Partnership and Cooperation

• Legal Definitions:

  • Article 1767 (Civil Code of the Philippines): A contract of partnership is formed when two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing profits among themselves. Two or more persons may also form a partnership to exercise a profession.

  • Section 6 (Uniform Partnership Act): A partnership is defined as an association of two or more persons to carry on as co-owners a business for profit.

  • Article 1768 (Civil Code of the Philippines): The partnership possesses a juridical personality separate and distinct from that of each of the partners. For example, if Vincent Fabela and Wilhelmina Neis establish a partnership, three distinct legal personalities exist: the partnership entity, Fabela, and Neis.

• Professional Partnerships vs. Commercial Operations:

  • A profession is an occupation requiring higher education or its equivalent, involving mental rather than manual labor. Strictly speaking, practicing a profession is not a commercial enterprise for profit, but the law allows professionals to form General Professional Partnerships (GPPs) for professions such as law, public accounting, and medicine.

  • Commercial or non-professional enterprises (service, retail trade, wholesale, and manufacturing) may also be legally organized as partnerships.

• Core Characteristics of a Partnership:

  • Mutual Contribution: A partnership cannot exist without contributions of money, property, or industry (personal manual labor or intellectual services) to a common fund.

  • Division of Profits or Losses: The essential purpose of the entity; every partner must share in the venture's profits or losses.

  • Co-Ownership of Contributed Assets: All assets contributed to the partnership become property of the firm by virtue of its separate juridical personality. Partners co-own contributed assets in a special joint sense.

  • Mutual Agency: Any partner can bind the other partners and the partnership to a contract provided they act within the scope of their express or implied authority.

  • Limited Life: A partnership is dissolved by the admission, death, insolvency, incapacity, or withdrawal of a partner, or by the expiration of the term specified in the partnership agreement.

  • Unlimited Liability: All partners (except limited partners), including industrial partners, are personally liable for all debts incurred by the partnership. If partnership assets are insufficient to settle obligations, creditors' claims are satisfied from the personal assets of the partners, subject to the rights of the partners' separate personal creditors.

  • Income Taxes: Partnerships (excluding General Professional Partnerships) are subject to income tax at a rate of $25\%$ of taxable income pursuant to R.A. No. $11534$ (CREATE Act). GPPs are exempt from income tax at the partnership level.

  • Partners' Equity Accounts: Accounting for partnerships resembles sole proprietorships, but separate capital and drawing (withdrawal) accounts are established for each individual partner.

Comparative Analysis: Partnership vs. Sole Proprietorship and Corporation

• Advantages and Disadvantages Relative to Sole Proprietorships:

  • Advantage: Provides greater financial capability and capital accumulation.

  • Advantage: Combines specialized skills, expertise, and operational experience of multiple partners.

  • Advantage: Offers relative freedom and flexibility of action in decision-making compared to corporations.

• Advantages and Disadvantages Relative to Corporations:

  • Advantage: Easier and less expensive to organize and establish legally.

  • Advantage: Operational atmosphere is more personal and informal.

  • Disadvantage: Easily dissolved and unstable compared to corporate perpetual existence.

  • Disadvantage: Mutual agency and unlimited liability create direct personal financial obligations for partners.

  • Disadvantage: Less effective than a corporation in raising large sums of capital.

• Structural Distinctions Between Partnership and Corporation:

  • Manner of Creation: A partnership is created by mere agreement of the partners; a corporation is created by operation of law.

  • Number of Persons: A partnership requires $2$ or more persons; a corporation requires incorporators not exceeding $15$ (a single stockholder may form a One Person Corporation under Sec. $10$ of the Revised Corporation Code of the Philippines).

  • Commencement of Juridical Personality: A partnership's juridical personality begins from the exact moment of execution of the Articles of Partnership; a corporation's personality begins only upon the issuance of its Certificate of Incorporation by the Securities and Exchange Commission (SEC).

  • Management: Every partner is an agent of the firm unless a managing partner is explicitly appointed; in a corporation, management is vested in the Board of Directors.

  • Extent of Liability: Partners (except limited partners) are liable to the extent of their personal assets; stockholders are liable only to the extent of their interest or investment in the corporation.

  • Right of Succession: A partnership has no right of succession (partner changes dissolve the firm); a corporation possesses the right of succession and continues existing regardless of the death, withdrawal, insolvency, or incapacity of directors or stockholders.

  • Terms of Existence: A partnership exists for any period stipulated by the partners; a corporation has perpetual existence (not to exceed 50 years) unless its Articles of Incorporation state otherwise (Sec. $11$, Revised Corporation Code).

Comprehensive Classifications of Partnerships and Partners

• Classifications According to Object:

  • Universal Partnership of All Present Property: All properties contributed by partners (current & existing) become part of the common partnership fund at formation.

  • Universal Partnership of Profits: The properties contributed (if any) are still owned by the individual partner and NOT by the partnership. Only the profits resulting from the utilization of the properties will form part of the partnership and divided among the partners.

  • Particular Partnership: Has for its object determinate things, their use or fruits, a specific undertaking, or the exercise of a professional practice or vocation. (Limited to a specific project).

• Classifications According to Liability:

  • General Partnership: Consists of general partners who are liable for partnership obligations to the extent of their separate personal properties.

  • Limited Partnership: Formed by one or more general partners and one or more limited partners. Limited partners are liable only to the extent of their individual capital contributions. Statutes mandate that a limited partnership must have at least one general partner.

• Classifications According to Duration:

  • Partnership with a Fixed Term: Formed with a stipulated duration or for a specific single undertaking.

  • Partnership at Will: No fixed term is specified, and the entity is not formed for a single definitive undertaking.

• Classifications According to Purpose:

  • Commercial or Trading Partnership: Formed for transacting business operations.

  • Professional or Non-Trading Partnership: Formed for the exercise of a profession.

• Classifications According to Legality of Existence:

  • De Jure Partnership: Has complied with all legal requirements for its formal establishment.

  • De Facto Partnership: Has failed to comply with all legal requirements necessary for its statutory establishment.

• Specific Kinds of Partners:

  • General Partner: Personal assets are liable for partnership debts after partnership assets are exhausted.

  • Limited Partner: Liable only to the extent of his capital contribution; prohibited by law from contributing industry or services only.

  • Capitalist Partner: Contributes cash or property to the common partnership fund.

  • Industrial Partner: Contributes technical knowledge, expertise, or personal services to the partnership.

  • Managing Partner: Designated by agreement to direct and manage firm operations. (Manager of the partnership).

  • Liquidating Partner: Designated to wind up or settle partnership affairs post-dissolution.

  • Dormant Partner: Does not take an active role in business operations and is not publicly known as a partner. (NOT KNOWN; NOT ACTIVE)

  • Silent Partner: Does not take an active role in business operations but is publicly known as a partner. (KNOWN; NOT ACTIVE)

  • Secret Partner: Takes an active role in managing operations but is not known to outside parties as a partner. (NOT KNOWN: ACTIVE)

  • Nominal Partner / Partner by Estoppel: Not an actual partner, but represents himself (or allows himself to be represented) as one.

Articles of Partnership, SEC Requirements, and PRC Accreditation

• Articles of Partnership Structure:

  • A partnership contract may be oral or written. When written, the agreement is embodied in the Articles of Partnership. Essential provisions include:

    1. Partnership name, nature, business purpose, and physical location.

    2. Names, citizenship, and residential addresses of all partners.

    3. Effective date of formation and stipulated duration.

    4. Capital contribution of each partner, valuation procedures for non-cash investments, treatment of excess contributions (as capital or loans), and financial penalties for failure to invest/maintain agreed capital.

    5. Specific rights, obligations, and operational duties of each partner.

    6. Selection of accounting period, nature of accounting records, preparation of financial statements, and mandatory audits by independent Certified Public Accountants (CPAs).

    7. Profit and loss distribution ratios, frequency of income measurement/distribution, and provisions recognizing differences in capital contributions.

    8. Stipulated drawings or salary allowances granted to partners.

    9. Arbitration protocols for settling internal disputes, dissolution rules, and liquidation procedures.

  • Statutory Invalidity Rule: A partnership contract is legally void whenever immovable property (real estate) or real rights are contributed and a signed inventory of said property is not attached to a public instrument.

• Securities and Exchange Commission (SEC) Registration Protocols:

  • Mandatory Threshold: If partnership capital is $\text{P}3,000$ or more in cash or property, the public instrument must be recorded with the SEC. If an entity fails to register, a partnership with capital of $\text{P}3,000$ or more remains legally valid and retains its separate juridical personality.

  • Corporate Accounting Restriction: The SEC shall not register any corporation organized for the practice of public accountancy pursuant to Section $28$ of the Philippine Accountancy Act of 2004.2004$.\n * *Purpose of Registration*: Establishes conditions for issuing business licenses, prevents tax evasion by large partnerships, and enables the public to verify firm membership and capital structure before conducting transactions.\n * *Step-by-Step SEC Registration Steps*:\n 1. Verify the proposed business name in the SEC Verification Unit. The name must include "Company" or "Co."; if a limited partnership, it must include "Limited" or "Ltd."; professional partnerships may use "Company", "Associates", "Partners", or similar terms (SEC Memorandum Circular 5, Series 2008).\n 2. Submit necessary documentation: Articles of Partnership, Business Name Verification Slip, written undertaking to change name if required, TIN of each partner and/or partnership, completed Partnership Registration Data 1/5\text{ of } 1\% of partnership capital (minimum $\text{P}1,000$), plus a Legal Research Fee equal to $1\%$ of the filing fee.\n 4. Forward documents to the SEC Commissioner for signature.\n\n* **Accreditation to Practice Public Accountancy**:\n * CPAs, audit firms, and CPA partnerships must register with the Professional Regulation Commission (PRC) and the Professional Regulatory Board of Accountancy.\n * Registration must be renewed every $3\text{ years}$ pursuant to Section $31$ of Republic Act $9298$ (Philippine Accountancy Act of $2004$) and Annex B of its Implementing Rules and Regulations.\n\n# Accounting for Partnerships: Capital, Drawing, and Loan Accounts\n\n* **Owners' Equity Structural Differences**:\n * Generally Accepted Accounting Principles (GAAP) apply equally to sole proprietorships and partnerships regarding asset, liability, revenue, and expense recording.\n * Unlike sole proprietorships (which utilize a single capital and single drawing account), partnerships maintain separate Capital and Drawing accounts for every partner.\n\n* **Partner's Capital Account Mechanics**:\n * *Debited for*: Permanent capital withdrawals; debit balance (net loss share) of the drawing account at the end of the accounting period.\n * *Credited for*: Initial net investment; additional net investments (contributed assets minus assumed liabilities); credit balance (net profit share) of the drawing account at the end of the accounting period.\n\n* **Partner's Drawing Account Mechanics**:\n * *Debited for*: Temporary withdrawals or regular periodic advances taken in anticipation of profits; direct share in net losses (if agreed to debit capital directly).\n * *Credited for*: Direct share in net profits (if credited to drawing rather than capital).\n * *Distinction*: Permanent withdrawals represent intentional long-term reductions in capital. Temporary withdrawals are regular advances against earnings. At period-end, drawing account balances are closed into the capital accounts.\n * *Accounting Method Choice*: If partners intend to maintain original investment levels, net profit or loss is closed to drawing accounts. If they intend to permanently integrate profits into capital, net profit or loss is closed directly to capital accounts. Final ending capital balances remain identical under both methods.\n\n* **Financial Statement Nomenclature Rules**:\n * Pursuant to revised International Accounting Standard (IAS) No. 1 (*Presentation of Financial Statements*, effective Sept. 6, $2017$, superseding $2003$ IAS 2 as amended in $2005$), the standard term **"profit or loss"** replaces "net income or net loss" on the Statement of Comprehensive Income. The balance sheet is titled the **Statement of Financial Position**.\n\n* **Accounting for Loans Receivable from / Payable to Partners**:\n * *Loans Receivable - Partner*: Substantial funds withdrawn by a partner with explicit intention to repay are debited to `Loans Receivable - Partner` (not drawing). Classified separately from general trade receivables.\n * *Loans Payable - Partner*: Funds advanced by a partner to the firm in excess of agreed permanent capital investments are credited to `Loans Payable - Partner`. Classified as liability accounts (distinct from outside creditors). In liquidation, loans payable to partners are paid after outside creditors' claims are fully satisfied, but hold absolute priority over partners' capital equity.\n\n# Valuation Rules and Pre-Formation Adjustments\n\n* **Asset Valuation Principles**:\n * Partnership books open with entries reflecting net contributions. Asset accounts are debited, liabilities assumed are credited, and capital accounts are credited for net investment (assets minus liabilities).\n * Non-cash assets contributed are recorded at values agreed upon by all partners. In the absence of an explicit agreement, assets are recorded at their Fair Market Value (FMV) at the date of transfer.\n * *Fair Market Value Definition*: Per IFRS No. 3, fair value is the price at which an asset or liability could be exchanged in a current transaction between knowledgeable, unrelated, willing parties in an arm's-length open market.\n\n* **Pre-Formation Book Adjustments for Existing Businesses**:\n * When prospective partners convert existing sole proprietorships into a partnership, individual proprietor books must be adjusted to reflect FMV and correct misstatements. Unadjusted books lead to inequitable capital credits.\n * *Underlying Principle*: Asset value appreciations or depreciations accruing prior to formation belong exclusively to the contributing partner.\n * *Accounting Mechanics for Adjustments*: Nominal income/expense accounts are not used prior to formation because the individual sole proprietorship ceases to be a going concern. All pre-formation adjustments to asset or liability values are debited or credited directly to the proprietor's individual Capital account.\n\n\n\n* *Accounting Equation Analysis for Pre-Formation Adjustments*:\n * Establishing an allowance for uncollectible accounts reduces net assets and decreases Owner's Equity.\n * Recognizing unrecorded prepaid expenses increases assets and increases Owner's Equity.\n * Recognizing omitted accrued liabilities increases liabilities and decreases Owner's Equity.\n\n# Detailed Accounting Procedures and Journal Entries for Formations\n\n* **Case 1: Formation by Individuals with No Existing Business**:\n * *Scenario*: On July 1, $2024$, Nilo Burgos and Helenita Ruiz form a partnership. Burgos contributes $\text{P}700,000$ cash. Ruiz contributes land with an agreed fair market value of $\text{P}1,300,000$, subject to a $\text{P}300,000$ mortgage assumed by the firm.\n * *Journal Entry*:\n * Debit: `Cash` = $\text{P}700,000$\n * Debit: `Land` = $\text{P}1,300,000$\n * Credit: `Mortgage Payable` = $\text{P}300,000$\n * Credit: `Nilo Burgos, Capital` = $\text{P}700,000$\n * Credit: `Helenita Ruiz, Capital` = $\text{P}1,000,000$\n * *(To record the initial capital contributions of Burgos and Ruiz)*\n * *Opening Statement of Financial Position (July 1, 2024)*:\n * Assets: Cash $\text{P}700,000$; Land $\text{P}1,300,000$; Total Assets = $\text{P}2,000,000$.\n * Liabilities & Owner's Equity: Mortgage Payable $\text{P}300,000$; Nilo Burgos, Capital $\text{P}700,000$; Helenita Ruiz, Capital $\text{P}1,000,000$; Total Liabilities & Equity = $\text{P}2,000,000$.\n * *Admission of Industrial Partner*: If Nora Elizabeth Maniquiz joins as an industrial partner contributing business expertise without financial/property assets, no monetary journal entries are made. A memorandum entry is recorded in the general journal.\n\n* **Case 2: Sole Proprietor and an Individual Form a Partnership**:\n * *Scenario*: On Oct. 1, $2024$, Galicano Del Mundo agrees to form a partnership with Marissa Dimarucat. Dimarucat invests cash equal to one-half ($50\%$) of Del Mundo's adjusted capital balance.\n * *Del Mundo's Ledger Balances Prior to Formation*:\n * Cash = $\text{P}60,000$\n * Notes Receivable = $\text{P}30,000$\n * Accounts Receivable = $\text{P}240,000$ (less Allowance for Uncollectible Accounts $\text{P}10,000$; Net = $\text{P}230,000$)\n * Merchandise Inventory = $\text{P}80,000$\n * Furniture and Fixtures = $\text{P}62,000$ (less Accumulated Depreciation $\text{P}8,000$; Net = $\text{P}54,000$)\n * Notes Payable = $\text{P}40,000$\n * Accounts Payable = $\text{P}100,000$\n * Galicano Del Mundo, Capital = $\text{P}314,000$\n * *Agreed Adjustments to Del Mundo's Books*:\n 1. Merchandise Inventory revalued at $\text{P}74,000$ (a $\text{P}6,000$ decrease).\n 2. Accounts Receivable evaluated as $95\%$ collectible. Target allowance = $5\% \times \text{P}240,000 = \text{P}12,000$. Existing allowance is $\text{P}10,000$, requiring a $\text{P}2,000$ increase in allowance.\n 3. Accrued interest on Notes Receivable recognized:\n * On $\text{P}10,000$ note at $12\%$ dated July 1 ($3\text{ months}$ elapsed): $\text{P}10,000 \times 12\% \times 3/12 = \text{P}300$.\n * On $\text{P}20,000$ note at $12\%$ dated Aug. 1 ($2\text{ months}$ elapsed): $\text{P}20,000 \times 12\% \times 2/12 = \text{P}400$.\n * Total Interest Receivable = $\text{P}700$.\n 4. Accrued interest on Notes Payable ($\text{P}40,000$ at $14\%$ per annum from April 1 to Oct. 1; $6\text{ months}$ elapsed): $\text{P}40,000 \times 14\% \times 6/12 = \text{P}2,800$ accrued interest payable.\n 5. Furniture and Fixtures revalued at $\text{P}46,000$ (book net value $\text{P}54,000$; requires a $\text{P}8,000$ increase in accumulated depreciation or asset write-down).\n 6. Office supplies on hand charged previously to expense equal $\text{P}4,000$ (recognized as asset).\n * *Adjustment Entries on Del Mundo's Books*:\n * Debit: `Office Supplies` = $\text{P}4,000$\n * Debit: `Interest Receivable` = $\text{P}700$\n * Debit: `Galicano Del Mundo, Capital` = $\text{P}14,100$\n * Credit: `Merchandise Inventory` = $\text{P}6,000$\n * Credit: `Allowance for Uncollectible Accounts` = $\text{P}2,000$\n * Credit: `Interest Payable` = $\text{P}2,800$\n * Credit: `Accumulated Depreciation` = $\text{P}8,000$\n * *(To record adjustments to restate Del Mundo's capital to $\text{P}299,900$)*\n * *Closing Entries on Del Mundo's Books*:\n * Debit: `Notes Payable` = $\text{P}40,000$\n * Debit: `Accounts Payable` = $\text{P}100,000$\n * Debit: `Interest Payable` = $\text{P}2,800$\n * Debit: `Allowance for Uncollectible Accounts` = $\text{P}12,000$\n * Debit: `Accumulated Depreciation` = $\text{P}16,000$\n * Debit: `Galicano Del Mundo, Capital` = $\text{P}299,900$\n * Credit: `Cash` = $\text{P}60,000$\n * Credit: `Notes Receivable` = $\text{P}30,000$\n * Credit: `Accounts Receivable` = $\text{P}240,000$\n * Credit: `Interest Receivable` = $\text{P}700$\n * Credit: `Merchandise Inventory` = $\text{P}74,000$\n * Credit: `Office Supplies` = $\text{P}4,000$\n * Credit: `Furniture and Fixtures` = $\text{P}62,000$\n * *(To close the books of Del Mundo)*\n * *Opening Entries on Partnership Books*:\n 1. **Del Mundo's Investment**:\n * Debit: `Cash` = $\text{P}60,000$\n * Debit: `Notes Receivable` = $\text{P}30,000$\n * Debit: `Accounts Receivable` = $\text{P}240,000$\n * Debit: `Interest Receivable` = $\text{P}700$\n * Debit: `Merchandise Inventory` = $\text{P}74,000$\n * Debit: `Office Supplies` = $\text{P}4,000$\n * Debit: `Furniture and Fixtures` = $\text{P}46,000$ *(recorded net at agreed value)*\n * Credit: `Notes Payable` = $\text{P}40,000$\n * Credit: `Accounts Payable` = $\text{P}100,000$\n * Credit: `Interest Payable` = $\text{P}2,800$\n * Credit: `Allowance for Uncollectible\n 2. **Dimarucat's Investment**n * Credit: `Marissa \n * Notes $\n * \n * Liabilities: No\textP}40,000; Accounts PayabEquity: Galicano Del Mundo\text{P}299,900$; Marissa Dimarucat, </span><span style="font-family: Arial, sans-serif; font-size: 1.6rem; color: rgb(231, 231, 231);">$)\n * Toal Liabilities & Owner's E; $; Corpuz</code><span style="background-color: rgb(0, 0, 0); font-family: Arial, sans-serif; font-size: 1.6rem; color: rgb(231, 231, 231);">\text{P}260,000</span>$.\n * **Esterlina Gevera**: Cash $\text{P}40,000$; $</span><span style="background-color: rgb(0, 0, 0); font-family: Arial, sans-serif; font-size: 1.6rem; color: rgb(231, 231, 231);">; </span><code>$.\n * *Agreed \n 1. Corpuz cash account shortage and unrecorded ex\text{P}3,500$($\text{P}50,000 - \text{P}3,500 = \text{P}46,500 ash).\n 2. Establish a \n 3. Gevera merchndise inventory increase).\n 4. Corpuz Furniture & Fixtures depreciated \n * \n * De\n * Merchandise the U.S. Internal Revenue Service (IRS) ruled that an LLC can be taxed as a partnership subject to specific conditions. All $50$ U.S. states legally recognize LLC structures.

  • Owners of an LLC are called members. Members may be individuals, partnerships, corporations, or other legal entities. Single-member LLCs are permitted in many jurisdictions.

  • Members maintain limited liability even if actively participating in company management. This structure protects owners from personal legal liability arising from other members' professional malpractice.

• Limited Liability Partnership (LLP) Characteristics:

  • An LLP is structurally similar to an LLC, but equity investment is legally restricted to licensed professionals.

  • The Big Four international public accounting firms (KPMG, Ernst & Young, PricewaterhouseCoopers, and Deloitte Touche) originated as general partnerships. As operating scope and legal risks increased, statutory enactments permitted them to convert by operation of law into LLPs.

  • Note: The legal concept of an LLP differs fundamentally from a statutory limited partnership.

  • Accounting Terminology for LLCs: Financial reporting mirrors partnership accounting, replacing the terms "partner" and "partner's equity" with "member" and "member's equity".