Chapter 4 Accounting For Partnership Operations

Chapter 4:
Accounting for Partnership Operations
Chapter Outline
1) Nature of Partnership Operations 8) Insufficient Net Income
2) Accounting Treatment of Partnership’s Profit & Loss 9) Partnership Income Taxes
3) Sharing Partnership Profits and Losses 10) Working Paper and Financial Statements
4) Agreements in Computing Profits and Losses 11) Correction of Profits in Prior Periods
5) Salaries and Bonus for Partners’ Services 12) Statement of Changes in Partners’ Capitals
6) Multiple Basis and Priority of Allocation 13) Adjusting Capital Balance Rations to P&L Ratios
7) Interests and Salaries Treated as Expenses
Nature of Partnership Operations
A business partnership operates like any other forms of profit-oriented business. It manufactures, sells produces or provides services for
a profit.
The accounting process of a partnership’s transactions is basically similar to the accounting process for sole proprietorships or
corporations. Their differences, however, lie in the plurality of presenting partners’ capital in the statement of financial position and in
the distribution of partnership’s earnings to the partners.
In sole proprietorship, there is no sharing of profit or loss because there is only one owner who takes the benefit or burden of the business.
In a partnership business, however, the distribution of profits or loss usually depends on the partners’ agreement and on the number
partners.
In corporation, profits are distributed in the form of dividends based on the declaration by the board of directors from the undistributed
retained earnings of the business.
COMPARATIVE PROFIT DISTRIBUTION

Sole Proprietorship Partnership Corporation
The profits or losses are all taken by the The profits or losses are divided based Profits are distributed in the forms of
only owner, the sole proprietor. on the partners’ agreement. dividends based on the decision by the
board of directors
Accounting for Partnership Operation
The accounting for partnership operation is primarily concerned about the following activities:
1. Accounting treatment of profit and loss;
2. Proper distribution of profit and loss; and
3. Preparation of financial statements such as;

a. Statement of Comprehensive Income (Income Statement)
b. Statement of Financial Position (formerly Balance Sheet)
c. Partners’ capital statement (Statement of Changes in Partners’ Equity)
Accounting Treatment of Partnership’s Profit and Loss
The determination of proper income or loss is made through the preparation of income statement with the following basic formula:
Revenues Pxxx
Less: Operating Expenses xxx
Net Income (loss) xxx
In the journal entry, there is net income if the income summary account has a credit balance. There is a net loss if the income summary
account has a debit balance.
The profit or loss is subsequently distributed to the partners by closing the income summary account to the respective partners’ capital
accounts.
Illustration 1
Assume that A&B Partnership has a credit balance of income summary account amounting to P500,000. If partners A and B divide
profit equally, the journal entry to distribute the net income would be:
GENERAL JOURNAL
Page Number 121
Date Description PR Debit Credit
6/01 Income summary 500,000
A, Capital 250,000
B, Capital 250,000
To record profit distribution, equally.
Illustration 2
Assume that A&B Partnership has a debit balance of income summary account amounting P500,000. If partners A and B divide losses
with 60% and 40% loss sharing respectively, the journal entry to distribute the net loss would be:
GENERAL JOURNAL
Page Number 121
6/01 A, Capital (P500,000 x 60%) 500,000
B, Capital (P500,000 x 40%) 250,000
Income summary 250,000
To record profit distribution to A & B, 60%
and 40%, respectively.
Note: The net income or loss can also be closed first to the partners’ drawing accounts and then partners’ drawing accounts and then
the partners’ drawing accounts are subsequently closed to the partners’ capital accounts. To simplify the entries, the net income or loss
is directly closed to the partners’ capital accounts.
Sharing Partnership Profits and Losses
The primary objective of the accounting for partnership operations is the determination of periodic net income and its distribution to the
partners.
Accountants usually observe the accrual method of accounting and generally accepted accounting principles (GAAP) better measure of
determining income.
The determination of net income is calculated in a traditional manner – that is, by relating the partnership’s periodic revenues and
expenses.
In measuring partnership income for the period, however, the expenses should be scrutinized to make sure that personal expenses of the
partners are not included among the partnership’s business expenses.
If personal expenses of a partner are paid with partnership assets, the payment is charged to drawing or capital account of the partner
whose personal obligations have been settled.
This is because the partnership business is treated as a separate and distinct person from the partners in accordance with the accounting
entity concept.
The Laws on Partnership Profits and Losses Distribution
Article 1799 of the new Civil Code provides that any stipulation that excludes one or more partners from any share in the profits or
losses is void. The reason for this is that partnership must exist for the common benefit and interest of the partners.
Article 1797 of the New Civil Code of the Philippines provides the following guidelines on how the partnership profits and losses shall
be distributed among the partners:
Rules on Profits Sharing
Profit Sharing Based on Partners’ Agreement. Profits of the partnership shall be divided among the partners in accordance with their
profit-sharing ratio agreement.
Illustration
Moses and Joshua have capital balances of P65,000 and P35,000 respectively. The partnership earned a net income of P100,000. Their
profit agreement is 60% and 40% respectively.
The profit distribution between Moses and Joshua would be:
Profit of 100,000: Moses (60%) Joshua (40%) Total (100%)

Share of Moses (P100,000 x 60%) P60,000 P60,000
Share of Joshua (P100,000 x 40%) P40,000 40,000
Total P60,000 P40,000 P100,000
Note: The capital contributions of the partners have no bearing in the profit distribution because their profit ratio agreement should be
followed.
Profit Sharing based on Capital Contribution. In the absence of a profit-sharing agreement, profits shall be divided among the partners
in proportion to their respective capital contributions.
Illustration
Using the same data in preceding illustration, the profit distribution between Moses and Joshua if they have no profit and loss agreement
would be:
Profit of 100,000: Moses (65%) Joshua (35%) Total (100%)

Share of Moses (P100,000 x 65/100) P65,000 P65,000
Share of Joshua (P100,000 x 35/100) P35,000 35,000
Total P65,000 P35,000 P100,000
Notes:
1. Since there is no P&L ratio agreement between Moses and Joshua, their capital contributions are now considered as the basis of
profit or loss distribution.
2. The fraction or percentage is derived from their capital ratio, computed as follows:
Fraction Percentage
Moses (P65,000 / P100,000) 65/100 65%
Joshua (P35,000 / P100,000) 35/100 35%
Profit Sharing Based on Capital Contribution and on Service. The following rules are observed when the profit distribution is based
on capital contribution and on services rendered by a partner.
Rule 1: If there is an industrial partner, he first gets a just and equitable share for his services (industry), before the capitalist partners
divide the balance of the profits in proportion to their capital contributions.
Illustration
Let us use the same illustration above, this time involving a third person whom we shall call Caleb, as industrial partner in the partnership.
It was agreed that Caleb, being an industrial partner, will receive a profit share equivalent to 10% of the partnership net income. The
distribution of P100,000 profit would be:
Profit of 100,000: Moses (65%) Joshua (35%) Caleb (Industrial) Total (100%)
Share of Caleb (P100,000 x 10%) P10,000 P10,000
Share of Moses (P100,000 x 65/100) P65,000 65,000
Total P65,000 P35,000 P10,000 P100,000
Rule 2: If there is no specified profit sharing for an industrial partner, he shall receive a share equal to the share of a capitalist partner
having the smallest share.
Again, take the illustration above, minus the profit agreement among the capitalist partners and industrial partner. In this case, the
distribution of the partnership net profit would be:
Profit of 100,000: Moses (65%) Joshua (35%) Caleb (Industrial) Total (100%)
Share of Caleb (P100,000 x 35/135) P25,926 P25,926
Share of Moses (P100,000 x 65/135) P48,148 48,148
Total P48,148 P25,926 P25,926 P100,000
Notes:
1. The capital contribution of Joshua shall be used to allocate the share of Caleb from the profit of the partnership because there was
no profit share agreement for the industrial partner.
2. The fraction is derived by simply adding 35 profit share of the industrial partner to the profit sharing of Moses and Joshua based on
their contributed capital as 65 and 35 respectively, or total units of profit to be shared as 135 computed as follows:
Profit share Fraction

Moses, per capital contribution 65/135
Joshua, per capital contribution 35/135
Caleb is equal to the smallest share of capitalist partner 35/135
(35)
Total 135/135
Rule 3: If there is a Capitalist/Industrial Partner, he gets just and equitable share as an industrial partner and another share as a capitalist
partner according to his capital contribution.
Illustration
Assume that Caleb contributed a capital of P25,000 and, per partnership agreement he would receive a profit share of 10% from the
profit of the partnership as an industrial partner. There is no sharing agreement between the pure capitalist partners.
The distribution of profit would be:
Profit of 100,000: Moses Joshua Caleb Total (100%)

Share of Caleb:
As industrial (P100,000 x 10%) P10,000
As capitalist (P100,000 x 18%) 18,000 P28,000
Share of Moses (P100,000 x 46.80%) P46,800 46,800
Share of Joshua (P100,000 x 25.20%) P25,200 25,200
Total P46,800 P25,200 P28,000 P100,000
Notes:
1. The new profit and loss sharing ratio is computed as follows:

Partners’ Capital Computations New profit ratio
Caleb as industrial - (!00% - 90%) 10.00%
Caleb as capitalist P25,000 90% x 25/125 18.00%
Moses 65,000 90% x 65/125 46.80%
Joshua 35,000 90% x 35/125 25.20%
Total P125,000 100.00%
2. Even if Caleb has already received his share as industrial partner, he I still entitled to receive additional share from the remaining
balance of the partnership profit because he is a capitalist partner at the same time.
Rules on Losses Sharing
Loss Sharing Based on Partners’ Agreement. The following rules are observed when the distribution is based on partners’ agreement:
Rule 1: Loss of the partnership shall be divided among the partners in accordance with their profit or loss sharing agreement.
Illustration
Moses and Joshua have capital balances of P65,000 and P35,000, respectively. The partnership suffered a net loss of P30,000. They
agreed that any profit shall be divided 60% and 40% respectively, but losses shall be divided equally.
The distribution of loss would be:
Loss of P30,000 Moses (50%) Joshua (50%) Total (100%)

Share of Moses (P30,000 x 50%) (P15,000) (P15,000)
Share of Joshua (P30,000 x 50%) (P15,000) ( 15,000)
Total (P15,000) (P15,000) (P30,000)
Notes:
1. The profit-sharing ratio is different from the loss-sharing ratio, so the latter shall be used because there is a loss from operation.
2. The capital contributions of the partners have no bearing in the profit distribution because their profit and loss ratio agreement
should be followed.
Rule 2: In absence of loss sharing agreement, loss shall be apportioned among the partners in accordance with their profit-sharing ratio.
Illustration
Using the same illustration above except there was no loss ratio agreement, the distribution of partnership net loss would be:

Share of Joshua (P30,000 x 40%) (P12,000) ( 12,000)
Total (P18,000) (P12,000) (P30,000)
The existing 60% and 40% profit ratio of Moses and Joshua, respectively, were applied.
Loss Sharing Based on Capital. In absence of any loss-sharing and profit-sharing ratio, loss shall be divided among the capitalist
partners in accordance with their capital contributions.
Illustration
Using the same illustration above except that there was no profit or loss sharing agreement among the partners, the distribution of the
P30,000 partnership loss would be:
Share of Joshua (P30,000 x 35%) (P10,500) ( P10,500)
Total (P19,500) (P10,500) (P30,000)
Note: The fraction or percentage is derived from their capital ratio, computed as follows:
Fraction Percentage
Moses (P65,000 / P100,000) 65/100 65%
Joshua (P35,000 / P100,000) 35/100 35%
Loss Sharing of an Industrial Partner. The following rules are applicable for loss distribution to an industrial partner:
Rule 1: If there is no agreed loss or profit-sharing ratio and there is “pure industrial partner, he is totally exempt from sharing in the
loss.
Illustration
Assume the same data as stated above, this time with a “pure” industrial partner named Caleb. If the partnership suffered a net loss of
P30,000, the distribution of the loss would be:
Loss of P30,000 Moses (65%) Joshua (35%) Caleb (Industrial) Total (100%)
Share of Caleb - - - -
Share of Moses (P30,000 x 65%) (P19,500) - (P19,500)
Share of Joshua (P30,000 x 35%) - (P10,500) - ( P10,500)
Total (P19,500) (P10,500) - (P30,000)
Notes:
1. The industrial partner does not share in partnership losses because he already rendered his service in vain.
2. If there is a profit and loss ratio agreement, in which the industrial partner is included in the profit and loss sharing ratio, he is bound
to respect the contract between them by his co-partners. He shall therefore share in the loss equivalent to his agreed loss ratio even
if he is an industrial partner.
3. However, if there is a profit-sharing ratio and there is no loss ratio, the industrial partner is not bound to share I the partnership
losses because he did not give his consent to have his share in the partnership losses.
Rule 2: However, it must be carefully note that with respect to an industrial – capitalist partner, if there is no loss sharing agreement but
there is a profit-sharing agreement in which he industrial – capitalist partner is entitled to a profit ratio, he then becomes liable for the
losses of the partnership in the same proportion as his profit-sharing ratio.
Illustration
Assume that Caleb contributed a capital of P25,000 and per partnership agreement, he would receive 10% of partnership profit as an
industrial partner. The partnership agreement also stipulates that the capitalist partner will share equally in the partnership’s profit and
loss. The distribution of P30,000 would be:
Loss of P30,000 Moses (1/3) Joshua (1/3) Caleb (1/3) Total (100%)
Share of Caleb - - (P10,000) (P10,000)
Share of Moses (P30,000 x 65%) (P10,000) - ( 10,000)
Share of Joshua (P30,000 x 35%) - (P10,000) - ( 10,000)
Total (P10,000) (P10,000) - (P30,000)
Notes:
1. The industrial partner is not exempted from the loss sharing once he becomes a capitalist partner.
2. If there are partnership losses, however, the industrial partner shall not absorb a share from the net losses. He shall share only in the
loss as a capitalist partner.
Arbitrary Agreements in Computing Profits and Losses
Partners may share the partnership profits and losses in any manner they wish. The profit and loss agreement should contain specific
and complete provisions to avid misunderstanding and disputes among the partners.
The agreement on partnership’s profits and losses may be divided into one of the following ways:
1. Equally
2. Specified ratio or percentage
3. Capital ratio
4. Interest allowed on partner’s capitals, the remainder to be divided in an agreed ratio
5. Salaries or bonus allowed for partners’ services, the remainder to be divided in an agreed ratio
6. Multiple bases of allocation
To illustrate the methods that could be agreed upon for profit and loss distribution, assume that Adam and Eve formed a partnership
with original capital contributions of P60,000 and P30,000 respectively.
In the second year of the partnership operations, the capital and drawing balances of partners Adam and Eve are traced from the
general ledger as follows:
Adam, Drawings
Debit Credit
5/30 10,000
Adam, Drawings
Debit Credit
8/30 60,000 1/1 60,000
6/30 40,000
9/30 110,000
Eve, Drawings
Debit Credit
8/30 5,000
Eve, Capital
Debit Credit
8/30 60,000 1/1 50,000
3/30 30,000
10/1 80,000
During the year, the partnership generated an income of P200,000.
Note: Unless otherwise stated, the data above shall be used as the basis for illustrations in the succeeding discussions.
Equally
The partners may mutually agree that the partnership profit shall be equally divided between them. In case of the losses and in the
absence of a specific agreement regarding division of losses, the existing equal division of profit agreement is to be followed by the
partners.
If Adam and Eve agreed to divide the partnership profit equally, the distribution of P200,000 profit would be:
ADAM & EVE PARTNERSHIP

Profit Distribution Schedule
December 31, 200x
Equally Adam (50%) Eve (50%) Total (100%)
Computation:
Adam (P200,000 x 50%) P100,000 P100,000
Eve (P200,000 x 50%) P100,000 100,000
Net income distribution P100,000 P200,000 P200,000
It is to be observed that Adam and Eve shared on the partnership profits equally regardless of the unequal balances of their capital
contributions. To record the distribution of profit, the following journal entries shall be made:
GENERAL JOURNAL
Page Number 100
Adam, Drawings 100,000
Eve, Drawings 100,000
Note: The profit or loss distribution can also immediately be closed to the partners’ capital accounts because the partners’ drawing
accounts are ultimately closed to the capital accounts.
An alternative journal entry is to distribute net income directly to the partners’ capital accounts, as follows:
GENERAL JOURNAL
Page Number 100
Adam, Capital 100,000
Eve, Capital 100,000
For succeeding illustrations, the drawing accounts will be used in closing the profit or loss account.
Specified Ratio or Percentage
Whenever the presence of one of the partners is perceived more vital to the success of the business due to experience, ability and
reputation, the profit and loss agreement may stipulate an unequal sharing expressed in agreed specified ratio or percentage, otherwise
called an arbitrary ratio.
In specified ratio, the difference in the partner’s capital balances has no bearing in the profit and loss sharing. The agreed profit and loss
ratio may be based on the partners’ better capability or influence over the other.
To illustrate, assume that Eve is perceived more vital than Adam for the success of the partnership business, so much so that they agreed
to share in profit and loss of 60% and 40% respectively.
Based on the profit and loss agreement, Adam and Eve shall apportion the P200,000 profit in the following manner:

December 31, 200x
Arbitrary percentage Adam (40%) Eve (60%) Total (100%)
Computation:
Adam (P200,000 x 40%) P80,000 P80,000
Eve (P200,000 x 60%) P120,000 120,000
In spite of Adam’s greater ending capital balance (P150,000) than that of Eve (P100,000), the latter received a greater share from the
partnership profit because the specific percentage on the profit and loss agreement provides her 60% from the partnership earnings.
The journal entry to effect the profit distribution in the books of accounts would be:
GENERAL JOURNAL
Page Number 100
To record profit distribution with 40% and 60%
sharing.
Relative Capital Balances
When money or properties invested by the partners represent the vital contribution to the success of the partnership business, partners
may agree that their respective capital balances shall be the basis of the profit and loss sharing.
This manner of dividing profit and loss is different from a situation where there is no profit and loss agreement at all or where an arbitrary
specified ratio or percentage is used for profit sharing. This is so far the allocation of profit and loss distribution is not fixed due to
fluctuation of the capital balances of the partners.
The accounting issue in the capital ratio lies on what amount of partners’ capital should be considered in the computation of profit
distribution. For this reason, the agreement should indicate specifically whether the ratio is to be defined in terms of:
1. Original contribution;
2. Beginning capital balance of the accounting year;
3. Ending capital balance of the accounting year and;
4. Average capital balance of the year.
Original Capital Contribution. If the partners agreed that the periodic division of profits and losses be based upon their respective
original capital contributions, the reference should be made to the amounts originally invested by the partners.
To distribute the P200,000 net income of the partnership to Adam and Eve, the following computation should be made:

December 31, 200x
Original Capital Investments Adam (P60,000) Eve (P30,000) Total (P90,000)
Computation:
Adam (P200,000 x 6/9)* P133,333 P133,333
Eve (P200,000 x 3/9)* P66,667 66,667
*Note: The fraction is computed by dividing the original capital investment by the total original capital investments as follows:
Partners: Amounts Fraction

Adam P60,000 6/9
Eve 30,000 3/9
Total P90,000 9/9
To record the profit distribution, the journal entries would be:
GENERAL JOURNAL
Page Number 100
To record profit distribution based on the partners’
original investments.
Beginning Capital Balances of the Accounting Year. If the partners’ agreement provides that the periodic division of profits and
losses shall be based upon the capital balances at the beginning of the year, then the opening partners’ capital balances of the current
year shall be the basis of the profit and loss allocation.
The distribution of P200,00 profit would be:

December 31, 200x
Beginning Capital Balances Adam (P60,000) Eve (P50,000) Total (P110,000)
Computation:
Adam (P200,000 x 6/11) P109,091 P109,091
Eve (P200,000 x 5/11) P90,909 90,909
Note: The disadvantage of beginning capital balance method is that it discourages additional investments during the accounting period
because such investments are not compensated in the division of profit until the next year’s period.
The journal entry in the distribution of the profit would be:
GENERAL JOURNAL
Page Number 100
beginning capitals.
Ending Capital Balances of the Accounting Year. If the partners agreed that the division of profits and losses shall be based upon the
partners’ capital balances at the end of each year, all transactions affecting the capital accounts shall be then considered and the ending
capital balance shall be the basis of the profit and loss allocation.
The ending capital accounts of each partner are determined by getting the account balances of the partners’ capital accounts, as follows:
Adam, Capital
Debit Credit
8/30 60,000 1/1 60,000
6/30 40,000
9/30 110,000
60,000 210,000
150,000
Eve, Capital
Debit Credit
5/1 60,000 1/1 50,000
6/30 30,000
10/1 80,000
60,000 160,000
100,000
The profit distribution schedule of Adam and Eve would be:

December 31, 200x
Computation:
Adam (P200,000 x 15/25) P120,000 P120,000
Eve (P200,000 x 10/25) P80,000 80,000
Notes:
1. Drawing accounts are not included in the computation of the ending capital balances because they only reflect temporary reduction
of the capital balances representing advances to partners in anticipation of partnership profit.
2. The disadvantage of using the year-end capital balance method is that there is no incentive for a partner to make nay investments
in the earlier parts of the year.
To record the profit distribution, the journal entry would be:
GENERAL JOURNAL
Page Number 100
ending capitals.
Average Capital Balances of the Accounting Year. When partners agreed to divide profits to recognize capital changes during the
current period, the use of the partners’ average capital balances shall be employed. This method also encourages partners to contribute
during the year additional investments to the partnership.
An accounting issue is raised as to whether or not drawings made by partners during the fiscal period shall be included in the computation
of average capital. As a rule, drawing accounts are not considered in the computation of ending capital except when stated otherwise.
Methods of Computing Average Capitals
There are two methods of computing the average capitals of the partners, it may be done by using the following methods:
1. Simple average, or
2. Weighted average.
Simple Average Capital Method. This method is computed by simply dividing the sum of the beginning and ending capital y 2. The
simple average capital balances are computed as follows:
Partners Computations Simple Average Fraction

Adam (P60,000 + 150,000) / 2 P105,000 105/180
Eve (P50,000 + 100,000) / 2 75,000 75/180
Total P180,000
Using the simple average capital method, the distribution of P200,000 profit would be:
December 31, 200x
Computation:
Adam (P200,000 x 105/180) P116,667 P116,667
Eve (P200,000 x 75/180) P33,333 33,333
Weighted Average Capital Method. This method is also known as “peso-month” or “peso-day” average capital method. Under this
method, the computation of the average capital considers the period in which the capital contributions have been used in a given
accounting period.
The weighted average capital based on peso months is computed as follows:
Partners Date Capital Balance (b) Number of Months (c) Months x (c) / (b) Peso- Fraction
Unchanged Capital Months
Balance Average
Adam Jan. 1 P60,000 x 6 P360,000
Jun. 30 100,000 x 2 200,000
Aug. 30 40,000 x 1 40,000
Sep. 30 150,000 x 3 450,000
12 P1,050,000 P 87,500 875/1,400
Eve Jan. 1 P50,000 x 3 P150,000
Mar. 30 80,000 x 1 80,000
May 1 20,000 x 5 100,000
Oct. 1 100,000 x 3 300,000
12 P630,000 52,500 525/1,400
Totals P140,000
Note: The product of c is divided by 12 months to get the peso-month average capital balance. Using this method, the P200,000
partnership income shall be distributed as follows:

December 31, 200x
Peso-Month Average Capitals Adam (P87,500) Eve (P52,500) Total (P140,000)
Computation:
Adam (P200,000 x 875/1400) P125,000 P125,000
Eve (P200,000 x 525/1400) P75,000 75,000
Notes:
1. Alternatively, the weighted average capital balances can be computed as follows:
Partners Date Number of Computations Peso-Months Fraction

Months Used Average
Adam Jan. 1 12 x P60,000 x 12/12
Jun. 30 6 x P40,000 x 6/12
Aug. 30 (4) x (P60,000) x 4/12
Sep. 30 3 x P110,000 x 3/12
P 87,500 875/1,400
Eve Jan. 1 12 x P50,000 x 12/12
Mar. 30 9 x P30,000 x 9/12
May 1 (8) x (P60,000) x 8/12
Oct. 1 3 x P80,000 x 3/12
52,500 525/1,400
Totals (P87,500 + 52,500) P140,000
2. The weighted average capital method should be assumed in the absence of evidence to the contrary. Average capital means weighted
average unless another interpretation of average capital is specified in the agreement.
3. The average capital method is the best alternative compared to beginning and ending capital methods because it provides the most
equitable basis for allocating partnership income.
Allowance of Interest on Partners’ Capitals
This agreement provides that the cost of money on the capital contributions of partners will be added as a profit-sharing device in
addition to the profit and loss ratio agreement.
It is based on the philosophy that if the capital contributions have been invested in other earning activities such as trading securities, the
partners should have realized additional revenue.
The allowance of interest may be computed on the following bases:
1. Interest on capital balances, and

2. Interest on excess investments.
Interest on Capital Balances. This method allocates first a portion of profit equivalent to a certain interest rate of the partners’ capital
balance. Accordingly, the capital balances should clearly be defined in the agreement. The remaining balance of the profit shall be
distributed in accordance with the agreed arbitrary ratio.
In the absence of the agreed arbitrary ratio, the partners’ original capital contribution may be used to allocate the undistributed balance
of profit.
Illustration
Assume that Adam and Eve agreed that their respective average capital balances are entitled to a 12% interest per year and the balance
will be distributed 60% and 40%, respectively. The average capital balances of Adam and Eve are P87,500 and 52,500, respectively.
The distribution of P200,000 profit would be:
December 31, 200x
Ratio on the remaining balance Adam (60%) Eve (40%) Total (100%)
12% Interest on average capital
Adam (P87,500 x 12%) P10,500
Eve (P52,500 x 12 %) P6,300 P16,800
Balance for distribution:
Adam (P200,000 – P16,800) x 60% 109,920
Eve (P200,000 – P16,800) x 40% 73,280 183,200
Net Income distribution P120,420 P79,580 P200,000
Interest on Excess Investments. This method allows ineptest on the excess capital balance of one partner over that of another.
Illustration
Assume that Adam and Eve agreed that the excess of one partner’s average capital balance is entitled to a 12% interest per year and the
balance of partnership profit will be distributed 60% and 40%, respectively.
The average capital balances of Adam and Eve are P87,500 and P52,500, respectively. The P200,000 profit will be distributed as follows:

December 31, 200x
Interest on excess of Adam’s
Capital over Eve (P87,500 – P 4,200 P 4,200
P52,500) x 12%
Balance for distribution, P195,800*
Adam (P195,800 x 60%) 117,480 117,480
Eve (P195,800 x 40%) P78,320 78,320
Notes:
1. The balance for distribution is computed as follows:
Net income of the partnership P200,000

Less: Interest on Adam’s excess capital over Eve 4,200
[(P87,500 – P52,500) x 12%)]
Balance for distribution P195,800
2. The agreement for interest may still employ other forms. For instance, a fixed capital contribution is agreed for each partner with
interest allowed on amounts in excess of such fixed amounts and interest charged on any deficiencies.
Special Note:
Interest on Loans. As a rule, interest on capital balances shall be part of profit and loss distribution but interest charges on loans made
by the partner in favor of the partnership shall be treated as interest expense on the income statement, and not a profit and loss haring
device.
Likewise, the interest on the money borrowed by the partner from the partnership shall be treated as part of the business revenue because
such transactions create a “debtor – creditor relationship” between the partner and the firm.
Salaries or Bonus Allowed for Partners’ Services
An equitable division of profits and losses frequently requires that financial consideration be given to skills, talents, efforts and work
hours that active partners devote to the partnership business in addition to their capital investment. Consequently, salaries and/or bonuses
may be given to a partner before the agreed profit-sharing ratio distribution is made.
Salaries. To recognize personal contribution by the partner to the business, they may agree to receive salary, and divide the remaining
profit among themselves by the agreed specified ratio. Except when stated otherwise, salary allowances are part of the net income/loss
allocation to the partners.
Illustration
Assume that the Adam and Eve Partnership’s operation was a 12-month period and that they agreed that a salary of P6,000 per month
be given to each of the partner for their personal services in addition to a 12% interest on their average capital balances. The balance
shall be distributed 60% and 40%, respectively. The average capital balances of Adam and Eve are P87,500 and P52,500, respectively.
The distribution of P200,000 profit shall be:

December 31, 200x
Salary of each partner (6,000 x 12) P 72,000 P72,000 P144,000
Interest on average capital:
Adam (P87,500 x 12%) 10,500
Eve (52,500 x 12%) 6,300 16,800
Balance for distribution, P39,200
Adam (P39,200 x 60%) 23,520
Eve (P39,200 x 40%) 15,680 39,200
Salary distribution must be made even though the result of operation is loss, except when partnership agreements state otherwise.
Bonus. A partnership agreement may provide that a managing partner be allowed a bonus on the earnings of the business to encourage
profit maximization.
The bonus may be computed as follows:
Bonus = Bonus rate x Base net income

(The base net income is always assumed to be 100%)
The bonus agreement is basically stated as percentage of net income. The bonus may be based on the following net income:
1. Net income before deducting salaries, interest (if any) and bonus;
2. Net income after deducting salaries and interest (if any) but before bonus; or
3. Net income after deducting salaries, interest (if any) and bonus.
Multiple Bases and Priority of Allocation
This procedure depends on the partners’ agreement regarding the order of priority in allocating the multiple basis of profit or loss.
To divide profit equitable, partners may agree that heir salaries be first given priority over interest on capital and bonus, and if there is
a remainder, it shall be divided in an agreed ratio.
Case 1: Bonus is based on net income before deducting salaries, ineptest (if any), and bonus (is treated as part of profit distribution).
Assume that Adam and Eve agreed to the following:
a. Each of them would have a salary of P5,000 per month (one-year operation)
b. 6% interest on their respective average capital.
c. 10% bonus of net income before salaries, before interest on capital and before the bonus to Adam, the managing partner, and
d. The balance of net income shall be divided on the basis of 60% and 40%, respectively.
The average capital balances of Adam and Eve are P87,500 and 52,500, respectively. The P200,00 partnership’s net income shall be
divided as follows:

December 31, 200x
Salary of each partner (5,000 x 12) P 60,000 P60.000 P120,000
Adam (P87,500 x 6%) 5,250
Eve (52,500 x 6%) 3,150 8,400
Bonus to Adam* 20,000 20,000
Adam (P51,600 x 60%) 30,960
Eve (P51,600 x 40%) 20,640 51,600
Notes:
1. The bonus is computed as follows:
Net income of the partnership before salaries, interest and bonus P200,000
Multiply by bonus rate 10%
Bonus P20,000
Since the P200,000 is assumed 100%, the bonus is just computed by multiplying it by the bonus rate.
Net Income of the partnership P200,000

Less: Salary of partners P120,000
Interest on partners’ average capital 8,400
Bonus 20,000 148,400
Balance for distribution P 51,600
Case 2: Bonus is based on net income after deducting salaries and interest (if any) but before bonus.
Assume that Adam and Eve agreed that each of them would have a salary of P5,000 per month (one-year operation), 6% interest on
their respective average capital, and to give bonus of 10% of net income after salaries and interest on capital but before the bonus to
Adam, the managing partner. The balance of the net income shall be divided on the basis of 60% and 40% respectively.
The average capital balances of Adam and Eve are P87,500 and 52,500, respectively.
The P200,000 partnership’s net income shall be divided as follows:

December 31, 200x
Salary of each partner (5,000 x 12) P 60,000 P60,000 P120,000
Interest on average capital
Adam (P87,500 x 6%) 5,250
Eve (52,500 x 6%) 3,150 8,400
Bonus to Adam* 7,160 7,160
Adam (P64,440 x 60%) 38,664
Eve (P64,440 x 40%) 25,776 64,440
Notes:
1. The bonus is computed as follows:

Interest on partners’ average capital 8,400 128,400
Net income after salary and interest but P 71,600
before bonus
Bonus P 7,160

Bonus 7,160 135,560
Case 3: Bonus is based on net income after deducting salaries, interest (if any) and bonus (is treated as expense)
Assume that Adam and Eve agreed that each of them would have a salary of P5,000 per month (one-year operation), 6% interest on
their respective average capital, and to give onus of 10% of net income after salaries, after interest on capital, and after the bonus to
Adam, the managing partner. The balance of net income shall be divided on the basis of 60% and 40%, respectively.
The average capital balances of Adam and Eve are P87,500 and P52,500, respectively.
The P200,000 partnership’s net income shall be divided as follows:

December 31, 200x
Salary of each partner (5,000 x 12) P 60,000 P 60,000 P120,000
Adam (P87,500 x 6%) 5,250
Eve (52,500 x 6%) 3,150 8,400
Bonus to Adam* 6,509 6,509
Adam (P65,091 x 60%) 39,054.60
Eve (P65,091 x 40%) 26,036.40 65,091
Net Income distribution P110,813.60 P98,186.40 P200,000
Notes:
1. The bonus (treated as expenses) is computed as follows:

Interest on partners’ average 8,400 128,400
capital
Net income after salary and P 71,600 110%
interest but before bonus
Less: Bonus 6,509 10%
Bonus P 65,091 100%
2. Since the base is the net income after salary, interest and bonus that is assumed 100%, and the bonus rate is 10%, therefore, the net
income after salary interest but before bonus is 100%. This is computed by adding back the 10% bonus rate to the base, 100%. The
net income after salary, interest and bonus is computed as follows:
Net income after salary, interest and bonus

= Net income after salary, interest but before bonus
110%
=P65,090
3. Then the bonus is then computed as follows:
Net income after salary, interest and bonus P65,091

Bonus P 6,509

Bonus 6,509 134,909
Accounting for Interests and Salaries Treated as Expenses
Payments of interest on capital or salaries to partners are considered an allocation of profit and are usually not expense on the income
statement.
In an attempt to emulate corporate financial reporting, however, some partnerships, with adequate disclosure, do display part or all of
such payments as expenses in income statement to determine the true performance of the business.
When the interests on capital and salary are treated as ordinary operating expense, they are first deducted from the partnership net income
prior to the profit and loss distribution to partners.
Illustration
A and B agreed that each of them will receive a P10,000 monthly salary, their respective capital balance is to earn 6% interest per year,
and the remaining balance of profit is to be shared equally.
Assume the following results of operations of A&B Partnership for an accounting year:
Sales P1,000,000
Cost of Sales 400,000
Rent Expense 75,000
Supplies Expense 50,000
Depreciation Expense 20,000
If the partners agreed that their salaries and interest on capital are to be treated as operating expense and their capital balances are
P100,000 and P150,000 respectively, compute and journalize the profit distribution.
1. Computation and distribution of profit
Sales P1,000,000
Less: Cost of Sales 400,000
Gross Income P 600,000
Less Operating Expenses:
Salaries (P10,000 x 12 x 2) 240,000
Rent Expense 75,000
Supplies Expense 50,000
Depreciation Expense 20,000
Interest (P6,000 + 9,000) 15,000 400,000
Net Income P 200,000
Profit distribution
Partner A (P200,000/2) P100,000
Partner B (P200,000/2) P100,000
2. Journal entry to record the profit distribution:
GENERAL JOURNAL
Page Number 100
A, Capital 100,000
B, Capital 100,000
Profit distribution for A and B.
Notes: Tax Law requires that the distributable share of partners is subject to the following taxes:
1. If the partnership is commercial, final tax of 10%

2. If the partnership is professional, creditable tax of 10% if the distributable share is P720,00 per year or 15% if more than P720,000
per year.
Distribution of Insufficient Net Income
As a rule, the prescribed allocation for salaries and/or interest on capital balances should still be given in spite of the insufficiency of
the partnership’s net income to cover them.
The earnings deficiency produced as a result of giving salaries and/or interests shall be allocated among the partners based on their profit
and loss sharing ratio.
Illustration
Martha and Mary have average capital balances in their partnership amounting to P80,000 and P120,000 respectively. They agreed to
have a profit and loss distribution of 60% and 40%, respectively.
They work in the partnership and agreed to have a salary of P6,000 each per month and that their respective average capital balances
shall be given an interest of 6% per year.
During a calendar year operation, the partnership earned a net income of P100,000. How would the profit be distributed if Mary, the
managing partner, shall receive a bonus of 10% based on net income before salaries and interest on average capital?
The distribution of the net income of the partnership shall be:

December 31, 200x
Profit and loss ratio Martha (60%) Mary (40%) Total (100%)
Bonus to Mary (P100,000 x 10%) P10,000 P 10,000
Salary (P6,000 x 12) P72,000 P72,000 144,000
Martha (P120,000 x 6%) 7,200
Mary (P80,000 x 6%) 4,800 12,000
Deficit for distribution, (P66,000):
Martha (P66,000 x 60%) (39,600)
Mary (P66,000 x 40%) (26,400) (66,000)
Note: The bonus shall still be given to the managing partner because it is based on the net income before deducting the partners’ salaries,
interest on capital and bonus. However, if the bonus is to be computed based net income after deducting partners’ salaries and interest
on capital, there would be an income deficit. In such a case, bonus to the managing partner hall no longer be available.
Distribution of Partnership Losses
If there were partnership net loss, the partners’ salaries and interests on capital shall still be given to them. However, the bonus to the
managing partner shall be forfeited because bonuses are given as incentives for earnings, not for losses.
Illustration
Using the same data of the preceding illustration of Martha and Mary Partnership, now with the partnership suffering a net loss of
P20,000 the distribution of loss to the partners should be:

December 31, 200x
Profit and loss ratio Martha (60%) Mary (40%) Total (100%)
Salary (P6,000 x 12) P 72,000 P72,000 P144,000
Martha (P120,000 x 6%) 7,200
Mary (P80,000 x 6%) 4,800 12,000
Martha P176,000 x 60%) (105,600)
Mary (P176,000 x 40%) (70,400) (176,000)
Net income distribution (P26,400) P 6,400 (P20,000)
To record the net loss, the journal entry would be:
GENERAL JOURNAL
Page Number 100
12/31 Martha, Capital 26,400
Mary, Capital 6,400
Income Summary 20,000
To record loss distribution.
Note: The partners’ salaries and interests on capital do not necessarily reduce the capital of all the partners. It is only the capital of the
partner with a negative share who will have a debit to his capital account.
Partnership Accounting for Income Taxes
The NIRC of the Philippines provides that income taxes for partnership would depend on whether the partnership is a general
professional partnership.
As a general rule, a partnership shall be taxed as a corporation except if it is a general professional partnership.
Co-partnership. If the partnership is not exclusively for a practice of profession, otherwise known as “co-partnership” or “commercial
partnership,” it shall be subject to a tax of 30% (effective of 2009) based on its taxable net income. The partners are considered as
stockholders, and therefore, their distributive share on profit of the partnership shall be subject to a final tax of 10%.
General Professional Partnership. However, if the partnership is a general professional partnership, it is income tax exempt. The
partners’ distributive shares from the profit of the partnership shall be taxed in their separate and individual capacities using the normal
tabular tax for individual taxpayers.
If the share of individual partners amounts to P720,000 and below, such is subject to a 10% creditable withholding income tax. If the
share exceeds P720,000 the entire amount is subject to a 15% creditable withholding income tax which will be remitted by the
professional partnership to the BIR.
Illustration
Peter and John formed a partnership named PJ Partnership, with a net income before tax of P100,000. It was agreed that the partners
should share profit or loss equally.
The comparative journal entries to record the income tax and distribution of profit PJ Partnership would be:
1. To record the income tax liability of the partnership:
GENERAL JOURNAL
Co-ownership
Page Number 100
12/31 Income tax expense 30,000
Income tax payable 30,000
GENERAL JOURNAL
As General Professional Partnership
Page Number 100
No Entry 30,000
30,000
Notes:
a. The general professional partnership as no journal entry because it is not subject to income tax liability. Only the co-
partnership has a provision for income tax liability computed as follows:
Net Taxable Income P100,000

Multiply by Corporate Income Tax Rate 30%
Income Tax Payable P 30,000
b. For taxation purposes, the income tax expense is a nondeductible expense from gross income. However, for accounting
purposes, it would still diminish the partnership profit to be distributed to the partners. Consequently, it shall be recorded
in the books of accounts.
2. To record distribution of profit to partners:
GENERAL JOURNAL
Co-ownership
Page Number 100
12/31 Income Summary 70,000
Peter, Capital 35,000
John, Capital 35,000
GENERAL JOURNAL
Page Number 100
12/31 Income Summary 100,000
Peter, Capital 50,000
John, Capital 50,000
Note: The share of each partner is computed as follows:
Co-Partnership General Professional Partnership

Co-Partnership: Peter John Peter John
P70,000/2 P35,000 P35,000 - -
Gen. Prof. Partnership
P100,000/2 - - P50,000 P50,000
Totals P35,000 P35,000 P50,000 P50,000
The net income of the co-partnership is reduced by the 30% corporate tax, while the general professional partnership’s net income
remains intact because of its income tax exemption.
3. To record withholding taxes from partner’s profit share:
GENERAL JOURNAL
Co-ownership
Page Number 100
12/31 Peter, Drawings 3,500
John, Drawings 3,500
Dividends withholding tax payable 7,000
GENERAL JOURNAL
Page Number 100
12/31 Peter, Drawings 5,000
John, Drawings 5,000
Income Tax withholding tax payable 10,000
Note:
a. The partnership, whether a co-partnership or a general professional partnership, is required to withhold income taxes from the
profit share of the partners.
If the partnership is a co-partnership, a 10% final dividends tax on the partners’ income from the partnership shall be withheld.
The computation of dividend withholding tax payable is as follows:
Peter John Total

Net income after tax P35,000 P35,000 P70,000
Multiply by dividend tax rate 10% 10% 10%
Final tax on dividends P 3,500 P 3,500 P 7,000
Once an income has been subjected to a final tax, it shall not anymore be reported as part of gross income subject to individual
normal tabular tax.
b. If the partnership is a general professional partnership, the profit shar of each partner is subject to a 10% creditable income tax,
computed as follows:
Peter John Total

Net income after tax P50,000 P50,000 P100,000
Multiply by dividend tax rate 10% 10% 10%
Final tax on dividends P 5,000 P 5,000 P 10,000
A professional partnership would be entitled to tax exemption only if it engages purely in the practice of a common profession.
A creditable withholding tax can be used as tax credit against the annual income tax payable of an individual taxpayer.
4. To record partnership’s subsequent tax payments to the BIR:
GENERAL JOURNAL
Co-ownership
Page Number 100
12/31 Income Tax Payable 30,000
Dividends 7,000
Withholding tax payable 37,000
GENERAL JOURNAL
Page Number 100
12/31 Income Tax Withheld Payable 10,000
Cash 10,000
SUMMARY
Income Taxes of Partnership
Co-Partnership General Professional Partnership
Partnership’s Income Tax Liability
Subject to corporate income tax of 30% beginning of 2009. Tax Exempt
Withholding Taxes on Partner’s Profit Share
Final tax of 10% based on partner’s profit share based on If the partner’s share is P720,000, the CWT is 10%
partnership net income after income tax If the partner’s share exceeds P720,000, the CWT is 15%
Individual Partner’s Income Tax Liability
None. It has been subjected to a final tax of 10% Subject too individual income tax liability of Sec.24 A,
NIRC to be reduced by the creditable withholding tax
Partnership’s Working Paper and Financial Statements
At the end of each accounting period, the partnership’s financial statements are prepared. To facilitate the adjustments of accounts and
preparation of financial statements, a working paper or worksheet is prepared.
The principle of preparing the worksheet and financial statements of partnership is the same as that the sole of proprietorship, except
that in a partnership there are more than one accounts representing the partner’s capital and partner’s drawing.
Comprehensive Problem: Matthew and Mark formed a general professional partnership of CPAs named M&M Partnership. The
following partnership agreements are extracted from the records of the partnership:
1. The ending capital balances of the partners shall be entitled to a 6% interest. The partners originally contributed cash amounting to
P80,000 for Matthew, and P35,000 for Mark.
2. A monthly salary of P5,000 for each of the partner shall be given. A 1% bonus after partners’ salaries, interest on capitals and bonus
shall be allowed to Matthew being the managing partner. The balance shall be shared equally.
3. The salaries shall be charged to their respective drawing accounts.
The partnership’s trial balance shows the following summary of its business activities from January to December 31, 200x:
A’s Proprietorship
Trial Balance
June 1, 200a
Account Title Debit Credit

Cash P 5,000
Accounts receivable 20,000
Loans to Mark P 200
Prepaid Supplies 8,000
Office Equipment 10,000
Accounts Payable 20,000
Matthew, Capital 8,900
Mark, Capital 5,000
Matthew, Drawings 500
Mark, Drawings 600
Professional revenue 180,000
Transportation expense 11,000
Telephone expense 6,000
Miscellaneous expense 1,000
P300,000 P300,000
Additional Information:
a. The office equipment is to be depreciated by10% per year. It was purchased on March 31, 200x
b. The remaining amount of unused supplies is only P500
c. The loans to Mark have an accrued interest of P240 at the end of the year.
d. The 5% of the accounts receivable is deemed uncollectible
e. Salaries of the partners for the month of December 31, 200xx were already taken but not yet recorded.
f. Shares of partners are subject to 10% withholding tax
Required:
1. Prepare the working paper of the partnership.

2. Prepare the financial reports:
a. Statement of Comprehensive Income (Income Statement)
b. Schedule of Profit Distribution
c. Statement of Partner’s Equity
d. Statement of Financial Position (Balance Sheet)
e. Statement of Cash Flows
3. Record adjustments.
4. Close the nominal accounts of the partnership.
5. Prepare the post-closing trial balance of the partnership.
Requirement 2 – FINANCIAL REPORTS
Statement of Comprehensive Income
M&M Partnership
Statement of Comprehensive Income
Year Ended, December 31, 200x Observe that the partners;
Professional revenue P180,000 salaries, interest on capital
Add: Interest income 240 and bonuses are not included
Total revenue P180,240 in the computation of
Less: Operating expenses: partnership’s net income.
Transportation expense P11,000 They are considered in the
Supplies expense 9,500 distribution of profit and loss.
Telephone expense 6,000
Depreciation expense 3,750 The net income of P145340
Bad debts expense 3,650 is forwarded to the profit
Miscellaneous expense 1,000 34,900 distribution schedule to
Net income P145,340 compute the profit share of
each partner.
Schedule of Profit Distribution
M&M Partnership
Year Ended, December 31, 200x
Matthew Mark Total
Ratio on the remaining balance
50% 50% 100%
Partner’s salaries:
Matthew (P5,000 x 12) P60,000
Mark (P5,000x12) P60,000 P120,000
Interest on capital
Matthew (P80,000 x 60%) 4,800
Mark (P35,000 x 6%) 2,100 6,900
Bonus to Matthew* 1,676
Balance P16,764 - equally 8,382 8,382 17,764
Profit distribution P74,858 P70,482 P145,340
Note: The bonus method is computed as follows:
Net income before salaries, interest and bonus P145,340

Less: Salaries of partner P120,000
Interest on partner’s capital 6,900 126,900
Net income after salaries and interest before P 18,440
bonus
Less: Net inc0pme after bonus (P18,440/P110%) 16,764
Bonus P 1,676
Statement of Partner’s Equity
M&M Partnership
Statement of Partner’s Equity
Matthew Mark Total
Partners’ capital, January 1,200x P 80,000 P 35,000 P115,000
Add: Profit distribution 74,858 70,482 145,340
Totals: P154,858 P105,482 P260,340
Less: Partners’ drawings* 67,485 67,048 134,533
Partner’s capital, December 31,200x P 87,373 P 38,434 P1258,07
*Salaries plus 10% creditable withholding tax of P60,000 + (P74.858 x 10%)
The amount of adjusted partners’ capital shall be recorded in the partner’s equity section of
balance sheet.
Statement of Financial Position
M&M Partnership
Statement of Financial Position
December 31, 200x
Current Assets:
Cash P 9,000
Accounts receivable P 73,000
Less: Allowance for bad debts 3,650 69,350
Loans to partner (Mark) 20,000
Accrued interest receivable 240
Prepaid supplies 500 P 99,090
Noncurrent Assets
Office equipment P 50,000
Less: Accum. depreciation 3,750 46,250
Total assets P145,340
Current Liabilities:
Accounts payable P 5,000
Withholding tax payable 14,533 19,533
Partners’ Equity:
Matthew, Capital P 87,373
Marl, Capital 38,434 125,807
Total liabilities and partners’ equity 145,340
Statement of Cash Flows
M&M Partnership
Statement of Cash Flows
Operating Activities:
Net Income P145,340
Add (Deduct) Adjustments
Depreciation expense 3,750
Increase in accounts payable 5,000
Increase in withholding tax 14,533
Increase in accounts receivable ( 69,350)
Increase in loans to partner ( 20,000)
Increase in accrued interest expense ( 240 )
Increase in prepaid supplies ( 500) P 78,533
Financing Activities:
Matthew contribution P 80,000
Mark contribution 35,000
Matthew withdrawals ( 67,485)
Mark withdrawals ( 67,048) ( 19,533 )
The final amount of
Investing Activities:
cash in the statement
Purchase of office equipment ( 50,000)
of cash flows must be
Increase in cash P 9,000
as the amount of cash
Add: Cash balance, January 1, 200x -0-
reported in balance
Cash balance, December 31, 200x P 9,000 sheet
Requirement 3 - ADJUSTMENTS
GENERAL JOURNAL
Page Number 9
Date
Description PR Debit Credit
200x
(a) Depreciation expense 3,750
Accumulated depreciation – Equipment 3,750
To record provision for depreciation, computed as:
(950,000 x 10% x9/12) P3,750
(b) Supplies 9,500 The adjusting entries

Prepaid supplies 9,500 are necessary to
To record supplies used, computed as follows: update mixed
(P10,000 – P500 ) P9,500 accounts or correct
unadjusted accounts
(c) Accrued interest receivable 240 receivable in the
Interest income 240 books of account.
To record accrued income advance from mark.
(d) Bad debts expense 3,650

Allowance for bad debts 3,650
To record provision for doubtful accounts
(P73,000 x 5%) P3,650
GENERAL JOURNAL
Page Number 9
Date
200x
(e) Matthew, Drawings 5,000
Mark, Drawings 5,000 Continuation of
Cash 10,000 Adjusting Entries
To record salaries of partners
The drawing accounts of
(f) Matthew, Drawings 7,485 the partners are charged
Mark, Drawings 7,048 to effect withholding
Withholding tax payable 14,533 taxes on each partner’s
To record tax withheld of 10% from the partners’ share from the net
profit share. income of partnership.
Matthew (P74,858 x 10%) P 7,485
Mark (P70,482 x 10%) 7,048
P14,533
Requirement 4 – CLOSING ENTRIES

GENERAL JOURNAL
Closing entries bring all
Page Number 10 the revenue and expense
Date accounts to zero
200x balance.
(a) Professional Revenue 180.000
Interest income 240 The balance of income
Income summary 180.240 summary account
To close revenue accounts. (representing either net
income or net loss) is
(b) Income summary 34,900 first closed to the
Transportation expense 11,000 drawing accounts, which
Supplies expense 9,500 shall be closed finally to
Telephone expense 6,000 the capital accounts.
Depreciation expense 3,750
The partners’ drawings
Bad debts expense 3,650
are summarized as
Miscellaneous expense 1,000
follows:
To close expense accounts.
Matthew, Drawings
(c) Income summary 145,340 55,000 74,858
Matthew, Drawings 74,858 5,000
Mark, Drawings 70,482 7,485
To close net income. 67,485 74,858
7,373
(e) Matthew, Drawings 7,373
Mark, Drawings 3,434
Matthew, Capital 7,373 Mark, Drawings
Mark, Capital 3,434 55,000 70,482
To close drawing accounts. 5,000
7,048
67,048 70,482
3.434
Requirement 5 – POST-CLOSING TRIAL BALANCE
M&M Partnership
Post-Closing Trial Balance
December 31, 200x
Account Title Debit Credit
Cash P 9,000
Accounts receivable 73,000
Allowance for bad debts P 3,650
Accrued interest receivable 240
Loans to Mark 20,000
The post-closing trial balance
Prepaid supplies 500
contains the adjusted real
Office equipment 50,000
accounts (balance sheet
Accumulated depreciation - equipment 3,750 accounts) at the end of the
Accounts payable 5,000 accounting period.
Withholding tax payable 14,533
Matthew, Capital 87,373
Mark, Capital 38,434
P152,740 P152,740
Correction of Profits in Prior Periods*

Whenever there are misstated earnings of the previous year and were subsequently discovered in the current period, the correction shall
be made directly to the partners’ capital accounts.
The correct earnings for the prior period, as well as the proper share of the profits or losses to which each of the partners was entitled,
should be calculated. The incorrect share that each partner actually received shall be compared with the correct share that he should
have received. The difference shall either increase or decrease the capital accounts of the affected partners.
Illustration
Based on the preceding illustration (distribution of partnership losses), assume that the loss of P20,000 was due to overstatement of
equipment depreciation by P50,000. Such error was discovered in the current period after the net loss has been closed to the capital
accounts.
*This topic is thoroughly discussed in Chapter 1 under the topic ‘Review of Correcting Accounting Errors.’
The overstatement of depreciation resulted in a net loss of P20,000 which should have been a net income of P30,000. The correct
distribution of profit that should have been made would be:

Martha Mary Total
Profit and loss ratio 60% 40% 100%
Bonus (P30,000 x 10%) P 3,000 P 3,000
Salary (P6,000 x 12) P 72,000 P 72,000 144,000
Martha (P120,000 x 6%) 7,200
Mary (P80,000 x 6%) 4,800 12,000
Martha (P129,000 x 60%) (77,400)
Mary (P129,000 x 40%) (51,600) (129,000)
Net income distribution P 1,800 P 28,000 P 30,000
The adjustments to correct the error of the prior period reported loss can first be made by comparing the recorded error and they
should have been reported income and its correct distribution, as follows:
Mary Martha Total

Should have been the income distribution P 1,800 P28,200 P30,000
Less: Recorded share in net income (loss) (26,400) 6,400 (20,000)
Increase (decrease) in partners’ capital P28,200 P21,800 P50,000
The effect correction in the partnership books, the correcting entry would be:
GENERAL JOURNAL
Date Page Number 100
200b Description PR Debit Credit
12/31 Accumulated depreciation - Equipment 50,000
Martha, Capital 28,200
Capital, Capital 21,800
To record correction of income of prior period.
Notes:
1. The total adjustments in the partners’ capital accounts are equal to the adjustment in the accumulated depreciation.
2. Alternatively a T-account approach c be used to analyze the adjustments, as follows:
Accumulated Depreciation -
Equipment Martha, Capital
Adj. 50,000 Error 26,400 Adj. 28,200
1,800
Mary, Capital
Correct net income, P30,000 Error 6,400
(P1,800 + P28,200) Adj. 21,800
28,200
Statement of Changes in Partners’ Capitals
Also called “statement of changes in partners’ equity,” this statement is a schedule which shows the changes in the capital interest of
each partner due to investments, withdrawals and net income or loss during an accounting period.
Illustration
Assume the following data affecting the capital balances of partners Lino and Roco:
Overstatement of depreciation, 200A P 25,000

Unrecorded supplies expense, 200A 15.000
Net income for distribution, 200B 200,000
200B Lino (60%) Roco (40%)

Capital balance, January 1 before adjustments P 120,000 P 90,000
Additional investments 50,000 60,000
Personal drawings 26,000 4,000
The statement of changes in partners’ capital of LINO & ROCO PARTNERSHIP would be:
LINO & ROCO PARTNERSHIP
Statement of Changes in Partners’ Equity
December 31, 200b
Lino (60%) Roco (40%) Total
Capital balance, Jan. 1, 200B P120,000 P 90,000 P210,000
Add (deduct): Prior period adjustments:
Overstatement of depreciation 15,000 10,000 25,000
Unrecorded supplies expense ( 9,000) ( 6,000) ( 15,000)
Corrected capital balances, Jan. 1, 200B P126,000 P 94,000 P220,000
Add: Additional investments 50,000 60,000 110,000
Net income per distribution 120,000 80,000 200,000
Totals: P296,000 P234,000 P530,000
Less: Partner’s drawings 26,000 4,000 30,000
Capital balance, Dec. 31, 200B P270,000 P230,000 P500,000
Adjusting Capital Balances Ratio to Profit and Loss Ratio
As an ordinary situation in business, the ratios of partners’ capital and profit/loss may not be the same from the very beginning of
partnership or may change as a result of varying amount of partners’ drawings and other capital adjustments.
The partners may continue this situation, but they may decide to adjust the ratios of their capital balances equal to their respective
profit/loss ratios.
Illustration
Assume the following data:
Partners: Profit and Loss Ratio Capital Balances

Ed 40% P 350,000
Greg 35% 340,000
Darl 25% 310,000
Totals 100% P1,000,000
To adjust the capital balance ratios to profit and loss ratios, the following methods may be observed:
1. Direct payment to the existing partner. Capital balances ratios are equalized with the profit and loss ratios by direct payment to
the partner(s) whose capital is to be reduced. The total partnership’s capital remains the same.
The increase (decrease) of partners’ capital is computed as follows:
Ed (40%) Greg (35%) Darl (25%) Total (100%)

Required capital P400,000 P350,000 P250,000 P1,000,000
Capital balances (350,000) (340,000) (310,000) (1,000,000)
Increase (decrease) P 50,000 P 10,000 P 60,000 P - 0 -
The journal entries would be:
GENERAL JOURNAL
12/31 Darl, Capital 60,000
Ed, Capital 50,000
Greg, Capital 10,000
Adjustments in partners’ capital.
Note: The entries for payments of P50000 and P10000 made by partners Ed and Greg to Dan are not reflected in the partnership’s
books because the transaction is personal transaction among them.
2. Additional investment to the firm. Capital balances ratios equalized with the profit and loss ratio by additional investments
using as the basis the capital of partner having the lowest possible cash investment. This results in the increase of the total
partnership’s capital.
The required partnership capital balance should be increased and is computed as follows:
Darl’s capital balance P 310,000

Divided by Darl’s P/L ratio 25%
Required partnership’s capital balances P1,240,000

Required capital P496,000 P434,000 P310,000 P1,240,000
Capital balances (350,000) (340,000) (310,000) (1,000,000)
Increase (decrease) P 146,000 P 94,000 P - 0 - P 240,000
GENERAL JOURNAL
12/31 Cash 240,000
Ed, Capital 146,000
Greg, Capital 94,000
Note: Partners Ed and Greg gave additional investments to the partnership to equalize the ratios of their capital balances and
profit & loss.
3. Capital withdrawal. Capital balance ratios are equalized with the profit and loss ratio by capital withdrawals using the capital of
partner having the highest possible cash investment as the basis, This results in the decrease of the total partnership‘s capital.
The required partnership capital balance should be decreased and is computed as follows:
Ed’s capital balance P 350,000

Divided by Ed’s P/L ratio 40%
Required partnership’s capital balance P 850,000

Required capital P350,000 P306,250 P218,750 P 875,000
Capital balances (350,000) (340,000) (310,000) 1,000,000
Increase (decrease) P - 0 - (P33,750) (P91,250) (P 125,000)
GENERAL JOURNAL
12/31 Greg, Capital 33,750
Darl, Capital 91,250
Cash 125,000
Note: Partners Greg and Darl received cash from the partnership to equalize the ratios of their capital balances and profit & loss.
Chapter 4 - REVIEW QUESTIONS
Chapter Discussions:
1. What is the main difference between partnership business accounting and single proprietorship business accounting?
2. What is the primary objective of accounting for partnership operations?
3. Give the summary rules of partnership profit and loss distribution.
4. Enumerate the methods of computing profit and loss distributions.
5. State the rules of the following:
a. Interest on partner’s capital balance
b. Interest on excess investments
c. Salaries or bonus for partners’ services
6. State the rule of profit distribution when there is (a) an insufficient net income, or (b) partnership incurred net loss.
7. What is the accounting procedure when there are prior period corrections in profit or loss?
8. Distinguish the income tax treatment between a co-partnership from a general professional partnership.

Chapter 4 Accounting For Partnership Operations

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Chapter 4 Accounting For Partnership Operations

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What are the main differences between partnership accounting and sole proprietorship accounting?

What are the main differences between partnership accounting and sole proprietorship accounting?

What is the primary objective of accounting for partnership operations?

What is the primary objective of accounting for partnership operations?

Chapter 4:

Accounting for Partnership Operations

Nature of Partnership Operations

COMPARATIVE PROFIT DISTRIBUTION

Accounting for Partnership Operation

1. Accounting treatment of profit and loss;

2. Proper distribution of profit and loss; and

3. Preparation of financial statements such as;

Accounting Treatment of Partnership’s Profit and Loss

Sharing Partnership Profits and Losses

Rules on Profits Sharing

The profit distribution between Moses and Joshua would be:

Profit of 100,000: Moses (60%) Joshua (40%) Total (100%)

Profit of 100,000: Moses (65%) Joshua (35%) Total (100%)

Profit share Fraction

The distribution of profit would be:

Profit of 100,000: Moses Joshua Caleb Total (100%)

1. The new profit and loss sharing ratio is computed as follows:

Rules on Losses Sharing

The distribution of loss would be:

Loss of P30,000 Moses (50%) Joshua (50%) Total (100%)

Loss of P30,000 Moses (60%) Joshua (40%) Total (100%)

Arbitrary Agreements in Computing Profits and Losses

During the year, the partnership generated an income of P200,000.

ADAM & EVE PARTNERSHIP

Specified Ratio or Percentage

ADAM & EVE PARTNERSHIP

ADAM & EVE PARTNERSHIP

Partners: Amounts Fraction

To record the profit distribution, the journal entries would be:

The distribution of P200,00 profit would be:

The journal entry in the distribution of the profit would be:

ADAM & EVE PARTNERSHIP

To record the profit distribution, the journal entry would be:

Methods of Computing Average Capitals

Partners Computations Simple Average Fraction

The weighted average capital based on peso months is computed as follows:

ADAM & EVE PARTNERSHIP

1. Alternatively, the weighted average capital balances can be computed as follows:

Partners Date Number of Computations Peso-Months Fraction

Allowance of Interest on Partners’ Capitals

The allowance of interest may be computed on the following bases:

1. Interest on capital balances, and

ADAM & EVE PARTNERSHIP

1. The balance for distribution is computed as follows:

Net income of the partnership P200,000

The distribution of P200,000 profit shall be:

ADAM & EVE PARTNERSHIP

The bonus may be computed as follows:

Bonus = Bonus rate x Base net income

Multiple Bases and Priority of Allocation

Assume that Adam and Eve agreed to the following:

ADAM & EVE PARTNERSHIP

1. The bonus is computed as follows: