Partnership Operations 31 Chapter 2 Partnership Operations ee a 1. State the items that affect the division of a partnership's profits or losses among the partners. 2. Compute for the share of a partner in the partnership's profit or loss. Division of profits and losses The partners share in partnership profits or losses in accordance with their partnership agreement. Art. 1797 of the Philippine Civil Code provides the following additional rules in the profit or loss sharing of partners: © Ifonly 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. @ In the absence of stipulation, the share of each partner in the profits and losses shall be in proportion to what he may have contributed, but the industrial partner shall not be liable for the losses. As for the profits, the industrial partner shall receive such share as may be just and equitable under the circumstances. If besides his services he has contributed capital, he shall also receive a share in the profits in proportion to his capital. > An industrial partner is one who contributes services to the partnership rather than cash or other non-cash assets. > A capitalist partner is one who contributes cash or other non-cash assets to the partnership. > A partner that contributes both services and cash or other non-cash asset is both a capitalist and an industrial partner.32 Chapter 2 The designation of losses and profits cannot be entrusted to one of the partners (art. 738). A stipulation which excludes one or more partners from any share in the profits or losses is void (Ant, 1798). In addition to profit or loss sharing, the partnership agreement may also stipulate any of the following: a. Salaries — normally, an industrial partner receives salary in addition to his share in the partnership's profits as compensation for his services to the partnership. b. Bonuses - the managing partner may be entitled to a bonus for excellent management performance. Unlike for salaries, a partner is entitled to a bonus only if the partnership earns profit. The partner is not entitled to any bonus if the partnership incurs loss. c. Interest on capital contributions — the partnership agreement may stipulate that capitalist partners are entitled to an annual interest on their capital contributions. The items above are normally provided first to the respective partners and any remaining amount of the profit or loss is shared among the partners based on their stipulated profit or loss ratio. Illustration 1.1: Salaries (w/ remaining profit) — different P/L ratios A and B formed a partnership. The partnership agreement stipulates the following: ¢ Annual salary allowances of P50,000 for A and P30,000 for B. Salary allowances are to be withdrawn by the partners throughout the period and are to be debited to their respective drawings accounts. * The partners share profits equally and losses on a 60:40 ratio.ship Operations During the period the partnership earned profit of P100,000 before salary allowances. Requirements: a. Compute for the respective shares of the partners in the profit. b. Provide journal entries Solution: Requirement (a): A B Total Amount being allocated 100,000 Allocation: 1. Salaries 50,000 30,000 80,000 2, Allocation of remaining profit (100K profit - 80K salaries) = 20K (20 x 50%); (20K x 50%) 10,000 10,000 _ 20,000 As allocated 60,000 __40,000 _ 100,000 & Notes: © Salaries are provided first and the remaining amount is allocated based on the profit sharing ratio. @ The sum of the amounts allocated to the partners is equal to the amount being allocated (i.e., 60K + 40K = 100K). Requirement (b): ‘Monthly | A, Drawings 50,000 entries | B, Drawings 30,000 Cash 80,000 to record the withdravoal of salary allowances Year-end | Income summary ~~ | 100,000 entry A, Capital 60,000 B, Capital 40,000 to record the distribution of profit34 Chapter 2 Year-end | A, Capital 50,000 entry | B, Capital 30,000. | A, Drawings 50,000 B, Drawings 30,000 to close the drawings accounts Illustration 1.2: Salaries (no remaining profit) ~ different P/L ratios ‘A and B formed a partnership. The partnership agreement stipulates the following: Annual salary allowances of P80,000 for A and P40,000 for B. The partners share profits equally and losses on a 60:40 ratio, During the period there partnership earned profit of P100,000. Requirement: Compute for the respective shares of the partners in the profit. Solution: A B Total Amount being allocated 100,000 Allocation: 1. Salaries 80,000 40,000 120,000 2. Allocation of remaining loss (100K profit - 120K salaries) = -20K (20x 60%); (-20K x 40%) (12,000) (8,000) __(20,000 As allocated 68,000 32,000 __ 100,000 & Notes: © After the salaries are provided, the remaining amount is negative (i., loss); thus, it is allocated based on the stipulated loss ratio of 60:40. ‘© The sum of the amounts allocated to the partners is equal to the amount being allocated (i.e., 68K + 32K = 100K).Bice aan j 4 Partnership Operations 39 31 h5. Illustration 1.3: No P/L ratio A and B formed a partnership on January 1, 20x1. Their contributions weré credited to their respective capital accounts as follows: Capital accounts ‘A, Capital 150,000 B, Capital 250,000 400,000 During the year, the partnership earned profit of P1,000,000. There ‘was no stipulation in the agreement on how profits are to be shared by the partners. Requirement: Compute for the respective shares of the partners in the profit. Solution: Total Amount being allocated 1,000,000 Allocation: (based on contributions) IM x (150K / 400K) 375,000 IM x (250K / 400K) 625,000 As allocated 375,000 _ 625,000 _ 1,000,000 Illustration 2.1: Bonus (with profit) A and B formed a partnership. The partnership agreement stipulates the following: © Annual salary allowances of P48,000 for A and P30,000 for B. © Bonus to A of 10% of the profit after partner's salaries and bonus. © The partners share profits and losses on a 60:40 ratio. During the period the partnership earned profit of P100,000 before deductions for salaries and bonus.YBED My tues a Ve RECO 944 42, Chapter2 “yet (——— Requirement: Compute for the respective shares of the partners in the profit. Solution: $e A B Total Amount being allocated . 100,000 Allocation: 1. Salaries 48,000 30,000 78,000 2. Bonus after bonus * 2,000 2,000 3. Allocation of remaining profit (100K ~ 78K - 2K) = 20K (20K x 60%); (20K x 40%) 12,000 8,000 20,000 As allocated 62,000 38,000 100,000 ——— 2,000 38,000 __100,000_ * The bonus is computed as follows: Profit before salaries and bonus « 100,000 Salaries (78,000) Profit after salaries but before deduction of bonus 22,000 The bonus scheme is “bonus after bonus.” The formula is as follows: P Pe OP eas Be Where: B = bonus P = profit before bonus and tax Br = bonus rate or bonus percentage + 22,000 B= 2 ~ 22000 22,000 Tox B= 22,000 = 20,000 B =2,000 Refer to Chapter 27 of Intermediate Accounting Part 2 for detailed discussion on bonuses.Partnership Operations Illustration 2.2: Bonus (with loss) A and B formed a partnership. The partnership agreement stipulates the following: ¢ Annual salary allowances of P25,000 for A and P4,000 for B. * Bonus to A of 10% of the profit after partner's salaries and bonus. The partners share profits and losses on a 60:40 ratio. During the period the partnership incurred loss of P10,000 before deduction for salaries. Requirements: a. Compute for the respective shares of the partners in the profit. b. By what amount did A’s capital account change? Solutions: Requirement (a): A B Total Amount being allocated (10,000) Allocation: 1. Salaries 25,000 4,000 29,000 2. Bonus after bonus » Z - : 3. Allocation of remaining loss (10K -29K) = 39K (39K x 60%); (39K x40%) 3400) _(15,600) (99,000) As allocated 1,600 (11,600) 10,000) ' No bonus is allocated because the partnership incurred a loss. However, salaries are provided whether the partnership earns profit or incurs loss because salaries are compensation for services rendered. Requirement (b): From the table above, A’s capital increased by P1,600. Notice that it is possible for a partner's capital to increase even if the Partnership incurs a loss.38 Chapter 2 The entry to record the allocation of loss is as follows: Year-end |B, Capital 11,600 entry Income summary 10,000 A, Capital 1,600 to record the distribution of loss Illustration 2.3: Bonus ~ With limit A and B formed a partnership. The partnership agreement stipulates the following: * First, A shall receive 10% of profit up to P100,000 and 20% over P100,000. * Second, B shall receive 5% of the remaining profit over 150,000. © Any remainder shall be shared equally. During the year, the partnership earned profit of P280,000. Requirement: Compute for the respective shares of the partners in the profit. Solution: A B Total Amount being allocated 280,000 Allocation: 1, Bonus to A First 100K: (100K x 10%) 10,000 10,000 Over 100K: [(280K - 100K) x 20%] 36,000 36,000 2. Bonus to B on remaining profit (280K - 10K - 36K - 150K) x 5% 4,200 4,200 3. Allocation of remaining profit (280K - 10K - 36K - 4.2K) +2 114,900 114,900__229,800 As allocated 160,900 119,100 _ 280,000. SS et 091002800Partnership Operations 39 Ilustration 2.4: Bonus - choice of profit sharing scheme Mr. A, a partner in ABC Co,, is deciding on whether to accept a salary of P8,000 or a salary of P5,000 plus a bonus of 10% of profit. The bonus shall be computed on profit after salaries and bonus. Salaries of the other partners amount to P20,000. Requirement: What amount of profit would be necessary so that Mr. A would be indifferent between the choices? Solution: ‘An algebraic equation is developed from the two choices above. Let: X = profit after salaries and bonus 10%X = bonus after bonus Choice #1 Choice #2 8,000 salary = 5,000 salary + 10%X X is computed from the equation above as follows: 8,000 = 5,000 + 10%X 10%X = 8,000 - 5,000 X=3,000 / 10% X = 30,000 Profit after salaries and bonus (X) 30,000 Multiply by: Bonus rate Bonus Profit after salaries and bonus 30,000 ‘Add back: Salaries (5K to Mr. A +20K to other partners) 25,000 Add back: Bonus __ 3,000 Profit before salaries and bonus 58,000 If the profit of the partnership is P58,000, it does not matter whether Mr. A chooses to receive a salary of P8,000 (‘choice #1’) ora salary of P5,000 plus a 10% bonus (choice #2); he will receive the same amount. Checking: Choice #1 Choice #2 8,000 salary = 5,000 salary + bonus The bonus is computed as follows: Profit before salaries and bonus 58,000 Salaries (5K + 20K) (25,000) Profit after salaries but before bonus 33,000 Bw poet = 1+ Br 33,000 = 33, eee ee . nee 1+10% B= 33,000 = 30,000 B= 3,000 Choice #1 Choice #2 8,000 salary = 5,000 salary +3,000 bonus Ilustration 2.5: Bonus ~ comparison of profit sharing scheme A and B formed a partnership. The partnership agreement stipulates the following: © Bonus to A of 10% of the profit before bonus. The partners share profits equally and losses in the ratio of 2:3, respectively. Requirement: Which partner has a greater advantage when the partnership has a profit or when it has a loss? Solution:yt Partnership Operations 41 Let: bonus P = profit after deducting bonus L= loss without deducting any bonus 1, When there is profit, the profit shall be shared as follows: A's share B's share Bonus + (50%P) > 50%P_ 2. When there is loss, the loss shall be shared as follows: A's share B's share 25L < 3/5L From the analyses above, we can conclude that A has a greater advantage whether the partnership earns profit or incurs loss. Illustration 3.1: Interest on capital A and B formed. a parinership. The partnership agreement stipulates the following: ¢ Annual salary allowance of P50,000 for A. © Interest of 10% on the weighted average capital balance of B. © The partners share profits and losses on a 60:40 ratio. During the period, the partnership earned profit of P100,000. The movements in B’s capital account are as follows: B, Capital 60,000 beg. July 3 withdrawal 30,000 | 20,000 April 1 additional investment 40,000 Sept. 30 additional investment 10,000 Dec. 31 additional investment end. 100,000 Requirement: Compute for the respective shares of the partners in the profit.Chapter 2 Solution: The weighted average balance of B’s capital account is computed as follows: perce Months outstanding + Total months ina Weighted Balances year average Beg. Balance 60,000 12/12 60,000 April 1 additional investment 20,000 9/2 15,000 July 31 withdrawal (30,000) 5/12 (42,500) Sept. 30 additional investment 40,000 3/2 10,000 Dec. 31 additional investment 10,000 on2 : Weighted average capital balance 72,500 A B Total Amount being allocated 100,000 Allocation: 1. Salaries 50,000 - 50,000 2, Interest on weighted ave. capital balance (72.5K x 10%) a coe rae 3. Allocation of remaining profit (100K = 50K - 7.250K) = 42.750K (42,750 x 60%); (42,750 x 40%) As allocated 75,650 24,350 __ 100,000 25,650 17,100 42,750 Illustration 3.2: Interest on capital and bonus A and B formed a partnership. The Partnership agreement stipulates the following: * Monthly salary of P5,000 for A. * 20% bonus to A, before deductions for salary, interest, and bonus. : ‘* 10% interest on the weighted average capital of B. * Salary, bonus and interest are considered partnership expenses.43 Partnership Opi The results of operations show the following: Revenues 150,000 Expenses (including salary, interest, and bonus) (120,000) _ Profit 30,000 The weighted average capital balance of B’s capital account is 100,000. Requirement: How much is the bonus of A? Solution: Profit (given) 30,000 Add back: Annual salary (5,000 x 12 mos.) 60,000 ‘Add back: Interest on capital (100K x 10%) 10,000 Profit before annual salary and interest but after bonu: Profit before salary and interest but after bonus 100,000 Divide by: (100% less 20% bonus rate) 80% Profit before salary, interest and bonus 125,000 Multiply by: Bonus rate 20% Bonus (bonus before bonus scheme) 25,000 Ilustration 3.3: Interest on capital ~ Partial year A and B formed a partnership on March 1, 20x1. The partnership agreement stipulates the following: Annual salary allowance of P50,000 for A. «© Interest of 10% on the weighted average capital balance of B. The partners share profits and losses on a 60:40 ratio. During the period, the partnership earned profit of P100,000. The movements in B’s capital account are as follows:44 Chapter 2 B, Capital 80,000 March 1 initial investment July 31 withdrawal 30,000 | 40,000 Sept. 30 additional investment 10,000 Dec. 31 additional investment end. 100,000 Requirement: Compute for the interest on B's weighted average capital. Solution: Months outstandin Belencee ot Total Welehted months ina “°™#8" ear March 1 - beg. Balance 80,000 10°/12 66,667, July 31 withdrawal (30,000) 5/12 (12,500) Sept. 30 additional investment 40,000 3fl2 10,000 Dec. 31 additional investment 10,000 on Weighted average capital balance 64,167 Multiply by: Interest rate 10% Interest on weighted average capital *Months outstanding (March 1 to December 31) Notice that the solution above is similar to the solution we had in ‘Illustration 3.1’ for a full year. Alternative solution #1; Months outstanding ‘otal — Weiglited Balances months average during the period March 1 - beg. Balance 80,000 10/10" 80,000 July 31 withdrawal (30,000) 5/10 (15,000)45 Sept. 30 additional invéstment 40,000 3/10 12,000 Dec: 31 additional investment 10,000 0/10 Total 77,000 Multiply by: Interest rate 10% Total 7,700 Multiply by: 10/12 Interest on weighted average capital Z “Total months during the period (March 1 to December 31) Alternative solution #2: No. of months the Amounts running of Running balance is transact- balance —_ outstanding tions until the next transaction. Totals be a previous « bal.+a March 1 -- be g9000 80,000 5 Balance 400,000 July 31 withdrawal (30,000) 50,000 = 100,000 Sept. 30 investment 40,000 90,000 3 270,000 Dec.31 investment 10,000-—100,000 0 Total Divide by: No. of months in the period Total Multiply by: Interest rate Multiply by: Months outstanding 19/12 Interest on weighted average capital 6417 “(from March 1 to July 31 is 5 months) (from July 31 to Sept. 30 is 2 months)46 Chapter2 Illustration 3.4: Interest on capital - With limit A and B formed a partnership. The partnership agreement stipulates the following: © A and B shall maintain average investments of P100,000 and P150,000, respectively. Interest on the,excess or deficiency in a capital contribution is to be computed at 10% per annum. © After interest allowances, the partners share profits and losses ona 60:40 ratio. During the first six months of operations, the partnership incurred loss amounting to P60,000. The average capital balances of the partners during this period were P120,000 and P110,000, respectively. Requirement: Compute for the respective shares of the partners in the loss. Solution: The interest on the excess or deficiency’ on capital contribution is computed as follows: A B. Capital balance to be maintained 100,000 150,000 Actual average balance 120,000 110,000, Excess (deficiency) 20,000 (40,000) Multiply by: Interest rate 10% 10% Multiply by: Months outstanding 6/12 6/12 Interest to (from) 1,000 (2,000) A B Total Amount being allocated (60,000) Allocation: 1. Interest to (from) 1,000 (2,000) (2,000) 2. Allocation of remaining loss [-60K - (-1K)] =-59K (59K x 60%); (59K x 40%) (35,400) (23,600) (59,000) As allocated (34,400) (25,600) __(60,000) —— Ee emerPartnership Operations Illustration 4.1: Partner's capital account 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. The monthly salaries are withdrawn by the partners at each month-end. The partnership earned profit of P210,000 during the period before deductions of bonus and interest. Requirement: Compute the ending balances of the capital accounts of the partners. Solution: The amount of profit given in the problem is already net of the monthly salaries which were recognized as expenses. Thus, the gross amount of profit subject to allocation needs to be computed first. Profit (after deduction of monthly salaries) 210,000 ‘Add back: Monthly salaries (2K x 10 mos.) + (10K x 10mos.) L Profit before salaries (Amount to be allocated) 330,000 The interest on capital and bonus are not yet deducted from the profit figure given in the problem. Unlike for monthly salaries which are withdrawn periodically (i.e., monthly basis), interests and bonuses are normally computed only at year-end.48 Chapter 2 a ‘Thus, we cannot validly assume that these items were already recognized during the period. The profit before salaries, interest and bonus is allocated as follows: A B Total ‘Amount being allocated (see computation above) 330,000 Allocation: 1. Salaries 20,000 100,000 120,000 2. Bonus * 55,000 55,000 3, Interest (00K x 12% x 10/12) 10,000 - 10,000 4, Allocation of remaining profit (30K - 120K - 55K - 10K) +2. 72,500 72,500 145,000 As allocated 102,500__ 227,500 330,000 »The “bonus after borius” is computed as follows: P Cais Be “330,000 B= 330,000 ST B= 330,000 - 275,000 B= 95,000 The ending balances of the partners’ respective capital accounts are computed as follows: B Capital, beg. 100,000 180,000 Additional investment 20,000 - Share in profit 102,500 227,500 Drawings (monthly salaries) (20,000) 100, 000 Capital, en 202,500 307,500 Illustration 4.2: Reconstruction of information Partner A has a 25% participation in the profits of a partnership: During the year, A’s capital account has a net increase of P10,000- Partner A made contributions of P40,000 and capital withdrawals of P60,000 during the year. —|wpm Partnership Operations 49 Requirement: How much profit did the partnership earn during the year? Solution: A, Capital - beg. Withdrawals 60,000 | 40,000 Additional investment 30,000 Share in profit (squeeze) end. 10,000 A's share in profit 30,000 Divide by: A's P/L ratio 25% Partnership's profit 120,000 Ilustration 4.3: Reconstruction of information - Required profit The partnership agreement of partners A, B and C stipulates the following: © Ashall receive a salary of P20,000. © Interest of 10% shall be computed on the partners’ capital contributions of P20,000, P50,000 and P 100,000. © Balance is divided among the partners on a 2:35 ratio. However, the minimum amounts that B and C shall receive if the partnership earns profit are P10,000 and 20,000, respectively, inclusive of interest and share in remaining profit. Requirement; How much is the level.of profit necessary so that A shall receive a total of P25,000, inclusive of salaries, interest and share in remaining profit, and all of the other partners shall receive their minimum allocable amounts? Solution: First step: Allocate the fixed amounts of salaries and interests to the partners.Chapter 2 A(20%) —B (30%) _C (50° Total Salaries 20,000 20,000 Interests* 2,000 5,000 10,000 17,000 *(20%10%) = 2K; (5010%) = 5K; (100x10%) = 10K Second step: Reconstruct the profit sharing column of partner A to his needed share of P25,000. A (20%) Salaries 20,000 Interest 2,000 Allocation of balance 3,000 (squeeze) As allocated 25,000 The total amount of remaining profit for allocation to the partners is computed as follows: Allocation to A (from above) 3,000 Divide by: A's P/L ratio 20% Total amount for allocation 15,000 Third step: Allocate the computed remaining profit for allocation to partners, A (20% B (30%) _C (50% Total Salaries 20,000 20,000, Interest 2,000 5,000 10,000 17,000 Allocation of balance _ 3,000 4,500. 7,500 15,000 As allocated 25,000__9,500 17,500 __ 52,000 Fourth step: Adjust the shares of B and C to their minimum required shares in profit of P10,000 and 20,000, respectively. A (20%) _B (30%) _C(50%) _— Total Salaries 20,000 20,000 Interest 2,000 5,000 10,000 17,000 Allocation of balance 3,000 4,500 7,500 15,000 Additional profit (squeeze) 500 2,500 3,000 As allocated 25,000 __ 10,000 __ 20,000 _55,000Partnership Operations 51 Answer: From the table above, the partnership needs to earn profit of P55,000 so that A shall receive a total share of P25,000 while partners B and C shall also receive their minimum shares of P 10,000 and P20,000, respectively. Illustration 5: P/L ratio in fractions The ABC Co,, on which A, B and C are partners, reported profit of 90,000 during the year Case #1: If partners A, B and C have a profit sharing agreement of 1/6, 2/6 and 3/6, respectively, how much are their respective shares in the profit? Solution: Partners Allocation of profit A (90,000 x 1/6) 15,000 B (90,000 x 2/6) 30,000 c. (90,000 x 3/6) 45,000 Total 90,000 Case #2: If partners A, B and C have a profit sharing agreement of 2:34, respectively, how much are their respective shares in the profit? Solution: Partners Alle A (90,000 x 2/9*) B (90,000 x 3/9) c (90,000 x 4/9) Total *(O=2434)