COLLEGE OF

BUSINESS AND
MANAGEMENT
FINANCIAL
REPORTING
AND
COURSE FACILITATOR: JESSIE R. MELMIDA, CPA
FB/MESSENGER: Jessie Rivera Melmida
Email: [email protected]
Phone No: 09562715098
 VISION

Northern Negros State College of Science and technology envisions a skillful and productive

manpower, qualified and competent professionals endowed with leadership qualities, commitment to

public service, a common shared values, and capacities to integrate and use new knowledge and skills in

various vocations and professions to meet the challenges of the new millennium.

MISSION

To train and develop semi-skilled manpower, middle level professionals and competent and

qualified leaders in the various professions responsive to the needs and requirements of the service areas

providing appropriate and relevant curricular programs and offerings, research projects and

entrepreneurial activities, extension services and develop progressive leadership to effect socio-economic

change and thereby improve the quality of life.

INSTITUTIONAL OUTCOMES

1. Demonstrate logical thinking, critical judgment and independent decision-making on any

confronting situations
2. Demonstrate necessary knowledge, skills and desirable attitudes expected of one’s educational
level and field of discipline
3. Exhibit necessary knowledge, skills and desirable attitudes in research
4. Exhibit proactive and collaborative attributes in diverse fields
5. Manifest abilities and willingness to work well with others either in the practice of one’s profession
or community involvement without compromising legal and ethical responsibilities and
accountabilities.
PROGRAM LEARNING OUTCOMES

The program shall produce a graduate who can:

1. Articulate and discuss the latest developments in the specific field of practice.
2. Effectively communicate orally and in writing using both English and Filipino.
3. Work effectively and independently in multi-disciplinary and multi-cultural teams.
4. Act in recognition of professional, social and ethical responsibility.
5. Preserve and promote “Filipino historical and cultural heritage”.
6. Perform the basic functions of management such as planning, organizing, staffing, directing and
controlling.
7. Apply the basic concepts that underlie each of the functional areas of business (marketing, finance,
human resource management, production and operations management, information technology,
and strategic management) and employ these concepts in various business situations.
8. Select the proper decision-making tools to critically, analytically and creatively solve problems and
drive results.
9. Express oneself clearly and communicate effectively with stakeholders both in oral and written
forms.
10. Apply information and communication technology (ICT) skills as required by the business
environment.
11. Work effectively with other stakeholders and manage conflict in the workplace.
12. Plan and implement business related activities.
13. Demonstrate corporate citizenship and social responsibility.
14. Exercise high personal moral and ethical standards.
15. Analyze the business environment for strategic direction.
16. Prepare operational plans.
17. Innovate business ideas based on emerging industry.
18. Manage a strategic business unit for economic sustainability.
19. Conduct business research.
Warm greetings!

Welcome to the second semester of School Year 2020-2021! Welcome to the College of Business and
Management and welcome to NONESCOST!

Despite of all the happenings around us, there is still so much to be thankful for and one of these is the
opportunity to continue learning.

You are right now browsing your course module in AISAE 103. As you read on, you will have an overview of
the course, the content, requirements and other related information regarding the course. The module is
made up of 8 lessons. Each lesson has seven parts:

INTRODUCTION- Overview of the lesson

LEARNING OUTCOMES- Lesson objectives for you to ponder on

MOTIVATION- Fuels you to go on

PRESENTATION- A smooth transition to the lesson

TEACHING POINTS- Collection of ideas that you must discover

LEARNING ACTIVITIES – To measure your learning in the lesson where you wandered

ASSESSMENT – To test your understanding in the lesson you discovered

Please read your modules and learn the concepts by heart. It would help you prepare to be effective and
efficient professional in your respective fields. You can explore more of the concepts by reading the
references and the supplementary readings.

I encourage you to get in touch with me in case you may encounter problems while studying your modules.
Keep a constant and open communication. Use your real names in your FB accounts or messenger so I can
recognize you based on the list of officially enrolled students in the course. I would be very glad to assist
you in your journey. Furthermore, I would also suggest that you build a workgroup among your classmates.
Participate actively in our discussion board or online discussion if possible and submit your
outputs/requirements on time. You may submit them online through email and messenger.

I hope that you will find this course interesting and fun. I hope to know more of your experiences, insights,
challenges and difficulties in learning as we go along this course. I am very positive that we will successfully
meet the objectives of the course.

May you continue to find inspiration to become a great professional. Keep safe and God bless!

Course Outline in AISAE 103 – FINANCIAL ACCOUNTING AND REPORTING

Course AISAE 103

Number
Course Title FINANCIAL ACCOUNTING AND REPORTING
Course
Description This is a continuation of the first course in accounting which primarily deals with
transactions, financial statements, and problems specific to the operations of partnerships
and corporations as distinguished from sole proprietorships. Topics include: partnership
formation and operations including accounting for the admission of partners, changes in
capital, and profit-and loss-sharing ratios; the conversion of an unincorporated enterprise
into a corporation; accounting for incorporated enterprises, including corporate
organizations; paid-in capital, accumulated earnings (loss); dividends and treasury shares.
The course also covers the preparation of financial statements and analysis of accounting
information for decision making.
No. of Units 3 units
Pre-requisites INTRODUCTION TO ACCOUNTING
Course 1. Explain the key concepts and accounting principles involving transactions of
Intended partnerships and corporations.
Learning 2. Record relevant transactions of partnerships and corporations.
Outcomes
Content I. Overview of Partnership (Lesson 1)
Coverage A. Partnership Defined
B. Characteristics of Partnership
C. Advantages and Disadvantages of Partnership
D. Classification of Partners and Partnerships

II. Partnership Formation (Lesson 2)

A. Nature of Partnership Formation
B. Valuation of the Partners’ Investment
C. Methods of Forming a Partnership
D. Accounting Procedures in Forming a Partnership

III. Partnership Operation (Lesson 3)

A. Nature of Partnership Operations
 B. Various Pro-forma Entries to Record the Business Operation
C. Various Methods of Dividing Profits and Losses
D. Accounting Treatment for Salary and Bonus Provided to the Partners
E. Statement of Changes in the Owner’s Equity of Partnership

IV. Partnership Dissolution (Lesson 4)

A. Concept of Dissolution
B. Causes of Dissolution
C. Accounting Procedures for an Admission by Purchase
D. Concept of Admission by Investment
E. Bonus and Revaluation of Assets in an Admission by Investment

V. Partnership Liquidation (Lesson 5)

A. Concept of Partnership Liquidation
B. Accounting Procedures Applicable to Partnership Liquidation
C. Types of Partnership Liquidation
D. Concept of Lump-sum Liquidation
E. Statement of Liquidation
F. Safe payment schedule and a Cash Priority Program

VI. Overview of Corporations (Lesson 6)

A. Nature of a Corporation
B. Corporation in Accordance with the Corporation Code
C. Characteristics of a Corporation
D. Powers of a Corporation
E. Advantages and Disadvantages of Using Corporate Vehicle in Conducting Business
F. Components of a Corporation
G. How Corporation is Formed and Organized
H. Articles of Incorporation and By-Laws
I. Minimum Subscription and Paid-in Capital Requirements

VII. Corporation Accounting of Share Capital (Lesson 7)

A. Account Titles in Recording Capital
B. Concept of Legal Capital and the Trust Fund Doctrine
C. Classes of Shares
D. Concept of Delinquent Subscription
E. Accounting Principles Used in Recording Treasury and Capital Shares
F. Accounting Procedures for Par Value and No-par-value Shares
G. Income and Expense Summary Related to Retained Earning

VIII. Corporation Operations and Retained Earnings (Lesson 8)

A. Concept of Retained Earnings
B. Types of Dividends
C. Accounting for Dividends
D. Concept of Appropriated Retained Earnings

References 1. Baysa, G. and Lupisan, M. (2018). Accounting for Partnership and Corporation
2. Aduana, N. (2016). Partnership and Corporation Accounting. Philippines: C&E
Publishing, Inc.
 Supplementary Readings:
1. Palma, R. (2014). Basic Accounting 2: Partnership and Corporation. Philippines: Rex
Book Store, Inc.
2. Ballada, W. & S. (2013). Partnership and Corporation Accounting. Philippines: Win
and Susan Ballada.
3. http://www.principlesofaccounting.com
4. www.netmba.com/accounting
5. https://www.sec.gov.ph/gender-and-development-2

Course 1. Active class participation (online discussion, FB Closed group account)

Requirements 2. Logbook/ Journal (Reflection, Observation and/or Activities on each Lesson)
3. Quizzes
4. Three (3) Examinations

Adapted by: MYKA D. AMISCUA, CPA

Reviewed and Approved by:

Department, Chairperson: ERNALYN AURETA

Subject Area Coordinator: FREYA WYAN S. DELA CRUZ, CPA, MBA

Dean, CBM : RICHEL P. ALOB, Ph. D.

GAD Director : MARY ANN T. ARCEŇO, Ph.D.

CIMD, Chairperson : MA. JANET S. GEROSO, Ph.D.

QA Director : DONNA FE V. TOLEDO, Ed. D.

VP- Academic Affairs : SAMSON M. LAUSA, Ph. D

 MODULE
1

LESSON

1 Overview of a Partnership
3
HOURS

This lesson explains the nature of a Partnership – its characteristics, advantages and disadvantages. This
also discusses the different kinds of partnerships and the class of partners.

At the end of this lesson, you should be able to:

1. Define and discuss the nature of a partnership.

2. Describe the advantages and disadvantages of partnership.
3. Identify the different kinds of partnerships and the classes of partners.
4. Share ideas about real-life partnership organizations.

“Don’t let what you cannot do interfere with what you can do.” – John Wooden

Before we dive into the accounting of a partnership, it is important that we learn the basics of partnership.
When two or more persons join hands to set up a business and share its profits and losses, it is called
Partnership. It is a relation between persons who have agreed to share the profits of a business carried on
by all or any of them acting for all.
I. DEFINITION

A partnership is defined in Article 1767 of the Civil Code of the Philippines as “a contract whereby two or
more persons bind themselves to contribute money, property, or industry into a common fund with the
intention of dividing profits among themselves.”

II. CHARACTERISTICS OF A PARTNERSHIP

1. Mutual Agency. Any partner may act as agent of the partnership in conducting its affairs.
2. Unlimited liability. The personal assets (assets not contributed to the partnership) of any partner
may be used to satisfy the partnership creditors’ claims upon liquidation, if partnership assets are
not enough to settle the liabilities to outsiders.
3. Limited life. A partnership may be dissolved at any time by action of the partners or by operation
of law.
4. Mutual participation in profits. A partner has the right to share in partnership profits.
5. Legal Entity. A partnership has legal personality separate and distinct from that of each of the
partners.
6. Co-ownership of contributed assets. Properties contributed to the partnership are owned by the
partnership by virtue of its separate legal personality.
7. Income tax. Partnerships, except general professional partnerships (i.e., those organized for the
exercise of professions like CPAs, lawyers, engineers, etc.) are subject to the 30% income tax.

III. ADVANTAGES OF A PARTNERSHIP

1. It is easy and inexpensive to organize, as it is formed by a simple contract between two or more
persons.
2. The unlimited liability of the partners makes it reliable from the point of view of creditors.
3. The combined personal credit of the partners offers better opportunity for obtaining additional
capital than does a sole proprietorship.
4. The participation in the business by more than one person makes it possible for a closer
supervision of all the partnership activities.
5. The direct gain to the partners is an incentive to give close attention to the business.
6. The personal element in the characters of the partners is retained.

IV. DISADVANTAGES OF A PARTNERSHIP

1. The personal liability of a partner for firm debts deters many from investing capital in a partnership.
2. A partner may be subject to personal liability to personal liability for the wrongful acts or omissions
of his/her associates.
3. It is less stable because it can easily be dissolved.
4. There is divided authority among the partners.
 5. There is constant likelihood of dissensions and disagreement when each of the partners has the
same authority in the management of the firm.

V. KINDS OF A PARTNERSHIP

1. As to activity
a. Trading partnership – one whose main activity is the manufacture and sale or the purchase and
sale of goods.
b. Non-trading partnership – one which is organized for the purpose of rendering services.

2. As to object
a. Universal Partnership
1. Universal partnership of all present property – one in which the partners contribute, at
the time of the constitution of the partnership, all the properties which actually belong to each
of them into a common fund with the intention of dividing the same among themselves as
well as the profits which they may acquire therewith.
All assets contributed to the partnership and subsequent acquisitions become common
partnership assets.
2. Universal partnership of all profit – one which comprises all that the partners may acquire
by their industry or work during the existence of the partnership and the usufruct of movable
or immovable property which each of the partners may possess at the time of the institution
of the contract.
Partnership assets consist of assets acquired during the life of the partnership and only the
usufruct or use of assets contributed at the time of partnership formation. The original
movable or immovable property contributed do not become common partnership assets.

b. Particular Partnership – one which has for its object determinate things, their use of fruits, or a
specific undertaking or the exercise of a profession or vocation.

3. As to liability of partners
a. General co-partnership – one consisting of general partners who are liable prorate and
sometimes solidarily with their separate property for partnership liaibilities.
b. Limited partnership – one formed by two or more persons having as members one or more
general partners and one or more limited partners, who as such are not bound by the obligations
of the partnership. The word “LIMITED” or “LTD.” is added to the name of the partnership to
inform the public that it is limited partnership.

4. As to duration
a. Partnership at will – one for which no term is specified and is not formed for a particular
undertaking or venture and which may be terminated any time by mutual agreement of the
partners or the will of one partner alone.
b. Partnership with a fixed term – one in which the term or period for which the partnership is to
exist is agreed upon. It may also refer to a partnership formed for a particular undertaking and
upon the expiration of that term or completion of the particular undertaking the partnership is
dissolved; unless continued by the partners.

5. As to representation to others
a. Ordinary Partnership – one which actually exists among the partners and also as to third
persons.
 b. Partnership by estoppel – one which in reality is not a partnership but is considered as one
only in relation to those who, by their conduct or omission are precluded to deny or disprove the
partnership’s existence.

6. As to legality of existence
a. De jure partnership – one which has complied with all the requirements for its establishment.
b. De facto partnership – one which failed to comply with one or more of the legal requirements
for its establishment.

7. As to publicity
a. Secret partnership – one wherein the existence of certain persons as partners is not made
known to the public by any of the partners.
b. Open partnership – one wherein the existence of certain persons as partners is made known to
the public by the members of the firm.

VI. CLASSES OF PARTNERS

1. As to contribution
a. Capitalist Partner – one who contributes capital in cash (money) or property.
b. Industrial Partner – one who contributes industry, labor, skill, talent or service.
c. Capitalist-Industrial Partner – one who contributes cash, property, and industry.

2. As to liability
a. General Partner – one whose liability to third persons extends to his separate (private)
property.
b. Limited Partner – one whose liability to third persons is limited only to the extent of his capital
contribution to the partnership.

3. As to management
a. Managing Partner – one who manages actively the business of the partnership.
b. Silent Partner – one who does not participate in the management of the partnership affairs.

4. Other Classification
a. Liquidating Partner – one who takes charge of the winding up of a partnership upon
dissolution.
b. Nominal Partner – one who is not really a partner, not being a party to the partnership
agreement, but is made liable as a partner for the protection of innocent third persons.
c. Ostensible Partner – one who takes active part in the management of the firm and is known to
the public as a partner in the business.
d. Secret Partner – one who takes active part in the management of the business but whose
connection with the partnership is concealed or unknown to the public.
e. Dormant Partner – one who does not take active part in the management of the business and
is not known to the public as a partner; he is both a silent and a secret partner.

VII. PARTNERSHIP CONTRACT

A partnership is created by an oral or a written agreement. Since partnerships are required to be

registered with the Office of the Securities and Exchange Commissions, it is necessary that the
agreement be in writing. In this case, misunderstandings and disputes among the partners relative to
the nature and terms of the contract may be avoided or minimized. The written agreement or among
the partners governing the formation, operation and dissolution of the partnership is referred to as the
Articles of Co-Partnership.
The Articles of Co-Partnership contains the following information:
1. The name of the partnership;
2. The names and addresses of the partners, classes of partners, stating whether the partner is a
general or a limited partner;
3. The effective date of the contract;
4. The purpose or purposes and principal office of the business;
5. The capital of the partnership stating the contributions of individual partners, their description and
agreed values;
6. The right and duties of each partner;
7. The manner of dividing net income or loss among the partners, including salary allowance and
interest on capital;
8. The conditions under which the partners may withdraw money or other assets for personal use;
9. The manner of keeping the books of accounts;
10. The causes for dissolution; and
11. The provision for arbitration in settling disputes.

1. How does a partnership differ from a sole proprietorship?

2. Why it is preferable to have a written contract of partnership? What are the contents of a typical
partnership contract?
3. When a partnership is a limited partnership, does the characteristic of “unlimited liability” still apply?
Why or Why not?

I. TRUE OR FALSE.
1. A written partnership contract is required to be prepared whenever a partnership is formed.
2. All partnerships are subject to income tax.
3. A partnership is much easier and less expensive to organize than a corporation.
4. Each general partner is personally liable for all of the partnership obligations.
5. All partnerships have at least one general partner.
6. In a limited partnership, the entity ceases to legally exist when an existing partner retires or
dies.
7. Both proprietorships and partnerships can use accounting method that does not conform to
Generally Accepted Accounting Principles.
8. Each partner generally has the authority to enter into contracts which are binding upon the
partnership.
9. The property invested in a partnership by a partner becomes the property of the partnership.
10. The unlimited liability of partners for partnership debts makes the partnership more reliable from
the point of view of creditors.
II. IDENTIFICATION
1. A partnership wherein all the partners have limited liability except for at least one general
partner.
2. A partner who contributes money, property and industry.
3. A characteristic of a partnership wherein any partner can act in behalf of the partnership as long
as these acts are within the scope of normal partnership activities.
4. A partnership which has failed to comply with one or more of the legal requirements for its
establishment.
5. A contract whereby two or more persons bind themselves to contribute property, money, or
industry to a common fund with the intention of dividing profits among themselves.
6. A partner who has a financial interest in the firm, not known to be a partner, but takes active part
in the management of the firm.
7. A partner whose liability is limited to the extent of her/his personal contribution into the
partnership.
8. Partnerships which are exempt from income tax.
9. A written partnership contract which governs the formation, operation and dissolution of the
partnership.
10. A partnership organized for the purpose of rendering services.
 LESSO
N

2 Partnership Formation
6
HOURS

This lesson will teach us how to value the partners’ initial contribution, which can either be in the form of
money, property or industry, from the time it is formed, as well as the three methods of forming a
partnership. This will also present the appropriate accounting procedures in forming a partnership.

At the end of this lesson, you should be able to:

5. Discuss the nature and requirements in the formation of a partnership.

6. State the valuation of contributions of partners.
7. Account for the initial investments of the partners to the partnership.

“Alone we can do so little; together we can do so much.” – Helen Keller

Many startups have been transformed into some of the most impressive and admired brands today due to
hard-working and cohesive teams. Seldom has anything of greatness been the result of a solo effort. When
partners share and respect each other’s thoughts and differences they stand a greater chance of being
more successful together. Partnership is not finding the perfect partners but finding someone whom you
can share your admirations, dreams, failures and successes.

The formation of partnership is similar to that of a sole proprietorship. The investments of the partners are
given proper accounting recognition by debiting the amount of investment and crediting the partner’s capital
amount.

The pro forma entry for the partner’s contribution is as follows:

 Assets xxxx
Partner, Capital xxxx

The term “assets” refers to the contribution of the partners during partnership formation or any
additional investment made during the year. If the types of assets of the partners have been clearly
identified, there is a need to indicate the specific types of the contributed assets. For instance, if cash and
merchandise inventories have been contributed, the cash account and inventory accounted for will be
debited.

It must be noted that the given pro forma entry has no distinct difference with the entry in a sole
proprietorship accounting when the owner makes an initial or additional investment.

The next step then is to determine at what amount must the investment of the partners be recorded.
The straightforward answer to this is that the amount that must be recorded to the partner’s capital is highly
dependent on the type of the investment made.

Therefore, the corollary question is, “What types of investment are contributed by the partners?”

VIII. FORMATION

A contract of Partnership is consensual. It is created by the agreement of the partners which may be
constituted in any form, such as oral or written. A partnership legal existence begins from the moment the
contract is executed, unless otherwise stipulated.

IX. ACCOUNTING FOR PARTNERSHIPS

Plurality of Capital and Drawing Accounts. Accounting for a partnership differs from other forms of
business organizations with regard to capital accounts. In a partnership, there should be as many
capital accounts and as many drawing accounts as there are partners (that is, one capital account and
one drawing account is maintained for each partner.)

CAPITAL ACCOUNT

1. Permanent withdrawal (decrease) of capital 1. Original investment by a partner

2. Share in partnership loss from operations 2. Additional investment by a partner

3. Debit balance of drawing account closed to 3. Share in partnership profits from operations to
capital be added to capital

DRAWING ACCOUNT

1. Personal withdrawal by a partner. 1. Share in partnership profits from operations

(this may be credited directly to the partner'

2. Share in partnership loss from operations (this

may be debited directly to the partner’s capital
account).
 Opening Entries
Partners may contribute cash, property, or industry to the partnership. Appropriate assets accounts are
debited for the assets contributed and partner’s capital accounts are credited for the total amount of
assets contributed.

If the asset contributed is in the form of cash, it is recorded on the partnership books at face value; if
the asset contributed is in the form of property or non-cash asset, it is recorded as at agreed value, or
in the absence of an agreement, at fair market value. When industry is contributed to the partnership, a
memorandum entry is prepared.

X. PARTNERSHIP FORMATION

Formation A: Two or more persons form a Partnership for the first time; all partners are new in
the business.

1. Cash Contributions Only (Capitalist Partners)

Abad and Alba agreed to form a partnership by contributing P600,000 cash each.
The entry to record the contributions in the partnership is:

Cash 1,200,000
Abad, Capital 600,000
Alba, Capital 600,000

2. Cash and Non-Cash Contributions (Capitalist Partners)

Abdon and Anton made the following contributions in the partnership.

Abdon Anton
Cash P600,000 P200,000
Inventories 300,000
Equipment 500,000

The entry to record the contributions of the partners follows:

Cash 800,000
Inventories 300,000
Equipment 500,000
Abdon, Capital 900,000
Anton, Capital 700,000

3. Contributions in the form of Cash, Non-cash Assets, and Industry (Capitalist and Industrial
Partners)
Alma, Anna, and Adela formed a partnership. Alma contributed P600,000 cash, Anna contributed
P300,000 cash and equipment valued at P450,000; Adela is an industrial partner to contribute her
special skills and talents to the partnership. Profit or loss is to be shared equally among partners.
The entry to record the contributions of partners Alma and Anna follows:

Cash 900,000
Equipment 450,000
Alma, Capital 600,000
Anna, Capital 750,000

The entry to record the contributions of partner Adela follows:

 Adela is admitted into the partnership as an industrial partner to share one-third in the
partnership profit.

Formation B: A sole proprietor and an individual form a Partnership

Usually, one of the prospective partners is already engaged in business prior to the formation of the
partnership. In such as case, the partner may transfer his/her assets and liabilities (net assets) to the
partnership at agreed values or at fair market values if there are no agreed values. The partnership
may either: (1) use the books of the sole proprietor, or (2) open a new set of books.
However, it is a common practice that a new set of books are opened for any new business
undertaking.
When individual set of books are kept by each partner or by any one of the partners, entries are made
on the separate books of the partners for adjustments to the recorded values. These adjustments are
made through the capital account. The capital account is credited for increases in the value of net
assets and is debited for decrease in the value of net assets.
Alternatively, a Capital Adjustment may also be used. The balance of this account, after recording all
the necessary adjustments, is transferred to the capital accounts.

Illustrative Problem A: Aguilar and Angeles formed a partnership wherein Aguilar is to contribute
cash while Angeles is to transfer the assets and liabilities (net assets) of his business. Account
balances on the books of Angeles are as follows:

Debit Credit
Cash P300,000
Accounts Receivable 450,000
Inventories 240,000
Accounts Payable 90,000
Angeles, Capital 900,000

The partners agreed on the following conditions:

1. An allowance for uncollectible accounts for P22,000 is to be established.
2. The inventories are to be valued at their current replacement cost of P270,000.
3. Prepaid expenses of P12,000 and accrued expenses of P5,000 are to be recognized.
4. Angeles is to be credited for an amount equal to the net assets transferred.
5. Aguilar is to contribute sufficient cash to have an equal interest in the partnership.

Assumption 1 – The partnership will use the books of the sole proprietor
The following procedures should be followed in accounting for this type of formation.
1. Adjust the books of the sole proprietor to bring the account balances to agreed values.
2. Record the investment of the other partner.

The adjusting entries necessary upon partnership formation, in order to arrive at the agreed values, are
recorded through the capital accounts of the partners. However, a capital adjustment account may also
be used and its balance is transferred to the capital accounts after all adjustment in net assets area
made.

The following rules will be helpful in making the necessary adjusting entries:

Debit asset and credit capital for increases in asset values

Debit capital and credit asset for decreases in asset values
Debit capital and credit liabilities for increases in liability balances
Debit liabilities and credit capital for decreases in liability balances
In the case of contra asset accounts, the following rules shall apply:

Debit contra asset account and credit capital for increases in asset values
Debit capital and credit contra asset account for decreases in asset values

Hence, the information on the partnership of Aguilar and Angeles will be accounted for as follows:

Step 1: Adjust the books of the sole proprietor Angeles to agreed values
a. Angeles, Capital 22,000
Allowance for Uncollectible Accounts 22,000

b. Inventories 30,000
Angeles, Capital 30,000

c. Prepaid Expenses 12,000

Expenses Payable 5,000
Angeles, Capital 7,000

The balance of the capital account of Angeles after the three adjusting entries are posted is P915,000
(P900,000-P22,000+P30,000+P7000).

Step 2: Record the investment of the other partner, Aguilar.

Cash 915,000
Aguilar, Capital 600,000

Assumption 2: The partnership will open a new set of books.

When a new set of books are opened for the partnership, the entry required on the new books of the
firm is the recording of the investment of the partners at agreed values. The opening entries on the
new partnership books using the data given in illustrative problem are shown below.

a. Cash 300,000
Accounts Receivable 450,000
Inventories 270,000
Prepaid Expenses 12,000
Allowance for Uncollectible Accounts 22,000
Accounts Payable 90,000
Expenses Payable 5,000
Angeles, Capital 915,000
To record the investment of Angeles

b. Cash 915,000
Aguilar, Capital 915,000
To record investment of Aguilar

Alternatively, a compound entry may be prepared to record the investment of the two partners.

Entries to adjust and close the accounts are made in the separate books of the sole proprietor but not
in the new books of the partnership. Using the same illustrative problem, the adjusting and closing
entries on the books of Angeles are as follows:

a. Angeles, Capital 22,000

Allowance for Uncollectible Accounts 22,000

b. Inventories 30,000
Angeles, Capital 30,000

c. Prepaid Expenses 12,000

 Expenses Payable 5,000
Angeles, Capital 7,000

d. Angeles, Capital 915,000

Expenses Payable 5,000
Accounts Payable 90,000
Allowance for Uncollectible Accounts 22,000
Cash 300,000
Accounts Receivable 450,000
Inventories 270,000
Prepaid Expenses 12,000
To close the books of Angeles

Formation C: Two or more sole proprietors form a partnership

When all the prospective partners are already in business, they may decide to transfer their asset and
liabilities (net assets) to the partnership at values agreed upon or at fair market values, in the absence
of agreed values. The partnership may either: (1)use the books of one of the sole proprietors, or
(2)open a new set of books for the partnership.
As mentioned earlier, however, it is more common to open a new set of books for the partnership.

Illustrative Problem B: Antonio, owner of Antonio Variety Store, and Albano, owner of Albano Trading
decided to combine their businesses on July 1, 2014. Each is to transfer business assets and liabilities
(net assets) at agreed values. Statements of financial position for the two proprietors are presented
below.

Antonio Variety Store

Statement of Financial Position
July 1, 2014

Assets
Cash P 120,000
Accounts Receivable P 72,000
Less Allowance for Uncollectible Accounts 6,000 66,000
Merchandise Inventory 330,000
Store Equipment P600,000
Less Accumulated Depreciation 30,000 570,000
Total Assets P1,086,000
Liabilities and Capital
Accounts Payable P 132,000
Antonio, Capital 954,000
Total Liabilities and Capital P1,086,000

Albano Trading
Statement of Financial Position
July 1, 2014

Assets
Cash P 30,000
Accounts Receivable P300,000
Less Allowance for Uncollectible Accounts 21,000 279,000
Merchandise Inventory 1,260,000
Delivery Equipment P480,000
Less Accumulated Depreciation 6,000 474,000
Total Assets P2,043,000
 Liabilities and Capital
Accounts Payable P 333,000
Albano, Capital 1,710,000
Total Liabilities and Capital P2,043,000

The partners agreed on the following conditions:

1. Partners’ capital in the partnership shall be equal to the adjusted net assets transferred.
2. Adjustments are to be made as follows:
a. Allowance for Uncollectible Accounts shall be P7,200 and P30,000, respectively.
b. Inventories are to be valued at 120% of their recorded values.
c. Both store and delivery equipment are 5% depreciated.

Assumption 1: The partnership will use the books of one of the sole proprietors.
The procedures to be followed under his assumption are similar to the procedures discussed under
Formation B – Assumption 1. Thus, if the books of Albano Trading will be used by the partnership, the
following procedures will be followed;

1. Adjust the books of Albano Trading to bring the balances of accounts to agreed values.
2. Record the investment of Antonio.

Step 1: Adjust the books of Albano Trading

a. Albano, Capital 9,000
Allowance for Uncollectible Accounts 9,000
P30,000-21,000=P9,000

b. Merchandise Inventory 252,000

Albano, Capital 252,000
P1,260,000*20%=P252,000

c. Albano, Capital 18,000

Accumulated Depreciation – Delivery Equipment 6,000
Delivery Equipment 24,000
P480,000 x 5% = P24,000
P474,000 – (P480,000x95%) = P18,000

Step 2: Record the investment of Antonio

a. Cash 120,000
Accounts Receivable 72,000
Merchandise Inventory (P330,000 x 120%) 396,000
Store Equipment (600,000x95%) 570,000
Allowance for Uncollectible Accounts 7,200
Accounts Payable 132,000
Antonio, Capital 1,018,000

The adjustments on the account balances of Antonio Variety Store are not taken up on the books of
Albano Trading which are now the partnership books. Instead the following adjusting and closing
entries are prepared on the separate books of Antonio Variety Store:

a. Antonio, Capital 1,200

Allowance for Uncollectible Accounts 1,200
P7,200-P6,000=P1,2000

b. Merchandise Inventory 66,000

Antonio, Capital 66,000
P330,000 x 20% = P66,000
 c. Allowance for Uncollectible Accounts 7,200
Accumulated Depreciation – Store Equipment 30,000
Accounts Payable 132,000
Antonio, Capital 1,018,800
Cash 120,000
Accounts Receivable 72,000
Merchandise Inventory 396,000
Store Inventory 600,000

Assumption 2: The partnership will use a new set of books

When a new set of books are opened for the partnership, entries are prepared to record the investment
of the partners at agreed values. The opening entries on the new partnership books using the data
given in Illustrative Problem B are shown below:

a. Cash 120,000
Accounts Receivable 72,000
Merchandise Inventory (P330,000 x 120%) 396,000
Store Equipment (P600,000 x 95%) 570,000
Allowance for Uncollectible Accounts 7,200
Accounts Payable 132,000
Antonio, Capital 1,018,800
To record the investment of Antonio

b. Cash 30,000
Accounts Receivable 300,000
Merchandise Inventory (P1,260,000 x 120%) 1,512,000
Delivery Equipment (P480,000 x 95%) 456,000
Allowance for Uncollectible Accounts 30,000
Accounts Payable 333,000
Albano, Capital 1,935,000
To record the investment of Albano

The new partnership may prepare a separate entry for each partner’s contribution as shown above or a
compound that shows the contributions of all partners.

Key Points: In the opening entry, the plant assets are recorded net of depreciation. The account
accumulated depreciation is not carried on the partnership books. The net amount, being the agreed
value, represents the cost of the plant assets to the partnership and such amount becomes the basis
for future depreciation by the partnership. On the other hand, both accounts receivable and the
corresponding allowance for uncollectible accounts are recorded on the partnership books. The
allowance for uncollectible accounts is carried on the partnership books because of the possibility of
collection. However, if there are specific accounts receivable which are deemed worthless, such must
be written off and removed permanently from the outstanding accounts receivable.

A statement of financial position prepared immediately after the formation of the partnership of Antonio
and Albanio is shown below.

Antonio and Albano

Statement of Financial Position
July 1, 2014

Assets
Cash P 150,000
Accounts Receivable P372,000
Less Allowance for Uncollectible Accounts 37,200 334,800
Merchandise Inventory 1,908,000
Store Equipment 570,000
 Delivery Equipment 456,000
Total Assets P3,418,800
Liabilities and Capital
Accounts Payable P 465,000
Antonio, Capital 1,018,800
Albano, Capital P1,935,000
Total Liabilities and Capital P3,418,800

Goodwill Resulting from the Acquisition of a Sole Proprietorship by a Partnership

The acquisition of a sole proprietorship/s by a partnership or formation of a partnership by a sole

proprietorship and an individual or among two or more sole proprietorships may involve the recognition
of goodwill. The goodwill shall be the result of the acquisition by the new partnership of the net assets
of the sole proprietorship/s. When the capital credit exceeds the agreed value or fair value of the net
assets acquired by the new partnership from the sole proprietorship, the excess is treated as goodwill.
The adjustment for the goodwill increases the capital of the sole proprietor.

PFRS 3 does not allow the amortization of goodwill acquired in a combination and instead requires the
goodwill to be tested for impairment annually, or more frequently, if events or changes in
circumstances indicate that the asset might be impaired.

XI. CAPITAL SHARE DIFFERENT FROM CAPITAL CONTRIBUTION

Prior to recording partners’ initial contributions to the partnership, the individual partners must first
agree not only on the valuation of the net assets contributions but also on their capital share. The
capital share of each partner is the percentage of equity that each of them will have in the net assets of
the newly formed partnership. Generally, the capital share of a partner is proportionate to his/her
capital contribution. However, in recognition of intangible factors such as partners’ special expertise,
established clientele or necessary business connections, partners may agree to a division of capital
that is not proportionate to their capital contributions. This situation will give rise to provision of bonus
on initial investments.

Illustrative Problem C: Alfonso and Afable formed a partnership by contributing P500,000 and
P600,000, respectively. Journal entries to record the investment of the partners under two approaches
are as follows:

1. Full investment approach

Cash 1,100,000
Alfonso, Capital 500,000
Afable, Capital 600,000

Assuming the partners agreed to have equal capital in the partnership, it is presumed that part of the
contribution of Afable is given as bonus to Alfonso in exchange for the intangible advantage that
Alfonso will be bringing in the partnership.

2. Bonus approach

Cash 1,100,000
Alfonso, Capital 550,000
Afable, Capital 550,000
(P500,000+P600,000)/2 = P550,000
XII. LOAN RECEIVABLE AND LOAN PAYABLE
Aside from the contributions, partners may also advance money to the partnership in the form of loan
when the business is in need of additional funds. Loans made by partners to the partnership, which are
payable immediately by the partnership and are usually with interest, are recorded in the account Loan
Payable or Due to Partners. This account is reported in the statement of financial position as a liability.

On the other hand, the partnership may advance money to partners, other than withdrawals, in the
form of loans. These loans, which are payable immediately by the partners and are usually with
interest, are recorded in the account Loan Receivable or Due from Partners. This account is reported
in the statement of financial position as an asset.

1. What are the steps to be followed in recording the formation of a partnership if the books of one
of the previous sole proprietors will be used? (10pts)
2. Why would a partnership decide to use the books of one of the previous sole proprietors instead
of opening new set of books? (10pts)

III. PROBLEM SOLVING.

1. Aquino and Asuncion have decided to form a partnership. Aquino invests the assets presented
below at their agreed valuation, and also transfers his liabilities to the new firm. (Cash and Net
Assets Contributions)

Ledger Balances Agreed Valuation

Cash P450,000 P450,000
Accounts Receivable 180,000 180,000
Allowance for Uncollectible 15,000 10,000
Accounts
Merchandise Inventory 300,000 270,000
Equipment 180,000 125,000
Accumulated Depreciation 30,000 ----
Accounts Payable 105,000 105,000
Notes Payable 90,000 90,000

Asuncion agrees to invest cash for a one-third interest in the firm.

A. Prepare the entries to record the investments of Aquino and Asuncion in the
partnership’s new set of books. (15pts)
B. Prepare the entries to adjust and close the balances of accounts in the books of
Aquino. (10pts)

2. On December 1, 2020, EE and FF formed a partnership, agreeing to share for profits and losses
in the ration of 2:3, respectively. EE invested a parcel of land that cost him P25,000. FF invested
P30,000 cash. The land was sold for P50,000 on the same date, three hours after the formation
of the partnership.
 How much should be the capital balance of EE right after the formation? (5pts)

3. On March 1, 2020, II and JJ formed a partnership with each contributing the following assets:

II JJ
Cash P300,000 P 700,000
Machinery and Equipment 250,000 750,000
Building ---- 2,250,000
Furniture and Fixtures 100,000 270,000

The building is subject to mortgage loan of P800,000, which is to be assumed by the partnership
agreement provides that II and JJ share profits and losses 30% and 70%, respectively.

a. Assuming, the partnership assumed the mortgage loan. How much should be the
balance in JJ’s capital on March 1, 2020? (3pts)
b. Assuming, the partnership did not assume the mortgage loan. How much should be
the balance in JJ’s capital on March 1, 2020? (2pts)

4. Amores admits Andrada to a partnership interest in his business. Accounts in the ledger of
Amores on January 1, 2020, before the admission of Andrada, show the following:

Debit Credit
Cash P 208,000
Accounts Receivable 460,000
Merchandise Inventory 1,440,000
Accounts Payable P 496,000
Amores, Capital 1,612,000

It is agreed that for the purpose of establishing the interest of Amores, the following adjustments
shall be made:

a. An allowance for uncollectible accounts of P25,000 is to be established.

b. The merchandise is to be valued at P1,600,000.
c. Prepaid expense of P72,000 and unrecorded liability of P102,000 are to be recognized.

Andrada is to invest sufficient cash for an equal interest in the partnership.

A. Assuming the new partnership will use the books of Amores, give the entries to adjust
the account balances of Amores and to record the investment of Andrade. (10pts)
B. Assuming the new partnership will open new set of books, give the entries to record
the investment of Amores and Andrade. (10pts)
 LESSO
N

3 Partnership Operation
6
HOURS

This lesson will discuss the term “partnership operation” as the conduct of the daily activities of the
business. This will also present the various methods of dividing the profits and losses including the proper
accounting treatment for salary and bonus provided to the partners, as well as the journal entries to record
the result of the business operations.

At the end of this lesson, you will be able to:

1. Discuss the nature of partnership operations;
2. Describe the various pro forma entries to record the business operations;
3. Identify the various methods of dividing the profits and losses;
4. Describe the proper accounting treatment for salary and bonus provided to the partners;
5. Discuss the statement of changes in the owner’s equity of partnership; and
6. Learn from examples of real-life cases of profit and loss distribution and emphasizing values of
accountability and respect especially in honoring the partners’ agreement

“Never give up. Today is hard, tomorrow will be worse, but the day after tomorrow will be
sunshine.”
– Jack Ma

Every business has its own struggles, most especially if it is just a start-up; it has always its ups and
downs. Partnership companies are not exempted from this fight. That’s why, partners must be very clear
from the very beginning on the rules being set in order to avoid misunderstandings and overcome the
struggles that they may meet along the way. Before starting, partners must set one of the very important
point, which is the distribution of profits and losses.
 Some days are like facing sunshine. However, some days are also like rainy days. That’s why,
partners must not only plan how to distribute profits, but they must also anticipate that they will also
shoulder or share in the distribution of losses. Whatever season it is, partners must never give up. Today is
hard, tomorrow will be worse, but the day after tomorrow will be sunshine.

The term “business operation” refers to the daily activities undertaken by the business to achieve its
goals and objectives. These different day-to-day activities performed by the business include, among
others, the following:

a. Sales of merchandise
b. Purchase of merchandise
c. Manufacture of goods
d. Purchase of raw materials
e. Payment of direct labor costs
f. Payment of operating expenses
g. Temporary withdrawal of investments
h. Return of merchandise

The accounting procedures covering these activities have been lengthily discussed in accounting for
sole proprietorship. Nonetheless, these same accounting procedures also apply to the partnership
operation. Therefore, it is assumed that you have fully understood the accounting procedures and concepts
in the preceding accounting subject and their application to the aforementioned business activities.

The discussion in this lesson focuses on the outcomes of the different activities affecting the
operation of the business, which will result in either profits or losses.

XIII. FORMATION

NATURE AND CONCEPT

In sole proprietorship, the profits realized or the losses incurred during the period are not distributed
but rather directly accrue to the owner’s capital in full amount. In a partnership, however, profits and losses
are distributed between or among the partners based on their agreement.

Before going further, some revisions on the preliminary accounting procedures in determining the
result of the operation must be pointed out first.

The result of the business operation is reflected in the statement of comprehensive income. This
particular financial statement shows two accounting elements: the revenues and the expenses. In case the
revenues are greater than the expenses, the result is a profit. Otherwise, if the revenues are less than the
expenses, the business incurs losses.

At the end of evert accounting period, the revenue and expense accounts are closed since they are
nominal or temporary accounts. To close a nominal account, another nominal account is temporarily
created. This temporary account is known as the income and expense summary account (IESA).
 If the IESA has a credit balance after closing all the nominal accounts, the balance represents the
amount of the profit. Otherwise, if the IESA has a debit balance, the amount represents the losses incurred
during the period.

Since it is temporary, the IESA is also closed, usually to the drawing account. It can, however, be
closed directly to the capita account in case the owner, to whom the profit is credited, does not have the
intention to withdraw the profit.

However, in a partnership, there are two or more owners. Thus, the amount of profits or losses are
divided among the partners based in their agreement.

The pro forma entries appear as follows:

1. To close the IESA with a credit balance, the following entry should be made:

Income and Expense Summary Account xxxx

Cyril, Drawing xxxx
Justine, Drawing xxxx

2. The drawing account of the partners is closed to the capital account. To close the drawing accounts,
the following entry should be made:

Cyril, Drawing xxxx

Justine, Drawing xxxx
Income and Expense Summary Account xxxx

This subject, in closing the IESA, will use the immediately preceding entry in all illustrations (i.e.,
IESA is closed to the capital account of partners). In other words, the profit-and-loss distribution simply
implies the closing of the IESA account.

METHODS OF DIVIDING PROFITS AND LOSSES

Since a partnership is composed of two or more partners, the amount of the profits or losses at the
end of accounting period is divided between or among them based on their agreement. There are several
ways to divide the profits and losses among the partners. These are as follows:

1. Equal distribution
2. Arbitrary ratio
3. Based on capital ratio
4. With interest on the capital
5. Salary allowances to the partners
6. Bonus to the managing partners

However, there are instances when partners adopt two different modes of dividing the profits and
losses. For example, the profits are divided equally between or among the partners, but when losses are
incurred, it will be divided based on the capital ratio.

 Equal Distribution

An equal distribution of profits and losses disregards the capital balances of or any efforts
contributed by the partners to the partnership.
Illustration 1. The Golden Partnership realized a net profit of ₱360,000.00 for the period which ended on
December 31, 2020. The capital balances of the partners are as follows:

Jocelyn, Capital ₱ 490,000.00

Loddy, Capital 510,000.00
Joji, Capital 600,000.00

Required: Prepare the entry recording the distribution of the profits equally.

Answer: The realization of the profits amounting to ₱360,000.00 during the period indicates that the IESA
has a credit balance. Since the IESA is a nominal account, it is closed by debiting.

The distribution of the profit is as follows:

Jocelyn Loddy Joji Total

Profit (₱360,000/3) ₱ 120,000.00 ₱ 120,000.00 ₱ 120,000.00 ₱ 360,000.00

To record the distribution of the profits, the following entry is made:

Income and Expense Summary Account 360,000

Jocelyn, Capital 120,000
Loddy, Capital 120,000
Joji, Capital 120,000

If this entry is correctly posted, the IESA will have a zero balance.

 Arbitrary Ratio

In dividing the profits and losses based on the arbitrary ratio, the capital contributions or the
services rendered are not given much consideration. In other words, the partners agree on a specific profit-
and-loss distribution mechanism based on what they believe is equitable, fair and just.

Arbitrary ratio can be presented in any of the following forms:

1. Fraction
2. Percentage
3. Decimal
4. Ratio

Illustration 2. The general partners in Prime Partnership are Gian Carlo and Justin, with capital
contributions of ₱320,000.00 and ₱180,000.00, respectively, and Ryven Vince, who contributes his
services. Gian Carlo, Justine and Ryven Vince share profits and losses of the partnership as follows: 3/6,
2/6 and 1/6, respectively. The partnership realized a profit amounting to ₱430,000 for 2020.

Required: Prepare the entry recording the distribution of profits.

Answer: The profits amounting to ₱430,000.00 indicate that the IESA has a credit balance. Being a nominal
account, it is closed by debiting ₱430,000.00. the corresponding credit will be made to the capital account
of the partners.

The distribution of profits is as follows:

Gian Carlo Justin Ryven Vince Total

₱430,000.00 x 3/6 ₱ 215,000.00 ₱ 215,000.00
₱430,000.00 x 2/6 ₱ 143,333.33 143,333.33
₱430,000.00 x 1/6 ____________ ___________ ₱71,666.67 ___71,666.67
 ₱ 215,000.00 ₱ 143,333.33 ₱ 7,666.67 ₱ 430,000.00

To record the distribution of the profits, the following entry is made:

Income and Expense Summary Account 430,000.00

Gian Carlo, Capital 215,00.00
Justin, Capital 143,333.33
Ryven Vince, Capital 71,666.67

Illustration 3. The partners of Jumbo Partnership, Princess, Izzy and Hyzel, share the profits and losses as
follows: 40%, 35% and 25%, respectively. During the first year of operation, the partners spent
considerable funds on advertisements and promotions to increase the market share of their business.
However, the first six months of operation incurred losses of ₱90,000.00

Required: Prepare the entry recording the distribution of the losses.

Answer: Since the business incurred losses during its first six months of operation, the IESA has a debit
balance of ₱90,000.00. To close this account, it must be credited by ₱90,000.00 and a debit must be made
to the individual capital accounts of the partners.

The distribution of losses is as follows:

Princess Izzy Hyzel Total

₱90,000 x 40% ₱ 36,000.00 ₱ 36,000.00
₱90,000 x 35% ₱ 31,500.00 31,500.00
₱90,000 x 25% __________ ___________ ₱ 22,500.00 __22,500.00
₱ 36,000.00 ₱ 31,500.00 ₱ 22,500.00 ₱ 90,000.00

To record the distribution of the losses, the following entry is made:

Princess, Capital 36,000

Izzy, Capital 31,500
Hyzel, Capital 22,500
Income and Expense Summary Account 90,000

It can be observed that the IESA is credited because the business incurred a loss during the period.
Before the entry for the profit distribution, the IESA has a debit balance of ₱ 90,000.

Illustration 4. Nicanor, Angel and Yvone are partners in ACME Partnership. The profits and losses are
divided in the ratio of 4:3:2, respectively. For 2020, the partnership realized a profit of ₱ 360,000.

Required: Prepare the entry recording the distribution of profits amounting to ₱ 360,000 to the partners.

Answer: The IESA has a credit balance of ₱ 360,000 which represents the amount of profits realized during
the period. The common divisor for the ratio of 4:3:2 is 9 which is computed by adding the three figures.
Thus, the fractional ratio for Nicanor, Angel and Yvone are 4/9, 3/9 and 2/9, respectively.

The distribution of profits is as follows:

Nicanor Angel Yvone Total

₱360,000 x 4/9 ₱ 160,000.00 ₱ 160,000.00
₱360,000 x 3/9 ₱ 120,000.00 120,000.00
₱360,000 x 2/9 ___________ ___________ ₱ 80,000.00 ___80,000.00
₱ 160,000.00 ₱ 120,000.00 ₱ 80,000.00 ₱ 360,000.00

To record the distribution of the profits, the following entry is made:

Income and Expense Summary Account 360,000.00

Nicanor, Capital 160,000.00
Angel, Capital 120,000.00
Yvone, Capital 80,000.00

 Capital Ratio

The distribution of the profits and losses based on the capital ratio emphasizes to the contributions
of the partners. In this perspective, the services, efforts, or time provided by the partners to the partnership
are disregarded.

The term “capital” may refer to any of the following:

1. Original capital
2. Beginning capital
3. Ending capital
4. Average capital

The general concept is that the profits and losses are distributed in accordance with the agreement
of the partners.
In the absence of an agreement, the share of each partner in the profits and losses is determined by
their contribution to the partnership. In other words, if there is no stipulation as to the division of profits and
losses, the share will be based on the original capital of each partner as specified in the articles of co-
partnership.

However, if the original capital is not provided or explicitly indicated in the articles, the term “capital”
will refer to the beginning capital of each partner at the start of any particular period.

In case the partnership agreement provides only the provision for the division of profits, the share of
each partner in the losses will be in the same proportion as the profit distribution.

It must be noted that industrial partners will share in the profits but are not liable for any losses.

Illustration 5. HI Partnership started operation on January 1, 2019 with the following original capital
contributions of the partners as indicated in the articles of co-partnership: Hyzel’s total contributions,
₱200,000; Izzy’s total contributions, ₱300,000.

On December 31, 2020, two years after the formation of the partnership, the capital accounts of the
partners showed the following information:

Hyzel, Capital
Date Particular Debit Credit Balance
Jan. 1, 2020 Beg. Balance 270,000.00
Mar. 1, 2020 Withdrawal 20,000.00 250,000.00
June 1, 2020 Additional Investment 60,000.00 310,000.00
Aug. 1, 2020 Additional Investment 40,000.00 350,000.00

Izzy, Capital
Date Particular Debit Credit Balance
Jan. 1, 2020 Beg. Balance 330,000.00
May 1, 2020 Additional Investment 90,000.00 420,000.00
July 1, 2020 Withdrawal 30,000.00 390,000.00
Sept. 1, 2020 Additional Investment 60,000.00 450,000.00

The partnership realized a profit of ₱400,000.00 for the year 2020.

Required: Distribute the profit of ₱400,000.00 based on the following:

a. Original capital balances

b. Beginning capital balances
c. Ending capital balances
d. Average capital balances

Answer A: Based on the Original Capital

The original capital is the capital contributions of the partners at the time of the partnership
formation. It is indicated in the articles of co-partnership.

When the partnership agreement is silent as to the division of profits and losses, the sharing will be
based on the original capital.

Sharing of profits and losses based on the original capital does not consider the changes in the
partners’ capital due to additional investments, temporary withdrawals, or net profits and losses in the
succeeding periods.

The amounts of the original capital of the partners indicated in the articles of co-partnership are as
follows: Hyzel, ₱200,000.00; Izzy ₱300,000.00.

The distribution of the profit of ₱400,000.00 is as follows:

Hyzel Izzy Total

₱200,000/₱500,000 x ₱400,000 ₱ 160,000.00 ₱160,000.00
₱300,000/₱500,000 x ₱400,000 ___________ ₱ 240,000.00 __240,000.00
₱ 160,000.00 ₱ 240,000.00 ₱ 400,000.00

To record the distribution of the profits, the following entry is made:

Income and Expense Summary Account 400,000.00

Hyzel, Capital 160,000.00
Izzy, Capital 240,000.00

Answer B: Based on the Beginning Capital

The beginning capital is the capital balances of the partners at the start of the calendar year. The
amount is equal to the ending capital balance of the immediately preceding year.

The beginning capital balances of the partners for year 2020 are as follows: Hyzel, ₱270,000.00;
Izzy ₱330,00.00.

The profit of ₱400,000.00 for 2020 is distributed based on the beginning capital balances as follows:

Hyzel Izzy Total

₱270,000/₱600,000 x ₱400,000 ₱ 180,000.00 ₱180,000.00
₱330,000/₱600,000 x ₱400,000 ___________ ₱ 220,000.00 __220,000.00
₱ 180,000.00 ₱ 220,000.00 ₱ 400,000.00

To record the distribution of the profits, the following entry is made:

 Income and Expense Summary Account 400,000.00
Hyzel, Capital 180,000.00
Izzy, Capital 220,000.00

Answer C: Based on the Ending Capital

When the partners agree to divide the profits and losses based on the ending capital balance for a
particular period, the ability of each partner to maintain or improve his/her capital contributions to the
partnership is being valued.

Consequently, partners are encouraged to maintain a favorable ending capital balance by the end
of the year. A partner with a high ending capital balance in terms of the total partnership capital received a
higher proportion of shares in the profits.

The ending capital balances of partners on December 31, 2020 are as follows: Hyzel, ₱350,000.00;
Izzy ₱450,00.00.

The profit of ₱400,000.00 for 2020 is distributed based on the beginning capital balances as follows:

Hyzel Izzy Total

₱350,000/₱800,000 x ₱400,000 ₱ 175,000.00 ₱175,000.00
₱450,000/₱800,000 x ₱400,000 ___________ ₱ 225,000.00 __225,000.00
₱ 175,000.00 ₱ 225,000.00 ₱ 400,000.00

To record the distribution of the profits, the following entry is made:

Income and Expense Summary Account 400,000.00

Hyzel, Capital 175,000.00
Izzy, Capital 225,000.00

Answer D: Based on the Average Capital

The distribution of the profits and losses based on the average capital emphasizes the movement of
the capital account during the period in view of the additional investments and permanent capital
withdrawals of the partners.

This method encourages the partners to make more investments during the year and discourages
permanent withdrawals of their capital.

There are two approached in finding the average capital of a partner. These are as follows:

1. The moving average approach

2. The net balance approach

Both approaches are in “peso months,” that is, the amount is multiplied with the applicable number
of months.

Illustrations for this will no longer be covered due to is complexity.

SALARY TO PARTNERS

The partners may agree to provide salary allowances for the services, efforts, and time devoted by
a partner in managing the daily affairs of the partnership.
 The provision of salary allowances to the partners is basically treated as a distribution of profits and
losses and not as a deductible business expense. Therefore, the amount of salary to the partners is not
included as part of the operating expenses in determining the net income for the period.

The provision of a salary is always applied even when the net income for the period is not sufficient
to absorb the total.

Illustration 5. ER Partnership, owned and managed by Edgar and Resa, has a net income of ₱180,000.00
for 2020. The partners agreed to share profits and losses as follows:

1. Salary allowances, Edgar ₱40,000.00; Resa ₱30,000.00

2. Remainder: Edgar, 60%; Resa, 40%

Required: Prepare the entry distributing the profits.

Answer: The salary allowances provided to Edgar and Resa are not considered as expenses of the
partnership but rather as a form of profit distribution. The distribution of the profits is as follows:

Edgar Resa Total

Salary allowances ₱ 40,000.00 ₱ 30,000.00 ₱70,000.00
Remainder: 60%, 40%
(₱180,000 - ₱70,000) x 60% 66,000.00 66,000.00
(₱180,000 - ₱70,000) x 40% ___________ __44,000.00 ___44,000.00
₱ 106,000.00 ₱ 74,000.00 ₱ 180,000.00

To record the distribution of the profits amounting to ₱180,000.00, the following entry is made:

Income and Expense Summary Account 180,000.00

Edgar, Capital 106,000.00
Resa, Capital 74,000.00

Illustration 6. ER Partnership, owned and managed by Edgar and Resa, has a net income of ₱120,000.00
for 2020. The partners agreed to share profits and losses as follows:

1. Salary allowances, Edgar ₱150,000.00; Resa ₱100,000.00

2. The remainder will be divided equally.

Required: Prepare the entry distributing the profits.

Answer: The total salary allowances provided to the partners amount to ₱250,000.00 while the net income
realized during the period is only ₱120,000.00. Although the net income for the period is insufficient to
absorb the total salary allowances, the distribution must still provide the required salary provision. The
distribution of the profits is as follows:

Edgar Resa Total

Salary allowances ₱ 150,000.00 ₱ 100,000.00 ₱250,000.00
Remainder: 50%; 50%
(₱120,000 - ₱250,000) / 2 (65,000.00) (65,000.00) (130,000.00)
₱ 85,000.00 ₱ 35,000.00 ₱ 120,000.00

After providing the salary allowances of the partners, the partnership has a ₱130,000.00 deficit (₱120,000 -
₱250,000) to distribute equally to the partners.

To distribute the profits amounting to ₱120,000.00, the following entry is made:

Income and Expense Summary Account 120,000.00

 Edgar, Capital 85,000.00
Resa, Capital 35,000.00

BONUS TO PARTNERS

As incentive to the partners, especially to the ones who directly manage the daily operations, a
bonus is usually awarded. The provision of a bonus to a managing partner is based on the assumption that
the partnership operation for the period is profitable. In other words, bonuses are provided only when there
is an income.

Otherwise, the provision for a bonus is not affected if the financial operation of the partnership has
incurred losses.

Illustrations for this will no longer be covered due to is complexity.

THE STATEMENT OF CHANGES IN EQUITY

The statement of changes in equity of a partnership is very similar to that of a sole proprietorship.
However, in a partnership, there are more capital accounts involved depending on the number of partners
composing the partnership.

The pro forma statement of changes in equity of a partnership appears as follows (all amounts are
assumed):

HI Partnership
Statement of Changes in Equity
As of December 31, 2020

Hyzel, Capital
Beginning balance, Jan. 1, 2020 ₱ 380,000.00
Add: Additional investment ₱ 50,000.00
Share in the net income 90,000.00 140,000.00
Total 520,000.00
Less: Drawing 30,000.00
Ending capital, Dec. 31, 2020 490,000.00

Izzy, Capital
Beginning balance, Jan. 1, 2020 ₱ 400,000.00
Add: Additional investment ₱ 70,000.00
Share in the net income 120,000.00 190,000.00
Total 590,000.00
Less: Drawing 60,000.00
Ending capital, Dec. 31, 2020 530,000.00

The ending capital balance of the statement of changes in equity appears in the equity section of
the statement of financial position or the balance sheet of the partnership.

;
Activity 1. Write TRUE if the statement is correct. Otherwise, write FALSE and briefly state your reason.
(This will part of your Participation. 2 points each)

1. The term “partnership operation” is directly related to the distribution of profits and losses to the
partners.
2. The result of the financial operation of the partnership is reflected in the statement of financial
position.
3. Both the nominal and real accounts are summarized and closed at the end of the accounting period.

4. When the Income and Expense Summary Account (IESA) has a credit balance, the amount
represents the loss incurred during the period.
5. The balance of the IESA can be closed either to the asset account of the partnership or to the
capital accounts of the partners.
6. The partners may agree to have different modes of dividing the profits and losses.
7. When profits and losses are divided equally, all the partners will have an equal amount in the
distribution of assets.
8. The arbitrary ratio agreed upon by the partners is assumed to give a fair and equitable distribution
of the profits and losses.
9. In the absence of any agreement, the division of the profits and losses is made equal.
10. All types of partners share the profits and losses at the end of the period.

Activity 2. (This will form part of your quizzes) DS Partnership started operation on January 1, 2019 with
the following original capital contributions of the partners as indicated in the articles of co-partnership:
Daniel’s total contributions, ₱300,000; Sharmaine’s total contributions, ₱200,000.

On December 31, 2020, two years after the formation of the partnership, the capital accounts of the
partners showed the following information:

Daniel, Capital
Date Particular Debit Credit Balance
Jan. 1, 2020 Beg. Balance 500,000.00
Mar. 1, 2020 Withdrawal 150,000.00 350,000.00
June 1, 2020 Additional Investment 50,000.00 400,000.00
Aug. 1, 2020 Additional Investment 50,000.00 450,000.00

Sharmaine, Capital
Date Particular Debit Credit Balance
Jan. 1, 2020 Beg. Balance 430,000.00
May 1, 2020 Additional Investment 100,000.00 530,000.00
July 1, 2020 Withdrawal 30,000.00 500,000.00
Sept. 1, 2020 Additional Investment 50,000.00 550,000.00

The partnership realized a profit of ₱1,000,000.00 for the year 2020.

Required:
(1) Distribute the profit of ₱1,000,000.00 based on the following:

a. Original capital balances (5 points)

b. Beginning capital balances (5 points)
c. Ending capital balances (5 points)

(2) Prepare journal entries to the record the distribution of profits for each method. (15 points)