Basic Financial Accounting & Reporting “Partnerships: Operations and Financial Reporting Learning Objectives: After studying this chapter, you should be able to: 1. Contrast @ partner's equity in assets from share in profits or losses. 2. Summarize the rules for the distribution of profits or losses. 3. Explain prior period errors and interpret the effects on partners’ shares in profits or losses. 4, Identify, describé and account for the different methods of dividing partnership profits or losses based on agreement. 5. Ascertain the effects of using original, beginning, ending and average capitals on the partners’ share in profits or losses. 6. Show the treatment of interest on capital, partners’ salariés and bonus in the distribution of profits or losses. 7, Propose equitable profits or losses sharing schemes after considering the partners’ contributions and other performance criteria 8. Understand and appreciate the usefulness of financial statements. 9. Pinpoint the differences in the financial statements of a partnership as compared to a sole proprietorship. 10. Develop skills in the,preparation of basic financial statements. PARTNERS' EQUITY IN ASSETS CONTRASTED WITH SHARE IN PROFITS OR LOSSES i The basis on which profits or losses are-shared is-a matter of agreement among the Partners and may not ‘necessarily bg the same as their capital contribution ratio. The equity of a partner in the net assets of the partnership should be distinguished from a “partner's share in profits'‘or losses: ‘480 1d Reporting 2021 Edition by Prof. WIN Ballada EY Mlustration. “Nelson Daganta is a one-third partner” is an ambiguous statement. aganta may have one-third equity in the net assets of the partnership but might have a larger or smaller share in the profit or loss of the firm. Such a statement may also be interpreted to mean that Daganta is entitled to one-third of the profit or loss, although his capital account may represent much more or much less than one-third of the total partners’ capital. Simply put, partners may agree on any type of profit and loss ratio regardless of the amount of their respective capital account balances. FACTORS TO CONSIDER IN ARRIVING AT A PLAN FOR DIVIDING PROFITS OR LOSSES Money, Property or Industry Partnership profits are realized as a result of putting together the contributions— money, property or industry—of the partners, The amount of capital invested by each partner, the amount of time each partner devotes to the business and other contributions are the factors being considered in the formulation of an equitable profit and loss ratio. There are profit-sharing plans which emphasize either the value of personal services rendered by individual partners or the amounts of capital invested by each partner.. Some agreements consider the importance. of both the amount and quality of managerial services rendered, and the amount of capital invested by the partners for the success or failure of a partnership. In this case, allowances may be provided for salaries to partners and interest on their respective capital balances as a preliminary step in the division of profits or losses; the balance may then be divided in a specified ratio. Among the other factors which may be considered are as follows: A partner has considerable personal financial resources, thus giving the partnership L strong credit rating. In general, partners have unlimited liability. A very solvent partner will make the partnership attractive to creditors. 2. A partner who is well known in a profession or an industry may contribute immensely to the success of the partnership although he may not participate actively in the operations of the partnership. These two factors may be incorporated in the plan to arrive at a ratio by which any remaining profits or losses are to be divided. Illustration. Daria Tolentino and Eleanor Tan are partners in a coco water business. Partner Daria Tolentino contributed most of the assets of the business but spends little time for its daily operations. On one hand, Partner Eleanor Tan contributed less in assets but devotes her full knowledge and attention to the partnership. To divide profits or losses based on capital contributions alone will result to iniquities. The profit and loss sharing agreement should have considered the provision of salaries or even bonus in recognition of the talent and time being contributed by Partner Eleanor Tan.Partnerships: Operations and Financial Reporting | 481 —————————————————— Performance Methods Many partnerships use profit and loss sharing arrangements that give some weight to the specific performance of each partner to provide incentives to perform well. This allocation of profits to a partner on the basis of performance is frequently referred to as abonus. Examples of the use of performance criteria are: 1. Chargeable hours. These are the total number of hours that a partner incurred on client- related assignments. Weight may be given to hours in excess of a standard, 2. Total billings. The total amount billed to clients for work performed and supervised by a partner constitutes total billings. Weight may bé given to billings in excess of norm. 3. Write-offs. Consist of uncollectible billings. Weight may be given to a write-off percentage belowa norm. 4. Promotional and civic activities. Time devoted to developing future business and enhancing the partnership name in the community is considered promotional and civic activity. Weight may be given to time spent in excess of @ norm or to specific accomplishments resulting in new clients. 5. Profits in excess of specified levels. Designated partners commonly receive a certain Percentage of profits in excess of a specified level of earnings. RULES FOR THE DISTRIBUTION OF PROFITS OR LOSSES The profits or losses 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 profits or losses shall be in Proportion to what he may have contributed (according to the ratio of original capital investments or in its absence, the ratio of capital balances at the beginning of the year), but the industrial partner may not be liable for the losses. As for the profits, ‘the industrial partner shall receive such sharé as may be just and equitable under the circumstances. If aside from his services he has contributed capital, he shall also receive a share in the profits in proportion to his capital (Civil Code of the Philippines, Article 1797). A stipulation which excludes one or more partners from any share in the profits or losses is void (Article 1799). The partnership must exist for the common benefit orinterest of the partners. A summary of the above legal provisions is Prepared as follows: 1. Profits a,» the profits will be divided according to partners’ agreement. b. if there is no agreement:482 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada ST > as to capitalist partners, the profits shall be divided according to their capital contributions (according to the ratio of original capital investments cor in its absence, the ratio of capital balances at the beginning of the year), as to industrial partners (if any), such share as may be just and equitable under the circumstances, provided, that the industrial partner shall receive such share before the capitalist partners shall divide the profits. 2. Losses a. the losses will be divided according to partners’ agreement. b, if there is no agreement as to distribution of losses but there is an agreement as to profits, the losses shall be distributed according to the profit sharing ratio. c._ inthe absence of any agreement: > as to capitalist partners, the losses shall be divided according to their capital contributions (according to the ratio of original capital investments or in its . absence, the ratio of capital balances at the beginning of the year). > _as to purely industrial partners (if there's any), shall not be liable for any losses. The industrial partner is not liable for losses because he cannot withdraw the work of labor already done by him, unlike the capitalist partners who can withdraw their capital In addition, if the partnership failed to realize any profits, then he has labored in vain and in areal sense, he has already contributed his share in the loss. CORRECTION OF PRIOR PERIOD ERRORS Any business entity will from time to time discover errors made in the measurement of profit in prior accounting periods. ‘Good internal control and the exercise of due care should serve to minimize the number of financial reporting errors that occur; however, these safeguards cannot be expected to completely eliminate errors in the financial statements. ‘ Per International Accounting Standards (IAS) No. 8, Accounting Policies, Changes in Accounting Estimates and Errors, prior period errors are omissions from and other misstatements of the entity's financial statements for one or more prior periods that are discovered in the current period. Errors may occur as a result of mathematical mistakes, mistakes in applying accounting policies, misinterpretation of facts, fraud or oversights. Examples include errors in the estimation of depreciation, errors in inventory valuation, and omission of accruals of revenue and expenses. Material prior periods must be restated to report financial position and results of operations as they would have been presented had the error never taken place. The ammount of the correction of a prior period error that relates to prior periods should bePartnerships: Operations and Financial Reporting | 483 a reported by adjusting the opening balances of partners’ equity and affected assets and liabilities. The correction of a prior period error is excluded from profit or loss for the period in which the errors discovered. ifan error resulted in an understatement of profit in previous periods, a correcting entry would be needed to increase Capital. If an error overstated profit in prior periods, then Capital would have to be decreased. The effect of the error correction will be divided based on the applicable profit and loss ratio. DISTRIBUTION OF PROFITS OR LOSSES BASED ON PARTNERS’ AGREEMENT In general, profits or losses shall be divided in accordance with the agreement of the partners. The ratio in which profits or losses from partnership operations are distributed is recognized as the profit and loss ratio. ‘The partners may agree on any of the following schemes distributing profits or losses: 1. Equally or in other agreed ratio 2. Based on partners’ capital contributions: ratio of original capital investments g ratio of capital balances at the beginning of the year ratio of capital balances at the end of the year . Fatio of average capital balances 3. By allowing interest on partners’ capital and the balance in an agreed ratio 4, By allowing salaries to partners and the balance‘in an agreed ratio. 5. By allowing bonus to the managing partner based on’ profit and the balance in an agreed ratio 6. By allowing salaries, interest on partners’ capital, bonus to the managing partner and the balance in an agreed ratio (combination of 3 to 5) Note that the partners can agree on not using a residual sharing ratio (“the balance in an agreed ratio’) if profits do not exceed the total salary and interest allowances. In such a case, the partners must agree on the priority of the various profit or loss distribution schemes. Mlustration. The following series of illustrations’are based on the figures obtained from the Aguilar and Porras Partnership which had a profit of P300,000 for the year ended Dec, 31, 2020, the first year of operations. The partnership contract provided that each partner may withdraw P5,000 on, the last day of each month; both partners did so during the year. The drawings are recorded by debits to the partners’ drawing accounts and shall not be considered in the division of profit or loss. It is the intention of the Partners that each partner's share in the profit or loss be either credited or debited to the drawing account.ic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada eT Lord Aguilar invested P400,000 on Jan. 1, 2020 and an additional P100,000 on April 1. Devzon Porras invested P800,000 on Jan. 1 and withdrew P50,000 on July 1. These transactions and events are summarized in the following capital, drawing and income summary ledger accounts: Lord Aguilar, Capital Devzon Porras, Capital Jan.1 400,000 July 1 50,000 | Jan.1 800,000 Apr.1 100,000 Lord Aguilar, Drawing Devzon Porras, Drawing Jan.-Dec. 60,000 Jan.-Dec, 60,000 Income Summary Dec. 31 300,000 Equally or in other Agreed Ratio Partnership contracts may provide that profit or loss be divided equally. The profit of 300,000 for the Aguilar and Porras Partnership is transferred by a closing entry on Dec. 31, 2020, from the income summary ledger account to the partners’ drawing accounts: Income Summary 300,000 Lord Aguilar, Drawing , 150,000 Devzon Porras, Drawing 150,000 To record the division of profits. If the partnership had a loss of P200,000 for the year ended Dec. 31, 2020, the income summary ledger account would have a debit balance of P200,000. This loss would be transferred to the partners' drawing accounts by a debit to each drawing account for P1400,000 and a credit to the income summary account for P200,000. . Lord Aguilar, Drawing 109,000 Devzon Porras, Drawing 100,000 4g Income Summary 2 200,000 To record the division of losses. Assume instead that Aguilar and Porras share profits and losses in a ratio of 60:40 and profit was P300,000, the profit would be divided as follows: Income Summary , 300,000 Lord Aguilar, Drawing 180,000 Devzon Porras, Drawing 120,000 To record the division of profits : Computation: Aguilar: 60% x P300,000 480,000 Porras: 40% x P300,000 120,000 ‘300,000sased on Partners’ Capital Contributions Division of partnership profits in proportion to the capital invested by each partner is most likely to be found in partnerships in which substantial investments is the principal ingredient for success. It is essential that the partnership contract be specific with respect to the concept of capital. Capital may refer to either of the following: Ratio of Original Capital Investments. Assume that the partnership agreement provides for the division of profits in the ratio of original capital investments. ‘The original investments of Aguilar and Porras are P400,000 and P800,000, respectively. The profit ‘of P300,000 for 2020 is divided as follows: * Income Summary 300,000 Lord Aguilar, Drawing 100,000 Devzon Porras, Drawing 200,000 To record the division of profits. Computation: Aguilar: P300,000 x P400,000/P1,200,000 P100,000 Porras: P300,000 x P800,000/P1,200,000 200,000, P300.900 After the entry allocating the profits of P300,000 to Aguilar and Porras, are the partners supposed to receive cash for their respective share in the profits? No, the partners’ share in the profits cannot be attributed to any particular asset, including cash. The entry increased the equity of Aguilar and Porras in all the assets of the partnership. Ratio of Capital Balances at the Beginning of the Year. Assume that the partnership agreement provided for the division of profits in the ratio of capital balances at the beginning of the year. In this case, the original capital investments are also the capital balances at the beginning of the year since the partnership is only on its first year of operations. The profit of P300,000 for 2020 is divided as follows: Income Summary : 300,000 Lord Aguilar, Drawing ; . 100,000 Devzon Porras, Drawing 200,000 To record the division of profits. Computatic ‘Aguilar: P300,000 x P400,000/P1,200,000 100,000 Porras: P300,000 x P800,000/P1,200,000 200,000 300,000tal Balances at the End of the Year. Assume that the profit is divided in at the end of the year before drawings and the distribution 500,000 for Aguilar and P750,000 for Porras; the 09,009 for 2020 is divided as follows: income Summary 300,000 u ar, Drawing 120,000 Deveon Porras, Drawing 180,000 the division of profits Tore Computation: ‘Aguilar: P300,000 x PS00,000/P1, 250,000 120,000 Porras: P300,000xP7S0,000/P1,250,000 180,000 300,000 Ratio of Average Capital Balances. Division of profits or losses on the basis of the three preceding capital concepts—original capital investments; capital balances at the beginning of the year; or capital balances at the end of the year—may prove inequitable if there are material changes in the capital accounts during the year. When beginning capital balances are used in allocating profits, additional investments during the year are discouraged because the partners making such investments are not compensated in the division of profits until the next year. if ending capital balances are used, year-end investments are encouraged, but there is ne incentive for a partner to make any investments before year-end. In addition, emaunts earlier withdrawn may be reinvested before year-end. These considerations suggest that using average balances as a basis for distributing profits or losses is preferable because it reflects the capital actually available for use by the partnership during the year. The agreement should also state the amount of drawings each partner may make. These drawings are considered temporary and are recorded as debits to the partner's Drawings within the allowable amount will not affect the rawing account. computation of the average capital balance. On the contrary, drawings in excess of the allowable amount are considered permanent reductions in capital; hence, the putation of the average capital balance is affected. 1 in the continuing illustration for the Aguilar and Porras Partnership, the partners are entitied to withdraw P5,000 monthly or a total of P60,000 per annum. Any additional withdrawals are directly debited to the partners’ capital accounts and therefore will computation of the average capital ratio. affect thePartnerships: Operations and Financial Reporting | 487 ———— Aguilar and Porras Computation of the Averege Capital Balances For the Year Ended Dec. 31, 2020 Lord Aguilar, Capital Date Capital Account Portion* of the Average Capital Balances Yeer Unchanged Balances Jan. Pago,co0 x 3/12 = 100,000 Apr. 1. 500,000 x 9/12 = 375,000 Average Capital 475,000 Devzon Porras, Capital Jan. 4 Pg00,000 x 6/12 = 400,000 July 750,000 x 6/12 = 375,000 ‘Average Capital 775,000 Total Average Capital Balances 1,250,000 ‘The fractions for each pa: 1 should add up to 12/12 or 2. This convention will help minimize counting errors as to the number of months the capital balance went unchanged. To state the Obvious, there are only 12 months in a year. For example, for Partner Aguiar, the fraction wil total t022/12( 3/12 + 9/12 = 12/12 Jor. The entry to record the division of P300,000 profits is as follows: Income Summary 300,000 Lord Aguilar, Drawing 114,000 Devzon Porras, Drawing 186,000 To record the division of profits. Computation: , ‘Aguilar; P300,000 x P475,000/P4,250,000 114,000 Porras: P300,000 x P775,000/P1,250,000 -185,000 é ‘P300,000 By Allowing Interest on Capital and the Balance in an Agreed Ratio In the preceding section, the plan for dividing the total profits in the ratio of partners! capital balances was based on the assumption that capital investments were the controlling factor in the success of the partnership. However, it is not always the case. Consequently, partnerships may choose to allocate a portion of the total profits in the capital ratio and the balance equally or in other agreed ratio after due consideration of the partners’ other contributions. To allow interest on partners' capital account balances is almost similar to dividing part Of profits in the ratio of partners' capital balances. If the partners agree to allow interest on capital as a first step in the division of profit, they should specify the interestWIN Ballada 488 | Basic Financial Accounting and Reporting 2021 Edition by Pr rate to be used. It should also state whether interest is to be computed on capital balances on specific dates or on average capital balances during the year. Partners invested in a partnership for profits, not for interest. The interest on partners’ capital, along with the other profit sharing plans to be discussed in the remainder of the chapter, are to be considered as mere techniques to share partnership profits or losses equitably and not as expenses of the partnership. On the other hand, the interest on loans from partners is recognized as expense and a factor in the measurement of profit or loss of the partnership. Similarly, interest earned on loans to partners is recognized as partnership income. This treatment is consistent with the discussion in the previous chapter that loans receivable from or payable to partners are assets and liabilities, respectively, of the partnership. Continuing the illustration of Aguilar and Porras Partnership with a profit of P300,000 for 2020 and capital balances as already shown, assume that the partnership agreement allowed 15% interest on average capital account. balances, with the balance to be divided equally. The profit of P300,000 for 2020 is divided as follows: Aguilar Porras Total 15% Interest on Average Capital: ‘Aguilar: P475,000 x 15% P 71,250 Porras: P775,000 x 15% P116,250 187,500 Subtotal Balance to be Divided Equally 1P300,000- 187,500 = P112,500): ‘Aguilar: P112,500 x 50% 56,250 Porras: P112,500 x 50% Share of Partners in Profits 56,250 112,500 P127,500 P172,500 P300,000 The journal entry to close the income summary ledger account on Dec. 31, 2020 follows: Income Summary 300,000 . Lord Aguilar, Drawing Devzon Porras, Drawing To record the division of profits. 127,500 172,500 Ina related case, assume that the Aguilar and Porras Partnership had a loss of P10,000 for the year ended Dec. 31, 2020. If the paitnership agreement provided for interest on capital accounts, this provision must be honored regardless of whether operations yielded profits or not. The loss will be shared by the partners in the same manner as the P300,000 profit. The total interest allowance of P187,500 would still be given to the partners. The only difference is that the division of profits or losses after the interest allowances would involve a larger negative amount of P197,500 which will be divided equally between Aguilar end Porras:fons and Financial Reporting | 489 Aguilar Porras Total 15% Interest on Average Capital: Aguilar: PA75,000 x 15% P 71,250 Porras: P775,000 x 15% P116,250 Subtotal P 187,500 Balance to be Divided Equally {(P10,000) - P187,500 = P(197,500)): Aguilar: P(197,500) x 50% (98,750) Porras: P(197,500) x50% 7 (98,750) Subtotal (197,500) Share of Partners in Profits (Losses) P(27,500) P 17,500 _P (10,000) The journal entry to close the income summary ledger account on Dec. 31, 2020 follows: Lord Aguilar, Drawing Income Summary Devzon Porras, Drawing To record the division of losses. 27,500 10,000 17,500 After initial consideration, the idea that @ loss of P10,000 should cause one partner's capital to increase and the other partner's capital to decrease may appear unreasonable. However, this result was planned and was with good reason. Partner Porras invested more capital than Partner Aguilar; this capital was used to carry out operations, and the partnership's incurrence of a loss in the first year is no reason to disregard Porras's larger capital investment. Comparison of distribution based solely on capital ratios as against distribution with interest on capital balances. There will be a significant difference between the two distribution plans if the partnership is operating at a loss. Under the capital ratio plan, the partner who invested more capital will ultimately shoulder a bigger share of the loss. This result may be considered inequitable because the investment of capital presumably is not the cause of the loss. Under the interest plan, the partner who invested more capital is credited (increased) for an interest on his capital and is ultimately debited (decreased) with a lesser share of the loss; in some cases, the result may even be a net credit (increase). By Allowing Salaries to Partners and the Balance in an Agreed Ratio The sharing agreement may provide for variations in compensating the personal Services contributed by partners. Even among partners who devote equal service time, One partner’s superior experience and knowledge may command a greater share of the profit. To acknowledge the harder working or more valuable partner, the profit-sharing plan may provide for salary allowances.490 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada The partnership agreement should be clear on the treatment of salary allowances when losses are incurred. in the absence of an agreement to govern this situation, salary allowances will be provided even when operations yielded losses. This allowance should not be confused with salaries expense or with the partner's drawing account which is | debited for periodic salary allowances. The cash withdrawals will in no way affect the division of profits; the division of profits is governed by the sharing agreement. Partners are the partnership’s owners; they are not employees of the business, If partners devote their time and services to the affairs of the partnership, they are understood to do so for profit, not for salary. Therefore, when the partners calculate the profit of the partnership, salaries to the partners are not deducted as expenses in the statement of recognized income and expense, Continuing the illustration for the Aguilar and Porras Partnership, assume that the partnership agreement provided for an annual salary of P100,000 to Aguilar and 60,000 to Porras, and the balance to be divided equally. The profit of P300,000 for 2020 is divided as follows: Aguilar Porras Total Salary Allowances P100,000 P 60,000 —_P160,000 Balance to be Divided Equally [300,000 - P160,000 = P140,000)]: Aguilar: P140,000 x 50% 70,000 Porras: P140,000x 50% 70,000___ 140,000 Share of Partners in Profits 170,000 __P130,000_P300,000 The journal entry to close the income summary ledger account on Dec. 31, 2020 follows: Income Summary 300,000 Lord Aguilar, Drawing . 170,000, Devzon Porras, Drawing 130,000 To record the division of profits. By Allowing Bonus to the Managing Partner Based on Profit and the Balance in an Agreed Ratio A partnership contract may provide for a special compensation in the form of bonus to the managing partner when the results of operations of the partnership are favorable. This allowance is given in order to encourage the partner to maximize the profit potentials of the partnership, Bonus is not being considered in the computation of profit, rather it is a mere technique to distribute profits. Assume that the Aguilar and Porras Partnership agreement provided for a bonus of 25% of profit before bonus to Partner Aguilar and the balance to be divided equally. The profit is P300,000,Partnerships: Operations and Financial Reporting | 491 Aguilar Porras Total Bonus { 25% x P300,000 |: P 75,000 P 75,000 Balance to be Divided Equally . [300,000 - P75,000 = P225,000)]: ‘Aguilar: P225,000 x 50% 112,500 Porras: 225,000 x 50% P112,500___225,000 Share of Partners in Profits ‘ P187,500___P112,500__P300,000 The journal entry to close the income summary ledger ‘account on Dec. 31, 2020 follows: Income Summary 300,000 Lord Aguilar, Drawing Devzon Porras, Drawing To record the division of profits. 187,500 112,500 Assume instead that the Aguilar and Porras Partnership agreement provided for a bonus of 25% of profit after bonus to Partner Aguilar and the balance to be divided equally. It is understood in the wording of the agreement that the 25% bonus will be based on the difference after deducting bonus from a certain amount. This certain amount is the profit after considering all the operating expenses but before this bonus. Here, the P300,000 profit still includes the bonus. The difference between this profit and bonus shall be the basis for the 25% bonus rate. Hence, profit after bonus represents 100% while the profit of P300,000 before bonus represents 125%, Profit before Bonus 300,000 125% Profit after Bonus (P300,000/125%) 240,000 __100% Bonus 1 Aguilar Porras, Total Bonus P 60,000 P 60,000 Balance to be Divided Equally { P300,000 - P60,000 = P240,000)]: 7 Aguilar: P240,000 x 50% 120,000 Porras: P240,000 x 50% P120,000___ 240,000 Share of Partners in Profits 180,000" _P120,000__ 300,000 The journal entry to close the income summary ledger account on Dec. 31, 2020 follows: Income Summary Lord Aguilar, Drawing Devzon Porras, Drawing To record the division of profits. 300,000 180,000 120,000ic Firtoncia Accounting and Reporting 2021 Edit By Allowing Salaries, Interest on Capital, Bonus to the Managing Partner and the Balance in an Agreed Ratio The service contributions and capital contributions of the partners are often not equal. If the service contributions are not equal, salary allowances can compensate for the | differences. Or, when capital contributions are not equal, interest allowances can make up for the unequal investments. When both service and capital contributions are | unequal, the allocation of profits or losses may include salary allowances, interest on their capital balances, bonus to the managing partner, and the balance to be divided in an agreed ratio. Note that the provisions for salaries and interest in the partnership agreement are called allowances. These allowances are not reported in the statement of recognized income and expense as salaries and interest expense; they are merely means of allocating profit to the partners. Assume that the profit for the year is P400,000 and the partnership agreement for the Aguilar and Porras Partnership provided for the following: 1. Bonus to Aguilar of 25% of profit after salaries-and interest but before bonus; 2. Annual salaries of P100,000 to Aguilar and P60,000 to Porras; 3, Interest on average capital balances of P71,250 and P116,250 to Aguilar and Porras, respectively; 4, Balance to be divided in a ratio of 40:60. Aguilar Porras Total P 100,000 P.60,000 P160,000 71,250 116,250 187,500 » 13,125 13,125 Salary Allowances Interest on Average Capital Balances Bonus [ 25% (P400,000 - P100,000 - 60,000 - P71,250 - P116,250) J: Balance to be Divided in a Ratio of 40:60 [ P400,000 - P160,000- P187,500 - P13,125 = P39,375]: Aguilar: P39,375 x 40% 15,750 23,625 39,375 Porras: P39,375 x 60% ‘Share of Partners in Profits 200,125 * P195,875 __P400,000 The journal entry to close the income summary ledger account on Dec. 31, 2020 follows: Income Summary 400,000 : 200,125 Lord Aguilar, Drawing Devron Porras, Drawing 199,875 To record the division of profits.Operations and Finan Assume instead that the bonus to Aguilar is 25% of profit after salaries, interest and after bonus. The computation of the bonus follows: Profit before Salaries, Interest and Bonus 400,000 Less: Salaries 160,000 Interest 187,500 347,500 Profit after Salaries and interest but before Bonus P 52,500 125% Profit after Salaries, Interest and after Bonus* 42,000 __ 100% Bonus 25% 52,500 divided by 125% = P42,000, Aguilar "Porras Total Salary Allowances 100,000 © P-60,000 ~—P160,000 Interest on Average Capital Balances 71,250 116,250 187,500 Bonus 10,500 10,500 Balance to be Divided in a Ratio of 40:60 [ P400,000 - P160,000 - 187,500 - P10,500 = P42,000): Aguilar: P42,000 x 40% 16,800 Porras: P42,000 x 60% 25,200 42,000 Share of Partners in Profits P198,550___P201,450 400,000 The journal entry to close the income summary ledger account on Dec. 31, 2020 follows: Income Summary 400,000 Lord Aguilar, Drawing. m * 198,550 Devzon Porras, Drawing ‘ 201,450 To record the division of profits. Unfamiliar terms in the succeeding discussions which are partly based on IAS No. 1 (revised 2007) will be fully appreciated in higher accounting subjects. Suffice it to say, though, that at this point you're in a better situation than the users of other ‘textbooks. FINANCIAL REPORTING Purpose of Financial Statements Financial statements are a structured representation with the objective of providing information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of the management's stewardship of the resources entrusted to it. To meet the objective, financial statements provide information aboutnancial Accountir ion by Prof. WIN Ballada an entity's assets, lial s, equity, income and expenses, other changes in equity and cash flows. Overall Considerations Fair Presentation and Compliance with International Financial Reporting Standards (lFRSs). The financial statements shall present fairly the financial position, financial performance and cash flows of the entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and Spenser set out in the IASB’s new Conceptual Framework. Under IAS No. 1 (revised 2007)/ entities are required to make an explicit and unreserved statement of compliance with IFRS in the notes. Going Concern. Financial statements should be prepared on a going concern basis unless management intends to liquidate the entity or cease trading or has no realistic option but to do so. Accrual Basis of Accounting, An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. Materiality and Aggregation. An_entity shall present separately each material class of similar items. Material items that are dissimilar in nature or function should be separately disclosed Offsetting. An entity shall not offset assets and liabilities, income and expenses unless required or permitted by an IFRS. Frequency of Reporting and Comparative Information. At least annually, an.entity shall present with equal prominencé each financial statement in a complete set of financial statements including comparative information in réspect of the previous period for all amounts reported in the current period’s financial statements. Consistency of Presentation. An entity shall retain the presentation and classification of items in the financial statements in successive periods unless an alternative would be more appropriate or an IFRS requires a change in presentation. Identification of the Financial Statements. An entity shall clearly identify the financial statements and distinguish them from other information in the same published document, international Financial Reporting Standards (IFRSs) apply only to the financial statements and not necessarily to other information presented in an annual report, a regulatory filing or another document. An entity shall clearly identify each financial statement and the nates. An entity shall display the following information prominently: , name of the reporting entity; © whether the financial statements are of the individual entity or a group of - entities;Partnerships: Operations and Financial Reporting | 495 + the date of the end of the reporting period or the period covered by the set of financial statements or notes; «the presentation currency; and the level of rounding used in presenting amounts in the financial statements. Complete Set of Financial Statements Per revised International Accounting Standards (IAS) No. 1, Presentation of Financial Statements, a complete set of financial statements comprises: a statement of financial position as at the end of the period; a statement of financial performance for the period; a statement of changes in equity for the period; © a statement of cash flows for the period; notes, comprising a summary significant accounting policies and other explanatory information; and f. astatement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a Tetrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements, paose Statement of Financial Performance The form and content of the income statement of the partnership resemble those of the sole proprietorship with the exception of the presentation of the division of profits or losses at the lower portion of the statement. Aguilar and Porras Partial Income Statement For the Year Ended Dec. 31, 2020 Profit : : 300,009 Division of Prafit (equally): Partner Aguilar é 150,000 Partner Porras * 150,000 Total . 300,000 The components of profit or loss may be presented either as part of a single statement of comprehensive income or in an income statement, as permitted by paragraph 81 of IAS No. 1 (revised 2007). When an income statement is presented, it is part of a complete set of financial statements ‘and shall be displayed immediately before the statement of comprehensive income. ‘496 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada ER As a minimum, the statement of financial performance shall include line items that present the following amounts for the period: a. Revenue; b. Finance costs; Share of profit or loss of associates and joint ventures accounted for using the equity method; d, Tax expense; e. Asingle amount comprising the total of: i, The post-tax profit or loss.of discontinued operations; and / ii, The post-tax gain or loss recognized on the measurement to fair value / less costs to sell on the disposal of the assets or disposal group(s) constituting the discontinued operations; f. Profit or loss; Each component of other financial performance classified by nature (excluding amounts in (h) below); * fh. Share of the other financial performance of associates and joint ventures accounted for using the equity method; and i. Total financial performance. Statement of Changes in Equity An entity shall present a statement of changes in equity, showing in the statement: a. total financial performance for the period showing separately the total amounts attributable to owners of the parent and to minority interests; b. for each component of equity, the effects of retrospective restatement recognized in accordance with IAS No. 8, Accounting Policies, Changes in Accounting Estimates and Errors; © the amounts of transactions with overs in their capacity as owners, showing separately contributions by and distributions to owners; and d. for each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing each change. The components of equity referred to above include for example, each class of contributed equity, the accumulated balance of each class’ of other comprehensive income and retained earnings (these are applicable to corporations). The amount of dividends recognized as distributions to owners during the period, and the related amount per share, shall be presented either in the statement of changes in equity or in the notes. ’ In the case of Aguilar and Porras, as contrasted with a’sole proprietorship, the number of capital and drawing accounts has made the preparation of this statement all the more useful. Changes in an entity’s equity between the beginning and the end of the reporting period reflect the increase or decrease in its nét assets during the period.Partnerships: Operations and Financial Reporting | 497 ‘Aguilar and Porras Statement of Changes in Partners’ Equity . For the Year Ended Dec. 31, 2020 Aguilar Porras Total Original Investments 400,000 P800,000 —P:1,200,000 Add: Additional Investments 100,000, * 100,000 Total 500,000 P800,000 —P1,300,000 Less: Permanent Withdrawals 50,000 50,000 Balances 500,000 750,000 1,250,000 ‘Add: Profit 150,000 __150,000__300,090 ‘ Total 650,000 300,000 P1,550,000 * Less: Temporary Withdrawals 60,000 00___120,000 Partners’ Equity, Dec. 31 590,000 ___P840,000 _P1,430,000 Statement of Financial Position After all the components of the statement of financial performance along with the changes in partners’ equity for the period have been properly presented, the preparation of the statement of financial position will present no major difficulty. The assets and liabilities will be presented in the statement of financial position as those of a sole proprietorship but the owners’ equity section should exhibit separately the capital balance of P590,000 and P840,000 for Aguilar and Porras, respectively. ‘Though some of the items are not as familiar yet, per revised International Accounting Standards (IAS) No. 1, Presentation of Financial Statements, as a minimum, the face of the statement of financial position shall include line items that present the following amounts: a Property, plant and equipment; ~ b. Investment property; Intangible assets; ‘Financial assets (excluding amounts shown under e, hand i); Investment accounted for using the equity method; Biological assets; Inventories; ? . , |. Trade and other receivables; . I. Cash and cash equivalents; “ The total of assets classified as held for sale and assets included in disposal groups classified as held for sale in accordance with IFRS 5; k. Trade and other payables; |. Provisions; & 4. e, f. 8. h. ™m._ Financial liabilities (excluding arhounts shown under k and I); 1, Liabilities and assets for current tax, as defined in 1AS 12; ©. Deferred tax liabilities and deferred tax assets, as defined in IAS 12; P abilities in disposal groups classified as held for sale in accordance with IFRS Ss498 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada 4. Minority interest, presented within equity; and r. Issued capital and reserves attributable to equity holders of the parent. IAS No. 1 (revised 2007) does not prescribe the order or format in which‘an entity presents items. The above enumeration (from Paragraph 54 of IAS No. 1, revised 2007) simply provides @’ list of items that are sufficiently different in nature or.function to warrant a separate presentation in the statement of financial position. Note that an entity makes the judgment about whether to present additional items" separately on the basis of an assessment of: j 2. the nature and liquidity of assets; b. the function of assets within the entity; and the amounts, nature and timing of liabilities. Current and noncurrent assets and liabilities should be separately classified on the face of the statement of financial position except when a presentation based on liquidity provides more reliable and relevant information, An entity shall classify an asset, as current asset when it satisfies any of the following criteria: it expects to realize the assets, intends to sell or consume it, in its normal operating cycle; or * it holds the asset primarily for the purpose of trading; or it expects to realize the asset within 12 months after the end of the reporting period; or the asset is cash or a cash equivalent as defined in IAS No. 7. All other assets are noncurrent. Operating cycle Is the time between the acquisition of assets for processing and their realization in cash or cash equivalents. A liability should be classified as a current liability when it: + is expected tobe settled in the normal operating cycle; oF * _ isheld primarily for the purpose of trading; or is due to be settled within 12 months after the end of the reporting period; or does not have an, unconditional right to defer settlement of the liability for at least 12 months after the reporting period. All other liabilities should be classified as non-current liabilities. The statement of cash flows has been discussed in an earlier chapter.