Partnership and Corporation Accounting

by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Chapter 3
Partnership Operations

Learning Objectives:

After studying this chapter, you should be able to:

1. Contrast a partner’s equity in assets from share in profits or losses.

2. Summarize the rules for the distribution of profits or losses.
3. Explain prior period errors and interpret the effects on partners’ shares in profits or losses.
4. Identify, describe and account for the different methods of dividing partnership profits or losses
based on agreement.
5. Ascertain the effects of using original, beginning, ending and average capitals on the partners’
share in profits or losses.
6. Show the treatment of interest on capital, partners’ salaries and bonus in the distribution of profits
or losses.
7. Propose equitable profits or losses sharing schemes after considering the partners’ contributions
and other performance criteria.

Partner’s Equity in Assets Contrasted with Share in Profits or Losses

The basis on which profits or losses are shared is a matter of agreement among the partners and
may not necessarily be the same as their capital contribution ratio. The equity of a partner in the net assets
of the partnership should be distinguished from a partner’s share in profits or losses.
Illustration. “Nelson Daganta is a one-third partner” is an ambiguous statement. Daganta may have one-
third equity in the net assets of the partnership but might have a larger or smaller share in the profit or loss
of the firm. Such a statement may also be interpreted to mean that Daganta is entitled to one-third of the
profit or loss, although his capital account may represent much more or much less than one-third of total
partners' capital. Simply put, partners may agree on any type of profit and loss ratio regardless of the
amount of their respective capital account balances.

Factors to Consider in Arriving at a Plan for Dividing Profits or Losses

 Money, Property or Industry
Partnership profits are realized as a result of putting together the contributions money, property or
industry-of the partners. The amount of capital invested by each partner, the amount of time each partner
devotes to the business and other contributions are the factors being considered in the formulation of an
equitable profit and loss ratio.

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

There are profit-sharing plans which emphasize either the value of personal services rendered by
individual partners or the amounts of capital invested by each partner. Some agreements consider the
importance of both the amount and quality of managerial services rendered, and the amount of capital
invested by the partners for the success or failure of a partnership. In this case, allowances may be provided
for salaries to partners and interest on their respective capital balances as a preliminary step in the division
of profits or losses; the balance may then be divided in a specified ratio. Among the other factors which
may be considered are as follows:
1. A partner has considerable personal financial resources, thus giving the partnership strong credit
rating. In general, partners have unlimited liability. A very solvent partner will make the
partnership attractive to creditors.
2. A partner who is well known in a profession or an industry may contribute immensely to the
success of the partnership although he may not participate actively in the operations of the
partnership.
These two factors may be incorporated in the plan to arrive at a ratio by which any remaining
profits or losses are to be divided.
Illustration. Daria Tolentino and Eleanor Tan are partners in a coco water business. Partner Daria
Tolentino contributed most of the assets of the business but spends little time for its daily operations. On
one hand, Partner Eleanor Tan contributed less in assets but devotes her full knowledge and attention to
the partnership. To divide profits or losses based on capital contributions alone will result to iniquities.
The profit and loss sharing agreement should have considered the provision of salaries or even bonus in
recognition of the talent and time being contributed by Partner Eleanor Tan.

 Performance Methods
Many partnerships use profit and loss sharing arrangements that give some weight to the specific
performance of each partner to provide incentives to perform well. This allocation of profits to a partner
on the basis of performance is frequently referred to as a bonus. Examples of the use of performance
criteria are:
1. Chargeable hours. These are the total number of hours that a partner incurred on client related
assignments. Weight may be given to hours in excess of a standard.
2. Total billings. The total amount billed to clients for work performed and supervised by partner
constitutes total billings. Weight may be given to billings in excess of norm.
3. Write-offs. Consist of uncollectible billings. Weight may be given to a write-off percentage below
a norm.
4. Promotional and civic activities. Time devoted to developing future business and enhancing the
partnership name in the community is considered promotional and civic activity. Weight may be
given to time spent in excess of a norm or to specific accomplishments resulting in new clients.
5. Profits in excess of specified levels. Designated partners commonly receive a certain percentage
of profits in excess of a specified level of earnings.

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Rules for the Distribution of Profits or Losses

The profits or losses shall be distributed in conformity with the agreement. If only the share of each
partner in the profits has been agreed upon, the share of each in the losses shall be in the same proportion.

In the absence of stipulation, the share of each partner in profits or losses shall be in proportion to
what he may have contributed (according to the ratio of original capital investments or in its absence, the
ratio of capital balances at the beginning of the year), but the industrial partner may 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 aside from his services he has contributed capital, he shall also receive a share in the
profits in proportion to his capital (Civil Code of the Philippines, Article 1797). A stipulation which
excludes one or more partners from any share in the profits or losses is void (Article 1799). The partnership
must exist for the common benefit or interest of the partners. A summary of the above legal provisions is
prepared as follows:

 Profits
a. The profits will be divided according to partners’ agreement;
b. if there is no agreement:
 as to capitalist partners, the profits shall be divided according to their capital contributions
(according to the ratio of original capital investments or in its absence, the ratio of capital
balances at the beginning of the year).
 as to industrial partners (if any), such share as may be just and equitable under the
circumstances, provided, that the industrial partner shall receive such share before the capitalist
partners shall divide the profits.

 Losses
a. The losses will be divided according to partners’ agreement;
b. if there is no agreement as to distribution of losses but there is an agreement as to profits, the losses
shall be distributed according to the profit sharing ratio;
c. in the absence of any agreement:
 as to capitalist partners, the losses shall be divided according to their capital contributions
(according to the ratio of original capital investments or in its absence, the ratio of capital
balances at the beginning of the year).
 as to purely industrial partners (if there’s any), shall not be liable for any

The industrial partner is not liable for losses because he cannot withdraw the work or labor already
done by him, unlike the capitalist partners who can withdraw their capital. In addition, if the partnership
failed to realize any profits, then he has labored in vain and in a real sense, he has already contributed his
share in the loss.

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Correction of Prior Period Errors

Any business entity will from time to time discover errors made in the measurement of profit in
prior accounting periods. Good internal control and the exercise of due care should serve to minimize the
number of financial reporting errors that occur; however, these safeguards cannot be expected to
completely eliminate errors in the financial statements.

Per International Accounting Standards (IAS) No. 8, Accounting Policies, Changes in Accounting
Estimates and Errors, prior period errors are omissions from and other misstatements of the entity’s
financial statements for one or more prior periods that are discovered in the current period. Errors may
occur as a result of mathematical mistakes, mistakes in applying accounting policies, misinterpretation of
facts, fraud or oversights. Examples include errors in the estimation of depreciation, errors in inventory
valuation. And omission of accruals of revenue and expenses.

Material prior periods must be restated to report financial position and results of operations as they
would have been presented had the error never taken place. The amount of the correction of a prior period
error that relates to prior periods should be reported by adjusting the opening balances of partners’ equity
and affected assets and liabilities. The correction of a prior period error is excluded from profit or loss for
the period in which the error is discovered.

If an error resulted in an understatement of profit in previous periods, a correcting entry would be

needed to increase Capital. If an error overstated profit in prior periods, then Capital would have to be
decreased. The effect of the error correction will be divided based on the applicable profit and loss ratio.

Distribution of Profits or Losses Based on Partners’ Agreement

In general, profits or losses shall be divided in accordance with the agreement of the partners. The
ratio in which profits or losses from partnership operations are distributed is recognized as the profit and
loss ratio.

The partners may agree on any of the following scheme in distributing profits or losses:
1. Equally or in other agreed ratio
2. Based on partners’ capital contributions:
a. ratio of original capital investments
b. ratio of capital balances at the beginning of the year
c. ratio of capital balances at the end of the year
d. ratio of average capital balances
3. By allowing interest on partners’ capital and the balance in an agreed ratio
4. By allowing salaries to partners and the balance in an agreed ratio
5. By allowing bonus to the managing partner based on profit and the balance in an agreed ratio
6. By allowing salaries, interest on partners’ capital, bonus to the managing partner and the balance
in an agreed ratio (combination of 3 to 5)

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Note that the partners can agree on not using a residual sharing ratio (“the balance in an agreed
ratio”) if profits do not exceed the total salary and interest allowances. In such a case, the partners must
agree on the priority of the various profit or loss distribution schemes.

Illustration. The following series of illustrations are based on the figures obtained from the Medina and
Detoya Partnership which had a profit of P300,000 for the year ended Dec. 31, 2015, the first year of
operations. The partnership contract provided that each partner may withdraw P5,000 on the last day of
each month; both partners did so during the year. The drawings are recorded by debits to the partners’
drawing accounts and shall not be considered in the division of profit or loss. It is the intention of the
partners that each partner’s share in the profit or loss be either credited or debited to the drawing account.

Leopoldo Medina invested P400,000 on Jan. 1, 2015 and an additional P100,000 on April 1. Edgar
Detoya invested P800,000 on Jan. 1 and withdrew P50,000 on July 1. These transactions and events are
summarized in the following capital, drawing and income summary ledger accounts:

Account: Leopoldo Medina, Capital Account No.

Date Explanation J.R. Debit Credit Balance
2015
1
January
1 P 400,000 P 400,000 1

2 April 1 100,000 500,000 2

Account: Edgar Detoya, Capital Account No.

Date Explanation J.R. Debit Credit Balance
2015
1
January
1 P 800,000 P 800,000 1

2 July 1 P 50,000 750,000 2

Account: Leopoldo Medina, Drawing Account No.

Date Explanation J.R. Debit Credit Balance
2015
1
Jan - Dec
1 P 60,000 P 60,000 1

Account: Edgar Detoya, Drawing Account No.

Date Explanation J.R. Debit Credit Balance
2015
1
Jan - Dec
1 P 60,000 P 60,000 1

Account: Income Summary Account No.

Date Explanation J.R. Debit Credit Balance
2015
1
December
31 P 300,000 P 300,000 1

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

 Equally or in other Agreed Ratio

Partnership contracts may provide that profit or loss be divided equally. The profit of P300,000
for the Medina and Detoya Partnership is transferred by a closing entry on Dec. 31, 2015, from the income
summary ledger account to the partners’ drawing accounts:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1

2 Leopoldo Medina, Drawing P 150,000 2

3 Edgar Detoya, Drawing 150,000 3

4 To record the division of profits. 4

If the partnership had a loss of P200,000 for the year ended Dec. 31, 2015, the income summary
ledger account would have a debit balance of P200,000. This loss would be transferred to the partners’
drawing accounts by a debit to each drawing account for P100,000 and a credit to the income summary
account for P200,000.

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Leopoldo Medina, Drawing P 100,000 1

2 Edgar Detoya, Drawing 100,000 2

3 Income Summary P 200,000 3

4 To record the division of losses. 4

Assume instead that Medina and Detoya share profits and losses in a ratio of 60:40 and profit was
P300,000, the profit would be divided as follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1

2 Leopoldo Medina, Drawing P 180,000 2

3 Edgar Detoya, Drawing 120,000 3

4 To record the division of profits. 4

Computation:
Medina: 60% x P300,000 = P 180,000
Detoya: 40% x P300,000 = 120,000
P 300,000

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

 Based on Partners’ Capital Contributions

Division of partnership profits in proportion to the capital invested by each partner is most likely
to be found in partnerships in which substantial investments is the principal ingredient for success. It is
essential that the partnership contract be specific with respect to the concept of capital. Capital may refer
to either of the following:

Ratio of Original Capital Investments. Assume that the partnership agreement provides for the
division of profits in the ratio of original capital investments. The original investments of Medina and
Detoya are P400,000 and P800,000, respectively. The profit of P300,000 for 2015 is divided as follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1

2 Leopoldo Medina, Drawing P 100,000 2

3 Edgar Detoya, Drawing 200,000 3

4 To record the division of profits. 4

Computation:
Medina: P300,000 x P400,000 / P1,200,000 = P 100,000
Detoya: P300,000 x P800,000 / P1,200,000 = 200,000
P 300,000

After the entry allocating the profits of P300,000 to Medina and Detoya, are the partners supposed
to receive cash for their respective share in the profits? No, the partners’ share in the profits cannot be
attributed to any particular asset, including cash. The entry increased the equity of Medina and Detoya in
all the assets of the partnership.

Ratio of Capital Balances at the Beginning of the Year. Assume that the partnership agreement
provided for the division of profits in the ratio of capital balances at the beginning of the year. In this case,
the original capital investments are also the capital balances at the beginning of the year since the
partnership is only on its first year of operations. The profit of P300,000 for 2015 is divided as follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1

2 Leopoldo Medina, Drawing P 100,000 2

3 Edgar Detoya, Drawing 200,000 3

4 To record the division of profits. 4

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Ratio of Capital Balances at the End of the Year. Assume that the profit is divided in the ratio
of capital balances at the end of the year before drawings and the distribution of profit. The ending balances
are P500,000 for Medina and P750,000 for Detoya; the profit of P300,000 for 2015 is divided as follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1

2 Leopoldo Medina, Drawing P 120,000 2

3 Edgar Detoya, Drawing 180,000 3

4 To record the division of profits. 4

Computation:
Medina: P300,000 x P500,000 / P1,250,000 = P 120,000
Detoya: P300,000 x P750,000 / P1,250,000 = 180,000
P 300,000

Ratio of Average Capital Balances. Division of profits or losses on the basis of the three
preceding capital concepts-original capital investments; capital balances at the beginning of the year; or
capital balances at the end of the year-may prove inequitable if there are material changes in the capital
accounts during the year.

When beginning capital balances are used in allocating profits, additional investments during the
year are discouraged because the partners making such investments are not compensated in the division
of profits until the next year.

If ending capital balances are used, year-end investments are encouraged, but there is no incentive
for a partner to make any investments before year-end. In addition, amounts earlier withdrawn may be
reinvested before year-end. These considerations suggest that using average balances as a basis for
distributing profits or losses is preferable because it reflects the capital actually available for use by the
partnership during the year.

The agreement should also state the amount of drawings each partner may make. These drawings
are considered temporary and are recorded as debits to the partner’s drawing account. Drawings within
the allowable amount will not affect the computation of the average capital balance. On the contrary,
drawings in excess of the allowable amount are considered permanent reductions in capital; hence, the
computation of the average capital balance is affected.

In the continuing illustration for the Medina and Detoya Partnership, the partners are entitled to
withdraw P5,000 monthly or a total of P60,000 per annum. Any additional withdrawals are directly debited
to the partners’ capital accounts and therefore will affect the computation of the average capital ratio.

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Medina and Detoya Company

Computation of the Average Capital Balances
For the Year Ended December 31, 2015

Leopoldo Medina, Capital

Capital Account Portion* of the Average Capital
Date
Balances Year Unchanged Balances
January 1 P 400,000 x 3 / 12 = P 100,000
April 1 500,000 x 9 / 12 = 375,000
Average Capital P 475,000

Edgar Detoya, Capital

January 1 P 800,000 x 6 / 12 = P 400,000

July 1 750,000 x 6 / 12 = 375,000
Average Capital P 775,000

Total Average Capital Balance P 1,250,000

Note to computation: *The fraction for each partner should add up to 12/12 or 1. This conversion
will help minimize the counting errors as to the number of months the capital balance went unchanged.
To state the obvious, there are only 12 months in a year. For example, for Partner Medina, the fraction
will total to 12/12 (3/12 + 9/12 = 12/12) or 1.

The entry to record the division of P300,000 profits is as follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1

2 Leopoldo Medina, Drawing P 114,000 2

3 Edgar Detoya, Drawing 186,000 3

4 To record the division of profits. 4

Computation:
Medina: P300,000 x P475,000 / P1,250,000 = P 114,000
Detoya: P300,000 x P775,000 / P1,250,000 = 186,000
P 300,000

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

By Allowing Interest on Capital and the Balance in an Agreed Ratio

In the preceding section, the plan for dividing the total profits in the ratio of partners' capital
balances was based on the assumption that capital investments were the controlling factor in the success
of the partnership. However, it is not always the case. Consequently, partnerships may choose to allocate
a portion of the total profits in the capital ratio and the balance equally or in other agreed ratio after due
consideration of the partners' other contributions.

To allow interest on partners’ capital account balances is almost similar to dividing part of profits
in the ratio of partners’ capital balances. If the partners agree to allow interest on capital as a first step in
the division of profit, they should specify the interest rate to be used. It should also state whether interest
is to be computed on capital balances on specific dates or on average capital balances during the year.

Partners invested in a partnership for profits, not for interest. The interest on partners’ capital,
along with the other profit sharing plans to be discussed in the remainder of the chapter, are to be
considered as mere techniques to share partnership profits or losses equitably and not as expenses of the
partnership. On the other hand, the interest on loans from partners is recognized as expense and a factor
in the measurement of profit or loss of the partnership. Similarly, interest earned on loans to partners is
recognized as partnership income. This treatment is consistent with the discussion in Chapter 1 that loans
receivable from or payable to partners are assets and liabilities, respectively, of the partnership.

Continuing the illustration of Medina and Detoya Partnership with a profit of P300,000 for 2015
and capital balances as already shown, assume that the partnership agreement allowed 15% interest on
average capital account balances, with the balance to be divided equally. The profit of P300,000 for 2015
is divided as follows:

Medina Detoya Total

15% Interest on Average Capital:
Medina: P475,000 x 15% P 71,250
Detoya: P775,000 x 15% P 116,250
Subtotal P 187,500
Balance to be Divided Equally
(P300,000 – P187,500 = P112,500):
Medina: P112,500 x 50% 56,250
Detoya: P112,500 x 50% 56,250 112,500
Share of Partners in Profits P 127,500 P 172,500 P 300,000

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

The journal entry to close the income summary ledger account on December 31, 2015 follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1
2 Leopoldo Medina, Drawing P 127,500 2
3 Edgar Detoya, Drawing 172,500 3
4 To record the division of profits. 4

In a related case, assume that the Medina and Detoya Partnership had a loss of P10,000 for the
year ended Dec. 31, 2015. If the partnership agreement provided for interest on capital accounts, this
provision must be honored regardless of whether operations yielded profits or not.

The loss will be shared by the partners in the same manner as the P300,000 profit. The total interest
allowance of P187,500 would still be given to the partners. The only difference is that the division of
profits or losses after the interest allowances would involve a larger negative amount of P197,500 which
will be divided equally between Medina and Detoya:

Medina Detoya Total

15% Interest on Average Capital:
Medina: P475,000 x 15% P 71,250
Detoya: P775,000 x 15% P 116,250
Subtotal P 187,500
Balance to be Divided Equally
((P10,000) – P187,500 = (P197,500)):
Medina: (P197,500) x 50% (98,750)
Detoya: (P197,500) x 50% (98,750) (197,500)
Share of Partners in Profits P (27,500) P 17,500 P (10,000)

The journal entry to close the income summary ledger account on December 31, 2015 follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Leopoldo Medina, Drawing P 27,500 1
2 Income Summary P 10,000 2
3 Edgar Detoya, Drawing 17,500 3
4 To record the division of losses. 4

After initial consideration, the idea that a loss of P10,000 should cause one partner’s capital to
increase and the other partner’s capital to decrease may appear unreasonable. However, this result was
planned and was with good reason. Partner Detoya invested more capital than Partner Medina; this capital
was used to carry out operations, and the partnership’s incurrence of a loss in the first year is no reason to
disregard Detoya’s larger capital investment.

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Comparison of distribution based solely on capital ratios as against distribution with interest
on capital balances. There will be a significant difference between the two distribution plans if the
partnership is operating at a loss. Under the capital ratio plan, the partner who invested more capital will
ultimately shoulder a bigger share of the loss. This result may be considered inequitable because the
investment of capital presumably is not the cause of the loss.
Under the interest plan, the partner who invested more capital is credited (increased) for an interest
on his capital and is ultimately debited (decreased) with a lesser share of the loss; in some cases, the result
may even be a net credit (increase).
By Allowing Salaries to Partners and the Balance in an Agreed Ratio
The sharing agreement may provide for variations in compensating the personal services
contributed by partners. Even among partners who devote equal service time, one partner’s superior
experience and knowledge may command a greater share of the profit. To acknowledge the harder working
or more valuable partner, the profit-sharing plan may provide for salary allowances.
The partnership agreement should be clear on the treatment of salary allowances when losses are
incurred. In the absence of an agreement to govern this situation, salary allowances will be provided even
when operations yielded losses. This allowance should not be confused with salaries expense or with the
partner’s drawing account which is debited for periodic salary allowances. The cash withdrawals will in
no way affect the division of profits; the division of profits is governed by the sharing agreement.
Partners are the partnership’s owners; they are not employees of the business. If partners devote
their time and services to the affairs of the partnership, they are understood to do so for profit, not for
salary. Therefore, when the partners calculate the profit of the partnership, salaries to the partners are not
deducted as expenses in the statement of recognized income and expense.
Continuing the illustration for the Medina and Detoya Partnership, assume that the partnership
agreement provided for an annual salary of P100,000 to Medina and P60,000 to Detoya, and the balance
to be divided equally. The profit of P300,000 for 2015 is divided as follows:
Medina Detoya Total
Salary Allowances P 100,000 P 60,000 P 160,000
Balance to be Divided Equally
(P300,000 – P160,000 = P140,000):
Medina: P140,000 x 50% 70,000
Detoya: P140,000 x 50% 70,000 140,000
Share of Partners in Profits P 170,000 P 130,000 P 300,000

The journal entry to close the income summary ledger account on December 31, 2015 follows:
Date Account Titles and Explanation P.R. Debit Credit
2015
1 December
31 Income Summary P 300,000 1
2 Leopoldo Medina, Drawing P 170,000 2
3 Edgar Detoya, Drawing 130,000 3
4 To record the division of profits. 4

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

By Allowing Bonus to the Managing Partner Based on Profit and the Balance in an Agreed Ratio

A partnership contract may provide for a special compensation in the form of bonus to the
managing partner when the results of operations of the partnership are favorable. This allowance is given
in order to encourage the partner to maximize the profit potentials of the partnership. Bonus is not being
considered in the computation of profit, rather it is a mere technique to distribute profits.

Assume that the Medina and Detoya Partnership agreement provided for a bonus of 25% of profit
before bonus to Partner Medina and the balance to be divided equally. The profit is P300,000.

Medina Detoya Total

Bonus (25% x P300,000) P 75,000 P 75,000
Balance to be Divided Equally
(P300,000 – P75,000 = P225,000):
Medina: P225,000 x 50% 112,500
Detoya: P225,000 x 50% 112,500 225,000
Share of Partners in Profits P 187,500 P 112,500 P 300,000

The journal entry to close the income summary ledger account on December 31, 2015 follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1
2 Leopoldo Medina, Drawing P 187,500 2
3 Edgar Detoya, Drawing 112,500 3
4 To record the division of profits. 4

Assume instead that the Medina and Detoya Partnership agreement provided for a bonus of 25%
of profit after bonus to Partner Medina and the balance to be divided equally. It is understood in the
wording of the agreement that the 25% bonus will be based on the difference after deducting bonus from
a certain amount. This certain amount is the profit after considering all the operating expenses but before
this bonus.

Here, the P300,000 Profit still includes the bonus. The difference between this profit and bonus
shall be the basis for the 25% bonus rate. Hence, profit after bonus represents 100% while the profit of
P300,000 before bonus represents 125%.

Profit before bonus P 300,000 125%

Profit after bonus (P300,000 / 125%) 240,000 100%
Bonus (P240, 000 x 25%) P 60,000 25%

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Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Medina Detoya Total

Bonus P 60,000 P 60,000
Balance to be Divided Equally
(P300,000 – P60,000 = P240,000):
Medina: P240,000 x 50% 120,000
Detoya: P240,000 x 50% 120,000 240,000
Share of Partners in Profits P 180,000 P 120,000 P 300,000

The journal entry to close the income summary ledger account on December 31, 2015 follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 300,000 1
2 Leopoldo Medina, Drawing P 180,000 2
3 Edgar Detoya, Drawing 120,000 3
4 To record the division of profits. 4

By Allowing Salaries, Interest on Capital, Bonus to the Managing Partner and the Balance in an
Agreed Ratio

The service contributions and capital contributions of the partners are often not equal. If the service
contributions are not equal, salary allowances can compensate for the differences. Or, when capital
contributions are not equal, interest allowances can make up for the unequal investments. When both
service and capital contributions are unequal, the allocation of profits or losses may include salary
allowances, interest on their capital balances, bonus to the managing partner, and the balance to be divided
in an agreed ratio.

Note that the provisions for salaries and interest in the partnership agreement are called
allowances. These allowances are not reported in the statement of recognized income and expense as
salaries and interest expense; they are merely means of allocating profit to the partners.

Assume that the profit for the year is P400,000 and the partnership agreement for the Medina and
Detoya Partnership provided for the following:

1. Bonus to Medina of 25% of profit after salaries and interest but before bonus;
2. Annual salaries of P100,000 to Medina and P60,000 to Detoya;
3. Interest on average capital balances of P71,250 and P116,250 to Medina and Detoya, respectively;
4. Balance to be divided in a ratio of 40:60.

14 | P a g e
Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

Medina Detoya Total

Salary Allowances P 100,000 P 60,000 P 160,000
Interest on Average Capital Balances 71,250 116,250 187,500
Bonus (25% (P400,000 – P160,000 – P187,500)): 13,125 13,125
Balance to be Divided in a Ratio of 40:60
(P400,000 – P160,000 – P187,500 – P13,125 = P39,375):
Medina: P39,375 x 40% 15,750
Detoya: P39,375 x 60% 23,625 39,375
Share of Partners in Profits P 200,125 P 199,875 P 400,000

The journal entry to close the income summary ledger account on December 31, 2015 follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 400,000 1
2 Leopoldo Medina, Drawing P 200,125 2
3 Edgar Detoya, Drawing 199,875 3
4 To record the division of profits. 4

Assume instead that the bonus to Medina is 25% of profit after salaries, interest and after bonus.
The computation of the bonus follows:

Profit before Salaries, Interest and Bonus P 400,000

Less: Salaries P 160,000
Interest 187,500 347,500
Profit after Salaries and Interest but before Bonus P 52,500 125%
Profit after Salaries and Interest but after Bonus
(P52,500 / 125%) 42,000 100%
Bonus (P42,000 x 25%) P 10,500 25%

Medina Detoya Total

Salary Allowances P 100,000 P 60,000 P 160,000
Interest on Average Capital Balances 71,250 116,250 187,500
Bonus 10,500 10,500
Balance to be Divided in a Ratio of 40:60
(P400,000 – P160,000 – P187,500 – P10,500 = P42,000):
Medina: P42,000 x 40% 16,800
Detoya: P42,000 x 60% 25,200 42,000
Share of Partners in Profits P 198,550 P 201,450 P 400,000

15 | P a g e
Partnership and Corporation Accounting
by WIN Ballada, CPA, CBE, MBA and Susan Ballada, CPA

The journal entry to close the income summary ledger account on December 31, 2015 follows:

Date Account Titles and Explanation P.R. Debit Credit

2015
1 December
31 Income Summary P 400,000 1
2 Leopoldo Medina, Drawing P 198,550 2
3 Edgar Detoya, Drawing 201,450 3
4 To record the division of profits. 4

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