partnership Operations ar Chapter 2 Partnership Operations Tearning 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. 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: ‘+ IFonly 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 that contributes both services and cash or other non-cash asset is both a capitalist and an industrial partner. > >Chapter? eee «The designation of losses and profits cannot be entrusted tg one ofthe partners (art 1738). A stipulation which excludes ong ‘or more partners from any share in the profits or losses is vig (an 9) In addition to profit or loss sharing, the partnership agreement may also stipulate any ofthe following: Salaries ~ normally, an industrial partner receives salary in addition to his share in the partnership's profits ag compensation for his services tothe partnership. >. Bonuses ~the managing partner may be entitled to a bonus fo excellent management performance. Unlike for salaries, partner is entitled to a bonus only if the partnership eam profit. The partner is not entitled to any bonus if th partnership incurs loss 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 ls is shared among the partners based on their stipulated profit or loss ratio, Illustration 1.1: Salaries (w/ remaining profit) ~ different P/L ratios ‘A and B formed a partnership. The partnership agreement stipulates the following: «Annual salary allowances of 50,000 for A and 30,000 for B Salary allowances are to be withdrawn by the throughout the period and are to be debited to their drawings accounts. «The partners share profits equally and losses on a 60:40 ratioOperations Pa During the period the partnership earned profit of 100,000 before salary allowances, Requirements: ‘a. Compute for the respective shares of the partners in the profit Provide journal entries ‘Solution: Requirement (@e See a ae “Amount beingallocated 100,000 “Allocation: 1 Salaries 50,000 30,000 80,000 2 Allocation of remaining profit (100K profit - 80K salaries) = 20K (20x50%); (20K x 50%) 10,000 10,000 _ 20,000 As alocated 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 partnets is equal to the amount being allocated (ie., OK + 40K = 100K). Requirement 0): ‘Monthly | A, Drawings 50,000 entries | B, Drawings 30,000 Cash 80,000 torecrd the withdrawal of salary alowences Yaerend | Income summary 1€0,000 entry A, Capital 60,000 B, Capital 40,000 so recrd te istributon of profentry | B, Capital A, Drawings i B, Drawings ; to close the da Illustration 1.2: Salaries (no remaining profit) ~ different py, tios A and B formed a partnership. The partnership agreemeny stipulates the following: Aaa salary allowances of P80,000 for A and P40,000 for B, + The partners share profits equally and losses on a 60:40 ratio, During the period there partnership earned profit of P100,000. Requirement: Compute for the respective shares of the partners in the profit. Allocation: : 1. Salaries 80,000 40,000 120,000 2. Allocation of remaining loss (100K profit - 120K salaries) = -20K (20 x 60%); (2 * After the salaries are provided, the remaini Negative (i.e, loss); thus, it is allocated based 1088 ratio of 60:40, © The sum of the amoui the amount being allo ints allocated to the pa cated (i.e, 68K + 32K =Berner Oper tMlustration 1.3: No P/L ratio A and B formed a partnership on January 1, 20x1. Their contributions were credited to their respective capital accounts as follows: Capital accounts ‘A. Capital 150,000 B, Capital 250,000 400,000 During the year, the partnership earned profit of P1,000,000. There ‘was no stipulation in the agreement on how profits are to be shared by the partners. i Requirement: Compute for the respective shares of the partners in the profit. Solution: ee A B Total “Amount being allocated 7,000,000, “Allocation: (based on contributions) 1M x (150K / 400K) 375,000 375,000 1M x (250K / 400K) 625,000 __ 625,000 As allocated 375,000 625,000 _ 1,000,000. Illustration 2.1: Bonus (with profit) ‘A and B formed a partnership. The partnership agreement stipulates the following: «Annual salary allowances of P48,000 for A and P30,000 for B. «© Bonus to A of 10% of the profit after partner's salaries and bonus. © The partners share profits and losses on a 60:40 ratio. During the period the partnership earned profit of 100,000 before deductions for salaries and bonus.respective shares of the partners in the profit, 2 Bonus after bonus * 3. Allocation of remaining profit (100K ~ 78K - 2K) = 20K (20K x 60%); (20K x 40%) “The bonus is computed as follows: Profit before salaries and bonus 100,000 Salaries (78,000) Profit after salaries but before deduction of bonus 2,000 ‘The bonus scheme is “bonus after bonus.” The formula is as fol P Bos -_—— aera Where: B= bonus P= profit before bonus and tax Br= bonus rate or bonus percentage B= 2,00 = 72,000 1+ 10% Pe aon = 20,000 B =2000 Bele to Chapter 27 of Intermediate Accounting Part 2 or detailed discussion onPartnership Operations 37 Illustration 2.2: Bonus (with loss) ‘A and B formed a partnershi stipulates the following: Annual salary allowances of 'P25,000 for A and 4,000 for B. + Bonus to A of a Of 10% of the profit after partner's salaries and ip. The partnership agreement «The partners share profits and losses on a 60:40 ratio, During the period the partnership incurred loss of P10,000 before deduction for salaries. Requirements: a. Compute for the respective shares of the partners in the profit. . By what amount did A’s capital account change? Solutions: Requirement (a): A B Total ‘Amount being allocated 104 “Allocation 1. Salaries 25,000 4,000 29,000 2. Bonus after bonus» - - “ 3. Allocation of remaining loss : (10K -29K) =-39K (23,400) (15,600) (39,000) (39K x 60%); (39K x 40%) As allocated 7,600__(11,600)__(10,000) + No bonus is allocated because the partnership incurred a loss. However, salaries are provided whether the partnership earns profit or incurs loss because salaries are compensation for services rendered. Requirement (0): From the table above, A’s capital increased by PI,600. Notice that it is possible for a partner’s capital to increase even if the partnership incurs a loss.The entry to record the allocation of loss is as follows: Yeerend_ | B, Capital 11,600 entry Income summary A, Capital tori te dirt ftp | itustration 2.3: Bonus ~ With limit ‘A and B formed a partnership. The partnership agreem stipulates the following: «First, A shall receive 10% of profit up to P100,000 and over P100,000. © Second, B shall receive 5% of the remaining profit o 150,000. * Any remainder shall be shared equally. During the year, the partnership earned profit of P280,000. Requirement: Compute for the respective shares of the partners in the profit Solution: ‘Amount being allocated “Allocation: 1. Bonus to A First 100K: (100K x 10%) 10,000 Over 100K: [(280K - 100K) x20%] 36,000 2. Bonus to B on remaining profit (280K - 10K - 36K - 150K) x 5% 3. Allocation of remaining profit (280K - 10K - 36K - 4.2K) +2 4,200 160,900‘partnership Operations wv peters Operon Mustration 24: Bonus - choice of profit sharing scheme Mr. A,a partner in ABC Co,, is deciding on whether to accept salary of P8,000 or a salary of P5,000 plus a bonus of 10% of profit. ‘The bonus shall be computed on profit after salaries and bonus. Salaries ofthe other partners amount to 20/000. Requirement: What amount of profit would be necessary #0 that Mr. A would be indifferent between the choices? Solution: ‘An algebraic equation is developed from the two choices above. Let: X= profit after salaries and bonus 10%6X = bonus after bonus Choice #1 Choice #2 8000 salary = 5,000 salary + 10%X X is computed from the equation above as follows: 8,000 = 5,000 + 10%X 10%X = 8,000 - 5,000 X=3,000 /10% x= m0 Profit after salaries and bonus (X) 30,000 ‘Multiply by: Bonus rate 10% Bonus 3,000 Profit after salaries and bonus 30,000 ‘Add back Salaries (5K to Mr. A+20K to other partners) 25,000 ‘Add back: Bonus 2 Profit before salaries and bonus 38,000 If the profit of the partnership is P58,000, it does not whether Mr. A chooses to receive a salary of P8000 (‘choice #1he will a salary of P5,000 plus a 10% bonus (choice #2); receive. same amount, Checking: Choice £1 Choice #2 . ‘8000 salary = 5,000 salary + bonus The bonus is computed as follows: Profit before salaries and bonus Salaries (SK + 20K) Profit after salaries but before bonus P mite 1+Br 33,000 B= 33000 T+ 10% B = 33,00 - 30,000 B= 3.000 Choice #1 Choice #2 8,000salary. = 5,000 salary + 3,000 bonus lustration 2.5: Bonus - comparison of profit sharing scheme A and B formed a partnership. The partnership a stipulates the following: + Bonus to A of 10% ofthe profit before bonus, + The partners share profit ts equally and losses in the ratio of respectively, Requirement: Which partner has a gr Breater advantage when Partnership has profit or when it has a loss? 7 Solution:Se Let: B= bonus P= profit after deducting bonus LL loss without deducting any bonus 1, When there is profit, the profit shal be shared as follows: A's share B's share Bonus +(S0%P) > ——50%P 2. When there is lass, the loss shall be shared as follows: Als share B's share 26L < 36L From the analyses above, we can conclude that A has a greater advantage whether the partnership earns profit or incurs loss. Mlustration 3.1: Interest on capital A and B formed a partnership. The 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. During the period, the partnership eamed profit of P100,000. ‘The movements in B's capital account are as follows: B, Capital (60,000 July 31 withdrawal 30,000 | 20,000 40,000 10,000 end, 100,000, Requirement: beg. April 1 additional investment Sept. 30 additional investment Dec. 31 additional investment Compute for the respective shares of the partners in the profit.Solution: ; ‘The weighted average balance of B’s capital account is com, 88 follows:_ ‘Months outstanding + Total ‘months ina We Balances Beg. Balance 60,000 122 April | additional investment 20,000 92 July 31 withdrawal (30,000) 5/2 tr Sept. 30 additional investment 40,000 32 Dec. 31 additional investment 10,000 on Weighted average capital balance ‘Amount being allocated “Allocation: 1. Salaries 50000, - 50 2. Interest on weighted ave. capital balance (72.5K x 10%) ae 3. Allocation of remaining profit (100K - 50K - 7 250K) = 42.750K (42,750 x 40%) Partnership. The partnership a stipulates the following: Monthly salary of P5,000 for A. 20% bonus to A, before deductions f i 200 be for salary, interest, 10% interest on the weighted average capi * Salary, bonus and oration inter expenses, interest are considered paPerinership Operation ee ‘The results of operations show the following: Revenues 000 Expenses (including salary, interest, and bonus) 120,000) Profit 30,000 The weighted average capital balance of B's capital account is 100,000, Requirement: How much is the bonus of A? Solution: Profit (given) ‘Add back: Armwual salary (5,000 x 12 mos.) ‘Add back: Interest on capital (100K x 10%) Profit before arnnual salary and interest but afer bonus Profit before salary and interest but after bonus: 100,000 Divide by: (100% less 20% bonus rate) 80% Profit before salary, interest and bonus 125,000 Multiply by: Bonus rate 20% Bonus (bonus before bonus scheme) 25,000 Ilustration 3.3: Interest on capital - Partial year ‘A and B formed a partnership on March 1, 20x1. The 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. During the period, the partnership earned profit of P100,000. ‘The movements in B’s capital account are as follows:Capita, Fc SO000 7 March nal ‘nvestmen, adlitional in rawal 30,000 | 40,000 Sept. 30ad va Renae 10,000_ Dec. 31 additional i end. 100,000 Requirement: Compute for the interest on B’s weighted aver, capital. / Solution: _ Months outstanding Balances =Total Weigh months ina 0°70 “ar March 1- beg, Balance 80,000 «10/12 July 31 withdrawal (30,000) 5/12 (12: Sept. 30 additional investment 40,000 an 10, Dec.31 additional investment 10,000 onz Weighted average capital balance Multiply by: Interest rate Interest on weighted average capital "Months outstanding (March 1 to December 31) Notice that the solution above is similar to the solution had in ‘lustration 3.1’ for a full year, Alternative solution #1: ‘Months outstanding LLbbL Balances Total, . Weight months average during the F riod March 1 - beg. Balance 80,000 io July 31 withdrawal (30,000) 5/10ee a ere Ss os. Ce Primes Opertions 45 sept. 0 additional investment 40,000 4/10 12000 Dec. 31 additional investment 10,000 (/10 7 Total 77,000 Multiply by: Interest rate 10% Total 7,700 Multiply by: wn Interest on weighted average capital oal7 *Total months during the period (March 1 to December 31) Alternative solution #2: No. of months the Amounts reining of Running balance is transact- balance outstanding fions srtl the next troveaction Totals = 4 previa bala arbre March 1 - beg. . Falance 80000 80,0005 ‘ain july 31 withdrawal (30,000) 50,000 2" 100,000 Sept. 30 investment 40,000 90,000 3 Dec.31 investment 10,000 1000000 Total Divide by: No. of months in the period Total Multiply by: Interest rate Multiply by: Months outstanding 1on2 Interest on weighted average capital 6417 from March 1 to uly 31 5 months) "(Gor uly 31 to Sept.30 2 months)Ilustration 3.4: Interest on capital ~ With limit A and B formed a partnership. The partnership. agen, stipulates the following: + A.and B shall maintain average investments of 100,099 150,000, respectively. Interest on the excess or deficien capital contribution isto be computed at 10% per anmum * After intrest allowances, the partners share profits and j (0n a 60:40 ratio. During the frst six months of operations, the partnership ‘oss amounting to 60,000. The average Requirement: Com ;Pute for the respective shares of the q ei Partners Exees (deficiency) Multiply by: Interest Tate by:Partnership Operations v tllustration 4.1: Partner's capital account ‘A and B formed a partnership and began operations on March 1, 20x1. A invested P100,000 cash while B invested equipment with a ‘book value of P300,000 and a fair value of 180,000. On August 31, 20x1, A invested additional cash of 20,000. The partnership agreement stipulates the following: ‘« Monthly salary allowances of P2,000 and P10,000 to A and B, respectively, recognized as expenses. «20% bonus on profit before salaries and interest but after bonus to B. «12% annual interest on the beginning capital of A. «Balance equally. The monthly salaries are withdrawn by the partners at each month-end. The partnership eared profit of 210,000 during the period before deductions of bonus and interest. Requirement: Compute the ending balances of the capital accounts of the partners. Solution: ‘The amount of profit given in the problem is already net of the monthly salaries which were recognized as expenses. Thus, the gross amount of profit subject to allocation needs to be computed first. Profit (after deduction of monthly salaries) 210,000 Add back: Monthly salaries (2K x 10 mos.) + (10K x 10mos.) 120,000 Profit before salaries (Amount to be allocated) 330,000, ‘The interest on capital and bonus are not yet deducted from the profit figure given in the problem. Unlike for monthly salaries which are withdrawn periodically (ie, monthly basis), interests and bonuses are normally computed only at year-end.oe ‘Thus, we cannot validly assume that these items were alr recognized during the period. re salaries, interest and bonus is allocated as follows, 20,000 100,000 120, 2. Bonus+ 55,000 85; 3. Interest (100K x 12% x 10/12) 10,000 : 4. Allocation of remaining profit (G30K - 120K - 55K - 10K) +2 72,500 _72,500 *The “bonus after bonus” is computed as follows: P Bo = p -P__ ? 330,000 B= 3304 -— o 1+ 20% B= 330,000 - 275,000 B= 55.000 The ending balances of the partners’ resp ective i eeccpiin eae e capital acco Additional investment yeertership Operations » Requirement: How much profit did the partnership eam during the year? Solution: A, Capital - beg. Withdrawals 60,000 | 40,000 Additional investment 30,000 __ 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 ‘The partnership agreement of partners A, B and C stipulates the following: ‘© A shall receive a salary of P20,000. ‘© Interest of 10% shall be computed on the partners’ capital ‘contributions of P20,000, ?50,000 and P 100,000. '* Balance is divided among the partners on a 235 ratio. However, the minimum amounts that B and C shall receive if the partnership earns profit are 10,000 and 20,000, respectively, inclusive of interest and share in remaining profit. Requirement: How much is the level of profit necessary so that A shall receive a total of P25,000, inclusive of salaries, interest and share in remaining profit, and all of the other partners shall receive their minimum allocable amounts? Solution: First step: Allocate the fixed amounts of salaries and interests to the partners."20,000 ae 2090 5,000 10,000 17, “CO1ON) = 2K; (SOx1O%) = SK; (100X10%) = 10K Second step: Reconstruct the profit sharing column of partner A his needed share of P25,000. A20%) Salaries 20,000 Interest 2,000 Allocation of balance 3,000 _ (squeeze) ‘As allocated 25,000 The total amount of remaining profit for allocation to the partney is computed as follows: Allocation to A (from above) 3,000 Divide by: A's P/I, ratio 20% Total amount for allacation 15,000 step: Adjust the shares of ised shares in profit of 10,000 an Salaries Interest Allocation of ba lan Additionay 7Partnership Operations 51 Partners Oper ‘Answer From the table above, the partnership needs to earn profit cof P55,000 so that A shall receive a total share of 25,000 while partners B and C shall also receive their minimum shares of £10,000 and P20,000, respectively. lustration 5: P/L ratio in fractions ‘The ABC Co., on which A, B and Care partners, reported profit of 90,000 during the year Case #1: If partners A, B and C have a profit sharing agreement of 1/6, 2/6 and 3/6, respectively, how much are their respective shares in the profit? Solution: Partners A (90,000 x 1/6) B (90,000 x 2/6) 30,000 c (90,000 x 3/6) 45,000 Total 90,000 Case #2: If partners A, B and C have a profit sharing agreement of 2: respectively, how much are their respective shares in the profit? Solution: Partners Allocation of profit A (90,000 x 2/9*) 20,000 B (90,000 x 3/9) 30,000 (90,000 x 4/9) 40,000 Total 90,000 *9-24004)