PARTNERSHIP OPERATIONS

I. RULES OF PROFIT DISTRIBUTION

o PARTNERSHIP LAW
 The Civil Code of the Philippines provides the rules on distributing profits (and
losses) among the partners.

o DISTRIBUTION OF PROFITS AND LOSSES AMONG THE PARTNERS

(1) With profit-sharing agreement
(2) With loss-sharing agreement
(3) Without any agreement

o EFFECT OF PROFITS AND LOSSES TO CAPITAL LEDGER ACCOUNTS

 Notice that each of the partner shares in either the net income or net loss of the
partnership.
 The usual debit and credit transactions related to the capital account per partner
have been summarized above.

II. PROFIT SHARING AGREEMENTS

o CASE 1 - DISTRIBUTION OF PROFITS WITH PROFIT-SHARING AGREEMENT
 The share in profit of each partner shall be in proportion to the agreed profit-
sharing ratio.
 Example: 50%-50%, 1/3 each
 Since partnerships are essentially contracts, the partners are free to stipulate and
agree on the distribution of profits.
  As part of the closing entry, the profit is
distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a
net credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.

 As part of the closing entry, the profit is

distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a
net credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.

III. LOSS SHARING AGREEMENTS

o CASE 2A – DISTRIBUTION OF LOSSES WITH LOSS-SHARING RATIO
 The share in losses of each partner shall be in proportion to the agreed loss-
sharing ratio.
 Example: 20%-40%-30%-10%
  Sometimes, losses are incurred by partnerships. Even losses are distributed among
the partners. As previously mentioned, since partnerships are essentially contracts,
the partners are free to stipulate and agree on the distribution of losses.

 As part of the closing entry, the loss is

distributed to the capital accounts.
 Since there is net loss, the income
summary account is expected to have a
net debit balance. To close the income
summary account, it is credited and the
capital accounts are debited accordingly.

o CASE 2B – DISTRIBUTION OF LOSSES WITHOUT LOSS-SHARING RATIO

 If there was no agreed loss-sharing ratio, the share in losses of each partner shall
be in proportion to the agreed profit-sharing ratio.
 Sometimes, losses are incurred by partnerships. Even losses are distributed among
the partners. As previously mentioned, since partnerships are essentially contracts,
the partners are free to stipulate and agree on the distribution of losses.
 This is deemed as a reasonable assumption because the agreed ownership interest
and profit sharing ratio also reflects the level of risk exposure for each partner
when he/she entered into the partnership.
  As part of the closing entry, the loss is
distributed to the capital accounts.
 Since there is net loss, the income
summary account is expected to have a
net debit balance. To close the income
summary account, it is credited and the
capital accounts are debited accordingly.

IV. ABSENCE OF SHARING AGREEMENTS

o CASE 3A – DISTRIBUTION OF PROFITS WITHOUT PROFIT-SHARING
AGREEMENT
 Without profit sharing agreements:
(1) Industrial partners will first receive a share that is just and equitable to
his/her service
(2) Capitalist partners will share the remaining profit in proportion to their
capital contribution.
 Industrial partners will receive a share of the profits before the capitalist partners.
What Is “just and equitable” is ultimately decided by the partners of the
partnership.

o RATIO OF CAPITAL DISTRIBUTION

 The ratio of capital contribution can either be based on:
(1) Average capital balance
(2) Original capital investment
(3) Beginning capital balance
(4) Ending capital balance
 The numbering above is hierarchical - - meaning, the most “just and equitable”
basis for the determination of capital contribution is average capital balance,
 followed by original capital investment, beginning capital balance, and finally
ending capital balance.
 Average capital balance takes into account the changes of capital over the year
due to additional capital investment and permanent drawings. This makes it the
most equitable ratio for profit distribution.
 In the absence of data related to the average capital balance, the original capital
investment is the most equitable basis for profit distribution because it goes back
to the original creation of the partnership.
 In the absence of data relating to the original capital investment, the beginning
capital balance is used as basis for the ratio of capital contribution because this is
the capital that was reasonably made available to the partnership for the
operations. Unlike the ending inventory, the beginning capital balance of the year
disregards sudden capital investments at the end of the year that was not
materially used to generate the profit for the current year. There are partners in
partnerships, in fact, who increases their capital investment near the year end just
to increase their possible share in profit.

 As part of the closing entry, the profit is

distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a
net credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.
 As part of the closing entry, the profit is
distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a net
credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.

 As part of the closing entry, the profit is

distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a net
credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.
  As part of the closing entry, the profit is
distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a net
credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.

o CASE 3B – DISTRIBUTION OF LOSSES WITHOUT SHARING AGREEMENT

 Without profit sharing agreements:
(1) Industrial partners will not share in the losses.
(2) Capitalist partners will share the remaining profit in proportion to their capital
contribution.
 Industrial partners have already rendered their services in vain. Therefore, there’s no
need for them to share further in the net losses of the partnership.
o RATIO OF CAPITAL CONTRIBUTION
 The ratio of capital contribution can either be based on:
(1) Average capital balance
(2) Original capital investment
(3) Beginning capital balance
(4) Ending capital balance
 The numbering above is hierarchical - - meaning, the most “just and equitable” basis
for the determination of capital contribution is average capital balance, followed by
original capital investment, beginning capital balance, and finally ending capital
balance.
 Average capital balance takes into account the changes of capital over the year due
to additional capital investment and permanent drawings. This makes it the most
equitable ratio for loss distribution.
 In the absence of data related to the average capital balance, the original capital
investment is the most equitable basis for loss distribution because it goes back to the
original creation of the partnership.
 In the absence of data relating to the original capital investment, the beginning
capital balance is used as basis for the ratio of capital contribution because this is the
capital that was reasonably made available to the partnership for the operations.
Unlike the ending inventory, the beginning capital balance of the year disregards
sudden capital investments at the end of the year that was not materially used to
generate the profit for the current year. There are partners in partnerships, in fact, who
decreases their capital investment near the year end just to decrease their possible
share in losses.

 As part of the closing entry, the loss is

distributed to the capital accounts.
 Since there is net loss, the income summary
account is expected to have a net debit
balance. To close the income summary
account, it is credited and the capital
accounts are debited accordingly.
VI. SPECIAL PROBLEMS IN PARTNERSHIP OPERATIONS
o BONUSES
 Bonuses are given to partners in times of profit and are agreed upon by the
partners.
 Example: 10% of ending capital balance; 5% of net income before bonus

o INTEREST ON CAPITAL
 Interest is computed on the capital balance based on what has been agreed
upon by the partners.
 Example: 10% interest on beginning capital balance. 5% interest on average
capital balance
o SALARY ALLOWANCES
 Salary allowances are often given to industrial and managing partners based on
what has been agreed upon by the partners.
 Example: P1,500 per month for all industrial partners
 As part of the closing entry, the profit is
distributed to the capital accounts.
 Since there is net income, the income
summary account is expected to have a net
credit balance. To close the income
summary account, it is debited and the
capital accounts are credited accordingly.