PARTNERSHIP

OPERATIONS
Kian Barredo
 DISTRIBUTION OF PROFIT AND
LOSS
Under the Partnership Law, the profit and loss agreement is based on the agreement of the
partners. In the absence of agreement, the following rules shall be observed:

Profits
Based on Capital Contribution
Based on Beginning Capital
Based on Ending Capital
Equally
Losses
Based on Profit and Loss Agreement
Based on Capital Contribution
*No loss to industrial partner
Equally
 DISTRIBUTION OF PROFITS AND
LOSSES
There are many ways of sharing the profits and losses among partners in the partnership. It includes
1. Equally
2. Arbitrary Ratio
3. Ratio of Capital Account balances and dividing the balance on agreed ratio.
3.1 Original Capital
3.2 Beginning Capital
3.3 Average Capital (Simple or Weighted)
4. Interest of Partners’ Capital Accounts and dividing the balance on the agreed ratio.
5. Salaries to partners and dividing the balance on the agreed ratio.
6. Bonus to partners
 EXAMPLES OF NET INCOME
ALLOCATION
Assume that a net income of P288,000 is determined by X and Y
partnership at the end of 2020. Regular withdrawal of the partners in
anticipation of net income have been summarized in the capital accounts.
Drawing and capital accounts at the end of 2020 are as follows:
 ALLOCATION OF NET INCOME

X, Capital Y, Capital

1/1/2020 P300,000 3/1/2020 P30,000 1/1/2020 P420,000

4/1/2020 P60,000 11/1/2020 P60,000

12/31/2020 P360,000 12/31/2020 P450,000

 ALLOCATION OF NET INCOME

X, Drawing Y, Drawing

1/1 – 12/31 36,000 1/1 – 12/31 114,000

36,000 114,000
 EQUALLY
This method may be proper if the capital or service contribution of partners are considered to
be the same
The Journal Entry of the Partnership X and Y to record the allocation of net income of 288,000
equally would be as follows:
Income Summary 288,000
X, Drawing 144,000
Y, Drawing 144,000

Share of X (288,000 x 50%) 144,000

Share of Y (288,000 x 50%) 144,000
Total 288,000
 ARBITRARY RATIO
Assumed that, since the expertise, ability and reputation of X are factors of special
significance to the success of the partnership, X and Y agreed to allocate the net income in the
ratio of 3:2. The entry to record the allocation of net income of P288,000 is:

Income Summary 288,000

X, Drawing 172,800
Y, Drawing 115,200

Share of X (288,000 x 3/5) 172,800

Share of Y (288,000 x 2/5) 115,200
Total 288,000
 BASED ON CAPITAL BALANCES
Original Capital – In absence of agreement, this is the first priority.
Beginning Capital – This is somehow discouraged because the partners investing are not yet
compensated in the division of profit until a later period.
Since the capital contribution is not stated in the problem, We can therefore use the beginning capital for
the purposes of this discussion.
The entry to record the allocation of net income of 288,000 for the year is:
Income Summary 288,000 X, Capital 01/01/2020 300,000
X, Drawing 120,000 Y, Capital 01/01/2020 420,000
Y, Drawing 168,000 Total 720,000

Share of X (288,000 x 30/72) 120,000

Share of Y (288,000 x 42/72) 168,000
Total 288,000
 BASED ON CAPITAL BALANCES
Ending Capital – Similar problem exists when ending capital balances are used. Investments
are encouraged due to the inclusion of profit. But no incentive exists for a partner to make any
investments before year-end.
The entry to record the allocation of net income of 288,000 for the year is:

Income Summary 288,000

X, Drawing 128,000 X, Capital 12/31/2020 360,000
Y, Drawing 160,000 Y, Capital 12/31/2020 450,000
Total 810,000

Share of X (288,000 x 36/81) 128,000

Share of Y (288,000 x 45/81) 160,000
Total 288,000
 AVERAGE CAPITAL
This is the most fair basis for allocating partnership profit because it
reflects the capital actually available for use by the partnership during the
year. If the partnership contract provides for sharing profit in the ratio of
average capital account balances during the year, It should also state the
amount of drawings each partner will make without affecting the capital
account. Additional drawings and investments are entered directly on
partners’ capital accounts and therefore influence the computation of
average capital ratio.
 SIMPLE AVERAGE CAPITAL

Income Summary 288,000 X, Average Capital 330,000 (300+360)/2

X, Drawing 124,235
Y, Drawing 163,765 Y, Average Capital 435,000 (420+450)/2
Total 765,000

Share of X (288,000 x 33/76.5) 124,235

Share of Y (288,000 x 43.5/76.5) 163,765
Total 288,000
 WEIGHTED AVERAGE CAPITAL
X Capital Months Unchanged
Balance
1/1/2020 300,000 X 3/12 75,000
4/1/2020 360,000 x 9/12 270,000
Total 345,000

X Capital Months Unchanged

Balance
1/1/2020 420,000 X 2/12 70,000
3/1/2020 390,000 X 8/12 260,000
11/1/2020 450,000 x 2/12 75,000
Total 405,000
 WEIGHTED AVERAGE CAPITAL
Share of X (288,000 x 34.5/75) 132,480
Share of Y (288,000 x 40.5/75) 155,520
Total 288,000

Income Summary 288,000

X, Drawing 132,480
Y, Drawing 155,520
SHORTCUT TECHNIQUE!
 INTEREST ON CAPITAL BALANCES
Allowing the provision on interest on capital is to give recognition to differences on capital
contribution by partners. It also recognizes the contribution of the partners’ capital
contribution to the partnership’s profit generating capacity. It is also appropriate when the
business is capital intensive rather than labor intensive.
Interest allowances on partners’ capital accounts as a technique for sharing partnership profit
equitably has no effect on the measurement of net oncome or loss of the partnership. And they
are not loans to the partnership. So it is not appropriate to charge an interest expense or interest
payable because interest is not an expense of the partnership.
 INTEREST ON CAPITAL BALANCES
Assume that X and Y agree to allow interest on average capital of 6%, any net income or loss
balance is to be allocated at 3:7.

Interest of X on Ave. Capital (345,000 x 6%) 20,700

Interest of Y on Ave. Capital (405,000 x 6%) 24,300
Total 45,000

Income Summary 45,000

X, Drawing 20,700
Y, Drawing 24,300
 INTEREST ON CAPITAL BALANCES
X Y Total
Interest on Average 20,700 24,300 45,000
Capital (6%)
Remaining 72,900 170,100 243,000
(3:7)
Total 93,600 194,400 288,000

Income Summary 243,000

X, Drawing 72,900
Y, Drawing 170,100
 SALARY ALLOWANCES
Those partners who devotes time to the partnership may receive salary allowances. The
purpose of salary allowances are also used to compensate for the difference in the fair value of
the talents of the partners, all of whom devote their time in the partnership.

Assume that X and Y agree to the allowance of monthly salaries of 10,000 and 9,000, respectively; any net
income or loss balance to be allocated in the ration of beginning capital.

Income Summary 228,000

X, Drawing 120,000
Y, Drawing 108,000

X’s Salary for 12 months 120,000

Y’s Salary for 12 months 108,000
 SALARY ALLOWANCES
X Y Total
Salaries 120,000 108,000 228,000
Balance (30:42) 25,000 35,000 60,000
Total 145,000 143,000 288,000

Income Summary 60,000

X, Drawing 25,000
Y, Drawing 35,000
 BONUSES
This is sometimes providing additional compensation to partners who have provided services
to the partnership. Bonuses are typically stated as a percentage of profit either before or after
bonus. If silent, Before Bonus.
The net income of X and Y partnership amounted to 420,000. A, as the managing partner, is
allowed as bonus based on the following assumptions:
A. Bonus of 20% net income before the bonus is deducted
B. Bonus of 20% net income after the deduction of the bonus.
 BONUSES
B.
A.
Let B = Bonus
Let B = Bonus B = 20%NI - B
B = 20%NI B = 20% (420,000-B)
B = 20% (420,000) B = P84,000 - .20B
B = P84,000 1.20B = 84,000
B = 70,000