INTRODUCTION TO PARTNERSHIP

DEFINITION OF PARTNERSHIP

UNDER ARTICLE 1767 OF THE PARTNERSHIP LAW

By the contract of partnership, two or more persons bind themselves to contribute money,
property, or industry to a common fund, with the intention of dividing the profit among
themselves. Two or more persons may also form a partnership for the exercise of a profession.

UNDER THE UNIFORM PARTNERSHIP ACT

An association of two or more persons to carry on, as co-owners, a business for profit. (Uniform
Partnership Act, Section 6).

Partnerships resemble sole proprietorships, except that there are two or more owners of the
business. Each owner is called a partner. Partnerships are often formed to bring together various
talents and knowledge or to bring needed capital into a business. Partnerships are generally
associated with the practice of law, public accounting, medicine and other professions.
Partnerships of this nature are called general professional partnerships. On the other hand,
service industries, retail trade, wholesale and manufacturing enterprises may also be organized as
partnerships.

CHARACTERISTICS OF PARTNERSHIPS

The characteristics of partnerships are different from the sole proprietorships already studied in
basic accounting. Some of the more important characteristics are as follows:

1. SEPARATE LEGAL PERSONALITY- A partnership has a juridical personality

separate and distinct from that of each of the partners. As such partnership can acquire
property, incur obligations, may sue and be sued.

2. MUTUAL AGENCY- Any partner can bind the other partners to a contract if he is
acting within his express or implied authority. Each partner can act as agent of the
partnership in matters which are within the nature of its business. Therefore, the act of
one partner binds the partnership if such acts fall into the category of carrying on
business in the usual manner.

3. LIMITED LIFE -A partnership has a limited life. It may be dissolved by the admission,
death, insolvency, and incapacity, withdrawal of a partner or expiration of the term
specified in the partnership agreement.

4. UNLIMITED LIABILITY -All partners (except limited partners), including industrial

partners, are personally liable for all debts incurred by the partnership. If the partnership
cannot settle its obligations, creditors' claims will be satisfied from the personal assets of
the partners without prejudice to the rights of the separate creditors of the partners.

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 5. DIVISION OF PROFITS OR LOSSES -The essence of partnership is that each partner
must share in the profits or losses of the venture. The profit or loss is divided among the
partners in accordance with their agreement. In the absence of any stipulation, profits or
losses will be shared by the partners in the ratio of their actual contributions in the
business. Industrial partners, however does not share in the losses.

CONCEPT OF PARTNERSHIP
1. A partnership is an association of two or more persons
2. A partnership is a legal relation.
3. A partnership is a joint undertaking
4. A partnership is the status arising out of a contract
5. A partnership is an organization.
6. A partnership is an entity.

KINDS OF PARTNERS

1. GENERAL PARTNER- One who is liable to the extent of his separate property after all
the assets of the partnership is exhausted.

2. LIMITED PARTNER- One who is liable only to the extent of his capital contribution.

3. CAPITALIST PARTNER- One who contributes money or property to the common fund
of the partnership.

4. INDUSTRIAL PARTNER- One who contributes his knowledge or personal service to

the partnership.

5. DORMANT PARTNER - One who does not take active part in the business of the
partnership and is not known as a partner.

6. SILENT PARTNER - One who does not take active part in the business of the
partnership though may be known as a partner.

7. SECRET PARTNER. - One who takes active part in the business but is not known to be
a partner by outside parties.

8. NOMINAL PARTNER - One who is actually not a partner but who represents himself
as one. A partner who has no contributions to the partnership at all but permits his name
to be used by the firm.

9. CAPITALIST-INDUSTRIAL PARTNER – One whose contributions to the partnership

consist of money, property and services.

ARTICLES OF PARTNERSHIP/PARTNERSHIP CONTRACT

- A partnership is created under a voluntary contract, which may either be written or verbal,
containing all the essential elements of an enforceable contract. Good business practice,

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however, requires that this partnership contract be in writing, to ensure a clearer and better
enforcement of its provisions. This written contract is called the Articles of Co-partnership or
simply Articles of Partnership containing such important provisions as the following:
1. Name of Partnership
2. Nature and purpose of the partnership
3. Location or place of business
4. Name of Partners
5. Agreed capital contribution of each partner, in terms of amount and specific form
6. Power, duties, authority, and limits of authority of each partner
7. Method(s) of division of profit and loss
8. The accounting period and the accounting records to be used
9. Partners’ investment and withdrawals subsequent to partnership formation
10. Provisions on arbitration of disputes among partners
11. Provisions on partnership dissolution or liquidation

KINDS OF PARTNERSHIP

Partnerships are classified as follows:

1. TRADING AND NON-TRADING PARTNERSHIP – a trading partnership is one
engaged in the manufacture or the purchase and sale of merchandise; while non-trading
partnership is one engaged in rendering services.

2. GENERAL AND LIMITED PARTNERSHIP – A GENERAL PARTNERSHIP is one

in which all the partners are general partners. A LIMITED PARTNERSHIP on the other
hand, is one wherein some of the partners have a limited liability for partnership debts
which is equal to the actual invested capital in the business.

3. UNIVERSAL AND PARTICULAR PARTNERSHIP – a universal partnership is of

two types, namely: a universal partnership of all present property and a universal
partnership of profits. A UNIVERSAL PARTNERSHIP OF ALL PRESENT
PROPERTY is one wherein the partners contribute to the common fund. It is the
intention of the partners to divide the property and all the profits that will be earned on
the property among themselves. A UNIVERSAL PARTNERSHIP OF PROFIT is a
partnership which is defined under article 1778 of the Partnership Law as one which
comprises all that the partners may acquire by their industry or work during the existence
of the partnership. A PARTICULAR PARTNERSHIP is an organization of two or more
persons who combine themselves to undertake a single individual transaction or
enterprise and divide among themselves the profits or whatever benefits that would be
derived therefrom.

ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP

A partnership offers certain advantages over a sole proprietorship and a corporation. It also has a
number of disadvantages. They are as follows:

ADVANTAGES VERSUS PROPRIETORSHIPS

1. Brings greater financial capability to the business.

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 2. Combines special skills, expertise and experience of the partners.
3. Offers relative freedom and flexibility of action in decision-making.

ADVANTAGES VERSUS CORPORATIONS

1. Easier and less expensive to organize.
2. More personal and informal.

DISADVANTAGES
1. Easily dissolved and thus unstable compared to a corporation.
2. Mutual agency and unlimited liability may create personal obligations to partners.
3. Less effective than a corporation in raising large amounts of capital.

PARTNERSHIP DISTINGUISHED FROM CORPORATION

MANNER OF CREATION - A partnership is created by mere agreement of the partners while

a corporation is created by operation of law.

NUMBER OF PERSONS - Two or more persons may form a partnership; in a corporation, at

least five (5) persons, not exceeding fifteen (15).

COMMENCEMENT OF JURIDICAL PERSONALITY - In a partnership, juridical

personality commences from the execution of the articles of partnership; in a corporation, from
the issuance of certificate of incorporation by the Securities and Exchange Commission.

MANAGEMENT - In a partnership, every partner is an agent of the partnership if the partners

did not appoint a managing partner; in a corporation, management is vested on the Board of
Directors.

EXTENT OF LIABILITY - In a partnership, each of the partners except a limited partner is

liable to the extent of his personal assets; in a corporation, stockholders are liable only to the
extent of their interest or investment in the corporation.

RIGHT OF SUCCESSION - In a partnership, there is no right of succession; in a corporation,

there is right of succession. A corporation has the capacity of continued existence regardless of
the death, withdrawal, insolvency or incapacity of its directors or stockholders.

TERMS OF EXISTENCE- In a partnership, for any period of time stipulated by the partners; in
a corporation, not to exceed fifty (50) years but subject to extension.

FORMATION OF A PARTNERSHIP

WAYS OF ORGANIZING A PARTNERSHIP

A partnership is organized at least two persons who will contribute cash, property or service into
the firm.

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A partnership is formed between the owner of and existing sole proprietorship and an individual,
with the former contributing his entire business and the latter investing cash or property.
Two or more existing sole proprietorship are merged or combined to form a partnership, wherein
the owners will both contribute their entire business as their capital investments.

PARTNERS' EQUITY ACCOUNTS-Accounting for partnerships are much like accounting for
sole proprietorships. The difference lies in the number of partners' equity accounts. Each partner
has a capital account and a withdrawal account that serves similar functions as the related
accounts for sole proprietorship.

PARTNERSHIP ACCOUNTS

As a rule, the account titles used in the accounting for sole proprietorship’s operation are also
used in the accounting for partnerships. However, some accounts of the partnership differ from
the sole proprietorship such as the following:
1. Partner’s capital and drawing accounts
2. Loans receivables from partners
3. Loan payable to partners

PARTNER’S CAPITAL ACCOUNT

A partner’s capital account is a permanent account. Each partner shall have his own capital
account which has a normal credit balance. The balance in the capital account represents the
partner’s shares in the net assets of the partnership.

A partner’s capital account gives information on the increase or decrease in his interest in the
partnership.

Occasionally, a partner’s capital account may have a debit balance called a deficiency –
sometimes termed as a partner deficit – which occurs because the partner’s share in losses and/or
withdrawals exceeds his capital contribution and share of profits. A deficiency is usually
eliminated by additional capital contributions.

PARTNER’S DRAWING ACCOUNT

A partner’s drawing account is a temporary account and is periodically closed to the partner’s
capital account. Each partner shall have his own drawing account to reflect temporary
withdrawals and minor amounts taken by the partner from the partnership.

LOANS RECEIVABLE FROM PARTNERS

Also called loans to partner or due from partner, represent the substantial advances made by the
partners from the partnership with the intention of paying it. Thus, the partner’s capital/drawing
account is not used to describe the partner’s withdrawals because of the creditor-debtor
relationship between the partnership and the partner.

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The loan receivable from partner account is generally classified as part of the current assets
except when the agreed collection period extends beyond the one-year period. Loans receivable
from partners is clearly distinguished from receivables from outsiders.

ISSUES IN CAPITAL CONTRIBUTION

The accounting issues regarding capital contribution are how much the contribution to be made
by the partners and at what amount the capital contribution should be recognized.

The answers to these issues depend on whether the partners agreed on their respective individual
contribution and whether cash or non-cash contributions are made.

The following rules shall then be observed when capital contribution issues will arise
1. AMOUNT OF CONTRIBUTION- shall be based on the partners’ agreement. In the
absence of any agreement, it shall be contributed equally.

2. VALUATION OF ASSET CONTRIBUTION – if cash contribution is made the face

amount of cash is the value to be recognized. If non-cash contribution is to be made, it
shall be recorded at agreed value; otherwise it will be recorded at the fair value of the
property to effect fair and equitable valuation.

STAGES FROM WHICH PARTNERSHIPS ARE FORMED

The complexity of accounting for partnership formation depends on the stage from which a
partnership is formed. These stages would be

1. FIRST TIME IN BUSINESS – individual persons without existing business formed a

partnership.

2. CONVERSION OF A SINGLE PROPRIETORSHIP TO A PARTNERSHIP –this

could be made when:
 A sole proprietor admits to join his business to another individual, who has no
business of his own.
 Two or more sole proprietorship converted into partnership.

3. ADMISSION OF A NEW PARTNER TO A PARTNERSHIP – by nature, this is a

form of dissolution of an old partnership which gives rise to the formation of a new
partnership.

RECORDING CONTRIBUTIONS/INVESTMENTS

-CASH CONTRIBUTION ONLY:

Example – on Aug. 16, 2015, A. Santos and M. Roque formed a partnership named Jireh Trading
with initial contributions of P250,000 and 150,000 respectively.

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The opening entry in the books of partnership is:
Cash 400,000
A Santos, Capital 250,000
M Roque, Capital 150,000
To record partner’s original contributions

-CASH AND NON CASH CONTRIBUTIONS

Example – on July 30, 2015, E. Garcia contributed cash of 120,000 and service equipment of
280,000. R. Fernandez contributed Cash of 80,000 and Delivery Truck with a fair value of
300,000.

The opening entries in the books of partnership are as follows:

Cash 120,000
Service Equipment 280,000
E Garcia, Capital 400,000
To record the initial investment of E. Garcia

Cash 80,000
Delivery Truck 300,000
R. Fernandez, Capital 380,000
To record the initial investment of R. Fernandez

A compound entry may also be prepared to record their initial contributions as follows:

Cash 200,000
Service Equipment 280,000
Delivery Truck 300,000
E Garcia, Capital 400,000
R. Fernandez, Capital 380,000
To record the initial investment of the partners

CAPITALIST AND INDUSTRIAL PARTNERS FORMING A PARTNERSHIP

Suppose, as in case E. Garcia and R. Fernandez agreed to form a partnership wherein E. Garcia
contributes cash of 120,000 and service equipment of 280,000, while R. Fernandez is to act as
industrial partner with a 40% share in the profits, the journal entry to record E. Garcia’s
investment will be:
Cash 120,000
Service Equipment 280,000
E Garcia, Capital 400,000
To record the initial investment of E. Garcia

A memorandum entry for the membership of R. Fernandez in the partnership books would
be as follows:
2015
July 30 – R. Fernandez is to act as industrial partner with a 40% share in the net profit.

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FORMATION OF PARTNERSHIP WHERE ONE OF THE PARTNERS IS ALREADY IN
BUSINESS

Where one of the partners is already engaged in business, before the partnership is organized,
both of them may agree that certain corrections or adjustments are to be made in the books of
accounts. Hence, asset values are adjusted through the owner’s capital account.

There are certain rules in the correction of values, as follows:

1. To increase the value of asset:
Debit: Appropriate Asset Account
Credit: Capital

2. To decrease the value of asset:

Debit: Capital
Credit: Appropriate Asset Account
These rules are applicable if the assets have no valuation account.

3. To adjust the values of fixed assets which have a valuation account such as accumulated
depreciation account, corrections of said fixed assets are made through this valuation
account:
 To increase the net amount of a fixed asset:
Debit: Accumulated Depreciation
Credit: Capital

 To decrease the net amount of a fixed asset:

Debit: Capital
Credit: Accumulated Depreciation

4. To adjust the value of accounts receivable, corrections are made through the allowance
for bad debts account.
 To increase the net amount of accounts receivables:
Debit: Allowance for Bad Debts
Credit: Capital
 To decrease the net amount of accounts receivables:
Debit: Capital
Credit: Allowance for Bad Debts

ADMISSION OF A NEW PARTNER IN PARTNERSHIP

When a new partner joins a partnership the old partnership is dissolved and a new partnership is
formed. Accounting for admission of new partner depends on the nature of arrangement between
the existing partners and the new partner. Such an arrangement can take any of the following
forms:
a. The new partner brings/invests in new assets
b. The new partner purchases interest in partnership from existing partners at book value

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 c. The new partner pays a bonus for the partnership's goodwill; and
d. The new partner receives a bonus for the partnership's negative goodwill.

New Partner Brings Additional Assets

When the new partner brings in new assets, the assets are debited at the value agreed by the
partners for the purpose and the partner's capital account is credited for the total value of those
assets.

Example 1
Pluto and Sedna were partners in Kuiper Space Consulting. Their respective capital balance was
45 million and 25 million. In 2005 they agreed to admit Eris who agreed to contribute a very
specialized telescope worth 20 million.
The admission through introduction of new assets is recorded by the following journal entry:

Telescope 20,000,000
Eris Capital Account 20,000,000

The new partner purchases his share from existing partners at book value.

New Partner Purchases Interest in Partnership from Existing Partners at Book Value
When the new partner purchases interest from existing partners at book value, the transaction is
recorded by crediting the capital account of the new partner and debiting the capital account of
existing partner(s). The transaction is reported in the books for the partnership at the book value
of the share transferred and it has nothing to do with the price which the new partner has paid to
the existing partner(s).

Example 2
Refer to Example 1 and assume that Eris purchased 25% of share of Pluto in KSC for 15 million
and 45% share of Sedna for 10 million.

For the purpose of accounting for the above transaction, we have to work with book values of the
transferred shares. The consideration at which the transfer is made between Pluto, Sedna and Eris
is not relevant because it is the partners' personal transaction. We just need to debit Pluto's capital
account by 11.25 million (25% of 45 million) and Sedna's capital account by 11.25 million (45%
of 25 million) and credit Eris capital account by 22.5 million (11.25 million worth of book value
purchased from Pluto and 11.25 million worth of book value purchased from Sedna). From
looking at the transaction, we see that Pluto sold the share at profit but Sedna sold it at a loss. But
all this is not relevant for accounting purpose in the given arrangement.

New Partner Pays a Bonus for Goodwill

When a partnership has good reputation and a profitable client base, new partners are normally
required to pay a hefty bonus for goodwill i.e. they introduce assets in excess of the book value
of the share they get in the firm. In such a situation, the bonus (which equals the assets they
introduce minus the book value of the share they get in the partnership) is credited to the existing
partners' capital accounts.

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Example 3
Refer Example 1 and assume that Eris brings in cash worth 40 million but in return it gets a
capital share of only 25 million. Any payment bonus representing goodwill is shared equally by
Pluto and Sedna.

The 15 million representing excess of assets introduced over the book value of the share
represents the bonus paid to the existing partners. This bonus is credited to Pluto's and Sedna's
capital accounts in a ratio agreed in the partnership agreement. (In their mutual profit sharing
ratio if no such provision exists the agreement). It is journalized as follows:

Cash 40,000,000
Eris Capital 25,000,000
Pluto Capital (15 million/2) 7,500,000
Sedna Capital (15 million/2) 7,500,000

New Partner Receives a Bonus for Negative Goodwill

Every partnership is interested in recruiting influential partners that could prove key in business
development. Existing partners might be willing to offer a bonus to a new partner i.e. they might
offer him a share in the book value of the partnership's equity which is in excess of assets
contributed by him. When this is the case, the existing partners share the bonus paid either in the
accordance with the partnership agreement or in their profit sharing ratio or equally. The
transaction is accounted for by debiting each partner’s capital account by their respective shares
of bonus paid and crediting the total bonus amount to the new partner's capital.

Example 4
Refer Example 1 and assume that Eris brings in cash worth 40 million but in return it gets a
capital share of 60 million. Any exchange of bonus is shared equally by Pluto and Sedna.

The 20 million representing excess of the Eris's share in partnership capital over his contribution
represents the bonus he receives for the 'negative goodwill'. The bonus is born by Pluto and
Sedna equally and transaction is journalized as follows:
Cash 40,000,000
Pluto Capital (15 million/2) 7,500,000
Sedna Capital (15 million/2) 7,500,000
Eris Capital 60,000,000

WAYS OF DIVIDING PROFITS AND LOSSES

Each partner is entitled to receive a share in the profits earned by the business. The profit or loss
of the partnership is divided among the partners according to their agreement and as set forth in
the partnership contract. In the absence of any stipulation, however, said profit or loss may be
distributed among them in the ratio of their actual capital contributions in the business.

There are different methods of distributing profits or losses such as the following:
1. Equally
2. Arbitrary Ratio (Percentage or Fractional)

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 3. Capital Ratio
 Original Capital Ratio
 Beg. Capital Ratio
 Ending Capital Ratio
 Average Capital Ratio
4. Allowing interest to partners, balance; equally or in agreed ratios.
5. Allowing both salaries and interest to partners, balance; equally or in agreed ratios.
6. Allowing interest, salaries and bonus to partners, balance in agreed ratios.

Distribution of Partnership Income Accounting

Once net income is allocated to the partners, it is transferred to the individual partners' capital
accounts through closing entries. Remember that allocating net income does not mean the
partners receive cash. Cash is paid to a partner only when it is withdrawn from the partnership.

Suppose for example, a partnership is formed between two people, partner A and partner B,
sharing net income and net losses equally (income sharing ratio of 1:1).

If the net income for the year is 40,000 then the following double entry bookkeeping entries
would be made:
Income Summary 40,000
Capital A 20,000
Capital B 20,000
Distribution of Partnership Income

The net income of 40,000 is shared equally between the two partners by transferring 20,000 to
each of the capital accounts.

Distribution of Partnership Income and Drawings

If partner A had drawings during the year of 5,000 this would now need to be transferred to the
capital account with the following journal.
Capital A 5,000
Drawing A 5,000

The capital of partner A is reduced by the drawings of 5,000.

Distribution of Partnership Income and Salaries

If the net income of the partnership was 40,000 but partner B had a salary of 15,000, then the
amount to be distributed equally would be 40,000 – 15,000 = 25,000, so each partner would
receive 25,000 / 2 = 12,500. The allocation of net income would be as follows:

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 A B Total
Salary 0 15,000 15,000
Capital 12,500 12,500 25,000
Total 12,500 27,500 40,000

Distribution of Partnership Income – With Salaries

The double entry bookkeeping journal to record the allocation of net income would be as
follows:
Income Summary 40,000
Capital A 12,500
Capital B 27,500

Distribution of Partnership Income and Interest

If the net income of the partnership was 40,000 but partner A receives interest on the opening
capital balance of 30,000 at 5%, then partner A would receive interest of 30,000 x 5% = 1,500.

The amount to be distributed equally would be 40,000 – 1,500 = 38,500, so each partner would
receive 38,500 / 2 = 19,250. The allocation of net income would be as follows:

Account A B Total
Interest 1,500 0 1,500
Capital 19,250 19,250 38,500
Total 20.750 19,250 40,000

The double entry bookkeeping journal to record the allocation of net income would be as
follows:
Income summary 40,000
Capital A 20,750
Capital B 19,250

In practice any combination of salary and interest can be deducted using an allocation table, and
the resulting net income or loss is then shared out between the partners in the income sharing
ratio.

It should be noted that the salary and interest is charged even if the partnership has made a loss,
the resulting net loss is then allocated to the partners according to the sharing ratio.

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FINANCIAL STATEMENT OF THE PARTNERSHIP

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DISSOLUTION OF A PARTNERSHIP

CAUSES OF DISSOLUTION
1. Sale of Partner’s Interest
2. Sale of Partnership Business
3. Death of a Partner
4. Admission of a New Partner
5. Liquidation

LIQUIDATION OF A PARTNERSHIP
The term liquidation is defined as the winding up of the affairs of the partnership. It consists of
the following steps:
1. Realization of Non-Cash Assets
2. Distribution of Realization Gain or Loss

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 3. Exercise the Right of Off-Set for Capital Deficiency
4. Payment of Liabilities
a. Preferred Creditors
b. Secured Creditors
c. Unsecured Creditors
5. Payment of Partner’s Interest
a. Partner’s Salaries
b. Partners’ Loan
c. Partner’s Capital Account Balances

Liquidation by Installment
When the non-cash assets were not sold on a lump sum, partnership liquidation may take place
over a period of time on a piecemeal basis. Thus, liquidation is said to happen in installment
and cash distribution to partners is effected after paying the outside creditors and as cash
become available. This call for a preparation of a separate schedule of cash distribution to
accompany the Statement of Liquidation in order to determine who among the partners will
participate in the cash distribution.

CORPORATION

DEFINITION UNDER CORPORATE CODE

A CORPORATION - is an artificial being created by operation of law, having the right of

succession and the powers, attributes and properties expressly authorized by law or incidence to
its existence.

ATTRIBUTES OF A CORPORATION
A. ARTIFICIAL BEING – it has a personality separate and distinct from that of a
stockholder.
B. CREATED BY OPERATION OF LAW- it is created and organized under a general law
and is considered a legal body with rights and powers.
C. HAS THE RIGHT OF SUCCESSION- it shall continue to exist for the period stated in
the Articles of Incorporation, and the death of any stockholder or director shall not
dissolve the corporation.
D. Has the powers, attributes and properties expressly authorized by law or incident to
its existence. – it should be noted that if the corporation exercises powers not within its
express, inherent or implied powers, it commits an ultra vires act which is a ground of
dissolution.

CHARACTERISTICS OF A CORPORATION
1. SEPARATE LEGAL ENTITY – it may acquire, own, and dispose property in its
corporate name. It may also incur liabilities and enter into other types of contracts
according to the provisions of its charter.
2. CONTINUOUS LIFE- it has a continuous life regardless of changes in the ownership of
stock. Sales or transfer of stocks by stockholders does not affect the continuity of the
corporation.

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 3. TRANSFERABILITY OF OWNERSHIP-stockholders may transfer their stocks as
they wish. They may sell or trade the stock, give it away, bequeath it in a will, or dispose
of it in any way they desire.
4. NO MUTUAL AGENCY –stockholder of a corporation cannot commit the corporation
to a contract (unless he or she is also an officer of the business).
5. SEPARATION OF OWNERSHIP AND MANAGEMENT – stockholders own the
business, but the board of directors –elected by the stockholders – appoints officers to
manage the business.
6. LIMITED LIABILITY – a stockholder has limited liability to the extent of his/her
subscription and paid investment in the corporation.
7. CORPORATE TAXATION – corporations are separate taxable entities and pay a
variety of taxes not borne by proprietorships or partnerships.
8. GOVERNMENT REGULATION – strong government regulation is an important
disadvantage to the corporation.

ADVANTAGES OF A CORPORATION
1. Capacity to act as a legal entity.
2. Continuity of life.
3. Liability of stockholders is limited to their paid investment.
4. Better management because of bigger membership.
5. Unified control given to the Board of Directors.
6. Ease of transferability of shares.
7. Greater source of capital.
DISADVANTAGES OF A CORPORATION
1. Subject to greater government control.
2. Frequent and varied reports are required of a corporation.
3. Cannot engage in business outside its charter.
4. Minority stockholders are at the mercy of majority of stockholders.
5. Subject to higher taxation than other form of business organization.
6. Greater possibility of abuse of power by the board of directors.
7. Higher cost of organization and operations.

ORGANIZATION OF A PRIVATE CORPORATION

Creation of a corporation begins when its organizers, called Incorporators, who shall draft the
Articles of Incorporation duly signed and acknowledged by all the incorporators showing:
1. The name of the corporation
2. The address of the corporation
3. The specific purpose or purposes of the corporate organization.
4. The term for which the corporation is to exist
5. The number of directors, which shall not be less than 5 nor more than 15. The names,
addresses and the length of appointment for the original directors.
6. The limitations, qualifications, restrictions, and the rights of each class of stock, if more
than one class of stock, if more than one class is to be issued.
7. The amount of its authorized capital stock, number of shares, and par value of each share.
8. The name, address, occupation, number of shares held, and amount paid for shares of
each of the incorporators.

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The Articles of Incorporation is then filed with other required documents to the Securities and
Exchange Commission (SEC) and pays the incorporation fees. The corporation is legally formed
when the Corporate Charter of Certificate of Incorporation is issued by SEC.

The incorporators have to adopt a set of By-laws within one month from the issuance of the
certificate of incorporation which act as the constitution for governing the corporation.

The corporate charter is the basic legal document of the corporation; the by-laws must not
contradict or violate the charter. At all times the directors and officers must carry out their duties
in accordance with the charter and the by-laws.

STEPS IN THE CREATION OF A CORPORATION:

1. PROMOTION – bringing together persons who interested in the formation of the
corporation as incorporators. It also includes procuring subscriptions of its capital stock,
making arrangement to finance the enterprise, and preparation of incorporation contracts.
2. INCORPORATION – this is the process of filing the Articles of Incorporation, pay the
required fees and file the other required documents to the Securities and Exchange
Commission.
3. ORGANIZATION AND COMMENCEMENT OF BUSINESS OPERATIONS – this
includes adoption of By-laws within one month from the issuance of the certificate of
incorporation, election of the Board of Directors and officers of the corporation stated in
the by-laws.

KEY TERMS TO REMEMBER:

ARTICLES OF INCORPORATION – a document submitted to the Securities and Exchange

Commission by persons wishing to form a corporation.

BY-LAWS – a set of rules and regulations adopted to be submitted with the SEC within one
month from the issuance of the certificate of incorporation which acts as the constitution for
governing the corporation.

CORPORATE CHARTER OR CERTIFICATE OF INCORPORATION – is a document

issued by SEC to acknowledge the legal existence of the corporation.

INCORPORATORS – persons who organized and apply for incorporation of an organization.

COST OF ORGANIZATION

ORGANIZATION COSTS – are costs such as incorporation fees, attorney’s fees, promotional
expense, and the cost of printing stock certificates that must be incurred to organize a
corporation. Such costs are paid only once, but they benefit the corporation during its entire
lifetime. Since organization costs benefit more than one period, they should not be expensed
during the first accounting period. They should be debited as intangible account called
Organization Costs and then amortized over a period of 20 years or less.

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CORPORATE BOOKS AND RECORDS:
Corporation use many books and records that are similar to those used by proprietorships and
partnerships. Corporate books and records to be kept are:

1. BOOKS AND RECORDS OF BUSINESS TRANSACTIONS – these are the books of

original and final entries that are similar to those used by proprietorships and partnerships
like special journals, general and subsidiary ledgers.
2. Minutes Book – the minutes of stockholders’ meetings and board of directors’ meetings
are recorded in the corporation’s minute’s book.
3. Subscriptions Record – when a corporation is formed, the incorporators and others who
wish to become owners subscribe for a certain number of shares of stock at a specified
price per share. This is where the account for each subscriber may be kept in a
subsidiary or stock payment record.
4. Stock Certificate and Transfer Book – the corporation issues stock certificates to each
subscriber who has fully paid for his or her stock. Stock certificates issued and
stockholders who transfer their stock to another are recorded in the stock certificate and
transfer book.
5. Stockholder’s Ledger – this contains an account for each stockholder that shows the
number of shares owned as of a particular date but do not include the peso amounts.

CAPITAL STOCK:
A corporation issues stock certificates to its owners in exchange for their investment in the
business. The basic unit of capital stock is called a share. There are two classes of capital stock,
Common and Preferred. The charter of incorporation indicates the maximum amount of shares
each class of capital stock that a company can legally issue.

STOCK CERTIFICATE – is a document that shows proof of ownership in a corporation.

AUTHORIZED CAPITAL STOCK – is the number of shares of capital stock (common and
preferred) that is stated in the charter that a corporation can sell. Under the corporation code at
least 25% of the authorized capital stock should be subscribed and at least 25% of the capital
stock subscribed is paid.

OUTSTANDING STOCKS –are stocks issued and in the hands of stockholders.

COMMON STOCK – it is the most basic form of capital stock. When a corporation has only
one kind of capital stock, it will be common.

PREFERRED STOCK – a class of stock that entitle its owners to certain rights and preferences
over common stockholders. Preferred stocks can be:
1. CUMULATIVE PREFERRED STOCK – the holders have a right to a certain dividend
every year. If in some years the board does not declare dividends, the amount payable
will accumulate until the earnings justify the payment.

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 2. NON-CUMULATIVE PREFERRED STOCK – the holders have a right to the current
year’s dividend but there are no holdovers from past years when dividends were not
declared.
3. NON-PARTICIPATING PREFERRED STOCK – the holders each year receive a
certain percent on dividends declared and the remainder goes to common stock.
4. PARTICIPATING PREFERRED STOCK – the holders each year receive a certain
percent on dividends and also can get a certain percent on the remainder.

STOCK VALUE FOR CAPITAL STOCK

When a corporation is created, it issues a certain number of shares of stock, which are then sold
to the stockholders. Stock can be issued with:
1. Par Value 2. No Par Value with No Stated Value 3. No Par Value with Stated
Value

Par Value – an arbitrary value placed on each share at the time of authorization. Par value of all
outstanding stock is the legal capital – an amount that a corporation must retain in the business
for protection of creditors.

Stated Value – an arbitrary amount assigned to each share of no-par stock by the board of
directors.

STOCKHOLDER’S EQUITY – the owners’ equity of a corporation. The two main sources of
stockholders’ equity are:
1. PAID-IN CAPITAL – this is the amount that stockholders have invested in the business.
It is equal to the values of the assets (usually cash) that have been contributed by the
stockholders.
2. RETAINED EARNINGS – these are accumulated profits of earnings that are retained or
kept in the corporation.

The paid-in capital contributed by the stockholders is recorded in accounts for each class of stock
and paid-in capital in excess of par. If there is only one class of stock, the account is entitled
common stock or capital stock.

The retained earnings amount resulting from crediting the balance in the income summary
account (the net income) to a retained earnings account at the end of an accounting period and
debiting it for dividends declared.

DIVIDENDS – a distribution of earnings by a corporation to its stockholders in proportion to the

number of shares held. The distribution may be in form of cash, other assets or the corporation’s
own stock.

ACCOUNTING FOR CAPITAL STOCK TRANSACTIONS

The procedures used to account for a corporation’s assets, liabilities, revenues and expenses are
generally the same as those used for sole proprietorships and partnerships. The main difference
is in accounting for owner’s equity.

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In accounting for the owner’s equity or stockholders’ equity for a corporation, the earnings are
kept separate from the amount invested by the stockholders. Thus, the stockholder’ equity is
composed of two amounts – the equity invested by the stockholders (paid-in capital) and the
equity resulting from profitable operations (retained earnings).

ACCOUNTING FOR CAPITAL STOCK TRANSACTIONS REQUIRES THE USE OF

SPECIAL ACCOUNTS AS FOLLOWS:
a) Authorized Capital Stock – the number of shares authorized multiplied the par value of
shares.
b) Common Stock – part of paid-in capital representing the basic ownership equity of the
corporation. If the corporation has only one class of stock, it will be common stock.
c) Discount on Common Stock- the amount by which the par value of the stock exceeds
the selling price newly issued stock.
d) Issued Capital Stock – stock which has been fully paid either by assets or services,
which has been issued and delivered to stockholders.
e) Organization Cost – an intangible asset that records the initial cost of forming the
corporation, such as legal fees, incorporation fees and for services due to promoters.
f) Paid-in Capital in Excess of Par – the amount by which the selling price of the newly
issued stock exceeds its par value. This also referred to as additional paid-in capital or
premium on common or preferred stock.
g) Paid-in Capital in Excess of Stated Value – the amount by which the selling price of the
newly issued stock exceeds its stated value.
h) Preferred Stock – stock that provides stockholders with a prior claim to a corporation’s
profits and assets over holders of common stock.
i) Subscription Receivables – The amount due from subscribers (common or preferred)
whose subscription are not fully paid.
j) Subscribed Capital Stock – This is the temporary stockholders’ equity account for
stocks subscribed until fully paid that is recorded at par value.
k) Unissued Capital Stock – Stock which has not been issued and delivered to
stockholders. Under the journal entry method, this account is debited based on the
authorized capital stock and credited whenever stocks are fully paid and stock certificates
are issued to stockholders.

RECORDING CAPITAL STOCK TRANSACTIONS:

There are two methods of used to record authorization and issuance of capital stock. These
two methods are:

1. MEMORANDUM ENTRY METHOD – under this method, only a memo entry is made
to indicate the number of shares authorized and its par value in the ledger account of the
capital stock.

Example - Authorized to issue ___ shares of stock at a par value or stated value of P ____
per share.

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 ISSUANCE OF STOCK CERTIFICATES IS RECORDED WITH THIS JOURNAL
ENTRY:
FOR SHARES SOLD FOR CASH:
A) Cash xxx
Capital Stock xxx

FOR SHARES SUBSCRIBED TO AND LATER PAID IN FULL:

B) Subscribed Capital Stock xxx
Capital Stock xxx

2. JOURNAL ENTRY METHOD – under this method, the entry to record the authorized
capital stock is:

Unissued Capital Stock xxx

Authorized Capital Stock xxx

ISSUANCE OF STOCK CERTIFICATES IS RECORDED WITH THIS

JOURNAL ENTRY:
FOR SHARES SOLD FOR CASH:
C) Cash xxx
Unissued Capital Stock xxx

FOR SHARES SUBSCRIBED TO AND LATER PAID IN FULL:

D) Subscribed Capital Stock xxx
Unissued Capital Stock xxx

CORPORATE EARNINGS
Corporate transactions such as purchases, production and sale of products, payment of expenses
and liabilities are the same way for any business organization engaged in similar business. The
determination of the net income or loss from ordinary activities of a corporation is also same, but
it is subject to a corporate income tax of 30% on net income before income taxes.

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