Chapter 4: Accounting for Partnership Operations 147

Illustration
Assume the same data as stated above, this time with a "pure" industrial
partner named Caleb. If the partnership suffered a net loss of P30,OOO,
the
distribution of the loss would be:
Moses Joshua Caleb
Loss of P30,OOO: (65%) (Industrial) Total
Share of Caleb
Share of Moses (P30.OOOx 65/ 100) (P19,500) ( 19,500)
Share of Joshua (P30,OOOx 35/ 100) (PIO.500) ( 10.500)
Total
Notes:
1. Industrial partner does not share in partnership losses because he already
rendered his service in vain.
2. If there is a profit and loss ratio agreementin which the industrialpartner is
included in the profit and loss sharing ratio, he is bound to respect the contract
between them by his co-partners. He•shall therefore share in the loss equivalent
to his agreed loss ratio even if he is an industrial partner.
3. However, if there is a profit sharing ratio and there is no loss ratio, the
industrial partner is not bound to share in the partnership losses because he
did not give his consent to have his share in the partnership losses.

Rule 2: However, it must be carefully noted that with respect to an

industrial-capitalist partner, if there is no loss sharing agreement but there
is a profit sharing agreement in which the industrial-capitalist partner is
entitled to a profit ratio, he then becomes liable for the losses of the
partnership in the same proportion as his profit sharing ratio.

Illustration
Assume that Caleb contributed a capital of P25,000 and per partnership
profit' as an industrial
agreement, he would receive 10% of partnership
partner. The partnership agreement also stipulates that the capitalist
partnership's profit and loss. The
partner will share equally in the be:
distribution of P30,OOO net loss would
Moses Joshua Caleb
Total
Loss of P30,OOO:
Share of Caleb: PIO,OOO PIO,OOO
As capitalist (P30,OOOx 1/3) PIO,OOO 10,000
Share of Moses (P30,OOOx 1/3) pi 0.000 10 000
Share of Joshua (P30,OOO x 1/3)
Total
a
industrial partner is not exempted from the loss sharing once he becomes
I. The
capitalist partner.
are.partnership losses, however,the industrial partner shall not absorb
2. If there loss as a capitalist
a share fromthe net losses. He shall share only in the
partner:
148
PARTNERSHIP AND CORPORATION ACCOUNTING
Chapter4: Accounting for Partnership Operations 149

Arbitrary Agreements in Computing Profitsand Losses

partners may share the partnership
profitsand losses in any manner they
wish. The profit and loss agreement
should contain specificand complete
provisions to avoid misunderstanding the partners.
and disputes among

The agreement on partnership's profitsand losses may be divided into one

of the following ways:
1. Equally
2. Specified ratio or percentage
3. Capital ratio
4. Interest allowed on partner's capitals, the remainder to be divided in an
agreed ratio
5, Salaries or bonus allowed for partners' services, the remainder to be
divided in an agreed ratio
6.• Multiple bases of allocation
To illustrate the methods that could be agreed upon for profit and loss
distribution, assume that Adam and Eve formed a partnership with original
capital contributions of P60,OOOand P30,000, respectively..
In the second year of the partnership operations, the capital and drawing
balances of partners Adam and Eve are traced from the general ledger as
follows:

Adam. Drawin s Adam. Ca ital

Debit Credit Debit C rod It
000 69,000 lil
40,000
9/30 110.000

Eve ital
Eve. Drawin s
Credit Debit C rod It
Debit 60rooo 1/1 50,000
5 000 30.000
80.000

generated an income of P2()(),()OO.

During the year, the partnership
the data above shall be used as the basis for
Note: Unless otherwise stated,
discussions.
illustrations in the succeeding
 150 PARTNERSHIP AND CORPORATION ACCOUNTING

Equally

The partners may mutually agee that the partnership profit shall be
equally divided between them. In case of losses and in the absence of a
specific agreement regarding division of losses, the existing equal division of
profit agreement is to be followedby the partners.
If Adam and Eve agreed to divide the partnership profit equally, the
distr±ution of profit would be:

ADAM & EVE PARTNERSHIP

Profit DistributionSchedule
December 31, 200*
Eve Total
100%

Adam@P200.OOOx 50% PIOO.OOO PIOO.ooo

Eve (P200,OOO
x 50% P100.ooo 100.000
Net income distribution PIOO.ooo P100.ooo P200.ooo

It is to be obser+ed that Adam and Eve shared on the partnership profits

equally regardless of the unequal balances of their capital contributions. To
record the distribution of profit, the followingjournal entries shall be made:

GENERAL JOURNAL
Page Number 100
Descri ons Credit
12 31 Income su 200,000
Adam. Drawin
100.000
Eve. Drawin
100,000
To record rofit distribution
u

Note: The profit or loss distribution can also immediately be closed

capital accounts because the partners' drawing accounts to the partners'
are ultimately closed to the
capital accounts.
An alternativejournal entry is to distn%.itenet income
capital accounts, as follows: directly to the partners'

Incomesummary
Adam, Capital 200,000
Eve, Capital 100,000
100,000
For the succeeding illustrations, the drawing
closing the profit accounts will be used
or loss account.
Chapter 4: Accounting for Partnership Operations 151

Specified Ratio or Percentage

Wheneverthe presence of one of the partners is
'success of the business due to experience, abilityperceived more vital to •the
and loss agreement
and reputation, the profit
may stipulate an •unequal sharing
expressed in agreed
specifiedratio or percentage, otherwise called as arbitrary ratio.
In specifiedratio, the differencein the partner's
capital balances has no
bearing in the profit and loss sharing. The agreed profit
be based on the partners' better capability or influence and loss ratio may
over the other.
To illustrate, assume that Eve is perceived more vital than
Adam for the
success of the partnership business, so much so that they agreed
in the profit and loss of 60% and 40%, respectively. to share

Based on the profit and loss agreement, Adam

and Eve shall apportion the
P200,000profit in the followingmanner:

ADAM & EVE PARTNERSHIP

Profit DistributionSchedule
December 31, 200x

Adam Total
Arbitra ercenta e 100%

Com utatlon:
Adam P200,OOOx P 80 P 80,000
Eve P200 000 x 60%) P120 000 120,000
Net income distribution P 80,000 P120,ooo P200.ooo

In spite of Adam's greater ending capital balance (PI50,000)than that of

Eve (P100,000), the latter received a greater share from the partnership
profit because the specific percentage on profit and loss agreement provides
her 60% share from the partnership earnings.
The journal entry to effect the profit distribution in the books of accounts
would be:

GENERAL JOURNAL
Pago Numbor 100
Date Descri tlons Doblt Crodit
12 31 Income summa.' 200 000
Adam, Drawings 80,000
Eve, Drawings 120,000
To recGd_profit distr!bution
with 40% and 60% sharin
152 PARTNERSHIP AND CORPORATION ACCOUNTING

Relative Capital Balances

When money or properties invested by the partners represent the
contribution to the success of the partnership business, partners may
their respective Capital balances shall be the basis of the profit and
sbüring.
This manner of dividingprofit and loss is different from a situation
there is no profit and loss agreement at all or where an arbitrary specified
ratio or percentage is used for profit sharing.This is so for the allocation of

profit and loss distribution is not fixed due to fluctuation of the capital
balances of the partners.
The accounting issue in the capital ratio lies on what amount of thc
partners' capital shall be considered in the computation of profit
distribution. For this reason, the agreement should indicate specifically
whether the ratio is to be defined in terms of:
l. Original capital contribution;
2. Beginning capital balance of the accounting year;
3. Ending capital balance of the accounting year; and
4. Average capital balance of the year.
Original Capital Contributions. If the partners agreed that the periodic
division of profits and losses be based upon their respective origtnal capital
contributions, the reference should be made to the amounts originally
invested by the partners.
To distribute the net income of the partnership to Adam and Eve'
the followingcomputation should be made:

ADAM& EVE PARTNERSHIP

Pront Distribution Schodulo
Docombor 31, 200x
Adam Total
Original Capital Invostmonts P 60 000 P 30 000 P 90 000
Computation:
Adam (P200,OOOx 6'9)• P133,333 P133,333
Evo (P200,OOOx 3/9) P 66 667 66,667
Not Incomo distribution P133,333 P 66,667 P200,000

*Note: The fraction is computed by dividing the origmal capital investtnent by

total original capital investments, as follows:
Partners: Amounts
Adam POO.OOO 6/9
Eve ao 000
Total P90tooo
Chapter 4: Accounting for Partnership Operations 153

To record the profit distribution, the journal entries would be:

GENERAL JOURNAL
Pago Number 100
Dato Descri tlons Doblt Credit
12 31 Incomesumm 200 000
Adam Drawin s 133 333
Eve Drawings 66 667
To record rofit distribution based
on the artners'•ori •nal investments.

Beginning Capital Balances of the Accounting Year. If the partners'

agreement provides that the periodic division of profits and losses shall be
based upon the capital balances at the beginning of the year, then the
opening partners' capital •balances of the current year shall be the basis of
the profit and loss allocation.

The distribution of P200,OOOprofit would be:

ADAM & EVE PARTNERSHIP

Profit Dlstrlbutlon Schedule
December 31, 200x
Adam Evo Total
Beginning Capital Balances P 60,000 P 50,000 P 110,000
Computation:
Adam (P200,ooo x 6111 Pi09,091 P109,091
x 5/11 P 90.909 90,909
Net income distribution PI 09,091 P 90,909 P200,ooo

is ,that it discourages
Note: The disadvantage of beginning capital balance method such
additional investments during the accounting period because investments are
next year's period.
not compensated in the division of profit until the

The journal entry in the distribution the profit would be:

GENERAL JOURNAL
Page Number 100
Descrl tlons Debit Credit
Dato
Incomesumma 200,000
12 31 109,091
Adam, Drawin s
90 909
Eve, Drawin s
To record rofit distribution based
on the artners' be • nin ca itals.

Ending Capital Balances of the Accounting Year. If the partners agreed

the partners'
of profits and losses shall be based upon
that the division
154 PARTNERSHIP AND CORPORATION ACCOUNTING

capital balances at the end of each year, all transactions affectingthe

capital balance
capital accounts shall be then considered and the ending
shall be the basis of the profit and loss allocation,
The ending capital accounts of each partner are determined by gettingthe
follows: as
account balances of the partners' capital accounts,

Eve. ca ital
Adam. Ca ital Credit
Debit Credlt Debit
60 000 1/1 50.000
60 000 1/1 60 000 30 000
40 000 10/1 80.000
110.000 160.000
210 000
60 000
60 000 100,000
150 000

The profitdistributionschedule of Adam and Eve would be:

ADAM& EVE PARTNERSHIP

Profit DistributionSchedule
December 31, 200x
Adam Eve Total
PI 50,000 PI 00,000 P250,ooo
Endln Ca ital Balances
Com utatlon: P120,000
Adam P200,OOOx 15/25 P120 000
Eve P200 000 x 10/25 P 80 000 80,000
Net Income distributlon P120,OOO P 80,000 P200,ooo

Notes:
1. Drawing accounts are not included in the' computation of *the ending capital
balances because they only reflect temporary reduction of the capital balances
representing advances to partners in anticipation of partnership profit.
2. The disadvantage of using the year-end capital balance method is that there ise
no incentive for a partner to make any investments in the earlier parts Ofth
year.

To record the profit distribution, the journal entry would be:

GENERAL JOURNAL
Page Number
Date Descri tlons Debit Credit
12 31 Income
summ 200 000
Adam Drawin s 120 000
Eve Drawin s 80 000
To record rofit distribution based
on the artners' endin ca itals.
Chapter 4: Accounting for Partnership Operations 155

AverageCapital Balances of the Accounting Year.

to divide profits to
When partners agreed
recognize capital changes during the current period, the
use of the partners' average capital
method also
balances shall be employed. This
encourages partners' to contribute during the year additional
investments to the partnership.

An accounting issue is raised as to

partners during the fiscal period shallwhether or not drawings made by
be included in the computation of
average capital. As a rule,
drawing accounts are not considered in the
computation of ending capital except when stated
otherwise.
Methods of Computing Average Capitals
There are two methods of computing the average
may be done by using
capitals of the partners
the followingmethods:
1. Simple average, or
2. Weightedaverage.

Simple Average Capital Method. This method is computed by

dividing the sum of the beginning and ending capital by 2. simply
average capital balances are computed as follows: The simple
Partners: Computations Simple Average
Adam Fraction
(P60,OOO + 2 P105,OOO
Eve 105/180
(P50,OOO+ 2 75 000 75/180
Totals

Using the simple average capital method, the distribution of P200,OOO

profit
would be:

ADAM& EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Adam Eve Total
Sim le Avera e Ca itals P105 000 P 75,000 P180,ooo
Com utation:
Adam (P2ÖO,OOO x 1051180) PI 16,667 Pli6,667
Eve (P200,OOO x 75/180 P 33,333 33,333
Net income distribution Pi16.667 P 33,333 P200,OOO

Weighted Average Capital Method. This method is also known as "peso-

month" or "peso-day" average capital method. Under this method, the
COmputationof the average capital considers the period in which the capital
contributions have been used in a given accounting
period.
156 PARTNERSHIP AND CORPORATION ACCOUNTING

The weighted average capital based on peso months is computed as follows:

(a) Number of Months x Peso-JMonths

Capital Months Capital Average
ners Date Balance Unchan ed Balance Fraction
Adam Jan. 1 P 60 000 x 6 P 369,000
Jun. 30 100,000 x 2 200,000
Au .30 40 000 x 40oof
Se .30 150 000 x 3 450 000
P 87,500 875 1,400
Jan. 1 P 50,000 x 3 P 150,000
Mar 30 x 1 8b 000
Ma 1 20 odö x 5 100 000
Oct. 1 100 000 x 3 300 000
52 500 525/ 1,400
Totals
Note: The product of c is divided by 12 months to get the peso-month average
capitålbalance. Using this method, the P200,000partnership income shall be
distributed as follows:

ADAM& EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Adam Eve Total
Peso-Month Avera e Ca itals• pji,500 P52,500 p140,OOO
Compytation:
Adam (P200,OOOx P125,ooo P125,OOO
Eve (P200,OOOx 525/180 P75,ooo 75.000
Net Income distribution P125,ooo P75,OOO P200,OOO

Notes:
1. Alternativel the wei hted average capital balances as foliows:
Part- Number of
ners: Months Months Used Com utations Peso-Month Avera e Fraction
Adam Jan. I 12 x 12 12 P 60.000
Jun. 30 6 PAOOOOX 6 12 20 000
Au .30 4 (P60,OOO)x 4/ 12 20,000)
Se .30 3 PI 10 000 x 3/12 27 500
P 87 500 875 1,400
Eve Jan. 1 12 P50,OOOx12 12 P 5Q,ooo
Mar 30 9 P30.OOOx9/12 22,500
Ma 1 8 (R60.@Q0)x 8/ 12 40,000)
Oct. 1 3 P80 OOOX 3 12 20.000
P 52 500 525/ f,qoo
Totals P87 500 + P52 500 P140 000
2. The weighted average capital method should be assumed in the absence Of
evidence to the contrary. Average capital means weighted average unless
another interpretation of average capital is specified in the agreement.
3. The average capital method is the best alternative compared to beginning and
ending capital methods because it provides the most equitable basis for
allocating partnership income.
Chapter 4: Accounting for Partnership Operations
157

Allowanceof Interest on Partners'

Capitals
This ageement provides that the
of partners will be added as cost of money on the capital contributions
a profit sharing device in addition to the profit
and loss ratio agreement.
It is based on the philosophy that
if the capital contributions have been
invested in other earning activities such as trading securities, the partner
should have realized additional revenue.

Theallowance of interest may be computed on the followingbases:

1. Interest on capital balances, and
2. Interest on excess investments.

Interest on Capital Balances. This method allocates first a portion of profit

equivalent to a certain interest rate of the partners' capital balance.•
Accordingly, the capital balances should clearly be defined in the
agreement. The remaining balance of the profit shall be distributed in
accordance with the agreed arbitrary ratio.
In the absence of the agreed arbitrary ratio, the partners' originalcapital
contribution may be used to allocate the undistributed balance of profit.
Illustration
Assume that Adam and Eve agreed that their respective average capital
balances are entitled to a 12% interest per year and the •balancewill be
distributed 60% and 40%, respectively. The average capital balances of
respectively. The distribution of
Adam and Eve are P87,500 and P52,500,
P200,OOO profit would be:

ADAM & EVE PARTNERHSIP

Profit DistributionSchedule
December 31, 200x
Ådam Eve Total
60% 40% 100%
Ratio on the remain!ng balance
12%Änterest on average ca ital P 10,500
Adam P87,500x 12% P 6,300 P 16,800
Eve P52,500x
Balance for distribution: 60% 109,920
Adam (P200,ooo- P16,800)x 73,280 483,200
Eve (P200,OOO - P120,420 P79,580 P200,000
Net income distribution

Investments. This •method allows interest on the

Interest on Excess of one partner over that of another.
excess capital balance
158 PARTNERSHIP AND CORPORATION ACCOUNTING

Illustration
Assume that Adam and Eve agreed that the excess of one partner's average
capital balance is entitled toa 12% interest per year and the balance
partnership profit will be distributed 60% and 40%, respectively.
The average capitalbalances of Adam and Eve are P87,500 and P52,500
respectively. The P200,000 profit willbe distributed as follows:

ADAM& EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x

Ratio on the remaining balance

Adam Eve Total
Interest on excess of 100%
over Eve P52,500 x 12% p 4 200 p 4,200
Balance for distribution, PI 95,800'.
Adam x 117,480
Eve CP195,800x 40% 117,480
Net income distribution P78,320 78,320
PI 21,680 P78,320 P200,ooo

Notes:
1. The balance for distribution is computed as follows:
Net income of the partnership
P200,OOO
Less: Interest on Adam's excess capital over Eve
[(P87,500 - P52,500) x 12%)) 4 200
Balance for distribution
2. The agreement for interest may still employother forms. For instance,
a fixed
capital contribution is agreed for each partner with interest allowed on amounts
in excess of such fixed amounts and interest charged on any deficiencies.

Special Note:
Interest on Loans. As a rule, interest on capital balances shall be part Of
profit and loss distribution but interest charges on loans made by
partner in favor of the partnershtp shall be treated as interest expense onthe
incomestatement, and not a profit and loss shanng device.8
Likewise,the interest on the money borrowed by the partner fromthe
Partnership shall be treated as part of the business revenue because such
transactions create a "debtor- creditor relationship" between the partner
and the firm.

BarryJ. Epstein and Abbas Ali Mirza, Wiley IAS 2002 Interpretation and Applicationof
ACCOUnting
Standards (Toronto:John Wiley & Sons, Inc., 2002), p. 92.
Chapter 4: Accounting for Partnership Operations 159

Salaries or Bonus Allowed for Partners' Services

An equitable division of profits and losses frequently requires that financial
consideration be given to the skills, talents, efforts and work hoGFS¯thÄt—
active partners devote to the partnership businesyfK addition to their
capitalinvestment. Consequently, salaries and/or bonuses may be given to
a partner before the agreed profit sharing ratio distribution is made.
Salaries. To recognize personal contribution by the partner to the business,
they may agree to receive salary, and divide the remaining profit among
themselves by the agreed specified ratio. Except When stated otherwise,
salary allowances are part of the net income/loss allocation to the partners.
Illustration
Assume that the Adam and Eve Partnership'soperation was a 12-month
period and that they agreed that a salary of P6,OOOper month be given to
each Ofthe partner for their personal services in addition to a 12% interest
on their average capital balances. The balance shall be distributed 60% and
40%, respectively. The average capital balances of Adam and Eve are
P87,500 and P52,500, respectively.
The distribution or P200,OOOprofit shall be:

ADAM& EVE PARTNERHSIP

Profit Distribution Schedule
December 31, 200x
Adam Eve Total
Ratio on the romalnln balanco 100%

x 12)
Salyy ofpach partner_(P6,OOO P 72 000 P72,ooo• P144,OOO
Interest on average capital
Adam (P87,500x 12%) 10,500
6,300 16,800
Balance for distribution, P39,200.
x 60% 23 520
Eve (P39,200 x 15 680 39,200
Net Income distribution P106,020 P93.980 P200,OOO

Salary distribution must be made even though the result of operation is

loss, except when partnership agreements state otherwise.
onus. A partnership agreement may provide that a managing partner be
allowed a bonus on the earnings of the business to encourage profit
maximization.
 160 PARTNERSHIP AND CORPORATION ACCOUNTING

The bonus may be computed as follows:

Bonus = Bonus rate x Base net income
(The base net income is always assumed to be 100%.)

The bonus agreement is basically stated as a percentage of net income. The

bonus may be based on the followingnet income:
1. Net income before deducting salaries, interest (ifany) and bonus;
2. Net income after deducting salaries and interest (if any) but before
bonus; or

3. Net income after deducting salaries, interest (ifany) and bonus.

Multiple Bases and Priority of Allocation

This procedure depends on the partners' agreement regarding the order of
priority in allocating the multiple basis of profit or loss.
To divide profit equitably, partners may agree that their salaries be first
given priority over interest on capital and bonus, and if there is a
remainder, it shall be divided in an agreed ratio.
Case 1: Bonus is based on net income before deducting salaries, interest (if
any), and bonus (is treated as part of profit distribution).
Assume that Adam and Eve agreed to the following:
a. Each of them would have a salary of P5,OOOper month (one-year
operation).
b. 6% interest on their respective average capital.
c. 10% bonus of net income before salaries, before interest on capital and
before the bonus to Adam, the managing partner, and
d. The balance of net income shall be divided on the basis of 60% and
40%, respectively.
The average capital'balancesof Adam and Eve
are P87,500 and
respectively.The P200,OOO
partnership's net income shall be divided as
follows:
 Chapter 4: Accounting for Partnership Operations 161

ADAM& EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Adam Eve Total
Ratio on the remaining balance 60% 100%

x 12 P 60,000 P60 000 P120 000

Interest on average ca ital
5,250
Eve P52,500x 6% 3,150 8,400
Bonus to Adam* 20,000 20,000
Balance for distribution, PSI ,6003
Adam (P51,600 x 600k 30,960
,600x 40%) 20,640 51,600
Net income distribution Pi16,210 P83,790 P200,000

Notes:

I. The bonus is computed as follows:

Net income of the partnership before salaries, interest and bonus P200,OOO
Multiply by bonus rate
Bonus
Since the P2()O,OOO is assumed 100%, the bonus is just computed by
multiplying it by the bonus rate.
2. The balance for distribution is computedas follows:
Net income of the partnership P200,OOO
Less: Salary of partners P120,ooo
Interest on partners' average capital 8,400
Bonus 20 000 148 400
Balance for distribution

Case 2: Bonus is based on net income after deducting salaries and interest
(ifany) but before bonus.
salary of
Assume that Adam and Eve agreed that each of them would have arespective
P5'OOOper month (one-year operation), 6% interest on their
of 10% of net income after salaries and
averagecapital, and to give bonus bonus to Adam, the managing partner.
•interest on capital but before thebe divided on the basis of 60% and 40%,
The balance of net income shall
respectively.
of Adam and Eve are P87,5()Oand P52,500,
The average capital balances
respectively.
162 PARTNERSHIP AND CORPORATION ACCOUNTING

The P200,000 partnership's neq income shall be divided as follows:

ADAM & EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Adam Eve Total
Ratio on the remalnln balance 60% 40% 100%

Sala P5 x 12 P 60,000 P60 000 PI 20,000

Intereston avera e ca Ital
Adam P87,500x 6% 5,250
Eve P52,500x 6% 3,150 8,400
Bonus to Adam' 7,160 7 160
Balance for distribution P64 440:
Adam P64,440x 38 664
Eve P64,440x 25,776 64,440
Net income distribution P111,074 P88,926 P200,ooo

Notes:
1. The bonus is computed as follows:

Net income of the partnership P200,ooo

Less: Salary of partners Pi20,OOO
Interest on partners' average capital 8 400 128 400
Net income after salary and interest but before bonus P 71,600
Multiply by bonus rate 10%
Bonus

2. The balance for distribution is computed as follows:

Net income of the partnership P200,OOO
Less: Salary of partners P120,OOO
Interest on partners' average capital 8,400
Bonus 7 160 135 560
Balance for distribution

Case 3: Bonus is based on net income after deducting salaries, interest (if
any) and bonus (istreated as expense).

Assume that Adam and Eve agreed that each of them would Of
have a salary'
P5,000 per month (one-year operation),6% interest on their respective
average capital, and to give bonus of 10% of net income after salaries, after
interest on capital and after the bonus to Adam, the managing partner• The
balance of net income shall be divided on the basis of 60% and 40 %'
respectively.
The average capital balances of Adam and Eve are P87,500 and P52'500'
respectively.
 163
Chapter 4: Accounting for Partnership Operations

partnership's net income shall be divided as follows:

The P200,OOO

ADAM& EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Adam Eve Total
Ratio on the remainin balance 100%

Sala P5 12 P 60000 P60 000 P120,ooo

Interest on ave_rAgeca ital
Adam P87,500x 5,250
Eve P52,500x 3 150 8,400
Bonus to Adam* 6,509 6,G09
Balance for distribution, P65,091:
Adam P65,091x 39 054.60
Eve P65 091x 26 036.40 65,091
Net income distribution Plio,813.60 P89,186.40 P200,000

Notes:
I.The bonus (treated as expenses) is computed as follows:

Net income of the partnership P200,OOO

Less: Salary of partners P120,000
Interest on partners' average capital 8 400 128 400
Net income after salary and interest but before bonus P 71,600 110%
Less:Bonus 6 509 10%
Net income after salary, interest and bonus
2. Since the base is the net income after salary, interest and bonus that is
assumed 100%, and the bonus rate is 10%, therefore, the net income after
salaiy, interest but before bonus is 110%.This is computed by adding back the
10%bonus rate to the base, 100%.The net income after salary, interest and
bonus is computed as follows:

Net income after salary, interest and bonus

= Net income after salarv. interest but before bonus
110%.

3. The'bonus is then computed as follows:

Net after salary, interest and bonus P65,091
X Bonus rate
Bonus

4. The balance for distribution is computed as follows:

Net income of the partnership P200,000
Less: Salary of partners P120,OOO
Interest on partners' average capital 8,400
Bonus 6 509 134 909
Balance for distribution
164 PARTNERSHIP AND CORPORATION ACCOUNTING

Accounting for Interests and Salaries Treated as Expenses

Payments of interest on capital or salaries to partners are considered
allocation of profit and are usually not expense on the income Statement.
In an attempt to emulate corporate financial reporting, however,
partnerships, with adequate disclosure, do display part or all of such
payments as expenses in the income statement to determine the true
performance of the business
When interests on capital and salary are treated as ordinary operating
expense, they are first deducted from the' partnership net income pnor
the profit and loss distribution to partners.
Illustration
A and B agreed that each of them will receive a PIO,OOO monthlysalary,
their respective capital balance is to earn 6% interest per year, and
the

remaining balance of profit is to be shared equally.

for an•
Assume the following results of operations of A&B Partnership
accounting year:

Sales 400,000
Cost of sales 75,000
Rent expense 50,000
Suppliesexpense 20,000
Depreciation expense
the partners agreed that their salaries and interest on capital are to be
If and
treated as operating expense and their capital balances are PI
compute and journalize the profit distribution.
PI 50,000, respectively,
and distributionof profit
1. Computation
Sales
Less: Cost of sales 400.000
Gross income p 600,000
Less: Operating eFpenses:
Salaries (PIO,öpox 12 x 2) P240,OOO
Rent expense
Supplies expense
75,000
Depreciation expense
50,000
Interest (P6,OOO+ P9,OOO)
20,000 400 000
Net income 15 000
p-20ugQ!
Profit distribution:
Partner A (P200,OOO/2) 0 00
Partner B (P200,OOO/2)
 Chapter 4: Accounting for Partnership Operations 165

2. Journal entry to record the

profit distribution

Date
GENERAL JOURNAL
200a Page Number 100
Descri tlons Doblt Credit
12 31 Income summa 200,000
A, CAp@tal 100,000
B, Capital 100,000
Profit distribution for A and B.

Notes: Tax Law requires that the distributable share of partners is subject
followingtaxes: to the
1. If the partnership is commercial, final tax of 10%.
2. If the partnership is professional, creditable tax of 10% if the distributable share
is P720,OOOper year or 15% if more than P720,OOO per year.

Distribution of Insufficient Net Income

As a rule, the prescribed allocation for salaries and/or interests on capital
balances should still be given in spite of the insufficiency of the
partnership's net income to cover them.
The earnings deficiencyproduced as a result of givingsalaries and/or
interests shall be allocated among the partners based on their profit and
loss sharing ratio.

Illustration
Martha and Mary have average capital balances in their partnership
amounting to P80,OOO• and P120,000,respectively.They agreed to have a
profit and loss distribution of 60% and 40%, respectively.
They work in the partnership and agreed to have a salary ofshall
P6,OOO each
per month and that their respectiveaveragecapital balances be given
an interest of 6% per year.
During a calendar year operation,the partnershipearned a the net incomeof
be distributed if Mary, managing
P100,000. How would the profit salaries
partner, shall receive a bonus of 10% based on net income before
and interest on average capital?
 166 PARTNERSHIP AND CORPORATION ACCOUNTING

The distribution of the net income of the partnership shall be:

ADAM & EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Martha Ma Total
Profit and loss ratio 60% 40% 100%
Bonus to Mary (PIOO,OOO
x 10% PIO,ooo P 10,000
x 12) P72,OOO 72 000 144,000
Interest on average capital
Martha (P120,OOOx 6% 7,200
4,800 12,000
Deficit for distribution. (P66,OOO:
x 60% 39,600
x 40% 26,400 66.000
Net income distribution P39 600 P60 400 PIOO.OOO

Note: The bonus shall still be givento the managingpartner because it is based
the net income before deducting the partners' salaries, interest on capital and
bonus. However, if the bonus is to be computed based on net income after deducung
partners' salaries and interest on capital, there would be an income deficit. In such
case, bonus to the managing partner shall no longer be available.

Distribution of Partnership Losses

If there were partnership net loss, the partners' salaries and interests on
capital shall still be given to them. However,the bonus to the managtng
partner shall be forfeited because bonuses are given as incentives for
earnings, not for losses.

Illustration
Using the same data of the preceding illustration of Martha and Mary
partnership, now with the partnership suffering a, net loss of P20,OOO,
the
distribution of loss to the partners should be:

ADAM& EVE PARTNERSHIP

Loss Distribution Schedule
December 31 200x
Profit and loss ratio Martha Mary Total
salary (P6.OOOx 12 40% 100%
Interest on average capital P72,000 P72,OOO p144,000
Martha(P120,OOOx 6%
Ma P80,OOOx 6% 7 200
Deficit for distribution, P176,OOO: 4,800 12,000
artha P176.OOO x 60%
Ma P176,000x 105,600
Net income distribution 70 400 (17610001