Financial Accounting and Reporting Part 1 51

MODULE 3

PARTNERSHIP OPERATIONS

Overview

This module gives us a background on how the partnership divides its profits and losses
to partners.

Module Objectives

After studying this module, the students should be able to

1. Differentiate the closing entries in a partnership and in a sole proprietorship.
2. Determine the factors affecting the distribution of profits and losses.
3. Identify the different methods and rules of dividing partnership profits and losses
among partners.
4. Understanding on how to prepare the financial statements of a partnership.

NATURE OF PARTNERSHIP OPERATION

Basically accounting for partnership operations and accounting for the operations of a
sole proprietorship is essentially the same. Steps of the accounting cycle and the rule of debit
and credit to record the transactions are also the same for both sole proprietorship and
partnership. Purchased of office chairs and table on account is debited to Furniture and Fixtures
and credited to Accounts Payable. Payment of expenses is debited to Expenses and credited to
Cash. Sale of merchandise on account is debited to Accounts Receivable and credited to Sales.
Collection of accounts is debited to Cash and credited to Accounts Receivable.

At the end of the accounting period, adjustments are made for merchandise inventory,
accruals, prepayments, provision for uncollectible accounts, and provision for depreciation.
Profit or loss is determined in the usual manner, that is, by matching periodic income and
expense.

However, special problems are encountered in accounting for partnership operations.

These problems include:

1. Closing entries of a partnership

2. Distribution of profits and losses
3. Preparation of a work sheet
4. Preparation of financial statements
a. Statement of income / statement of comprehensive income
b. Statement of financial position
c. Statement of changes in partners‟ equity
52 Financial Accounting and Reporting Part 1

CLOSING ENTRIES OF A PARTNERSHIP

The procedures for the preparation of closing entries for a partnership are similar to that
of a sole proprietorship. First, all revenue and other nominal accounts with credit balances
(such as Purchases Discounts and Purchases Returns and Allowances) are debited and

Income Summary is credited. Second, income Summary is debited and all expense and other
nominal accounts with debit balances (such as Sales Discounts and Sales Returns and
Allowances) are credited. Third, the balance of the Income Summary account, which
represents profit or loss of the partners. Finally, the balance of the drawing account of each
partner is transferred to his/her capital account.

The balance of the Income Summary account is transferred to the drawing accounts of the
partners if the partners‟ intention is to keep the capital account intact for investments and
permanent withdrawals of capital. A credit balance in the Income Summary account represents
a profit and its balance is transferred to the drawing accounts of the partners based on their
profit and loss sharing ratio. The entry is as follows:

Income Summary xxx

X, Drawing xxx
Y, Drawing xxx

Any resulting credit balance in the drawing account of a partner may be withdrawn by the
partner or reinvested into the firm. If the balance in the drawing accounts is withdrawn in cas,
the entry is as follows:

X, Drawing xxx
X, Cash xxx

However if the partner decides to reinvest into the firm this balance in his drawing account, the
entry is as follows:

X, Drawing xxx
X, Capital xxx

A debit balance in the Income Summary account represents a loss and its balance is
transferred to the drawing accounts of the partners based on their profit and loss sharing ratio.
The entry is as follows:

X, Drawing xxx
Y, Drawing xxx
Income Summary xxx

The resulting debit balance in the drawing account of a partner is charged against his capital
with the following entry:

X, Capital xxx
X, Drawing xxx
 Financial Accounting and Reporting Part 1 53

On the other hand, the balance of the Income Summary account may be transferred directly to
the capital accounts of the partners if the partners‟ intention is to make the profit or loss a part of
permanent capital. It should be noted, however, that either treatment will result to the same net
effect on partners‟ ending capital balances. All illustrations mentioned, pertaining to distribution
of profit or loss are recorded directly to the capital accounts with the assumption that partners
intend to make their respective share on the profit loss as a direct part of their permanent
capital.

A credit balance in the Income Summary account represent a profit and its balance is
transferred to the capital accounts of the partners based on their profit and loss sharing ratio.
The entry is as follows:

Income Summary xxx

X, Capital xxx
Y, Capital xxx

A debit balance in the Income Summary account represents a loss and its balance is transferred
to the capital accounts of the partners based on their profit and loss sharing ratio. The entry is
as follows:

X, Capital xxx
Y, Capital xxx
Income Summary xxx

DISTRIBUTION OF PROFIT AND LOSSES

To make distribution of partnership profits and losses equitable, the following factors are
considered:
1. Services rendered by the partners to the partnership
2. Amount of capital contributed by the partners to the business
3. Entrepreneurial ability or managerial skill of the partners

RULES FOR DIVIDING PROFITS AND LOSSES

Profits and losses in general shall be divided in accordance with the agreement among the
partners. In the absence of an agreement, the partners shall share in the profits in proportion to
their capital contributions after satisfying the share of the industrial partner on such profit.

The following is the list of rules in the division of profits and losses of the partnership
based on the provision of the New Civil Code:

1. As to Capital Partners
a. Division of profits
1. in accordance with agreement
2. in the absence of an agreement, division of profits is in accordance with capital
contributions
54 Financial Accounting and Reporting Part 1

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

2. As to Industrial Partners
a. Division of profits
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 and the capitalist partners shall receive profits in
accordance with their capital contributions

b. Division of losses
1. In accordance with agreement
2. In the absence of an agreement, the capitalist- industrial partner in his/her character
as industrial partner shall have no share in the losses, but in his/her character as a
capitalist partner will share in proportion to the capital contribution

METHODS OF DISTRIBUTING PROFITS BASED ON PARTNERS’ AGREEMENT

1. Arbitrary ratio (Percentage, Decimal, Fraction, Ratio)- it is simple to apply but does not
give recognition on the disparity of capital contributions nor does it recognize the time
and effort that a partner may devote in running the firm‟s business operations.

2. Capital ratio (Original, Beginning, Ending, Average) – this method recognizes the
differences in the capital contributions but does not take into account the time and effort
that a partner may devote in running the firm‟s business operations.

3. Interest on capital and the balance on agreed ratio- this method recognizes the
differences in the capital contributions but does not take into account the time and effort
that partner may devote in running the firm‟s business operations. Interest is allowed to
partners for the use of invested capital. Interest as agreed by the partners shall be
allowed in proportion over the period such capital was actually used. Moreover, the
interest shall be provided whether profit is sufficient or insufficient or there is a net loss
unless otherwise agreed upon by the partners.

4. Salary allowances to partners and the balance on agreed ratio- this method recognizes
the time and effort that a partner may devote in running the firm‟s business operations
but does not take into consideration the differences in capital contributions.

Salaries are allowed to partners as a compensation for their time devoted in the
business. Salaries as agreed by the partners shall be allowed in proportion to the time
the partners actually rendered services to the firm. Such salaries shall be provided
whether the profit is sufficient or insufficient or there is net a loss unless otherwise
agreed upon by the partners.
 Financial Accounting and Reporting Part 1 55

5. Bonus to managing partner and the balance on agreed ratio- this method allows a
bonus, as an incentive, to the managing partner. It is usually a percentage of the profit.
Bonus, therefore, is allowed only when there is a profit. It may be computed using
any one of the following as basis:

a. Bonus is based on profit before deducting bonus and income tax

b. Bonus is based on profit after deducting bonus but before deducting income tax
c. Bonus is based on profit after deducting income tax but before deducting bonus
d. Bonus is based on profit after deducting both bonus and income tax.

6. Interest on capital, salaries to partners, bonus to managing partner, and the balance on
agreed ratio.

Illustrative Problem : The following accounts and balances are available in the books of
Ciara and Dolly Partnership for the year 2019.

Ciara, Capital
May 1 P150,000 Jan.1 Beg‟g. Balance P2,200,000
Apr. 1 250,000
Oct. 1 500,000
Bal. P2,800,000

Ciara, Drawing
Jan. 1 – Dec. 31 P300,000

Dolly, Capital
May 1 P150,000 Jan.1 Beg‟g. Balance P1,500,000
Dec.1 50,000 Oct. 1 500,000
Balance- P1,800,000

Dolly, Drawing
Jan. 1 – Dec. 31 P225,000

Income Summary
Dec. 31 P800,000

Case 1- Profit is divided in the ratio of 75% and 25% to Ciara and Dolly

Income Summary 800,000

Ciara, Capital 600,000
Dolly, Capital 200,000
P800,000 x 70% = P600,000
P800,000 x 25% = P200,000
56 Financial Accounting and Reporting Part 1

Case 2- Profit is allocated based on the beginning capital ratio

Income Summary 800,000

Ciara, Capital 476,676
Dolly, Capital 324,324
P800,000 x 2,200/3,700 = P475,676
P800,000 x 1,500/3,700 = P324,324

Case 3- Profit is allocated based on the ending capital ratio

Income Summary 800,000

Ciara, Capital 486,957
Dolly, Capital 313,043
P800,000 x 2,800/4,600 = P486,957
P800,000 x 1,800/4,600 = P313,043

Case 4 - Profit is allocated based on the average capital ratio.

Income Summary 800,000

Ciara, Capital 490,678
Dolly, Capital 309,322
P800,000 x 2,412,500/ 3,933,333.33 = P490,678
P800,000 x 1,520,833.33/ 3,933,333.33 = P309,322

Average capital ratio is a method of dividing profits based on the amount of capital
invested and the time during which such capital is actually used in the business.

The following steps are to be followed in determining the average capital of each partner using
the peso month method; thus, arriving at the average capital ratio:

1. Multiply beginning capital by the number of months that it remained unchanged.

2. Determine each new capital balance in chronological order and multiply by the number
of months it remained unchanged.
3. Add the products which represents peso month and divide the total by twelve (12) to
obtain the average monthly capital.

By following the steps given, the average capital of each partner can be calculated as follows:

Ciara, Average Capital

No. of Mos.
Period Capital Balance Unchanged Peso Months Average
Capital
Jan.1 – Mar.31 P2,200,000 3 P 6,600,000
Apr. 1 – Apr.30 2,450,000 1 2,450,000
May 1 – Sept.30 2,300,000 5 11,500,000
Oct. 1 – Dec. 31 2,800,000 3 8,400,000
12P28,950,000 P2,412,500
Dolly, Average Capital
 Financial Accounting and Reporting Part 1 57

Jan.1 – Apr. 30 P1,500,000 4 P 6,000,000

May 1– Sept. 30 1,350,000 5 6,750,000
Oct. 1 – Nov. 30 1,850,000 2 3,700,000
Dec. – Dec. 31 1,800,000 1 1,800,000
12P18,250,000P1,520,833.33
P3,933,333.33

Case 5- Each partner is allowed 12% interest on ending capital and the remaining profit is
divided equally.

Income Summary 800,000

Ciara, Capital 460,000
Dolly, Capital 340,000

Alternative entry to record the distribution of profits may be recorded separately as follows:

Income Summary 552,000

Ciara, Capital 336,000
Dolly, Capital 216,000
Interest on ending capital.

Income Summary 248,000

Ciara, Capital 124,000
Dolly, Capital 124,000
Remaining income divided equally

Division of profit
CiaraDollyTotal
Interest on ending capital
P2,800,000 x 12% P336,000
P1,800,000 x 12% P216,000 P552,000
Remainder-equally
P248,000 /2 124,000124,000 248,000

Totals P460,000P340,000P800,000

Case 6- Ciara is allowed a salaries of P600,000 and the remaining profit is divided in the ratio of
1:4

Income Summary 800,000

Ciara, Capital 640,000
Dolly, Capital 160,000

Division of profit
Ciara Dolly Total
58 Financial Accounting and Reporting Part 1

Salaries P600,000 P600,000

Remainder- 1:4
P200,000 x 1/5 P 40,000
P200,000 x 4/5 160,000 200,000
Total P640,000 P160,000 P800,000

Case 7- Dolly, the managing partner, is allowed a bonus of 20% of profit BEFORE bonus and
income tax and the remainder is divided in the ratio of beginning capital.

Using the income tax rate of 30%, the partnership income before income tax is P1,142,857, that
is, net profit of P800,000 divided by 70%.

Income Summary 800,000

Ciara, Capital 267,857
Dolly, Capital 332,143

Division of profit
Ciara Dolly Total
Bonus(1,142,857x20%) P228,571 P228,571
Remainder:
P571,429 x 2,200/3,700 P339,769
P571,429 x 1,500/3,700 231,660 571,429
Total P339,769 P460,231 P800,000

Case 8- The partners are allowed P5,000 and P10,000 weekly salaries, respectively, 10%
interest on average capital, and the remainder is divided in the ratio of 2:3.

Income Summary 800,000

Ciara, Capital 339,769
Dolly, Capital 460,231

Division of profit CiaraDollyTotal

Salaries to partners
P 5,000 x 52weeks P260,000
P10,000 x 52weeks P520,000 P780,000
Interest on average capital
P2,412,500 x10% 241,250
P1,520,833.33 x 10% 152,083 393,333
Remainder – (P373,333.33)
(P373,333.33) x 2/5 ( 149,333)
(P373,333.33) x 3/5 (224,000) (373,333)
Total P 351,917 P448,083 P800,000

The sum of the salary allowance and interest allowed on the average capital of the
partners exceeded the profit of P800,000 resulting in a negative remainder (loss or deficit).
Such loss is distributed as provided in the profit and loss sharing agreement.
 Financial Accounting and Reporting Part 1 59

Case 9- Assume the same agreement as in Case 8 except that instead of a profit, the
partnership has incurred a loss of P100,000. The allowance for salaries and interest will still be
provided, thereby resulting in a total loss to be divided as agreed.

Dolly, Capital 109,750

Ciara, Capital 9,750
Income Summary 100,000

Division of profit
Ciara Dolly Total

Salaries to partners
P 5,000 x 52 P260,000
P10,000 x 52 P520,000 P780,000
Interest on average capital
P2,412,500 x10% 241,250
P1,520,833.33 x 10% 152,083 393,333
Remainder–(P1,273,333)
(P1,273,333) x 2/5 ( 509,333)
(P1,273,333) x 3/5 (764,000) (1,273,333)
Total (P 8,083) (P 91,917) (P100,000)

The allocation of partnership profit follows the order of the profit sharing agreement in allocating
the bonus, the salary allowances, the interests and the remainder to individual partners.

The bonus is computed on the basis of the partnership profit as the concept of “partnership
profit” is generally understood in accounting practice. Partners may, however, intend for salary
and interest allowances to be deducted in determining the base for computing the bonus. In
such case, no bonus is allowed if there is insufficient profit after distribution of salaries and
interests.
The interests of the partners may not be apparent when technical accounting terms are used;
so, the partnership agreement should be precise in specifying measurement procedures to be
used in determining the amount of a bonus.

Illustrations on the computation of bonus using other assumptions. The same data in Illustrative
Problem A shall be used. Bonus rate is 20%

1. Bonus is based on profit after deducting bonus but before deducting income tax.

B = .20 x (P P1,142,857– B)
B = P228,571 - .20B
B + .20B = P228,571
B = P228,571 / 1.20
B = P190,475.83

2. Bonus is based on profit before deducting bonus but after deducting income tax

B = .20 (P1,142,857 – T)

T = .30 x P1,142,857
= P342,857
60 Financial Accounting and Reporting Part 1

Substituting for T in the first equation and solving for B

B = .20 x (P1,142,857 – P342,857)

B = .20 x P800,000
B = P160,000

Key Points. The bonus was not deducted from the profit subject to income tax. The
bonus being computed is not an expense but a distribution of profit after income tax.

3. Bonus is based on profit after deducting bonus and income tax

B = .20 (P1,142,857 – B-T)

T = .30 x P P1,142,857
= P342,857

Substituting for T in the first equation and solving for B

B = .20 x (P1,142,857 – B – P342,857)

B = .20 (P800,000 – B)
B = P160,000 - .20 B
B + .20B = P160,000
B = P160,000 / 1.20
B = P133,333

Key Points. In the preceding examples, bonus is treated as distribution of partnership profit,
and therefore such bonus is not deductible as an expense in determining the amount of taxable
profit. The same is true for salaries and interest allowed on capital.

The partnership form of business allows a wide selection of profit distribution ratios to meet the
individual desires of the partners. Ratios for profit distributions may be based on the percentage
of total partnership capital, time and effort invested in the partnership, or a variety of other
factors. Some partnerships, however, have a profit sharing ratio that is different from their loss
sharing ratio.

PREPARATION OF WORK SHEET and FINANCIAL STATEMENTS

At the end of each accounting period, the partnership books are adjusted and closed and
financial statements are prepared. In order to classify accounting data in a convenient and
orderly manner and to facilitate the preparation of financial statements, a work sheet is
prepared. The form or columns of the worksheet may vary depending on the needs of the
company. The following illustrative problem will use the simplest form of worksheet with
emphasis not on the form but the underlying principles and procedures in preparing such
worksheet.
 Financial Accounting and Reporting Part 1 61

Illustrative Problem: The trial balance for EXCEL CORPORATION as at December 31, 2019 is
presented below:

EXCEL CORPORATION
Trial balance
December 31, 2019

Debit Credit
Cash 1,900,000
Notes Receivable 625,000
Accounts Receivable 1,125,000
Allowance for Uncollectible Accounts 50,000
Merchandise Inventory 1,250,000
Furniture and Equipment 1,500,000
Accumulated Depreciation 200,000
Notes Payable 500,000
Accounts Payable 375,000
FERNANDO, Capital 1,250,000
FERNANDO, Drawing 155,000
GOMEZ, Capital 3,125,000
GOMEZ, Drawing 250,000
Sales 5,000,000
Sales Returns and Allowances 50,000
Sales Discounts 75,000
Purchases 2,412,500
Purchases Returns and Allowances 100,000
Purchase Discounts 62,500
Freight- In 125,000
Selling Expenses 825,000
General Expenses 362,500
Interest Income 17,500
Interest Expense 25,000
10,680,000 10,680,000

Data for adjustments as of December 31, 2019:

a. Merchandise inventory, P1,000,000.

b. Depreciation of furniture and equipment, 10% per year, 40% of which us considered part
of general expenses.
c. Unpaid sales salaries, P25,000
d. Accrued interest on notes receivable, P2,500
e. Accrued interest on notes payable, P1,500
f. Allowance for uncollectible accounts to be increased to P112,500
g. Unused supplies: office-P10,000, store- P15,000
h. Income tax, 30% of profit before income tax

The Articles of Co-Partnership contain the following provisions regarding the division of profits
and losses:
1. Annual salaries of P400,000 and P500,000, respectively.
2. Interest of 10% on beginning capital
 62

EXCEL CORPORATION
Work Sheet
For the Year Ended December 31, 2019

Trial Balance Adjustments Statement of Income Statement of Financial Position

Debit Credit Debit Credit Debit Credit Debit Credit
Cash 1,900,000.00 1,900,000.00
Notes Receivable 625,000.00 625,000.00
income statement are presented.

Accounts Receivable 1,125,000.00 1,125,000.00

Allowance for Uncollectible Accounts 50,000.00 f. 62,500 112,500.00
Merchandise Inventory 1,250,000.00 1,250,000.00 1,000,000.00 1,000,000.00
Furniture and Equipment 1,500,000.00 1,500,000.00
Accumulated Depreciation 200,000.00 b. 150,000 350,000.00
Notes Payable 500,000.00 500,000.00
Accounts Payable 375,000.00 375,000.00
Fernando, Capital 1,250,000.00 1,250,000.00
Fernando, drawing 155,000.00 155,000.00
Gomez, Capital 3,125,000.00 3,125,000.00
3. The remainder is divided in the ratio of 3:2.

Gomez, Drawing 250,000.00 250,000.00

Sales 5,000,000.00 5,000,000.00
Sales Returns and Allowances 50,000.00 50,000.00
Sales Discount 75,000.00 75,000.00
Purchases 2,412,500.00 2,412,500.00
Purchases Returns and Allowances 100,000.00 100,000.00
Purchase Discounts 62,500.00 62,500.00
Freight- In 125,000.00 125,000.00
825,000.00 b. 90,000 g. 15,000 925,000.00
Selling Expenses c. 25,000
General Expenses 362,500.00 b. 60,000 g. 10,000 475,000.00
c. 62,500
Interest Income 17,500.00 d. 2,500 20,000.00
Interest Expense 25,000.00 e. 1,500 26,500.00
Total 10,680,000.00 10,680,000.00
Salaries Payable c. 25,000 25,000.00
Interest Receivable d. 2,500 2,500.00
Interest payable e. 1,500 1,500.00
Supplies on Hand g. 25,000 25,000.00
Income tax Expense h. 253,050 253,050.00
Income Tax Payable h. 253,050 253,050.00
TOTALS 519,550.00 519,550.00 5,592,050.00 6,182,500.00 6,582,500.00 5,992,050.00
PROFIT 590,450.00 590,450.00
A work sheet prepared for the partnership and the related statement of financial position and

TOTALS 590,450.00 6,182,500.00 6,582,500.00 6,582,500.00

Financial Accounting and Reporting Part 1

Computation of income tax and profit :

Total credit per income statement before income tax ₱ 6,182,500.00
Total debit per income statement before income tax 5,339,000
Profit before tax ₱ 843,500.00
Income tax (P843,500 x 30%) 253,050
Profit ₱ 590,450.00
 Financial Accounting and Reporting Part 1 63

EXCEL CORPORATION
Statement of Changes in Partner‟s Equity
For the Year Ended December 31, 2019

Fernando Gomez Total

Equity, January 1 P1,250,000 P3,125,000 P4,375,000
Add Profit for 2019:
Salaries P 400,000 P 500,000 P 900,000
Interest on beginning capital 125,000 312,500 437,500
Balance – 3:2 (P747,050)
P747,050 x 3/5 ( 448,230)
P747,050 x 2/5 ( 298,820) (747,050)
Total share profit P 76,770 P 513,680 P 590,450
Total P1,326,770 P3,638,680 P4,965,450
Less Withdrawals 155,000 250,000 405,000
Equity, December 31 P1,171,770 P3,388,680 P4,560,450

EXCEL CORPORATION
Comprehensive Statement of Income
For the Year Ended December 31, 2019

Schedule
Net Sales 1 P4,875,000
Cost of Sales 2 2,625,000
Gross Profit P2,250,000
Other Operating Income- Interest 20,000
Operating Expenses:
Selling P925,000
General 475,000 (1,400,000)
Operating Profit P 870,000
Interest Expense ( 26,500)
Profit before tax P 843,500
Income Tax Expense (30%) ( 253,050)
Profit for the Period P 590,450

Division of profit
Fernando Gomez Total
Salaries P400,000 P500,000 P900,000
Interest on beginning capital 125,000 312,500 437,500
Balance – 3:2 (P747,050)
P747,050 x 3/5 (448,230)
P747,050 x 2/5 (298,820) (747,050)
Total share in profit P 76,770 P 513,680 P 590,450

Schedule 1- Net Sales

Sales P5,000,000
Less: Sales Returns and Allowances P50,000
Sales Discounts 75,000125,000
Net Sales P4,875,000
64 Financial Accounting and Reporting Part 1

Schedule 2- Cost of Sales

Merchandise Inventory, January 1 P1,1250,000

Net Purchases
Purchases P2,412,500
Add Freight In 125,000
Total P2,537,500
Less: Purchases Returns and Allowances P100,000
Purchases Discounts 62,500 162,500 2,375,000
Cost of Goods Available for Sale P3,625,000
Less Merchandise Inventory, December 3 1,000,000
Cost of Sales P2,625,000

Key points. The Statement of Income of a partnership is similar to that of a sole proprietorship except
that it includes a schedule showing the division or distribution of profit to partners.

EXCEL CORPORATION
Statement of Financial Position
December 31, 2019

Assets
Current Assets:
Cash P1,900,000
Notes Receivable 625,000
Accounts Receivable P1,125,000
Less Allowance for Uncollectible Accounts 112,500 1,012,500
Interest Receivable 2,500
Merchandise Inventory 1,000,000
Supplies 25,000 P4,565,000

Furniture and Equipment P1,500,000

Less Accumulated Depreciation 350,0001,150,000

Total Assets P5,715,000

Liabilities
Current Liabilities:
Notes Payable P 500,000
Accounts Payable 375,000
Salaries Payable 25,000
Interest Payable 1,500
Income Tax Payable 253,050
Total Liabilities P1,154,550

Partners‟ Equity

Fernando, Capital P1,171,770

G0mez, Capital 3,388,680
Totals Partners‟ Equity 4,560,450

Total Liabilities and Partners‟ Equity P5,715,000

 Financial Accounting and Reporting Part 1 65

JOURNALIZING CLOSING ENTRIES IN THE PARTNERSHIP BOOKS

DATE DESCRIPTIONS DEBIT CREDIT

Sales 5,000,000
Interest Income 20,000
Purchase Returns and Allowances 100,000
Purchase Discounts 62,500
Income Summary 5,182,500
To close the revenue and other nominal
accounts with credit balance.

Income Summary 4,342,050

Sales Returns and Allowances 50,000
Sales Discounts 75,000
General Expenses 475,000
Selling Expenses 925,000
Purchases 2,412,500
Freight In 125,000
Interest Expense 26,500
Income Tax Expense 253,050
To close the expenses and other
nominal accounts with debit balance.

Income Summary 590,450 513,680

Fernando, Capital 76,770
Gomez, Capital
To close the income summary account.

Fernando, Drawing 155,000

Gomez, Drawing 250,000
Fernando, Capital 155,000
Gomez, Capital 250,000
To close the drawing accounts.

CORRECTION IN PROFIT FOR ERRORS ANDOMISSIONS PRIOR TO DISTRIBUTION

The partnership books may show an incorrect profit because of errors and omissions. Such include
failure to record prepaid expenses, accrued expenses, accrued income, unearned income and also
overstatement or understatement in purchases, inventories, and depreciation. The reported profit should
be corrected before it is distributed to the partners. The required corrections may be summarized as
follows:
66 Financial Accounting and Reporting Part 1

Correction to profit of current year for

errors made in
Prior Year Current Year
1. Unrecorded prepaid expenses - +
2. Unrecorded accrued expenses + -
3. Unrecorded accrued income - +
4. Unrecorded unearned income + -
5. Overstatement of inventories + -
6. Understatement of inventories - +
7. Understatement of purchases - +
8. Understatement of purchases + -
9. Overstatement of depreciation none +
10. Understatement of depreciation none -

It is understood that the tax implications of these corrections are properly accounted for particularly if the
partnership is not a general professional partnership.

Illustrative Problem : Honey, Ina, and Juan are partners sharing profits on a 2:3:5 ratio. On January 1,
2019, Kent was admitted into the partnership with a 20% share in profits. The old partners shall continue
to participate in profits in proportion to their original ratios.

For the year 2019, the partnership books showed a profit of P450,000. It was ascertained, however, that
the following errors were made:

1. Accrued expenses not recorded at the end of 2018 P 5,000

2. Overstatement of 2019 ending inventory 48,000
3. Goods received and inventoried in 2019 but related purchases
not recorded 20,000
4. Income received in advance (unearned income), not recorded
at the end of 2018 10,000
5. Prepaid expenses not recorded at the end of 2018 3,000

The correct profit of 2019 based on a 30% income tax rate shall be computed as follows:

Reported profit P450,000

Corrections:
Unrecorded accrued expense, 2018 P 5,000
Unrecorded unearned income, 2018 10,000
Overstatement of ending inventory, 2019 (48,000)
Unrecorded purchases, 2019 ( 20,000)
Unrecorded prepaid expenses, 2018 ( 3,000)
Total corrections before income tax P(56,000)
x 70%

Total corrections after income tax (39,200)

Corrected profit P358,800
 Financial Accounting and Reporting Part 1 67

The corrected profit shall be divided among partners as follows:

Honey P450,000 x (20% x 80%) P57,408

Ina P450,000 x (30% x 80%) 86,112
Juan P450,000 x (50% x 80%) 143,520
Kent P450,000 x 20% 71,760
P358,800

REVIEW of the LEARNING OBJECTIVES

1. Discuss the closing entries in a partnership and differentiate them form the
closing entries in a sole proprietorship. The closing entries of a partnership
are almost similar to those of a sole proprietorship. However, the profit or loss of
the partnership is transferred to the individual drawing account or capital account
of the partners and is distributed according to the profit and loss sharing
agreement.

2. Identify and discuss the different methods and rules of dividing partnership
profits and losses to the partners. The distribution of partnership profits and
losses to the partners may be expresses in any of the following ways: (1) by
percentage; (2) by fraction; (3) by decimal; or (4) by ratio. The Civil Code of the
Philippines provides rules on how partnership profits and losses be divided
among the partners. As a general rule, profits or losses should be divided in
accordance with the partner‟s agreement. In the absence of an agreement, the
division shall be made in accordance with capital contributions. To give
recognition to the services rendered by the partners or to the differences in the
amount contributed in the partnership or to the entrepreneurial ability or
managerial skill of the partners, salaries, interest and bonuses may be allowed to
partners as part of the division of profits and losses.

3. Discuss and understand the preparation of financial statements of a

partnership. The financial statements are prepared after the work sheet is
completed ( or after journalizing and posting the adjusting entries if a work sheet
is not prepared). These financial statements include the income statement, the
statement of financial position, and the statement of changes in partners equity.
The income statement includes a schedule showing the division of the
partnership profit or loss to the “Partner‟s Equity” and it shows capital balances of
individual partners. The statement of changes in partners equity shows the
division of profit or loss to the partners, the amount of withdrawals during the
period, and the partner‟s capital balances at the end of the period.