1.

Overview
This learning material provides discussion of Partnership Operation concepts. It
introduces the learner to the subject, guides the learner through the official text, develops the
learner’s understanding of the requirements through the use of examples and indicates significant
judgements that are required in accounting for partnerships. Furthermore, the module includes
questions that are designed to test the learner’s knowledge of the concepts pertaining to
accounting for special transactions.

2. Desired Learning Outcomes

At the end of the learning session, you should be able to:
a. Understand the purpose of partnership operation.
b. Identify the legal provisions for profit and loss distribution.
c. State the items that affect the division of a partnership’s profits or losses among
partners.
d. Identify the factors for a fair and equitable method of distribution.
e. Understand the accounting procedures and concepts of partnership operation.
f. Compute for the share of a partner in the partnership’s profit or loss.

3. Content/Discussion

PARTNERSHIP OPERATION
The accounting process for recording revenues and expenses depends on the kind of operation of
the business. At the end of the year, these nominal accounts are closed to the title Income
Summary. For a merchandising business, the postings to this account will appear as follows:

Income Summary
Cost of Sales Net Sales
Expenses

The Income Summary account is also to be closed. Its closing entry depends on the form of
ownership. A credit balance (representing profit) should be closed as follows:

For a sole proprietorship : Income, Summary xxx

Owner's, Capital or Drawings xxx
For a partnership : Income Summary xxx
Partner X, Drawings xxx
Partner Y, Drawings xxx
For a Corporation : Income Summary xxx
Retained Earnings xxx

Note that in a sole proprietorship, it does not make a lot of difference if net income is
immediately credited to the capital account since there is only one owner to reckon with.
However, in a partnership, distinguishing the capital account from the drawing account is
important as there are two or more owners who must agree on how profit drawings will be made
by them and this is usually contained in the Articles of Co-Partnership. It is advisable to use
separately and carry to the next accounting period the balance of the drawing accounts when it is
the intention of the partners to withdraw regularly their profit share (especially if in the form of
salaries) or when profit sharing agreement is based on capital in excess of capital investment.
When the partners' drawings accounts are used to record profit share less withdrawals, it parallels
the retained earnings account in a corporation. The balances of the capital account and drawing
account make up the partners' equity at the end of the period whether or not the drawing account
balance is closed to the capital account as illustrated and explained in previous module.

LEGAL PROVISIONS ON DIVISION OF PROFIT OR LOSS

1. Profit and loss are distributed based on the partners' agreement as provided in the Articles of
Co-Partnership.
2. If the agreement is only on distribution of profit, but the result of operations is a loss, the same
agreement may be applied.
3. In the absence of an agreement as to how to distribute the profit or loss, then the
distribution should be based on the partners' contribution. Illustration:

PROFIT RATIO LOSS RATIO

1. Profit Ratio, Loss Ratio  
2. Profit Ratio, Loss Ratio  Χ
3. Original Capital Ratio, Loss Ratio Χ 
4. Original Capital Ratio, Original Χ Χ
Capital Ratio

4. An industrial partner shares in the profit only unless there is a specific agreement that the
partner shares in the loss sustained by the business.
5. The profit contemplated for distribution to the partners should be the net profit after tax.
Partnerships, like corporations, are subject to the 30% tax as provided for in The National
Internal Revenue Code. Exempted from this tax liability are the general professional partnerships
such as the consultancy firms rendering professional services.

The law has made no specific provision on what partners' contribution balance should be
used when allocating profit. Should it be the beginning, the average or the ending capital
contribution? Author's opinion, in this case, would be to use the average capital at the end of the
year if only for a fair and equitable distribution. Should it also consider all changes including
profit share net of regular drawings? It is the author's opinion that when the partner's withdrawal
and unwithdrawn profit share are material in amount then they must be closed to the capital
account and considered capital contributions. In both cases, it is advisable that provisions
regarding these problems be contained in the Articles of Co-Partnership.

METHODS OF DIVIDING PROFIT OR LOSS

The usual methods of dividing profits and losses are as follows:
1. Arbitrary or any agreed ratio
2. Capital ratio using either initial or original capital, beginning capital, ending capital or average
capital
3. Interest on investments, remaining profit to be divided in an agreed ratio
4. Salaries to partners, balance to be divided in an agreed ratio
5. Combination of: interest on investments, salaries to partners, balance to be divided in an
agreed ratio
6. Bonus to the managing partner, balance to be divided in an agreed ratio

FACTORS FOR A FAIR AND EQUITABLE DISTRIBUTION METHOD

Usually the profit or loss distribution is based on the partners' capital contributions.
However, if the partners do not render equal time in managing the business or do not have the
same skills or entrepreneurial ability, then the capital contribution would not result in a fair and
equitable distribution. To illustrate, suppose Wency, Rex and Vhinson, CPAs, contributed
P200,000 each to put up an accounting and tax service business, but only Rex is rendering full
time service with Wency and Vhinson rendering half time. A fair and equitable way of
distributing the profit would be to give them salaries in proportion to the time service rendered
with the remaining profit distributed equally among them. Or suppose all of them are rendering
full time service but their capital contributions are not the same, then the best way is to give them
equal monthly salaries for their services and any residual profit to be distributed in proportion to
their capital contributions. Or compute interest based on their capital contributions with the
residual profit distributed equally considering the equal time of service they will render.

ACCOUNTING PROCEDURES
Compute for the Adjusted Net Income/Loss prior to distribution and allocate based on (in
particular order):
Profit Distribution Rule:
1. Profit sharing agreement
2. Capital ratio
a. Original capital balance
b. Capital during the year the profit is earned
a) Weighted average capital balance
b) Opening capital balance

Loss Distribution Rule:

1. Loss sharing agreement
2. How profit is divided

In addition to p/l agreement, the partners may provide for the following methods of profit or
loss distribution:

1. Salary – compensation for services; provided for regardless of the existence of profit because
the provision of services by a partner is independent from the earnings of profit.
 This could be in fractional year (It considers time)
 Given, regardless of the result of operation
2. Interest – compensation for use of partner’s capital; provided for regardless of the existence
of profit because the use of the partner’s capital is independent from the earnings of profit.
 This could be in fractional year (It considers time)
 Given, regardless whether there is profit or loss
(*Use the salary/interest ratio if the problem states that the amount to be distributed to the
partners is up to the extent of profit only or the profit is distributed based on priority.)

3. Bonus – compensation for good performance; provided only when the partnership has profit
Bonus bases:
a. before bonus: bonus = bonus base x bonus rate
b. after bonus: bonus = bonus base x [bonus rate/(100% + bonus rate)]

CASE 1: Net income of P500,000 before salaries of P55,000, interest of P13,000 and bonus of
15%.

B = Net Income – Salaries -Interest X Bonus Rate

1 + Bonus Rate

B = P500,000 – P55,000-P13,000 X 15%

1+.15

B =P432,000 X
1.15

B = P56,347.83

CASE 2: Net income of P10,000 before salaries of P5,000, interest of P3,000 and bonus
of 10%.

B = Net Income + Salaries +Interest X Bonus Rate

1 – Bonus Rate

B = P100,000 + P5,000+P3,000 X 10%

1 - .10

B =P108,000 X
0.90

B = P12,000

4. Remainder (whether positive or negative) based on P/L ratio

Illustrative Problems:
A. Basic profit or loss distribution rules
Alexander and Eddie formed a partnership on January 1, 2008 by contributing P80,000 and
P120,000, respectively. As of January 1, 2009, their partnership capital were P90,000; P110,000,
respectively.

Situations:
A. No profit sharing agreement C. Profit is divided equally
B. No loss sharing agreement D. Loss divided 30:70 to Alexander and Eddie,
respectively

Required: Compute the share of Alexander and Eddie assuming:

P40,000 profit P40,000 loss

*Situational Cases Alexander Eddie Alexander Eddie
1. A and B _________ _________ _________ _________
_ _ _ _
2. B and C _________ _________ _________ _________
_ _ _ _
3. A and D _________ _________ _________ _________
_ _ _ _
4. C and D _________ _________ _________ _________
_ _ _ _
5. C and D with guaranteed
P25,000 minimum profit _________ _________ _________ _________
sharing to Eddie _ _ _ _

Weighted Interest computation

The following summarizes the capital transactions of partners Grace and Loida which started
operation during 2009:

Investments Grace Loida

(Drawings)
April 1 P 90,000- P 108,000-
June 30 60,000- 12,000-
August 1 -- ( 16,000)
September 30 ( 18,000) --
November 1 27,000- --
December 31 -- ( 30,000)

Required: Compute the weighted average capital balance of each partner.

B. Bonus Computation
Mandy and Soledad shares profit equally after providing for annual salaries of P150,000 and
P180,000, respectively, and a 10% bonus after salaries and bonus to Mandy. The profit or loss
statement of the partnership for whole year is shown below:
Sales P 6,000,000
Cost of sales 3,000,000
Gross profit P 3,000,000
Expenses 2,450,000
Net profit P 550,000

Required:
1. Compute the amount of the bonus ______________
2. Compute the bonus assuming expenses is inclusive of the salaries ______________
3. Compute the bonus assuming expenses includes bonus and salaries ______________

4. Progress Check

1. Enumerate at least five methods of dividing partnership profit and loss. How do you make
a choice on what is the best and equitable method of distribution?
2. The partnership of Popoy and Kokoy decided to admit Dodoy to a one-fourth interest in the
partnership upon his investment of P500,000. Does this necessarily mean that Dodoy would be
entitled to a one-fourth share in the net income or loss of the business? Explain.
3. The partnership agreement provided for the following: Rolly and Polly are to divide profit and
loss in the ratio of 7:3, respectively and each one is to draw P5,000 salary per month, Explain
what possible difficulties may be encountered by the accountant.
4. Partners Lard and Oil had the following agreement: 24% interest on average capital,
remainder to be divided in the average capital ratio. Comment on this agreement.
5. Partners Sammy and David established a partnership on January 1, 2010 by investing cash of
P500,000 and P750,000, respectively. There was no agreement on the division of profit. The
result of operation after one year is P250,000. How would this amount be divided between them?
6. The partnership agreement provides for division of profit and loss based on capital
balances of the partners. Comment on this agreement.
7. If the partnership agreement provides for interest on capital contributions and salaries to
partners, will there be a distribution for these even if the operation resulted in a net loss? Explain.

5. DRILL PROBLEMS

1. At the end of the year of operation, the profit or loss summary has a debit balance of
P60,000. Partners A, B and C contributed P100,000, P200,000 and P300,000 and shares
profit 20:30:50, respectively. In closing the profit or loss summary, which statement is
correct?
a. A’s capital, P10,000 debit c. B’s capital, P18,000 debit
b. A’s capital, P10,000 credit d. C’s capital, P30,000 credit

2. As of December 31, 2008, D, E and F has adjusted capital balances of P100,000, P250,000
and P150,000, respectively, and shares profit equally. At the start of 2009, the partners
 admitted G for a 10% interest in profit and capital by contributing P100,000. The partnership
earned P120,000 net income in 2009. How much is E’s share in the partnership profit?
a. P24,000 b. P36,000 c. P54,000 d. P40,000

3. Partners A and B agreed to share profits in the following order of distribution:

a. Interest of 10% on weighted average capital
b. Salaries of P60,000 to A and P40,000 to B
c. Residual profit, equally

Loss is shared by A and B 40:60. Details of the capital accounts of A and B is shown as
follows:
A B
Debit Credit Debit Credit
January 1 - P 240,000 - P 360,000
March 30 - 40,000 P 20,000 -
April 30 - - - 18,000
July 1 P 20,000 - 21,000 -
September 30 - 80,000 - 60,000
November 1 30,000 - - -
December 30 - - 30,000 -
The partnership made P180,000 net income. B’s share in the profit is
a. P95,675 b. P95,550 c. P84,450 d. P84,325

What is A’s ending capital balance?

a. P394,325 b. P394,450 c. P394,450 d. P405,675

4. D, E and F agreed to share profit and losses as follows:

a. Salaries of P50,000, P40,000 and P20,000 to D, E and F, respectively
b. First P100,000 of profits after salaries, 20% bonus to D
c. Excess profits after salaries and the bonus to D above P100,000, 10% bonus to E
d. Residual profits or loss to F

The partnership made P250,000 net profit. How much is E’s profit sharing?
a. P43,200 b. P42,000 c. P41,200 d. P45,000

5. D and E agreed to share profits and losses 40:60, respectively after providing E 17% bonuses
on partnership net income after tax and after bonus. D received P36,000 as final profit
distribution. The share of the partners on partnership profit is subject to 10% withholding tax.
The partnership is also subject to 35% income tax. Compute the partnership operating
income assuming that it equals taxable income.
a. P117,000 b. P150,000 c. P180,000 d. P160,000

6. Darrel, Rhad and Bal are partners. The partners agreed to share profit 40:30:20. Darrel sold
½ o his interest to Rhad for P100,000. Subsequently, the partnership admitted Andrix for a
10% interest. What is Rhad’s profit sharing after Andrix’ admission?
 a. 27% c. 50%
b. 45% d. 54%

7. The partnership reports profits of P80,000, net of P20,000 salaries and P30,000 interest and a
bonus. The bonus is computed as 20% of profits after salaries and interest. Compute the
amount of the bonus.
a. P16,000 c. P26,000
b. P20,000 d. P32,500

8. The partnership of Alec and Boy reported profits of P120,000 in 2009 and divided the same
to their profit sharing ratio of 40:60, respectively. An examination conducted on the books
revealed the following:
 An equipment costing P30,000 which should have depreciated for 4 years was expensed
on January 2, 2009.
 Supplies of P5,000 was omitted on the records.
 An inventory costing P15,000 was omitted from the records. The purchase was not
recorded because the invoice was in transit as of the balance sheet date.

What is the net adjustment to the Capital account of Alec?

a. P11,000 increase c. P17,000 increase
b. P11,000 decrease d. P17,000 decrease

9. Katrina and Horace formed a partnership. They agreed to divide profits 40:30, respectively,
after providing for salaries of P10,000 to Katrina and P20,000, to Horace and an interest on
beginning capital. Interest traceable to Katrina and Horace were P4,000 and P2,000,
respectively. If Horace received total profit sharing of P28,000, compute the partnership
profit during the year.
a. P46,200 c. P56,000
b. P48,000 d. P50,000

10. Elvie and Lito are partners sharing profits as follows:

 P10,000 and P20,000 salaries to Elvie and Lito, respectively. The salary provision shall
be increased by 50% each when profit exceeds P50,000.
 Residual profit is shared equally.
If Elvie received P25,000 profit sharing, what is the partnership profit?
a. P75,000 b. P65,000 c. P60,000 d. P50,000
11. Cabrera, Mateo and Ampil agreed to the following profit sharing:
 Salary of P20,000 and P30,000 to Mateo and Ampil, respectively.
 Residual profit sharing of 50:30:20 to Cabrera, Mateo and Ampil, respectively.
 Guaranteed minimum profit sharing of P40,000 to Cabrera and P30,000 to Mateo,
respectively.

Compute the partnership profits if Ampil received P40,000 profit sharing.

a. P115,000 b. P120,000 c. P135,000 d. P150,000
12. A, B and C share profits on a 5:3:2 ratio. On January 1, 2009, D was admitted into the
partnership with a 10% share in profits. The old partners continue to participate in profits in
their original ratio. For the year 2009, the net income of the partnership was reported as
P12,500. However, it was discovered that the following items were omitted in the firm’s
books:
Unrecorded at year-end 2008 2009
Prepaid expenses P 800
Accrued expenses P 600
Unearned income 700
Accrued income 500

The new profit and loss ratio for B, and the share of C in the 2009 net income:
a. 30%; P2,214 c. 27%; P2,286
b. 27%; P2,214 d. 30%; P2,286

13. A, B and C are partners. A and B contributed P100,000 and P200,000, respectively while C
contributes his industry. It was agreed that profit shall be divided 40:40:20, respectively.
During the first year of operation, the partnership incurred a loss of P30,000. C’s share in the
loss is?
a. P0 since C is an industrial partner
b. P0 since there is no stipulation exempting C from losses
c. P6,000, equal to his profit sharing
d. P7,500, equal to the share of the capitalist partner with the least profit sharing

14. A, B and C are partners. A and B are capitalist but C is an industrial partner. Which
statement is incorrect?
a. The partnership agreement is void if it provides that C shall share in any profit but not of
any loss.
b. C shall be liable for losses if so agreed by the partners.
c. The partnership agreement is void if B share for the profit but not of the losses
d. The partnership agreement is void if B shares for the losses but not profits

15. As of February 1, 2010, A, B and C have beginning capital balances of P100,000, P200,000
and P200,000, respectively. They agreed to share any losses in the ratio of 30:30:40,
respectively. The partnership profit was reported as P50,000. Ending capital balances of A, B
and C was properly determined as P120,000, P220,000 and P180,000, respectively, based on
the reported profit.
An evaluation of the books as of December 31, 2010 disclosed that the correct partnership
income was only P30,000. Based on the above facts, compute the net drawings or additional
investments made by partners A, B and C during the year, respectively.
a. P5,000, P5,000; (P40,000) c. P10,000; P0; (40,000)
b. P5,000, P5,000; (P20,000) d. P14,000; P8,000; (P32,000)

B. References
1. Manuel, Z.V. (2016). Advanced Accounting. Manila, Philippines: GIC Enterprises
2. Advanced Financial Accounting and Reporting review materials by Wency Giron