METHODS OF DISTRIBUTING PROFITS PARTNERSHIP OPERATIONS

Methods of Distributing Profits Based on Partners’ Agreement  1. Equally – it is simple to apply but does not give due recognition on the disparity of capital contribution nor does it recognize the time and effort that a partner may devote in running the firm’s business operations.  2. Arbitrary ratio (percentage, decimal, fraction, ratio) – it is simple to apply but does not give recognition on the disparity of capital contributions nor does it recognize the time and effort that a partner may devote in running the firm’s business operations.  3. Capital ratio (Original, Beginning, Ending, Average) – this method recognizes the differences in the capital contributions but does not take into account the time and effort that a partner may devote in running the firm’s business operations.

Methods of Distributing Profits Based on Partners’ Agreement  4. Interest on capital and the balance on agreed ratio – this method recognizes the differences in the capital contributions but does not take into account the time and effort that a partner may devote in running the firm’s business operations. Interest is allowed to partners for the use of invested capital. Interest as agreed by the partners shall be allowed in proportion over the period such capital was actually used. Moreover, the interest shall be provided whether the income is sufficient or insufficient or there is a net loss unless otherwise agreed upon by the partners.

Methods of Distributing Profits Based on Partners’ Agreement  5. Salary allowances to partners and the balance on agreed ratio – this method recognizes the time and effort that a partner may devote in running the firm’s business operations but does not take into consideration the differences in capital contributions. Salaries are allowed to partners as compensation for their time devoted in the business. Salaries as agreed by the partners shall be allowed in proportion to the time the partners actually rendered services to the firm. Such salaries shall be provided whether the profit is sufficient or not and when there is a loss unless otherwise agreed upon by the partners.

Methods of Distributing Profits Based on Partners’ Agreement  6. Bonus to managing partner and the balance on agreed ratio – this method allows a bonus, as an incentive, to the managing partner. It is usually a percentage of the profit. Bonus, therefore, is allowed only when there is a profit. It may be computed using any one of the following as basis: a. Bonus is based on profit before deducting bonus and income tax. b. Bonus is based on profit after deducting bonus but before deducting income tax. c. Bonus is based on profit after deducting income tax but before deducting bonus. d. Bonus is based on profit after deducting both bonus and income tax.

Illustrative Problem:  : The following data are available in the books of Erik and Vincent Partnership for the year 2012.

Illustrative Problem:  Twelve cases will be illustrated using the given data:  Case 1 – Profit is divided equally  Case 2 – Profit is divided ¾ and ¼ to Erik and Vincent  Case 3 – Profit is divided in the ratio of 1:2 to Erik and Vincent  Case 4 – Profit is divided 20% and 80% to Erik and Vincent  Case 5 – Profit is allocated based on beginning capital ratio  Case 6 – Profit is allocated based on the ending capital ratio  Case 7 – Profit is allocated based on the average capital ratio  Case 8 – Each partner is allowed 10% interest on ending capital and the remaining income is divided 60% and 40%  Case 9 – Vincent is allowed salaries of P500,000 and the remaining profit is divided in the ratio 1:4  Case 10 – Vincent, the managing partner is allowed a bonus of 20% of profit before bonus and income tax and the remainder is divided in the ratio of beginning capital.  Case 11 – The partners are allowed P5,000 and P10,000 weekly salaries respectively, 10% interest on average capital and the remainder is divided in the ratio of 2:3.  Case 12 – Assume the same agreement in Case 11 except that instead of profit, the partnership has incurred a loss of P100,000.

Illustrative Problem: