ACCOUNTING FOR PARTNERSHIP: Formation

A partnership is an association of two or more person who contribute money, property or industry to a common fund with the the intention of dividing profits among themselves. The person can be an individual, corporation or partnership themselves.


The reason why partnership is the upper hand to other form of business is that it allows the prospective owners to increase their capital easily without the complexity and formalities of  a corporation. Partnership is also easier to form and is commonly used by service profession like law, accounting and medicine.

Accounting for Partnership Formation

In the definition. the prospective owners are going to contribute either money, property or industry. And all these money and property are going to be the partnership's property. These investments are generally measured at fair value but specifically these are to be measured:

1. Cash investments - at face value, face value is actually the fair value of the cash
2. Other cash investments - Cash denominated in foreign currency is to be valued at current exchange rate
3. Noncash investments - at agreed value, normally agreed value is the fair value of the noncash investment. Fair value should be determined by independent valuation, but its more practical to determine the fair value base on the agreement of the partners. Hence, agreed value is preferred when there is conflict.
4. Services - only memo if there is no agreed value.
5. Liabilities - at Fair value, which is the present value of remaining cash flow.

NOTE:

• The accumulated depreciation of the related asset is not carried forward when forming a partnership
• Receivables is to be recorded at gross amount less allowance for doubtful accounts.

Capital Interest

It is the claim of a partner to the net assets (Capital) of the partnership. It can also be expressed using %, Example: A and B formed a partnership, A invested 50,000 while B invested 150,000. The net assets of their partnership is the sum of their investment which is 200,000. A has 25% capital interest and B has 75% capital interest (50/200 = .25 and 150/200 = .75)

Bonus and Revaluation Approach

Sometimes, the partners will agree to fix their capital interest by giving a bonus or recognizing an intangible asset.

Example: A and B formed a partnership, A invested 50,000 while B invested 150,000.

Bonus Approach: 

A and B agreed that they will both have 50% capital interest in the partnership.

To achieve this agreement, B will give 50,000 worth of bonus to A so that both of them will have a capital of 100,000.

Entry:

B, Capital 50,000

   A, Capital 50,000

Revaluation Approach:

In revaluation approach, A's capital should be increased by 100,000 to have the same capital with B. Here we assume that A is contributing something of value to the partnership that is intangible. For illustration purposes:

Agreed Capital (150,000/50%)                      300,000

less: Contributed capital (50,000 + 150,000) 200,000

Goodwill or intangible asset                          100,000

Entry:
Goodwill 100,000
  A, Capital 100,000

Note that we used the invested capital of B to determine the agreed capital  instead of A to yield a positive revaluation. If we used A's invested capital (50,000/50% = 100,000) it will lower than the contributed capital.

BONUS OR REVALUATION?

The bonus approach is the preferred approach, I'm not sure why but maybe because revaluation violates PFRS 3, which prohibits entities recognizing goodwill that was not acquired by purchase or acquisition.

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