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PARTNERSHIP OPERATIONS Accounting Cycle of a Partnership – same as in sole proprietorship 1. 2. 3. 4. 5. 6. 7. 8.

Prepare journal entries Post to ledgers Prepare a trial balance Prepare adjusting entries Prepare financial statements Prepare closing entries Prepare a post-closing trial balance 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 Accounts/Loans/ Notes Payable or Due to Partner or Loan from Partner

xxx xxx

b. Partners’ borrowings from partnership – partnership lends money to partners Accounts/Loans/ Notes Receivable or Due from Partner or Loan to Partner Cash

xxx

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 Income Summary To set up ending inventory

xx xx

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 Partners’ Drawing To distribute profits to partners

xx xx

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

xx xx

INCREASES/DECREASES IN CAPITAL DRAWING ACCOUNTS CAPITAL Decrease Permanent withdrawal0 Sale of equity

Debit balance in drawing

Increase Initial investment Additional Investment Payment of partnership liability from personal funds Credit balance in drawing

Rules for Dividing Profit and Loss 1. As to Capitalist Partner a. Division of Profit

&

DRAWING Increase Temporary withdrawal Share in Net Loss

Decrease Share in Net Income

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 Permanent Withdrawals

Credit Initial Investment Additional Investments

Partner, Drawing Debit Net Loss Temporary Withdrawals

Credit Net Income

Pro-forma Entries To distribute net income

Income Summary A, Drawing B, Drawing

xxx

To distribute net loss

A, Drawing B, Drawing Income Summary

xxx xxx

xxx xxx

xxx

EXAMPLE

5/1 10,000 10/31 50,000

1/1 7/1

400,000 160,000

JOHN CAPITAL MARTHA CAPITAL 7/1 50,000 1/1 300,000 4/1 200,000 9/30 150,000

NET INCOME FOR THE PERIOD –P 150,000

DIVISION OF PROFITS & LOSSES 1. equally Income Summary John, Drawing Martha, Drawing To distribute profits to partners

150,000 75,000 75,000

2. arbitrary ratio a. percentage 40%:60% b. fraction 2/5:3/5 Income Summary John, Drawing Martha, Drawing To distribute profits to partners

150,000 60,000 90,000

3. Capital RATIO a. Beginning Capital Ratio : 400:300 or 4/7:3/7 Income Summary John, Drawing Martha, Drawing To distribute profits to partners

150,000 85,714.29 64,285.71

b. Ending Capital Ratio 500: 600 or 5/11:6/11 Income Summary John, Drawing Martha, Drawing To distribute profits to partners

150,000 68,181.82 81,818.18

c. Average Capital Ratio Income Summary John, Drawing Martha, Drawing

150,000 75,202.16 74,797.84

To distribute profits to partners

Computation of Average Capital Date Capital Peso Months Balance John ‘Jan 1 400,000 4 ‘May 1 390,000 2 ‘July1 550,000 4 Oct 31 500,000 2 Martha ‘Jan 1 300,000 3 April 1 500,000 3 ‘July1 450,000 3 Sept 30 600,000 3

Computation Average Capital: John P465,000 Martha 462,500 P927,500 =======

No. of Months Unchanged

P1,600,000 780,000 2,200,000 1,000,000 P5,580,000/12 P900,000 1,500,000 1,350,000 1,800,000 P5,550,000/12

Average Capital

P465,000

462,500

Share in Net Income of P150,000

150,000 x 465000/927,500= P 75,202.16 150,000x 462,500/927,500 = P 74,797.84

4. Allowing interest on partners’ capital balances 10% interest on beginning capital, balance equally Schedule of Distribution of Profits John 10% Interest on beginning Capital John (400,000 x 10%) Martha (300,000 x 10%) Balance equally(150,000-70,000) Share in Net Income

Income Summary John, Drawing Martha, Drawing To distribute profits to partners

Martha

Total

P30,000 40,000 P70,000

P70,000 80,000 P150,000

P40,000 40,000 P80,000

150,000 80,000 70,000

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 Salary allowance Balance 2:3 Share in Net Income Income Summary John, Drawing Martha, Drawing To distribute profits to partners

John P50,000 24,000 P74,000

Martha P40,000 36,000 P76,000

Total P90,000 60,000 P150,000

150,000 74,000 76,000

6.Bonus to managing partner based on net income 20% Bonus to John, the managing partner, balance equally Schedule of Distribution of Profits 20% Bonus to John Balance equally Share in Net Income Income Summary John, Drawing Martha, Drawing To distribute profits to partners

John P30,000 60,000 P90,000

Martha 60,000 P60,000

Total P30,000 120,000 P150,000

150,000 90,000 60,000

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 10% interest on ending capital John- 500,000 x5% Martha- 600,000 x 5% Salary allowance 10% Bonus to John Balance equally Share in Net Income Income Summary John, Drawing Martha, Drawing To distribute profits to partners

Martha

Total

P25,000 30,000 15,000 5,000 P75,000 150,000 75,000 75,000

P30,000 40,000 5,000 P75,000

P55,000 70,000 15,000 10,000 P150,000

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 10% interest on ending capital John- 500,000 x10% Martha- 600,000 x 10% Salary allowance 20% Bonus to John Excess equally Share in Net Income

Income Summary John, Drawing Martha, Drawing To distribute profits to partners

Martha

Total

P50,000 50,000 30,000 (50,000) P80,000

P60,000 60,000 (50,000) P70,000

P110,000 110,000 30,000 (100,000) P150,000

150,000 80,000 70,000

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 Martha, Drawing Income Summary To distribute losses to partners

48,000 102,000 150,000

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

Net Sales Cost of Sales Gross Profit Other Income Total Income Operating expenses Administrative expense Distribution costs Finance cost NET INCOME

Note 1 2

P627,635 (456,225) P171,410 1,771 P173,181

3

4 5 7

P90,890 19,615 5,100

(114.625) P57,576 ======

Schedule of Distribution of Profits Marlon 10% interest on beginning capital Marlon- 120,000 x10% Miranda- 100,000 x 10% Balance equally Share in Net Income

Miranda

Total

P12,000 P10,000 17,788 P27,788 ======

17,788 P29,788 ======

P22,000 35,576 P57,576 ======

NOTES TO FINANCIAL STATEMENTS Note 1

Net Sales Sales Sales Discount Sales Returns & Allowances Net Sales Revenue

P P

642,775

10,580 4,560

15,140 P

627,635

Note 2

Cost of Sales Merchandise Inventory, January 1 Add: Net cost of purchases

P

Purchases Purchase Discounts

P P

Purchase Returns and Allowances Net purchases Add: Freight in Total goods available for sale

366,200

3,653 18,265

21,918 P

344,282 1,250

345,532 P

Merchandise Inventory, December 31 Cost of Sales Note 3

Note 4

Note 5

Note 7

188,500

534,032 77,777

P

456,255

Gain on Sale of Office Equipment Interest Income

P

351 1,420

Total

P

1,771

P

54,200 30,000 3,830 2,340 520 90,890

Other Income

Administrative Expenses Salaries & Wages Rent Expense Depreciation Expense-Office Equipment Doubtful Accounts Expense Office Supplies used Total Distribution Costs Sales Commission Freight out Total Finance cost Interest expense Discount lost Total

P

P P

18,935 680 19,615

P P P

4,850 250 5,100

NMA Company Statement of Changes in Partners’ Equity For the Year Ended, December 31, 2015 Marlon Capital balances, January 1 Net Income Sub-total Partners’ Drawing Capital balances, December 31

P120,000 29,788 P149,788 (5,500) P144,288 ========

Miranda

Total

P100,000 27,788 P127,788 (10,500) P117,288 ========

P220,000 57,576 P277,576 (16,000) 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

3/1

Bea, Capital 20,000 1/1

Carmi, Capital 1/1 4/1

70,000

30,000 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