Partnership and Corporation Accounting

Chapter 1 Review of Accounting Process Nature of accounting  

Accounting is a service activity Accounting is the language of business

Function of accounting   

Main function – to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decision. Basic function – to record and report accurately the economic reality of the business. Audit function – to test the truthfullness of the financial reports, to trace fraudelent transactions and to locate and rectify accounting errors.

ACCOUNTING CYCLE 2

3 Transactions are recorded in the journal

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Journal entries are posted to the ledger

Identification of events to be recorded

4 Preparation of the trial balance

5 Preparation of the worksheet including adjusting entries

6 Preparation of the financial statements

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10 Reversing journal entries are journalized and posted

Adjusting journal entries are journalized and posted

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Closing journal entries are journalized and posted

Preparation of the post-closing trial balance 1

Chapter 2 Nature of Partnership Business Definition of PARTNERSHIP: “By the contract of the partnership, two or more persons bind themselves to contribute money, property and industry to a common fund with the intention of deviding the profits among themselves. Two or more persons may also form a partnership for the exercise of a profession.

CHARACTERISTICS OF A PARTNERSHIP

Based on contract

Mutual Agency

Association of individuals

Income Participation

Ease of Formation

Co-Ownership

Unlimited Liability

Limited Life

Assignment of Interest

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ADVANTAGES and DISADVANTAGES of PARTNERSHIP Advantages

Disadvantages

Ease of Formation

Unlimited Liability

Joint Resources

Mutual Agency

Tax Exemption

Consensual

Less Govenrment Supervision

Limited Life

Kinds of Partnerships 1. As to nature of business  Trading Partnership  Non-Trading Partnership 2. As to Purpose  Commercial Partnership  General Professional Partnership 3. As to Object  Universal Partnership o Of all present Partnership o Of Profits  Particular Partnership 4. As to Liability  General Partnership  Limited Partnership 5. As to Duration  Partnership at Will  Partnership with a fixed term

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6. As to Legality  De jure Partnership  De facto artnership

Kinds of Partners As to Contribution

As to Liability

As to Participation

As to third Persons

Capitalist Partner

General Partner

Managing Partner

Secret Partner

Limited Partner

Silent Partner

Dormant Partner

Liquidating Partner

Nominal or Ostensible Partner

Industrial Partner

Capitalist-Industrial Partner

Chapter 3 Accounting for Partnership Formation

ASSETS

=

LIABILITIES + CAPITAL

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Partnership Accounts    

Partner’s capital and drawing accounts Loans recievable from partners Loans payable to partners Loans to and from partners

Partner’s Capital Account -

It is a permanent account. Each partner has its own capital account which has a normal credit balance. The balance in the capita account represents the partner’s share in the net assets of the partnership.

Partner’s Drawing Account -

It is a temporary account and its periodically closed to the partner’s capital account. Each partner has its own drawing account to reflect temporary withdrawals and other minor amounts taken by the partner from the partnership in anticipation of his share in the partnership income.

Loans Recievable from Partners -

Also called “loans to partner” or “due from partners,” It represent the substantial advances made by the partners from the partnership with the intention of repaying it.

Loans Payable to Partners -

Also called “loans from partner” or :due to partner,” It represent the subtantial amounts lent to the partnership by the partner which the partnership is obliged to pay.

Loans to and from Partners -

This account titles is a combination of loans receivable from partner and loans payable to partners account. It represent both a claim and obligation. It is a claim when its balance is found on the debit side. If its balance is found on the credit side, it represent a liability.

Note: any loans between a partner and the partnership should always be accompanied by proper loan documentation, such as a promissory note. As in any other loan, a loan from a partner is shown as a payable on the partnership’s books.

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Partnership Formation    I.

Execution of partners’ agreement. Valuation of partners’ investments. Adjustment of accounts. Initial Investments by partners AMOUNT OF PARTNER’S CONTRIBUTION

Do partners agree upon their respective capital contribution?

II.

Contribute and record as per agreement.

YES

To be contributed equally.

NO

Valuation of partners’ contribution VALUATION OF PARTNERS’ CONTRIBUTION Is it cash contribution?

NO

YES

To be recorded at ACTUAL AMOUNT of cash contributed

Is it property

N

YE

Industry (skill/labor)

To be recorded at AGREED VALUE, otherwise at FAIR VALUE

Recorded in MEMORANDUM ENTRY form

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Recording Industrial Partner’s Contribution Mendoza, Capital Mendoza is an industrial partner Partnership profits.

to share 10% in the

Note: when the net income of the partnership has been distributed to the partners, the capital account of an industrial partner would have a journal entry equivalent to his share in the profit.

STAGES FROM WHICH PARTNERSHIPS ARE FORMED 1. First time in business – individual persons without existing business form a partnership 2. Convertion of single propriertorship to a partnership – this could be made when:  A sole proprietor admits into his business another individual who has no business of is own.  Two or more sole propriertorship converted into a partnership. 3. Admission of a new partner to an existing partnership – by nature, this is a form of dissolution of an old partnership which gives rise to the formation of a new partnership.

Actual investment method -

When the agreed partners’ capital shares are credited with the same value as their actual net contributed tangible assets, the approech of initial investment used is called “Actual Investment Method.”

Bonus Method BONUS METHOD Partnership’s Total Agreed Capital (TAC) = Partners’ Total Contributed Capital (TCC)

Is any of the partner’s agreed Capital Credit GREATER THAN his ACTUAL CONTRIBUTION?

YE

N

No Bonus

Additional Investments and Withdrawals There is a BONUS : The bonus is equal to the INCREASE of his actual capital contribution. 8

The partnership agreement should include guidelines regarding additional investments and withdrawals. The additional investment is recerded directly to the capital account. However, the accounting treatment of withdrawals would depend on whether the withdrawn amount is subtantial or irregular. Withdrawals in Large Amounts -

It is charge directly to the capital account of a withdrawing partner.

Withdrawals of Allowances -

The business rewards of partners are not in the form of a salary as the take-home pay of employees, but in the form of a share in the partnership profits.

Chapter 4 ACCOUNTING FOR PARTNERSHIP OPERATIONS The accounting for partnership operation is concerned with the following activities: 1. Accounting treatment of profit and loss - The profit and loss is subsequently distributed to the partners by closing the income summary account to the respective partners’ capital accounts. 2. Proper distribution of profit and loss Arbitrary agreements in Computing Profits and Losses  Equally  Specified ratio or percentage  Capital ratio o Original capital contribution o Beginning capital balance o Ending capital balance o Average capital balace  Simple average capital  Weighted average capital  Interest allowed on partner’s capitals, the remainder to be devided in an agreed ratio  Salaries or bonus allowed for partners’ services, the remainder to be devided in an agreed ratio  Multiple bases of allocation 3. Preparation of financial statements such as:  Income statement (Statement of Recognized Income and Expenses)  Statement of Financial Position  Statement of Changes in Partners’ Equity

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Salaries or Bonus Allowed for Partner’s Services

Salaries To recognize personal contribution by the partner to the business, they may agree to recieve salary, and devide the remaining profit among themselves by the agreed specified ratio., salary allowances are part of the net income / loss allocation to the partners.

Bonus A partnership agreement may provide that a managing partner be allowed a bonus on the earnings of the business to encourage profit maximination. Bonus = Bonus rate x Base net income (the base net income is always assumed to be 100%) The bonus may be based on the following net income:  Net income before deducting salaries, interest (if any) and bonus  Net income after deducting salaries and interest (if any) but before bonus  Net income after deducting salaries, interest (if any) and bonus

Distribution of Partnership Losses If there were partnership net loss, the partners’ salaries and interests on capital shall still be given to them. However the bonus to the managing partner shall be forfeited because bonuses are given as incentives for earnings, not for losses. General Professional Partnership - exemted from income taxes.

Chapter 5 ACCOUNTING FOR PARTNERSHIP DISSOLUTION

Nature Of Partnership Dissolution “ The dissolution of the partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business” -

dissolution terminates all the authority of any partner to act for the partnership. It does not necessarily mean an automatic terminaton of the business activities. The dissolved partnership may continue until the winding up or liquidation of partnership affairs is completed.

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Causes of Dissolution

Dissolution Ends the original partnerships agreement as caused by:  Admission or withdrawal of a partner  Insolvency of a partner  Death of a partner  Incorporation of partnership

Formation of a New Partnership Remaining partners may continue the business operation under a new partnership agreement.

Liquidation Partnership’s business activities are terminated and noncash assets are converted into cash to pay partnership’s creditors and distribute remaining assets to the partners.

Asset Revaluation The accounting process for the partnership dissolution requires that the existing partners’ capital accounts be updated first before dissolution. Accordingly, assets and liabilities of the partnership should be restated at thier fair market values to determine the fair and equitable capital balances of the existing partners. Negative Asset Revaluation Decreases the old partners capital balances as an effect of decreasing the value of the old partnership’s existing assets. Possitive Asset Revaluation Increases the old partners capital as an effect of increasing the value of the old partnership’s existing assets.

Accounting for Dissolution Admission of a New Partner 



By purchase of interest of existing partner(s)  Purchase of interest from one partner  Purchase of interest from all partners By direct investment to partnership  Investment equals capital credits  Bonus method

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ADMISSION BY INVESTMENT Partnership’s Total Agreed Capital (TAC) = Partners’ Total Contributed Capital (TCC)

Is the New Partner’s Agreed Capital Credit equal to his Actual Contribution?

NO

YES

No Bonus

There is Bonus

Bonus to the New Partner if his Capital Credit is GREATER THAN his Actual Contribution

Bonus to the Old Partner if the New Partner’s Capital Credit is LESSER THAN his Actual Contribution

BONUS METHOD Under this method, the total contributed capital is equal to the total partnership agreed capital, but some individual partners’ contribution is not equal to their respective capital credit because there is a transfer of capital from one partner to another. Withdrawal or Retirement of a Partner Whenever dissolution is made due to the withdrawal or retirement of a partner, he may sell his interest to the:  Outside Party  Remaining Partner(s)  Partnership

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Insolvency of Partnership or a Partner It is commonly a result of excessive losses from operations, the over-extension of credit to customers, or excessive investments in inventories or in plant assets. Dissolution Procedures when Partnership is Insolvent

Insolvent Partnership Dissolution Procedures

Are all general partners solvent?

NO

The solvent general partner will absorb the required payment to outside creditors and will have existing claim against the other general partners.

YES

The general partners must invest additional amount to pay the outside creditors.

Dissolution due to Death of a Partner Death is involuntary termination of one’s participation in the partnership which automatically dissolves the partnersip. The business activities of the partnership may continue with the remaining partners and an heir to serve the lieu of a deceased partner as provided in the partnership contract. Incorporation of a Partnership If the partnership is incorporated, the partners will become the stockholders of the corporation. The corporation then takes place over the assets and assumes the liabilities of the partnership. As a result, the partnership is dissolved.

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