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Lesson 2: PARTNERSHIP OPERATIONS

Lesson Objectives

At the end of the lesson, the students will be able to:

To compute the share in profit/loss to partners,
To journalize the share of the result of operation, and
To prepare a Statement of Changes in Partners' Equity.

Getting Started
After the formation of partnership is the operations. The operations may result in either net income
or net loss and entry these in the books.

When it has net income: When it has a net loss:

Income Summary XX Partner A, Drawing XX

Partner A, Drawing XX Partner B, Drawing XX
Partner B, Drawing XX Income Summary XX

Discussion
FACTORS TO CONSIDER when dividing the profit or loss
Invested Capital
Time or labor given
Expertise contributed

CAPITAL BALANCES may be based on:

Beginning balances
Ending balances
Average balances

METHODS (CASES) OF DIVIDING PROFIT OR LOSS AMONG THE PARTNERS

Arbitrary ratio - equally, percentages, fractions, or ratios (Case 1)
Providing interest on Capital, balance in an agreed ratio (Case 2)
Providing salary to partner(s), balance in an agreed ratio (Case 3)
Providing both interest on Capital & salaries to partner(s) and balance in agreed ratio (Case 4)
Providing interest on Capital, salaries, bonus to partner(s), and balance as agreed upon (Case 5)

However, suppose there is no agreement on how to divide the profit or loss. In that case, the capital
balance will be the basis of division. The industrial partner will only share with the profit and will have
no share in the loss.

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Application
The following illustrations show the different cases of dividing the partnership profits or losses to
partners, related journal entries, and the changes in partners equity statement upon distribution.
CASE 1: ARBITRARY RATIO

Assume partners, Mr. Reyes and Mr. Santos have the following changes in their capital accounts.
The partnership had a net income of P300,000 at the end of the current year.
Reyes, Capital Santos, Capital
Oct. 1 200,000 Jan. 1 400,000 Jan. 1 200,000
Apr. 1 100,000

1A: Distribute based on BEGINNING CAPITAL

Reyes, Capital Santos, Capital

Oct. 1 200,000 Jan. 1 400,000 Jan. 1 200,000
Apr. 1 100,000

Dec. 31 Income Summary 3 0 0 0 0 0

Reyes, Drawing 2 0 0 0 0 0
Santos, Drawing 1 0 0 0 0 0
To record distribution of profits to partners
Basis: P600,000 (P400,000 + P200,000) Profits: P300,000
Reyes = P200,000 (P400,000 / P600,000 x P300,000 profits)
Santos = P100,000 (P200,000 / P600,000 x P300,000 profits)

1B: Distribute based on ENDING CAPITAL

Reyes, Capital Santos, Capital

Oct. 1 200,000 Jan. 1 400,000 Jan. 1 200,000
Apr. 1 100,000

Ending 200,000 Ending 300,000

Dec. 31 Income Summary 3 0 0 0 0 0

Reyes, Drawing 1 2 0 0 0 0
Santos, Drawing 1 8 0 0 0 0
To record distribution of profits to partners
Basis: P500,000 (P200,000 + P300,000) Profits: P300,000
Reyes = P120,000 (P200,000 / P500,000 x P300,000 profits)
Santos = P180,000 (P300,000 / P500,000 x P300,000 profits)

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1C: Distribute based on AVERAGE CAPITAL

Computation of Average Capital:

No. of Divided by
Investment Capital Multiply Months (A-Cycle) Average
Partner Date (Withdrawal) Balance by UNUSED TOTAL 12 Capital
Jan. 1 400,000 400,000 x 9 3,600,000 / 12 300,000
Oct. 1 ( 200,000 ) 200,000 x 3 600,000 / 12 50,000
Reyes 350,000
Jan. 1 200,000 200,000 X 3 600,000 / 12 50,000
Apr. 1 100,000 300,000 X 9 2,700,000 / 12 225,000
Santos 275,000

Dec. 31 Income Summary 3 0 0 0 0 0

Reyes, Drawing 1 6 8 0 0 0
Santos, Drawing 1 3 2 0 0 0
To record distribution of profits to partners
Basis: P625,000 (P350,000 + P275,000) Profits: P300,000
Reyes = P168,000 (P350,000 / P625,000 x P300,000 profits)
Santos = P132,000 (P275,000 / P625,000 x P300,000 profits)

CASE 2: PROVIDING INTEREST ON CAPITAL, BALANCE IN AN AGREED RATIO

Assume that Mr. Reyes and Mr. Santos are partners with capital balances of P400,000 and P200,000
respectively. They agreed to distribute profit of P300,000 as follows: 10% interest on capital and the
residual profit equally.

Distribution Schedule:
PARTNERS REYES SANTOS TOTAL Profit/(Loss)
CAPITAL BALANCES (Basis) 400,000 200,000 600,000 300,000
INTEREST on Capital,10%(10% x 400,000) 40,000 (10% x 200,000) 20,000 60,000 240,000
REM AINDER: Equally (240,000x1/2) 120,000 (240,000x1/2) 120,000 240,000 -
160,000 140,000 300,000

Dec. 31 Income Summary 3 0 0 0 0 0

Reyes, Drawing 1 6 0 0 0 0
Santos, Drawing 1 4 0 0 0 0
To record distribution of profits to partners

CASE 3: PROVIDING SALARY TO PARTNER(S), BALANCE IN AN AGREED RATIO

Assume that Mr. Reyes and Mr. Santos are partners with capital balances of P400,000 and P200,000
respectively. They agreed to distribute profit of P300,000 by allowing P12,000 monthly salary to Mr. Reyes
and the residual profit equally.

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Distribution Schedule:
PARTNERS REYES SANTOS TOTAL Profit/(Loss)
CAPITAL BALANCES (Basis) 400,000 200,000 600,000 300,000
SALARIES to Reyes,12K (12,000X12) 144,000 (10% x 200,000) - 144,000 156,000
REM AINDER: Equally (156,000x1/2) 78,000 (156,000x1/2) 78,000 156,000 -
222,000 78,000 300,000

Dec. 31 Income Summary 3 0 0 0 0 0

Reyes, Drawing 2 2 2 0 0 0
Santos, Drawing 7 8 0 0 0
To record distribution of profits to partners

CASE 4: PROVIDING BOTH INTEREST ON CAPITAL & SALARIES TO PARTNER(S) AND BALANCE IN AN AGREED
RATIO
Assume that Mr. Reyes and Mr. Santos are partners with capital balances of P400,000 and P200,000
respectively. They agreed to distribute loss of P200,000 by allowing P12,000 monthly salary to Mr. Reyes,
10% interest on capital and the residual profit equally.

Distribution Schedule:
PARTNERS REYES SANTOS TOTAL Profit/(Loss)
CAPITAL BALANCES (Basis) 400,000 200,000 600,000 ( 200,000 )
INTEREST,10% on capital (400,000X10%) 40,000 (200,000X10%) 20,000 60,000 ( 260,000 )
SALARIES to Reyes,12K (12,000X12) 144,000 - 144,000 ( 404,000 )
REM AINDER: Equally (404,000x1/2) ( 202,000 ) (404,000x1/2) ( 202,000 ) ( 404,000 ) -
( 18,000 ) ( 182,000 ) ( 200,000 )
Dec. 31 Reyes, Drawing 1 8 0 0 0
Santos, Drawing 1 8 2 0 0 0
Income Summary 2 0 0 0 0 0
To record distribution of loss to partners
CASE 5: Providing interest on Capital, salaries, bonus to partner(s), and balance as agreed upon
Assume that Mr. Reyes and Mr. Santos are partners with capital balances of P400,000 and P200,000
respectively. They agreed to distribute profit of P300,000, as follows: P12,000 monthly salary to Mr. Reyes,
10% interest on capital, a bonus of P20,000 to Mr. Reyes, and residual profit will be distributed as 30:70.

Distribution Schedule:
PARTNERS REYES SANTOS TOTAL Profit/(Loss)
CAPITAL BALANCES (Basis) 400,000 200,000 600,000 300,000
INTEREST,10% on capital (400,000X10%) 40,000 (200,000X10%) 20,000 60,000 240,000
SALARIES to Reyes,12K (12,000X12) 144,000 - 144,000 96,000
BONUS to Reyes,20K 20,000 - 20,000 76,000
REM AINDER: 30:70 (76,000x30%) 22,800 (76,000x70%) 53,200 76,000 -
226,800 73,200 280,000

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Dec. 31 Income Summary 3 0 0 0 0 0

Reyes, Drawing 2 2 6 8 0 0
Santos, Drawing 7 3 2 0 0
To record distribution of profits to partners

WHAT-IF-CASE 5: Providing interest on Capital, Salaries, Bonus to partner(s), and balance as agreed
upon resulting to a loss. Please observe the following computation on treatment to bonus.

5A: Assume that Mr. Reyes and Mr. Santos are partners with average capital balances of P350,000 and
P275,000 respectively. They agreed to distribute profit of P166,500, as follows: P12,000 monthly salary to
Mr. Reyes starting month of March, 10% interest on average capital, a 5% bonus to Mr. Reyes, and the
remaining profit equally.

Distribution Schedule:
PARTNERS REYES SANTOS TOTAL Profit/(Loss)
AVERAGE CAPITAL (Basis) 350,000 275,000 625,000 166,500
INTEREST,10% on capital (350,000X10%) 35,000 (275,000X10%) 27,500 62,500 104,000
SALARIES to Reyes,12K (12,000X10) 120,000 - 120,000 ( 16,000 )
BONUS to Reyes, 5% - - - ( 16,000 )
REM AINDER: 50:50 (16,000x50%) ( 8,000 ) (16,000x50%) ( 8,000 ) ( 16,000 ) -
147,000 19,500 166,500

5B: Assume that Mr. Reyes and Mr. Santos are partners with ending capital balances of P200,000 and
P300,000 respectively. They agreed to provide the following: Mr. Reyes is entitled to a 5% bonus of profit
after bonus, P12,000 monthly salary to Mr. Reyes starting month of March, 10% interest on their ending
capital, and a ¾ share on remaining profit for Mr. Santos. The partnership net profit is P166,500.

Distribution Schedule:
PARTNERS REYES SANTOS TOTAL Profit/(Loss)
ENDING CAPITAL (Basis) 200,000 300,000 500,000 166,500
INTEREST,10% on capital (200,000X10%) 20,000 (300,000X10%) 30,000 50,000 116,500
SALARIES to Reyes,12K (12,000X10) 120,000 - 120,000 ( 3,500 )
BONUS to Reyes, 5% of Profit* 8,325 - 8,325 ( 11,825 )
REM AINDER: 25:75 (11,825x25%) ( 2,956 ) (11,825x75%) ( 8,869 ) ( 11,825 ) -
145,369 21,131 158,175
*P166,500 is 100% profit less bonus,
So, you need to add back the bonus of 5% and the difference will be the bonus,
P166,500 x 105% = P174,825 - P166,500 = P8,325 Bonus on profit after bonus

5C: Assume that Mr. Reyes and Mr. Santos agreed to distribute profit and loss as follows: P120,000 salary
to Mr. Reyes, a 5% bonus after salaries, and a ¼ share on remaining profit for Mr. Reyes and allow both
partners 10% interest on ending capital balances. The partnership suffered loss of P22,500.

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The STATEMENT OF CHANGES IN is presented based on data of changes in the capital

on Case No. I and in the Profit/Loss distribution of Case5.c

REYES AND SANTOS Partnership

Statement of Changes in Partners' Equity
as of December 31, 2021

REYES SANTOS TOTAL

CAPITAL BALANCES, Beginning 400,000 200,000 600,000
Add/(Less) Permanent changes:
Investments/(Withdrawals) ( 200,000 ) 100,000 ( 100,000 )
Add/(Less) Drawings:
Share in Profit/(Loss) 43,750 ( 66,250 ) ( 22,500 )
CAPITAL BALANCES, Ending 243,750 233,750 477,500

Summary of the Lesson

Partnership operations may result to either net income or loss.

Partners may agree on how to distribute the net income or loss namely:
Arbitrary ratio (equally, percentages, fractions or ratios)
Providing interest on Capital, balance in an agreed ratio
Providing salary to partner(s), balance in an agreed ratio
Providing both interest on Capital and salaries to partners, balance in an agreed ratio
Providing interest on Capital, salaries and bonuses to partners, balance as agreed upon
The Partners' Equity Statement shows the changes in the capital accounts of the partners.

Suggested Links

1. https://books.google.com.ph/books?id=UtAat916438C&pg=PA1&source=gbs_toc_r&cad=3#v=on
epage&q&f=false
2. https://www.thebalancesmb.com/selecting-a-business-partnership-398880

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References
1. Manuel, Z.V.C, (2019), 21st Century Financial Accounting and Reporting for: Partnership and
Corporation. (2019 Edition) Manila: Zenaida Vera Cruz Manuel.
2. Ballada, W. & Ballada, S. (2019). Partnership and Corporation Accounting: Made Easy. (2019 ed.)
Manila: Dom Dane Pub.: Made Easy Books.
3. Empleo, Robles, German (2016) Fundamentals of Accounting Volume 2 Partnership and Corporation
(2016 Ed.) Mandaluyong City Millennium Books Inc.
4. Frias, Fajardo (2018), Elementary Accounting (Partnership and Corporation) (2018 Ed.), Manila,
Unlimited Books Library Services & Publishing Inc

Learning Module on PAC101 PARTNERSHIP AND CORPORATION ACCOUNTING