Chapter 14 Partnerships
Chapter 14 Partnerships
Chapter 14 Partnerships
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.
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 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:
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.
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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.
Chapter 14 - Partnerships: Formation and Operation
15. In selling an interest in a partnership, three rights are conveyed to the new owner:
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
STATEMENT OF CAPITAL
ALFRED BERNARD COLLINS TOTAL
Beginning capital ................... $50,000 $60,000 $70,000 $180,000
Net income (above) ................ 12,400 30,900 16,700 60,000
Drawings (given) .................... (5,000) (5,000) (5,000) (15,000)
Ending capital ........................ $57,400 $85,900 $81,700 $225,000
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Chapter 14 - Partnerships: Formation and Operation
11. (continued)
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 partner’s capital balance from $30,000 to $24,000.
Goodwill 50,000
Manning, capital (30%) 15,000
Gonzalez, capital(30%) 15,000
Clark, capital (20%) 10,000
Freeney, capital(20%) 10,000
14. B Under the bonus method, Clark’s excess payment is deducted from the
remaining partners’ capital accounts according to their relative profit and loss
ratios, 3:3:2. Manning’s balance is then $126,250 = $130,000 – $3,750.
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%) .............. $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
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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%).
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%).
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%).
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.
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. 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 Investment Bonus Total
Nixon .................... $200,000 $(1,000) $199,000
Hoover .................. 120,000 (400) 119,600
Polk ....................... 90,000 (600) 89,400
Grant ..................... -0- 100,000 2,000 102,000
Total ................ $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.
Part b.
Prince Robbins Jeffrey Total
Interest .................................. $8,440 $6,360 $3,700 $18,500
Remaining loss ..................... (1,750) (1,050) (700) (3,500)
Income allocation ........... $6,690 $5,310 $3,000 $15,000
ALLOCATION OF INCOME
Purkerson Smith Traynor Totals
Interest (10%) $ 6,600 (below) $ 4,000 $ 2,000 $12,600
Salary 18,000 25,000 8,000 51,000
Remaining income (loss):
$ 23,600
(12,600)
(51,000)
$(40,000) (16,000) (8,000) (16,000) (40,000)
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Chapter 14 - Partnerships: Formation and Operation
23. (30 Minutes) (Allocate income for several years and determine ending capital
balances)
INCOME ALLOCATION—2014
INCOME ALLOCATION—2015
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)
$(8,400) (2,520) (4,200) (1,680) (8,400)
Totals.................. $10,046 $7,688 $2,266 $20,000
*Rounded
23. (continued)
INCOME ALLOCATION—2016
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
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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.
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.
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 40,000
Matteson, capital 12,000
Richton, capital 20,000
O’Toole, capital 8,000
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.
26. (continued)
CAPITAL BALANCES
A B C D E
Original balances $20,000 $40,000 $ 90,000 $120,000 $-0-
Goodwill (above) 16,200 5,400 21,600 10,800 -0-
Investment -0- -0- -0- -0- 36,000
Capital balances $ 36,200 $45,400 $111,600 $130,800 $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'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).
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Chapter 14 - Partnerships: Formation and Operation
27. (continued)
Bonus from:
A (10%) ............................................................... $1,000
B (30%) ............................................................... 3,000
C (20%) ............................................................... 2,000
D (40%) ............................................................... 4,000 $10,000
CAPITAL BALANCES
A B C D E
Original balances $20,000 $40,000 $90,000 $120,000 $-0-
Investment -0- -0- -0- -0- 55,000
Bonus (above) (1,000) (3,000) (2,000) (4,000) 10,000
Capital balances $19,000 $37,000 $88,000 $116,000 $65,000
Bonus from:
A (1/3) $7,500
B (1/3) 7,500
D (1/3) 7,500 $22,500
CAPITAL BALANCES
A B C D
Original balances ................. $20,000 $40,000 $ 90,000 $120,000
Bonus (above) ...................... (7,500) (7,500) 22,500 (7,500)
Payment ................................ -0- -0- (112,500) -0-
Capital balances ................... $12,500 $32,500 $ -0- $112,500
Chapter 14 - Partnerships: Formation and Operation
28. (55 Minutes) (Allocation of income to the partners and determination of capital
balances)
ALLOCATION OF INCOME—2013
Boswell Johnson Total
Salary (8 months) ................. $8,000 $-0- $ 8,000
Remaining $3,000 ................. 1,200 (40%) 1,800 (60%) 3,000
Totals ............................... $9,200 $1,800 $11,000
ALLOCATION OF INCOME—2014
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Chapter 14 - Partnerships: Formation and Operation
28. (continued)
ADMISSION OF POPE—JANUARY 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:
ALLOCATION OF INCOME—2015
29. (60 Minutes) (Allocate income and prepare a statement of partners' capital)
a. Income Allocation—2013
Gray Stone Lawson Totals
Salary allowance ($8 per billable
hour) $13,680 $11,520 $10,400 $35,600
Interest (see Note A) 25,928 21,600 10,800 58,328
Bonus (not applicable because
salary and interest would
necessitate a negative bonus) -0- -0- -0- -0-
Remaining loss (split evenly):
$ 65,000
(35,600)
(58,328)
$(28,928) (9,643) (9,643) (9,642) (28,928)
Profit allocation $29,965 $23,477 $11,558 $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.
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Chapter 14 - Partnerships: Formation and Operation
29. a. (continued)
Income Allocation—2014
Gray Stone Lawson Monet Totals
Salary allowance ($8
per billable hour) $14,400 $ 12,000 $ 11,040 $ 9,520 $ 46,960
Interest (12% of begin-
ning capital balances
for the year) 27,368 22,257 11,107 20,244 80,976
Bonus (not applicable) -0- -0- -0- -0- -0-
Remaining loss (split
evenly):
$ (20,400)
(46,960)
(80,976)
$(148,336) (37,084) (37,084) (37,084) (37,084) (148,336)
Loss allocation $ 4,684 $(2,827) $(14,937) $ (7,320) $(20,400)
Income Allocation—2015
Gray Stone Lawson Monet Totals
Salary allowance ($8
per billable hour) $15,040 $12,960 $10,480 $12,640 $ 51,120
Interest (12% of
beginning capital
balances for the
year) 25,193 19,692 8,204 17,341 70,430
Bonus (see Note B) 2,604 2,604 -0- -0- 5,208
Remaining profit split
evenly:
$152,800
(51,120)
(70,430)
(5,208)
$ 26,042 6,510 6,510 6,511 6,511 26,042
Profit allocation $49,347 $41,766 $25,195 $36,492 $152,800
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)
b.
GRAY, STONE, LAWSON, and MONET
Statement of Partners' Capital
For Year Ending December 31, 2015
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Chapter 14 - Partnerships: Formation and Operation
30. (40 Minutes) (Recording admission and retirement of partners using both the
bonus and goodwill methods)
30. (continued)
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Chapter 14 - Partnerships: Formation and Operation
31. a. (continued)
O'Donnell Reese Dunn
Interest (20% of $51,700
beginning capital balance)........ $10,340
15% of $44,000 income .................. 6,600
60:40 split of remaining $27,060
income ....................................... $16,236 $10,824
Total ................................................ $16,940 $16,236 $10,824
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Chapter 14 - Partnerships: Formation and Operation
31. a. (continued)
1/1/16 Postner, capital ......................................... 33,900
O'Donnell, capital (15%) ........................... 509
Reese, capital (85%) ................................. 2,881
Cash ..................................................... 37,290
(Postner's capital is $33,900 [$22,824 –
$5,000 + $16,076]. Extra 10% payment is
deducted from the two remaining
partners' capital accounts.)
31. b. (continued)
12/31/14 O'Donnell, capital ..................................... 20,000
Reese, capital ........................................... 10,000
Dunn, capital ............................................. 7,500
O'Donnell, drawings............................. 20,000
Reese, drawings .................................. 10,000
Dunn, drawings ................................... 7,500
(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 ................................ 26,600
Reese, capital ...................................... 10,440
Dunn, capital ........................................ 6,960
(To allocate $44,000 income figure as follows)
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Chapter 14 - Partnerships: Formation and Operation
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:
Chapter 14 - Partnerships: Formation and Operation
31. b. (continued)
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Chapter 14 - Partnerships: Formation and Operation
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.
Analysis Case
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 Higgins’s work in the day-to-day operations of
the business so a large part of that remainder could be assigned to her.
work, one in gaining new clients and the other in the day-to-day operations of the
business.
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 Hours–Red”.In Cell B2 enter 2,000. In Cell C2, enter $20 hourly rate.
In Cell A3, enter text “Billable Hours–Blue”. In Cell B3 enter 1,500. In Cell C3, enter $30 hourly rate.
In Cell A4, enter text “Investment–Red” and in Cell B4 enter $80,000. In Cell C4, enter the rate of
return of 10%.
In Cell A5, enter text “Investment–Blue” 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 partner’s 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.
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:
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 14-9 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.
14-36
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Education.
Chapter 14 - Partnerships: Formation and Operation
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.
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
10. A partnership begins its first year with the following capital balances:
LO 14-6
LO 14-4, 14- 11. A partnership begins its first year of operations with the following
5, 14-6 capital balances:
14-38
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Education.
Chapter 14 - Partnerships: Formation and Operation
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:
LO 14-10 14. If instead the partnership uses the bonus method, what is the balance
of Manning's capital account after Clark withdraws?
a. $100,000.
b. $126,250.
Chapter 14 - Partnerships: Formation and Operation
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 18. The Distance Plus partnership has the following capital balances at the
beginning of the current year:
14-40
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Education.
Chapter 14 - Partnerships: Formation and Operation
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:
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:
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.
LO 14-10 24. The E.N.D. partnership has the following capital balances as of the end
of the current year:
14-42
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Education.
Chapter 14 - Partnerships: Formation and Operation
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:
LO 14-3, 14- 27. Following is the current balance sheet for a local partnership of
9, 14-10 doctors:
14-44
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Education.
Chapter 14 - Partnerships: Formation and Operation
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
28. Boswell and Johnson form a partnership on May 1, 2013. Boswell
LO 14-5, 14- contributes cash of $50,000; Johnson conveys title to the following
6, 14-9 properties to the partnership:
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:
For the year of 2015, the partnership earned a profit of $46,000, and
Chapter 14 - Partnerships: Formation and Operation
The partnership reports net income for 2013 through 2015 as follows:
14-46
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Education.
Chapter 14 - Partnerships: Formation and Operation
LO 14-8, 14- 30. A partnership of attorneys in the St. Louis, Missouri, area has the
9, 14-10 following balance sheet accounts as of January 1, 2015:
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.
14-48
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Education.
Chapter 14 - Partnerships: Formation and Operation
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, 14- 11. A partnership begins its first year of operations with
5 the following capital balances:
,
14-52
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Education.
Chapter 14 - Partnerships: Formation and Operation
14-54
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Education.
Chapter 14 - Partnerships: Formation and Operation
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.
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:
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 23. On January 1, 2014, the dental partnership of Left,
LO 14-4, 14- Center, and Right was formed when the
5 partners contributed $20,000, $60,000, and
, $50,000, respectively. Over the next three
years, the business reported net income
1 and (loss) as follows:
4
-
6 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.
LO 14-10 24. The E.N.D. partnership has the following capital
balances as of the end of the current year:
1
4
-
The following questions
1
represent independent situations:
0
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 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?
14-60
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Education.
Chapter 14 - Partnerships: Formation and Operation
1
4
- The partners agree to start their partnership with equal
9 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. Remaining profits are
now allocated:
14-62
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Education.
Chapter 14 - Partnerships: Formation and Operation
1
4
- According to the articles of partnership, Athos is to
1 receive an allocation of 50 percent of all
0 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 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.
14-64
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Chapter 14 - Partnerships: Formation and Operation
14-66
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