PARTNERSHIP

OPERATIONS

Prof. Joseph Emmanuel I. Romero, CPA, MBA

Session Topics

 Nature of Partnership Operations

 Closing Entries

 Distribution of Partnership Profits

 Preparation of Financial Statements

Nature of Partnership
Operations

Accounting for partnership operations is

essentially the same as accounting for the
operations of a sole proprietorship.
Nature of Partnership
Operations

Sale of merchandise on account is debited to

________ and credited to __________.
Nature of Partnership
Operations

Collection of accounts is debited to _________

and credited to _____________.
Nature of Partnership
Operations

The purchase of merchandise on account is

recorded by a debit to Purchases and credit to
Accounts Payable.
Nature of Partnership
Operations

Using the periodic inventory system. The purchase

of merchandise on account is recorded by a debit
to ______ and credit to ________.
Nature of Partnership
Operations

Using the perpetual inventory system. The purchase

of merchandise on account is recorded by a debit
to ______ and credit to ________.
Nature of Partnership
Operations

Payment of accounts is debited to _______ and

credited to _________.
Nature of Partnership
Operations

Payment of expenses is debited to _______ and

credited to _________.
Nature of Partnership
Operations

The owner’s temporary withdrawal is debited to

_______ and credited to _________.
Nature of Partnership
Operations

At the end of the accounting period, adjustments are

made for merchandise inventory (periodic inventory
system), accruals, prepayments, provision for
uncollectible accounts, and estimates for
depreciation. Profit or loss is determined in the usual
manner, that is, by matching periodic income and
expenses.
CLOSING ENTRIES
STEPS IN CLOSING
THE BOOKS

Closing entries are entries prepared at the end of the

accounting period to "zero out" all nominal accounts in the
ledger.

This done so that the transactions during the period will not
commingle with the transactions in the next period. The
preparation of closing entries is also referred to as "closing
the books." This is an application of the time period concept.
 STEPS IN CLOSING
THE BOOKS
1. CLOSE THE BALANCES OF INCOME ACCOUNTS
Revenue/Income XXX
Income Summary XXX

2. CLOSE THE BALANCES OF EXPENSE ACCOUNTS

Income Summary XXX

Expenses XXX
 STEPS IN CLOSING
THE BOOKS
3.1 CLOSE THE BALANCE OF INCOME SUMMARY ACCOUNT (CREDIT BALANCE)

Income Summary XXX

A, Capital XXX
B, Capital XXX

3.2 CLOSE THE BALANCE OF INCOME SUMMARY ACCOUNT (DEBIT BALANCE)

A, Capital XXX
B, Capital XXX
Income Summary XXX
 STEPS IN CLOSING
THE BOOKS
4. CLOSE THE BALANCE OF THE DRAWING ACCOUNT
A, Capital XXX
A, Drawing XXX
DISTRIBUTION OF
PROFITS AND
LOSSES
 DISTRIBUTION OF
PROFITS AND LOSSES

To make distribution of partnership profits and losses equitable, the

following factors are considered:
a) Services rendered by the partners to the partnership;
b) Amount of capital contributed by the partners to the business;
c) Entrepreneurial ability or managerial skill of the partners
 DISTRIBUTION OF
PROFITS AND LOSSES
The distribution or division of profits and losses may be
expressed in several ways as follows:
by Percentage by Fraction by Decimal by Ratio
25%; 75% 1/4; 3/4 .25; .75 1:3
100%
80%
60%
40%
20%
0%
0 0.5 1
 DISTRIBUTION OF
PROFITS AND LOSSES
Illustration: Alba and Bueno are partners sharing profits and losses based
on their capital contributions of P100,000 and P300,000, respectively.
Their profit and loss sharing can be expressed as follows:

Alba Bueno
(100,000/400,000) (300,000/400,000)

By Percentage 25% 75%

By fraction 1/4 3/4

By decimal .25 .75

By ratio 1:3
 RULES FOR
DIVIDING PROFITS
AND LOSSES

The following is the list of rules in the

division of profits and losses of the
partnership based on the provisions of the
New Civil Code:
 As to Capitalist Partners
DIVISION OF PROFITS DIVISION OF LOSSES
in accordance
in accordance with agreement
with agreement
if only division of profits is
agreed upon, the same as
in the absence of an the agreement on the
agreement, division of division of profits
profits is in accordance
in the absence of an
with capital contributions
agreement, division of
losses is in accordance
with capital contributions
 As to Industrial Partners
DIVISION OF PROFITS DIVISION OF LOSSES
in accordance
in accordance with agreement
with agreement

in the absence of an in the absence of an agreement,

the capitalist-industrial partner in
agreement, the industrial
his/her character as industrial
partner shall receive a just partner shall have no share in the
and equitable share of the losses, but in his/her character as
profits and the capitalist a capitalist partner will share in
partners shall receive profits proportion to the capital
in accordance with their contribution
capital contributions
 METHODS OF
DISTRIBUTING
PROFITS BASED ON
PARTNERS'
AGREEMENT
 METHODS OF DISTRIBUTING PROFITS

1. EQUALLY - it is simple to apply but does not give due recognition on the
disparity of capital contribution nor does it recognize the time and
effort that a partner may devote in running the firm's business
operations.
2. ARBITRARY RATIO (percentage, decimal, fraction, ratio) - it is simple to
apply but does not give recognition on the disparity of capital
contributions nor does it recognize the time and effort that a partner
may devote in running the firm’s business operations.
3. CAPITAL RATIO (Original, Beginning, Ending, Average) - 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.
 METHODS OF DISTRIBUTING PROFITS

4. INTEREST ON CAPITAL AND THE BALANCE 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.

Interest is allowed to partners for the use of invested capital. Interest

as agreed by the partners shall be allowed in proportion over the
period such capital was actually used. Moreover, the interest shall be
provided whether the profit is sufficient or insufficient or there is a net
loss unless otherwise agreed upon by the partners.
 METHODS OF DISTRIBUTING PROFITS

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. 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.
 METHODS OF DISTRIBUTING PROFITS

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 on agreed ratio.
Illustrative Problem
• The following data are available in the books of Calma and David
Partnership for the year 2023.
Calma, Capital David, Capital
May 1 P 100,000 Jan 1 P 2,500,000 June 1 P 150,000 Jan 1 P 1,500,000
Apr 1 250,000 Dec 1 50,000 Sep 1 500,000
Oct 1 500,000
Balance 3,150,000 Balance 1,800,000

Calma, Drawing David, Drawing

June 1 300,000 June 1 225,000
Bal. 300,000 Bal. 225,000

Income Summary
Dec 31 600,000
Illustrative Problem

Case 1: Profit is divided Equally

2023 Income Summary 600,000

Dec 31

Calma, Capital 300,000

David Capital 300,000

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate 1/2 1/2
Profit Share 300,000 300,000
Illustrative Problem

Case 2: Profit is divided 3/4 and 1/4 to Calma and David, respectively.

2023 Income Summary 600,000

Dec 31

Calma, Capital 450,000

David Capital 150,000

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate 3/4 1/4
Profit Share 450,000 150,000
Illustrative Problem

Case 3: Profit is divided in the ratio of 1:2 to Calma and David

2023 Income Summary 600,000

Dec 31

Calma, Capital 200,000

David Capital 400,000

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate 1/3 2/3
Profit Share 200,000 400,000
Illustrative Problem

Case 4: Profit is divided 20% and 80% to Calma and David

2023 Income Summary 600,000

Dec 31

Calma, Capital 120,000

David Capital 480,000

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate 20% 80%
Profit Share 120,000 480,000
Illustrative Problem

Case 5: Profit is allocated based on the beginning capital ratio

2023 Income Summary 600,000

Dec 31

Calma, Capital 375,000

David Capital 225,000

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate 25/40 15/40
Profit Share 375,000 225,000
Illustrative Problem

Case 6: Profit is allocated based on the ending capital ratio

2023 Income Summary 600,000

Dec 31

Calma, Capital 381,818

David Capital 218,182

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate 315/495 180/495
Profit Share 381,818 218,182
TAKE NOTE!

1. Withdrawals deducted for purposes of determining ending

capital balances are the debit entries in the capital accounts of
each of the partners These debit entries represent PERMANENT
WITHDRAWALS or decreases on capital. The credit entries
represent initial and/or additional investments.
2. On the other hand, TEMPORARY WITHDRAWALS and other
entries in the drawing accounts are not considered in computing
ending capital for the purpose of establishing the ratio.
Illustrative Problem

Case 7: Profit is allocated based on the average capital ratio

2023 Income Summary 600,000

Dec 31

Calma, Capital 381,300

David Capital 218,700

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate *2,745,833/ *1,575,000/
4,320,833 4,320,833
Profit Share 381,300 218,700
Illustrative Problem

Case 7: Profit is allocated based on the average capital ratio

Method 1

Calma, Capital
A B C D E
No. of Months Peso Months
Period Capital Balance Average Capital
Unchanged (B x C)
Jan 1-Mar 31 2,500,000 3 7,500,000
Apr 1-Apr 30 2,750,000 1 2,750,000
May 1-Sept 30 2,650,000 5 13,250,000
Oct 1-Dec 31 3,150,000 3 9,450,000
12 32,950,000 2,745,833
Illustrative Problem

Case 7: Profit is allocated based on the average capital ratio

David, Capital
A B C D E
No. of Months Peso Months
Period Capital Balance Average Capital
Unchanged (B x C)
Jan 1-May 31 1,500,000 5 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
Dec 1-Dec 31 1,800,000 1 1,800,000
12 18,900,000 1,575,000
Total 4,320,833
Illustrative Problem

Case 7: Profit is allocated based on the average capital ratio

Method 2

Calma, Capital
A B C D E
No. of Months Peso Months
Particular Amount Average Capital
Outstanding/ 12mos (B x C)
Beginning Balance 2,500,000 12/12 2,500,000
Apr 1 250,000 9/12 187,500
May 1 (100,000) 8/12 66,667
Oct 1 500,000 3/12 125,000 2,745,833
Illustrative Problem

Case 7: Profit is allocated based on the average capital ratio

Method 2

David, Capital
A B C D E
No. of Months Peso Months
Particular Amount Average Capital
Outstanding/ 12mos (B x C)
Beginning Balance 1,500,000 12/12 1,500,000
June 1 (150,000) 7/12 (87,500)
Sept 1 500,000 4/12 166,667
Dec 1 (50,000) 1/12 (4,167) 1,575,000
Total 4,320,833
Illustrative Problem

Case 7: Profit is allocated based on the average capital ratio

2023 Income Summary 600,000

Dec 31

Calma, Capital 381,300

David Capital 218,700

SOLUTION
Calma David
Net Income 600,000 600,000
Multiply by: profit distribution rate *2,745,833/ *1,575,000/
4,320,833 4,320,833
Profit Share 381,300 218,700
Illustrative Problem

Case 8: Each partner is allowed 10% interest on ending capital and the
remaining profit is divided 60%, 40%.

Calma David Total

Interest on Ending Capital
P3,150,000 x 10% 315,000
P1,800,000x10% 180,000 495,000
Remainder – 60:40
105,000x60/100 63,000
105,000x40/100 42,000 105,000
Profit Share 378,000 222,000 600,000
Illustrative Problem

Case 8: Each partner is allowed 10% interest on ending capital and the
remaining profit is divided 60%, 40%.

2023 Income Summary 600,000

Dec 31

Calma, Capital 378,000

David Capital 222,000
Illustrative Problem

Case 9: David is allowed salaries of P500,000 and the remaining profit is

divided in the ratio of 1:4

Calma David Total

Salaries 500,000 500,000
Remainder – 1:4
100,000 x 1/5 20,000
100,000 x 4/5 80,000 100,000
Profit Share 20,000 580,000 600,000
Illustrative Problem

Case 8: Each partner is allowed 10% interest on ending capital and the
remaining profit is divided 60%, 40%.

2023 Income Summary 600,000

Dec 31

Calma, Capital 20,000

David Capital 580,000
Illustrative Problem
Case 10: David, the managing partner, is allowed a bonus of 20% of profit
BEFORE bonus and income tax and the remainder is divided in the ratio
of beginning capital.
Using the income tax rate of 25%, the partnership income before income tax is
P750,000 that is, net profit of P600,000 divided by 80%.

Calma David Total

Bonus (800,000 x 20%) 160,000 160,000
Remainder –
440,000 x 25/40 275,000
440,000 x 15/40 165,000 440,000
Profit Share 275,000 325,000 600,000
Illustrative Problem
Case 10: David, the managing partner, is allowed a bonus of 20% of profit
BEFORE bonus and income tax and the remainder is divided in the ratio
of beginning capital.

2023 Income Summary 600,000

Dec 31

Calma, Capital 275,000

David Capital 325.000
Illustrative Problem
Case 11: The partners are allowed P5,000 and P10,000 weekly salaries,
respectively, 10% interest on average capital, and the remainder is
divided in the ratio of 2:3
Calma David Total
Salaries to partners
P5,000 x 52 260,000
P10,000 x 52 520,000 780,000
Interest on average capital
P2,745,833 x 10% 274,583
P1,575,000 x 10% 157,500 432,083
Remainder – 2:3
(612,083) x 2/5 (244,833)
(612,083) x 3/5 (367,250) (612,083)
Profit Share 289,750 310,250 600,000
Illustrative Problem
Case 11: The partners are allowed P5,000 and P10,000 weekly salaries,
respectively, 10% interest on average capital, and the remainder is
divided in the ratio of 2:3

2023 Income Summary 600,000

Dec 31

Calma, Capital 289,750

David Capital 310,250
Illustrative Problem
Case 12: Assume the same agreement as in Case 11 except that instead of a profit,
the 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.

Calma David Total

Salaries to partners
P5,000 x 52 260,000
P10,000 x 52 520,000 780,000
Interest on average capital
P2,745,833 x 10% 274,583
P1,575,000 x 10% 157,500 432,083
Remainder – 2:3
(1,312,083) x 2/5 (524,833)
(1,312,083) x 3/5 (787,250) (1,312,083)
Profit Share 9,750 (109,750) (100,000)
Illustrative Problem
Case 12: The partners are allowed P5,000 and P10,000 weekly salaries,
respectively, 10% interest on average capital, and the remainder is
divided in the ratio of 2:3

2023 David Capital 109,250

Dec 31

Calma, Capital 9,250

Income Summary 100,000
Computation of Bonus
Illustrations on the computation of bonus using other assumptions.

Net Income P 600,000 Income before tax 800,000 100%

Income tax rate 25% Income Tax (200,000) 25%
Bonus rate 20% Net Income 600,000 75%

1. Bonus is based on profit after deducting bonus but before deducting

income tax.
B = 20% x (NET INCOME + INCOME TAX – BONUS)
B = 20% x (800,000 – BONUS)
B = P160,000 – .2B
B + .2B = P160,000
B = P160,000/ 1.2
B = P133,333
Computation of Bonus
Illustrations on the computation of bonus using other assumptions.

Net Income P 600,000 Income before tax 800,000 100%

Income tax rate 25% Income Tax (200,000) 25%
Bonus rate 20% Net Income 600,000 75%

2. Bonus is based on profit before deducting bonus but after deducting

income tax
B = 20% x (NET INCOME)
B = 20% x (600,000)
B = P120,000
Computation of Bonus
Illustrations on the computation of bonus using other assumptions.

Net Income P 600,000 Income before tax 800,000 100%

Income tax rate 25% Income Tax (200,000) 25%
Bonus rate 20% Net Income 600,000 75%

3. Bonus is based on profit after deducting bonus and income tax

B = 20% x (NI – BONUS)
B = 20% x (600,000 – BONUS)
B = P120,000 – .2B
B + .2B = P120,000
B = P120,000/ 1.2
B = P100,000
ORDER OF
PRIORITY
PROVISION
ORDER OF PRIORITY
PROVISION

• 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.
ORDER OF PRIORITY
PROVISION

• Illustrative Problem B: Santos and Tomas are partners with capital

balances ofP315,000 and P180,000, respectively. The profit and loss
agreement provides salaries of P500,000 to Santos 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 allowance. Partnership net income for the
year is P600,000.

• The following is the division of the P600,000 profit in accordance with

the order of priority provision.
ORDER OF PRIORITY
PROVISION
Santos Tomas Total
Interest on capital
P315,000 x 10% 31,500
P180,000 x 10% 18,000 49,500
Salaries (50:25)
P550,500 x 50/75 367,000
P550,500 x 25/75 183,500 550,500
Profit Share 398,500 201,500 600,000

2023 Income Summary 600,000

Dec 31

Santos, Capital 398,500

Tomas, Capital 201,500
Thank
you!