PARTNERSHIP OPERATION @IVISION OF PROFIT OR LOSS) Learning Outcomes: CHAPTER 3 At the end of this chapter, the student should be able to: a) Determine profit or loss b) Enumerate legal provisions regarding di ¢) Prepare the profit/loss al d) Prepare the statement of by preparing the income statement, ivision of partnership profit and loss. location table and record profit or loss share of each partner. changes in partners’ equity. ¢) Use partners’ current accounts aside from partners’ capital and drawing accounts. f) Present the statement of comprehensive income. INCOME STATEMENT This statement presents the Tevenues carned and the expenses incurred for a period of time. Just like in a sole proprietorship, the account titles for revenues and expenses depend on whether the business is a service provider, a merchandiser, or a manufacturer. To illustrate, assume that BUENAS Grocery owned and managed by Buen and Aster, general partners, showed the following adjuste d trial balance at the end of the year: Debit Cash P 50,500 Accounts Receivable 15,000 Allowance for Bad Debts Merchandise Inventory, Jan | 45,000 Furniture & Equipment 37,000 Accumulated Depreciation Accounts Payable Buen, Capital Buen, Drawing 2,500 Aster, Capital Aster, Drawing 5,000 Sales Sales Returns and Allowances 5,500 Purchases 60,000 Freight In 2,000 Bad Debts 700 Freight Out 13,500 Depreciation Expense 4,000 Miscellaneous Expense 1,000 Rent Expense 21,000 Sales Salaries Expense 20,000 Office Salaries Expense 6,500 Store Supplies Expense 3,000 Office Supplies Expense 600 Utilities Expense 17,000 309,800 Credit P 1,500 6,300 10,000 45,000 55,000 192,000 63tribution. Inventory coun, The partners agree to divide profits based on capital con ilities are classi December 31 shovel unsold goods of ?27,000, One fourth 21 eal ape as follows Seneral expenses. Using the multiple step form, the income staterm : BUENAS GROCERY INCOME STATEMENT For the Year Ended December 31, 2020 Net less 192,000 Less: Sales Returns & Allowances S800 - P1865 Less Cost of Sales: 45,000 Merchandise Inventory, January 1 ’ Add: Purchases 60,000 2 Freight In 2,000 rary Total Goods Available for Sale 7700) 8. Less: Merchandise Inventory, December 31 77.008 Gross Profit on Sales P106,500 Less Operating Expenses: Satings Salen 20,000 15,750 13,300 uU 12,750 Supplies 3,000 65,000 General Salaries Pgs00 a 5,250 Utilities que Depreciation £000 Supplies oan Bad Debts 0 Miscellaneous tn oe fis Net Income Before Tax —im a Pee 30% Tax Provision e760 Net Income Psa Allocation of Profit: Buen (45,000/100,000 x P13,440) P 6,048 Aster (55,000/100,000 x P13,440) 7302 Total PLa.440 The presentation of costs and expenses according to its use {cost of sales, selling, administrative) is called functlon of expense method. A profit allocation below the income statement shows profit distribution at net of tax. Ordinary Partnerships and corporations art subject to tax at 30% but was reduced effective April 2021 to 20% % if taxable income is not ‘more than P5,000,000. This tax rule is not applicable for general professional partnerships where partners are taxed individually on their profit share. A general professional partnership is one where two ot more persons put up firm the practice of a profession such as law, tex, accour ing, and evelboarlig: Te illustrate, assume Maribel and Carla (both CPAs) sharing poft in a ratio of 2:1 respectively, presented the following statement of income after its fist year of aperation: , 64 -M & CCONSULTANTS INCOME STATEMENT. For the year ended December 31, 2020 Revenues: Professional Fee 320,000 Commission Income 15,500 Interest Income 2,750 P338,250 Expenses: Rent P 72,000 Salaries, 34,000 Depreciation — Furniture & Equipment 15,000 Utilities 12,200 Supplies 7,550 Miscellaneous 2375 163,125 Net Income PLZ5125 Profit Distribution Table: Maribel (2/3 x 175,125) P116,750, Carla (1/3 x 175,125) 58.315 Total PI75,125 The presentation of expenses is under the nature of expense method since these are shown according to their nature, such as rent, salaries, utilities and depreciation. TAS REQUIREMENT. The Intemational Accounting Standards provides, at a minimum, that financial statements should contain line items only, the details of which should be Presented as supporting notes, Using the statement on page 64, only net sales of P186,500, cost of sales of P80,000, distribution expenses P65,000 and General Expenses P22,300 should be presented on the face of the income statement with the details shown separately using supporting notes 1, 2, 3 and 4. The income statement presents only the net income resulting from sales eamed and cost and expenses incurred for a period. There are gains and losses that are presented as Other Comprehensive Income. A Statement of Comprehensive Income covering both regular income and other comprehensive income is given on pages 69 and 221. A working paper facilitates the preparation of the financial statements and is prepared in this manner: 1) the first two money columns are for the unadjusted balances copied from the trial balance, 2) it is then followed by third and fourth money columns for the adjustments, 3} from these four money columns, the adjusted income statement accounts are extended to the fifth and sixth money columns and the balance extracted to represent net income or net. loss, 4) the seventh and eighth money columns are for each of the partners’ equity accounts where the sapital accounts, drawing accounts and profit share are located, the balance representing each Partner's equity, 5) these are then extended to the last two money columns together with the other real accounts to represent the statement of financial position. Using the Buenas Grocery Problem, the adjusted trial balance on page 63 is a result of 4 twelve-column worksheet appearing next page: 65BIOS | OWT ELT | WSS | ONTIELT | OUTRO TS conor | Worcs WES Oo StS Sr O0'8bS'Sh cozerze | avo00's | oosos | onoosz | mover | torer worerz ones rer oo0sL's 09's oz'et moar | sovete west” 5 900°61Z | oos'66! | SORE WER 0000022 OTT 009, 009 o00's ooo'e Ce) 000'F 000'r (@) 00k oot 1) poo‘ 005'9 00'0r 00017 0001 00S'ET 00% ove o0s's 00°26) 00'000"5 00000°SS o00s'z 00°000'Se 90 000'0! 7 oo 00rs oo0'y (2) ogooo'e oo9'e (e) 00'S 0000s" oon =) 00 0005 00 005'0S BPUD ued BPD 1920 upaa) oa re) YPC PUD 970 : GonIsog URUS ruden BIsy Tidea Wang qu BU030T USUI 0702 “1¢ soquieoaq sAYSHOA BUINIOD-O] ‘Arooory seuongCLOSING ENTRIES AND THE DISTRIBUTION OF PROFIT The accounting procedure for determining the net income or net loss of a business has ‘een discussed in Accounting 1, with revenues and expenses closed to the Income Summary account. which in tum is closed to the Drawing account. In a partnership, because of the plurality of the capital and drawing accounts, the Income Summary account is closed to as imany drawing accounts as there are partners. In other words, after determining whether the result of operation is a net income or net loss, the next step would be to distribute or allocate this to the partners based on their agreement. _ Using the Buenas Grocery illustration, the following entries are to be prepared at the end of the year to close the nominal accounts and distribute the net profit as follows: 2020 Dec.31 1) Sales 192,000 a Sales Returns and Allowances 5,500 : Income Summary 186,500 2 To close net sales. 2) Merchandise Inventory, December 31 27,000 Income Summary 80,000 Merchandise Inventory, January 1 45,000 : Purchases 60,000 FreightIn 2,000 To close cost of sales, 3) Income Summary 87,300 Salaries 26,500 Rent 21,000 Utilities 17,000 Freight Out 13,500 Supplies . 3,600 Bad Debts 700 Depreciation 4,000 Miscellaneous 1,000 ‘The income summary account (a T Account of which is shown next page) represents a profit since it is a eredit balance of P19,200. A 30% tax provision should be deducted, and the profit after tax is then distributed to the partners based on their capital contributions. The last two entries will appear thus: 4) Income Summary 5,160 Income Taxes Payable 5,760 To record the income tax liability. 5) Income Summary 13,440 Buen, Drawing 6,048* Aster, Drawing 7,392* To record the profit share of each partner. 67partni (CFCS dug in the yoreAsCS he Income Summary Note that the drawing accounts are used to reflect jn Postings (0 t to: Profit share which are recorded on the credit side* Account and to the drawing accounts will appear thus: Income Summni _Buen, Drawi 1) 186,500 3/1 2,5004 | 6) in 6,048" 4) 5760 5) 13440 balance. # Th : alance. , __ The Income Summnry account after che fifth eniry will be & fare Te | during Postings to Buen and Aster drawing accounts aro assumed regu! rollaas? e Year. The general ledger will show four accounts with balances as follows: Bal 2,30 Bal, 3,548 Buen, Capital P 45,000 Credit Buen, Drawin, 3,548 Credit Tot p 48,548 Aster, Capital P-55,000 Gre Aster, Drawiny 2,392 Credit ne P 457,392 Total The credit balances of P3,548 and P2,392 in the drawing accounts could be withdraym by the partners or it could be made part of the capital accounts. FIXED CAPITAL, If they agree that any credit balance can be withdrawn anytime then the balance of the drawing account may be left open just like the capital account. It also means that the balance in the drawing account will not be periodically closed to the capital account, This way the capital account will show only the permanent capital and permanent withdrawals and will not be fluctuating from one period to another period. Additionally, the balance in the drawing account will serve as a caution for partners not to make excessive withdrawals. Partners will be careful.to withdraw within the limits of their profit share. The Partners’ agreement contained in the Articles of Co-Partnership must state clearly what to do with profit share and what is the amount that a parmer may be allowed to withdraw. For example, 2 salary allowance is provided in the agreement for a partner. This gives the partner a right to make withdrawals against the salary allowance. FLUCTUATING CAPITAL. If they agree that any balance in the drawing account be made part of their capital accounts then an entry to this effect should be made, Using the Buenas illustration: Buen, Drawing 3,548 Aster, Drawing 2,392 Buen, Capital 3,548 Aster, Capital 2,392 The general ledger will now show only two open accounts with credit balances as follows: Buen, Capital - P 48,548 and Aster, Capital - P 57,392. These accounts will change every year because of the regular drawings and profit share, hence it is called fluctuating capital. . Whether or not the drawing accounts are closed, the statement of partners* equity and the statement of financial position will still show the same final balances. 68STATEMENT OF CHANGES IN PARTNERS’ L£QUITY This statement summarizes the changes affecting cach partner's equity during the year Itis also called the capital statement, For Bucnas Grocery, it will appear as follows Buenas Grocory Statement of Changes in Partners’ Equity For the year ended December 3 1, 2020 Buen Aster Total Balances, January 1 P 45,000 P 55,000 P._-100,000 Add Share in Net Income 6,048 1392 13,440 Total P 51,048 P 62,392 ~~ 113,440 Less Regular Drawings 2.500 3,000 7,500 Balances, December 31 P 48.548 P 57,392 ‘108,940 STATEMENT OF COMPREHENSIVE INCOME Comprehensive income represents all changes in the equity excluding investments and withdrawals. Comprehensive income has two major parts: 1) profit or loss 2) other comprehensive income. IAS 1 as of June 2011 requires the classification of other comprehensive income into gains or losses that would subsequently be realized and those that will not. The following are the other comprehensive income accounts: gain or loss on available for sale financial assets, gain or loss from foreign exchange currency or operation, cash flow hedge, to name a few. Other comprehensive income will directly affect the equity accounts of the partners and presented in the statement of changes in partners” equity Following the Income Statement of Buenas Grocery on page 64, assume that there are other comprehensive income items: Gain on Forward Contract P5,000 and Unrealized Gain on Debt Securities P5,000. A second statement is prepared called the Statement of Comprehensive Income. BUENAS GROCERY STATEMENT OF COMPREHENSIVE INCOME For the year ended December 31, 2020 Net Income (refer to income statement) P13,440 Add Other Comprenensive Income: Gain on Forward Contract P 5,000 Unrealized Gain on Debt Securities 5,000 10,000 Comprehensive Income 23,440 Alternatively, a single statement of comprehensive income may be prepared starting with the revenue and expense accounts from regular operation and ending with the other comprehensive income. Statement of Comprehensive Income will be discussed more extensively in Chapter 8. 69EI o” TRIBUTION LEGAL PROVISIONS AFFECTING PROFIT OR LOSS pis nner in which profit _ lis important thatthe articles of co-partnership provide I ive methods loss is to be distributed among the partners given. that there are allocating this, isi how to distri Article 1797 of the New Civil Code gives the following provisions 2” ‘te the profit or loss: 1, Profit or loss may be distributed on the basis of partners ogres articles of co-partnership. ol 2. I the agreement is only on how to distribute the profit but esult of ope then the same agreement is applicable, Jement as provided in the ration is @ net loss ‘tri fit or loss, then the 3. In the absence of an agreement on how to distribute the profit oF devs distribution should be based on what the partners: contributed with the industrial partner receiving what may be just and equitable, 4. An industrial partner has a priority in the profit distributi industrial partner must be computed first before that of the other partner does not share in the losses incurred by the firm. ion. [t means that the share of the partners. An industrat WHAT IS THE FAIREST WAY OF DISTRIBUTING PROFIT? In determining the best method of distributing profit, the partners may consider the following factors: 1. Capital contribution 2. Service rendered 3. Skill or expertise To illustrate: 1, A,B and C contributed P50,000, P75,000 and P25,000, respectively, to put up an audit firm. All are CPAs and will be rendering full time service. The best method for a fair and equitable distribution would be the capital contributions since this is the only differing variable. 2. A,B and C contributed P100,000 each. All are CPAs with A rendering eight hours of service and the others four hours each. The best method would be to give salary to A twice than that of B and C and any profit balance to be distributed equally to all based on their equal contributions. 3. A, Band C contributed P50,000, P100,000 and P75,000, respectively. A was chosen as managing partner because of her expertise. The best method would be to give salary or bonus to A, the remaining profit to be distributed based on capital contributions. The giving of salaries, interest or bonus is a way of distributing profit as a reward for extra responsibility or time, or a contribution of skill. Profit share increases the right of the partner to the assets of the partnership. It does not involve cash flow. A cash flow will need an actual cash withdrawal of a partner. Additionally, profit share as salary, bonus or interest 70should not be considered as business expenses. ‘This is based on the tax regulation in the Phitippines. The articles of co-partnership should state clearly the manner of withdrawing profits for salary or bonus earned, whether these should be withdrawn regularly and at what specific amounts. They could further agree that any amount over and above bonus or salaries withdrawn be made a permanent reduction from the capital account, METHODS OF DIVIDING PROFIT AND LOSS The profit and loss agreement as provided in the articles of co-partnership may take the following forms: 1, Arbitrary Ratio (any agreed ratio), 2. Capital Ratio based on any of the following: a. initial or original capital b. beginning yearly capital ©. ending yearly capital 4. average capital Interest based on contributions made, residual profit in an agreed ratio. Salaries to partners for service rendered, residual profit based on contributions. Interest on contributions, salaries to partners, residual profit in an agreed ratio. ae ae Interest on contributions, salaries to partners, bonus to managing partner, and residual profit in an agreed ratio. Where bonus is expressed as: a. a distribution of profit (a certain percent of net income) b. an expense (a certain percent of net income after bonus) DIVISION OF PROFIT OR LOSS BASED ON SOME ARBITRARY RATIO Assume that A, B and C established a law office with capital contributions of P300,000, P200,000 and P100,000 respectively. They agreed to distribute profit and loss equally. At the end of the year, the business earned a net income of P90,000. Entry will be: Income Summary 90,000 A, Drawing 30,000 B, Drawing 30,000 C, Drawing 30,000 To distribute profit equally among the partners. Partners can share profits or losses in any way they wish although it is often based on the amount of contribution. In the above illustration, although the partners’ contributions are not of the same amounts, the agreement calls for an equal sharing of profit. DIVISION OF PROFIT OR LOSS BASED ON CAPITAL CONTRIBUTIONS Assume that ABBA Realtor earned a net income after tax of P300,000 at the end of the year. The articles provided for a division of profit and loss based on capital ratio, Ledger balances showed the following: 71OO - Bello, Capital Abner, Capital 1 200,009 10/1 P200,000 [1/1 P400,000 4/1 100,000 istribute the profit will be: 1) I beginning capital ratio is to be used, then the entry 10 iar 1e profit will be: Income Summary 3000 200,000 Abner, Drawing 110,000 Bello, Drawing To distribute profit as follows: Abner (400,000/600,000 x 300,000) 200,000 Bello (200,090/600,000 x P300,000) 100,000 2) If the ending ratio is to be used: 300,000 Income Summary ‘Abner, Drawing tav'c0e Bello, Drawing M To distribute profit as follows: Abner (200,000/500,000 x P300,000) 120,000 Bello (300,000/500,000 x P300,000) 180,000 3) Ifaverage capital ratio is to be used: Income Summary 300,000 Abner, Drawing 168,000 Bello, Drawing 132,000 To distribute profit as follows: Abner (350,000/625,000 x P300,000) 168,000 Bello (275,000/623,000 x P300,000) 132,000 Computation of average investments: Capital No.of Average Date Balance Months used ‘Pesos Mos Capital Abner " P 400,000 9 P 3,600,000 10/l 200,000 3 600,000 PE200,000/12 350.000 Bello 1 200,000 3 600,000 an 300,000 9 2.700.000 P3.300,000/12 P 275,000 Alternatively, it may be computed in this manner: ‘Abner: P4,800,000 (P400,000 x 12) - P600,000 (P200,000 x 3) = P4 ‘=P350,000 Bello: P2,400,000 (P200,000 x 12) + P900,600 (P100,000 x % Pi sohae iy It is still based on the investment (withdrawal) made a (withdrawn) to the end of the accounting period. from the time it was investet 2Among the three methods, the Average capital ratio is the best or most equitable method because it considers the number of months a partner’s contribution was used by the business. The articles of co-partnership must identify the capital ratio to be used and also whether all changes should be taken into consideration including temporary changes in the drawing account. INTEREST ON PARTNERS? CONTRIBUTION, RESIDUAL PROFIT IN AN AGREED RATIO Assume that X and Y are doctor-partners in a medical clinic with capital of P350,000 and P250,000, respectively. They agreed to distribute profit or loss as follows: 12% interest on capital, residual profit to be divided equally. 1) Assume the business eamed a net income of P300,000. The entry will be: Income Summary 300,000 . X, Drawing 156,000 Y, Drawing 144,000 To distribute net profit as follows: x y¥. Total 12% interest on capital “P 42,000 P 30,000 P 72,000 reminder equally 114,000 114,000 228,000 P'156.000 P44,000 P309,000 Or two entries may be prepared as follows: Income Summary 72,000 X, Drawing 42,000 Y, Drawing 30,000 To distribute interest to the partners. Income Summary 228,000 X, Drawing 114,000 Y, Drawing 114,000 To distribute equally the remaining profit to the partners. 2) [fthe result of operation is a net profit of P60,000, the entry will be: Income Summary 60,000 X, Drawing 36,000 Y, Drawing 24,000 To distribute the profit as follows: x ¥ Total 12% interest on capital P 42,000 P-30,000 P 72,000 remainder equally 6,000) (6,000) (12,000) P 36,000 24,000 P 60,000 73itled the partners P72,009 ____ The net profit is only P60,000 but the First profit share ent interest, making the balance a residual loss of P12,000. Or two entries may be prepared as follows: 72,000 Income Summary 42,000 X, Drawing 30,000 Y, Drawing To distribute profit as interest X and Y 000 X, Drawing 4 Y, Drawing . 12,000 Income Summary ay. To distribute the balance equally to X and Y- aioe: 3) Assume the result of operation is a net loss of P28,000. The entry will be: X, Drawing on Y, Drawing 20, sant Income Summary - To distribute the loss ai follows: ota 12% interest on capital P 42,000 P 30,000 P 72,000 remainder equally (50,000) (50,000) _(100.000) P(_$,000) (20,000) PC-28.000) Or two entries may be prepared as follows: 72,000 42,000 30,000 Income Summary X, Drawing Y, Drawing To distribute interest to partners. X, Drawing 50,000 Y, Drawing 50,000 Income Summary 100,000 To distribute the batance equally to X and Y. Note that the remainder becomes a bigger loss because of the profit distribution made in the form of interest even if operation is a net loss. The agreement to distribute profit inthe form of interest should be followed regardless of result of operation. Be.guided by the period of operation of the partnership. In the given illustrations, the net profit is for a period of one year, Suppose the reported profit is only for a quarter? The adjust interest accordingly. Instead of 12%, use 3% (12% x 3/12). 4SALARIES TO PARTNERS, RESIDUAL PROFIT BASED ON CAPITAL RATIO. Assume that partners A, B and C invested assets in a restaurant business amounting to 200,000, P300,000 and P100.000, respectively. A, as managing partner, is to receive an ual salary of P120,000 and the remaini ii ii isteit Il the: ears Nai on their sopra le Femaning prof, any, i to be distibued toa 1) ifthe operation is a net profit after tax of P180,000, the entry will be: Income Summary 180,000 A, Drawing 140,000 B, Drawing 30,000 C, Drawing 10,000 To distribute profit as follows: —A__ e Total Salary to A 120,000 120,000 Remainder based on capital ratio —_20.009 3,000 10,000 _60,000 20,000 10,000 180,000 Again, two entries may be prepared as follows: Income Summary 120,000 A, Drawing 120,000 ‘To distribute salary as profit to A. Income Summary 60,000 A, Drawing 20,000 B, Drawing 30,000 C, Drawing 10,000 To distribute the residual profit according to capital ratio. 2) Ifthe operation is a net profit after tax of P90,000 the entry will be: Income Summary 90,000 B, Drawing 15,000 C, Drawing 5,000 ‘A, Drawing 110,000 To distribute the profit as follows: A B Cc. _ Total Salary to A 720,000 OO 120,000 Balance based on capital ratio (10,000) (15,000) (5,000) __(_30,000) 10,000 (15.000) (5,000) 90,000 Ortwo entries may be prepared as follows: Income Summary 120,000 A, Drawing 120,000 To distribute salary as profit to A. 15 |A, Drawing 10a B, Drawing $000 C, Drawing. ” 30,000 Income Summary To distribute the balance based ‘on the capital ratio, 3. Ifthe operation is a net loss of P30,000, he entry will be: B, Drawing ob C, Drawing 254 70,000 A, Drawing 30.000 Income Summary A B Cc Total Salary to A 120,000 120,000 Remainder based on capital ratio (50,000) (75,000) (25,000) (150,000) 20,000 (75,000) (25,000) ! To distribute the net loss as follows: Or two entries may be prepared as follows: Income Summ 120,000 ’, Drawing {20,000 To distribute salary as profit to A. A, Drawing 50,000 B, Drawing 75,000 C, Drawing 25,000 Income Summary 150,000 To distribute the balance according to the capital ratio. Hl Note that in the above illustrations, just like in interest agreement, if the profit distribution is : in the form of salaries, the agreement must be followed whether the operation is a net profit or net loss. In no. 1, the profit of P180,000 is enough to distribute the salaries of P120,000 with still a profit balance of P60,000. In the second illustration, the profit balance resulted in a negative figure of P30,000 because the profit is only P90,000 but the salary distribution is P120,000. In the third illustation, the negative figure of P150,000 is a.resutt of a salary distribution of P120,000 and the net Joss of P30,000. The Income Summary becomes a debit balance (representing a bigger loss) and must be credited to close the account. { If the reported profit or toss is only for a quarter, salaries to be distributed should only be P30,000 (120,000 x 3/12). USE OF THE TITLE PARTNER’S SALARY Based on partners’ agreement, if salaries are to be withdrawn regularly, a temporary litle - Partner, Salary may be used. To illustrate, assume capital balances of A and B are 500,000 and P1,000,000, respectively. They agreed to withdraw their monthly salaries of P 12,000 which were recorded as follows: 6_—~ EE! A, Salary 12,000 B, Salary 12,000 Cash ‘ 24,000 ‘these were recorded up to December and amounted to P144,000 for each partner. They also to divide remaining profits in the ratio of 1:2, respectively. At the end of the year, profit eared was PS00,000. entries at year end will appear as follows: Income Summary 288,000 A, Salary 144,000 B, Salary 144,000 To close the salary accounts, Income Summary 212,000 A, Drawing 70,667" B, Drawing 141,333* To distribute the remaining profit based on a 1:2 ratio. Since they have already withdrawn their profit share in the form of salaries, their drawing accounts will show only their share in the residual profit*. Suppose Partner A did not withdraw the salary for December, how will the above entries change? Only the first entry will change as follows: Income Summary 288,000 A, Salary 132,000 A, Drawings 12,000 B, Salary 144,000 To close the salary accounts and credit A for the unwithdrawn salary. A and B will have the following credit balances in their drawing accounts: A P82,667 (12,000 + 70,667) and B P141,333. INTEREST, SALARIES, RESIDUAL PROFIT IN AN AGREED RATIO Assume that partners A and B with capital contributions of P500,000 and P300,000, respectively, agreed on the following division of profit and loss: 12% interest on capital contributions, salary of P15,000 per month for B, residual profit to be divided equally. 1. Assume that at the end of the year the net income is P376,000. Entry will be: Income Summary 376,000 ‘A, Drawing 110,000 B Drawing 266,000 7i ——— i To distri © distritmite the profit as follows: ‘i Jotal A Be 96,000 12% ‘imerest on capital 60,000 36,000 180,000 Salary to 8 180,000 69.990 Remainder Equally $0,009 50,099 376900 140,090 206,000 Or three entries may be prepared as follows: Income Summary A, Drawing B, Drawing To distribute the profit in the form of interest. 180,000 Income Summary B, Drawing To distribute the profit in the form of salary. 100,000 Income Summary A, Drawing B, Drawing To distribute the remaining profit equally. 2. Assume that at the end of the year, net income, is P2I Income Summary 200,000 A, Drawing B, Drawing Foddiaiboe he profits lows: gt 12% interest on capital — 60,000 36,000 96,000 Salary to B 180,000 180,000 Remainder equally (38.000) (38.000) (76.000) 22,000 178,000 © 200,000 Or three entries may be prepared as follows: Income Summary 96,000 A, Drawing B, Drawing To distribute interest to partners. Income Summary 180,000 B, Drawing A, Drawing 38,000 B, Drawing 38,000 Income Summary To distribute the balance equally. 8 36,0009 180,000 50,000 50,000 00,000. Entry will be: 22,000 178,000 60,000 36,000 180,000 76,0003, Assume that at the end of the year, nef loss is P24,000. Entry will be: A, Drawing 90,000 B, Drawing 66,000 Income Summary 24,000 To distribute the loss as follows: ; A B Total 12% interest on capital — 60,000 36,000 96,000 Salary to B 180,000 ‘180,000 Remainder Equally (180,000) (150,000) (300,000) (20,000) _66,000 24,000 Or three entries may be prepared as follows: Income Summary 96,000 A, Drawing 60,000 B, Drawing 36,000 To distribute interest to partners. Income Summary 180,000 B, Drawing 180,000 To distribute salary to B. A, Drawing 150,000 B, Drawing 150,000 Income Summary 300,000 To distribute the balance equally. Again, distribute entitlements in the form of salaries and interests regardless of whether operation is a profit or a loss. MINIMUM REQUIRED PROFIT SHARE OF A PARTNER Partners may agree that a partner be guaranteed a minimum profit. If profit is not sufficient to mect the guaranteed share, bonus is given by the other partners to cover for the deficiency. To illustrate: Partners A, B and C agreed to an equal profit sharing after giving A salaries of P60,000. Profit at the end of the year amounted to P135,000. A is guaranteed a minimum profit share of P100,000. Transfer of profit o: bonus is made to A by B and C. A B c Total Salary to A 60,000 60,000 Remainder equally 25,000 25,000 25,000 75,000 ‘Transfer of profit 15,000 (7,800) (7,500) 109,000 17,500 12,500 135.000 BONUS TO MANAGING PARTNER ‘A managing partner may be entitled, by agreement, to receive a bonus. A bonus is a special compensation in recognition of the pariner’s ability or expertise in generating income 19——>—————————_— ON er the basis of the bonus is hey tlon of bonus, oda eee income after the deduct tiction of bomis or the net i ho 1% interest On capital Contribution. be divided equally. The busigt for the partnership. Tho agreement should state wheth Assume for instance, that A and B have capital Jepatively. The articles provided for the following: 1 % bonus to A as managing partner, remaining profit Camed a net income of P400,000 at the end of the year. jstribution will sh 1. fbonus is based on the net income before inert and Fn ee tet 2) 12% interest F 36000 Feo on ) Bonus to A (.25 x 400,000) 100,00 02,000 204,000 ©) Remainder divided equally 192,000 ! Oa pzga.o00 © P462.000 —PA00,009 2. Ifbonus is based on net income after interest and bonus, distribution will be as follows; B Total A —B_ —__Total_ a) 12% interest P 36,000 60,000 P 25005, b) Bonus to A (refer to computation) 60,800 . ¢) Remainder divided equally 21,601 121,60 243,200 raigdga — PuBL.60—P400.000 *Let B Bonus 25% (Net Income - Interest - Bonus) = 25% (P400,000 ~ 96,000- B) P76,000 - 25 B B+.25B = 76,000 1.25B = 76,000 '6,000/1.25 = 60,800 To prove: 25% (400,000-96,000-60,800) = 25% of 243,200 (the remainder)* = 60,800 Bonus is not applicable when result of operation is a net loss. ALTERNATIVE ACCOUNTING APPROACH FOR PARTNERS’ EQUITY As an alternative accounting approach, three accounts may be maintained for each partner in accounting for partners’ equity. The capital account represents contribution as provided in the Articles of Co- Partnership. It is considered fixed or permanent and agreed by the partners to be retained in the partnership. The current account represents each partner's accumulated share of profits less amounts withdrawn by partners which are debited first to the drawing account and then closed to this account at the end of the period. The balance of this account will represent, accumulated net profit share of a partner if a credit balance. It means that accumulated profit share is more than actual withdrawals made by the partner. If a debit balance, it means excessive drawings were made against accumulated profit share. It follows the Fixed Capital method mentioned in the first part of this chapter, 80SS ‘The drawing account as mentioned earlier is usually reprosented by the regular cash withdrawals made by the parters, and is a debit balance. At the end of each year this is closed to the current account, To illustrate: The trial balance of A and B Consultants on December 31 showed, among others, the following: Accounts Debit Credit A, Capital P100,000 B, Capital 90,000 A, Current 30,000 B, Current 20,000 A, Drawings P 80,000 B, Drawings 60,000 Revenues 750,000 Expenses 550,000 Appropriation of the profit or loss is based on the following agreement: 1. Salary allowances are to be given to A P40,000 and B P60,000 per annum. 2. Profit sharing ratio is 1:1. Appropriation table: A B Net Income Salaries P 40,000 P 60,000 P 100,000 Residual Profit 1:1 50,000 50,000 100.000 Total P.20,000 P110,000 P200,000 Closing Entries: Revenues 750,000 Expenses 550,000 Income Summary 200,000 To close nominal accounts. Income Summary 200,000 A, Current 90,000 B, Current 110,000 To distribute and close net income A, Current 80,000 B, Current 60,000 A, Drawings 80,000 B, Drawings “60,000 To close the regular drawings. Prepare a supporting statement to disclose changes in partners’ current accounts and to come up withthe final balances to be presented in the statement of financial position: A, Current B, Current January 1, 2013 P 30,000 20,000 Add profit share 90,000 110,000 Less regular drawings 30,000 60,000 December 31, 2014 P-40,000 P.20,000Th ey : Ne statement of financial position will include this information: Partners’ Equity: A. Capital 100,000 A, Current 49.000 «140,000 B, Capital 190,000 B, Current “opp © —-—_160,000 Total P300,000 Each of the three accounts shows specific information: 1. The capital contributions for A and B are in the eupital accounts {100.000 one Tt 2. The net profit shares (with regular drawings already dedueted) are In FO" Bort ns for what cach one has accumulated from tho start of the partnership oper 10,000 nd 70,000). 3. The regular cash withdrawals are inthe drawing accounts (PB0,000 and P60.000), Again, the current accounts serve as a monitoring device over withdrawals made by the partners. RETURN ON PARTNERS’ EQUITY (ROE) To measure whether profit of the business is adequate and attractive, profitability of each of the partner's equity or total partners’ equity should be computed. This return on equity represents the ability of the business to earn adequate profits for the partners. Compare the ROE against the competitors’ or the bank's prime investment rate. The formula for ROE is profitaverage partner's equity x 100. Using the Buenas Grocery on page 69, assessment of how profitable a partner's investment is using ROE: First, compute for average capital: Beginning Partner’s Equity + Ending Parter’s Equity / 2: For Buen (45,000 + 48,548) = 46,774 For Aster (55,000 + 57,392) = $6,196 2 2 Second, compute for ROE to determine profitability of partners’ investments: Buen = 6,048/ 46,774 = 12.93% Aster=7,392/ 56,196 = 13.15% To determine profitability of the partnership itself, its ROE may also be computed as: ‘Average partners? equity= (100,000 + 105,940) /2= 102,970 ROE: Net Income / Average of Total Partners Equity = 12,480 / 102,970 = 122% Finally, benchmark against competitors or compare against the bank's prime: interest rate on tong term investments. The above rates are quite high considering that governments current treasury bond rate is only 5% to 6%, 82REVIEW QUESTIONS 1, What information in tho Articles of Co-Partnership serve as a guide in accounting for parthor's equity, considering not only capital account but also partner's drawing account. 2. List at lenst five methods of dividing partnership income. How do you make @ choice on which is the best ard equitable method of distribution? 3, Give the legal provisions based on the following situations: a, There is ne agreement on profit or loss sharing, b, There is an agreement on profit but no agreement on how to share losses. ¢. Profit and loss sharing for industrial partner. 4, Differentiate the method of carrying the drawing account under the Fluctuating Capital approach and the Fixed Capital approach. Explain which one is preferable and why? 5, The partnership agreement provides for division of profit and loss based on capital balances. Comment on why this agreement is vague. 6, If profit and loss sharing agreement is based on capital balances, which of these capital balances will give the fairest and most equitable distribution: beginning, ending or average? Explain why, 7, The partnership agreement provides for interest on capital contributions and a salary allowance for the managing partner, Will there be a distribution for interest and salary allowance even if the operation is a loss? Explain. 8. The partnership agreement provides for bonus to managing partner. Will there be a distribution for this even if the operation is a loss? Explain. 9, The partnership agreement of Cindy and Jolly provides for division of profit and loss in the ratio of 2:1, respectively. It further permits each partner to withdraw P5,000 salary per month. Can these salaries be treated as expenses? Explain. 10. Allowing interest on capital or allowing salaries to partners are technical devices used in dividing profit in the business. Explain. 11. Abella, the industrial partner, is allowed a salary of P15,000 a year. The operation of the partnership resulted in a net income after the salaries, The remaining three partners shared this without giving any portion to Abella. Is the distribution valid? Why or why not? 12. The partnership agreement provided for the followin; Rolly and Polly are to divide profit and Joss in the ratio of 70% and 30% and each one is entitled to draw P5,000 cash per month. Explain what possible difficulties may be encountered by the accountant. 13. Laredo and Pinero, partners, suggested the following agreement: 24% interest allowed on average capital with the remaining profit to be divided based on average capital ratio. Comment on this agreement. The partnership book of Moore Jake and Company shows three partners’ equity accounts: capital, current and drawing accounts. Explain each use, 14. Partners Jake, Moore, Keith and Luke gave the following agreement: salaries to each partner of P15,000 per month, residual profit according to capital contributions. Jake's expertise is badly needed in the operation of the company. He wants a fair and equitable 8319, + The bank's prime rate is 10%. The partners shared in the net . Statement of Comprehensive Income for a partn . The Statement of Comprehensive Income shows two st J on net profi Genttibution and it wns agreed that a 5% bonus be given 40 fly bese . : sauawion of snlaties. The operation netted P600,000- low much i cei ch bonus will he receive? profit of P200,000 a8 flows: f d of th rs.o00 for A and 40,000 for B, Avernge capital contributions At aiiiiia: 40.000 and PS50,000, int of each parte 1s the profitability of the patership edequate? What about from the view an showed an The capital accounts of Verna and Sierra at the start of the Yee pi. Pua contributions of P500,000 each but their current accounls St Caving a ond 25,000 for Verna and P50,000 for Sierra. AL the end of the year te NEB tonal information were piven: profi share of 90,000 for Verna and P1S0,000 Tr Seta ang ravings of P30,600 for Verna and P20,000 for Slerra. How ws ‘equity to be presented in the statement of financial position . ership presents all changes in equiy except for two items, Cite these two items. ets of income. The second set ig called Other Comprehensive Income. Mention four items included in this section. The books of the partners show three accounts, other than partners’ capital accounts: A, Salary P15,000 debit A, Drawings P 3,000 debit B, Salary P12,000 debit Policy of the firm is to use the Salary account to record withdrawals of salary. Both and B are given salary allowances of P15,000 cach. As soon as salaries have been completely withdrawn, additional drawings are debited to the drawing accounts. a) Based on the accounts presented how much more can A withdraw? What about B? b) Give the entry for the salary profit, EXERCISES The parmership of Diaz and Bravo, lawyers, was formed on January 1, 2019 with Diaz investing cash of P250,000 and Bravo investing equipment (computer and printer) costing P250,000, with a book value of P200,000 and a fair value of P150,000. Bravo invested sufficient cash to comply with the agreement that both partners shall have'equal interest on the net assets and profits of the partnership. At the end of the year, the following selected accounts were found in their adjusted trial balance: Debit Credit Diaz, Drawings P 40,000 Bravo, Drawings 50,008 Service Revenues P4,970,000 Depreciation Expense $00,000 Rent Expense 1,200,000 Representation Expense 480,000 Salaries Expense 850,000 Supplies Expense 250,000 Transportation Expense 675,500 Utilities Expense 475,000 aeDirection: a) Prepnte one entry to record partners’ contributions. » Prepare two entries to 1) cloge the nominal accounts 2) distribute profit, ©) Prepare a statement of pariners’ equity for the year just ended . The following is the adjusted trial balance of F lyper Mart as of December 31, 2021: Debit Credit Cash 63 000 - P103,000 Accounts Receivable (net of P8,000 allowance) 162,000 Merchandise Inventory, January 1 537,500 Prepaid Insurance 56.500 Furniture & Fixtures (net of accumulated depreciation of PI 16,500) 465,500 Land 400,000 Equipment (net of accumulated depreciation of P95,000) 240,000 Accounts Payable 31,000 Accrued Expenses. x Young, Capital 450,000 Young, Personal 40,040 Go, Capital ° 550,000 Go, Personal 32,500 Sales 2,498,140 Sales Discounts 11,620 Purchases 545,890 Freight In 27,540 Bad Debts Expense 1,500 Depreciation Expense 31,000 Insurance Expense 128,500 Rent Expense 520,350 Other Operating Expenses 201,700 Gain on Sale of Marketable Socuiios 30,000 To Direction: a) Three entries to close the nominal accounts: a) net sales and gain, b) cost of sales with unsold good of P125,800 at year end, c) operating expenses. b) Record 20% tax liability. c) Compute for share of each partner in the profit or loss. d) Record the distribution of the profit (loss). Firm uses the fixed capital method. ©) Prepare a Statement of Changes in Partners’ Equity 1) Compute for the retum on equity (ROE) of each partner. Refer to page 82. Is the profit share attractive given that the bank prime interest rate on investment is 5%? . Toys For All Company was set up on July 1, 2018 with Barbie investing properties costing P320,000 but with a current fair value’ of P450,000. Hannah invested twice Barbie’s contribution. Partners have no agreement on the division of profits and losses. The business incurred a net loss of P210,000 in 2018 but recovered to eam a net profit of P720,000 in 2019. It was further agreed that annual salaries be withdrawn by each as follows: Barbie, P80,000 and Hannah, P120,000 but only if operation is a profit. Direction: a) Distribute the 2018 loss and give the journal entry. b) Distribute the 2019 profit and give the journal entry. c) Prepare a statement of partners’ equity for each year. . At the end of its first year of operation on December 31, 2018, the GMC Music Store accounts showed the following: 8586 Drawings Capital R. Valera 18,000 ra ee A. Rivera 13,500 15,000 J. Chan 6,000 , The capital balances represent partners’ inital capital investments Direction: rod . ui to: 2) Given the following indepondent agreements you a6 FAS iy spree (1) Prepare the entry to distribute profit of P45,000 ua of 4:3:2, respectively i (2) Propare the entry 10 distributo profit of 54,000. Valera and Fiver are given salary allowances of P16,500 and P12,750, respectively. Residual prov is shared by all based on capital contributions. @) Prepare an allocation table to distribute profit before tax of P75,000. Each pare is allowed 10% interest on beginning capital balances Valet is given a 27,000 salary allowance. The remainder is shared equally. Using me on table, prepare one entry to record the profit distribution. Tax rate is 3 f. ) Prepare a partnership statement of changes in equity for the year 2018 using agreement (3) only. Max and Kenneth are partners in an eatery business with balances of P250,000 and 150,000 respectively. Partnership agreement calls for: 12% interest on capital, 6,000 monthly salary for Max as managing partner, remaining profit to be divided equally by the two partners. You are given the following independent situations: a) Result of a one year operation is a net profit of P170,000 after tax. b) Result of a one year operation was a net loss of P240,000. c) Result of a one year operation was a net profit of P120,000 before tax of 30%, 4). Result of a six-month operation was a net profit of P110,250 before tax of 30% ©) Result of a three-month operation was a net loss of P75,000. Direction: Record the distribution based on the aforementioned situations supported by profit/loss allocation table, The following are the capital accounts and drawing accounts of the partners of READ Co, a bookstore, at the end of their second year of operation: Reina, Capital Ador, Capital ei 300,000 [1/1 1,800,000 WI 1,200.06 9/30 800,000 ‘At the end of the year the business resulted in a net profit of P140,000, and the partners asked you to compute their profit share based on capital contributions. Direction: a) Make a computation using three possible ways of distributing profit, b) Which one will give the highest share for Ador? Explain why_ 7. The IR Asia Consultancy Firm is owned and managed by two CPAS, Joffre and Ric. Initial investments of the partners are foftre PROU,OINT and Rie P400,000, Twa options on how to distribute the profit are being considered by the partners: Option 1: Distribute profit based on capital contributions afer a 20% bonus is given to __ Ric based on profit for distribution. Option 2; Distribute Profit by giving them a 10% interest on contributions, a salary allowanec of P100.000 to Ric as managing partner, and the remaining profit to be divided equally between them Duc to the disparity in the contributions, the partners want to find out if it will be better to use option 2. The objective is to find a way of compensating fairly the partners considering not only asset contribution but also contribution in the form of time and expertise. Direction: a) Prepare tel abies 1 flow its Profit distribution under two option plans if profits at b) Comparing the total profit share of it i ill givea fairer sharing of proke? fe of cach partner in cach option, which one will gi 8, Bruce and Rachel agree to form a partnership on July 1. Bruce, who has been trading as a sole proprietor, will invest certain business assets at agreed valuations, transfer his business liabilities and Contribute sufficient cash to bring his total contribution to a 60% interest over the new business. Details of Bruce's assets and liabilities are given below. . Book value Agreed value Accounts Receivable P32,000 P 30,000 Inventory 240,000 138,000 Equipment 322,000 240,000 Accounts Payable 200,000 200,000 Notes Payable 14,000 14,000 Rachel agrees to bring in inventory with a value of P146,500 and P93,500 in cash for a 40% interest in the partnership. ‘The partners have agreed on the following: a) capital accounts will remain fixed; b) 12% interest profit computed on capital; ¢) salaries of P30,000 each for 2019 but will be twice this amount next year and thereafter; d) 10% interest charge on partners’ drawings made beyond the agreed salaries; and ¢) remaining profits are to be shared equally. Direction: a. Prepare two journal entries to set up the partnership. b. Prepare a statement of financial position for the partnership as at July 1 just after formation, ¢. Profit (before interest and salaries) on Dec. 31 was P120,500. Cash withdrawals made by Bruce and Rachel! amounted to P30,000 and P40,000, respectively. Prepare a profit distribution table and one entry to record the distribution, 4. Sct up the general ledger (T Accounts) accounts to show each partner's equity. . Prepare a statement of changes in partners’ eauitv. 9. Refer to Exercise 8. The following year the business earned P250,000 before tax with cash withdrawn by the partners as follows: P50,000 by Bruce and P60,000 by Rachel Direction: Requirements c, d, and ¢ of Exercise 8.88 10, t 4 1 ' 1 . Amber and Berta share profits and losses equally after a 10% interest on their average artners are fixed. The Capita The BJ Co. is in its second year of operation. Capital of P ership appear below: ‘ccounts and the Income Summary account af the BY TELE-Care parin 1 crit Jane, Capital Income Summal Betty, Capita TY 640,06 5) 4.050.000 a) 6.750,000 TW $60,000 I ©) 1.012.500 Salary, Jane Salary, Bet 710,000 Jan-Dee 120,000 Jan-Nov 11s . Drawings, Jane Drawings, Bet 1 _120,800 mm 3,000 [1/1 179,200 on 15,000 Income Summary posting legends: a) net sales b) cost of sales ¢) expenses ‘The company is subject to a 30% tax. Direction: a) Determine profit before tax, Record tax liability, post and get th Summary, . . b) Prepare a table to distribute profit according to agreement. Partnership amen Provides for a profit distribution based on capital after allowing salaries of ‘120,000 for each partner, ¢) Prepare two journal entries: , 1) to record profit based on salary allowance: close the salary accounts and credit partner Jane’s personal account for the salary profit not withdrawn. Post your entry to income summary, salary and drawings accounts. - 2) to record residual profit: credit to partners’ drawings. Post your entry to income summary and drawings accounts. . . 4) Determine each partner's equity based on the balances of the drawings and capital accounts, balance of the Income capital balances. Consider additional capital contributions and permanent withdrawals as made at the end of the month. Total net income after tax for 2019 is P320,000. Amber Berta January | capital balances P 105,000 P 140,000 Additional investment of capital: March 15 20,000 Permanent withdrawal of capital: April 12 (15,000) Drawings for each on October 28 50,000 40,000 Direction: Give the entries to record the distribution based on the following two independent cases: a) Partners’ drawings are not used in determining the average capital balances. b) All changes in capital and drawing should be considered in determining the average capital balances : Bert, Ben and Bello are partners in a sports equipment store with capital investments of P150,000, P200,000 and P300,000, respectively. Partnership agreement provides for the foltowing: monthly salary of P10,000 to Ben who is the managing partner, 12% intereston capital contributions, remaining profit to be allocated equally. Direction: For Ben (o be eredited for a profit share of P200,000, how much should the company earn’? 3, Ms. Emy Co is an industrial partner of Quest Travel and Tours Company getting a monthly solary allowance of P20,000, The company started operation on July 1, 2018, The other capitalist partners, Marcy Glas and Corry Poe, invested P200,000 each. Parmership agreement provides that Emy can make cash withdrawal of only half her monthly salary. The capital accounts are not fixed as balances of the drawing accounts at the end of the year are closed to their capital accounts as per provision of agreement. The other partners are permitted to withdraw a maximum amount of PS,000 per month. Remaining profits after salaries are divided equally between the capitalist partners. The mners withdrew the amounts as agreed upon, At the end of the year the business earned 600,000 profit. . Direction: a) Prepare one summary entry to record the withdrawals made by the partners. ») Prepare an allocation table and the entry to record profit share. ©) Determine the balances of the drawing accounts and close to the capital accounts, 4) Prepare a Statement of Partners’ Equity. |. Refer to exercise 13. Ms. Emy Co, with the unwithdrawn salaries, is now a capitalist parmer. They revised the agreement to show that salaries of Emy may now be withdrawn in fall. Residual profits will be divided based on beginning capital. The other partners are allowed to make monthly withdrawals up to P10,000. The business earned P950,000 profit and partners made their cash withdrawals accordingly. Direction: 2) Give the summary entry to record the withdrawals made by partners. b) Record the distribution of profit based on an allocation schedule. ©) Close the drawing accounts. 4) Propare a Statement of Partners’ Equity for the year ended Dec. 31, 2019. De La Cruz, Quizon and Ocampo are partners operating a gym for physical fitness with contributions of P250,000 from De La Cruz and P150,000 from Quizon. The partnership agreement provides for the following agreement in the event the operation is a profit: De La Cruz Quizon Ocampo (Capitalist Partoer) (Capitalist Partner) (Industrial Partner) Monthly Salary P10,000 Interest on capital contribution 18% 18% Balance of profit 50% 50% In the event the operation is a loss, the industrial partner gets half of her salaries only. Tax rate is 30% Direction: Prepare the entries to close the profit or loss based on the following information: a) The income summary account for 2018 before tax and distribution to the partners showed a credit balance of P225,000. b) The income summary account for 2019 showed a debit balance of P75,000 before tax and distribution to the partners. 8916. 1 Beth, Luz and Ana divide profit and loss in the ratlo of 18, 90 OC 4 ng profit distribution plan: feliow echo remainder in an equal ey, hare of P100,000. Partners A, B and C are conteniplating using the Salary is to be given to A in the amount of P60,000, to all the partners. A is guaranteed a minimum profit s 8) Profit for the first year Is P240,000. ») Profit for the second year is P150,000. Direction: Compute for the profit share of partners B and Clin both years. respectively, ar givin moithly salary of P10,000 fo each partner and bonus of 20% to ae eeaens she of each partner and record the distribution on the following inden : 4) Net income earned was P480,000 and bonus is based on net income Before salar, and bonus. —_— i ) Net income eared was P480,000 and bonus is based on net te cia bona, ©) Net loss for the year was P480,000 and bonus based on net income bom, Refer tono, 17. . ths, h di a). If Luz received a profit share of P50,000 after six months, how much did Bey receive? Assume bonus is based on net income before bonus. ia ; b) If Luz received a profit share of P50,000 after one year, how much did Beth receive, Bonus is based on net income after bonus. |. (Adapted) Mr. Zed and Mr. Wye are partners sharing profits 4/7 and 3/7. They allow fay interest on capital account balances at 10% and Mr. Wye is paid a salary of P1,000 per month, The following is summarized from their trial balance at year end. Debit Credit Capital Accounts: Zed 150,000 wye 140,000 Current Accounts: Zed 32,000 ‘Wye 29,000 Drawings: Zed : 42,000 Wye 37,000 Sales 222,000 Cost of goods sold 80,000 Expenses 31,000 Cash 383,000, 373,000. 573,000 Direction: 1) Prepare a profit and loss, and appropriation table for the partners b): Prepare the statement of changes in the current accounts, c) ‘Prepare the partners’‘equity section of the statement of financial position.er 20. (Adapted) Quinlan and Alves enter into a Partnership agreement and set up @ business providing coaching lessons, The Partnership agreement provides for profit to be shared equally and for cach partner to receive Interest of 15% per annum on their capital. Quinlan and Alves are entitied to salaries of P70,000 and P80,000, respectively. The business has revenue of P260,000 and operating expenses of P180,000, prior to interest, tex and partners’ salaries. Quinlan, whose current account had a balance at the beginning of the financial year of P20,000 credit, had invested P50,000 to start the business. Alves had a current account balance of P40,000 debit and had originally invested P30,000. Both partners had withdrawn P15,000 cash from the business on the last day of the financial year, Direction: 8) Prepare a profit and loss, and appropriation table for the partners. b) Prepare the statement of changes in the current accounts, c) Prepare the partners’ equity section of the statement of financial position. _ The following list of accounts and their balances appear on the books of MJ Thai Spa as of December 31, 2018: Cash | P 58,850 Mel, Capital 40,000 Accounts Receivable 32,400 Membership Fee 945,900 Allowance for Bad Debts 2,500 Service Fee Income 1,530,500 Notes Receivable 19,000 Advertising Expense _ 300,160 ‘Unexpired Insurance 2,575 Taxes and Licenses 108,970 Fumiture & Fixtures 238,000 Rent 644.000 ‘Accumulated Depn. - Furniture 5,950 Sales Salaries 346,000 Equipment 432,000 Office Salaries 150,000 Acoumulated Depn.- Equipment 21°60 Store Supplies Expense 3,400 Accounts Payable 15,000 Office Supplies Expense 2,090 Notes Payable 50,000 Utilities Expense 310,850 ‘Unearned Commissions 600 Interest Expense 10.610 Jay, Capital 60,000 Interest Income 5,455 Jay, Personal 3,600 Loss on Foreign Exchange 15,000 Partnership agreement calls for the following: ‘Monthly salary allowance of P5,000 for Mc! and P7,500 for Jay, 12% interest on capital balances, and residual profit to be shared equally Additional information were given to adjust the books: a) Provision for bad debts should be 10% of the outstanding accounts receivable. b) Office Furniture and Fixtures were acquired Jaly 1, 2017 and the Delivery Equipment were acquired January 1, 2017: Depreciation rate is the same for both assets. ©) One half of the uncamed commission is already earned, 4) Prepaid insurance on the delivery equipment is payable annually starting May 1. e) P10,000 of the notes receivable is interest bearing at 18% dated December 1, 2018 and due after 60 days. f) The note payable was issued to the bank and discounted at 18% December 1, 2018. The discount was charged to interest expense. 8) Tax rate is 30%. Direction: Prepare a 10-column worksheet with a profit distribution table, for a year on OL22, Refer to exercise 21 8) Prepare the adjusting entries. 2 ‘lose the nom accounts. f mn 7 oy Pepa a ate ae BBY ensive Income under the function, oF EPCS Mehy and use line items with supporting notes. Rent and utililes wre 72 Ge Oo Ese °) Prepare a stetement ‘of partners" equity. Mel Capital was!” : ° mi fl L. i i it @) Prepue a ctaectt a Moeeial position also using line items with SuPPOrtng nor LEGAL AND ETHICAL ISSUES - Complex will be funded by A ang A, B and C formed a partnership, The Dance-O-Rama COMPA Ts 1.5 and be the ag With cash and equipments. C, a professional dancer, wi dance instructor, Questions: 1. Can C accept dancing engagements for a fee outside of the partnership? 2. Explain if professional ethics is violated. 3. Is there a legal provision violated? . . . 4, Can C coe pee restaurant business or any other kind of business not in ty same class as the Dance-O-Rama formed by them? Explain if there is a ethical or legal implication. ACCOUNTING ISSUE Using the data in the first issue, A invested cash of P500,000 and B invested equipment for an equal amount. C, the industrial partner, will be given a profit share of 20%. Question: 1. What is the share of each partner if profit is P350,000? - 2. What is the share of each partner if the loss is P350,000?CHAPTER 4 CHANGE IN OWNERSHIP (DISSOLUTION) Learning Outcomes: ‘Atthe end of this chapter, the student should be able to: a} Explain dissolution and its effect on the partnership. b) Describe the different causes of dissolution » ) Record the change in ownership and revise the partners’ equity 4) Explain the concept of asset revaluation, bonus and goodwill. Dissolution occurs when there is change in ownership, There are many reasons why change in ownership of partners will occur and the most possible reasons are the following: a) partners decide to admit a new partner or partners; b) a current partner decides to retire or withdraw from the partnership; ) apartner dies; d) parmers decide to incorporate. __ Expansion, infusion of more capital, special skills, all needed to strengthen competitive position are some reasons why partners may decide to admit a new partner or convert this into a corporation. On the other hand, a partner who is dissatisfied with the way the business i+ operating may decide to leave the partnership. DISSOLUTION DEFINED. ARTICLE 1828 of the New Civil Code defines dissolution as a change in the relation of the partners ceasing to be associated in carrying on the business. The legal provisions (Articles 1830 and 1831) further give us four causes of dissolution: 1. By the acts of the partners, like when the partnership purpose or objective has already been accomplished or by mutual agreement among the partners or a decision to withdraw from the parmership. 2. By operation of law, like when an event makes it illegal for the business to be carried on, of when a partner becomes insolvent or dies, or by the civil interdiction of any one of the partners, 3. By judicial decree, like insanity of a partner or commission of fraud by a partner or by the internal dissension among the partners, Dissolution does not necessarily terminate the basic business operation of the partnership except for the change in ownership. In some instances, though, it may lead to the termination or liquidation of the firm. In this chapter, dissolution without interruption in the regular operation of the business will be discussed. The next chapter will discuss dissolution which will lead to the liquidation or the winding up of the affairs of the partnership. The change in the ownership structure of the partnership dissolves the existing partnership with the creation of a new partnership, The accountant refers to the Articles of Co-Partnership for the agreement on how the dissolution shall be implemented and may also advise the partners in the structuring of the buy/sell agreement, The accountant records the dissolution accordingly and revises the partners’ quity. 93The following, changes im ownership will be discussed artner, A new partner is admitted by buying interest directly iran oe " | new partner is admitted by investing directly to the pt I 4 partner retires and his interest is bought by either an outsider, oF co-Partner OF the partnership itself. +s estate 4 partner dies and the partnership settles through the partner's esta the partnership is incorporated. ACCOUNTING PROCEDURES JUST BEFORE DISSOLUTION With the change in ownership, it is as if a “new” partnership is created hence gy adjustments and revaluations ofthe existing partnership assets should be made before the ney association of partners is to take over: 1, Update the capital accounts of the existing partners as of dissolution date by revaluing the partnership assets, determining the profit share of the partners from the fast statement of financial position to dissolution date, and closing their drawing accounts. were ae 2. If the dissolution contemplated upon was not provided for in the articles, the terms ang conditions for the dissolution should be ascertained from the partners. 3. Record the dissolution or change in ownership and revise the partners’ equity. If the partners’ equity is given just before dissolution without mention of a need tp Tevalue assets or record profit share, it is understood that the capital accounts have already been updated and therefore ready for dissolution. ARTICLES OF CO-PARTNERSHIP REDRAWN It is important to redraw the Articles of Co-Partnership upon dissolution since some provisions will be affected such as: the names of the partners and their contributions, manner of management, duties and responsibilities of each partner, their profit - sharing ratio, and manner of dissolving or tiquidating the partnership, to name a few. UPDATING PARTNERS’ EQUITY BEFORE DISSOLUTION ‘Assume that Alex and Amado of AA Tours and Travel decide to dissolve thei partnership and admit Adrian 2s a new partner on March 31. The following were agreed by the partners: 1) revalue the land by P262,500 and 2) distribute the profit reported by the accountant for the first quarter amounting to P300,000. Additionally, cash withdrawals made during the first quarter of the year amounts to P25,000 for each partner. As of January |, three months before dissolution date, records show their capital accounts as P400,000 fot Alex and P600,000 for Amado. The articles of co-partnership provided profit distribution based on capital contribution. The accountant prepared the following entries: a. Land P262,500 Alex, Capital P105,000 Amado, Capital 157,500 Adjust for the undervaluation of land ; Alex (400,000/1,000,000 x P262,500) 105,000 Amado (600,000/1,000,000 x P262,500) 157,500 94| aie EE I income and Expense Summa : bine ctex, Drawing 2 300,000 2 120,000 Amado, Drawing, 180,000 To record profit sharo of the partners based on the cupital contribution ratio of 4:6, respectively. g, Ales, Drawing 95,000 ‘Amado, Drawing 155,000 iatscaptat 95,000 Amado, Capital 155,000 To close the drawing accounts: profit share less regular drawings made by the partners (120,000 — 25,000 and 180,000-25,000), At dissolution date the updated partner's capital balances are: Alex, Capital "(400,000 + 105,000 + 95,000) P 600,000 Amado, Capital (600,000 +157,500 + 155,000) 912,500 ADMISSION OF A NEW PARTNER From the legal point of view, a new pariner cannot be admitted without the unanimous consent of all the partners, Admission ofa new partner may take place in one of two ways: 1) Purchasing an interest from one or more existing partners 2) Investing cash or other assets in the partnership PURCHASING AN INTEREST FROM ONE OR MORE EXISTING PARTNERS A new partner may purchase a partnership interest from one or more existing partners. - In this case, « capital account is set up for the new partner by transferring interest equal to the portion purchased from the existing partner(s). This transaction is a personal transaction between the existing partner(s) and the new partner. Partnership assets are not affected. CASE 1: TRANSFER OF INTEREST IS EQUAL TO THE AMOUNT PAID Lucas paid Sarah P10,000 to purchase half of her interest in thé retail business owned by Angel and Sarah whose capital balances are P30,000 and P20,000, respectively. Angel and Sarah shares profits and losses 3/5 and 2/5, respectively. Observe the followin, ‘The analysis will affect the following accounts in this manner: 1) The payment gocs to Sarah, not to the partnership. Partnership assets will not change. 2) The purchase requires a transfer of capital from Sarah to Lucas for P10,000. 3) Total partners’. equity P50,000 will not change although there will be a change in the composition of the partners’ equity, as follows: Existing Equity Transfer of Interest Revised Equiy Angel, Capital P 30,000 P30,000 Sarah, Capital 20,000 x A= (P 10,000) 10,000 Lucas, Capital _ 10,000 10,000 Total Equity PEo.000 = P $0,000 Fundamental rule in accounting for the basic elements should always be applied: The relationship of balances expressed in an accounting equation between the assets, liabilities 95EEO OO \0 = Partners’ Equity. Sin, and partners’ equity must always be maintained Net asscts re he same after admission’ Lucas did not invest in the firm,{otal partners” equity should stl 4 MOUNT PAID CASE 2. TRANSFER OF INTEREST iS NOT EQUAL TO THE Al +g interest of P10,0007 Suppose in the above case, Lucas pays P15,000 for hell of Sarah's irs ees Analysis will still be the same as in case 1. It is emphasized that tt cit paid pot by pirchase, the payment does not affect the partnership assets SITE I 4 personal ios. the selling partner. It is Sarah who will recognize either a persone! Fare or interest att this case, Sarah recognizes a personal gain of P5,000, Record only m the selling partner to the buying partners. Entry for Case | or Case 2 will be: P 10,000 Sarah, Capital P10,000 Lucas, Capital , ‘Admission of Lucas as a new partner with the purchase of half of Sarah’s interest, ASSET REVALUATION When the current values of the partnership asset record values (book values), the partners may agree to revalue the assets. Asset revaluation isa requirement to update capital accounts of partners before admitting anew partner. Upward or downward adjustment of partnership assets should affect only the existing partners, if partnership assets are undervalued, an upward adjustment should be made to increase assets and partners’ equity. For asset impairment, if the current fair values (less cost to dispose) of the assets are lower than their book values, a downward adjustment should be made to decrease the assets with a corresponding decrease in current partners’ capital. 1s are greater/lesser than the recorded CASE 3. ASSET REVALUATION (UPWARD ADJUSTMENT) Refer to Case 2. Lucas agrees to pay P15,000 for half of Sarah’s interest but the assets must first be revalued. How do we arrive at the revaluation? If the amount for revaluation is not given, it can be inferred from the amount the new partner is willing to give. The analysis will affect the following accounts in this manner: 1) Since the payment is higher by PS,000 than the book value of the interest being purchased of P10,000, the implication is that’ the assets of the partnership are undervalued. Asset revaluation will be based on the amount that the new partner is willing to pay, thus: Amount Lucas is willing to pay for $0% of Sarah’s equity 15,000 Sarah’s Equity should be (15,000/50%) 30,000 Sarah’s Equity per books 20,000 Share of Sarah in the revaluation P10,000 Total asset revaluation (10,000/40% equity of Sarah) = P25,000 2) Adjust the existing partners’ equity by P25,000. Parmers’ equity will be P75,000 after the revaluation with Sarah’s adjusted capital as P30,000. This will now be the basis for transferring capital to Lucas. Since the amount to be paid (P15,000) was used as the basis for revaluation, it will also be the amount for the transfer of interest. 963) Partners’ Equity after the j rovaluntion wi izing transfer oteapital Romrabe ce ion will not change aymore in recognizing tr Partner to the buying partner. Thus: Existing * Baul ai Asse Parnes’ Faulty Transfer of . Revised nae! 7 Ban (60%) 15,000 45,000 P 45,000 Eis : (49%) 10,000 30,000 x 1/72 (15,000) 15,000 — 15,000 15,000 P 0,000 725.000 = PZ5.a0 P 75.000 assuming that land is the asset to be Tevalued, two entries will be required: Land ‘Angel, Capital passano P15,000 Sarah, Capital P10,000 To adjust the land based ‘on tl fixed by the partners, the agreed value Sarah, Capital PU Lucas, Capital id capi P15,000 Admission of Lucas as a new partner with the purchase of half of Sarah's interest, Revaluation of assets cannot be implied in admission by purchase. This must be agreed upon by partners and specifically mentioned in the problem. REVISED PROFIT AND LOSS RATIO. _It is necessary that the articles of co-partnership be redrawn in consideration of the admission of a new partner. Likewise, a new agreement as to managerial functions, division of profit and loss and the inclusion of the new partner are to be considered, In the event that a revised profit and loss ratio was not considered by the partners, the current profit and loss ratio should be revised accordingly based on the percent of interest the existing partner is selling to the buying partner. If there is no profit or loss agreement from the start of partnership operation, distribution of profit and loss after the dissolution shall be based on adjusted capital contributions. In all the above cases, it can be inferred that with the half of the interest purchased from Sarah, half of her profit ratio is also purchased: Partners Original P.andL = Transfer of Interest Revised P and L ‘Angel 60% 60% Sarah 40% % (20%) 20% Lucas 20% 20% INTEREST OVER ASSETS AGAINST INTEREST OVER PROFIT The equity or capital account represents interest of a partner over partnership assets. Interest over profit may also be based on the capital account if that is the agreement. This is provided by law and was explained in the preceding chapter: if there is no profit agreement, profit or loss share should be based on what partners contributed. The point is, interest over profit may not always be based on the capital contribution as there are other factors which should be considered in determining fair and equitable distribution of profit. This was also discussed in the previous chapter. 97INVESTING IN A PARTNERSHIP A now partner may invest assets in the existing pa be applied 1) Since the new partner is contributing to the partnershi new partner and the partnership. 2) Contribution increnses the partnership assets and the part nership, The following rules shoug p, the transaction is between the ners’ equity. HIS CAPITAL CREDIT, OR REVISED EQUITY 1 be given a 1/3 interest in CASE 4, NEW PARTNER'S INVESTMENT IS EQUAL TOTAL CONTRIBUTIONS EQUAL TO AGI Assume that Lucas will invest P2S,000 cash and wi the partnership agreed equity of P75,000. The analysis will affect the following accounts in this manner: ill , thus: 1). Partnership assets and partners’ equity will increase by P25,000, Existing New Revised Partners Equity Contribution Esuily, Angel P 30,000 P ae Sarah 20,000 000 Lucas _ P.25,000 25,000"! Total . P.50,000 25,000 P_5,000" 2) Total contributions will be equal to total agreed partners’ oat ats 0 3) New partner gets a 33.33% interest in the total partners” equity o1 i 4) Entry to record the investment will be: Cash P25,000 Lucas, Capital Lucas invested cash for a 33.33% interest. oor, 25.000 CASE 5. NEW PARTNER’S CONTRIBUTION IS EQUAL TO HIS CAPITAL (CREDIT. CURRENT PARTNERS AGREE TO REVALUE THE ASSETS. Lucas will invest P30,000 cash for a 30% interest in the net assets of the partnership. Partnership assets should be revalued first by P20,000. 1) Partnership assets will increase twice: for the revaluation and for the cash investment 2) Asset revaluation should be recorded first before admitting the new parmer, It should be based on the agreed profit ratio for the existing partners or the capital ratio if there is no agreed profit ratio. 3) New partner’s equity is equal to what was invested. Existing Asset New Revised ‘Angel P 30,000 P 12,000 P 42,000 Sarah 20,000 8,000 28,000 Lucas —_— — P.30,000 30,000 Toul —, PS0000 —P20,000P30,009 +P 100,000 * Lucas Capital will be credited for 30% based on total agreed or revised equity of P100,000. 98