WESLEYAN UNIVERSITY – PHILIPPINES
College of Business and Accountancy
Cabanatuan City
ACCOUNTING FOR SPECIAL TRANSACTION
MODULE 2
Partnership Operations
LEARNING OUTCOMES
At the end of the topic the learners will be able to:
1. Understand the impact that the allocation of partnership income has on the partners’ individual
capital balances
2. Allocate income to partners when interest and/or salary factors are included.
BIBLICAL VALUES INTEGRATION
Proverbs 3:5-6
“Trust in the LORD with all your heart; and lean not to your own understanding. In all your
ways acknowledge him, and he shall direct your paths.”
INTRODUCTION
The operations of a partnership are similar in most respects to those of other forms of
organizations operating m the same line of business. At the end of each fiscal year, when
revenues and expenses are closed out, some assignments must be made of the resulting
income figure because a partnership will have two or more capital accounts rather than a
single retained earnings balance This allocation to the capital accounts is based on the
agreement established by the partners preferably as a part of the Articles of Partnership.
A wide range of profit allocation is found in the business world. Some partnerships
have straightforward distribution plans while others have extremely complex ones. It is the
accountant's responsibility to distribute the profit or loss according to the partnership
agreement regardless of how simple or complex that agreement is. Profit distributions are
similar to dividends for a corporation.
This module will introduce to you to topics about partnership operation including the
allocation of income to partners.
BODY
Required Readings: Accounting for Special Transaction (Advanced Accounting 1) by Zeus Vernon
Millan – Partnership Operations
Methods to Allocate Net Income or Loss
Practically all partnerships have a profit or loss allocation agreement. It would be rare to find
a partnership that did not spell out the divisions of profits or losses in details. The agreement
must be followed precisely, and if it is unclear, the accountant should make sure that all
partners agree to the profit or loss distribution. Partners should select a formula that is
sensible, practical, and equitable. The formula used to divide profits and losses is determined
through negotiations among the partners. Whether it is fair or not, it does not concern the
accountant.
The Partnership Law provides that if the profit has been agreed upon, the share of each
partner in the losses shall be in the same proportion with the net income allocation. It also
provides that in the absence of agreement, the share of each partner in the profits and
losses shall be in proportion to what they have contributed (based on capital contribution),
but the industrial partner shall receive such share as may be just and equitable under the
circumstances. However, the law is not clear as to what capital balances shall be applied,
whether the capital balances refers to original capital, beginning or end of each period or the
average capital during the period. In as much as the law does not clearly specify the capital
balance, it is therefore, presumed to be the original capital, in the absence of such original
capital it should be the beginning capital.
The reason behind the usage of original capital (in its absence, the beginning capital) is that, if
at the time of formation there is no agreement, the law should apply and the only available
capital balance is the original capital. Even though usage of original capital seems to be
unreasonable because of inequity, logic dictates that profit and loss should be established at
the time of formation due to some of the following reasons:
1. Subsequent adjustments in assets and liabilities;
2. Admission of o new partner;
3. Retirement or withdrawal of a partner; and
4. Liquidation of partnership.
Profits and loss can be shared in many ways among partners of a partnership. Most profit
and loss sharing formula includes one or more of the following features or techniques:
1. Arbitrary ratio
2. In the ratio of partner's capital account balances and the dividing the balance on agreed
ratio:
a. Original capital – the initial investment/capital at the
time of formation. b. Beginning capital of the period
c. Average capital
i. Simple average
ii. Weighted average
1. Peso-day approach
2. Peso-month approach
3. Interest on partners' capital accounts and dividing the balance on agreed ratio
4. Salaries to partners and dividing the balance on agreed ratio
5. Bonus to partners and dividing the balance on agreed ratio
6. Interest on capital account balance, salaries and bonus to partners and dividing the
balance on agreed ratio.
7. Equally
Because of its simplicity, the equally or the arbitrary ratio approach is the most common of
allocating profit or loss. It is simple because it, ignores capital balances. However, this approach
is not necessarily equitable to all partners. No single ratio is likely to reflect properly the various
contributions made by a partner. Indeed, an unlimited number of alternative allocation plans
could be devised in hope of achieving fair treatment for all parties.
REFERENCE:
Accounting for Special Transaction (Advanced Accounting 1) by Zeus Vernon Millan
Advanced Accounting 1 by Antonio J. Dayag