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Business organizations that are formed legally as partnerships, although they are not
always as visible as corporations, still proliferate throughout this country especially in the
legal, medical, and accounting professions.
A. Advantages of the partnership format include ease of creation and the absence of the
double taxation effect inherent to the income earned by a corporation and distributed to
its owners.
B. Partnerships, however, rarely grow to a significant size (when compared with large
corporate organizations) primarily because of the unlimited liability being assumed by
each general partner.
C. Alternative legal formats have been created over the years to combine the benefits of
corporations and partnerships such as S corporations, limited liability partnerships, and
limited liability companies.
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
1. The partners can simply assume an equal division of profits and losses.
2. The partners, however, can select any method that is designed to arrive at an
equitable allocation. Such factors as the amounts of capital invested, the time
worked in the business, and the degree of business expertise may all serve to
influence the assignment of income.
IV. Accounting for partnership dissolution
A. Over time, the identity of the individuals within a partnership can change through
admission of a new partner or the death, retirement, or withdrawal of a present partner.
B. Each change in composition serves to dissolve the original partnership usually so that a
new partnership can be formed to continue the business. Thus, dissolution does not
necessarily affect the operations of the business.
C. Admission of a new partner.
1. A new partner will often buy all (or a portion) of the interest owned by one or more
of the present partners.
a. The capital account balances can simply be reclassified to reflect the identity of
the new ownership.
b. As an alternative, all accounts may be adjusted to fair market value with the
price paid being used as the basis for calculating any goodwill.
2. A new partner can also be admitted by a direct contribution to the partnership
business.
a. The bonus (or no revaluation) method records the identifiable assets being
contributed at fair market value. The new partners capital is set equal to a
prearranged percentage or amount. The remaining capital balances are then
aligned based on profit and loss percentages.
b. The goodwill (or revaluation) approach initially adjusts all assets and liabilities of
the partnership to fair market value and records goodwill based on the amount
being paid (which is used to calculate the implied value of the business).
D. Withdrawal of a partner
1. The final asset distribution to an individual should be based on the agreement
established in the Articles of Partnership and will often vary in amount from that
partner's ending capital balance.
2. The difference between the amount paid and the final capital balance can simply be
recorded as an adjustment to the remaining partners' capital accounts in the same
manner as the bonus method.
3. As an alternative, all accounts can be adjusted to fair value with the amount of
payment being used as the basis for computing goodwill.
McGraw-Hill/Irwin
14-2
Learning Objectives
Having completed Chapter 14 of this textbook, "Partnerships: Formation and Operation,"
students should be able to fulfill each of the following learning objectives:
1. Discuss the advantages and disadvantages of organizing a business as a partnership
instead of as a corporation including such factors as the ease of formation, taxation effects,
and the unlimited liability of the partners.
2. Describe the purpose of an Articles of Partnership and list specific items that should be
included in this agreement.
3. Prepare the journal entry to record the initial capital investment made by a partner when
either cash or another asset is being contributed.
4. Use both the bonus method and the goodwill method to record a capital investment made
by a partner who is contributing an attribute such as a specific expertise or an established
clientele.
5. Understand the impact that the allocation of income earned by a partnership has on the
individual capital balances.
6. Allocate income to partners when interest and/or salary factors are included.
7. Discuss the meaning of a partnership dissolution and understand that a dissolution will
often have little or no effect on the operations of the partnership business.
8. Prepare journal entries to record the acquisition by a new partner of a current partner's
interest. These entries should be made both as a reclassification as well as by means of
the goodwill approach.
9. Prepare journal entries to record a new partner's admission by a contribution made directly
to the partnership. These entries should be made both by the bonus method as well as by
the goodwill method.
10. Prepare journal entries to record the withdrawal of a current partner. These entries should
be made by the bonus method, the goodwill method, or a modified method whereby assets
and liabilities are revalued but no goodwill is recognized.
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
The accountant should discuss the following issues with the two owners:
Ease of formation. A formal partnership can be created by the writing of an Articles of
Partnership. If the allocation of income and the contributions by the partners have already
been resolved, the development of this document should be relatively simple. Forming a
corporation can be a more difficult task but the degree of difficulty does depend on
individual state laws. Normally, the documents to be completed are more complicated
although that is not necessarily so. The accountant should explain the specific procedures
that apply to partnerships in the state where the business is organized and conducts its
operations.
Business liabilities. In a partnership, either partner may be held liable for all business debts.
Thus, if liabilities escalate and the business fails, each partner does risk the possible loss of
an enormous sum. The same problem would not exist in a corporation where owners and
the business are considered separate entities. For the owners, potential losses are, in
corporations, normally limited to the amount being invested. However, in many small, newly
created, corporations, the owners are required to personally guarantee any loans.
Therefore, to an extent, the concept of unlimited liability may actually be present in either
case. The partners should forecast the amount of debts that will be incurred and the
possible outcome if the business would happen to fail.
Lawsuits. Some businesses are more susceptible to lawsuits than others. A florist, for
example, would seem to have less risk than a pharmaceutical company. The concept of
personal liability for business debts becomes especially important in a business with a high
possibility of litigation and resulting losses. In a business with such a risk, creating a
corporation to protect the personal property of the stockholders would appear to be a wise
move. The owners of a partnership might become personally responsible for losses created
by a business mistake or accident. Obviously, this need for responsibility is recognized in
states that prohibit doctors, lawyers, accountants, and the like from incorporating. This is a
primary reason for such states to allow licensed professionals to operate LLPs.
Taxation. In a partnership, all income is allocated to the owners immediately and they are
taxed on this amount. Double-taxation is avoided. A corporation pays an income tax and any
dividends are then taxed again when collected by the owners. Therefore, traditionally,
partnerships are viewed as having a tax advantage. The accountant should also mention to
the partners other possible tax factors that may affect their decision. For example, in small
corporations, double taxation may not be a problem. If salaries paid to the owners are
reasonable and approximate the company's profits so that no dividends are distributed, only
one tax is paid in either case. As another issue, if a partnership suffers a loss (which often
happens when companies begin operations), that loss is passed to the partners and can be
used to reduce other taxable income. However, in a corporation, losses are carried back
and forward to reduce other taxable income that is earned by the business, possibly
delaying the benefits of the loss. As mentioned in the textbook, the owners should consider
forming an S Corporationa business that is incorporated but still taxed as a partnership.
McGraw-Hill/Irwin
14-4
Bankruptcy. If the business should ever fail and have to be liquidated, losses of a
partnership are passed directly to the owners to reduce taxable income immediately. For a
corporation, the loss is a capital loss to the stockholders which can only offset their own
capital gains or be deducted at the rate of $3,000 per year. Thus, if a large loss is incurred,
the tax benefits may not be realized for years into the future.
Growth potential. Traditionally, corporations have more growth potential than do
partnerships. Ownership interests can be easily transferred. The limitation on liability
encourages ownership by individuals who cannot participate in the management of the
company. Partnerships are more restricted in adding new owners. Partnerships usually have
to entice individuals who are willing to work in the business in order to obtain additional
capital.
Therefore, the accountant may want to address the following questions in advising these
clients:
What amount of time and energy is involved in becoming incorporated?
How much profit or loss is anticipated from the operations of this business in the
foreseeable future?
How much debt will the new business incur?
Will this debt be guaranteed by the owners?
How much salary do the owners anticipate withdrawing from the business?
What are the chances of incurring lawsuits?
What is the possibility that the business will fail?
How large do the owners expect this business to grow? Do they anticipate the need
for new owners and new capital?
Does the creation of an S Corporation apply to this particular business?
How Will the Profits Be Split?
This case is designed to point up the difficulty of designing a profit -sharing arrangement that is
fair to all parties. Currently, these three individuals have incomes totaling an amount in excess
of the first year income that is expected. Thus, the adopted plan will have an immediate impact
on them. The reduction of income must be absorbed by the partners in some equitable
manner. In addition, the income is projected to increase relatively fast so that the agreed -upon
method needs to reward all participants properly over time.
Dewars has built up the firm and still handles the bigger clients although he plans to reduce his
workload over the next few years. Thus, one method of compensation would be to credit him
with interest on the capital built up in the business. However, if that number alone is used, it will
tend to escalate even if his work hours are reduced. For this reason, Dewars' share of the
profits could also be based in some way on the number of hours that he works. According to
the information presented, this number will probably shrink over the years, reducing the profits
allocated to Dewars. Thus, this partner might be given interest equal to 10 percent of his
capital balance and $50 for each hour worked.
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
Huffman is contributing a significant number of hours to the firm but tends to work on the
smaller jobs. A possible allocation technique would be to give this partner a per hour allocation
but one that is somewhat smaller than Dewars. For example, Huffman could receive an income
allocation of $30 per hour to begin. That number could then be programmed to escalate over
the years as Huffman starts to take over the bigger jobs.
Scriba's role is to develop a tax practice within the firm. Consequently, one suggestion would
be to credit her capital account with a percentage of the tax revenues (20 percent, for
example) each year. In that way, she benefits by the amount of business that she is able to
bring to the organization. During the first years, though, she may have trouble getting the new
part of this business to generate significant revenues. Thus, the partners may want to set a
minimum figure for her income allocation. She could be credited, as an example, with 20
percent of tax revenues but not less than $50,000.
Many answers to this question are possible. The above is just a simple suggestion based on
the facts presented in the case. Income allocation techniques are usually designed to reward
the partners for the attributes that they bring to the organization. Even with the above system,
percentages would still be necessary to assign any remaining profit or loss. If the partners are
not totally satisfied with the system as designed, the percentages could be weighted or
adjusted to reward any partner not being properly compensated.
McGraw-Hill/Irwin
14-6
Answers to Questions
1. The advantages of operating a business as a partnership include the ease of formation
and the avoidance of the double taxation effect that inherently reduces the profits
distributed to the owners of a corporation. In addition, since the losses of a partnership
pass, for tax purposes, directly through to the owners, partnerships have historically been
used (especially in certain industries) to reduce or defer income taxes.
Several disadvantages also accrue from the partnership format. Each general partner, for
example, has unlimited liability for all debts of the business. This potential liability can be
especially significant in light of the concept of mutual agency, the right that each partner
has to create liabilities in the name of the partnership. Because of the risks created by
unlimited liability and mutual agency, the growth potential of most partnerships is severely
limited. Few people are willing to become general partners in an organization unless they
can maintain some day-to-day contact and control over the business.
Further discussion of these issues can be found in the Answer to the first Discussion
Question that appears above.
2. Specific partnership accounting problems center in the equity (or capital) section of the
balance sheet. In a corporation, stockholders' equity is divided between earned capital and
contributed capital. Conversely, for a partnership, each partner has an individual capital
account that is not differentiated according to its sources. Virtually all accounting issues
encountered purely in connection with the partnership format are related to recording and
maintaining these capital balances.
3. The balance in each partner's capital account measures that partner's interest in the book
value of the business net assets. This figure arises from contributions, earnings, drawings,
and other capital transactions.
4. A Subchapter S corporation is formed legally as a corporation so that its owners enjoy
limited legal liability and easy transferability of ownership. However, if a company qualifies
and becomes a Subchapter S Corporation, it will be taxed in virtually the same manner as
a partnership. Hence, income will be taxed only once and that is to the owners at the time
that it is earned by the corporation.
Use of this designation is quite restricted. To qualify as a Subchapter S Corporation, a
company can only have one class of stock and must have no more than 100 owners.
These owners can only be individuals, estates, certain tax-exempt entities, and certain
types of trusts. Most corporations that do not qualify as Subchapter S Corporations are
automatically Subchapter C Corporations. These entities are also corporations but they pay
income taxes when the income is earned. Additionally, the owners are liable for a second
income tax when dividends are distributed to them. Thus, the income earned by a
Subchapter C Corporation faces the double taxation effect commonly associated with
corporations.
5. In a general partnership, each partner can have unlimited liability for the debts of the
business. Therefore, a partner may face a significant risk, especially in connection with the
actions and activities of other partners. However, general partnerships are easy to form
and often serve well in smaller businesses where all partners know each other. The major
advantage of a general partnership is that all income earned by the business is only taxed
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
once when earned by the business so that no second tax is incurred when distributions are
made to owners.
A limited liability partnership (LLP) is very similar to a general partnership except in the
method by which a partners liability is measured. In an LLP, the partners can still lose their
entire investment and be held responsible for all contractual debts of the business such as
loans. However, partners cannot be held responsible for damages caused by other
partners. For example, if one partner carelessly causes damage and is sued, the other
partners are not held responsible.
A limited liability company can now be created in certain situations. This type of
organization is classified as a partnership for tax purposes so that the double-taxation
effect is avoided. However, the liability of the owners is limited to their individual
investments like a Subchapter C Corporation. Depending on state law, the number of
owners is not restricted in the same manner as a Subchapter S Corporation so that there is
a greater potential for growth.
6. The Articles of Partnership is a legal agreement that should be created as a prerequisite for
the formation of a partnership. This document defines the rights and responsibilities of the
partners in relation to the business and in relation to each other. Thus, it serves as a
governing document for the partnership. The Articles of Partnership may contain any
number of provisions but should normally specify each of the following:
a.
b.
c.
d.
e.
McGraw-Hill/Irwin
14-8
As an alternative, the amounts contributed along with the established capital percentages
can be used to determine mathematically the implied total value of the business and the
presence of any goodwill brought into the business. This goodwill is recognized at the time
that the partnership is created so that the amount can be credited to the appropriate
partner.
9. The Drawing account measures the amount of assets that a particular partner takes from
the business during the current period. Often, only regularly allowed distributions are
recorded in the Drawing account with larger, more sporadic withdrawals being recorded as
direct reductions to the partner's capital balance.
10. At the end of each fiscal year, when revenues and expenses are closed out, some
assignment must be made of the resulting income figure since a partnership will have two
or more capital accounts rather than a single retained earnings balance. This allocation to
the capital accounts is based on the agreement established by the partners preferably as a
part of the Articles of Partnership.
11. The allocation process can be based on any number of factors. The actual assignment of
income should be designed to give fair and equitable treatment to each of the partners.
Often, an interest factor is used to reward the capital investment of the partners. A salary
allowance is utilized as a means of recognizing the amount of time worked by an individual
or a certain degree of business expertise. The allocation process can be further refined by
a ratio that is either divided evenly among the partners or weighted in favor of one or more
members.
12. If agreement as to the allocation of income has not been specified, an equal division
among all partners is presumed. If an agreement has been reached for assigning profits
but no mention is made concerning losses, the assumption is made that the same method
is intended in either case.
13. The dissolution of a partnership is the breakup or cessation of the partnership. Many
reasons can exist for a partnership to dissolve. One partner may withdraw, retire, or die. A
new partner may be admitted to the partnership. The original partnership terminates
whenever the identity of the individuals serving as partners has changed.
Dissolution, however, does not necessarily lead to the liquidation of the business. In most
cases, but not all, a new partnership is formed which takes over the business. Such
dissolutions are no more than changes in the composition of the ownership and should not
affect operations.
14. A new partner can join a partnership by acquiring part or all of the interest of one or more
of the present partners. This transaction is carried out with the individual partners directly
and not with the partnership. A new partner may also enter through a contribution to the
business. In such cases, the investment is made to the partnership rather than to the
individuals.
15. In selling an interest in a partnership, three rights are conveyed to the new owner:
a. The right of co-ownership of the business property;
b. The right to a specified allocation of profits and losses generated by the partnership's
business; and
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
McGraw-Hill/Irwin
14-10
Answers to Problems
1. B
2. C
3. C Mary Ann's investment is equal to 1/3 of the total capital ($50,000/$150,000).
However, she is receiving a smaller capital balance, only a 1/4 interest. One
explanation for this difference is that the business assets may be worth
more than book value. To achieve agreement, the net assets could be
valued upward to fair value with the adjustment recorded to the capital
accounts of the original partners. As an alternative, a bonus could be
credited to the original partners.
4. D The implied value of the company based on the new contribution is only
$233,333 ($70,000/30%) which is below the total of the capital balances
($280,000 in original capital plus $70,000 to be invested). Thus, either the
assets are overvalued or the new partner is also contributing goodwill.
Since the problem indicates that goodwill is being recognized, that figure
must be computed. Note that the $70,000 is going into the business and,
thus, increases capital.
Danville's investment
$70,000 + Goodwill
$70,000 + Goodwill
.70 Goodwill
Goodwill
Danville's Investment (Capital)
=
=
=
=
=
=
their profit and loss ratio: Bishop $18,000 (60%) and Cotton $12,000
(40%). The increase raises Cotton's capital from $90,000 to $102,000.
8. A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new
investment. As Claudius's portion is to be 20 percent, the new capital
balance would be $90,000 ($450,000 20%). Since $100,000 was paid, a
bonus of $10,000 is being given to the two original partners based on their
profit and loss ratio: Messalina $6,000 (60%) and Romulus $4,000 (40%).
The increase raises Messalina's capital balance from $210,000 to $216,000
and Romulus's capital balance from $140,000 to $144,000.
9. D ASSIGNMENT OF INCOME2007
Interest10% of
beginning capital ...............
Salary........................................
Allocation of remaining income
($6,000 divided on a 3:3:4 basis)
Totals .............................
ARTHUR
BAXTER
CARTWRIGHT
TOTAL
$ 6,000
20,000
$ 8,000
$10,000
20,000
$24,000
1,800
$ 7,800
1,800
$29,800
2,400
$12,400
6,000
$50,000
ARTHUR
BAXTER
$60,000
7,800
(5,000)
$62,800
$80,000
29,800
(5,000)
$104,800
STATEMENT OF CAPITAL2007
Beginning capital ....................
Net income (above) .................
Drawings (given) .....................
Ending capital .........................
CARTWRIGHT
TOTAL
$100,000 $240,000
12,400
50,000
(5,000) (15,000)
$107,400 $275,000
Interest10% of
beginning capital ...............
$11,000
Salary........................................20,000
-0Allocation of remaining loss
($80,000 divided on a 5:2:3 basis) (40,000)
Totals .............................
$(9,000)
DURHAM
SALEM
TOTAL
$ 8,000
10,000
$11,000
30,000
$30,000
(16,000)
$ (8,000)
(24,000) (80,000)
$ (3,000) $(20,000)
McGraw-Hill/Irwin
14-12
$110,000
(9,000)
(10,000)
$ 91,000
DURHAM
$80,000
(8,000)
(10,000)
$62,000
SALEM
TOTAL
$110,000 $300,000
(3,000) (20,000)
(10,000) (30,000)
$ 97,000 $250,000
10. (continued)
ASSIGNMENT OF INCOMEYEAR TWO
WINSTON
Interest10% of
beginning capital ...............
$ 9,100
Salary........................................20,000
-0Allocation of remaining loss
($15,000 divided on a 5:2:3 basis) (7,500)
Totals .............................
$21,600
DURHAM
SALEM
TOTAL
$ 6,200
10,000
$ 9,700
30,000
$25,000
(3,000)
$3,200
(4,500) (15,000)
$15,200 $ 40,000
WINSTON
DURHAM
$ 91,000
21,600
(10,000)
$102,600
$62,000
3,200
(10,000)
$55,200
SALEM
TOTAL
$ 97,000 $250,000
15,200
40,000
(10,000) (30,000)
$102,200 $260,000
11. A A $10,000 bonus is paid to Costello ($100,000 is paid rather than the
$90,000 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 Burns or a decrease of $6,000 which drops that
partners capital balance from $30,000 to $24,000.
12. D Craig receives an additional $10,000. Since Craig is assigned 20 percent of
all profits and losses, this allocation indicates total goodwill of $50,000.
20% of Goodwill = $10,000
.20 G = $10,000
G = $10,000/.20
G = $50,000
Montana is assigned 30% of all profits and losses and would, therefore,
record $15,000 of this goodwill, an entry that raises this partner's capital
balance from $130,000 to $145,000.
13. A The implied value of the company is $900,000 ($270,000/30%). Since the
money is going to the partners rather than into the business, the capital
total is $490,000 before realigning the balances. Hence, goodwill of
$410,000 must be recognized based on the implied value ($900,000
$490,000). This goodwill is assumed to represent unrealized business
gains and is attributed to the original partners according to their profit and
loss ratio. They will then each convey 30 percent ownership of the $900,000
partnership to Darrow for a capital balance of $270,000.
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
14. D Since the money goes into the business, total capital becomes $740,000
($490,000 + $250,000). Darrow is allotted 30 percent of this total or
$222,000. Because Darrow invested $250,000, the extra $28,000 is assumed
to be a bonus to the original partners. Jennings will be assigned 40 percent
of this extra amount or $11,200. This bonus increases Jennings capital
from $160,000 to $171,200.
15. (10 Minutes) (Compute capital balances under both goodwill and bonus
methods)
a. Goodwill Method
Implied value of partnership ($80,000/40%) ..................
Total capital after investment ($70,000 + $40,000 + $80,000)
Goodwill ............................................................................
$200,000
190,000
$ 10,000
7,000
$ 3,000
$ 77,000
$ 43,000
$ 80,000
b. Bonus Method
Total capital after investment ($70,000 + 40,000 + $80,000)
Ownership portionLear ................................................
Lear, capital ......................................................................
$190,000
40%
$ 76,000
4,000
2,800
1,200
$ 72,800
$ 41,200
$ 76,000
McGraw-Hill/Irwin
14-14
16. (15 Minutes) (Prepare journal entries to record admission of new partner under
both the goodwill and the bonus methods)
Part a.
Total capital is $300,000 ($85,000 + $60,000 + $55,000 + $100,000) after the
new investment. As Sergio's portion is 25 percent, this partner's capital
balance would be $75,000. Since $100,000 was paid, a bonus of $25,000 is
given to the three original partners based on their profit and loss ratio:
Tiger$12,500 (50%), Phil$7,500 (30%), and Ernie$5,000 (20%).
Cash ............................................................................
Sergio, Capital .......................................................
Tiger, Capital .........................................................
Phil, Capital ...........................................................
Ernie, Capital .........................................................
100,000
75,000
12,500
7,500
5,000
Part b.
Total capital is $260,000 ($85,000 + $60,000 + $55,000 + $60,000) after the
new investment. As Sergio's portion is to be 25 percent, this partner's
capital balance would be $65,000. Because only $60,000 was paid, a bonus
of $5,000 is taken from the three original partners based on their profit and
loss ratio: Tiger$2,500 (50%), Phil$1,500 (30%), and Ernie$1,000
(20%).
Cash ............................................................................
Tiger, Capital ...............................................................
Phil, Capital .................................................................
Ernie, Capital ..............................................................
Sergio, Capital .......................................................
60,000
2,500
1,500
1,000
65,000
Part c.
Total capital is $272,000 ($85,000 + $60,000 + $55,000 + $72,000) after the
new investment. However, the implied value of the business based on the
new investment is $288,000 ($72,000/25%). Consequently, goodwill of
$16,000 must be recognized with the offsetting allocation to the original
partners based on their profit and loss ratio: Tiger$8,000 (50%), Phil
$4,800 (30%), and Ernie$3,200 (20%).
Goodwill .....................................................................
Tiger, Capital .........................................................
Phil, Capital ...........................................................
Ernie, Capital .........................................................
Cash .............................................................................
Sergio, Capital .......................................................
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
16,000
8,000
4,800
3,200
72,000
72,000
17. (16 Minutes) (Determine capital balances after admission of new partner using
both goodwill and bonus methods)
Part a.
Total capital is $490,000 ($200,000 + $120,000 + $90,000 + $80,000) after the
new investment. However, the implied value of the business based on the
new investment is only $444,444 ($80,000/18%). According to the goodwill
method, this situation indicates that the new partner must be bringing
some intangible attribute to the partnership other than just cash. This
contribution must be computed algebraically and is recorded as goodwill
to the new partner.
G's Investment = .18 ($200,000 + $120,000 + $90,000 + G's Investment)
$80,000 + Goodwill = .18 ($410,000 + $80,000 + Goodwill)
$80,000 + Goodwill = $88,200 + .18 Goodwill
.82 Goodwill = $8,200
Goodwill = $10,000
The above goodwill balance indicates that Grant's total investment is
$90,000 (cash of $80,000 and goodwill of $10,000). A $90,000 contribution
raises the total capital to $500,000 so that Grant does, indeed, have an 18
percent interest ($90,000/$500,000).
CAPITAL BALANCES:
Nixon ......................................................................
Hoover ....................................................................
Polk ......................................................................
Grant ......................................................................
$200,000
120,000
90,000
90,000
Part b.
Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after
the new investment. As Grant's portion is to be 20 percent, this partner's
capital balance will be $102,000. Since only $100,000 was paid, a bonus of
$2,000 is taken from the three original partners based on their profit and
loss ratio: Nixon$1,000 (50%), Hoover$400 (20%), and Polk$600
(30%).
CAPITAL BALANCES
Original
Nixon .....................
Hoover ...................
Polk ........................
Grant ......................
Total .................
McGraw-Hill/Irwin
14-16
$200,000
120,000
90,000
-0-
Investment
Bonus
100,000
$(1,000)
( 400)
( 600)
2,000
Total
$199,000
119,600
89,400
102,000
$510,000
18. (8 Minutes) (Record admission of new partner and allocation of new income)
Part a.
Total capital is $336,000 ($150,000 + $110,000 + $76,000) after the new
investment. However, the implied value of the business based on the new
investment is $380,000 ($76,000/20%). Consequently, goodwill of $44,000
must be recognized with the offsetting allocation to the original two
partners based on their profit and loss ratio: Com$26,400 (60%) and Pack
$17,600 (40%).
Goodwill..................................................................
Com, Capital .....................................................
Pack, Capital ....................................................
Cash ......................................................................
Hal, Capital .......................................................
44,000
26,400
17,600
76,000
76,000
Part b.
Interest ..................................
Remaining loss......................
Income allocation ...........
Com
$17,640
(1,000)
$16,640
Pack
$12,760
(600)
$12,160
Hal
$7,600
(400)
$7,200
Total
$38,000
(2,000)
$36,000
Lane
-045,000
(6,000)
$39,000
Total
$18,000
90,000
(18,000)
$90,000
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
King
-030,000
(6,000)
$24,000
Purkerson
Smith
$ 6,600 (below) $ 4,000
18,000
25,000
(16,000)
$ 8,600
(8,000)
$21,000
Traynor
$ 2,000
8,000
Totals
$12,600
51,000
(16,000)
(40,000)
$(6,000)
$23,600
$180,000
612,000
$792,000
12
$ 66,000
10%
$ 6,600
McGraw-Hill/Irwin
14-18
$60,000
8,000
8,600
(12,000)
$64,600
Smith
$40,000
-021,000
(12,000)
$49,000
Traynor
Totals
$20,000 $120,000
-08,000
(6,000)
23,600
(12,000)
(36,000)
$ 2,000 $115,600
21. (30 Minutes) (Allocate income for several years and determine ending capital
balances)
INCOME ALLOCATION2009
Left
Interest (12% of beginning capital) $2,400
Salary
12,000
Remaining income/loss:
$(30,000)
(15,600)
(20,000)
$(65,600)
(19,680)
Totals
$(5,280)
Center
$ 7,200
8,000
(32,800)
$(17,600)
Right
$ 6,000
-0-
Total
$ 15,600
20,000
(13,120)
(65,600)
$(7,120) $(30,000)
Left
$20,000
(5,280)
(10,000)
$ 4,720
Center
$60,000
(17,600)
(10,000)
$32,400
INCOME ALLOCATION2010
Left
Center
Interest(12% of beginning capital above) *$566
$3,888
Salary ..................................
12,000
8,000
Remaining income/loss:
$20,000
(8,400)
(20,000)
$(8,400)
(2,520)
(4,200)
Totals...................
$10,046
$7,688
*Rounded
Right
Total
$50,000 $130,000
(7,120)
(30,000)
(10,000)
(30,000)
$32,880 $ 70,000
Right
$3,946
-0-
Total
$ 8,400
20,000
(1,680)
$2,266
(8,400)
$20,000
Left
$ 4,720
-010,046
(10,000)
$ 4,766
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
Center
$32,400
-07,688
(10,000)
$30,088
Right
$32,880
12,000
2,266
(10,000)
$37,146
Total
$70,000
12,000
20,000
(30,000)
$72,000
21. (continued)
INCOME ALLOCATION2011
Left
Center
Interest (12% of beginning capital
above)* ............................
$ 572
$ 3,611
Salary ...................................
12,000
8,000
Remaining income:
$40,000
(8,640)
(20,000)
$11,360.........................
2,272
4,544
Totals..........................
$14,844
$16,155
Right
Total
$4,457
-0-
$ 8,640
20,000
4,544
$9,001
11,360
$40,000
*Rounded
STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2011
Left
Center
Right
Total
Beginning balances (above)
$ 4,766
$30,088
$37,146
$72,000
Income allocation
14,844
16,155
9,001
40,000
Drawings
(10,000)
(10,000)
(10,000)
(30,000)
Ending balances
$ 9,610
$36,243
$36,147
$82,000
McGraw-Hill/Irwin
14-20
22. (12 Minutes) (Determine capital balances after retirement of a partner using
both the goodwill and the bonus approaches)
a. Harrison receives an additional $30,000 about the capital balance. Since
Harrison is assigned 20 percent of all profits and losses, this extra
allocation indicates total goodwill of $150,000, which must be split among
all partners.
20% of Goodwill = $30,000
.20 G = $30,000
G = $150,000
CAPITAL BALANCES AFTER WITHDRAWAL
Original Balance
Lennon
McCartney
Harrison
Starr
Total
$230,000
190,000
160,000
140,000
Goodwill
$45,000
45,000
30,000
30,000
$(190,000)
$275,000
235,000
-0170,000
$680,000
b. A $50,000 bonus is paid to Lennon ($280,000 is paid rather than the $230,000
capital balance). This bonus is deducted from the three remaining partners
according to their relative profit and loss ratio (3:2:1). A reduction of 50
percent (3/6) is assigned to McCartney or a decrease of $25,000 which drops
this partner's capital balance from $190,000 to $165,000. A reduction of 33.3
percent (2/6) is assigned to Harrison or a decrease of $16,667 which drops
this partner's capital balance from $160,000 to $143,333. A reduction of 16.7
percent (1/6) is assigned to Starr or a decrease of $8,333 which drops this
partner's capital balance from $140,000 to $131,667.
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
23. (45 Minutes) (Discussion of P&L allocations and admission of a new partner)
a. The interest factor was probably inserted to reward Page for contributing
$50,000 more to the partnership than Childers. The salary allowance gives
an additional $15,000 to Childers in recognition of the full-time (rather than
part-time) employment. The 40:60 split of the remaining income was
probably negotiated by the partners based on other factors such as
business experience, reputation, etc.
b. The drawings show the assets removed by a partner during a period of
time. A salary allowance is added to each partner's capital for the year
(usually in recognition of work done) and is a component of net income
allocation. The two numbers are often designed to be equal but agreement
is not necessary. For example, a salary allowance might be high to
recognize work contributed by one partner. The allowance increases the
appropriate capital balance. The partner might, though, remove little or no
money so that the partnership could maintain its liquidity.
c. Page, Drawings ...........................................................
5,000
Repair Expense .....................................................
(To reclassify payment made to repair personal residence.)
Page, Capital ...............................................................
Childers, Capital .........................................................
Page, Drawings (adjusted) ...................................
Childers, Drawings ...............................................
(To close drawings accounts for 2008.)
13,000
11,000
Revenues .....................................................................
Expenses (adjusted by first entry) ......................
Income Summary ..................................................
(To close revenue and expense accounts for 2008.)
90,000
5,000
13,000
11,000
59,000
31,000
McGraw-Hill/Irwin
14-22
23. (continued)
d. Total capital (original balances of $110,000 plus 2008
net income less drawings) ...................................
$117,000
Investment by Smith ..................................................
43,000
Total capital after investment ...................................
$160,000
Ownership portion acquired by Smith .....................
20%
Smith, capital ..............................................................
$ 32,000
Amount paid ................................................................
43,000
Bonus paid by Smithassigned to original partners $ 11,000
Bonus to Page (40%) ..................................................
$4,400
$6,600
Cash ............................................................................
Smith, Capital (20% of total capital) ...................
Page, Capital .........................................................
Childers, Capital ....................................................
43,000
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
32,000
4,400
6,600
$360,000
306,000
$ 54,000
CAPITAL BALANCES
Original balances
Goodwill (above)
Investment
Capital balances
A
$20,000
16,200
- 0$ 36,200
B
$40,000
5,400
- 0$45,400
C
$ 90,000
21,600
- 0$111,600
D
$120,000
10,800
- 0$130,800
E
$-0-036,000
$36,000
c. Since E's investment of $42,000 is less than 20% of the resulting capital
($312,000). E is apparently bringing some other attribute to the partnership
(goodwill) that must be computed:
E Investment = 20% (Original Capital + E Investment)
$42,000 + Goodwill = .20 ($270,000 + $42,000 + Goodwill)
$42,000 + Goodwill = $62,400 + .20 Goodwill
.80 Goodwill = $20,400
Goodwill = $25,500
E's investment is, therefore, $42,000 in cash and $25,500 in goodwill for a total
capital balance of $67,500; the other capital accounts remain unchanged. Note
that E's capital of $67,500 is 20% of the new total capital $337,500 ($270,000 +
$67,500).
McGraw-Hill/Irwin
14-24
24.(continued)
d.
Original balances
Investment
Bonus (above)
Capital balances
CAPITAL BALANCES
A
B
C
$20,000
$40,000
$90,000
-0-0-0(1,000)
(3,000)
(2,000)
$19,000
$37,000
$88,000
$325,000
20%
$ 65,000
55,000
$ 10,000
$1,000
3,000
2,000
4,000
D
$120,000
-0(4,000)
$116,000
$10,000
E
$-055,000
10,000
$65,000
$ 90,000
112,500
$ 22,500
$7,500
7,500
7,500
$22,500
CAPITAL BALANCES
A
B
Original balances .................
$20,000
$40,000
Bonus (above) ......................
(7,500)
(7,500)
Payment ................................
- 0- 0Capital balances ...................
$12,500
$32,500
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
C
D
$ 90,000 $120,000
22,500
(7,500)
(112,500)
- 0$
-0- $112,500
25. (55 Minutes) (Allocation of income to the partners and determination of capital
balances)
ALLOCATION OF INCOME2008
Boswell
Johnson
Salary (8 months) .................
$8,000
$-0Remaining $3,000 .................
1,200 (40%)
3,000
Totals ................................
$9,200
$1,800
Total
$ 8,000
$11,000
Johnson
$-0(3,840)
$(3,840)
Walpole
$24,000
(3,200)
$20,800
Total
$36,000
(8,000)
$28,000
McGraw-Hill/Irwin
14-26
Boswell
$66,200
(7,040)
11,040
(5,000)
$65,200
Johnson
$58,800
(10,560)
(3,840)
(5,000)
$39,400
Walpole
Total
$ -0- $125,000
71,600
54,000
20,800
28,000
(10,000) (20,000)
$82,400 $187,000
26.(continued)
ADMISSION OF POPEJANUARY 1, 2010
Pope's payment was made directly to the partners. Therefore, neither goodwill
nor a bonus need be recognized. Instead, 10% of each capital balance shown
above will be reclassified to Pope. The journal entry would be as follows:
Boswell, Capital ...............................................................
Johnson Capital ...............................................................
Walpole, Capital ...............................................................
Pope, Capital ...............................................................
6,520
3,940
8,240
18,700
ALLOCATION OF INCOME2010
Boswell
Johnson
Walpole
Pope
Total
$12,000
Remaining $400 income
54
Totals
$12,054
$-0162
$162
$24,000
144
$24,144
$9,600
40
$9,640
$45,600
400
$46,000
Salary
Boswell Johnson
$65,200
$39,400
(6,520)
(3,940)
12,054
(5,000)
$65,734
162
(5,000)
$30,622
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
Walpole
$82,400
(8,240)
24,144
(10,000)
$88,304
Pope
$-018,700
Total
$187,000
-0-
9,640
46,000
(4,000) (24,000)
$24,340 $209,000
26. (60 Minutes) (Allocate income and prepare a statement of partners' capital)
a. Income Allocation2009
Gray
Salary allowance ($8 per billable
hour)
$13,680
Interest (see Note A)
25,928
Bonus (not applicable because
salary and interest would
necessitate a negative bonus)
-0Remaining loss (split evenly):
$ 65,000
(35,600)
(58,328)
$(28,928)
(9,643)
Profit allocation
$29,965
Stone
Lawson
Totals
$11,520
21,600
$10,400
10,800
$35,600
58,328
-0-
-0-
-0-
(9,643)
(9,642)
$23,477
$11,558
(28,928)
$65,000
Note A: Interest for Stone and Lawson is calculated at 12% of their beginning
capital balances ($180,000 and $90,000, respectively) while for Gray the
computation is based on a $210,000 balance for 4/12 of the year and $219,100
for the remaining 8/12.
Capital Account Balances1/1/09 12/31/09
Beginning contributions
Added Investment
Profit allocation (from above)
Drawing (10% of beginning
balances)
Ending balances
Gray
$210,000
9,100
29,965
Stone
$180,000
-023,477
Lawson
$90,000
-011,558
Totals
$480,000
9,100
65,000
(21,000)
$228,065
(18,000)
$185,477
(9,000)
$92,558
(48,000)
$506,100
McGraw-Hill/Irwin
14-28
26. a. (continued)
Income Allocation2010
Gray
Salary allowance ($8
per billable hour) $14,400
Interest (12% of beginning capital balances
for the year)
27,368
Bonus (not applicable) -0Remaining loss (split
evenly):
$ (20,400)
(46,960)
(80,976)
$(148,336)
(37,084)
Loss allocation
$ 4,684
Stone
Lawson
Monet
Totals
$ 12,000
$ 11,040
$ 9,520
$ 46,960
22,257
-0-
11,107
-0-
20,244
-0-
80,976
-0-
(37,084)
$(2,827)
(37,084)
$(14,937)
Lawson
$92,558
(37,084)
$ (7,320)
Monet
$168,700
(148,336)
$(20,400)
Totals
$674,800
(14,937)
(7,320)
(20,400)
(9,256)
$68,365
(16,870)
$144,510
(67,480)
$586,920
Stone
Lawson
Monet
Totals
$12,960
$10,480
$12,640
$ 51,120
19,692
2,604
8,204
-0-
17,341
-0-
70,430
5,208
6,510
$41,766
6,511
$25,195
6,511
$36,492
26,042
$152,800
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
26. a. (continued)
Note B: The bonus to Gray and Stone can only be derived algebraically. Since
each of the two partners is entitled to 10% of net income as defined, the total
bonus is 20% and can be computed as follows:
Bonus = 20% (Net income Salary Interest Bonus)
B = .2 ($152,800 $51,120 $70,430 B)
B = .2 ($31,250 B)
B = $6,250 .2B
1.2 B = $6,250
B = $5,208 (or $2,604 per person)
Capital Account Balances 1/1/11 12/31/11
Gray
Stone
Beginning balances $209,943 $164,102
Profit allocation (from
above)
49,347
41,766
Drawings (10% of
beginning
balances)
(20,994) (16,410)
Ending balances
$238,296 $189,458
Lawson
$68,365
Monet
$144,510
Totals
$586,920
25,195
36,492
152,800
(6,837)
$86,723
(14,451)
$166,551
(58,692)
$681,028
Lawson
$90,000
-011,558
(9,000)
$92,558
Totals
$480,000
9,100
65,000
(48,000)
$506,100
b.
GRAY, STONE, AND LAWSON
Statement of Partners' Capital
For Year Ending December 31, 2009
Beginning balances
Added Investment
Profit allocation
Drawings
Ending balances
McGraw-Hill/Irwin
14-30
Gray
$210,000
9,100
29,965
(21,000)
$228,065
Stone
$180,000
-023,477
(18,000)
$185,477
27. (40 Minutes) (Recording admission and retirement of partners using both the
bonus and goodwill methods)
a. Porthos, Capital ..........................................................
35,000
D'Artagnan, Capital ...............................................
35,000
(To reclassify half of Porthos's capital balance to reflect transfer of interest
to D'Artagnan.)
b. Goodwill
.................................................................
50,000
Athos, Capital (50%) ............................................
25,000
Porthos, Capital (30%) .........................................
15,000
Aramis, Capital (20%) ..........................................
10,000
(To record goodwill based on $250,000 implied value of partnership
[$25,000/10%]. Since current capital is only $200,000 [the $25,000 goes
directly to the partners], goodwill of $50,000 has to be recorded and
allocated using profit and loss ratio.)
Athos, Capital (10% of balance) ................................
10,500
Porthos, Capital (10% of balance) ............................
8,500
Aramis, Capital (10% of balance) ..............................
6,000
D'Artagnan, Capital................................................
25,000
(To reclassify 10% of each partner's capital to reflect transfer of interest to
D'Artagnan.)
c. Cash ............................................................................
30,000
D'Artagnan, Capital (10% of total capital)...........
23,000
Athos, Capital (50% of excess payment) ............
3,500
Porthos, Capital (30% of excess payment) ........
2,100
Aramis, Capital (20% of excess payment) ..........
1,400
(To record $30,000 payment by D'Artagnan which increases total capital to
$230,000. D'Artagnan is credited for only 10% of that balance with the extra
$7,000 payment being recorded as a bonus to the original partners.)
d. Cash ............................................................................
30,000
Goodwill ......................................................................
70,000
D'Artagnan, Capital ...............................................
30,000
Athos, Capital (50% of goodwill) ........................
35,000
Porthos, Capital (30% of goodwill) ....................
21,000
Aramis, Capital (20% of goodwill) .......................
14,000
(To record D'Artagnan's contribution to the partnership. The $30,000
payment for 10% interest indicates a $300,000 value for the business
although the capital balances would only increase to $230,000. The $70,000
difference is recorded as goodwill, an amount assigned to the original
partners.)
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
27. (continued)
e. Cash .............................................................................
12,222
Goodwill . ....................................................................
10,000
D'Artagnan, Capital ...............................................
22,222
To record investment by D'Artagnan. The implied value of the investment as
a whole would be only $122,220 ($12,222/10%). Since the capital balances
are well in excess of this figure, D'Artagnan is apparently bringing some
other factor (goodwill) into the partnership. This goodwill can be computed
as follows:
$12,222 + Goodwill = 10% (Original Capital + $12,222 + Goodwill)
$12,222 + Goodwill = 10% ($200,000 + $12,222 + Goodwill)
$12,222 + Goodwill = $21,222 + .10 Goodwill
.90 Goodwill = $9,000
Goodwill = $10,000
f. Goodwill ......................................................................
80,000
Athos, Capital (50%) .............................................
40,000
Porthos, Capital (30%) ..........................................
24,000
Aramis, Capital (20%) ...........................................
16,000
(To record goodwill of $80,000 based on $280,000 appraisal of business.)
Aramis, Capital ...........................................................
66,000
Cash ......................................................................
66,000
(To distribute cash to retiring partner based on final capital balance.)
McGraw-Hill/Irwin
14-32
Building .......................................................
52,000
Equipment....................................................
16,000
Cash .............................................................
12,000
O'Donnell, Capital .................................
40,000
Reese, Capital .......................................
40,000
(To record initial investment. Assets recorded at fair value with
two equal capital balances.)
Cash .............................................................
15,000
O'Donnell, Capital (15%) ............................
300
Reese, Capital (85%) ..................................
1,700
Dunn, Capital .........................................
17,000
(New investment by Dunn brings total capital to $85,000 after
2008 loss [$80,000 $10,000 + $15,000]. Dunn's 20% interest is
$17,000 [$85,000 20%] with the extra $2,000 coming from the
two original partners [allocated between them according to their
profit and loss ratio].)
$10,340
6,600
$16,940
$16,236
$16,236
$10,824
$10,824
O'Donnell
$40,000
12,000
(300)
(10,340)
16,940
$58,300
Reese
$40,000
(22,000)
(1,700)
(5,000)
16,236
$27,536
22,824
11,660
5,507
5,000
McGraw-Hill/Irwin
14-34
O'Donnell
$11,660
9,150
______
$20,810
$17,000
(5,000)
10,824
$22,824
22,824
11,660
5,507
5,000
Dunn
20,810
24,114
16,076
Reese
Postner
$24,114
$24,114
$16,076
$16,076
28. a. (continued)
1/1/11
Postner, Capital ..........................................
O'Donnell, Capital (15%) ............................
Reese, Capital (85%) ..................................
Cash .......................................................
(Postner's capital is $33,900 [$22,824
$5,000 + $16,076]. Extra 10% payment is
deducted from the two remaining
partners' capital accounts.)
b. 1/1/08
33,900
509
2,881
37,290
Building........................................................
Equipment ...................................................
Cash .............................................................
Goodwill ......................................................
O'Donnell, Capital .................................
Reese, Capital .......................................
(To record initial capital investments.
Reese is credited with goodwill of
$80,000
to
match
O'Donnell's
investment.)
52,000
16,000
12,000
80,000
30,000
1/1/09
15,000
22,500
Cash .............................................................
Goodwill ......................................................
Dunn, Capital .........................................
(Cash and goodwill being contributed by
Dunn are recorded. Goodwill must be
calculated algebraically.)
80,000
80,000
20,000
10,000
37,500
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
28. b. (continued)
12/31/09 O'Donnell, Capital ......................................
20,000
Reese, Capital ............................................
10,000
Dunn, Capital ..............................................
7,500
O'Donnell, Drawings..............................
Reese, Drawings ...................................
Dunn, Drawings ....................................
(To close out drawings accounts for the
year based on 20 % of beginning capital
balances: O'Donnell$100,000, Reese
$50,000, and Dunn$37,500.)
12/31/09 Income Summary .......................................
44,000
O'Donnell, Capital .................................
Reese, Capital .......................................
Dunn, Capital .........................................
(To allocate $44,000 income figure as follows)
O'Donnell
Interest (20% of $100,000
beginning capital balance)
15% of $44,000 income
60:40 split of remaining $17,400
Totals
26,600
10,440
6,960
Reese
Dunn
$10,440
$10,440
$6,960
$6,960
$20,000
6,600
$26,600
20,000
10,000
7,500
Reese
$80,000
(30,000)
(10,000)
10,440
$50,440
Dunn
$37,500
(7,500)
6,960
$36,960
Goodwill ......................................................
26,588
O'Donnell, Capital (15%) ......................
3,988
Reese, Capital (51%) ............................
13,560
Dunn, Capital (34%) ..............................
9,040
(To record goodwill indicated by purchase of Dunn's interest.)
In effect, profits are shared 15% to O'Donnell, 51% to Reese (60% of the 85%
remaining after O'Donnell's income), and 34% to Dunn (40% of the 85%
remaining after O'Donnell's income). Postner is paying $46,000, an amount
$9,040 in excess of Dunn's capital ($36,960). The additional payment for this
34% income interest indicates total goodwill of $26,588 ($9,040/34%). Since
Dunn is entitled to 34% of the profits but only holds 19% of the total capital, an
28.
b. (continued)
implied value for the company as a whole cannot be determined directly from
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14-36
the payment of $46,000. Thus, goodwill can only be computed based on the
excess payment.
1/1/10
46,000
46,000
61,000
O'Donnell
Reese
Postner
$17,839
$17,839
$11,893
$11,893
Reese
$50,440
13,560
(12,800)
17,839
$69,039
Postner
$36,960
9,040
(9,200)
11,893
$48,693
31,268
17,839
11,893
$22,118
9,150
$31,268
O'Donnell
$106,600
3,988
(22,118)
31,268
$119,738
Postner will be paid $53,562 (110% of the capital balance) for her interest. This
amount is $4,869 in excess of the capital account. Since Postner is only
entitled to a 34% share of profits and losses, the additional $4,869 must
indicate that the partnership as a whole is undervalued by $14,321
(4,869/34%). Only in that circumstance would the extra payment to Postner be
justified:
28.
b. (continued)
14,321
2,148
McGraw-Hill/Irwin
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7,304
4,869
53,562
53,562
The issue of the security provided by an LLP has been raised recently by
the Enron scandal and its role in the destruction of the international
accounting firm Arthur Andersen (an LLP).
The LLP was created so that a partner could protect personal assets
despite the actions of other partners or the firm itself.
The legal validity of the LLP designation has never before been seriously
challenged in court so the ultimate outcome of the Enron debacle as it
relates to the partners of Arthur Andersen will provide legal guidance for
years to come.
The LLP organization is an out-growth of the savings and loan scandals of
the 1980s. In some cases, wrongdoing was traced back to law firms and
innocent partners suffered.
Texas was the first state (in 1991) to allow the LLP organization. Now,
however, virtually every state but Illinois allows the LLP in some form.
For law partnerships, the LLP has become more popular than either the
professional corporation or the limited liability corporation.
The LLP organization, though, only becomes important in huge loss cases.
Normally a firms malpractice insurance and assets can cover all losses.
The Arthur Andersen situation has given the legal profession a chance to
test the LLP structure.
Legal experts feel that the LLP will not be seriously damaged by the cases
brought up in connection with Arthur Andersen and Enron.
Research Case 2
This assignment allows the student to make use of the SEC website and, then,
the EDGAR system. It also provides a chance to use actual statements created
for a partnership rather than those typically produced for a corporation.
Probably the most noticeable characteristic of the statements for Buckeye
Partners is that they resemble corporate financial statements in most ways. A
casual overview might not bring any differences to mind. However, a close
reading will show several differences including the following:
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
The balance sheet does not present a stockholders equity section but
rather partnership capital. That section is comprised of just two figures:
one for the general partner and the other for the limited partners.
The first two paragraphs of Note One to the financial statements describe
the partnership organization.
A later paragraph presents a schedule reflecting the changes in
partnership capital for both the general partner and the limited partners.
Analysis Case
An unlimited number of allocation plans can be developed for any partnership.
Here, Wilson will be interested in some reward for investing the capital used to
create the business. Higgins will expect to be recognized for the work put into
the operation. Poncelet should seek some reward for any new clients that she is
able to bring to the business.
One possibility would be to accrue interest to Wilson on her capital balance for
the year based, perhaps, on the prime rate. Poncelet could be assigned a
particularly high share of any revenues generated from new clients. The amount
of income left would result from Higginss work in the day-to-day operations of
the business so a large part of that remainder could be assigned to her.
As an alternative, Wilson could be allocated an interest factor but only based on
the initial amount invested in the business rather than the capital balance as a
whole. Higgins could be assigned some type of allowance for the number of
hours of work put in each period. Any remaining income could be divided evenly
among the three partners but only up to a certain level. Beyond that, perhaps
only Poncelet and Higgins would share in the income since they are doing the
work, one in gaining new clients and the other in the day-to-day operations of the
business.
Communication Cases 1 and 2
These two cases ask the student to identify the types of factors that will lend
themselves toward the organization becoming a corporation (in Case 1) or a
partnership (in Case 2). Several issues should be considered when looking into a
legal format for a business enterprise:
Do state laws play any role in the decision? In some states, particular
types of organizations are prohibited from operating as a corporation. Will
state law come into play in making this decision? If so, the partnership
form of organization will be required.
How big do the owners expect the company to become? If the business
will remain small, there may be no need to raise additional capital so that
the ability to sell ownership may not be an issue. This favors creation of a
partnership. However, if Birmingham and Roberts expect the business to
prosper and grow, they should consider which type of business will enable
them to attract other capital or debt investments. Usually, it is a
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14-40
Excel Case 1
There are a number of different ways that a spreadsheet could be created to
solve this particular problem. Here is one possible approach:
In Cell A1, enter label text Net Income and in Cell B1 enter $200,000.
In Cell A2, enter label text Billable Hours Red and in Cell B2 enter 2,000. In
Cell C2, enter the hourly rate of $20.
In Cell A3, enter label text Billable Hours Blue and in Cell B3 enter 1,500. In
Cell C3, enter the hourly rate of $30.
In Cell A4, enter label text Investment Red and in Cell B4 enter $80,000. In Cell
C4, enter the rate of return of 10%.
In Cell A5, enter label text Investment Blue and in Cell B5 enter $50,000. In
Cell C5, enter the rate of return of 10%.
Perform calculations:
In Cell D2, enter formula to multiply number of hours by hourly rate. Formula:
=+B2*C2
The formula for the next three line items is identical to this first formula; copy the
formula to Cells D3, D4, and D5. (To copy a formula across a range of cells,
select the cell containing formula, then drag the fill handle, which is the small
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e
square in the lower right corner of this box, over the adjacent cells. Note that the
formula will adjust automatically for the different lines.)
In Cell A6, enter label text Subtotal and SUM the amounts in Cells D2 through
D5. Click in Cell D6, press the symbol on the standard toolbar. Click and drag
across the range of cells to be summed (D2 through D5) and press enter.
Subtract the subtotal of the partners initial allocations (Cell D6) from the Net
Income (Cell B1) with the following formula: In Cell A8, enter the label text Profit
to be Split and in Cell D8, enter the following formula: =+B1-D6.
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McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e