ALLOCATING PARTNERSHIP PROFITS AND LOSSES

Lamar Van Dusen
ALLOCATING PROFIT/LOSS IN A PARTNERSHIP

PARTNERSHIP
 Def. - “..an association of two or more persons who carry on, as co-owners,
a business for profit”
o Used for all types of
enterprises
• More popular in
service industry than
merchandising
businesses

PARTNERSHIP AGREEMENT
 Def. - a written agreement containing the provisions for
operating a partnership.
o Essential provisions include:
• Date of the agreement
• Names of the partners
• Kind of business to be conducted
• Length of time the partnership is to run
• Name and location of the business
• Investment of each partner
• Basis on which profits and losses are to be shared
• Limitation of partners’ rights and activities
• Salary allowance to partners
• Division of assets upon dissolution of the partnership
• Signatures of the partners

CHARACTERISTICS
CO-OWNERSHIP OF ASSETS
All assets held by a partnership are co-owned by all partners. If one
partner contributes an asset to the business, the asset is jointly owned by
all partners.
Advantages:
Ability and expertise
combined into one enterprise
& easier to raise capital

CHARACTERISTICS
MUTUAL AGENCY
Any partner can bind the other partners to a contract if he or she
is acting within the general scope of the business.
Disadvantage:
Serious consequences if
partners don’t act responsibly

CHARACTERISTICS
LIMITED LIFE
Partnership may be dissolved as
the result of any change in the
ownership. (e.g. death, bankruptcy,
incapacity, withdrawal of a partner,
addition of a new partner, or
expiration of the time specified in
the partnership agreement)

CHARACTERISTICS
UNLIMITED LIABILITY
Each partner is personally liable for ALL debts incurred by the
partnership.
Major Disadvantage:
A partner could lose
personal assets.

CHARACTERISTICS
FEDERAL INCOME TAXES
Partnership is not subject to federal income tax. But, partners
must report their share of the partnership’s income on their
income tax return.

INVESTMENTS
EXAMPLE: Sam Mitchell and Lisa Jenkins begin the Mitchell & Jenkins
partnership by investing $350,000 and $200,000, respectively.
Let’s look at the
journal entry!

GENERAL JOURNAL
DATE DESCRIPTION PR DEBIT CREDIT
1
2
3
4
5
6
7
8
9
10
11
Cash 350,000
Sam Mitchell, Capital 350,000
S. Mitchell invested
$350,000 in cash
Cash
Lisa Jenkins, Capital
L. Jenkins invested
$200,000 in cash
200,000
200,000
Separate Capital and Drawing accounts
are maintained for each partner.

INVESTMENTS
 What if instead of $200,000 in cash, Lisa Jenkins had invested:
o Inventory valued at $47,500
• on which $10,500 was owed
o Office Equipment valued at $40,000
o Delivery Equipment valued at $92,000
• on which $19,000 was owed on a note
o $50,000 in cash

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 50,000
47,500Inventory
Lisa Jenkins, Capital
19,000
200,000
Each asset invested and liability assumed
is recorded. The difference is credited
to the Capital account.
Office Equipment 40,000
Delivery Equipment 92,000
Notes Payable
Accounts Payable 10,500

COMBINING BUSINESSES
• On April 1, Donna Morning and Larry Knight form
a partnership under the firm name of Morning &
Knight Sports.
• They agree to invest their assets in the partnership.
The partnership will also assume the liabilities shown
on their balance sheets.
• Profits/losses are to be shared 50-50.
• In the case of dissolution, assets are to be
distributed between partners in the ratio of their
capital interests at the time of dissolution.

Morning Sports
Balance Sheet
March 31, 20--
Assets Liabilities
Cash $ 6,344
Accts. Receivable $ 5,524
Less Allow for
Bad debts 430 5,094
Merchandise Inv 24,574
Store Equipment $3,840
Less Accum Depr 1,000 2,840
Total Assets $38,852
Notes Payable $ 4,600
Total Liabilities $ 13,682
Owner’s Equity
Morning, Capital 25,170
$38,852Total Liab & O.E.
Let’s look at the journal entry
to record Donna Morning’s
investment in the new partnership.

GENERAL JOURNAL
DATE DESCRIPTION PRDEBIT CREDIT
1
2
3
4
5
6
7
8
9
10
11
Cash 6,344
5,524Accounts Receivable
Any uncollectible accounts should
be written off before forming
the partnership….
Morning Sports had no
accounts considered uncollectible.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 6,344
Merchandise Inventory 24,574
Since Donna uses FIFO,
the Merchandise Inventory account
reflects current market values.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 6,344
Store Equipment 3,600
Assets are recorded at their
fair market values (not book values)
at the time of investment.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 6,344
Accounts Payable
430
9,082
Allowance for Bad Debts
Notes Payable 4,600
The allowance account and the liabilities
are recorded at the values shown
on Morning Sports’ Balance Sheet.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 6,344
Accounts Payable
430
9,082
Notes Payable 4,600
Capital account is credited for the
difference between assets
invested and liabilities assumed.
D. Morning, Capital 25,930

Knight Athletics
Balance Sheet
March 31, 20--
Assets Liabilities
Cash $ 3,544
Less Allow for
Bad debts 720 4,560
Supplies
$ 4,320
Total Liabilities $ 19,238
Owner’s Equity
Knight, Capital 25,644
720
Office Equipment
Store Equipment $ 4,800
Knight’s assets and
liabilities are brought into
the new partnership.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 3,544
Accounts Payable
3,850
720
Store Equipment
286
Notes Payable
4,200
L. Knight, Capital
6,000
Supplies
Office Equipment
13,238
26,894

ALLOCATING PROFIT/LOSS
Example: The partnership of Mitchell and
Jenkins earned net income of $190,800 for the
year.
S. Mitchell L. Jenkins
$95,400 $95,400
If Mitchell and Jenkins had not
specified how the income was to be
split, it would be split evenly.

PARTNERSHIP CLOSING
ENTRIES
FOUR ENTRIES:
Entries #1 & 2 are the same as for sole proprietorships.
Entries #3 & 4 are different for partnerships.
1. Close all revenues to Income Summary
2. Close all expenses to Income Summary
3. Close Income Summary by allocating each partner’s share
of net income or loss to the individual capital accounts
4. Close each partner’s drawing account to the individual
capital accounts.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Income Summary 190,800
95,400S. Mitchell, Capital
Instead of all the net income being
credited to one capital account…
it is allocated to each partner’s
capital account.
95,400L. Jenkins, Capital
Closing Entry #3

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
S. Mitchell, Capital
S. Mitchell, Drawing
36,000
36,000
L. Jenkins, Capital
L. Jenkins, Drawing
48,000
48,000
Closing Entry #3

Example: The partnership of Mitchell and Jenkins
earned net income of $190,800 for the year.
Mitchell and Jenkins did specify
how the income was to be split...
after salary allowances, the remaining
net income was to be split 60-40.

year.
$36,000 $48,000
Salary allowances total $84,000.
Remaining Net Income is $106,800
($190,800-$84,000).
Salary allowances

year.
$36,000 $48,000
$106,800 x 60% = $64,080
Salary allowances
64,080

year.
$36,000 $48,000
$106,800 x 40% = $42,720
Salary allowances
64,080 42,720Remaining Income

year.
$36,000 $48,000Salary allowances
64,080 42,720Remaining Income
$100,08
0
$90,720

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Closing entry is made for
the total allocated to each
partner.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
S. Mitchell, Capital
S. Mitchell, Drawing
36,000
36,000
L. Jenkins, Capital
L. Jenkins, Drawing
48,000
48,000
Close each
owner’s drawing
account

Example: Let’s look at the allocation if the
partnership of Mitchell and Jenkins earned net
income of $44,000 for the year.
The salary allowances
alone total more
than the Net Income!

$84,000 Salary Allow.
- 44,000
$40,000
Net Income
Excess to be
absorbed by
partners

$40,000 x 60%
(24,000)

$40,000 x 40%
(24,000) (16,000)

(24,000) (16,000)
$12,000 $32,000
$12,000 + $32,000 =
$44,000 Net Income

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Entries to close the drawing
accounts would be
the same as the previous example.

Example: B. K. Kelly and S. B. Arthur form a
partnership on January 1 of the current year.
Kelly will devote full time to operating the
business, invest $50,000, and draw a salary of
$35,000 per year. Arthur will devote about 10
hours per week, invest $150,000, and draw a
salary of $10,000 per year. The partners will
be allowed interest of 10% on capital balances
on January 1 of each year and the balance of
the earnings will be divided equally.
Let’s allocate the first year
Net Income of $80,000.

Kelly had a capital balance
of $50,000 on January 1.
$50,000 x 10%
B. K. Kelly S. B. Arthur
Salary Allow.$35,000 $10,000
Interest Allow.5,000

Arthur had a capital balance
of $150,000 on January 1.
$150,000 x 10%
Salary Allow.$35,000 $10,000
Interest Allow.5,000 15,000

Kelly has allowances of $40,000 so far
Arthur has $25,000 so far…
$80,000 - $65,000 = $15,000 remaining
Split evenly = $7,500 each
Salary Allow.$35,000 $10,000
Remaining Income7,500 7,500

Salary Allow.$35,000 $10,000
Remaining Income7,500 7,500
$47,500 $32,500
What if the partnership had
a loss of $20,000 in the first year?

Salary Allow.$35,000 $10,000
Salary and Interest allowances
would still be given, totaling $65,000.

Salary Allow.$35,000 $10,000
The allowances plus the loss
leave $85,000 to be absorbed
equally.
(42,500) (42,500)
$(2,500) $(17,500)

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Income Summary
2,500
17,500
B. K. Kelly, Capital
20,000
S. B. Arthur, Capital
Capital accounts are
reduced this year.

PARTNERSHIP FINANCIAL STATEMENTS
The allocation of
net income and its
impact on the
capital balances
should be disclosed
in the financial
statements.

FINANCIAL STATEMENTS
Kelly and Arthur
Income Statement (Partial)
For Year Ended December 31, 20--
Net Income $80,000
Kelly Arthur Total
Allocation of net income:
Salary allowances
Interest allowances
Remaining income
Allocation of net income $47,500 $32,500 $80,000
$35,000 $10,000 $45,000
5,000
7,500
15,000
7,500
20,000
15,000
Distribution of income is shown at
the bottom of the Income Statement.

Kelly and Arthur
Statement of Partners’ Equity
For Year Ended December 31, 20--
Kelly Arthur Total
Capital, January 1, 20--
Net Income for the year
Withdrawals (salaries during the year)
Capital, December 31, 20-- $62,500 $182,500 $245,000
$50,000 $150,000 $200,000
35,000
10,000
10,000 45,000
Additional Investments during year 10,000
$50,000 $160,000 $210,000
47,500 32,500 80,000
$97,500 $192,500 $290,000
Replaces
Statement of
Owner’s
Equity

Kelly and Arthur
Balance Sheet (Partial)
December 31, 20--
B. K. Kelly, capital
Total partners’ equity
$ 62,500
182,500S. B. Arthur, capital
$245,000
Partners’ Equity
Owner’s Equity is now
Partners’ Equity

DISSOLUTION
 Any change in the members of the partnership results in
dissolution.
o Does not imply that business operations will halt
o New Partnership agreement is created
o Can be caused by:
• Admitting a new partner
• Death or withdrawal of a partner
• Bankruptcy

ADMITTING A NEW PARTNER
 A new partner may buy into the business in three ways:
o by purchasing an interest directly from existing partners
o by making a cash investment in the business
o by contributing assets from an existing business

Example: Morning and Knight admit Sunny Noon
as a new partner as of July 1, 20--, when Morning
and Knight have capital interests of $30,000 and
$20,000, respectively. Noon pays $12,000 to
Morning for one-third of her interest and $12,000
to Knight for one-half of his interest.
The payments go to the partners
directly, not the business.

Morning, Capital x 1/3
$30,000 x 1/3
Noon buys $10,000 of
Morning’s equity.

Knight, Capital x 1/2
$20,000 x 1/2
Noon buys $10,000 of
Knight’s equity.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Donna Morning, Capital 10,000
Donna’s Capital account is reduced
by the amount sold to Sunny Noon.
20--
July 1

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
10,000Larry Knight, Capital
20,000Sunny Noon, Capital
Larry’s Capital account
is reduced by the 1/2 interest
he sold to Sunny.
A Capital account is created for Sunny.
20--
July 1

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
10,000Larry Knight, Capital
The $12,000 paid to each
partner is not recorded
on the partnership books.
20--
July 1

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 25,000
If Sunny had paid $25,000
directly to the partnership…..
20--
July 1

Sunny Noon’s Golf
Balance Sheet
June 30, 20--
Assets Liabilities
Cash $ 5,000
Less Allow for
Bad debts 1,078 13,212
Total Liabilities $16,598
Owner’s Equity
Noon, Capital 28,904
If Sunny has a business that the
new partnership will take over...

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 5,000
Accounts Receivable
No adjustment necessary
since Noon has no knowledge
of any uncollectible accounts.
20--
July 1
14,290

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 5,000
Accounts Receivable
No adjustment necessary
since Noon has been
using the FIFO method.
20--
July 1
14,290

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 5,000
Accounts Receivable
20--
July 1
14,290
Allowance for Bad Debts 1,078
Notes Payable 9,048
Sunny Noon, Capital 28,904

WITHDRAWAL OF A PARTNER
 A partner may retire and withdraw assets equal to, less than, or
greater than the amount of his or her interest in the partnership.
o determined after all profits and losses are allocated
o and books are closed

WITHDRAWAL OF A PARTNER
Example: Many years later Sunny Noon
decides to retire. The partners have agreed to
the withdrawal of cash equal to the amount
of Noon’s equity in the assets of the
partnership.
Donna Morning
20,000
Sunny Noon will take home
$40,000 cash.
Capital account balances:
$55,000
Sunny Noon 40,000
Larry Knight

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Her capital account is closed out.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
The other capital accounts
are not affected.
Cash 40,000

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
What if Sunny agrees
to only $30,000 cash?
Cash 40,000

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Sunny’s capital account
is closed out.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
But Cash received is less
than the capital balance…
difference is split between two
remaining partners.
Cash 30,000

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 30,000
Remaining capital = $100,000
($55,000 + $45,000)
Morning has 55% interest
She received 55% of the $10,000 difference.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 30,000
Donna Morning, Capital
Larry Knight, Capital
5,500
4,500
Larry receives 45% of the difference.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 30,000
5,500
4,500
If Noon received $45,000 cash
($5,000 more than her capital balance)

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 45,000
2,750
2,250
The remaining partners contribute
their capital to make the $5,000 difference.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 45,000
2,750
2,250
One last alternative…..
Sunny sells her interest
in the business to Donna.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11

LIQUIDATION OF A PARTNERSHIP
 Assets are sold
 Liabilities are paid
 Remaining cash and assets are distributed to the partners

Example: After many years of operations the
partnership is to be liquidated. After closing
entries the following accounts remain:
Cash
220,000
$ 10,000
Inventory 120,000
Other Assets
Liabilities 80,000
L. Knight, Capital 120,000
S. Noon, Capital 55,000
Non-Cash
Assets are
sold for
$370,000.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 370,000
Inventory 120,000
Other Assets 220,000
Gain on Sale of Assets 30,000

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 370,000
Inventory 120,000
Gain is shared equally
by the partners.

Cash
0
$380,00
00
Other Assets
Inventory
Cash is now $380,000 ($10,000 + $370,000),
Inventory and Other Assets are now zero.

Cash
0
$380,00
0Inventory 0
Other Assets
Liabilities 80,000
D. Morning, Capital 105,000 95,000+10,000

Cash
0
$380,00
0Inventory 0
Other Assets
Liabilities 80,000
L. Knight, Capital 130,000 120,000+10,000

Cash
0
$380,00
0Inventory 0
Other Assets
Liabilities 80,000
S. Noon, Capital 65,000 55,000+10,000
Liabilities
are paid
off.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Liabilities 80,000
Cash 80,000

Cash
0
$300,00
0Inventory 0
Other Assets
Liabilities 0
Remaining Cash = Capital account balances
Cash is distributed to partners.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 300,000

Cash
0
$
0Inventory 0
Other Assets
Liabilities 0
D. Morning, Capital 0
L. Knight, Capital 0
S. Noon, Capital 0
Partnership is liquidated!

Cash
220,000
$ 10,000
Inventory 120,000
Other Assets
Liabilities 80,000
If these
Assets had
been sold
for only
$295,000

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 295,000
Inventory 120,000
Loss on Sale of Assets 45,000
There is a $45,000 loss to be
allocated to the partners.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 295,000
Inventory 120,000

Cash
0
$
305,000Inventory 0
Other Assets
Liabilities 80,000
Liabilities
are paid
off.

Cash
0
$
225,000Inventory 0
Other Assets
Liabilities 0
Cash is
paid
to
partners.

GENERAL JOURNAL
1
2
3
4
5
6
7
8
9
10
11
Cash 225,000

ALLOCATING PARTNERSHIP PROFITS AND LOSSES

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