The net worth of these two great wealth accumulators are simply unimaginable by

Philippine standards. Their informal programming partnership started in the early

1970s. Gates and Allen are pioneers in the production of vaporware. Vaporware reters
tothe tactic to announcing a software product before it exists, typically to discourage
rivals from proceeding with development of competing versions.

In 1975, they have developed a product tolicense--BASIC (Beginners' All-Purpose

Symbolic Instruction Code), which is an easy-to-learn programming language. Gates and
Allen formed apartnership, initially called "Micro-Soft" (short for "microcomputer
software"). Profits were to be split 60:40. Later amended to 64:36 with Gates receiving
the larger share in recognition of his greater contribution to the original development of
the BASIC software.

Gates eventually dropped out of Harvard to work full time at Microsoft. Within a year
of Microsoft's founding, its BASIC program had effectively become the standard for
microcomputers. Now, the Microsoft'screed of "Acomputer on every desk and in every
home, running Microsoft software" is coming into fruition. In 1990, the Windows 3.0
became the hottest software product of all time, selling amillion copies within four
months. Several Windows versions and Microsoft Offices later; as they say, the rest is
history! Adapted from: Forbes Asia, Top Five of The 400 Richest People in America, Forbes
Global, Special 2013, 2012, 2008, 2007, 2005, 2002 & 2000 Issue and How To Be A Billiongire by
Martin S. Fridson.

What are the factors to be considered in arriving at a plan for dividing profits or losses in
the case of Gates and Allen (assuming they did not incorporate at the outset)? In the
instant case, Gates has the net worth of USD 61 billion while Allen has USD 14.2 billion,
one reason being their sharing is in the ratio of 64:36.

Should capital investment be given more weight than technical contribution with regard
to the formulation of the profit-sharing scheme? If there is no agreement as to how
profits or losses will be shared, then what rules will apply? Assuming there is an
agreement, what are the common arrangements to govern the distribution of profits or
losses? There are partnerships that allow salary allowances, bonus, and/or interest on
partners' capital balances. Why are these techniques resorted to?

PARTNERS' EQUITY IN ASSETS CONTRASTED WITHSHARE IN PROFITS OR

LOSSES

The basis on which profits or losses are shared is a matter of agreement among the
partners and may not necessarily be the same as their capital contribution ratio. The
equity of a partner in the net assets of the partnership should be distinguished from a
partner's share in profits or losses.

Illustration. "Nelson Daganta is a one-third partner" is an ambiguous statement.

Daganta may have one-third equity in the net assets of the partnership but might have a

Partnership Operations and Financial Reporting | 2-3

 statement may also be
loss of the firm. Such a
larger or smaller
interpreted share
to mean that profitis or
Daganta
in the entitled to one-third of the profit or loss. although
his capital account may represent much more or much less than one-third of the total

agree on any type or proit and loss ratio

PalunerS capital. Simply put. partners may balances.
regardless of the amòunt of their respective capital account
DIVIDING PROFITS OR
tACTORS TO CONSIDER IN ARRIVING ATAPLAN FOR
LOSSES

Money, Property or Industry

Partnership profits are realized as a result of putting together the contributions
money, property or industry-of the partners. The amount of capital invested by each
partner, the amount of time each partner devotes to the business and other
contributions are the factors being considered in the formulation of an equitable profit
and loss ratio.

There are profit-sharing plans which emphasize either the value of personal services
rendered by individual partners or the amounts of capital invested by each partner.
Some agreements consider the importance of both the amount and quality of
managerial services rendered, and the amount of capital invested by the partners for
the success or failure of a partnership. In this case, allowances may be provided for
salaries to partners and interest on their respective capital balances as a preliminary
step in the division of profits or losses; the balance may then be divided in a specified
ratio. Among the other factors which may be considered are as follows:
1 A partner has considerable personal financial
resources, thus giving the
strong credit rating. In general, partners have unlimited liability. A very partnership a
will make the partnership attractive to creditors. solvent partner
2. A partner who is well known in a
profession or an
the success of the partnership although he may not industry may contribute immensely to
the partnership.
participate actively in the operations of
These two factors may be incorporated in the plan to
arrive at a ratio by which any
remaining profits or losses are to be divided.

llustration. Daria Tolentino and Eleanor Tan are

Partner Daria Tolentino contributed most of the partners in a coco water businesS.
time for its daily operations. On one assets of the business but spends little
hand, Partner Eleànor Tan
assets but devotes her full knowledge and contributed less in
attention to the
contributions alone will result partnership.
profits or losses based on capital To divide
and loss sharing agreement should to iniguities. The profit
bonus in recognition of the talent andhave considered the provision of
time being contributed byPartnersalaries or even
Eleanor Tan.

2-4 | Partnership and Corporation Accoun ting

Performance Methods
Many partnerships use profit and loss sharing arrangements that give some Welgnt to
the specific performance of each partner to provide incentives to perform welI. This
allocation of profits to a partner on the basis of performance is frequently referred to as
abonus. Examples of the use of performance criteria are:
1. Chargeable hours. These are the total number of hours that a partner incurred on client
related ass0gnments. Weight may be given tohours in excess of a standard.
2 Total billings. The total amount billed to clients for work performed and supervised by a
partner constitutes total billings. Weight may be given to billings in excess of norm.
3. Write-offs. Consist of uncollectible billings. Weight may be given to a write-off percentage
below a norm.

4. Promotional and civic activities. Time devoted to developing future business and enhancing
the partnership name in the community is considered promotional and civic activity. Weight
may be given to time spent in excess of a norm or to specific accomplishments resulting in
new clients.

5 Profits in excess of specified levels. Designated partners commonly receive a certain

percentage of profits in excess of a specified level of earnings.

RULES FORTHE DISTRIBUTION OFPROFITS OR LOSSES

The profits or losses shall be distributed in conformity with the agreement. 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 profits or losses shall be in
proportion to what he may have contributed (according to the ratio of original capital
investments or in its absence, the ratio of capital balances at the beginning of the year),
but the industrial partner may not be liable for the losses.

As for the profits, the industrial partner shall receive such share as may be just and
equitable under the circumstances. If aside from his services he has contributed capital,
he shall also receive a share in the profits in proportion to his capital (Civil Code of the
Philippines, Article 1797). Astipulation which excludes one or more partners from any
share in the profits or losses is void (Article 1799). The partnership must exist for the
common benefit or interest of the partners. Asummary of the above legal provisions is
prepared as follows:
1, Profits

a. the profits will be divided according to partners' agreement.

b. if there is no agreement:
as to capitalist partners, the profits shall be divided according to their
capitalcontributions (according to the ratio of original capital investments
or in its absence, the ratio of capital balances at the beginning of the year).
Partnership Operations and Financial Reporting | 2-5
 as to industrial partners (if any), such share as may be just and equitable
under the circumstances, provided, that the industrial partner shall receive
Such share before the capitalist partners shall divide the protts.
2. Losses
the losses will be divided according to partners' agreement.
D. IT there is no agreement as to distribution of losses but there is an agreement as
to protits, the losses shallbe distributed according to the profit sharing ratio.
C. in the absence of any
agreement:
as to capitalist partners, the losses shall be divided according to their capital
contributions (according to the ratio of original capital investments or in its
absence, the ratio of capital balances at the beginning of the year).
as to purely industrial partners (if there's any), shall not be liable for any
losses.
The industrial partner is not liable for losses because he cannot
withdraw the work or
labor already done by him, unlike the capitalist partners who can
In addition, if the partnership failed to realize any withdraw their capital.
profits, then he has labored in vain
and in a real sense, he has already contributed his share in the
loss.
CORRECTION OF PRIOR PERIOD ERRORS

Any business entity will from time to time

discover
profit in prior accounting periods. Good internal errors made in the measurement of
should serve to minimize the number of financial control and the exercise of due care
these safeguards cannot be expected to reporting errors that occur; however,
statements.
completely eliminate errors in the financial

Per International Accounting Standards (|AS) No. 8, Accounting Policies,

Accounting Estimates and Errors, prior period errors åre Changes in
omissions
misstatements of the entity's financial statements for one or more prior from and other
discovered in the current period. Errors may occur as a periods that are
mistakes in applying accounting policies, result of mathematical mistakes,
misinterpretation
Examples include errors in the estimation of of facts, fraud or oversights.
and omission of accruals of revenue and depreciation, errors
expenses.
in inventory valuation,
Material prior periods must be restated to
operations as they would have been presentedreport had
financial position and results of
the
amount of the correction of apror period error error never taken place. The
reported by adjusting the opening balances of that relates to prior periods should be
liabilities. The correction of a prior period errorpartners' equity and affected assets and
is excluded from profit or loss
period in which the error is discovered, for the

2-6 | Partnership and Corporation Accounting

 If anerror resulted in an understatement of profit in previous periods, acorrecting entry
would be needed to increase Capital. If an error overstated profit in prior periods, then
Capital would have to be decreased. The effect of the error correction will be divided
based on the applicable profit and loss ratio.

DISTRIBUTION OF PROFITS OR LOSSES BASED ON PARTNERS' AGREEMENT

In general, profits or losses shall be divided in accordance with the agreement of the
partners. The ratio in which profits or losses from partnership operations are
distributed is recognized as the profit and loss ratio.

The partners may agree on any of the following scheme in distributing profits or losses:
1. Equally or in other agreed ratio
2. Based on partners' capital contributions:
ratio of original capital investments
b ratio of capital balances at the beginning of the year
C ratioof capital balances at the end of the year
d. ratio of average capital balances
3. By allowing interest on partners' capital and the balance in an agreed ratio
4. By allowing salaries topartners and the balance in an agreed ratio
5. By allowing bonus to the managing partner based on profit and the balance in
an agreed ratio
6. By allowing salaries, interest on partners' capital, bonus to the managing
partner and the balance in an agreed ratio (combination of 3 to 5)

Note that the partners can agree on not using a residual sharing ratio ("the balance in
an agreed ratio") if profits do not exceed the total salary and interest allowances. In
Such a case, the partners must agree on the priority of the various profit or loss
distribution schemes.

Illustration. The following series of illustrations are based on the figures obtained from
the Medina and Detoya Partnership which had a profit of P300,000 for the year ended
Dec. 31, 2015, the first year of operations. The partnership contract provided that each
partner may withdraw P5,000 on the last day of each month; both partners did so
during the year. The drawings are recorded by debits to the partners' drawing accounts
and shall not be considered in the division of profit or loss. It is the intention of the
partners that each partner's share in the profit or loss be either credited or debited to
the drawing account.

Leopoldo Medina invested P400,000 on Jan. 1, 2015 and an additional P100,000 on April
1. Edgar Detoya invested P800,000 on Jan. 1 and withdrew P50,000 on July 1. These
transactions and events are summarized in the following capital, drawing and income
Summary ledger accounts:

Partnership Operations and Financial Reporting | 2-7

 Edgar Detoya, Capital
Leopoldo Medina,Capital
Jan. 1
Jan. 1 400,000 July 1 50,000 800,000
Apr. 1 100,000
Edgar Detoya, Drawing
Leopoldo Medina, Drawing
Jan. - Dec. 60,000 Jan. - Dec. 60,000

Income Summary
Dec. 31 300,000

Equally or inother Agreed Ratio

Partnership contracts may provide that profit or loss be divided equally. The profit of
P300,000 for the Medina and Detoya Partnership is transferred by a closing entry on
Dec. 31, 2015, from the income summary ledger account to the partners' drawing
accounts:

Income Summary 300,000

Leopoldo Medina, Drawing 150,000
Edgar Detoya, Drawing 150,000
To record the division of profits.
If the partnership had a loss of P200,000 for the year ended Dec. 31, 2015, the income
summary ledger account would have a debit balance of P200,000. This loss would be
transferred to the partners' drawing accounts by a debit to each drawing account for
P100,000 and a credit to the income summary account for P200,000.
Leopoldo Medina, Drawing 100,000
Edgar Detoya, Drawing 100,000
Income Summary
To record the division of losses. 200,000

Assume instead that Medina and Detoya share profits and

profit was P300,000, the profit would be divided as losses in a ratio of 60:40 and
follows:
Income Summary
300,000
Leopoldo Medina, Drawing
Edgar Detoya, Drawing 180,000
To record the division of 120,000
profits.
Computation:
Medina: 60% x P300,000
Detoya: 40% x P300,000 P180,000
120,000
P300,000
Based on Partners' Capital Contributions
Division of partnership profits in
most likely to be found in proportion to the capital
partnerships which substantialinvested by each
in partner is
2-8 | Partnership and
Corporation Accounting investments is the pprincipal
ingredient for success. It is essential that the partnership contract be specific with
respect to the concept of capital. Capital may refer to either of the following:
Ratio of Original Capital Investments. Assume that the partnership agreement provides
for the division of profits in the ratio of original capital investments. The original
investments of Medina and'Detoya are P400,000 and P800,000, respectively. The profit
of P300,000 for 2015 is divided as follows:

Income Summary 300,000

Leopoldo Medina, Drawing 100,000
Edgar Detoya, Drawing 200,000
To record the division of profits.

Computation:
Medina: P300,000x P400,000/P1,200,000 P100,000
Detoya: P300,000 x P800,000/P1,200,000 200,000
P300,000

After the entry allocating the profits of P300,000 to Medina and Detoya, are the
partners supposed to receive cash for their respective share in the profits? No, the
partners' share in the profits cannot be attributed to any particular asset, including cash.
The entry increased the equity of Medina and Detoya in allthe assets of the partnership.
Ratio of Capital Balances at the Beginning of the Year. Assume that the partnership
agreement provided for the division of profits in the ratio of capital balances at the
beginning of the year. In this case, the original capital investments are also the capital
balances at the beginning of the year since the partnership is only on its first year of
operations. The profit of P300,000 for 2015 is divided as follows:
Income Summary 300,000
Leopoldo Medina, Drawing 100,000
Edgar Detoya, Drawing 200,000
To record the division of profits.
Computation:
Medina: P300,000 x P400,000/P1,200,000 P100,000
Detoya: P300,000 x P800,000/P1,200,000 200,000
P300,000
Ratio of Capital Balances at the End of the Year. Assume that the profit is divided in
the ratio of capital balances at the end of the year before drawings and the distribution
of profit. The ending balances are PS00,000 for Medina and P750,000 for Detoya; the
profit of P300,000 for 2015 is divided as follows:
Income Summary 300,000
Leopoldo Medina, Drawing 120,000
Edgar Detoya, Drawing 180,000
To record the division of profits.

PartnershipOperations and Financial Reporting | 2-9

 Computation:
P120,000
Medina: P300,000 x P500,000/P1,250,000
180,000
Detoya: P300,000 x P750,000/P1,250,000 P300,000

Katio oft Average Capital Balances Division of profits or losses on the basis of the three
Geu"8 capital concepts-original capital investments; capital balances at the
beginning of the year; or capital balances at the end of the year-may prove inequitable
if there are material changes in the capital accounts during the year.

When beginning capital balances are used in allocating profits, additional investments
during the year are discouraged because the partners making such investments are not
compensated in the division of profits until the next year.

If ending capital balances are used, vear-end investments are encouraged, but there is
no incentive for a partner to make any investments before year-end. In
addition,
amounts earlier withdrawn may be reinvested before year-end. These
considerations
suggest that using average balances as a basis for distributing profits or losses is
preferable because it reflects the capital actually available for use by the
during the year. partnership
The agreement should also state the amount of
These drawings are considered temporary and are drawings each partner may make.
drawing account. Drawings within the allowable recorded as debits to the partner's
amount will not affect the
computation of the average capital balance. On the contrary, drawings in excess of the
allowable amount are considered permanent
reductions
computation of the average capital balance is affected. in capital; hence, the

In the continuing illustration for the

entitled to withdraw P5,000 monthly Medina and Detoya
or a total of P60,000Partnership,
the partners are
withdrawals are directly debited to the partners' capital per annum, Any additional
affect thecomputation of the average capital ratio. accounts and therefore will

Medina and Detoya

Computation
For
of the Average Capital
Balances
the Year Ended Dec. 31,
20115
Leopoldo Medina, Capital
Date Capital Account Portion* of the
Balances Year Unchanged Average Capital
Jan. 1 P400,000 Balances
3/ 12
Apr. 1 500,000 X
9/ 12 P100,000
Average Capital 375,000
P475,000
2-10| Partnership and Corporation Accounting
 Edgar Detoya, Capital
Jan. 1 P800,000 X 6/ 12 P400,000
July 1 750,000 X 6/ 12 375,000
Average Capital P775,000

Total Average Capital Balances P1,250,000

*The fractions for each partner should add up to 12/12 or 1. This convention will help minimize
counting errors as to the number of months the capital balance went unchanged. To state the
obvious, there are only 12 months in a year. For example, for Partner Medina, the fraction willtotal
to 12/12 [3/12 + 9/12 = 12/12 ] or 1.

The entry to record the division of P300,000 profits is as follows:

Income Summary 300,000
Leopoldo Medina, Drawing 114,000
Edgar Detoya, Drawing 186,000
To record the division of profits.
Computation:
Medina: P300,000 x P475,000/P1,250,000 P114,000
Detoya: P300,000 x P775,000/P1,250,000 186,000
P300,000

By Allowing Interest on Capital and the Balance in an Agreed Ratio

In the preceding section, the plan for dividing the total profits in the ratio of partners'
capital balances was based on the assumption that capital investments were the
controlling factor in the success of the partnership. However, it is not always the case.
Consequently, partnerships may choose to allocate a portion of the total profits in the
capital ratio and the balance equally or in other agreed ratio after due consideration of
the partners' other contributions.

To allow interest on partners' capital account balances is almost similar to dividing part
of profits in the ratio of partners' capital balances. If the partners agree to allow
interest on capitalas afirst step inthe division of profit,they should specify the interest
rate to be used. It should also state whether interest is to be computed on capital
balances on specific dates or on average capital balances during the year.

Partners invested in apartnership for profits, not for interest. The interest on partners'
capital, along with the other profit sharing plans to be discussed in the remainder of the
chapter, are to be considered as mere techniques to share partnership profits or losses
equitably and not as expenses of the partnership. On the other hand, the interest on
loans from partners is recognized as expense and a factor in the measurement of profit
or loss of the partnership. Similarly, interest earned on loans to partners is recognized
as partnership income. This treatment is consistent with the discussion in Chapter 1
that loans receivable from or payable to partners are assets and liabilities, respectively,
of the partnership.
Partnership Operations and Financial Reporting | 2-11
 Partnership with a profit of
Continuing the illustration of Medina and
Detoya
that the partnership
P300,000
shown, assume
for 2015 and capital balances as already account balances, with the agreement
balance to be
allowed 15% interest on averrage capital
profit of P300,000 for 2015 is divided as follows:
divided equally. The
Detoya Total
Medina
15% Interest on Average Capital:
P 71,250
Medina: P475,000 x 15% P116,250
Detoya: P775,000 x 15%
Subtotal
P187,500
Balance to be Divided Equally
[P300,000 - P187,500=P112,500}:
Medina: P112,500 x 50% 56,250
Detoya: P112,500 x 50% 56,250 112,500
Share of Partners in Profits P127,500 P172,500 P300,000

The journal entry to close the income summary ledger account on Dec. 31, 2015 follows:
Income Summary 300,000
Leopoldo Medina, Drawing 127,500
Edgar Detoya, Drawing 172,500
To record the division of profits.

In a related case, assume that the Medina and Detoya Partnership had a loss of
P10,000
for the year ended Dec. 31, 2015. If the partnership agreement provided for
capital accounts, this provision must be honored regardless of whether
interest on
yielded profits or not. operations

The loss will be shared by the partners in the

same
total interest allowance of P187,500 would still bemanner the P300,000 profit. Ihe
as
given to the partners. The only
difference is that the division of profits or losses after the interest allowances would
involve a larger negative amount of P197,500
Medina and Detoya: which will be divided egually between

15% Interest on Average Capital:

Medina Detoya Total
Medina: P475,000 x15%
P 71,250
Detoya: P775,000x 15%
Subtotal P116,250
Balance to be Divided Equally P 187,500
[(P10,000) - P187,500 = P(197,500)):
Medina: P(197,500) x50%
Detoya: P(197,500) x50%
Subtotal
(98,750)
(98,750)
Share of Partners in Profits (Losses) (197,500)
P(27,500) P 17,500
P(10,000)
2-12 | Partnership and Corporation
Accounting
 The journal entry to close the income summary ledger account on Dec. 31, 2015 follows:
Leopoldo Medina, Drawing 27,500
Income Summary 10,000
Edgar Detoya, Drawing 17,500
To record the division of losses.

After initial consideration, the idea that a loss of P10,000 should cause one
partner's
capital to increase and the other partner's capital to decrease may
appear
unreasonable. However, this result was planned and was with good reason. Partner
Detoyainvested more capital than Partner Medina; this capital was used to carry out
operations, and the partnership's incurrence of a loss in the first year is no reason to
disregard Detoya's larger capital investment.
Comparison of distribution based solely on capital ratios as against distribution with
interest on capital balances. There will be a significant difference between the two
distribution plans if the partnership is operating at a loss. Under the capital ratio plan,
the partner who invested more capital will ultimately shoulder a bigger share of the
loss. This result may be considered inequitable because the investment of capital
presumably isnot the cause of the loss.
Under the interest plan, the partner who invested more capital is credited (increased)
for an interest on his capital and is ultimately debited (decreased) with a lesser share of
the loss; in some cases, the result may even be a net credit (increase).

By Allowing Salaries to Partners and the Balance in an Agreed Ratio

The sharing agreement may provide for variations in compnsating the personal
services contributed by partners. Even among partners who devote equal service time,
one partner's superior experience and knowledge may command a greater share of the
profit. To acknowledge the harder working or more valuable partner, the profit-sharing
plan may provide for salary allowances.

The partnership agreement should be clear on the treatment of salary allowances when
losses are incurred. In the absence of an agreement to govern this situation, salary
allowances willbe provided even when operations yielded losses. This allowance should
not be confused with salaries expense or with the partner's drawing account which is
debited for periodic salary allowances. The cash withdrawals will in no way affect the
division of profits; the divisionof profits is governed by the sharing agreement.

Partners are the partnership's owners; they are not employees of the business. If
partners devote their time and services to the affairs of the partnership, they are
understood to do so for profit, not for salary. Therefore, when the partners calculate
the profit of the partnership, salaries to the partners are not deducted as expenses in
the statement of recognized income and expense.

Partnership Operations and Financial Reporting | 2-13

 Detoya Partnership, assume that the
Medina and P100,000 to Medina and
Continuing the illustration for the salary of
an annual
partnership agreement provided for be divided equally. The profit of P300,000 for
P60,000 to Detoya, and the balance to
2015 is divided as follows:
Detoya Total
Medina
P 60,000 P160,000
P100,000
Salary Allowances
Balance to be Divided Equally
[P300,000 - P160,000 =P140,000)]:
Medina: P140,000 x 50% 70,000
70,000 140,000
Detoya: P140,000 x 50%
P170,000 P130,000 P300,000
Share of Partners in Profits

2015 follows:
The journalentry toclose the income summary ledger account on Dec. 31,
Income Summary 300,000
Leopoldo Medina, Drawing 170,000
Edgar Detoya, Drawing 130,000
To record the division of profits.

By Allowing Bonus to the Managing Partner Based on Profit and the Balance in an
Agreed Ratio
Apartnership contract may provide for a special compensation in the form of bonus to
the managing partner when the results of operations of the partnership are favorable.
This allowance is given in order to encourage the partner to maximize the profit
potentials of the partnership. Bonus is not being considered in the computation of
profit, rather it is a mere technique to distribute profits.

Assume that the Medina and Detoya Partnership agreement provided for a bonus of
25% of profit before bonus to Partner Medina and the balance to
be divided equally.
The profit is P300,000.

Medina
Detoya Total
Bonus [ 25% x P300,000 ): P 75,000
P 75,000
Balance to be Divided Equally
(P300,000 - P75,000 =P225,000)):
Medina: P225,000x 50%
112,500
Detoya: P225,000 x 50%
Share of Partners in Profits
P112,500 225,000
P187,500 P112,500 P300,000

2-14 | Partnership and Corporation Accounting

The journal entry to close the income summary ledger account on Dec. 31, 2015 follows:
Income Summary 300,000
Leopoldo Medina, Drawing 187,500
Edgar Detoya, Drawing 112,500
To record the division of profits.

Assume instead that the Medina and Detoya Partnership agreement provided for a
bonus of 25% of profit after bonus to Partner Medina and the balance to be divided
equally. t is understood in the wording of the agreement that the 25% bonus will be
based on the difference after deducting bonus from a certain amount. This certain
amount is the profit after considering all the operating expenses but before this bonus.
Here, the P300,000 profit still includes the bonuS. The difference between this profit
and bonus shall be the basis for the 25% bonus rate. Hence, profit after bonus
represents 100% while the profit of P300,000 before bonus represents 125%.
Profit before Bonus P300,000 125%
Profit after Bonus (P300,000/125%) 240,000 100%
Bonus P 60,000 25%

Medina Detoya Total

Bonus P 60,000 P 60,000
Balance to be Divided Equally
[P300,000-P60,000 =P240,000)):
Medina: P240,000 x 50% 120,000
Detoya: P240,000 x 50% P120,000 240,000
Share of Partners in Profits P180,000 P120,000 P300,000

The journal entry to close the income summary ledger account on Dec. 31, 2015 follows:
Income Summary 300,000
Leopoldo Medina, Drawing 180,000
Edgar Detoya, Drawing 120,000
To recordthe division of profits.

By Allowing Salaries, Intèrest on Capital, Bonus to the Managing Partner and the
Balance in an Agreed Ratio
The service contributions and capital contributions of the partners are often not equal.
If the service contributions are not equal, salary allowances can compensate for the
differences. Or, when capital contributions are not equal, interest allowances can make
up for the unequal investments. When both service and capital contributions are
unequal, the allocation of profits or losses may include aalary allowances, interest on
their capital balances, bonus to the managing partner, and the balance to be divided in
an agreed ratio.

Partnership Operations and Financial Reporting | 2-15

 Note that the provisions for salaries and interest in the partnership agreement are
called allowances. These allowances are not reported in the statement of recognized
income and expense as salaries and interest expense; they are merely means of

allocating profit to the partners.

Assume that the profit for the vear is P400.000 and the partnership agreement for tha
Medina and Detoya Partnership provided for the following:
I. Bonus to Medina of 25% of profit after salaries and interest but before bonus;
2. Annual salaries of P100,000to Medinaand P60,000 to Detoya;
3. Interest on average capital balances of P71,250 and P116,250 to Medina and
Detoya, respectively;
4. Balance to be divided in a ratio of 40:60.

Medina Detoya Total

Salary Allowances P100,000 P 60,000 P160,000
Interest on Average Capital Balances 71,250 116,250 187,500
Bonus [ 25% (P400,000 - P100,000. 13,125 13,125
P60,000 - P71,250- P116,250) ):
Balance to be Divided in a Ratio of
40:60 [ P400,000 - P160,000 -
P187,500- P13,125 = P39,375]:
Medina: P39,375 x 40% 15,750
Detoya: P39,375 x 60%
23,625 39,375
Share of Partners in Profits
P200,125 P199,875 P400,000
The journal entry to close the income
summary ledger account on Dec. 31, 2015 follows:
Income Summary
Leopoldo Medina, Drawing 400,000
Edgar Detoya, Drawing 200,125
To record the division of
profits. 199,87S

Assume instead that the bonus to

after bonus. The computation of theMedina is 25% of profit after
bonus follows: salaries, interest and
Profit before Salaries, Interest and Bonus
Less: Salaries
P400,000
Interest
Profit after Salaries and Interest but P160,000
187,500 347,500
Profit gfter Salaries, Interest and afterbefore Bonus P52,500 125%
Bonus Bonus*
42,000 100%
*P52,500 divided by 125% = P42,000. P 10,500 25%

2-16 | Partnership and Corporation Accounting

 Medina Detoya Total
Salary Allowances P100,000 P60,000 P160,000
Interest on Average Capital Balances 71,250 116,250 187,500
Bonus
10,500 10,500
Balance to be Divided in a Ratio of
40:60 P400,000- P160,000
P187,500 - P10,500 = P42,000]:
Medina: P42,000 x40% 16,800
Detoya: P42,000 x 60% 25,200 42,000
Share of Partners in Profits P198,550 P201,450 P400,000

The journal entry to close the income summary ledger account on Dec. 31, 2015 follows:
Income Summary 400,000
Leopoldo Medina, Drawing 198,550
Edgar Detoya, Drawing 201,450
To record the division of profits.

Some of the topics below are required inclusions in this subject per Commission on
Higher Education Memorandum Order No. 3 (series of 2007), As Amended. Unfamiliar
terms in the succeeding discussions which are partly based on IAS No. 1 (revised 2007)
will be fully appreciated in higher accounting subjects. Suffice it to say, though, that at
this point you're in a better situation than the users of other textbooks.

The International Accounting Standards Board (IASB) issued a revised International

Accounting Standards (AS) No. 1, Presentation of Financial Statements last Sept. 6,
2007. This standard supersedes the 2003 version of lAS 1 as amended in 2005. IAS No.
1 (revised 2007) is effective for periods beginning on or after 1 January 2009.
FINANCIAL REPORTING

Purpose of Financial Statements

Financial statements are a structured representation with the objective of providing
information about the financial position, financial performance and cash flowS of an
entity that is useful to a wide range of users in making economic decisions. Financial
statements also show the results of the management's stewardship of the resources
entrusted to it. To meet the objective, financial statements provide information about
an entity's assets, liabilities, equity, income and expenses, other changes in equity and
cash flows.

Overall Considerations
Fair Presentation and Compliance with International Financial Reporting Standards
(IFRSS). The financial statements shall present fairly the financial position, financial
Partnership Operations and Financial Reporting| 2-17