Partnership Formation

Fair Value Concept

Fair value in the perspective of partnership
accounting pertains to the value agreed upon by
the partners with regards to their investments
and the liabilities assumed by the partnership as
a result of the creation of the partnership.
In considering this concept, always look
for fair value indications or the agreement of the
partnership and use such in the valuation of
investments and liabilities.
In the absence of any agreement and
other information, the book values or cost of
certain assets may be used as the fair value.
Formation Scenarios
Two or more individuals form a partnership
A sole proprietorship and an individual
form a partnership
Two
sole
proprietorships
form
a
partnership
Scenario 1
The basic concept to be remembered here
is to always be careful with the valuation of
investments. Always remember the fair value
concept.
Cash investments are valued at face
value. Property investments are valued at fair
value. Liabilities assumed are also valued at fair
value.
Investment of services or skills is recorded
using a memorandum entry.
***Note that there are certain problems where a
liability is attached or related to a particular asset
invested just like mortgages. As a general rule,
such liabilities will be assumed by the partnership
unless otherwise stated. Thus, if the problem is
silent, it is safe to assume that such liabilities will
be assumed by the partnership. Furthermore, if
the problem stated that such liabilities will not be
assumed, the liability will be netted off to the
value of the investment.
Scenario 2
The treatment of the investment of the
individual in this scenario will be the same in
scenario 1.
With regard to the sole proprietorship,
three steps should be followed.
Step 1 is to close the nominal accounts
just in case nominal accounts still exist in the
books of the sole proprietorship.
Step 2 is to adjust the books of the sole
proprietorship. In doing this, certain guidelines
must be followed. First, the allowance method
should be used in adjusting accounts receivable,
unless the direct write off method was stated to

be used. Second, adjustments to PPE may be

done by directly adjusting the asset or by
adjusting the contra-asset. Third, adjustments to
inventory are directly made to the inventory
account. Finally, information should be read
carefully so that correct adjustments will be
made.
Step 3 is to close the books of the sole
proprietorship, meaning eliminating the values of
all accounts. In this step, all accounts with credit
balances will be debited and all accounts with
debit balances will be credited in the closing
entry. It is to be noted that the effects of the
adjustments in step 2 should be reflected to the
balances of all accounts affected before step 3 is
done.
Step 4 is to record the investment of the
partners to the books of the partnership. In doing
this step, certain guidelines must be followed.
First, accounts receivable and allowance for
doubtful accounts will be recorded separately not
unless direct write off was used during the
adjustments in step 2. Second, PPE will be
recorded net of accumulated depreciation. This is
because on the point of view of the partnership, it
has received a new property and therefore, no
accumulated depreciation should be recognized
yet even if on the point of view of the partner it is
already an old property. Finally, in recording the
investments, the actual investment method
should be used unless bonus method was stated
to be used.
***Step 1 and 2 may be done interchangeable.
However, it is more advisable to follow the steps
provided so that procedures and analysis would
be less complicated.
***For step 2, it is advisable for adjustment to be
done on a per item basis as to avoid complicated
analysis. However, compound adjustments may
also be done.
***For step 3, it is suggested that an adjusted
trial balance should be prepared before
proceeding with closing entries as to assure that
all adjustments will be reflected in affected
accounts.
***After step 4, the preparation of the Statement
of Financial Position may be prepared just to
assure that everything is balance after all entries.
Scenario 3
Steps for scenario 3 will be the same with
steps in scenario 2. The only difference is that in
this scenario, more adjustments will be required
considering that two or more sole proprietorships
will be forming a partnership, thus, more
adjustments and entries will be required.
Bonus Method

This happens when the capital balance of

a partner is not equal to his actual contribution as
a result of certain adjustment. This method is
used if partners want their capital balances to be
in proportion to a desired ratio, usually the
profit/loss ratio.

It should be noted that in using this

method, careful analysis should be done as to
correctly analyze bonus to and from partners. It
should also be noted that careful analysis should
be done in using the ratio provided so that the
correct capital balance or credit will be satisfied,
especially in cases where there are more than
two partners involved.