COLLEGE OF ACCOUNTANCY

C-APrE6 Accounting for Special Transactions

First Semester | AY 2020-2021

Module 2

A. Course Code – Title : Accounting for Special Transactions

B. Module No – Title : MO2 – Partnership Operation
C. Time Frame : 1 week – 3 hours
D. Materials : Course Guide, reference books, writing materials

1. Overview
This learning material provides a discussion of Partnership Operation concepts. It
introduces the learner to the subject, guides the learner through the official text, develops
the learner’s understanding of the requirements through the use of examples and indicates
significant judgements that are required in accounting for partnerships. Furthermore, the
module includes questions that are designed to test the learner’s knowledge of the
concepts pertaining to accounting for special transactions.

2. Desired Learning Outcomes

At the end of the learning session, you should be able to:
a. Explain the purpose of partnership operation.
b. Identify the legal provisions on profit and loss distribution.
c. State the items that affect the division of a partnership’s profits or losses
among partners.
d. Identify the factors for a fair and equitable method of distribution.
e. Discuss the accounting procedures and concepts of partnership operation.
f. Compute for the share of a partner in the partnership’s profit or loss.

3. Content/Discussion

PARTNERSHIP OPERATION
The accounting process for recording revenues and expenses depends on the kind of
operation of the business. At the end of the year, these nominal accounts are closed to the
title Income Summary. For a merchandising business, the postings to this account will
appear as follows:

Income Summary
Cost of Sales Net Sales
Expenses

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

The Income Summary account is also to be closed. Its closing entry depends on the form of
ownership. A credit balance (representing profit) should be closed as follows:

For a sole proprietorship : Income Summary xxx

Owner's, Capital or Drawings xxx
For a partnership : Income Summary xxx
Partner X, Drawings xxx
Partner Y, Drawings xxx
For a Corporation : Income Summary xxx
Retained Earnings xxx

Note that in a sole proprietorship, it does not make a lot of difference if net income
is immediately credited to the capital account since there is only one owner to reckon with.
However, in a partnership, distinguishing the capital account from the drawing account is
important as there are two or more owners who must agree on how profit drawings will be
made and this is usually contained in the Articles of Co-Partnership. It is advisable to use
separately and carry to the next accounting period the balance of the drawing accounts
when it is the intention of the partners to withdraw regularly their profit share (especially
if in the form of salaries) or when the profit sharing agreement is based on capital in excess
of capital investment. When the partners' drawings accounts are used to record profit
share less withdrawals, it parallels the retained earnings account in a corporation. The
balances of the capital accounts and drawing accounts make up the partners' equity at the
end of the period, whether or not the drawing account balance is closed to the capital
account as illustrated and explained in the previous module.

LEGAL PROVISIONS ON DIVISION OF PROFIT OR LOSS

1. Profit and loss are distributed based on the partners' agreement as provided in the
Articles of Co-Partnership.
2. If the agreement is only on distribution of profit, but the result of operations is a loss, the
same agreement may be applied.
3. In the absence of an agreement as to how to distribute the profit or loss, then the
distribution should be based on the partners' contribution.
4. An industrial partner shares in the profit only unless there is a specific agreement that
the partner shares in the loss sustained by the business.
5. The profit contemplated for distribution to the partners should be the net profit after tax.
Partnerships, like corporations, are subject to the 30% tax as provided for in The National
Internal Revenue Code. Exempted from this tax liability are the general professional
partnerships such as the consultancy firms rendering professional services.

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

The law has made no specific provision on what partners' contribution balance
should be used when allocating profit. Should it be the beginning, the average or the ending
capital contribution? Author's opinion, in this case, would be to use the average capital at
the end of the year if only for a fair and equitable distribution. Should it also consider all
changes including profit share net of regular drawings? It is the author's opinion that when
the partner's withdrawal and unwithdrawn profit share are material in amount then they
must be closed to the capital account and considered capital contributions. In both cases, it
is advisable that provisions regarding these problems be contained in the Articles of Co-
Partnership.

METHODS OF DIVIDING PROFIT OR LOSS

The usual methods of dividing profits and losses are as follows:
1. Arbitrary or any agreed ratio
2. Capital ratio using either initial or original capital, beginning capital, ending capital or
average capital
3. Interest on investments, remaining profit to be divided in an agreed ratio
4. Salaries to partners, balance to be divided in an agreed ratio
5. Combination of: interest on investments, salaries to partners, balance to be divided in an
agreed ratio
6. Bonus to the managing partner, balance to be divided in an agreed ratio

FACTORS FOR A FAIR AND EQUITABLE DISTRIBUTION METHOD

Usually the profit or loss distribution is based on the partners' capital contributions.
However, if the partners do not render equal time in managing the business or do not have
the same skills or entrepreneurial ability, then the capital contribution would not result in
a fair and equitable distribution. To illustrate, suppose Wency, Rex and Vhinson, CPAs,
contributed P200,000 each to put up an accounting and tax service business, but only Rex
is rendering full time service with Wency and Vhinson rendering half time. A fair and
equitable way of distributing the profit would be to give them salaries in proportion to the
time service rendered with the remaining profit distributed equally among them. Or
suppose all of them are rendering full time service but their capital contributions are not
the same, then the best way is to give them equal monthly salaries for their services and
any residual profit to be distributed in proportion to their capital contributions. Or
compute interest based on their capital contributions with the residual profit distributed
equally considering the equal time of service they will render.

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

ACCOUNTING PROCEDURES
Compute for the Adjusted Net Income/Loss prior to distribution and allocate based on (in
particular order):

Profit Distribution Rule:

1. Profit sharing agreement
2. Capital ratio
a. Original capital balance
b. Capital during the year the profit is earned
a) Weighted average capital balance
b) Opening capital balance

Loss Distribution Rule:

1. Loss sharing agreement
2. How profit is divided

In addition to p/l agreement, the partners may provide for the following methods of
profit or loss distribution:

1. Salary – compensation for services; provided for regardless of the existence of profit
because the provision of services by a partner is independent from the earnings of
profit.
 This could be in fractional year (It considers time)
 Given, regardless of the result of operation

2. Interest – compensation for use of partner’s capital; provided for regardless of the
existence of profit because the use of the partner’s capital is independent from the
earnings of profit.
 This could be in fractional year (It considers time)
 Given, regardless whether there is profit or loss
(*Use the salary/interest ratio if the problem states that the amount to be distributed to the
partners is up to the extent of profit only or the profit is distributed based on priority.)

3. Bonus – compensation for good performance; provided only when the partnership has
profit. Bonus bases:
a. before bonus: bonus = bonus base x bonus rate
b. after bonus: bonus = bonus base x [bonus rate/(100% + bonus rate)]

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

CASE 1: Net income of P500,000 before salaries of P55,000, interest of P13,000 and bonus
of 15%.

B = Net Income – Salaries -Interest X Bonus Rate

1 + Bonus Rate

B = P500,000 – P55,000-P13,000 X 15%

1+.15

B =P432,000 X
1.15

B = P56,347.83

CASE 2: Net income of P100,000 after salaries of P5,000, interest of P3,000 and bonus of
10%.

B = Net Income + Salaries +Interest X Bonus Rate

1 – Bonus Rate

B = P100,000 + P5,000+P3,000 X 10%

1 - .10

B =P108,000 X
0.90

B = P12,000

4. Remainder (whether positive or negative) based on P/L ratio

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

Illustrative Problems:
A. Basic profit or loss distribution rules
Alexander and Eddie formed a partnership on January 1, 2008 by contributing P80,000 and
P120,000, respectively. As of January 1, 2009, their partnership capital were P90,000;
P110,000, respectively.

Situations:
A. No profit sharing agreement C. Profit is divided equally
B. No loss sharing agreement D. Loss divided 30:70 to Alexander and Eddie, respectively

Required: Compute the share of Alexander and Eddie assuming:

P40,000 profit P40,000 loss

*Situational Cases Alexander Eddie Alexander Eddie
1. A and B __________ __________ __________ __________
2. B and C __________ __________ __________ __________
3. A and D __________ __________ __________ __________
4. C and D __________ __________ __________ __________
5. C and D with guaranteed P25,000
minimum profit sharing to Eddie __________ __________ __________ __________

Weighted-interest computation
The following summarizes the capital transactions of partners Grace and Loida which
started operation during 2009:

Investments Grace Loida

(Drawings)
April 1 P 90,000 P 108,000
June 30 60,000 12,000
August 1 -- ( 16,000)
September 30 ( 18,000) --
November 1 27,000 --
December 31 -- ( 30,000)

Required: Compute the weighted average capital balance of each partner.

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

B. Bonus Computation
Mandy and Soledad shares profit equally after providing for annual salaries of P150,000
and P180,000, respectively, and a 10% bonus after salaries and bonus to Mandy. The profit
or loss statement of the partnership for whole year is shown below:
Sales P 6,000,000
Cost of sales 3,000,000
Gross profit P 3,000,000
Expenses 2,450,000
Net profit P 550,000

Required:
1. Compute the amount of the bonus ______________
2. Compute the bonus assuming expenses are inclusive of the salaries ______________
3. Compute the bonus assuming expenses includes bonus and salaries ______________

4. Progress Check

1) Enumerate at least five methods of dividing partnership profit and loss. How do
you make a choice on what is the best and equitable method of distribution?
2) The partnership of Popoy and Kokoy decided to admit Dodoy to a one-fourth
interest in the partnership upon his investment of P500,000. Does this
necessarily mean that Dodoy would be entitled to a one-fourth share in the net
income or loss of the business? Explain.
3) The partnership agreement provided for the following: Rolly and Polly are to
divide profit and loss in the ratio of 7:3, respectively and each one is to draw
P5,000 salary per month, Explain what possible difficulties may be encountered
by the accountant.
4) Partners Lard and Oil had the following agreement: 24% interest on average
capital, remainder to be divided in the average capital ratio. Comment on this
agreement.
5) Partners Sammy and David established a partnership on January 1, 2010 by
investing cash of P500,000 and P750,000, respectively. There was no agreement
on the division of profit. The result of operation after one year is P250,000. How
would this amount be divided between them?
6) The partnership agreement provides for division of profit and loss based on
capital balances of the partners. Comment on this agreement.
7) If the partnership agreement provides for interest on capital contributions and
salaries to partners, will there be a distribution for these even if the operation
resulted in a net loss? Explain.

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

5. Assignment
Partners A and B agreed to share profits in the following order of distribution:
a. Interest of 10% on weighted average capital
b. Salaries of P60,000 to A and P40,000 to B
c. Residual profit, equally

Loss is shared by A and B 40:60. Details of the capital accounts of A and B is shown as
follows:
A B
Debit Credit Debit Credit
January 1 - P 240,000 - P 360,000
March 30 - 40,000 P 20,000 -
April 30 - - - 18,000
July 1 P 20,000 - 21,000 -
September 30 - 80,000 - 60,000
November 1 30,000 - - -
December 30 - - 30,000 -

The partnership made P180,000 net income. B’s share in the profit is
a. P95,675 b. P95,550 c. P84,450 d. P84,325

What is A’s ending capital balance?

a. P394,325 b. P394,450 c. P394,450 d. P405,675

6. Evaluation
Answer the following questions:
1. At the end of the year of operation, the profit or loss summary has a debit balance of
P60,000. Partners A, B and C contributed P100,000, P200,000 and P300,000 and shares
profits 20:30:50, respectively. In closing the profit or loss summary, which statement is
correct?
a. A’s capital, P10,000 debit c. B’s capital, P18,000 debit
b. A’s capital, P10,000 credit d. C’s capital, P30,000 credit

2. As of December 31, 2008, D, E and F have adjusted capital balances of P100,000,

P250,000 and P150,000, respectively, and shares profits equally. At the start of 2009,
the partners admitted G for a 10% interest in profit and capital by contributing
P100,000. The partnership earned P120,000 net income in 2009. How much is E’s share
in the partnership profit?
a. P24,000 b. P36,000 c. P54,000 d. P40,000

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

3. D and E agreed to share profits and losses 40:60, respectively after providing E 17%
bonus on partnership net income after tax and after bonus. D received P36,000 as final
profit distribution. The share of the partners in partnership profit is subject to 10%
withholding tax. The partnership is also subject to 35% income tax. Compute the
partnership operating income assuming that it equals taxable income.
a. P117,000 b. P150,000 c. P180,000 d. P160,000

4. Darrel, Rhad and Bal are partners. The partners agreed to share profit 40:30:20. Darrel
sold ½ o his interest to Rhad for P100,000. Subsequently, the partnership admitted
Andrix for a 10% interest. What is Rhad’s profit ratio after Andrix’ admission?
a. 27% c. 50%
b. 45% d. 54%

5. The partnership reports profits of P80,000, net of P20,000 salaries and P30,000 interest
and a bonus. The bonus is computed as 20% of profits after salaries and interest.
Compute the amount of the bonus.
a. P16,000 c. P26,000
b. P20,000 d. P32,500

6. The partnership of Alec and Boy reported profits of P120,000 in 2009 and divided the
same in their profit-sharing ratio of 40:60, respectively. An examination of the books
revealed the following:
 An equipment costing P30,000 which should have depreciated for 4 years was
expensed on January 2, 2009.
 Supplies of P5,000 was omitted from the records.
 An inventory costing P15,000 was omitted from the records. The purchase was not
recorded because the invoice was in transit as of the balance sheet date.

What is the net adjustment to the Capital account of Alec?

a. P11,000 increase c. P17,000 increase
b. P11,000 decrease d. P17,000 decrease

7. Katrina and Horace formed a partnership. They agreed to divide profits 40:30,
respectively, after providing for salaries of P10,000 to Katrina and P20,000, to Horace
and an interest on beginning capital. Interest traceable to Katrina and Horace were
P4,000 and P2,000, respectively. If Horace received total profit sharing of P28,000,
compute the partnership profit during the year.
a. P46,200 c. P56,000
b. P48,000 d. P50,000

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 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

8. Elvie and Lito are partners sharing profits as follows:

 P10,000 and P20,000 salaries to Elvie and Lito, respectively. The salary provision
shall be increased by 50% each when profit exceeds P50,000.
 Residual profit is shared equally.

If Elvie received P25,000 profit share, what was the partnership profit?
a. P75,000 b. P65,000 c. P60,000 d. P50,000

9. Cabrera, Mateo and Ampil agreed to the following profit share:

 Salaries of P20,000 and P30,000 to Mateo and Ampil, respectively.
 Residual profit sharing of 50:30:20 to Cabrera, Mateo and Ampil, respectively.
 Guaranteed minimum profit share of P40,000 to Cabrera and P30,000 to Mateo,
respectively.

Compute the partnership profits if Ampil received P40,000 profit sharing.

a. P115,000 b. P120,000 c. P135,000 d. P150,000

10. As of February 1, 2010, A, B and C have beginning capital balances of P100,000,

P200,000 and P200,000, respectively. They agreed to share any losses in the ratio of
30:30:40, respectively. The partnership profit was reported as P50,000. Ending capital
balances of A, B and C were properly determined as P120,000, P220,000 and P180,000,
respectively, based on the reported profit.

An evaluation of the books as of December 31, 2010 disclosed that the correct
partnership income was only P30,000. Based on the above facts, compute the net
drawings or additional investments made by partners A, B and C, respectively, during
the year.
a. P5,000, P5,000; (P40,000) c. P10,000; P0; (40,000)
b. P5,000, P5,000; (P20,000) d. P14,000; P8,000; (P32,000)

Faculty: WENCY M. GIRON 10 | P a g e

 COLLEGE OF ACCOUNTANCY
C-APrE6 Accounting for Special Transactions
First Semester | AY 2020-2021

E. References

1. Manuel, Z.V. (2016). Advanced Accounting. Manila, Philippines: GIC Enterprises

2. Advanced Financial Accounting and Reporting review materials by Wency Giron

Prepared by:
Mr. Wency M. Giron

Faculty: WENCY M. GIRON 11 | P a g e