Accounting
Allocating Income among Partners
Most partnership agreements specify how profits will be divided among the partners. As you should remember from your accounting class, there are three common methods for dividing income or loss. First, a stated ratio basis provides each partner with a proportion of the total income or loss, based on agreement among the partners on the specific ratios. Second, the capital balances method divides income among partners on the basis of individual capital contributions. Hence, if partner A contributes two-thirds of the total capital and partner B contributes one-third, A receives two-thirds of the income and B one-third. Third, the services, capital, and stated ratio method allocates income or loss on the basis of differences in service and capital contributions.

This third method of allocating income and loss provides salary allowances for differences in service contributions and interest allowances for differences in capital contributions, while including a stated ratio for any remaining income or loss. The partnership agreement for A and B might allocate salary allowances of $45,000 and $20,000, respectively, based on higher service levels for A. The partnership agreement might also specify that each partner receives an interest allowance of 10 percent of each partner's beginning-year capital balance, and that any remaining income or loss be divided equally between them. Assuming A had a beginning-year capital balance of $20,000 and B had $10,000, and assuming the partnership generated $100,000 net income, the accounting under the services, capital, and stated ratio would be as follows: A receives $63,000 [$45,000 of salary allowance plus $2,000 interest allowance (10 percent of capital balance of $20,000) plus $16,000 (half the remaining balance)]; B receives $37,000 [$20,000 of salary allowance plus $1,000 interest allowance (10 percent of capital balance of $10,000) plus $16,000 (half the remaining balance)]. However, as the chapter mentions, when the partnership agreement does not specify the allocation of income and losses, courts will generally divide them equally among the partners.