Basics of partnership accounting (Part I)

3. Income allocation in partnership accounting

One of the elements of partnership flexibility is the fact that partners can decide how to split up income and losses -- in fact, the allocation percentages do not have to equal ownership percentages. Partnerships can even have one allocation formula for profits and a different formula for losses. To keep things simple, however, let’s assume that Jerry, Tom, and Bill from our example earlier allocate both income and losses based on ownership percentage.

For its first year of business, JTB had $90,000 in revenue and $60,000 in expenses for a total profit of $30,000. After all temporary accounts are closed to Income Summary, the final entry will close Income Summary to partner capital accounts based on the allocation percentages. Note that the withdrawal accounts will also be closed to partner capital accounts at this time if there were any withdrawals during the year.

Account Names

Debits

Credits

Income Summary

30,000

 

     Partner Capital – Jerry

 

15,000

     Partner Capital – Tom

 

9,000

     Partner Capital – Bill

 

6,000

Jerry’s capital account is credited with $15,000 (i.e., $30,000 x 50% where 50% is Jerry’s ownership interest); Tom’s capital account is credited with $9,000 (i.e., $30,000 x 30%); and Bill’s capital account is credited with $6,000 (i.e., $30,000 x 20%).

If JTB instead had $30,000 in revenue and $60,000 in expenses, the closing entry above would be reversed, resulting in a decrease in capital accounts for the three founders.

As a final note, you should be aware that partnerships do not have to compensate its owners solely through the allocation method described above. Two other types of compensation commonly encountered in partnerships are guaranteed payments - basically salaries - and capital account interest, which rewards partners for keeping capital invested in the company instead of withdrawing it. The accounting treatment for these kinds of compensation is beyond the scope of this article.

We’ve just described partner capital transactions and income allocation - in the next article, we’ll go over what happens when a partnership terminates.

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