PARTNERSHIP OPERATIONS

Accounting Cycle of a Partnership – same as in sole proprietorship

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

Special Concerns
I. Journal entries – same as in sole proprietorship except for the following transactions which are peculiar to
a partnership:
a. Partners’ loans – partner lends money to partnership
Cash xxx
Accounts/Loans/ xxx
Notes Payable or Due
to Partner or Loan from
Partner

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

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

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

a. Statement of Financial Position– the owner’s equity section is labeled Partners’ Equity
b. Income Statement – an additional section called Division of Profit and Loss is included. This
profit distribution provides a full analysis of the distribution of earnings which is presented at
the bottom of the partnership income statement.

c. Statement of Changes in Partners’ Equity – a statement that reports the changes that have
taken place in partners’ equity during the period. Each partner is provided a column heading
which explains details of the changes in their equity account.

III. Closing entries – drawing accounts are not automatically closed to the capital accounts; drawing accounts
are closed to the capital accounts only if agreed upon in the articles of co-partnership.
Closing the books at the end of the accounting period:

1. Merchandise Inventory xx
Income Summary xx
To set up ending inventory

2. All Nominal Accounts with Credit Balancesxx

Income Summary xx
To close all nominal accounts with credit balances to income summary.

3. Income Summary xx
All Nominal Accounts with Debit Balances xx
To close all nominal accounts with debit balances to income summary.

NET Income
4. Income Summary xx
Partners’ Drawing xx
To distribute profits to partners

NET Loss
4. Partners’ Drawing xx
Income Summary xx
To distribute losses to partners

INCREASES/DECREASES IN CAPITAL &

DRAWING ACCOUNTS

CAPITAL DRAWING
Decrease Increase Increase Decrease
Permanent Initial investment Temporary Share in Net Income
withdrawal0 withdrawal
Sale of equity Additional Share in Net Loss
Investment
Payment of
partnership liability
from personal funds
Debit balance in Credit balance in
drawing drawing

Rules for Dividing Profit and Loss

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

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

2. As to Industrial Partner
a. Division of Profit
1. In accordance with agreement.
2. In the absence of an agreement, the industrial partner shall receive a just and equitable
share of the profits.

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

Net income is viewed as a return for

1. services rendered (salaries)

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

Methods of Dividing Net Income

1. Equally

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

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

4. Allowing Salaries, Interest and Bonus – considered as part of the distribution of net income
a. Salaries – to give recognition to the ability, experience or time devoted by a partner to the
business.
b. Interest - to give recognition to differences in the capital contribution given in proportion to the
period such capital was actually used.
c. Bonus – incentive/special compensation given to a partner for superior income realized. It is
usually based on net income.
General Guidelines
1. Partner salary allowances, interest allowances on capital account balances and bonus are not expenses
in the determination of partnership net income.
2. The provision on salaries and interest must be enforced regardless of whether operating results is a
profit or loss.
3. The provision on bonus is enforced only when operating results is a profit.
4. If the partnership agreement specifies that income is to be divided based on partners’ capital balances
but fails to specify how capital balances are to be computed, the average capital balances should be
used if it can be computed. If not, the original capital balances should be used.

Capital and Drawing Accounts of a Partner

Partner, Capital
Debit Credit
Permanent Withdrawals Initial Investment
Additional Investments

Partner, Drawing
Debit Credit
Net Loss Net Income
Temporary Withdrawals

Pro-forma Entries

To distribute Income Summary xxx

net income A, Drawing xxx
B, Drawing xxx

To distribute A, Drawing xxx

net loss B, Drawing xxx
Income Summary xxx
EXAMPLE

JOHN CAPITAL MARTHA CAPITAL

5/1 10,000 1/1 400,000 7/1 50,000 1/1 300,000
10/31 50,000 7/1 160,000 4/1 200,000
9/30 150,000
NET INCOME FOR THE PERIOD –P 150,000

DIVISION OF PROFITS & LOSSES

1. equally
Income Summary 150,000
John, Drawing 75,000
Martha, Drawing 75,000
To distribute profits to partners

2. arbitrary ratio
a. percentage 40%:60%
b. fraction 2/5:3/5

Income Summary 150,000

John, Drawing 60,000
Martha, Drawing 90,000
To distribute profits to partners

3. Capital RATIO

a. Beginning Capital Ratio : 400:300 or 4/7:3/7

Income Summary 150,000

John, Drawing 85,714.29
Martha, Drawing 64,285.71
To distribute profits to partners

b. Ending Capital Ratio 500: 600 or 5/11:6/11

Income Summary 150,000

John, Drawing 68,181.82
Martha, Drawing 81,818.18
To distribute profits to partners

c. Average Capital Ratio

Income Summary 150,000

John, Drawing 75,202.16
Martha, Drawing 74,797.84
 To distribute profits to partners

Computation of Average Capital

Date Capital Peso Months No. of Months Unchanged Average Capital
Balance
John
‘Jan 1 400,000 4 P1,600,000
‘May 1 390,000 2 780,000
‘July1 550,000 4 2,200,000
Oct 31 500,000 2 1,000,000
Martha P5,580,000/12 P465,000
‘Jan 1 300,000 3 P900,000
April 1 500,000 3 1,500,000
‘July1 450,000 3 1,350,000
Sept 30 600,000 3 1,800,000
P5,550,000/12 462,500

Computation Share in Net Income of P150,000

Average Capital:
John P465,000 150,000 x 465000/927,500= P 75,202.16
Martha 462,500 150,000x 462,500/927,500 = P 74,797.84
P927,500
=======

4. Allowing interest on partners’ capital balances

10% interest on beginning capital, balance equally

Schedule of Distribution of Profits

John Martha Total
10% Interest on beginning Capital
John (400,000 x 10%) P40,000
Martha (300,000 x 10%) P30,000 P70,000
Balance equally(150,000-70,000) 40,000 40,000 80,000
Share in Net Income P80,000 P70,000 P150,000

Income Summary 150,000

John, Drawing 80,000
Martha, Drawing 70,000
To distribute profits to partners

5.Allowing salaries to partners

Salary allowance of P50,000 to John and P40,000 to Martha, balance in the ratio of 2:3
 Schedule of Distribution of Profits
John Martha Total
Salary allowance P50,000 P40,000 P90,000
Balance 2:3 24,000 36,000 60,000
Share in Net Income P74,000 P76,000 P150,000

Income Summary 150,000

John, Drawing 74,000
Martha, Drawing 76,000
To distribute profits to partners

6.Bonus to managing partner based on net income

20% Bonus to John, the managing partner, balance equally

Schedule of Distribution of Profits

John Martha Total
20% Bonus to John P30,000 P30,000
Balance equally 60,000 60,000 120,000
Share in Net Income P90,000 P60,000 P150,000

Income Summary 150,000

John, Drawing 90,000
Martha, Drawing 60,000
To distribute profits to partners

7. Allowing interest on partners’ capital balances, salaries and bonus, balance equally.

-5% interest on ending capital,

-salary allowance to John, P30,000; Martha, P40,000
-10% bonus to John
-balance equally

Schedule of Distribution of Profits

John Martha Total
10% interest on ending capital
John- 500,000 x5% P25,000
Martha- 600,000 x 5% P30,000 P55,000
Salary allowance 30,000 40,000 70,000
10% Bonus to John 15,000 15,000
Balance equally 5,000 5,000 10,000
Share in Net Income P75,000 P75,000 P150,000

Income Summary 150,000

John, Drawing 75,000
Martha, Drawing 75,000
To distribute profits to partners
8. Allowing interest on partners’ capital balances, salaries and bonus, balance equally.(NET INCOME IS
INSUFFICIENT)
-10% interest on ending capital,
-salary allowance to John, P50,000; Martha, P60,000
-20% bonus to John
-balance equally

Schedule of Distribution of Profits

John Martha Total
10% interest on ending capital
John- 500,000 x10% P50,000
Martha- 600,000 x 10% P60,000 P110,000
Salary allowance 50,000 60,000 110,000
20% Bonus to John 30,000 30,000
Excess equally (50,000) (50,000) (100,000)
Share in Net Income P80,000 P70,000 P150,000

Income Summary 150,000

John, Drawing 80,000
Martha, Drawing 70,000
To distribute profits to partners

NET LOSS- P150,000

9. Allowing interest on partners’ capital balances, salaries and bonus, balance 4:6

-10% interest on ending capital,

-salary allowance to John, P50,000; Martha, P60,000
-20% bonus to John
-balance 4:6

Schedule of Distribution of Net Loss

John Martha Total
10% interest on ending capital
John- 500,000 x10% P50,000
Martha- 600,000 x 10% P60,000 P110,000
Salary allowance 50,000 60,000 110,000
Balance 4:6 (148,000) (222,000) (370,000)
Share in Net Income (P48,000) (P102,000) (P150,000)
 No bonus since Bonus is always based on net income.

John, Drawing 48,000

Martha, Drawing 102,000
Income Summary 150,000
To distribute losses to partners
PREPARATION OF INCOME STATEMENT & STATEMENT OF PARTNERS’ EQUITY
The following selected ledger balances were taken from the books of NMA Company
Depreciation Expense-Office Equipment 3,830
Discount Lost 250
Doubtful Accounts Expense 2,340
Freight in 1,250
Freight out 680
Gain on Sale of Office Equipment 351
Interest Expense 4,850
Interest Income 1,420
Marlon, Drawing 5,500
Marlon, Capital 120,000
Miranda, Drawing 10,500
Miranda, Capital 100,000
Merchandise Inventory, January 1 188,500
Merchandise Inventory, December 31 77,777
Office Supplies used 520
Purchases 366,200
Purchase Discount 3,653
Purchase Returns and Allowances 18,265
Rent Expense 30,000
Salaries & Wages 54,200
Sales 642,775
Sales Commission 18,935
Sales Discount 10,580
Sales Returns & Allowances 4,560
 NMA Company
Income Statement
For the Year Ended, December 31, 2015

Note
Net Sales 1 P627,635
Cost of Sales 2 (456,225)
Gross Profit P171,410
Other Income 3 1,771
Total Income P173,181
Operating expenses
Administrative expense 4 P90,890
Distribution costs 5 19,615
Finance cost 7 5,100 (114.625)
NET INCOME P57,576
======

Schedule of Distribution of Profits

Marlon Miranda Total
10% interest on beginning capital
Marlon- 120,000 x10% P12,000
Miranda- 100,000 x 10% P10,000 P22,000
Balance equally 17,788 17,788 35,576
Share in Net Income P29,788 P27,788 P57,576
====== ====== ======

NOTES TO FINANCIAL STATEMENTS

Note 1 Net Sales

Sales P 642,775

Sales Discount P 10,580

Sales Returns & Allowances 4,560 15,140

Net Sales Revenue P 627,635

Note 2 Cost of Sales

Merchandise Inventory, January 1 P 188,500

Add: Net cost of purchases

Purchases P 366,200

Purchase Discounts P 3,653

Purchase Returns and Allowances 18,265 21,918

Net purchases P 344,282

Add: Freight in 1,250 345,532

Total goods available for sale P 534,032

Merchandise Inventory, December 31 77,777

Cost of Sales P 456,255

Note 3 Other Income

Gain on Sale of Office Equipment P 351

Interest Income 1,420

Total P 1,771

Note 4 Administrative Expenses

Salaries & Wages P 54,200
Rent Expense 30,000
Depreciation Expense-Office Equipment 3,830
Doubtful Accounts Expense 2,340
Office Supplies used 520
Total P 90,890

Note 5 Distribution Costs

Sales Commission P 18,935
Freight out 680
Total P 19,615

Note 7 Finance cost

Interest expense P 4,850
Discount lost P 250
Total P 5,100
 NMA Company
Statement of Changes in Partners’ Equity
For the Year Ended, December 31, 2015

Marlon Miranda Total

Capital balances, January 1 P120,000 P100,000 P220,000
Net Income 29,788 27,788 57,576
Sub-total P149,788 P127,788 P277,576
Partners’ Drawing (5,500) (10,500) (16,000)
Capital balances, December 31 P144,288 P117,288 P261,576
======== ======== ========

Classroom Exercises – Partnership Operations

1. Assume ABC Partnership earned a net income of P120,000 for the year. Three partners Ana, Bea and
Carmi will share in the net income. Their capital accounts are as follows:
Ana, Capital
9/1 30,000 1/1 50,000
6/1 10,000

Bea, Capital
3/1 20,000 1/1 70,000

Carmi, Capital
1/1 30,000
4/1 10,000

Prepare the entry to distribute net income among the three partners assuming:
a. Net income is divided equally.
b. Net income is divided as follows: Ana – ½; Bea – ¼; Carmi – ¼.
c. Net income is divided as follows: Ana – 50%; Bea – 30%; Carmi – 20%.
d. Net income is divided as follows: 3:2:1
e. Net income is divided based on original/initial capital contribution which were as follows: Ana
– P20,000; Bea – P30,000; Carmi – P10,000.
 f. Net income is divided based on beginning capital balances.
g. Net income is divided based on ending capital balances.
h. Net income is divided based on average capital.

2. Assume the same given information in No. 1. Prepare the entry to divide net income if net income is
to be divided as follows:
a. Interest of 10% on beginning capital balances.
b. Annual salaries of P5,000 to Ana and P4,000 to Bea.
c. Bonus to Carmi amounting to P16,000.
d. Remainder to be divided – 50:30:20.

3. Using the same given information in No. 2, prepare the entry to divide net income if net income is
P35,000 only.

4. Using the same given information in No. 2, prepare the entry to close income summary if the
partnership incurred a net loss of P60,000 for the year.

2016