Chapter 4: ACCOUNTING FOR PARTNERSHIP OPERATIONS Chapter Outline ‘ 1) _Nature of Partnership __~ Operations 4) “Agreements in Computing Profits and Losses 5) Salaries and Bonus for _ ‘Partners’ Services 6) _ Multiple Basis and Priority of g Capital Balance Allocat Nature of Partnership Operations P&L A business partnership operates like any other forms of profit- oriented business. It manufactures, sells products or provides services for a profit. The accounting process of a partnership’s transactions is basically similar to the accounting process for sole proprietorships’ or corporations. Their differences, however, lie in the plurality of presenting partners’ capital in_ the balance sheet and in the distribution of partnership’s earnings to the partners. In sole proprietorship, there is no sharing of profit or loss because there is only one owner who takes the benefit or burden of the business. In a partnership business, however, the distribution of profits or Joss usually" depends on’ the partners’ agreement and on the number of partners. “Your real wealth can be measured, not by what you have, but by what youare.” Anonymous Scanned with CamScanner122 PARTNERSHIP AND CORPORATION ACCOUNTING d in the form of dividends base, is rofits are distribute acs, In corporation, P! directors from the undistributey on ‘the declaration by the board of retained earnings of the business. COMPARATIVE PROFIT etorsh ~Partnershi Profits are distributed in the forms of dividends based on the decision by the board of directors. ‘The profits or losses are | The profits or losses are all taken by the only divided based on the ‘owner, the sole proprietor. | partners’ agreement. I Accounting for Partnership Operation ‘The accounting for partnership operation is concerned with the following activities: 1. Accounting treatment of profit and loss 2. Proper distribution of profit and loss 3. Preparation of financial statements such as: a. Income statement (Statement of Recognized Income’ and Expenses) b. Statement of Financial Position (formerly Balance Sheet) c. Partners’ capital statement (Statement of Changes in Partners Equity) Accounting Treatment of Partnership’s Profit and Loss The determination of proper income or loss is made through tht preparation of income statement with the following basic formula: Revenues : Pxxx Less: Operating expenses XXX Net income (loss) Pxxx In the journal entry, there is net income if the income summa! account has a credit balance. There is net loss if the incom summary account has a debit balance. Scanned with CamScannerChapter 4: Accounting for Partnership Operations 123 The profit or loss is subsequently distributed to the partners by closing the income summary account to the respective partners’ ‘capital accounts. Illustration 1 Assume that A&B Partnership has a credit balance of income summary account amounting to P500,000. If partners A and B divide profit equally, the journal entry to distribute the net income would be: GENERAL JOURNAL _B, Capital ae + To record profit dist Illustration 2 Assume that A&B Partnership has a debit balance of income summary account amounting to P500,000. If partners A and B divide losses with 60% and 40% loss sharing respectively, the journal entry to distribute the net loss would be: GENERAL JOURNAL B, Capital (P500,000 e summary _ Note: The net income or loss can also be closed first td 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. Scanned with CamScanner124 | PARTNERSHIP AND CORPORATION ACCOUNTING Sharing Partnership Profits and Losses The primary objective of the accounting for partnership operations is the determination of periodic net income and its distribution to the partners. Accountants usually observe the accrual method of accounting ang generally accepted accounting principles (GAAP) because GAap results in a better measure of determining income. The determination of net income is calculated in a_ traditional manner - that is, by relating the partnership’s periodic revenues and expenses. In measuring partnership: income for the period, however, the expenses should be scrutinized to make sure that personal expenses of the partners are not included among the partnership’s business expenses. lf 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. This is because the partnership business is treated as a separate and distinct person from the partners in accordance with the accounting entity concept. The Laws on Partnership Profits and Losses Distribution Article 1799 of the New Civil Code provides that any stipulation that excludes one or more partners from any share in the profits. or losses is void. The reason for this is that partnership must exist 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: 1 Civil Code of the Philippines, Art. 1770. Scanned with CamScannerChapter 4: Accounting for Partnership Operations 125 Rules on Profits Sharing Profit Sharing Based on Partners’ Agreement Profits of the partnership shall be divided among the partners in accordance with their profit-sharing ratio agreement.? Illustration Moses and Joshua have capital balances of P65,000 and P35,000, respectively. The Partnership earned a net income of P100,000. Their profit agreement is 60% and 40%, respectively. The profit distribution between Moses and Joshua would be: Moses Joshua Profit of P100,000: (60%) (4.0%) Total Share of Moses (P100,000 x 60%) P60,000 P 60,000 Share of Joshua (P100,000 x 40%) ai P40,000 40,000 Total 60,000 40,000 100,000 Note: The capital contributions of the partners have no bearing in the profit distribution because their profit ratio agreement should be followed. Profit Sharing Based on Capital Contribution In the absence ofia profit-sharing agreement, profits shall be divided among the partners in proportion to their respective capital contributions. ‘ Illustration Using .the same data in the preceding illustration, the profit distribution between Moses and Joshua if they have no profit and loss agreement would be: Moses Joshua Profit of P100,000: (65%) —(35%) Total Share.of Moses (P100,000 x 65/100) 65,000 * P 65,000 Share of Joshua (P100,000 x 35/100) . 35,000 35,000 Total 55,000 P35,000 B100,000 Notes: 1. Since there is ho Pél. ratio agreement between Moses and Joshua, their capital contributions are now considered as the basis of profit or loss distribution, Scanned with CamScanner126 PARTNERSHIP AND CORPORATION ACCOUNTING 2, The fraction or percentage is derived from their capital ratio, computed as follows: : Fraction —_ Percentage 65/100 65% Moses (P65,000/ P100,000) 35/100 aan Joshua (P35,000/ P100,000) Profit Sharing Based on Capital Contribution and on Service ° 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 P100,000 profit would be: : Moses Joshua Caleb Profit of P100,000: (65%) (35%) industrial) Total Share of Caleb (P100,000 x 10%) P 10,000 P 10,000 Share of Moses (P100,000-P10,000) x 65/100 P58,500 58,500 Share of Joshua (P100,000-P10,000) x 35/100 .° P31,500 . * 31,500 Total P58,500 . 31500, 10,000 100.000 Rule 2: If there is no specified profit sharing for an industrial partner, he shall receive a share equal to the share ‘of a capitalist partner having the smallest share.+ 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: . Moses Joshua Caleb Profit of P100,000: (65%) (35%) (industrial) Total Share of Caleb (P100,000 x 35/135) P25,926 P 25,926 Share of Moses (P100,000 x 65/135) P48,148 48,148 Share of Joshua (P100,000 x 35/135) P25,926 xe 25,926 Total 225,926 25,926 100,000 Notes: 1. The capital contribution of Joshua shall be used to allocate the share of Cale? from the profit of the partnership because there was no profit share agreement for the industrial partner. ats aie Na TS Bee 4 Code of Commerce, Art. 140. Scanned with CamScanners Z Chapter 4: Accounting for Partnership Operations 127 2. The fraction is derived by simply adding 35 profit share of the industrial partner to the profit sharing of Moses and Joshua based on their contributed capital as 65 and 35 respectively, or total units of profit to be shared as 135 computed as follows: Profit share Fraction Moses, per capital contribution = 65 65/135 Joshua, per capital contribution = 35 35/135 Caleb = to the smallest share of capitalist partner or 35 35/135 Total (65 + 35 + 35) = 135 135035 Rule 3: If there is a Capitalist/Industrial Partner, he gets just and equitable share as an industrial partner and another share as a capitalist partner according to his capital contribution.5 Illustration Assume that Caleb contributed a capital of P25,000 and,’ per partnership agreement, he would receive a profit share of 10% from the profit of the partnership as an industrial partner. There is no sharing agreement between the pure capitalist partner. The distribution of profit would be: , Profit of P100,000: Moses Joshua _. Caleb Total Share of Caleb: As industrial (P100,000 x 10%) ‘ P10,000. As capitalist (P100,000 x 18%) 18,000 P 28,000 Share of Moses (P100,000 x 46.80%) — P46,800 p 46,800 Share of Joshua (P100,000 x 25.20%) * . 25,200 . 25.200 Total 246,800 25,200 P28,000 P100,000 Notes: 1. The new profit and loss sharing ratio is computed as follows: Partners’ Capital Computations New profit ratio Caleb as industrial (100% - 90%) 10.00% Caleb as capitalist P 25,000 90% x 25/125, 18.00% Moses 65,000 90% x 65/125 46.80% Joshua —35,000 90% x 35/125 25.20% P125,000 100.00% 2. Even if Caleb has already received his share as industrial partner, he is still entitled to receive additional share from the remaining ‘balance of the partnership profit because he is a capitalist partner at the same time. Seal Be eect ede ds ® Civil Code of the Philippines, Art. 16898 Scanned with CamScanner128 PARTNERSHIP AND CORPORATION ACCOUNTING Rules on Losses Sharing Loss Sharing Based on Partners’ Agreement ft Rule 1: Loss of the partnership shall be divided among the partners in accordance with their profit or loss sharing agreement. Illustration “Moses and Joshua have capital balances of P65,000 and P35,000, respectively. The partnership suffered’ a net loss of P30,000. They agreed that any profit shall be divided 60% and 40%, respectively, but losses shall be divided equally. The distribution of loss would be: Moses — Joshua Loss of P30,000: (50%) (50%) Total Share of Moses (P30,000 x 50%) (P15,000). (P_ 15,000) Share of Joshua (P30,000 x 50%) . {P15,000) 15,000) Total (P15,000) {P15,000) {P30,000) Notes: 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 loss sharing agreement, loss 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: Moses Joshua Loss of P30,000: (60%) 40%) Total Share of Moses (P30,000 x 60%) (P18,000) (P 18,000) Share of Joshua (P30,000 x 40%) - {(P12,000) (12,000) Total {P18,000) (P12,000) {P_30,000) The existing 60% and 40% profit ratio’ of Moses and Joshua, respectively, was applied. Scanned with CamScannerChapter 4: Accounting for Partnership Operations 129 Loss Sharing Based on Capital Contribution In the absence of any loss sharing and profit sharing ratios, loss shall be divided among the capitalist partners in accordance with their capital contributions, 6 Illustration Using the same illustration above except that there was no profit or ‘joss sharing agreement among the partners, the distribution of the P30,000 partnership loss would be: Loss of P30,000: Moses (65%) Joshua (35%) Total Share of Moses (P30,000 x 65%) (P19,500) 1 (P 19,500) Share of Joshua (P30,000 x 35%) {P10,500) 10,500) Total (P19,500) (P10,500) {P-30,000) Note: The fraction or percentage is derived from their capital ratio, computed as follows: Fraction Percentage Moses (P65,000/ P100,000) 65/100 65% Joshua (P35,000/ P100,000) 35/100 35% Loss Sharing of an Industrial Partner Rule 1: If there is no agreed loss 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 P30,000, the distribution of the loss would be: Moses Joshua Caleb Loss of P30,000: 65%) ___(35%) (Industrial) Share of Caleb Pi. 08 Share of Moses (P30,000 x65/100) _ (P19,500) + (19,500) Share of Joshua (P30,000 x 35/100) . {P10,500) 10.500) Total (P19,500} {P10,500) P= O- - [P30-000) Notes: 1.\ Industrial partner docs not share in partnership losses because he already rendered his service in vain. oe dat ay ae Art. 1 Partners and Corporation Law F Mestor de en Lawo'on Partnership and Corporation, p, $4. Scanned with CamScanner130 PARTNERSHIP AND CORPORATION ACCOUNTING 2. If there is a profit and loss ratio agreement in which the industrial partner ig included in the profit and loss sharing ratio, he is botind to respect the contrac, between them by his co-partners. He shall therefore share in the loss equivalent to his agreed loss ratio even if he is an industrial partner. i 3. However, if there is a profit sharing ratio and there is no’ loss ratio, the industrial partner is not bound to share in.the partnership losses because he did not give his consent to have his share in the partnership losses. Rule 2: However, it must be carefully noted that with respect to an industrial-capitalist partner, if there is no loss sharing agreement but there is a profit sharing agreement in which the industrial. capitalist partner is entitled to a profit ratio, he then becomes liable for the losses of the partnership in the same proportion as his profit sharing ratio. Illustration \ Assume that Caleb contributed a capital of P25,000 and per partnership agreement, he would receive 10% of partnership profit as an industrial partner. The partnership agreement also stipulates that the capitalist partner will share equally in the partnership’s profit and loss. The distribution of P30,000 net loss would be: \y Moses, Joshua Caleb Loss of P30,000: 1/3) 1/3) 1/3) Total Share of Caleb: ‘ As capitalist (P30,000 x 1/3) P10,000 P10,000 Share of Moses (P30,000 x 1/3) P10,000 s “10,000 Share of Joshua (P30,000 x 1/3) 4. P10,000 2 10,000 Total P10,000 P10,000 10,000 —P30,000 Notes: : 1; ‘The industrial partner is not exempted from the loss sharing once he becomes @ _ capitalist partner. 2. If there are partnership losses, however, the industrial partner shall not absorb ‘a share from the net losses. He shall share only in the loss as a capitalist partner. Scanned with CamScannerSUMMARY OF PROFIT AND LOSS DISTRIBUTION | Profit? yes: ‘Yes -Divide profit based Yes -Divide profit based “ “Yes -Divide profit based profit based wae Com »| eras ‘on profit and loss ratio, Equal to share of capitalist with nai pstcet Sra Industrial - Capitalist None >| Contribution 4 ‘Yes -Divide loss based ‘Yes - Divide loss based a Loss occas —— I Capitalist Con | iene: | ntionsie Gi eet Industrial ‘None None already rendered his service in — a : Recon ata Inaustial - Capita C Wine woe or Soetuton Scanned with CamScanner ty 1ajdeYyD suonesedo diysseuped 40) Bujunosay Ter132 PARTNERSHIP AND CORPORATION ACCOUNTING Arbitrary Agreements in Computing Profits and Losses Partners may share the partnership profits and losses in any manner they wish. The profit and loss agreement should contain specific anq complete provisions to avoid misunderstanding and disputes among the partners. The agreement on partnership’s profits and losses may be divided into one of the following ways: . . Equally . Specified ratio or percentage Capital ratio Interest allowed on partner’s capitals, the remainder to be divided in an agreed ratio 5. Salaries or bonus allowed for partners’ services, the remainder to be divided in an agreed ratio 6. Multiple bases of allocation PONH To illustrate the methods that could be agreed upon for profit and loss distribution, assume that Adam and Eve formed a partnership with original capital contributions of .P60,000 and P30,000, respectively. In the second year of the partnership operations, the capital an¢ drawing balances of partners Adam and Eve are ‘traced from the general ledger as follows: “Adam, Capital Debit Credit 880 60,000 in| 60,000 are 630" 40,000__| Irs ‘S80 {110,000 _| During the year, the partnership generated an income of P200,000. Note: Unless otherwise stated, the data above shall be used as the basis illustrations in the succeeding discussions, Scanned with CamScannerChapter 4: Accounting for Partnership Operations 133 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 a specific agreement regarding division of losses, the existing equal division of profit agreement is to be followed by the partners. If Adam and Eve agreed to divide the partnership profit equally, the distribution of P200,000 profit would be: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x ‘Adam (50%) = —P400,000 Eve (P200,000x 60%) | TP 00,000 100,000 Net income distribution {00,000 | _P100,000 | P200,000 It is to be observed that Adam and Eve shared’ on the partnership profits equally regardless of the unequal balances of their capital contributions. To record the distribution of profit, the following journal entries shall be made: GENERAL JOURNAL gat [Page Number 400 | _ tate Descriptions PR Debit | Credit 12/31 Income summary BA 200,000 P ‘Adam, Drawings Pee ta 100,000 "Eve, Drawings _ ; To record profit distribution i equally. SAB ed | 100,000 Note! The profit or loss distribution can also immediately be closed to the partners’ capital accounts because the partners’ drawing accounts are ultimately closed to the capital accounts. An alternative journal entry is to distribute net income directly to the partners’ capital accounts, as follows: Income summary 200,000 Adam, Capital 100,000 Eve, Capital 100,000 Scanned with CamScanner134 PARTNERSHIP AND CORPORATION ACCOUNTING For the succeeding illustrations, the drawing accounts will be Useg in closing the profit;or loss account. Specified Ratio or Percentage Whenever the presence of one of the partners is perceived more vita to the success of the business due to experience, ability ang reputation, the profit and loss agreement may stipulate an unequa| sharing expressed in agreed specified ratio or percentage, otherwise called as arbitrary ratio. In specified ratio, the difference in the partner’s capital balances has no bearing in the profit and loss sharing. The agreed profit and loss ratio may be based on the partners’ better capability or influence over the other. To illustrate, assume that Eve is perceived more vital than Adam 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 P200,000 profit in the following manner: ADAM & EVE PARTNERSHIP Profit Distribution Schedule . December 31, 200x Total (00%) 2 (P200, Ey P720,000 420,000 Net income distributioi __1 [TP 80,000 | P120,000 | P200,000 In spite of Adam’s greater ending capital balance (P150,000) that that of Eve (P100,000), the latter received a greater share from the partnership profit because the specific percentage on profit and loss agreement provides her 60% share from the partnership earnings. The journal entry to effect the profit distribution in the books accounts would be: Scanned with CamScannerChapter 4: Accounting for Partnership Operations 135 GENERAL JOURNAL _ Relative Capital Balances When money or properties invested by the partners represent the vital contribution to the success of. the partnership business, partners may agree that their respective capital balances shall be the basis of the profit and loss sharing. 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 so for the allocation of profit and loss distribution is not fixed due to fluctuation of the capital balances of the partners. f 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: , Original capital contribution . Beginning capital balance of the accounting year . Ending capital balance of the accounting year Reve Average capital balance of the year Original Capital Contributions. If the partners agreed. that -the periodic division of profits and losses be based upon their respective original capital contributions, the reference should be made to. the amounts originally invested by the partners. To distribute the P200,000 net income of the partnership to Adam and Eve, the following computation should be made: Scanned with CamScanner136 PARTNERSHIP AND CORPORATION ACCOUNTING ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x ‘Note: The fraction is computed by dividing the original capital investment by the total original capital investments, as follows: Partners: Amounts Fraction Adam 60,000 6/9 Eve 30,000 3/9 Total Poo.000 8-9/9. To record the profit distribution, the journal entries would be: _ GENERAL JOURNAL Gescriptions Adam, Drawings e, Drawings _ Beginning Capital Balances of the Accounting Year. If the partners’ agreement provides that the periodic division of profits and losses shall be based upon, the capital balances at the beginning of the year, then the opening partners’ capital balances of the current year shall be the basis of the profit and loss allocation, The distribution of P200,000 profit would be: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x afar Eve i Total P 50,000 | 410,000 | 1 1 - 109,091 19 | 'P 90;908 | 90,809] P_90,909 Scanned with CamScannerChapter 4: Accounting for Partnership Operations 137 Note: The disadvantage of beginnin additional investments during the a not compensated in the di @ capital balance method is that it discourages urin, ‘ccounting period because such investments are ivision of profit until the next year’s period. The journal entry in the distribution the profit would be: GENERAL JOURNAL ite ase [412/31 “Income summai =A Adam, Drawings _ ___Eve, Drawings —__To record profit distribution based _._on the partners’ be; Ending Capital Balances of the Accounting Year. If the partners agreed that the division of profits and losses shall be based upon the partners’ capital balances at the end of. each year, all transactions affecting the capital accounts shall be then considered and’ the ending capital balance shall be the basis of the profit and loss allocation. The ending capital accounts of each partner is determined by getting the account balances of the partners’ capital accounts, as follows: Eve. Capital 160,000} 100,000 ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x lances 5 120,000 200 40/25) {et P 80,000 80,000 Eve (P200,000 x 10/26) ____ j__{_ P120,000 | P 80,000; —P 200,000 Computation: = aint I 7 ‘Adam (200,000 x 18725) a 120,000 1 Scanned with CamScanner138 PARTNERSHIP AND CORPORATION ACCOUNTING Notes: 1, Drawing accounts are not included in the computation of the ending capita balances because they only reflect temporary reduction of the capital balance, representing advances to partners in anticipation of partnership profit. 2. The disadvantage of using the year-end capital balance method is that there jg no incentive for a partner to make any investments in the earlier parts of the year. To record the profit distribution, the journal entry would be: Bs 3S. lneilig To record profit distribution based Average Capital Balances of the Accounting Year. When partners agreed to divide profits to recognize capital changes during the current period, the use of the partners’ average capital balances shall be employed. This method also encourages partners’ to contribute during the year additional investments to the partnership. An accounting issue is raised as to whether or not drawings made by partners during the fiscal period shall be included in the computation of average. capital. As a rule, drawing accounts are not consideréd in the computation of ending capital except when stated otherwise. ~ Methods of Computing Average Capitals There are two methods of computing. the’ average capitals of the partners - (a) simple average, and (b) weighted average. Simple Average Capital Method This method is computed by simply dividing the sum of the beginning and ending capital by 2. Scanned with CamScannerChapter 4: Accounting for Partnership Operations 139 The simple average capital balances are computed as follows: Partners: Computations Simple Average Fraction Adam {P60,000 + P150,000)/ 2 105,000 105/180 Eve (P50,000 + P100,000)/ 2 75,000 75/180 Totals P180,000 Using the simple ‘average capital method, the distribution of P200,000 profit would be: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x a i Eve Total. Simple Average Capitals [“Pt0s,000°TP'75,000 480,000 Computation: ge i fu ay = |__Adam (200,000 x 108/180) [Pt 667 146,667 [Eve (P200,000 x 75/180) moe P 33,333 33,333, ("Net income distribution P11 667 33,333 | _P200,000 Weighted Average Capital Method This method is also known as “peso-month” or “peso-day” average capital method. Under this method, the computation of the average capital considers the period in which the capital contributions have been used in a given accounting period. The weighted average capital based on peso months is computed as follows: : (b) (J) (c) / (b) Number of Months x | Peso-Months Months | Average | 100,000 | x "40,000 | x | 150,000 | x 450,000 | _B1050,000 B_150,060 [eco oral 00 | 875/1,400_| $2,500 |” 525/1;400 140,000 | | Noté: The product of ¢ is divided by 12 months to get the peso-month average capital balance. Scanned with CamScanner140 ‘PARTNERSHIP AND CORPORATION ACCOUNTING Using this method, the P200,000 partnership income shall be distributed as follows: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x { Computation: = [Adi (200,000 x 787-400 P75,000 | 200,000 Notes: 1, Alternatively, the weighted average capital balances can be computed as follows: Computations Peso-Month Average | Fraction _ 12/12 | x 6/ 1 )x4/1 Part- © Number of (40,000) 20,000 P 52,500 P140,000 2. 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. 3. 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’ Capitals This agreement provides that the cost of money on the. capital contributions of partners will be added as a profit sharing device i addition to the profit and loss ratio agreement. It is based on the philosophy that if the capital contributions hav? been invested in other earning activities such as trading securities the partner should have realized additional revenue. Scanned with CamScannerChapter 4: Accounting for Partnership Operations 141 The allowance of interest may be computed on the following bases: 1. Interest on capital balances 2. Interest on excess investments Interest on Capital Balances. This method allocates first a portion of profit equivalent to a certain interest rate of the partners’ capital balance. Accordingly, the Capital balances should clearly be defined in the agreement. The remaining balance of the profit shall: be distributed in accordance with the agreed arbitrary ratio. 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 Adam and Eve agreed that their respective avetage * 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 Adam and Eve are P87,500 and P52,500, respectively. The distribution of P200,000 profit would be: ADAM & EVE PARTNERHSIP Profit Distribution Schedule December 31, 200x _Total {Ratio on the remaining balance [a] 100% [712% Interest on average capital [Adam (P87,500 x 12%) _ P46,800 16,800) x a0} a8 Eve (P200,000 - P16,800) 4 fs 73,280 3,2 “Nat nec distribution P120,420_ | P79,680_| 200,000 Interest on Excess Investments. This method allows interest on the excess capital balance of one partner over that of another, Illustration A tt Adam and Eve agreed that the excess of one partner’s are guia palance is entitled to a 12% interest per year and the Scanned with CamScanner142 PARTNERSHIP AND CORPORATION ACCOUNTING balance of partnership profit will be distributed 60% and 40%, respectively. The average capital balances of Adam and Eve are P87,500 and P52,500, respectively. The P200,000 profit will be distributed as follows: Z ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x P78,320__ Notes: 1. The balance for distribution is computed as follows: Net income of the partnership P200,000 Less: Interest on Adam’s excess capital over Eve [(P87,500 - P52,500) x 12%)] 4,200 Balance for distribution P195,800 2. The agreement for interest may still employ other forms. For instance, a fixed capital contribution is agreed for each partner with interest allowed on amounts in excess of such fixed amounts and interest charged on any deficiencies. Special Note: Interest on Loans. As a rule, interest on capital balances shall be. part of profit and loss distribution but interest charges on loans made by # partner in favor of the partnership shall be treated as interest expense on the income statement, and not a profit and loss sharing device.® i Likewise, the interest on the money borrowed by the partner from the partnership shall be treated as part of the business revenue because suc transactions create a “debtor- creditor relationship” between the partnet and the firm. — z cont! ® Barry J. Epstein and Abbas Ali Mirza, Wiley IAS 2002 Interpretation and Applicati Internation ‘Accounting Standards (Toronto: Johri Wiley & Sons, Inc., 2002), p. 92. ne Scanned with CamScannerChapter 4: Accounting for Partnership Operations 143 Salaries or Bonus Allowed for Partners’ Services an equitable division of profits’ and losses frequently requires that Soanciel consideration be given’ to the skills, talents, efforts and work hours that active partners devote to the partnership business in addition to their capital investment. Consequently, salaries and/or bonus may be given to a partner before the agreed profit sharing ratio are made. Salaries. To recognize personal contribution by the partner to the business, they may agreé to receive salary, and divide the remaining profit among themselves by the agreed specified ratio. Except when’ stated otherwise, salary allowances are part of the net income/loss allocation to the partners. - ‘ Illustration Assume that the Adam and Eve Partnership’s operation was a 12- month period and that they agreed that a salary of P6,000 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 shall be distributed 60% and 40%, respectively. The average capital balances of Adam and Eve are P87,500 and P52,500, respectively. The distribution of P200,000 profit shall be: ADAM & EVE PARTNERHSIP, Profit Distribution Schedule December 31, 200x [Eve (P52,500 x 12%) i Balance for distribution, P3 Adam {P39,200 x 60%) Eve (P39,200 x 40%) 106,020 | P93,960 | P200,000 Net income distribution _ ciate i though the result of operation Salary distribution must be made even th of op is lose, cecene when partnership agreements state otherwise. ship agreement may Provide that a managing = ae se parent a bons on the earnings of the business to Scanned with CamScanner144 PARTNERSHIP AND CORPORATION ACCOUNTING encourage profit maximization. The bonus may be computed ag follows: Bonus = Bonusrate x Base net income (The. base net income is always assumed to be 100%.) The bonus agreement is basically stated asa percentage of net income. The bonus may be based on the following net income: "1. Net income before deducting salaries, interest (if any) and bonus 2. Net income after deducting salaries and interest (if any) but before bonus 3. Net income after deducting salaries, interest (if any) and bonus Multiple Bases and Priority of Allocation This procedure depends on the partners’ agreement regarding the order of priority in allocating the multiple basis of profit or loss. 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 (if any) and bonus. Assume that Adam and Eve agreed to the following: a. Each of them would have a salary of P5,000 per month (one-ye# operation). 5 b. 6% interest on their respective average capital. c. 10% bonus of net income before salaries, before interest capital and before the bonus to Adam, 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 Adam and Bve are P87,500 and P52,500, respectively. , Scanned with CamScannerChapter 4: Accounting for Partnership Operations ae The:F200,000,p artnership’s net income shall be divided as follows: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x [Ratio on the remaining balance re iL distribution, P61,600 [Adam (P51,600 x 60%) Eve (P51,600 x 40%) i [Net income distribution Z | P 83,790 Notes: 1. The bonus is computed as follows: Net incomevof the partnership before salaries, interest and bonus _ P200,000 Multiply by bonus rate 10% Bonus Since. the P200,000 is assumed 100%, the bonus is just computed by multiplying it by the bonus rate. 2. . The balance for distribution is computed as follows: Net income of the partnership 200,000 Less: Salary of partners 4 P120,000 Interest on partners’ average capital 8,400 Bonus 20,006 148,400 Balance for distribution Case 2: Bonus is based on net income after deducting salaries and interest (if any) but before bonus. Assume that Adam and Eve agreed that each of them would have a salary of P5,000 per month (one-year operation), 6% interest on their respective average capital, and to give bonus of 10% of net income ane salaries and interest on capital but before the bonus to Adam, the managing partner. The balance of net income shall be divided on the basis of 60% and 40%, respectively. ; The average capital balances of Adam and Eve aré P87,500 and P52,500, respectively. Scanned with CamScanner146 PARTNERSHIP AND CORPORATION ACCOUNTING The P200,000 partnership’s net income shall be divided as follows; ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x | Salary (P5,000 x 12) (Interest on averat ‘Adam (P87,500 Notes:. 1. The bonus is computed as follows: Net income of the partnership Less: Salary of partners Interest on partners’ average capital “Net income after salary and interest but before bonus Multiply by bonus rate : Bonus 2. The balance for distribution is computed as follows: Net income of the partnership Less: Salary of partners Interest on partners’ average capital Bonus Balance for distribution. P120,000 8,400 P120;000 8,400 7160 200,000 128,400 P 71,600 10% P7160 7 200,000 135,560 Case 3: ‘Bonus is based on net income after deducting salaries, interest (if any) and bonus. Assume that Adam and Eve agreed that each of them would have 2 salary of P5,000 per month (one-year operation), 6% interest on theit respective average capital, and to give bonus of 10% of net income after salaries, after interest on capital,and after the bonus to Adam the. managing partner. The balance of net income shall be divided the. basis of 60% and 40%, respectively. The average capital balances of Adam and Eve are P87,500 ond P52,500, respectively. £ Scanned with CamScannerChapter 4: Account Ng for Partnership Operations 187 The P200,000 in”, : partnership’s net income shall be divided as follows: ADAM & EVE PARTNERSHIP : Profit Distribution Schedule ; _Pecember 34, 200x Total "Se P110,813.60 | P89,186.40 P200,000 | Notes: 1. The bonus is computed as follows: Net income of the partnership P200,000 Less: Salary of partners ; P120,000 Interest on partners’ average capital 8.400 128,400 Net income after salary and interest but before bonus P 71,600 110% Less: Bonus 6,509 10% Net income after salary, interest and bonus P_65,091 100% 2. Since'the base is the net income after salary, interest and bonus that is assumed 100%, and the bonus rate is 10%, therefore, the net income after ‘salary, interest but before bonus is 110%. This is computed by adding back the 10% bonus rate to the base, 100%. The net*income after salary, interest’ and bonus is computed as follows: Net income after salary, interest and bonus = Net income after salary, interest but before bonus 110%. -. = P65,090 3. The bonus is then computed as follows: Net income after salary, interest and bonus P65. 09 a X Bonus rate s ay Bonus : P_6,509 4.” The balance for distribution is computed as follows:, Po Net income of the partnership Pi poiaOD a. , Less: Salary of partner: ae capital 8/400 Interssh el partners loa 6.509 _134,909 x Bonus Balance for distribution Scanned with CamScanner148 PARTNERSHIP AND CORPORATION ACCOUNTING Accounting for Interests and Salaries Treated as Expenses Payments of interest on capital or salaries to partners are considereq an allocation of profit and are usually not expense on the income statement. : : In an attempt to emulate corporate financial reporting, however, some partnerships, with adequate disclosure, do display part or all of such payments as expenses in the income statement to determine the true performance of the business In this case, the interests on capital and salary are treated as ordinary operating expense prior to the profit and loss distribution to partners. Illustration A and B agreed that each of them will receive a P10,000 monthly salary, their respective capital balance is‘ to earn 6% interest per year, and the remaining balance of profit is to be shared equally. , Assume the following results of operations’ of A&B Partnership for an accounting year: Sales ‘ P1,000,000 Cost of sales i 400,000 Rent expense ‘ 75,000 Supplies expense 50,000 Depreciation expense ‘ 20,000 If the partners agreed that their salaries and interest on’ capital are to be treated as operating expense and their capital balances are P100,000 and P150,000, respectively, compute. and journalize the profit distribution. 1. Computation and distribution of profit Sales ; 000 _ Less: Cost of sales Ps f00,000 Gross income n P 600,000 Less: Operating expenses: : Salaries (P10,000.x 12 x 2) P240,000. Rent expense 75,000 Supplies expense 50,000 Depreciation expense : 20,000 Interest (P6,000 + P9,000) 15,000 __490,008 Net income 3 P Scanned with CamScannerChapter 4: Accounting for Partnership Operations 149 Profit distribution: Partner A (P200,000/2) Partner B (P200,000/2) 2, Journal entry to record the profit distribution Notes: Tax Law requires that the distributable share of partners is subject to the following taxes: : 1. If the partnership is commercial, final tax of 10%. 2. If the partnership is professional, creditable tax of 10% if the distributable share is P720,000 per year or 15% if more than P720,000 per year. Distribution of Insufficient Net Income As a-rule, the prescribed allocation for salaries and/or interests on capital balances should still be given in spite of the insufficiency of the partnership’s net income to cover them. The earnings deficiency produced as a result of giving salaries and/or. interests shall be allocated among the partners based on their profit and loss sharing ratio. Illustration ave average capital balances in their partnership area eee and P120,000, respectively. They agreed to have a profit and loss distribution of 60% and 40%, respectively. They work in the partnership and agreed to have a salary of P6,000 each per month and that their respective average capital balances shall be given an interest of 6% per year. During a calendar year operation, the partnership earned a net i would the profit be distributed if Mary, the wtaes e nee Phe ene a bonus of 10% based on net income aging > before salaries and interest on average capital? Scanned with CamScanner150 PARTNERSHIP AND CORPORATION ACCOUNTING The distribution of the net income of the partnership shall be: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 31, 200x jus to Mary (P100 lary (P6,000x12) 0 rest on average capital _ Deficit for distr (espe soit 26,400 (66,000) ~ | P39,600_ | P60,400 | P 100,000 | Note: The bonus shall still be given to the managing partner because it is based on the net income before deducting the partners’ salaries, interest on capital and bonus. However, if the bonus is to be computed based on net income after deducting partners’ salaries and interest on capital, there would be an income deficit. In sucha case, bonus to the managing partner shall no longer be available. 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 : ‘ Using the same data of the preceding illustration of Martha and Mary Partnership, now with the partnership suffering a net loss of P20,000, the distribution of loss to the partners should be: ADAM & EVE PARTNERSHIP Loss Distribution Schedule December 31, 200x Scanned with CamScannerChaptery Accounting for Partnership Operations 151 To record the net loss, the journal entry would be: : Note: The partners’ salaries and interests on capital do not necessarily reduce the capital of all of the partners. It is only the capital of the partner with a negative share who will have a debit to his capital account. i Partnership Accounting for Income Taxes The NIRC of the Philippines? provides that income taxes for partnership would depend on whether the partnership is a general professional partnership. $ As a general rule, a partnership shall be taxed as a corporation except if.it is a general professional partnership.!° Co-Partnership. If the partnership is not exclusively for a practice of profession, otherwise known as “co-partnership,” it shall be subject to a tax of 30% (effective 2009) based on its taxable net income. The partners are considered as stockholders, and therefore, their distributive share on profit of the partnership shall be subject to.a final tax of 10%.11 General Professional Partnership. However, if the partnership is a general professional partnership, it is exempted from income taxes: The partners’ distributive shares on profit of the partnership shall be taxed in their separate and individual capacities using the normal tabular tax for individual taxpayers. !2 If t f individual partners amounts to P720,000 and below, eee, paee to a 10% creditable withholding income tax. If the share is exceeds P720,000 the entire amount is subject to a 15% ‘Tax Reform Program R J vio F. Roxas, Income Taxation Principles and*Laws with Accounting (Baguio City, Philippines: Valencia Educational Supply, 2006) pp. ° R.A, 8424 - The Comprehensive io Edwin G. Valencia and Gregor, Applications, 2007-2008 Revised Edition, 561 - 564, 4 R.A, 9337 (2005); NIRC, Sec. 26- NIRC,, Sec. 24A and See. 26. Scanned with CamScanner152 PARTNERSHIP AND CORPORATION ACCOUNTING creditable withholding income tax which will be remitted by the professional partnership to the BIR.!3 Illustration Peter and John formed a partnership named PJ Partnership, with a net income before tax of P100,000. It was agreed that the partners should share profit-or loss equally. The comparative journal entries to record the income tax and distribution of profit PJ Partnership would be: 1. To record income tax liability of the partnership: . General Journal As Co-Partnership As General Professional peeinere Uh Income tax expense | 30,000 | | / Income tax payable 30,000 No entry | | Notes: a. The general professional partnership has no journal entry because it is not subject to income tax liability. Only the Sorpartnership, has a provision for income tax liability, computed as follows: Net taxable income P100,000 Multiply by corporate income tax rate 30% Income tax payable P_30,000 b. For taxation purposes, the income: tax expense is a nondeductible expense from gross income. However, for accounting purposes, it would still diminish the partnership profit to be distributed to the partners. Consequently, it shall be recorded in the books of accounts. 2. To record distribution of profit to. partners: General Journal ) As Co-Partnership, As General Professional Fanner a Income summary | 70,000 | Income summary | 100,000 | Peter, Capital 35,000 i Peter, Capital John, Capital | 35,000 | John, Capital Note: The share of each PE ParEACE is cothipuited as follows: ; . Co- Partnership Gen. Professional Co-Partnership: : Peter John Peter __ John (P70,000/ 2) P35,000, P35,000 Gen; Prof. Partnership + ‘ (P100,000/ 2). —___. _. P50,000 —_P50,000 Totals 235,000 295,000 _P50,000 13 Ibid., Sec. 2.57 - 1(h); Rev. Regs. 2- 98 ll Scanned with CamScannerChapter 4: Accounting for Partnership Operations 153 The net income of the co- de the general professional Feaierahip ‘is reduced by the 30% corporate tax, while income tax exemption. ership’s net income remains intact because of its 3. To record withholding taxes from partners’ profit share: General Journal As General Professional Partnership As Co-Partnership Peter, Drawings 3,500 i Peter, Drawings 5,000 OTT aoe hi 3,500 Hohn, Drawings 5,000 d "Income tax withheld holding tax payable _| 7,000 payable 10,000 | Notes: a. The partnership, whether a co-partnership or a general professional partnership, is required to withhold income taxes from the profit share of the partners. : If the partnership is a co-partnership, a 10% final dividends tax on the partners’ income from the partnership shall be withheld. The computation of dividend withholding tax payable is as follows: Peter __John __Total Net income after income tax P35,000 P35,000 P70,000 Multiply by dividend tax rate : 10% * 10% > 10% _Final tax on dividends P3500 P 3,500 P_7,000 Once an income has been subjected to a final tax, it shall not anymore be reported as part of gross income subject to individual normal tabular tax. b. If the partnership is a general professional partnership, the profit share of each partner is subject to a 10% creditable income tax, computed as follows: —Peter’ __John Total Net income (P100,000/ 2) P50,000 P50,000 P100,000 Multiplied by withholding tax rate ‘10% 10% 10% Creditable withholding tax B.5,000 P5,000 P_10,000 A professional partnership would be entitled to tax exemption only if it engages purely in the practice of a common profession. A creditable withholding tax can ‘be used as tax credit against the annual income tax payable of an individual taxpayer. 4. To record partnership’s subsequent tax payments to the BIR: General Journal As Co-Partnership re As Gerieral Professional Partnership a | withheld payable 10,000 | Income tax payable 30,000 Dividends withholding tax payable Cash 10,000 | 37,000 | | 7,000 Scanned with CamScanner154 PARTNERSHIP AND CORPORATION ACCOUNTING SUMMARY Income Taxes of Partnerships General Professional Partnership Partnership's Income Tax Liability Subject to corporate income tax of 30% ~ Tax exempt beginning 2009. Withholding Taxes on Partner’s Profit Share Final tax of 10% based on partner’s |. If the ‘partner’s share is P720,000, the profit share based on partnership net |’ | CWT is 10%. income, after income tax If the partner's share exceeds P720,000, Fe | the CWT is 15%. Individual Partner’s Income Tax Liability None. Subject to individual income tax liability of It has been subjected Sec. 24 A, NIRC to be reduced by the to a final tax of 10%, creditable withholding tax (CWT). Partnership’s Working Paper and Financial Statements At the end of each accounting period, the partnership’s financid statements are prepared. To facilitate the adjustments of accounts and preparation. of financial statements, a working paper worksheet is prepared. The principle of preparing the worksheet and financial statements df a partnership is the same as that of the sole proprietorship, excep! . that in a partnership there are more than one accounts representiné the partner’s capital and partners’ drawing. The following comprehensive problem illustrates the preparation af partnership working paper and financial statements. Comprehensive Problem Matthew and Mark forthed a general professional partnership ¢ d CPAs named M&M Partnership. The following partnership agree™ are extracted from the records of the partnership: Scanned with CamScannerChapter 4: Accounting for Partnership Operations 155 bi The ending capital bal : : 6% interest. The “ ‘ances of the partners shall be entitled to a artners originally contributed cash amounting to P80,000 for Matthew, and P35,000 for Mark. 2. a poo! salary of P5,000 for each of the partner shall be given. ° -Ponus after partners’ salaries, interest on capitals and bonus shall be allowed to Matthew being the managing partner. The balance shall be shared equally. 3. The salaries shall be charged to their respective drawing accounts. : The partnership’s trial balance shows the following summary of its business activities from January to December 31, 200x: M&M PARTNERSHIP Trial Balance December 31, 200x al (Office equi (Accounts payable thew, Capital ~ rk, Capital (Matthew, Drawi (Mark, Drawing: [Professional revei [Transportation expe en Ee 1,0 / l P300,000 300,000 | Additional information: a. The office equipment is to be depreciated by 10% per year. Tt wes purchased on March 31, 200x. : b. The remaining amount of unused supplies is only P500. ¢. The loans to Mark have an accrued interest of P240 at the end of the year. d. The 5% of the accounts receivable is deemed uncollectible. Scanned with CamScanner156 PARTNERSHIP AND CORPORATION ACCOUNTING e. Salaries of the partners for the month of December 31, 200x Were already taken but not yet recorded. f. Shares of partners are subject to 10% withholding tax. Required: 1. Prepare the working paper of the partnership. 2. Prepare the financial reports: a. Income statement b. Schedule of profit distribution c. Statement of partners’ equity d. Statement of Financial Position (Balance sheet) e. Statement of cash flows 3. Record adjustments. 4. Close the nominal accounts of the partnership. ‘ 5. Prepare the post-closing trial balance of the partnership. Scanned with CamScannerM&M PARTNERSHIP Worksheet For the Period Ended December 31, 200x Prepaid supplies Office equipment _ | Adjustments G mp ‘Mark, Capital - Matthew, Drawings ‘Adjusted Trial Balance Mark, Drawings Professional revenue (Transportation expense Telephone expense Miscellaneous expense Adjustments: Depreciation expense ‘Accum. dpn - Equipment Supplies expense | Accrued interest receivable Interest income Bad debts expense “| 3650 Allowance for bad debts “(44,533 Withholding tax payable f Totals 41,673 | 41,873 | 322,173 322,173 | + 3 Net income Se elf ree a a5 140) ~_| 180,240 The worksheet of a partnership is almost the same as that of the sole proprietorship. The only difference lies on the presence of two or more capital and drawing accounts. 14,533 340 287,273 | 287,273 i 480,240 The P145,340 difference is a net income because the credit total of the income statement column is greater than its debit total. Scanned with CamScanner addvd ONINYOM - T }uourerynbed y aaydeud suojesedo diysiaupeg 10 Bununossy zst158 PARTNERSHIP AND CORPORATION ACCOUNTING Requirement 2 - FINANCIAL REPORTS Income Statement M&M PARTNERHSIP Income Statement Year Ended December 31, 200x Professional revenue Add: Interest income Total revenue Less: Operating expenses: ‘Transportation expense P 14,000 Supplies expense 9,500 Telephone expense 6,000 Depreciation expense 3,750 Bad debts expense 3,650 Miscellaneous expense 4,000 Net income Schedule of Profit’ Distribution M&M PARTNERHSIP Profit Distribution Schedule ” Matthew” T {Ratio on the remaining balance 50% | Partners’ salaries: | Matthew (P5,000 x 12) 60,000 | Mark (P5,000 x 12) { | Interest on capital i Matthew (P80,000 x 6%) 4,800 | Mar®7P35,000 x 6%) ° | Bonus go Matthew" 1976 | Balance, P16,764 — equally Profit di¥tribution P74,888 | Year Ended December 31, 200x po Observe that the partners’ salaries, interest on capita and bonuses are ng Pipa included as "operating 240 | expenses in the computati 180,240 Ps Putation of partnership's net income, They are considered in the distribution of profit and loss. The net income of P145,349 is forwarded to the profit distribution schedule ‘to compute the profit share of each partner. 34,900, P 145,340 “Mark ‘Total | 50% | 100% - | + i i | P60,000 | P420,000.| i 6,900 2,100 | 8,382\| *Note: The bonus is computed as follows: Net income before salaries, interest and Bonus Less: Salaries of partners Interest on partners’ capital Net income after salaries and interest before ‘bonus , Less: Net income after bonus (P18,440/110%) Bonus " P145,340 P120,000 — 6.900 _126,900 P 18,440 _—16,764 A Scanned with CamScannerChapter 4: Statement of Partners’ Equity M&M PARTNERHSIP Statement of Partners’ Equity Year Ended December 31, 200x Matthew | Mark 67,485 P_35,000 67,048" _[P87,373 | P 38,434 | P 125,607 | Accounting for Partnership Operations 159 Total P4115,000 | Pi 134,533, *Salaries plus 10% creditable withholding tax or P60,000 + (P74,858 x 10%) The amount of the adjusted partners’ capital shall be reported in the partners’ equity section of the balance sheet. Statement of Financial Position M&M_ PARTNERHSIP Balance Sheet As of December 34, 200x Current Assets: Cash P 9,000 Accounts receivable P 73,000 ; Less: Allowance for bad debts 69,350 Loans to partner (Mark) 20,000 “Accrued interest receivable 240 Prepaid supplies E 500 Noncurrent Assets: Office equipment P soon Less: Accum. depreciation 3,750 Total assets Current Liabilities: : : P. 5,000 Accounts payable , Withholding tax payable 14,533, Partners’ Equity: ee Matthew, Capital " 4 iH Mark, Capital ’ Total liabilities and partners’ equity P 99,090 46,250 P 19,533 + 425,807 Ba45.40, Scanned with CamScanner160 PARTNERSHIP AND CORPORATION ACCOUNTING Statement of Cash Flows M&M PARTNERHSIP Statement of Cash Flows Year Ended December 31, 200x Operating Activities: Net income 145,340 Add (Deduct) Adjustments: Depreciation expense 3,750 Increase in accounts payable 5,000 Increase in withholding tax.payable 14,533 Increase in accounts receivable (69,350) Increase in loans to partner (20,000) Increase in accrued interest receivable (240) Increase in prepaid supplies 500) P 78,533 | Financing Activities: x i 3a Matthew contribution P 80,000 Mark contribution 35,000 The final amount Matthew withdrawals (67,485) of cash - in. the Mark withdrawals (67,048) (_ 19,533) ‘Statement of cash Investing Activity: _ ive ue i. Purchase of office equipment £50,000) crete Rae P. 9,000 amount of cash Add: Cash balance, January 1, 200x -0- reported in the Cash balance, December 31, 200x P_9,000 balance sheet, Requirement 3 - ADJUSTMENTS accrued in ivances to Mark, GENERAL JOURNAL The adjusting entrées are —_necessaly update mixed accourls or correct unadust accounts in the bom of accounts. Scanned with CamScannerChapter 4: Accounting for Partnership Operations 161 __ GENERAL JOURNAL Continuation of | Adjusting Entries The drawing accounts of the partners are charged to effect withholding taxes on each. partners share from the net income’ of the partnership. Requirement 4 - CLOSING ENTRIES Closing entries bring all revenue and expense accounts to zero balance. GENERAL JOURNAL The balance ‘of income summary account (representing either net income or net loss) is first “closed to . the drawing accounts, which shall be closed finally to the capital accounts. _..Transp' "Supplies expense _ —Teleph e expense The partners’ drawings are summarized as follows; Matthew, Drawings Mark, Drawings ‘Scanned with CamScanner162 PARTNERSHIP AND CORPORATION ACCOUNTING Requirement 5 - POST-CLOSING TRIAL BALANCE M&M PARTNERSHIP Post-Closing Trial Balance The post-closing trial balance contains the adjusted real accounts (balance sheet accounts) at the end of the accounting period. P152,740 P152,740 | Correction of Profits in Prior Periods* Whenever there are misstated earnings of the previous year and were subsequently discovered in the current period, the correction shall be made directly to the partners’ capital accounts. The corréct earnings for the prior period, as well as the proper share of the profits or losses to which each of the ‘partners was entitled, should be calculated. The incorrect share that each partner actually received shall be compared with the correct share that he should have received. The difference shall.either increase or decrease the capital accounts of the affected partners. : Illustration Based on the preceding illustration (distribution ‘of - partnership losses), assume that the loss of P20,000:was due to overstatement o! equipment depreciation by P50,000. Such error was discovered i* the current period after the net loss has been closed to the capit accounits. i f *This topic is thoroughly discussed in Chapter 1 under the topic “Review. of Correcti" Accounting Errors.” ‘ : al Scanned with CamScannerChapter 4 Accounting for Partnership Operations nes The S aieatie of depreciation resulted in a net loss of P20,000 which should have been a net income of P30,000. The correct distribution of profit that should have been made would be: ADAM & EVE PARTNERSHIP Profit Distribution Schedule December 3 200x Martha re" 60% Net income distribut ar if P_1,800 P28,200 P30,000 The adjustments to correct the error of the prior period’ reported loss can first be made by comparing the recorded error and they should have been reported income and its correct distribution, as follows: : Martha ___Mary' __ Total, Should have been income and its distribution P 1,800 P28,200 P30,000 Less: Recorded share in the net income (loss) (26,400) 6,400 (20,000) Increase (decrease) in partner’s capital 28.200 21,800 P50,000 To effect correction in the partnership books, the correcting entry would be: 4 Notes: 1. The total adjustments in the partners’ capital accounts are equal to the ‘ adjustment in the accumulated depreciation. ‘ 2. Alternatively, a T-account approach ¢ can be used to analyze the adjustments, as follows: Scanned with CamScanner164 PARTNERSHIP AND CORPORATION ACCOUNTING Accum. Depreciation - Martha, Capital uipment | 5 Adj. 28.200 ‘Adj. 50,000 Error 26,400 ij 28.200 Correct net income, P30,000. Exro 01400 Adj. 21,800 28,200 Statement of Changes in Partners’ Capitals Also called “statement of changes in partners’ equity,” this statement is a schedule which shows the changes in the capital interest of each partner due to investments, withdrawals and net income or loss during an accounting period. | Illustration Assume the following data affecting the capital balances of partners ‘ Lino and Roco: Overstatement of depreciation, 200A P 25,000 Unrecorded supplies expense, 200A 15,000 Net income for distribution, 200B 200,000 200B Lino (60%) Roco (40%) Capital balances, Jan. 1 before adjustments P 120,000 P 90,000 Additional investments 50,000 "60,000 Personal drawings * 26,000 4,000 The statement of changes in partners’ capitals of LINO & Roc! PARTNERSHIP would be: : LINO & ROCO PARTNERSHIP Statement of Changes in Partners’ Equity December 31, 200B AB OOB see titila k Ma cde CR | Lino (60%) | Roco (40%) Total _— P120, t 000 10 Unre: “Corrected 1: Ac 200,000 (P234,000___P530,000 — 4,000 30,002 500,000 Scanned with CamScannerChapter 4: Accounting for Partnership Operations 165 Adjusting Capital Balances Ratio to Profit and Loss Ratio As an ordinary situation in business, the ratios of partners’ capital and profit/ loss may not. be the same from the very. beginning of partnership or may change as a result of varying amount of partners’ drawings and other capital adjustments. The partners may continue this situation, but they may decide to adjust the ratios of their capital balances equal to their respective profit/loss ratios. Illustration Assume the following data: Profit and 2 Partners: Loss Ratio Capital Balances Ed 40% P 350,000 Greg 35% : 340,000 Darl ? 25% 310,000 Totals 100% : P1,000,000 To adjust the capital balance ratios to profit and loss ratios, the following methods may be observed: , 1. Direct payment to the existing partner. Capital balances ratios are equalized with the profit and loss ratios by direct payment to the partner(s) whose capital is to be reduced. The total partnership’s capital remains the same. The increase (decrease) of partners’ capital is computed as follows: Ed (40%) Greg (35%) Darl (25%) Total (100%) Required capital P400,000 350,000 P250,000 P1,000,000 Capital balances (350,000) (340,000) (310,000) (1,000,000) Increase (decrease) P_50,000 P10,000 (P60,000) P-. O.- The journal entries would be: Note: The entries for payments of P50,000 and P10,000 made by partners Ed | are not reflected in the partnership’s books because the ‘to Darl and Greg to transaction among them. transaction is personal Scanned with CamScanner166 PARTNERSHIP AND CORPORATION ACCOUNTING 2. Additional investment to the firm. Capital balances ratiog an equalized with the profit and loss ratio by additional investment, ‘using as the basis the capital of partner having the lowes, possible cash investment. This results in the increase of the totai partnership’s capital. The required partnership capital balance should be increased and is computed as follows: : Darl’s capital balance : P 310,009 Divided by Darl’s P/L ratio 25%, Required partnership’s capital balance P1,240,000 40,000 Ed (40%) Greg (35%) Darl(25%) Total (100% Required capital P496,000 434,000 310,000 —P1,240,000 Capital balances (350,000) (340,000) (310,000) — (1,000,009) Increase P146,000 P_94,000 P- 0 - P_ 240,000 (decrease) The journal entries would be: ____240,000 |" Note: Partners Ed and ‘Greg gave additional investments to the partnership to equalize the ratios of their capital balances and profit & loss. 3. Capital withdrawal. Capital balance ratios are equalized with the profit and loss ratio by capital withdrawals using the capital of partner having the highest possible cash investment as the basis. This results in the decrease of the total partnership’s capital. The required partnership capital balance should be decreased and is computed 'as follows: , Ed’s capital balance fi ‘ P 350,00? Divided by Ed’s P/L ratio ae nO Required partnership’s capital balance 875,000 Ed (40%) Greg (35%) Darl (25%) Total (100%) Required capital P350,000, P306,250 + P218,750 P. 875,009 Capital balances —_ (350,000) (340,000) (310,000): _1,000,09 Increase (decrease) P- 0 - (P33,750 P9 1,250, (Pl é ll Scanned with CamScannerer 4: i Chapt Accounting for Partnership Operations 167 The journal entries would be: Note: Partners Ed and Gre i i i t ¢ d € received cash from the partnership to equalize the ratios of their capital balances and Profit & loss. s . ’ Chapter 4 - REVIEW QUESTIONS Chapter Discussions: 1. What is the main difference between partnership business accounting and single proprietorship business accounting? . What is the primary objective of accounting for partnership operations? Give the summary rules of partnership profit and: loss distribution. Enumerate the methods of computing profit and loss distributions. Ghee BON, State the rules of the following: a. Interest on partner’s capital balance b. Interest on excess investments c. Salaries or bonus for partners’ services ! 6. ‘State the rule of profit distribution when there is (a) an insufficient net ingome; or (b) partnership incurred net loss. 7. What is the accounting procedure when there are prior period corrections in profit or loss? 8. Distinguish the income tax treatment between a co-partnership from a general professional partnership. Scanned with CamScanner168 PARTNERSHIP AND CORPORATION ACCOUNTING PROFESSOR: [ section: __] Problem 4-1 True or False Instruction: Write TRUE before the statement if it is correct, or FALSp if it is incorrect. 1. A partnership is confined to servicing and cannot engage in trading business. 2. The accrual method of accounting for revenue and expense ‘is mog, applicable for. sole proprietorship and corporation, ‘but not fo partnership. 3. The partnership’s profit and loss sharing ratio is always the same ag the partner’s capital contribution ratio. 4. In the absence of agreed capital contribution ratio, the partners! capital contribution must be equal to. their agreed profit and loss distribution ratio. . 5. An industrial partner gets first a just and equitable share before the capitalist partners divide the balance of the profits in ‘proportion to their capital contribution, even if there is an existing agreed profit and loss agreement. ' 6. In the absence of profit and loss agreement, the industrial partner shall receive a share equal to the share of a capitalist partner having the smallest share. \ 7. In the absence of loss sharing agreement, losses shall not be divided among the partners, . 8. In the absence of profit and loss agreement, an industrial partner is exempt from sharing in the partnership loss. 9. An industrial partner is not exempted from sharing in the loss of the partnership if he is also a capitalist partner. 10. In the absence of a specific agreement Tegarding division of lossé ‘ the existing division of Profit agreement is to be followed. / 11. Interest'on the partner’s capital is a profit sharing device 12. The weighted-average capital method of co; also known as “peso-month”. average capit: mputing average capita ® ‘al method. Scanned with CamScannerCut here and submit this page to your professor. ! I ! ! Chapter 4 Accounting for Partnership Operations 169 PROFESSOR: ee eat | Problem 4-2 True or False | Instruction: Write TRUE before the statement if it is correct, or FALSE if it , is incorrect. 1. 10. As a rule, a partner’s salary and interest on capital are treated ‘as ordinary operating expenses. Interest on capital balances is part of the profit and loss distribution plan, but interest charges on loans provided by partners to the partnership are treated as’ interest expense reportable in the partnership income statement, The disadvantage of using the year-end capital balance method is, that there is no incentive for a partner to make any investments during year-end. If part of the agreed profit and loss distribution is the allocation of interest on capital balances, such allocation shall be given in spite of the insufficiency of the partnership’s income. e If part of the agreed profit and loss agreement is the allocation of bonus to the managing partner, such allocation shall be given in spite of the insufficiency of the partnership’s income. All partnerships are to be taxed on their income as.corporations. The distributable’ shares of the partners in the partnership are subject to withholding tax, whether the partnership is general professional or general commercial. i All income taxes withheld from the distributable sharé ofthe partner are-creditable against the partner's income tax due in the income tax return. A professional partnership would be entitled to tax exemption only if it engages purely in the practice of a profession. ‘ For accounting purposes, the income tax expense is a nondeductible expense. Scanned with CamScanner170 PARTNERSHIP AND CORPORATION ACCOUNTING Problem 4-3 Multiple Choice (Theory) Instruction: Encircle the letter corresponding to the best answer. $ ) 1. A partnership is basically a a. benevolence-oriented organization. b. profit-oriented business. c. loss-oriented business. d. profit-and-loss oriented business. 2. Which of the following statements best describes the fundamentals of the partnership’s profit or loss distribution? a. Profit or loss taken only by one owner b. Profit or loss distributed based on the number of partners c. Profit or loss allocated based on the partners’ agreement d. Profit or loss divided by capital contribution 3. The accounting method used for partnership operation is a. cash method. . c. cost method. b. fair market value method. d. accrual method. 4. If partner’s personal expenses are paid by the partnership, the payment is charged to the a. partner’s drawing account. c. partner’s expense account. b. partnership’s expense d. partnership’s nominal account. account. 5. The following partner would share in the losses of the partnership, except a.. limited partner. c. industrial partner. b. capital partner. ; d. industrial-capitalist. 6. Industrial partner would share in the partnership’s losses if he is Option 1: Included in the profit and loss agreement. Option 2: If he is included in the profit agreement. a.» Only option 1 is correct. b. Only option 2 is correct. c. Both options'are correct. x d. Both options are incorrect. 7. Which of the following partners would receive a profit share equal to the share of a capitalist partrier having the smallest profit ratio in absence of profit agreement? a, Industrial-capitalist partner c. Nominal partner b. Industrial partner d. Silent partner a Scanned with CamScannerChapter 4: Accounting for Partnership Operations m7 . The computation of a Partner’s share in the profits and losses of the partnership becomes more complex: because of the a. differences in capital contributions. b. abilities and talents of individual partners. c, time spent on partnership by the individual partners. d. All of the above, ae . ; . In the absence of any agreement, profits and losses are divided a. equally. b. based on contributed capital. c. based on ending capital. d. No distribution of profit and loss is to be made. . In conformity with GAAP, the following are to be treated as an income- sharing device, except ‘ a. partner’s salary. b. partner’s bonus, c. partner’s interest on capital contribution: d. partner’s interest on loans to partnership. eid + - This average capital method should be used in the absence of an agreement to the contrary. a. Simple average c. Weighted average b. Complex average d. Basic capital average 12. This allowance for profit distribution is granted only if there is profit. a. Salary c. Bonus b. Interest d. All of the above! Scanned with CamScanner172 PARTNERSHIP AND CORPORATION ACCOUNTING NAME: PROFESSOR: Problem 4-4 Multiple Choice (Theory) Instruction: Encircle the letter that corresponds to the best answer. 1. Statement 1: When the partners agreed to divide the profit and loss using specified percentage, the inequality of the profit and loss sharing is due to capital balances. ; Statement 2: When money or properties are important to the success of partnership, the preferred profit and loss sharing should be based on the partners’ capital contributions. a. Only statement 1 is correct. b. Only statement 2 is correct. c. Both statemeats.are correct. d. Both statements are incorrect. 2. This statement shows the variation in the partners’ interest in the partnership. : a. Statement of changes in financial position b. Statement of partner’s profit and loss distribution c. Statement of partner’s variable capital i d. Statement of.changes in partner’s capital 3. In the absence of any agreement in the share of industrial partner in the partnership profit, he is entitled to share in the partnership profit a. .equally. b. by ten percent. 3 : c. equal to the share of capitalist partner with the smallest share. d. None, because he did not contribute capital; 4. If there is agreement as to the distribution of profit but not stipulations to the distribution of loss, any partnership loss shall be shared bY partners, ‘ a. equally. b. proportionalte to his capital contribution. ‘ c,. based on profit ratio. d. None. 5. If the primary. consideration is the partner’s capital contribution, the most equitable profit and loss distribution is made on the basis of a. equal share. } b, beginning capital balanoes. c. ending capital balances. d, average capital balances, Scanned with CamScannerChapter 4 Accounting for Partnership Operations 173 10. 11, 12. This item is not treated as Oj a. Salaries of manager employed by the partnership b. Interest on the partnership’s outstanding loan c. Bonus to the managing partner d. Office supplies used perating expense of the partnership. Periodic withdrawals by partners are best viewed as a. nontaxable income earned from the general professional partnership. b. payment of Partner’s share in the partnership profit. c. distribution of partnership assets to the partners. d. loan to the partner. Which of the following statements about partnership’s financial statements is true? a. Details of the distribution of net income are shown in the owner's equity statement. b. The distribution of net income is shown on the:statement of finaricial position. 2 c. Only the total of all partner capital balances is shown in the statement of financial position.. d. The owner’s equity statement is called the partner’s capital statement. : P Which of the following is not considered as a legitimate expense of a partnership? | a. Interest paid to partners based on’ the amount of their invested capital 5 b.. Depreciation on assets contributed to the partnership by the partners 7 s c.. Salaries for management hired to run the business d. Supplies used. in the partners’ offices As a general rule, in computing the partner’s average ¢apital, the partner’s temporary withdrawals are \ ‘ a. regarded in the computation of the average capital. b. not considered in the computation of average capital. considered in the computation of average capital if the drawing is made in anticipation for accruing profit. ue d. All of the above. Interest on the money borrowed by the partner from the partnership shall be treated.as a. profit sharing device. b. financing cost. This method of profit sharing on the relative capital balances ditional investments during the accounting period. 1 contribution ‘tal balance of the fiscal year balance of the fiscal year f the. year c €. operating expense. d. revenue. discourages ad a. Original capital b. Beginning cap! c. Ending capital d. Average capital balance o Scanned with CamScanner