Chapter 2 – Partnership

Operations
 Accounting for Partnership Operations

In Measuring partnership profit for a period, expenses

should be scrutinized to make sure partners’ personal
expenses are excluded for the partnership’s business
expenses. If so, such expenses should be charged to
drawing or capital accounts of the partners.

All partnerships have profit or loss allocation

agreement.
Accounting for Partnership Operations
The partnership Law provides that if the profit has
been agreed upon, the share of each partner in
the losses shall be in the same proportion with
the net income allocation. It also provides that
in the absence of any agreement , the share of
each partner in the profits and losses shall be in
the proportion to what they have contributed,
but the industrial partner shall receive such
share as may be just and equitable under the
circumstances.
 Accounting for Partnership Operations

The law is not clear as to what capital balances

shall be applied, whether the capital balances
refer to original capital, beginning or end of
each period or the average capital during the
period.
The Law, however, does not clearly specify the
capital balance, it is presumed to be the
ORIGINAL CAPITAL, in the absence of the
original capital, it should be the BEGINNING
CAPITAL.
 Methods to Allocate Net Income or Loss

1. Equally
2. Arbitrary Ratio (Ex. 2:2; 5:3:2)
3. In the ratio of Capital Balances
* Original
* Beginning Capital of the period
* Average Capital
- Simple Average
- Weighted Average
= Peso-day approach
= Peso-month approach
 Methods to Allocate Net Income or Loss
4. Interest on Partners’ Capital accounts and
dividing the balance on agreed ratio
5. Salaries to partners and dividing the balance
on agreed ratio
6. Bonus to partners and dividing the balance on
agreed ratio
7. Interest on Capital, salaries and bonus to
partners and dividing the balance on agreed
ratio.
 Illustrative Problem
Assume that a net income of P288,000 is determined
for X and Y Partnership at the end of 2019. Regular
withdrawals by partners in anticipation of net income
have been summarized in the drawing accounts,
permanent capital changes have been summarized in
the capital accounts. Drawing and capital accounts
at the end of 2019 appear as follows:

X, Capital Y, Capital
01/01/2019 300,000.00 03/01/2019 30,000.00 01/01/2019 420,000.00
04/01/2019 60,000.00 04/01/2019 60,000.00
12/31/2019 360,000.00 30,000.00   480,000.00
  12/31/2019 450,000.00

X, Drawing Y, Drawing
1/1/-12/31 36,000.00   1/1/-12/31 114,000.00  
   
 Illustrative Problem

Equally:

Income Summary 288,000.00

X, Capital (P288,000 / 2) 144,000.00
Y, Capital (P288,000 / 2) 144,000.00

Arbitrary Ratio (3:2):

Income Summary 288,000.00

X, Capital (P288,000 X 3/5) 172,800.00
Y, Capital (P288,000 X 2/5) 115,200.00
 Illustrative Problem
Beginning Capital:
Income Summary 288,000.00
X, Capital (P288,000 X 30/72) 120,000.00
Y, Capital (P288,000 X 42/72) 168,000.00

Ending Capital:

Income Summary 288,000.00

X, Capital (P288,000 X 36/81) 128,000.00
Y, Capital (P288,000 X 45/81) 160,000.00

Simple Average Capital:

Income Summary 288,000.00

X, Capital (P288,000 X 36/81) 128,000.00
Y, Capital (P288,000 X 45/81) 160,000.00

X: Beg Cap + Ending Cap = P300K + 360K = P330,000.00

2 2

Y: Beg Cap + Ending Cap = P420K + 450K = P330,000.00

2 2
 Illustrative Problem
Weighted Average:

Income Summary 288,000.00

X, Capital (P288,000 X 345/750) 132,480.00
Y, Capital (P288,000 X 405/750) 155,520.00

Partner X:
Date Mos. Unchanged Cap. Balance Fraction Peso Month
Jan-01 3 300,000.00 3/12 75,000.00
Apr-01 9 360,000.00 9/12 270,000.00
Total --> 12 660,000.00 345,000.00

Partner Y:
Jan-01 2 420,000.00 2/12 70,000.00
Mar-01 8 390,000.00 8/12 260,000.00
Nov-01 2 450,000.00 2/12 75,000.00
Total --> 12 1,260,000.00 405,000.00
 Additional Profit Sharing Considerations
1. Interest on Capital Balances
- Its purpose of allowing this is to give recognition to differences on
capital contribution by partners. It is to encourage partners to invest
more and to avoid withdrawals of capital. Interest on capital is more
appropriate when the business in capital intensive versus labor intensive.
Remember, this is not an expenses on the partnership.

2. Salary Allowances
- This is allowed in order to give recognition on the personal services
rendered by partners. The purpose of salary allowances are means of
achieving a fair division of profit among the partners based on the time
and talents devoted to partnership business.

3. Bonuses
- these are sometimes used as a means of providing additional
compensation to partners who have provided services to pertnership,
usually to the managing partner.
 Illustrative Problem
Interest on Capital
Assume that X and Y agree to allow interest on Average
Capital at 6%. Any net income or loss balance is to be
allocated 3:7. Assuming no entries for interest during
the course of the year, what entries are necessary to
record the distribution of Net Income?

Income Summary 288,000.00

X, capital 93,600.00
Y, Capital 194,400.00

X Y Total
Interest on Average Cap. 20,700.00 24,300.00 45,000.00
Balance (3:7) 72,900.00 170,100.00 243,000.00
Total 93,600.00 194,400.00 288,000.00
 Illustrative Problem
Salary Allowances
Assume that X and Y agree to the allowance of monthly salaries of
P10,000 and P9,000, respectively; any net income or loss balance to
be allocated in the ratio of beginning capital. Amounts actually
withdrawn by partners during the year were recorded in their
drawing accounts as presented in the original problem.
Allocation of net income would be as follows:

Income Summary 288,000.00

X, capital 145,000.00
Y, Capital 143,000.00

X Y Total
Salaries (salary x 12 mos) 120,000.00 108,000.00 228,000.00
Balance (300:420) 25,000.00 35,000.00 60,000.00
Total 145,000.00 143,000.00 288,000.00
 Illustrative Problem
Bonuses
Bonuses are sometimes used as a means of providing
additional compensation to partners who have provided
services to the partnership.

A. A bonus of 20% of net income before the bonus is deducted:

Let B = Bonus
B = 20% of Net Income
= 20% of P288,000
= P57,600.00

B. A bonus of 20% of net income after the bonus is deducted:

Let B = Bonus
B = 20% of Net Income after Bonus
= 20% of (P288,000 - B)
= P57,600.00 -.20B
1.20B = P57,600.00
= P48,000.00
 Partnership Operations

Note that:

Interest on Capitals and Salary allowances are

provided in the distribution whether the
result is an income or a loss, unless
otherwise, it is stipulated in the problem that
such items are not considered when the
result is a loss.
 Comprehensive Illustrative Problem

Assume that the net income of the partnership

is P420,000 and that partners A and B agreed
on the allocation of net income as follows:
* Bonus of 20% to A
* Salaries to A P40,000 and B P60,000
* Interest on average capital balances –
P12,000 and B P8,000
* Residual Balance in net income to be
allocated to A and B in the ratio of 2:1.
 Comprehensive Illustrative Problem
1. Bonus is based on NI before bonus, salaries and interest.
A. A bonus of 20% of net income before the bonus, salaries and interest:

Income Summary 420,000.00

A, capital 280,000.00
B, Capital 140,000.00

A B Total
Bonus to A 84,000.00 - 84,000.00
Salaries 40,000.00 60,000.00 100,000.00
Interest on Ave Capital 12,000.00 8,000.00 20,000.00
Balance (2:1) 144,000.00 72,000.00 216,000.00
Total 280,000.00 140,000.00 420,000.00

Let B = Bonus
B = 20% of Net Income
= 20% of P420,000
= 84,000.00
 Comprehensive Illustrative Problem
2. Bonus is based on NI after bonus but before salaries and
interest.
2. A bonus of 20% of net income after bonus but before salaries and interest:

Income Summary 420,000

A, capital 275,333
B, Capital 144,667

A B Total
Bonus to A 70,000 - 70,000
Salaries 40,000 60,000 100,000
Interest on Ave Capital 12,000 8,000 20,000
Balance (2:1) 153,333 76,667 230,000
Total 275,333 144,667 420,000
Let B = Bonus
B = 20% of Net Income after Bonus
= 20% of (P420,000 - B)
= P84,000 -.20B
1.20B = P84,000
= 70,000.00
 Comprehensive Illustrative Problem
3. Bonus is based on NI after bonus and salaries but before
interest.
3. A bonus of 20% of net income after bonus and salaries but before interest:

Income Summary 420,000

A, capital 269,778
B, Capital 150,222

A B Total
Bonus to A 53,333 - 53,333
Salaries 40,000 60,000 100,000
Interest on Ave Capital 12,000 8,000 20,000
Balance (2:1) 164,445 82,222 246,667
Total 269,778 150,222 420,000

Let B = Bonus
B = 20% (P420,000 - B - S)
= 20% (P420,000 - B - P100,000)
= 20% (P320,000 - B)
= P64,000 -.20B
1.20B = P64,000
= 53,333.33
 Comprehensive Illustrative Problem
4. Bonus is based on NI after bonus, salaries and interest.
4. A bonus of 20% of net income after bonus, salaries and interest:

Income Summary 420,000

A, capital 268,667
B, Capital 151,333

A B Total
Bonus to A 50,000 - 50,000
Salaries 40,000 60,000 100,000
Interest on Ave Capital 12,000 8,000 20,000
Balance (2:1) 166,667 83,333 250,000
Total 268,667 151,333 420,000

Let B = Bonus
B = 20% (P420,000 - B - S - I)
= 20% (P420,000 - B - P100,000 - 20,000)
= 20% (P300,000 - B)
= P60,000 -.20B
1.20B = P60,000
= 50,000.00
 Comprehensive Illustrative Problem
Computation of Bonus:
Bonus is Based on NI after salaries but before Bonus and Interest

Let B = Bonus
B = 20% (P420,000 - S)
= 20% (P420,000 - P100,000)

= 20% (P320,000)

= 64,000.00

Bonus is Based on NI after Interest but before Bonus and

Salaries

Let B = Bonus
B = 20% (P420,000 - I)
= 20% (P420,000 - P20,000)
= 20% (P400,000)
= 80,000.00
 Comprehensive Illustrative Problem
• Computation of Bonus
Bonus is Based on NI before Bonus but after Income Tax. (Tax rate is 35%)
Let B = Bonus
B = 20% (P420,000 - T)
= 20% (P420,000 - (P420,000 x 35%))
= 20% (P420,000 - 147,000)
= 54,600.00

Bonus is Based on Net Income, that is, after Bonus and Income Tax
Let B = Bonus
B = 20% (P420,000 - B - T)
= 20% (P420,000 - B - (35% x P420,000))
= 20% (P420,000 - B - 147,000)
= 20% (273,000 - B)
= 54,600 - .2B
1.2B = 54,600.00
= 45,500.00
 Chapter 3 – Partnership Operations
Note well that:
The concept of bonus is not applicable to a net
loss. When a partnership operates at a loss,
the bonus provision is disregarded because it
defeats the purpose of giving a bonus.
 Chapter 3 – Partnership Operations
Special Problems in Allocation of Profit and Loss:

1. Salaries and Interest to be treated as an Expense

2. Correction of Partnership Net Income of Prior

Period

3. Subsequent Changes in Methods to Allocate Net

Income or Loss
 Chapter 3 – Partnership Operations

Special Profit Allocation Methods:

1. Partnership Units
2. Performance Methods
a. Chargeable hours
b. Total Billings
c. Write-offs
d. Promotional and civic activities
e. Profits in excess of specified level
 Chapter 3 – Partnership Operations

Problem Solving
Choose problems to be solved
Chapter 3 – Partnership Operations