Chapter (2): Net Income Allocation in Partnerships

This chapter includes the following main points:

2-1 Closing accounts in the partnership
2-2 Accounting Treatment of Net Income Allocation
2-3 Problems in Allocation of Net Income.

2-1 Closing accounts in the partnership

The partnerships have the closing accounts are prepared at the end of the year to indicate the results
of the operations whether profits or losses. Due to the relationships occurred between the partners
and the partnerships during the year, there are two closing accounts related to the characteristics
of partnerships, besides those used in the a sole-enterprise, which are profit and loss distribution
account and the current accounts of the partners. We will focus on these two accounts as
follows:
A- The profit and loss distribution account (P&LDistribution):
This account is used to close the profits and losses account. In this context there are two cases as
follows:
The first case is the firm realized net profits at the end of the year, which the income summary
(profit) should be debited and P&LDistribution account should be credited

The second case is the firm realized net losses at the end of the year, in this case the income
summary (profit) should be debited, and the P&LDistribution account should be credited

B- The Current Account of the partners:

This account is used to accumulate both of the rights and the liabilities of the partners. The Current
Account Balance has No Nature because this account is debited by the inabilities of the partners
but it is credited by the rights of the partners
With regard to the rights of the partners, they include:
(a)-The share of the partners in the net profits of the partnership
(b)-The interest on the capital,
(c)- The interest on the partner’s loans granted to the partnership
(d)- The annual salaries and Bonus
On the other side, the obligations of the partners include:
(a)-The share of the partners in the losses
(b)-The due amounts from drawings by the partners
(c) The interest on the withdrawal’s partners from the partnership
(d)-The interest on the partner’s loans from the partnership

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 2-2- The accounting treatments of the net income allocation
According to the terms of the contract which are agreed upon the partners, the net profit is allocated
to the partners in different forms such as the interest on the capital, Annual salary, and Bonus Then
the remainder of profits or losses should be allocated either according to the agreed ratios or their
shares in the capital of the partnership
In this context, it is necessary to know the main objective of the profit allocation into these forms
1- Interest on the capital: To satisfy the partner who has larger capital
2- Salary: To satisfy the partner who carries out the business
3- Bonus: To satisfy the partner who makes profitable deals to the company
In order to allocate Net Income or Loss between partners we should follow two main steps:
1) Prepare Income Allocation Schedule.
2) Prepare Income Allocation Entries.
1st Income Allocation Schedule:
Total
Factor A B
Xx
1) Interest on Capital Xx Xx
Xx
2) Annual Salary Xx Xx
Xx
3) Bonus Xx Xx
Xx
4) The Remainder of the profits xx xx
Net income
Total xx xx

2nd: Income Allocation Entries:

1- Closing the “Income Summary Account” in a new account called “Profit & Loss Distribution”:

Case of Profit Case of Loss

Income Summary (Profit)  XX P & L Distribution XX

P & L Distribution XX Income Summary (Loss)  XX

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 2- Recording and Closing the Factors (Interest & Salary & Bonus):

Record Factor Close Factor

Factor (Interest or Salary or Bonus) XX P & L distribution  XX

Current Account  XX Factor (Interest or Salary or Bonus) XX

3- Distributing the Remainder:

Case of Profit Case of Loss

P & L distribution XX Current Account  XX

Current Account  XX
P & L distribution XX

Exercise (1):
AB Partnership realized Net Income during the period of $100,000 and the agreement between
the partners A & B is to allocate the profit and loss as follows:
1. 10% Interest on Capital Balances, which are $200,000 to Capital (A) & $300,000 to
Capital (B).
2. Salaries $12,000 Annually to Partner (A), & $8,000 Annually to Partner (B).
3. Bonus 10% of Net Income to Partner (A).
4. The remainder is to be allocated in the ratio of 1: 4.
Required: Prepare Income Allocation Table & Income Allocation Entries
Solution:
1st: Income Allocation Table:

A B Total
20,000 30,000
1) Interest on Capital 50,000
(200,000 x 10 ) (300,000 x 10%)
%

2) Annual Salary 12,000 8,000 20,000

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 10,000
3) Bonus -- 10,000
(100,000 x 10%)
4) The Remainder 4,000 16,000
(20,000 x 1/5) 20,000
(100,000 - 50,000 - 20,000 – 10,000 =20.000 (20,000 x 4/5)
Total 46,000 54,000 100,000

2nd Income Allocation Entries:

2/1- Closing the “Income Summary Account” in a new account called “Profit & Loss Distribution”:

Income Summary (Profit) 100,000

P & L Distribution 100,000

2/2- Recording & closing the “Factors”

Recording & Closing Interest Recording & Closing Salary Recording & Closing Bonus
Interest Salary Bonus
50,000 20,000 10,000
Current Account Current Account
(A):30.000 50,000 (A):12.000 20.,000 Current Account (A) 10,000
(B):20.000 (B):8.000
P & L Distribution 50,000 P & L Distribution
P & L Distribution 20,000 10,000
Interest 50,000 Salary 20,000 Bonus 10,000

2/3- Allocating the Remainer Directly from P & L Distribution:

P & L Distribution
20,000
Current Account
Current Account (A):4000 20.000
Current Account (B):16000

Exercise (2):
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 $100,000 and the agreement stated that:
1) To allow Interest 10% Interest on Capital Balances.
2) To allow Annual Salary $20,000 to Partner (A) only.
3) To allow Bonus 20% of Net Income 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 & Prepare the Income Allocation Entries.

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 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

20,000
3) Bonus -- -- 20,000
(100,000 x 20%)
4) The Remainder 12,000 9,000
9,000
(100,000 - 30,000 - 20,000 (30,000 x 4/10) (30,000 x 3/10) 30,000
(30,000 x 3/10)
– 20,000)=30.000
Total 42,000 19,000 39,000 100,000

2nd Income Allocation Entries:

1. Closing the “Income Summary Account” in a new account called “Profit & Loss Distribution”:

Income Summary (Profit) 100,000

P & L Distribution 100,000

2. Recording & closing the “Factors”

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

P & L Distribution 30,000 P & L Distribution

P & L Distribution 20,000 20,000
Interest 30,000 Salary 20,000 Bonus 20,000

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3. Allocating the Remainer Directly from P & L Distribution:

P & L Distribution
30,000
Current account
Current Account (A):12000 30.000
Current Account (B)”9000
Current Account (C):9000