Partnership
Operations
ACCOUNTING FOR partnership CHAPTER 2
BSA 1-8 REVIEW
Nature of Partnership Operation
Accounting for partnership operations is essentially the same as
accounting for the operations of a sole proprietorship. However,
special problems are encountered in accounting for partnership
operations. These problems include:
1.) Closing entries of a partnership
2.) Distribution of profits and losses
3.) Preparation of a worksheet
4.) Preparation of financial statements
a. Income statement
b. Statement of financial position
c. Statement of changes in partners’ equity
Closing Entries of a Partnership
* First, all revenue and other nominal accounts with credit balances
(such as Purchases Discounts and Purchases Returns and Allowances)
are debited and Income Summary is credited.
* Second, Income Summary is debited and all expense and other
nominal accounts with debit balances (such as Sales Discounts and
Sales Returns and allowances) are credited.
* Third, the balance of the Income Summary account which
represents profit or loss of the partnership is transferred either to the
drawing accounts or directly to the capital accounts of the partners.
* Finally, the balance of the drawing account of each partner is
transferred to his/her capital account.
The balance of the Income Summary account is transferred
to the drawing accounts of the partner’s; intention is to
keep the capital account intact for investments and
permanent withdrawals of capital. A credit balance in the
Income Summary account represents a profit and its
balance is transferred to the drawing accounts of the
partners based on their profit and loss sharing ratio. The
entry is as follows:
Any resulting credit balance in the drawing account of a
partner may be withdrawn by the partner or reinvested
into the firm. If the balance in the drawing account is
withdrawn in cash, the entry is as follows:
However, if the partner decides to reinvest into the firm this
balance to his drawing account, the entry is as follows:
A debit balance in the Income Summary account
represents a loss and its balance is transferred to the
drawing accounts of the partners based on their profit and
loss sharing ratio. The entry is as follows:
The resulting debit balance in the drawing account of a partner is
charged against his capital with the following entry:
On the other hand, the balance of the Income Summary account may
be transferred directly to the capital accounts of the partners if the
partners’ intention is to make the profit or loss a part of permanent
account capital. It should be noted, however, that either treatment will
result will result to the same net effect on partners’ ending capital
balances. All illustrations in this chapter pertaining to distribution of
profit or loss as a direct part of their permanent capital.
A credit balance in the Income Summary account represents a profit and its
balance is transferred to the capital accounts of the partners based on their
profit and loss sharing ratio. The entry is as follows:
A debit balance in the Income Summary account
represents a loss and its balance its transferred to the
capital accounts of the partners based on their profit
and loss sharing ratio. The entry is as follows:
Distribution of Profits and Losses
Factors to be considered:
* Services rendered by the partners to the partnership
* Amount of capital contribution by the partners to the business
* Entrepreneurial ability of managerial skill of the partners
Expressed in several ways:
* By percentage
* By fraction
* By decimal
* By ratio
Rules for Dividing Profits and Losses
The following is the list of rules in the division of profits and losses of the
partnership based on the provisions of the New Civil Code
1.) As the Capitalist Partners
a. Division of profits
1. In accordance with agreement
2. In the absence of an agreement, division of profits is in accordance with
capital contributions
b. Division of losses
1. In accordance with agreement
2. If only division of losses will be the same as the agreement on the
division of profits
3. In the absence of an agreement ,division of losses is in accordance with
capital contributions.
2.) As to Industrial Partners
a. Division of profits
1. In accordance with agreement
2. In the absence of an agreement, the industrial partner shall
receive a just and equitable share of the profits and the capitalist
partners shall receive profits in accordance with their capital
contributions.
b. Division of losses
1. In accordance with agreement
2. In the absence of an agreement, the capitalist –industrial
partner in his/her character as industrial partner shall have no
share in the losses, but in his/her character as a capitalist partner
will share in proportion to the capital contribution.
Profits and losses in general shall be divided in accordance with
the agreement among the partners. In the absence of an
agreement, the partners shall share in the profits in proportion
to their capital contributions after satisfying the share of the
industrial partner on such income.
Methods of Distributing Profits
Based on Partner's Agreement
1.) Equally - simple to apply but does not give due recognition on the disparity of
capital contribution nor does it recognize the time and effort that a partner may
devote in running the firms’ business operations.
2.) Arbitrary ratio ( Percentage, Decimal, Fraction, Ratio) - simple to apply but does
not give recognition on the disparity of capital contributions nor does it recognize the
time and effort that a partner may devote in running the firm’s business operations.
3.) Capital ratio (Original, Beginning, Ending, Average) - recognizes the differences in
the capital contributions but does not take into account the time and effort that a
partner may devote in running the firm’s business operations.
4.) Interest on capital and the balance on agreed ratio - recognizes the differences in
the capital contribution but does not take into account the time and effort that a
partner may devote in running the firm’s business operations.
5.) Salary allowances to partners and the balance on agreed ratio – recognizes the
time and effort that a partner may devote in running the firm’s business
operations but does not take in to consideration the differences in capital
contributions.
6.) Bonus to managing partner and the balance on agreed ratio – allows a bonus, as
an incentive, to the managing partner. It is usually a percentage of the profit.
Bonus, therefor, is allowed only when there is a profit. It may be computed using
any of the following as basis:
a. Bonus is based on profit before deducting bonus and income tax
b. Bonus is based on profit after deducting bonus but before deducting income tax
c. Bonus is based on profit after deducting income tax but before deducting bonus
d. Bonus is based on profit after deducting both bonus and income tax.
7.) Interest on capital, salaries to partners, bonus to managing partner, and the
balance on agreed ratio.
The following steps are to be followed
in determining the average capital of
each partner using the peso month
method; thus, arriving at the average
capital ratio:
1. Multiply beginning capital by the
number of months that it remained
unchanged
2. Determine each new capital balance
in chronological order and multiply by
the number of months it remained
unchanged
3. Add the products which represent
peso months and divide the total by 12
to obtain the average monthly capital
Order of Priority Division
In some instances, the partners may agree not to
use a residual sharing ratio if the event profits did not
exceed the total of the salary and interest allowances.
In the case, the partners must agree on the priority of
the various features. If the partnership agreement
gives salary allowances priority over interest on
capital balances, then profit would first apply to
salaries and the balances would be divided in the ratio
of interest allowance and vice-versa.
Special Profit Allocation Methods
Some partnership distribute profits on the basis of the criteria. For example,
most public accounting firms distribute profits on the basis of partnership units. A
new partner acquires a certain number of units and additional units are assigned by
a firm wide compensation committee based on:
*Obtain new clients;
*Providing the firm with specific areas of industrial expertise
*Serving as a managing partner of a local office; or
*Accepting a variety of the other responsibilities
Other partnerships devise profit distribution plans that reflect the earnings of
the partnership. For example some medical or dental firms allocate profits on the
basis of billed services. Other criteria may include number or size of clients, years
of service within the firm, or the partner’s position within the firm.
PREPARATION OF WORKSHEET
In order to classify accounting data in a convenient
and orderly manner and to facilitate the preparation of
financial statements, a work sheet is prepared.
The form or columns of the work sheet may vary
depending on the needs of the company.
Illustrative Problem C: The trial balance for EXCELLENCE COMPANY as of December 31,2014.
Key Points: The Statement of Income of a
partnership is similar to that of a sole
proprietorship except that it includes a
schedule showing the division or distribution
of profit to partners.
CORRECTIONS IN PROFIT FOR ERRORS AND
OMISSIONS PRIOR TO DISTRIBUTION
The partnership books may show an incorrect profit because of errors and omissions.
It is understood that the tax implications of these corrections are properly accounted for
particularly if the partnership is not a general professional partnership.
CAPITAL BALANCES RATIO ADJUSTED
TO PROFIT AND LOSS RATIO
While it is usual that capital ratios do not equal profit and loss ratios;
yet, partners may decide to bring their capital balances into their profit
and loss ratio. This can be accomplished through either of the following:
1. The capital balances are t be brought into the profit and ratio by
payments outside of the firm among the partners and where the total firm
capital is to remain the same.
2. The capital balances are to be brought into the profit and loss ratio by
the lowest possible additional cash investment in the firm by the partners.
3. The capital balances are to be brought into the profit and loss ratio by
the lowest possible additional cash investment or cash withdrawal from
the firm by the partners.
