Chapter 2

Partnership Operations
The accounting
system of a partnership, including the
and the accounting classification of accounts
concepts, is essentially the same as that
businesses. The accurate determination of otherprofit-oriented
to the of periodic net income and its distribution
partners is still the primary objective of the
end, a partnership is treated as a accounting process. To this
separate and distinct accounting entity
Net income is computed in the usual
manner, that is
expenses, then credited to the individual capital accounts.matching revenues and
becomes more complex because of the However, the treatment
differences
abilities and talents of individual partners, and in time
in capital contributions, in
spent on partnership duties
by the individual partners.
The usual types of
accountingproblems for partnership operations are classified
as follows:
1. Determination of the proper distribution of pårtnership profits and losses among
the partners.
2
Preparation offinancial statementsfor the partnership, such as balance sheet,
income statement, statement ofpartners capitals; and cash flows.
3. Changes in the profit and loss ratios.
4. Correction of net income (loss) of prior jyears.

DIVISION OF PROFITS AND LOSSES

The partnership law provides that profits and losses ofthe partnership are to be divided
in accordance with the partners agreement. If no agreemetis made between and among
the partners, profits and losses are to be divided according to their original capital
dontributions. Should the partners agree to divide the profits only,losses, if any areto
be divided in the same manner as that of dividing profits. However, should the partners
agree to divide losses only, profits, if any shall be divided by the partners according to

uheir original capital contributions.

49
 50 Chapter 2
The ratio in which partnership profits and losses are divided is known as the profit and
loss ratio. The manypossible methods of dividing net income or loss among
partners
may be summarized as follows:

1. Equally.
2. In an unequal or arbitrary ratio.
3. In theratio of partners'
of average capital
capital account balances on a particular date, or in the ratio
account balances during the year.
4. Allowing interest òn
partners' capital account balances and dividing the remaining
net income or loss in a
5. Allowing salaries to
specified ratio.
partners and dividing the remaining net income or loss in a
specified ratio.
6. Bonus to managing
partner based on net income.
These altemative methods
emphasize that the value of personal services rendered by
individual partners may vary widely, as
may the amounts of capital invested by each
partner. The amount and quality of managerial services rendered and the amount
of
capital invested are also important factors to be considered in
sharing agreement. Therefore, as a preliminary step, agreements determining profit
the
salaries to partners and interest on their should be made for
respective capital account balances. Any
remaining
profit or loss then may be divided in a specified ratio. The
will show how each of following series ofilustrations
the methods of dividing profits and loses may be applied.
ILLUSTRATION OF PROFIT DISTRIBUTION
Assume that on January 1,2016,Siy and Tiu formed a
of 30,000 by Siy and P60,000 byTiu. On December partnership with an investment
income and expense accounts, the Income 31, 2016, after closing all
Summary account shows a credit balancce
ofP60,000, representing the profit for the year 2016. Changes in the
during 2016 are summarized as follows: capital accounts
lustration 2-1
Changes in Partners' Capital Accounts

Siy Tiu
Capital balances, January 1, 2016 P40,000 P 60,000
Additional investments, March 1
20,000 50,000
Additional investments, August 1
20,000 40,000
Withdrawal, October 1
Withdrawal, November 1 20,000)
(50,000)
Capital balances, December 31, 2016 P60,000 PI00,000o
Partnership Operations

Division of Profit and Loss Equally

This agreement to divide profits and loases is common in practice because of its simplicity
On December 31, 2016, the net income of P60,000 is transferred from the Income
Summary account to the partners' capital account by the following closing entry

Income summary 60,000

Siy capital 30,000
Tiu capital 30,000
To record division ofnet income for 2016.

On the other hand,if the business operations resulted to a loss of P10,000 during the
year, the Income Summary account would show a debit balanceof P10,000.The loss
is transferred to the partners' capital accounts by the following closing entry.

Siy capital 5,000

Tiu capital 5,000
Income summary 10,000
To record division of net loss for 2016.

Ratios
Division of Profit and Loss in an Arbitrary (unequal)
ASsume that Siy and Tiu agreed to divide profits of
and losses in the ratio 60% to Siy
receive 60% ofthe net income (perhaps
and40% to Tiu. The agreement that Siy should
in the field or various business contacts)
because ofgreater experience and expertise net loss if the partnership operated
Would cause Siy to shoulder a larger share of the
individual partners
income of P60,000 to
unprofitable. Closing entry to divide the net
capital accounts for 2016 follows:
60,000
Income summary 36,000
Siy capital 24,000
Tiu capital
10 record division of profit computed as Jollows:
Siy: 60%x P60,000=P36,000
Tiu: 40%x P60,000 24,000
Total P60,000
 52
Chapter 2

Division of Profit and Loss in the Ratio of Partners'Capital Account Balances

The capital contributions of partners are usually considered in the determination
off
profit and loss sharing agreements. If partners' capital
is considered in allocating
partnership income, the agreement should specify whether the ratio is based on the
original capital contributions, beginning capital balances, ending capital balances, or
average capital balances. In addition, several interpretations
are possible, and
ofaverage capital balances
capital balances may be determined before or after drawing accounts
are closed to the
partners' capital accounts.
Ratio of Original
Capital Contributions. This ratio is used if no agreement is made
between partners. The allocation is as follows:
Inome hmmary G6K

Siy: P60,000 x 30,000 P90,000 Siy, Capita

P20,000 Tt, cnpifal
Tar P60,000 xé60,000 P90,000 P40,000
The journal entry to close the Income Summary account would be
entry presented on page 51. similar to the journal

Ratio of Beginning
Capital Balances. Assuming that the net income is divided in the
ratio of capital balances at the
income ofP60,000 for 2016 isbeginning of the year, as shown in Illustration 2-1, the net
divided as follows:
Siy: P60,000 x P40,000 P100,000 P24,000
Tr P60,000 x
P60,000 P100,000 P36,000
Ratio of Ending Capital Balances.
ratio of capital balances at the end Assuming
that profit or loss is to be
divided in the
of
income ofP60,000 for 2016 is divided isthe year, as shown in Illustration 2-1. The net
follows:
Siy P60,000 x P60,000/ P160,000 P22,500
Tir P60,000 x
P100,000/ P160,000P37,500
Partnership Operations 53

Division of net income on the basis of (1) original capital investments, (2) Depu
capital ccount balances, or (3) ending capital account
capital a c c balances may be unreasonable
if there are
material changes in the capital accounts during the year, Use of avera
capital balances is preferable because it reflects the capital actually available for use oy
the partnership during the year.

Ratio ofAverage Capital Balances. If the partnership agreement provides to divide

net income in the ratio of average capital balances during the year, it should also
statc
the amount of drawings each partner may make without affecting the capital accounl.
Any additional withdrawals or investments are entered directly to the partners' capital
accounts and therefore should be considered in the computation of the average capital
ratio.

The average capital balances for year can be computed using two methods (1) the
simple average of the beginning and ending capital balances of each partner, or (2) the
peso month/peso day method.

SimpleAverage Method Refering to thedatain lustration 2-1, the average capitals

of Siy and Tiu using this method are computed first as follows:

Siy:
Siy: (P40,000 P60,000)* 2 P 50,000
Thr (P60,000P100,000) + 2 (80,000
Total P130,000

The net income can now be divided as follows:

Siy: P60,000 x P50,000/ P130,000 P23,077

Tr P60,000 x P80,000,/ P130,000 P36,923

Under this method, partners drawing account

Peso-Month /Peso-Day Method. not be deducted in
to the amounts specified in the agreement would
balances up or year-end capital
balances. For purposes of dividing
the partners' average
determining amounts are deducted from the
income, drawings in excess of allowable
partnership average capital balances.
The partnership
partners' accounts in computing
capital be computed to the
account balances are to
whether capítal
Contract should also state Acommon practice is to treat
withdrawals and
nearest day.
nearest month or to the asif they were made on the first day
the first half of the month
nvestments made during withdrawals and investments during the latter half of the
ofthe month, and to treat ofthe following month.
made on the first day
nonth as if they were

tne Monh
)
s fist day of month )
*Hofint dy of Hhe fbllowIn9
54 Chapter 2

Using the data in Ilfustration 2-1, the computation of average capital balances to the
nearest month and the division ofnet income for
Siy and Tiu for 2016 are as follows:
lustration 2-2
Siy and Tiu Partnership
Computation of Average Capital Account Balances
Year Ended December 31, 2016

Capital Average
Investments
Fraction Capital
Account ofYear Account
Partner Date
(Withdrawals) Balance Unchanged Balances
Siy January 1-Fc> A P40,000 P 40,000 2/12 P 6,667
March 1 - 20,000 60,000 5/12
August 1 20,000 25,000
80,000 2/12 13.333
October 1 (20,000) 60,000 3/12
15,000
P 60,000
Tiu January l P60,000 P 60,000 2/12
March 1 P 10,000
50,000 110,000 5/12
August 11 40,000 45,833
150,000 3/12
November 1 & (50,000) 100,000
37,500
2/12
16,667
Total average capital account
PI10,000
baBances
PI70,000
The net income of P60,000 on December
31,2016 can now be divided as follows:
Siy: P60,000x P60,000 P170,000 =P21.177
Tur P60,000 x P110,000 P170,000 P38,823
If the
partnership agreement of Siy and Tiu specifies that income is to
based on partners' be divided
capital balances, but fails to specify how capital balances are to be
computed
the
the average capital balances should be used if it can
be computed. If
origina)capital balances should be used. not.
Partnership Operations
55
Interest Allowed on Partners' Capital with Remaining Profit or Loss Divideu
in an Agreed Ratio.

Partnership contract may provide for interest allowances on partners' capital in order
to encourage capital
investments. Remaining profits are then divided
other specitied ratio. Interest allowed to partners varies from one equally
or in
any
to
partner anotne
due to the differences of capital contributions and balances.
Partnership contract
therefore provide that a specific interest rate shall be allowed to a partner basedshould
on his
beginning capital balances, ending capital balances, or average capital balances.
Using interest allowances on partners' capital account in order to achieve a reasonable
profit distribution has no effect on the computation of the net income or loss of the
partnership. nterest on partners capital accounts is not an expense of the
partnership
Ilustration of Allocating Net Profit. Again refer to Siy andTiu Partnership with a
net income of P60,000 for 2016 and capital account balances as shown in Ilustration
2-1.Assume that the partnership agreementallows interestonpartners'average.capital
account balances at 12%, with anyremaining net income or loss to be divided equally.
The net income of P60,000for 2016 is divided as follows:

lustration 2-3
Schedule of Profit Distribution

Siy Tiu Total

Interest on average capital: P 7,200

12% P 7,200
Siy: P 60,000x
Tiu: PI10,000x 12%
P13.200 13,200/0400
19,800 19,800 39,600
Remainder (P60,000- P20,400), equally P60,000) he amne

Totals
P27,000 P33,000 P60,000Otinsom
Income Summary
account on December 31, 2016 is
to close the
The journal entry
presented below:
60,000
Income summar 27,000
33,000 nls
Siy capital
Tiucapilal income.
To record division of net
56 Chapter 2

Illustration ofAllocating Net Loss. As a separate case, assume thatthe partnership

operation results at a loss of P10,000. Ifthe agreement provides to allow interest on
capital account balances, the provision must be enforced regardless ofwhether
operating results is a profit orloss The interest allowance is not applicable during a
loss year only if the partners agreement contains a specific provision requiring Such
omission. Note that on thefollowingschedule ofloss distribution, the net loss ofP10,000
1Sincreased by the allowance for interest of P20,400 to determine the remainder of
P30,400 which is then divided equally.
lustration 2-4
Schedule of Loss Distribution

Siy Tiu Total

Interest on average capital account balances P 7,200 P 13,200 P 20,400
Remainder, equally -16K - 2040 = - o 6 o z (15,200)
(15,200) 30,400)
Totals P8,000) P2,000) P10,000)
The joumalentryto close the Income Summary account on December 31,2016 is as
follows:

Siy capital 8,000

Tiu capital 2,000
Income summary
To record division of net loss of 2016
10,000

In some cases, agreement allowing interest on

partners' capital accountbalances may
result to a net increase in one partners capital account
even though
vear resulted to aloss. To illustrate, assume the same conditions operations for the
as in the preceding
examples except that the net loss for the year is P1,000. The schedule of loss distribution
is presented below:

Ilustration 2-5
Schedule of Loss Distribution

Siy Tiu Total

Interest on average capital account balances P 7,200
P 13,200
Remainder, (P20,400+P1,000), equally P 20,400
(10,700) (10,700) (21,400)
Totals
P3,500) P2,500 P 1,000)
Partnership Operations
57
Take note that in the schedule (lustration 2-5). Siy capital will be decreased by P3.,500
while Tiu capital will be increased by P2,500.At first thought, the idea ofa businessio
ofP1,000 causing one partners' capital to increase and the other partners capi
decrease may appear unreasonable, but there is a sound logic to support this resu
Partner Iu contributed substantially more capital than Partner Siy; the capital was u s
in the partnership operations, therefore the fact that a loss was incurred is not a reaso
to deny recognition of Tiu'sgreater capital contribution.
The closingentry on December 31, 2016 is:

Siy capital 3,500

Tiu capital 2,500
Income summaryy 1,000
To record division ofnet loss for 2016.

Salary and Bonus Allowances

not equal,
the individual partners to the partnership are
When the services rendered by on partnership business,
or differences in time spent
due to differing abilities of partners and loss sharing
such differences through the use ofprofit
it is not proper to provide for profit sharing ratio
losses may fluctuate from year year, a fair
to
ratios. Since profits and for
division in another year. The best way to provide
an unfair
in one year may produce devotes time to the partnership
allow salaries to a partner who
these differences is to is to provide a bous
variation in profit and loss sharing agreements
business. Another maximization.
to encourage profit
to the managing partner
Wet Profit o r Loss Divided in
to Partners with Remaining
Salary Allowance
an Agreed Ratio.
allowances on capital
partner salary
allowances like interest income.
In partnership accounting,
expenses in
the
deternination
of partnershipnet
account balances are not of i n c o m e among the partners
based on the
ofachievingafair diyiSIon
They are a means
partnership
business.

time and talents devoted to

Partnership.
data for Siy and Tiu
Using the same P30,000 to Siv
llustration ofAllocating Net Profit. for an annual salary of
partnership agreement provides divided equally. The salaries
assume that the income or loss to be
net
with resultant income of P60,000 for
2016 is divided as
and P20,000 to Tiu, The net
during the year.
are paid monthly
follows:
 58 Chapter 2

Illustration 2-6
Schedule ofProfit Distribution

Siy Tiu Total

Salaries P30,000 P20,000 P50,000

Remainder (P60,000-P50,000), equally 5,000 5,000 10,000
Totals P35,000 P25,000 P60,000

The followingjournal entries are requiredfor the foregoing:

Monthly Journal Entries:

Siy drawing (P30,000/12) 2,500

Tiu drawing (P20,000/12) 1,667
Cash 4,167
To recordsalary allowances to partners.

End of Year Closing Journal Entries:

(1) Income summary 60,000

Siy capita 35,000
Tiu capital 25;000
To record division of net income for 2016.

2) Siy capital 30,000

Tiu capital 20,000
Siy drawing 30,000
Tiudrawing 20,000
To close partners' drawing accounts.

Partnership agreement should provide not only for partners salary allowances and the
sharing of profits but also for the treatment of salaries when losses are incurred. In the
absence of an agreement, salaries ate automatically allowed
are incurred even when losses

Illustration of Allocating Net Loss. Continuing our

December 31, 2016 Siy and Tiu illustration, assume that on
salary allowances to partners. ThePartnership
has a net loss of P20,000 before
schedule showing the
presented on the next page. distribution of loss 1S
 59
Partnership Operations

Tlhustration 2-7
Schedule of Distribution of Loss
Total
Siy Tiu
P 50,000
Salaries P 30,000 P 20,000
Remainder(P50,000 + P20,000), equally (35,000) (70,000)
(35,000)
P(20,000)
Totals P( 5,000) P(15,000)

The entry to record the division of loss on December 31,2013 is:

Siy capital 5,000

Tiu capital 15,000
Income summaryy 20,000
To record division of lossfor 2016.

But if partnership agreement provides that salaries are allowed to

the extent ofthe
occurs. Partners may also agree
earnings only, then no salaries are allowed when a loss
lower than the total salaries. Thus,
to allow salaries on a pro-rata basis if earnings are
salaries are allowed only to the
for example, ifa partnership agreement provides that
extent of income earned, and the agreement
also provides for salaries of P24,000 and
is divided as follows:
P36,000 to Allan and Boom respectively, a profit of P30,000

Siy: (P24,000/ P60,000) x P30,000 P12,000

Tr (P36,000/ P60,000) x P30,000 P18,000 deec.

Net Income
Bonus to Managing Partner Based
on

for a managing
bonus to the partner equal to a
A partnership contract may provide
When bonuses are to be allowed, the agreement must
specified percentage of income.
The computation of the bonus may be based on:
clearlyspecify the basis of the bonus.
interest and bonus.
1. Netincome before allowances for salaries,
for salaries and interest but after deduction of
2. Net income before allowancés
the bonus.
for salaries and interest but before bonus,
3. Net income after allowances
for salaries, interest and bonus.
4. Net income after allowances
 60
Chapter 2
Illustration. Assume that the partnership of Siy and Tiu has a net income of P190.200
before salaries, interest and bonus to partners. The partnership contract
the following
provides for

a. Salaries to Siy and Tiu, P30,000 each.

b. Interest on
capital account balances:
Siy P7,000
Tu 3,200
c. Bonus to Siy, 20%
d.
of net income.
Remaining profit or loss after salaries, interest and bonus, equally.
The share of the
partners in the net income of P190,200 using different basis
bonus is computed as follows: of the
Net Income Before Allowances
for Salaries, Interest and Bonus.
If the bonus is
computed based on the net income before salaries, interest and
computed as follows: bonus, the bonus is
Net income before
salaries, interest and bonus
Bonus percentage P190,200
Bonus 20%
P 38.040
Under this method, bonus
isvnot freated as an expense of the
ofcomputing the profit share of the partners. partnership but as a tool
The schedule showing the division
of net profit is presented below:
llustratlon 2-8
Schedule of Profit Distribution

Siy Tiu Total

Salary allowances
Interest allowances P 30,0000
P30,000 P 60,000
Bonus to Siy 7,000 3,200 10,200
Remainder, equally (140 200 -(ok 246)/2 38,040 38,040/ A
Totals 40,980 40,980 81,960
P116,020 P74,180 P190,200
 Partnership Operations 61

Net Income Before Allowances for Salaries and Interest, but After Deauc
of the Bonus. Using this as the base, the bonus is computed using algebraic equiau
as shown below:

>bon
Bonus+income after bonus= P190,200 Nef income befort plint,
intome
intomt
AFTCR
oons
+br 7.
LetX income after bonus inwmr
0.20X bonus Br * AFTER Bonuu
onus
Then 1.20X P190,200 income before bonus
X P190,000/ 1.20
X P158,500
20X P31,700

Alternatively the computation ofthe bonus may be as follows:

P190,200 = 120%
Net income before salaries, interest and bonus 158,500 = 100%
Net income after bonus (P190,200/120%)
P 31,700 = 20%
Bonus
ofbonus computation, the bonus to Siyistreated as
Under this method, for purposes
an expense.
schedule:
The division ofnet income
is shown in the following

Ilustration 2-9
Schedule ofProfit Distribution

Siy Tiu Total

P30,000 P 60,000
P 30,000
3,200 10,200
Salary allowances 7,000 31,700 1 O
Interest allowances 31,700 88,300
44,150 44,150
Bonus to Siy P101,900)
emainder, equally
(190,200-
P112,850 P77,350 P190,200
Totals
 64 Chapter 2

Statement of Changes in Partners' Equity

Changes affecting the partners' capital accounts each year are reported in a separate
statement known as the Statement of
Changes in Partners' Equity. The purpose of this
statement is to present the details that cannot be
readily incorporated in the statement of
financiai position. The following illustrative statement
ofchanges in partners' equity for
Siy and Tiu Partnership is based on the capital accounts presented in Illustration 2-1
and includes the division of
nt income presented in the statementof comprehensive
income (lustration 2-12).

llustration 2-13
Siy and Tiu Partnership
Statement of Changes in Partner's
Year Ended December Equity
31, 2016

Siy Tiu Total

Capital balances, January 1 P 40,000
Additional investments P 60,000
P100,000
40,000
Withdrawals (20,000)
90,000 130,000
Balances before (50,000) (70,000)
net income and drawings P 60,000
Comprehensive income (loss) P100,000 P160,000
Drawings 107,000 83,200 190,200
(30,000) (20,000)
Capital balances, December 31 (50,000)
PI37,000 P163,200- P300,200
Partners' capital balances at the end
of the year is reported in the
statement of financiai
position illustrated in the
as
next page. December31,2016
 Partmership Operations
65
Illustration 2-14
Siy and Tiu Partnership
Statement of Financial Position
December 31, 2016

Assets
Current Assets
Cash
Accounts receivable (net) P 62,000
Inventories 74,000
Noncurrent Assets 90,000
Properties and equipment (net)
154,200
Total assets
P380,200
Liabilities and Partners' Equity
Current Liabilities
Accounts payable P 60,000
Loans payable
20,000
Total liabilities P 80,000

Partners' Equity:
Siy capital P137,000
Tiu capital 163,200 300,200
Total liabilities and partners' capital P380,200
 Chapter 2
66

Statement of Cash Flows

flows is prepared for the partnership as it
is för a corporation. This
A statement of cash
intermediate accounting textbooks, presents
statement as explained and illustrated in
or used in investing activities,
the net cash provided by operations, net cash provided
and net cash providedor used in financing activities. A statement of cash flows for Siy
income
and Tiu Partnership including the net income from the statement ofcomprehensive
in Ilustration 2-12 is as follows:

Illustration 2-15
Statement of Cash Flows
Siy and Tiu Partnership
Year Ended December 31, 2016

Cash flows from operating activities:

Net income P190,200
Adjustments to reconcile net income to net cash provided
By operating activities:
Depreciation 60,000
Changes in operating assets and liabilities
Decrease (increase) in accounts receivable (74,000)
Decrease (increase) in inventories 90,000)
Increase (decrease) in accounts payable 60,000
Increase (decrease) in loans payable 20,000
Net cash provided by operating activities. P166,200
Cash flows from investing activities:
Acquisition of property and equipment (214,200)
Cash flows from financing activities:
Partners' invesuments P230,000
Partners withdrawals (70,000)
Partners' drawings (50,000)
Net cash provided by financing activities 110,000
Net increase in cash 62,000
Cash at beginning of year
Cash at end of year P 62,000
 Partnership Operations
67
CHANGES IN THE PROFITAND LOSS RATIO
Partners may agree to change their profit and loss ratio. When
loss ratio occur, several problems will be encountered in changes in the profit ana
the determination of partuned
interests, among which are the following:
1. There may be a difference between the book value and the fair value
assets. of tangible
2. The partnership might have
intangibles such as
the books but which must be considered in goodwill
that are not recorded in
partners interests.
determining the fair value of the
3. The partnership might have
keep its books on a cash basis, and as a result,
there may be unrecorded assets and liabilities. These
too, must be considered.
After considering the above items, two approaches can be used for a fair valuation of
the partners' interest, as follows:

1. Adjust all assets and

liabilities to retlect theirfair value_.
unrecorded assets or liabilities, if any. These should be madeAlso
record any
to the partners
capital account in accordance with their old protit and lOSs ratio.
2. Calculate the effects ofall the differences between the book values and fair
values the
as well as unrecorded assets and liabilities,
and adjust only the
partners' capital account for the net effect oftheseadjustments using the old
profit and loss ratio. Under this approach, no adjustients.ofassets and liabilities
are recorded in the books of the partnership.

Illustration. Assume that Ben and Cob, sharing profits and losses 10% and 90%,
respectively, decided to change their ratio to 25% to Ben and 75% to Cob. Assume
also that on the date of the change, the partnership held land that was carried at a cost
of P50,000 but had a fair value of P350,000.

First Approach:
Iftheadjustment ofthe book value is made, the requiréd entry would be as follows:

300,000
Land
Ben capital o i0 ujing the 30,000
Cob capital eok x 102 od rqati'o 270,000
lo record the increase
Land account and
in the
account
O respective partners'capital
credit the
ratio.
4sing the old profit and loss
68 Chapter 2

Second Approach:
Ifno adjustments are made on the date ofthe change, the required entry would be:
l i a b i l

Ben capital 45,000

Cob capital 45,000
To credit Cob with 15% (90% - 75%) of P300,000
Jor his share increase in value of the Land account
and to charge Ben's capital account accordingly.

Let us nowassume that the land was later sold for P400,000. Using the two approaches,
the gain would be divided as follows:

First Approach:
r a t i o

n e u )

6ying

Ben: P50,000 x25% P12,500

Cob: P50,000 x 75% 37,500
Total P50,000

Second Approach:
Ben Cob Total
Portion of gain developed prior to change in
Ratio, P300,000 (P3S0,000- P50,000),
Divided, 10:90 old ratio P30,000 P270,000 P300,000
Portion of gain developed subsequently,
P50,000 (P400,000-P350,000), divided,
new fato 50,000
25:75 12,500 37,500
Totals P42,500 P307,500 P350,000

cORRECTION OF PARTNERSHIPNET INCOME OF PRIOR PERIOD

The partnership may discover errors made in computing net income of prior accounting
periods. Examplesofthese errors are: eror in computing depreciation, error in inventory
valuation, and omission of accrued expenses. When thesé errors are discovered, the
partners' capital accounts should be adjusted. The following accounting procedures
may be used:

1. Determine the correct net profit of the prior period.

2. Compute the proper share of each partner using the profit and loss ratio in tne
year in which the error occurred.
Partnership Operations 69

3. Compute the ditièrence between the share in the profit that each partner actuauy
received and the share each would have received
4. Adjust
the from No. 2
partners' capital accountsby the amount in No. 3.
Tllustration. Assume that in 2015, the reported net income of Dan and Eve was
P100,000 and that the partners divide profits and losses, equally.In the year 2016, they
changed the ratio to 60% for Dan and 40% for Eve. During 2016, the following errors
in computing the 2015 net income were discovered:

a. Depreciation was understated by P20,000.

b. Prepaid expenses ofP15,000 was omitted.
C. Accrued expenses of P5,000 was omitted.

Using the procedures, the amount of adjustment to the partners' capital accounts is
computed as tollows:

1. Net income per books, 20155 P100,000

Adjustments:
Understatement of depreciation P(20,000)
Omissionof prepaid expenses 15,000
Omission of accrued expenses (5,000) (10,000)
P 90,000
Corrected net income, 2015

capital accounts can nowbedetermined

2. Therequired adjustment to partners'
as follows:
Eve Total
Dan
P50,000 P100,000
corrections P50,000
2015 net income before 45,000 90,000
45,000
2015 corrected net income P10,000
10,000
accounts P 5,000 P5,000P
3. Required reduction to.capital is
accounts on
December 31, 2016
the partners' capital
4.
The entry to adjust
therefore:
5,000
Dan capital 5,000
Eve capital 15,000
Prepaid expenses
5,000
20,000
Accrued expenses
Accumulated depreciation
accountsjor
lo adjust partners'capital income
in computing net
errorsdiscovered
of 2015.