Afar 2 Module CH 2

COURSE AFAR 2: ADVANCED FINANCIAL ACCOUNTING AND REPORTING 1
This module is prepared by professor Venus L. Catacutan. She’s an

associate professor in the College of Business and Accountancy-
DEVELOPER AND THEIR Accountancy department at Tarlac State University . Being a Certified
BACKGROUND Accountant, in addition to her teaching profession, shes’ likewise involve
in public practice which brings to this module some experiences on
specialized accounting concerns of different industries.
This course is designed to provide fundamental knowledge to students

concerning accounting for special transactions and advanced financial
reporting issues likely to be encountered in practice. It deals with the
sthe study of fundamental valuation accounting theory as applied to
special income and expense recognition methods and expanded
COURSE DESCRIPTION business operations. The course includes specialized problems in
partnership accounting, revenue from contract with customers (PFRS 15)
and accounting for domestic branches. The other topics deal with
accounting for the effect of changes in foreign exchange rates and other
similar current issues. Likewise discussed are debt restructuring and
accounting for financially distressed corporations.
1. Partnership Formation
2. Partnership Operations
3. Partnership Dissolutions
4. Partnership Liquidation (lump-Sum and Installment method)
5. Corporate Liquidation
6. Revenue Recognition- contract with customers (PFRS 15)
7. Revenue Recognition- contract with customers (Construction
Contract)
8. Renenue Recognition- contract with customers ( Franchise and
COURSE OUTLINE
Consignment)
9. Home Office, Branch, and Agency Accounting (General
Procedures)
10. Home Office, Branch, and Agency Accounting (Special
Procedures)
11. Foreign Currency Transactions
12. Hedging and Derivatives (FOREX)
13. Foreign Currency Translation
CHAPTER 2
TITLE PARTNERSHIP OPERATION
This module deals with topics concerning partnership operations,the
discussion focuses on the factors that affect the distribution of profit and
loss and the detaisl about profit and loss allocation methods. Similarly,
thru this module students will be trained to compute and solve
I. RATIONALE
accounting for partnership problems e.g change in profit and loss
allocation method and correction of profit in prior period, lastly they will
be given insights on what will be the proper treatment and the outcome
of these accounting concerns.
This module covers the topic regarding partnership operation, the
expected learning to be achieved by the student are properly disclosed in
the learning objectives stated below. Prior to taking this course, a
student must have already a concrete knowledge on basic accounting
concepts , and skills in preparing financial statements otherwise the user
of this module must review the basic and financial accounting undertaken
in previous courses. Uderstanding of the first chapter of this course is
INSTRUCTION TO THE USERS likewise important (preparatory activities)
The developmental activities section provides the comprehensive and
vital information concerning accounting for partnership operation. For
assessment of learning,closure activities like theoretical questions and
problem solving with different degree in terms of difficulty were provided.
For evaluation , see the evaluation section for details, and lastly for
activities and preparation to be undertaken for next topic this module
provides the student/s the details.
PRE-TEST
At the end of the chapter, the student should be able to:
✓ Determine the legal basis of profit distribution between or
among the partners.
✓ Identify factors that affect the division of a partnership’s profit or
losses among the partners.
✓ Explain the different profit and loss allocation methods and their
II. LEARNING OBJECTIVES
advantages and disadvantages.
✓ Journalize all transactions concerning partnership operations.
✓ Solve all problems related to partnership operations
✓ Identify the effect of corrections of prior profit of the partnership
in each partners interest in the partnership
III. CONTENT
This module covers the discussion concerning partnership operations.
The students must have already knowledge on how to determine the
result of the operations of a business, hence the students must;
1. Revisit what have been discussed in previous accounting
subjects regarding activities and accounts used in operation of
A. PREPARATORY ACTIVITIES
the business.
2. Likewise review on how Statement of Comprehensive Income
or Income Statement are prepared
3. Have in-depth understanding of the general concepts of
partnership which has been discussed in the first module.
B. DEVELOPMENTAL ACTIVITIES
DISTRIBUTION OF PROFIT OR LOSSES
Profit Generation
A Partnership is organized primarily to generate profit that is intended to be divided among the partners. Partners
pool their resources, which become a common fund of the partnership and this fund is intended to be used in the
business operation in generating profit.
The law provides that profit generated by the partnership has to be divided among the partners. The basis of
distribution is governed by existing laws on partnership.
Legal basis of Profit Distribution

The law on partnership Article 1797 of the Philippine Civil Code provides that the losses and profits shall be
distributed in conformity with the agreement of the partners. Article 1797 also provides the following additional rules
in the profit or loss sharing of the partners: (In order of priorities)
• In absence of the agreement, according to their capital contribution.
• If what was agreed is only on how the profits are to be distributed, the said loss is to be distributed the same
manner on what was agreed on how profits are to be distributed.
• Industrial partners shares with the profits based on the agreement of the partners.
• If there is no stipulation on the share of the industrial partner, his share will be based on what is deemed to
be just and equitable.
• If an industrial partner also contributes capital, he shall receive a share on the profits for the capital
investments and shall also receive a share for his skills.
• An industrial partner does not share in the loss of the partnership.
Methods of Dividing Profit or Loss

The following are the possible methods of dividing profits or losses among the partners:
1. Equally.
2. In an unequal or arbitrary ratio.
3. In the ratio of the partners’ capital account balances on a particular date, or in the ratio of average capital
account balances during the year.
4. Allowing interest on the partners’ capital account balances and dividing the remaining net income or loss in
the specified ratio.
5. Allowing salaries to partners and dividing the remaining net income or loss in a specified ratio.
6. Bonus to managing partner based on:
6.1 Net income.
6.2 Net income after bonus
6.3 Net income after interest
6.4 Net income after salaries
6.5 Net income after tax
6.6 Net income after bonus, salaries and interest
6.7 Net income after bonus, salaries, interest and taxes
Equally – this method may be proper when the capital or service contribution of the partners are considered to be
the same.
Arbitrary Ratio – this method maybe employed to recognize the difference in capital or service contribution.
Capital Balances – This method is not only easy to apply but can also prevent certain inequities from occurring
between or among partners if case of partnership liquidation. It may be based on Original capital balances, the
reason behind this is that, if at the time of the formation there is no agreement on how profit or loss will be allocated,
the law should apply and capital balance available at that time is the original capital balances. It may also be based
on Beginning Capital, however this is being discouraged due to additional investments during the accounting period
are not compensated in the allocation. Another one is based on Ending Capital, in this method, year-end
investments are encouraged, however no incentives exist for a partner to make any investments before year end.
The last one is based on Average Capital this is the fairest basis for allocating partnership profit because it reflects
the capital actually available for use by the partnership during the year. It may be based on Simple Average or
Weighted Average. Simple average fails to take into consideration the periods of time the changes in capital takes
place. Using the weighted average it recognizes all the changes in the capital as well as in the drawing accounts in
determining the capital ratio to be used in the distribution. It should be clearly stipulated whether the computation of
average capital is computed based on peso-day approach or peso-month approach.
Interest on Capital Balances – the purpose of allowing interest on capital is to give recognition to difference on
capital contributions by partners. It also recognizes the contribution of the partners’ capital to the partnership’s profit
generating capacity. It also appropriate when the business is capital intensive against labor intensive if the partners
are not significantly involved in the day-to-day operations. It should be noted that interest on capital balances is not
an expense but it is one of the tools in profit allocation. On the other hand interest on loan payable to partners is an
interest expense. Interest on capital balances shall be enforced regardless of whether operations are profitable or
not.
Salary Allowances –The purpose of which is to give due recognition to the time effort and talent devoted by
partner/s to the partnership. It is likewise not considered as an expense since partners are not employees of the
partnership. they will be given even if the results of operation is not profitable.
Bonus – bonus were given to motivate partner/s especially the managing partner to give their best shot in managing
the operation. Bonuses are typically computed based on percentage of profit. The concept of which is not applicable
if the result of the operation is a net loss because if defeat the purpose of giving bonus. It is not also given if after all
the considerations will be deducted, and the profit is not enough to provide for a bonus.
ILLUSTRATIONS OF PROFIT DISTRIBUTION TO PARTNERS
JJ and KK agreed to form JK Partnership on January 1, 2018. JJ invested P60,000 while KK invested P40,000 cash.
On December 31, 2020, after closing all income and expense accounts, the Income Summary account shows a
credit balance of P50,000, representing the profit for the year 2020. Changes in the Capital accounts during 2020 are
as follows:
JJ KK
Capital balances, January 1, 2020 P80,000 P60,000
Additional investment – Apr 1 10,000 20,000
Additional investment – June 1 10,000 5,000
Withdrawal – July 1 - (10,000)
Withdrawal – Sep 1 (15,000) (5,000)
Additional investment – Nov 1 5,000 10,000
Capital Balances, December 31, 2020 P90,000 P80,000
CASE 1: Division of Profit or Losses Equally

Profit is divided equally among the partners if the partners have agreed to do so. Equal distribution of profit is used by
the partners since they see it as an equitable basis. Equal distribution however, disregarded the capital contributions
of partners and/or the efforts or skills contributed by them.
Journal entry for the distribution of profit and to close the Income Summary account to the capital account of the
partners on December 31, 2020:
Income Summary 50,000

JJ, Capital (50,000/2) 25,000
KK, Capital (50,000/2) 25,000
CASE 2: Division of Profit or Losses in an Arbitrary (Unequal) Ratio
2.1 Percentage
Assume that JJ and KK agreed to share 70% and 30% in the profit or loss respectively.

JJ, Capital (50,000 * 70%) 35,000
KK, Capital (50,000 * 30%) 15,000
2.2 Ratio
2.2.a. Based on Agreement
Assume that JJ and KK agreed to share in a ratio of 3:1, respectively.


JJ, Capital (50,000 * 3/4) 37,500
KK, Capital (50,000 * 1/4) 12,500
2.2.b. No Agreement
If no agreement is made between the partners, use the ratio of Original Capital Contributions.
Partner Original Capital Contribution Ratio

JJ 60,000 60/100 or 60%
KK 40,000 40/100 or 40%
Total 100,000

JJ, Capital (50,000 * 60%) 30,000
KK, Capital (50,000 * 40%) 20,000
2.2.c. Based on Beginning Capital Balances

Determine the profit share of the partners using their beginning capital balances on January 1, 2020.
Partner Beginning Capital Balances Ratio

JJ 80,000 80/140 or 57%
KK 60,000 60/140 or 43%
Total 140,000

JJ, Capital (50,000 * 57%) 28,500
KK, Capital (50,000 * 43%) 21,500
2.2.d. Based on Ending Capital Balances

Determine the profit share of the partners using their ending capital balances on December 31, 2020 before closing
the Income Summary account.
Partner Ending Capital Balances Ratio

JJ 90,000 90/170 or 53%
KK 80,000 80/170 or 47%
Total 170,000

JJ, Capital (50,000 * 53%) 26,500
KK, Capital (50,000 * 47%) 23,500
2.2.d. Based on Average Capital Balances
Division of net income on the basis of (1) original capital contributions, (2) beginning capital account balances, or (3)
ending capital account balances may be unreasonable if there are material changes in the capital accounts during
the year. Use of average capital balances is preferable because it reflects the capital actually available for use by the
partnership during the year.
If the partnership agreement provides to divide net income in the ratio of average capital balances during the year, it
should also state the amount drawings each partners may make without affecting the capital account. Any additional
withdrawals or investments are entered directly to the partners’ capital accounts and therefore should be considered
in the computation of the average capital ratio.
• Simple Average Method.

Compute the average of the beginning and ending capital balances as follows:
Average
Partner Beginning Capital Ending Capital Simple Average Capital Ratio
Balances Balances Method Balances
JJ 80,000 90,000 85,000 85/155 or
(80,000 + 90,000) / 2 55%
KK 60,000 80,000 70,000 70/155 or
(60,000 + 80,000) / 2 45%
Total 140,000 170,000 155,000

JJ, Capital (50,000 * 55%) 27,500
KK, Capital (50,000 * 45%) 22,500
• Peso-Month/ Peso-Day Method.

Under this method, partners drawing account balances up to the amounts specified in the agreement would
not be deducted in determining the partners’ average or year-end capital balances. For the purpose of
dividing partnership income, drawing in excess of allowable amounts are deducted from the partners’ capital
accounts in computing average capital balances.
The partnership contract should also state whether capital account balances are to be computed to the
nearest month or to the nearest day. A common practice is to treat withdrawals and investments made
during the first half of the month as if they were made on the first day of the month, while the latter half of
the month, as if they were made on the first day of the following month.
Computing the division of net income for 2020:

Computation of Average Capital Account Balances - JJ
Capital Fraction of Year Average
JJ Account Unchanged Capital
Balance Balances
Capital balances, Jan 1, 2020 P80,000 P80,000 3/12 P20,000
Additional investment – Apr 1 10,000 90,000 2/12 15,000
Additional investment – June 1 10,000 100,000 3/12 25,000
Withdrawal – Sep 1 (15,000) 85,000 2/12 14,167
Additional investment – Nov 1 5,000 90,000 2/12 15,000
TOTAL 90,000 P89,167
Computation of Average Capital Account Balances - KK

Capital Fraction of Year Average
KK Account Unchanged Capital
Balance Balances
Capital balances, Jan 1, 2020 P60,000 P60,000 3/12 15,000
Additional investment – Apr 1 20,000 80,000 2/12 13,333
Additional investment – June 1 5,000 85,000 1/12 7,083
Withdrawal – July 1 (10,000) 75,000 2/12 12,500
Withdrawal – Sep 1 (5,000) 70,000 2/12 11,667
Additional investment – Nov 1 10,000 80,000 2/12 13,333
TOTAL P80,000 P72,916
Determine the profit share of the partners using their average capital balances.
Partner Average Capital Balances Ratio

JJ 89,167 89,167/162,083 or 55%
KK 72,916 72,916/162,083 or 45%
Total 162,083

JJ, Capital (50,000 * 55%) 27,500
KK, Capital (50,000 * 45%) 22,500
CASE 3: Provision of Salaries
Partners may agree to distribute profit by providing salaries to each of the partners or to selected partners only. In
this case, the following have to be observed:
a) The salaries have to be given first to respective partner/s.

b) The salaries are to be deducted from the profit.
c) The remainder balance of the profit after deducting the salaries is to be distributed according to agreement
and if there is no agreement stipulated, the capital ratio is to be used.
3.1. The remainder of Net Income after Deducting Salaries is Positive:
Assume that the partners stipulate the following:

a) JJ will receive monthly salary of P1,000.
b) KK will receive semi-annual salary of P5,000.
c) The remainder is to be divided equally.
Profit Distribution Table:

JJ KK Total
Salaries –JJ (P1,000 * 12) P12,000 P12,000
Salaries –KK (P5,000 * 2) P10,000 10,000
Remainder: (P28,000/2) 14,000 14,000 28,000
***Net Income – P50,000
Salaries –JJ – (12,000)
Salaries - KK - (10,000)
Balance - P 28,000
TOTAL P26,000 P24,000 P50,000
Monthly Journal Entry for the salary of JJ:
JJ, Drawings 1,000

Cash 1,000
To record salary allowances of JJ
Semi-annual Journal Entry for the salary of KK:
KK, Drawings 5,000

Cash 5,000
To record salary allowances of KK

JJ, Capital 26,000
KK, Capital 24,000
Journal entry close partners’ drawing accounts for 2020:
JJ, Capital 12,000

KK, Capital 10,000
JJ, Drawings 12,000
KK, Drawings 10,000
3.2. The remainder of Net Income after Deducting Salaries is Negative:

JJ KK Total
Salaries –JJ (P2,000 * 12) P24,000 P24,000
Salaries –KK (P15,000 * 2) P30,000 30,000
Remainder: (-P4,000/2) (2,000) (2,000) (4,000)
Balance - (P 4,000)
TOTAL P22,000 P28,000 P50,000
JJ, Drawings 2,000

Cash 2,000
KK, Drawings 15,000

Cash 15,000

JJ, Capital 22,000
KK, Capital 28,000
JJ, Capital 24,000

KK, Capital 30,000
JJ, Drawings 24,000
KK, Drawings 30,000
3.3. Provision for salaries and the result of Partnership Operations is Net Loss
Partnership agreements should provide not only for partners salary allowances and the sharing of profits but also the
treatment of salaries when losses are incurred. In absence of such agreement, salaries are automatically allowed
even when losses are incurred.
Assume that instead of a net profit, JK Partnership incurred a net loss of P50,000. Also, the partners stipulate
the following:

JJ KK Total
Salaries –JJ (P1,000 * 12) P12,000 P12,000
Salaries –KK (P5,000 * 2) P10,000 10,000
Remainder: (-P72,000/2) (36,000) (36,000) (72,000)
***Net Income – (P50,000)
Balance - (P72,000)
TOTAL (P24,000) (P26,000) (P50,000)
JJ, Drawings 1,000

Cash 1,000
KK, Drawings 5,000

Cash 5,000
JJ, Capital 24,000

KK, Capital 26,000
JJ, Capital 12,000

KK, Capital 10,000
JJ, Drawings 12,000
KK, Drawings 10,000
CASE 4: Provision of Interest on Capital

Interest on capital is also provided as a means of distributing profits among the partners. The capital investments of
partners are given interest as remuneration for the use by the business of the invested money and other assets. The
interest in capital can be computed on the beginning, ending or average capital balances.
4.1. The remainder of Net Income after Deducting Interest on Capital is Positive:

a) JJ will receive quarterly interest of 2% on his beginning capital balance.
b) KK will receive semi-annual interest of 6% on his average capital balance.
c) The remainder is to be divided based on their ending capital balances.
JJ KK Total
Interest –JJ (P80,000 *2%* 4) P6,400 P6,400
Interest –KK (P72,916*6% * 2) P8,750 8,750
Remainder:
JJ= 34,850*90/170 18,450
KK= 34,850*80/170 16,400
Interest –JJ – (6,400)
Interest –KK - (8,750)
Balance - P 34,850 34,850
TOTAL P24, 850 P25,150 P50,000
Quarterly Journal Entry for the interest on beginning capital balance of JJ:
JJ, Drawings 1,600
Cash 1,600
To record interest allowances of JJ
Semi-annual Journal Entry for interest on average capital balance of KK:
KK, Drawings 4,375

Cash 4,375
To record interest allowances of KK

JJ, Capital 24,850
KK, Capital 25,150
JJ, Capital 6,400

KK, Capital 8,750
JJ, Drawings 6,400
KK, Drawings 8,750
3.2. The remainder of Net Income after Deducting Interest on Capital is Negative:


JJ KK Total
Interest –JJ (P80,000 *10%* 4) P32,000 P32,000
Interest –KK (P72,916*20% * 2) P29,166 29,166
Remainder:
JJ= (11,166)*90/170 (5,911)
KK= (11,166)*80/170 (5,255)
Balance - P (11,166) (11,166)
TOTAL P26,089 P23,911 P50,000
JJ, Drawings 8,000

Cash 8,000
KK, Drawings 14,583

Cash 14,583

JJ, Capital 26,089
KK, Capital 23,911
JJ, Capital 32,000

KK, Capital 29,166
JJ, Drawings 32,000
KK, Drawings 29,166
4.3. Provision for interest on capital and the result of Partnership Operations is Net Loss
Assume that instead of a net profit, JK Partnership incurred a net loss of P50,000. Also, the partners stipulate
the following:
JJ KK Total
Interest –JJ (P80,000 *2%* 4) P6,400 P6,400
Interest –KK (P72,916*6% * 2) P8,750 8,750
Remainder:
JJ= (P65,150)*90/170 (34,491)
KK= (P65,150)*80/170 (30,659)
***Net Income – (P50,000)
Balance - (P65,150) (65,150)
TOTAL (P28,091) (P21,909) (P50,000)
JJ, Drawings 1,600

Cash 1,600
KK, Drawings 4,375

Cash 4,375
JJ, Capital 28,091

KK, Capital 21,909
JJ, Capital 6,400

KK, Capital 8,750
JJ, Drawings 6,400
KK, Drawings 8,750
CASE 5: Bonus to Partners

Bonus is another means of distributing the profit generated by the partnership during the accounting period to its
partners. It represents the incentive or reward extended by the partnership to the partners who have caused
favourable results in the operation of the former. Hence, bonus is only given when the result of operation is net
income and the same is enough to cover for its payment. Bonus may be expressed based on the following:
5.1 Based on net income before bonus, salaries and interest

Formula:
Net Income before bonus, salaries and interest xxx

Multiplied by Bonus Rate %
BONUS xxx

b) KK will receive semi-annual salary of P5,000
c) JJ will receive quarterly interest of 2% on his beginning capital balance.
d) KK will receive semi-annual interest of 6% on his average capital balance.
e) 10% Bonus before bonus, salaries and interest to KK.
f) The remainder is to be divided 3:1 to JJ and KK, respectively.
JJ KK Total
Salaries –JJ (P1,000 * 12) P12,000 P12,000
Salaries –KK (P5,000 * 2) P10,000 10,000
Interest –JJ (P80,000 *2%* 4) 6,400 6,400
Interest –KK (P72,916*6% * 2) 8,750 8,750
Bonus (50,000*10%) 5,000 5,000
Remainder:
JJ = 7,850*3/4 5,888
KK= 7,850*1/4 1,962
Interest –JJ - (6,400)
Bonus to KK- (5,000)
Salaries –JJ –(12,000)
Salaries - KK -(10,000)
Balance - P 7,850 7,850
TOTAL P24,288 P25,712 P50,000
JJ, Drawings 2,000

Cash 2,000
KK, Drawings 15,000

Cash 15,000
JJ, Drawings 1,600
Cash 1,600
KK, Drawings 4,375

Cash 4,375

JJ, Capital 24,288
KK, Capital 25,712
JJ, Capital 18,400

KK, Capital 18,750
JJ, Drawings 18,400
KK, Drawings 18,750
5.2 Based on net income after bonus but before salaries and interest
Formula:

Divided by 100% plus Bonus Rate %
Net Income after bonus but before salaries and interest xxx
BONUS xxx
Alternatively, bonus may be computed algebraically as follows:

Let B stand for bonus and NI stand for net income.
Therefore:
B = rate (NI-B)

e) 10% Bonus after bonus but before salaries and interest to KK.
JJ KK Total
Salaries –JJ (P1,000 * 12) P12,000 P12,000
Salaries –KK (P5,000 * 2) P10,000 10,000
Interest –JJ (P80,000 *2%* 4) 6,400 6,400
Interest –KK (P72,916*6% * 2) 8,750 8,750
Bonus to KK
B = 10%*(50,000 - B) 4,545 4,545

B = 5,000 - .10 B
1B+.10 B = 5,000
1.10 B = 5,000
1.10 𝐵 = 5,000
1.10
B = 4,545
Remainder:
JJ = 8,305*3/4 6,229
KK= 8,305*1/4 2,076
Salaries –JJ –(12,000)
Salaries - KK -(10,000)
Balance - P 8,305 8,305
TOTAL P24,629 P25,317 P50,000
JJ, Drawings 2,000

Cash 2,000
KK, Drawings 15,000

Cash 15,000
JJ, Drawings 1,600

Cash 1,600
KK, Drawings 4,375

Cash 4,375

JJ, Capital 24,629
KK, Capital 25,317
JJ, Capital 18,400

KK, Capital 18,750
JJ, Drawings 18,400
KK, Drawings 18,750
5.3 Based on net income after bonus, salaries and interest

Formula:

Less Salaries and Interest xxx
Net income after salaries and interest but before bonus xx
Divided by 100% plus Bonus Rate %
Net Income after bonus but before salaries and interest xxx
BONUS xxx
Alternatively, bonus may be computed algebraically as follows:
Let B stand for bonus; NI stand for net income; SAL for salaries and INT for interest.
Therefore:
B = rate (NI - B - SAL - INT)

e) 10% Bonus after bonus, salaries and interest to KK.

JJ KK Total
Salaries –JJ (P1,000 * 12) P12,000 P12,000
Salaries –KK (P5,000 * 2) P10,000 10,000
Interest –JJ (P80,000 *2%* 4) 6,400 6,400
Interest –KK (P72,916*6% * 2) 8,750 8,750
Bonus to KK
B = 10%*(50,000 – B - 22,000 -15,150) 1,168 1,168

B = 10%*(12,850 – B)
B = 1,285 - .10 B
1B+.10 B = 1,285
1.10 B = 1,285
1.10 𝐵 = 1,285
1.10
B = 1,168
Remainder:
JJ = 11,682*3/4 8,762
KK= 11,682*1/4 2,920
Balance - P 11,682 11,682
TOTAL P27,162 P22,838 P50,000
JJ, Drawings 2,000

Cash 2,000
KK, Drawings 15,000

Cash 15,000
JJ, Drawings 1,600

Cash 1,600

KK, Drawings 4,375
Cash 4,375

JJ, Capital 27,162
KK, Capital 22,838
JJ, Capital 18,400

KK, Capital 18,750
JJ, Drawings 18,400
KK, Drawings 18,750
IMPORTANT NOTE: Unlike salary and interest, Bonus agreement is NOT APPLICABLE if the operation of the
partnership result to NET LOSS.
FINANCIAL STATEMENTS FOR A PARTNERSHIP
Statement of Comprehensive Income

The form and contents of the statement of comprehensive income of partnership are somewhat similar to that of the
statement of a sole proprietorship or a corporation. Explanations of the division of net income among the partners
may be included in the partnership’s statement of comprehensive income or in note to the financial statements.
Using the information from the previous illustration:
JK Partnership
Statement of Comprehensive Income
Year Ended December 31, 2020
Sales P500,000
Cost of Sales (400,000)
Gross Income 100,000
Operating Expenses (50,000)
Comprehensive Income P50,000
Distribution of Net Income

JJ 27,162
KK 22,838
TOTAL P50,000
Statement in Changes in Partners’ Equity
Changes affecting the partners’ capital accounts each year are reported in a separate statement known as Statement
of Changes in Partners’ equity. The purpose of this statement is to present the details that cannot be readily
incorporated in the statement of financial position.
JK Partnership
Statement of Changes in Partners’ Equity
JJ KK Total
Capital Balances, Jan. 1 P80,000 P60,000 P140,000
Additional Investments 25,000 35,000 60,000
Withdrawals (15,000) (15,000) (30,000)
Balances before net income and drawings 90,000 80,000 170,000
Comprehensive income (loss) 27,162 22,838 50,000
Drawings (18,400) (18,750) (37,150)
Capital Balances, Dec. 31 P98,762 P84,088 182,850
The Partners’ Capital Balance at the year end of the year 2020 is reported in the December 31, 2020 statement of
financial position.
Statement of Financial Position

JK Partnership
Statement of Financial Position
As of December 31, 2020
ASSETS
Current Assets
Cash P50,000
Accounts Receivable 60,000
Inventories 40,000
Non-Current Assets
Properties and Equipment, net 200,000
TOTAL ASSETS 350,000
LIABILITIES AND PARTNERS’ EQUITY

Current Liabilities
Accounts Payable 60,000
Loans Payable 107,150
Total Liabilities 167,150
Partners’ Equity
JJ, Capital P98,762
KK, Capital 84,088 182,850
TOTAL LIABILITIES AND PARTNERS’ EQUITY 350,000
Statement of Cash Flows

A statement of cash flow is prepared for the partnership as it is for a corporation. This statement presents the net
cash provided or used in financing activities.
JK Partnership
Statement of Cash Flows
Cash flows from operating activities:

Net Income P50,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 20,000
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable (15,000)
Decrease (increase) in inventories 17,150
Increase (decrease) in accounts payable 20,000
Increase (decrease) in loans payable (25,000)
Net cash flow provided by Operating Activities 67,150
Cash flows from investing activities:
Acquisition of Equipment (20,000)
Net cash flow provided by Investing Activities (20,000)
Cash flows from financing activities:

Partners’ investments 60,000
Partners’ withdrawals (30,000)
Partner’s drawings (37,150) (7,150)
Net cash flow provided by Financing Activities (7,150)
Net Increase in Cash 40,000

Cash at the beginning of year 10,000
Cash at the End of the Year P50,000
CHANGES IN THE PROFIT AND LOSS RATIO
Partners may agree to change their profit and loss ratio. When changes in profit and loss ratio occur, several
problems will be encountered in the determination of partners’ interests, among which are the following:
1. There may be difference between the book value and the fair value of tangible assets.
2. The partnership might have intangible such as goodwill that are not recorded in the books but which must
be considered determining the fair value of the partners’ interest.
3. The partnership might have kept its books on a cash basis, and as a result, there may be unrecorded assets
and liabilities. These too, must be considered.
After considering the above items, two approaches can be used for a fair valuation of the partners’ interest, as
follows:
1. Adjust all assets and liabilities to reflect their fair values. Also record any unrecorded assets or
liabilities, if any. These should be made to the partners’ capital accounts in accordance with their old
profit or loss ratio.
2. Calculate the effects of all the differences between the book values and fair values as well as the
unrecorded assets and liabilities, and adjust only the partners’ capital account for the net effect of these
adjustments using the old profit or loss ratio. Under this approach, no adjustments of assets and
liabilities are recorded in the books of the partnership.
Illustration. Assume that JJ and KK, share profits and losses equally decided to change their ratio 1:3, respectively.
Assume also that at the date of change, the partnership held the land that was carried at a cost of P50,000 but had a
fair value of P350,000.
First Approach:
If the adjustment of the book value is made, the required entry would be as follows:
Land 300,000
JJ, Capital 150,000
KK, Capital 150,000
To record the increase in the Land and to credit to respective partner’s capital account using the old profit or loss
Second Approach:
If no adjustments are made on the date of change, the required entry would be:
KK, Capital 75,000

JJ, Capital 75,000
To credit JJ with 25% (50% - 25%) of P300,000 for his share increase in value of the Land account and charge
KK’s Capital account accordingly.
Let us now assume that the land was later sold for P400,000. Using the two approaches, the gain would be divided
as follows:
First Approach:
JJ P50,000 * ¼ P12,500
KK P50,000* ¾ 37,500
TOTAL P50,000
Second Approach:
JJ KK Total
Portion of gain developed prior to change in
ratio, P300,000 (P350,000 – P50,000), P150,000 P150,000 P300,000
Divided equally
Portion of gain developed subsequently,
P50,000 (P400,000 – P350,000) 12,500 37,500 50,000
Divided, 1:4
TOTALS P162,500 P187,500 P350,000
CORRECTION OF PARTNERSHIP NET INCOME OF PRIOR PERIOD
The partnership may discover errors made in computing net income of prior accounting periods. Examples of these
errors are: errors in computing depreciation, error in inventory valuation, and omission of accrued expenses. When
these errors are discovered, the partners’ capital accounts should be adjusted. The following accounting procedures
may be used:
1. Determine the correct net profit of the prior period.

2. Compute the proper share of each partner using the profit and loss ratio in the year in which the error
occurred.
3. Compute the difference between the share in the profit that each partner actually received and the share
would have received from No. 2.
4. Adjust the partners’ capital accounts by the amount in No.3.
Illustration. Assume that in 2019, the reported net income of JK Partnership was P50,000 and that the partners
divide profits and losses, equally. In the year 2020, they changed the ratio to 60% for JJ and 40% for KK. During
2020, the following errors in computing the 2019 net income were discovered:
a. Depreciation was understated by P10,000

b. Prepaid expenses of P5,000 was omitted.
c. Accrued expenses of P2,000 was omitted
Using the procedures, the amount of adjustment to partners’ capital account is computed as follows:
Net Income per books, 2019 P50,000

Adjustments:
Understatement of depreciation P(20,000)
omission of prepaid expenses 5,000
omission of accrued expenses P(2,000) (17,000)
Corrected net income, 2019 P33,000
The required adjustments to partners’ capital account can now be determined as follows:
JJ KK Total
2019 net income before corrections P25,000 P25,000 P50,000
2019 corrected net income 16,500 16,500 33,000
Required reduction to capital accounts P8,500 P8,500 P17,000
The entry to adjust the partners’ capital accounts on December 31, 2020 is therefore:
JJ, Capital 8,500

KK, Capital 8,500
Prepaid Expenses 5,000
Accrued expenses 2,000
Accumulated Depreciation 20,000
To adjust partners’ capital accounts for errors discovered in computing net income of 2019.
A. CLOSURE ACTIVITIES
The following work exercises intend to evaluate what the learners have learned in this topic. Write your answers
in your portfolio journal.
I. REVIEW QUESTIONS
1. How is partnership profit divided among partners?

2. How is partnership loss divided among partners?
3. Why are salaries, interests to capital and bonuses are given to partners?
4. How is partner’s average capital computed?
5. What is the journal entry to close the income to the capital accounts of the partners?
6. How income from prior period will be computed and what will be the proper treatment for adjusted shares of
partners?
III. TRUE OR FALSE
1. No bonus is allocated to any partner when partnership incurred loss during the period.
2. Interest on capital is also provided as a means of distributing profits among the partners.
3. The designation of losses and profits can be entrusted to one or more partners.
4. Like for salaries, a partner is entitled to bonus only if the partnership earns profit.
5. The partnership may discover errors made in computing net income of prior accounting periods. In
computing for the proper share of each partner, correction is allocated to the individual partners’ capital
account based on the profit and loss agreement in effect during period of the error.
6. A partner’s residual profit ratio must be the same as the loss ratio
7. Residual profit and loss ratios can be changed by agreement.
8. When the partnership profit or loss ratios are changed, the capital accounts should be modified to reflect
new profit or loss ratios.
9. Bonus is component of the partnership profit and loss allocation compensates partners for the routine time
and efforts expended in the business.
10. The residual profit ratio must always be applied.
III. PROBLEMS.
Problem 1. Assume that on January 1, 20x0, Sha and Poy formed a partnership with an investment of P30,000 and
P60,000 by Sha and Poy respectively. On December 31, 20X1 after closing all income and expense accounts, the
income and summary of account show a credit balance of P160,000, representing the profit for 20x1. Changes in the
capital account during 20x1 are summarized as follows:
Sha Capital Poy Capital

1/1 20x1 40,000 1/1 20x1 60,000
3/1 20x1 20,000 4/1/20x1 50,000
8/1 20x1 20,000 10/1/20x1 40,000
10/1/20x1 (20,000 ) 11/1/20x1 (50,000)
Required: Prepare all the journal entries if profit is allocated (assume cases are independent)
a. Equally
b. Arbitrary ratio, assume 40% and 60% to Sha and Poy respectively
c. Capital Balances:
1. Original capital
2. Beginning Capital
3. Ending Capital
4. Average capital (simple average)
5. Average capital (peso-month method)
d. Assume that the partnership agreement allows interest on partners’ average capital account balances
at 12% with any remaining net income or loss divided equally.
e. Assume that the partnership agreement provides for annual salaries of P30,000 and P20,000 to sha and
Poy respectively, with resultant net income or loss to be allocated in the ratio of beginning capital.
f. Assume a bonus of 20% of net income after bonus will be given to Sha as a managing partner.
Remainder to be distributed 60:40 to sha and poy respectively
g. Assume that partners agreed to allocate the profit by providing monthly salaries of 2,000 and 3,0000
respectively to sha and poy, an interest of 10% on average capital using peso-month method, and a
bonus of 12 % of net income after bonus, salaries and interest. And the balance to be divided equally.
h. Prepare a Statement of Changes in Partners’ Capital Accounts.
i. What will be your answers to assumptions A-G if the result of operation for period ending 12/31/20x7
was a loss of P60,000
Problem 2: Knight Cervantes, a partner in the WLI Partnership, has a 30% participation in partnership profits and
losses. Cervantes’ capital account has a net decrease of P60,000 during the calendar year 2020. During the 2020,
Cervantes withdrew P130,000 (charged against the capital account) and contributed property valued at P25,000 to
the partnership.
What was the net income of the WLI Partnership?
Problem 3: On January 2, 2019, Zachary and Drew formed ZD Partnership. Zachary contributed capital of P 175 000
and Drew P25 000. They agreed to share a profits and losses 80% and 20%, respectively. Drew is the general
partner and works in the partnership full time. Drew is given a salary of P5000 a month; an interest of 5% of starting
capital (of both partners) and a bonus of 15% of net profit before the salary, interest and the bonus. The details taken
from the condensed profit and loss statement of the partnership for the year ended December 31, 2019 are as
follows: Net Sales, P 875 000; Cost of Sales P 700 000; Expenses (including the salary interest and bonus), P143
000.
Bonus of Drew in 2019 is:
Problem 4: The following Balance sheet was taken as of Sept 30, 2020 for BARBYDAL Partnership
Assets Liabilities and Capital

Cash P80.000 Liabilities P200,000
Other Assets 520,000 Bar, Capital 100,000
BY.Capital 180,000
DAL, Capital 120,000
TotAL 600,000 Total 600,000
Partners agreed the following distribution of profits : 6% interest on capital contribution; annual salaries of P20,000
each; 10% bonus to Bar after salaries, interest and bonus: remainder distributed 40%, 40% and 20% respectively.
The partnership uses a fiscal period starting October 1
Required:
4.a) if DAL receives a total profit share of P20,000, compute for the total net income earned by the business before
salaries, interest and bonus for the period ending Sept 30, 2020.
4.b ) if DAL receives a total profit share of P20,000, compute for the total net income earned by the business before
salaries, interest and bonus for the period ending Sept 30, 2020, but the bonus is based on net income before
salaries, interest and bonus.
Problem 5. Rain and Bow are partners with capital balances as of 12-31-20 of P300,000 and P200,000 respectively
before profit distribution. The partnership agreement provides for distribution of profits as follows;
Monthly salaries of P6,000 and P5,000 are to be allowed on the partners with the remaining profit to be divided
equally. However, if profit is not sufficient for the monthly salaries agreed upon, the profit will be divided according to
the salary ratio. If the result of the operation is a loss, the loss will be divided based on the capital ratio at the end of
the year.
Required:
5. a) Entries to record the distribution of net loss in the amount of P99,000 for the year ended 2020 and a net profit of
P55,000 for the year ended 2021.
5. b) Assume that the result of operation in 2020 was a net income of P135,000 and in 2021 was P132,000, however
an error was discovered in 2021 related to an accrued expense amounting to P5,000 which was overlooked in
making the yearend adjustments in 2020. Such amount when paid in 2021 was charged to expenses. Reconstruct
the profit distribution entry that was prepared in 2020, and what should be the correct net income distribution for 2020
5. c) Using the info given in 5b) what will be the correcting entry in 2021 and what will be the profit distribution entry in
2021?
Problem 6: A and B formed a partnership and began operations on march 1, 20x1. A invested P100,000 cash while
B invested equipment with a book value of P300,000 and a fair value of P180,000. On august 31, 20x1, A invested
additional cash of P20,000. The partnership agreement stipulates the following
• Monthly salary allowances of P2,000 and P10,000 to A and B respectively, recognized as expenses.
• 20% bonus on profit before salaries and interest but after bonus to B
• 12% annual interest on the beginning capital of A
• Balance equally
Required: How much is the adjusted capital of partners A and B at the end of 20x1 if the business earned a
profit of P50,000 in 20x1?
Problem 7. Ree, Reo and Red Stein formed R. Stein Partnership on January 1, 2020. Ree, Reo and Red original
investments are P80,000, P120,000 and P180,000, respectively. According to the partnership agreement, net income
or loss will be divided among the respective partners as follows:
a. Salaries of P12,000 for Ree, P10,000 for Reo, and P8,000 for Red.
b. Interest of 8% on average capital balance of each partner during the year.
c. Remainder divided equally.
Additional information is as follows: Net income of the R. Stein during the year was P 70,000; Ree invested an
additional P20,000 in the partnership on July 1, 2020; Red withdrew P 30,000 from the partnership on October 1,
2020; and Ree, Reo and Red made regular drawings against their shares of net income during 2020 of P 10,000
each.
Ree’s, Reo’s and Red’s capital balances as December 31, 2020 are:
Problem 8: Aikee and Aiko entered into a partnership on March 1, 2018 by investing P125 000 and P75 000,
respectively. The agreed that Aikee, as a managing partner, is to receive a salary of P30 000 per year and a bonus
computed at 10% of the net profit after for the adjustments for the salary; the balance of the profit was to be
distributed in the ratio of their original capital balances. On December 31, 2019, account balances were: Cash, P70
000; accounts receivable, P67 000; Furniture and fixtures, P45 000; Sales returns and Allowances, P5 000; Net
Purchases, P196 000; Operating expenses, P60 000, Accounts Payable, P60 000; Aikee Capital, P125 000; Aiko
Capital, P75 000; Aikee Drawings, (P20 000); Aiko Drawings, (P30 000); Sales P233 000.
Inventories on December 31, 2019 were as follows; supplies, P2 500; merchandise, P73 000. Prepaid insurance was
P950 while accrued expenses were P1 550. Depreciation rate was 20% per year.
The Aikee’s and Aiko’s capital balances on December 31, 2019, after closing the net profit and drawing
accounts, were?
IV. SYNTHESIS/ GENERALIZATION
CHAPTER SUMMARY:
• The partners share in the net profit and losses of a partnership is in accordance with their partnership
agreement.
• If only the share of each partner in the profits has been agreed upon, the share of each partner in the losses
shall be in the same proportion
• In absence of stipulation, the share of each partner in the profits and losses shall be in the proportion to
what he may have contributed, but the industrial partner shall not be liable for the losses.
• In allocation of profit, the following items are allocated first if, they are stipulated in the partnership
agreement: (a) salaries; (b) interest on capital; and (c) bonuses to partners (allocated only if there’s enough
profit for provision.) After allocating these items, any remaining profit or loss is allocated based on the
stipulated P/L ratio.
• Partner/s adjusted share in the corrected prior period earnings should be computed based on profit and loss
ratio in the period when the error was made, not when the error was discovered
V. EVALUATION
The student’s performance will be evaluated as follows:
20% Attendance, Poll Questioning and Oral Exercises

20% Portfolio Journal for work exercises
20% Formative Examination (One online/Offline written quiz covering this specific topic)
40% Summative Examination (This topic is one of the topics included in the Online/Offline Written Examination)
Read and understand and learn the following regarding the next
topic which is Partnership Dissolution
a. The nature of Partnership Dissolution and its effect on

business operation
VI. ASSIGNMENT/ AGREEMENT
b. The different causes of dissolution
c. How to journalize the different cases of Partnership
Dissolution
d. How to prepare Statement of Partners’ Equity after the
dissolution Process.
Millan, Accounting for Special Transactions 2018e

Dayag, Advanced Financial Accounting and Reporting 2019e
VII. REFERENCES Guerrero, Advanced Accounting
Catacutan, et al, Fundamentals of Accounting Part II
Baysa and lupisan, Advanced Accounting 2018e
END OF CHAPTER 2

Afar 2 Module CH 2

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COURSE AFAR 2: ADVANCED FINANCIAL ACCOUNTING AND REPORTING 1

This module is prepared by professor Venus L. Catacutan. She’s an

This course is designed to provide fundamental knowledge to students

DISTRIBUTION OF PROFIT OR LOSSES

Legal basis of Profit Distribution

Methods of Dividing Profit or Loss

ILLUSTRATIONS OF PROFIT DISTRIBUTION TO PARTNERS

CASE 1: Division of Profit or Losses Equally

Income Summary 50,000

CASE 2: Division of Profit or Losses in an Arbitrary (Unequal) Ratio

Income Summary 50,000

Assume that JJ and KK agreed to share in a ratio of 3:1, respectively.

Income Summary 50,000

Partner Original Capital Contribution Ratio

Income Summary 50,000

2.2.c. Based on Beginning Capital Balances

Partner Beginning Capital Balances Ratio

Income Summary 50,000

2.2.d. Based on Ending Capital Balances

Partner Ending Capital Balances Ratio

Income Summary 50,000

2.2.d. Based on Average Capital Balances

• Simple Average Method.

Income Summary 50,000

• Peso-Month/ Peso-Day Method.

Computing the division of net income for 2020:

Computation of Average Capital Account Balances - KK

Partner Average Capital Balances Ratio

Income Summary 50,000

CASE 3: Provision of Salaries

a) The salaries have to be given first to respective partner/s.

3.1. The remainder of Net Income after Deducting Salaries is Positive:

Assume that the partners stipulate the following:

Profit Distribution Table:

Monthly Journal Entry for the salary of JJ:

JJ, Drawings 1,000

KK, Drawings 5,000

Income Summary 50,000

Journal entry close partners’ drawing accounts for 2020:

JJ, Capital 12,000

3.2. The remainder of Net Income after Deducting Salaries is Negative:

Assume that the partners stipulate the following:

Profit Distribution Table:

Monthly Journal Entry for the salary of JJ:

JJ, Drawings 2,000

Semi-annual Journal Entry for the salary of KK:

KK, Drawings 15,000

Income Summary 50,000

Journal entry close partners’ drawing accounts for 2020:

JJ, Capital 24,000

Profit Distribution Table:

Monthly Journal Entry for the salary of JJ:

JJ, Drawings 1,000

Semi-annual Journal Entry for the salary of KK:

KK, Drawings 5,000

JJ, Capital 24,000

Journal entry close partners’ drawing accounts for 2020:

JJ, Capital 12,000

CASE 4: Provision of Interest on Capital

Assume that the partners stipulate the following:

Semi-annual Journal Entry for interest on average capital balance of KK:

KK, Drawings 4,375

Income Summary 50,000