PARTNERSHIP

INTRODUCTION

There are no authoritative pronouncements concerning the accounting for partnership; thus all
principles prescribed herein have evolved through accounting practice.

PARTNERSHIP FORMATION

The partnership is a separate accounting entity, and therefore, its assets and liabilities should remain
separate and distinct from individual partner’s personal assets and liabilities. Thus, all assets
contributed to the partnership are recorded in the books of the partnership at their fair market values,
and all liabilities assumed by the partnership are recorded at their present values.

The accounting problems peculiar to a partnership relate to the measurement of the individual partner’s
ownership of equities or interests in the partnership. A partner’s interest in a firm should be
distinguished from the right to share in firm’s profits. A partner’s interest is summarized in an individual
capital account and consists of the original investment, subsequent additional investments and
withdrawals, and the partner’s share of the firm’s profits and losses.

ALLOCATION OF PARTNERSHIP INCOME OR LOSS

Partners may agree to share profit and losses in any manner, irrespective of capital interests. This
agreement should be stipulated in the articles of partnership. In the absence of an expressed
agreement, profits and losses shall be divided based on the contributed capital of the partners.

Generally, the division of partnership income should be based on an analysis of the correlation between
the capital and labor committed to the firm by individual partners and the income that subsequently is
generated. As a result, profits might be divided in one or more of the following ways:

A. Profit and Loss Ratio

This method obviously provides a simplified way and equitable division of profits. Normally, the
ratio designed for the division of profits also is used for the division of losses, unless a specific
provision to the contrary exists.

B. Capital Investment of Partners

The division of the portion of the profit using the capital investment of partners may be
accomplished by imputing interest on the invested capital at some specified rate. This interest
is not viewed as a partnership expense, but rather as a means of allocating profits and losses
among partners. When this approach will be used, the partnership agreement should specify
the partners’ capital investment whether the capital balances are before or after respective
withdrawals; capital investment at the beginning or end of an accounting period or the weighted
average capital during the period.

C. Services Rendered by Partners

 Normally, the profit and loss agreement recognizes variations in effort by calling for a portion of
income to be allocated to partners as salaries, which, like interest on capital investments, are
viewed as a means of allocating income rather than as an expense. Thus, this treatment of
partners’ salaries differs from the treatment of employee/shareholder salaries in a corporation.

To reward partners’ services to the partnership beyond that already recognized by salaries
and/or interest, bonuses may be provided to partner/s. The bonus may be expressed as a
percentage of partnership net income before or after bonus.

Allocation of Profit Deficiencies and Losses

When the partnership income was large enough to satisfy all of the provisions of the profit and
loss agreement, the allocation of profit may be simple; however if the income is not sufficient or
an operating loss exists, one of the following alternatives may be used:

1. Completely satisfy all provisions of the profit and loss agreement and use the profit and
loss ratios to absorb any deficiency or additional loss caused by such action.
2. Satisfy each of the provisions to whatever extent it is possible. In other words, satisfy
each of the provisions based on the order of priority agreed by the partners.

PARTNERSHIP DISSOLUTION (CHANGES IN OWNERSHIP)

A partnership is said to be dissolved when the original association for the purposes of carrying on
activities has ended. Although dissolution brings to an end the association of individuals for their
original purpose, it does not mean the termination of business of even an interruption of its continuity.
Upon death or retirement of a partner, the business may continue as a new partnership composed of
the remaining partners. This is not to be confused with partnership liquidation, which is the winding up
of partnership affairs and termination of the business. In short, under dissolution, the partnership
business continues, but under different ownership.

When partnership dissolution occurs, a new accounting entity results, therefore, the partnership, after
allocation of income or loss to the existing partner’s capital accounts, should adjust all assets and
liabilities to their fair market values and present values, respectively.

After all adjustments have been made, the accounting for dissolution depends on the type of
transactions that caused the dissolution, such as:

1. Transactions between the partnership and a partner (e.g. a new partner contributes assets, or a
retiring partner withdraws assets).
2. Transactions between partners (e.g. a new partner purchases an interest from one or more
existing partners, or a retiring partner sells his interest to one or more existing partners).

Transactions between a Partner and the Partnership

1. Admission of a New Partner

 When a new partner is admitted to the partnership, the new partner can invest assets into the
partnership and receive a capital balance equal or greater/less than to the assets invested. If
the new partner’s capital balance is not equal to the assets invested, then either the bonus or
goodwill method must be used to account for the difference.

a. Bonus Method
The bonus method adheres to the historical concept, thus, strictly observes that net assets
should be recorded at historical cost. Any increase in the value of net assets should not be
recognized until they are realized in an actual exchange transaction; however, write-downs
in the value of net assets may be recognized.

Under this method, the total contributed capital (including that of the new partner) is equal
to the new partnership capital. The bonus method implies that the old partners either
received a bonus from the new partner, or they paid bonus to the new partner.

Bonus to the Old Partner

The book value approach of the bonus method does not recognize increase in net asset
values or recognition of goodwill. Therefore, when an incoming partner’s contribution
indicates the existence of which, bonus may be granted to the old partners. This will
eventually increase the capital accounts of the old partners and reducing the new partner’s
capital account.

Bonus to New Partner

When the incoming partner invests some intangible assets to the partnership, bonus
may be credited to him. This may be viewed as a cost incurred to acquire the intangible
assets contributed by the incoming partner, since all costs to acquire assets eventually affect
income and are allocated among the partners.

b. Goodwill Method

(NOTE: During the Dean Jesus A. Casino Forum held in Tacloban City, it was suggested that goodwill
will no longer be recognized. However, the author decided to include this topic while waiting for the
official position of the FRSC/ASC and the Board of Accountancy regarding this matter.)

This method emphasizes the legal significance of a change in the capital structure of a partnership.
From a legal point of view, the admission of a new partner results