CAC – Advanced Financial Accounting and Reporting (AFAR) – Hand-out 1.

0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 1

PARTNERSHIP ACCOUNTING

I. Nature, Scope, and Objectives

• A partnership is defined as an association of two or more persons who contribute
money, property, or industry to a common fund with the intention of dividing the
profits among themselves.
• Accounting for a partnership should comply with the legal requirements
as set forth by the Partnership Law as well as complying with the partnership
agreement itself.
II. Formation of Partnership
• All assets contributed to the partnership are recorded by the partnership at their
agreed values (or fair market value, in the absence of agreed values).
• All liabilities assumed are recorded by the partnership at their net
present values.
• The capital account is an equity account. It is used to account for permanent
withdrawals and additional contributions.
• The drawing account is used to account for net income or loss and personal
or normal withdrawals.
• The loan accounts are set up for amounts intended as loans, rather than
as additional capital investments. In the liquidation process, loans to or loans
from a partner is in essence treated as an increase or decrease in a partner’s
capital accounts.
DISCUSSION PROBLEMS – PARTNERSHIP FORMATION

Problem 1. On December 1, 2023, A and B formed a partnership agreeing to share profits and
losses in the ratio of 2:3, respectively. Partner A invested a parcel of land that that cost
him 25,000. Partner B invested 30,000 cash. The land was sold for 50,000 on the same date,
three hours after the formation of the partnership. How much should be the capital balance of
Partner A after formation?

Problem 2. Jones and Smith formed a partnership with each partner contributing the following
items:
Jones Smith
Cash 80,000 40,000
Building – cost to Jones (fair value is 400,000) 300,000
Inventory – cost to Smith (fair value is 280,000) 200,000
Mortgage payable 120,000
Accounts payable 60,000
Assume that for tax purposes Jones and Smith agree to share equally in the liabilities assumed
by Jones and Smith partnership. What is the balance in each partner’s capital account for
financial accounting purposes?

III. Operations, Dissolutions, and Changes in Ownership of Interest of the Partners

A. Division of Profits and Losses
• The rules profit is allocated based on agreement. There are various methods
exist for the division of partnership profits and losses. The following are
common examples:
1. Equally;
2. Arbitrary Ratio;
3. Capital Contribution Ratio:
a. Original Capital or Initial Investment
b. Beginning Capital of each year
c. Average Capital
d. Ending Capital of each year
4. Interest on Capital Balance and/or Loan Balances and the balance on Agreed
Ratio;
Page 1 of 7
Sources:
Advanced Financial Accounting and Reporting (Theories and Problems) – Dayag, A. (2019)
 CAC – Advanced Financial Accounting and Reporting (AFAR) – Hand-out 1.0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 1
5. Salaries to Partners and the Balance on Agreed Ratio;
6. Bonus to Partners and the Balance on Agreed Ratio:
a. Bonus as an expense in computing the bonus account. The bonus is
computed based on net income after the bonus.
b. Bonus as a distribution of profit. The bonus is computed based on net
income before deducting the bonus.
7. Interest on Capital and/or Loan Balances, Salaries to Partners, Bonus to
the Partner, and the Balance on Agreed Ratio.
• If no method of sharing for profit or loss is specified in the
agreement, it shall be shared based on capital contribution – specifically,
the original capital contributed. If original capital data is not available,
use the beginning capital of each year.
• If an agreement in the sharing of profit is specified but no
agreement for losses, it shall be based on the sharing of profits.

DISCUSSION PROBLEMS – PARTNERSHIP OPERATIONS

Problem 3. Johnson and Pritchard are partners. They are changing the profit and loss ratios
from the current 60:40 to 70:30. At the date of the change, vacant land owned by the partnership
has a book value of 50,000 and a market value of 60,000. The partners choose to prepare an
itemized list of assets with market values different from book values. If the land is sold in
the future for 80,000, how much of the gain will be assigned to Johnson and Pritchard?

Problem 4. A, B and C are partners in the accounting firm. Their capital account balances at
year-end were A 90,000, B 110,000 and C 50,000. They share profit and losses on a 4:4:2 ratio,
after the following terms:
I. Partner C is to receive a bonus of 10% of net income after the bonus.
II. Interest of 10% shall be paid on that portion of a partner’s capital in excess of
100,000.
III. Salaries of 10,000 and 12,000 shall be paid to partners A and C, respectively.
Assuming a net income of 44,000 for the year, the total profit share of Partner C was:

B. Dissolution
• Dissolution occurs for three (3) reasons:
1. Admission of a New Partner
A new partner may be admitted to the partnership by:
a. Purchase of Interest
• This happens when a new partner enters the partnership by purchasing the
interest of an existing partner. The price paid for the interest is
irrelevant to the partnership accounting records because it is treated
as a private or personal transaction between the buyer and the seller.
• The assets and liabilities of the partnership are not affected.
• The capital account of the new partner is recorded by simply
reclassifying the capital account of the old partner.
b. Admission by Investment of Additional Assets
• A new partner may be granted an interest in the partnership in exchange
for contributed assets and/or goodwill. The admission of the new partner
may be recorded using:
i. Bonus Method
o This method is based on the historical cost
principle. This involves debiting cash or other
assets at their fair market value and crediting the
new partner’s capital for the agreed percentage.
o The total capital after admission will be equal to
the book value of the net assets before admission
plus the FMV of the asset contributed by the new
Page 2 of 7
Sources:
Advanced Financial Accounting and Reporting (Theories and Problems) – Dayag, A. (2019)
 CAC – Advanced Financial Accounting and Reporting (AFAR) – Hand-out 1.0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 1
partner. The difference between the FMV of the asset
contributed and the interest granted to the partner
results in the recognition of the bonus.
▪ No bonus recognized. When the incoming
partner’s capital is equal to the purchase price.
▪ Bonus granted to old partners. When the FMV
exceeds the amount of ownership interest credited to
the new partner. The bonus is allocated using their
income allocation ratio.
▪ The bonus is granted to a new partner. When
the FMV of the asset contributed is less than the
interest credited to the new partner. In this case, the
capital of old partners is reduced based on their P&L
ratio.
ii. Goodwill Method
o The standard provides that goodwill attaches only to a
business as a whole and is recognized only when a business
is acquired. This provision outlawed the use of the goodwill
method in partnership accounting.
2. Withdrawal of a Partner
Over the lifetime of the partnership, partners may leave the organization.
For the partner to retire or withdraw from the partnership, the total
interest of the partner should be properly determined which includes the
following:
i. Share in the profit or loss of the partnership
ii. Adjustments in assets and liabilities to reflect FMV
iii. Loans to and from the partnership
iv. Drawing accounts
v. Capital interest/accounts

Withdrawal or retirement from the partnership may either be:

i.
Selling of an interest to an outsider. This is similar to admission
by purchase.
ii. Selling of an interest to an existing partner. The interest of the
retiring partner will be purchased with the personal assets of
existing partners rather than with the assets of the partnerships.
iii. Selling of an interest to the partnership/payment from the partnership
fund. Under this approach, the withdrawal of the partner may be
treated as:
o Payment at BV
o Payment at less than BV – Bonus method
o Payment at more than BV – Bonus method
3. Incorporation of a Partnership
Partners of a partnership may choose to incorporate for a variety
of reasons. There are two approaches to open the corporate books:
i. Retain the books of the partnership and to record all
assets and liabilities at their FMV, closing the partners’
equity account, and opening Common Stock account.
ii. Close the partnership books completely and open a new set
of books for the corporation.
DISCUSSION PROBLEMS – PARTNERSHIP DISSOLUTION

Problem 5. Presented below is the condensed balance sheet of the partnership of KK,
LL, and MM who share profits and losses in the ration of 6:3:1, respectively:
Cash 85,000 Liabilities 80,000
Other assets 415,000 KK, capital 252,000
LL, capital 126,000

Page 3 of 7
Sources:
Advanced Financial Accounting and Reporting (Theories and Problems) – Dayag, A. (2019)
 CAC – AFAR – Handout 1.0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 1

________ MM, capital 42,000

Total 500,000 Total 500,000
The partner agreed to sell NN 20% of their respective capital profit and loss
interests for a total payment of 90,000. The payment by NN is to be made directly to
the individual partners. The capital balances of KK, LL and MM, respectively, after
admission of NN are:

Problem 6. Erika, Fredric, and Gustav are partners in a manufacturing concern.

Relevant data regarding income-sharing relationships and capital balances are as
follows:
Partner Capital Balances Income Share
Erica 150,000 35%
Fredric 100,000 30%
Gustav 200,000 35%
Fredric decides to retire and receives 145,000 in cash from the partnership.
Requirements:
I. If the bonus method is used to account for the retirement, Erica’s capital
balance subsequent to Fredric’s retirement will be:
II. If the excess payment is attributed entirely to goodwill and the partial
goodwill approach is used, goodwill will be recognized at:
III. If the excess payment is attributed to entirely goodwill, and the total
goodwill approach is used, Gustav’s capital balance after Fredric’s
departure will be:
IV. Using the partial goodwill approach, Erica’s capital balance, after
Fredric’s departure will be:

Problem 7. Partners Art and Tony, who share equally in profits and losses, have the
following balance sheet as of December 31, 2023:
Cash 120,000 A/P 172,000
A/R 100,000 Accum. Dep. 8,000
Inventory 140,000 Art, Capital 140,000
Equipment 80,000 Tony, Capital 120,000
Total 440,000 Total 440,000
They agreed to incorporate their partnership, with the new corporation absorbing the
net assets after the following adjustments: provision of allowance for bad debts of
10,000; restatement of inventory at its current fair value of 160,000; and recognition
of further depreciation on the equipment of 3,000. The corporation’s capital stock
is to have a par value of 100, and the partners are to be issued corresponding shares
equivalent to their adjusted capital balances. The total par value of the shares of
capital stock that were issued to partners Art and Tony was:

IV. Liquidation of Partnership

• Liquidation is the process of converting partnership assets into cash
and distributing the cash to creditors and partners. The creditor has
priority on any distribution. The basic rule is no distribution is made
to any partner until all possible losses and liquidation expenses have
been paid and provided for.
• The proceeds may be distributed using:
1. Lump-Sum Distribution
- This method with selling all assets and allocating the results of
gain or loss to the capital accounts of the partners using their
P&L ratio.
- The next step is satisfying the liabilities owing to creditors
other than partners.
- Afterward, settle the liabilities to partners other than capital
and profits.
- Lastly, distribute the remaining to partners for capital and
finally for profits.

Sources:
Advanced Financial Accounting and Reporting (Theories and Problems) – Dayag, A. (2019)
 CAC – AFAR – Handout 1.0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 1
-
Any deficiency of a solvent partner’s capital would require him
to contribute cash equal to the debit balance. If the deficient
partner is insolvent, the debit balance must be absorbed by the
remaining partners (usually, in their P&L Ratio).
2. Installment Distribution
- The liquidation process may take months, thus a need for an
installment distribution. This may be in the form of:
a. Schedule of Safe Payments
✓ This takes a conservative approach to the distribution
assuming that noncash assets are worthless, thus
distribution may be made to partners on the basis the value
of the partnership assets until the assets are sold.
b. Cash Priority Program
✓ Similar to lump-sum liquidation

DISCUSSION PROBLEMS – PARTNERSHIP LIQUIDATION

Problem 8. Larry, Marsha and Natalie are partners in a company that is being
liquidated. They share profits and losses 55:20:25, respectively. When the
liquidation begins, they have capital account balances of 108,000, 62,000, and
56,000, respectively. The partnership just sold an equipment with a historical cost
and accumulated depreciation of 25,000 and 18,000 respectively for 10,000. What is
the balance in Marsha’s capital account after the transaction is completed?

Problem 9. The assets and equities of the Queen, Reed, and Stacy Partnership at the
end of the fiscal year on October 31, 2025 are as follows:
Cash 15,000 Liabilities 50,000
Receivables – net 20,000 Loan from Stacy 10,000
Inventory 40,000 Queen, capital (30%) 45,000
Plant assets – net 70,000 Reed, capital (50%) 30,000
Loan to Reed 5,000 Stacy, capital (20%) 15,000
Total Assets 150,000 Total Liabilities and 150,000
Equity
The partners decide to liquidate the partnership. They estimate that the noncash
assets, other than the Loan to Reed, can be converted to 100,000 cash over the two
months period ending December 31, 2025.

Cash is to be distributed to the appropriate parties as it becomes available during

the liquidation process.
I. The partner most vulnerable to the partnership losses on liquidation is:’
II. If 65,000 is available for first distribution, it should be paid to
(Priority Creditors; Queen; Reed; Stacy):

Sources:
Advanced Financial Accounting and Reporting (Theories and Problems) – Dayag, A. (2019)
 CAC – AFAR – Handout 1.0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 1

Sources:
Advanced Financial Accounting and Reporting (Theories and Problems) – Dayag, A. (2019)
 CAC – AFAR – Handout 1.0
Topic: Partnership Accounting
Instructor: Marj Jules Lorain V. Juntilla, CPA
REV: 0

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