CHAPTER 14PARTNERSHIPS: 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 partnerb. Business locationc. Description of the nature of the businessd. Rights and responsibilities of each partnere. 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 allocatedg. Periodic withdrawals to be allowed each partnerh. Procedure for admitting new partnersi. Method for arbitrating partnership disputesj. 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; andc. 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 = $35,000Goodwill = $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—2007ARTHUR BAXTER CARTWRIGHT TOTAL

Interest—10% ofbeginning capital .............. $ 6,000 $ 8,000 $10,000 $24,000

Salary........................................ 20,000 20,000Allocation 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—2007ARTHUR BAXTER CARTWRIGHT TOTAL

Beginning capital ................... $60,000 $80,000 $100,000 $240,000Net income (above) ................ 7,800 29,800 12,400 50,000Drawings (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 ONEWINSTON DURHAM SALEM TOTAL

Interest—10% ofbeginning capital .............. $11,000 $ 8,000 $11,000 $30,000

Salary........................................ 20,000 -0- 10,000 30,000Allocation 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 ONEWINSTON DURHAM SALEM TOTAL

Beginning capital ................... $110,000 $80,000 $110,000 $300,000Net 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 TWOWINSTON DURHAM SALEM TOTAL

Interest—10% ofbeginning capital .............. $ 9,100 $ 6,200 $ 9,700 $25,000

Salary........................................ 20,000 -0- 10,000 30,000Allocation 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 TWOWINSTON DURHAM SALEM TOTAL

Beginning capital (above) ..... $ 91,000 $62,000 $ 97,000 $250,000Net income (above) ................ 21,600 3,200 15,200 40,000Drawings (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 = $10,000G = $10,000/.20G = $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 MethodImplied value of partnership ($80,000/40%) ................. $200,000Total capital after investment ($70,000 + $40,000 + $80,000) 190,000Goodwill ........................................................................... $ 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 MethodTotal capital after investment ($70,000 + 40,000 + $80,000) $190,000Ownership 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 ........................................................................... 100,000Sergio, Capital ...................................................... 75,000Tiger, Capital ........................................................ 12,500Phil, Capital .......................................................... 7,500Ernie, 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 ........................................................................... 60,000Tiger, Capital .............................................................. 2,500Phil, Capital ................................................................ 1,500Ernie, 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 .................................................................... 16,000Tiger, Capital ........................................................ 8,000Phil, Capital .......................................................... 4,800Ernie, Capital ........................................................ 3,200

Cash ............................................................................ 72,000Sergio, 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 = $8,200Goodwill = $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 ..................................................................... $200,000Hoover ................................................................... 120,000Polk ..................................................................... 90,000Grant ..................................................................... 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 BALANCESOriginal Investment Bonus Total

Nixon ..................... $200,000 $(1,000) $199,000Hoover .................. 120,000 ( 400) 119,600Polk ....................... 90,000 ( 600) 89,400Grant ..................... -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................................................................. 44,000Com, Capital .................................................... 26,400Pack, Capital ................................................... 17,600

Cash ..................................................................... 76,000Hal, Capital ...................................................... 76,000

Part b.

Com Pack Hal TotalInterest .................................. $17,640 $12,760 $7,600 $38,000Remaining 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 TotalBonus (20%) ......................... $18,000 $ -0- $ -0- $18,000Interest (15% of average capital) 15,000 30,000 45,000 90,000Remaining 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 INCOMEPurkerson Smith Traynor Totals

Interest (10%) $ 6,600 (below) $ 4,000 $ 2,000 $12,600Salary 18,000 25,000 8,000 51,000Remaining 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) $180,000Balance, April 1—December 31 ($68,000 × 9) 612,000Total ................................................................................. $792,000Months.............................................................................. 12 Average monthly capital balance .................................. $ 66,000Interest rate ..................................................................... × 10%Interest allocation (above) ............................................. $ 6,600

STATEMENT OF PARTNERS' CAPITALPurkerson Smith Traynor Totals

Beginning balances .............. $60,000 $40,000 $20,000 $120,000Additional contribution ........ 8,000 -0- -0- 8,000Income (above) ...................... 8,600 21,000 (6,000) 23,600Drawings ($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 TotalInterest (12% of beginning capital)$2,400 $ 7,200 $ 6,000 $ 15,600Salary 12,000 8,000 -0- 20,000Remaining 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 TotalBeginning balances ........... $20,000 $60,000 $50,000 $130,000Income 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—2010Left Center Right Total

Interest(12% of beginning capital above) *$566 $3,888 $3,946 $ 8,400Salary .................................. 12,000 8,000 -0- 20,000Remaining 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 TotalBeginning balances (above) $ 4,720 $32,400 $32,880 $70,000Additional investment ........ -0- -0- 12,000 12,000Income allocation ............... 10,046 7,688 2,266 20,000Drawings ............................. (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 TotalInterest (12% of beginning capital

above)* ........................... $ 572 $ 3,611 $4,457 $ 8,640Salary ................................... 12,000 8,000 -0- 20,000Remaining 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, 2011Left Center Right Total

Beginning balances (above) $ 4,766 $30,088 $37,146 $72,000Income allocation 14,844 16,155 9,001 40,000Drawings (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 = $30,000G = $150,000

CAPITAL BALANCES AFTER WITHDRAWALOriginal Balance Goodwill Withdrawal Final Balance

Lennon $230,000 $45,000 $275,000McCartney 190,000 45,000 235,000Harrison 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 .......................................................... 5,000Repair Expense .................................................... 5,000

(To reclassify payment made to repair personal residence.)Page, Capital .............................................................. 13,000Childers, Capital ........................................................ 11,000

Page, Drawings (adjusted) .................................. 13,000Childers, Drawings ............................................... 11,000

(To close drawings accounts for 2008.)Revenues ................................................................... 90,000

Expenses (adjusted by first entry) ..................... 59,000Income Summary ................................................. 31,000

(To close revenue and expense accounts for 2008.)

Income Summary ....................................................... 31,000Page, Capital ........................................................ 11,000Childers, Capital ................................................... 20,000

(To close net income to partners' capital–see allocation plan shown below.)

Allocation of Income Page ChildersInterest (10% of beginning balance) $ 8,000 $ 3,000Salary allowances 5,000 20,000Remaining 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) .................................. $117,000Investment by Smith ................................................. 43,000Total capital after investment .................................. $160,000Ownership portion acquired by Smith .................... 20%Smith, capital ............................................................. $ 32,000Amount paid .............................................................. 43,000Bonus paid by Smith—assigned to original partners $ 11,000

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

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

Cash ........................................................................... 43,000Smith, Capital (20% of total capital) ................... 32,000Page, Capital ........................................................ 4,400Childers, 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%)............. $360,000Total capital after investment by E ($270,000 + $36,000) 306,000Goodwill ..................................................................... $ 54,000Allocation of Goodwill:

A (30%) ................................................................ $16,200B (10%) ................................................................ 5,400C (40%) ................................................................ 21,600D (20%) ................................................................ 10,800

Total ................................................................. $54,000

CAPITAL BALANCESA 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 - 36,000Capital 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) $325,000Amount acquired by E .............................................. 20%E's capital balance .................................................... $ 65,000E's payment ............................................................... 55,000Bonus being given to E ............................................ $ 10,000

Bonus from:A (10%) ................................................................ $1,000B (30%) ................................................................ 3,000C (20%) ................................................................ 2,000D (40%) ................................................................ 4,000 $10,000

CAPITAL BALANCESA B C D E

Original balances $20,000 $40,000 $90,000 $120,000 $-0-Investment -0- -0- -0- -0- 55,000Bonus (above) (1,000) (3,000) (2,000) (4,000) 10,000Capital balances $19,000 $37,000 $88,000 $116,000 $65,000

e. C's capital balance $ 90,000C's collection (125%) 112,500Bonus being paid to C $ 22,500

Bonus from:A (1/3) $7,500B (1/3) 7,500D (1/3) 7,500 $22,500

CAPITAL BALANCESA B C D

Original balances ................. $20,000 $40,000 $ 90,000 $120,000Bonus (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—2008Boswell Johnson Total

Salary (8 months) ................. $8,000 $-0- $ 8,000Remaining $3,000 ................ 1,200 (40%) 1,800 (60%) 3,000

Totals ............................... $9,200 $1,800 $11,000

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2008Boswell Johnson Total

Beginning Balances ($114,000Invested capital split evenly—market value used for assets) $57,000 $57,000 $114,000

Income allocation (above) . . 9,200 1,800 11,000Drawings ............................... - 0 - - 0 - - 0 -

Ending balances ............. $66,200 $58,800 $125,000

WALPOLE INVESTMENT JANUARY 1, 2009Walpole'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 TotalSalary .................................... $12,000 $-0- $24,000 $36,000Remaining $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 TotalBeginning balances ............. $66,200 $58,800 $ -0- $125,000Walpole's contribution ........ (7,040) (10,560) 71,600 54,000Income allocation (above) . . 11,040 (3,840) 20,800 28,000Drawings ............................... (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 .............................................................. 6,520Johnson Capital .............................................................. 3,940Walpole, Capital .............................................................. 8,240

Pope, Capital .............................................................. 18,700

ALLOCATION OF INCOME—2010

Boswell Johnson Walpole Pope TotalSalary $12,000 $-0- $24,000 $9,600 $45,600Remaining $400 income 54 162 144 40 400Totals $12,054 $162 $24,144 $9,640 $46,000

STATEMENT OF PARTNERSHIP CAPITAL—DECEMBER 31, 2010

Boswell Johnson Walpole Pope TotalBeginning balances $65,200 $39,400 $82,400 $-0- $187,000Admission of Pope (6,520) (3,940) (8,240) 18,700 -0-Allocation of income

(above) 12,054 162 24,144 9,640 46,000Drawings (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—2009Gray Stone Lawson Totals

Salary allowance ($8 per billablehour) $13,680 $11,520 $10,400 $35,600

Interest (see Note A) 25,928 21,600 10,800 58,328Bonus (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 TotalsBeginning contributions $210,000 $180,000 $90,000 $480,000Added Investment 9,100 -0- -0- 9,100Profit allocation (from above) 29,965 23,477 11,558 65,000Drawing (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 = $126,525Ml = $168,700

26. a. (continued)Income Allocation—2010

Gray Stone Lawson Monet TotalsSalary allowance ($8

per billable hour) $14,400 $ 12,000 $ 11,040 $ 9,520 $ 46,960Interest (12% of begin-

ning capital balancesfor 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 – 12/31/10Gray Stone Lawson Monet Totals

Beginning balances $228,065 $185,477 $92,558 $168,700 $674,800Loss allocation (from

above) 4,684 (2,827) (14,937) (7,320) (20,400)Drawings (10% of

beginningbalances) (22,806) (18,548) (9,256) (16,870) (67,480)

Ending balances $209,943 $164,102 $68,365 $144,510 $586,920

Income Allocation—2011Gray Stone Lawson Monet Totals

Salary allowance ($8per billable hour) $15,040 $12,960 $10,480 $12,640 $ 51,120

Interest (12% ofbeginning capitalbalances for theyear) 25,193 19,692 8,204 17,341 70,430

Bonus (see Note B) 2,604 2,604 -0- -0- 5,208Remaining profit splitevenly:

$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 TotalsBeginning balances $209,943 $164,102 $68,365 $144,510 $586,920Profit allocation (from

above) 49,347 41,766 25,195 36,492 152,800Drawings (10% of

beginningbalances) (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 LAWSONStatement of Partners' Capital

For Year Ending December 31, 2009

Gray Stone Lawson TotalsBeginning balances $210,000 $180,000 $90,000 $480,000Added Investment 9,100 -0- -0- 9,100Profit allocation 29,965 23,477 11,558 65,000Drawings (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 ......................................................... 35,000D'Artagnan, Capital .............................................. 35,000

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

b. Goodwill ................................................................ 50,000Athos, Capital (50%) ........................................... 25,000Porthos, Capital (30%) ........................................ 15,000Aramis, 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) ............................... 10,500Porthos, Capital (10% of balance) ........................... 8,500Aramis, 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 ........................................................................... 30,000D'Artagnan, Capital (10% of total capital)........... 23,000Athos, Capital (50% of excess payment) ........... 3,500Porthos, Capital (30% of excess payment) ........ 2,100Aramis, 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 ........................................................................... 30,000Goodwill ..................................................................... 70,000

D'Artagnan, Capital .............................................. 30,000Athos, Capital (50% of goodwill) ....................... 35,000Porthos, Capital (30% of goodwill) .................... 21,000Aramis, 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 ............................................................................ 12,222Goodwill . ................................................................... 10,000

D'Artagnan, Capital .............................................. 22,222To 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 = $9,000Goodwill = $10,000

f. Goodwill ..................................................................... 80,000Athos, Capital (50%) ............................................ 40,000Porthos, Capital (30%) ......................................... 24,000Aramis, Capital (20%) .......................................... 16,000

(To record goodwill of $80,000 based on $280,000 appraisal of business.)

Aramis, Capital .......................................................... 66,000Cash ..................................................................... 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 ...................................................... 52,000Equipment................................................... 16,000Cash ............................................................ 12,000

O'Donnell, Capital ................................ 40,000Reese, Capital ...................................... 40,000

(To record initial investment. Assets recorded at fair value with two equal capital balances.)

12/31/08 Reese, Capital ............................................ 22,000O'Donnell, Capital ................................ 12,000Income 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 ............................................................ 15,000O'Donnell, Capital (15%) ........................... 300Reese, 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 ..................................... 10,340Reese, Capital ............................................ 5,000Dunn, Capital ............................................. 5,000

O'Donnell, Drawings............................. 10,340Reese, Drawings .................................. 5,000Dunn, 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 ...................................... 44,000O'Donnell, Capital ................................ 16,940Reese, Capital ...................................... 16,236Dunn, Capital ........................................ 10,824

(To allocate $44,000 income figure for 2009 as determined below.)28.a. (continued)

O'Donnell Reese DunnInterest (20% of $51,700

beginning capital balance)........ $10,34015% of $44,000 income .................. 6,60060:40 spilt of remaining $27,060

income ........................................ $16,236 $10,824Total ................................................. $16,940 $16,236 $10,824

Capital Balances as of December 31, 2009:O'Donnell Reese Dunn

Initial 2008 investment ................... $40,000 $40,0002008 profit allocation ..................... 12,000 (22,000)Dunn's investment ......................... (300) (1,700) $17,0002009 drawings ................................. (10,340) (5,000) (5,000)2009 profit allocation ..................... 16,940 16,236 10,82412/31/09 balances ........................... $58,300 $27,536 $22,824

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

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

12/31/10 O'Donnell, Capital ..................................... 11,660Reese, Capital ............................................ 5,507Postner, Capital ......................................... 5,000

O'Donnell, Drawings ............................ 11,660Reese, Drawings .................................. 5,507Postner, 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....................................... 61,000O'Donnell, Capital ................................ 20,810Reese, Capital ...................................... 24,114Postner, Capital .................................... 16,076

(To allocate profit for 2010 determined as follows)

O'Donnell Reese PostnerInterest (20% of $58,300 beg. capital) $11,66015% of $61,000 income ............. 9,15060:40 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%) ........................... 509Reese, 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....................................................... 52,000Equipment .................................................. 16,000Cash ............................................................ 12,000Goodwill ..................................................... 80,000

O'Donnell, Capital ................................ 80,000Reese, 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 ............................................ 30,000O'Donnell, Capital ................................ 20,000Income 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 ............................................................ 15,000Goodwill ..................................................... 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 ............................................ 10,000Dunn, Capital ............................................. 7,500

O'Donnell, Drawings............................. 20,000Reese, Drawings .................................. 10,000Dunn, 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 ...................................... 44,000O'Donnell, Capital ................................ 26,600Reese, Capital ...................................... 10,440Dunn, Capital ........................................ 6,960

(To allocate $44,000 income figure as follows)

O'Donnell Reese DunnInterest (20% of $100,000

beginning capital balance) $20,00015% of $44,000 income 6,60060:40 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 $80,0002008 profit allocation ..... 20,000 (30,000)Additional investment .... $37,5002009 drawings ................. (20,000) (10,000) (7,500)2009 profit allocation ..... 26,600 10,440 6,96012/31/09 balances ........... $106,600 $50,440 $36,960

1/1/10 Goodwill ..................................................... 26,588O'Donnell, Capital (15%) ..................... 3,988Reese, Capital (51%) ............................ 13,560Dunn, 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 .................................................. 46,000Postner, Capital ......................................... 46,000

(To reclassify capital balance to new partner.)12/31/10 O'Donnell, Capital ........................................... 22,118

Reese, Capital ................................................. 12,800Postner, Capital .............................................. 9,200

O'Donnell, Drawings ................................. 22,118Reese, Drawings ........................................ 12,800Postner, 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 ............................................ 61,000O'Donnell, Capital ..................................... 31,268Reese, Capital ............................................ 17,839Postner, Capital ......................................... 11,893

To allocate profit for 2010 as follows:O'Donnell Reese Postner

Interest (20% of $110,588beginning capital balance) $22,118

15% of $61,000 income ........ 9,15060:40 spilt of remaining

$29,732 ............................ $17,839 $11,893Totals................................ $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 $36,960Adjustment for goodwill ...... 3,988 13,560 9,040Drawings................................ (22,118) (12,800) (9,200)Profit allocation..................... 31,268 17,839 11,89312/31/10 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 ................................................................ 14,321O'Donnell, Capital (15%) ................................ 2,148Reese, Capital (51%) ...................................... 7,304Postner, Capital (34%) .................................... 4,869

(To recognize implied goodwill.)1/1/11 Postner, Capital .................................................... 53,562

Cash ................................................................ 53,562(To record final distribution to Postner.)