Partnership Operations

Part 1 of 2
Partnership and Corporation Accounting 1
Learning Objectives
1. Discuss the closing entries in a partnership
and differentiate them from the closing entries
in a sole proprietorship
2. Identify and discuss the different methods
and rules in dividing partnership profits and
losses among partners.
3. Discuss and understand the preparation of
financial statements of a partnership.
Nature of Partnership
Operation
• Same as accounting for the operations of a
sole proprietorship
• At the end of the accounting period,
adjustments are made
• Profit or loss is determined in the usual
manner—matching periodic revenues and
expenses
Nature of Partnership
Operation
Special problems for partnership operations
1. Closing entries of a partnership
2. Distribution of profits and losses
3. Preparation of worksheet
4. Preparation of financial statements
a. Income statement
b. Statement of financial position
c. Statement of changes in partners’ equity
Closing Entries

STEP 1. STEP 2. STEP 3. STEP 4.

All revenue Income The balance The balance
and other Summary is of the of the
nominal debited and Income drawing
balances all expense Summary account of
are debited and other account is each partner
and Income nominal transferred is
Summary is accounts either to the transferred
credited. with debit drawing to his/her
balance are accounts or capital
credited. directly to accounts.
the capital
accounts of
the partners.
Closing Entries
APPROACH 1
• The balance of the Income Summary account
is transferred to the drawing accounts of the
partners if the partners’ intention is to keep
the capital account intact for investments
and permanent withdrawals of capital.
Closing Entries
APPROACH 2
• The balance of the Income Summary may be
transferred directly to the capital accounts of
the partners if the partners’ intention is to
make the profit or loss part of permanent
capital.
Distribution of Profits and
Losses
Factors to be considered
1. Services rendered by
the partners to the
partnership
2. Amount of capital
contributed by the
partners to the business
3. Entrepreneurial ability or
managerial skill of the
partners
Distribution of Profits and
Losses
May be expressed in
several ways as
follows:
1. By percentage
2. By fraction
3. By decimal
4. By ratio
Rules for Dividing Profits
and Losses
As to Capitalist Partners
a. Division of profits
1. In accordance with
agreement
2. In the absence of
agreement, division of
profits is in accordance
with capital
contributions
As to Capitalist Partners
b. Division of losses
1. In accordance with
agreement
2. In the absence of
agreement, division of
losses will be the same as
the agreement on the
division of profits
3. In the absence of an
agreement, division of
losses is in accordance
with capital contributions
Rules for Dividing Profits
and Losses
As to Industrial Partners As to Industrial Partners
a. Division of profits b. Division of losses
1. In accordance with 1. In accordance with
agreement agreement
2. In the absence of 2. In the absence of
agreement, the industrial agreement, the capitalist-
partner shall receive a industrial partner in his/her
just and equitable share character as industrial
of the profits and the partner shall have no
capitalist partner shall share in the losses, but in
receive profits in his/her character as a
accordance with capital capitalist partner will share
contributions in proportion to the capital
contribution.
Rules for Dividing Profits
and Losses
• In general – in accordance with the agreement
• In the absence of an agreement – in
proportion to capital contributions after
satisfying the share of the industrial partner on
such income
Methods of Distributing Profits
based on Partners’ Agreement
Equally
Arbitrary ratio (Percentage, Decimal, Fraction, Ratio)
Capital ratio (Original, Beginning, Ending, Average)

Interest on capital and the balance on agreed ratio

Salary allowances to partners and the balance on agreed ratio

Bonus to managing partner and the balance on agreed ratio

Interest on capital, salaries to partners, bonus to managing

partner, and the balance on agreed ratio
Illustrative Problem A
The following data are available in the books of Calma and
David Partnership for the year 2010

Calma, Capital
May 1 P100,000 Jan. 1 Balance P2,500,000
Apr. 1 250,000
Oct. 1 500,000
Balance - P3, 150, 000

Calma, Drawing
Jan. 1 - Dec. 31 P300,000
Illustrative Problem A
David, Capital
Jun. 1 P150,000 Jan. 1 Balance P1,500,000
Dec. 1 50,000 Sep. 1 500,000
Balance - P1, 800, 000

David, Drawing
Jan. 1 - Dec. 31 P225,000

Income Summary
Dec. 31 P600,000
Illustrative Problem A
Case 1 — Profit is divided equally

Income Summary 600,000

Calma, Capital 300,000
David, Capital 300,000
P600,000 ÷ 2 = P300,000

Case 2 — Profit is divided 3/4 and 1/4 to Calma and David

Income Summary 600,000

Calma, Capital 450,000
David, Capital 150,000
P600,000 x 3/4 = P450,000
P600,000 x 1/4 = P150,000
Illustrative Problem A
Case 3 — Profit is divided in the ratio of 1:2 to Calma and David

Income Summary 600,000

Calma, Capital 200,000
David, Capital 400,000
P600,000 x 1/3 = P200,000
P600,000 x 2/4 = P400,000

Case 4 — Profit is divided 20% and 80% to Calma and David

Income Summary 600,000

Calma, Capital 120,000
David, Capital 480,000
P600,000 x 20% = P120,000
P600,000 x 80% = P480,000
 Illustrative Problem A
Case 5 — Profit is allocated based on the beginning capital ratio.

Income Summary 600,000

Calma, Capital 375,000
David, Capital 225,000
Calma David
P600,000 x 25/40 = P375,000 Beginning balances P2,500,000 P1,500,000
P600,000 x 15/40 = P225,000 Additional investment 750,000 500,000
Drawing (100,000) (200,000)
Ending balances 3,150,000 1,800,000

Case 6 — Profit is allocated based in the ending capital ratio.

Income Summary 600,000

Calma, Capital 381,820
David, Capital 218,180
P600,000 x 315/495 = P381,820
P600,000 x 180/495 = P218,180
Illustrative Problem A
Case 7 — Profit is allocated based on the average capital ratio.

Income Summary 600,000

Calma, Capital 381,290
David, Capital 218,710
P600,000 x 2,745,830/4,320,830 = P381,290
P600,000 x 2,745,830/4,320,830 = P218,710
 Illustrative Problem A
Calma, Capital
No. of Months Average
Period Capital Balance Unchanged Peso Months Capital
Jan. 1 - Mar. 31 P2,500,000 3 P7,500,000
Apr. 1 - Apr. 30 2,750,000 1 2,750,000
May 1 - Sep. 30 2,650,000 5 13,250,000
Oct. 1 - Dec. 31 3,150,000 3 9,450,000
12 P32,950,000 P2,745,830

David, Capital

Jan. 1 - May 31 P1,500,000 5 P7,500,000

Jun. 1 - Aug. 31 1,350,000 3 4,050,000
Sep. 1 - Nov. 30 1,850,000 3 5,550,000
Dec. 1 - Dec. 31 1,800,000 1 1,800,000
12 P18,900,000 1,575,000
P4,320,830
Illustrative Problem A
Case 8 — Each partner is allowed 10% interest on ending capital and the
remaining income is divided 60%, 40%.

Income Summary 600,000

Calma, Capital 378,000
David, Capital 222,000

The distribution of profits may be recorded separately as follows

Income Summary 495,000

Calma, Capital 315,000
David, Capital 180,000
Interest on ending capital.

Income Summary 105,000

Calma, Capital 63,000
David, Capital 42,000
Remaining income divided 60%, 40%.
Illustrative Problem A
Division of profit
Calma David Total
Interest on ending capital
P3,150,000 x 10% P315,000
P1,800,000 x 10% P180,000 P495,000
Remainder — 60%, 40%
P105,000 x 60% 63,000
P105,000 x 40% 42,000 105,000
P378,000 P222,000 P600,000
Illustrative Problem A
Case 9 — David is allowed salaries of P500,000 and the remaining
profit divided in the ratio of 1:4

Income Summary 600,000

Calma, Capital 20,000
David, Capital 580,000

Division of profit
Calma David Total
Salaries P500,000 P500,000
Remainder — 60%, 40%
P100,000 x 1/5 P20,000
P100,000 x 4/5 80,000 100,000
P20,000 P580,000 P600,000
Illustrative Problem A
Case 10 — David, the managing partner, is allowed a bonus
of 20% of profit BEFORE bonus and income tax and the remainder
is divided in the ratio of beginning capital (tax rate 30%)

Income Summary 600,000

Calma, Capital 267,857
David, Capital 332,143

Division of profit
Calma David Total
Bonus — P857,143 x 20% P171,429 P171,429
Remainder — 60%, 40%
P100,000 x 1/5 P267,857
P100,000 x 4/5 160,714 428,571
P267,857 P332,143 P600,000
Illustrative Problem A
Case 11 — The partners are allowed P5,000 and P10,000 weekly salaries,
respectively, 10% interest on the average capital and the remainder is
divided in the ratio of 2:3.

Income Summary 600,000

Calma, Capital 289,750
David, Capital 310,250

Division of profit
Calma David Total
Salaries to partners
P5,000 x 52 P260,000
P10,000 x 52 P520,000 P780,000
Interest on average capital
P2,745,830 x 10% 274,580
P1,575,000 x 10% 157,500 432,080
Remainder — (P612,080)
P612,080 x 2/5 (244,830)
P612,080 x 3/5 (367,250) (612,080)
P289,750 P310,250 P600,000
Illustrative Problem A
Case 12 — Assume the same agreement as in Case 11 except that
instead of a profit, the partnership has incurred a loss of P100,000.
The allowance for salaries and interest will still be provided, thereby
resulting in a total loss to be divided as agreed.

David, Capital 109,750

Calma, Capital 9,750
Income Summary 100,000

Division of profit
Calma David Total
Salaries to partners
P5,000 x 52 P260,000
P10,000 x 52 P520,000 P780,000
Interest on average capital
P2,745,830 x 10% 274,580
P1,575,000 x 10% 157,500 432,080
Remainder — (P1,312,080)
P1,312,080 x 2/5 (524,830)
P1,312,080 x 3/5 (787,250) (1,312,080)
Net loss P9,750 (P109,750) P100,000
Illustrative Problem A –
Bonus
Illustrations on the computation of bonus using other
assumptions. The same data in Illustrative Problem A shall
be used. Bonus rate is 20%.
1. Bonus is based on profit after deducting bonus before
deducting income tax.

B = .20 x (P857,143 - B)
B = P171,428 - .20B
B + .20B = P171,428
B = P171,428 / 1.20
B = P142,857
Illustrative Problem A –
Bonus
2. Bonus is based on profit before deducting bonus but after
deducting income tax.

B = .20 x (P857,143 - T)

T = .30 x P857,143
= P257,143

Substituting for T in the first equation and solving for B

B = .20 x (P857,143 - P257,143)

B = .20 x P600,000
B = P120,000
Illustrative Problem A –
Bonus
3. Bonus is based on profit after deducting bonus and
income tax

B = .20 x (P857,143 — B — T)

T = .30 x P857,143
= P257,143

Substituting for T in the first equation and solving for B

B = .20 x (P857,143 — B — P257,143)

B = .20 x (P600,000 — B)
B = P120,000 — .20B
B + .20B = P120,000
B = P120,000 / 1.20
B = P100,000
Bonus
• Bonus is treated as a distribution of
partnership profit, and therefore, such bonus
is not deductible as an expense in
determining the amount of taxable profit.
• The same is true for salaries and interest
allowed on capital.
End of Presentation
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