ADVANCED FINANCIAL ACCOUNTING AND REPORTING

TOPIC 1: PARTNERSHIP ACCOUNTING

Definition of a Partnership

A partnership is "a contract whereby two or more persons bind themselves to contribute money, property, or industry
to a common fund, with the intention of dividing the profits among themselves."

Two or more persons may also form a partnership for the exercise of a profession. (GPP) Article 1767, Civil Code of the
Philippines.
LEGAL: Article 1767 to 1867, Civil Code of the Philippines
PROFESSIONAL: All PFRS including the conceptual framework, as applicable

Characteristics of a Partnership (SECMULI) Stages in the Life of the Partnership:

1. Separate legal personality 1. Formation – the first-time creation of the
2. Ease of formation partnership
3. Co-ownership of contributed assets 2. Operation – the reason why a partnership is
4. Mutual Agency, Mutual participation in the profits formed, to operate and earn "profit”
5. Unlimited liability 3. Dissolution – changes in the partnership
6. Limited life agreement or relations among the partners
4. Liquidation – realization of the assets of the
7. Income tax
partnership and settlement of partnership
liabilities.

1.1 PARTNERSHIP FORMATION

Primary formation issues include:

1. Valuation of contribution
2. Re-alignment of contribution with partnership agreement
Contribution
PFRS (External) Internal
 Money  
 Property  
 Industry x 
 *Opportunity Cost x 
 *Liability
 Assumed by the partnership  
 Assumed by the partner x x

Valuation of Contribution

1. Assets – contributed by the - partners to the partnership should be valued in the following order of priority:
a. Agreed values (Art. 1787 Civil Code)
When the capital or a part thereof which a partner is bound to contribute consists of goods, their appraisal
must be made in the manner prescribed in the contract of partnership, and in the absence of stipulation, it
shall be made by experts chosen by the partners, and according to current prices, the subsequent changes
thereof being for the account of the partnership. (Article 1787, Civil Code)

b. Fair values (Art. 1787 Civil Code & PFRS 2)

2. Liabilities – liabilities attached to assets contributed by the partners are recognized only in the partnership books to
the extent that they are assumed by the partnership. When assumed by the partnership, contributed liabilities operate
to decrease the contributed capital of the contributing partner; otherwise, the liabilities remain to be personal liabilities
of the contributing partner. Liabilities assumed by the partnership is valued in the following order of priority:
a. Agreed values (Art. 1787 Civil Code)
b. Fair value or Present value (Art. 1787 Civil Code & PFRS 2)

1
Re-alignment of contribution with partnership agreement
PFRS
TCC = TAC
a. Bonus method with cash settlement 
b. Bonus method without cash settlement 

TCC > TAC

a. Withdrawal 
b. Revaluation downwards 

TCC < TAC

a. Additional investment 
b. Revaluation upwards ?
c. Goodwill/unidentifiable x

PARTNERSHIP BOOKS TO BE USED

Individuals with no existing business New Books
Existing business and another existing New Books
business or individual with no existing Existing Books (Adjust the books first to align with the agreement, then close the
business books)

Capital Contribution vs. Capital Credit

Capital contributions represent the net assets invested by a partner whereas capital credit represents the agreed capital for a
partner. An accounting issue will arise when the two do not equal. Such difference is accounted for by either:
1. Bonus method – a transfer of capital from one partner to another.
2. Goodwill method – an increase in the partner's contributed capital as a result of recording an unidentifiable However,
goodwill method is not allowed under PFRS.
3. Revaluation method – an increase in the partner's contributed capital as a result of an adjustment to an identifiable
4. Additional investment – an increase in a partner's contributed capital as a result of additional investment
5. Withdrawal – a decrease in a partner's contributed capital because of withdrawal

If the partner's agreed capital is known, the partners will contribute an amount that will be the same as their agreed capital.
This method is known as net investment method.

1.2 PARTNERSHIP OPERATION

PARTNERSHIP OPERATION Allocation of Profit and Loss

No profit and loss sharing, no original capital?
Primary accounting issues include:  Industrial Partner
a. Profit or loss allocation o Net Income
b. Periodic adjustment of capital after operation o Net Loss
 Capitalist – Industrial Partner
Profit Division: o Net Income
a. Profit sharing agreement o Net Loss
b. Original capital

Loss Division:
a. Loss sharing agreement.
b. How profit is divided.

Arbitrary Allocation:

The partners may provide for the following methods of profit or loss distribution:

1. Salary – compensation for SERVICES; provided for regardless of the existence of profit because the provision of services
by a partner is independent from earning a profit.
 Time proportioned
 Theories
 Proprietary Theory
i. The partnership is owned by the parties
ii. Means distributing profit
iii. NOT considered as expenses
 Entity Theory – considered as EXPENSE

2
 2. Interest – compensation for USE OF PARTNER'S CAPITAL; provided for regardless of the existence of profit because
the use of the partner's capital is independent from earning a profit.
 Time proportioned
 Interest = Capital x Rate x Time

 Can be based on different capital ratio

 Average: Simple vs. Weighted Average
SIMPLE AVERAGE WEIGHTED AVERAGE
Included?
𝟏
= (𝐁𝐞𝐠𝐢𝐧𝐧𝐢𝐧𝐠 + 𝐄𝐧𝐝𝐢𝐧𝐠 𝐛𝐞𝐟𝐨𝐫𝐞 𝐂𝐥𝐨𝐬𝐢𝐧𝐠) 𝐱 Beginning Capital xx 
𝟐
Add: Investment xx 
Less: Withdrawals (Permanent) xx 
Drawings (Temporary) xx IT DEPENDS

Normally made in the

anticipation in the profits

3. Bonus compensation for GOOD PERFORMANCE; provided only when the partnership has profit and if there is a positive
balance in net income after deducting any salaries and interest. Expense Not Expenses (Silent)
 Given if the: Net income and Base is POSITIVE Net Income After Before
 Not time proportioned After expense BIS BIS

Bonus bases:
a. Before bonus: Bonus = Bonus rate x bonus factor
b. After bonus: Bonus = Bonus rate x [bonus factor/ (100% + bonus rate)]

Special Allocation
1. Distribution of profit in order of priority
2. Minimum profit sharing
3. Bonus, interest or salaries are regarded as expense

Statement of Partner's Capital

Beginning / Original Capital xx
Add: Additional Investment xx
Ending Capital Balance before Closing
Less: Withdrawals (xx)
Less: Drawings (xx)
Add: Share in Net Income Xx
Less: Share in Net Loss (xx)
Ending Capital xx

1.3 PARTNERSHIP DISSOLUTION

Dissolution is the change in the relation of the partners caused by any partner being disassociated from the business or by
change in agreements of the partners. This may include: (RAID)
1. Admission of a new partner
2. Retirement or withdrawal of a partner
3. Death of a partner
4. Incorporation of the partnership

Note: Please refer to your RFBT for the discussion of other modes of dissolution.

Dissolution Accounting Procedures:

1. Adjust the capital for share in profit or loss during the period up to the date of dissolution
2. Adjust the capital for any other agreement of the partners
3. Record the dissolution

3
ADMISSION OF NEW PARTNERS

1. Admission by purchase - this is a personal transaction between the new and existing partner(s)

Methods:
a. No adjustment or book value method - assets are not adjusted regardless of the amount paid by the new partner. A
personal gain (loss) is determined but not recorded in the partnership books.
b. With adjustment or revaluation method - assets of the existing partnership are adjusted based on the amount paid
by the new partner. A revaluation upwards (downwards) are shared by the existing partners.

2. Admission by investment this is a transaction between the new partner and the partnership

Methods:
a. Bonus method – bonus to old or new partner(s) of
b. Revaluation method – revaluation existing partnership
c. Goodwill method – goodwill to new or existing partners. This method however is not allowed under PFRS.
d. Withdrawal – withdrawal of assets as a result of re-alignment
e. Additional investment – additional investment as a result of re-alignment

RETIREMENT / WITHDRAWAL Sold to THIRD PARTIES

PURCHASE
Sold to OTHER PARTIES
Scenarios: Sold to the PARTNERSHIP ADMISSION BY INVESTMENT

Retiring or withdrawing partner's interest is sold to

1. One or more of the remaining partners

a. No adjustment or book value method assets are not adjusted regardless of the amount paid to the retiring/withdrawing
partner
b. With adjustment or revaluation method assets of the existing partnership are adjusted based on the amount paid to
the retiring/withdrawing partner

2. Outside party (with the consent of all partners)

a. No adjustment or book value method - assets are not adjusted regardless of the amount paid to the
retiring/withdrawing partner
b. With adjustment or revaluation method assets of the existing partnership are adjusted based on the amount paid to
the retiring/withdrawing partner –
PFRS
3. Partnership PP = BV 
a. Settlement > Net interest PP > BB
1. Bonus to retiring partner Bonus to Retiring 
2. Goodwill to retiring partner (not allowed under PFRS) Revaluation Upwards (All/Specific) ?
i. Total goodwill approach Goodwill (All/Specific) X
ii. Partial goodwill approach PP < BV
3. Revaluation (upwards) of the partnership Bonus to Remaining Partner 
Revaluation Downward (All/Specific) 
b. Settlement < Net interest
1. Bonus to remaining partners
2. Revaluation (downward) or write - down of assets of the partnership

c. Settlement = net interest: 

BEFORE AFTER
WHO? Partner Creditor
WHAT? Capital Liability
DEATH OF A PARTNER INTEREST Not an expense Expense

The death of a partner results in automatic dissolution of the partnership at the point of death.

Procedures:
1. Adjust the capital of deceased partner for share in profit or loss during the period up to the date of death
2. Adjust the capital for share in revaluation (if any) as at the date of death
3. The adjusted capital of the deceased partner shall be transferred to a liability account.
4. Interest payable to the estate is an expense on the books of the continuing partners.

4
INCORPORATION BEFORE AFTER
WHO? Partner Incorporator/Shareholder
WHAT? Capital Share Capital
Procedures:
1. Adjust the capital the partners for share in profit or loss during the period up to the date of incorporation
2. Adjust the capital the partners for share in revaluation (if any) as at the date of incorporation
3. The adjusted capital shall be transferred to share capital. Excess of the aggregate capital accounts over the par
value or stated value of shares of stocks issued to the partners is treated as share premium.

ASSIGNMENT OF INTEREST

A partner's interest may be assigned to:

1. Partnership - rules of retirement applies
2. Other partners - reclassification of capital
3. Third party
a. With consent of other partners - rules on formation apply
b. Without consent of other partners - no accounting issue

1.4 PARTNERSHIP LIQUIDATION

Liquidation is the winding up of the partnership business. This involves:

1. Converting non-cash assets into cash (i.e., realization)

2. Settlement of liabilities (i.e., liquidation)
3. Distribution of any remaining amount to the partners

Basic Concepts on Partnership Liquidation

1. Unlimited Liability – partners have unlimited liability hence external creditors can run after their separate personal
property in case the partnership asset is insufficient to satisfy their claims. The personal creditors; however, of a
partner is preferred over partnership creditors with respect to the personal assets of a partner. When a partner is
personally insolvent and has capital deficiency, the other solvent partners absorbs his capital deficiency.
2. Right of offset – the right of a partner to set-off his loan to the partnership against his capital deficiency

Steps to a partnership's liquidation

1. Any operating income or loss up date of the liquidation should be to the computed and allocated to the partner's
capital accounts on the basis of their P&L ratio.
2. All noncash assets are converted to cash. The gain (loss) realized on the sale of such assets is allocated to the
partners based on their P&L ratio.
3. Any creditors' claims, including liquidation expenses or anticipated future claims, are satisfied through the payment
or reserve of cash.
4. The remaining unreserved cash is distributed to the remaining partners in accordance with the balance in their capital
accounts. Note that this is not necessarily the P&L ratio.

Methods of Partnership Liquidation

When the partnership is to be liquidated by the sale of assets, the following methods may be used:

1. Lump-Sum Liquidation / Total Liquidation / Single Distribution

 All non-cash assets are realized into cash and one-time cash distributions to the creditors and partners

Procedures:
a. Record the realization of assets and distribute the realized gains or losses among the partners using the profit
and loss ratio.
b. Record the payment of liquidation expenses and distribute to the partners based on the profit and loss ratio
c. Payment of liabilities (external)
d. Elimination of partner's capital deficiencies. If after the distribution of loss on realization, a partner incurs a
capital deficiency (i.e., partner's share of realization loss exceeds his capital credit), this deficiency must be
eliminated by using one of the following methods, in the order of priority.
1. If the deficient partner has a loan balance, exercise the right of offset.
2. If the deficient partner is solvent, make him invest cash to eliminate his deficiency.
3. If the deficient partner is insolvent, let the other partners absorb his deficiency.

5
 e. Payment of partners (in order of priority):
1. Loan accounts
2. Capital accounts

2. Installment Liquidation / Installment Distribution

Cash distributions to partners are made once cash becomes available from the realization of non-cash assets

Procedures:
a. Record the realization of assets and distribute the realized gains or losses among the partners using the profit
and loss ratio.
b. Pay liquidation expenses and unrecorded liabilities, if there are any, and distribute these among the partners
using the profit and loss ratio.
c. Pay the outside creditors.
d. Distribute cash to the partners (in order of priority):
1. Loan accounts
2. Capital accounts

Methods of Installment Liquidation

1. Safe Payments Schedule

This schedule shows how much cash can be "safely" distributed to the partners by determining the amount of loss
(theoretical/assumed loss) required to eliminate each partner's capital account. Any positive balance in the partners'
capital balances represents the safe payments.

Theoretical loss or assumed loss NCA

SPS: Assumed Loss
a. Remaining noncash assets CE
b. Cash withheld for contingent Vulnerability
CPP: Law Ranking
Priority
2. Cash Priority Program

This schedule determines the order of priority of cash distribution to partners.

• Steps:
a. Compute for the total interest or partners' equity
b. Computer for the Loss Absorption Potential (LAP)* of each partner
c. Determine the priority of payments to partners
d. Compute the amount of cash to be paid to the partners under each priority by multiplying the incremental
differences in the partner's LAP and respective P&L

*Loss Absorption Potential = Total interest/P&L ratio

Assumptions in Installment Liquidation

1. The individual partners are assumed to be personally insolvent
2. The remaining noncash assets are deemed to be worthless (thus creating a maximum possible amount of loss).

Statement of Partnership Liquidation

The partnership liquidation schedule shows in detail all the transactions associated with the liquidation of the partnership.

Partner’s Equity/Interest
Partner’s Capital Balance X
Less: Drawing Accounts (If not yet closed) (X)
Add: Payable to Partner X
Less: Receivable from Partner (X)
Partner’s Equity/Interest X

Receivable Payable
1. Loans to Partner 1. Loans from Partner
2. Due from Partner 2. Due to Partner
3. Advances to Partner 3. Advances from Partner
4. Receivable from Partner 4. Payable to Partner

6
PARTNERSHIP ASSETS (General Partnership) Article 1839 (2), Civil Code
1. Those owing to creditors other than partner. (external creditors)
2. Those owing to partners other than for capital and profit. (internal creditors, payable to the partner)
3. Those owing to partners in respect of capital.
4. Those owing to partners in respect to profits.

PARTNERSHIP ASSET
1. Those owing to separate creditors.
2. Those owing to partnership creditors.
3. Those owing to partnership by way of contribution.

PARTNERSHIP ASSETS (Limited Parties)

1. Those owing to creditors other than partner. (external creditors)
2. Those owing to partners other than for capital and profit. (internal creditors, payable to the partner)
3. Those owing to partners in respect to profits.
4. Those owing to partners in respect of capital.