Solution manual fundamentals of accounting by cabrera chapter 04 SM

Chapter Allocation of Partnership Income and Loss Review Questions 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 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 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 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 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 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 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 Chapter 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 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 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 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 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 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 ) Chapter 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 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 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 Chapter Divided 40:40:20 Income allocation Exercise (460,000) 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 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 year = P 80,000 x 10% = 8,000 Yellow P 75,000 x year = P 75,000 x 10% = 7,500 P26,000 Exercise 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) P 4,000 (4,000) Psyche P18,000 1,500 P1,500 2,400 P21,900 1,600 P3,100 Allocation of Partnership Income and Loss Exercise Elite, Fantastic and Grand Partnership Statement of Partnership Capital For the year ended December 31, 2007 Balance January 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 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 Chapter 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 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 * 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 Weighted Pesos P210,000 135,000 P345,000 Weighted average capital: P345,000  12 = P28,750 Interest: P28,750 x 10% = P2,875 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 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 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 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 12 P 72,000 256,500 P328,500 P27,375 12 P210,000 P17,500 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 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 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 12 P 15,000 13,500 16,500 15,000 P 60,000 P5,000 3 12 P 18,000 15,000 12,000 P 45,000 P3,750 3 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 ... 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 Test Material 4-3 Requirement (1) The advantage of using... 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... (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