Chapter 3 – Partnership Operations

At the end of the accounting period, adjustments are made for merchandise inventory, accruals,
CHAPTER 3 prepayments, provision for uncollectible accounts, and provision for depreciation. Profit or loss
PARTNERSHIP OPERATIONS is determined in the usual manner, that is, by matching periodic income and expenses.

However, special problems are encountered in accounting for partnership operation. These
LEARNING OBJECTIVES problems include:

1. Discuss the closing entries in a partnership and differentiate then from the closing entries in a sole 1. Closing entries of a partnership
proprietorship. 2. Distribution of profits and losses
2. Identify and discuss the different methods and rules of dividing partnership profits and losses 3. Preparation of a work sheet
among partners. 4. Preparation of financial statements
3. Discuss and understand the preparation of financial statements of a partnership. a. Statement of income/statement of comprehensive income
b. Statement of financial position
c. Statement of changes in partner’s equity
PREVIEW OF THE CHAPTER
CLOSING ENTRIES OF A PARTNERSHIP
PARTNERSHIP
OPERATIONS The procedures for the preparation of closing entries for a partnership are similar to that of a
sole proprietorship. First, all revenue and other nominal accounts with credit balances (such as
Purchase 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,
Closing Entries Distribution of Partnership Preparation of the balance of the Income Summary account, which represents profit or loss of the partnership,
Profits and Losses Financial Statements 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
• Revenue and gains • Equally • Statement of account.
• Expenses and losses • Arbitrary ratio Income/Statement of
Comprehensive Income The balance of the Income Summary account is transferred to the drawing accounts of the
• Partners’ share in • Capital ratio partners if the partners’ intention is to keep the capital account intact for investments and
profits and losses • Interest on capital • Statement of permanent a profit and its balance is transferred to the drawing accounts of the partners based
• Partners’ drawing • Salary allowance Financial Position on their profit and loss sharing ratio, The entry is as follows:
• Bonus • Statement of Changes
in Partners’ Equity Income Summary xxx
A, Drawing xxx
NATURE OF PARTNERSHIP OPERATION B, Drawing xxx

Any resulting credit balance in the drawing account of a partner may be withdrawn by the
Accounting for partnership operations is essentially the same as accounting for the operations of partner or reinvested into the firm. If the balance in the drawing account is withdrawn in cash,
a sole proprietorship. Sale of merchandise on account is debited to Accounts Receivable and the entry is as follows:
credited to Sales Collection of accounts is debited to Cash and credited to Accounts Receivable.
The purchase of merchandise on account is recorded by a debit to Purchases and credit to A, Drawing xxx
Accounts Payable. Payments of accounts is debited to accounts payable and credited to Cash. Cash xxx
Payment of expenses is debited to Expenses and credited to Cash.

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However, if the partner decides to reinvest into the firm this balance in his drawing account, the DISTRIBUTION OF PROFITS AND LOSSES
entry is as follows:
To make distribution of partnership profits and losses equitable, the following factors are
A, Drawing xxx
considered:
A, Capital xxx
1. Services rendered by the partners to the partnerships
2. Amount of capital contributed by the partners to the business
A debit balance in the Income Summary account represents a loss and its balance is transferred
3. Entrepreneurial ability or managerial skill of the partners
to the drawing accounts of the partners based on their profit and loss sharing ration. The entry
is as follows:
To distribution or division of profits and losses may be expressed in several ways as follows:
1. by percentage
A, Drawing xxx
2. by fraction
B, Drawing xxx
3. by decimal
Income Summary xxx
4. by ratio
The resulting debit balance in the drawing account of a partner is charged against his capital with
Illustration: Alba and Bueno are partners sharing profits and losses based on their capital
the following entry:
contributions of P100,000 and P300,000, respectively. Their profit and loss sharing can be
expressed as follows:
A, Capital xxx
A, Drawing xxx
1. By percentage Alba 25% (P100,000/P400,000)
Bueno 75% (P300,000/P400,000)
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
2. By fraction Alba 1/4 (P100,000/P400,000)
if permanent capital. It should be noted, however, that either treatment will result to the same
Bueno 3/4 (P300,000/P400,000)
net effect on partners’ ending capital balances. All illustrations in this chapter pertaining to
distribution of profit or loss are recorded directly to the capital accounts with the assumption
3. By decimal Alba .25 (P100,000/P400,000)
that partners intend to make their respective share on the profit or loss as a direct part of their
Bueno .75 (P300,000/P400,000)
permanent capital.
4. By ratio Alba and Bueno 1:3
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: RULES FOR DIVIDING PROFITS AND LOSSES

Income Summary xxx The following is the list of rules in the division of profits and losses of the partnership based on
A, Capital xxx the provision of the New Civil Code:
B, Capital xxx
1. As to Capitalist Partners
A debit balance in the Income Summary account represents a loss and its balance is transferred a. Division of profits
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is as 1. in accordance with agreement
follows: 2. in the absence of an agreement, division of profits is in accordance with capital
A, Capital xxx contributions
B, Capital xxx
Income Summary xxx b. Division of losses
1. in accordance with agreement

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2. if only division of profits is agreed upon, the division of losses will be the same as Interest is allowed to partners for the use of invested capital. Interest as agreed by the
the agreement on the division of profits partners shall be allowed in proportion over the period such capital was actually used.
3. in the absence of an agreement, division of losses is in accordance with capital Moreover, the interest shall be provided whether the profit is sufficient or insufficient or
contributions there is a net loss unless otherwise agreed upon by the partners.

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 contribution.
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 profit.
5. Salary allowances to partners and the balance on agreed ratio – this method recognizes
the time and effort that a partner may devote in running the firm’s business operations but
does not take into consideration the differences in capital contributions.
Salaries are allowed to partners as compensation for their devoted in the business, Salaries
as agreed by the partners shall be allowed in proportion to the time the partners actually
rendered services to the firm. Such salaries shall be provided whether the profit is sufficient
or insufficient or there is net a loss unless otherwise agreed upon by the partners.
6. Bonus to managing partner and the balance on agreed ratio – this method allows a
bonus, as an incentive, to the managing partner. It is usually a percentage of the profit.
Bonus, therefore, is allowed only when there is a profit. It may be computed using any one
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
METHODS OF DISTRIBUTING PROFITS BASED ON PARTNERS’ on agreed ratio.
AGREEMENT
Illustrative Problem A: The following data are available in the books of Calma and David
1. Equally – it is simple to apply but does not give due recognition on the disparity of capital Partnership for the year 2014.
contributions nor does it recognize the time and effort that a partner may devote in running
the firm’s business operations. Calma, Capital
May P100,000 Jan. 1 Balance P2,500,000
2. Arbitrary ratio (Percentage, Decimal, Fraction, Ratio) – it is simple to apply but does not Apr. 1 250,000
give recognition on the disparity of capital contributions nor does it recognize the time and Oct. 1 500,000
effort that a partner may devote in running the firm’s business operations. Balance – P3,150,000

3. Capital ratio (Original, Beginning, Ending, Average)- this method recognizes the
differences in the capital contributions but does not take into account the time and effort Calma, Drawing
that a partner may devote I running the firm’s business operations. Jan. 1 – Dec. 31 P300,000

4. Interest on capital and the balances on agreed ratio – this method 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.

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David, Capital Case 4 – Profit is divided 20% and 80% to Calma and David
June 1 P150,000 Jan. 1 Balance P1,500,000
Dec. 1 50,000 Sept. 1 500,000 Income Summary 600,000
Balance – P1,800,000 Calma, Capital 120,000
David, Capital 480,000
P600,000 x 20% = P120,000
David, Drawing P600,000 x 89% = P480,000
Jan. 1 – Dec. 31 225,000
Case 5 – Profit is allocated based on the beginning capital ratio

Income Summary Income Summary 600,000

Dec. 31 P 600,000 Calma, Capital 375,000
David, Capital 225,000
P600,000 x 25/40 = P375,000
P600,000 x 15/40 = P225,000
Twelve cases will be illustrated using the given data. Cases 1-10 will show sufficient profit. Case
11 will show insufficient profit, and Case 12 shows a loss. Case 6 – Profit is allocated based on the ending capital ratio
Case 1 – Profit is divided equally Income Summary 600,000
Calma, Capital 381,820
Income Summary 600,000 David, Capital 218,180
Calma, Capital 300,000 P600,000 x 315/495 = P381,820
David, Capital 300,000 P600,000 x 180/495 = P218,180
P600,000 / 2 = P300,000
The ending capital balances of the partners are computed as follows:
Calma David
Case 2 – Profit is divided 3/4 and 1/4 to Calma and David
Beginning balances P2,500,000 P1,500,000
Income Summary 600,000 Additional investment 750,000 500,000
Calma, Capital 450,000 Drawing ( 100,000) ( 200,000)
David, Capital 150,000 Ending balances P3,150,000 P1,800,000
P600,000 x 3/4 = P450,000
P600,000 x 1/4 = P150,000 Key Points. Withdrawals deducted for purposes of determining ending capital balances are the
debit entries in the capital accounts of each pf the partners (see partners’ accounts shown I the
Case 3 – Profit is divided in the ratio of 1:2 to Calma and David previous page). The credit entries in the drawing accounts are not considered in computing
ending capital for the purpose of establishing the ratio.
Income Summary 600,000
Calma, Capital 200,000 Case 7 – Profit is allocated based on the average capital ratio
David, Capital 400,000
P600,000 x 1/3 = P200,000 Income Summary 600,000
P600,000 x 2/3 = P400,000 Calma, Capital 381,290
David, Capital 218,710
P600,000 x 2,745,830/4,320,830 = P381,290
P600,000 x 1,575,000/4,320,830 = P2818,710

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Average capital ratio is a method of dividing profits based on the amount of capital invested and Case 8 – Each partner is allowed 10% interest on ending capital and the remaining profit
the time during which such capital is actually used in the business. is divided 60%. 40%.

The following steps are to be followed in determine the average capital of each partner using the Income Summary 600,000
peso month method; thus, arriving at the average capital ratio: Calma, Capital 378,000
David, Capital 222,000
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 The distribution of profits may be recorded separately as follows:
months it remained unchanged.
3. Add the products which represent peso months and divide the total the total by twelve (12) Income Summary 495,000
to obtain the average monthly capital. Calma, Capital 315,000
David, Capital 180,000
By following the steps given, the average capital of each partner can be calculated as follows: Interest on ending capital.

Calma, Capital Income Summary 105,000

Calma, Capital 63,000
No. of Mos. David, Capital 42,000
Period Capital Balance Unchanged Peso Months Average Capital Remaining income divided 60%, 40%.
Jan. 1 – Mar. 31 P2,500,000 3 P 7,500,000
Apr. 1 – Apr. 30 2,750,000 1 2,750,000 Division of profit
May 1 – Sept 30 2,650,000 5 13,250,000 Calma David Total
Oct. 1 – Dec. 31 3,150,000 3 9,450,000 Interest on ending capital
12 P32,950,000 P2,745,830 P3,150,000 x 10% P315,000
P1,800,000 x 10% P180,000 P495,000
Remainder – 60%, 40%
P105,000 x 60% 63,000
David, Capital P105,000 x 40% 42,000 105,000
Total P378,000 P222,000 P600,000
Jan. 1 – May. 31 P1,500,000 5 P 7,500,000
June 1 – Aug. 31 1,350,000 3 4,050,000
Sept. 1 – Nov. 30 1,850,000 3 5,550,000 Case 9 – David is allowed salaries of P500,000 and the remaining profit is divided in the
Dec. 1 – Dec. 31 1,800,000 1 1,800,000 ratio of 1:4
12 P18,900,000 1,575,000
P4,320,830 Income Summary 600,000
Calma, Capital 20,000
David, Capital 580,000
Cases 1 to 7 provide for division of profits using a single allocation procedure. However, there
are instances when the partnership agreement may provide for a combination of several Division of profit
allocation procedures (multiple bases of profit allocation) to be used in the distribution of profit. Calma David Total
Since partnerships specify a profit distribution to be followed to whatever extent possible, most Salaries P500,000 P500,000
agreements specify that the entire process is to be completed and any remainder is to be Remainder – 1:4
allocated in the profit and loss ratio. The following case are used to illustrate various multiple P100,000 x 1/5 P 20,000
P100,000 x 4/5 80,000 100,000
allocation procedures.
Total P 20,000 P580,000 P600,000

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Case 10 – David, the managing partner, is allowed a bonus of 20% of profit BEFORE bonus Case 12 – Assume the same agreement as in Case 11 except that instead of a prodit, the
and income tax and the remainder is divided in the ratio of beginning capital. partnership has incurred a loss of P100,000. The allowance for salaries and interest will still
be provided, thereby resulting in a total loss to be divided as agreed.
Using the income tax rate of 30%, the partnership income before income tax is P857,143 that is,
net profit of P600,000 divided by 70%. David, Capital 109,750
Calma, Capital 9,750
Income Summary 600,000 Income Summary 100,000
Calma, Capital 267,857
David, Capital 332,143 Division of profit
Calma David Total
Division of profit Salaries to partners
Calma David Total P 5,000 x 52 P260,000
Bonus – P857,143 x 20% P171,429 P171,429 P10,000 x 52 P520,000 P780,000
Remainder: Interest on average capital
P428,571 x 25/40 P267,857 P2,745,830 x 10% 274,580
P428,571 x 15/40 267,587 428,571 P1,575,000 x 10% 157,500 432,080
Total P267,857 P332,143 P600,000 Remainder – (P1,312,080)
P1,312,080 x 2/5 (524,830)
P1,312,080 x 3/5 (787,250) (1,312,080)
Other assumptions on the computation of bonus shall be illustrated later in the chapter.
Total P 9,750 P109,750 P100,000

Case 11 – The partners are allowed P5,000 and P10,000 weekly salaries, respectively,
The allocation of partnership profit follows the order of the profit sharing agreement in
10% interest on average capital, and the remainder is divided in the ratio of 2:3.
allocating the bonus, the salary allowances, the interests and the remainder to individual
partners.
Income Summary 600,000
Calma, Capital 289,750
The bonus is computed on the basis of the partnership profit as the concept of “partnership
David, Capital 310,250
profit” is generally understood in accounting practice. Partners may, however, intend for salary
and interest allowances to be deducted in determining the base for computing the bonus. In such
Division of profit
case, no bonus is allowed if there is insufficient profit after distribution of salaries and interests.
Calma David Total
Salaries to partners
P 5,000 x 52 P260,000 The interests of the partners may not be apparent when technical accounting terms are used; so
P10,000 x 52 P520,000 P780,000 the partnership agreement should be precise in specifying measurement procedures to be used
Interest on average capital in determining the amount of a bonus.
P2,745,830 x 10% 274,580
P1,575,000 x 10% 157,500 432,080 Illustrations on the computation of bonus using other assumptions. The same data in Illustrative
Remainder – (P612,080) Problem A shall be used. Bonus rate is 20%.
P612,080 x 2/5 (244,830)
P612,080 x 3/5 (367,250) (612,080)
Total P289,750 P310,250 P600,000 1. Bonus is based on profit after deducting bonus but before deducting income tax.

The sum of the salary allowance and interest allowed on the average capital of the partners B = .20 x (P857,143 – B)
exceeded the profit of P600,000 resulting in a negative remainder (loss or deficit). Such loss is B = P171,428 – 020B
distributed in the profit and loss sharing agreement. B + .20B = P171,428
B = P171,428 / 1.20
B = P142,857

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2. Bonus is based on profit before deducting bonus after deducting income tax and P250,000 to Tomas, 10% interest on capital and the balance will be divided equally. Income
is to be allocated by first giving priority to interest on invested capital and then on salary
B = .20 (P857,143 – T) allowance. Partnership net income for the year is P600,000.

T = .30 x P857,143 The following is the division of the P600,000 profit in accordance with the order of priority
= P257,143 provision.

Substituting for T in the first equation and solving for B Santos Tomas Total
Interest on capital
, B = .20 (P857,143 – P257,143) P315,000 x 10% P 31,500
B = .20 x P600,000 P180,000 x 10% P 18,000 P 49,500
B = P120,000 Salaries (ratio of 50:25) 183,500 367,000 550,500
Total P 215,000 P 385,000 P 600,000
Key Points. The bonus was not deducted from the profit subject to income tax. The bonus
being computed is not an expense but a distribution of profit after income tax. The entry to record the distribution of the profit is as follows:

3. Bonus is based on profit after deducting bonus and income tax Income Summary 600,000
Santos, Capital 215,000
B = .20 (P857,143 – B – T) Tomas, Capital 385,000

T = .30 x P 857,143 SPECIAL PROFIT ALLOCATION METHODS

= P257,143
Some partnerships distribute profits on the basis of other criteria. For example, most public
Substituting for T in the first equation and solving for B
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 firmwide compensation
B = .20 (P857,143 – B – P257,143)
committee based on:
B = .20 (P600,000 – B)
• obtaining new clients;
B = P120,000 - .20 B
• providing the firm with specific areas of industrial expertise;
B = .20B = P120,000
B = P120,000/1.20 • serving as a managing partner of a local office; or
B = P100,000 • accepting a variety of other responsibilities

Key Points. In the preceding example, bonus is treated as a distribution of partnership profit,
and therefore such bonus is not deductible as an expense in determining the amount of taxable
profit. The same is true for salaries and interest allowed on capital.
In some instances, the partners may agree not to use a residual sharing ratio in the event profits
did not exceed the total of the salary and interest allowances. In this 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.
Illustrative Problem B: Santos and Tomas are partners with capital balances of P315,000 and
P180,000, respectively. The profit and loss agreement provides salaries of P500,000 to Santos
Other partnerships devise profit distribution plans that the 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 WORK SHEET
At the end of each accounting period, the partnership bools are adjusted and closed and financial
statements are prepared. 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. The following

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illustrative problem will use the simplest form of work sheet with emphasis not on the form but e. Accrued interest on notes payable, P1,500
the underlying principles and procedures in preparing such work sheet. f. Allowance for uncollectible accounts to be increased to P112,500
g. Unused supplies: office – P10,000, store – P15,000
Illustrative Problem C: The trial balance for EXCELLENCE COMPANY as at December 31, 2014 h. Income tax, 30% profit before income tax
is presented.
The Articles of Co- Partnership contain the following provisions regarding the division of profits
EXCELLENCE COMPANY and losses:
Trial Balance
December 31, 2014 1. Annual salaried of P400,000 and P500,000, respectively.
2. Interest of 10% on beginning capital
Debit Credit 3. The remainder is divided in the ratio of 3:2
Cash 1,900,000
Notes Receivable 625,000 A work sheet prepared for the partnership and the related statement of financial position and
Accounts Receivable 1,125,000 income statement are presented on the next pages. The statement of changes in partners’ equity
Allowance for Uncollectible Accounts 50,000 is presented below.
Merchandise Inventory 1,250,000
Furniture and Equipment 1,500,000 EXCELLENCE COMPANY
Accumulated Depreciation 200,000 Statement of Changes in Partners’ Equity
Notes Payable 500,000 For the Year Ended December 31, 2014
Accounts Payable 375,000
Flores, Capital 1,250,000
Flores, Drawing 155,000 Flores Garcia Total
Garcia, Capital 3,125,000 Equity, January 1 P1,250,00
Garcia, Drawing 250,000 Add Profit for 2014:
Sales 5,000,000 Salaries P 400,000 P 500,000 P 900,000
Sales Returns and Allowances 50,000 Interest on beginning capital 125,000 312,500 437,500
Sales Discounts 75,000 Balance – 3:2 (P747,050)
Purchases 2,412,500 P747,050x 3/5 ( 448,230)
Purchases Returns and Allowances 100,000 P747,050x 2/5 ( 298,820) ( 747,050)
Purchases Discounts 62,500 Total share in profit P 76,770 P 513,680 P 590,450
Freight-In 125,000 Total P1,3261770 P3,638,680 P4,965,450
Selling Expenses 825,000 Less Withdrawals 155,000 250,000 405,000
General Expenses 362,500 Equity, December 31 P1,171,770 P3,388,680 P4,560,450
Interest Income 17,500
Interest Expense 25,000
10,680,000 10,680,000

Data for adjustments as of December 31, 2014:

a. Merchandise inventory, P1,000,000

b. Depreciation of furniture and equipment, 10% per year, 40% of which is considered part of
general expenses
c. Unpaid sales salaries, P25,000
d. Accrued interest on notes receivable, P2,500

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EXCELLENCE COMPANY
Work Sheet
For the Year Ended December 31, 2014
Trial Balance Adjustments Statement of Income Statement of Financial Position
Debit Credit Debit Credit Debit Credit Debit Credit
Cash 1,900,000 1,900,000
Notes Receivable 625,000 625,000
Accounts Receivable 1,125,000 1,125,000
Allowance for Uncollectible Accounts 50,000 f. 62,500 112,500
Merchandise Inventory 1,250,000 1,250,000 1,000,000 1,000,000
Furniture and Equipment 1,500,000 1,500,000
Accumulated Depreciation 200,000 b. 150,000 350,000
Notes Payable 500,000 500,000
Accounts Payable 375,000 375,000
Flores, Capital 1,250,000 1,250,000
Flores, Drawing 155,000 155,000
Garcia, Capital 3,125,000 3,125,000
Garcia, Drawing 250,000 250,000
Sales 5,000,000 5,000,000
Sales Returns and Allowances 50,000 50,000
Sales Discounts 75,000 75,000
Purchases 2,412,500 2,412,500
Purchase Returns and Allowances 100,000 100,000
Purchase Discounts 62,500 62,500
Freight-In 125,000 125,000
Selling Expenses 825,000 b. 90,000 g. 15,000 925,000
c. 25,000
General Expenses 362,500 b. 60,000 g. 10,000 475,000
f. 62,500
Interest Income 17,500 d. 2,500 20,000
Interest Expense 25,000 e. 1,500 26,300
10,680,000 10,680,000

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Salaries Payable c.25,000 25,000

Interest Receivable d. 2,500 2,500
Interest Payable e. 1,500 1,500
Supplies on Hand g. 25,000 25,000
Income Tax Expense h. 253,050 253,050
Income Tax Payable h. 253,050 253,050
519,550 519,550 5,592,050 6,182,500 6,582,500 5,992,050
Profit 590,450 590,450
6,182,500 6,182,500 6,582,500 6,582,500

Computation of income tax and profit:

Total credit per income statement before income tax P 6,182,500
Total debit per income statement before income tax 5,339,000
Profit before tax P 843,500
Income tax (P843,500 x 30%) 253,050
Profit P 590,450

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EXCELLENCE COMPANY Cost of Goods Available for Sale P 3,625,000

Statement of Income Less Merchandise Inventory, December 31 1,000,000
For the Year Ended December 31, 2014 Cost of Sales P 2,625,000

Schedule Key Points. The Statement of Income of a partnership is similar to that of a sole proprietorship
Net Sales 1 P4,875,000 except that it includes a schedule showing the division or distribution of profit to partners.
Cost of Sales 2 2,625,000
Gross Profit P2,250,000 EXCELLENCE COMPANY
Other Operating Income - Interest 20,000 Statement of Financial Position
Operating Expenses: December 31, 2014
Selling P 925,000
General 475,000 (1,400,000) Assets
Cash Assets:
Operating Profit P 870,000
Cash P1,900,000
Interest Expense ( 26,500) Notes Receivable 625,000
Profit before Tax P 843,500 Accounts Receivable P1,125,000
Income Tax Expense (30%) ( 253,050) Less Allowance for Uncollectible Accounts 112,500 1,012,500
Profit for the Period P 590,450 Interest Receivable 2,500
Merchandise Inventory 1,000,000
Supplies 25,000 P4,565,000
Division of profit
Furniture and Equipment P1,500,000
Flores Garcia Total Less Accumulated Depreciation 350,000 1,150,000
Salaries P 400,000 P 500,000 P 900,000
Interest on beginning capital 125,000 312,500 437,500 Total Assets P5,715,000
Balance – 3:2 (P747,050)
P747,050 x 3/5 ( 448,230) Liabilities
P747,050 x 2/5 ( 298,820) ( 747,050) Current Liabilities
Total share in profit P 76,770 P 513,680 P 590,450 Notes Payable P 500,000
Accounts Payable 375,000
Salaries Payable 25,000
Interest Payable 1,500
Schedule 1 – Net Sales Income Tax Payable 253,050
Total Liabilities P1,154,550
Sales P5,000,000
Less: Sales Returns and Allowances P50,000 Partners Equity
Sales Discounts 75,000 125,000 Flores, Capital P1,171,770
Net Sales P4,875,000 Garcia, Capital 3,886,680
Total Partners’ Equity 4,560,450

Schedule 2 – Cost of Sales Total Liabilities and Partners’ Equity P5,715,000

Merchandise Inventory, January 1 P 1,250,000
Net Purchases
Purchases P 2,412,500
Add Freight-In 125,000
Total P 2,537,500
Less: Purchase Returns and Allowances P100,000
Purchases Discounts 62,500 162,500 2,375,000

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Chapter 3 – Partnership Operations

CORRECTIONS IN PROFIT ERRORS AND OMISSIONS PRIOR RO The corrected profit for 2014 based on a 30% income tax rate shall be computed as follows:
DISTRIBUTION
Reported profit P398,000
Corrections:
The partnership books may show an incorrect profit because of errors and omissions. Such Unrecorded accrued expense, 2013 P 5,000
include failure to record prepaid expenses, accrued expenses, accrued income, unearned income Unrecorded unearned income, 2013 10,000
and also overstatement or understatement in purchases, inventories, and depreciation. The Overstatement of ending inventory, 2014 (48,000)
reported profit should be corrected before it is distributed to the partners. The required Unrecorded purchases, 2014 (20,000)
corrections may be summarized as follows: Unrecorded prepaid expenses, 2013 ( 3,000)
Total corrections before income tax P(56,000)
Correction to profit of current year for x 70%
errors made in Total corrections after income tax ( 39,200)
Prior Year Current Year Corrected profit P358,800
1. Unrecorded prepaid expenses - +
2. Unrecorded accrued expenses + - The distribution of the corrected profit shall be based on the new profit and loss ratios computed
3. Unrecorded accrued income - + as follows:
4. Unrecorded unearned income + -
5. Overstatement of inventories + - Hannah 20% x 80% = 16%
6. Understatement of inventories - + Ines 30% x 80% = 24%
7. Overstatement of purchases - + Julian 50% x 80% = 40%
8. Understatement of purchases + - Karina 20%
9. Overstatement of depreciation none + 100%
10. Understatement of depreciation none -
The corrected profit shall be divided among partners as follows:
It is understood that the tax implications of these corrections are properly accounted for
particularly if the partnership is not a general profession partnership. Hannah P358,800 x 16% P57,408
Ines P258,800 x 24% 86,112
Julian P358,800 x 40% 143,520
Illustrative Problem D. Hannah, Ines, and Julian are partners sharing profits on a 2:3:5 ratio. Karina P358,800 x 20% 71,760
On January 1, 20014. Karina was admitted into the partnership with a 20% share in profits. The P358,800
old partners shall continue to participate in profits in proportion to their original ratios.

For the year 2014, the partnership books showed a profit of P398,000. It was ascertained, CAPITAL BALANCES RATIO ADJUSTED TO PROFIT AND LOSS RATIO
however, that the following errors were made:
While it is usual that capital ratios do not equal profit and loss ratios; yet, partners may decide
1. Accrued expenses not recorded at the end of 2013 P 5,000 to bring their capital balances into their profit and loss ratio. This can be accomplished through
2. Overstatement of 2014 ending inventory 48,000 either of the following:
3. Goods received and inventories in 2014 but the related
purchases not recorded 20,000 1. The capital balances are to be brought into the profit and loss ratio by payments outside
4. Income received in advance (unearned income), not of the firm among the partners and where the total firm capital is to remain the same.
recorded at the end of 2013 10,000 2. The capital balances are to be brought into the profit and loss ratio by the lowest
5. Prepaid expenses not recorded at the end of 2013 3,000 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.
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Illustrative Problem E. Lopez, Martin, and Nunag are partners whose original capital balances Assumption 3. Capital balances are to be brought into the profit and loss by the lowest possible
were in their profit and loss ratio. On December 31, 2014, capital balances are as follows: additional investment or cash withdrawal from the firm by the partners.

Lopez P400,000 20% Lopez Martin Nunag Total

Martin 200,000 30% Capital balances P400,000 P200,000 P400,000 P1,000,000
Nunag 400,000 50% Required capital 160,000 240,000 400,000 800,000
Add’l investment (withdrawals) (P240,000) P 40,000 P 200,000
Partners want to bring their capital balances into the profit and loss ratio.

Assumption 1. Capital balances are to be brought into the profit and loss ratio by payments In order to bring the capital balances into the profit and loss ratio by the lowest possible
outside of the firm among partners and with the total firm capital to remain the same. additional cash investment or cash withdrawal from the firm by the partners, use as basis for
determining the required capital, the capital of Nunag divided by his profit share (P400,000 /
50% equals P800,000.) The required entry on the books of the partnership is as follows:
Capital balances P400,000 P200,000 P400,000 P1,000,000
Required capital 200,000 300,000 500,000 1,000,000 Lopez, Capital 240,000
Cash received (paid) P200,000 (P100,000) (P100,000) - Cash 200,000
Martin, Capital 40,000
For the capital balances to be brought into the profit and loss ratio and total firm capital to remain
the same, Martin and Nunag have to pay Lopez P100,000 each. The entry required on the REVIEW of the LEARNING OBJECTIVES
partnership books is as follows:
1. Discuss the closing entries in a partnership and differentiate them from the closing
Lopez, Capital 200,000 entries in a sole proprietorship. The closing entries of a partnership are almost similar to
Martin, Capital 100,000 those of a sole proprietorship. However, the profit or loss of the partnership is transferred
Nunag, Capital 100,000 to the individual drawing account or capital account of the partners and is distributed
according to the profit and loss sharing agreement.
Assumption 2. Capital balances are to be brought into the profit and loss ratio by the lowest
possible cash investment in the firm by the partners. 2. Identify and discuss the different methods and rules of dividing partnership profits and
losses to the partners. The distribution of partnership profits and losses to the partners
Lopez Martin Nunag Total may be expressed in any of the following ways: (1) by percentage; (2) by fraction; (3) by
Capital balances P400,000 P200,000 P400,000 P1,000,000 decimal; or (4) by ratio. The Civil Code of the Philippines provides rules on how partnership
Required capital 400,000 600,000 1,000,000 2,000,000 profits and losses be divided among the partners. As a general rule, profits or losses should
Additional investment - P400,000 P600,000 P1,000,000 be divided among with the partners’ agreement. In the absence of an agreement, the division
shall be made in accordance with capital contributions. To give recognition to the services
P400,000 / 20% = P2,000,000; P200,000 / 30% = P666,666 rendered by the partners or to the differences in the amount contributed in the partnership
P400,000 / 50% = P800,000 or to the entrepreneurial ability or managerial skill of the partners, salaries, interest and
bonuses may be allowed to partners part of the division of profits and losses.
In order to bring the capital balances into the profit and loss ratio by the lowest possible
additional cash investment, use as basis for determining the required capital, the capital of Lopez 3. Discuss and understand the preparation of financial statements of a partnership. The
divided by his profit share (P400,000/20% equals P2,000,000(. The required entry on the books financial statements are prepared after the work sheet is completed (or after journalizing
of the partnership is as follows: and posting the adjusting entries if a work sheet is not prepared). These financial statements
include the income statement, the statement of financial position, and the statement of
Cash 1,000,000 changes in partners’ equity. The income statement includes a schedule showing the division
Martin, Capital 400,000 of the partnership profit or loss to the partners. The owners’ equity section of the statement
Nunag, Capital 600,000 of financial position is called “Partners’ Equity’ and it shows capital balances of individual

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partners. The statement of changes in partners’ equity shoes the division of profit or loss to MULTIPLE CHOICE
the partners, the amount of withdrawals during the period, and the partners’ capital
balances at the end of the period.
MC 3-1 Banayo and his very close friend Buendia formed a partnership on January 1, 2014 with
Banayo contributing P160,000 cash and Buendia contributing equipment with a book
value of P64,000 and a fair value of P48,000, and inventory items with a book value of
GLOSSARY of ACCOUNTING TERMINOLOGIES P24,000 and a fair value of P32,000. During 2014, Buendia made additional investment
of P16,000 on April 1, and P16,000 on June 1. On September 1, withdrew P40,000.
Average capital – the amount of capital invested by a partner determined by the time during Banayo had no additional investment nor withdrawals during the year. The average
which such capital is actually used in the business. capital balance of Buendia at the end of the fiscal year 2014 is
a. P72,000
Bonus – an incentive normally given to the managing partner in recognition of managerial or b. P80,000
entrepreneurial skill or ability. It is usually a percentage of profit. c. P88,000
d. P96,000
Interest on capital – incentive given to partners to give recognition to the differences in
capital contributions and is computed in proportion to the period such capital was actually MC 3-2 Banas and Belda are partners who share profits equally and losses in a 2:1 ratio. If they
used. have beginning capital balances of P120,000 and P118,000, made no additional
investments nor withdrawals, and suffered an unprofitable year with loss of P48,000,
Salary allowances – compensation given to partners in proportion to the time devoted to the their capital balances will be:
business. Banas Belda
a. P 40,000 P 80,000
Statement of Changes in Partners’ Equity – a statement showing the division of partnership b. 88,000 102,000
profit or loss to the partners, additional investments made by partners, the amount of c. 120,000 118,000
withdrawals of individual partners, and the ending capital balances. d. 152,000 134,000

MC 3-3 Bernardo and Belo formed a partnership in the year 2014. The partnership agreement
provides for annual salary allowances of P110,000 for Bernardo and P90,000 for Belo.
The partners share profits equally and losses in a 60:40 ratio. The partnership had
profit of P180,000 for the year 2014 before any allowance to partners. What amount
should be credited to each partner’s capital account as a result of the distribution of the
partnership profit?
Bernardo Belo
e. P 98,000 P 82,000
f. 100,000 80,000
g. 96,000 84,000
h. 90,000 90,000

MC 3-4 Bunag, Belen, and Bustos are partners in an accounting firm. Their capital account
balances at year-end were P180,000, P220,000, and P100,000, respectively. They share
profits and losses on a 4:4:2 ratio, after considering the following items:
a. Bustos is to receive a bonus of 10% of profit after bonus.
b. Interest of 10% shall be paid on that portion of a partner’s capital in excess of
P200,000
c. Salaries of P20,000 and P24,000 shall be paid to partners Bunag and Bustos,
respectively.
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