Chapter 2 - Partnership Operations 1 in most respects to those of Other forms Introduction , A oe me operations of a partnership are similar in most respects (0 Epcot vent izations operating in the same line of business. year, eearies ‘ond eeenee ‘are closed out, some assignments Lane pac the resulting hy figure because a partnership will have two or more C : rained eamings balance. This allocation to the capital. accounts is oe on the agreeng established by the partners preferably as a part of the Articles of Partnership. cation is found in the business world. cite partnerships ha, i istributic i tremely complex ones. It is 5 straightforward distribution plans while others have extrem Qf 5 atcountant's responsibility to distribute the profit or loss according to the partnership greene regardless of how simple or complex that agreement is. Profit distributions are similar to divider, for a corporation. Accounting for Partnership Operations: Methods to Allocate Net Income or Loss A wide range of profit allo In measuring partnership profit for a period, expenses shoula ve scrutinized to make suet partners’ personal expenses are excluded from the partnership's business expenses. If pena expenses of a partner are paid with partnership assets, the payment is charged fo the drav: or capital account of that partner. Drawings are closed to the capital accounts of the part: rather to an income summary account. es Practically all partnerships have a profi or loss allocation agreement. It would be rare to ft partnership that did not spell out the divisions of profits or losses in details. The agreement m be followed precisely, and if it is unclear, the accountant should make sure that all pat! agree to the profit or loss distribution. Partners should select a.formula that is sensible, pracic ond equitable. The formula used fo divide profits and losses is determined through negoldlé among the partners. Whether itis fair or not, it does not concern the accountant. It is necessary that the benefit the partners expect to obt inati hat | i jain from the combination of f respective contribution should be common to all the partners, because faeH were nol case, there would be no partnership. Now the question that atises is: “How will the partners divi _ gt the operation of the partnership?" Partners divide the profits or losses resulting The Partnership Law provides thot it the profit has been agreed upon, the share of each P# in the losses shail be in the same proportion with the net income allocation ive provic® in the absence of agreement. the share of each partner in the prant cn Ices anal Of proportion to what they have contributed (based on capital erase ea se portner shall receive such share as may be just and équitable under ph cin ony. an eas However, the law !s not clear as to what capital balance. a 4 2c . 6s shall Us ner the bolances refers to original capital, beginning or ehd bole dec pa ereage A during the period, in os much as the law does not ciety specify the captial bain" ~ Scanned with CamScanner33 fore, presumed to be the original capital, in the ab. eginning capital. Fence Of Such etiginal capttal man tne'teason behind the usage of original capital (in his absence. { at the time of formation there 's NO agreement, the law should copital balance is the original capital. Even though usage of origir unreasonable because of inequity, logic dictates that profit and jo the time of formation due to some of the following reasons: 1. Subsequent adjustments in assets and liabilities: 2. Admission of a new partner: 3. Retirement or withdrawal of a partner; and 4. Liquidation of partnership. All of the above reasons require the use of profit and loss ratio. The wait period for the end-of- the-year balances to determine the average or ending capital would be in exercise of because of the urgency of profit and loss ratio. Deferral of such action would not address the above reasons. In the United States, in the absence of any agreement, profit or loss should be allocated equally and ii they agreed on capital balances it is presumed to be the average capital, Nevertheless, these are practices which are not applicable under Philippine setting because of its differing law provisions. . Profits and loss can be shared in many ways among partners of a partnership. Most profitand loss sharing formula includes one or more of the following features or techniques: 1. Equally: 2. Arbitrary ratio; 3. In the ratio of partner's capital account balances and the dividing the balance on agreed ratio: Q. Original capital - the initial investment / capital at the time of formation. b. Beginning capital of the period c. Average capital . Simple average ©.2. Weighted average Peso-day approach month approach; Interest on parmors coptil ‘accounts and dividing the balance on agreed ratio; Salaries to partners and dividing the balance on agreed ratio: Bonus to partners and dividing the balance on agreed i es a - Interest on capital account balance. salaries and bonus lo Ps balance on agreed ratio. ae tners and dividing the Ne 3 ct @ most common of Because of its simplicity. tne equally or the arbitrary oe peroach is the Allocating profit or loss. itis simple because il ignores Capita 7 - ple. but this approach is no! ia it i be sim 7 Assigning profit ‘on an arbitrary ratio rnay + properly the various PATS eet neat tingle ratio is likely to reflect propery Oh een, necessarily equit all partners. No i item ontibutions made by a partner. Indeed on unimited number of ‘Ould Be devised in hope of achieving fair reatment for all par , oe Scanned with CamScannerIllustration 2-1: Allocation of Net Income Assume that a net income of P288,000 is determined for X and ¥: Partnership at the end of Regular withdrawals by partners in anticipation of net income have been summarized in 4, drawing accounts; permanent capital changes have been summarized in the capital ACCOun, Drawing and capital accounts at the end of 20x4 appear as follows: ¥, copital X. capital 1/1/7204 300,000 «3/1/20x4 30,000 T/1720x4 420,000 4/1 /20%4 60,000 11/1/20x4 60,000 12/31/20x4 360,000 12/31/20x4 450,000 X, drawing ¥, drawing VW/1/-12/31 36,000 W/-12/31 114,000 36,000 114,000 Equally e copital or service contribution of the partners a This method may be proper when th considered to be the same. ‘of X and Y to record the allocation of net income of P28, The entry of the partnership equally would be as follows: Income summary... 2... se ese peeeeeer ane vo. 288,000 X, drawing... paneer 144,000 Ly, drawing.» 144,000 X's share of net income ¥4 of P288,000 Y's share of net income "4 of P288.000 Total... ei Pee eee The resulting balances in the drawing accounts may be. elosed into thé capital accounts. Arbitrary Ratio ‘when the capital and service contribution of the partners are unequal, an arbitrary profit rat may be employed to recognize these differences An infrequently used variation of this methed.specifies one ratio for profits and a different rat for losses, Because profit and loss years may alternate, it is extremely important that profit or for each year be determined accurately in all material respects when this variation is used. Although agreements to share profits and losses equally or in specified ratios are common, mot complex profit sharing agreements are also, encountered in practice. The time that porn devote to the partnership business and he capital contributed in the business by individu? partners are frequently considered ia,de termining the profit sharing agreement. Assume tat since the expertise abilily, and reputation of X are factors of special significance Ui of the partmership. X ond ¥ agree to aliocate net ini i ji ! tt igvacard ies onecalionieh nel income st Poa cone enna | Income surnmay |X. drawing veces aaa 288,000 fy crowing . eee 172800 X's share of net income 3/5 share of net ined: Stee icon Scanned with CamScannerCopital Balances Many firms ee profs ood oe solely on the basis of capital balance. In these cases, each Miner must moiniain a specified capital boance that is corelated to the level of re on Prsumed in the porinershp. Ths method isnot only easy to apply bul con aso preven! ceoh inequities from occuring omong porines ithe porinership is tauidaled. Tis allocation of profils is most likely found in limite partnerships in which substantial invest i ingredient for success. wesiment is the principal To avoid argument. it is essential that the partnership contract specifies whether the profil- Troring ratio is based on (1) the original capital investments, (2} the Beginning capitol account balances at the beginning of each year. (3} the balances ot the end of each yeor (before the distribution of net income or loss). or (4) the average balances during each year. ‘ original Copital. If the agreement between X and Y provides tha! the allocation of net Pegme shall be based upon original capitals, reference would be made to Ihe ‘amounts originally invested by the partners. Beginning Capital. When beginning capital balances are used in allocaling partnership profit, additional investments during the accounting period may be discouraged because fhe partners making such investments are not compensated in ihe division of profit until & later period. Usage of this will prove to be inequitable. Assuming this agreement for X and ¥ 1 288,000 for the year is: the entry to record the allocation of net income of - “288,000 - 120,000 Income summary X, drawing... + vichqwing cc coiesseeeecses 168,000 % copital, Janu X, capital, January 1 Total capitals . Xs share of net income: 300/720 of P285-000 Yrs share of net income 420/720 of P286,000 Total capitals : pital balances are used. Yearend when ending ca are of profit. Jusion in determining each partner's sh ‘oke any investments belore yearend. Also, no 15 withdrawn are reinvested before the period's for an allocation of net income based upon ecord the allocation of net income ol Ending Capital, A similar problem ext: investments are encouraged by iheir incl but no incentive exists for @ partner tom penalty exists for withdrawals if the ome-r! per the parinership agreement Provides pantner's capital at the end of each yeor. Ne entry tor 288,000 for the year is 3 782000 128,000 _ 160.00 | income summary X, drawing 360.00) X capital, December 31 X. capital. December 31 . "450.000 | Tota! copito's . Paioo00 | ee Xi share of net income: 360/810 of P288.000... P 128.000 Y's share of net incomé 450/810 of P288,000 140,000 | peers 286,09 Scanned with CamScannerAverage Capital. It must have provided the fairest basis for ailocating porinerthip » because if reflecis the capital actually available for use by the partnership dufing the yy An agreement fot the use cf average capitc's also acts as an ince tk investments when these can be profitably employed. partnership contract provides for sharing profit in the ratio of average capital acco, balonees dying the year, ft should also state the amount of drawings trefer G Chapter nt further distussian a3 drawing accounts) each pariner may make without affecting 4 capital account. Any aaditional withdrawals or investments are entered rectly ON Paring, capital accounts und therefore influence the computation of average capital ratio. The probiem with the average capital computation is what withdrawal or drawing accoy, are to be considered to reduce capital necessary to compute the average amount, following guidelines should be considered: * An agreement should indicate clearly what withdrawals or drawings accounts are, be recognized; + Apartnership agreement may state that only withdrawals above a certain limit are} be viewed as offsets (reduction) against capital balances. It means that eawin account belances up to the amounts specified in the agreement would not b deducted in determining the partners’ average or year-end capital balances. Purposes .of allocating portnership profit. drawings in excess of allowable amour Gre deducted fiom the partner's capital accounts in computing average or endi, Copital balances. * Typically, elfther personal withdrawals or temporary withdrawals or drawing accout (which are withdrawal against share in anticipated profi). are not recognized in Computation of average capital. Conversely capital withdrawals or permane! withdrawals (which are withdrawal agains? oiginal or additional investments) a recognized, oonnrs The reason for the non-inclusion of the personal withdrawals in the computation 6 overage copital is that in as much as profits are generated evenly throughout tir year, the figure itself is already an average amount. Mathematically, the result, figure of inciusion of such withdrawals or excluded in the average copii! co tc 1. Simple average. This method is not so widely used take into considerétion the periods of time the cha 2. Weighted average. The poriners may wish to recognize al in their capital the profits or tosses in the operation of the partnership, The Porinership contract shoves State whetner weighted ccpital account balances are to be coe sled fo tne neo day (using doily baicnces/peso-day epproach) or te ee Ce ee i the nearest inning?” ~ Month daiances cr end-cf-month boalances/peso-menth SpEraacH ea fpeginning? as For peso-month opproach, investments and withdrawals made at th inning of te? month if made before the midcle of the month ai 2 Beginning of nd are to be consid ded the beginning of the fotlowing month if made after the middle of the moans omer" Scanned with CamScannerIf the allocation of net income is to be based upon - the entry to record the allocation of net income Ot P268.000 i Ine eee Capitals for the year, income summary . X, drawing « wees =~ Y. drawing « cone 135600 : Capital No. of Mos. x balance Unchanged W1/xa: | P300,000 |x 3 P_ 900,000 4/\txa: | 360,000 | x 3 3,240,000 domes 2 | Beal Capital No. of Mos. : balance Unchanged T//x& | P420,000 | x 2 3/1/x4: | 390,000 | x,| 8 Hipxa: | 450,000 | x 2 2 Average Total Xs share of net income: 345/750 of P288,000... 132.480 Y's share of net income: 405/750 of P288,000: 155,520 [Total steers 288,009 | it in the ratio of partners’ capital account balances was uted capital was the dominant factor in the success of the portnership. However, in most cases the amount of contributed capital is only one factor that Contributes to the success of the parinership. Consequently. many partnerships choose to divide only a portion of the profit by giving interest on ‘capital, salary allowances and bonus. The plan for dividing the entire profi based on the assumption that contrib! Interest on Capital Balances The purpose of allowing interest on capital is to give recognition to differences on capital contributions by partners. It also recognizes the contribution of the partners’ capital contribution to the partnership's profit-generating-capacily. the use of interest on capital as a mear’ of allocating profits would be appropriate when ihe business is capital intensive versus !abor intensive or if the partners were not significantly involved in the day-to-day operations, Interest on Capital os @ Distribution/Allocation of Net inconie, Using interest’ allowances on partners’ capitc! accounts as a technique for sharing partnership profit equitably has no effect lon the measurement of net income or loss of the partnership. capital contributions are just that - they are not loans to the Remember that the pariners’ n not appropriate to charge an Interest Expense account and an partnership. According'y it is not a4 Poet rayoble account, because interes! on partner's capital account is not an expense of the artnership. ‘ome porinerships do record imputed interest in this manner, although, not technical c at : cally correct, it oes not affect the final profit and loss allocations. Eventually, any remaining olanée in the Interest Payable account at year-end is then transferred to the partner account. Scanned with CamScanner— OO ee a partnership and one ofits paring properly from a lessor who It gj! Another ttem of expense arising front dealings between commonly encountated when the partnership lea: partner, Rent expense Is recognized by the partnership Assume that X and Y agree to allow Interest on average capital at 6%; any net Income o balance is to be Gllocated 3:7, Assuming no entries for interest duting the course of tho ya, entties to record the allowance of interest and the remaining allocation of net income follow, Income summary 45,000 20.700 X, drawing . 24.300 Yedrowing 7 —— 24,300 | X's intoros! on average Capital: 6% of P345,000 . . . Y's interest on average capital: 6% of P405,000 . Jotal , sees seeeee . Income summary X. drawing 72.900 |__Y. drawing . 170,100 Interest on average capital Balance (3:7). Total... The allocation of net income may be summarized in a single entry as follows: Income Soolias : 288,000 X, drawi fone : : : : 93,600 Y. drawing... . . ; 194,400 Interest on Capital Accounts with Resultant Net Loss lI the partnership contract provides for allowing interest on capital accounts, this provision be enforced regardless of whether operations are profitable or unprofitable. The only justification for omitting the allowance of interest on partners’ capital accounts duit loss year would be in the case of a partnership contract containing a specific provision reaui such omission, After the entry for interest in such a case, the debit balance in the ined summary account is transferred to the partners’ drawing accounts in the profit-and-lossrafo. In case of loss, the interest allowed to the partners shall be added to the net loss and the # resulting loss shall be distributed In the ratio agreed upon by the partn bution the balance after allowance of interest. ” ers for the csi Further. when the partnership agreement also provides without qualificatto interes! be allowed on capital, interest must be allowed even hough the opens hover rewitedi! income that are less than the allowable interest or loss. For example, assume that operation’ X and Y prior to the recognition of interest had resulted in a net loss of P80,000 and any willbe allocated into 1:4 rato. Enites to close the income summary account would hove DF as follows: income summary . E X, drawing . , Y.drawing........... rae Intores! alowed based on average Capito. sf 7 Scanned with CamScanner” _ [Xsinterest on average capital 6% of Pad: Y's interest on average capital: orpusoe Benzo) Total... Pri B.45,000 X drawing - Y. drawing... veoo00 Income summary . 125.000 The net effect of the foregoing on copitals is: x Y Total inferest on average capital P 20700 P 24,300 P 45,000 Balance (1:4). £25,000) £100,000) {125,000} Total. {2.4.300) — {P75.200) _ {P80,000) The allocation of net income may be summarized in a single entry as follows: X, drawing : ane 4300 Y. drawing : 75.700 Income summary . 80,000 Partners can provide by agreement that net income or loss shall be allocated in some arbitrary manner without recognition of interest when the results from operations fail to cover a specified interest allowance. Interest on Excess Capital Balance. It may be agreed to allow. interest on the excess of the ‘average capital of one partner over that of another. If these were the agreement between X ‘and Y, the entry to record interest and the balance in nét income assuming 1:2 ratio is: 3,600 Income summary .'-. Y, drawing... Interest allowed ba: Y's interest on excess average capital: 6% of (P405,000 - P345,000) .... P 3,600 284,400 94,800 189,600 Income summary. + X, drawing . Y, drawing The net effect of the foregoing oncapitals is: x Interest on excess ‘average capital Balance (1:2) P_ 24,800 Total £94800 _P.123,200 288,000 | The allocation of net income may be summarized in a single entry 9s follows: Income summary . : 288,000 X. drawing Y, drawing Interest on temporary advances or loans. When a partnership makes a temporary advance to a partner or recelves an amount as a temporary loan from a partner and these lransactions are recognized as creating debtor — creditor relationships between the partner and the partnership 94,800 193,200 VOLUME I | Advanced Accounting - (A Comprehensive & Procedural Approach! Scanned with CamScannerInterest charges and credit’ on such-transactions are recognized as Interest-expense-inyy Income. Interest accruals are recognized periodically on these items just as other receivable payable balances. When settlement for interest is, made by cash, entries to record the Coleg, of interest or the payment of interest are made in the usual manner. When settlement is not to be made in cash but by adjustments to partners’ capitals, interes, an advance to a partner is recorded by a charge to the partner's drawing account ang credit to Interest Income, interest on a loan made by a partner to the partnership by a chorgs, interest Expense and a credit to the partner's drawing account. In summary, interest on loans from partners is recognized as expense and as a factor in, measurement of ret income or loss of the partnership. Similarly, interest earned on lors recognized as partnership revenue. This is consistent with the principle that loans from pare are assets and liabilities, respectively. Personal Services Rendered in Net Income and Loss Sharing Agreements Partners may wish to provide for an allocation of net income that recognizes differences in te abilities and experience or in the time devoted by them to business. Partners moy agree toc arbitrary ratio for this purpose. However, the use of an arbitrary ratio to recognize perso differences is subjeét fo the same limitations as those found in the use of the capital ratiot recognize capital differences; ie., it may fail to provide satisfactory recognition of the seve: factors contributing to the success of the’partnership and it may prove inequitable in the eve of loss when the pariner who has made the greater personal contribution to the partnershio charged with the greater part of the loss. Salary Allowances In recognizing differences in personal contribution as well as other factors that are responsible! the success of the partnership, it may be agreed that partners shall be allowed salaries, with ©) net income or loss balance after salaries divided in some arbitrary ratio. Philippine partnes! low makes no provision for remuneration for partner's services in the absence of an agreerme 50 it is up to the partners to agree on what is just and fair compensation. 7 A partner who devotes time fo the partnership business while the other partners work elsewh?® may receive a salary allowance. Salary allowances are also used to compensate for differenct. in the fair valve of the talents for partners, all of whom devote thelr iime to the partnership. - The purpose of salary allowances are means of achieving a fair division of profit among Ht partners based on the time and talents devoted to partnership business. Salaries to partners offen included as part of the profit distribution plan to recognize and compensate for diffe amounts of personal services partners provide to the business. Following ore the reasons ‘*" salaries cannot be treated as expense of the partnershi - ; = |, It is important to note that this treatment of partner's salaries differs from the treatment“ employee/shareholder salaries of a corporation. Calculating partnership income allé” salary allowances |s proper when comparing the performance of a purinership pusine® with sinrilar businesses operated under the corporate structure. Scanned with CamScannerI Calculation of partnership income after sat the success of a business. The financial suc: @ fair retum for the services performed by ‘and for the risks taken. ry allowances is likewise proper in dssessing ess Of a partnership business lies in its earning Partners, for capital invested in the business, To Mlustrate the effect of a salary arrangement, assume thal X and Y « monthly solaries of 10,000 and 9.000, respectively; any net income or loss balance tev ke allocated in the ratfo of beginning capital, Amounts «x of bes ) ‘clually withdrawn by partners during the year were recorded in their drawing accounts as riesented in the original problem. The net income of P288,000 before recognition of salaties is allocated to the partners by the following igree to the allowance of enties: Income summary . 228,000 X. drawing ,.. 120,000 Y. drawing? 108,000 X: Salary for 12 months at P10,000 per month .......P120/000 ¥: Salary for 12 months at P9,000 per month . 108,000 Total eee pee £228,000 income summary 60,000 X drawing . 25,000 Y. drawing - 35.000 The net effect of the foregoing on capitalsis: x Y Total Salaries 120,000 P108,000 —_P228,000 Balance (300:420) ~25,.000 =_35,000 __60,000 Total £145.000 £143,000 288,000 Tre allocation of net income may be summarized in a single entry as follows: Income summary . 5 - 88,000 X, drawing . 145,000 L_Y. drawing. ane 143,000 A general precept of partnership accounting is that salaries to partners are not expenses in the {determination of partnership net profit but are part of the allocation plan, This precept is closely felated to the proprietary concept of owner's equily os discussed in Chapter 1. According to the Proprietary theory, the proprietor contributes capital and personal services in pursuit of profit, The Profits ore the results of those two investments. The same logic applies to the parinership fc-m of ganization. Some partners contribute capital while others contribute personal time. Those who ‘ontibute copital are typically rewarded with interest on their capital: those who contribute Nal time are rewarded with salories. _ . imitarly situated with interest on Capital discussed above. partners ary owners, not employees, tis not appropriate to charge a Salory Expense account and cred Salary Payable. Some nerships do record salary allowances in this manner, although, not technically comect, it $ No affect the final profil ond los: allocations. Eventually, any remaining balance in the \cetued Salary Payable account at year-end is then fransiered to the partnér account, lowever, both interest and salaries are results of the respective investment 1@ delermination of income but rather cs an allocation of profit. ts that are used not in OLUME I | Acwanced Arcounting ~(a Comprehensive é Procedural Approach) Scanned with CamScannerSatary Allowances with Resultant Net Loss When an agreement provides for salaries without qualification, salary allocations must be my there is a loss. After salaries are even though profit is inadequate to cover salaries or Tec, the income summary account shows a debit balance that is transfered to the Po accounts as agreed. . Bonuses Bonuses are sometimes used as a means of providing additional compensation to partner, have provided services to the partnership. Bonuses are typically stated as a percentage of; : either before or after the bonus. In the absence of any agreed basis, bonus is computed on basis of partnership net income and the concept of “partnership net income" is Gene understood in accounting practice (i.e., before bonuses are deducted.) However, partney agreement should be precise in specifying the measurement procedures to be usey determining the amount of the bonus. As with interest on capitals and salary allowances, a bonus should be considered a distribution of profit and not to be charged to an expense account. Sometimes the partnership agreement requires a minimum profit to be earned before bow ~ calculated. Mlustration 2-2, Allocation of Net Income with Bonus. The net income of A and B Partnership for 20x4 amounted to P420,000. A, as the manoy partner, is allowed as a bonus based on the following assumptions: A. A bonus of 20% of net income before the bonus is déducted, the bonus would computed as follows: LetB Bonus — B 20% of Net income B 20% of P420,000 8 = P84,000 B. A bonus of 20% of net income after deduction of the bonus, the bonus woud! computed as follows: LetB = Bonus B= 20% of Net income after Bonus 8 = 20% (420,000 - 8) 8 = P84,000- 208 1.208 =P84,000 8 _=P70,000 As a general rule, when the partnership provides witha ut qualificatic 5 is 10° allowed, bonus should be based on net income before de ato Eee ‘duction of bonus. Basis of Computation for Bonus ' As long as the basis of computation for bonus will be a positive amount, the resulting 4 should alwoys be allocated to partners enitied to it, regardless of the availabilty of the 1 amount. illustration 2-3: Allocation of Net Incorne with Bonus, Salaries, Interest and Income tax. Refer to illustration 2-2, ::1m2 that the partners further agreed on the allocation of net inc © Bonus of 20% to A Salaries to A, P40.000 and 8, P60,000; Scanned with CamScanner« Interest on average capital balances ~ A, P12,000 and 8, P8,000 + Residual balance in net income be allocated to 4 and 2 in the ratio of 2-1 ratio The following assumptions for bonus are considered 1. Bonus is based on net income before bonus, salaries and interest - same as titustration 2-2 (A). F The schedule showing the allocation of net income is presented as follows A 3 Total BONUS. ...e2e oe P 4.000 2s Solaries . _ 40.000 or 2006 Interest . 12.000 8 200% Balance ( 144.000 AK. 216.900 Total .. P280.000 _P140.000 P420.000 2, Bohus is based on net income after bonus bu! before suianes and interest same as Wustration 2-2 (B). The schedule showing the allocation of net income Bonus . P 70.000 Salaries 40,000 P60.000 100.000 } Interest 12. 8.000 20.000 | | 153333 __76,667 _230.000 | P275.333 Pl44.667 PAO. 3. Bonus is based on net income after bonus and sataries but before interest LetB = Bdnus: § = Solaries; and I= Interest. —T = 20% of Net income after Bonus and Salaries before interest 20% (P-420,000 - B -S) 20% (P-420,000 - B - P100.000) 20% (P320,000 - 8) P64,000 - .208 1.208 = P64,000 | B= P53,333 ‘Note: Ii should be noted ihat the term “before” used in the allocation of ner income Bar culony in the computation of bonus does not give any sense at all because the gene’a! 1Wle as 10 the interpretation of “net income" means it is before deduction of bonus. ssianes fo povtners ont interests on capital. These three elements (bonus. solaries to partners and interest on cata!) of ‘location of net income cre not expenses of the partnership but merely asc dsmnbuton or allocation of net income. Proof: re ‘Net income before bonus, salaries and interests...... 420,000 | Less: Bonus. Spepeopdoseoraa 53.333 Salaries... Beerceecooeneaa cee 100.000 | Net income after bonus, salaries before interests... 66... 266.667 Multiplied by: Bonus rate Boegue 20% Bonus . : P.53.333 The schedule showing the allocation of net income is presented as follows: A B Total Bons . P 53,333 P 53,333 Salaries . 40,000 P 60,000 100,000 Interest . 12,000 8.000 20.000 Balance (2:1) . 164.445 _82.222 _246.667 Total ..- ces P262.778 —P180.222 _P420.000 Scanned with CamScanner4, Bonus is based on net income after bonus. salaries and interest; LetB = Bonus: $= Salaries: andi Interest. : & = 20% of Net income after Bonus, Salaries and Interest B= 20% (P420,000 - 8 -S -1) B= 20% (P420,000 - B - P100,000 - 20,000) B= 20% (F300,000 - B) B= P60,000 - .208 1,208 = P40,000 : B= P5000 a oo Proof : Net income befote bonus, salaries and interests . . Less: Bonus Salaries Interest . [ seeantacees bee Net income after bonus, suiaries before interests Multiplied by: Bonus rate . . Bonus . ae The schedule showing the allocation of net income is presented as follows: A B Total P 50,000 P 50,000 ‘i 40,000 " P.60,000 100,000 Interest . 12,000 8,000 20,000 Betance 166.667 __83,333 __250.000 otal... E2eB667 PIS1333 —P420,000 5. Bonus is based on net income aitef'salaries_but before bonus and interest: LetB . = Bonus; $ = Solaries: and | = interest. : 8 = 20% of Net income atfer Salaries before Bonus and Int. B = 20% (P420,000- s) elaine B = 20% (P420,000~ P100,000) B = 20% (P320,000) B_=P64,000 Refer to Note of No. 3. 6. Bonus is based on net income after interest but before bonus and salaries: LSB "= Bonus: $= Salaries; and |= Interest, Glories: 8 = 20% of Net income atter interest before B; ; B = 20% (P420,000 - 20,0001 jonus and Sclaries 8 = 20% (P400,000) 8_=P80.000 Refer to Note of No. 3. 20% (P420,000- 1) 784,000 - 207 stituting the equation for T in the equation for B: Sup Let 8 = P84,000- .20 {P147,000) B . =P84,000 - P29,400 B_=P54,600___ Scanned with CamScanner awProof Netincome before bonus and income tax Paap.p00 Loss: BONUS... ee : ee Net income after bonus b wisi Less: Income tox... eens ar Net income after bonus and income tax Pana Bonus as computed above: ‘Net income before bonus and income fax........... +. PA20,000 Less: Income tax (35% x P420,000) 2. _aa7.o09 Net income after income tax before BONUS... .eeseeeevveees ee P278000 Multiplied by: Bonus rate . ne 20% Net income alter bonus and income tax P 54.600 8. Bonus is based on net income. that is, after bonus and income tax: LetB = Bonus; T= Income tax 8 = 20% (P420,000-B - 1) 8 _=P84,000- 208 - .20T Lett =income tax 1 1 Substituting the equation for Tin the equation for B: Let 8 : 8 1.208 1.208 Proof: . Net income before bonus and income tox . | Less: Bonus.........664 . | Net income after bonus before income tax. Less: Income tax (35% x P420,000) .. : | Net income after bonus and income tax... Bonus as computed above: | Net income ctter bonus and income tax . . Multiplied by: Bonus rate Boris Bonus with Resullant Net Loss of bonus is not applicable fo a nel lass. When a partnership operates at 8 loss, the ‘ats the purpose of giving bonus. The con bonus provision is divegarded because it defe Insuficient Income to Covar Allocation in some cases. the partnership net income may be less than the interest, salary and/or bonus rovided for in the partnership agreement. : in occurrence in the profit and loss formula, the 1, sclery and/or bonus as if sufficient incorne had ‘or bonus exceeds the net income is the pariners fall to provide for such 3 stablished practice is to allocate the intere: een eamed. The amount by which the inteles!. salary ond/ ceeds located to the individual portness in their agreed ratio for atocating residual income. Scanned with CamScannera oe ie This it is simply all provisions of the profit and loss agreement epciaaeseieaeaeren the partnership has an overall-loss (see previous dha interest. salary and bonus with a resultant net loss). Special Problems In Allocation of Profit and Loss - Salaries and Inféres? as an Expense VIOU 1s discussions, net Income was viewed es the retum to the parmers for thy Coton othe buses os owner ~copholor wel ex perional sence, nem et cllowances to partners were regarded as a means of providing for an equitable distibuiy such Income. | is possible'to record salaries and interest as Part of expense items rather than as istributiy allocation of net income. When these items aré made to expense accounts rather than to the partners’ drawing acci, {or capital accounts); expense balance are then closed into the Income Summary accoy, arriving at the net income to be allocated in the agreed profit and loss ratio. On the income statement, Partners’ interest and salaries would be listed with the other expe, in ariving at net income or loss of the partnership. Whether partners! interest and sdlaries are treated in the Gistributions or allocation of net income, the eventual distrib. income or loss amongathe partners remain éxactly the same. accounts as expense items a ution or allocation of partnestig Corrections of Partnership Net Income of Prior Period - Errors may occur ‘in accounting for partnershi expenses or revenue errors in the inventory amortization of assets. ID Operations, such as failure to accrue or Count or Pncing, or errors in the calculate Problems in the allocation of profit and loss can result if (1) errors are discovered that occur! specific prior years, and (2) the pariners have altered the Profit and loss agreement since! Period in which the error occurred. Tor correction is accounted for o8¢ In corporation, an er Adjustment to the beginning retaine d ecmmings balance. However, in a partnership the Corection is allocated to the individual Partners’ cof accounts. The allocation should be based on the Profit and loss agreement in effect during period of the error. : Subsequent Changes in Methods to Allocate Net Income or loss If the partners subsequently agree to change the m ‘ethod to allocate profit and losses, &¢ Gictates that assets be revalued to their current value, es : Sat the time of the Change. For example. assume that partners X and Y shared profits nd losses in a 6:4 ratio respec but at a later date agreed to share profits and losses equally, Suppose that the partnershio @ piece of machinery cared on the books at P100,000, but with a P140,000 current ¥9 Partner Y would receive a larger share of the pro} fit on the machinery (when it is later sotd) had the machinery been sold tefore the change in the method tee Profits and losses shared 6:4 ratio. Scanned with CamScannerfemative to revaluing the jrachinery to its current value to stipulate in the new bast fis emul ha he et P40,000 of proton he sce of that machina ene ayy ae sr and loss sharing ratio. Under this method, the partnership avoids making on entty that & old prot wth what is Generally Accepted Accounting Principles (GAAP). This is not o major iorer selecting this ollemative: however: Tevaluing assets is more practical, | Prof and loss sharing formula is revised, the new formula should contain a provision jac that the old formula apples fo certain types of subsequent adjustments orl oof of ‘octivlies tht fook place before the revision date. Examples are cc follone 1. Untecorded liabilities at the revision date: 2. Settlement on lawsuits not provided for at the revision date, even though the liability may not have been probable as to payment or reasonably estimate at that time: 3. Write-offs of accounts receivable existing as of the revision date. Regardless of the fact that some of these items do not qualify as prior period adjustments seater equity usually achieved among the partners by using the old sharing formula. Because Partnerships need not follow GAAP, the will of the partners may prevail, Special Profit Allocation Methods Some portnerships distbute net income on the bosis of other citerio. For example, most public Occounting partnerships distribute profit: 1. On the basis of partnership “units”. A new partner may Acquire a certain number of units, Sern ational units are assigned by a partnership compensation committee for Obtaining new clients, or for providing the fim with specific oreo ot industrial expertise. 2. Performance methods. It gives some weight to the specific performance of each partner fo provide incentives to Perform well. Some examples of the use of performance criteria Ore listed below: @. Chargeable hours. These ore the total number of hours that a partner incured on Client-related assignments. Weight may be given to hours in excess of normal. Total billings. The total amount billed to clients for work Performed and supervised by © Partner constitutes total bilings. Weight may be given to billings in exces of normal, ¢. Write-offs. Write-offs consist of the amount of uncollectible billings. Weight may be Sven to a write-off percentage below normal. . Promotional and civic activities. Time devoted to developing future business and enhancing the partnership name in the community is considered promotional and accompk: + Profits in excess of spectfied level. Designcted partners common! 'Y receive a certain Percentage of profits in excass of © specified level of earnings, Scanned with CamScannerStatement of Changes In Partners’ Capital Accounts The balance sheet’ and income statement for a partnership are accompanied by g statement that reports the changes that have taken place in the partners’ interests du period. The statement of changes in partners’ capital accounts based on Mlustration {assuming that 6% interest is based on average capital with the remaining net income allocated based on a 3:7 ratio for X and Y, respectively) may be prepared in the folly manner: X and Y Partnership Statement of Changes in Partner's Capital Accounts For the Year Ended, Decémber 31, 20x4 x Y Total Capitals, January 1, 20x4.. ~ P300,000 P420,000 P 720,05 Add: Additional Investments . 60,000 __60,000 Total see 360,000 PA480,000 P_ 640,00) Less: Capital withdrawals —__-0- _30,000 Ending Capital before Net Income . 360,000 450,000 P 810.000 Add: Net Income (see schedule) —93,600 _194,400 Total : 153,600 P1,078,000 Less: Personal withdrawals . . 1004 Copitals, December 31, 20x4 . P_248,000 X and Y Partnership Schedule - Allocation of Net Income For the Year Ended, December 31, 20x4 7 x xX. Y Total Interest on average Capital... 02.6... ec ecsvecusr vee P 20,700 24,300 P 45,000 Bdiance (3:7) P 72,200 170,100 243,000 Total .. 293.600 P194.400 p286.000 Scanned with CamScanner