MODULE 2

PARTNERSHIP OPERATION
Week 3-5

INTRODUCTION

Partners are owners, not employees, so they do not generally get a regular paycheck.
Each partner receives a distributive share of the profits and losses of the business each
year. Payments are made based on the partnership agreement, and the partners are
taxed individually on these payments. In addition, some partners may receive a
guaranteed payment which is not tied to their partnership share. This payment is usually
for services like management duties.1

The purpose of a partnership is ultimately to distribute “money or other property from a

partnership to a partner in the partner’s capacity.”2

Profits and losses may be shared according to any formula on which the partners agree.
For example, the partnership agreement may provide that two senior partners are entitled
to 35 percent each of the profit from the year and the two junior partners are entitled to
15 percent each. The next year the percentages will be adjusted based on such things
as number of new clients garnered, number of billable hours, or amount of income
generated. Eventually, the senior partners might retire, and each be entitled to 2 percent
1
https://www.thebalancesmb.com/what-is-a-business-partnership-398402
2
https://saylordotorg.github.io/text_foundations-of-business-law-and-the-legal-environment
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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
of the firm’s income, and the previous junior partners become senior, with new junior
partners admitted.3

The right to share in the profits is the reason people want to “make partner”: a partner will
reap the benefits of other partners’ successes (and pay for their failures too). A person
working for the firm who is not a partner is an associate and usually only gets only a
salary.

A quick view on partnership operation:

Problems on partnership operation dwell on the profit and loss distribution phase
of the partnership. The following rules apply:

1. If a profit and loss distribution ratio has been agreed upon, profits and losses
shall be distributed using these ratios.

2. If there is no profit and loss distribution ratio agreed upon, distribution shall be
based on their capital balances, whether based on their initial, ending or
weighted/moving average capital balances.

INITIAL CAPITAL CONTRIBUTION – distribution of profit and loss will be based

on their respective capital contribution upon formation.

ENDING CAPITAL CONTRIBUTION – distribution of profit and loss will be based

on their respective capital balances before distribution.

WEIGHTED/MOVING AVERAGE BALANCES – which uses the formula:

Weighted Average

Note that the total number of months untouched, when summed up, must always
be equal to 12.

When partnership agreement provides salaries, interests and bonuses to partners:

1. Net profit – partnership may distribute salaries, interests and bonuses to

partners as agreed
2. Net loss – partnership may distribute salaries and interests to partners as
agreed, but not bonus.

3
Ibid.
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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
It would also depend on the agreement of the partners if they would include an
order of priority provision as to distribution of salaries, interests, and bonuses,
especially on cases where the net income is insufficient to satisfy the said
distribution scheme.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 INTENDED LEARNING OUTCOMES

1. To identify and illustrate the different methods of distributing profits

of the partnership.
2. To know how to compute the share of each partner in the profits
and determine the pro-forma entries to record the distribution.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 PARTNERSHIP OPERATION

Accounting Cycle of a Partnership – same as in sole proprietorship

1. Prepare journal entries

2. Post to ledgers
3. Prepare a trial balance
4. Prepare adjusting entries
5. Prepare financial statements
6. Prepare closing entries
7. Prepare a post-closing trial balance
8. Prepare reversing entries

Special Concerns

I. Journal entries – same as in sole proprietorship except for the following

transactions which are peculiar to a partnership:

a. Partners’ loans – partner lends money to partnership

Cash xxx
Accounts/Loans/Notes Payable or
Due to Partner or Loan from Partner xxx

b. Partners’ borrowings from partnership – partnership lends money to

partners
Accounts/Loans/Notes Receivable or
Loan to Partner xxx
Cash xxx

II. Financial statements – the same as in sole proprietorship except:

a. Balance Sheet or Statement of Financial Position – the owner’s equity

section is labeled Partners’ Equity

b. Income Statement – an additional section called Division of Profit and

Loss is included. This profit distribution provides a full analysis of the
distribution of earnings which is presented at the bottom of the partnership
income statement.

c. Statement of Changes in Partners’ Equity – a statement that reports the

changes that have taken place in partners’ equity during the period. Each
partner is provided a column heading which explains details of the
changes in their equity account.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
III. Closing entries – drawing accounts are not automatically closed to the capital
accounts; drawing accounts are closed to the capital accounts only if agreed upon in
the articles of co-partnership.

Rules for Dividing Profit and Loss

1. As to Capitalist Partner
a. Division of Profit
1. In accordance with agreement.
2. In the absence of an agreement, division of profits is in accordance
with capital contributions.

b. Division of Loss
1. In accordance with agreement.
2. If only the division of profits is agreed upon, then the division of losses
will be the same as the agreement on division of profits.
3. In the absence of an agreement, division of losses is in accordance
with capital contribution.

2. As to Industrial Partner
a. Division of Profit
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.

b. Division of Loss
1. In accordance with agreement.
2. In the absence of an agreement, the industrial partner shall have no
share in the losses.

Net income is viewed as a return for

1. services rendered (salaries)

2. capital investment (interest)
3. entrepreneurial ability or managerial skills (bonus)

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
Methods of Dividing Net Income

1. Equally

2. Arbitrary Ratio
a. Fractions
b. Percentages
c. Ratio and Proportion

3. Capital Ratio
a. Original/Initial investment
b. Beginning capital balance
c. Ending capital balance
d. Average capital – most equitable method

4. Allowing Salaries, Interest and Bonus – considered as part of the distribution

of net income
a. Salaries – to give recognition to the ability, experience or time devoted by
a partner to the business.
b. Interest - to give recognition to differences in the capital contribution given
in proportion to the period such capital was actually used.
c. Bonus – incentive/special compensation given to a partner for superior
income realized. It is usually based on net income.

General Guidelines

1. Partner salary allowances, interest allowances on capital account balances and

bonus are not expenses in the determination of partnership net income.

2. The provision on salaries and interest must be enforced regardless of whether

operating results is a profit or loss.

3. The provision on bonus is enforced only when operating results is a profit.

4. If the partnership agreement specifies that income is to be divided based on

partners’ capital balances but fails to specify how capital balances are to be
computed, the average capital balances should be used if it can be computed. If
not, the original capital balances should be used.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
Capital Account of a Partner

Partner, Capital
Debit Credit
Initial Investment/Beginning Balance
Permanent Withdrawals Additional Investments
Deficit ending balance Ending balance

Pro-forma Entries

1. To distribute net income against drawing accounts

Income Summary xxx
A, Drawing xxx
B, Drawing xxx

2. To distribute net loss against drawing accounts

A, Drawing xxx
B, Drawing xxx
Income Summary xxx

3. To distribute net income against capital accounts

Income Summary xxx
A, Capital xxx
B, Capital xxx

4. To distribute net loss against capital accounts

A, Capital xxx
B, Capital xxx
Income Summary xxx

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 END CHAPTER TEST

• The drafts of this module were submitted to our classroom as assignments.

• Submit your answers with solutions with the following heading format:
LAST NAME, FIRST NAME, MIDDLE INITIAL
MODULE 2 PARTNERSHIP OPERATION
• Typewritten or handwritten will do and your document must be submitted on time
in PDF format only.
• Name of your document: LASTNAMEFIRSTNAME_MODULE(NUMBER)
Example: BAGSITMARUBY_MODULE1
• Deadline: Before MIDTERMS

Problem 1

On December 1, 2015, Eleanor and Franco formed a partnership, agreeing to share for
profits and losses in the ratio of 2:3, respectively.

Eleanor invested a parcel of land that cost her P250,000. Franco invested P300,000 cash.

The land was sold for P500,000 on the same date, three hours after formation of the
partnership. How much should be the capital balance of Eleanor right after formation?
_______________________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 2

On March 1, 2015, Peter and Quinn decide to combine their businesses and form a
partnership. Their balance sheets on March 1, before adjustments, showed the following:
Peter Quinn
Cash P 9,000 P 3,750
Accounts receivable 18,500 13,500
Inventories 30,000 19,500
Furniture and fixtures (net) 30,000 9,000
Office equipment (net) 11,500 2,750
Prepaid expenses 6,375 3,000
Total P 105, 375 P 51,500

Accounts payable P 45,750 P 18,000

Capital 59,625 33,500
Total P 105,375 P 51,500

They agreed to have the following items recorded in their books:

1. Provide 2% allowance for doubtful accounts
2. Peter’s furniture and fixtures should be P31,000, while Quinn’s office equipment is
under-depreciated by P250.
3. Rent expense incurred previously by Peter was not yet recorded amounting to
P1,000, while salary expense incurred by Quinn was not also recorded amounting
to P800.
4. The fair market value of the inventory amounted to:
For Peter P 29,500
For Quinn 21,000

Compute the net (debit) credit adjustment for Peter and Quinn: _____________________

Compute the total liabilities after formation: ________________

Compute the total assets after formation: ________________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 3

Partner A first contributed P50,000 of capital into an existing partnership on March 1,

2018. On June 1, 2018, the partner contributed another P20,000. On September 1, 2018,
the partner withdrew P15,000 from the partnership. Withdrawals in excess of P 10,000
are charged to the partner’s capital account. The annual weighted-average capital
balance is __________________.

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 4

On June 30, 2015, the balance sheet of Western Marketing, a partnership, is summarized
as follows:

Sundry assets P 150,000

West, capital 90,000
Tern, capital 60,000

West and Tern share profit and losses at a 60:40 ratio, respectively. They agreed to take
in Cuba as a new partner, who purchases 1/8 interest of West and Tern for P25,000.
What is the amount of Cuba’s capital to be taken up in the partnership books if book value
method is used? ____________________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 5

A summary balance sheet for the McCune, Nall, and Oakley partnership appears below.
McCune, Nall, and Oakley share profits and losses in a ratio of 2:3:5, respectively.

Assets
Cash P 50,000
Inventory 62,500
Marketable securities 100,000
Land 50,000
Building-net 250,000
Total assets P 512,500

Equities
McCune, capital P 212,500
Nall, capital 200,000
Oakely, capital 100,000
Total equities P 512,500

The partners agree to admit Pavic for a one-fifth interest. The fair market value of
partnership land is appraised at P100,000 and the fair market value of inventory is
P87,500. The assets are to be revalued prior to the admission of Pavic and there is
P15,000 of goodwill that attaches to the old partnership.

By how much will the capital accounts of McCune, Nall, and Oakley increase,
respectively, due to the revaluation of the assets and the recognition of goodwill?
_____________________

How much cash must Pavic invest to acquire a one-fifth interest?

____________________

What will the profit and loss sharing ratios be after Pavic’s investment?
____________________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 6
Partnership Formation
A, B and C decided to form ABC Partnership. It was agreed that A will contribute an equipment
with assessed value of P100,000 with historical cost of P800,000 and accumulated depreciation of
P600,000. A day after the partnership formation, the equipment was sold for P 300,000.

B will contribute a land and building with carrying amount of P1,200,000 and fair value of
P1,500,000. The land and building are subject to a mortgage payable amounting to P300,000 to be
assumed by the partnership. The partners agreed that B will have 60% capital interest in the
partnership. The partners also agreed that C will contribute sufficient cash to the partnership.

What is the total agreed capitalization of the ABC Partnership? ______________

What is the cash to be contributed by C in the ABC Partnership? ______________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 7
Partnership Operation – Capital Account Transactions

On January 1, 2018, A, B and C formed ABC Partnership with total agreed capitalization
of P1,000,000. The capital interest ratio of the ABC Partnership is 5:1:4 while the profit or
loss ratio is 3:2:5, respectively for A, B and C.

During 2018, A and B made additional investments of P200,000 and P500,000,

respectively. At the end of 2018, B and C made drawings of P300,000 and P100,000,
respectively. On December 31, 2018, the capital balance of B is reported at P200,000.

What is the net income or net loss of ABC Partnership for the year ended December 31,
2018?
______________

What is the capital balance of C on December 31, 2018? ______________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 8
Partnership Operation – Distribution of profit or loss

On January 1, 2018, A, B and C formed ABC Partnership with original capital contribution
of P300,000, P500,000 and P200,000. A is appointed as managing partner.

During 2018, A, B and C made additional investments of P500,000, P200,000 and

P300,000, respectively. At the end of 2018, A, B and C made drawings of P200,000,
P100,000 and P400,000, respectively. At the end of 2018, the capital balance of C is
reported at P320,000. The profit or loss agreement of the partners is as follows:

• 10% interest on original capital contribution of the partners.

• Quarterly salary of P40,000 and P10,000 for A and B, respectively.
• Bonus to A equivalent to 20% of Net Income after interest and salary to all partners
• Remainder is to be distributed equally among the partners.

What is the partnership profit for the year ended December 31, 2018? ______________

What is A’s share in partnership profit for 2018? ______________

What is B’s share in partnership profit for 2018? ______________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 9
Admission of partner by purchase

On December 31, 2018, the Statement of Financial Position of ABC Partnership provided
the following data with profit or loss ratio of 1:6:3:

Current Assets 1,000,000 Total Liabilities

600,000
Noncurrent Assets 2,000,000 A, Capital 900,000
B, Capital 800,000
C, Capital 700,000

On January 1, 2019, D is admitted to the partnership by purchasing 40% of the capital

interest of B at a price of P500,000.

What is the capital balance of B after the admission of D on January 1, 2019?

______________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 10
Retirement of partner

On December 31, 2018, ABC Partnership’s Statement of Financial Positions shows that
A, B and C have capital balances of P500,000, P300,000 and P200,000 with profit or loss
ratio of 1:3:6. On January 1, 2019, C retired from the partnership and received P350,000.
At the time of C’s retirement, an asset of the partnership is undervalued.

What is the capital balance of A after the retirement of C? ______________

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit
 Problem 11
Retirement of partners

On December 31, 2018, ABC Partnership’s Statement of Financial Position shows that
A, B and C have capital balances of P400,000, P300,000 and P100,000 with profit or loss
ratio of 1:4:5. On January 1, 2019, C retired from the partnership and received P80,000.
At the time of C’s retirement, the assets and liabilities of the partnership are properly
valued.

What is the capital balance of B after the retirement of C? ______________

END OF MODULE

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MODULE FOR FINANCIAL ACCOUNTING AND REPORTING II
BATANGAS STATE UNIVERSITY – MAIN 1
Guess Lecturer: Ma. Ruby A. Bagsit