Professional Documents
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HOURS)
Nature of Partnership Operations
Revenues ₱xxxx
Less: Operating Expenses xxxx
Net Income (Loss) ₱xxxx
In the journal entry, there is net income if the income summary account has a
credit balance. There is net loss if the income summary account has debit
balance.
ILLUSTRATION 1
Assume that Eye & Bee Partnership has credit balance of income summary
account amounting to P500,000. If partners Eye and Bee divide profit equally,
the journal entry to distribute the net income would be:
GENERAL JOURNAL
ILLUSTRATION 2
Assume that Eye and Bee Partnership has a credit balance of income summary
account amounting to ₱250,000. If partners Eye and Bee divide losses with 60%
and 40% loss sharing respectively, the journal entry to distribute the net loss
would be:
GENERAL JOURNAL
TEACHER’S INSIGHTS:
The net income or loss can also be closed first to the partners drawing accounts and
then the partners drawing accounts and then the partners’ drawing accounts are
subsequently closed to the partners’ capital accounts. To simplify the entries, the net
income or loss is directly closed to the partners’ capital accounts.
In measuring partnership income for the period, however, the expenses should
be scrutinized to make sure that personal expenses of the partners are not
suited among the partnership's business expenses.
If personal expenses of a partner are paid with partnership assets, the payment
is charged to the drawing or capital account of the partner whose personal
obligations have been settled.
Article 1799 of the New Civil Code provides that any stipulation that exclude
one or more partners from any share in the profits or losses is void. The reason
for this is that partnership must coast for the common benefit and interest of
the partners.
Article 1797 of the New Civil Code of the Philippines provides the following
guidelines on how partnership profits and losses shall be distributed among
the partners:
ILLUSTRATION
TEACHER’S INSIGHT:
The capital contribution of the partners has no bearing in the profit distribution base
their profit rating agreement should be followed.
ILLUSTRATION
Using the same data in the preceding illustration, the profit distribution
between Moses and Joshua if they have no profit and loan agreement would
be:
1. Since there is no P&L ratio agreement between Moses and Jonas, their capital
contributions are considered as the basis of profit or loss distribution.
2. The fraction or percentage follows derived from their capital ratio, computed as
follows:
Fraction Percentage
Moses (₱550,000/ ₱1,000,000) 55/100 55%
Joshua (₱450,000/ ₱1,000,000) 45/100 45%
Rule 1: If there is an industrial partner. he first gets a just and equitable share
for his services (industry), before the capitalist partners divide the balance of
the profits in proportion to their capital contributions.
ILLUSTRATION
Let us use the same illustration above, this time involving a third person whom
we shall call Caleb, as industrial partner in the partnership. It was agreed that
Caleb, being an industrial partner, will receive a profit share equivalent to 10%
of the partnership net income. The distribution of ₱300,000 profit would be:
Again, take the illustration above, minus the profit agreement among the
capitalist partners and industrial partner. In this case, the distribution of the
partnership net profit would be:
Profit of ₱300,000: Moses (55%) Joshua (45%) Caleb Total
(Industrial)
Share of Caleb (₱300,000 x 45/ 145) ₱93,103 ₱93,103
Share of Moses (₱300,000 x 55/ 145) ₱113,794 ₱113,794
Share of Joshua (₱300,000 x 45/ 145) . ₱93,103 . ₱93,103
Total ₱180,000 ₱120,000 ₱30,000 ₱300,000
TEACHER’S INSIGHTS:
1. The capital contribution of Joshua shall be used to allocate the share of Caleb from the profit of
the partnership because there was no profit share agreement for the industrial partner.
2. The fraction is derived by simply adding 45 profit shares of the industrial partner to the profit
sharing of Moses and Joshua based on their contributed capital as 55 and 45 respectively, or total
units of profit to be shared on 145 computed as follow:
Fraction Percentage
Moses, per capital contribution = 55 55/145 37.94%
Joshua, per capital contribution = 45 45/145 31.03%
Caleb = the smallest share of capitalist partner or 45 45/145 31.03%
Total (55 + 45 + 45) = 145 145/145 100%
ILLUSTRATION
(Industrial)
Share of Caleb
As industrial (₱300,000 x 10%) ₱30,000 ₱30,000
As capitalist (₱300,000 x 18%) 54,000 54,000
Share of Moses (₱300,000 x 39.60%) ₱118,800 118,000
Share of Joshua (₱300,000 x 32.40% . ₱97,200 . 97,200
Total ₱180,000 ₱120,000 ₱30,000 ₱300,000
TEACHER’S INSIGHTS:
ILLUSTRATION
Moses and Joshua have capital balance of ₱65,000 and ₱35,000, respectively.
The partnership suffered a net loss of ₱30,000, They agree that any profit shall
be divided 60% and 40% respectively, but losses shall be divided equally.
TEACHER’S INSIGHTS:
1. The profit-sharing ratio is different from the loss sharing ratio, so the latter shall be
used because there is a loss from operation.
2. The capital contributions of the partners have no bearing in the profit distribution
because their profit and loss ratio agreement should be followed.
Rule 2: In the absence of loan sharing agreement, loan shall be apportioned
among the partners in accordance with their profit-sharing ratio.
ILLUSTRATION
Using the same information above except that there was no loss ratio
agreement, the distribution of partnership net loss would be:
The existing 60% and 40% profit ratio of Moses and Joshua, respectively, was
applied.
ILLUSTRATION
Using the same illustration above except that there was no profit or loss
sharing agreement among the partners, the distribution of the ₱300,000
partnership loss would be:
TEACHER’S INSIGHT:
The fraction or percentage is derived from their capital ratio, computed as follows:
Fraction Percentage
Moses (₱550,000/ ₱1,000,000) 55/100 55%
Joshua (₱450,000/ ₱1,000,000) 45/100 45%
100/100 100%
Loss Sharing of an Industrial Partner. The following rules are applicable for
loss distribution to an industrial partner:
Rule 1: If there is no agreed loan or profit-sharing ratio and there is a "pure”
industrial partner, he is totally exempt from sharing in the loss.
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 ₱300,000, the
distribution of the loss would be:
TEACHER’S INSIGHT:
1. Industrial partner does not share in partnership losses because he already rendered
in space his service in vain.
2. If there is profit and loss ratio agreement in which the industrial partner in included
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 he is an industrial partner
3. However, there profit sharing ratio and there is no loss ratio, the industrial partner
in not bound to share in the partnership losses because he did not give his consent to
have his share in the partnership loss.
ILLUSTRATION
TEACHER’S INSIGHTS
1. The industrial partner is not exempted from the loss sharing once he becomes a
capitalist partner.
2. If there are partnership loss however, the industrial partner shall not absorb share
from the net losses. He shall share only in the loss as a capitalist partner.
Partners may share the partnership profits and losses in any manner they wish.
The profit and loss agreement should contain specific and complete provisions
to avoid misunderstanding and disputes among the partners.
The agreement on partnership profits and losses may be divided into one of
the following ways:
1. Equally
3 Capital ratios
To illustrate the methods that could be agreed upon for profit and loss
distribution, assume that Ralph and Vince formed a partnership with original
capital contributions of ₱180,000 and ₱90,000, respectively.
In the second year of the partnership operations, the capital and drawing
balances of partners Ralph and Vince traced from the general ledger as
follows:
Ralph, Drawing
Debit Credit
5/30 30,000 .
30,000
Vince, Drawing
Debit Credit
5/30 15,000 .
15,000
Ralph, Capital
Debit Credit
8/30 180,000 180,0001/1
120,0006/30
. 330,0009/30
180,000 630,000
450,000
Vince, Capital
Debit Credit
5/1 180,000 150,0001/1
90,0002/30
. 240,00010/1
180,000 480,000
300,000
Note: Unless otherwise stated, the data above shall be used as the basis for
illustrations in the succeeding discussions.
Equally
The partners may mutually agree that the partnership profit shall be equally
divided between them. In case of losses and in the absence of specified
agreement regarding division of losses, the existing equal division of profit
agreement is to be followed by the partners.
Adam and Eve agreed to divide the partnership profit equally the distribution
of ₱600,000 profit would be:
GENERAL JOURNAL
The profit and loss distribution can also immediately be closed to the partners’
capital accounts because the partners' drawing accounts are ultimately closed
to the capital accounts.
GENERAL JOURNAL
Whenever the presence of one of the partners in perceived more vital to the
success of the business due to experience, ability and reputation, the profit and
loss agreement may stipulate an unequal sharing expressed in agreed or
percentage, otherwise called as arbitrary ratio.
In specific ratio, the difference in the partner's capital balance has no bearing
in the profit and share the agreed profit and loss ratio may be based on the
partners better capability or influence over the other.
To illustrate assume that Vince is perceived more vital than Ralph for the
success of the partnership business, so much so that they agreed to share in
the profit and loss of 60% and 40%, respectively.
Based on the profit and loss agreement, Adam and Eve shall apportion the
₱600,000 profit in the following manner:
In spite of Ralph’s greater ending capital balance (₱450,000) than that of Vince
(₱300,000), the latter received a greater share from the partnership profit
because the specified percentage on profit and loss agreement provides her
60% share from the partnership earnings.
The journal entry to affect the profit distribution in the books of accounts
would be:
GENERAL JOURNAL
This manner of dividing profit and loss is different from a situation where there
is no profit and loss agreement at all or where an arbitrary specified ratio or
percentage is used for profit sharing. This is for the allocation of profit and loss
distribution in not fixed due to fluctuation of the capital balances of the
partners.
The accounting issue in the capital ratio lies on what amount of the 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:
To distribute the ₱600,000 net income of the partnership to Ralph and Vince,
the following computation should be made:
TEACHER’S INSIGHTS
The fraction is computed by dividing the original capital investment by the total
original capital investments, as follows:
AL JOURNAL
To distribute the ₱600,000 net income of the partnership to Ralph and Vince,
the following computation should be made:
TEACHER’S INSIGHTS
GENERAL JOURNAL
The ending capital accounts of each partner are determined by getting the
account balances of the partners' capital accounts, as follows:
Ralph, Capital
Debit Credit
8/30 180,000 1/1 180,000
6/30 120,000
. 9/30 330,000
180,000 630,000
450,000
Vince, Capital
Debit Credit
5/1 180,000 1/1 150,000
2/30 90,000
.10/1 240,000
180,000 480,000
300,000
TEACHER’S INSIGHTS
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 i no
incentive for a partner to make any investments in the earlier parts of the year.
GENERAL JOURNAL
There are methods of computing the average capitals of the partners may be
done by using the following methods:
Using the simple average capital method, the distribution of ₱600,000 profit
would be:
Using this method, the ₱600,000 partnership income shall be distributed as follows:
TEACHER’S INSIGHTS
1. 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.
2. 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.
Allowance of Interest on Partners' Capital
This agreement provides that the cost of money on the capital contributions of
partners will be added as a profit-sharing device in addition to the profit and
loss ratio agreement.
In the absence of the agreed arbitrary ratio, the partners' original capital
contribution may be used to allocate the undistributed balance of profit
ILLUSTRATION
Assume that Ralph and Vince agreed that their respective average capital
balances are entitled to a 12% interest per year and the balance will be
distributed 60% and 40%, respectively. The average capital balances of Ralph
and Vince are ₱262,500 and ₱157,500, respectively. The distribution of
₱600,000 profit would be:
ILLUSTRATION
Assume that Ralph and Vince agreed that the excess of one partner's average
capital balance is entitled to a 12% interest per year and the balance
partnership profit will be distributed 60% and 40%, respectively.
The average capital balances of Ralph and Vince are ₱262,500 and ₱157,500,
respectively. The distribution of ₱600,000 profit would be:
TEACHER’S INSIGHT
Ø The agreement for interest may still employ other forms. For instance, a fixed
capital contribution is agreed for each partner with interest allowed on amount in
excess of such fixed amounts and interest charged on any deficiencies.
ILLUSTRATION
Assume that the Ralph and Vince Partnership's operation was a 12-month
period and that they agreed that a salary of ₱6,000 per month be given to each
of the partner for their personal services in addition to a 12% interest on their
average capital balances. The balance partnership profit will be distributed
60% and 40%, respectively. The average capital balances of Ralph and Vince
are ₱262,500 and ₱157,500, respectively. The distribution of ₱600,000 profit
would be:
TEACHER’S INSIGHT
1. Net income before deducting salaries, interest (if any) and bonus;
2. Net income after deducting salaries and interest (if any) but before bonus; or
3. Net income after deducting salaries, interest (if any) and bonus.
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 any (if
any), and bonus (is treated as part of profit distribution).
a. Each of them would have a salary of ₱15,000 per month one-year operation;
b. 12% interest on their respective average capital;
c. 10% bonus of net income before salaries, before interest on capital and before the
bonus to Ralph, the managing partner; and
d. The balance of net income shall be divided on the basis of 60% and 40%,
respectively.
The average capital balances of Ralph and Vince are ₱262,500 and ₱157,500,
respectively. The distribution of ₱600,000 profit would be:
Case 2. Bonus is based on net income after deducting salaries and interest (if
any) but before bonus.
a. Each of them would have a salary of ₱15,000 per month one-year operation;
b. 12% interest on their respective average capital;
c. 10% bonus of net income after salaries and interest on capital and before the bonus
to Ralph, the managing partner; and
d. The balance of net income shall be divided on the basis of 60% and 40%,
respectively.
The average capital balances of Ralph and Vince are ₱262,500 and ₱157,500,
respectively. The distribution of ₱600,000 profit would be:
Case 2. Bonus is based on net income after deducting salaries, interest (if any)
and bonus.
a. Each of them would have a salary of ₱15,000 per month one-year operation;
b. 12% interest on their respective average capital;
c. 10% bonus of net income after salaries, interest on capital and bonus to Ralph, the
managing partner; and
d. The balance of net income shall be divided on the basis of 60% and 40%,
respectively.
The average capital balances of Ralph and Vince are ₱262,500 and ₱157,500,
respectively. The distribution of ₱600,000 profit would be:
When interests on capital and salary are treated as ordinary operating expense,
they are first deducted from the partnership net income prior to the profit, and
loss distribution to partners.
ILLUSTRATION
Ralph and Vince agreed that each of them will receive a ₱20,000 monthly
salary their respective capital balance is to earn 6% interest per year, and the
remaining balance of profit is to be shared equally.
Sales ₱ 2,000,000
Cost of sales 800,000
Rent expense 150,000
Supplies expense 100,000
Depreciation expense 40,000
If the partners agreed that their salaries and interest on capital are to be
treated as operating expense and their capital balances are ₱200,000 and
₱300,000, respectively, compute and journalize the profit distribution.
GENERAL JOURNAL
ILLUSTRATION
Ralph and Vince have average capital balances in their partnership amounting
to ₱320,000 and ₱480,000, respectively. They agreed to have a profit and loss
distribution of 60% and 40%, respectively
They work in the partnership and agree to have a salary of ₱24,000 each per
month and that their respective average capital balances shall be given an
interest of 6% per year.
TEACHER’S INSIGHT
Ø Notice that the bonus is still given to the managing partner regardless of the deficit
in the net income after deducting salaries and salaries, this is because of the
agreement that the bonus is based on the net income before deducting salary, interest
and bonus. However, if the bonus is based on the net income after deducting salary
and interest, there will be no bonus given to Vince because the net income cannot
already cover the bonus.
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 managing partner shall
be forfeited because bonuses are given as incentives for earnings, not for
losses
ILLUSTRATION
Ralph and Vince have average capital balances in their partnership amounting
to ₱320,000 and ₱480,000, respectively. They agreed to have a profit and loss
distribution of 60% and 40%, respectively
They work in the partnership and agree to have a salary of ₱24,000 each per
month and that their respective average capital balances shall be given an
interest of 6% per year.
GENERAL JOURNAL
TEACHER’S INSIGHT
· If only the share of each partner in the profits has been agreed upon,
the share of each in the losses shall be in the same proportion.