Basic Financial Accounting & Reporting
“Partnerships: Operations and Financial Reporting
Learning Objectives:
After studying this chapter, you should be able to:
1. Contrast a partner's equity in assets from share in profits or losses.
2. Summarize the rules for the distribution of profits or losses.
3, Explain prior period errors and interpret the effects on partners’ shares in
profits or losses.
4, Identify, describe and account for the different methods of dividing partnership
profits or losses based on agreement.
5. Ascertain the effects of using original, beginning, ending and average capitals on
the partners’ share in profits or losses.
6. Show the treatmeht of interest on capital, partners’ salariés and bonus in the
distribution of profits or losses.
7.. Propose equitable profits or losses sharing schemes after considering the
partners’ contributions and other performance criteria.
8. Understand and appreciate the usefulness of financial statements.
9. Pinpoint the differences in the financial statements of a partnership as
compared toa sole proprietorship.
10. Develop skills in the preparation of basic financial statements.
PARTNERS' EQUITY IN ASSETS CONTRASTED WITH SHARE: 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 pent should be distinguished from a
“partner's share in profits or losses. 4480 | Bo: | Accounting and Reporting 2021 Edition by Prof. WIN Ballada
ee
Mlustration. “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
larger or smaller share in the profit or loss of the firm. Such a statement may also be
interpreted to mean that Daganta is 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
partners’ capital. Simply put, partners may agree on any type of profit and loss ratio
regardless of the amount of their respective capital account balances.
FACTORS TO CONSIDER IN ARRIVING AT A PLAN FOR DIVIDING PROFITS OR
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:
A partner has considerable personal financial resources, thus giving the partnership @
a
strong credit rating. In general, partners have unlimited liability. A very solvent partner
will make the partnership attractive to creditors. -
2. A partner who is well known in a profession or an industry may contribute imrtensely to
the success of the partnership although he may not participate actively in the operations of
the partnership.
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.
Illustration. Daria Tolentino and Eleanor Tan are partners in a coco water business.
Partner Daria Tolentino contributed most of the assets of the business but spends little
On one hand, Partner Eleanor Tan contributed less in
time for its daily operations.
To divide
assets but devotes her full knowledge and attention to the partnership.
profits or losses based on capital contributions alone will result to iniquities. The profit
and loss sharing agreement should have considered the provision of salaries or even
bonus in recognition of the talent and time being contributed by Partner Eleanor Tan.Performance Methods
Many partnerships use profit and loss sharing arrangements that give some weight to
the specific performance of each partner to provide incentives to perform well. This
allocation of profits to a partner on the basis of performance is frequently referred to as
a bonus. 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 assignments. Weight may be given to hours 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 bé 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. Prom
nal 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 Jevels. Designated partners commonly receive a certain
percentage of profits in excess of a specified level of earnings.
RULES FOR THE DISTRIBUTION OF PROFITS 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 sharé 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). A stipulation 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. A summary 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:482 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada
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> as to capitalist partners, the profits 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 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 profits.
2. Losses
a. the losses will be divided according to partners’ agreement:
b. if there is no agreement as to distribution of losses but there is an agreement as
to profits, the losses shall be distributed according to the profit sharing ratio.
c._ inthe 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 of
labor already done by him, unlike the capitalist partners who can withdraw their capital.
In addition, if the partnership failed to realize any profits, then he has labored in vain’
and ina real sense, he has already contributed his share in the loss.
CORRECTION OF PRIOR PERIOD EMO
Bese
Any business entity will from time to time discover errors made in the measurement of
profit in prior accounting periods. Good internal control and the exercise of due care
should serve to minimize the number of financial reporting errors that occur; however,
these safeguards cannot be expected to completely eliminate errors in the financial
statements.
Per International Accounting Standards (IAS) No. 8, Accounting Policies, Changes in
Accounting Estimates and Errors, ptior period errors are omissions from and ‘other
misstatements of the entity's financial statements for one or more prior periods that are
discovered in the current period. Errors may occur as a result of mathematical mistakes,
mistakes in applying accounting policies, misinterpretation of facts, fraud or oversights.
Examples include errors in the estimation of depreciation, errors in inventory valuation,
and omission of accruals of revenue and expenses.
Material prior periods must be restated to report financial position and results of
‘operations as they would have been presented had the error never taken place. The
amount of the correction of a prior period error that relates to prior periods should be
sinincllPartnerships: Operations and Financial Reporting | 483
SS
reported by adjusting the opening balances of partners’ equity and affected assets and
liabilities. The correction of a prior period error is excluded from profit or loss for the
period in which the error is discovered.
ifan error resulted in an understatement of profit in previous periods, a correcting 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:
a. ratio of original capital investments
be ratio of capital balances at the beginning of the year
. ratio of 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 to partners 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.
Mlustration. The following series of illustrations’are based on the figures obtained from
the Aguilar and Porras Partnership which had a profit of P300,000 for the year ended
Dec, 31, 2020, 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.484 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada
ES
Lord Aguilar invested P400,000 on Jan. 1, 2020 and an additional P100,000 on April 1,
Devzon Porras 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:
Lord Aguilar, Capital Devzon Porras, Capital
. Jan.1 400,000 July2 50,000 | Jan.2 800,000
Apr.1 100,000
Lord Aguilar, Drawing Devzon Porras, Drawing
Jan.-Dec. 60,000 Jan.-Dec. 60,000
Income Summary
Dec. 31 300,000
Equally or in other Agreed Ratio
Partnership contracts may provide that profit or loss be divided equally. The profit of
300,000 for the Aguilar and Porras Partnership is transferred by a-closing entry on Dec.
31, 2020, from the income summary ledger account to the partners’ drawing accounts:
Income Summary 300,000
Lord Aguilar, Drawing ° 150,000
Devzon Porras, Drawing 150,000
To record the division of profits.
If the partnership had a loss of P200,000 for the year ended Dec. 31, 2020, 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
100,000 and a credit to the income summary account for P200,000. ;
Lord Aguilar, Drawing 199,000
Devzon Porras, Drawing 100,000 ,
Income Summary 200,000
To record the division of losses.
Assume instead that Aguilar and Porras share profits and losses in a ratio of 60:40 and
profit was P300,000, the profit would be divided as follows:
Income Summary 300,000 .
Lord Aguilar, Drawing 180,000
Devzon Porras, Drawing 120,000
Torecord the division of profits. ’
Computation:
Aguilar: 60% x P300,000 180,000
Porras: 40% x P300,000 120,000
300,000Partnerships: Operations and Finane
Based on Partners’ Capital Contributions
Division of partnership profits in proportion to the capital invested by each partner is
most likely to be found in partnerships in which substantial investments is the principal
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 Aguilar and Porras are P400,000 and P800,000, respectively. The profit
of P300,000 for 2020 is divided as follows: *
Income Summary 300,000
Lord Aguilar, Drawing 100,000
Devzon Porras, Drawing 200,000
To record the division of profits.
Computation:
Aguilar: P300,000 x P400,000/P1,200,000 100,000
Porras: P300,000 x P800,000/P1,200,000 200,000
‘300,000
After the entry allocating the profits of P300,000 to Aguilar and Porras, 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 Aguilar and Porras in al the 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 2020 is divided as follows;
Income Summary . 300,000
Lord Aguilar, Drawing. ' 100,000
Devzon Porras, Drawing : 200,000
To record the division of profits. ;
‘Computation: ‘
‘Aguilar: P300,000 x P400,000/P1,200,000 100,000
Porras: P300,000 x P800,000/P1,200,000 200,000
300,000 ,Ratio of Capital Balances at the End of the Year. Assume that the profit is divided in
of the year before drawings and the distribution
lances are P$00,000 for Aguilar and P750,000 for Porras;
The ending b
300,000 for 2020 is divided as follows:
me Summary 300,000
Aguilar, Drawing 120,000
380,000
n Porras, Drawing
To record the division of profits.
Computation:
Aguilar: P300,000 x P500,000/P2,250,000 120,000
Porras: P300,000 x P750,000/P1,250,000 180,000
PB
Ratio of Average Capital Balances. Division of profits or losses on the basis of the three
preceding 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, year-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 partnership
during the year.
The agreement should also state the amount of drawings each partner may make.
These drawings are considered temporary and are recorded as debits to the partner's
crewing account. Drawings within the allowable amount will not affect the
computation of the average capital balance. On the contrary, drawings in excess of the
@ amount are considered permanent reductions in capital; hence, the
alloy
computation of the average capital balance is affected.
the continuing illustration for the Aguilar and Porras Partnership, the partners are
entitied to withdraw PS5,000 monthly or a total of P60,000 per annum. Any additional
withdrawals are directly debited to the partners’ capital accounts and therefore will
atfect the computation of the average capital ratio.Partnerships: Operations and Financial Reporting | 487
eT
Aguilar and Porras
Computation of the Average Capital Balances
For the Year Ended Dec. 31, 2020
Lord Aguilar, Capital
Date Capital Account Portion* of the Average Capital
Balances Year Unchanged Balances
Jan. P4g0,000 x 3/12 = 100,000
Apr. 500,000 x 9/12 375,000
Average Capital 475,000
Devzon Porras, Capital
Jan. Pg00,000 x 6/12 a00,000
July 750,000 x 6/12 375,000
Average Capital 775,000
Total Average Capital Balances 1,250,000
‘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 onty 12 months ina year. For example, for Partner Aguilar, the fraction will total
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
Lord Aguilar, Drawing 114,000
Devzon Porras, Drawing 186,000
To record the division of profits.
Computation: ‘
‘Aguilar: P300,000 x P475,000/P1,250,000 114,000
Porras: P300,000 x P775,000/P1,250,000 186,000
300,000
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 capital as a first step in the division of profit, they should specify the interest488 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada
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 a partnership 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 the previous
chapter that loans receivable from or payable to partners are assets and liabilities,
respectively, of the partnership.
Continuing the illustration of Aguilar and Porras Partnership with a profit of 300,000
for 2020 and capital balances as already shown, assume that the partnership agreement
allowed 15% interest on average capital account balances, with the balance to be
divided equally. The profit of P300,000 for 2020 is divided as follows:
Aguilar Porras Total
15% Interest on Average Capital:
‘Aguilar: P475,000 x 159% P 71,250
Porras: P775,000x 15% P116,250
Subtotal P187,500
Balance to be Divided Equally
{P300,000 - P187,500 = P112,500):
‘Aguilar: P112,500 x 50% 56,250
Porras: P112,500 x 50%
Share of Partners in Profits
56,250 112,500
P172,500___ P300,000
The journal entry to close the income summary ledger account on Dec. 31, 2020 follows:
Income Summary 300,000
Lord Aguilar, Drawing
Devzon Porras, Drawing
To record the division of profits.
127,500
172,500
Ina related case, assume that the Aguilar and Porras Partnership had a loss of P10,000
for the year ended Dec. 31, 2020. if the partnership agreement provided for interest on
capital accounts, this provision must be honored regardless. of whether operations
yielded profits or not.
The loss will be shared by the partners in the same manner as the P300,000 profit. The
total interest allowance of P187,500 would still be 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 which will be divided equally between
Aguilar and Porras:Operations and Financial Reporting | 489
Aguilar Porras Total
15% Interest on Average Capital:
‘Aguilar: P475,000 x 159% P 71,250
Porras: P775,000 x 15% P116,250
Subtotal P 187,500
Balance to be Divided Equally
[(P10,000) - P187,500 = P(197,500)]:
Aguilar: P(197,500) x 50% (98,750)
Porras: P(197,500) x 50% (98,750)
Subtotal (197,500)
Share of Partners in Profits (Losses) P(27,500)__P-17,500___P (10,000)
The journal entry to close the income summary. ledger account on Dec. 31, 2020 follows:
Lord Aguilar, Drawing * 27,500
Income Summary 10,000
Devzon Porras, 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
Porras invested more capital than Partner Aguilar; 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 Porras'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 is not 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 compensating 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. 4490 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Balada |
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 will be 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 division of 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. Therefdre, 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.
Continuing the illustration for the Aguilar and Porras Partnership, assume that the
partnership agreement provided for an annual salary of P100,000 to Aguilar and
60,000 to Porras, and the balance to be divided equally. The profit of P300,000 for
2020 is divided as follows:
Aguilar Porras Total
Salary Allowances 100,000 60,000 P160,000
Balance to be Divided Equally
[ P300,000 - P160,000 = P:140,000)]:
‘Aguilar: P140,000 x 50% 70,000
Porras: P140,000 x 50% 70,000 __140,000
Share of Partners in Profits 170,000 __P130,000__ 300,000
The journal entry to close the income summary ledger account on Dec. 31, 2020 follows:
Income Summary 300,000
Lord Aguilar, Drawing
Devzon Porras, Drawing
To record the division of profits.
170,000
130,000
By Allowing Bonus to the Managing Partner Based on Profit and the Balance in an
Agreed Ratio
A partnership 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 isa mere technique to distribute profits.
Assume that the Aguilar and Porras Partnership agreement provided for a bonus of 25%
of profit before bonus to Partner Aguilar and the balance to be divided equally. The
profit is P300,000.Partnerships: Operations and Financial Reporting | 491
Aguilar Porras Total
Bonus [ 25% x P300,000 }:
P 75,000 P 75,000
Balance to be Divided Equally .
[ P300,000 - P75,000 = P225,000)):
Aguilar: P225,000 x 50% 112,500
Porras: P225,000 x 50% P112,500___ 225,000
Share of Partners in Profits : P187,500___P112,500___P300,000
The journal entry to close the income summary ledger ‘account on Dec. 31, 2020 follows:
Income Summary 300,000
Lord Aguilar, Drawing 187,500
Devzon Porras, Drawing 112,500
To record the division of profits.
Assume instead that the Aguilar and Porras Partnership agreement provided for a bonus
of 25% of profit after bonus to Partner Aguilar and the balance to be divided equally. It
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 300,000 125%
Profit after Bonus (P300,000/125%) 240,000 100%
Bonus P 60,000 25%
Aguilar Porras Total
Bonus P 60,000 P 60,000
Balance to be Divided Equally
[ P300,000 - P60,000 = P240,000)): '
‘Aguilar: P240,000 x 50% 120,000
Porras: P240,000 x 50% 120,000 240,000
Share of Partners in Profits 180,000" _P120,000__P300,000
The journal entry to close the income summary ledger account on Dec. 31, 2020 follows:
Income Summary
Lord Aguilar, Drawing
Devzon Porras, Drawing
To record the division of profits.
300,000
180,000
120,000By Allowing Salaries, Interest 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 salary allowances, interest on
their capital balances, bonus to the managing partner, and the balance to be divided in
an agreed ratio.
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 thé year is P400,000 and the partnership agreement for the
‘Aguilar and Porras Partnership provided for the following;
1. Bonus to Aguilar of 25% of profit after salaries-and interest but before bonus;
2. Annual salaries of P100,000 to Aguilar and P60,000 to Porras;
3. Interest on average capital balances of P71,250 and P116,250 to Aguilar and Porras,
respectively;
4, Balance to be divided in a ratio of 40:60.
Aguilar Porras Total
Salary Allowances P100,000 —-P60,000_—P160,000
71,250 116,250 187,500
Interest on Average Capital Balances
13,125 13,125
Bonus [ 25% (P400,000 - 100,000 -
60,000 - P71,250 - 116,250) }:
Balance to be Divided in a Ratio of
40:60 [ P400,000 - P160,000-
187,500 - P13,125 = P39,375]:
15,750 . .
Aguilar: P39,375 x 40%
Porras: P39,375 x 60% 23,625 39,375
Share of Partners in Profits 200,125 "199,875 __ P400,000
The journal entry to close the income summary ledger account on Dec. 31, 2020 follows:
Income Summary 400,000
Lord Aguilar, Drawing
Devzon Porras, Drawing
To record the division of profits.
+ 200,125
199,875,~__ Partnerships: Operations and Financial Reporting | 493
‘Assume instead that the bonus to Aguilar is 25% of profit after salaries, interest and
ofter bonus. The computation of the bonus follows:
Profit before Salaries, Interest and Bonus
400,000
Less: Salaries 160,000
Interest 187,500__ 347,500
Profit after Salaries and Interest but before Bonus P 52,500 125%
Profit after Salaries, Interest and after Bonus* 42,000 _ 100%
Bonus
—P10500 25%
*P52,500 divided by 125% = P42,000.
Aguilar Porras Total
Salary Allowances P100,000 60,000 160,000
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 - P:160,000 -
P187,500 - P10,500 = P42,000):
‘Aguilar: P42,000 x 40% 16,800
Porras: 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, 2020 follows:
Income Summary 400,000
Lord Aguilar, Drawing E 198,550,
Devzon Porras, Drawing 201,450
To record the division of profits.
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.
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 about494 | Basic Financial Accounting and Reporting 2021 Edit
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
performance and cash flows of the entity. Fair presentation requires the faithful
representation of the effects of transactions, other events and conditions in accordance
with the definitions and recognition criteria for assets, liabilities, income and expenses|
set out in the IASB’s new Conceptual Framework. Under IAS No. 1 (revised 2007)/
entities are required to make an explicit and unreserved statement of compliance with
IFRS in the notes. f
Going Concern. Financial statements should be prepared on a going concern basis
unless management intends to liquidate the entity or cease trading or has no realistic
option but to do so.
Accrual Basis of Accounting. An entity shall prepare its financial statements, except for
cash flow information, using the accrual basis of accounting.
Materiality and Aggregation, An entity shall present separately each material class of
similar items. Material items that are dissimilar in nature or function should be
separately disclosed.
Offsetting. An entity shall not offset assets and liabilities, income and expenses unless
required or permitted by an IFRS.
Frequency of Reporting and Comparative Information. At least annually, an.entity shall
present with equal prominencé each financial statement in a complete set of financial
statements including comparative information in respect of the previous period for all
amounts reported in the current period’s financial statements.
Consistency of Presentation. An entity shall retain the presentation and classification of
items in the financial statements in successive periods unless an alternative would be
more appropriate or an IFRS requires a change in presentation,
Identification of the Financial Statenients. An entity shall clearly identify the financial
statements and distinguish them from other information in the same published
document. International Financial Reporting Standards (IFRSs) apply only to the financial
‘Statements and not necessarily to other information presented in an annual report, a
regulatory filing or another document.
‘An entity shall clearly identify each financial statement and the notes. An entity shall
display the following information prominently:
* name of the reporting entity;
* whether the financial statements are of the individual entity or a group of
entities;Partnerships: Operations and Financial Reporting | 495
«the date of the end of the reporting period or the period covered by the set of
financial statements or notes;
«the presentation currency;
and the level of rounding used in presenting amounts in the finan
statements.
Complete Set of Financial Statements
Per revised International Accounting Standards (IAS) No. 1, Presentation of Financial
Statements, a complete set of financial statements comprises:
a. statement of financial position as at the end of the period;
b. astatement of financial performance for the period;
c. statement of changes in equity for the period;
d, statement of cash flows for the period;
fe, notes, comprising a summary significant accounting policies and other
. explanatory information; and
f. a statement of financial position as at the beginning of the earliest comparative
period when an entity applies an accounting policy retrospectively or makes a
retrospective restatement of items in its financial statements, or when it
reclassifies items in its financial statements.
Statement of Financial Performance
The form and content of the income statement of the partnership resemble those of the
sole proprietorship with the exception of the presentation of the division of profits or
losses at the lower portion of the statement.
Aguilar and Porras,
Partial Income Statement
. For the Year Ended Dec. 31, 2020
Profit
Q : 300,000
Division of Prafit (equally):
Partner Aguilar . P150,000
Partner Porras 150,000
Total 300,000
The components of profit or:loss may be presented either as part of a single statement
of comprehensive income or in an income statement, as, permitted by paragraph 81 of
IAS No. 1 (revised 2007). When an income statement is presented, it is part of a
complete set of financial statements ‘and shall be displayed immediately before the
statement of comprehensive income. :496 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada
As a minimum, the statement of financial performance shall include line items that
present the following amounts for the period: :
a. Revenue;
b. Finance costs;
Share of profit or loss of associates and joint ventures accounted for using the
equity method;
d, Tax expense;
e. Asingle amount comprising the total of:
i, The post-tax profit or loss of discontinued operations; and
The post-tax gain or loss recognized on the measurement to fair value
less costs to sell on the disposal of the assets or disposal group(s)
constituting the discontinued operations;
f. Profit or loss; .
g. Each component of other financial performance classified by nature (excluding
amounts in (h) below); oy
h. Share of the other financial performance of associates and joint ventures
accounted for using the equity method; and
i. Total financial performance.
Statement of Changes in Equity
‘An entity shall present a statement of changes in equity, showing in the statement:
a. total financial performance for the period showing separately the total
amounts attributable to owners of the parent and to minority interests;
b. for each component of equity, the effects of retrospective restatement
recognized in accordance with IAS No. 8, Accounting Policies, Changes in
Accounting Estimates and Errors;
the amounts of transactions with owners in their capacity as owners, showing
separately contributions by and distributions to owners; and
d. for each component of equity, a reconciliation between the carrying amount at
the beginning and the end of the period, separately discloging each change.
The components of equity referred to above include for example, each class of
contributed equity, the accumulated balance of each class’ of other comprehensive
income and retained earnings (these are applicable to corporations). The amount of _
dividends recognized as distributions to owners during the period, and the related
amount per share, shall be presented either in the statement of changes in equity or in
the notes. 7
In the case of Aguilar and Porras, as contrasted with a'sole proprietorship, the number
of capital and drawing accounts has made the preparation of this statement all the
more useful. Changes in an entity's equity between the beginning and the end of the
reporting period reflect the increase or decrease in its nét assets during the period.Iperations and Financial Reporting | 497
ee ETS
Aguilar and Porras
‘Statement of Changes in Partners’ Equity
. Forthe Year Ended Dec. 31, 2020
Aguilar Porras Total
Original Investments 400,000 800,000 1,200,000
‘Add; Additional Investments 100,000 i 100,000
Total 500,000 800,000 —_P1,300,000
Less: Permanent Withdrawals 50,000 50,000
Balances 500,000 750,000 1,250,000
Add: Profit 150,000__150,000__300,000 :
Total 650,000 900,000 1,550,000 :
Less: Temporary Withdrawals 60,000 60,000 120,000,
Partners’ Equity, Dec. 31 590,000 ___P840,000_P1,430,000
Statement of Financial Position
After all the components of the statement of financial performance along with the
changes in partners’ equity for the period have been properly presented, the
Preparation of the statement of financial position will present no major difficulty. The
assets and liabilities will be presented in the statement of financial position as those of a
sole proprietorship but the owners’ equity section should exhibit separately the capital
balance of P590,000 and P840,000 for Aguilar and Porras, respectively.
Though some of the items are not as familiar yet, per revised International Accounting
Standards (IAS) No. 1, Presentation of Financial Statements, as a minimum, the face of
the statement of financial position shall include line items that present the following
amounts:
Property, plant and equipment;
Investment property;
Intangible assets;
‘Financial assets (excluding amounts shown under e, h and i);
Investment accounted for using the equity method;
Biological assets;
Inventories; 7
Trade and other receivables;
Cash and cash equivalents;
" The total of assets classified as held for sale and assets included in disposal
groups classified as héld for sale in accordance with IFRS S;
Trade and other payables;
Provisions;
|. Financial liabilities (excluding amounts shown under k and I);
Liabilities and assets for current tax, as defined in 1AS 12;
Deferred tax liabilities and deferred tax assets, as defined in IAS 12;
Liabilities in disposal groups classified as held for sale in accordance with IFRS
3
go
wore mp eo
pons498 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada
, Issued capital and reserves attributable to equity holders of the parent.
IAS No. 1 (revised 2007) does not prescribe the order or format in which‘an entity
presents items. The above enumeration (from Paragraph 54 of IAS No. 1, revised 2007)
simply provides a list of items that are sufficiently different in nature or function to
warrant a separate presentation in the statement of financial position.
Note that an entity makes the judgment about whether to present additional items’/
separately on the basis of an assessment of: {
a. the nature and liquidity of assets;
b. the function of assets within the entity; and
c. the amounts, nature and timing of liabilities.
Current and noncurrent assets and liabilities should be separately classified on the face
of the statement of financial position except when a presentation based on liquidity
provides more reliable and relevant information.
An entity shall classify an asset, as current asset when it satisfies any of the following
criteria: 5
it expects to realize the assets, intends to sell or consume it, in its normal
operating cycle; or
it holds the asset primarily for the purpose of trading; or
itexpeets to rélze the aset within 12 months after the end ofthe reporting
period; or
the asset is cash ora cash equivalent as defined in IAS No. 7. z
All other assets are noncurrent. Operating cycle is the time between the acquisition of
assets for processing and their realization in cash or cash equivalents.
Aliability should be classified as a current liability when it:
is expected tobe settled inthe normal operating cycle; of
‘*¢ isheld primarily for the purpose of trading; or
is due to be settled within 12 months after the end of thie reporting period; or
does not have an,unconditional right to defer settlement of the liability for at least
12 months after the reporting period.
All other liabilities should be classified as non-current liabilities.
The statement of cash flows has been discussed in an earlier chapter.