ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

MODULE 2
Partnership Operations and Financial Reporting
Week 2 to 4

After partnership formation, the main concern now of the partners is to operate the business
profitably and to formulate profits or losses sharing scheme. Like any other forms of business, it is
profit-oriented. Some of the many questions that will arise are as follows:
1. What are the factors to consider in arriving at a plan for dividing profits or losses?
2. What rules to apply if there is no agreement as to division of profits or losses?
3. If there is an agreement, what are the common arrangements to govern the distribution of
profits or losses?

Learning Objectives:

After studying this module, the students should be able to:

1. summarize the various rules to be followed in the distribution of profit and loss;
2. contrast a partner’s equity in assets from share in profits and losses;
3. identify, describe and account for the different methods of dividing partnership profits or
losses based on agreement;
4. ascertain the effects of using original, beginning, ending and average capital balances on
the partner’s share in profits and losses;
5. understand and appreciate the usefulness of financial statements and develop skills in its
preparation;
6. differentiate between capital account and the current account of a partner used in other
jurisdictions.

PERTINENT LAWS ON THE DISTRIBUTION OF THE PARTNERSHIP

PROFIT & LOSS

Factors to consider
1. Money, property or Industry. The amount of capital invested by each partner. The
amount of capital invested by each partner, the amount of time each partner devotes to
the business and other contributions.
2. Performance Methods. Some partnerships give some weight to the specific
performance of each partner to provide incentives to perform well. This is frequently
referred to a
Bonus.

Example of performance criteria:

a. Chargeable hours- total number of hours that a partner incurred on a client-related
assignments. Weight may be given to hours in excess of a standard.
b. Total billings-total amount billed to clients for work performed and supervisd.
c. Write-offs – uncollected billings , weight may be given to billings in excess of norm.
d. Promotional activities-enhancing partnership’s name in the community
e. Profits in excess of specified levels.

RULES FOR THE DISTRIBUTION OF PROFITS OR LOSSES

1. The profits and losses shall be distributed in conformity with the agreement.
2. 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.
3. In the absence of stipulation, the share of each partner in profits or losses shall be in proportion
to what they have contributed (according to ratio of original capital investments or in its
absence, the ratio of capital balances at the beginning of the year).
4. The industrial partner shall receive such share as may be just and equitable under the
circumstances but he may not be liable for losses incurred by the business.
As “ industrial – capitalist partner”, he shall also receive his share in the profits in proportion
to his capital.”
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

SUMMARY OF THE ABOVE RULES:

1. PROFITS
A. The profits will be divided according to partners’ agreement.
B. If there is NO agreement
⮚ As to Capitalist partners, profits shall be divided according to their capital
contributions (either ratio of original capital investment or in its absence, ratio of
capital balances at the beginning of the year).
⮚ As to Industrial partners, if any, such share as maybe just and equitable under the
circumstances, provided the industrial partner shall receive such share before the
capitalist partners shall divide the profits.

2. LOSSES
A. 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 profit sharing ratio.
C. In the absence of any agreement,
⮚ As to Capitalist Partner, the losses shall be divided according to their capital
contribution (ratio of the original capital investments or in its absence, ratio of capital
balances at the beginning of the year).

⮚ As to purely industrial partners, they shall not be liable for losses.

Rationale: an industrial partner cannot anymore withdraw the work or labor already
done by him , unlike the capitalist partners who can withdraw their capital .
If the partnership failed to realize profits, the industrial partner has already
contributed to the loss, .he in fact, has labored in vain.

CORRECTION OF PRIOR PERIOD ERRORS

As per 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
are results of Mathematical mistakes, mistakes in applying accounting policies, misinterpretation
of facts, fraud or oversights.

Example: errors in the estimation of depreciation, errors in inventory valuation, and omissions of
accruals of revenue and expenses.

Material prior period errors must be restated to report financial position and results of operations as
they would have been presented had the error never taken place. It should be corrected by adjusting
the opening balances or partner’s equity and affected assts and liabilities.

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

needed to increase Capital. If an error overstated profit in prior periods, the Capital would have to
be decreased. The correction is excluded from profit or loss for the period in which the error is
discovered and the effect of the error correction will be divided based on the applicable profit and
loss ratio.

DISTRIBUTION OF PROFITS BASED ON PARTNERSHIP AGREEMENT (Ballada, 2020)

To illustrate the different methods or scheme of profit and loss distribution, we will use the
partnership of King and Kong as a basis for illustration in the succeeding discussions:

Illustration:
Assume King and Kong formed a partnership with original capital contribution of P600,000
and P500,000 respectively. Partners allowed withdrawals of P5,000 every month which will be
recorded using their respective Withdrawal account. It will not be considered in the division of
profits and losses. During the year, the partnership made a profit of P220,000. As of December 31,
2019, the general ledger showed the following balances for equity accounts:
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

King, Capital Kong, Capital

8/30 60,000 1/1 P600,000 5/1 60,000 1/1 P500,000
6/30 140,000 3/30 130,000
9/30 110,000 10/1 80,000

12/31 60,000 850,000 12/31 60,000 710,000

( 60,000) ( 60,000)
Bal. P 790,000 Bal. 650,000___

King, Drawing Kong, Drawing Income Summary

5/30 5,000 6/30 5,000

12/31 P220,000

8/30 5,000

121/31 10,000

I. a. Equally or at any agreed ratio

KING-KONG Partnership
Profit Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: (50%) (50%) 100%
Computation:
King (220,000 x 50%) 110,000 110,000
Kong (220,000 x 50%) 110,000 110,000
Share of partners in profits P110,000 110,000 220,000

Journal Entry:
Dec 31 Income Summary 220,000
King, Drawing P110,000
Kong, Drawing 110,000
To record distribution of profits equally.

b. Using same data, assume that profit sharing agreement is 2/3 for King and 1/3 for
Kong.
KING-KONG Partnership
Profit Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: (2/3) (1/3) 3/3
Computation:
King (220,000 x 2/3) 146,667 146,667
Kong (220,000 x 1/3) 73,333 73,333
Share of partners in profits P146,667 73,333 220,000

Journal Entry
Dec. 31 Income Summary 220,000
King, Drawing 146,667
Kong, Drawing 73,333
To record distribution of fractional share of profits.

c. Assume King-Kong Partnership, incurred a loss of (P220,000) instead of profit.

The profit-sharing ratio is 60:40 respectively but no loss sharing agreement. Therefore, loss
will be distributed to partners in the same proportion as in profit sharing.

KING-KONG Partnership
Profit Distribution Schedule
December 31, 2019
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

King Kong Total

Profit Sharing Ratio: (60%) (40%) 100%
Computation:
King (220,000 x 60%) (132,000) (132,000)
Kong (220,000 x 40%) (88,000) (88,000)
Share of partners in losses (P132,000) (88,000) (220,000)

Journal Entry:
Dec 31 King, Drawing 132,000
Kong, Drawing 88,000
Income Summary 220,000
To record distribution of losses at 60%: 40% loss sharing ratio.

I. Based on Partner’s Capital Contribution which may refer to either of the

following:
a). Ratio of Original Capital Investments-
Based on partner’s agreement, the following amounts were originally contributed:
King, Capital P600,000 = 6/11
Fractional part
Kong, Capital 500,000 = 5/11

Total Capital P1,100,000

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 6/11 5/11 100%
Computation:
King (220,000 x 6/11) 120,000 120,000
Kong (220,000 x 5/11) 100,000 100,000
Share of partners in profits P120,000 100,000 220,000

Journal Entry:
Dec. 31 Income Summary P220,000
King, Drawing 120,000
Kong, Drawing 100,000
To distribute profits according to ratio of original capital
investment.

b). Ratio of capital balances at the beginning of the year.

As of January 1, both partners have the following capital:
King, Capital P600,000
Kong, Capital 500,000

Total Capital P1,100,000

*Same computation as in a) because the capital balances at the beginning of the year are the same as
the original capital balances.
c). Ratio of the capital balances at the end of the year.
As of December 31, 2019, the capital ending balances are as follows:
King, Capital 790,000 =79/144 Fractional part
Kong, Capital 650,000=65/144
Total Capital ending balances P1,440,000

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 79/144 65/144 100%
Computation:
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

King (220,000 x 79/144) 120,694 120,694

Kong (220,000 x 65/144) 99,306 99,306
Share of partners in profits P120,694 99,306 220,000

Journal Entry:
Dec. 31 Income Summary P220,000
King, Drawing P120,694
Kong, Drawing 99,306
To record distribution of profits according to ratio of their
capital ending balances.

d. Ratio of Average Capital Balances

Division of profits based on the above three (3) concepts, a), b) and c) may prove to be
inequitable if there are material changes in the capital accounts during the year.
Temporary withdrawals as stated in the agreement, in this example is P5,000 a month,
will not affect the computation of average capital however, withdrawals in excess of the
allowed amount will be debited to the Capital account and therefore will affect the average
capital ratio. Because of the following considerations, using average capital ratio 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. It is also considered to be the most
equitable of all methods. Average capital balances of partners are computed as follows:

King-Kong Partnership
Computation of the Average Capital Balance
For the Year ended December 31, 2019

KING, CAPITAL
Date Capital Account Portion of the Year* Average
Balances Unchanged Capital
Balances
Jan. 1 P600,000 x 6/12 P300,000
June 30 740,000 x 2/12 123,333
Aug 30 680,000 x 1/12 56,667
Sept. 30 790,000 x 3/12 197,500
AVERAGE CAPITAL 677,500

KONG, CAPITAL
Date Capital Account Portion of the Year* Average
Balances Unchanged Capital
Balances
Jan. 1 P500,000 x 3/12 P125,000
March 630,000 x 1/12 52,500
30
May 1 570,000 x 5/12 237,500
Oct 1. 30 650,000 x 3/12 162,500
AVERAGE CAPITAL 577,500

TOTAL AVERAGE CAPITAL P 1,255,000

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 6775/12550 5775/12550 100%
Computation:
King (220,000 x 6775/12550) 118,765 118,765
Kong (220,000 x 5775/12550) 101,235 101,235
Share of partners in profits P118,765 101,235 220,000
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

Journal Entries

Dec. 31 Income Summary P220,000

King, Drawing P 118,765
Kong, Drawing 101,235
To distribute partnership profits based on average capital
balances.

e. By allowing Interest on Capital and the balance to shared in an agreed ratio

To allow interest on partner’s capital account balances is the same as dividing profits
based on the ratio of partner’s capital balances. If the partners agree to allow interest on
capital, it is the first step in the division of profit and the interest rate to be used must be
clearly specified. Interests on partner’s capital along with other profit-sharing plans are
considered techniques to share profits and losses equitably and not as expenses of the
partnership. However, the interest on Loans from Partners is recognized as expense.
Similarly, interest earned on Loans to Partners is recognized as partnership income.

As per our illustrative problem, King-Kong Partnership with a profit of P220,000, assume
that partnership agreement allowed to give 15% interest on average capital balances
with the remaining balance to be divided equally. The computation will be:

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 50% 50% 100%
Computation:
15% interest on Average Capital
balances
King ( 677,500 x 15%) 101,625 101,625
Kong ( 577,500 x 15%) 86,625 86,625

Sub-total 188,250
Balance to be divided equally:
(P220,000-188,250) = P31,750/2 15,875 15,875 31,750

Share of partners in profits 117,500 102,500 220,000

Journal Entry
Dec. 31 Income Summary P220,000
King, Drawing 117,500
Kong, Drawing 102,500
To record distribution of partnership profits.

In relation to this case, assume King-Kong Partnership incurred a loss of P15,000 for the
year 2019, if the partnership agreement provided for 15% interest on capital accounts, this
provision must be honored regardless of whether operations yielded profit or loss.

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 50% 50% 100%
Computation:
15% interest on Average Capital
balances
King ( 677,500 x 15%) 101,625 101,625
Kong ( 577,500 x 15%) 86,625 86,625
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

Sub-total 188,250
Balance to be divided equally:
188,250+ 15,000= (203,250) /2 = (101,625) (101,625) (203,250)

Share of partners in losses -o- (15,000) (15,000)

Journal Entry
Dec. 31 Kong, Drawing 15,000
Income Summary 15,000
To record division of loss.

f. By allowing Salaries to partners and the balance to be shared in an agreed ratio.

To compensate for the personal services contributed by partners, especially if one
partner, though devoting equal time as the other partners, may have superior experience
and knowledge of the business may command greater share of the profit. In order to
provide for this, a profit-sharing plan may provide for salary allowances.

In the absence of agreement regarding salary allowances, the incurrence of “loss” of

the business will not be a reason not to provide for it. Unless there is stipulation to the
contrary, salary allowances will continue to be given to partners even if the business
yielded a loss. This should not be confused with Salaries Expense, because salary
allowances is one way of compensating the partners for the time and services they
have put in as owners of the business and therefore should not be deducted as expense
in the Statement of Comprehensive Income.

Assuming the partnership agreement provided for an annual salary allowance of P50,000 to
King and P40,000 to Kong and the balance to be divided equally, then the profit of
P220,000 will be distributed as follows:

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 50% 50% 100%
Computation:
Salary Allowances 50,000 40,000 90,000

Balance to be divided equally:

(220,000-90,000) = P130,000 /2 65,000 65,000 130,000
Share of partners in profits 115,000 105,000 220,000
Journal Entry:
Dec. 31 Income Summary P220,000
King, Drawing 115,000
Kong, Drawing 105,000
To record distribution of profits with salary allowances to partners.

g. By allowing BONUS to the managing partner based on profit and the balance in an
agreed ratio.
A partnership contract may provide for special compensation in the form of
“bonus” to the managing partner when the results of its business operations are
favorable. This will encourage the partner to maximize the profit potentials of the
partnership. Bonus is a mere technique to distribute profits.

Assume that the partnership agreement of King and Kong, provided for a bonus of
20% of profit before bonus to King, the managing partner and the balance divided
equally. The profit of P220,000 will be distributed as follows:

KING-KONG Partnership
Profit & Loss Distribution Schedule
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

December 31, 2019

King Kong Total

Profit Sharing Ratio: 50% 50% 100%
Computation:
Bonus based on 20% of profit 44,000 44,000
before bonus.(20% x P220,000)

Balance to be divided equally: 88,000 88,000 176,000

(220,000-44,000)= P176,000/ 2
Share of partners in profits 132,000 88,000 220,000

Journal Entry:
Dec. 31 Income Summary P220,000
King, Drawing 132,000
Kong, Drawing 88,000
To distribute profits with bonus.

Assume that 20% BONUS will be provided based on P220,000 profit after bonus.
Computation:
Profit before Bonus P220,000 120%
Profit after Bonus
(220,000/120%) 183,333 100%

Bonus 36,667 20%

KING-KONG Partnership
Profit & Loss Distribution Schedule
December 31, 2019

King Kong Total

Profit Sharing Ratio: 50% 50% 100%
Computation:
Bonus based on 20% of profit 36,667 36,667
after bonus

Balance to be divided equally: 91,666.50 91,666.50 183,333

(220,000-36,667)= P183,333/ 2

Share of partners in profits 128,333.50 91,666.50 220,000

Journal Entry:
Dec. 31 Income Summary P220,000
King, Drawing 128,333.50
Kong, Drawing 91,666.50
To record distribution of profits.

h). By allowing Salaries, Interest on Capital, Bonus to Managing Partner and Balance
in an Agreed Ratio.
When both service and capital contributions are unequal , the allocation of profits and
losses may include salary allowances, interest on capital, bonus to managing partner and
balance to be divided in an agreed ratio, all are merely means of allocating profit to the
partners.

For purposes of illustration, assume KING-KONG Partnership agreement provides for

the following:
a. Bonus to King of 30% of profit after salaries and interest but before bonus.
b. Salary allowances of P50,000 to King and 45,000 to Kong.
c. Interest of 10% based on average capital balances.
d. Balance to be divided in the ratio of 55%: 45% respectively.

KING-KONG Partnership
Profit & Loss Distribution Schedule
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

December 31, 2019

King Kong Total

Profit Sharing Ratio: 55% 45% 100%
Computation:
Salary Allowances 45,000 35,000 80,000
Interest on Ave. Capital Balances:
King (677,500 x 10%) 67,750
Kong(577,500 x 10%) 57,750 125,500
Bonus based on 30% of profit after salary
allowances and interest but before bonus
(220,000-80,000-125,500)=14,500 x 30% 4,350 4,350

Balance to be divided equally-55:45

(220,000-80,000-125,500-4,350) = 10,150
King (10,150 x 55%) 5,582.50
Kong (10,150) x 45%) 4,567.50 10,150

Share of partners in profits 122,682.50 97,317.50 220,000

Journal Entry
Dec. 31 Income Summary P220,000
King, Drawing 122,682.50
Kong, Drawing 97,317.50
To record distribution of profits

FINANCIAL REPORTING (Ballada 2020)

Similar to other forms of business organization, a partnership business is also required to accomplish set of
financial reports that will provide users with accounting information about the financial position, financial
performance and cash flows of an entity. Financial statements show the results of the management’s
stewardship of the resources entrusted to them.

Overall Considerations:
● Fair presentation and compliance with International Financial Reporting Standards (IFRS)
Fair presentation means faithful representation of the effects of transactions, other events and
conditions in accordance with the definition and recognition criteria for Assets, Liabilities, Income
and Expenses set out in IASB’s conceptual framework. The revised IAS No.1 (revised 2007)
entities are required to make an explicit and unreserved compliance with IFRS in the notes.

● Going Concern
Financial statements should be prepared on a going concern basis unless management intends to
liquidate the entity or cease trading or has no realistic option but to do so.

● Accrual Basis of Accounting

An entity shall be using the accrual basis of accounting in preparing its financial statements except
for cash flow information.

● Materiality and Aggregation

An entity shall present separately each material class of similar items and those material
items which are dissimilar in nature or function shall be separately disclosed.

● Offsetting
An entity shall not offset Assets, Liabilities, Income and Expenses unless required or
permitted by an IFRS.

● Frequency of Reporting and Comparative Information

An entity is expected to present at least annually a complete set of financial statements
including comparative information in respect of the previous period for all amounts
reported in the current period’s financial statements.

● Consistency of Preparation
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

An entity shall retain the presentation and classification of items in the financial
statements in successive periods unless an alternative would be more appropriate or an
IFRS requires a change in presentation.

● Identification of the Financial Statements

International Financial reporting Standards (IFRS) apply only to financial statements and
not necessarily to other information presented in an annual report, a regulatory filing or
another document.

An entity shall clearly identify the financial statements and the notes with the following
information displayed prominently:
⮚ name of reporting entity;
⮚ whether the financial statements are of the individual or a group of entities;
⮚ the date of the end of the reporting period
⮚ the presentation currency
⮚ the level of rounding off used in presenting amounts in the financial
statements.

Complete Set of Financial Statements

Per revised International Accounting Standards (IAS) No.1, Presentation of Financial Statements,
a complete set comprises of:
a. Statement of Financial Position at the end of the period;
b. Statement of Financial Performance for the period;
c. Statement of Changes in Equity for the period;
d. Statement of Cash Flows for the period;
e. Notes comprising of summary of significant accounting policies and other explanatory
information

Statement of Financial Performance

The form and content of the Income Statement of the partnership is similar to those of the sole
proprietorship with the exception of the presentation of the division of profits or losses at the
lower portion of the statement as shown below:

King-Kong Partnership
Partial Income Statement
For the Year ended December 31, 2019

Profit P 220,000

Division of Profit: 60:40

Partner King 132,000
Partner Kong 88,000
Total P 220,000

The components of profit or loss maybe presented either as part of a single Statement of
Comprehensive Income or Income Statement as permitted by paragraph 81 of IAS No.1 (revised
2007). It is part of complete set of financial statements and shall be displayed immediately before
the Statement of Comprehensive Income.

Statement of Changes in Equity

As contrasted to sole proprietorship, the number of capital and drawing accounts has made the
preparation more useful. Changes in an entity’s equity before the beginning and end of reporting
period reflects the increase and decrease in its net assets during the period.

KING-KONG PARTNERSHIP
Statement of Changes in Equity
For the year ended December 31, 2019
 ACC 102 FINANCIAL ACCOUNTING AND REPORTING 2

King Kong Total

Original Investments P600,000 P500,000 P1,100,00
Add: Additional Investments 250,000 210,000 460,000
Total 850,000 710,000 1,560,000
Less: Permanent Withdrawals 60,000 60,000 120,000
Balances 790,000 650,000 1,440,000
Add: Profit 132,000 88,000 220,000
Total 922,000 738,000 1,660,000
Less: Temporary withdrawals 10,000 5,000 15,000
Partner’s Equity, Dec. 31 P912,000 P733,000 P1,645,000

Statement of Financial Position

After the Statement of Financial Performance and Statement of Changes in Partner’s Equity for the
period has been properly presented, preparation of Statement of Financial Position will be of no
major difficulty. The Assets and Liabilities will be presented as those of a sole proprietorship except
for the owner’s equity section. It should exhibit separately the capital balance of King P912,000
and of Kong P733,000. The Statement of Financial Position shall include as minimum, line items
identified in the revised IAS No. 1 Presentation of Financial Statements in relation to Assets and
Liabilities.

IAS No. 1 (revised 2007) does not prescribe the order or format in which an entity presents items.
Note that an entity makes the judgement about whether to present additional items separately on
the basis of an assessment of:
a. nature and liquidity of assets
b. function of assets with the entity
c. the amounts, nature and timing of liabilities.

Current and non-current assets and liabilities should be separately classified on the face of
Statement of Financial Position.

Statement of Cash Flows

It serves as the basis for evaluating the company’s or entity’s ability to generate cash and cash
equivalents and its needs to utilize these cash flows. It also provides information as to Cash
receipts and Cash payment . Important concepts involved in the preparation of the cash flows
statement includes :

A. Cash Flows from Operating Activities

Operating activities involve the Cash effect of transactions and other events that
enter into determination of profit or Loss

Cash Flows from Investing Activities

B. Cash Flows from Financing Activities

REFERENCES

Text books-
Ballada, W.L. (2020). Partnership & Corporation Accounting. Manila. Domdane
Publishers
Ballada, W.L.(2018). Basic Accounting: Made Easy. Manila. Domdane Publishers
Palma, R. (2015). Basic Accounting 2. Partnership & Corporation. Manila. REX
Valencia, E. G. et al (2016). Basic accounting: Concepts, principles, procedures and
applications. Baguio City. Valencia Educational Supply

Internet:
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