Solution manual fundamentals of accounting by cabrera chapter 04 SM

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

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

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

Net Income (Net Loss) Luna Basco Total

a Half to each partner P22,000 P22,000 P44,000

b Luna (P40,000/P110,000 x P66,000) P24,000

P66,000 Basco (P70,000/P110,000 x P66,000) P42,000

c Luna (P40,000/P110,000 x P77,000) P28,000

P(77,000) Basco (P70,000/P110,000 x P77,000) P(49,000)

Sharing of first P60,000 based on

capital contributions:

Luna

(P40,000/P110,000 x P60,000) P 21,818

Basco

(P70,000/P110,000 x P60,000) P 38,182 60,000

Net Income (Net Loss)

Luna Basco Total (Letter d cont’d)

Sharing based on service:

Luna (P45,000 x 0.30) 13,500

Balance shared equally:

Net income left for allocation P -0-Net income allocated to the partners P 45,318 P 79,682 P125,000

Exercise 2

Requirement (1)

Lulu, Lily and Lala Allocation of Profits and Losses

Lulu Lily Lala Total

Allocation to the partners:

Lulu (P42,900 x 1/3) P(14,300)

Lily (P42,900 x 1/3) P(14,300)

-0-Net loss allocated to partners P(14,300) P(14,300) P(14,300) P(42,900)

) Lulu (P60,000 x 0.40) P(24,000

) Lily (P60,000 x 0.25) P(15,000)

) Net income left for allocation P -0-Net income allocated to partners P(24,000

) P(15,000) P(21,000) P(60,000)

Lulu, Lily and Lala Allocation of Profits and Losses

Lulu Lily Lala Total

Allocation to the partners:

Sharing of first P40,000 based on

salaries:

Lulu (P15,000/P60,000 x

Lily (P18,000/P60,000 x

Lala (P27,000/P60,000 x

-0-Net income allocated to partners P41,000 P27,600 P23,400 P92,000

Allocation to the partners:

Sharing of first P75,000 based on

capital contributions:

Lulu (P15,000/P60,000 x

P75,000)

P18,750 Lily (P18,000/P60,000 x

Lala (P27,000/P60,000 x

Sharing of next P36,000 of profit

based on service:

Remainder shared equally:

Lulu (P69,000 x 1/3) P23,000

Lily (P69,000 x 1/3) P23,000

Net income left for allocation P -0-Net income allocated to partners P69,750 P53,500 P 56,750 P180,000

Requirement (2)

Lulu, Lily and Lala Statement of Comprehensive Income For the Year Ended January 31, 2007

Allocation of earnings:

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

Net income to distribute P506,000

Remainder to divide 460,000

Divided 40:40:20 (460,000) P184,000 184,000 P 92,000

Exercise 4

Schedule to Allocate Partnership Income for 2007

Balance Violet White Yellow

Net income to distribute P 14,000

Salary allocation (21,000) P - P 9,000 P 12,000

* Interest on average capital:

Jan 1, 2007

Balances Average Capital Interest on Capital

Violet P100,000 x ½ year = P 50,000

120,000 x ¼ year = 30,000 100,000 x ¼ year = 25,000

P105,000 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 Psyche

2007 income to divided

(P25,000 – P4,000) P 21,000

Remainder to divided 3,000

0

2006 income understatement P 4,000

Divided in the 2006 –

Exercise 6

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

Elite Capital

Fantastic Capital

Grand Capital

Total Capital

Balance December 31 P104,000 P124,000 P144,000 P372,000

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

Multiple Choice Questions

1 A (P40,000 x 3/12 = P10,000)

2 D (P40,000 x 3/12 = P16,667)

3 A

4 A ASSIGNMENT OF INCOME—YEAR ONE

Willow Dreamer Smallville Total

Interest—10% of

beginning capital P11,000 P 8,000 P11,000 P30,000 Salary 20,000 -0- 10,000 30,000 Allocation of remaining loss

(P80,000 divided on a

5:2:3 basis) (40,000) (16,000) (24,000) (80,000) Totals P(9,000) P (8,000) P (3,000) P(20,000) STATEMENT OF CAPITAL—YEAR ONE

Willow Dreamer Smallville Total

Beginning capital P110,000 P80,000 P110,000 P300,000 Net loss (above) (9,000) (8,000) (3,000) (20,000) Drawings (given) (10,000) (10,000) (10,000) (30,000) Ending capital P 91,000 P62,000 P 97,000 P250,000 ASSIGNMENT OF INCOME—YEAR TWO

Willow Dreamer Smallville Total

Interest—10% of

beginning capital P 9,100 P 6,200 P 9,700 P25,000 Salary 20,000 -0- 10,000 30,000 Allocation of remaining loss

(P15,000 divided on a

5:2:3 basis) (7,500) (3,000) (4,500) (15,000) Totals P21,600 P3,200 P15,200 P 40,000 STATEMENT OF CAPITAL—YEAR TWO

Willow Dreamer Smallville Total

Beginning capital (above) P 91,000 P62,000 P 97,000 P250,000 Net income (above) 21,600 3,200 15,200 40,000 Drawings (given) (10,000) (10,000) (10,000) (30,000) Ending capital P102,600 P55,200 P102,200 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)

Orange Strawberry Peach Total

Interest on capital 3,000 4,500 10,000 17,500

Requirement (2)

Orange Strawberry Peach Total

Interest on capital 3,000 4,500 10,000 17,500

* 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

Number of Months Invested Weighted Pesos

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

Number of Months Invested Weighted Pesos

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)

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

Number of Months Invested Weighted Pesos Average

Gold

Silver

Bronze

Interest for 2007:

P5,110

Requirement (3)

Analysis of Capital Accounts

Gold Silver Bronze Total

Beginning balance (1/1/07) P24,000 P17,500 P13,000 P54,500

Income for year (see Schedule A) 7,520 6,730 6,850 21,100 Less: Withdrawals (1,000) (1,000) (500) (2,500) Ending balance (12/31/07) P35,020 P23,230 P36,350 P94,600

Schedule A – Profit Allocation:

Gold Silver Bronze Total

Balance 5,330 5,330 5,330 15,990

Test Material 4-4

Profit Allocation Black Blue Brown Total

Interest on capital (See Schedule A) 500 375 2,300 3,175 Bonus1 6,500 – – 6,500 Subtotal P27,000 P18,375 P 9,125 P54,500 Remaining profit 3,500 3,500 3,500

1 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

S = salaries of P44,825

I = interest of P3,175

Schedule A Weighted Average Capital Balances

Amount Invested

Number of Months Invested Weighted Pesos Average

Black

Blue

Brown

Interest on Weighted Average Capital

Black P 5,000 x 0.10 = P 500 Blue 3,750 x 0.10 = 375 Brown 23,000 x 0.10 = 2,300

P3,175