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Chapter 14 - Partnerships: Formation and Operation

CHAPTER 14
PARTNERSHIPS: FORMATION AND OPERATION
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, because 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.
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Chapter 14 - Partnerships: Formation and Operation

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
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.

Name and address of each partner


Business location
Description of the nature of the business
Rights and responsibilities of each partner
Initial investment to be made by each partner along with the method to be used for
valuation
f. Specific method by which profits and losses are to be allocated
g. Periodic withdrawals to be allowed each partner
h. Procedure for admitting new partners
i. Method for arbitrating partnership disputes
j. Method for settling a partner's share in the business upon withdrawal, retirement, or
death
7.

To give fair recognition to noncash contributions, all assets donated by the partners (such as
land or inventory) should be recorded by the partnership at their fair values at the date of
investment. However, for taxation purposes, the partners book value is retained.

8.

In forming a partnership, one or more of the partners may be contributing some factor (such
as an established clientele or an expertise) which is not viewed normally as an asset in the
traditional accounting sense. In effect, the partner will be receiving a larger capital balance
than the identifiable contributions would warrant.
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Chapter 14 - Partnerships: Formation and Operation

The bonus method of recording this transaction is to value and record only the identifiable
assets such as land and buildings. The capital accounts are then aligned to recognize the
proportionate interest being assigned to each partner's investment. If, for example, the
capital balances are to be equal, they are set at identical amounts that correspond in total to
the value of the identifiable assets.
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 Because 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.
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Chapter 14 - Partnerships: Formation and Operation

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
c. The right to participate in the management of the business.
No problem exists in selling or assigning the first two of these rights. However, the right to
participate in management decisions can only be transferred with the consent of all partners.
16. Goodwill recognized in a capital transaction is allocated to the original partners based on the
profit and loss ratio. The amount is assumed to represent unrealized gains in the value of
the business. To determine the amount of goodwill, the implied value of the business as a
whole must be calculated based on the price being paid for a portion by the new partner.
The difference between this implied value and the total capital is assumed to be goodwill or
some other adjustment to asset value.
17. Allocating goodwill to an entering partner may be necessary for several reasons. One of the
most common is that the partner is bringing to the partnership an attribute that is not an
asset in the traditional accounting sense. For example, a new partner with an excellent
business reputation might be credited with goodwill at the time of entrance. Other factors
such as an established clientele or a professional expertise can justify attributing goodwill to
the new partner. The partnership might make this same concession to an entering partner if
cash is urgently needed by the business and a larger share of the capital has to be offered
as an enticement to generate the new investment.
18. Book values in most cases measure historical cost expenditures which often have
undergone years of allocation and changes in value. For this reason, book value will
frequently fail to mirror or even resemble the actual worth of a business. In addition, the
goodwill that is assumed to be present in a business as a going concern is not a factor that
is always reflected within book values. Therefore, distributing partnership property to a
withdrawing partner based on book value would not necessarily be fair. Hence, the Articles
of Partnership should spell out a method by which an equitable settlement can be achieved.

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Chapter 14 - Partnerships: Formation and Operation

Answers to Problems
1. B
2. C
3. D
4. C Mary Ann's investment equals 1/3 of total capital ($50,000 $150,000).
However, she receives only a 1/4 interest capital balance. One explanation
for the difference is that the business assets are worth more than book
value. To achieve agreement, the net assets could be valued upward to fair
value with the adjustment credited to the original partners capital
accounts. Alternatively, a bonus could be credited to the original partners.
5. D Based on the new contribution, the companys implied value is $350,000
($105,000 30%) which is less than the capital balances ($315,000 in
original capital plus $105,000 to be invested). Thus, either the assets are
overvalued or the new partner is contributing goodwill in addition to a cash
investment. Because the problem indicates that goodwill is recognized,
goodwill must be computed. Note that the $105,000 is going into the
business and, thus, increases capital.
David's investment = 30% (Original capital plus David's investment)
$105,000 + Goodwill = .30 ($315,000 + $105,000 + Goodwill)
$105,000 + Goodwill = $126,000 + .30 Goodwill
.70 Goodwill = $21,000
Goodwill = $30,000
David's investment (Capital) = $105,000 + $30,000 = $135,000
6. B The implied value of the company is $960,000 ($240,000 25%). Because
the current capital total is only $760,000, goodwill of $200,000 must be
recognized. Krystal's investment is paid directly to the partners and does
not affect the capital total. Of the $200,000 in goodwill, 30 percent or
$60,000 is attributed to Dane which brings that capital balance to $340,000.
Because a 25% interest is conveyed to the new partner, Dane's balance
decreases by 25% or $85,000resulting in a new balance of $255,000.
7. B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new
investment. As Kansas's portion is 30 percent, the capital balance becomes
$60,000 ($200,000 30%). Because only $50,000 was paid, a bonus of
$10,000 is taken from the two original partners based on their profit
and
loss ratios: Bolcar $7,000 (70%) and Neary $3,000 (30%). The reduction
drops Neary's capital balance from $40,000 to $37,000.

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Chapter 14 - Partnerships: Formation and Operation

8. B Total capital is $270,000 ($120,000 + $90,000 + $60,000) after the new


investment. However, the implied value of the business based on the new
investment is $300,000 ($60,000 20%). Thus, goodwill of $30,000 must be
recognized with the offsetting allocation to the original partners based on
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.
9. A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new
investment. As Claudius' portion is to be 20 percent, the new capital
balance would be $90,000 ($450,000 20%). Because $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.
10. D ASSIGNMENT OF INCOME
ALFRED

Interest5% of
beginning capital .................
$ 2,500
Salary........................................
Allocation of remaining income
($33,000 divided on a 3:3:4 basis)
9,900
Totals .............................
$12,400

BERNARD

COLLINS

TOTAL

$ 3,000
18,000

$ 3,500

$ 9,000
18,000

9,900
$30,900

13,200
$16,700

33,000
$60,000

BERNARD

COLLINS

TOTAL

STATEMENT OF CAPITAL
ALFRED

Beginning capital ....................


Net income (above) .................
Drawings (given) .....................
Ending capital .........................

$50,000
12,400
(5,000)
$57,400

$60,000
30,900
(5,000)
$85,900

$70,000 $180,000
16,700
60,000
(5,000) (15,000)
$81,700 $225,000

11. A ASSIGNMENT OF INCOMEYEAR ONE


WINSTON

Interest10% of
beginning capital ...............
$11,000
Salary........................................
20,000
Allocation of remaining loss
($80,000 divided on a 5:2:3 basis) (40,000)
Totals .............................
$(9,000)

DURHAM

SALEM

TOTAL

$ 8,000
-0-

$11,000
10,000

$30,000
30,000

(16,000)
$ (8,000)

(24,000) (80,000)
$ (3,000) $(20,000)

STATEMENT OF CAPITALYEAR ONE


WINSTON

Beginning capital ....................


Net loss (above) ......................
Drawings (given) .....................
Ending capital ....................

$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

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Chapter 14 - Partnerships: Formation and Operation

11. (continued)
ASSIGNMENT OF INCOMEYEAR TWO
WINSTON

Interest10% of
beginning capital ...............
$ 9,100
Salary........................................
20,000
Allocation of remaining loss
($15,000 divided on a 5:2:3 basis)
(7,500)
Totals .............................
$21,600

DURHAM

SALEM

TOTAL

$ 6,200
-0-

$ 9,700
10,000

$25,000
30,000

(3,000)
$3,200

(4,500) (15,000)
$15,200 $ 40,000

STATEMENT OF CAPITALYEAR TWO


Beginning capital (above) ......
Net income (above) .................
Drawings (given) .....................
Ending capital ....................

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

12. A Costello receives a $10,000 bonus ($100,000 less $90,000 capital balance).
This bonus is deducted from the two remaining partners according to their
profit and loss ratio (2:3). A 60 percent (3/5) reduction is assigned to Burns
which decreases that partners capital balance from $30,000 to $24,000.
13. D Clark receives an additional $10,000. Because Clark receives 20 percent of
profits and losses, this allocation indicates total goodwill of $50,000.
20% of Goodwill = $10,000
Goodwill = $10,000 .20 = $50,000
Goodwill
Manning, capital (30%)
Gonzalez, capital (30%)
Clark, capital (20%)
Freeney, capital (20%)

50,000
15,000
15,000
10,000
10,000

The above entry raises Mannings capital from $130,000 to $145,000.


14. B Under the bonus method, Clarks excess payment is deducted from the
remaining partners capital accounts according to their relative profit and loss
ratios, 3:3:2. Mannings balance is then $126,250 = $130,000 $3,750.
Manning, capital
Gonzalez, capital
Freeney, capital
Clark, capital
Cash

3,750
3,750
2,500
80,000
90,000
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Chapter 14 - Partnerships: Formation and Operation

15. A The implied value of the company is $900,000 ($270,000 30%). Because
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 is 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.
16. D Because 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.
17. (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

Goodwill to Hamlet (7/10) ................................................

7,000

Goodwill to MacBeth (3/10) .............................................

$ 3,000

Hamlet, capital (original balance plus goodwill) ..........

$ 77,000

MacBeth, capital (original balance plus goodwill) .......

$ 43,000

Lear, capital (payment) (40% of total capital) ...............

$ 80,000

b. Bonus Method
Total capital after investment ($70,000 + 40,000 + $80,000)
Ownership portionLear ................................................
Lear, capital ......................................................................

$190,000
40%
$ 76,000

Bonus payment made by Lear ($80,000 $76,000).......

4,000

Bonus to Hamlet (7/10) ....................................................

2,800

Bonus to MacBeth (3/10) .................................................

1,200

Hamlet, capital (original balance plus bonus) ..............

$ 72,800

MacBeth, capital (original balance plus bonus) ...........

$ 41,200

Lear, capital (40% of total capital) ..................................

$ 76,000

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Chapter 14 - Partnerships: Formation and Operation

18. (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. Because $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 25 percent, this partner's capital
balance is $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 .......................................................

16,000
8,000
4,800
3,200
72,000
72,000

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Chapter 14 - Partnerships: Formation and Operation

19. (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. Because 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 .................

$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

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Chapter 14 - Partnerships: Formation and Operation

20. (10 Minutes) (Record admission of new partner and allocation of new income)
Part a.
Total capital is $167,000 ($70,000 + $60,000 + $37,000) after the new
investment. However, the implied value of the business based on the new
investment is $185,000 ($37,000 20%). Consequently, goodwill of $18,000
must be recognized with the offsetting allocation to the original two
partners based on their profit and loss ratio: Prince$14,400 (80%) and
Robbins$3,600 (20%).
Goodwill..................................................................
Prince, capital ..................................................
Robbins, capital ...............................................
Cash ......................................................................
Jeffrey, capital ..................................................

18,000
14,400
3,600
37,000
37,000

Part b.
Interest ..................................
Remaining loss......................
Income allocation ...........

Prince
$8,440
(1,750)
$6,690

Robbins
$6,360
(1,050)
$5,310

Jeffrey
$3,700
(700)
$3,000

Total
$18,500
(3,500)
$15,000

Lane
$
-045,000
(6,000)
$39,000

Total
$18,000
90,000
(18,000)
$90,000

21. (5 Minutes) (Allocation of income to partners)


Jones
Bonus (20%) ..........................
$18,000
Interest (15% of average capital) 15,000
Remaining loss ($18,000) ...
(6,000)
Income assignment ..............
$27,000

King
$
-030,000
(6,000)
$24,000

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Chapter 14 - Partnerships: Formation and Operation

22. (15 Minutes) (Allocate income and determine capital balances)


ALLOCATION OF INCOME
Interest (10%)
Salary
Remaining income (loss):
$ 23,600
(12,600)
(51,000)
$(40,000)
Totals

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

CALCULATION OF PURKERSON'S INTEREST ALLOCATION


Balance, January 1April 1 ($60,000 3)
Balance, April 1December 31 ($68,000 9)
Total ...................................................................................
Months...............................................................................
Average monthly capital balance ...................................
Interest rate ......................................................................
Interest allocation (above) ..............................................

$180,000
612,000
$792,000
12
$ 66,000
10%
$ 6,600

STATEMENT OF PARTNERS' CAPITAL


Purkerson

Beginning balances ...............


Additional contribution .........
Income (above) ......................
Drawings ($1,000 per month)
Ending capital balances.........

$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

14-12
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Education.

Chapter 14 - Partnerships: Formation and Operation

23. (30 Minutes) (Allocate income for several years and determine ending capital
balances)
INCOME ALLOCATION2014
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)

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2014


Beginning balances ............
Income allocation ................
Drawings ..............................
Ending balances ............

Left
$20,000
(5,280)
(10,000)
$ 4,720

Center
$60,000
(17,600)
(10,000)
$32,400

INCOME ALLOCATION2015
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

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2015


Beginning balances (above)
Additional investment ........
Income allocation ................
Drawings ..............................
Ending balances ............

Left
$ 4,720
-010,046
(10,000)
$ 4,766

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

14-13
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Education.

Chapter 14 - Partnerships: Formation and Operation

23. (continued)
INCOME ALLOCATION2016
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, 2016
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

14-14
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Education.

Chapter 14 - Partnerships: Formation and Operation

24. (12 Minutes) (Determine capital balances after retirement of a partner using
both the goodwill and the bonus approaches)
a. Fergie receives $30,000 more than her capital balance. Because Fergie 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

Pineda
Adams
Fergie
Gomez
Total

$230,000
190,000
160,000
140,000

Goodwill

$45,000
45,000
30,000
30,000

Withdrawal

Final Balance

$(190,000)

$275,000
235,000
-0170,000
$680,000

b. A $50,000 bonus is paid to Pineda ($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 Adams 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 Fergie 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 Gomez or a decrease of $8,333 which drops this
partner's capital balance from $140,000 to $131,667.
25. (10 minutes) (Hybrid method for recording a partner withdrawal)
Because the continuing partners do not wish to record goodwill, a hybrid approach
records identifiable asset fair value changes and corresponding capital
adjustments, but no goodwill. The remaining excess payment to the withdrawing
partner after the revaluation is then treated as a bonus.
Building
Matteson, capital
Richton, capital
OToole, capital

40,000
12,000
20,000
8,000

OToole, capital
Matteson, capital
Richton, capital
Cash

108,000
4,500
7,500
120,000
14-15

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Education.

Chapter 14 - Partnerships: Formation and Operation

26.

(45 Minutes) (P&L allocations and admission of a new partner)


a. The interest factor was probably inserted to reward Hugh for contributing
$50,000 more to the partnership than Jacobs. The salary allowance gives
an additional $20,000 to Jacobs 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. Hugh, drawings ..........................................................
7,500
Repair expense .....................................................
(To reclassify payment made to repair personal residence.)
Hugh, capital ...............................................................
Jacobs, capital ............................................................
Hugh, drawings (adjusted for home repairs) .....
Jacobs, drawings ..................................................
(To close drawings accounts for 2014.)

16,500
14,000

Revenues .....................................................................
Expenses (adjusted by first entry) ......................
Income summary ..................................................
(To close revenue and expense accounts for 2014.)

175,000

7,500

16,500
14,000

138,500
36,500

Income summary ........................................................


36,500
Hugh, capital .........................................................
12,600
Jacobs, capital ......................................................
23,900
(To close net income to partners' capitalsee allocation plan shown below.)
Allocation of Income
Interest (10% of beginning balance)
Salary allowances
Remaining income (loss):
Net income
$ 36,500
Interest
(25,000)
Salary
(30,000)
Remainder
$ (18,500)
Profit allocation

Hugh
$ 15,000
5,000

Jacobs
$ 10,000
25,000

(7,400) (40%)
$12,600

(11,100) (60%)
$23,900

14-16
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Education.

Chapter 14 - Partnerships: Formation and Operation

26. (continued)
d. Total capital (original balances of $250,000 plus 2014
net income less drawings) ...................................
$256,000
Investment by Thomas ..............................................
64,000
Total capital after investment ....................................
$320,000
Ownership portion acquired by Thomas .................
15%
Thomas, capital ..........................................................
$ 48,000
Amount paid ................................................................
64,000
Bonus paid by Thomasassigned to original partners $ 16,000
Bonus to Hugh (40%) .................................................

$6,400

Bonus to Jacobs (60%) ..............................................

$9,600

Cash ............................................................................
Thomas, capital (20% of total capital) ................
Hugh, capital .........................................................
Jacobs, capital ......................................................

64,000
48,000
6,400
9,600

14-17
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Education.

Chapter 14 - Partnerships: Formation and Operation

27. (40 Minutes) (Reporting a change in the composition of a partnership)


a. Exact amount of investment can only be computed algebraically:
E Investment = 25% (Original Capital + E Investment)
El = .25 ($270,000 + El)
El = $67,500 + .25 El
.75 El = $67,500
E Investment = $90,000
b. Implied value of partnership ($36,000 10%)..........
Total capital after investment by E ($270,000 + $36,000)
Goodwill ......................................................................
Allocation of Goodwill:
A (30%) .................................................................
B (10%) .................................................................
C (40%) .................................................................
D (20%) .................................................................
Total ..................................................................

$360,000
306,000
$ 54,000
$16,200
5,400
21,600
10,800
$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. Because 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).

14-18
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Education.

Chapter 14 - Partnerships: Formation and Operation

27. (continued)
d.

Total capital after investment ($270,000 + $55,000) $325,000


Amount acquired by E ...............................................
E's capital balance .....................................................
E's payment ................................................................
Bonus being given to E .............................................

20%
$ 65,000
55,000
$ 10,000

Bonus from:
A (10%) .................................................................
B (30%) .................................................................
C (20%) .................................................................
D (40%) .................................................................

$10,000

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

e. C's capital balance


C's collection (125%)
Bonus being paid to C
Bonus from:
A (1/3)
B (1/3)
D (1/3)

$1,000
3,000
2,000
4,000
D
$120,000
-0(4,000)
$116,000

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 -0 Capital balances ...................
$12,500
$32,500

C
D
$ 90,000 $120,000
22,500
(7,500)
(112,500)
-0 $
-0- $112,500

14-19
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Education.

Chapter 14 - Partnerships: Formation and Operation

28. (55 Minutes) (Allocation of income to the partners and determination of capital
balances)
ALLOCATION OF INCOME2013
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

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2013


Boswell
Johnson
Total
Beginning Balances ($114,000
Invested capital split evenly
market value used for assets)
$57,000
$57,000 $114,000
Income allocation (above) ...
9,200
1,800
11,000
Drawings ...............................
-0 -0 -0 Ending balances .............
$66,200
$58,800 $125,000
WALPOLE INVESTMENT JANUARY 1, 2014
Walpole's $54,000 investment increases total capital to $179,000. Walpole is
credited with a 40% interest or $71,600. According to the problem, the excess
$17,600 is a bonus from the original partners. Of this amount, $10,560 is
allocated from Johnson (60%) and $7,040 from Boswell (40%).
ALLOCATION OF INCOME2014
Boswell
Salary .....................................
$12,000
Remaining $8,000 loss ($28,000
$36,000) ............................
(960)
Totals ..........................
$11,040

Johnson
$-0(3,840)
$(3,840)

Walpole
$24,000
(3,200)
$20,800

Total
$36,000
(8,000)
$28,000

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2014


Beginning balances .............
Walpole's contribution .........
Income allocation (above) ...
Drawings ...............................
Ending balances .............

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

14-20
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Education.

Chapter 14 - Partnerships: Formation and Operation

28. (continued)
ADMISSION OF POPEJANUARY 1, 2015
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 INCOME2015
Salary
Remaining $400 income

Totals

Boswell

Johnson

Walpole

Pope

Total

$12,000
54
$12,054

$-0162
$162

$24,000
144
$24,144

$9,600
40
$9,640

$45,600
400
$46,000

STATEMENT OF PARTNERSHIP CAPITALDECEMBER 31, 2015


Beginning balances
Admission of Pope
Allocation of income
(above)
Drawings
Ending balances

Boswell Johnson
$65,200
$39,400
(6,520)
(3,940)
12,054
(5,000)
$65,734

162
(5,000)
$30,622

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

14-21
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Education.

Chapter 14 - Partnerships: Formation and Operation

29. (60 Minutes) (Allocate income and prepare a statement of partners' capital)
a. Income Allocation2013
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)
$23,477

(9,642)
$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 Balances1/1/13 12/31/13
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

Prior to developing the information for 2014, a computation of Monet's


investment must be made:
Monet's Investment = 25% ($506,100 + Monet's Investment)
Ml = $126,525 + .25 Ml
.75 Ml = $126,525
Ml = $168,700

14-22
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Education.

Chapter 14 - Partnerships: Formation and Operation

29. a. (continued)
Income Allocation2014
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)

Capital Account Balances 1/1/14 12/31/14


Gray
Stone
Beginning balances $228,065
$185,477
Loss allocation (from
above)
4,684
(2,827)
Drawings (10% of
beginning
balances)
(22,806)
(18,548)
Ending balances $209,943
$164,102
Income Allocation2015
Gray
Salary allowance ($8
per billable hour) $15,040
Interest (12% of
beginning capital
balances for the
year)
25,193
Bonus (see Note B)
2,604
Remaining profit split
evenly:
$152,800
(51,120)
(70,430)
(5,208)
$ 26,042
6,510
Profit allocation
$49,347

(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

14-23
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Education.

Chapter 14 - Partnerships: Formation and Operation

29. a. (continued)
Note B: The bonus to Gray and Stone can only be derived algebraically.
Because 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 1/1/15 12/31/15
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
$68,365

Monet
$144,510

Totals
$586,920

25,195

36,492

152,800

b.
GRAY, STONE, LAWSON, and MONET
Statement of Partners' Capital
For Year Ending December 31, 2015
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

(6,837)
$86,723

(14,451)
$166,551

(58,692)
$681,028

14-24
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Education.

Chapter 14 - Partnerships: Formation and Operation

30. (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 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%]. Because 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.)

14-25
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Education.

Chapter 14 - Partnerships: Formation and Operation

30. (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%). Because 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.)

14-26
Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.

Chapter 14 - Partnerships: Formation and Operation

31. (75 Minutes) (Recording of changes in the composition of a partnership


including allocation of income)
a. 1/1/13

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.)

12/31/13 Reese, capital .............................................


22,000
O'Donnell, capital .................................
12,000
Income summary ..................................
10,000
(The allocation plan specifies that O'Donnell receives 20% in
interest [or $8,000 based on $40,000 capital balance] plus $4,000
more [Because that amount exceeds 15% of the profits from the
period]. The remaining $22,000 loss is assigned to Reese.)
1/1/14

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 2013
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].)

12/31/14 O'Donnell, capital .......................................


10,340
Reese, capital .............................................
5,000
Dunn, capital ...............................................
5,000
O'Donnell, drawings..............................
10,340
Reese, drawings ...................................
5,000
Dunn, drawings .....................................
5,000
(To close out drawings accounts for the year based on
distributing 20% of each partner's beginning capital balances
[after adjustment for Dunn's investment] or $5,000 whichever is
greater. O'Donnell's capital is $51,700 [$40,000 + $12,000 $300])
12/31/14 Income summary .......................................
44,000
O'Donnell, capital .................................
16,940
Reese, capital ........................................
16,236
Dunn, capital .........................................
10,824
(To allocate $44,000 income figure for 2014 as determined below.)
14-27
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Education.

Chapter 14 - Partnerships: Formation and Operation

31. a. (continued)
O'Donnell
Interest (20% of $51,700
beginning capital balance)........
15% of $44,000 income ...................
60:40 split of remaining $27,060
income ........................................
Total ..................................................

Reese

Dunn

$16,236
$16,236

$10,824
$10,824

$10,340
6,600
$16,940

Capital Balances as of December 31, 2014:


O'Donnell
$40,000
12,000
(300)
(10,340)
16,940
$58,300

Initial 2013 investment ....................


2013 profit allocation ......................
Dunn's investment ..........................
2014 drawings .................................
2014 profit allocation ......................
12/31/14 balances ............................
1/1/15

Reese
$40,000
(22,000)
(1,700)
(5,000)
16,236
$27,536

Dunn, capital ...............................................


Postner, capital .....................................
(To reclassify balance to reflect
acquisition of Dunn's interest.)

22,824

12/31/15 O'Donnell, capital .......................................


Reese, capital .............................................
Postner, capital ...........................................
O'Donnell, drawings .............................
Reese, drawings ...................................
Postner, drawings .................................
(To close out drawings accounts for the
year based on 20% of beginning capital
balances [above] or $5,000 [whichever is
greater].)

11,660
5,507
5,000

Interest (20% of $58,300 beg. capital)


15% of $61,000 income .............
60:40 split of remaining $40,190
Totals ................................

$17,000
(5,000)
10,824
$22,824
22,824

11,660
5,507
5,000

12/31/15 Income summary.........................................


61,000
O'Donnell, capital .................................
Reese, capital ........................................
Postner, capital .....................................
(To allocate profit for 2015 determined as follows)
O'Donnell
$11,660
9,150
______
$20,810

Dunn

20,810
24,114
16,076

Reese

Postner

$24,114
$24,114

$16,076
$16,076

14-28
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Education.

Chapter 14 - Partnerships: Formation and Operation

31. a. (continued)
1/1/16
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. 1/1/13

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

12/31/13 Reese, capital .............................................


O'Donnell, capital .................................
Income summary ..................................
(Interest of $16,000 is credited to
O'Donnell [$80,000 20%] along with a
base of $4,000. The remaining amount is
now a $30,000 loss that is attributed
entirely to Reese.)

30,000

1/1/14

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

$15,000 + Goodwill = 20% (Current Capital + $15,000 + Goodwill)


$15,000 + Goodwill = 20% ($150,000 + $15,000 + Goodwill)
$15,000 + Goodwill = $33,000 + .2 Goodwill
.8 Goodwill = $18,000
Goodwill = $22,500

14-29
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Education.

Chapter 14 - Partnerships: Formation and Operation

31. b. (continued)
12/31/14 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.)
12/31/14 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

Capital balances as of December 31, 2014:


O'Donnell
Initial 2013 investment . . .
$ 80,000
2013 profit allocation ......
20,000
Additional investment ....
2014 drawings .................
(20,000)
2014 profit allocation ......
26,600
12/31/14 balances ...........
$106,600
1/1/15

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%).
Because Dunn is entitled to 34% of the profits but only holds 19% of the total
capital, an implied value for the company as a whole cannot be determined
14-30
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Education.

Chapter 14 - Partnerships: Formation and Operation

directly from the payment of $46,000. Thus, goodwill can only be computed
based on the excess payment.
31. b. (continued)
1/1/15

Dunn, capital ....................................................


Postner, capital ...........................................
(To reclassify capital balance to new partner.)

46,000
46,000

12/31/15 O'Donnell, capital ............................................


22,118
Reese, capital ...................................................
12,800
Postner, capital ................................................
9,200
O'Donnell, drawings ..................................
22,118
Reese, drawings .........................................
12,800
Postner, drawings ......................................
9,200
(To close out drawings accounts for the year based on 20% of beginning
capital balances [after adjustment for goodwill].)
12/31/15 Income summary .............................................
O'Donnell, capital .......................................
Reese, capital .............................................
Postner, capital ...........................................
To allocate profit for 2015 as follows:

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

Interest (20% of $110,588


beginning capital balance)
15% of $61,000 income ........
60:40 split of remaining
$29,732 .............................
Totals ................................

31,268
17,839
11,893

$22,118
9,150
$31,268

Capital Balances as of December 31, 2015:


O'Donnell
$106,600
3,988
(22,118)
31,268
$119,738

12/31/14 balances .................


Adjustment for goodwill ......
Drawings................................
Profit allocation.....................
12/31/15 balances..................

Postner will be paid $53,562 (110% of the capital balance) for her interest. This
amount exceeds her capital balance by $4,869. Because Postner is only
entitled to a 34% share of profits and losses, the additional $4,869 indicates
that the partnership as a whole is undervalued by $14,321 (4,869 34%). Only
in that circumstance is the extra payment to Postner justified:

14-31
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Education.

Chapter 14 - Partnerships: Formation and Operation

31. b. (continued)
1/1/16 Goodwill .................................................................
O'Donnell, capital (15%) ..................................
Reese, capital (51%) ........................................
Postner, capital (34%) .....................................
(To recognize implied goodwill.)

14,321

1/1/16 Postner, capital .....................................................


Cash .................................................................
(To record final distribution to Postner.)

53,562

2,148
7,304
4,869

53,562

14-32
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Education.

Chapter 14 - Partnerships: Formation and Operation

Develop Your Skills


Research Case
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:

On the income statement, net income is allocated between the general


partner and limited partners.
Also, on the income statement earnings per share is replaced with a figure
labeled as earnings per partnership unit.
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 Because they are doing the
14-33
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Education.

Chapter 14 - Partnerships: Formation and Operation

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
corporation that is best set up to enable growth through the issuance of
securities.
How risky is the business operation? If the company is operating in a
business where liability is not a significant problem, the limited liability of a
corporation might not be of much interest. However, if there is some risk
involved, the two owners may need the corporate type of organization just
for their own financial security.
How well do the owners know and trust each other? As with the previous
comment, potential liability can be greatly enhanced if the owners do not
know each other well or if additional owners are expected to join at a later
point in time. Under that circumstance, everyone may feel more
comfortable if the business is created as a corporation or as one of the
limited liability organizations. If the owners, though, are comfortable with
each other, they may not feel the necessity of creating a formalized
corporation.
What changes will occur in the tax laws? At this writing, dividends paid by
a corporation to its owners are taxable at 15%. However, from time to time
various politicians have proposed the elimination of part or all of that tax.
Corporations gain appeal if dividend income is not taxed.
How much money do they have available to create a legal organization? In
most states, creation of a partnership can be virtually free whereas the
legal formality of a corporation can cost money. If finances are tight, the
business could begin as a partnership and then convert to a corporation at
a later date as monetary restrictions ease.
14-34

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Education.

Chapter 14 - Partnerships: Formation and Operation


Excel Case: There are a variety of ways to create a spreadsheet to solve this particular problem.
Here is one possible approach:
In Cell A1, enter text Net Income and in Cell B1 enter $200,000.
In Cell A2, enter text Billable HoursRed. In Cell B2 enter 2,000. In Cell C2, enter $20 hourly rate.
In Cell A3, enter text Billable HoursBlue. In Cell B3 enter 1,500. In Cell C3, enter $30 hourly rate.
In Cell A4, enter text InvestmentRed and in Cell B4 enter $80,000. In Cell C4, enter the rate of
return of 10%.
In Cell A5, enter text InvestmentBlue and in Cell B5 enter $50,000. In Cell C5, enter the rate of
return of 10%.
Perform calculation: 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 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.
Determine the distribution of Profit between partners:
In Cell A10, enter label text Profit Red and in Cell C10 enter 50%.
In Cell A11, enter label text Profit Blue and in Cell C11 enter 50%.
Perform calculations: In Cell D10, enter formula to multiply Profit to be Split (Cell D8) by
distribution percentage (Cell C10). Formula: =+D8*C10
Repeat this calculation for the other partner. In Cell D11, enter the formula: =+D8*C11
Once the spreadsheet is created, any variable may be changed and the results will adjust
automatically. There are eleven variables that can be changed: B1, B2, B3, B4, B5, C2, C3, C4,
and C5, as well as C10 and C11 (which must add up to 100%).
Example:
Net Income
Billable Hours-Red
Billable Hours-Blue
Investment-Red
Investment-Blue
Subtotal

$200,000
2,000
1,500
$80,000
$50,000

$20
$30
10%
10%

Profit to be Split:

$40,000
45,000
8,000
5,000
$98,000
$102,000

Profit-Red
Profit-Blue

50%
50%

$51,000
$51,000

14-35
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Education.

Chapter 14 - Partnerships: Formation and Operation

Problems
LO 14-1

1.

Which of the following is not a reason for the popularity of


partnerships as a legal form for businesses?
a. Partnerships may be formed merely by an oral agreement.
b. Partnerships can more easily generate significant amounts of capital.
c. Partnerships avoid the double taxation of income that is found in
corporations.
d. In some cases, losses may be used to offset gains for tax purposes.

LO 14-1

2.

How does partnership accounting differ from corporate accounting?


a. The matching principle is not considered appropriate for partnership
accounting.
b. Revenues are recognized at a different time by a partnership than is
appropriate for a corporation.
c. Individual capital accounts replace the contributed capital and retained
earnings balances found in corporate accounting.
d. Partnerships report all assets at fair value as of the latest balance sheet
date.

LO 14-2

3.

Which of the following best describes the articles of partnership


agreement?
a. The purpose of the partnership and partners' rights and responsibilities
are required elements of the articles of partnership.
b. The articles of partnership are a legal covenant and must be expressed in
writing to be valid.
c. The articles of partnership are an agreement that limits partners' liability
to partnership assets.
d. The articles of partnership are a legal covenant that may be expressed
orally or in writing, and forms the central governance for a partnership's
operations.

LO 14-9

4.

Pat, Jean Lou, and Diane are partners with capital balances of
$50,000, $30,000, and $20,000, respectively. These three partners
share profits and losses equally. For an investment of $50,000 cash
(paid to the business), MaryAnn will be admitted as a partner with a
one-fourth interest in capital and profits. Based on this information,
which of the following best justifies the amount of MaryAnn's
investment?
a. MaryAnn will receive a bonus from the other partners upon her
admission to the partnership.
b. Assets of the partnership were overvalued immediately prior to
MaryAnn's investment.
c.

Page 657

The book value of the partnership's net assets was less than the fair value
immediately prior to MaryAnn's investment.

d. MaryAnn is apparently bringing goodwill into the partnership, and her


14-36
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Education.

Chapter 14 - Partnerships: Formation and Operation

capital account will be credited for the appropriate amount.


LO 14-10

5.

A partnership has the following capital balances:

David is going to invest $105,000 into the business to acquire a 30


percent ownership interest. Goodwill is to be recorded. What will be
David's beginning capital balance?
a. $94,500.
b. $105,000.
c. $126,000.
d. $135,000.
LO 14-8

6.

A partnership has the following capital balances:

Krystal is going to pay a total of $240,000 directly to these three


partners to acquire a 25 percent ownership interest from each.
Goodwill is to be recorded. What is Dane's capital balance after the
transaction?
a. $210,000.
b. $255,000.
c. $340,000.
d. $352,000.
LO 14-9

7.

The capital balance for Bolcar is $110,000 and for Neary is $40,000.
These two partners share profits and losses 70 percent (Bolcar) and
30 percent (Neary). Kansas invests $50,000 in cash into the
partnership for a 30 percent ownership. The bonus method will be
used. What is Neary's capital balance after Kansas's investment?
a. $35,000.
b. $37,000.
c. $40,000.
d. $43,000.

LO 14-9

8.

Bishop has a capital balance of $120,000 in a local partnership, and


Cotton has a $90,000 balance. These two partners share profits and
losses by a ratio of 60 percent to Bishop and 40 percent to Cotton.
Lovett invests $60,000 in cash in the partnership for a 20 percent
ownership. The goodwill method will be used. What is Cotton's capital
balance after this new investment?
a. $99,600.
b. $102,000.
c. $112,000.
14-37

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Education.

Chapter 14 - Partnerships: Formation and Operation

d. $126,000.
LO 14-9

9.

The capital balance for Messalina is $210,000 and for Romulus is


$140,000. These two partners share profits and losses 60 percent
(Messalina) and 40 percent (Romulus). Claudius invests $100,000 in
cash in the partnership for a 20 percent ownership. The bonus method
will be used. What are the capital balances for Messalina, Romulus,
and Claudius after this investment is recorded?
a. $216,000, $144,000, $90,000.
b. $218,000, $142,000, $88,000.
c. $222,000, $148,000, $80,000.
d. $240,000, $160,000, $100,000.

Page 658

LO 14-6

10. A partnership begins its first year with the following capital balances:

The articles of partnership stipulate that profits and losses be


assigned in the following manner:

Each partner is allocated interest equal to 5 percent of the


beginning capital balance.

Bernard is allocated compensation of $18,000 per year.

Any remaining profits and losses are allocated on a 3:3:4


basis, respectively.

Each partner is allowed to withdraw up to $5,000 cash per


year.

Assuming that the net income is $60,000 and that each partner
withdraws the maximum amount allowed, what is the balance in
Collins capital account at the end of that year?
a. $70,800.
b. $86,700.
c. $73,500.
d. $81,700.
LO 14-4, 145, 14-6

11. A partnership begins its first year of operations with the following
capital balances:

According to the articles of partnership, all profits will be assigned as


follows:

Winston will be awarded an annual salary of $20,000 with


$10,000 assigned to Salem.

The partners will be attributed interest equal to 10 percent of


the capital balance as of the first day of the year.

The remainder will be assigned on a 5:2:3 basis, respectively.


14-38

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Education.

Chapter 14 - Partnerships: Formation and Operation

Each partner is allowed to withdraw up to $10,000 per year.

The net loss for the first year of operations is $20,000 and net income
for the subsequent year is $40,000. Each partner withdraws the
maximum amount from the business each period. What is the balance
in Winston's capital account at the end of the second year?
a. $102,600.
b. $104,400.
c. $108,600.
d. $109,200.
LO 14-10

12. A partnership has the following capital balances:

Profits and losses are split as follows: Allen (20 percent), Burns (30
percent), and Costello (50 percent). Costello wants to leave the
partnership and is paid $100,000 from the business based on
provisions in the articles of partnership. If the partnership uses the
bonus method, what is the balance of Burns's capital account after
Costello withdraws?
a. $24,000.
b. $27,000.
c. $33,000.
d. $36,000.
Page 659

Problems 13 and 14 are independent problems based on the


following scenario:
At year-end, the Circle City partnership has the following capital
balances:

Profits and losses are split on a 3:3:2:2 basis, respectively. Clark


decides to leave the partnership and is paid $90,000 from the
business based on the original contractual agreement.
LO 14-10

13. Using the goodwill method, what is Manning's capital balance after
Clark withdraws?
a. $133,000.
b. $137,500.
c. $140,000.
d. $145,000.

LO 14-10

14. If instead the partnership uses the bonus method, what is the balance
of Manning's capital account after Clark withdraws?
14-39

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Education.

Chapter 14 - Partnerships: Formation and Operation

a. $100,000.
b. $126,250.
c. $130,000.
d. $133,750.
Problems 15 and 16 are independent problems based on the
following capital account balances:

LO 14-8

15. Darrow invests $270,000 in cash for a 30 percent ownership interest.


The money goes to the original partners. Goodwill is to be recorded.
How much goodwill should be recognized, and what is Darrow's
beginning capital balance?
a. $410,000 and $270,000.
b. $140,000 and $270,000.
c. $140,000 and $189,000.
d. $410,000 and $189,000.

LO 14-9

16. Darrow invests $250,000 in cash for a 30 percent ownership interest.


The money goes to the business. No goodwill or other revaluation is to
be recorded. After the transaction, what is Jennings's capital balance?
a. $160,000.
b. $168,000.
c. $170,200.
d. $171,200.

LO 14-9

17. Lear is to become a partner in the WS partnership by paying $80,000


in cash to the business. At present, the capital balance for Hamlet is
$70,000 and for MacBeth is $40,000. Hamlet and MacBeth share
profits on a 7:3 basis. Lear is acquiring 40 percent of the new
partnership.
a. If the goodwill method is applied, what will the three capital balances be
following the payment by Lear?
b. If the bonus method is applied, what will the three capital balances be
following the payment by Lear?

LO 14-9

18. The Distance Plus partnership has the following capital balances at
the beginning of the current year:

Each of the following questions should be viewed independently.


a.

Page 660

If Sergio invests $100,000 in cash in the business for a 25 percent


interest, what journal entry is recorded? Assume that the bonus method
is used.
14-40

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Education.

Chapter 14 - Partnerships: Formation and Operation

b. If Sergio invests $60,000 in cash in the business for a 25 percent interest,


what journal entry is recorded? Assume that the bonus method is used.
c. If Sergio invests $72,000 in cash in the business for a 25 percent interest,
what journal entry is recorded? Assume that the goodwill method is
used.
LO 14-9

19. A partnership has the following account balances: Cash $50,000;


Other Assets $600,000; Liabilities $240,000; Nixon, Capital (50
percent of profits and losses) $200,000; Hoover, Capital (20 percent)
$120,000; and Polk, Capital (30 percent) $90,000. Each of the
following questions should be viewed as an independent situation:
a. Grant invests $80,000 in the partnership for an 18 percent capital
interest. Goodwill is to be recognized. What are the capital accounts
thereafter?
b. Grant invests $100,000 in the partnership to get a 20 percent capital
balance. Goodwill is not to be recorded. What are the capital accounts
thereafter?

LO 14-9

20. The Prince-Robbins partnership has the following capital account


balances on January 1, 2015:
Prince is allocated 80 percent of all profits and losses with the
remaining 20 percent assigned to Robbins after interest of 10 percent
is given to each partner based on beginning capital balances.
On January 2, 2015, Jeffrey invests $37,000 cash for a 20 percent
interest in the partnership. This transaction is recorded by the goodwill
method. After this transaction, 10 percent interest is still to go to each
partner. Profits and losses will then be split as follows: Prince (50
percent), Robbins (30 percent), and Jeffrey (20 percent). In 2015, the
partnership reports a net income of $15,000.
a. Prepare the journal entry to record Jeffrey's entrance into the partnership
on January 2, 2015.
b. Determine the allocation of income at the end of 2015.

LO 14-6

21. The partnership agreement of Jones, King, and Lane provides for the
annual allocation of the business's profit or loss in the following
sequence:

Jones, the managing partner, receives a bonus equal to 20


percent of the business's profit.

Each partner receives 15 percent interest on average capital


investment.

Any residual profit or loss is divided equally.

The average capital investments for 2015 were as follows:

14-41
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Education.

Chapter 14 - Partnerships: Formation and Operation

How much of the $90,000 partnership profit for 2015 should be


assigned to each partner?
LO 14-4, 145, 14-6

22. Purkerson, Smith, and Traynor have operated a bookstore for a


number of years as a partnership. At the beginning of 2015, capital
balances were as follows:

Due to a cash shortage, Purkerson invests an additional $8,000 in the


business on April 1, 2015.
Each partner is allowed to withdraw $1,000 cash each month.
The partners have used the same method of allocating profits and
losses since the business's inception:

Each partner is given the following compensation allowance


for work done in the business: Purkerson, $18,000; Smith,
$25,000; and Traynor, $8,000.

Each partner is credited with interest equal to 10 percent of


the average monthly capital balance for the year without regard
for normal drawings.

Any remaining profit or loss is allocated 4:2:4 to Purkerson,


Smith, and Traynor, respectively. The net income for 2015 is
$23,600. Each partner withdraws the allotted amount each
month.

What are the ending capital balances for 2015?


Page 661

LO 14-4, 145, 14-6

23. On January 1, 2014, the dental partnership of Left, Center, and Right
was formed when the partners contributed $20,000, $60,000, and
$50,000, respectively. Over the next three years, the business
reported net income and (loss) as follows:

During this period, each partner withdrew cash of $10,000 per year.
Right invested an additional $12,000 in cash on February 9, 2015.
At the time that the partnership was created, the three partners
agreed to allocate all profits and losses according to a specified plan
written as follows:

Each partner is entitled to interest computed at the rate of 12


percent per year based on the individual capital balances at the
beginning of that year.

Because of prior work experience, Left is entitled to an annual


salary allowance of $12,000, and Center is credited with $8,000
per year.

Any remaining profit will be split as follows: Left, 20 percent;


Center, 40 percent; and Right, 40 percent. If a loss remains, the
14-42

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Education.

Chapter 14 - Partnerships: Formation and Operation

balance will be allocated: Left, 30 percent; Center, 50 percent;


and Right, 20 percent.
Determine the ending capital balance for each partner as of the end of
each of these three years.
LO 14-10

24. The E.N.D. partnership has the following capital balances as of the
end of the current year:

Answer each of the following independent questions:


a. Assume that the partners share profits and losses 3:3:2:2, respectively.
Fergie retires and is paid $190,000 based on the terms of the original
partnership agreement. If the goodwill method is used, what is the
capital balance of the remaining three partners?
b. Assume that the partners share profits and losses 4:3:2:1, respectively.
Pineda retires and is paid $280,000 based on the terms of the original
partnership agreement. If the bonus method is used, what is the capital
balance of the remaining three partners?
LO 14-10

25. The partnership of Matteson, Richton, and O'Toole has existed for a
number of years. At the present time the partners have the following
capital balances and profit and loss sharing percentages:

O'Toole elects to withdraw from the partnership, leaving Matteson and


Richton to operate the business. Following the original partnership
agreement, when a partner withdraws, the partnership and all of its
individual assets are to be reassessed to current fair values by an
independent appraiser. The withdrawing partner will receive cash or
other assets equal to that partner's current capital balance after
including an appropriate share of any adjustment indicated by the
appraisal. Gains and losses indicated by the appraisal are allocated
using the regular profit and loss percentages.
An independent appraiser is hired and estimates that the partnership
as a whole is worth $600,000. Regarding the individual assets, the
appraiser finds that a building with a book value of $180,000 has a fair
value of $220,000. The book values for all other identifiable assets
and liabilities are the same as their appraised fair values.
Page 662

Accordingly, the partnership agrees to pay O'Toole $120,000 upon


withdrawal. Matteson and Richton, however, do not wish to record any
14-43
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Education.

Chapter 14 - Partnerships: Formation and Operation

goodwill in connection with the change in ownership.


Prepare the journal entry to record O'Toole's withdrawal from the
partnership.
LO 14-2, 144, 14-6, 14-9

26. In the early part of 2015, the partners of Hugh, Jacobs, and Thomas
sought assistance from a local accountant. They had begun a new
business in 2014 but had never used an accountant's services.
Hugh and Jacobs began the partnership by contributing $150,000 and
$100,000 in cash, respectively. Hugh was to work occasionally at the
business, and Jacobs was to be employed full-time. They decided that
year-end profits and losses should be assigned as follows:

Each partner was to be allocated 10 percent interest


computed on the beginning capital balances for the period.

A compensation allowance of $5,000 was to go to Hugh with a


$25,000 amount assigned to Jacobs.

Any remaining income would be split on a 4:6 basis to Hugh


and Jacobs, respectively.

In 2014, revenues totaled $175,000, and expenses were $146,000


(not including the partners' compensation allowance). Hugh withdrew
cash of $9,000 during the year, and Jacobs took out $14,000. In
addition, the business paid $7,500 for repairs made to Hugh's home
and charged it to repair expense.
On January 1, 2015, the partnership sold a 15 percent interest to
Thomas for $64,000 cash. This money was contributed to the
business with the bonus method used for accounting purposes.
Answer the following questions:
a. Why was the original profit and loss allocation, as just outlined,
designed by the partners?
b. Why did the drawings for 2014 not agree with the compensation
allowances provided for in the partnership agreement?
c. What journal entries should the partnership have recorded on December
31, 2014?
d. What journal entry should the partnership have recorded on January 1,
2015?
LO 14-3, 149, 14-10

27. Following is the current balance sheet for a local partnership of


doctors:

The following questions represent independent situations:


a. E is going to invest enough money in this partnership to receive a 25
percent interest. No goodwill or bonus is to be recorded. How much
14-44
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Education.

Chapter 14 - Partnerships: Formation and Operation

should E invest?
b. E contributes $36,000 in cash to the business to receive a 10 percent
interest in the partnership. Goodwill is to be recorded. Profits and losses
have previously been split according to the following percentages: A, 30
percent; B, 10 percent; C, 40 percent; and D, 20 percent. After E makes
this investment, what are the individual capital balances?
c. E contributes $42,000 in cash to the business to receive a 20 percent
interest in the partnership. Goodwill is to be recorded. The four original
partners share all profits and losses equally. After E makes this
investment, what are the individual capital balances?
d. E contributes $55,000 in cash to the business to receive a 20 percent
interest in the partnership. No goodwill or other asset revaluation is to be
recorded. Profits and losses have previously been split according to the
following percentages: A, 10 percent; B, 30 percent; C, 20 percent; and
D, 40 percent. After E makes this investment, what are the individual
capital balances?
e. C retires from the partnership and, as per the original partnership
agreement, is to receive cash equal to 125 percent of her final capital
balance. No goodwill or other asset revaluation is to be recognized. All
partners share profits and losses equally. After the withdrawal, what are
the individual capital balances of the remaining partners?
Page 663

LO 14-5, 146, 14-9

28. Boswell and Johnson form a partnership on May 1, 2013. Boswell


contributes cash of $50,000; Johnson conveys title to the following
properties to the partnership:

The partners agree to start their partnership with equal capital


balances. No goodwill is to be recognized.
According to the articles of partnership written by the partners, profits
and losses are allocated based on the following formula:

Boswell receives a compensation allowance of $1,000 per


month.

All remaining profits and losses are split 60:40 to Johnson and
Boswell, respectively.

Each partner can make annual cash drawings of $5,000


beginning in 2014.

Net income of $11,000 is earned by the business during 2013.


Walpole is invited to join the partnership on January 1, 2014. Because
of her business reputation and financial expertise, she is given a 40
percent interest for $54,000 cash. The bonus approach is used to
record this investment, made directly to the business. The articles of
partnership are amended to give Walpole a $2,000 compensation
allowance per month and an annual cash drawing of $10,000.
14-45
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Education.

Chapter 14 - Partnerships: Formation and Operation

Remaining profits are now allocated:

All drawings are taken by the partners during 2014. At year-end, the
partnership reports an earned net income of $28,000.
On January 1, 2015, Pope (previously a partnership employee) is
admitted into the partnership. Each partner transfers 10 percent to
Pope, who makes the following payments directly to the partners:

Once again, the articles of partnership must be amended to allow for


the entrance of the new partner. This change entitles Pope to a
compensation allowance of $800 per month and an annual drawing of
$4,000. Profits and losses are now assigned as follows:

For the year of 2015, the partnership earned a profit of $46,000, and
each partner withdrew the allowed amount of cash.
Determine the capital balances for the individual partners as of the
end of each year: 2013 through 2015.
LO 14-4, 145, 14-6, 14-9

29. Gray, Stone, and Lawson open an accounting practice on January 1,


2013, in San Diego, California, to be operated as a partnership. Gray
and Stone will serve as the senior partners because of their years of
experience. To establish the business, Gray, Stone, and Lawson
contribute cash and other properties valued at $210,000, $180,000,
and $90,000, respectively. An articles of partnership agreement is
drawn up. It has the following stipulations:

Personal drawings are allowed annually up to an amount


equal to 10 percent of the beginning capital balance for the year.

Profits and losses are allocated according to the following


plan:

(1) A salary allowance is credited to each partner in an amount equal to


$8 per billable hour worked by that individual during the year.
(2) Interest is credited to the partners' capital accounts at the rate of 12
percent of the average monthly balance for the year (computed
without regard for current income or drawings).
(3)

Page 664

An annual bonus is to be credited to Gray and Stone. Each bonus is to


be 10 percent of net income after subtracting the bonus, the salary
allowance, and the interest. Also included in the agreement is the
provision that the bonus cannot be a negative amount.

(4) Any remaining partnership profit or loss is to be divided evenly


among all partners.
14-46
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Education.

Chapter 14 - Partnerships: Formation and Operation

Because of monetary problems encountered in getting the business


started, Gray invests an additional $9,100 on May 1, 2013. On
January 1, 2014, the partners allow Monet to buy into the partnership.
Monet contributes cash directly to the business in an amount equal to
a 25 percent interest in the book value of the partnership property
subsequent to this contribution. The partnership agreement as to
splitting profits and losses is not altered upon Monet's entrance into
the firm; the general provisions continue to be applicable.
The billable hours for the partners during the first three years of
operation follow:

The partnership reports net income for 2013 through 2015 as follows:

Each partner withdraws the maximum allowable amount each year.


a. Determine the allocation of income for each of these three years (to the
nearest dollar).
b. Prepare in appropriate form a statement of partners' capital for the year
ending December 31, 2015.
LO 14-8, 149, 14-10

30. A partnership of attorneys in the St. Louis, Missouri, area has the
following balance sheet accounts as of January 1, 2015:

According to the articles of partnership, Athos is to receive an


allocation of 50 percent of all partnership profits and losses while
Porthos receives 30 percent and Aramis, 20 percent. The book value
of each asset and liability should be considered an accurate
representation of fair value.
For each of the following independent situations, prepare the journal
entry or entries to be recorded by the partnership. (Round to nearest
dollar.)
a. Porthos, with permission of the other partners, decides to sell half of his
partnership interest to D'Artagnan for $50,000 in cash. No asset
revaluation or goodwill is to be recorded by the partnership.
b. All three of the present partners agree to sell 10 percent of each
partnership interest to D'Artagnan for a total cash payment of $25,000.
Each partner receives a negotiated portion of this amount. Goodwill is
recorded as a result of the transaction.
c. D'Artagnan is allowed to become a partner with a 10 percent ownership
14-47
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Education.

Chapter 14 - Partnerships: Formation and Operation

interest by contributing $30,000 in cash directly into the business. The


bonus method is used to record this admission.
d. Use the same facts as in requirement (c) except that the entrance into the
partnership is recorded by the goodwill method.
e. D'Artagnan is allowed to become a partner with a 10 percent ownership
interest by contributing $12,222 in cash directly to the business. The
goodwill method is used to record this transaction.
f. Aramis decides to retire and leave the partnership. An independent
appraisal of the business and its assets indicates a current fair value of
$280,000. Goodwill is to be recorded. Aramis will then be given the
exact amount of cash that will close out his capital account.
Page 665

LO 14-2, 143, 14-5, 14-6, 148, 14-10

31. Steve Reese is a well-known interior designer in Fort Worth, Texas.


He wants to start his own business and convinces Rob O'Donnell, a
local merchant, to contribute the capital to form a partnership. On
January 1, 2013, O'Donnell invests a building worth $52,000 and
equipment valued at $16,000 as well as $12,000 in cash. Although
Reese makes no tangible contribution to the partnership, he will
operate the business and be an equal partner in the beginning capital
balances.
To entice O'Donnell to join this partnership, Reese draws up the
following profit and loss agreement:

O'Donnell will be credited annually with interest equal to 20


percent of the beginning capital balance for the year.

O'Donnell will also have added to his capital account 15


percent of partnership income each year (without regard for the
preceding interest figure) or $4,000, whichever is larger. All
remaining income is credited to Reese.

Neither partner is allowed to withdraw funds from the


partnership during 2013. Thereafter, each can draw $5,000
annually or 20 percent of the beginning capital balance for the
year, whichever is larger.

The partnership reported a net loss of $10,000 during the first year of
its operation. On January 1, 2014, Terri Dunn becomes a third partner
in this business by contributing $15,000 cash to the partnership. Dunn
receives a 20 percent share of the business's capital. The profit and
loss agreement is altered as follows:

O'Donnell is still entitled to (1) interest on his beginning capital


balance as well as (2) the share of partnership income just
specified.

Any remaining profit or loss will be split on a 6:4 basis


between Reese and Dunn, respectively.

Partnership income for 2014 is reported as $44,000. Each partner


withdraws the full amount that is allowed.
14-48
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Education.

Chapter 14 - Partnerships: Formation and Operation

On January 1, 2015, Dunn becomes ill and sells her interest in the
partnership (with the consent of the other two partners) to Judy
Postner. Postner pays $46,000 directly to Dunn. Net income for 2015
is $61,000 with the partners again taking their full drawing allowance.
On January 1, 2016, Postner withdraws from the business for
personal reasons. The articles of partnership state that any partner
may leave the partnership at any time and is entitled to receive cash in
an amount equal to the recorded capital balance at that time plus 10
percent.
a. Prepare journal entries to record the preceding transactions on the
assumption that the bonus (or no revaluation) method is used. Drawings
need not be recorded, although the balances should be included in the
closing entries.
b. Prepare journal entries to record the previous transactions on the
assumption that the goodwill (or revaluation) method is used. Drawings
need not be recorded, although the balances should be included in the
closing entries.
(Round all amounts to the nearest dollar.)

Problems
LO 14-1

LO 14-1

Which of the following is not a reason for the


popularity of partnerships as a legal
form for businesses?
Partnerships may be formed merely by an oral
agreement.
Partnerships can more easily generate
significant amounts of capital.
Partnerships avoid the double taxation of
income that is found in
corporations.
In some cases, losses may be used to offset
gains for tax purposes.
How does partnership accounting differ from
corporate accounting?
The matching principle is not considered
appropriate for partnership
accounting.
Revenues are recognized at a different time by a
partnership than is appropriate for a
corporation.
Individual capital accounts replace the
contributed capital and retained
earnings balances found in
corporate accounting.
14-49

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Education.

Chapter 14 - Partnerships: Formation and Operation

LO 14-2

LO 14-9

Partnerships report all assets at fair value as of


the latest balance sheet date.
Which of the following best describes the
articles of partnership agreement?
The purpose of the partnership and partners'
rights and responsibilities are
required elements of the articles of
partnership.
The articles of partnership are a legal covenant
and must be expressed in writing to
be valid.
The articles of partnership are an agreement that
limits partners' liability to
partnership assets.
The articles of partnership are a legal covenant
that may be expressed orally or in
writing, and forms the central
governance for a partnership's
operations.
Pat, Jean Lou, and Diane are partners with
capital balances of $50,000, $30,000,
and $20,000, respectively. These
three partners share profits and
losses equally. For an investment of
$50,000 cash (paid to the business),
MaryAnn will be admitted as a
partner with a one-fourth interest in
capital and profits. Based on this
information, which of the following
best justifies the amount of
MaryAnn's investment?
MaryAnn will receive a bonus from the other
partners upon her admission to the
partnership.
Assets of the partnership were overvalued
immediately prior to MaryAnn's
investment.
Page 657
The book value of the partnership's net assets
was less than the fair value
immediately prior to MaryAnn's
investment.
MaryAnn is apparently bringing goodwill into the
partnership, and her capital account
will be credited for the appropriate
14-50

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Education.

Chapter 14 - Partnerships: Formation and Operation

LO 14-10

amount.
A partnership has the following capital balances:

LO 14-8

David is going to invest $105,000 into the


business to acquire a 30 percent
ownership interest. Goodwill is to be
recorded. What will be David's
beginning capital balance?
$94,500.
$105,000.
$126,000.
$135,000.
A partnership has the following capital balances:

LO 14-9

LO 14-9

Krystal is going to pay a total of $240,000


directly to these three partners to
acquire a 25 percent ownership
interest from each. Goodwill is to be
recorded. What is Dane's capital
balance after the transaction?
$210,000.
$255,000.
$340,000.
$352,000.
The capital balance for Bolcar is $110,000 and for
Neary is $40,000. These two partners
share profits and losses 70 percent
(Bolcar) and 30 percent (Neary).
Kansas invests $50,000 in cash into
the partnership for a 30 percent
ownership. The bonus method will
be used. What is Neary's capital
balance after Kansas's investment?
$35,000.
$37,000.
$40,000.
$43,000.
Bishop has a capital balance of $120,000 in a
local partnership, and Cotton has a
$90,000 balance. These two partners
share profits and losses by a ratio of
60 percent to Bishop and 40 percent
14-51

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Education.

Chapter 14 - Partnerships: Formation and Operation

to Cotton. Lovett invests $60,000 in


cash in the partnership for a 20
percent ownership. The goodwill
method will be used. What is
Cotton's capital balance after this
new investment?

LO 14-9

Page 658
LO 14-6

$99,600.
$102,000.
$112,000.
$126,000.
The capital balance for Messalina is $210,000
and for Romulus is $140,000. These
two partners share profits and
losses 60 percent (Messalina) and 40
percent (Romulus). Claudius invests
$100,000 in cash in the partnership
for a 20 percent ownership. The
bonus method will be used. What are
the capital balances for Messalina,
Romulus, and Claudius after this
investment is recorded?
$216,000, $144,000, $90,000.
$218,000, $142,000, $88,000.
$222,000, $148,000, $80,000.
$240,000, $160,000, $100,000.
A partnership begins its first year with the
following capital balances:
The articles of partnership stipulate that profits
and losses be assigned in the
following manner:
Each partner is allocated interest equal to 5
percent of the beginning capital balance.
Bernard is allocated compensation of
$18,000 per year.
Any remaining profits and losses are
allocated on a 3:3:4 basis, respectively.
Each partner is allowed to withdraw up to
$5,000 cash per year.
Assuming that the net income is $60,000 and
that each partner withdraws the
maximum amount allowed, what is
the balance in Collins capital
14-52

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Education.

Chapter 14 - Partnerships: Formation and Operation

LO 14-4, 145, 1
4-6

LO 14-10

account at the end of that year?


$70,800.
$86,700.
$73,500.
$81,700.
A partnership begins its first year of operations
with the following capital balances:
According to the articles of partnership, all
profits will be assigned as follows:
Winston will be awarded an annual salary of
$20,000 with $10,000 assigned to Salem.
The partners will be attributed interest
equal to 10 percent of the capital balance as
of the first day of the year.
The remainder will be assigned on a 5:2:3
basis, respectively.
Each partner is allowed to withdraw up to
$10,000 per year.
The net loss for the first year of operations is
$20,000 and net income for the
subsequent year is $40,000. Each
partner withdraws the maximum
amount from the business each
period. What is the balance in
Winston's capital account at the end
of the second year?
$102,600.
$104,400.
$108,600.
$109,200.
A partnership has the following capital balances:
Profits and losses are split as follows: Allen (20
percent), Burns (30 percent), and
Costello (50 percent). Costello wants
to leave the partnership and is paid
$100,000 from the business based
on provisions in the articles of
partnership. If the partnership uses
the bonus method, what is the
balance of Burns's capital account
14-53

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Education.

Chapter 14 - Partnerships: Formation and Operation

after Costello withdraws?


$24,000.
$27,000.
$33,000.
$36,000.
Page 659
Problems 13 and 14 are independent problems
based on the following scenario:
At year-end, the Circle City partnership has the
following capital balances:

LO 14-10

LO 14-10

LO 14-8

Profits and losses are split on a 3:3:2:2 basis,


respectively. Clark decides to leave
the partnership and is paid $90,000
from the business based on the
original contractual agreement.
Using the goodwill method, what is Manning's
capital balance after Clark
withdraws?
$133,000.
$137,500.
$140,000.
$145,000.
If instead the partnership uses the bonus
method, what is the balance of
Manning's capital account after
Clark withdraws?
$100,000.
$126,250.
$130,000.
$133,750.
Problems 15 and 16 are independent problems
based on the following capital
account balances:

Darrow invests $270,000 in cash for a 30 percent


ownership interest. The money goes
to the original partners. Goodwill is
to be recorded. How much goodwill
should be recognized, and what is
Darrow's beginning capital balance?
14-54

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Chapter 14 - Partnerships: Formation and Operation

LO 14-9

LO 14-9

LO 14-9

$410,000 and $270,000.


$140,000 and $270,000.
$140,000 and $189,000.
$410,000 and $189,000.
Darrow invests $250,000 in cash for a 30 percent
ownership interest. The money goes
to the business. No goodwill or other
revaluation is to be recorded. After
the transaction, what is Jennings's
capital balance?
$160,000.
$168,000.
$170,200.
$171,200.
Lear is to become a partner in the WS
partnership by paying $80,000 in
cash to the business. At present, the
capital balance for Hamlet is $70,000
and for MacBeth is $40,000. Hamlet
and MacBeth share profits on a 7:3
basis. Lear is acquiring 40 percent of
the new partnership.
If the goodwill method is applied, what will the
three capital balances be following
the payment by Lear?
If the bonus method is applied, what will the
three capital balances be following
the payment by Lear?
The Distance Plus partnership has the following
capital balances at the beginning of
the current year:
Each of the following questions should be
viewed independently.
Page 660
If Sergio invests $100,000 in cash in the
business for a 25 percent interest,
what journal entry is recorded?
Assume that the bonus method is
used.
If Sergio invests $60,000 in cash in the business
for a 25 percent interest, what
journal entry is recorded? Assume
14-55

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Chapter 14 - Partnerships: Formation and Operation

LO 14-9

LO 14-9

that the bonus method is used.


If Sergio invests $72,000 in cash in the business
for a 25 percent interest, what
journal entry is recorded? Assume
that the goodwill method is used.
A partnership has the following account
balances: Cash $50,000; Other
Assets $600,000; Liabilities
$240,000; Nixon, Capital (50 percent
of profits and losses) $200,000;
Hoover, Capital (20 percent)
$120,000; and Polk, Capital (30
percent) $90,000. Each of the
following questions should be
viewed as an independent situation:
Grant invests $80,000 in the partnership for an
18 percent capital interest. Goodwill
is to be recognized. What are the
capital accounts thereafter?
Grant invests $100,000 in the partnership to get
a 20 percent capital balance.
Goodwill is not to be recorded. What
are the capital accounts thereafter?
The Prince-Robbins partnership has the
following capital account balances
on January 1, 2015:
Prince is allocated 80 percent of all profits and
losses with the remaining 20 percent
assigned to Robbins after interest of
10 percent is given to each partner
based on beginning capital
balances.
On January 2, 2015, Jeffrey invests $37,000 cash
for a 20 percent interest in the
partnership. This transaction is
recorded by the goodwill method.
After this transaction, 10 percent
interest is still to go to each partner.
Profits and losses will then be split
as follows: Prince (50 percent),
Robbins (30 percent), and Jeffrey (20
percent). In 2015, the partnership
reports a net income of $15,000.
Prepare the journal entry to record Jeffrey's
14-56

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Chapter 14 - Partnerships: Formation and Operation

entrance into the partnership on


January 2, 2015.
Determine the allocation of income at the end of
2015.
The partnership agreement of Jones, King, and
Lane provides for the annual
allocation of the business's profit or
loss in the following sequence:
Jones, the managing partner, receives a
bonus equal to 20 percent of the business's
profit.
Each partner receives 15 percent interest
on average capital investment.
Any residual profit or loss is divided
equally.
The average capital investments for 2015 were
as follows:

LO 14-6

LO 14-4, 145, 1
4-6

How much of the $90,000 partnership profit for


2015 should be assigned to each
partner?
Purkerson, Smith, and Traynor have operated a
bookstore for a number of years as a
partnership. At the beginning of
2015, capital balances were as
follows:
Due to a cash shortage, Purkerson invests an
additional $8,000 in the business on
April 1, 2015.
Each partner is allowed to withdraw $1,000 cash
each month.
The partners have used the same method of
allocating profits and losses since
the business's inception:
Each partner is given the following
compensation allowance for work done in
the business: Purkerson, $18,000; Smith,
$25,000; and Traynor, $8,000.
Each partner is credited with interest equal
to 10 percent of the average monthly capital
balance for the year without regard for
normal drawings.
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Chapter 14 - Partnerships: Formation and Operation

Page 661
LO 14-4, 145, 1
4-6

LO 14-10

Any remaining profit or loss is allocated


4:2:4 to Purkerson, Smith, and Traynor,
respectively. The net income for 2015 is
$23,600. Each partner withdraws the
allotted amount each month.
What are the ending capital balances for 2015?
On January 1, 2014, the dental partnership of
Left, Center, and Right was formed
when the partners contributed
$20,000, $60,000, and $50,000,
respectively. Over the next three
years, the business reported net
income and (loss) as follows:
During this period, each partner withdrew cash
of $10,000 per year. Right invested
an additional $12,000 in cash on
February 9, 2015.
At the time that the partnership was created, the
three partners agreed to allocate all
profits and losses according to a
specified plan written as follows:
Each partner is entitled to interest
computed at the rate of 12 percent per year
based on the individual capital balances at
the beginning of that year.
Because of prior work experience, Left is
entitled to an annual salary allowance of
$12,000, and Center is credited with $8,000
per year.
Any remaining profit will be split as follows:
Left, 20 percent; Center, 40 percent; and
Right, 40 percent. If a loss remains, the
balance will be allocated: Left, 30 percent;
Center, 50 percent; and Right, 20 percent.
Determine the ending capital balance for each
partner as of the end of each of
these three years.
The E.N.D. partnership has the following capital
balances as of the end of the current
year:

14-58
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Chapter 14 - Partnerships: Formation and Operation

LO 14-10

Answer each of the


following independent questions:
Assume that the partners share profits and
losses 3:3:2:2, respectively. Fergie
retires and is paid $190,000 based
on the terms of the original
partnership agreement. If the
goodwill method is used, what is the
capital balance of the remaining
three partners?
Assume that the partners share profits and
losses 4:3:2:1, respectively. Pineda
retires and is paid $280,000 based
on the terms of the original
partnership agreement. If the bonus
method is used, what is the capital
balance of the remaining three
partners?
The partnership of Matteson, Richton, and
O'Toole has existed for a number of
years. At the present time the
partners have the following capital
balances and profit and loss sharing
percentages:

O'Toole elects to withdraw from the partnership,


leaving Matteson and Richton to
operate the business. Following the
original partnership agreement,
when a partner withdraws, the
partnership and all of its individual
assets are to be reassessed to
current fair values by an
independent appraiser. The
withdrawing partner will receive
cash or other assets equal to that
partner's current capital balance
after including an appropriate share
14-59
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Education.

Chapter 14 - Partnerships: Formation and Operation

LO 14-2, 144, 1
46, 1
4-9

of any adjustment indicated by the


appraisal. Gains and losses
indicated by the appraisal are
allocated using the regular profit and
loss percentages.
An independent appraiser is hired and estimates
that the partnership as a whole is
worth $600,000. Regarding the
individual assets, the appraiser finds
that a building with a book value of
$180,000 has a fair value of $220,000.
The book values for all other
identifiable assets and liabilities are
the same as their appraised fair
values.
Page 662
Accordingly, the partnership agrees to pay
O'Toole $120,000 upon withdrawal.
Matteson and Richton, however, do
not wish to record any goodwill in
connection with the change in
ownership.
Prepare the journal entry to record O'Toole's
withdrawal from the partnership.
In the early part of 2015, the partners of Hugh,
Jacobs, and Thomas sought
assistance from a local accountant.
They had begun a new business in
2014 but had never used an
accountant's services.
Hugh and Jacobs began the partnership by
contributing $150,000 and $100,000
in cash, respectively. Hugh was to
work occasionally at the business,
and Jacobs was to be employed fulltime. They decided that year-end
profits and losses should be
assigned as follows:
Each partner was to be allocated 10 percent
interest computed on the beginning capital
balances for the period.
A compensation allowance of $5,000 was to
go to Hugh with a $25,000 amount assigned
to Jacobs.
Any remaining income would be split on a
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Chapter 14 - Partnerships: Formation and Operation

LO 14-3, 149, 1
410

4:6 basis to Hugh and Jacobs, respectively.


In 2014, revenues totaled $175,000, and
expenses were $146,000 (not
including the partners'
compensation allowance). Hugh
withdrew cash of $9,000 during the
year, and Jacobs took out $14,000. In
addition, the business paid $7,500
for repairs made to Hugh's home
and charged it to repair expense.
On January 1, 2015, the partnership sold a 15
percent interest to Thomas for
$64,000 cash. This money was
contributed to the business with the
bonus method used for accounting
purposes.
Answer the following questions:
Why was the original profit and loss allocation,
as just outlined, designed by the
partners?
Why did the drawings for 2014 not agree with the
compensation allowances provided
for in the partnership agreement?
What journal entries should the partnership have
recorded on December 31, 2014?
What journal entry should the partnership have
recorded on January 1, 2015?
Following is the current balance sheet for a local
partnership of doctors:

The following questions


represent independent situations:
E is going to invest enough money in this
partnership to receive a 25 percent
interest. No goodwill or bonus is to
be recorded. How much should E
invest?
E contributes $36,000 in cash to the business to
receive a 10 percent interest in the
partnership. Goodwill is to be
recorded. Profits and losses have
previously been split according to
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Chapter 14 - Partnerships: Formation and Operation

Page 663
LO 14-5, 146, 1
4-9

the following percentages: A, 30


percent; B, 10 percent; C, 40
percent; and D, 20 percent. After E
makes this investment, what are the
individual capital balances?
E contributes $42,000 in cash to the business to
receive a 20 percent interest in the
partnership. Goodwill is to be
recorded. The four original partners
share all profits and losses equally.
After E makes this investment, what
are the individual capital balances?
E contributes $55,000 in cash to the business to
receive a 20 percent interest in the
partnership. No goodwill or other
asset revaluation is to be recorded.
Profits and losses have previously
been split according to the following
percentages: A, 10 percent; B, 30
percent; C, 20 percent; and D, 40
percent. After E makes this
investment, what are the individual
capital balances?
C retires from the partnership and, as per the
original partnership agreement, is to
receive cash equal to 125 percent of
her final capital balance. No goodwill
or other asset revaluation is to be
recognized. All partners share
profits and losses equally. After the
withdrawal, what are the individual
capital balances of the remaining
partners?
Boswell and Johnson form a partnership on May
1, 2013. Boswell contributes cash of
$50,000; Johnson conveys title to
the following properties to the
partnership:

The partners agree to start their partnership with


equal capital balances. No goodwill
is to be recognized.
According to the articles of partnership written
14-62
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Education.

Chapter 14 - Partnerships: Formation and Operation

by the partners, profits and losses


are allocated based on the following
formula:
Boswell receives a compensation allowance
of $1,000 per month.
All remaining profits and losses are split
60:40 to Johnson and Boswell, respectively.
Each partner can make annual cash
drawings of $5,000 beginning in 2014.
Net income of $11,000 is earned by the business
during 2013.
Walpole is invited to join the partnership on
January 1, 2014. Because of her
business reputation and financial
expertise, she is given a 40 percent
interest for $54,000 cash. The bonus
approach is used to record this
investment, made directly to the
business. The articles of partnership
are amended to give Walpole a
$2,000 compensation allowance per
month and an annual cash drawing
of $10,000. Remaining profits are
now allocated:
All drawings are taken by the partners during
2014. At year-end, the partnership
reports an earned net income of
$28,000.
On January 1, 2015, Pope (previously a
partnership employee) is admitted
into the partnership. Each partner
transfers 10 percent to Pope, who
makes the following payments
directly to the partners:
Once again, the articles of partnership must be
amended to allow for the entrance of
the new partner. This change entitles
Pope to a compensation allowance
of $800 per month and an annual
drawing of $4,000. Profits and losses
are now assigned as follows:
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Chapter 14 - Partnerships: Formation and Operation

LO 14-4, 145, 1
46, 1
4-9

For the year of 2015, the partnership earned a


profit of $46,000, and each partner
withdrew the allowed amount of
cash.
Determine the capital balances for the individual
partners as of the end of each year:
2013 through 2015.
Gray, Stone, and Lawson open an accounting
practice on January 1, 2013, in San
Diego, California, to be operated as a
partnership. Gray and Stone will
serve as the senior partners because
of their years of experience. To
establish the business, Gray, Stone,
and Lawson contribute cash and
other properties valued at $210,000,
$180,000, and $90,000, respectively.
An articles of partnership agreement
is drawn up. It has the following
stipulations:
Personal drawings are allowed annually up
to an amount equal to 10 percent of the
beginning capital balance for the year.
Profits and losses are allocated according
to the following plan:
A salary allowance is credited to each partner
in an amount equal to $8 per
billable hour worked by that
individual during the year.
Interest is credited to the partners' capital
accounts at the rate of 12 percent
of the average monthly balance
for the year (computed without
regard for current income or
drawings).
Page 664
An annual bonus is to be credited to Gray and
Stone. Each bonus is to be 10
percent of net income after
subtracting the bonus, the salary
allowance, and the interest. Also
included in the agreement is the
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Chapter 14 - Partnerships: Formation and Operation

provision that the bonus cannot


be a negative amount.
Any remaining partnership profit or loss is to
be divided evenly among all
partners.
Because of monetary problems encountered in
getting the business started, Gray
invests an additional $9,100 on May
1, 2013. On January 1, 2014, the
partners allow Monet to buy into the
partnership. Monet contributes cash
directly to the business in an
amount equal to a 25 percent
interest in the book value of the
partnership property subsequent to
this contribution. The partnership
agreement as to splitting profits and
losses is not altered upon Monet's
entrance into the firm; the general
provisions continue to be applicable.
The billable hours for the partners during the
first three years of operation follow:

The partnership reports net income for 2013


through 2015 as follows:

LO 14-8, 149, 1
410

Each partner withdraws the maximum allowable


amount each year.
Determine the allocation of income for each of
these three years (to the nearest
dollar).
Prepare in appropriate form a statement of
partners' capital for the year ending
December 31, 2015.
A partnership of attorneys in the St. Louis,
Missouri, area has the following
balance sheet accounts as of
January 1, 2015:

14-65
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Chapter 14 - Partnerships: Formation and Operation

According to the articles of partnership, Athos is


to receive an allocation of 50 percent
of all partnership profits and losses
while Porthos receives 30 percent
and Aramis, 20 percent. The book
value of each asset and liability
should be considered an accurate
representation of fair value.
For each of the following independent situations,
prepare the journal entry or entries
to be recorded by the partnership.
(Round to nearest dollar.)
Porthos, with permission of the other partners,
decides to sell half of his
partnership interest to D'Artagnan
for $50,000 in cash. No asset
revaluation or goodwill is to be
recorded by the partnership.
All three of the present partners agree to sell 10
percent of each partnership interest
to D'Artagnan for a total cash
payment of $25,000. Each partner
receives a negotiated portion of this
amount. Goodwill is recorded as a
result of the transaction.
D'Artagnan is allowed to become a partner with
a 10 percent ownership interest by
contributing $30,000 in cash directly
into the business. The bonus
method is used to record this
admission.
Use the same facts as in requirement (c) except
that the entrance into the
partnership is recorded by the
goodwill method.
D'Artagnan is allowed to become a partner with
a 10 percent ownership interest by
contributing $12,222 in cash directly
to the business. The goodwill
method is used to record this
transaction.
Aramis decides to retire and leave the
partnership. An independent
appraisal of the business and its
assets indicates a current fair value
14-66
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Chapter 14 - Partnerships: Formation and Operation

Page 665
LO 14-2, 143, 1
45, 1
46, 1
48, 1
410

of $280,000. Goodwill is to be
recorded. Aramis will then be given
the exact amount of cash that will
close out his capital account.
Steve Reese is a well-known interior designer in
Fort Worth, Texas. He wants to start
his own business and convinces
Rob O'Donnell, a local merchant, to
contribute the capital to form a
partnership. On January 1, 2013,
O'Donnell invests a building worth
$52,000 and equipment valued at
$16,000 as well as $12,000 in cash.
Although Reese makes no tangible
contribution to the partnership, he
will operate the business and be an
equal partner in the beginning
capital balances.
To entice O'Donnell to join this partnership,
Reese draws up the following profit
and loss agreement:
O'Donnell will be credited annually with
interest equal to 20 percent of the
beginning capital balance for the year.
O'Donnell will also have added to his
capital account 15 percent of partnership
income each year (without regard for the
preceding interest figure) or $4,000,
whichever is larger. All remaining income is
credited to Reese.
Neither partner is allowed to withdraw
funds from the partnership during 2013.
Thereafter, each can draw $5,000 annually
or 20 percent of the beginning capital
balance for the year, whichever is larger.
The partnership reported a net loss of $10,000
during the first year of its operation.
On January 1, 2014, Terri Dunn
becomes a third partner in this
business by contributing $15,000
cash to the partnership. Dunn
receives a 20 percent share of the
business's capital. The profit and
loss agreement is altered as follows:
O'Donnell is still entitled to (1) interest on
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Chapter 14 - Partnerships: Formation and Operation

his beginning capital balance as well as (2)


the share of partnership income just
specified.
Any remaining profit or loss will be split on
a 6:4 basis between Reese and Dunn,
respectively.
Partnership income for 2014 is reported as
$44,000. Each partner withdraws the
full amount that is allowed.
On January 1, 2015, Dunn becomes ill and sells
her interest in the partnership (with
the consent of the other two
partners) to Judy Postner. Postner
pays $46,000 directly to Dunn. Net
income for 2015 is $61,000 with the
partners again taking their full
drawing allowance.
On January 1, 2016, Postner withdraws from the
business for personal reasons. The
articles of partnership state that any
partner may leave the partnership at
any time and is entitled to receive
cash in an amount equal to the
recorded capital balance at that time
plus 10 percent.
Prepare journal entries to record the preceding
transactions on the assumption that
the bonus (or no revaluation)
method is used. Drawings need not
be recorded, although the balances
should be included in the closing
entries.
Prepare journal entries to record the previous
transactions on the assumption that
the goodwill (or revaluation) method
is used. Drawings need not be
recorded, although the balances
should be included in the closing
entries.
(Round all amounts to the nearest dollar.)

14-68
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