Solution manual fundamentals of accounting by cabrera chapter 04 SM

Chapter 4
Allocation of Partnership Income and Loss
Review Questions
1. Salary and interest allowances are included in some partnership agreements
in order to reward partners for the time and effort that they devote to
partnership business (salary allowances) and for capital investments (interest
allowances) that they make in the business.
2. Salary allowances to partners are not expenses of a partnership. Rather, they
are a means of recognizing the efforts of individual partners in the division of
partnership income.
3. When profits are divided in the ratio of capital balances, capital balances
should be computed on the basis of weighted average capital balances in the
absence of evidence that another interpretation of capital balances is intended
by the partners.
4. An individual partner may have a loss from his share of partnership operating
activities even though the partnership has income. This situation results if
priority allocations to other partners exceed partnership net income. For
example, if net income for the A and B Partnership is P5,000 and profits are
divided equally after a salary allowance of P8,000 to A, A will have
partnership income of P6,500 and B will have a partnership loss of P1,500.
5. Partners share losses in the same ratio that they share profits if the
partnership agreement does not discuss sharing the losses. If the agreement
specifies no profit-and-loss ratio, the partners share profits and losses equally.
6. Two methods are available for dividing income when profits are not
sufficient to cover the full distribution required by the agreement. One is to
divide the profits until they are used up and then stop. The second, and more
preferable, is to allocate salaries and interest first, and then divide the
remainder in the loss ratio for the partnership.
7. The use of a salary or bonus as a means of allocating profits would be
appropriate when there is a desire to reward partners for personal services or
significant personal time commitments to the partnership. The use of interest

2

Chapter 4

on capital as a means of allocating profits would be appropriate when the
business is capital intensive versus labor intensive or if the partners are not
significantly involved in the day-to-day operations.
8. Interest that is based on capital balances at a point in time, whether beginning
or year end, may result in manipulation. This is due to the fact that the
capital balance may be increased momentarily to produce a higher amount of
interest. Shortly thereafter, the capital may be withdrawn. The result is a
measure of capital and resulting interest that may not be representative of the
capital available to the partnership during the year.
9. If the amount is a withdrawal, then it is a direct reduction of capital and does
not affect income distribution. If salary, then the amount will first be
deducted from the income and the remainder will be distributed among the
partners. Clearly, there would be variations in each partner’s share of income
under each view.

Exercises
Exercise 1

a.

Half to each partner

b.

Luna (P40,000/P110,000 x P66,000)

Net Income (Net Loss)
Luna
Basco
Total
P22,000
P22,000
P44,000
P24,000
P66,000

Basco (P70,000/P110,000 x P66,000)
c.

Luna (P40,000/P110,000 x P77,000)

P42,000
P28,000
P(77,000)

Basco (P70,000/P110,000 x P77,000)
Total net income
Sharing of first P60,000 based on
capital contributions:
Luna
(P40,000/P110,000 x P60,000)
Basco
(P70,000/P110,000 x P60,000)
Net income left for allocation

P(49,000)

d.

P125,000

P 21,818
P 38,182
Net Income (Net Loss)

60,000
65,000


Allocation of Partnership Income and Loss

Luna
(Letter d. cont’d)
Sharing based on service:
Luna (P45,000 x 0.30)
Basco (P45,000 x 0.70)
Net income left for allocation
Balance shared equally:
Luna (P20,000 x ½)
Basco (P20,000 x ½)
Net income left for allocation
Net income allocated to the partners

Basco

3

Total

13,500
31,500

45,000
20,000

10,000

20,000
P
-0P125,000

10,000

P 45,318

P 79,682

Exercise 2
Requirement (1)
Lulu, Lily and Lala
Allocation of Profits and Losses
Lulu
Total net income (net loss)
Allocation to the partners:

Lulu (P42,900 x 1/3)
Lily (P42,900 x 1/3)
Lala (P42,900 x 1/3)
Total
Net loss left for allocation
Net loss allocated to partners

Lily

Lala

a.

b.

P(14,300)
P(14,300)
P(14,300)

P(14,300)

P(14,300)

P(14,300)

Total net income (net loss)
Lulu (P60,000 x 0.40)

P(42,900)
P

-0P(42,900)
P(60,000
)

P(24,000
)

Lily (P60,000 x 0.25)
Lala (P60,000 x 0.35)
Total
Net income left for allocation
Net income allocated to partners

Total
P(42,900)

P(15,000)
P(21,000)

P(24,000
)

P(15,000)

P(21,000)

P(60,000
)
P
-0P(60,000

)


4

Chapter 4

Lulu, Lily and Lala
Allocation of Profits and Losses
Lulu
Total net income
Allocation to the partners:
Sharing of first P40,000 based on
salaries:
Lulu (P15,000/P60,000 x
P52,000)
Lily (P18,000/P60,000 x
P52,000)
Lala (P27,000/P60,000 x
P52,000)
Total
Net income left for allocation
Net income allocated to partners

Lily

Lala

c.

Total net income
Allocation to the partners:
Sharing of first P75,000 based on
capital contributions:
Lulu (P15,000/P60,000 x
P75,000)
Lily (P18,000/P60,000 x
P75,000)
Lala (P27,000/P60,000 x
P75,000)
Total
Net income left for allocation
Sharing of next P36,000 of profit
based on service:
Lulu
Lily
Total
Net income left for allocation
Remainder shared equally:
Lulu (P69,000 x 1/3)
Lily (P69,000 x 1/3)
Lala (P69,000 x 1/3)
Total

Total
P92,000

P13,000
P15,600
P23,400

P41,000

P27,600

P23,400

d.

P52,000
P -0P92,000
P180,000

P18,750
P22,500
P33,750
P 75,000
P105,000
P28,000
P 8,000
P 36,000
P 69,000
P23,000
P23,000
P23,000
P 69,000


Allocation of Partnership Income and Loss

Net income left for allocation
Net income allocated to partners

P69,750

P53,500

P 56,750

5

P
-0P180,000

Requirement (2)
Lulu, Lily and Lala
Statement of Comprehensive Income
For the Year Ended January 31, 2007
Revenues
Expenses
Net income

P870,000
690,000
P180,000

Allocation of earnings:
Lulu
Lily
Lala

Total

P 69,750
53,500
56,750
P180,000

Requirement (3)
This problem will help students learn to allocate partnership profits and losses to
the partners. This allocation is important because one of the main points of
contention among partners is the sharing of profits and losses. Learning this
material should help partners design an agreement that is understandable. In
turn, that may help the partners avoid disagreements.
Exercise 3
Computation of Red’s bonus:
Let B = bonus
B = 10% x (P506,000 – B)
B = P50,600 – 0.1B
1.1B = P50,600
B = P46,000
Schedule to Allocate Partnership Income
White
Net income to distribute
Bonus to Red
Remainder to divide

P506,000
(46,000)
460,000

Red
P 46,000

Black


6

Chapter 4

Divided 40:40:20
Income allocation
Exercise 4

(460,000)
0

P184,000
P184,000

184,000
P230,000

P 92,000
P 92,000

Schedule to Allocate Partnership Income for 2007
Balance
P 14,000
(21,000)

(26,000
(33,000)
33,000
0

Net income to distribute
Salary allocation
Interest on capital*
Loss to divide
Divided equally
Income to partners

Violet

White

Yellow

P

--10,500

P 9,000
8,000

P 12,000
7,500

(11,000)
P (500)

(11,000)
P 6,000

(11,000)
P 8,500

* Interest on average capital:

Violet

Jan. 1, 2007
Balances
P100,000
120,000
100,000

x ½ year =
x ¼ year =
x ¼ year =

Average
Capital
P 50,000
30,000
25,000
P105,000

Interest on
Capital

x 10% =

P10,500

White

P 80,000

x 1 year =

P 80,000

x 10% =

8,000

Yellow

P 75,000

x 1 year =

P 75,000

x 10% =

7,500
P26,000

Exercise 5
Cupid
2007 income to divided
(P25,000 – P4,000)
Salary to Cupid
Remainder to divided
Divided equally
2006 income understatement
Divided in the 2006 –
60:40 ratio
Income allocation

P 21,000
(18,000)
3,000
(3,000)
0
P 4,000
(4,000)
0

Psyche

P18,000
1,500

P1,500

2,400
P21,900

1,600
P3,100


Allocation of Partnership Income and Loss

7

Exercise 6
Elite, Fantastic and Grand Partnership
Statement of Partnership Capital
For the year ended December 31, 2007

Balance January 1
Add: Investments
Less: Withdrawals
Less: Drawings
Net contributed capital
Add: Net income*
Balance December 31

Elite
Capital
P120,000
(30,000)
(10,000)
80,000
24,000
P104,000

Fantastic
Capital
P 90,000
20,000
(10,000)
100,000
24,000
P124,000

Grand
Capital
P140,000
20,000
(30,000)
(10,000)
120,000
24,000
P144,000

Total
Capital
P350,000
40,000
(60,000)
(30,000)
300,000
72,000
P372,000

* Net income = P372,000 ending capital – P300,000 net contributed capital.

Multiple Choice Questions
1.
2.
3.
4.

A (P40,000 x 3/12 = P10,000)
D (P40,000 x 3/12 = P16,667)
A
A ASSIGNMENT OF INCOME—YEAR ONE
Willow

Dreamer

Smallville

Total

P11,000
20,000

P 8,000
-0-

P11,000
10,000

P30,000

30,000

(40,000)
P(9,000)

(16,000)
P (8,000)

(24,000)
P (3,000)

(80,000)
P(20,000)

STATEMENT OF CAPITAL—YEAR ONE
Willow
Beginning capital ....................
P110,000
Net loss (above) ......................
(9,000)
Drawings (given) ....................
(10,000)
Ending capital ..................
P 91,000

Dreamer
P80,000
(8,000)
(10,000)
P62,000

Smallville
P110,000
(3,000)
(10,000)
P 97,000

Total
P300,000
(20,000)
(30,000)
P250,000

Dreamer

Smallville

Total

Interest—10% of
beginning capital .............
Salary......................................
Allocation of remaining loss
(P80,000 divided on a
5:2:3 basis) ......................
Totals ........................

ASSIGNMENT OF INCOME—YEAR TWO
Willow
Interest—10% of

8

Chapter 4

beginning capital .............
Salary......................................
Allocation of remaining loss
(P15,000 divided on a
5:2:3 basis) ......................
Totals ........................

P 9,100
20,000

P 6,200
-0-

P 9,700
10,000

P25,000
30,000

(7,500)
P21,600

(3,000)
P3,200

(4,500)
P15,200

(15,000)
P 40,000

STATEMENT OF CAPITAL—YEAR TWO
Willow
Beginning capital (above) .......
P 91,000
Net income (above) ................
21,600
Drawings (given) ....................
(10,000)
Ending capital .................. P102,600

Dreamer
P62,000
3,200
(10,000)
P55,200

Smallville
P 97,000
15,200
(10,000)
P102,200

Total

P250,000
40,000
(30,000)
P260,000

5. A A P10,000 bonus is paid to PJ (P100,000 is paid rather than the P90,000
capital balance). This bonus is deducted from the two remaining partners
according to their profit and loss ratio (2:3). A reduction of 60 percent
(3/5) is assigned to Pong or a decrease of P6,000 which drops that
partner’s capital balance from P30,000 to P24,000.

Test Material
Test Material 4-1
Requirement (1)
Salaries
Bonuses
Interest on capital
Subtotal
Remaining profit
Income

Orange
P15,000
2,000
3,000
P20,000
10,500
P30,500

Strawberry

P10,000
4,000
4,500
P18,500
10,500
P29,000

Peach
P
10,000
P10,000
10,500
P20,500

Total
P25,000
6,000
17,500
P48,500
31,500
P80,000

Orange
P15,000
–
3,000
P18,000
(20,000)
P(2,000)

Strawberry
P10,000
–
4,500
P14,500
(20,000)
P(5,500)

Peach
P
–
–
10,000
P10,000
(20,000)
P(10,000)

Total
P25,000
–
17,500
P42,500
(60,000)
P(17,500)

Requirement (2)
Salaries
Bonuses*
Interest on capital
Subtotal

Deficiency
Loss


Allocation of Partnership Income and Loss

9

* The bonus is a percentage of net income only, not net loss.

Test Material 4-2
Interest on weighted average capital balances:
Katrina
Amount Invested
P30,000
27,0001

Number of
Months Invested
7
5

Weighted Pesos
P210,000
135,000
P345,000

Weighted average capital: P345,000  12 = P28,750
Interest: P28,750 x 10% = P2,875
1

This amount represents the previous capital balance of P30,000 less the P3,000
of accumulated withdraws in excess of the P4,000 annual limit (P3,000 + P4,000
– P4,000).
Lorenzo
Amount Invested
P24,000
27,000
26,0002

Number of
Months Invested
4
6
2

Weighted Pesos
P 96,000
162,000
52,000
P310,000

Weighted average capital: P310,000  12 = P25,833
Interest: P25,833 x 10% = P2,583
2

This amount represents the previous capital balance of P27,000 less the P1,000
of accumulated withdraws in excess of the P4,000 annual limit (P1,000 + P500 +
P3,500 – P4,000).

10

Chapter 4

Test Material 4-3
Requirement (1)
The advantage of using the weighted average capital balance is that the interest
paid then represents payment for the use of funds in the partnership throughout
the year, and thus buffers the distribution of interest from large deposits made for
the sole purpose of obtaining an advantage if the interest calculations were based
on the beginning or ending capital balance. The disadvantage is that the
calculation is more complex than alternative means of computing interest on
capital contributed.
Requirement (2)
Amount Invested
Gold
P24,000
28,500
Silver
P17,500
Bronze
P13,000
15,000
30,000

Number of
Months Invested

Weighted Pesos

Average

3
9
12

P 72,000
256,500
P328,500

P27,375

12

P210,000

P17,500

6
2
4
12

P 78,000
30,000
120,000
P228,000

P19,000

Interest for 2007:
Gold
Silver
Bronze

P27,375 x 0.08
17,500 x 0.08
19,000 x 0.08

=
=
=

P2,190
1,400
1,520
P5,110


Allocation of Partnership Income and Loss

11

Requirement (3)
Analysis of Capital Accounts
Beginning balance (1/1/07)
Add: Investments
Income for year (see Schedule A)
Less: Withdrawals

Ending balance (12/31/07)

Gold
P24,000
4,500
7,520
(1,000)
P35,020

Silver
P17,500
6,730
(1,000)
P23,230

Bronze
P13,000
17,000
6,850
(500)
P36,350

Total
P54,500
21,500
21,100
(2,500)
P94,600

Gold

P2,190
5,330
P7,520

Silver
P1,400
5,330
P6,730

Bronze
P1,520
5,330
P6,850

Total
P 5,110
15,990
P21,100

Schedule A – Profit Allocation:
Interest
Balance
Income

Test Material 4-4

Salaries
Interest on capital (See Schedule A)
Bonus1
Subtotal

Remaining profit
Income
1

Black
P20,000
500
6,500
P27,000
3,500
P30,500

Profit Allocation
Blue
Brown
P18,000
P 6,825
375
2,300
–
–
P18,375
P 9,125
3,500
3,500
P21,875
P12,625

Total
P44,825

3,175
6,500
P54,500
P21,100

Bonus = 10% of partnership income

Black’s share of remaining income plus bonus equals P10,000 (P30,500 – P20,500)
Black’s interest in remaining profits equals 1/3.
Therefore:
[(PI – S – I – 10% PI) x 1/3] + 10% PI = P10,000
[(PI – P44,825 – P3,175 – 10% PI) x 1/3] + 10% PI = P10,000
30% PI = P26,000
PI = P65,000
where: PI = partnership income


12

Chapter 4

S =
I =

salaries of P44,825
interest of P3,175

Schedule A
Weighted Average Capital Balances
Amount Invested

Black
P5,000
4,500
5,500
5,000

Number of
Months Invested

Weighted Pesos

Average

3
3
3
3
12

P 15,000
13,500
16,500
15,000
P 60,000

P5,000

6
3
3

12

P 18,000
15,000
12,000
P 45,000

P3,750

3
3
6
12

P 60,000
57,000
159,000
P276,000

P23,000

Blue
P3,000
5,000
4,000
Brown
P20,000
19,000
26,500

Interest on Weighted Average Capital
Black......................................................................
Blue........................................................................
Brown....................................................................

P 5,000 x 0.10
3,750 x 0.10
23,000 x 0.10

=
=
=

P 500
375
2,300
P3,175