PARTNERSHIP OPERATIONS

Learning Objectives
1. State the items that affect the division of a partnership's profits or losses among the partners.
2. Compute for the share of a partner in the partnership's profit or loss.

Nature of Partnership Operations

• A business partnership operates like any other forms of profit-oriented business. It manufactures, sells
produces or provides services for a profit.
• The accounting process of a partnership’s transactions is basically similar to the accounting process for
sole proprietorships or corporations. Their differences, however, lie in the plurality of presenting
partners’ capital in the statement of financial position and in the distribution of partnership’s earnings to
the partners.
• In sole proprietorship, there is no sharing of profit or loss because there is only one owner who takes the
benefit or burden of the business. In a partnership business, however, the distribution of profits or loss
usually depends on the partners’ agreement and on the number partners.
• In corporation, profits are distributed in the form of dividends based on the declaration by the board of
directors from the undistributed retained earnings of the business.

COMPARATIVE PROFIT DISTRIBUTION

Sole Proprietorship Partnership Corporation
The profits or losses are all taken The profits or losses are divided Profits are distributed in the forms
by the only owner, the sole based on the partners’ agreement. of dividends based on the
proprietor. decision by the board of directors

Division of profits and losses

The partners share in partnership profits or losses in accordance with their partnership agreement.
Art. 1797 of the Philippine Civil Code provides the following additional rules in the profit or loss sharing of
partners:
• If only the share of each partner in the profits has been agreed upon, the share of each in the losses shall
be in the same proportion.
• In the absence of stipulation, the share of each partner in the profits and losses shall be in proportion to
what he may have contributed, but the industrial partner shall not be liable for the losses. As for the
profits, the industrial partner shall receive such share as may be just and equitable under the
circumstances. If besides his services he has contributed capital, he shall also receive a share in the
profits in proportion to his capital.

➢ An industrial partner is one who contributes services to the partnership rather than cash or other non-
cash assets.
➢ A capitalist partner is one who contributes cash or other non-cash assets to the partnership.
➢ A partner who contributes both services and cash or other non-cash asset is both an industrial and a
capitalist partner.
The designation of losses and profits cannot be entrusted t one of the partners 4rt. 17981. A stipulation which
excludes one or more partners from any share in the profits or losses is void (Art 199).

In addition to profit or loss sharing, the partnership agreement may also stipulate any of the following:
a. Salaries - normally, an industrial partner receives salary in addition to his share in the partnership's
profits as compensation for his services to the partnership.
 b. Bonuses- the managing partner may be entitled to a bonus for excellent management performance.
Unlike for salaries, a partner is entitled to a bonus only if the partnership earns profit. The partner is not entitled
to any bonus if the partnership incurs loss.
c. Interest on capital contributions - the partnership agreement may stipulate that capitalist partners are
entitled to an annual interest on their capital contributions.

The items above are normally provided first to the respective partners and any remaining amount of the profit or
loss is shared among the partners based on their stipulated profit or
loss ratio.

Illustration 1: Salaries
A and B's partnership agreement provides for annual salary allowances of P50,000 for A and P30,000 for B. The
salary allowances are to be withdrawn throughout the period and are to be debited to the partners' respective
drawings accounts.

Case 1: With remaining profit - different P/L ratios

✓ The partners share profits equally and losses on a 60:40 ratio.
✓ The partnership earned profit of P100,000 before salary allowances.

Requirements:
a. Compute for the respective shares of the partners in the profit.
b. Provide the journal entries

Solution:
Requirement (a):
A B TOTAL
Amount being allocated 100,000

Allocation:
1. Salaries 50,000 30,000 80,000
2. Allocation of remaining profit
(100K profit-80K salaries) = 20K
(20K x 50%); (20k x 50%) 10,000 10,000 20,000

As allocated 60,000 40,000 100,000

Notes:
• Salaries are provided first and the remaining amount is allocated based on the profit sharing ratio.
• The sum of the amounts allocated to the partners is equal to the amount being allocated
(i.e., 60K + 40K = 100K).

Requirement (b):
Monthly Entries A, Drawings 50,000
B, Drawings 30,000
Cash 80,000
to record the withdrawal of salary
allowances

Year-end entry Income summary 100,000

A, Capital 60,000
 B, Capital 40,000
to record the distribution of profit
Year-end entry A, Capital 50,000
B, Capital 30,000
A, Drawings 50,000
B, Drawings 30,000
to close the drawings accounts

Case 2: No remaining profit - different P/L ratios

✓ The partners share profits equally and losses on a 60:40 ratio.
✓ The partnership earned profit of P70,000 before salary allowances.

Requirement: Compute for the respective shares of the partners in the profit.

Solution:
A B TOTAL
Amount being allocated 70,000

Allocation:
1. Salaries 50,000 30,000 80,000
2. Allocation of remaining loss
(70K protit 80K salaries) = 10k
(10k 60%); (10K 40%) (6,000) (4,000) (10,000)

As allocated 44,000 26,000 70,000

After the salaries are provided, the remaining amount is negative (i.e., loss); thus, it is allocated based on the
stipulated loss ratio of 60:40.

Case 3: No P/L ratio

✓ The partnership agreement does not state how profits and losses are to be divided.
✓ A contributed P10,000, while B contributed P20,000.
✓ The partnership earned profit of 95,000 before salary allowances.

Requirement: Compute for the respective shares of the partners in the profit.

Solution:
A B TOTAL
Amount being allocated 95,000

Allocation:
1. Salaries 50,000 30,000 80,000
2. Allocation of remaining profit
(95K profit-80K salaries) = 15K
(15K x 10K/30K*); (15K x 20K/30K*) 5,000 10,000 15,000

As allocated 55,000 40,000 95,000

*The fractions are derived from the partners' respective contributions.

Illustration 2: Bonus
A and B's partnership agreement stipulates the following:
• Annual salary allowances of P30,000 for A and P10,000 for B.
• Bonus to A of 10% of the profit after partner's salaries and bonus.
• The profit and loss sharing ratio is 60:40.

Case 1: With profit

✓ The partnership earned profit of P106,000 before deductions for salaries and bonus.

Requirement: Compute for the respective shares of the partners in the profit.
Solution:
A B TOTAL
Amount being allocated 106,000

Allocation:
1. Salaries 30,000 10,000 40,000
2. Bonus after bonus (a) 6,000 6,000
3. Allocation of remaining profit
(106K-40K - 6K) = 60K
(60K x 60%); (60K x 40%) 36,000 24,000 60,000

As allocated 72,000 34,000 106,000

(a)The bonus is computed as follows:

Profit before salaries and bonus 106,000
Salaries (40,000)
Profit after salaries but before deduction of bonus 66,000

The bonus scheme is "bonus after bonus." The formula is as follows:

P
B = P - ----------
1+ Br

Where: B = bonus
P = profit before bonus and tax
Br = bonus rate
66,000
B = 66,000 - ------------
1+10%
B = 66,000 – 60,000
B = 6,000

Case 2: With loss

✓ The partnership incurred loss of P5,000 before deductions for salaries and bonus.

Requirements:
a. Compute for the respective shares of the partners in the profit.
b. By what amount did A's capital account change?
Solutions:
Requirement (a):
A B TOTAL
Amount being allocated (5,000)

Allocation:
1. Salaries 30,000 10,000 40,000
2. Bonus after bonus (b) - - -
3. Allocation of remaining loss
(-5K-40K)=-45K
(-45K x 60%); (-45K x 40%) (27,000) (18,000) (45,000)

As allocated 3,000 (8,000) (5,000)

(b) No bonus is allocated because the partnership incurred loss. However, salaries are nonetheless provided
because salaries are compensation for services rendered.

Requirement (b):
A's capital increased by P3,000. Notice that a partner's capital can increase despite of partnership loss. The entry
to record the allocation of loss is as follows:
Year-end entry B, Capital 8,000
Income summary 5,000
A, Capital 3,000

Illustration 2.1: Bonus - With limit

A and B's partnership agreement stipulates the following:
• First, A shall receive 10% of profit up to $100,000 and 20% over P100,000.
• Second, B shall receive 5% of the remaining profit over P150,000.
• Any remainder shall be shared equally.

The partnership earned profit of P280,000.

Requirement: Compute for the respective shares of the partners in the profit.

Solution:
A B TOTAL
Amount being allocated 280,000

Allocation:
1. Bonus to A 10,000 10,000
First 100K: (100K x 10%) 36,000 36,000
Over 100K: [(280K - 100K) x 20%]
2. Bonus to B on remaining profit
(280K-10K-36K-150K) x 5% 4,200 4,200
3. Allocation of remaining profit
(280K-10K-36K -4.2K)/2 114,900 114,900 229,800

As allocated 160,900 119,100 280,000

Illustration 3: Interest on capital
A and B's partnership agreement stipulates the following:
• Annual salary allowance of P50,000 for A.
• Interest of 10% on the weighted average capital balance of B.
• The partners share profits and losses on a 60:40 ratio.
>The partnership earned profit of P100,000.
>The movements in B's capital account are as follows:
B, Capital .
60,000 beg.
July 31withdrawal 30,000 20,000 April 1 additional investment
40,000 Sept. 30 additional investment
10,000 Dec. 31 additional investment
end. 100,000

Requirement: Compute for the respective shares of the partners in the profit.

Solution:
The weighted average balance of B's capital account is computed as follows:

Balances Months outstanding / Total Weighted average

months in a year

Beg. balance 60,000 12/12 60,000

April 1 additional investment 20,000 9/12 15,000
July 31 withdrawal (30,000) 5/12 (12,500)
Sept. 30 additional investment 40,000 3/12 10,000
Dec. 31 additional investment 10,000 0/12 -
Weighted average capital balance 72,500

A B TOTAL
Amount being allocated 100,000

Allocation:
1. Salaries 50,000 - 50,000
2. Interest on weighted ave. capital
balance (72.5K x 10%) - 7,250 7,250
3. Allocation of remaining profit
(100K-50K-7.250K) = 42,750
(42,750 x 60%); (42,750 x 40%) 25,650 17,100 42,750

As allocated 75,650 24,350 100,000

Illustration 4.1: Reconstruction of information

Partner A has a 25% participation in the profits of a partnership. During the year, A's capital account had a net
increase of P10,00 Partner A made contributions of P40,000 and capital withdrawal of P60,000 during the year.

Requirement: How much profit did the partnership earn during the year?
Solution:
A, Capital .
- beg.
withdrawal 60,000 40,000 additional investment
30,000 A’s share in profit (squeeze)
end. 10,000

A's share in profit 30,000

Divide by: A's P/L ratio 25%
Partnership's profit 120,000

Illustration 4.3: Reconstruction of information - Required profit

A, B, C and D's partnership agreement stipulates the following:
• A and B shall receive salaries of P20,000 and P10,000, respectively, and 10% interest on their capital
contributions of P100,000 and P60,000, respectively.
• Balance is divided on a 4:4:1:1 basis. However, C and D are guaranteed minimum shares of P5,000
each.
Partner A is contemplating on obtaining a housing loan which he intends to repay through his share from the
partnership profit. The loan requires annual payment of P42,000. Partner A wants to know the minimum level of
partnership profit that could secure him a share of P42,000, inclusive of salaries, interest and share in remaining
profit.

Requirement: Help Partner A.

Solution:
Step 1: Prepare a pro-forma allocation table.
A (40%) B (40%) C (10%) D (10%) Total

Salaries 20,000 10,000 - - 30,000

Interests on
capital (a) 10,000 6,000 - - 16,000
Allocation of
balance ? ? ? ? ?

As allocated 42,000(b) ? 5,000 (c) 5,000 (c) ?

(a) (100K x 10%) = 10,000; (60K x 10%) = 6,000

(b) Partner A's needed share in partnership profit
(c) Guaranteed minimum share

Step 2: 'Squeeze' for A's share in the allocation of balance.

A (40%) B (40%) C (10%) D (10%) Total

Salaries 20,000 10,000 - - 30,000

Interests on
capital 10,000 6,000 - - 16,000
Allocation of
balance 12,000 (d) ? ? ? ?
 As allocated 42,000 ? 5,000 5,000 ?

(d) 42K-20K - 10K = 12K

Step 3: 'Squeeze' for the total remaining profit for allocation.

A (40%) B (40%) C (10%) D (10%) Total

Salaries 20,000 10,000 - - 30,000

Interests on
capital 10,000 6,000 - - 16,000
Allocation of
balance 12,000 ? ? ? 30,000 (e)

As allocated 42,000 ? 5,000 (c) 5,000 (c) ?

(e) 12K allocation to A+ 40% P/L ratio of A= 30,000

Step 4: Allocate the remaining profit.

A (40%) B (40%) C (10%) D (10%) Total

Salaries 20,000 10,000 - - 30,000

Interests on
capital 10,000 6,000 - - 16,000
Allocation of
balance 12,000 12,000 (f) 3,000 (f) 3,000 (f) 30,000

As allocated 42,000 ? 5,000 5,000 ?

(f) 30k x 40% = 12,000; 30K x 10% = 3,000; 30K x 10% = 3,000

Step 5: Adjust the shares of C and D to their guaranteed amounts

A (40%) B (40%) C (10%) D (10%) Total

Salaries 20,000 10,000 - - 30,000

Interests on
capital 10,000 6,000 - - 16,000
Allocation of
balance 12,000 12,000 3,000 3,000 30,000
Adjustments
(squeeze) 2,000 2,000 4,000

As allocated 42,000 28,000 5,000 5,000 80,000

Answer: In order for Partner A to secure a P42,000 share, the partnership profit must be at least P80,000.
Summary:
❖ The partners share in partnership profits and losses based on their agreement.
❖ If only the share in profits has been agreed upon, the share losses shall be in the same proportion.
❖ If no profit sharing has been agreed upon, the partners shall share in proportion to their contributions.
However, industrial partner shall not be liable for losses.
❖ Profit or loss is allocated as follows:
(1) Salaries, Bonus (allocated only if there is profit), and Interest on capital, if these are stipulated; and
(2) Any remaining amount is allocated based on the P/L ratio.