Partnership Formation

In order to form the partnership, partners have to invest in the entity. The investment may be in the form of fixed assets which is taken in the partnership business at the value as mutually decided among the partners.  The investment may be in the form of cash as well. 

Reasons for Partnership Formation

There are many reasons for building a partnershop firm. Most common are:

  • larger amount of capital can be raised because more than one persons invest in the business,
  • it is very easy to form a partnership, even you can set it up in a day.
  • partners contribute diverse skills, expertise and ideas into the business.
  • workload is shared among partners, so each partner can focus on its specific areas.

Essentials Features of Partnership Agreement

  • Though, partnership can be created orally. But, in order to protect the interest of each partner, it is always good to have the agreement in writing.
  • Agreement among partners is called Partnership Deed.
  • the deed must mention the way of distributing profits and losses among partners. They can decide to share equally or in other agreed ratio.
  • Interest on profits may be shared among existing partners according to the ratio of capital invested by each of them. Such amount is called Interest on Capital.Usually, this interest rate is decided and mutually agreed among partners is written in the deed document.
  • Whenever a partner draws funds from the partnership, it is referred to as drawing. Partners may decide to charge interest on drawing amount. Such interest is mentioned in the partnership deed on per annum basis. It is a penalty amount which reduces the profit share of the individuals in the firm.
  • If some of the partners take lead role or active role in managing the business, then he or she may be allowed to take reward which is called Partnership Salary.

Partnership accounting problems with answers

Example

Adam, Boon and Chelsey decided to form the partnership firm. They contributed as follows:

Adam – computers $500,000 and cash $300,000

Boon – cash 700,000 and stock 100,000

Chelsay – plant 280,000 and cash $520,000

Required:

Calculate the initial capital of each partner,

Pass journal entries for the above transaction in the books of partnership firm,

Prepare the statement of financial position/ balance sheet on the formation of the partnership.

Solution

Initial Capital Calculation

Adam – Cash 300,000 + computers 500,000 = $800,000

Boon – Cash 700,000 + stock 100,000 = $800,000

Chelsey – Cash 520,000 + plant 280,000 = $800,000

Journal Entries

Description Debit Credit
Cash 300,000   
Computers 500,000   
      Adam's capital   800,000 
     
Cash  700,000  
Stock 100,000   
     Boon's capital   800,000 
     
Cash  520,000  
Plant   280,000   
      Chelsey's capital    800,000

 

Example 2

Ryan and Smith were the main competitors in the shoe industry. Due to unhealthy competition between them, On May 15, 2014, they decided to form a new partnership entity with the name of RS & Co by merging out their businesses. On 15th May, 2014, their accounts balances are as follows:

 

Mr Ryan

Mr Smith

Cash

16,000

24,000

Account receivable

80,000

96,000

Inventory

64,000

40,000

Machinery – cost

120,000

96,000

Factory equipment – cost

56,000

64,000

Accumulated depreciation – machinery

64,000

32,000

Accumulated depreciation – factory equipment

24,000

40,000

Allowance for doubtful debts

5,600

3200

Accounts payable

64,000

76,000

In order to complete the formation of a new partnership, the following valuations were agreed upon between Ryan and Smith as follows:

Ryan:

Accounts receivable: $ 51,000, inventory at: $ 56,000 & machinery at: 30,000.

Smith:

Accounts receivable: $16,000, factory equipment: $10,000

Required

  1. Record the journal entries to form the new partnership,
  2. Make initial balance sheet of the newly established firm.

Solution

RS & Co.

Partnership Accounting Journal Entries

Particulars

Debit

Credit

In order to record the investment of Mr. Ryan, the following entry would be recorded:

Cash

Accounts receivable

Inventory

Machinery

Factory equipment

Accumulated depreciation – factory equipment

Accounts payable

Ryan capital

 

16,000

51,000

56,000

30,000

56,000

 

 

 

 

 

 

24,000

64,000

121,000

In order to record the investment of Mr. Smith, the following entry would be recorded:

Cash

Accounts receivable

Inventory

Machinery

Factory equipment

Accumulated depreciation – machinery

Accounts payable

Smith capital

24,000

16,000

40,000

96,000

10,000

 

 

 

 

 

 

 

32,000

76,000

78,000

RS & Co.

Balance Sheet

As at May 15, 2014

ASSETS

CAPITAL & LIABILITIES

Cash

Accounts receivable

Inventory

Machinery

Less: acc dep

Factory equipment

Less: acc dep

40,000

67,000

96,000

126,000

(32,000)

66,000

(24,000)

Accounts payable

Capital

Ryan

Smith

140

121,000

78,000

 

339,000

 

339,000

 

Partnership Question Partnership Formation

Mr Alan, Mr Bond and Mr Charlie created a partnership business with equal amount of capital as follows:

Mr Alan - cash 300,000, office equipment worth INR 500,000.

Mr Bond - cash 700,000 and merchandise for the balance amount.

Mr Charlie - machi nery worth INR 560,000 and cash for the balance amount.

As per their partnership deed, the capital of each partner would be equal to the capital of Mr Alan.

Required:

a. calculate the capital of each partner.

b. record entries in the general journal of the partnership firm for the above mentioned transactions.

c. prepare balance sheet on the formation of the partnership firm in the classifed form.

Solution

a. Calculation of initial amount of capital

Initial capital of Mr Alan

Cash                          300,000

Office equipment       500,000

Total capital               800,000

Initial capital of Mr Bond

Cash                          700,000

Office equipment       100,000

Total capital               800,000

Initial capital of Mr Charlie

Machinery                 560,000

Cash                         240,000

Total capital              800,000

b. General Journal Entries

Date

Particulars

Debit

Credit

 

Cash

Office equipment

Mr. Alan’s Capital

(To record investment in partnership business by Mr. Alan)

300,000

500,000

 

 

800,000

 

Cash

Merchandise

Mr. Bond’s Capital

(To record investment in partnership business by Mr. Bond)

700,000

100,000

 

 

800,000

 

 Cash

Machinery

Mr. Charlie’s Capital

(To record investment in partnership business by Mr. Charlie)

240,000

560,000

 

 

800,000

 

b. Balance Sheet

As on

Assets

Capital & Liabilities

Cash

Merchandise

Office equipments

machinery

1,240,000

100,000

500,000

560,000

Mr. Alan’s Capital

Mr. Bond’s  Capital

Mr. Charlie’s Capital

800,000

800,000

800,000

 

2,400,000

 

2,400,000

 

Partnership Accounting Example On Jan 1, 2017 Raju, Sanjay and Tendulkar formed a shoe manufacturing partnership. Each of the partners have strong reputation in the shoe industry and as a result, their venture could bring about significant benefits for every partner. They agreed to share profit & loss in the ratio of 1:2:3  respectively. The said ratio is based on the basis of capital contribution of each partner.

Raju, who is the oldest among all partners contributed with a cash money of INR 60,000 and machinery costing INR 120,000.

Sanjay who has vast experience in supply chain management contributed with furniture of INR 100,000 and with cash.

On the other hand, Tendulkar just contributed with cash balance.

Required

a. record entries in the general journal of the partnership.

Solution

First, we need to calculate capital of each partner.

Raju's capital (60,000 + 120,000)                           180,000

As Raju's shae of capital is  1/6th, so we can calculate total capital of the firm as follows:

Total capital of the partnership firm (6x180,000)     10,80,000

Now, we can easily calculate Sanjay and Tendulkar's capital a s follows:

Sanjay's capital (10,80,000 x 2/6)                            360,000        

Tendulkar's capital (10,80,000 x 3/6)                        540,000

 

Raju, Sanjay & Tendulkar Partnership

Journal Entries

Date

Particulars

Debit

Credit

 

Cash

Machine

Raju’s capital

(To record the contribution of raju in the partnership firm)

60,000

120,000

 

 

180,000

 

C ash

Furniture

Sanjay’s capital

(To record the contribution of Sanjay in the partnership firm)

260,000

100,000

 

 

360,000

 

Cash

Tendulkar’s capital

(To record the contribution of Tendulkar in the partnership firm)

540,000

 

540,000

 

Point to be noted: It should be noted that the value at which assets and liabilities are taken into the partnership are important for us. It does not matter what are their original value. The relevant value for partnership formation is the agreed value among the partners. So, simply ignore the actual value of the assets or liabilities. 

Question: Aiman and Fazila fomed a retial outlet for grocery named "Savers" with a capital investment of 1,000,000 of which Aiman has 40 % share while Fazila has 60 %. 

Aiman contributed with furniture which costs INR 400,000  at an  agrred value of 325,000. On the other hand, Fazila contributed in the partnership with equipment costing 350,000 but at an agrred value of 450,000. Apart from this, each partner invested necessary cash to meet the capital requirement.

Required

i. prepare journal entries to record the capital investment of Aiman and Fazila.

ii. prepare balance sheet of the newly formed partnership.

Solution

Savers Partnership

General Journal Entries

Date

Particular

Debit

Credit

 

Cash

Furniture

Aiman capital

(To record the investment of Aiman)

75,000

325,000

 

 

400,000

 

Cash

Equipment

Fazila capital

(To record the investment of Fazila)

150,000

450,000

 

 

600,000

Savers Partnership

Balance Sheet

As on ………..

Assets

Equities

Cash

225,000

Aiman capital

400,000

Furniture

325,000

Fazila capital

600,000

Equipment

450,000

   
 

1,000,000

 

1,000,000

 

Example:

Alex and Albert were conducting a business of selling high brand shoes in the major cities of UK. On June 05, they taken a big decision of merge their  business  and form a partnership under the name of AA & Co. On this date, the status of assets and liabilities were as under: 

 

Alan

Albert

Cash

Other assets

Accounts payable

80,000

400,000

100,000

120,000

480,000
160,000

The assets and liabilities of the Alan and Albert were taken at the book value in the newly established partnership firm. At the time of making a partnership deed, they mutually decided that the capital of each partner would be 420,000. In case of any deficiency, they will contribute from their private fund.

Required

As chief accountant of the partnership firm, you are required to prepare journal entries to record formation of the firm.

Solution

AA & Co.

Journal Entries

Date

Particulars

Debit

Credit

 

Cash

Other assets

Accounts payable

Alan capital

(To record investment from Alan)

80,000

400,000

 

 

100,000

380,000

 

Cash

Other assets

Accounts payable

Albert capital

(To record investment from Albert)

120,000

480,000

 

 

160,000

440,000

 

Cash

Alan capital

40,000

 

40,000

 

Albert capital

Cash

20,000

 

20,000

Contents
Financial Ratios Accounting Cycle Accounting Principles Financial Accounting Basics Financial Statements Reporting Bad Debts Current Assets Long-term Assets Voucher System Partnership Partnership Formation Withdrawal of Funds from Partnership Distribution of Profit or Loss in Partnership Revaluation of Assets in Partnership Admission of Partner(s) Retirement of a Partner in a Partnership Dissolution of Partnership - Partnership Liquidation Partnership accounting multiple choice questions and answers Pdf Depreciation Work Sheet - 10 Column Work Sheet Difference Between Reserve and Fund Accounting for Leases Capital reduction and reconstruction Absorption of Company Amalgamation Accounting for Installment Sales Basis of Recording Profit and Loss Branch Accounting Construction Contracts Revenue Recognition Accounting for Groups Financial Analysis Events After the Balance Sheet Date Deferred Tax Cost Accounting Activity Based Costing (ABC) Throughput Accounting Relevant Cost Break Even Analysis Standard Costing Inventory Management Payroll Accounting Royalty Accounting Statistics Master Budget Salary Income Microsoft Excel Tutorial Other Topics Share or Stock Valuation Model Financial Management Topics Kinds of Endorsement Letter of Credit, Kinds and Its Advantages/ Utilities Modern Functions of a Commercial Banks Difference Between Secured And Unsecured Loan Excel conditional formatting red if negative green if positive How to Remove Extra Spaces in Excel Result Card or Result Sheet Creation Using Excel Basic Accounting MCQS Multiple Choice Questions