Chapter 2 ballada

"An eye for an eye will make the whole world blind." (Mahatma Gandhi)

CHAPTER 2PARTNERSHIP OPERATIONS AND

FINANCIAL REPORTING

PARTNERS’ EQUITY IN ASSETS CONTRASTED WITH SHARE IN PROFITS OR LOSSES

The basis on which profits or losses are shared is a matter of agreement among the partners and may not necessarily be the same as their capital contribution ratio. The equity of a partner in the net assets of the partnership should be distinguished from a partner’s share in profit or losses.


FACTORS TO CONSIDER IN ARRIVING AT A PLAN FOR DIVIDING PROFITS OR LOSSES


OTHER FACTORS TO BE CONSIDERED:1. Partners having

considerable financial resources, hence, strong credit standing.

2. A partner who is well known in a profession or an industry may contributed immensely to the success of the partnership although he may not participate actively in the operations of the partnership.


PERFORMANCE METHODMany partnerships use profit and loss sharing arrangements

that give some weight to th specific performance of each partner to provide incentives to perform well. This allocation of profits to a partner on the basis of performance is frequently referred to as a BONUS.

Examples of the use of performance criteria are:1. Chargeable hours2. Total billings3. Write-offs4. Promotional and civic activities5. Profits in excess of specified levels


RULES FOR THE DISTRIBUTION OF PROFITS OR LOSSESBased on the legal provisions of the Civil Code of the Philippines, the following are the rules for the distribution of profits or losses1. PROFITS

a. The profits will be divided according to partners’ agreementb. If there is no agreement:

As to capitalist partners, the profits shall be divided according to their capital contributions (according to the ratio of original capital investments or in its absence, the ratio of capital balances at the beginning of the year)

As to industrial partners (if any), such share as may be just and equitable under the circumstances, provided, that the industrial partner shall receive such share before the capitalist partnes shall divide the profits.


RULES FOR THE DISTRIBUTION OF PROFITS OR LOSSES (CONT’D)

2. LOSSESa. The losses will be divided according to partners’ agreementb. If there is no agreement as to distribution of losses butthere is an

agreement as to profits, the losses shall be distributed according to the profit sharing ratio

c. In the absence of any agreement: As to capitalist partners, the losses shall be divided according to

their capital contributions (according to the ratio of original capital investments or in its absence, the ratio of capital balances at the beginning of the year).

As to purely industrial partners (if there’s any), shall not be liable for any losses.


CORRECTION OF PRIOR PERIOD ERRORS

Per International Accounting Stadards (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 may occur as a result of mathematical mistakes in applying accounting policies, misintepretation of facts, fraud or oversights. Examples include errors in the estimation of depreciation, errors in inventory valuation and omission of accruals of revenue and expenses.


DISTRIBUTION OF PROFIT OR LOSSES BASED ON PARTNER’S AGREEMENTThe partners may agree on any of the following scheme in distributing

profits or losses:1. Equally or in other agreed ratio2. Based on partners’ capital contributions

a. Ratio of original capital investmentsb. Ratio of capital balances at the beginning of the yearc. Ratio of capital balances at the end of the yeard. Ratio of average capital balances

3. By allowing interest on partners’ capital and the balance in an agreed ratio


DISTRIBUTION OF PROFIT OR LOSSES BASED ON PARTNER’S AGREEMENT (CONT’D)4. By allowing salaries to partners and the balance in an agreed

ratio5. By allowing bonus to the managing partner based on profit and

the balance in an agreed ratio6. By allowing salaries, interest on partners’ capital, bonus to the

managing partner and the balance in an agreed ratio (combination of 3 to 5)


REMINDERPartners’ withdrawal and salaries that are considered to be temporary

withdrawal are to be recorded in the “partner’s drawing” account. As such the following entry:

Partner A, Drawings xxxCash xxx

Partner B, Drawings xxxCash xxx


PRO-FORMA JOURNAL ENTRIES IN DIVISION OF PROFITS AND LOSSESAfter computing the profits and losses, the following is the pro-forma

journal entries:

PROFITSIncome Summary xxx

Partner A, Drawing xxxPartner B, Drawing xxx


Partner A, Capital xxxPartner B, Capital xxx


PRO-FORMA JOURNAL ENTRIES IN DIVISION OF PROFITS AND LOSSES (CONT’D)After computing the profits and losses, the following is the pro-forma

journal entries:

LOSSESPartner A, Drawing xxxPartner B, Drawing xxx

Income Summary xxx

Partner A, Capital xxxPartner B, Capital xxx



ILLUSTRATIVE PROBLEM

The following series of illustrations are based on the figures obtained from the Medina and Matero Partnership which had a profit of P300,00 for the year ended Dec. 31, 2009, the first year of operations. The partnership contractprovided that each partner may withdraw P5,000 on the last day of each month; both partners did so during the year. The drawings are recorded by debits to the partners’ drawing accounts and shall not be considered in division of profit or loss. It is the intention of the partners that each partner’s share in the profit or loss be either credited or debited to the drawing account.


ILLUSTRATIVE PROBLEM(CONT’D)Leopoldo Medina invested P400,000 on January 1, 2009 and an additional P100,000

on April 1. Challoner Matero invested P800,000 on January 1 and withdrew P50,000 on July 1. These transactions and events are summarized in the following capital, drawing and income summary ledger accounts:

L. Medina, Capital C. Matero, Capital 400,000 1/1 7/1 P50,000 P800,000 1/1 100,000 4/1

L. Medina, Drawing C. Matero, Drawing12/31 60,000 12/31 60,000

Income Summary 300,000 12/31


EQUALLY OR IN OTHER AGREED RATIOA. EQUALLY

Journal Entry:Income Summary 300,000L. Medina, Drawings 150,000C. Matero, Drawings 150,000 To record to division of profits.

L. Medina, Drawings 90,000C. Matero, Drawings 90,000L. Medina, Capital 90,000C. Matero, Capital 90,000 To close drawing

account.



L. Medina, Capital

400,000 1/1

100,000 4/1

90,000 12/31

590,000

L. Medina, Drawing

12/31 60,000 150,000 12/31

12/31 90,000 _______

150,000 150,000

C. Matero, Capital

7/1 50,000 800,000 1/1

90,000 12/31

50,000 890,000

840,000

C. Matero, Drawing

12/31 60,000 150,000 12/31

12/31 90,000____________

150,000 150,000

Income Summary

12/31 300,000 300,000 12/31

B. OTHER AGREED RATIO Assume instead that Medina and Matero share profits and losses in a ratio

of 60:40 and profit was P300,000, the profit would be divided as follows:

Journal Entry:Income Summary 300,000

L. Medina, Drawings 180,000C. Matero, Drawings 120,000 To record to division of profits.

L. Medina, Drawings 120,000C. Matero, Drawings 60,000

L. Medina, Capital 120,000C. Matero, Capital 60,000 To close drawing account.



L. Medina, Capital

400,000 1/1

100,000 4/1

120,000 12/31

620,000

L. Medina, Drawing

12/31 60,000 180,000 12/31

12/31 120,000 _______

180,000 180,000

C. Matero, Capital

7/1 50,000 800,000 1/1

60,000 12/31

50,000 860,000

810,000

C. Matero, Drawing

12/31 60,000 120,000 12/31

12/31 60,000____________

120,000 120,000

Income Summary

12/31 300,000 300,000 12/31

C. LOSSES


A. EQUALLYAssume that there is a loss of P200,000:Journal Entry:L. Medina, Drawings 100,000C. Matero, Drawings 100,000

Income Summary 200,000 To record to division of losses.

L. Medina, Capital 160,000C. Matero, Capital 160,000

L. Medina, Drawings 160,000C. Matero, Drawings 160,000 To close the drawing accounts.


L. Medina, Capital

12/31 120,000 400,000 1/1

100,000 4/1

120,000 500,000

380,000

L. Medina, Drawing

12/31 60,000 120,000 12/31

12/31 100,000 _______

120,000 120,000

C. Matero, Capital

7/1 50,000 800,000 1/1

12/31 120,000_____________

170,000 800,000

630,000

C. Matero, Drawing

12/31 60,000 160,000 12/31

12/31 100,000____________

160,000 160,000

Income Summary

12/31 200,000 200,000 12/31

BASED ON PARTNERS’ CAPITAL CONTRIBUTIONRATIO OF ORIGINAL CAPITAL INVESTMENTSJournal Entry:Income Summary 300,000



account.

Computations:L. Medina P300,000 x 400,000/1,200,000= P100,000C. Matero P300,000 x 800,000/1,200,000= P200,000

P300,000

"An eye for an eye will make the whole world

blind." (Mahatma Gandhi)


RATIO OF CAPITAL BALANCES AT THE BEGINNING OF THE YEAR. In this case, since the beginning is similar to the investment, the entries are the same.

Journal Entry:Income Summary 300,000



account.


P300,000

RATIO OF CAPITAL BALANCES AT THE END OF THE YEAR. Journal Entry:Income Summary 300,000



account.


P300,000"An eye for an eye will make the whole world blind." (Mahatma Gandhi)


RATIO OF AVERAGE BALANCES:

Journal Entry:

Income Summary 300,000

L. Medina, Drawings 114,000

C. Matero, Drawings 186,000

To record to division

of profits.



L. Medina, Capital 54,000

C. Matero, Capital 126,000

To close drawing

account.

Computations:

L. Medina P300,000 x 475,000/1,250,000= P114,000

C. Matero P300,000 x 775,000/1,250,000= P186,000

P300,000

COMPUTATION OF AVERAGE CAPITAL BALANCESLEOPOLDO MEDINA, CAPITAL


Date Capital Acct. Balances

Portion of the Year

Unchanged

Average Capital

Balances1/1 400,000 x 3/12 = 100,000

4/1 500,000 x 9/12 = 375,000

Average Capital 475,000

CHALLONER MATERO, CAPITAL


Date Capital Acct. Balances

Portion of the Year

Unchanged

Average Capital

Balances

1/1 800,000 x 6/12 = 400,000

7/1 750,000 x 6/12 = 375,000

Average Capital 775,000

ALLOWING INTEREST ON CAPITAL AND THE BALANCE IN AGREED RATIOContinuing the illustration of Medina and Matero Partnership with a

profit of P300,000 for 2009 and capital balances as already shown, assume that the partnership agreement allowed 15% interest on the average capital account balances, with the balance to be divided equally. The profit of P300,000 for 2009 is divided as follows:


Medina Matero Total15% interest on Average Capital:

Medina: P475,000 x 15%

71,250

Matero: P775,000 x 15%

116,250

Sub-total 187,500Balance to be divided equally:Medina: P112,500 x 50%

56,250

Matero: P112,500 x 50%

56,250

Sub-total _______ _______ 112,500Share of Partners in Profits

127,500 172,500 300,000



RATIO OF AVERAGE BALANCES:

Journal Entry:

Income Summary 300,000



To record to division

of profits.



L. Medina, Capital 67,500

C. Matero, Capital 112,500

To close drawing

account.


L. Medina, Capital

400,000 1/1

100,000 4/1

67,500 12/31

567,500

L. Medina, Drawing

12/31 60,000 127,500 12/31

12/31 67,500 _______

127,500 127,500

C. Matero, Capital

7/1 50,000 800,000 1/1

_____________ 112,500 12/31

50,000 912,500

862,500

C. Matero, Drawing

12/31 60,000 172,500 12/31

12/31 112,500____________

172,500 172,500

Income Summary

12/31 300,000 300,000 12/31

Education

Chapter 2 ballada