Accounting Review II WJGuzman

San Beda University Accounting for Partnership

Partnership Formation

Each partner’s initial investment in a partnership should be recorded at the fair market value of the assets
or present value of the liabilities at the date of their transfer to the partnership. The values assigned to
each partner’s capital must be agreed to by all of the partners. After the partnership has been formed, the
accounting is similar to accounting for transactions of any other type of business organization.

Partnership Operation

Partnership net income or net loss is shared by the partners based on their agreement. If no agreement
has been made, then net income or net loss is shared based on each partner’s original capital investment.
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 (60% and 40%), or a fraction (3/5 and 2/5).
2. A ratio based on either 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 or capital ratio.
4. Interest on partners’ capital balances and the remainder on a fixed or capital ratio.
5. Salaries to partners, interest on partners’ capital balances, and the remainder on a fixed or capital ratio.
Bonus to partners may also be given provided that the basis for bonus is a positive amount.

The following 4 closing entries are required for a partnership:

1. Debit each revenue account for its balance and credit income summary for total revenues.
Revenues xx
Income Summary xx
2. Debit income summary for total expenses and credit each expense account for its balance.
Income Summary xx
Expenses xx
3. Debit (credit) income summary account for its balance and credit (debit) each partner’s drawing
account for his/her share of net income (net loss).
Income Summary xx
Partner A, Drawing xx
Partner B, Drawing xx

or if net loss
Partner A, Drawing xx
Partner B, Drawing xx
Income Summary xx
4. Debit (credit) each partner’s drawing account for its balance and credit (debit) each partner’s capital
account for the same amount.
Partner A, Drawing xx
Partner B, Drawing xx
Partner A, Capital xx
Partner B, Capital xx

Partnership Dissolution

Partnership dissolution is different to partnership liquidation as the former indicates ending of agreement
only to replace it with a new one and the latter indicates the ending of the partnership business altogether.
Partnership dissolution may takes place under the following circumstances:
1. Admission of a new partner either by:
a. Purchasing the interest of an existing partner
b. Investing assets in the partnership
2. Withdrawal of a partner
3. Incorporation

Admission by purchase
The admission of a partner by purchase of an interest in the firm is a personal transaction between one
or more existing partners and the new partner. The price paid is negotiated and determined by the
individuals involved; it may be equal to or different from the capital equity acquired. Any money or other
consideration exchanged is the personal property of the participants and not the property of the partnership.
Any gain or loss on the exchange is also personal to the participants.

Admission by investment
When a partner is admitted by investment, both the total net assets and the total capital change. When the
new partner’s investment differs from the capital equity acquired, the difference is considered a bonus either
to: 1) the existing (old) partners, or 2) the new partner.
Assets may be under (over) valued at the time of the admission (in both cases) of new partners. Any
difference in the revaluation of partnership assets shall be shared only by the existing (old) partners.

Withdrawal of a partner
A partner may withdraw from a partnership voluntarily by selling his or her equity in the firm or involuntarily
by reaching mandatory retirement age or by dying. The withdrawal of a partner may be accomplished by 1)
payment from remaining partners’ personal assets, or 2) payment from partnership assets.

The withdrawal of a partner when payment is made from partners’ personal assets is the direct opposite of
admitting a new partner who purchases a partner’s interest. Withdrawal by payment from partners’ personal
assets is a personal transaction between the partners.

Using partnership assets to pay for a withdrawing partner’s interest decreases both total assets and total
partnership capital. In accounting for a withdrawal by payment from partnership assets:
1. Asset revaluations may be recorded
2. Any difference between the amount paid and the withdrawing partner’s capital balance should be
considered a bonus to the retiring partner or a bonus to the remaining partners.

The death of a partner dissolves the partnership. But provision generally is made for the surviving partners
to continue operations. When a partner dies, it is necessary to determine the partners’ equity at the date of
death. This is done by determining the net income or loss for the year to date of death. The surviving
partners will agree to either:
1. Purchase the deceased partner’s equity from their personal assets
2. Use partnership assets to settle with the deceased partners estate

Procedures in Incorporation of a partnership

1. Adjust the assets and liabilities of the partnership to their fair market values and allocate the
difference to the partners’ capital accounts according to their profit and loss ratio.
2. Compute for and record the goodwill by comparing the total par value of the stocks to be issued to
the partners with the total adjusted partners’ capital accounts. If the total par value of the stocks
issued is greater than the adjusted partners’ capital accounts, the difference represents goodwill.
If the par value of the stocks issued is less than the adjusted partners’ capital accounts, the
difference is considered as additional paid in capital.
3. Close the partnership books because a new book will be used for the new entity.
4. Record in the new set of books by debiting the assets at their fair market values, crediting the
liabilities at their current values, and crediting capital stock for the total par value of the stocks
issued to the partners.

Partnership Liquidation

The liquidation of a partnership terminates the business. In a liquidation, it is necessary to:

1. Sell non cash assets for cash and recognize a gain or loss on realization,
2. Allocate gain or loss on realization to the partners based on their income or loss ratios
3. Pay partnership liabilities in cash
4. Distribute remaining cash to partners on the basis of their remaining capital balances.
Each of the steps must be performed in sequence. Creditors must be paid before partners receive any cash
distributions and must be recorded by an accounting entry.

The term no capital deficiency means that all partners have credit balances in their capital accounts. If at
least one partner’s capital account has a debit balance, the situation is termed a capital deficiency. A capital
deficiency may be caused by: 1) recurring net losses, 2) excessive drawings before liquidation, or 3) losses
from realization suffered through liquidation. The capital deficiency of a partner may be eliminated through:
1) offsetting of partnership loan payable to the deficient partner (if there’s any), 2) additional investment of
the deficient partner (if partner is solvent), or 3) absorption of the other partners.

Partnership liquidation may be performed under:

1. Lump sum – all non-cash assets are sold for cash.
2. Installment – involves the distribution of cash to partners as it becomes available during the
liquidation period and before all liquidation gains and losses have been realized.

In the second kind of liquidation, a schedule of safe payment of computation must be performed. The
calculation of safe payment is based on the following assumptions: 1) all partners are personally insolvent,
and 2) all noncash assets represent possible losses. The development of cash distribution plan for the
liquidation of a partnership involves ranking the partners in terms of their vulnerability to possible losses.

Partnership Formation
Problem 1
Henry, a sole proprietor, invited John and Lucio to form a trading partnership. Henry will invest his existing
business while John and Lucio will both invest cash and non-cash assets. The Statement of Financial
Position of Henry Trading on January 1, 2018 showed the following:

Cash 50,000 Accounts Payable 60,000

Accounts Receivable 220,000 Notes Payable 270,000
Merchandise Inventory 575,000 Henry, Capital 715,000
Office Equipment 150,000
Accum. Depreciation – Office Equipment 50,000
Land 100,000

The partners agreed that the following adjustments be made in the books of Henry:
 Merchandise Inventory is to be recorded at its fair value of P550,000.
 10% of the Accounts Receivable is estimated to be uncollectible.
 The office equipment was estimated to have fair value of P110,000.
 The market value of the land amounts to P120,000.
 Accrued interest on notes of P13,500 should be set up.

John will invest cash P200,000 and merchandise inventory P200,000. Lucio will invest cash P100,000, land
P100,000 and building P600,000.

1. How much is the net investment of Henry in the partnership?

2. If the partners agreed to have initial investment equal to 4:2:4 for Henry, John and Lucio,
respectively, with Henry investing additional cash. How much is the total cash of the partnership?

Problem 2
Mars and Pars formed a partnership and agreed to divide initial capital equally even though Mars
contributed P318,000 and Pars contributed P282,000 in identifiable assets.
1. Assuming the bonus method was used to adjust the capital accounts, how much capital is to be
credited to Mars and Pars?
2. Assuming the goodwill method was used to adjust the capital accounts, how much is the amount
of goodwill and the capital balances of Mars and Pars?

Problem 3
The partnership of Alrene and Chris was formed on January 1, 2018. The following assets were contributed:
Alrene Chris
Cash P 125,000 P 175,000
Merchandise 275,000
Building 500,000
Furniture and Equipment 75,000

The building is subject to a mortgage loan of P150,000 which is to be assumed by the partnership. The
partnership agreement provides that Alrene and Chris share profits or losses 1:3, respectively.

1. If the partnership agreement provides that the partners initially should have an equal interest in
partnership capital with no contribution of intangible assets, Alrene’s capital account would be
___________.

Partnership Operation

1. Ronda and Holly are partners who share income in the ratio of 3:1. Their capital balances are P80,000
and P120,000, respectively. Income Summary has a debit balance of P30,000. What is Ronda’s capital
balance after sharing the results of the partnership operation?

2. A, B, and C, doctors, agree to form a partnership and to share profits in the ratio 5:3:2. They also agreed
that C is to be allowed a salary of P140,000 and that B is to be guaranteed P105,000 as his share of
the profits. During the first year of operations, income from fees are P900,000, while expenses total
P480,000. How much of the profit should be credited to A? to B? to C?

3. D and E entered into partnership on March 1, 2018, investing P62,500 and P37,500, respectively. It
was agreed that D, the managing partner was to receive a salary of P15,000 per year and also 10%
bonus of the net profit after adjustment for the salary, the balance of the profit was to be divided in the
ratio of original capitals. On December 31, 2018, account balances were as follows:
Cash P35,000 Payable P30,000
Receivable 33,500 Sales 116,500
Fixtures 22,500 D, capital 62,500
Purchases 98,000 E, capital 37,500
 Returns and allowances 2,500
Operating expenses 30,000
D, drawing 10,000
E, drawing 15,000 _______
P246,500 P246,500
Inventories on December 31, 2018, were: merchandise, P36,500; supplies, P1,250. Prepaid taxes and
insurance were P475 and accrued liabilities totaled P775. Depreciation on fixtures is to be computed
at 20% per year.
a. How much is the net income of the partnership for 2018?
b. How much is the share of D and E on the above computed net income:
c. How much is the capital balance of partner D and E as of Dec. 31, 2018.

4. The capital accounts of E and F shows the following facts for the fiscal year ended December 31, 2018:
E F
Jan. 1 Balance 260,000 Jan 1 Balance 165,000
Mar 30 Investment 30,000 May 18 Investment 50,000
May 10 Investment 70,000 Aug 24 Withdrawal 20,000
July 25 Withdrawal 40,000 Dec. 31 Balance 195,000
Dec. 31 Balance 320,000
Profit or loss are distributed by giving allowance to E of a bonus of 25% of the net profit after bonus,
interest of 6% to be allowed on the on each partner’s average capital, and any balance in the ratio of
3:2 to E and F, respectively.
The income summary account shows a credit balance of P238,000 on Dec. 31.
Investments and withdrawals are to be considered as made at the beginning of the month if made
before the middle of the month and are to be considered as made at the beginning of the following
month if made after the middle of the month.

How much should be the share of E and F in the result of the partnership operation?

Partnership Dissolution

Admission of a new partner

In the Bagani partnership, Ganda's capital is P200,000 and Lakas' is P100,000 and they share income in a
3:2 ratio, respectively. They decide to admit Babaylan to the partnership. Compute for each partners’ capital
balance after Babaylan’s admission.

1. Assume that Babaylan purchased 20% interest of the old partners by paying P60,000 to the partners
in exchange of 20% of their equity.

2. Assume that Babaylan purchased 20% interest of the old partners by paying P50,000 to the partners
in exchange of 20% of their equity.

3. Assume that Babaylan purchased 20% interest of the old partners by paying P70,000 to the partners
in exchange of 20% of their equity.

4. Assume that Babaylan purchased 20% interest of the partnership by paying P75,000 to Ganda.

5. Assume that Babaylan purchased 20% interest of Ganda by paying her P60,000.

6. Assume that Babaylan purchased 20% interest of Ganda by paying her P55,000 but only after the land
account is revalued.

7. Assume that Babaylan purchased 20% interest of the partnership by paying P80,000 to the partners
but only after land account is revalued.

8. Assume that Babaylan will invest cash to give him 20% interest in the partnership. How much cash will
he invest?

9. Assume that Babaylan invests P90,000 for a 20% interest in the partnership and that revaluation of the
land is to be recorded.

10. Assume that Babaylan invests P60,000 for a 20% interest in the partnership and that bonus is to be
recorded.

11. Ganda and Lakas agree that some of the inventory is obsolete. The inventory account is decreased
before Babaylan is admitted. Babaylan invests P80,000 for 25% interest in the partnership. How much
should the inventory account be written-off?

12. Assume instead that Babaylan invests P75,000 for a 20% interest in the total capital of P375,000. What
are the capital balances of Ganda and Lakas after Babaylan is admitted into the partnership?
13. Assume instead that Babaylan invests P75,000 for a 20% interest in the total capital of P400,000. What
are the capital balances of Ganda and Lakas after Babaylan is admitted into the partnership?

Retirement of a partner
On December 31, 2017, partners Uno, Dos and Tres have capital balances of P175,000, P200,000 and
P125,000 respectively. They share profit and loss in the ratio 3:3:4. On April 1, 2018, Tres decided to retire
to the partnership. Net income on the first quarter of the year amounted to P100,000.

1. How much will Tres receive as settlement?

2. If Tres received P175,000 cash as settlement after receiving share in asset revaluation, how much is
Uno’s balance after Tres’s retirement?

3. If Tres received P150,000 cash as settlement after bonus is distributed, how much is Dos’s balance
after Tres’s retirement?

4. If Uno decided to buy Tres’s interest for P140,000, how much will Uno’s capital balance be after Tres’s
retirement?

5. If Dos decided to buy Tres’s interest for P185,000 but only after revaluing the assets, how much will
Dos’s capital balance be after Tres’s retirement?

Incorporation of a partnership
The balance sheet of R and S, a partnership appears as follows:
R AND S PARTNERSHIP
Balance Sheet
October 31, 2018
ASSETS
Current Assets:
Cash P 41,100
Accounts Receivable P 212,160
Allowance for bad debts 8,000 204,160
Inventories 241,100
Prepaid expenses 10,140
P 496,500
Plant Assets:
Furniture and Fixtures P 241,000
Accumulated Depreciation 68,200 172,800
Total assets P 669,300

LIABILITIES AND CAPITAL

Current Liabilities:
Accounts payable P 162,200
Accrued expenses 20,000
P 182,200
Partner’s capital:
R, capital P 260,350
S, capital 226,750 487,100
Total Liabilities and capital P 669,300

R and S share profits and losses equally.

The partners incorporate as H & G Corporation with an authorized capital of 5,000 shares at P100 par
stock, of which 4,400 are issued to the partners in exchange for their interest in the net assets of R and
S, and the remainder are issued at P120 per share for cash. The partners agree that the following
adjustment should be recorded:
Allowance for bad debts decreased by P 4,000
Inventories increased by 12,000
Accumulated depreciation decreased by 6,200
Goodwill is to be recognized in an amount which will cause the net assets of the partnership to equal
the cash issuance price of the shares to be issued therefore.
Questions: 1. How much is the additional paid-capital contributed by R and S to the new corp.?
2. How much goodwill is to be recognized in the corporation’s books?
3. How many shares R will receive?

Partnership Liquidation

Problem 1
On December 31, 2017, Allan, Belen and Carlos have the following accounts and balances: Allan,
Capital(40%) - 235,000; Belen, Capital(40%) - 158,000; Carlos, Capital (20%) - 163,000; Loan due to Carlos
- 34,000; Loan due to Belen - 10,000. Because of some misunderstanding between partners, they decided
to liquidate. At this time, the partnership has Cash of 180,000, Other Assets of 870,000 and Liabilities of
450,000. The partnership paid P100,000 for liquidation expenses.

Compute for each partner’s final cash settlement

Case 1 - The Other Assets were sold for 1,000,000.

Case 2 - The Other Assets were sold for 456,000.

Case 3 - The Other Assets were sold for 387,000.

Case 4 - The Other Assets were sold for 387,000 and B is a Limited Partner.

Problem 2
On January 1, 2016, Rus and Tan, who share profits and losses on a 60:40 ratio, decided to liquidate their
partnership. After all of the non-cash assets of the partnership were sold for P760,000 and all of the
P120,000 liabilities were settled, the partners had P720,000 to distribute among themselves. Rus received
P112,000 in the settlement of his P400,000 capital balance
a. How much was the total assets immediately before liquidation?
b. How much was the cash balance immediately before the non-cash assets were sold?

Problem 3
The balance sheet to Allan Pera, Duke Huh, Lou Ge partnership shows the following information as of
December 31, 2017:

Cash P 400,000 Liabilities P 1,000,000

Other Assets 5,600,000 Allan Pera, Loan 500,000
Allan Pera, Capital 2,500,000
Duke Huh, Capital 1,400,000
Lou Ge, Capital 600,000
P 6,000,000 P 6,000,000

Profit and loss ratio is 3:2:1 for Allan Pera, Duke Huh, and Lou Ge, respectively. Other assets were realized
as follows:
Date Cash Received Book Value
January 2016 P 1,200,000 P 1,800,000
February 2016 700,000 1,540,000
March 2016 2,500,000 2,260,000

 Cash is distributed as assets are realized

 Liabilities were settled on January and February for P600,000 and P400,000, respectively.
 Partnership paid P100,000 as liquidation expense in January and estimated to pay P50,000 more.
 Partnership paid P80,000 as liquidation expense in February and estimated to pay P40,000 more.
 Partnership paid P20,000 as liquidation expense in March.

Compute for the installment settlement to each partner from January to March.