Compensation For Services and Capital
The partnership agreement may specify that partners should be compensated for services they provide to the partnership and for capital invested by partners.
For example, one partner contributed more of the assets, and works full-time in the partnership, while the other partner contributed a smaller amount of assets and does not provide as much services to the partnership.
Compensation for services is provided in the form of salary allowance. Compensation for capital is provided in the form of interest allowance. Amount of compensation is added to the capital account of the partner.
To illustrate, assume that a partner received $500 as an interest allowance. The amount is included in the net income/loss distribution entry when the books are closed to the capital accounts at year end:
| Debit | Credit | |
|---|---|---|
| Partner A, Capital | $500 | |
| Income Summary | $500 |
As a result, the above entry Income Summary, which is a temporary equity closing account used for year-end, is reduced by $500, and the capital account is increased by the same amount.
When the partner makes a cash withdrawal of moneys he received as an allowance, it is treated as a withdrawal, or drawing.
| Debit | Credit | |
|---|---|---|
| Partner A, Drawing | $500 | |
| Cash | $500 |
As a result, Drawing account increased by $500, and the Cash account of the partnership is reduced by the same account.
At the end of the accounting period the drawing account is closed to the capital account of the partner. The capital account will be reduced by the amount of drawing made by the partner during the accounting period.
Read more about this topic: Partnership Accounting
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