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, since the losses of a partnership
pass, for tax purposes, directly through to the owners, partnerships have historically been
used (especially in certain industries) to reduce or defer income taxes.

Several disadvantages also accrue from the partnership format. Each general partner, for
example, has unlimited liability for all debts of the business. This potential liability can be
especially significant in light of the concept of mutual agency, the right that each partner
has to create liabilities in the name of the partnership. Because of the risks created by
unlimited liability and mutual agency, the growth potential of most partnerships is severely
limited. Few people are willing to become general partners in an organization unless they
can maintain some day-to-day contact and control over the business.

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

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

3. The balance in each partner's capital account measures that partner's interest in the book
value of the business’ net assets. This figure arises from contributions, earnings, drawings,
and other capital transactions.

4. A Subchapter S corporation is formed legally as a corporation so that its owners enjoy

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

Use of this designation is quite restricted. To qualify as a Subchapter S Corporation, a

company can only have one class of stock and must have no more than 100 owners.
These owners can only be individuals, estates, certain tax-exempt entities, and certain
types of trusts. Most corporations that do not qualify as Subchapter S Corporations are
automatically Subchapter C Corporations. These entities are also corporations but they pay
income taxes when the income is earned. Additionally, the owners are liable for a second
income tax when dividends are distributed to them. Thus, the income earned by a
Subchapter C Corporation faces the double taxation effect commonly associated with
corporations.
5. In a general partnership, each partner can have unlimited liability for the debts of the
business. Therefore, a partner may face a significant risk, especially in connection with the
actions and activities of other partners. However, general partnerships are easy to form
and often serve well in smaller businesses where all partners know each other. The major
advantage of a general partnership is that all income earned by the business is only taxed
once when earned by the business so that no second tax is incurred when distributions are
made to owners.

A limited liability partnership (LLP) is very similar to a general partnership except in the
method by which a partner’s liability is measured. In an LLP, the partners can still lose their
entire investment and be held responsible for all contractual debts of the business such as
loans. However, partners cannot be held responsible for damages caused by other
partners. For example, if one partner carelessly causes damage and is sued, the other
partners are not held responsible.

A limited liability company can now be created in certain situations. This type of
organization is classified as a partnership for tax purposes so that the double-taxation
effect is avoided. However, the liability of the owners is limited to their individual
investments like a Subchapter C Corporation. Depending on state law, the number of
owners is not restricted in the same manner as a Subchapter S Corporation so that there is
a greater potential for growth.

6. The Articles of Partnership is a legal agreement that should be created as a prerequisite for
the formation of a partnership. This document defines the rights and responsibilities of the
partners in relation to the business and in relation to each other. Thus, it serves as a
governing document for the partnership. The Articles of Partnership may contain any
number of provisions but should normally specify each of the following:

a. Name and address of each partner

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

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

8. In forming a partnership, one or more of the partners may be contributing some factor
(such as an established clientele or an expertise) which is not viewed normally as an asset
in the traditional accounting sense. In effect, the partner will be receiving a larger capital
balance than the identifiable contributions would warrant.
 The bonus method of recording this transaction is to value and record only the identifiable
assets such as land and buildings. The capital accounts are then aligned to recognize the
proportionate interest being assigned to each partner's investment. If, for example, the
capital balances are to be equal, they are set at identical amounts that correspond in total
to the value of the identifiable assets.

As an alternative, the amounts contributed along with the established capital percentages
can be used to determine mathematically the implied total value of the business and the
presence of any goodwill brought into the business. This goodwill is recognized at the time
that the partnership is created so that the amount can be credited to the appropriate
partner.

9. The Drawing account measures the amount of assets that a particular partner takes from
the business during the current period. Often, only regularly allowed distributions are
recorded in the Drawing account with larger, more sporadic withdrawals being recorded as
direct reductions to the partner's capital balance.

10. At the end of each fiscal year, when revenues and expenses are closed out, some
assignment must be made of the resulting income figure since a partnership will have two
or more capital accounts rather than a single retained earnings balance. This allocation to
the capital accounts is based on the agreement established by the partners preferably as a
part of the Articles of Partnership.

11. The allocation process can be based on any number of factors. The actual assignment of
income should be designed to give fair and equitable treatment to each of the partners.
Often, an interest factor is used to reward the capital investment of the partners. A salary
allowance is utilized as a means of recognizing the amount of time worked by an individual
or a certain degree of business expertise. The allocation process can be further refined by
a ratio that is either divided evenly among the partners or weighted in favor of one or more
members.

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

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

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

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

a. The right of co-ownership of the business property;

b. The right to a specified allocation of profits and losses generated by the partnership's
business; and
c. The right to participate in the management of the business.

No problem exists in selling or assigning the first two of these rights. However, the right to
participate in management decisions can only be transferred with the consent of all
partners.

16. Any goodwill being recognized in a capital transaction that is allocated to the original
partners is based on the profit and loss ratio. The amount is assumed to represent
unrealized gains in the value of the business. To determine the amount of goodwill, the
implied value of the business as a whole must be calculated based on the price being paid
for a portion by the new partner. The difference between this implied value and the total
capital is assumed to be goodwill or some other adjustment to asset value.

17. Allocating goodwill to an entering partner may be necessary for several reasons. One of
the most common is that the partner is bringing to the partnership an attribute that is not an
asset in the traditional accounting sense. For example, a new partner with an excellent
business reputation might be credited with goodwill at the time of entrance. Other factors
such as an established clientele or a professional expertise can justify attributing goodwill
to the new partner. The partnership might make this same concession to an entering
partner if cash is urgently needed by the business and a larger share of the capital has to
be offered as an enticement to generate the new investment.

18. Book values in most cases measure historical cost expenditures which often have
undergone years of allocation and changes in value. For this reason, book value will
frequently fail to mirror or even resemble the actual worth of a business. In addition, the
goodwill that is assumed to be present in a business as a going concern is not a factor that
is always reflected within book values. Therefore, distributing partnership property to a
withdrawing partner based on book value would not necessarily be fair. Hence, the Articles
of Partnership should spell out a method by which an equitable settlement can be
achieved.
Answers to Problems

1. B

2. C

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

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

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

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

$70,000 + Goodwill = .30 ($280,000 + $70,000 + Goodwill)
$70,000 + Goodwill = $105,000 + .30 Goodwill
.70 Goodwill = $35,000
Goodwill = $50,000
Danville's Investment (Capital) = $70,000 + $50,000 or $120,000

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

current capital total is only $600,000, goodwill of $200,000 must be
recognized. Oscar's investment is going to the partners so that it does not
affect the capital total directly. Of the $200,000 in goodwill, 30 percent or
$60,000 is attributed to Jethro which brings that capital balance to
$260,000. Since a 25 percent interest is being conveyed to the new partner,
Jethro's balance will then decrease by 25% or $65,000—a drop to $195,000.

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

investment. As Kansas's portion is to be 30 percent, the capital balance
would be $60,000 ($200,000 × 30%). Since only $50,000 was paid, a bonus
of $10,000 must be taken from the two original partners based on their
profit and loss ratio: Bolcar – $7,000 (70%) and Neary – $3,000 (30%). The
reduction drops Neary's capital balance from $40,000 to $37,000.

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

investment. However, the implied value of the business based on the new
investment is $300,000 ($60,000/20%). Thus, goodwill of $30,000 must be
recognized with the offsetting allocation to the original partners based on
 their profit and loss ratio: Bishop – $18,000 (60%) and Cotton $12,000
(40%). The increase raises Cotton's capital from $90,000 to $102,000.

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

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

9. D ASSIGNMENT OF INCOME—2007
ARTHUR BAXTER CARTWRIGHT TOTAL
Interest—10% of
beginning capital ............... $ 6,000 $ 8,000 $10,000 $24,000
Salary........................................ 20,000 20,000
Allocation of remaining income
($6,000 divided on a 3:3:4 basis) 1,800 1,800 2,400 6,000
Totals ............................. $ 7,800 $29,800 $12,400 $50,000

STATEMENT OF CAPITAL—2007
ARTHUR BAXTER CARTWRIGHT TOTAL
Beginning capital .................... $60,000 $80,000 $100,000 $240,000
Net income (above) ................. 7,800 29,800 12,400 50,000
Drawings (given) ..................... (5,000) (5,000) (5,000) (15,000)
Ending capital ......................... $62,800 $104,800 $107,400 $275,000

10. A ASSIGNMENT OF INCOME—YEAR ONE

WINSTON DURHAM SALEM TOTAL
Interest—10% of
beginning capital ............... $11,000 $ 8,000 $11,000 $30,000
Salary........................................20,000 -0- 10,000 30,000
Allocation of remaining loss
($80,000 divided on a 5:2:3 basis) (40,000) (16,000) (24,000) (80,000)
Totals ............................. $(9,000) $ (8,000) $ (3,000) $(20,000)

STATEMENT OF CAPITAL—YEAR ONE

WINSTON DURHAM SALEM TOTAL
Beginning capital .................... $110,000 $80,000 $110,000 $300,000
Net loss (above) ...................... (9,000) (8,000) (3,000) (20,000)
Drawings (given) ..................... (10,000) (10,000) (10,000) (30,000)
Ending capital .................... $ 91,000 $62,000 $ 97,000 $250,000
10. (continued)

ASSIGNMENT OF INCOME—YEAR TWO

WINSTON DURHAM SALEM TOTAL
Interest—10% of
beginning capital ............... $ 9,100 $ 6,200 $ 9,700 $25,000
Salary........................................20,000 -0- 10,000 30,000
Allocation of remaining loss
($15,000 divided on a 5:2:3 basis) (7,500) (3,000) (4,500) (15,000)
Totals ............................. $21,600 $3,200 $15,200 $ 40,000

STATEMENT OF CAPITAL—YEAR TWO

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

11. A A $10,000 bonus is paid to Costello ($100,000 is paid rather than the
$90,000 capital balance). This bonus is deducted from the two remaining
partners according to their profit and loss ratio (2:3). A reduction of 60
percent (3/5) is assigned to Burns or a decrease of $6,000 which drops that
partner’s capital balance from $30,000 to $24,000.

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

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

20% of Goodwill = $10,000

.20 G = $10,000
G = $10,000/.20
G = $50,000

Montana is assigned 30% of all profits and losses and would, therefore,
record $15,000 of this goodwill, an entry that raises this partner's capital
balance from $130,000 to $145,000.

13. A The implied value of the company is $900,000 ($270,000/30%). Since the
money is going to the partners rather than into the business, the capital
total is $490,000 before realigning the balances. Hence, goodwill of
$410,000 must be recognized based on the implied value ($900,000 –
$490,000). This goodwill is assumed to represent unrealized business
gains and is attributed to the original partners according to their profit and
loss ratio. They will then each convey 30 percent ownership of the $900,000
partnership to Darrow for a capital balance of $270,000.
14. D Since the money goes into the business, total capital becomes $740,000
($490,000 + $250,000). Darrow is allotted 30 percent of this total or
$222,000. Because Darrow invested $250,000, the extra $28,000 is assumed
to be a bonus to the original partners. Jennings will be assigned 40 percent
of this extra amount or $11,200. This bonus increases Jennings’ capital
from $160,000 to $171,200.

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

a. Goodwill Method
Implied value of partnership ($80,000/40%) .................. $200,000
Total capital after investment ($70,000 + $40,000 + $80,000) 190,000
Goodwill ............................................................................ $ 10,000

Goodwill to Hamlet (7/10) ............................................... $ 7,000

Goodwill to MacBeth (3/10) ............................................ $ 3,000

Hamlet, capital (original balance plus goodwill) .......... $ 77,000

MacBeth, capital (original balance plus goodwill) ....... $ 43,000

Lear, capital (payment) (40% of total capital) ............... $ 80,000

b. Bonus Method
Total capital after investment ($70,000 + 40,000 + $80,000) $190,000
Ownership portion—Lear ................................................ 40%
Lear, capital ...................................................................... $ 76,000

Bonus payment made by Lear ($80,000 – $76,000)...... $ 4,000

Bonus to Hamlet (7/10) .................................................... $ 2,800

Bonus to MacBeth (3/10) ................................................. $ 1,200

Hamlet, capital (original balance plus bonus) .............. $ 72,800

MacBeth, capital (original balance plus bonus) ........... $ 41,200

Lear, capital (40% of total capital) ................................. $ 76,000

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

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

Cash ............................................................................ 100,000

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

Part b.
Total capital is $260,000 ($85,000 + $60,000 + $55,000 + $60,000) after the
new investment. As Sergio's portion is to be 25 percent, this partner's
capital balance would be $65,000. Because only $60,000 was paid, a bonus
of $5,000 is taken from the three original partners based on their profit and
loss ratio: Tiger—$2,500 (50%), Phil—$1,500 (30%), and Ernie—$1,000
(20%).

Cash ............................................................................ 60,000

Tiger, Capital ............................................................... 2,500
Phil, Capital ................................................................. 1,500
Ernie, Capital .............................................................. 1,000
Sergio, Capital ....................................................... 65,000

Part c.
Total capital is $272,000 ($85,000 + $60,000 + $55,000 + $72,000) after the
new investment. However, the implied value of the business based on the
new investment is $288,000 ($72,000/25%). Consequently, goodwill of
$16,000 must be recognized with the offsetting allocation to the original
partners based on their profit and loss ratio: Tiger—$8,000 (50%), Phil—
$4,800 (30%), and Ernie—$3,200 (20%).

Goodwill ..................................................................... 16,000

Tiger, Capital ......................................................... 8,000
Phil, Capital ........................................................... 4,800
Ernie, Capital ......................................................... 3,200
Cash ............................................................................. 72,000
Sergio, Capital ....................................................... 72,000
17. (16 Minutes) (Determine capital balances after admission of new partner using
both goodwill and bonus methods)

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

G's Investment = .18 ($200,000 + $120,000 + $90,000 + G's Investment)

$80,000 + Goodwill = .18 ($410,000 + $80,000 + Goodwill)
$80,000 + Goodwill = $88,200 + .18 Goodwill
.82 Goodwill = $8,200
Goodwill = $10,000

The above goodwill balance indicates that Grant's total investment is

$90,000 (cash of $80,000 and goodwill of $10,000). A $90,000 contribution
raises the total capital to $500,000 so that Grant does, indeed, have an 18
percent interest ($90,000/$500,000).

CAPITAL BALANCES:
Nixon ...................................................................... $200,000
Hoover .................................................................... 120,000
Polk ...................................................................... 90,000
Grant ...................................................................... 90,000

Part b.
Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after
the new investment. As Grant's portion is to be 20 percent, this partner's
capital balance will be $102,000. Since only $100,000 was paid, a bonus of
$2,000 is taken from the three original partners based on their profit and
loss ratio: Nixon—$1,000 (50%), Hoover—$400 (20%), and Polk—$600
(30%).

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

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

Goodwill.................................................................. 44,000
Com, Capital ..................................................... 26,400
Pack, Capital .................................................... 17,600
Cash ...................................................................... 76,000
Hal, Capital ....................................................... 76,000

Part b.

Com Pack Hal Total

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

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

Jones King Lane Total

Bonus (20%) .......................... $18,000 $ -0- $ -0- $18,000
Interest (15% of average capital) 15,000 30,000 45,000 90,000
Remaining loss ($18,000) ... (6,000) (6,000) (6,000) (18,000)
Income assignment .............. $27,000 $24,000 $39,000 $90,000
20. (15 Minutes) (Allocate income and determine capital balances)

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)

Totals $ 8,600 $21,000 $(6,000) $23,600

CALCULATION OF PURKERSON'S INTEREST ALLOCATION

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

Balance, April 1—December 31 ($68,000 × 9) 612,000
Total ................................................................................... $792,000
Months...............................................................................  12
Average monthly capital balance ................................... $ 66,000
Interest rate ...................................................................... × 10%
Interest allocation (above) .............................................. $ 6,600

STATEMENT OF PARTNERS' CAPITAL

Purkerson Smith Traynor Totals
Beginning balances ............... $60,000 $40,000 $20,000 $120,000
Additional contribution ......... 8,000 -0- -0- 8,000
Income (above) ...................... 8,600 21,000 (6,000) 23,600
Drawings ($1,000 per month) (12,000) (12,000) (12,000) (36,000)
Ending capital balances........ $64,600 $49,000 $ 2,000 $115,600
21. (30 Minutes) (Allocate income for several years and determine ending capital
balances)

INCOME ALLOCATION—2009

Left Center Right Total

Interest (12% of beginning capital) $2,400 $ 7,200 $ 6,000 $ 15,600
Salary 12,000 8,000 -0- 20,000
Remaining income/loss:
$(30,000)
(15,600)
(20,000)
$(65,600) (19,680) (32,800) (13,120) (65,600)
Totals $(5,280) $(17,600) $(7,120) $(30,000)

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2009

Left Center Right Total

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

INCOME ALLOCATION—2010
Left Center Right Total
Interest(12% of beginning capital above) *$566 $3,888 $3,946 $ 8,400
Salary .................................. 12,000 8,000 -0- 20,000
Remaining income/loss:
$20,000
(8,400)
(20,000)
$(8,400) (2,520) (4,200) (1,680) (8,400)
Totals................... $10,046 $7,688 $2,266 $20,000
*Rounded

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2010

Left Center Right Total

Beginning balances (above) $ 4,720 $32,400 $32,880 $70,000
Additional investment ........ -0- -0- 12,000 12,000
Income allocation ............... 10,046 7,688 2,266 20,000
Drawings .............................. (10,000) (10,000) (10,000) (30,000)
Ending balances ............ $ 4,766 $30,088 $37,146 $72,000
21. (continued)
INCOME ALLOCATION—2011
Left Center Right Total
Interest (12% of beginning capital
above)* ............................ $ 572 $ 3,611 $4,457 $ 8,640
Salary ................................... 12,000 8,000 -0- 20,000
Remaining income:
$40,000
(8,640)
(20,000)
$11,360......................... 2,272 4,544 4,544 11,360
Totals.......................... $14,844 $16,155 $9,001 $40,000

*Rounded

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2011

Left Center Right Total
Beginning balances (above) $ 4,766 $30,088 $37,146 $72,000
Income allocation 14,844 16,155 9,001 40,000
Drawings (10,000) (10,000) (10,000) (30,000)
Ending balances $ 9,610 $36,243 $36,147 $82,000
22. (12 Minutes) (Determine capital balances after retirement of a partner using
both the goodwill and the bonus approaches)

a. Harrison receives an additional $30,000 about the capital balance. Since

Harrison is assigned 20 percent of all profits and losses, this extra
allocation indicates total goodwill of $150,000, which must be split among
all partners.

20% of Goodwill = $30,000

.20 G = $30,000
G = $150,000

CAPITAL BALANCES AFTER WITHDRAWAL

Original Balance Goodwill Withdrawal Final Balance
Lennon $230,000 $45,000 $275,000
McCartney 190,000 45,000 235,000
Harrison 160,000 30,000 $(190,000) -0-
Starr 140,000 30,000 170,000
Total $680,000

b. A $50,000 bonus is paid to Lennon ($280,000 is paid rather than the $230,000
capital balance). This bonus is deducted from the three remaining partners
according to their relative profit and loss ratio (3:2:1). A reduction of 50
percent (3/6) is assigned to McCartney or a decrease of $25,000 which drops
this partner's capital balance from $190,000 to $165,000. A reduction of 33.3
percent (2/6) is assigned to Harrison or a decrease of $16,667 which drops
this partner's capital balance from $160,000 to $143,333. A reduction of 16.7
percent (1/6) is assigned to Starr or a decrease of $8,333 which drops this
partner's capital balance from $140,000 to $131,667.
23. (45 Minutes) (Discussion of P&L allocations and admission of a new partner)

a. The interest factor was probably inserted to reward Page for contributing
$50,000 more to the partnership than Childers. The salary allowance gives
an additional $15,000 to Childers in recognition of the full-time (rather than
part-time) employment. The 40:60 split of the remaining income was
probably negotiated by the partners based on other factors such as
business experience, reputation, etc.

b. The drawings show the assets removed by a partner during a period of

time. A salary allowance is added to each partner's capital for the year
(usually in recognition of work done) and is a component of net income
allocation. The two numbers are often designed to be equal but agreement
is not necessary. For example, a salary allowance might be high to
recognize work contributed by one partner. The allowance increases the
appropriate capital balance. The partner might, though, remove little or no
money so that the partnership could maintain its liquidity.

c. Page, Drawings ........................................................... 5,000

Repair Expense ..................................................... 5,000
(To reclassify payment made to repair personal residence.)
Page, Capital ............................................................... 13,000
Childers, Capital ......................................................... 11,000
Page, Drawings (adjusted) ................................... 13,000
Childers, Drawings ............................................... 11,000
(To close drawings accounts for 2008.)
Revenues ..................................................................... 90,000
Expenses (adjusted by first entry) ...................... 59,000
Income Summary .................................................. 31,000
(To close revenue and expense accounts for 2008.)

Income Summary ........................................................ 31,000

Page, Capital ......................................................... 11,000
Childers, Capital .................................................... 20,000
(To close net income to partners' capital–see allocation plan shown below.)
Allocation of Income Page Childers
Interest (10% of beginning balance) $ 8,000 $ 3,000
Salary allowances 5,000 20,000
Remaining income (loss):
$31,000
(11,000)
(25,000)
$ (5,000) (2,000) (40%) (3,000) (60%)
$11,000 $20,000
23. (continued)
d. Total capital (original balances of $110,000 plus 2008
net income less drawings) ................................... $117,000
Investment by Smith .................................................. 43,000
Total capital after investment ................................... $160,000
Ownership portion acquired by Smith ..................... 20%
Smith, capital .............................................................. $ 32,000
Amount paid ................................................................ 43,000
Bonus paid by Smith—assigned to original partners $ 11,000

Bonus to Page (40%) .................................................. $4,400

Bonus to Childers (60%) ............................................ $6,600

Cash ............................................................................ 43,000

Smith, Capital (20% of total capital) ................... 32,000
Page, Capital ......................................................... 4,400
Childers, Capital .................................................... 6,600
24. (40 Minutes) (Reporting a change in the composition of a partnership)

a. Exact amount of investment can only be computed algebraically:

E Investment = 25% (Original Capital + E Investment)

El = .25 ($270,000 + El)
El = $67,500 + .25 El
.75 El = $67,500
E Investment = $90,000

b. Implied value of partnership ($36,000/10%)............. $360,000

Total capital after investment by E ($270,000 + $36,000) 306,000
Goodwill ...................................................................... $ 54,000
Allocation of Goodwill:
A (30%) ................................................................. $16,200
B (10%) ................................................................. 5,400
C (40%) ................................................................. 21,600
D (20%) ................................................................. 10,800
Total .................................................................. $54,000

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. Since E's investment of $42,000 is less than 20% of the resulting capital
($312,000). E is apparently bringing some other attribute to the partnership
(goodwill) that must be computed:

E Investment = 20% (Original Capital + E Investment)

$42,000 + Goodwill = .20 ($270,000 + $42,000 + Goodwill)
$42,000 + Goodwill = $62,400 + .20 Goodwill
.80 Goodwill = $20,400
Goodwill = $25,500

E's investment is, therefore, $42,000 in cash and $25,500 in goodwill for a total
capital balance of $67,500; the other capital accounts remain unchanged. Note
that E's capital of $67,500 is 20% of the new total capital $337,500 ($270,000 +
$67,500).
24.(continued)

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

Amount acquired by E ............................................... 20%
E's capital balance ..................................................... $ 65,000
E's payment ................................................................. 55,000
Bonus being given to E ............................................. $ 10,000

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

e. C's capital balance $ 90,000

C's collection (125%) 112,500
Bonus being paid to C $ 22,500

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
25. (55 Minutes) (Allocation of income to the partners and determination of capital
balances)

ALLOCATION OF INCOME—2008
Boswell Johnson Total
Salary (8 months) ................. $8,000 $-0- $ 8,000
Remaining $3,000 ................. 1,200 (40%)
3,000
Totals ................................ $9,200 $1,800 $11,000

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2008

Boswell Johnson Total
Beginning Balances ($114,000
Invested capital split evenly—
market value used for assets) $57,000 $57,000 $114,000
Income allocation (above) ... 9,200 1,800 11,000
Drawings ............................... - 0- - 0- - 0-
Ending balances ............. $66,200 $58,800 $125,000

WALPOLE INVESTMENT JANUARY 1, 2009

Walpole's $54,000 investment increases total capital to $179,000. Walpole is
credited with a 40% interest or $71,600. According to the problem, the excess
$17,600 is a bonus from the original partners. Of this amount, $10,560 is
allocated from Johnson (60%) and $7,040 from Boswell (40%).

ALLOCATION OF INCOME—2009

Boswell Johnson Walpole Total

Salary ..................................... $12,000 $-0- $24,000 $36,000
Remaining $8,000 loss ($28,000 –
$36,000) ............................ (960) (3,840) (3,200) (8,000)
Totals .......................... $11,040 $(3,840) $20,800 $28,000

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2009

Boswell Johnson Walpole Total

Beginning balances ............. $66,200 $58,800 $ -0- $125,000
Walpole's contribution ......... (7,040) (10,560) 71,600 54,000
Income allocation (above) ... 11,040 (3,840) 20,800 28,000
Drawings ............................... (5,000) (5,000) (10,000) (20,000)
Ending balances ............. $65,200 $39,400 $82,400 $187,000
26.(continued)
ADMISSION OF POPE—JANUARY 1, 2010
Pope's payment was made directly to the partners. Therefore, neither goodwill
nor a bonus need be recognized. Instead, 10% of each capital balance shown
above will be reclassified to Pope. The journal entry would be as follows:

Boswell, Capital ............................................................... 6,520

Johnson Capital ............................................................... 3,940
Walpole, Capital ............................................................... 8,240
Pope, Capital ............................................................... 18,700

ALLOCATION OF INCOME—2010

Boswell Johnson Walpole Pope Total

Salary $12,000 $-0- $24,000 $9,600 $45,600
Remaining $400 income 54 162 144 40 400
Totals $12,054 $162 $24,144 $9,640 $46,000

STATEMENT OF PARTNERSHIP CAPITAL—DECEMBER 31, 2010

Boswell Johnson Walpole Pope Total

Beginning balances $65,200 $39,400 $82,400 $-0- $187,000
Admission of Pope (6,520) (3,940) (8,240) 18,700 -0-
Allocation of income
(above) 12,054 162 24,144 9,640 46,000
Drawings (5,000) (5,000) (10,000) (4,000) (24,000)
Ending balances $65,734 $30,622 $88,304 $24,340 $209,000
26. (60 Minutes) (Allocate income and prepare a statement of partners' capital)

a. Income Allocation—2009
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.

Capital Account Balances—1/1/09 – 12/31/09

Gray Stone Lawson Totals

Beginning contributions $210,000 $180,000 $90,000 $480,000
Added Investment 9,100 -0- -0- 9,100
Profit allocation (from above) 29,965 23,477 11,558 65,000
Drawing (10% of beginning
balances) (21,000) (18,000) (9,000) (48,000)
Ending balances $228,065 $185,477 $92,558 $506,100

Prior to developing the information for 2010, a computation of Monet's

investment must be made:

Monet's Investment = 25% ($506,100 + Monet's Investment)

Ml = $126,525 + .25 Ml
.75 Ml = $126,525
Ml = $168,700
26. a. (continued)
Income Allocation—2010
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)

Capital Account Balances 1/1/10 – 12/31/10

Gray Stone Lawson Monet Totals
Beginning balances $228,065 $185,477 $92,558 $168,700 $674,800
Loss allocation (from
above) 4,684 (2,827) (14,937) (7,320) (20,400)
Drawings (10% of
beginning
balances) (22,806) (18,548) (9,256) (16,870) (67,480)
Ending balances $209,943 $164,102 $68,365 $144,510 $586,920

Income Allocation—2011
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
26. a. (continued)

Note B: The bonus to Gray and Stone can only be derived algebraically. Since
each of the two partners is entitled to 10% of net income as defined, the total
bonus is 20% and can be computed as follows:
Bonus = 20% (Net income – Salary – Interest – Bonus)
B = .2 ($152,800 – $51,120 – $70,430 – B)
B = .2 ($31,250 – B)
B = $6,250 – .2B
1.2 B = $6,250
B = $5,208 (or $2,604 per person)

Capital Account Balances 1/1/11 – 12/31/11

Gray Stone Lawson Monet Totals

Beginning balances $209,943 $164,102 $68,365 $144,510 $586,920
Profit allocation (from
above) 49,347 41,766 25,195 36,492 152,800
Drawings (10% of
beginning
balances) (20,994) (16,410) (6,837) (14,451) (58,692)
Ending balances $238,296 $189,458 $86,723 $166,551 $681,028

b.
GRAY, STONE, AND LAWSON
Statement of Partners' Capital
For Year Ending December 31, 2009

Gray Stone Lawson Totals

Beginning balances $210,000 $180,000 $90,000 $480,000
Added Investment 9,100 -0- -0- 9,100
Profit allocation 29,965 23,477 11,558 65,000
Drawings (21,000) (18,000) (9,000) (48,000)
Ending balances $228,065 $185,477 $92,558 $506,100
27. (40 Minutes) (Recording admission and retirement of partners using both the
bonus and goodwill methods)

a. Porthos, Capital .......................................................... 35,000

D'Artagnan, Capital ............................................... 35,000
(To reclassify half of Porthos's capital balance to reflect transfer of interest
to D'Artagnan.)

b. Goodwill ................................................................. 50,000

Athos, Capital (50%) ............................................ 25,000
Porthos, Capital (30%) ......................................... 15,000
Aramis, Capital (20%) .......................................... 10,000
(To record goodwill based on $250,000 implied value of partnership
[$25,000/10%]. Since current capital is only $200,000 [the $25,000 goes
directly to the partners], goodwill of $50,000 has to be recorded and
allocated using profit and loss ratio.)

Athos, Capital (10% of balance) ................................ 10,500

Porthos, Capital (10% of balance) ............................ 8,500
Aramis, Capital (10% of balance) .............................. 6,000
D'Artagnan, Capital................................................ 25,000
(To reclassify 10% of each partner's capital to reflect transfer of interest to
D'Artagnan.)

c. Cash ............................................................................ 30,000

D'Artagnan, Capital (10% of total capital)........... 23,000
Athos, Capital (50% of excess payment) ............ 3,500
Porthos, Capital (30% of excess payment) ........ 2,100
Aramis, Capital (20% of excess payment) .......... 1,400
(To record $30,000 payment by D'Artagnan which increases total capital to
$230,000. D'Artagnan is credited for only 10% of that balance with the extra
$7,000 payment being recorded as a bonus to the original partners.)

d. Cash ............................................................................ 30,000

Goodwill ...................................................................... 70,000
D'Artagnan, Capital ............................................... 30,000
Athos, Capital (50% of goodwill) ........................ 35,000
Porthos, Capital (30% of goodwill) .................... 21,000
Aramis, Capital (20% of goodwill) ....................... 14,000
(To record D'Artagnan's contribution to the partnership. The $30,000
payment for 10% interest indicates a $300,000 value for the business
although the capital balances would only increase to $230,000. The $70,000
difference is recorded as goodwill, an amount assigned to the original
partners.)
27. (continued)

e. Cash ............................................................................. 12,222

Goodwill . .................................................................... 10,000
D'Artagnan, Capital ............................................... 22,222
To record investment by D'Artagnan. The implied value of the investment as
a whole would be only $122,220 ($12,222/10%). Since the capital balances
are well in excess of this figure, D'Artagnan is apparently bringing some
other factor (goodwill) into the partnership. This goodwill can be computed
as follows:
$12,222 + Goodwill = 10% (Original Capital + $12,222 + Goodwill)
$12,222 + Goodwill = 10% ($200,000 + $12,222 + Goodwill)
$12,222 + Goodwill = $21,222 + .10 Goodwill
.90 Goodwill = $9,000
Goodwill = $10,000

f. Goodwill ...................................................................... 80,000

Athos, Capital (50%) ............................................. 40,000
Porthos, Capital (30%) .......................................... 24,000
Aramis, Capital (20%) ........................................... 16,000
(To record goodwill of $80,000 based on $280,000 appraisal of business.)

Aramis, Capital ........................................................... 66,000

Cash ...................................................................... 66,000
(To distribute cash to retiring partner based on final capital balance.)
28. (75 Minutes) (Recording of changes in the composition of a partnership
including allocation of income)

a. 1/1/08 Building ....................................................... 52,000

Equipment.................................................... 16,000
Cash ............................................................. 12,000
O'Donnell, Capital ................................. 40,000
Reese, Capital ....................................... 40,000
(To record initial investment. Assets recorded at fair value with
two equal capital balances.)

12/31/08 Reese, Capital ............................................ 22,000

O'Donnell, Capital ................................. 12,000
Income Summary .................................. 10,000
(The allocation plan specifies that O'Donnell will receive 20% in
interest [or $8,000 based on $40,000 capital balance] plus $4,000
more [since that amount is greater than 15% of the profits from
the period]. The remaining $22,000 loss is assigned to Reese.)

1/1/09 Cash ............................................................. 15,000

O'Donnell, Capital (15%) ............................ 300
Reese, Capital (85%) .................................. 1,700
Dunn, Capital ......................................... 17,000
(New investment by Dunn brings total capital to $85,000 after
2008 loss [$80,000 – $10,000 + $15,000]. Dunn's 20% interest is
$17,000 [$85,000 × 20%] with the extra $2,000 coming from the
two original partners [allocated between them according to their
profit and loss ratio].)

12/31/09 O'Donnell, Capital ...................................... 10,340

Reese, Capital ............................................ 5,000
Dunn, Capital .............................................. 5,000
O'Donnell, Drawings.............................. 10,340
Reese, Drawings ................................... 5,000
Dunn, Drawings .................................... 5,000
(To close out drawings accounts for the year based on
distributing 20% of each partner's beginning capital balances
[after adjustment for Dunn's investment] or $5,000 whichever is
greater. O'Donnell's capital is $51,700 [$40,000 + $12,000 – $300])

12/31/09 Income Summary ....................................... 44,000

O'Donnell, Capital ................................. 16,940
Reese, Capital ....................................... 16,236
Dunn, Capital ......................................... 10,824
(To allocate $44,000 income figure for 2009 as determined below.)
28. 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 spilt of remaining $27,060
income ........................................ $16,236 $10,824
Total .................................................. $16,940 $16,236 $10,824

Capital Balances as of December 31, 2009:

O'Donnell Reese Dunn
Initial 2008 investment .................... $40,000 $40,000
2008 profit allocation ...................... 12,000 (22,000)
Dunn's investment .......................... (300) (1,700) $17,000
2009 drawings ................................. (10,340) (5,000) (5,000)
2009 profit allocation ...................... 16,940 16,236 10,824
12/31/09 balances ............................ $58,300 $27,536 $22,824

1/1/10 Dunn, Capital .............................................. 22,824

Postner, Capital .................................... 22,824
(To reclassify balance to reflect
acquisition of Dunn's interest.)

12/31/10 O'Donnell, Capital ...................................... 11,660

Reese, Capital ............................................ 5,507
Postner, Capital .......................................... 5,000
O'Donnell, Drawings ............................. 11,660
Reese, Drawings ................................... 5,507
Postner, Drawings ................................ 5,000
(To close out drawings accounts for the
year based on 20% of beginning capital
balances [above] or $5,000 [whichever is
greater].)

12/31/10 Income Summary........................................ 61,000

O'Donnell, Capital ................................. 20,810
Reese, Capital ....................................... 24,114
Postner, Capital .................................... 16,076
(To allocate profit for 2010 determined as follows)

O'Donnell Reese Postner

Interest (20% of $58,300 beg. capital) $11,660
15% of $61,000 income ............. 9,150
60:40 split of remaining $40,190 ______ $24,114 $16,076
Totals................................ $20,810 $24,114 $16,076
28. a. (continued)
1/1/11 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.)

b. 1/1/08 Building........................................................ 52,000

Equipment ................................................... 16,000
Cash ............................................................. 12,000
Goodwill ...................................................... 80,000
O'Donnell, Capital ................................. 80,000
Reese, Capital ....................................... 80,000
(To record initial capital investments.
Reese is credited with goodwill of
$80,000 to match O'Donnell's
investment.)

12/31/08 Reese, Capital ............................................ 30,000

O'Donnell, Capital ................................. 20,000
Income Summary .................................. 10,000
(Interest of $16,000 is credited to
O'Donnell [$80,000 × 20%] along with a
base of $4,000. The remaining amount is
now a $30,000 loss that is attributed
entirely to Reese.)

1/1/09 Cash ............................................................. 15,000

Goodwill ...................................................... 22,500
Dunn, Capital ......................................... 37,500
(Cash and goodwill being contributed by
Dunn are recorded. Goodwill must be
calculated algebraically.)

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

$15,000 + Goodwill = 20% ($150,000 + $15,000 + Goodwill)
$15,000 + Goodwill = $33,000 + .2 Goodwill
.8 Goodwill = $18,000
Goodwill = $22,500
28. b. (continued)
12/31/09 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.)
12/31/09 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)

O'Donnell Reese Dunn

Interest (20% of $100,000
beginning capital balance) $20,000
15% of $44,000 income 6,600
60:40 split of remaining $17,400 $10,440 $6,960
Totals $26,600 $10,440 $6,960

Capital balances as of December 31, 2009:

O'Donnell Reese Dunn
Initial 2008 investment . . . $ 80,000 $80,000
2008 profit allocation ..... 20,000 (30,000)
Additional investment .... $37,500
2009 drawings ................. (20,000) (10,000) (7,500)
2009 profit allocation ..... 26,600 10,440 6,960
12/31/09 balances ........... $106,600 $50,440 $36,960
1/1/10 Goodwill ...................................................... 26,588
O'Donnell, Capital (15%) ...................... 3,988
Reese, Capital (51%) ............................ 13,560
Dunn, Capital (34%) .............................. 9,040
(To record goodwill indicated by purchase of Dunn's interest.)
In effect, profits are shared 15% to O'Donnell, 51% to Reese – (60% of the 85%
remaining after O'Donnell's income), and 34% to Dunn (40% of the 85%
remaining after O'Donnell's income). Postner is paying $46,000, an amount
$9,040 in excess of Dunn's capital ($36,960). The additional payment for this
34% income interest indicates total goodwill of $26,588 ($9,040/34%). Since
Dunn is entitled to 34% of the profits but only holds 19% of the total capital, an

28. b. (continued)

implied value for the company as a whole cannot be determined directly from
the payment of $46,000. Thus, goodwill can only be computed based on the
excess payment.

1/1/10 Dunn, Capital ................................................... 46,000

Postner, Capital .......................................... 46,000
(To reclassify capital balance to new partner.)
12/31/10 O'Donnell, Capital ............................................ 22,118
Reese, Capital .................................................. 12,800
Postner, Capital ............................................... 9,200
O'Donnell, Drawings .................................. 22,118
Reese, Drawings ........................................ 12,800
Postner, Drawings ...................................... 9,200
(To close out drawings accounts for the year based on 20% of
beginning capital balances [after adjustment for goodwill].)
12/31/10 Income Summary ............................................. 61,000
O'Donnell, Capital ...................................... 31,268
Reese, Capital ............................................ 17,839
Postner, Capital .......................................... 11,893
To allocate profit for 2010 as follows:
O'Donnell Reese Postner
Interest (20% of $110,588
beginning capital balance) $22,118
15% of $61,000 income ........ 9,150
60:40 spilt of remaining
$29,732 ............................. $17,839 $11,893
Totals................................ $31,268 $17,839 $11,893
Capital Balances as of December 31, 2010:
O'Donnell Reese Postner
12/31/09 balances ................. $106,600 $50,440 $36,960
Adjustment for goodwill ...... 3,988 13,560 9,040
Drawings................................ (22,118) (12,800) (9,200)
Profit allocation..................... 31,268 17,839 11,893
12/31/10 balances.................. $119,738 $69,039 $48,693
Postner will be paid $53,562 (110% of the capital balance) for her interest. This
amount is $4,869 in excess of the capital account. Since Postner is only
entitled to a 34% share of profits and losses, the additional $4,869 must
indicate that the partnership as a whole is undervalued by $14,321
(4,869/34%). Only in that circumstance would the extra payment to Postner be
justified:

28. b. (continued)

1/1/11 Goodwill ................................................................. 14,321

O'Donnell, Capital (15%) ................................. 2,148
 Reese, Capital (51%) ....................................... 7,304
Postner, Capital (34%) ..................................... 4,869
(To recognize implied goodwill.)
1/1/11 Postner, Capital ..................................................... 53,562
Cash ................................................................. 53,562
(To record final distribution to Postner.)