UNIT 2: ACCOUNTING FOR PARTNERSHIP

2.3. Partnership operations

2.3.1 Account titles unique to partnership accounting

Partner's Capital
Permanent withdrawal of capital [d] xxx Initial investment [a] xxx
Amount of interest sold [e] xxx Additional investment [b] xxx
Closing of dr balance of Income Summary account [f] xxx Closing of cr balance of Income Summary account [c] xxx
Closing of dr balance of Drawing account xxx Closing of cr balance of Drawing account xxx

[a] Investment of cash and non-cash assets

[b] Additional investment could be:
• Investment of cash and non-cash assets
• Payment of partnership obligation by a partner from personal funds
• Collection by the partnership of personal claims of a partner
[c] Direct method – a credit balance in the Income Summary means there is a net income → profit
[d] Provided the permanent withdrawal will not prejudice the partnership creditors
[e] With the consent of the other partners
[f] Direct method – a debit balance in the Income Summary means there is a net loss → loss

Note: Investments and permanent withdrawals require an amendment of the Articles of Partnership.

Partner's Drawing
Temporary withdrawal [a] xxx Closing of cr balance of Income Summary account [c] xxx
Closing of dr balance of Income Summary account [b] xxx Salaries and bonuses [d] xxx
Closing of cr balance of Drawing account xxx Interest allowed on capital balances [e] xxx
xxx Closing of dr balance of Drawing account xxx

[a] Withdrawal of cash and non-cash assets by a partner in anticipation of profits

The Securities and Exchange Commission (SEC) rules that a partner can withdraw only up to the extent of his share in the profit
realized from business operations.
[b] Indirect method – a debit balance in the Income Summary means there is a net loss → loss
[c] Indirect method – a credit balance in the Income Summary means there is a net income → profit
[d] As a share in the profit & loss and not as an expense of the partnership, only if agreed upon
[e] Only if agreed upon

Loan Payable - Partner

Payment of cash and non-cash assets to a partner xxx Receipt of cash and non-cash assets from a partner* xxx
* If a promissory note is issued, then Notes Payable - Partner

Loan Receivable – Partner

Disbursement of cash and non-cash assets to a partner* xxx Receipt of cash and non-cash assets from a partner** xxx
* If a promissory note is received, then Notes Receivable - Partner
** As a settlement of receivable from a partner

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2.3.2 Closing journal entries applicable to partnership accounting
Indirect Method
• Net income (loss) from operations is closed to the Drawing accounts of the partners
• Used when the partners intend to keep the Capital accounts intact for investments and permanent withdrawals of
capital

Steps in the closing process

1. Close nominal accounts with normal credit balances to Income Summary
2. Close nominal accounts with normal debit balances to Income Summary
3. Close Income Summary (the balance of which reflects the net income or net loss for the period)
to Partners’ Drawing accounts

Net income
Income Summary xxx
Partner A – Drawings xxx
Partner B – Drawings xxx
Net loss
Partner A – Drawings xxx
Partner B – Drawings xxx
Income Summary xxx

4. Close Partners’ Drawing accounts to Partners’ Capital accounts

Direct Method
• Net income (loss) from operations is closed directly to the Capital accounts of the partners
• Used when the partners intend to make the profit or loss a part of permanent capital

Steps in the closing process

1. Close nominal accounts with normal credit balances to Income Summary
2. Close nominal accounts with normal debit balances to Income Summary
3. Close Income Summary (the balance of which reflects the net income or net loss for the period)
to Partners’ Capital accounts

Net income
Income Summary xxx
Partner A – Capital xxx
Partner B – Capital xxx
Net loss
Partner A – Capital xxx
Partner B – Capital xxx
Income Summary xxx

4. Close Partners’ Drawing accounts to Partners’ Capital accounts

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2.3.3 Methods and rules for dividing partnership profits and losses

ARTICLE 1797. The losses and profits shall be distributed in conformity with the agreement. 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.

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.

Net income Net loss

Capitalist Industrial Capitalist Industrial
partner partner partner partner
With Profit & Loss As agreed As agreed As agreed As agreed
agreement
With Profit As agreed As agreedFollow No share
agreement only profit ratio
No Profit & Loss In proportion Just and In proportion No share
agreement to capital equitable to capital
contribution share* contribution
*Could be equal to share of capitalist partner with smallest share

Examples of Profit & Loss sharing agreement

• Equally
• Arbitrary ratio
• Capital contribution ratio
• With interest on capital balance and balance based on agreed ratio
• With salary allowances to partners and balance based on agreed ratio
• With bonus to managing partner and balance based on agreed ratio
• Any combination of interest, salary, and/or bonus and the balance based on agreed ratio

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REFERENCES:
• Dela Cruz, A.L.C., Rabo, J.S., & Tugas, F.C. (2019). Basic financial accounting and reporting.
• Palma, Roberto C. (2014). Basic Accounting 2: Partnership and Corporation. Rex Bookstore, Inc.
• Electronic Source:
o Republic Act No. 386 An act to ordain and institute the Civil Code of the Philippines. [On-line] Available
https://www.officialgazette.gov.ph/1949/06/18/republic-act-no-386/

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