15,000 for a 40% interest in the firm. 1. If the bonus method is used, the entry to admit ZZ should be: 2. If goodwill method is used, the entry to admit ZZ should be: Situation 8: ZZ invests Php40,000 in the firm, Php10,000 is considered a bonus to Partners XX and YY. Situation 9: ZZ invests Php40,000 in the firm and is allowed a credit of Php12,000 for goodwill upon admission. Situation 10: ZZ invest Php30,000 for a 37.5% interest in the firm . the total firm capital is to be Php80,000 and partners agreed that their capital balances should made to equal to their new profit and loss ratio. ILLUSTRATION 2: In the AD partnership, Allen’s capital is Php140,000 and Daniel’s is Php40,000 and they share income in a 3:1 ratio, respectively. They decide to admit David to the partnership. Each of the following questions is independent of the others. 1. David directly purchases a one-fifth interest by paying Allen Php34,000 and Daniel Php10,000. The land account is increased before David is admitted. By what amount is the land account increased? 2. Allen and Daniel agree that some of the inventory is obsolete. The inventory account is decreased before David is admitter. David invests Php40,000 for one-fifth interest. What is the amount of inventory written down? ILLUSTRATION 3: DD, EE and FF are partners sharing profits and losses of 50%, 30% and 20%, respectively. The December 31, 2011 balance sheet of the partnership before any profit allocation was summarized as follows Assets

Liabilities and Capital

Cash ………………………………………. Php 120,000.00

Accounts payable ..…………..…..………..Php8,000.00

Inventories……. …………………….…………. 80,000.00 Furn. & Fixt. (net) ……………………………100,000.00

FF, load …………………………….………..…………6,000.00 DD, capital ……….……………..……..….….... 140,000.00 EE, capital ………………………….………..…….120,000.00 FF, capital ………..…………….………….......…..60,000.00 FF, drawings ………………………………..……..( 4,000.00) Totalliab. &capital …………………….. Php 330,000

Total assets ...……………………….. Php 330,000.00

The partnership net income for the year amounted to Php60,000.00 On January 1, 2011, FF has decided to retire from the partnership and by mutual agreement among partnerships; the following have been arrived at: a. Inventories amounting to Php10,000 is considered obsolete and must be written-off. b. Furniture and fixtures should be adjusted to their current value of Php130,000. c. Patents are considered worthless and must be written-off immediately before the retirement of FF. It was agreed that the partnership will pay FF for this interest in the partnership inclusive of loan balance.

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18.

The entity to record the allocation of net income on December 31, 2010 should be: The entry to record the adjustments on assets on January 1, 2010 should be: The entry to close the drawing and loan accounts: Considering Question Nos. 1, 2, and 3 above the interest of FF immediately before his retirement amounted to: Considering Question No. 4 and FF retires by receiving Php72,000 cash (payment at book value), the entry to record withdrawal of FF should be: Considering Question Nos. 4 & 5, the capital balances of DD and EE after the retirement of EE: Considering Question No. 4 and FF retires by receiving Php76,000 cash (payment at more than book value), using bonus method, the entity to record the withdrawal of FF should be: Considering Question Nos. 4 and 7, the capital balances of DD and EE after the retirement of FF: Considering Question No. 4 and FF retires by receiving Php76,000 cash (payment at more than book value), using partial goodwill method , the entry to record the withdrawal of FF should be: Considering Question Nos. 4 and 9, the capital balances of DD and EE after the retirement of EE: Considering Question No. 4 and FF retires by receiving Php76,000 cash (payment at more than book value), using total (implied) goodwill method, the entry to record the withdrawal of FF should be: Considering Question Nos. 4 and 11, the capital balances of DD and EE after the retirement of FF: Considering Question No. 4 and FF retires by receiving Php69,000 cash (pay at less than book value), using bonus method , the entry to record the withdrawal of FF should be: Considering Question Nos. 4 & 13, the capital balances of DD and EE after the retirement of FF: Considering Question No. 4 and FF retires by receiving Php69,000 cash (payment at less than the book value), using specific adjustment in assets, the entry to record the withdrawal of FF should be: Considering Question Nos. 4 and 15, the capital balances of DD and EE after retirement of FF: Considering Question No. 4 and FF retires by receiving Php69,000 cash (payment at less than book value), using asset write-down traceable to the entry, the entry to record the withdrawal of FF should be: Considering Question Nos. 4 & 17, the capital balances of DD and EE after the retirement of FF: Sometimes, God breaks our spirit to save our soul Sometimes, He breaks our heart to make us whole Sometimes He sends us pain so we can be stronger Sometimes, He sends us failure so we can be humble Sometimes He sends us illness so we can take better care of ourselves Sometimes He takes everything away from us so we can learn the value of everything we have. 

--Prepared by: Keisha D. Morales, CPA, FRIAcc, MPA©