ACCOUNTING FOR PARTNERSHIP: P&L Allocation

Accounting for Partnership: Profit or Loss Allocation

Like any other business, a partnership conducts their operations to generate profit and to allocate them at the end of the fiscal year. It is common and practical to all partnership to have a profit or loss agreement. This agreement can be simple or complex but should be equitable for the partners.

In the absence of agreement, the share of each partners in profit or loss shall be in proportion to their capital contribution.

Example: A contributed 50,000 and B contributed 150,000 to form a partnership. It is assumed that the profit sharing ratio is 25% for A and 75% for B (50/200 and 150/200).

Profit or loss sharing methods

Problem: A contributed 50,000 and B contributed 150,000 to form a partnership. The net income of the partnership for the first year was 100,000 and they agreed to share the profit or loss;

1.       Equally – 50,000 for A and 50,000 for B

2.       Arbitrarily – 25,000 for A and 50,000 for B (25% for A and 75% for B)

Sometimes or most of the time the agreement will include BONUS, INTEREST or SALARIES in the formula to make the profit or loss sharing more equitable to them. Bonus, interest and salaries are not to be expense but to be included in the distribution of net income or loss.

Interest Allowances

This is added to the agreement to recognize the difference of their contributed capital or more likely because the partners or a partner doesn’t involve in the day-to-day operation. In our problem, B can ask for Interest allowance because he contributed more.

Example: They agreed to give B interest on contributed capital at 10%.

100,000 x 10% = 10,000 or

148,000 x 10% = 14,800 (See weighted average below)

Simple Average and Weighted Average

In some cases, partners will withdraw or contribute more capital into the partnership in a year. That’s why using the average capital of the partners as the basis of the interest will be more practical.

Example: During the year, B contributed another 10,000 on May 1 and withdrew 50,000 on November 1.

Using Weighted Average:

150,000 4/12 = 50,000    * 150,000 capital is not changed for 4 months (Jan 1 to July 31)

160,000 6/12 = 80,000    * 150,000 + 10,000 contribution and not changed for 6 months (May 1 to Oct31)

110,000 2/12 = 18,000    *160,000 – 50,0000 withdrawal and not changed for 2 months (Nov 1 to Dec 31)

W.Average Cap = 148,000

Salary Allowances

A partnership can also include salary to the agreement. This for the partner who devotes time to the partnership business or sometimes talent and skills (Industrial partner). To compensate these personal services, giving salary is a practical way to do it.

Bonus

For extra compensation, partnership will give bonus to compensate the services provided by a partner. The partnership can also require a minimum profit before bonus is calculated.

Bonus is computed on the basis of partnership net income and can be specific by using the word before and after.

Example: Net income is 100,000

1.       A bonus of 10% of net income before the bonus, salaries and interest

2.       A bonus of 10% of net income after bonus but before salaries and interest

3.       A bonus of 10% of net income after salaries and bonus but before interest

4.       A bonus of 10% of net income after salaries, bonus and interest

5.       A bonus of 10% of net income before salaries and interest but after bonus and income tax

(there’s a lot more! But this is easy)

The technique here is the word OF , BEFORE and AFTER. OF= ( ), Before = don’t include and After = Include but deducted, then proceed to make a formula.

Using example 3:

B= Bonus             S= Salaries 20,000             I= Interest 20,000            T= Tax 30%

B= 10% of 100,000 after – 20,000 and -B but before salaries OR

B= 10% (100,000 – 20,000 - B)

B= 8,000 - .10B

.10B +B= 8,000

1.1B= 8,000

B= 7,273

Using example 5:

B= 10% of 100,000 – T – B or

B= 10% (100,000 – T - B)

The T is  T= 100,000 x .30 or 30,000

So B= 10% (100,000 – 30,000 – B)

B= 7,000 - .10B

1.1B=7,000

B= 6,364

NOTE:

1.       Bonus is not included when it is NEGATIVE or there is NET LOSS

2.       Salaries and Interest is always included as part of the distribution.

1.       The profit sharing ratio is always the basis. If the net income more than enough or not enough, the excess should be shared by the partners in agreed profit sharing ratio (If not stated, use the contributed capital as basis)