ACCOUNTING FOR PARTNERSHIPS Partnership Operations and Financial Reporting Learning Objectives: After studying this chapter, you should be able to: 1. Contrast a partner’s equity in assets from share in profits or losses. 2. Summarize the rules for the distribution of profits or losses. 3. Explain prior period errors and interpret the effects on partners’ shares in profits or losses. r 4, Identify, describe and account for the different methods of dividing partnership profits or losses based on agreement. 5. Ascertain the effects of using original, beginning, ending and average capitals on the partners’ share in profits or losses. : 6. Show the treatment of interest on capital, partners’ salaries and bonus in the distribution of profits or losses. 7. Propose equitable profits or losses sharing schemes after considering the partners’ contributions and other performance criteria. 8. Understand and appreciate the usefulness of financial statements. 9. Pinpoint the differences in the financial statements of a partnership as compared to a sole proprietorship. 10. Develop skills in the preparation of basic financial statements. 11. Differentiate between the capital account and the current account of a partner used in other jurisdictions. t 12, Show the treatment of interest on drawings in other jurisdictions. William H. “Bill” Gates Ill and Paul Allen - Microsoft Co-founders in 1975 Gates, 58, married, 3 children, Forbes 2013 Ranked 2, net worth US$67 billion. He was No. 1 for 13 years. Microsoft’s chief visionary has moved away from day-to-day corporate work. Instead, he prefers to dive into innovative projects, foster collaboration among Microsoft's many divisions., Microsoft aims to be omnipotent, selling software for PCs, servers, smartphones, television set-top boxes, gaming consoles and the Web. Recent product launches include the new version of Windows, Windows 8, and tablet, Surface. Scanned with CamScannerGates is methodically diversifying wealth and reinvests through Cascade Investment in non-tech companies. He has big stakes in Canadian National Railway, Republic Services, Ecolab, Televisa and Berkshire Hathaway. The world’s richest man is the most charitable. He has given away US$28 billion so far. The Bill and Melinda Gates Foundation donates money to global health care and education (high school), specifically disease prevention (meningitis, pneumococcal disease, rotavirus, severe diarrhea, hepatitis B, AIDS) and vaccine (malaria) development. The vaccine non-profit he founded, the Global Alliance for Vaccines and Immunization (GAVI), has raised US$4.3 billion in pledges from various countries to provide life-saving vaccines against a range of deadly infections that harm millions of children in developing countries. Gates has a new obsession: to build a better toilet for those without water or sewage systems. Every year 1.5 million children die from food and water, tainted with fecal matter, more than the annual deaths from AIDS and malaria combined. Gates and his good friend, Warren Buffett, continue to recruit new members to their Giving Pledge, in which the very wealthy promise to give away at least half of their net worth during their lifetime or after they die. Allen, 60, single, net worth US$15 billion, Forbes 2013 Ranked 53. Microsoft co-founder has carefully built a multimedia empire. He sold huge chunks of his stake in Microsoft to finance his wired-world investment strategy, in which he plans to create and distribute broadband content, Places bets through his Vulcan Ventures, which has made 140 investments in early stage Internet and telecom companies. Recently, claims to have liquidated 75% of 'the diverse equity holdings in private investment firm, Vulcan Ventures, reinvesting much InrU.S. Treasury paper. Left Microsoft in 1983, to fight Hodgkin's disease and rejoined the board of Microsoft in 1990 after the disease went into remission. Allen is that rare billionaire who combines passioris for sports and science. , Owns the NBA basketball team, the Portland Trailblazers and professional football’s Seattle Seahawks. He is a part-owner in the Seattle Sounders FC, a pro soccer tedm. The cancer survivor also has a keen interest in neuroscience, having recently. lost his mother to Alztieimer's disease. To date, he has committed US$S00 million to the Allen Institute for Brain Science, which makes public a detailed “atlas” of genes that control the human brain. He loaned his 414-foot yacht, Octopus and its personal deep-sea remote-operated vehicle to survey populations of the rare Coelacanth and recover the bell from the British warship HMS Hood, sunk in 1941 by the Nazis. Named the most philanthropic American in 2011 by the Chronicle of Philanthropy, Allen donates prolifically to Seattle-area causes in education, the arts and health care. 2-2. | WIN Ballado’s Partnership and Corporation Accounting Scanned with CamScannerThe net worth of these two great wealth accumulators are simply unimaginable by Philippine standards. Their informal programming partnership started in the early 1970s. Gates and Allen are pioneers in the production of vaporware. Vaporware refers to the tactic to announcing a software product before it exists, typically to discourage rivals from proceeding with development of competing versions. In 1975, they have developed a product to license—BASIC (Beginners’ All-Purpose Symbolic Instruction’Code), which is an easy-to-learn programming language. Gates and Allen formed a partnership, initially called “Micro-Soft” (short for “microcomputer software”). Profits were to be split 60:40. Later amended to 64:36 with Gates receiving the larger share in recognition of his greater contribution to the original development of the BASIC software. Gates eventually dropped out of Harvard to work full time at Microsoft. Within a year of Microsoft's founding, its BASIC program had effectively become the standard for microcomputers. Now, the Microsofts creed of “A computer on every desk and in every home, running Microsoft software” is coming into fruition. In 1990, the Windows 3.0 became the hottest software product of all time, selling a million copies within four months. Several Windows versions and Microsoft Offices later; as they say, the rest is history! Adapted from: Forbes Asia, Top Five of The 400 Richest People in America, Forbes Global, Special 2013, 2012, 2008, 2007, 2005, 2002 & 2000 Issue and How To Be A Billionaire by Martin S. Fridson. What are the factors to be considered in arriving at a plan for dividing profits or losses in the case of Gates and Allen (assuming they did not incorporate at the outset)? In the instant case, Gates has the net worth of USD 61 billion while Allen has USD 14.2 billion, one reason being their sharing is in the ratio of 64:36. Should capital investment be given more weight than technical contribution with regard to the formulation of the profit-sharing schemé? If there is no agreement as to how profits or losses will be shared, then what rules will apply? Assuming there is an agreement, what are the common arrangements to govern the distribution ‘of profits or losses? There are partnerships that allow salary allowances, bonus, and/or interest on partners’ capital balances. Why are these techniques resorted to? 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 profits or losses. Illustration. “Nelson Daganta is a one-third partner” is an ambiguous statement. Daganta may have one-third equity in the net assets of the partnership but might have a Chapter 2: Partnership Operations and Financial Reporting |°2-3 Scanned with CamScannerlarger or smaller share in the profit or loss of the firm. Such a statement may also be interpreted to mean that Daganta is entitled to one-third of the profit or loss, although his capital account may represent much more or much less than one-third of the total Partners’ capital. Simply put, partners may agree on any type of profit and loss ratio regardless of the amount of their respective capital account balances. FACTORS TO CONSIDER IN ARRIVING AT A PLAN FOR DIVIDING PROFITS OR LOSSES * Money, Property or Industry Partnership profits are realized as a result of putting together the contributions— money, property or industry—of the partners. The amount of capital invested by each partner, the amount of time each partner devotes to the business and other contributions are the factors being considered in the formulation of an equitable profit and loss ratio, There are profit-sharing plans which emphasize either the value of personal services rendered by individual partners or the amounis of capital invested by each partner. Some agreements consider the importance of both the amount and quality of managerial services rendered, and the amount of capital invested by the partners for. the success or failure of a partnership. In this case, allowances may be provided for salaries to partners and interest on their respective capital balances as a preliminary step in the division of profits or losses; the balance may then be divided in a specified ratio. Among the other factors which may be considered are as follows: 1. A partner has considerable personal financial resources, thus giving the partnership a strong credit rating. In general, partners have unlimited liability. A very solvent partner will make the partnership attractive to creditors. 2. A partner who is well known in a profession or an industry may contribute immensely to the success of the partnership although he may not participate actively in the operations of ‘the partnership. These two factors may be incorporated in the plan to arrive at a ratio by which any remaining profits or losses are to be divided. Illustration. Daria Tolentino and Eleanor Tan aré partners in a coco water business. Partner Daria Tolentino contributed most of the assets of the business but spends little time for its daily operations. On one hand, Partner Eleanor Tan contributed less. in assets but devotes her full knowledge and attention to the partnership. To divide profits or losses based on capital contributions alone will result to iniquities. The'profit and loss sharing agreement should have considered the provision of salaries or even bonus in recognition of the talent and time being contributed by Partner Eleanor Tan. 2-4. | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerPerformance Methods Many partnerships use profit and loss sharing arrangements that give some weight to ” the 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 hours. ‘These are the total number of hours that a partner incurred on client related assignments. Weight may be given to hours in excess of a standard._ : Total billings.. The total amount billed to clients for work performed and supervised by a partner constitutes total billings. Weight may be given to billings in excess of norm. 3. Write-offs.. Consist of uncollectible billings. Weight may be given to a write-off percentage below a norm. 4, Promotional and civic activities. Time devoted to developing future business and enhat the partnership name in the community is considered promotional and civic activity. Weight may be given to time spent in excess of a norm or to specific accomplishments resulting in new clients. 5. Profits_in_excess_of specified levels, Designated partners commonly receive a certain percentage of profits in excess of a specified level of earnings. Cems) at ‘The profits or losses shall be distributed in conformity with the agreement. If only the share of each partner in the profits has beer agreed upon, the share of each in the losses shall be in the same proportion. In the absence of stipulation, the share of each partner in profits or losses shall be.in proportion to what he may have contributed (according to the ratio of original capital investments or in its absence, the ratio of capital balances at the beginning of the year), but the industrial partner may not be liable for the losses.’ ‘As for the profits, the industrial partner shall receive.such share as may be just and ‘equitable under the circumstances. ‘If aside from his services he has contributed capital, he shall also receive a share in the profits in proportion to his capital (Civil Code of the Philippines, Article 1797). A stipulation which excludes one or more partners from any share in the profits or losses is void (Article 1799). The partnership must exist for the common benefit or interest of the partners. A summary of the above legal provisions is prepared as follows: . 1., Profits a. the profits will be divided according to partners’ agreement. here 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). Chapter 2: Partnership Operations and Financial Reporting | 2-5 Scanned with CamScanner> 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 partners shall divide the profits. Losses a. the losses will be divided according to partners’ agreement. b. if there is no agreement as to distribution of losses but there is an agreement as to profits, the losses shall be distributed according to the profit sharing ratio. 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. The industrial partner is not liable for losses because he cannot withdraw the work or labor already done by him, unlike the capitalist partners who can withdraw their capital. In addition, if the partnership failed to realize any profits, then he has labored in vain and ina real sense, he has already contributed his share in the loss. CORRECTION OF PRIOR PERIOD ERRORS Any business entity will from, time to time discover errors made in the measurement of profit in prior accounting periods. Good internal control and the exercise of due care should serve to minimize.the number of financial reporting errors that occur; however, these.safeguards cannot be expected to completely eliminate errors in the financial statements. Per International Accounting Standards (IAS) No. 8, Accounting Policies, Changes in Accounting .Estimates and. Errors, prior period errors are omissions from and other misstatements of the entity's finaficial statements for one or more prior periods that are discovered in the current period... Errors may occur as a result of mathematical mistakes, mistakes in applying accounting policies, misinterpretation 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... 5 Material prior periods must be restated to report financial position and, results. of operations as they Would have been presented had the error never taken place. The amount of the correction of a prior period error that relates to prior periods should be reported by, adjusting the, opening balances of partners’ equity and.affected assets:and liabilities, . The correction of a prior period error.is.excluded from profit or.loss for. the period in which the error is discovered. Awe 2-6 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerIf an error resulted in an understatement of profit in previous periods, a correcting entry would be needed to increase Capital. If an error overstated profit in prior periods, then Capital would have to be decreased. The effect of the error correction will be divided based on the applicable profit and loss ratio. DISTRIBUTION OF PROFITS OR LOSSES BASED ON PARTNERS’ AGREEMENT In general, profits or losses shall be divided in accordance with the agreement of the Partners. The ratio in which profits or losses from partnership operations are distributed is recognized as the profit and loss ratio. The partners may agree on any of the following scheme in distributing profits or losses: 1. Equally or in other agreed ratio 2. Based on partners’ capital contributions: 2. ratio of original capital investments b. ratio of capital balances at the beginning of the year, . . ratio of capital balances at the end of the year d. ratio of average capital balances 3. Byallowing interest on partners’ capital and the balance in an agreed ratio. 4. By allowing salaries to partners and the balance in an agreed ratio 5. By allowing bonus to the managing partner based on profit and the balance in an agreed ratio 6. By allowing salaries, interest on partners’ capital, bonus to the managing partner and the balance in an agreed ratio (combination of 3 to 5) Note that the partners can agree on not using a residual sharing ratio (“the balance in an agreed ratio”) if profits do not exceed the total salary and interest allowances. In such a case, the partners must agree on the priority of the various profit or loss distribution schemes. Mlustration. The following series of illustrations are based on the figures obtained from the Biore and Besario Partnership which had a profit of P300,000 for the year.ended Dec, 31, 2019, the first year of operations. The partnership contract provided 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 the 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. Christopher Biore invested P400,000 on Jan. 1, 2019 and an additional P100,000 on April 1. Rose Besario invested P800,000 on Jan. 1 and:withdrew P50,000 on July 1. These transactions and events are summarized in the following capital, drawing and income summary ledger accounts: Chapter 2: Partnership Operations and Financial Reporting | 2-7 Scanned with CamScannerio, Capital Christopher Biore, Capital Rose Besari a Jan.1 400,000 julya 50,000. | Jan.2 { ‘Apr.1. 100,000 awin Christopher Biore, Drawing a Jan,-Dec. 60,000 Jan.-Dec. 60,000 Income Summary ‘Lec. 31 300,000 Equally or in other Agreed Ratio : Partnership contracts may provide that profit or loss be divided equally. The profit of 300,000 for the Biore and Besario Partnership is transferred by a closing entry on Dec. 31, 2019, from the income summary ledger account to the partners’ drawing accounts: Income Summary 300,000 Christopher Biore, Drawing 150,000 Rose Besario, Drawing 150,000 To record the division of profits. If the partnership had a loss of P200,000 for the year ended Dec. 31, 2019, the income summary ledger. account would have a.debit balance of P200,000. This loss would be transferred to the partners' drawing accounts by a debit to each: drawing account for. 100,000 and a credit to the income summary account for P200,000. Christopher Biore, Drawing —* 100,000" Rose Besario, Drawing i ~~ 100,000: Income Summary 200,000 To record the division of losses. ue w we Assume instead that Biore and Besario share profits and losses in'a ratio of 60:40 and profit was P300,000, the profit would be divided as follows: Income Summary. 300,000 Christopher Biore, Drawing eee ‘180,000 Rose Besario, Drawing 120,000 To record the division of profits. Computation: Bior 30% x P300,000 - ‘180,000. Besario: 40% x P300,000. . 120,000 x Based on Partners’ Capital Contributions Division of partnership profits in proportion to the capital invested by each. partner is most likely to be found in partnerships in which substantial investments is the principal 2-8. |, WIN Ballada’s Partnership and Corporation-Accounting Scanned with CamScanneringredient for success. It is essential that the partnership contract be specific with respect to the concept of capital. Capital may refer to either of the following: Ratio of Original Capital Investments. Assume that the partnership agreement provides for the division of profits in the ratio of original capital investments. The original investments of Biore and Besario are P400,000 and P800,000, respectively. The profit of 300,000 for 2019 is divided as follows: a Income Summary 300,000 Christopher Biore, Drawing 100,000 Rose Besario, Drawing 200,000 To record the division of profits. Computation: i Biore: P300,000 x P400,000/P1,200,000 100,000 Besario: P300,000 x P800,000/P1,200,000 200,000 © _ After the entry allocating the profits of P300,000 to Biore and Besario, ae the partners supposed to receive cash for their respective share in the profits? No, the partners’ share in the profits cannot be attributed to any particular asset, including cash. The entry increased the equity of Biore and Besario in all the assets of the partnership. Ratio of Capital Balances at the Beginning of the Year. Assime’that the partnership agreement provided for the division of profits in the ratio of capital balances at the beginning of the year. In this case, the original capital investments are also the capital balances at the beginning of the year since the partnership is.only.on its first year of operations. The profit of P300,000 for. 2019 is divided as follows: Income Summary, 300,000... Christopher Biore, Drawing 100,000, _ Rose Besario, Drawing 200,000 tan To record the division of profits. oe ‘Computation: Biore: P300,000 x P400,000/P1,200,000 100,000, Besario: P300,000 x P800,000/P1,200,000 200,000 .. 300,000 Ratio of Capital Balances at the End of the Year. Assume that'the profit is divided in the ratio of capital balances at the end of the year before drawings and.the distribution of profit. The ending balances are P500,000 for Biore and P750,000 for Besario; the profit of P300,000 for 2019 is divided as follows: Income Summary 300,000... 1. edt nes eens Christopher Biore, Drawing 120,000 Rose Besario, Drawing 180,000 “': ©To record the division of profits. . Chapter 2:.Partnership Operations and Financial Reporting’| 2-9 Scanned with CamScannerComputation: 300,000 x P500,000/P1,250,000 120,000 300,000 x P750,000/P1,250,000 180,000 300,000 Ratio of Average Capital Balances. n of profits or losses on the basis of the three preceding capital concepts—original capital investments; capital balances at the beginning of the year; or capital balances at the end of the year—may prove inequitable if there are material changes in the capital accounts during the year. When beginning capital balances are used in allocating profits, additional investments during the year are discouraged because the partners making such investments are not compensated in the division of profits until the next year. If ending capital balances are used, year-end investments are encouraged, but there is no incentive for a partner to make any investments before year-end. In addition, amounts earlier withdrawn may be reinvested before year-end. These considerations suggest that using average balances as a basis for distributing profits or losses is preferable because it reflects the capital actually available for use by the partnership during the year. : The agreement should also state the amount of drawings each partner may make. These drawings are considered temporary and are recorded as debits to the partner's drawing account. Drawings within the. allowable amount will not affect the computation of the average capital balance. On-the contrary, drawings in excess of the allowable amount are considered permanent reductions in capital; hence, the computation of the average capital balance is affected. In the continuing illustration for the Biore and Besario Partnership, the partners are entitled to withdraw P5,000 monthly or a total of P60,000 per annum. Any additional withdrawals are directly debited to the partners’ capital accounts and therefore will affect the computation of the average capital ratio. Bjore and Besario Computation of the Average Capital Balances For the Year Ended Dec. 31, 2019 Christopher Biore, Capital Date Capital Account Portion* of the Average Capital 1 Balances Year Unchanged Balances Aaa Jan.1 400,000 x 3/12 = P100,000 Gro, Apr. 1 500,000 x 9/12 375,000. Jag a" Average Capital P475,000 2-10 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerRose Besario, Capital Jan. 800,000 x 6/12 = 400,000 July 1 750,000 x 6/12 = 375,000 ‘Average Capital 775,000 ‘ Total Average Capital Balances 1,250,000 ‘The fractions for each partner should add up to 12/12 oF 1. This eonvention wil help minimize counting errors as to the number of months the capital balance went unchanged. To state the ‘obvious, there are only 12 months na year. For example, for Partner Bor, the faction wil total to 32/32 (3/32 + 9/12 = 12/12 Jor The entry to record the division of P300,000 profits is as follows: Income Summary 300,000 Christopher Biore, Drawing 114,000 Rose Besario, Drawing 186,000 To record the division of profits. Computation: Biore: P300,000 x P475,000/P1,250,000 114,000 Besario: P300,000 x P775,000/P1,250,000 186,000 aR 300,000 By Allowing Interest on Capital and the Balance in an Agreed Ratio In the preceding section, the plan for dividing the total profits in the ratio of partners' capital balances was based on the assumption that capital investments were the controlling factor in the success of the partnership. However, it is not always the case. Consequently, partnerships may choose to allocate a portion of the total profits in the capital ratio and the balance equally or in other agreed ratio after due consideration of the partners’ other contributions. To allow interest on partners’ capital account balances is almost similar to dividing part of profits in the ratio of partners' capital balances. If the partners agree to allow interest on capital as a first step in the division of profit, they should specify the interest rate to be used. It should also state whether interest is to be computed on capital ic dates or on average capital balances during the year. balances on spe Partners invested in a partnership for profits, not for interest. The interest on partners’ capital, along with the other profit sharing plans to be discussed in the remainder of the chapter, are to be considered as mere techniques to share partnership profits or losses equitably and not as expenses of the partnership. On the other hand, the interest on loans from partners is recognized as expense and a factor in the measurement of profit or loss of the partnership. Similarly, interest earned on loans to partners is recognized as partnership income. This treatment is consistent with the discussion in Chapter 1 that loans receivable from or payable to partners are assets and liabilities, respectively, of the partnership. Chapter 2: Partnership Operations and Financial Reporting | 2-11 Scanned with CamScannerContinuing the illustration of Biore and Besario Partnership with a profit of P300,000 for 2019 and capital balances as already shown, assume that the partnership agreement allowed 15% interest on average capital account balances, with the balance to be divided equally. The profit of P300,000 for 2019 is divided as follows: Besario Total 15% Interest on Average Capital: Biore: P475,000 x 15% Besario: P775,000 x 15% 116,250 Subtotal P187,500 Balance to be Divided Equally [P300,000 - P187,500 = P112,500): Biore: P112,500 x 50% 56,250 Besario: P112,500 x 50% 56,250 112,500, Share of Partners in Profits P127,500__P172,500___P300,000 ‘The journal entry to close the income summary ledger account on Dec. 31, 2019 follows: Income Summary 300,000 Christopher Biore, Drawing 127,500 Rose Besario, Drawing 372,500 To record the division of profits. Ina related case, assume that the Biore and Besario Partnership had a loss of P10,000 for the year ended Dec. 31, 2019. If the partnership agreement provided for interest on copital accounts, this provision must be honored regardless of whether operations: yielded profits or not. The loss will be shared by the partners in the same manner as the P300,000 profit. The total interest allowance of P187,500 would still be given to the partners. The only difference is that the division of profits or losses after the interest allowances would involve a larger negative amount of P197,500 which will be divided equally between | Biore and Besario: Biore —Besario.©——Total 15% Interest on Average Capital: Biore: P475,000 x 15% P 71,250 Besario: P775,000 x 15% 116,250 Subtotal P 187,500 Balance to be Divided Equally [(P10,000) - P187,500 = P(197,500)]: Biore: P(197,500) x 50% (98,750) Besario: P(197,500) x 50% (98,750) Subtotal (197,500) Share of Partners in Profits (Losses) P(27,500)___P.17,500__P (10,000) E00 P 10,000) 2-12. | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerof 1 The journal entry to close the income summary ledger account on Dec. 31, 2019 follows: Christopher Biore, Drawing 27,500 Income Summary 10,000 Rose Besario, Drawing 17,500 To record the division of losses. After initial consideration, the idea that a loss of 10,000 should cause one partner's capital to increase. and the other partner's capital to decrease may appear unreasonable. However, this result was planned and was with good reason. Partner Besario invested more capital than Partner Biore; this capital was used to carry out operations, and the partnership's incurrence of a loss in the first year is no reason to disregard Besario's larger capital investment. Comparison of distribution based solely on capital ratios as against distribution with interest on capital balances. There will be a significant difference between the two distribution plans if the partnership is operating at a loss. Under the capital ratio plan, the partner who invested more capital will ultimately shoulder a bigger share of the loss. This result may be considered inequitable because the investment of capital presumably is not the cause of the loss. Under the interest plan, the partner who invested more capital is credited (increased) for an interest on his capital and is ultimately debited (decreased) with a lesser share of the loss; in some cases, the result may even be a net credit (increase). By Allowing Salaries to Partners and the Balance in an Agreed Ratio The sharing agreement may provide for variations in compensating the personal services contributed by partners. Even among partners who devote equal service time, one partner's superior experience and knowledge may command a greater share of the profit. To acknowledge the harder working or more valuable partner, the profit-sharing Plan may provide for salary allowances, eps 004 be gulch Clee fue 4 «| boy The partnership agreement should be clear on the treatment of salary allowances when losses are incurred. In the absence of an agreement to govern this situation, salary allowances will-be provided even.when operations yielded losses. This allowance should not be confused with salaries expense or with the partner's drawing account which is. debited for periodic salary allowances. The cash withdrawals will in no way affect the division of profits; the division of profits is governed by the sharing agreement. Partners are the partnership's owners; they are not employees of the business. If partners devote their time and services to the affairs of the partnership, they are understood to do so for profit, not for salary. Therefore, when the partners calculate the profit of the partnership, salaries to the partners are not deducted as expenses in the statement of comprehensive income. Chapter 2: Partnership Operations and Financial Reporting | 2-13 Scanned with CamScannerContinuing the illustration for the Biore and Besario Partnership, assume that the partnership agreement provided for an annual salary of P100,000 to Biore and P60,000 to Besario, and the balance to be divided equally. The profit of P300,000 for 2019 is divided as follows: re Besario Total Salary Allowances 100,000 Pp 60,000 P160,000 Balance to be Divided Equally [300,000 - P160,000 = P140,000)]: Biore: P140,000 x 50% 70,000 Besario: P140,000 x 50% 70,000 __ 140,000 Share of Partners in Profits 170,000 _P130,000__P300,000 ‘The journal entry to close the income summary ledger account on Dec. 31, 2019 follows: Income Summary 300,000 Christopher Biore, Drawing 170,000 Rose Besario, Drawing 130,000 To record the division of profits. By Allowing Bonus to the Managing Partner Based on Profit and the Balance in an Agreed Ratio A partnership contract may provide for a special compensation in the form of bonus to the managing partner when the results of operations of the partnership are favorable. This allowance is given in order to encourage the partner to maximize the profit potentials of the partnership. Bonus is not being considered in the computation of profit, rather it is a mere technique to distribute profits. ‘Assume that the Biore and Besario Partnership agreement provided for a bonus of 25% of profit before bonus to Partner Biore and the balance to be divided equally. The profit is P300,000. Biore Besario Total Bonus [ 25% x P300,000 }: P 75,000 P 75,000 Balance to be Divided Equally [ P300,000 - P75,000 = P225,000)]: Biore: P225,000 x 50% 112,500 Besario: P225,000 x 50% 112,500 225,000 Share of Partners in Profits P187,500___P112,500__ 300,000 . 800,000 2-14 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerThe journal entry to close the income summary ledger account on Dec. 31, 2019 follows: Income Summary 300,000 Christopher Biore, Drawing 187,500 Rose Besario, Drawing 112,500 To record the division of profits. ‘Assume instead that the Biore and Besario Partnership agreement provided for a bonus of 25% of profit after bonus to Partner Biore and the balance to be divided equally. It is understood in the wording of the agreement that the 25% bonus will be based on the difference after deducting bonus from a certain amount. This certain amount is the profit after considering all the operating expenses but before this bonus. Here, the P300,000 profit still includes the bonus. The difference between this profit and bonus shall-be-the basis for the 25% bonus-rate, Hence, profit after bonus represents 100% while the profit of P300,000 before bonus represents 125% Profit before Bonus 300,000 125% S \\_ Profit after Bonus (P300,000/125%) 240,000 100% —-— 8 —— P 60,00 Biore Besario Total Bonus P 60,000 P 60,000 Balance to be Divided Equally [:P300,000 - P60,000 = P240,000)): Biore: P240,000 x 50% 120,000 Besario: P240,000 x 50% 120,000___240,000 ‘Share of Partners in Profits P180,000___P120,000__P300,000 Income Summary 300,000 Christopher Biore, Drawing 180,000 Rose Besario, Drawing 120,000 To record the division of profits. By Allowing Salaries, Interest on Capital, Bonus to the Managing Partner and the Balance in an Agreed Ratio ‘The service contributions and capital contributions of the partners are often not equal. If the service contributions are not equal, salary allowances can compensate for the differences, Or, when capital contributions are not equal, interest allowances can make up for the unequal investments. When both service and capital contributions are unequal, the allocation of profits or losses may include salary allowances, interest on their capital balances, bonus to the managing partner, and the balance to be divided in an agreed ratio. Chapter 2: Partnership Operations and Financial Reporting | 2-15 Scanned with CamScannerNote that the provisions for salaries and interest in the partnership agreement are called allowances. These allowances are not reported in the statement of recog) d income and expense as salaries and interest expense; they are merely means of allocating profit to the partners. ‘Assume that the profit for the year is P400,000 and the partnership agreement for the Biore and Besario Partnership provided for the following: 1. Bonus to Biore of 25% of profit after salaries and interest but before bonus; 2. Annual salaries of P100,000 to Biore and P60,000 to Besario; 3. Interest on average capital balances of P71,250 and P116,250 to Biore and Besario, respectively; 4, Balance to be divided in a ratio of 40:60. Biore Besario Salary Allowances 100,000 P 60,000 Interest on Average Capital Balances 71,250 116,250 Bonus [ 25% (P400,000 - P100,000 - 13,125 60,000 - P71,250 - P116,250) J: Balance to be Divided in a Ratio of ‘40:60 [ P400,000 - P160,000- 2 \ P187,500 - P13,125 = P39,375): Biore: P39,375 x 40% 15,750 Besario: P39,375 x 60% 23,625 Share of Partners in Profits 200,125 _P199,875 Total 160,000 187,500 13,125 39,375 400,000 The journal entry to close the income summary ledger account on Dec. 31, 2019 follows: Income Summary 400,000 Christopher Biore, Drawing 200,125 Rose Besario, Drawing 199,875 To record the division of profits. Assume instead that the bonus to Biore is 25% of profit after salaries, interest and after bonus. The computation of the bonus follows: Profit before Salaries, Interest and Bonus Less: Salaries P160,000 Interest < 187,500 Profit after Salaries and Interest but before Bonus ) Profit after Salaries, Interest and ofter Bonus* _/ Bonus +P52,500 divided by 125% = P42,000. 2-16 | WIN Ballada’s Partnership and Corporation Accounting 400,000 347,500_ P 52,500 125 -42,000.7/100%) ~P 10,500 25% Scanned with CamScannerBiore Besario Total Salary Allowances P100,000 60,000 P160,000 Interest on Average Capital Balances 71,250 116,250 * 187,500 Bonus 10,500 10,500 Balance to be Divided in a Ratio of, 40:60 [ P400,000 - P160,000 - 187,500 - P10,500 = P42,000): jiore: P42,000 x 40% 16,800 . Besario: P42,000 x 60% 25,200 42,000 Share of Partners in Profits P198,550__P201,450_P400,000 The journal entry to close the income summary ledger account on Dec. 31, 2019 follows: Income Summary 400,000 Christopher Biore, Drawing 198,550 Rose Besario, Drawing 201,450 To record the division of profits. Some of the topics below are required inclusions in this subject per Commission on Higher Education Memorandum Order No. 3 (series of 2007), As Amended. Unfamiliar terms in the succeeding discussions which are partly based on IAS No. 1 (revised 2007) will be fully appreciated in higher accounting subjects. Suffice it to say, though, that at this point you're in a better situation than the users of other textbooks. The International Accounting Standards Board (IASB) issued a revised International Accounting Standards (IAS) No. 1, Presentation of Financial Statements last Sept. 6, 2007. This standard supersedes the 2003 version of IAS 1 as amended in 2005. IAS No. 1 (revised 2007) is effective for periods beginning on or after 1 January 2009. FINANCIAL REPORTING Purpose of Financial Statements , Financial statements are a structured representation with the objective of providing information about the financial, position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of the management's stewardship of the resources entrusted to it, To meet the objective, financial statements provide information about an entity's assets, liabilities, equity, income and expenses, other changes in equity and cash flows. : Overall Considerations Fair Presentation and Compliance with International Financial Reporting Standards (IFRSs). The financial statements shall present fairly the financial position, financial Chapter 2: Partnership Operations and Financial Reporting | 2-17 Scanned with CamScannerPerformance and cash flows of the entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the IASB’s Framework. Under IAS No. 1 (revised 2007), entities are required to make an explicit and unreserved statement of compliance with IFRS in the notes. Going Concern. Financial statements should be prepared on a going concern basis unless management intends to liquidate the entity or cease trading or has no realistic option but to do so. Accrual Basis of Accounting. An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. Materiality and Aggregation. An entity shall present separately each material class of similar items. Material items that are dissimilar in nature or function should be separately disclosed. Offsetting. An entity shall not offset assets and required or permitted by an IFRS. ies, income and expenses unless Frequency of Reporting and Comparative Information. At least annually, an entity shall present with equal prominence each financial statement in a complete set of financial statements including comparative information in respect of the previous period for all amounts reported in the current periods financial statements. Consistency of Presentation. An entity shall retain the presentation and classification of items in the financial statements in successive periods unless an alternative would be more appropriate or an IFRS requires a change in presentation. Identification of the Financial Statements. An entity shall clearly identify the financial statements and distinguish them from other information in the same published document. International Financial Reporting Standards (IFRSs) apply only to the financial statements and not necessarily to other information presented in an annual report, 2 regulatory filing or another document. An entity shall clearly identify each financial statement and the notes. An entity shall display the following information prominently: name of the reporting entity; whether the financial statements are of the indi entities; © the date of the end of the reporting period or the period covered by the set of financial statements or notes; © the presentation currency; © and the level of rounding used in presenting amounts in the financial statements. : 3 ual entity or a group of 2-18 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerComplete Set of Financial Statements Per revised International Accounting Standards (IAS) No. 1, Presentation of Financial Statements, a complete set of financial statements comprises: a b. © qd. e. f. a statement of financial position as at the end of the period; a statement of comprehensive income for the period; a statement of changes in equity for the period; a statement of cash flows for the period; notes, comprising a summary significant accounting policies and other explanatory information; and a statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes @ retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. Statement of Comprehensive Income The form and content of the income statement of the partnership resemble those of the sole proprietorship with the exception of the presentation of the division of profits or losses at the lower portion of the statement. Biore and Besario Partial Income Statement For the Year Ended Dec. 31, 2019 Proft P300,000 Division of Profit (equally): Partner Biore P150,000 Partner Besario 150,000 Total 300,009 ‘The components of profit or loss may be presented either as part of a single statement of comprehensive income or in an income statement, as permitted by paragraph 81 of IAS No. 1 (revised 2007), When an income statement is presented, it is part of a complete set of financial statements and shall be displayed immediately before the statement of comprehensive income. ‘As a minimum, the statement of comprehensive income shall include present the following amounts for the period: e items that Revenue; Finance costs; Share of profit or loss of associates and joint ventures accounted for using the equity method; Tax expense; ." Assingle amount comprising the total of: i. The post-tax profit or loss of discontinued operations; and Chapter 2: Partnership Operations and Financial Reporting | 2-19 Scanned with CamScannerThe post-tax gain or loss recognized on the measurement to fair value less costs to sell on the disposal of the assets or disposal group(s) constituting the discontinued operations; f. Profit or loss; B. Each component of other comprehensive income classified by nature (excluding amounts in (h) below); h. Share of the other comprehensive income of associates and joint ventures accounted for using the equity method; and i. Total comprehensive income. Statement of Changes in Equity An entity shall present a statement of changes in equity, showing in the statement: a, total comprehensive income for the period showing separately the total amounts attributable to owners of the parent and to minority interests; b. for each component of equity, the effects of retrospective restatement recognized in accordance with IAS No. 8, Accounting Policies, Changes in ‘Accounting Estimates and Errors; c. the amounts of transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners; and 4. for each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing each change. The components of equity referred to above include for example, each class of contributed equity, the accumulated balance of each class of other comprehensive income and retained earnings (these are applicable to corporations). The amount of idends recognized as distributions to owners during the period, and the related amount per share, shall be presented either. in the statement of changes in equity or in the notes. In the case of Biore and Besario, as contrasted with a sole proprietorship, the number of capital and drawing accounts has made the preparation of this statement all the more useful. Changes in an entity's equity between the beginning and the end of the reporting period reflect the increase or decrease in its net assets during the period. Biore and Besario ‘Statement of Changes in Partners’ Equity For the Year Ended Dec. 31, 2019 Biore Besario Total Original investments 400,000 800,000 —_P,200,000 Add: Additional Investments _100,000__- _—_100,000_ rafal 500,000 800,000 _P,300,000 Less: Permanent Withdrawals 50,000 50,000 fotencel 500,000 —P750,000 1,250,000 ‘Add: Profit 150,000 150,000 300,000 2-20 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerTotal 650,000 P900,000 1,550,000 Less: Temporary Withdrawals 60,000 60,000___120,000 Partners’ Equity, Dec. 31 590,000 __P840,000_P 1,430,000 Statement of Financial Position After all the components of the statement of comprehensive income along with the changes in partners’ equity for the period have been properly presented, the preparation of the statement of financial position will present no major difficulty. The assets and liabilities will be presented in the statement of financial position as those of a sole proprietorship but the owners’ equity section should exhibit separately the capital balance of P590,000 and P840,000 for Biore and Besario, respectively. Though some of the items are not as familiar yet, per revised International Accounting Standards (IAS) No. 1, Presentation of Financial Statements, as a minimum, the face of the staternent of financial position shall include line items that: present the following amounts: a. Property, plant and equipment; b. Investment property; c. Intangible assets; d. Financial assets (excluding amounts shown under e, h and i); €. Investment accounted for using the equity method; f. Biological assets; & Inventories; h, Trade and other receivables; i. Cash and cash equivalents; j. The total of assets classified as held for sale and assets included in disposal groups classified as held for sale in accordance with IFRS 5; Trade and other payables; Provisions; Financial liabilities (excluding amounts shown under k and I); Liabilities and assets for current tax, as defined in IAS 12; Deferred tax liabilities and deferred tax assets, as defined in IAS 12; Liabilities in disposal groups classified as held for sale in accordance with IFRS 5; @: Minority interest, presented within equity; and 1. Issued capital and reserves attributable to equity holders of the parent. posacr IAS No. 1 (revised 2007) does not prescribe the order or format in which an entity presents items. The above enumeration (from Paragraph 54 of IAS No. 1, revised 2007) simply provides a list of items that are sufficiently different in nature or function to warrant a separate presentation in the statement of financial position, Chapter 2: Partnership Operations and Financial Reporting | 2-21 Scanned with CamScannerNote that an entity makes the judgment about whether to present additional items separately on the basis of an assessment of: a. the nature and liquidity of assets; b. the function of assets within the entity; and ¢. the amounts, nature and timing of liabilities. Current and noncurrent assets and liabilities should be separately classified on the face of the statement of financial position except when a presentation based on liquidity provides more reliable and relevant information. An entity shall classify an asset as current asset when it satisfies any of the following criteria: ‘it expects to realize the assets, intends to sell or consume it, in its normal operating cycle; or + itholds the asset primarily for the purpose of trading; or + it expects to realize the asset within 12 months after the end of the reporting period; or ‘© the asset is cash or a cash equivalent as defined in IAS No. 7. All other assets are noncurrent. Operating cycle is the time between the acquisition of assets for processing and their realization in cash or cash equivalents. A liability should be classified as a current liability when it: is expected to be settled in the normal operating cycle; or is held primarily for the purpose of trading; or is due to be settled within 12 months after the end of the reporting period; or does not have an unconditional right to defer settlement of the liability for at least 412 months after the reporting period. eee All other liabilities should be classified as non-current liabilities. Statement of Cash Flows The cash flow statement serves as a basis for evaluating the entity's ability to generate cash and cash equivalents and the needs to utilize these cash flows. The statement of cash flows provides information about the cash receipts and cash payments of an entity during a period. It is a formal statement that classifies cash receipts (inflows) and cash payments (outflows) into operating, investing and financing activities. This statement shows the net increase or decrease in cash during the period and the cash balance at the end of the period; it also helps project the future net cash flows of the entity. The discussion below gives an overview of some important concepts involved in the preparation of the cash flow statement. 2-22 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerCash Flows from Operating Activities Operating activities generally involve providing services, and producing and delivering goods. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of profit or loss. This cash flow can be presented using either the direct or the indirect method. Using th¢ direct method, the entity’s net cash provided by (used in) operating activities is obtainéd-by-adding the individual operating cash inflows and then subtracting the individual operating cash outflows. ThE indirect method derives the net cash provided by (used in) operating activities by adjusting profit for income and expense items not resulting from cash transactions. The adjustment begins with profit followed by the addition of expenses and charges (e.8. depreciation) that did not entail cash payments. Then, increases in current assets and decreases in current liabilities involved in the determination of profit but which did not actually increase or decrease cash, are subtracted from profit. Finally, decreases in current assets and increases in current liabilities are added to profit to obtain net cash provided by (used in) operating activities. Profit P xxx Adjustments for: Non-Cash Expenses (e.g. Depreciation) xx Increases in Current Asset Accounts (ax) -Decreases in Current Liability Accounts (x) Decreases in Current Asset Accounts x Increases in Current Liability Accounts xx Cash Flows from Operating Activities P xxx For example, increases in accounts receivable from sale of services or goods represented an increase in profit without the corresponding increase in cash—for it is still a receivable. Since these revenues are already included in the computation of profit, the increase in accounts receivable should be deducted from the profit figure. To illustrate further, assume that salaries payable increased. Increases in salaries payable meant that the entity did not pay the full amount of salaries expense for the period. The expense in the income statement, for cash flow purposes, is overstated by the amount of unpaid salaries. If expense is overstated, then profit is understated by the same amount; hence, the increase in current liability is added to profit. Per International Accounting Standards (IAS) No. 7, Cash Flow Statements, enterprises are encouraged to report cash flows from operating activities using the direct method but the indirect method is acceptable. Only the direct method is illustrated here using, assumed amounts, The following are the major classes of operating cash flows using the direct method: Chapter 2: Partnership Operations and Financial Reporting | 2-23 Scanned with CamScannerCash Inflows 4 receipts from sale of goods and performance of services j ¢ receipts from royalties, fees, commissions and other revenues Cash Outflows ‘¢ payments to suppliers of goods and services payments to employees payments for taxes payments for interest expense payments for other operating expenses soos Cash Flows from Investing Activities Investing activities include making and collecting loans; acquiring and. disposing of investments in debt or equity securities; and obtaining and selling of property and equipment and other productive assets. Cash Inflows ‘¢ receipts from sale of property and equipment ¢ receipts from sale of investments in debt or equity securities receipts from collections on notes receivable Cash Outflows + payments to acquire property and equipment payments to acquire debt or equity securities ‘payments to make loansto others generally in the form of notes receivable Cash Flows from Financing Activities Financing activities include obtai ing resources from owners and creditors. Cash Inflows 4 receipts from investments by owners + receipts from issuance of notes payable Cash Outflows ‘¢ payments to owners in the form of withdrawals 4 payments to settle notes payable Eva Cammayo and Company Statement of Cash Flows For the Month Ended May 31, 2019 Cash Flows from Operating Activities: Cash received from clients P 604,000 Payments to suppliers (100,000) Payments to employees (138,000) Payments for office rent in. Payments for insurance (140,000) 2-24 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerPayments for utilities (30,000) Net cash provided by (used in) operating activities P 116,000 Cash Flows from Investing Activities: Payments to acquire service vehicle (4,200,000) Payments to acquire office equipment (150,000) Net cash provided by (used in) investing activities (4,350,000) Cash Flows from Financing Activities: . Cash received as investments by owners 2,500,000 Cash received from borrowings 2,100,000 Payments for withdrawals by owners (240,000) Net cash provided by (used in) financing activities 4,460,000, Net increase (Decrease) in Cash and Cash Equivalents P 226,000 Cash and Cash Equivalents at the beginning of the period 125,000 ‘Cash and Cash Equivalents at the end of the period 351,000 The establishment and maintenance of a petty’cash fund and the control of cash through a bank account were also illustrated lengthily. PARTNERSHIPS IN ASIA Origins Malaysia (gained independence in 1957), Singapore (1963), Brunei (1984) and Hong Kong (1997) were former British colonies. The Dutch had Indonesia (1949) while the French had Cambodia (1953), Laos (1953) and Vietnam (1954), Naturally, colonization had its effects on how entities are formed or being formed owing to the origins of the laws in place in the former colonies. It is not surprising that after comparing the Partnership Acts of these former British colonies they showed strong resemblances to the English’s Partnership Act of 1890. For example, an excerpt of Ordinances of the Hong Kong Special Administrative Region (HKSAR) of the People's Republic of China, CAP 38 Partnership Ordinance shows: Cap 38 + 26 Rules as to interests and duties of partners, subject to special agreement The interests of partnefs in the partnership property, and their rights and duties in relation to the partnership, shall be determined, subject to any agreement, express or implied, between the partners, by the following rules- ‘ ‘2, _allthe partners are entitled to share equally in the capital and profits ofthe business, and must contribute equally towards the losses, whether of capital or otherwise, sustained by the firm; 'b. the firm must indemnify every partner in respect of payments made and personal abilities incurred by him- i. inthe ordinary and proper conduct of the business ofthe firm; or ii, ino about anything necessarily done for the preservation of the business or property of the firm; Chapter 2: Partnership Operations and Financial Reporting | 2-25 Scanned with CamScanner©. partner making, for the purposes of the partnership, any actual payment or advance beyond the ‘amount of capital which he has agreed to subscribe, is entitled to interest at the rate of eight per cent per annum from the date of the payment or advance; d._apartneris not entitled, before the ascertainment of profits, to interest on the capital subscribed by him; fe. everypartner may take part in the management of the partnership business; f. no partner shall be entitled to remuneration for acting in the partnership business; & no person may be introduced as a partner without the consent of al existing partners; hh. anydifference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners, but no change may be made in the nature of the partnership business without the consent ofall existing partners; and i. the partnership books are to be kept at the place of business of the partnership (or the principal place, if there are more places than one], and every partner may, when he thinks fit, have access to and inspect and copy any of them. This section is an exact reproduction of the Section 24 of the Partnership Act of 1890 except for the rate used in letter “c” which was 5% in the original. The Malaysian, Partnership Act of 1961, Section 26, and the Partnership Act of Singapore, showed the same commonalities. Partner's Equity Capital Accounts The capital account of each partner will be credited with the partner's original and additional capital contributions, and debited with any permanent withdrawals. The balances of the partners’ account will not change frequently. Capital accounts prepared in thismanner are referred to as fixed capital accounts. Current Accounts The current account will be credited for salaries and interest on capital (in this case, with a debit to profit and loss appropriation account). It will be debited for interest on drawings. At the end of the year, it will be debited with the drawings account balance. Partner's Current Account Debit Credit | 1. Interest on Drawings 1, Interest on Capital 2. Drawings 2. Partner's Salaries 3. Share in Residual Losses ~| 3. Share in Residual Profits ‘The account shall also be credited with the share in the residual profits. Residual profits to be divided using the profit or loss ratio is derived by adding interest on drawings and deducting salaries and interest on capital to the accounting profit. 2-26 | WIN Ballada’s Partnership and Corporation Accounting Scanned with CamScannerCurrent accounts can have either a debit or a credit balance. A credit balance will be - undrawn profits while a debit balance will be drawings in excess of the profits to which the partner is entitled. Drawing Accounts A drawing account is maintained for each partner. This will be debited for any cash drawings during the year. The balance of this account is transferred to the partner's current account at the end of the year. Interest on Drawings Some partnership agreements will provide that partners will be charged interest on any drawings made during the year, This is to deter partners from drawing cash from the business. The interest on drawings is added to the profit for the year. It is debited to the individual partner's current accounts and credited to the profit and loss appropriation account. Illustration. Maribeth Buenviaje and Rey Fernan Refozar are partners sharing profits ‘and losses in the ratio 7:3, respectively. The following were taken from the partnership records for the fiscal year ended May 31, 2019: a. Partners’ Capital account balances: Buenviaje, P200,000 and Refozar, 140,000. b. Partners’ Current accounts balances as at June 1, 2018: Buenviaje, P15,000 credit and Refozar, P13,000 credit. ig the year, the partners made the following drawings from the partnership bank Du account: Buenviaje: P10,000 on Aug. 31, 2018 Refozar: 7,000 on Aug, 31, 2018 10,000 on Nov. 30, 2018 7,000 on Nov. 30, 2018 10,000 on Feb. 28, 2019 7,000 on Feb. 28, 2019 10,000 on May 31, 2019 P7,000 on May 31, 2019 Interest is charged on drawings at 12% per annum. Interest is allowed on capital accounts and credit balances on current accounts at 12% per annum. Refozar will receive a salary of P15,000 per annum, Profit for the year ended May 31, 2019 is 102,940. a. Calculate the total interest chargeable on the partner's drawings. Buenviaje: 8/31/2018 10,000 x 12% x 9/12 900 11/30/2018 10,000 x 12% x 6/12 600 2/28/2019 10,000 x 1296 x 3/12 300 1,800 Chapter 2: Partnership Operations and Financial Reporting | 2-27 Scanned with CamScanner