Salary

If Adams devotes full time to the business activity

and Brown spends a limited amount of time, the
partnership agreement may specify that Adams is
allowed a salary of $1000 per mounth and that the
remaining income is to be divided on the basis of the
ratio of the beginning capital balances ($60000 and
$40000, respectively). Net income $20000
adams brown
total
Salary allowance
remainder
($60000/$100000) x
$8000
($40000/$100000) x
$8000
total to be allocated

$12000

$12000

$3200

$8000

4800

$16800 $3200 $20000

THE NET INCOME USED IN BONUS CALCULATION CAN

BE:
Net income $24000. bonus 20% to adam. Interest $4000 and $2000 to adam & brown.

1.before allocation of income to

partners (before interest on
capital,salaries to partners and
any bonus)
= net income * % of bonus
= $24000 * 20%
= $4800

2.after other allocations, but before

the bonus
={net income - (interest+salary)}*
% of bonus
=($24000 - $6000)* 20%
= $3600

3. after subtracting bonus, but

before other allocation
=% of bonus * (net income
bonus)
Bonus = 0.2 ($24000) - bonus)
Bonus = $4800 0.2bonus
1.2bonus = $4800
Bonus = $4000

4. After subtracting bonus and all

other allocation
Bonus= % of bonus*(net incomeinterest-bonus-salary)
Bonus = 0.2($24000 - $6000 bonus)
Bonus = 0.2($18000 - bonus)
Bonus = $3600 - 0.2bonus
Bonus = $3000

Insufficient Income to Cover Allocation

If partnership
income < interest
and/or salary
allocation

allocate the
deficiency in the
agreed ratio for
allocating residual

16 - 3

Insufficient Income to Cover Allocation

Profit $11,000

Salary
allocatio
n
Deficiency
in profit

Adams
($2,100)

1:1

Adams
$4,000

Brown
($2,100)

Brown7:3
$2,000

Interest
allocatio
n
Adams
$6,200

Brown
$3,000

Income summary $11000

Adams, Capital
$8100
Brown, Capital
$2900
16 - 4

Problems
Problems in
in Allocation
Allocation of
of Income
Income and
and Loss
Loss
Salaries and Interest as an Expense
Same change in capital accounts as if salaries and
interest were considered an allocation of profit.
Since the normal practice is to recognize salaries
and interest as an allocation of profit, any such
amounts treated as an expense should be
adequately disclosed.
The statement reader can properly evaluate the
operating performance of the firm.

Slide
15-5

Special Problem of Income and Loss

Profit $11,000

Salary
Expense
Deficiency
in profit

Adams
($2,100)

Adams
$4,000

1:1

Brown
($2,100)

Brown7:3
$2,000

Interest
Expense
Adams
$6,200

Brown
$3,000

Adams, Capital 2,100

Brown, Capital 2,100
Income Summary

4,200
16 - 6

Problems
Problems in
in Allocation
Allocation of
of Income
Income and
and Loss
Loss
Adjustment of Income of Prior Years
Problems in allocation of profit and loss can result if
1. Errors are discovered that occurred in specific
prior years, and
2. Partners have altered profit and loss agreement
since period in which error occurred.
Corrections are allocated to partners capital accounts.

Slide
15-7

Financial
Financial Statement
Statement Presentation
Presentation
Differences from GAAP:
1. Changes in partners equity should be disclosed.
2. Salary allowances are generally not an expense.
3. No income tax expense.
4. Interest allowance on capital investment is
considered an allocation of profit.

Slide
15-8

Financial
Financial Statement
Statement Presentation
Presentation
Exercise 15-2: B. Prepare a statement of changes in
partners capital for the year ended December 31, 2008.

Slide
15-9