Solution manual advanced accounting 9e by hoyle ch14

The distinctive aspects of partnership accounting center on the capital accounts maintained for each individual partner.. The basis of accounting for these capital balances is the Articl

CHAPTER 14 PARTNERSHIPS: FORMATION AND OPERATION

Chapter Outline

I Business organizations that are formed legally as partnerships, although they are not always

as visible as corporations, still proliferate throughout this country especially in the legal, medical, and accounting professions

A Advantages of the partnership format include ease of creation and the absence of the double taxation effect inherent to the income earned by a corporation and distributed to its owners

B Partnerships, however, rarely grow to a significant size (when compared with large corporate organizations) primarily because of the unlimited liability being assumed by each general partner

C Alternative legal formats have been created over the years to combine the benefits of corporations and partnerships such as S corporations, limited liability partnerships, and limited liability companies

II Partnership accounting and the capital accounts

A The distinctive aspects of partnership accounting center on the capital accounts maintained for each individual partner

B The basis of accounting for these capital balances is the Articles of Partnership agreement which establishes provisions for initial investments, withdrawals, admission of

a new partner, retirement of a partner, etc

C The actual contribution made by the partners to the business should be recorded at fair market value A problem arises, however, when a contribution is truly intangible such as

a particular expertise or an established client base

1 In the bonus method, only identifiable assets are valued and recorded The capital account balances are then aligned to indicate the percentage of the actual contributions being made by each partner

2 In the goodwill method, the amount being contributed and the corresponding percentage of the initial capital balance are used to calculate the value of the business and the presence of goodwill, a figure which is physically recorded as an intangible asset

III Allocation of income

A At the end of each fiscal period, the revenue and expense accounts must be closed out with the resulting income figure being assigned to the individual capital accounts

B The method of allocating income to the capital accounts should be established within the Articles of Partnership

1 The partners can simply assume an equal division of profits and losses

2 The partners, however, can select any method that is designed to arrive at an equitable allocation Such factors as the amounts of capital invested, the time worked in the business, and the degree of business expertise may all serve to influence the assignment of income

IV Accounting for partnership dissolution

A Over time, the identity of the individuals within a partnership can change through admission of a new partner or the death, retirement, or withdrawal of a present partner

B Each change in composition serves to dissolve the original partnership usually so that a new partnership can be formed to continue the business Thus, dissolution does not necessarily affect the operations of the business

C Admission of a new partner

1 A new partner will often buy all (or a portion) of the interest owned by one or more of the present partners

a The capital account balances can simply be reclassified to reflect the identity of the new ownership

b As an alternative, all accounts may be adjusted to fair market value with the price paid being used as the basis for calculating any goodwill

2 A new partner can also be admitted by a direct contribution to the partnership business

a The bonus (or no revaluation) method records the identifiable assets being contributed at fair market value The new partner’s capital is set equal to a prearranged percentage or amount The remaining capital balances are then aligned based on profit and loss percentages

b The goodwill (or revaluation) approach initially adjusts all assets and liabilities of the partnership to fair market value and records goodwill based on the amount being paid (which is used to calculate the implied value of the business)

D Withdrawal of a partner

1 The final asset distribution to an individual should be based on the agreement established in the Articles of Partnership and will often vary in amount from that partner's ending capital balance

2 The difference between the amount paid and the final capital balance can simply be recorded as an adjustment to the remaining partners' capital accounts in the same manner as the bonus method

3 As an alternative, all accounts can be adjusted to fair value with the amount of payment being used as the basis for computing goodwill

2 Describe the purpose of an Articles of Partnership and list specific items that should be included in this agreement

3 Prepare the journal entry to record the initial capital investment made by a partner when either cash or another asset is being contributed

4 Use both the bonus method and the goodwill method to record a capital investment made

by a partner who is contributing an attribute such as a specific expertise or an established clientele

5 Understand the impact that the allocation of income earned by a partnership has on the individual capital balances

6 Allocate income to partners when interest and/or salary factors are included

7 Discuss the meaning of a partnership dissolution and understand that a dissolution will often have little or no effect on the operations of the partnership business

8 Prepare journal entries to record the acquisition by a new partner of a current partner's interest These entries should be made both as a reclassification as well as by means of the goodwill approach

9 Prepare journal entries to record a new partner's admission by a contribution made directly

to the partnership These entries should be made both by the bonus method as well as by the goodwill method

10 Prepare journal entries to record the withdrawal of a current partner These entries should

be made by the bonus method, the goodwill method, or a modified method whereby assets and liabilities are revalued but no goodwill is recognized

Answers to Discussion Questions

What Kind of Business is This?

The owners of this business face a common problem: they have started operations without giving serious consideration to the legal formation of the company The accountant now needs

to spell out for them the advantages and disadvantages of creating a partnership versus a

corporation or some other type of legal form Eventually, the owners must make this decision but they should consider all of the relevant factors before arriving at their choice

The accountant should discuss the following issues with the two owners:

—Ease of formation A formal partnership can be created by the writing of an Articles of Partnership If the allocation of income and the contributions by the partners have already been resolved, the development of this document should be relatively simple Forming a corporation can be a more difficult task but the degree of difficulty does depend on individual state laws Normally, the documents to be completed are more complicated although that is not necessarily so The accountant should explain the specific procedures that apply to partnerships in the state where the business is organized and conducts its operations

—Business liabilities In a partnership, either partner may be held liable for all business debts Thus, if liabilities escalate and the business fails, each partner does risk the possible loss of

an enormous sum The same problem would not exist in a corporation where owners and the business are considered separate entities For the owners, potential losses are, in corporations, normally limited to the amount being invested However, in many small, newly created, corporations, the owners are required to personally guarantee any loans Therefore,

to an extent, the concept of unlimited liability may actually be present in either case The partners should forecast the amount of debts that will be incurred and the possible outcome if the business would happen to fail

—Lawsuits Some businesses are more susceptible to lawsuits than others A florist, for example, would seem to have less risk than a pharmaceutical company The concept of personal liability for business debts becomes especially important in a business with a high possibility of litigation and resulting losses In a business with such a risk, creating a corporation to protect the personal property of the stockholders would appear to be a wise move The owners of a partnership might become personally responsible for losses created

by a business mistake or accident Obviously, this need for responsibility is recognized in states that prohibit doctors, lawyers, accountants, and the like from incorporating This is a primary reason for such states to allow licensed professionals to operate LLPs

—Taxation In a partnership, all income is allocated to the owners immediately and they are taxed on this amount Double-taxation is avoided A corporation pays an income tax and any dividends are then taxed again when collected by the owners Therefore, traditionally, partnerships are viewed as having a tax advantage The accountant should also mention to the partners other possible tax factors that may affect their decision For example, in small corporations, double taxation may not be a problem If salaries paid to the owners are reasonable and approximate the company's profits so that no dividends are distributed, only one tax is paid in either case As another issue, if a partnership suffers a loss (which often happens when companies begin operations), that loss is passed to the partners and can be used to reduce other taxable income However, in a corporation, losses are carried back and forward to reduce other taxable income that is earned by the business, possibly delaying the benefits of the loss As mentioned in the textbook, the owners should consider forming an S Corporation—a business that is incorporated but still taxed as a partnership

—Bankruptcy If the business should ever fail and have to be liquidated, losses of a partnership are passed directly to the owners to reduce taxable income immediately For a corporation, the loss is a capital loss to the stockholders which can only offset their own capital gains or

be deducted at the rate of $3,000 per year Thus, if a large loss is incurred, the tax benefits may not be realized for years into the future

—Growth potential Traditionally, corporations have more growth potential than do partnerships Ownership interests can be easily transferred The limitation on liability encourages ownership by individuals who cannot participate in the management of the company Partnerships are more restricted in adding new owners Partnerships usually have to entice individuals who are willing to work in the business in order to obtain additional capital

Therefore, the accountant may want to address the following questions in advising these clients:

 What amount of time and energy is involved in becoming incorporated?

 How much profit or loss is anticipated from the operations of this business in the foreseeable future?

 How much debt will the new business incur?

 Will this debt be guaranteed by the owners?

 How much salary do the owners anticipate withdrawing from the business?

 What are the chances of incurring lawsuits?

 What is the possibility that the business will fail?

 How large do the owners expect this business to grow? Do they anticipate the need for new owners and new capital?

 Does the creation of an S Corporation apply to this particular business?

How Will the Profits Be Split?

This case is designed to point up the difficulty of designing a profit-sharing arrangement that is fair to all parties Currently, these three individuals have incomes totaling an amount in excess

of the first year income that is expected Thus, the adopted plan will have an immediate impact

on them The reduction of income must be absorbed by the partners in some equitable manner

In addition, the income is projected to increase relatively fast so that the agreed-upon method needs to reward all participants properly over time

Dewars has built up the firm and still handles the bigger clients although he plans to reduce his workload over the next few years Thus, one method of compensation would be to credit him with interest on the capital built up in the business However, if that number alone is used, it will tend to escalate even if his work hours are reduced For this reason, Dewars' share of the profits could also be based in some way on the number of hours that he works According to the information presented, this number will probably shrink over the years, reducing the profits allocated to Dewars Thus, this partner might be given interest equal to 10 percent of his capital balance and $50 for each hour worked

Huffman is contributing a significant number of hours to the firm but tends to work on the smaller jobs A possible allocation technique would be to give this partner a per hour allocation but one that is somewhat smaller than Dewars For example, Huffman could receive an income allocation of $30 per hour to begin That number could then be programmed to escalate over the years as Huffman starts to take over the bigger jobs

Scriba's role is to develop a tax practice within the firm Consequently, one suggestion would be

to credit her capital account with a percentage of the tax revenues (20 percent, for example) each year In that way, she benefits by the amount of business that she is able to bring to the organization During the first years, though, she may have trouble getting the new part of this business to generate significant revenues Thus, the partners may want to set a minimum figure for her income allocation She could be credited, as an example, with 20 percent of tax revenues but not less than $50,000

Many answers to this question are possible The above is just a simple suggestion based on the facts presented in the case Income allocation techniques are usually designed to reward the partners for the attributes that they bring to the organization Even with the above system, percentages would still be necessary to assign any remaining profit or loss If the partners are not totally satisfied with the system as designed, the percentages could be weighted or adjusted

to reward any partner not being properly compensated

Answers to Questions

1 The advantages of operating a business as a partnership include the ease of formation and the avoidance of the double taxation effect that inherently reduces the profits distributed to the owners of a corporation In addition, since the losses of a partnership pass, for tax purposes, directly through to the owners, partnerships have historically been used (especially in certain industries) to reduce or defer income taxes

Several disadvantages also accrue from the partnership format Each general partner, for example, has unlimited liability for all debts of the business This potential liability can be especially significant in light of the concept of mutual agency, the right that each partner has

to create liabilities in the name of the partnership Because of the risks created by unlimited liability and mutual agency, the growth potential of most partnerships is severely limited Few people are willing to become general partners in an organization unless they can maintain some day-to-day contact and control over the business

Further discussion of these issues can be found in the Answer to the first Discussion Question that appears above

2 Specific partnership accounting problems center in the equity (or capital) section of the balance sheet In a corporation, stockholders' equity is divided between earned capital and contributed capital Conversely, for a partnership, each partner has an individual capital account that is not differentiated according to its sources Virtually all accounting issues encountered purely in connection with the partnership format are related to recording and maintaining these capital balances

3 The balance in each partner's capital account measures that partner's interest in the book

value of the business’ net assets This figure arises from contributions, earnings, drawings, and other capital transactions

4 A Subchapter S corporation is formed legally as a corporation so that its owners enjoy limited legal liability and easy transferability of ownership However, if a company qualifies and becomes a Subchapter S Corporation, it will be taxed in virtually the same manner as a partnership Hence, income will be taxed only once and that is to the owners at the time that

it is earned by the corporation

Use of this designation is quite restricted To qualify as a Subchapter S Corporation, a company can only have one class of stock and must have no more than 100 owners These owners can only be individuals, estates, certain tax-exempt entities, and certain types of trusts Most corporations that do not qualify as Subchapter S Corporations are automatically Subchapter C Corporations These entities are also corporations but they pay income taxes when the income is earned Additionally, the owners are liable for a second income tax when dividends are distributed to them Thus, the income earned by a Subchapter C Corporation faces the double taxation effect commonly associated with corporations

5 In a general partnership, each partner can have unlimited liability for the debts of the business Therefore, a partner may face a significant risk, especially in connection with the actions and activities of other partners However, general partnerships are easy to form and

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 partner’s 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 Name and address of each partner

b Business location

c Description of the nature of the business

d Rights and responsibilities of each partner

e 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 partner’s 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

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 since a partnership will have two or more capital accounts rather than a single retained earnings balance This allocation to the capital accounts is based on the agreement established by the partners preferably as a part

of the Articles of Partnership

11 The allocation process can be based on any number of factors The actual assignment of income should be designed to give fair and equitable treatment to each of the partners Often, an interest factor is used to reward the capital investment of the partners A salary allowance is utilized as a means of recognizing the amount of time worked by an individual

or a certain degree of business expertise The allocation process can be further refined by a ratio that is either divided evenly among the partners or weighted in favor of one or more members

12 If agreement as to the allocation of income has not been specified, an equal division among all partners is presumed If an agreement has been reached for assigning profits but no mention is made concerning losses, the assumption is made that the same method is intended in either case

13 The dissolution of a partnership is the breakup or cessation of the partnership Many reasons can exist for a partnership to dissolve One partner may withdraw, retire, or die A new partner may be admitted to the partnership The original partnership terminates whenever the identity of the individuals serving as partners has changed

Dissolution, however, does not necessarily lead to the liquidation of the business In most cases, but not all, a new partnership is formed which takes over the business Such dissolutions are no more than changes in the composition of the ownership and should not affect operations

14 A new partner can join a partnership by acquiring part or all of the interest of one or more of the present partners This transaction is carried out with the individual partners directly and not with the partnership A new partner may also enter through a contribution to the business In such cases, the investment is made to the partnership rather than to the individuals

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 Any goodwill being recognized in a capital transaction that is allocated to the original partners is 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

Answers to Problems

1 B

2 C

3 C Mary Ann's investment is equal to 1/3 of the total capital ($50,000/$150,000)

However, she is receiving a smaller capital balance, only a 1/4 interest One explanation for this difference is that the business assets may be worth more than book value To achieve agreement, the net assets could be valued upward to fair value with the adjustment recorded to the capital accounts of the original partners As an alternative, a bonus could be credited to the original partners

4 D The implied value of the company based on the new contribution is only

$233,333 ($70,000/30%) which is below the total of the capital balances ($280,000 in original capital plus $70,000 to be invested) Thus, either the assets are overvalued or the new partner is also contributing goodwill Since the problem indicates that goodwill is being recognized, that figure must be computed Note that the $70,000 is going into the business and, thus, increases capital

Danville's investment = 30 % (Original Capital Plus Danville's Investment)

$70,000 + Goodwill = 30 ($280,000 + $70,000 + Goodwill)

$70,000 + Goodwill = $105,000 + 30 Goodwill

.70 Goodwill = $35,000 Goodwill = $50,000 Danville's Investment (Capital) = $70,000 + $50,000 or $120,000

5 C The implied value of the company is $800,000 ($200,000/25%) Since the

current capital total is only $600,000, goodwill of $200,000 must be recognized Oscar's investment is going to the partners so that it does not affect the capital total directly Of the $200,000 in goodwill, 30 percent or

$60,000 is attributed to Jethro which brings that capital balance to

$260,000 Since a 25 percent interest is being conveyed to the new partner, Jethro's balance will then decrease by 25% or $65,000—a drop to $195,000

6 B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new

investment As Kansas's portion is to be 30 percent, the capital balance would be $60,000 ($200,000 × 30%) Since only $50,000 was paid, a bonus

of $10,000 must be taken from the two original partners based on their profit and loss ratio: Bolcar – $7,000 (70%) and Neary – $3,000 (30%) The reduction drops Neary's capital balance from $40,000 to $37,000

7 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

8 A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new

investment As Claudius's portion is to be 20 percent, the new capital balance would be $90,000 ($450,000 × 20%) Since $100,000 was paid, a bonus of $10,000 is being given to the two original partners based on their profit and loss ratio: Messalina – $6,000 (60%) and Romulus – $4,000 (40%) The increase raises Messalina's capital balance from $210,000 to $216,000 and Romulus's capital balance from $140,000 to $144,000

9 D ASSIGNMENT OF INCOME—2007

ARTHUR BAXTER CARTWRIGHT TOTAL

Interest—10% of

beginning capital $ 6,000 $ 8,000 $10,000 $24,000 Salary 20,000 20,000

Allocation of remaining income

($6,000 divided on a 3:3:4 basis) 1,800 1,800 2,400 6,000

Totals $ 7,800 $29,800 $12,400 $50,000 STATEMENT OF CAPITAL—2007

ARTHUR BAXTER CARTWRIGHT TOTAL

Beginning capital $60,000 $80,000 $100,000 $240,000 Net income (above) 7,800 29,800 12,400 50,000 Drawings (given) (5,000) (5,000) (5,000) (15,000) Ending capital $62,800 $104,800 $107,400 $275,000

10 A ASSIGNMENT OF INCOME—YEAR ONE

Interest—10% of

beginning capital $11,000 $ 8,000 $11,000 $30,000 Salary 20,000 -0- 10,000 30,000

Allocation of remaining loss

($80,000 divided on a 5:2:3 basis) (40,000) (16,000) (24,000) (80,000)

Totals $(9,000) $ (8,000) $ (3,000) $(20,000) STATEMENT OF CAPITAL—YEAR ONE

Beginning capital $110,000 $80,000 $110,000 $300,000 Net loss (above) (9,000) (8,000) (3,000) (20,000) Drawings (given) (10,000) (10,000) (10,000) (30,000)

Ending capital $ 91,000 $62,000 $ 97,000 $250,000

10 (continued)

ASSIGNMENT OF INCOME—YEAR TWO

Interest—10% of

beginning capital $ 9,100 $ 6,200 $ 9,700 $25,000 Salary 20,000 -0- 10,000 30,000

Allocation of remaining loss

($15,000 divided on a 5:2:3 basis) (7,500) (3,000) (4,500) (15,000)

Totals $21,600 $3,200 $15,200 $ 40,000 STATEMENT OF CAPITAL—YEAR TWO

Beginning capital (above) $ 91,000 $62,000 $ 97,000 $250,000 Net income (above) 21,600 3,200 15,200 40,000 Drawings (given) (10,000) (10,000) (10,000) (30,000) Ending capital $102,600 $55,200 $102,200 $260,000

11 A A $10,000 bonus is paid to Costello ($100,000 is paid rather than the

$90,000 capital balance) This bonus is deducted from the two remaining partners according to their profit and loss ratio (2:3) A reduction of 60 percent (3/5) is assigned to Burns or a decrease of $6,000 which drops that partner’s capital balance from $30,000 to $24,000

12 D Craig receives an additional $10,000 Since Craig is assigned 20 percent of

all profits and losses, this allocation indicates total goodwill of $50,000

13 A The implied value of the company is $900,000 ($270,000/30%) Since the

money is going to the partners rather than into the business, the capital total is $490,000 before realigning the balances Hence, goodwill of

$410,000 must be recognized based on the implied value ($900,000 –

$490,000) This goodwill is assumed to represent unrealized business gains and is attributed to the original partners according to their profit and loss ratio They will then each convey 30 percent ownership of the $900,000 partnership to Darrow for a capital balance of $270,000

14 D Since the money goes into the business, total capital becomes $740,000

($490,000 + $250,000) Darrow is allotted 30 percent of this total or

$222,000 Because Darrow invested $250,000, the extra $28,000 is assumed

to be a bonus to the original partners Jennings will be assigned 40 percent

of this extra amount or $11,200 This bonus increases Jennings’ capital from $160,000 to $171,200

15 (10 Minutes) (Compute capital balances under both goodwill and bonus methods)

a Goodwill Method

Implied value of partnership ($80,000/40%) $200,000 Total capital after investment ($70,000 + $40,000 + $80,000) 190,000 Goodwill $ 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) $190,000 Ownership portion—Lear 40% Lear, capital $ 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

16 (15 Minutes) (Prepare journal entries to record admission of new partner under both the goodwill and the bonus methods)

Part a

Total capital is $300,000 ($85,000 + $60,000 + $55,000 + $100,000) after the new investment As Sergio's portion is 25 percent, this partner's capital balance would be $75,000 Since $100,000 was paid, a bonus of $25,000 is given to the three original partners based on their profit and loss ratio: Tiger—$12,500 (50%), Phil—$7,500 (30%), and Ernie—$5,000 (20%)

Cash 100,000

Sergio, Capital 75,000 Tiger, Capital 12,500 Phil, Capital 7,500 Ernie, Capital 5,000

Part b

Total capital is $260,000 ($85,000 + $60,000 + $55,000 + $60,000) after the new investment As Sergio's portion is to be 25 percent, this partner's capital balance would be $65,000 Because only $60,000 was paid, a bonus

of $5,000 is taken from the three original partners based on their profit and loss ratio: Tiger—$2,500 (50%), Phil—$1,500 (30%), and Ernie—$1,000

$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 16,000

Tiger, Capital 8,000 Phil, Capital 4,800 Ernie, Capital 3,200 Cash 72,000

Sergio, Capital 72,000

17 (16 Minutes) (Determine capital balances after admission of new partner using both goodwill and bonus methods)

Part a

Total capital is $490,000 ($200,000 + $120,000 + $90,000 + $80,000) after the new investment However, the implied value of the business based on the new investment is only $444,444 ($80,000/18%) According to the goodwill method, this situation indicates that the new partner must be bringing some intangible attribute to the partnership other than just cash This contribution must be computed algebraically and is recorded as goodwill

to the new partner

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 $200,000 Hoover 120,000 Polk 90,000 Grant 90,000

Part b

Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after the new investment As Grant's portion is to be 20 percent, this partner's capital balance will be $102,000 Since only $100,000 was paid, a bonus of

$2,000 is taken from the three original partners based on their profit and loss ratio: Nixon—$1,000 (50%), Hoover—$400 (20%), and Polk—$600 (30%)

18 (8 Minutes) (Record admission of new partner and allocation of new income)

Part a

Total capital is $336,000 ($150,000 + $110,000 + $76,000) after the new investment However, the implied value of the business based on the new investment is $380,000 ($76,000/20%) Consequently, goodwill of $44,000 must be recognized with the offsetting allocation to the original two partners based on their profit and loss ratio: Com—$26,400 (60%) and Pack—$17,600 (40%)

Goodwill 44,000

Com, Capital 26,400 Pack, Capital 17,600 Cash 76,000

Hal, Capital 76,000 Part b

Com Pack Hal Total

Interest $17,640 $12,760 $7,600 $38,000 Remaining loss (1,000) (600) (400) (2,000) Income allocation $16,640 $12,160 $7,200 $36,000

19 (5 Minutes) (Allocation of income to partners)

Jones King Lane Total

Bonus (20%) $18,000 $ -0- $ -0- $18,000 Interest (15% of average capital) 15,000 30,000 45,000 90,000 Remaining loss ($18,000) (6,000) (6,000) (6,000) (18,000) Income assignment $27,000 $24,000 $39,000 $90,000

20 (15 Minutes) (Allocate income and determine capital balances)

$(40,000) (16,000) (8,000) (16,000) (40,000)

CALCULATION OF PURKERSON'S INTEREST ALLOCATION

Balance, January 1—April 1 ($60,000 × 3) $180,000

Balance, April 1—December 31 ($68,000 × 9) 612,000

Total $792,000

Months  12

Average monthly capital balance $ 66,000

Interest rate × 10%

Interest allocation (above) $ 6,600

STATEMENT OF PARTNERS' CAPITAL

Purkerson Smith Traynor Totals

Beginning balances $60,000 $40,000 $20,000 $120,000 Additional contribution 8,000 -0- -0- 8,000 Income (above) 8,600 21,000 (6,000) 23,600 Drawings ($1,000 per month) (12,000) (12,000) (12,000) (36,000) Ending capital balances $64,600 $49,000 $ 2,000 $115,600

21 (30 Minutes) (Allocate income for several years and determine ending capital balances)

INCOME ALLOCATION—2009

Left Center Right Total

Interest (12% of beginning capital) $2,400 $ 7,200 $ 6,000 $ 15,600

Left Center Right Total

Beginning balances $20,000 $60,000 $50,000 $130,000 Income allocation (5,280) (17,600) (7,120) (30,000) Drawings (10,000) (10,000) (10,000) (30,000) Ending balances $ 4,720 $32,400 $32,880 $ 70,000

INCOME ALLOCATION—2010

Left Center Right Total

Interest(12% of beginning capital above) * $566 $3,888 $3,946 $ 8,400 Salary 12,000 8,000 -0- 20,000 Remaining income/loss:

$20,000

(8,400) (20,000)

Totals $10,046 $7,688 $2,266 $20,000

*Rounded

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2010

Left Center Right Total

Beginning balances (above) $ 4,720 $32,400 $32,880 $70,000 Additional investment -0- -0- 12,000 12,000 Income allocation 10,046 7,688 2,266 20,000 Drawings (10,000) (10,000) (10,000) (30,000) Ending balances $ 4,766 $30,088 $37,146 $72,000

21 (continued)

INCOME ALLOCATION—2011

Left Center Right Total

Interest (12% of beginning capital

above)* $ 572 $ 3,611 $4,457 $ 8,640 Salary 12,000 8,000 -0- 20,000 Remaining income:

$40,000

(8,640)

(20,000)

$11,360 2,272 4,544 4,544 11,360 Totals $14,844 $16,155 $9,001 $40,000

*Rounded

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2011

Left Center Right Total

Beginning balances (above) $ 4,766 $30,088 $37,146 $72,000 Income allocation 14,844 16,155 9,001 40,000 Drawings (10,000) (10,000) (10,000) (30,000) Ending balances $ 9,610 $36,243 $36,147 $82,000

22 (12 Minutes) (Determine capital balances after retirement of a partner using both the goodwill and the bonus approaches)

a Harrison receives an additional $30,000 about the capital balance Since Harrison is assigned 20 percent of all profits and losses, this extra allocation indicates total goodwill of $150,000, which must be split among all partners

20% of Goodwill = $30,000

.20 G = $30,000

G = $150,000

CAPITAL BALANCES AFTER WITHDRAWAL

Original Balance Goodwill Withdrawal Final Balance