Continue: Allocation of net income

During the Allocation Process, the Accountant may face some problems:
 Problems of Computing Interest on Capital.
 Problems of Computing Salary.
 Problems of Computing Bonus.
 Problem under which the Remainder is Loss.
 Problems under which there is Net Loss not Net Income

1/1- Problems of Computing Interest on Capital.

Assume that Partner (A) has BEGINNING Capital Balance of $100,000 and during the year, he
INCREASED his Capital by $50,000 on 1/4 and INCREASED his Capital by $250,000 on 1/10
(Interest Rate 10%).

+ 50,000 + 250,000

3 months 6 months 3 months

1/1 1/4 1/10 31/12

150,000 400,000 400,000

100,000

Here we have (3) Cases

Interest on Interest on
Interest on
Beginning Capital Ending Capital Average Capital
Interest = Interest =
2nd Computing
100,000 x 10% 400,000 x 10% 100,000 X 3/12 = 25,000
= 10,000 = = 40,000 150,000 X 6/12 = 75,000
400,000 X 3/12 = 100,000
Average Capital = 200,000

Interest = 200,000 x 10%

= 20,000
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 Example (1):
A & B & C started their business on 1/1/2005 with Capital Balances of $30,000 to (A), $40,000
to (B), & $50,000 to (C). By the end of the year, the following information has been available:
 The reported Net Income of the year was $41,000
 The agreement between the partners stated that:
1) To allow interest of 12% on Weighted average capital balances (moving balances).
2) To allow annual salaries of $10,000 to Partner (A).
3) To allow bonus of $5,000 to Partner (B).
4) The remainder is to be allocated at a ratio 1 : 2 : 2 respectively.

The following table summarized additions & reductions on their balances during the year:

Partner Additions Reductions Date

$
A 10,000 --- 1/10
$
B 20,000 --- 1/4
$
B --- 10,000 1/11
$
C --- 5,000 1/7

Required: Prepare the Income Allocation Table.

Solution
1st Computing Interest on Weighted Average Capital:

Partner (A) Partner (B)

Partner (C)
3 7 3 6 6
9 3

1/1 1/7
31/12
1/1 1/10 1/1 1/4 1/11 31/12
31/12
50,000 45,000 45,000
40,000 60,000
30,000 40,000 40,000 40,000 X 3/12 =50,000
10,000 50,000

30,000 X 9/12 = 22,500

60,000 X 7/12 = 35,000 50,000 X 6/12 = 25,000
40,000 X 3/12 = 10,000
50,000 X 2/12 = 8,333 45,000 X 6/12 = 22,500
Average Capital = 32,500
Average Capital = 53,333 Average Capital = 47,500

Interest = 32,500 x Interest = 53,333 x 12% =

12% = 3,900 6,400 Interest = 47,500 x 12% =
5,700

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 2nd Income Allocation Table:

A B C Total

3,900 6,400 5,700

1) Interest on Capital 16,000
(32,500 x 12%) (53,333 x 12%) (47,500 x 12%)

2) Annual Salary 10,000 -- -- 10,000

3) Bonus -- 5,000 -- 5,000

4) The Remainder
2,000 4,000 4,000
(41,000 - 16,000 - 10,000 – 10,000
(10,000 x 1/5) (10,000 x 2/5) (10,000 x 2/5)
5,000)

Total 15,900 15,400 9,700 41,000

2nd Computing Annual Salary

Salaries are paid to the partner who is managing the Partnership (General Partner in most cases)..
we should note that Salaries should be computed on Annual Basis:

 If Salary is given Annually No Problem

 If Salary is given Monthly x 12

 If Salary is given Semi
x 2
Annually
 If Salary is given Quarterly x 4
\

3rd Computing Bonus

Bonus is paid to the partner who makes profitable contracts to the company & it is only
computed if the Company realized Net Income not Loss.
Assume that Net Income was $330,000 & Interest on Capital was $55,000 & Salaries was
$110,000. Compute the amount of Bonus under each of the following cases:

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1) 10% of Net Income = 330,000 x = 33,000
100
10
2) 10% of Net Income after Interest = (330,000 - 55,000) x = 27,000
100
27500
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 10
3) 10% of Net Income after Salaries = (330,000 - 110,000) x = 22,000
100

4) 10% of Net Income after Interest (330,000 - 110,000 – 10

= x = 16,000 16500
& Salary 55,000) 100
10
5) 10% of NI after Bonus = 330,000 x = 30,000
110
10
6) 10% of NI after Interest & Bonus = (330,000 – 55,000) x = 25,000
110
10
7) 10% of NI after Salaries & Bonus = (330,000 – 110,000) x = 20,000
110

8) 10% of NI after Interest, Salaries (330,000 – 55,000 - 10

= x 110 = 15,000
& Bonus 110,000)

Example (2):
A & B & C started their partnership on 1/1/2019 with Capital Balances $60,000, $40,000 &
$
20,000 respectively. By the end of the year, the Partnership realized Net Income $132,000 and
the agreement between the partners is to allocate the profit and loss as follows:
1) To allow 10% Interest on the Weighted Average Capital Balances.
2) To allow Monthly Salary $2,500 to Partner (B).
3) To allow Bonus 25% of Net Income after deducting Interest & Salary & Bonus to Partner (A).
4) The remainder is to be allocated Equally.

Required: Prepare Income Allocation Table & Income Allocation Entries.

Solution
1st Income Allocation Table:

A B C Total
6,000 4,000 2,000
1) Interest on Capital (60,000 x (40,000 x (20,000 x 12,000
10%) 10%) 10%)
30,000
2) Annual Salary -- -- 30,000
(2,500 x 12)
3) Bonus to (A)
[(132,000 – 12,000 – 30,000) x 18,000 -- -- 18,000
25/125]

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 24,000 24,000 24,000
4) The Remainder
(72,000 x (72,000 x (72,000 x 72,000
(132,000 - 12,000 - 30,000 – 18,000)
1/3) 1/3) 1/3)
Total 48,000 58,000 26,000 132,000

2nd Income Allocation Entries:

 Closing the “Income Summary Account” in “Profit & Loss Distribution”:

Income Summary (Profit) 132,000

P & L Distribution 132,000

 Recording & closing the “Factors”:

Recording & Closing Interest Recording & Closing Salary Recording & Closing Bonus
Interest Salary
12,000 Bonus
30,000 18,000
Current Account Current Account (B):
(A):6.000 12,000 30.,000 Current Account (A) 18,000
(B):4.000
(C): 2.000
P & L Distribution 12,000 P & L Distribution
P & L Distribution 30,000 18,000
Interest 12,000 Salary 30,000 Bonus 18,000

 Allocating the Remainer Directly from P & L Distribution:

P & L Distribution 72,000

Current Account (A) 24,000 72.000
Current Account (B) 24,000
Current Account (C) 24,000

4th The Remainder is a Loss

Example:
A & B & C started their business with Total Capital $300,000 divided between them equally. By
the end of the year, the company realized Net Income of $33,000 and the agreement stated that:
1) To allow Interest 10% Interest on Capital Balances.

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 2) To allow Annual Salary $20,000 to Partner (A) only.
3) To allow Bonus 10% of Net Income after deducting Bonus to Partner (C) only.
4) The remainder is to be allocated in the ratio of 4:3:3 respectively

Required: Prepare the Income Allocation Table & Journal Entries to allocate Net Income.

Solution
1st Income Allocation Table:

A B C Total
10,000 10,000 10,000
1) Interest on Capital 30,000
(100,000 x 10%) (100,000 x 10%) (100,000 x 10%)

2) Annual Salary 20,000 -- -- 20,000

3,000
3) Bonus -- -- (33,000 x 3,000
10/110)
4) The Remainder
(8,000) (6,000) (6,000)
(33,000 - 30,000 - 20,000 – (20,000)
(20,000 x 4/10) (20,000 x 3/10) (20,000 x 3/10)
3,000)
Total 22,000 4,000 7,000 33,000

1st Income Allocation Entries:

 Closing the “Income Summary Account” in “Profit & Loss Distribution”:

Income Summary (Profit) 33,000

P & L Distribution 33,000

2nd Income Allocation Entries:

Recording & Closing Interest Recording & Closing Salary Recording & Closing Bonus
Interest Salary
30,000 Bonus
20,000 3,000
Current Account Current Account (A):
(A):10.000 30,000 20.,000 Current Account (C) 3,000
(B):10.000
(C): 10.000
P & L Distribution 30,000 P & L Distribution
P & L Distribution 20,000 3,000
Interest 30,000 Salary 20,000 Bonus 3,000

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  Allocating the Remainer Directly from P & L Distribution:

Current Account (A) :8.000 20,000

Current Account (B) :6.000
Current Account (C) :6.000

P & L Distribution 20,000

5th Allocating Net Loss to Partners

In case of Loss, No Bonus will be given to Partners, and the rest of steps will be the same without
any changes.
Example:
A & B started their business with Capital Balances $30,000 & $45,000 respectively. By the end of
the year, the company realized Net Loss of $2,000 and the agreement stated the following:
1) To allow Interest 8% Interest on Capital Balances.
2) To allow Semiannual Salary $6,000 to Partner (A), & Quarterly Salary $5,000 to Partner (B).
3) To allow Bonus 10% of Net Income after deducting Bonus to Partner (A) only.
4) The remainder is to be allocated in the ratio of 3:2 respectively

Required: Prepare the Income Allocation Table.

Solution

A B Total

2,400 3,600
1) Interest on Capital 6,000
(30,000 x 8%) (45,000 x 8%)

12,000 20,000
2) Annual Salary 32,000
(6,000 x 2) (5,000 x 4)

3) Bonus (No Bonus in Case of

-- -- ---
Loss)

4) The Remainder (24,000) (16,000)

(40,000)
( - 2,000 - 6,000 - 32,000) (40,000 x 3/5) (40,000 x 2/5)

Total (9,600) 7,600 (2,000)