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CHAPTER 15 PARTNERSHIPS: FORMATION, OPERATION, AND CHANGES IN OWNERSHIP

ANSWERS TO QUESTIONS Q15-1 Partnerships are a popular form of business because they are easy to form (informal methods of organization), and because they allow several individuals to combine their talents and skills in a particular business venture. In addition, partnerships provide a means of obtaining more equity capital than a single individual can invest and allow the sharing of risks for rapidly growing businesses. Partnerships are also allowed to exercise greater freedom in their choice of accounting methods. Q15-2 The Uniform Partnership Act (UPA) is the general governing authority for partnerships since its adoption by virtually all the states. The UPA describes many of the rights of each partner and of creditors during creation, operation, or liquidation of the partnership. Q15-3 The types of items Copartnership include: a. b. c. d. that are typically included in the Articles of

e.

f.

The name of the partnership and the names of the partners The type of business to be conducted by the partnership and the duration of the partnership agreement The initial capital contribution of each partner and how future capital contributions are to be accounted for A complete discussion of the profit or loss distribution, including salaries, interest on capital balances, bonuses, limits on withdrawals in anticipation of profits, and the percentages used to distribute any residual profit or loss Procedures used for changes in the partnership such as methods of admitting new partners and procedures to be used on the retirement of a partner Other aspects of operations the partners decide on, such as the management rights of each partner, election procedures, and accounting methods

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Q15-4 (a) Limited life means that a partnership legally terminates as a business entity each time there is a change in membership. This legal termination is called a dissolution of the partnership. (b) Creditors view each partner as an agent of the partnership capable of transacting business in the name of the partnership. Consequently, any partner can bind the partnership when acting within the scope of the partnership activities. (c) In the event the partnership fails and its assets are not sufficient to pay its liabilities, partnership creditors may take recourse by obtaining liens or attachments against the personal assets of any or all of the partners. This means that any individual partner has unlimited liability and may be required to pay the partnership's creditors from personal assets in an amount exceeding that partner's capital balance in the partnership. Q15-5 A deficiency in a partner's capital account would exist when the partner's share of losses and withdrawals exceeds the capital contribution and share of profits. A deficiency is usually eliminated by additional capital contributions. Q15-6 The percentage of profits each partner will receive, along with the allocation of $60,000 profit, is calculated as follows: Percentage of Profits Partner 1 Partner 2 Partner 3 4/15 = 26.67% 6/15 = 40.00% 5/15 = 33.33% Profit to be Allocated $60,000 $60,000 $60,000

Allocation $16,000 $24,000 $20,000

Q15-7 The choices of capital balances available to the partners include beginning capital balances, ending capital balances, or an average (usually weighted-average) capital balance for the period. The preferred capital balance is the weighted-average capital balance because this method explicitly recognizes the time span each capital level was maintained during the period. Q15-8 Salaries to partners are not an expense of the partnership because salaries, like interest on capital balances, are a result of the respective investments and are used not in the determination of income, but rather in the determination of the proportion of income to be credited to each partner's capital account. Q15-9 A dissolution of a partnership means the partnership's books are brought up to date through any necessary adjusting entries and the partners' present capital account balances are determined. A dissolution may be caused by the admission of a new partner or the withdrawal of an old partner. A partnership need not terminate business upon dissolution.

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Q15-10 The book value of a partnership is the total value of the capital, which is also the difference between total assets and total liabilities. The book value may or may not represent the market value of the partnership. Q15-11 The arguments for the bonus method include preservation of the historical cost principle and the accounting principles stated in APB No. 17. The arguments against the bonus method include a necessity for a fair valuation of the partnership assets and the new partner may dislike having a capital balance less than his or her investment in the partnership. Q15-12 The new partner's capital credit is equal to the investment made when (1) the investment equals the proportionate present book value, (2) the assets of the partnership are revalued prior to admission of the new partner, or (3) goodwill is recognized for the present partners. The new partner's capital credit is not equal to the investment made when bonus is recognized or when goodwill is recognized for the new partner. Q15-13 Aabel's bonus is $3,000 ($20,000 x .15) if the bonus is computed as a percentage of income before the bonus. Aabel's bonus is $2,608.70 [Bonus = . 15($20,000 - Bonus)] if the bonus is computed as a percentage of income after deducting the bonus. Q15-14 The implied true value of the ABC partnership is $36,000 ($12,000 / . 33). The entry the ABC partnership should make upon the admission of Caine follows. Cash Goodwill [$36,000 - ($12,000 + $21,000)] Other Partners' Capitals Caine, Capital 12,000 3,000 3,000 12,000

Q15-15A The basis of Horton's contribution for tax purposes is $3,500 and is calculated as follows: $5,000 book value less ($2,000 assumed liability x .75) = $3,500 The basis of Horton's contribution for GAAP purposes is $8,000 and is calculated as follows: $10,000 market value less $2,000 assumed liability = $8,000 Q15-16B A joint venture is a short-term association of two or more parties to fulfill a specific project. Corporate joint ventures are accounted for on the books of the investor companies by the equity method of accounting for investments in common stock.

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SOLUTIONS TO CASES C15-1 a. Partnership Agreement

The partnership agreement should be as specific as possible to avoid later differences of opinion. In addition, the partnership agreement, also often called the Articles of Copartnership, should be written in a formal agreement and signed by all partners. The basic elements of a partnership agreement should include the following: 1. 2. 3. 4. 5. 6. The name of the partnership and the names of the partners The type of business to be conducted and the term, if any, of the partnership The initial capital contribution of each partner and the method(s) of accounting for future capital contributions The income or loss sharing procedures Procedures for changes in the partnership such as admission of new partners or retirements of present partners Any other specific procedures important to the partners

b.

Salaries and bonuses to partners are part of the income distribution process regardless of how they are reported by the partnership. Some partnerships prefer to report these within the partnership's income statement in order to compare the results of the partnership with other business entities. Not recording salaries and bonuses to partners in the income statement reflects the true nature of these items and reports income from the partnership before any distributions. Thus, the income statement reflects the total profit to be distributed to the partners. The partnership agreement should state the following if interest is to be provided on invested capital: 1. The capital balance to be used as the base for interest: Beginning of period, average (simple or weighted) for the period, or ending-of-period balances. The rate of interest to be paid, or the basis by which the rate is to be determined. When interest is to be determined in the profit or loss distribution process. For example, should salaries and bonuses be added to the capital accounts before interest is computed?

c.

d.

2. 3.

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C15-2

Comparisons of Bonus, Goodwill, and Asset Revaluation Methods

MEMO to BGA Partnership: This memo discusses the three alternative methods of accounting for the admission of Newt, a new partner. To state the present positions, Bill favors the bonus method, George favors the goodwill method, and Anne favors the revaluation of existing tangible assets. First, all three methods are allowed to account for the admission of a new partner. Partnership accounting views the admission of a partner as a dissolution of the old partnership and the creation of a new business entity. The bonus method is a realignment of present partnership capital. No additional capital, beyond the tangible investment of the new partner, is created in the admission process. Some partners prefer this approach because it immediately states the proper capital relationships on the admission of the new partner and does not require the write-up of assets. The goodwill method results in the recognition of goodwill, either the goodwill generated by the prior partners during the existence of the old partnership, or the goodwill being contributed by the new partner. Goodwill is an amortizable asset and must be amortized in future periods. This will affect all partners' capital accounts in proportion to their profit and loss sharing ratios in the future periods as the goodwill is amortized. If new partners are allowed into the partnership, or a present partner withdraws, the effect on each partner's capital account will be different than if the bonus method is used. New partners will have to share in the amortization of goodwill, even goodwill created before a new partner's admission. The revaluation of existing assets could be done under either of the two above cases. This provides for the proper recognition of the assets and the distribution of any holding gain to the partners who were part of the partnership while the market increase took place. For example, the assets could be revalued to their market value on the basis of appraisals and then the bonus or goodwill method could be used. This would preclude a new partner from sharing in the holding gain that was appreciated before the new partner's admission. The final decision must be made by the partners. All partners should agree to the specific method, or methods, to be used to account for the admission of Newt. The decision should be formalized, written, and signed by all partners.

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C15-3

Uniform Partnership Act Issues You

This solution uses the Uniform Partnership Act (UPA) for its references. may also use the Revised Uniform Partnership Act (RUPA) for this case.

a. Section 9 (1) of the UPA specifies that every partner does have the right to act as an agent of the partnership, unless the partner has in fact no authority to act for the partnership in the particular manner, and the person with whom the partner is dealing has knowledge of the fact that the partner has no such authority. b. Section 17 of the UPA specifies that a new partner is liable for all the obligations of the partnership arising before admission, but only to the extent of the new partners capital contribution. The liability of the new partner for obligations incurred after admission is unlimited for a general partner, but this liability can be limited by the form of the partnership. For example, partners in limited liability partnerships (LLPs) have a liability only to the extent of their capital contributions. c. Section 19 of the UPA specifies that each partner may inspect the partnerships books, and copy any of them, at all times. The courts have agreed that at all times means during normal working hours. d. Section 23 of the UPA specifies that if the initial term of the partnership is completed, and the partnership continues, the rights and duties of the partners remain the same. A new partnership agreement is not needed for the continuation, but is a good idea if there are any changes in the way the partnership operates since its initial creation date. e. While it is very easy to form a partnership, it is very difficult to simply leave a partnership. The causes of dissolution are specified in Sections 31 and 32 of the UPA, and the standards for dissolution are quite limited. If a partner simply expresses the request that the partner no longer wishes to be engaged in the partnership, the remaining partners are typically not specifically required to accept the partners resignation. The remaining partners may all decide to permit a partner to resign, but generally are not required to by the UPA. This suggests that the initial partnership agreement should include any specific provisions on resignations of partners if the partners feel the UPAs guidelines are not sufficient for their partnership. f. The items to be included in the partnership agreement are dependent upon the wishes of the initial partners. The partnership agreement should include any items that the partners want to reach agreement on as a basis of the partnership, its operations, and its possible future dissolution. It is better to have agreement on many of the difficult items up front rather than ignoring them and then having them turn into large problems later on.

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SOLUTIONS TO EXERCISES E15-1 1. 2. 3. 4. 5. a c d b d $330,000 = $50,000 + ($310,000 - $30,000) Multiple-Choice Questions on Initial Investment [AICPA Adapted]

E15-2 a.

Division of Income__Multiple Bases

Distribution of $100,000 income: John Profit percentage Average capital Net income Interest on average capital (8%) Salary Residual income Allocate 60%:40% Total 60% $100,000 Pete 40% $60,000 Total 100%

$ 8,000 35,000 16,320 $59,320

$ 4,800 25,000 10,880 $40,680

$100,000 (12,800) (60,000) $ 27,200 (27,200) $ -0-

b.

Distribution of $40,000 income: John Profit percentage Average capital Net income Interest on average capital (8%) Salary Residual income (deficit) Allocate 60%:40% Total 60% $100,000 Pete 40% $60,000 Total 100%

$ 8,000 35,000 (19,680) $23,320

$ 4,800 25,000 (13,120) $16,680

$ 40,000 (12,800) (60,000) $(32,800) 32,800 $ -0-

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E15-3

Division of Income__Interest on Capital Balances

Computation of average capital: Average capital for Left Months Maintained 3 5 2 2 12 Months x Dollar Balance $ 90,000 190,000 64,000 76,000 $420,000 $ 35,000

Date 1/1 4/3 8/28 10/31 Total

Debit

Credit

Balance $30,000 38,000 32,000 38,000

$8,000 $6,000 6,000

Average capital ($420,000 / 12 months)

Average capital for Right Months Maintained 2 4 3 3 12 Months x Dollar Balance $100,000 164,000 144,000 159,000 $567,000 $ 47,250

Date 1/1 3/5 7/6 10/7 Total

Debit

Credit

Balance $50,000 41,000 48,000 53,000

$9,000 $7,000 5,000

Average capital ($567,000 / 12 months)

Distribution of $50,000 income: Left Profit percentage Average capital Net income Interest on average capital (8%) Residual income Allocate 50%:50% Total 50% $35,000 Right 50% $47,250 Total 100%

$ 2,800 21,710 $24,510

$ 3,780 21,710 $25,490

$50,000 (6,580) $43,420 (43,420) $ -0-

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E15-4

Distribution of Partnership Income and the Preparation of a Statement of Partners' Capital

a. Distribution of partnership net income for 20X5: Apple 70% 50% Jack 30% 50% Total 100% 100% $80,000 $ 3,123 $ 7,220 (10,343) $69,657

Profit percentage (if positive) (if negative) Net income Interest on average capital balances(see Schedule 1) Bonus on net income before the bonus but after interest (see Schedule 2) Salaries Residual income__allocate 70:30 Total

6,966 25,000 5,384 $40,473 30,000 2,307 $39,527

(6,966) $62,691 (55,000) $ 7,691 (7,691) $ -0-

Schedule 1: Partners' average capital balances for 20X5 Months Outstanding 3 9 12 Months x Capital Balance $ 122,400 502,200 $ 624,600

Apple__January 1 to April 1 __April 1 to December 31 Total Average capital balance ($624,600 / 12) Interest rate Interest on average capital balance

Capital Balance $40,800 $55,800

$ x $ 7 5 12 $

52,050 .06 3,123

Jack__January 1 to August 1 $112,000 __August 1 to December 31 $132,000 Total Average capital balance ($1,444,000 / 12) Interest rate Interest on average capital balance

784,000 660,000 $1,444,000 $ x $ 120,333 .06 7,220

Schedule 2: Bonus on net income after interest on capital Bonus = .10(net income - interest on capital) = .10($80,000 - $10,343) = $6,966

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E15-4

(continued) b.Apple__Jack Partnership Statement of Partners' Capital For the Year Ended December 31, 20X5 Apple Jack $112,000 20,000 39,527 $171,527 (20,800) $150,727 Total $152,800 35,000 80,000 $267,800 (41,600) $226,200

Balance, January 1, 20X5 Add: Additional investment Net income distribution Less: Withdrawals Balance, December 31, 20X5

$40,800 15,000 40,473 $96,273 (20,800) $75,473

c. Apple__Jack Partnership Distribution of $80,000 Net Income Apple Profit percentage (if positive) Profit percentage (if negative) Net income Interest on average capital balances (see Schedule 1) Bonus on net income before the bonus and after interest (see Schedule 2) Salaries Residual loss__allocate 50:50 Total 70% 50% Jack 30% 50% Total 100% 100% $80,000 $ 3,123 $ 7,220 (10,343) $69,657

6,966 30,000 (1,155) $38,934 35,000 (1,154) $41,066

(6,966) $62,691 (65,000) (2,309) 2,309 $ -0-

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E15-5 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

Matching Partnership Terms With Their Descriptions F E H C G A I D M B J L J D B

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E15-6 a.

Admission of a Partner

Determine required payment if no bonus or goodwill recognized: 2/3 total resulting capital Total resulting capital ($400,000 / .6667) Total net assets prior to admission Required contribution ($600,000 x .3333) $400,000

$600,000 (400,000) $200,000

Therefore, Elan must invest $200,000 for a 1/3 interest.

b.

Elan invests $80,000 for a one-fifth interest; goodwill recorded: Investment in partnership New partner's proportionate book value [($400,000 + $80,000 ) x 1/5] Difference (investment cost < book value) Method: Goodwill to new partner Step 1: 4/5 estimated total resulting capital Estimated total resulting capital ($400,000 / .80) Step 2: Estimated total resulting capital Total net assets not including goodwill ($400,000 + $80,000) Estimated goodwill to new partner $ 80,000 (96,000) $(16,000)

$400,000 $500,000

$500,000 (480,000) $ 20,000

Cash Goodwill Elan, Capital $100,000 = $500,000 x .20

80,000 20,000 100,000

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E15-6 c.

(continued)

Elan invests $200,000 for a 20 percent interest; total capital specified as $600,000: Investment in partnership New partner's proportionate book value [($400,000 + $200,000) x .20] Difference (investment cost > book value) Method: Goodwill or bonus to prior partners Specified total capital Total net assets not including goodwill ($400,000 + $200,000) Estimated goodwill $600,000 (600,000) $ -0$200,000 (120,000) $ 80,000

Therefore, bonus method is used because no additional capital is created. Cash Mary, Capital Gene, Capital Pat, Capital Elan, Capital ($80,000 x .60) ($80,000 x .30) ($80,000 x .10) ($600,000 x .20) 200,000 48,000 24,000 8,000 120,000

E15-7 a.

Admission of a Partner

Brad invests $60,000 and goodwill is to be recorded: Investment in partnership New partner's proportionate book value [($140,000 + $60,000) x 1/5] Difference (investment cost > book value) Method: Goodwill to prior partners Step 1: .20 estimated total resulting capital Estimated total resulting capital ($60,000 / .20) $60,000 (40,000) $20,000

$60,000 $300,000

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E15-7

(continued)

Step 2: Estimated total resulting capital Total net assets not including goodwill ($140,000 + $60,000) Estimated goodwill to prior partners Cash Goodwill Jeff, Capital ($100,000 x .80) Kristie, Capital ($100,000 x .20) Brad, Capital ($300,000 x .20)

$300,000 (200,000) $100,000 60,000 100,000 80,000 20,000 60,000

b.

Brad invests $60,000; total capital is to be $200,000: Investment in partnership New partner's proportionate book value [($140,000 + $60,000) x .20] Difference (investment > book value) Method: Goodwill or bonus to prior partners Specified total capital Total net assets not including goodwill ($140,000 + $60,000) Estimated goodwill Therefore, bonus of $20,000 to prior partners Cash Jeff, Capital ($20,000 x .80) Kristie, Capital ($20,000 x. 20) Brad, Capital ($200,000 x .20) 60,000 16,000 4,000 40,000 $200,000 (200,000) $ -0$60,000 (40,000) $20,000

c.

Direct purchase; thus, only reclassify capital: Jeff, Capital ($100,000 capital x .20) Kristie, Capital ($40,000 capital x .20) Brad, Capital 20,000 8,000 28,000

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E15-7 d.

(continued)

Brad invests $32,000; total capital to be $172,000: Investment in partnership New partner's proportionate book value [($140,000 + $32,000) x .20] Difference (investment < book value) Method: Goodwill or bonus to new partner Specified total capital Total net assets not including goodwill ($140,000 + $32,000) Estimated goodwill Therefore, bonus of $2,400 to new partner Cash Jeff, Capital ($2,400 x .80) Kristie, Capital ($2,400 x .20) Brad, Capital ($172,000 x .20) 32,000 1,920 480 34,400 $172,000 (172,000) $ -0$32,000 (34,400) $(2,400)

e.

Brad invests $32,000 and goodwill to be recorded: Investment in partnership New partner's proportionate book value [($140,000 + $32,000) x .20] Difference (investment < book value) Method: Goodwill to new partner Step 1: .80 estimated total resulting capital Estimated total resulting capital ($140,000 / .80) Step 2: Estimated total resulting capital Total net assets not including goodwill ($140,000 + $32,000) Estimated goodwill to new partner Cash Goodwill Brad, Capital $35,000 = $175,000 x .20 $32,000 (34,400) $(2,400)

$140,000 $175,000

$175,000 (172,000) $ 3,000 32,000 3,000 35,000

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E15-8 1. d

Multiple-Choice Questions on the Admission of a Partner Specified no bonus or goodwill: 5/6 estimated total resulting capital Estimated total resulting capital Required investment ($180,000 x 1/6)

$150,000 $180,000 $ 30,000

2.

Direct purchase; reclassify Claire's capital only.

3.

West invests $36,000 for a 1/5 interest: Investment in partnership New partner's proportionate book value [($120,000 + $36,000) x .20] Difference (investment > book value) Method: Goodwill to prior partners Step 1: 1/5 estimated total resulting capital Estimated total resulting capital ($36,000 / .20) Step 2: Estimated total resulting capital Total net assets not including goodwill ($120,000 + $36,000) Estimated goodwill to prior partners

$36,000 (31,200) $ 4,800

$ 36,000 $180,000

$180,000 (156,000) $ 24,000

4.

Lisa invests $40,000 and total capital specified as $150,000: Investment in partnership New partner's proportionate book value [($110,000 + $40,000) x 1/3] Difference (investment < book value) Method: Bonus or goodwill to new partner Specified total resulting capital Total net assets not including goodwill ($110,000 + $40,000) Estimated goodwill $150,000 (150,000) $ -0$ 40,000 (50,000) $(10,000)

Therefore, bonus of $10,000 to new partner Borris' capital = $54,000 = $60,000 - ($10,000 x 6/10)

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E15-8 5. c

(continued) Pete invests $17,000; no goodwill recorded: Investment in partnership New partner's proportionate book value [($60,000 + $17,000) x 1/5] Difference (investment > book value) Method: Bonus to prior partners Pete's capital credit = $77,000 x 1/5 = $15,400 $17,000 (15,400) $ 1,600

6.

Direct purchase and computation of gain to prior partners: Selling price Book value of interest sold [($139,000 + $209,000 + $96,000) x 1/5] Gain to Ella and Nick $132,000 (88,800)* $ 43,200

*Tony acquired a one-fifth interest in the net assets of the partnership. 7. b Lute invests $25,000 and total capital specified as $90,000: Investment in partnership New partner's proportionate book value [($65,000 + $25,000) x 1/3] Difference (investment < book value) Method: Bonus or goodwill to new partner Specified Total net ($65,000 Estimated total resulting capital assets not including goodwill + $25,000) goodwill $90,000 (90,000) $ -0$25,000 (30,000) $(5,000)

Therefore, bonus of $5,000 to new partner Cash Fred, Capital ($5,000 x .70) Ralph, Capital ($5,000 x .70) Lute, Capital ($90,000 x 1/3) 8. b 25,000 3,500 1,500 30,000

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E15-9

Withdrawal of a Partner

a.

Karl receives $38,000 and no goodwill is recorded: Bonus to withdrawing partner: Payment Karls capital account Bonus paid Karl, Capital Luis, Capital ($8,000 x .80) Marty, Capital ($8,000 x .20) Cash $38,000 (30,000) $ 8,000 30,000 6,400 1,600 38,000

b.

Karl receives $40,000 and only the withdrawing partner's share of goodwill is recognized: Payment to Karl Karl's capital account Karl's share of goodwill Goodwill Karl, Capital Cash $42,000 (30,000) $12,000 12,000 30,000 42,000

c.

Recognize all implied goodwill on payment of $35,000: Karl's share of goodwill ($35,000 - $30,000 capital) 1/6 Total estimated goodwill Total estimated goodwill ($5,000 / .1667) Record goodwill: Goodwill Luis, Capital ($30,000 x .6667) Marty, Capital ($30,000 x .1667) Karl, Capital ($30,000 x .1667) 30,000 20,000 5,000 5,000

$5,000 $5,000 $30,000

Withdrawal of Karl: Karl, Capital Cash 35,000 35,000

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E15-10

Retirement of a Partner

Case 1: Bonus of $10,000 to Eddy Eddy, Capital Cobb, Capital ($10,000 x 3/5) Davis, Capital ($10,000 x 2/5) Cash Case 2: Distribution of Eddy's Share of Goodwill Goodwill Eddy, Capital Eddy, Capital Cash 4,000 4,000 74,000 74,000 70,000 6,000 4,000 80,000

Case 3: Bonus of $5,000 Distributed to Remaining Partners Eddy, Capital Cash Cobb, Capital ($5,000 x 3/5) Davis, Capital ($5,000 x 2/5) Case 4: Recognize Total Implied Goodwill Goodwill Cobb, Capital ($24,000 x 3/6) Davis, Capital ($24,000 x 2/6) Eddy, Capital ($24,000 x 1/6) Eddy, Capital Cash Case 5: Other Assets Disbursed Other Assets Cobb, Capital ($60,000 x 3/6) Davis, Capital ($60,000 x 2/6) Eddy, Capital ($60,000 x 1/6) Eddy, Capital Cash Other Assets 60,000 30,000 20,000 10,000 80,000 40,000 40,000 24,000 12,000 8,000 4,000 74,000 74,000 70,000 65,000 3,000 2,000

Case 6: Davis Directly Purchases Eddy's Capital Interest Eddy, Capital Davis, Capital 70,000 70,000

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SOLUTIONS TO PROBLEMS P15-11 a. Admission of a Partner

Wayne purchases one-half of Merina's investment for $90,000: Merina, Capital Wayne, Capital 80,000 80,000

b.

Wayne invests amount for one-third interest; no goodwill or bonus: 2/3 Total resulting capital Total resulting capital Amount to be invested by Wayne ($540,000 x 1/3) Cash Wayne, Capital $360,000 $540,000 $180,000 180,000 180,000

c.

Wayne invests $110,000 for a one-fourth interest; goodwill: Investment in partnership New partner's proportionate book value [($360,000 + $110,000) x 1/4] Difference (investment cost < book value) Method: Goodwill to new partner Step 1: 3/4 estimated total resulting capital Estimated total resulting capital ($360,000 / 3/4) Step 2: Estimated total resulting capital Total net assets not including goodwill ($360,000 + $110,000) Estimated goodwill to new partner Cash Goodwill Wayne, Capital $120,000 = $480,000 total resulting capital x .25 $110,000 (117,500) $ (7,500)

$360,000 $480,000

$480,000 (470,000) $ 10,000 110,000 10,000 120,000

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P15-11 d.

(continued)

Wayne invests $100,000 for a one-fourth interest. Some inventory is obsolete. Investment in partnership New partner's proportionate book value [($360,000 + $100,000) x 1/4] Difference (investment cost < book value) $100,000 (115,000) $(15,000)

Method: Asset revaluation decrease to prior partners Step 1: 1/4 estimated total resulting capital Estimated total resulting capital ($100,000 / 1/4) Step 2: Estimated total resulting capital Total net assets before inventory write-down ($360,000 + $100,000) Inventory write-down required Record write-down: Debra, Capital ($60,000 x .60) Merina, Capital ($60,000 x .40) Inventory Record admission of Wayne: Cash Wayne, Capital $100,000 = 1/4 of $400,000 resulting total capital after write-down 100,000 100,000 36,000 24,000 60,000

$100,000 $400,000

$400,000 (460,000) $(60,000)

e.

Wayne purchases one-fourth interest directly from Debra and Merina. revalued. New partner's proportionate book value ($360,000 x 1/4) Method stated: Increase land valuation Step 1: 1/4 estimated total resulting capital ($80,000 + $60,000) Estimated total resulting capital ($140,000 / 1/4)

Land

$90,000

$140,000 $560,000

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P15-11

(continued) Step 2: Estimated total resulting capital Total net assets before land revaluation ($200,000 + $160,000) Increase in value of land

$560,000 (360,000) $200,000

Revalue land: Land Debra, Capital ($200,000 x .60) Merina, Capital ($200,000 x .40) Reclassification of capital for admission of Wayne: Debra, Capital ($320,000 x .25) Merina, Capital ($240,000 x .25) Wayne, Capital $140,000 = 1/4 of $560,000 total resulting capital after recording increase in value of land 80,000 60,000 140,000 200,000 120,000 80,000

f.

Wayne invests $80,000 for a one-fifth interest; total capital specified as $440,000: Investment in partnership New partner's proportionate book value [($360,000 + $80,000) x 1/5] Difference (investment cost < book value) Method: Bonus or goodwill to new partner Specified total resulting capital Total net assets not including goodwill ($360,000 + $80,000) Estimated goodwill Therefore, bonus of $8,000 to new partner Cash Debra, Capital ($8,000 x .60) Merina, Capital ($8,000 x .40) Wayne, Capital ($440,000 x 1/5) 80,000 4,800 3,200 88,000 $440,000 (440,000) $ -0$ 80,000 (88,000) $ (8,000)

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-11 g.

(continued)

Wayne invests $100,000 for a one-fifth interest; goodwill recorded. Investment in partnership New partner's proportionate book value [($360,000 + $100,000) x 1/5] Difference (investment cost > book value) Method: Goodwill to prior partners Step 1: 1/5 estimated total resulting capital Estimated total resulting capital ($100,000 / 1/5) Step 2: Estimated total resulting capital Total net assets not including goodwill ($360,000 + $100,000) Estimated goodwill to prior partners Record goodwill: Goodwill Debra, Capital ($40,000 x .60) Merina, Capital ($40,000 x .40) Admission of Wayne: Cash Wayne, Capital $100,000 = 1/5 of $500,000 total resulting capital after recording goodwill of $40,000 Balance Sheet Prior partners capital $360,000 100,000 100,000 40,000 24,000 16,000 $100,000 (92,000) 8,000

$100,000 $500,000

$500,000 (460,000) $ 40,000

Prior to admission of new partner Wayne Net Assets $360,000 New partners cash investment Cash 100,000 Capital prior to recognizing goodwill $460,000 Estimated new goodwill Goodwill 40,000 Total resulting capital Net Assets $500,000

New tangible capital 100,000

$460,000 Capital from goodwill 40,000 Total resulting capital $500,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-12 a.

Division of Income

Distribution of $78,960 income: Eastwood Profit ratio Ending capital 3 $28,000 North 3 $40,000 West 4 $48,000 Total 10

Net income Salary $15,000 Bonusa 3,760 Interest on ending capital balance (10%) 2,800 Residual income Allocate 3:3:4 3,180 Total $24,740

$20,000

$18,000

$78,960 (53,000) (3,760) (11,600) $10,600 (10,600) $ -0-

4,000 3,180 $27,180

4,800 4,240 $27,040

Bonus B 20B 21B B

= = = = =

.05(Net Income - Bonus) .05($78,960 - B) $78,960 - B $78,960 $3,760

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-12 b.

(continued)

Distribution of $68,080 net income: Average capital for Eastwood Months Maintained 4 4 4 12 Months x Dollar Balance $120,000 144,000 112,000 $376,000 $31,333

Date 1/1 5/1 9/1 Total

Debit

Credit

Balance $30,000 36,000 28,000

$6,000 $8,000

Average capital ($376,000 / 12 months)

Average capital for North Months Maintained 2 4 2 4 12 Months x Dollar Balance $ 80,000 124,000 72,000 160,000 $436,000 $36,333

Date 1/1 3/1 7/1 9/1 Total

Debit

Credit

Balance $40,000 31,000 36,000 40,000

$9,000 $5,000 4,000

Average capital ($436,000 / 12 months)

Average capital for West Months Maintained 3 2 2 5 12 Months x Dollar Balance $150,000 114,000 120,000 240,000 $624,000 $52,000

Date 1/1 4/1 6/1 8/1 Total

Debit

Credit

Balance $50,000 57,000 60,000 48,000

$7,000 3,000 $12,000

Average capital ($624,000 / 12 months)

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-12

(continued)

Distribution of $68,080 income: Eastwood Profit ratio Average capital 1 $31,333 North 1 $36,333 West 1 $52,000 Total 3

Net income Interest on average capital balance (10%) $ 3,133 Salary 24,000 Bonusa Residual income (deficit) Allocate 1:1:1 (6,055) Total $21,078

$ 68,080 $ 3,633 21,000 4,280 (6,055) $22,858 $ 5,200 25,000 (11,966) (70,000) (4,280) $(18,166) 18,166 $ -0-

(6,056) $24,144

Bonus B B 10B 11B B

= = = = = =

.10(Net Income - Bonus - North's Salary) .10($68,080 - B - $21,000) .10($47,080 - B) $47,080 - B $47,080 $4,280

c.

Distribution of $92,940 net income: Eastwood Profit ratio Beginning capital Net income Bonusa Salary Interest on beginning capital balance (10%) Residual income Allocate 8:7:5 Total 8 $30,000 North 7 $40,000 West 5 $50,000 Total 20

$21,000 3,000 8,180 $32,180

$18,000 4,000 7,158 $29,158

$ 6,490 15,000 5,000 5,112 $31,602

$92,940 (6,490) (54,000) (12,000) $20,450 (20,450) $ -0-

Bonus B B 5B 6B B

= = = = = =

.20(Net Income - Bonus - Salaries) .20($92,940 - B - $54,000) .20($38,940 - B) $38,940 - B $38,940 $6,490

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-13 a.

Determining a New Partner's Investment Cost (No goodwill or bonus recorded) 200,000 Snider, Capital ($800,000 x 1/4) .75 estimated total resulting capital Estimated total resulting capital ($600,000 / .75) Prior capital Cash contribution required from Snider $600,000 $800,000 (600,000) $200,000 200,000

$200,000 Cash

b.

$210,000

(Goodwill of $30,000 to prior partners) 30,000 12,000 9,000 9,000 210,000 Snider, Capital ($840,000 x 1/4) 210,000 $630,000 $840,000 (630,000) $210,000

Goodwill Der, Capital ($30,000 x .40) Egan, Capital ($30,000 x .30) Oprins, Capital ($30,000 x .30) Cash

.75 estimated total resulting capital Estimated total resulting capital ($630,000 / .75) Prior capital after goodwill recognition Cash contribution required from Snider

c.

$232,000 Cash

(Bonus of $24,000 to be paid to Snider) 232,000 Der, Capital ($24,000 x .40) Egan, Capital ($24,000 x .30) Oprins, Capital ($24,000 x .30) Snider, Capital ($832,000 x 1/4) 9,600 7,200 7,200 208,000

.75 estimated total resulting capital ($600,000 + $24,000 bonus) Estimated total resulting capital ($624,000 / .75) Prior capital before bonus from Snider Cash contribution required from Snider

$624,000 $832,000 (600,000) $232,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-13 d.

(continued) (New partner given $10,000 of goodwill) 190,000 10,000 200,000 $600,000 $800,000 (600,000) $200,000 (10,000) $190,000

$190,000

Cash Goodwill Snider, Capital ($800,000 x 1/4) .75 estimated total resulting capital Estimated total resulting capital ($600,000 / .75) Prior capital Capital credit to Snider Goodwill to Snider Cash contribution required from Snider

e.

$220,000

(Other assets increased by $20,000 and goodwill of $40,000 allocated to prior partners) 20,000 40,000 24,000 18,000 18,000 220,000 Snider, Capital ($880,000 x 1/4) 220,000

Other Assets Goodwill Der, Capital ($60,000 x .40) Egan, Capital ($60,000 x .30) Oprins, Capital ($60,000 x .30) Cash

.75 estimated total resulting capital ($600,000 + $60,000 revaluation and goodwill) Estimated total resulting capital ($660,000 / .75) Prior capital after recognition of asset revaluation and goodwill to prior partners Cash contribution required from Snider

$660,000 $880,000 (660,000) $220,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-13 f.

(continued) (No goodwill; total resulting capital is $820,000) 220,000 Der, Capital ($15,000 x .40) Egan, Capital ($15,000 x .30) Oprins, Capital ($15,000 x .30) Snider, Capital ($820,000 x 1/4) Specified total resulting capital Prior capital Cash contribution required from Snider Investment in partnership New partner's proportionate book value [($600,000 + $220,000 ) x .25] Difference (investment > book value) Method: Bonus of $15,000 to prior partners $820,000 (600,000) $220,000 $220,000 (205,000) $ 15,000 6,000 4,500 4,500 205,000

$220,000 Cash

g.

$140,000

(Other assets decreased $20,000; bonus of $40,000 to new partner) 8,000 6,000 6,000 20,000 140,000 16,000 12,000 12,000 180,000

Der, Capital ($20,000 x .40) Egan, Capital ($20,000 x .30) Oprins, Capital ($20,000 x .30) Other Assets Cash Der, Capital ($40,000 x .40) Egan, Capital ($40,000 x .30) Oprins, Capital ($40,000 x .30) Snider, Capital ($720,000 x 1/4) .75 estimated total resulting capital after asset write-downs and bonus to new partner ($600,000 - $60,000) Estimated total resulting capital ($540,000 / .75) Prior capital after asset write-downs and bonus to new partner Capital credit to Snider Bonus to Snider Cash contribution required from Snider

$540,000 $720,000 (540,000) $180,000 (40,000) $140,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-14 a.

Division of Income

Distribution of $64,260 net income: Average capital for Luc Months Maintained 3 4 5 12 Months x Dollar Balance $150,000 220,000 200,000 $570,000 $47,500

Date 1/1 4/1 8/1 Total

Debit

Credit $ 5,000

$15,000

Balance $50,000 55,000 40,000

Average capital ($570,000 / 12 months)

Average capital for Dennis Months Maintained 6 2 4 12 Months x Dollar Balance $420,000 120,000 330,000 $870,000 $72,500

Date 1/1 7/1 9/1 Total

Debit

Credit

Balance $70,000 60,000 82,500

$10,000 $22,500

Average capital ($870,000 / 12 months)

Luc Profit ratio Average capital Net income Salary Interest on average capital (10%) Bonusa Residual income Allocate 3:2 Total
a

Dennis 2 $72,500

Total 5

3 $47,500

$24,000 4,750 3,060 (1,680) $30,130

$28,000 7,250

(1,120) $34,130

$64,260 (52,000) (12,000) (3,060) $(2,800) 2,800 $ -0-

Bonus B 20B 21B B

= = = = =

.05(Net Income - Bonus) .05($64,260 - B) $64,260 - B $64,260 $3,060

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-14 b.

(continued)

Distribution of $108,700 income: Luc Profit ratio Ending capital balance after deducting salaries of $24,000 for Luc and $28,000 for Dennis Net income Salary Interest on ending capital balance (10%) Bonusa Residual income Allocate 1:1 Total
a

Dennis 1

Total 2

$16,000

$54,500 $108,700 (52,000) (7,050) (4,200) $ 45,450 (45,450) $ -0-

$24,000 1,600 4,200 22,725 $52,525

$28,000 5,450

22,725 $56,175

Bonus B 12.50B 13.50B B

= = = = =

.08(Net Income - Bonus - Salaries) .08($108,700 - B - $52,000) $56,700 - B $56,700 $ 4,200

c.

Distribution of $76,950 income: Luc Profit ratio Beginning capital balance Net income Salary Interest on beginning capital balance (10%) Bonusa Residual income Allocate 4:2 Total
a

Dennis 2 $70,000

Total 6

4 $50,000

$24,000 5,000 8,550 2,933 $40,483

$28,000 7,000

$76,950 (52,000) (12,000) (8,550) $ 4,400 (4,400) $ -0-

1,467 $36,467

Bonus B 8B 9B B

= = = = =

.125(Net Income - Bonus) .125($76,950 - B) $76,950 - B $76,950 $8,550

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-15 a.

Withdrawal of a Partner under Various Circumstances Spade's capital interest was acquired in a personal transaction with Jack. Spade, Capital Jack, Capital 120,000 120,000

b.

Amount paid by Jack for Spade's capital interest Recorded amount of Spade's capital interest Goodwill attributable to Spade Spade's share of profits/losses Implied value of the partnership's goodwill ($30,000 / .50)__allocated to all partners in the ratio 20:30:50 Goodwill Ace, Capital (.20 x $60,000) Jack, Capital (.30 x $60,000) Spade, Capital (.50 x $60,000) Spade, Capital($120,000 + 30,000) Jack, Capital 60,000

$150,000 (120,000) $ 30,000 50%

$60,000

12,000 18,000 30,000 150,000 150,000

c. The partnership paid a bonus to Spade upon retirement. the partnership after Spade's retirement was $290,000. Amount paid to Spade upon retirement Spade's capital credit Bonus paid to Spade__allocated to Ace and Jack in the ratio 40:60 Spade, Capital Ace, Capital (.40 x $60,000) Jack, Capital (.60 x $60,000) Cash Capital balances after retirement: Ace, Capital ($150,000 - $24,000) Jack, Capital ($200,000 - $36,000) Total capital 120,000 24,000 36,000

Total capital of

$180,000 (120,000) $ 60,000

180,000

$136,000 154,000 $290,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-15 d.

(continued) Capital of the partnership after Spade's

Spade was given cash and land. retirement was $310,000.

Ace Profit ratio Capital balances before Spade's retirement Gain recognized on transfer of land to Spade ($120,000 minus $100,000) Capital balances after allocation of gain 20% $150,000

Jack 30% $200,000

Spade 50% $120,000

4,000 $154,000

6,000 $206,000

10,000 $130,000

Amount paid to Spade ($60,000 cash and $120,000 land) Spade's capital interest__see above schedule Bonus to Spade allocated between Ace and Jack in the ratio 40:60 Land Ace, Capital (.20 x $20,000) Jack, Capital (.30 x $20,000) Spade, Capital (.50 x $20,000) Spade, Capital Ace, Capital (.40 x $50,000) Jack, Capital (.60 x $50,000) Cash Land Capital balances after Spade's retirement: Ace, Capital ($154,000 - $20,000) Jack, Capital ($206,000 - $30,000) Total capital 130,000 20,000 30,000 20,000

$180,000 (130,000) $ 50,000

4,000 6,000 10,000

60,000 120,000

$134,000 176,000 $310,000

e.

Spade was given $150,000 upon retirement, and the goodwill attributable to Spade was recognized. Amount paid to Spade Spade's capital interest Goodwill attributable to Spade Spade, Capital Goodwill Cash 120,000 30,000 150,000 $150,000 (120,000) $ 30,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-15 f.

(continued)

Spade was given $150,000 upon retirement, and goodwill applicable to the entire business was recorded. Amount paid to Spade Spade's capital interest Goodwill attributable to Spade Spade's share of profits/losses Goodwill attributable to the entire partnership $30,000/.50__allocated to all the partners in the ratio 20:30:50 $150,000 (120,000) $ 30,000 50%

$60,000

Goodwill Ace, Capital (.20 x $60,000) Jack, Capital (.30 x $60,000) Spade, Capital (.50 x $60,000) Spade, Capital Cash

60,000 12,000 18,000 30,000 150,000 150,000

g.

Spade was given land and a note payable upon retirement. Capital of the partnership after Spade's retirement was $360,000. Ace Profit ratio 20% Capital balances before Spade's retirement $150,000 Allocation of gain on transfer of land ($100,000 - $60,000 = $40,000) 8,000 Capital balances before Spade's retirement, adjusted for gain $158,000 Amount paid to Spade ($100,000 of land + $50,000 note) Spade's capital interest__adjusted Bonus given to Spade__allocated between Ace and Jack in the ratio 40:60 Land Ace, Capital (.20 x $40,000) Jack, Capital (.30 x $40,000) Spade, Capital (.50 x $40,000) Spade, capital Ace, Capital (.40 x $10,000) Jack, Capital (.60 x $10,000) Land Note Payable 140,000 4,000 6,000 100,000 50,000 Jack 30% $200,000 12,000 $212,000 Spade 50% $120,000 20,000 $140,000 $150,000 (140,000) $ 10,000 40,000 8,000 12,000 20,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-15

(continued)

Capital balances after Spade's retirement: Ace, Capital ($158,000 - $4,000) Jack, Capital ($212,000 - $6,000) Total capital

$154,000 206,000 $360,000

P15-16

Multiple Choice Questions__Initial Investments, Division of Income, Admission and Retirement of a Partner [AICPA Adapted]

1. d The contribution of noncash property into a partnership should be recorded by crediting the partner's capital account for the fair value of the property contributed. In effect, the partnership is acquiring the property from the partner at its fair value. 2. b The capital balances of William and Martha at the date of partnership formation are determined as follows: William $20,000 15,000 $35,000 Martha $30,000 15,000 40,000 $85,000 (10,000) $75,000 $80,000 15,000 $95,000 $19,000

Cash Inventory Building Furniture and Equipment Total Less mortgage assumed by partnership Amounts credited to capital 3. d Total of old partners' capital Investment by new partner Total of new partnership capital Capital amount credited to Johnson ($95,000 x .20)

$35,000

4. c

The capital balances of each partner are determined as follows: Apple $50,000 Blue $80,000 (35,000) $55,000 $50,000 $45,000 $55,000 Crown

Cash Property Mortgage assumed Equipment Amount credited to capital accounts

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-16

(continued)

5. d Since both partners have equal capital balances, Norbert's capital has to be increased to equal that of Moon's. Since Moon's capital balance is $60,000 and Norbert's is $20,000, an additional $40,000 has to be credited to Norbert's capital to make it equal Moon's capital. This additional amount credited to Norbert's capital is the goodwill that Norbert is bringing to the partnership. 6. a Moon's share of the net income of $25,000 is 60%, or $15,000.

7. d Crowe and Dagwood are getting a bonus from Elman, since the amount of Elman's investment into the partnership exceeds the amount credited to Elman's capital account. The bonus should be allocated to Crowe and Dagwood in their respective profit and loss ratio before the admission of Elman__the old profit and loss ratio. 8. b The net income of $80,000 is allocated to Blue and Green in the following manner:

Blue Salary allowances Remainder Allocation of the negative remainder in the 60:40 ratio Allocation of net income $55,000

Green $45,000

Net Income $ 80,000 (100,000) $(20,000)

(12,000) $43,000

(8,000) $37,000

20,000 -0-

9. c Jill received a bonus when she retired from the partnership. The bonus is being given to Jill by Bill and Hill, which means that the bonus is allocated to Bill's and Hill's capital accounts in their respective profit and loss sharing ratio.

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-17

Admission of a New Partner under Various Circumstances Total

a. Sea acquired a 25% capital interest directly from Can and Yu. assets were not changed. Can, Capital ($60,000 x .25) Yu, Capital ($90,000 x .25) Sea, Capital 15,000 22,500 37,500

b. Sea acquired a 25% capital interest directly from Can and Yu. Inventories and property, plant, and equipment were revalued. Total assets of the new partnership were $410,000. Inventories ($85,000 - $75,000) Property, Plant, and Equipment ($265,000 - $225,000) Can, Capital ($50,000 x .30) Yu, Capital ($50,000 x .70) Can, Capital ($60,000 + $15,000 x .25) Yu, Capital ($90,000 + $35,000 x .25) Sea, Capital 10,000 40,000 15,000 35,000 18,750 31,250 50,000

c. Sea invested $50,000 cash into the partnership for interest. Total capital of the new partnership was $200,000. Sea's investment into partnership Old partners' capital Total capital of new partnership Sea's capital credit (.25 x $200,000)

25%

capital

$ 50,000 150,000 $200,000 $ 50,000

Since Sea's investment = Sea's capital credit, there is no bonus or goodwill. Cash Sea, Capital d. Sea invested $80,000 cash into the partnership for interest. Total capital of the new partnership was $230,000. Sea's investment into partnership Old partners' capital Total capital of new partnership Sea's capital credit (.25 x $230,000) Bonus to old partners ($80,000 - $57,500): Allocated to Can and Yu 30:70 Cash Can, Capital (.30 x $22,500) Yu, Capital (.70 x $22,500) Sea, Capital 80,000 6,750 15,750 57,500 50,000 50,000 a 25% capital

$ 80,000 150,000 $230,000 $ 57,500 $ 22,500

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-17

(continued)

e. Sea invested $80,000 cash into the partnership for a 25% capital interest. Total capital of the new partnership was $320,000. Goodwill was recognized. Sea's investment into the partnership Old partners' capital Total capital, excluding goodwill Total capital, including goodwill Goodwill recognized__allocated to Can and Yu in the ratio of 30:70 Sea's capital credit (.25 x $320,000) Goodwill Can, Capital (.30 x $90,000) Yu, Capital (.70 x $90,000) Cash Sea, Capital 90,000 27,000 63,000 80,000 80,000 $ 80,000 150,000 $230,000 320,000 $ 90,000 $ 80,000

f. Sea invested $80,000 cash into the partnership for a 25% capital interest. Total capital of the new partnership was $320,000. Undervalued assets were revalued by the partnership. Sea's investment into the partnership Old partners' capital Total capital, excluding revalued assets Total capital, including revalued assets Asset revaluation__allocated to Can and Yu in the ratio 30:70 Sea's capital credit (.25 x $320,000) Inventories ($85,000 - $75,000) Property, Plant, and Equipment ($305,000 - $225,000) Can, Capital (.30 x $90,000) Yu, Capital (.70 x $90,000) Cash Sea, Capital 10,000 80,000 27,000 63,000 80,000 80,000 $ 80,000 150,000 $230,000 320,000 $ 90,000 $ 80,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-17

(continued) a 25% capital

g. Sea invested $30,000 cash into the partnership for interest. Total capital of the new partnership was $180,000. Sea's investment into the partnership Old partners' capital Total capital of new partnership Sea's capital credit (.25 x $180,000) Bonus to Sea, allocated to Can and Yu in the ratio of 30:70 ($45,000 minus $30,000) Cash Can, Capital (.30 x $15,000) Yu, Capital (.70 x $15,000) Sea, Capital 30,000 4,500 10,500

$ 30,000 150,000 $180,000 $ 45,000 $ 15,000

45,000

h. Sea invested $30,000 cash into the partnership for a 25% capital interest. Total capital of the new partnership was $200,000. Goodwill was recognized. Sea's investment into the partnership Old partners' capital Total capital, excluding goodwill Total capital, including goodwill Goodwill recognized Sea's capital credit (.25 x $200,000) Cash Goodwill ($50,000 - $30,000) Sea, Capital 30,000 20,000 50,000 $ 30,000 150,000 $180,000 200,000 $ 20,000 $ 50,000

i. Sea invested $30,000 cash into the partnership for a 25% capital interest. Total capital of the new partnership was $120,000. Overvalued assets are written down to their fair values. Sea's investment into the partnership Old partners' capital Total capital, including overvalued assets Total capital, excluding overvalued assets Overvalued assets__allocated to Can and Yu in the ratio 30:70 Sea's capital credit (.25 x $120,000) $ 30,000 150,000 $180,000 120,000 $ 60,000 $ 30,000

Can, Capital (.30 x $60,000) Yu, Capital (.70 x $60,000) Inventories ($75,000 - $65,000) Property, Plant, and Equipment ($225,000 - $175,000) Cash Sea, Capital

18,000 42,000 10,000 50,000 30,000 30,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-18

Partnership Formation, Operation, and Changes in Ownership

a. Entries to record the formation of the partnership and the events that occurred during 20X7: Cash Inventory Land Equipment Mortgage payable Installment Note Payable Jordan, Capital ($60,000 + $80,000 + $100,000 - $20,000) ONeal, Capital ($50,000 + $130,000 - $50,000) (1) Inventory Cash Accounts Payable Mortgage Payable Interest Expense Cash Installment Note Payable Interest Expense Cash Accounts Receivable Cash Sales Selling and General Expenses Cash Accrued Expenses Payable Depreciation Expense Accumulated Depreciation Jordan, Drawing ($200 x 52) ONeal, Drawing Cash Sales Income Summary (9) Cost of Goods Sold Inventory $90,000 = $80,000 beginning inventory + 30,000 purchases - 20,000 ending inventory 90,000 90,000 110,000 80,000 130,000 100,000 50,000 20,000 220,000 130,000 30,000 24,000 6,000 5,000 2,000 7,000 3,500 2,000 5,500 21,000 134,000 155,000 34,000 27,800 6,200 6,000 6,000 10,400 10,400 20,800 155,000 155,000

(2)

(3)

(4)

(5)

(6)

(7)

(8)

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-18

(continued) Income Summary Cost of Goods Sold Selling and General Expenses Depreciation Expense Interest Expense Income Summary Jordan, Capital ONeal, Capital Jordan, Capital ONeal, Capital Jordan, Drawing ONeal, Drawing 134,000 90,000 34,000 6,000 4,000 21,000 10,500 10,500 10,400 10,400 10,400 10,400

Schedule to allocate partnership net income for 20X7: Jordan 60% $220,000 ONeal 40% $130,000 Total 100% $350,000 $ 21,000 $ 6,600 12,000 (8,100) $10,500 $ 3,900 12,000 (5,400) $10,500 (10,500) $ 10,500 (24,000) $(13,500) 13,500 $ -0-

Profit percentage Beginning capital balance Net income ($155,000 revenue - $134,000 expenses) Interest on beginning capital balances (3%) Salaries Residual deficit Total

b. Jordan__ONeal Partnership Income Statement For the Year Ended December 31, 20X7 Sales Less cost of goods sold: Inventory, January 1 Purchases Goods available for sale Less inventory, December 31 Gross profit Less: Selling and general expenses Depreciation expense Operating income Nonoperating expense__interest Net income P15-18 c. Jordan__ONeal Partnership
McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

$155,000 $ 80,000 30,000 $110,000 ( 20,000) $34,000 6,000

(90,000) $ 65,000 (40,000) $ 25,000 (4,000) $ 21,000

(continued)

Balance Sheet At December 31, 20X7 Assets Cash Accounts Receivable Inventory Land Equipment(net) Total Assets Liabilities and Capital Liabilities: Accounts Payable Accrued Expenses Payable Installment Note Payable Mortgage Payable Total Liabilities Capital: Jordan, Capital $220,100 ONeal, Capital 130,100 Total Capital Total Liabilities and Capital $158,900 21,000 20,000 130,000 94,000 $423,900

6,000 6,200 16,500 45,000 $ 73,700

350,200 $423,900

d.

Hill's investment into the partnership Prior partners' capital Total capital of the new partnership Hill's capital credit (.20 x $450,000) Bonus allocated to Jordan and ONeal in the ratio 60:40

$ 99,800 350,200 $450,000 $ 90,000 $ 9,800

January 1, 20X8 journal entry: Cash Jordan, Capital (.60 x $9,800) ONeal, Capital (.40 x $9,800) Hill, Capital

99,800 5,880 3,920 90,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-19 a.

Division of Income

Determine net income for 20X3: Billings Expenses (excluding depreciation and uncollectibles expense but including the excess rent) Add: Uncollectible accounts expense on new client ($1,600 x .50) Depreciation expense: Old equipment ($13,000 x .10) New equipment ($5,000 x .10 x 1/2) Total expenses Profit for 20X3 $120,000

$29,350 800 1,300 250 (31,700) $ 88,300

b.

Distribute 20X3 profit: Candy Total profit Excess rent to be absorbed by Evans Percentage of billings: Candy__$44,000 x .20 Davis__$24,000 x .20 Evans__$22,000 x .20 *Flint__$18,000 x .20 Residual profit Candy__40% Davis__35% Evans__25% Davis Evans Flint Total $88,300 $ $ 8,800 $ 4,800 4,400 3,600 27,040 23,660 $35,840 $28,460 16,900 $20,400 $3,600 (900) 900 (8,800) (4,800) (4,400) (3,600) $67,600 (27,040) (23,660) (16,900) $ -0-

*Basis of $18,000 for computing Flint's 20%: Total expenses per income statement (Requirement a) Less: Excess rent Uncollectible accounts charged to income Apportionable expenses Apportionable expenses Total fees = $30,000 $120,000 = .25

$31,700 (900) (800) $30,000

New fees after April 1 Less: Pro rata share of expenses, at 25% Basis for computing Flint's 20%

$24,000 (6,000) $18,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-19 c.

(continued)

Statement of partners' capital for the year ended December 31, 20X3. Statement of Partners' Capital For the Year Ended December 31, 20X3 Candy Davis Evans Flint Total

Balance, January 1, 20X3 Net income for 20X3 Withdrawal Write-off of receivables contributed Balance, December 31, 20X3

$20,600 $10,600 $21,800 $ 53,000 35,840 28,460 20,400 $3,600 88,300 (5,200) (4,400) (5,800) (2,500) (17,900) (1,200) (450) $50,040 $34,210 $36,400 (1,650) $121,750

$1,100

Note: The receivables contributed by Candy and Davis that were uncollectible are chargeable to the capital accounts since their collectibility was guaranteed. The excess rent of $900 is an expense in determining profits since it represents the actual cost of using the facilities. Evans, by having agreed to absorb this portion of the rent expense, has effectively included this item in the profit and loss distribution.

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-20

Error Correction and Partnership Financial Statements

a. Income statement for 20X7 for the partnership Glidden Manufacturing Company Income Statement For the Year Ended December 31, 20X7 Sales ($68,800 cash + $4,300 receivables + $1,000 unrecorded) Cost of Goods Sold: Beginning Inventory Purchases paid for with cash Purchases still on account Unrecorded purchase Goods available for sale Ending inventory Cost of goods sold Operating expenses (cash) Depreciation expense Interest expense Net income

$74,100 $16,500 28,200 3,200 3,000 $50,900 (6,000) (44,900) (22,700) (800) (200) $ 5,500

b. Statement of partners capitals for the year 20X7 Glidden Manufacturing Company Statement of Partners Capitals For the Year Ended December 31, 20X7 Howard $15,500 2,750 $18,250 Pat $16,000 2,750 $18,750 Total $31,500 5,500 $37,000

Initial investments Profit distribution ($5,500 x .50) Balance, December 31, 20X7 c.

Journal entry to record admission of Mary with an investment of $20,000 for a one-third interest Investment in partnership Book value [($37,000 + $20,000) x 1/3] Difference (investment cost > book value) Method: Bonus to prior partners Cash 20,000 Howard, Capital ($1,000 x .50) Pat, Capital ($1,000 x .50) Mary, Capital $19,000 = $57,000 total resulting capital x 1/3 $20,000 (19,000) $ 1,000

500 500 19,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-21

Partnership Accounting__Cash to Accrual Comprehensive [AICPA Adapted]

a. Adjusting entries for Abbott, Robinson, and Stevens as of December 1, 20X6 (keyed to workpaper) (1) Prepaid Insurance Stevens, Capital Advances from Customers Abbott, Capital Robinson, Capital Adjust for year-end prepayments and accruals. 700 20 200 400 120

Computation of effect on capital account balances: Increase (Decrease) in Capital Account Balance 20X6 20X5 Prepaid insurance: December 31, 20X6 December 31, 20X5 Advances from customers: December 31, 20X6 December 31, 20X5 Accrued interest expense: December 31, 20X5 $ 700 (650) (200) 1,100 450 $1,400

650

(1,100) (450) $ (900)

Distribution of increase (decrease) in capital account balances: Total Increase in 20X6 income (distributed in 5:3:2 ratio) Decrease in 20X5 income (distributed equally) Increase (decrease) in capital account balances $1,400 (900) $ 500 Abbott $700 (300) $400 Robinson $420 (300) $120 Stevens $280 (300) $(20)

(2)

Provision for Future Inventory Losses Abbott, Capital Robinson, Capital Stevens, Capital Remove provision for anticipated declines in inventory prices from 20X6 expenses.

3,000 1,500 900 600

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-21 (3)

(continued) Equipment Accumulated Depreciation__Equipment Abbott, Capital Robinson, Capital Stevens, Capital Capitalize equipment expenditure erroneously charged to expense during 20X6 and to set up appropriate accumulated depreciation: $880 = $4,400 x .20 4,400 880 1,760 1,056 704

(4)

Abbott, Capital Robinson, Capital Stevens, Capital Allowance for Uncollectible Accounts Provide for an allowance for uncollectible accounts as follows: Current accounts ($40,00 x .85 x .02) Past due accounts ($40,000 x .15 x .05) Total

290 334 356 980

$680 300 $980

Computation of increase (decrease) in capital account balances: Allowance required at December 31, 20X5: Current accounts ($50,000 x .02) $1,000 Past due accounts ($4,000 x .05) 200 Allowance at December 31, 20X5 $1,200 Allowance at December 31, 20X6 (as shown above) (980) Decrease in allowance $ 220 To provide the required allowance as of December 31, 20X5, capital accounts must be decreased by $1,200. To adjust to the required allowance as of December 31, 20X6, capital accounts must be increased by $220. Distribution of increase (decrease) in capital account balances: Total Increase in 20X6 income (distributed in 5:3:2 ratio) Decrease in 20X5 income (distributed equally) Total $ 220 Abbott $ 110 (400) $(290) Robinson $ 66 Stevens $ 44

(1,200) $ (980)

(400) $(334)

(400) $(356)

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-21

(continued) (5) Abbott, Capital Robinson, Capital Stevens, Capital Goodwill Write off goodwill recorded on the books in 20X6. 2,500 1,500 1,000 5,000

Abbott, Robinson, and Stevens Workpaper to Adjust and Place All Accounts On the Accrual Basis (not required) December 31, 20X6 Adjusted General Ledger Trial Balance December 31, 20X6 Debit Credit 10,000 40,000 26,000 9,000 50,000 2,000 56,000 6,000 5,000 55,000 3,000 40,000 (2) 3,000 (4) 290 (5) 2,500 (4) 334 (5) 1,500 (1) 20 (4) 356 (5) 1,000 (1) 700 (3) 4,400 (3) 880 (5) 5,000 60,400 6,880 55,000 2,000

General Ledger Trial Balance December 31, 20X6 Debit Credit Cash Accounts Receivable Inventory Land Buildings Accumulated Depreciation__Buildings Equipment Accumulated Depreciation__Equipment Goodwill Accounts Payable Provision for Future Inventory Losses Capital, Abbott 10,000 40,000 26,000 9,000 50,000

Adjustments Debit Credit

Capital, Robinson

60,000

(1) 400 (2) 1,500 (3) 1,760 (1) 120 (2) 900 (3) 1,056 (2) (3) 600 704 700 (1) (4) 200 980 14,100

40,870

60,242

Capital, Stevens

30,000

29,928

Prepaid Insurance Advances from Customers Allowance for Uncollectibles Total

200 980 196,100

196,000

196,000

14,100

196,100

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P16-51 b.

(continued) Goodwill Abbott, Capital ($25,000 x.50) Robinson, Capital ($25,000 x .30) Stevens, Capital (25,000 x .20) Recognize goodwill to prior partners. Cash Kingston, Capital Record investment by new partner. Investment in partnership New partner's proportionate book value [($140,000 + $55,000 ) x 1/4] Difference (investment > book value) Method: Goodwill to prior partners Step 1: 1/4 estimated total resulting capital Estimated total resulting capital ($55,000 / 1/4) Step 2: Estimated total resulting capital Total net assets not including goodwill ($140,000 + $55,000) Estimated goodwill to prior partners $55,000 (48,750) $ 6,250 25,000 12,500 7,500 5,000

55,000 55,000

$ 55,000 $220,000

$220,000 (195,000) $ 25,000

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

P15-22A a.

Initial Investments and Tax Bases [AICPA Adapted]

Entry to record initial investments using GAAP accounting: Cash Computers and Printers Office Furniture Library Building Notes Payable Mortgage Payable Delaney, Capital Engstrom, Capital Lahey, Capital Simon, Capital Record initial investments in DELS partnership. 50,000 18,000 23,000 7,000 60,000 25,000 36,000 32,000 22,000 15,000 28,000

b.

Tax bases: Delaney Engstrom $26,000 Lahey $33,000 Simon $26,000

Tax basis of assets contributed Add: Partner's share of other partners' liabilities assumed by the partnership: $36,000 from Delaney x 1/4 $10,000 from Engstrom x 1/4 $15,000 from Lahey x 1/4 Less: Partner's liabilities assumed by other partners: $36,000 x 3/4 $10,000 x 3/4 $15,000 x 3/4 Total

$40,000

9,000 2,500 3,750 3,750

9,000 2,500

9,000 2,500 3,750

(27,000) (7,500) $19,250 $31,250 (11,250) $33,250 $41,250

McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2002

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