Unit 3

Accounting for Division of Profits & Losses

Partnership Operations

Accounting for a partnership form of business is basically similar to that of a sole

proprietorship. For example, Purchase of supplies is debited either to Supplies or Supplies
Expense account and when merchandise are sold on account, the entry is to debit Accounts
receivable and credit the Sales account which is the same as that of a sole proprietorship In fact
the Accounting Cycle of a Partnership is similar to that of sole proprietorship:
1. Recording of the business transactions
2. Posting to ledgers
3. Preparing a trial balance
4. Preparing the worksheet
5. Recording adjusting entries
6. Prepare financial statements
7. Recording and posting closing entries
8. Preparing a post-closing trial balance
9. Recording and posting reversing entries

However, problems distinctive only to partnership operations are encountered in the

following:

1. Recording of partner’s loan account when a partner lends money to a

partnership.

Date P AR T IC UL AR S P/R DEBIT CREDIT

July 1 Cash X X X X
Partner, loan or Loan Payable to Partner X X X X

2. Recording of loan extended by the partnership to the partner/s.

Date P AR T IC UL AR S P/R DEBIT CREDIT

July 1 Receivable from Partner X X X X
Cash X X X X

3. Recording of the closing entries of a partnership/Dividing partnership

profits or losses– individual drawing accounts of partners are not
automatically closed to their capital accounts in order to maintain the original
capital balances of the partners as stated in the Articles of Co-Partnership;
drawing accounts are closed to the capital accounts only if agreed upon in the
articles of co-partnership.

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 a. Distributing net income
Date P AR T IC UL AR S P/R DEBIT CREDIT
Dec. 31 Income Summary X X X X
Rose, drawing X X X X
Guada, drawing X X X X

a. Distributing net loss

Date P AR T IC UL AR S P/R DEBIT CREDIT
Dec. 31 Rose, drawing X X X X
Guada, drawing X X X X
Income Summary X X X X

Partnership net income or net loss is shared according to the partners’ capital ratio unless the
partnership contract specifically indicates otherwise.

a. A partner's share of net income or net loss is recognized in the accounts through
closing entries.

b. Closing entries for a partnership are identical to the entries made for a proprietorship,
except for the use of multiple capital and drawing accounts.

The various income ratios that may be used include:

a. A fixed ratio, expressed as a proportion (6:4), a percentage (70% and 30%), or a

fraction (2/3 and 1/3).

b. A ratio based either on capital balances at the beginning of the year or on average
capital balances during the year.

c. Salaries to partners and the remainder on a fixed ratio.

d. Interest on partners' capitals and the remainder on a fixed ratio.

e. Salaries to partners, interest on partners' capitals, and the remainder on a fixed ratio.

The objective is to reach agreement on a basis that will equitably reflect the
differences among partners in terms of their capital investment and service to the partnership.

Provisions for salaries and interest must be applied before the remainder of net income or
net loss is allocated on the specified fixed ratio. Detailed information concerning the division of
net income or net loss should be shown at the bottom of the income statement.
 4. Preparation of financial statements - the financial statements prepared for a
partnership form of business is basically the same as sole proprietorship except for
the following:

a. Statement of Financial Position – the owner’s equity section is labeled Partners’

Equity

RGem Trading

Statement of Financial Position

December 31, 20X5

Assets

Note

Current assets

Cash P 78,000

Investment in Trading Securities 80,000

Trade and other receivables 3 154,000

Merchandise Inventory 120,000

495,000
Prepaid expenses 63,000 P

505,000
Property, Plant and Equipment 4
1,000,000
Total Assets P

Liabilites and Partners' Equity

Current liabilites
178,000
Trade and other payables 5 P

Long term liabilities

314,000
Mortgage Payable

492,000
Total liabilities P

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Partners' Equity

Rose, Capital P 208,875

508,000
Guada, Capital 299,125
1,000,000
Total Labilities and Partners' Equity P
 b. Income Statement – an additional section called Distribution of Net Income or Net
Loss is included. This profit or loss distribution provides a full analysis of the
distribution of earnings or losses which is presented at the bottom part of the
partnership income statement.

RGem Trading

Income Statement

For the year ended December 31, 20X5

Note
880,000
Net Sales Revenue 1 P
475,000
Cost of Sales 2
405,000
Gross profit P

Operating Expenses

General and administrative expense P 114,500

217,000
Distribution expense 102,500
188,000
Net income P

Distribution of Net Income

Total
Rose Guada
60,000
Annual salary to managing partner P 60,000 P
40,000
10% interest on beginning capital 15,000 25,000
9,400
5% bonus based on net income 9,400
78,600
Balance: capital ratio (15/40; 25/40) 29,475 49,125
188,000
Net Income P 113,875 P 74,125 P

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

RGem Trading

Statement of Changes in Partners' Equity

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 For the year ended December 31, 20X5

Total
Rose Guada
400,000
Capital balances, January 1 P 150,000 P 250,000 P
188,000
Add: Net Income 113,875 74,125
588,000
Sub-total P 263,875 P 324,125 P
80,000
Less: Drawings 55,000 25,000
508,000
Capital balances P 208,875 P 299,125 P
Capital Account of a Partner

Rose, Capital
Debit Credit
Permanent Initial and
withdrawals additional
investments

Rules for Dividing Profit and Loss in a Partnership business

The computation of the result of business’ operation of a partnership is essentially the

same as that of the sole proprietorship. But the distribution to individual partners of this profit or
loss is the primary objective of the accounting process.

The income of the partnership is realized as the result of combining the contribution of
the partners in terms of capital investment, services rendered or time devoted in the management
of the business, and entrepreneurial ability or the partner’s personal business contacts and his
credit rating in the business community. And if profits or losses are to be divided fairly and
equitably these contributions by the partners must be properly considered. Therefore, the
following scheme may be adapted since the partnership’s net income may be viewed as a return
for:

1. services rendered – provide salaries to give recognition to the ability, experience or time
devoted by a partner to the business.

2. capital investment – provide interest to give recognition to differences in the capital

contribution given in proportion to the period such capital was actually used.

3. entrepreneurial ability or managerial skills - provide bonus which is an incentive or

special compensation which is usually based on net income.

The partnership may come up with their profit and loss ratio in the distribution of profits
and losses of the firm. This is the ratio in which partnership profits and losses are divided and
must be stated in the Articles of Co-Partnership. In the absence of any agreement as to the
division of profits or losses, the Philippine Partnership Law provides that the share of each
partner in the profit or loss shall be in proportion to what he has contributed, i.e., in accordance

Marivic Valenzuela-Manalo 7
with the partners’ contributed capital, but the industrial partner shall receive such shares as what
is just and equitable under the circumstances. The law also provides that if the sharing of profits
has been agreed upon by the partners, but no provision was made as to the distribution of losses,
the share of each partner in the losses shall be divided in the same manner that profits are
divided.

Methods of Dividing Net Income

1. Equally

2. Arbitrary Ratio

a. Fractions

b. Percentages

c. Ratio and Proportion

3. Based on 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