De La Salle University

ACTBFAR – Basic Financial Accounting and Reporting

Accounting for Partnership

Teaser Questions:
• How Is Profit Calculated In A Partnership?
• How Is Profit and Loss Distributed In A Partnership?
• How To Split Profit In A Business Partnership? What If One Partner Contributed More
Capital Than The Other?

PARTNERSHIP OPERATIONS

Operation – division of profits or losses

The Accounting Cycle of a Partnership is similar to that of sole proprietorship. After recording all
transactions of the partnership for a certain period, Financial statements are prepared. One of the
important reports to check financial performance is the Statement of Profit or Loss (generally known
as Income Statement).

However, one of the questions distinctive only to partnership operations is “How do we allocate
the partnership profit among the partners?”

ABC Trading Co.

Statement of Profit or Loss
For the year ended December 31,2020

Notes
Net Sales 1 9,730,000
Cost of Sales 2 (3,576,000)
Gross Profit 6,154,000
Other income -
Total income 6,154,000
Operating Expenses
Distribution Costs 3 (1,454,750)
General and Administrative Expense 4 (1,064,750)
Other Expenses -
Interest Expense -
Profit for the year 3,634,500
Division of profits and losses

• The partners shall share in the profits or losses of a partnership in accordance with the
partnership agreement. (Articles of Partnership)
• If only the share of each partner in the profits has been agreed upon, the share of each in
the losses shall be in the same proportion.
• In the absence of stipulation, the share of each partner in the profits and losses shall be in
proportion to what he may have contributed, but the industrial partner shall not be liable
for the losses. (Art. 1797 of the Philippine Civil Code)
• The designation of losses and profits cannot be entrusted to one of the partners (Art.
1798).
• A stipulation which excludes one or more partners from any share in the profits or losses is
void (Art. 1799).

Situation: If the result of the operation is Capitalist-

profit Capitalist Industrial Industrial
Basis: Profit
With profit or Loss Agreement Basis: Profit ratio Basis: Profit ratio
ratio
Basis: Profit
With profit agreement only Basis: Profit ratio Basis: Profit ratio
ratio
Proportionate to
capital
Equal to the contribution (as
Basis:
share of capitalist capitalist) ; equal
No profit or loss agreement Capital
with smallest to share of
Contribution
share capitalist with
smallest share (as
industrial)

Situation: If the result of the operation is Capitalist-

Capitalist Industrial
loss Industrial
Basis: Loss
With profit or Loss Agreement Basis: Loss ratio Basis: Loss ratio
ratio
Basis: Profit ratio
Basis: Profit as capitalist and
With profit agreement only No Share
ratio No share as
industrial
Basis: capital
Basis: contribution ratio
No profit or loss agreement Capital No Share as capitalist and
Contribution No share as
industrial
What ratio to use in allocating the profits and losses?

The allocation process can be further refined by a ratio that is either divided evenly among the
partners or weighted in favor of one or more members.

• Equally – “the partners agreed to divide the profit or loss equally”

• Arbitrary ratio - “the partners agree to have a 60:20:20 profit and loss ratio”
• Capital Ratios:
o Original Capital Ratios - “the partners agreed to divide the profit or loss based on
the initial capital investments”.
o Beginning Capital Ratios - “the partners agreed to divide the profit or loss based on
the beginning capital balance of each year”
o Ending Capital Ratios - “the partners agreed to divide the profit or loss based on the
ending capital balance”
o Average Capital Ratios - “the partners agreed to divide the profit or loss based on
the average capital balance” – Average capital means based on the fluctuations of
the investments and drawings on each partner for the year.

Profit Allocation Process

The allocation process can be based on any number of factors. The actual assignment of income
should be designed to give fair and equitable treatment to each of the partners. These schemes are
the following:

1. Salaries – normally, an industrial partner shall receive salary, in addition to his share in the
partnership’s profits, as compensation for his services to the partnership.

2. Bonuses – the partnership agreement may stipulate a bonus to be given to a managing

partner to encourage excellent management performance. Unlike for salaries though, a
partner is entitled to a bonus only if the partnership earns profit.
• Bonus (B) based on profit before deducting bonus but after deducting income tax
(T)
• Bonus based on profit after deducting bonus but before deducting income tax
• Bonus based on profit after deducting both bonus and income tax

3. Interest on capital contributions – the partnership agreement may stipulate that each partner
may be entitled to a per annum interest computed on his capital contributions.
• Interest on beginning capital balance
• Interest on ending capital balance
• Interest on average capital balance

The above-mentioned items are normally provided first to the respective partners and any remaining
amount of the profit or loss is shared based on the stipulated profit or loss ratio.
Salaries

Salaries – normally, an industrial partner shall receive salary, in addition to his share in the
partnership’s profits, as compensation for his services to the partnership.

Example #1: The partnership agreement of A, B and C stipulates the following:

• Partners A and C shall receive annual salaries of ₱12,000 and ₱8,000, respectively.
• Any remaining profit or loss shall be shared as follows: 40% to A and 30% each to B and C.

The partnership earns profit of ₱100,000. Compute for the respective shares of the partners.

A (40%) B (30%) C (30%) Total

Salaries 12,000 8,000 20,000
Remainder:
40:30:30 32,000 24,000 24,000 80,000
Allocation 44,000 24,000 32,000 100,000

Example #2: The partnership agreement of A, B and C stipulates the following:

• Partners A and C shall receive annual salaries of ₱12,000 and ₱8,000, respectively.
• Any remaining profit or loss shall be shared as follows: 40% to A and 30% each to B and C.

At the end of December (reporting date), the partnership earns profit of ₱100,00. The partnership
started on April 1 of the year. Compute for the respective shares of the partners.

Months
Annual Salaries Months Covered Salaries
A 12,000 9/12 (April-Dec) 9,000
C 8,000 9/12 (April-Dec) 6,000

A (40%) B (30%) C (30%) Total

Salaries* 9,000 6,000 15,000
Remainder:
40:30:30 34,000 25,500 25,500 85,000
Allocation 43,000 25,500 31,500 100,000

Bonuses

Bonuses – the partnership agreement may stipulate a bonus to be given to a managing partner to
encourage excellent management performance. Unlike for salaries though, a partner is entitled to a
bonus only if the partnership earns profit.
• Bonus (B) based on profit before deducting bonus but after deducting income tax
(T)
• Bonus based on profit after deducting bonus but before deducting income tax
• Bonus based on profit after deducting both bonus and income tax
• Bonus based on profit after deducting both salaries, bonus and income tax
Formula in getting the Bonus
Assume that the ratio of bonus is 20%. B = Bonus ; S = Salaries ; T = Tax; P= Profit
B = 20% (P – T) à Bonus based on profit before deducting bonus but after deducting income tax
B = 20% (P – B) à Bonus based on profit after deducting bonus but before deducting income tax
B = 20% (P – B - T) à Bonus based on profit after deducting both bonus and income tax
B = 20% (P – S – B - T) à Bonus based on profit after deducting salaries, bonus and income tax

Example #3. The partnership agreement of A, B and C stipulates the following:

• Partners A and C shall receive annual salaries of ₱12,000 and ₱8,000, respectively.
• A bonus of 10% of profit after salaries but before deduction of bonus shall be given to
Partner A, the managing partner.
• Any remaining profit or loss shall be shared as follows: 40% to A and 30% each to B and C.

The partnership earns profit of ₱100,000. Compute for the respective shares of the partners.

Compute the bonus and derive the formula: B = 10% (P-S)

B=?
P = 100,000
Salaries = 20,000

B = 10% (100,000 – 20,000)

B = 10% (80,000)
B = 8,000

A (40%) B (30%) C (30%) Total

Salaries 12,000 8,000 20,000
Bonus 8,000 8,000
Remainder:
40:30:30 28,800 21,600 21,600 72,000
Allocation 48,800 21,600 29,600 100,000

Example #4. The partnership agreement of A, B and C stipulates the following:

• Partners A and C shall receive annual salaries of ₱12,000 and ₱8,000, respectively.
• A bonus of 10% of profit after salaries, bonus, and tax to be given to Partner A, managing
partner. Assuming that tax is 30%.
• Any remaining profit or loss shall be shared as follows: 40% to A and 30% each to B and C.

The partnership earns profit of ₱100,000. Compute for bonus.

Compute the bonus and derive the formula: B = 10% (P-S)
B = ? ; P = 100,000 ; Salaries = 20,000 ; T = 30% of Profit

Income Tax is computed as profit multiply by the tax rate. P100,000 X 30% = 30,000.
B = 10% (100,000 – 20,000 – B - 30,000 )
B = 10% (50,000 – B
B = 5,000 – 1.1B
B = 5,000/1.1
B =4,545.45
Interest on capital contributions

Interest on capital contributions – the partnership agreement may stipulate that each partner may be
entitled to a per annum interest computed on his capital contributions.
• Interest on beginning capital balance
• Interest on ending capital balance
• Interest on average capital balance

Example #5. The partnership agreement of A, B and C stipulates the following:

• Partners A and C shall receive annual salaries of ₱12,000 and ₱8,000, respectively.
• A bonus of 10% of profit after salaries but before deduction of bonus shall be given to
Partner A, the managing partner.
• Each partner shall receive 10% interest on average capital investments.
• Any remaining profit or loss shall be shared as follows: 40% to A and 30% each to B and C.

The average capital investments of partners during the year are as follows:
A ₱100,000
B 60,000
C 120,000

The partnership earns profit of ₱100,000. Compute for the respective shares of the partners.

A (40%) B (30%) C (30%) Total

Allocation:
1. Salaries 12,000 8,000 20,000
2. Bonus (100K - 20K) x 10% 8,000 8,000
3. Interest on average cap.
(100K x 10%);(60K x 10%);(120K x 10%) 10,000 6,000 12,000 28,000
4. Allocation of remainder:
(100K - 20K - 8K - 28K) = 44K;
(44K x 40%); (44K x 30%); (44K x 30%) 17,600 13,200 13,200 44,000
As allocated 47,600 19,200 33,200 100,000

Interest on average capital is

A = 100,000 X10% = 10,000
B = 60,000 X 10% = 6,000
C = 120,000 X 10% = 12,000

This is the same allocation process with beginning capital balance and ending capital balance.
What if Average capital is not given and only investments and drawings are provided?

Example #6. Assume that A&B Partnership earns profit of ₱100,000 in 2020. The movements
in the capital accounts of the partners are shown below:

A, capital B, capital
Dr. Cr. Dr. Cr.
Jan. 1 120,000 80,000
May 1 20,000 10,000
July 1 20,000
Aug. 1 10,000
Oct. 1 10,000 5,000

• Each partner shall receive 10% interest on average capital investments.

• Any remaining profit or loss shall be shared equally.

Compute for the average capital of each partner.

Recall: the Normal balance (account increases) of a Capital account is Credit .

• Capital account increases by investments (original and additional) and profit; and
• Capital account deceases by withdrawals (either through capital or drawing account) and
loss.

Profit or loss is accounted at the end of the year thus these the capital balances are more on
investments and withdrawals since partners have transactions evenly during the year.

Partner A: Amount Months remaining Total

Balance, Jan. 1, 2020 120,000 12 1,440,000
Withdrawal, May 1 (20,000) 8 (160,000)
Additional investment, Aug. 1 10,000 5 50,000
Withdrawal, Oct. 1 (10,000) 3 (30,000)
Total 1,300,000
Divided by total months 12
Weighted Ave. Capital 108,333

Partner B: Amount Months remaining Total

Balance, Jan. 1, 2020 80,000 12 960,000
Withdrawal, May 1 (10,000) 8 (80,000)
Additional investment, July 1 20,000 6 120,000
Withdrawal, Oct. 1 (5,000) 3 (15,000)
Total 985,000
Divided by total months 12
Weighted Ave. Capital 82,083
Allocation of Insufficient Profit

Example #7. The partnership agreement of A, B and C stipulates the following:

• Partners A and C shall receive annual salaries of ₱12,000 and ₱8,000, respectively.
• A bonus of 10% of profit after salaries but before deduction of bonus shall be given to
Partner A, the managing partner.
• Each partner shall receive 10% interest on average capital investments.
• Any remaining profit or loss shall be shared as follows: 40% to A and 30% each to B and C.
The average capital investments of partners during the year are as follows:
A ₱100,000
B 60,000
C 120,000

The partnership earns P10,000. Compute for the respective shares of the partners.

A B C Total
Allocation:
1. Salaries 12,000 8,000 20,000
2. Bonus (N/A) - -
2. Interest on cap.
(100K x 10%);(60K x 10%);(120K x 10%) 10,000 6,000 12,000 28,000
3. Allocation of remainder
(10K - 20K - 28K) = -38K
(-38K x 40%); (-38K x 30%); (-38K x 30%) (15,200) (11,400) (11,400) (38,000)
As allocated 6,800 (5,400) 8,600 10,000

Bonus is given if there is a profit. Although the partnership earned profit, it appears that there would
be an income deficit after deducting salaries. Thus, no bonus shall be given to managing partner. If
the case is before deducting salaries, then bonus shall still be given to managing partner.

What if Partnership incurs loss?

Example #8. Use the example above but partnership incurs loss of P20,000. How do we
allocate the loss to each partner?

Allocation Process:
A B C Total
Allocation:
1. Salaries 12,000 8,000 20,000
2. Bonus (N/A) - -
2. Interest on cap.
(100K x 10%);(60K x 10%);(120K x 10%) 10,000 6,000 12,000 28,000
3. Allocation of remainder
(-20K - 20K - 28K) = -68K
(-68K x 40%); (-68K x 30%); (-68K x 30%) (27,200) (20,400) (20,400) (68,000)
As allocated (5,200) (14,400) (400) (20,000)

No Bonus shall be given because the partnership incurs loss.

Statement of Changes in Partners’ Equity

What are the movements in equity accounts?

At the end of each fiscal year, when revenues and expenses are closed out, some assignment must
be made of the resulting income figure because a partnership will have two or more capital accounts
rather than a single capital balance. This allocation to the capital accounts is based on the agreement
established by the partners preferably as a part of the Articles of Partnership.

Movements in the equity accounts are almost similar except that profits and losses are distributed
and shared among and with the partners in adherence to the partnership agreement.

Movements in Equity accounts are the following:

a. Profit or Loss
b. Additional investments to the firm
c. Withdrawals

Profit or Loss:

• If the intention of the partners is to make the profit or loss a part of permanent capital.

Partnership books
Profit
Accounts DR CR
Income Summary XX
A, Capital XX
B, Capital XX
To close profit for the year

Loss
Accounts DR CR
A, Capital XX
B, Capital XX
Income Summary XX
To close loss for the year

• If the intention of the partners is to keep the capital accounts intact for investments and
permanent withdrawals of capital. Permanent capital balances are maintained.

Profit
Accounts DR CR
Income Summary XX
A, Drawings XX
B, Drawings XX
To close profit for the year
 Loss
Accounts DR CR
A, Drawings XX
B, Drawings XX
Income Summary XX
To close loss for the year

If the problem is silent then the assumption is permanent capital balances are maintained. Individual
drawing accounts of partners are not automatically closed to their capital accounts in order to
maintain the original capital balances of the partners as stated in the Articles of Co- Partnership;
drawing accounts are closed to the capital accounts only if agreed upon.

Additional investments to the firm

Cash Investments
Accounts DR CR
Cash XX
A, Capital XX
B, Capital XX
To record the additional investment of the partners

Non-cash Investments
Accounts DR CR
Land XX
A, Capital XX
B, Capital XX
To record the additional investment of the partners

Withdrawals

Permanent Withdrawals

Withdrawals
Accounts DR CR
A, Capital XX
B, Capital XX
Cash XX
To record the withdrawals of the partners
Temporary Withdrawals

What if the partners intention is to maintain the capital accounts?

Example #9. Assume that AB Partnership earns P100,000 profit. The profit is divided equally.

Profit
Accounts DR CR
Income Summary 100,000
A, Drawings 50,000
B, Drawings 50,000
To close profit for the year

Personal withdrawals by a partner in anticipation of profits are not considered as permanent in

substance. The Securities and Exchange Commission (SEC) rules that a partner can withdraw only
up to the extent of his or her share in the profits realized from business operations.

A, partner withdraw 40,000. What is the journal entry?

Drawings
Accounts DR CR
A, Drawings 40,000
Cash 40,000
To record the withdrawals

What will happen to the P10,000 balance? Either A would withdraw or reinvest the P10,000. If
reinvested, entry should be:

Drawings
Accounts DR CR
A, Drawings 10,000
A, Capital 10,000
To record the reinvestment of the profit

Investments and permanent withdrawals will require amendment of the Articles of Co-Partnership.

Note that individual capital and drawing balances shall be combined to arrive at partner’s
ending capital balance. As such, either treatment would result in the same partner’s ending
capital balances presented in the Statement of Financial Position.
Accounting for partnership operations is best documented in a schedule of distribution of net
income. See sample below:

Distribution of Net Income

A B C Total
Annual salaries given to A & C 12,000 8,000 20,000
10% Bonus after salaries given to A 8,000 8,000
10% Interest on average capital 10,000 6,000 12,000 28,000
Allocation of remainder; 40:30:30 17,600 13,200 13,200 44,000
Share in profit 47,600 19,200 33,200 100,000

Statement of Changes in Partner’s Equity - A statement that reports the movements that have
taken place in the partners’ equity during the period.

ABC Trading Co.

Statement of Changes in Partner’s Equity
For the year ended December 31,2020

A B C Total
Beginning Capital 1/1/2020 325,000 250,000 300,000 875,000
Additional Investments - 10,000 20,000 30,000
Profit for the year 47,600 19,200 33,200 100,000
Drawings (50,000) (50,000) (50,000) (150,000)
Ending Capital 12/31/2020 322,600 229,200 303,200 855,000

____MJ ESPIRITU____