SAMPLE: CHAPTER 14
SOLUTIONS TO EXERCISES AND PROBLEMS
EXERCISES
E14.1 Partnership Formation
a.
Capital balances are equal to fair market value of contributed assets.
| Cheng | Morales | |
| Cash | $ 4,000 | $ 0 |
| Computer equipment | 60,000 | 0 |
| Building | 0 | 130,000 |
| Liability | (28,000) | (42,000) |
| $ 36,000 | $ 88,000 |
The entry to record the formation of the partnership is:
| Cash | 4,000 | ||
| Computer equipment | 60,000 | ||
| Building | 130,000 | ||
| Loan payable | 28,000 | ||
| Mortgage payable | 42,000 | ||
| Capital, Cheng | 36,000 | ||
| Capital, Morales | 88,000 |
b.
| Investment by Cheng | $ 36,000 |
| Investment by Morales | 88,000 |
| Total capital | $124,000 |
| Capital account of Cheng ($124,000/2) | $ 62,000 |
| Capital account of Morales ($124,000/2) | $ 62,000 |
There is a bonus of $26,000 from Morales to Cheng. The entry to record the formation of the partnership, reflecting that bonus, is:
| Cash | 4,000 | ||
| Computer equipment | 60,000 | ||
| Building | 130,000 | ||
| Loan payable | 28,000 | ||
| Mortgage payable | 42,000 | ||
| Capital, Cheng (= $36,000 + $26,000) | 62,000 | ||
| Capital, Morales (= $88,000 – $26,000) | 62,000 |
Since the partners are to have equal capital and Morales has invested $88,000, Cheng is presumed to have invested a similar amount. Specific assets account for $36,000 of Cheng’s investment; goodwill of $52,000 must therefore be recorded to bring Cheng’s investment to $88,000. The entry to record the formation of the partnership is:
| Cash | 4,000 | ||
| Computer equipment | 60,000 | ||
| Building | 130,000 | ||
| Goodwill | 52,000 | ||
| Loan payable | 28,000 | ||
| Mortgage payable | 42,000 | ||
| Capital, Cheng (= $36,000 + $52,000) | 88,000 | ||
| Capital, Morales | 88,000 |
E14.2 Partnership Formation
Because Roberta is the only partner not contributing expertise that would support goodwill recognition, we base the apparent total value of the firm on her investment.
Total value = $450,000 = $75,000/(1/6)
Total tangible assets invested amount to $285,000 (= $20,000 + $150,000 + $40,000 + $15,000 + $60,000), implying goodwill of $165,000 (= $450,000 – $285,000).
The following entry is needed to record formation of the partnership under the goodwill approach.
| Cash | 75,000 | ||
| Note receivable | 60,000 | ||
| Equipment | 150,000 | ||
| Goodwill | 165,000 | ||
| Capital – Max (= 3/6 x $450,000) | 225,000 | ||
| Capital – Nat (= 2/6 x $450,000) | 150,000 | ||
| Capital – Roberta (= 1/6 x $450,000) | 75,000 |
Total tangible assets invested amount to $285,000 (= $20,000 + $150,000 + $40,000 + $15,000 + $60,000). Max’s share (1/2) is $142,500, Nat’s share (1/3) is $95,000 and Roberta’s share (1/6) is $47,500. To bring the respective amounts invested into this alignment, bonuses will flow from Max ($170,000 – $142,500) and Roberta ($75,000 – $47,500) to Nat.
Thus the entry to record the formation under the bonus method is:
| Cash | 75,000 | ||
| Note receivable | 60,000 | ||
| Equipment | 150,000 | ||
| Capital – Max | 142,500 | ||
| Capital – Nat | 95,000 | ||
| Capital – Roberta | 47,500 |
E14.3 Partnership Income Allocation
a.
| Maddox | Gross | |
| Original balance | $ 85,000 | $ 93,000 |
| Salary | 35,000 | 0 |
| Withdrawal of salary | (35,000) | 0 |
| Loss distribution* | (8,500) | (8,500) |
| Ending balance | $ 76,500 | $ 84,500 |
*Net income $ 18,000
Less salary (35,000)
Balance of net income $(17,000)
b.
| Maddox | Gross | |
| Original balance | $ 85,000 | $ 93,000 |
| Salary | 35,000 | 0 |
| Withdrawal of salary | (35,000) | 0 |
| Income distribution** | 6,500 | 6,500 |
| $ 91,500 | $ 99,500 |
**Net income $48,000
Less salary 35,000
Balance of net income $13,000
E14.4 Partnership Income Allocation – Various Options
Net income of partnership:
| Revenues | $ 80,000 |
| Expenses | 55,000 |
| Net income | $ 25,000 |
a.
| Kingston | Allen | |
| Capital, January 1 | $ 56,000 | $ 84,000 |
| Investment | 8,000 | |
| Allocation of income (assumed equal) | 12,500 | 12,500 |
| Capital, December 31 | $ 76,500 | $ 96,500 |
b.
| Kingston | Allen | |
| Capital, January 1 | $ 56,000 | $ 84,000 |
| Investment | 8,000 | |
| Allocation of income: | ||
| Kingston, 65% | 16,250 | |
| Allen, 35% | _______ | 8,750 |
| Capital, December 31 | $ 80,250 | $ 92,750 |
c.
| Kingston | Allen | |
| Capital, January 1 | $ 56,000 | $ 84,000 |
| Investment | 8,000 | |
| Allocation of income: | ||
| Interest on average capital: | ||
| Kingston, 10% x $60,000* | 6,000 | |
| Allen, 10% x $84,000 | 8,400 | |
| Balance is $10,600 ($25,000-$14,400) divided equally | 5,300 | 5,300 |
| Capital, December 31 | $ 75,300 | $ 97,700 |
* $60,000 = ($56,000 + $64,000)/2
d.
| Kingston | Allen | |
| Capital, January 1 | $ 56,000 | $ 84,000 |
| Investment | 8,000 | |
| Allocation of income: | ||
| Salaries | 12,000 | 8,000 |
| Interest on beginning capital: | ||
| Kingston, 5% x $56,000 | 2,800 | |
| Allen, 5% x $84,000 | 4,200 | |
| Balance is ($2,000), divided equally** | (1,000) | (1,000) |
| Capital, December 31 | $ 77,800 | $ 95,200 |
** ($2,000) = $25,000 – ($12,000 + $8,000 + $2,800 + $4,200)
E14.5 Multiple Income Allocation Provisions
a.
| Judi (.4) | Ken (.5) | Lee (.1) | Total | |
| SalariesInterestResidualTotal Share | $22,00024,00015,200$61,200 | $18,00036,00019,000$73,000 | $30,00012,000 3,800$45,800 | $ 70,00072,000 38,000$180,000 |
b.
| Judi (.4) | Ken (.5) | Lee (.1) | Total | |
| SalariesInterestResidualTotal Share | $22,00024,000(10,400)$35,600 | $18,00036,000(13,000)$41,000 | $30,00012,000(2,600)$39,400 | $ 70,00072,000(26,000)$116,000 |
Judi’s bonus (B) amounts to $16,364, calculated as follows:
B = .1(180,000 – B)
B = 16,364
Judi’s net allocation increases by $9,818 (= 16,364 -.4 x 16,364).
Ken’s net allocation decreases by $8,182 (= -.5 x 16,364).
Lee’s net allocation decreases by $1,636 (= -.1 x 16,364).
E14.6 Admission of New Partner
If total capital after admission remains at $210,000 and Jordan receives a one-fourth interest ($52,500) for no investment, the existing partners must be paying Jordan a bonus of $52,500. Existing partners contribute to the bonus based on their income-sharing ratio. Hawk contributes $31,500 ( = .6 x $52,500) and Dove contributes $21,000 ( = .4 x $52,500).
Capital balances after admission are:
| Hawk – capital: | $120,000 – $31,500 = | $ 88,500 |
| Dove – capital: | $ 90,000 – $21,000 = | 69,000 |
| Jordan – capital: | 52,500 | |
| Total | $210,000 |
Under the goodwill approach, Hawk and Dove will own 75 percent of the partnership. Their combined capital of $210,000 for a 75 percent share of the new partnership implies a value of $280,000 for the new partnership (= $210,000/.75). Since Jordan makes no tangible investment, Jordan’s entire share of $70,000 (= $280,000 – $210,000) is deemed to be goodwill.
Capital balances after admission are:
| Hawk – capital | $120,000 |
| Dove – capital | 90,000 |
| Jordan – capital | 70,000 |
| Total | $280,000 |
E14.7 Admission of New Partner
Xavier must pay $1,257,750 to be admitted to the partnership.
Under the proposed arrangements, Blackman, Coulter, and Xavier would be equal partners. The annual amount available for income sharing is the $1,350,000 currently earned by Blackman ($600,000), Coulter ($600,000), and Xavier ($150,000). Thus each partner would receive $450,000 annually (= $1,350,000/3).
Xavier’s increased earnings would be $300,000 annually (= $450,000 – $150,000). The present value of this amount, discounted at 20% over ten years, is $1,257,750 (= $300,000 x present value of annuity factor, 10 years, 20% = $300,000 x 4.1925).
E14.8 Admission of New Partner
- Jeter should contribute $257,142.86
| Capital – Martinez | $108,000 |
| Capital – O’Neill | 176,000 |
| Capital – Clemens | 316,000 |
| Total capital | $600,000 |
This capital will represent 70 percent of the partnership after Jeter’s admission. The total capital will be $857,142.86 (= $600,000/.7). Hence, Jeter must invest $257,142.86 (= $857,142.86 ‑ $600,000).
Jeter’s payment of $210,000 for a 30 percent interest implies that the total value of the partnership is $700,000 (= $210,000/.30). First record implied goodwill of $100,000 (= $700,000 ‑ $600,000), and then transfer 30 percent of each partner’s capital to Jeter. The resulting capital balances are:
| OriginalCapital | ImpliedGoodwill | Total | TransferTo Jeter | Balances After Acquisition | |
| Martinez O’NeillClemensJeter | $108,000 176,000316,000 0 $600,000 | $20,000 (.2) 30,000 (.3)50,000 (.5) 0 $100,000 | $128,000 206,000366,000 0 $700,000 | $(38,400) (61,800)(109,800)210,000$ 0 | $ 89,600 144,200256,200 210,000$700,000 |
E14.9 Post-Retirement Capital Balances
| Bosworth | Cunneyworth | |
| Capital balances before Ashworth’s retirement | $80,000 | $100,000 |
| Write‑up of assets | 20,000 | 40,000 |
| Bonus to Ashworth | (11,667) | (23,333) |
| Capital balances after Ashworth’s retirement | $88,333 | $116,667 |
Following are the journal entries (not required) leading to these capital balances.
- Adjust capital accounts to reflect write‑up of assets from $400,000 to $480,000.
| Assets | 80,000 | ||
| Ashworth, Capital | 20,000 | ||
| Bosworth, Capital | 20,000 | ||
| Cunneyworth, Capital | 40,000 |
- Record Ashworth’s retirement under the bonus method.
| Ashworth, Capital | 65,000 | ||
| Bosworth, Capital (1/3) | 11,667 | ||
| Cunneyworth, Capital (2/3) | 23,333 | ||
| Cash | 100,000 |
E14.10 Retirement: Bonus and Goodwill Calculations
After deducting drawings of $50,000, Stevens’ capital account is $190,000. Stevens’ bonus is therefore $60,000 (= $250,000 – $190,000). Once Stevens’ retirement is recorded, total capital net of drawings is $350,000 [= ($780,000 – $180,000) – ($190,000 + $60,000)].
Partial goodwill amounts to $60,000 [= $250,000 – ($240,000 – $50,000). Thus goodwill increases by $60,000, capital decreases by $190,000 (or by $250,000 if the $60,000 goodwill increment is added to Stevens’ capital) and cash decreases by $250,000.
Total goodwill is $200,000 (= $60,000/.3), of which $140,000 (= .7 x $200,000) pertains to the other partners. Thus total capital net of drawings is $550,000 [(= $600,000 + $200,000 goodwill – $250,000 withdrawal by Stevens) = $600,000 – $190,000 net decrease in Stevens’ capital + $140,000 increase in capital of other partners].
E14.11 Retirement Journal Entries: Various Assumptions
a.
| Capital ‑ Baxter | 70,000 | ||
| Capital ‑ Helman | 35,000 | ||
| Capital ‑ Caines | 35,000 |
To record transfer of Baxter’s capital to Helman and Caines. Payment was made from personal funds.
b.
| Capital ‑ Helman | 10,000 | ||
| Capital ‑ Caines | 10,000 | ||
| Capital ‑ Baxter | 20,000 |
To record bonus to retiring partner.
| Capital ‑ Baxter | 90,000 | ||
| Cash | 90,000 |
To record payment to Baxter from partnership funds.
c.
| Goodwill | 40,000 | ||
| Capital – Baxter | 20,000 | ||
| Capital – Helman | 10,000 | ||
| Capital – Caines | 10,000 |
To record goodwill under the total goodwill approach; $90,000 ‑ $70,000 = $20,000
goodwill attributable to Baxter; $20,000/.5 = $40,000 goodwill of the firm.
| Capital ‑ Baxter | 90,000 | ||
| Cash | 90,000 |
To record payment to Baxter from partnership funds.
d.
| Goodwill | 20,000 | ||
| Capital ‑ Baxter | 20,000 |
To record goodwill under the partial goodwill approach; $90,000 ‑ $70,000 = $20,000 goodwill attributable to Baxter.
| Capital ‑ Baxter | 90,000 | ||
| Cash | 90,000 |
To record payment to Baxter from partnership funds.
e.
| Capital ‑ Baxter | 70,000 | ||
| Cash | 70,000 |
To record payment to Baxter from partnership funds. (The $20,000 transfer of personal funds is not recorded on partnership books.)
E14.12 Lump-Sum Liquidation
Callahan receives $25,600.
Koh receives zero.
Mateer receives $34,400.
| Cash from sale of assets | $105,000 |
| Cash on hand | 7,000 |
| Total cash available | 112,000 |
| Less: Payments to creditors | (52,000) |
| Cash available to partners | $ 60,000 |
If assets are sold for $105,000, there is a loss of $30,000 which the partners must share in their income‑sharing ratio.
| Callahan | Koh | Mateer | |
| Original capital balance | $ 40,000 | $ 6,000 | $44,000 |
| Loss of $30,000 divided (6:5:4) | (12,000) | (10,000) | (8,000) |
| 28,000 | (4,000) | 36,000 | |
| Allocation of Koh’s deficit, divided (6:4) | (2,400) | 4,000 | (1,600) |
| Cash distribution | $ 25,600 | $ 0 | $34,400 |
E14.13 Rights of Creditors
| Distribution of assets of AB Partnership: | Case 1 | Case 2 |
| Partnership creditors | $42,000 | $31,000 |
| Creditors of Partner A | 3,000 | |
| Partner B | 3,000 | ______ |
| $48,000 | $31,000 | |
| Distribution of assets of Partner A: | ||
| Creditors of Partner A | $10,000 | $17,000 |
| Partnership creditors | _____ | 13,000 |
| $10,000 | $30,000 | |
| Distribution of assets of Partner B: | ||
| Creditors of Partner B | $ 9,000 | $15,000 |
In case 1, the partnership is solvent, and A’s creditors collect only $13,000 of the $17,000 owed them. In case 2, the partnership is insolvent and partnership creditors collect only $44,000 of the $51,000 owed them.
E14.14 Safe Payment Calculation
| Rane | $ 0 |
| Snow | 50,000 |
| Hale | 0 |
| Cash from sale of assets | $ 130,000 |
| Cash on hand | 10,000 |
| Total cash available | 140,000 |
| Less: Payments to creditors | (90,000) |
| Cash available to partners | $ 50,000 |
| Rane (.5) | Snow (.3) | Hale (.2) | |
| Original capital balances | $100,000 | $170,000 | $ 80,000 |
| Loss of $60,000 on sale of assets | (30,000) | (18,000) | (12,000) |
| Assume total loss on remaining assets of $240,000 | (120,000) | (72,000) | (48,000) |
| (50,000) | 80,000 | 20,000 | |
| Allocate Rane’s deficit (3:2) | 50,000 | (30,000) | (20,000) |
| $ 0 | $ 50,000 | $ 0 |
E14.15 Lump-Sum Liquidation
| Conley (.6) | Lewis (.4) | Total | |
| Balances per books | $140,000 | $ 90,000 | $230,000 |
| Add Lewis’ loan | — | 80,000 | 80,000 |
| Pre-liquidation balances | 140,000 | 170,000 | 310,000 |
| Gain on sale of assets | 12,000 | 8,000 | 20,000* |
| Pre-distribution balances | $152,000 | $178,000 | $330,000 |
* $20,000 = $450,000 – ($130,000 + $100,000 + $200,000)
| Cash available (70,000 + 450,000) | $520,000 |
| Payment of liabilities | (190,000) |
| Cash available for the partners | 330,000 |
| Distribution to Conley | (152,000) |
| Distribution to Lewis | (178,000) |
| Cash balance after distributions to partners | $ – |
E14.16 Cash Distribution Plan
| White (.5) | Ellis (.3) | Riley (.2) | |
| Capital balances per books | $ 75,000 | $ 60,000 | $100,000 |
| Deduct loan receivable | ( 40,000) | ||
| Pre-liquidation balances | 75,000 | 60,000 | 60,000 |
| Divide by income-sharing % | .5 | .3 | .2 |
| Standardized capital balances | 150,000 | 200,000 | 300,000 |
| Equalize Ellis and Riley | (100,000) | ||
| 150,000 | 200,000 | 200,000 | |
| Equalize White, Ellis & Riley | (50,000) | (50,000) | |
| $150,000 | $150,000 | $150,000 |
| Convert equalization adjustments | 20,000 | ||
| Convert equalization adjustments | 15,000 | 10,000 | |
Cash Distribution Plan: First $48,000 to creditors;
Next $20,000 to Riley;
Next $25,000 to Ellis and Riley in a 3:2 ratio;
Cash over $93,000 to White, Ellis and Riley in a 5:3:2 ratio
PROBLEMS
P14.1 Partnership Formation: Working Backward
Tangible net assets invested amount to $66,000 (= $12,000 cash + $18,000 equipment + $15,000 cash + $11,000 library + $10,000 note). Because the capital balances in Scenario #2 add up to $66,000, Scenario #2 must reflect the bonus approach. The flow of bonuses is as follows:
| Tangible Investment | Capital Balance | Bonus To (From) | |
| Brian | $30,000 | $22,000 | $(8,000) |
| Jennifer | 26,000 | 33,000 | 7,000 |
| Eric | 10,000 | 11,000 | 1,000 |
In Scenario #1, total capital of $90,000 (= $30,000 + $45,000 + $15,000) and goodwill of $24,000 (= $90,000 – $66,000) were recorded, based on Brian’s investment of $30,000 for a 1/3 (= 2/6) interest. Thus goodwill of $19,000 (= $45,000 – $26,000) is being attributed to Jennifer and $5,000 (= $15,000 – $10,000) to Eric.
In Scenario #3, total capital of $108,000 (= $36,000 + $54,000 + $18,000) and goodwill of $42,000 (= $108,000 – $66,000) were recorded. Because these amounts cannot be calculated from the problem data, the partners apparently decided that their various skills have a total value of $42,000. Goodwill is now attributed to each partner as follows: Brian–$6,000, Jennifer–$28,000 and Eric–$8,000.
First, as to profitability, the fact that goodwill is subject to annual impairment testing means that its presence in the accounts may result in lower earnings than under the bonus method in Scenario #2, other things being equal. The larger amount of goodwill recognized in Scenario #3 may depress earnings more than in Scenario #1. Moreover, conventional return-on-assets measures will be further reduced because the firm’s asset base is inflated by the presence of goodwill (the numerator could be smaller and the denominator is always larger).
Second, as to leverage, if one takes the account balances without adjustment, the presence of goodwill results in lower leverage measures because total assets and equity are higher than in the bonus case. And, without the ability to set higher prices, any interest coverage ratio (or times interest earned) will be reduced by the effect of any goodwill impairment losses on earnings.
The presence of goodwill will weaken some profitability measures but has mixed effects on credit-worthiness. Recognizing the “softness” inherent in goodwill, particularly in the non-purchased goodwill here, an analyst may remove its effects.
P14.2 Partnership Formation
a.
Partnership Balance Sheet
Date of Partnership Formation
| Assets | Liabilities | ||
| Cash (a) | $ 46,000 | Accounts payable | $ 53,000 |
| Accounts receivable (net) | 48,000 | Mortgage payable | 55,000 |
| Marketable securities | 57,500 | Total liabilities | 108,000 |
| Inventory | 85,000 | Invested capital | |
| Equipment (b) | 15,000 | Capital, Berrini (d) | 116,750 |
| Building | 65,000 | Capital, Fiedler (e) | 58,375 |
| Land | 25,000 | Capital, Wade (e) | 58,375 |
| ______ | Total invested capital (c) | 233,500 | |
| Total assets | $341,500 | Total liabilities and invested capital | $341,500 |
Supporting computations:
(a) $7,000 (Berrini) + $28,000 (Fiedler) + $11,000 (Wade) = $46,000.
(b) Original cost of equipment = $18,000 + $12,000 (depreciation) = $30,000. One half of $30,000 = $15,000.
(c) Note that Berrini’s investment = $137,000, the fair market value of net assets invested, as shown next:
| Cash | $ 7,000 |
| Accounts receivable | 48,000 |
| Inventory | 85,000 |
| Equipment | 15,000 |
| Building | 65,000 |
| Land | 25,000 |
| Accounts payable | (53,000) |
| Mortgage payable | (55,000) |
| $137,000 |
Fiedler’s investment = $28,000
Wade’s investment = $11,000 + $57,500 (securities) = $68,500
Total investment = $137,000 + $28,000 + $68,500 = $233,500
(d) $233,500 (total investment) x 50% = $116,750
(e) $233,500 (total investment) x 25% = $ 58,375
b.
Partnership Balance Sheet
Date of Partnership Formation
| Assets | Liabilities | ||
| Cash | $ 46,000 | Accounts payable | $ 53,000 |
| Accounts receivable (net) | 48,000 | Mortgage payable | 55,000 |
| Marketable securities | 57,500 | Total liabilities | 108,000 |
| Inventory | 85,000 | Invested capital | |
| Goodwill (c) | 40,500 | Capital, Berrini (a) | 137,000 |
| Equipment | 15,000 | Capital, Fiedler (b) | 68,500 |
| Building | 65,000 | Capital, Wade (a) | 68,500 |
| Land | 25,000 | Total invested capital | 274,000 |
| Total Assets | $382,000 | Total liabilities and invested capital | $382,000 |
Supporting calculations:
(a) Both Berrini and Wade contributed more than their fair share, whereas Fiedler contributed less, and will be credited with the goodwill. Berrini’s investment of $137,000 = 50% (total investment of $274,000 including goodwill. Berrini’s and Wade’s investment are in the proper ratio ($137,000 = 50% of $274,000, $68,500 = 25% of $274,000). Goodwill of $40,500 is attributed to Fiedler’s admission to bring capital balances into the correct relationship.
(b) $68,500 = 25% (total investment of $274,000 including goodwill)
(c)
| Fiedler’s capital account | $68,500 |
| Less Fiedler’s cash investment | 28,000 |
| Goodwill | $40,500 |
P14.3 Partners’ Disputes Over Income Allocations
The basic problem seems to be that the actual workload of the three partners differs from that originally contemplated. Although the existing provisions allow ample opportunity for a nice share of the income to flow to Hillie, the lower net income along with the partial implementation provision* shut her out in 2013 and almost shut her out in 2012. In contrast, Bill and Al continue to receive almost all of the partnership income despite the declining value of their efforts in the firm.
* Salaries to Bill and Al absorbed all of the 2013 income and Hillie’s share of the 2012
income amounted to only $26,800 [= .2 x $134,000 = $160,000 – ($80,000 + $50,000) –
.04($30,000 + $50,000)].
The proposed bonus provision ought to ameliorate Hillie’s discontent; in 2013 and 2012 she would have received $31,250 and $40,000, respectively, off the top. Al, however, would have seen his share reduced to $46,154 [= 5/13($125,000 – $31,250)] in 2013 and to $36,058 [= 5/13($160,000 – $40,000)] in 2012 . Note: When income is insufficient to cover both salaries, Bill and Al share proportionately. Al’s share of the total salary allocation is 5/13 [= $50,000/($80,000 + $50,000)].
Under the new bonus provision, Hillie’s 2014 bonus (B), based on income of $175,000, is $35,000 [B = .25($175,000 – B) = $43,750/1.25]. The comparative income allocation is therefore:
| Bill | Al | Hillie | ||||
| New | Old | New | Old | New | Old | |
| BonusSalaryInterest**ResidualTotal | —$80,000400 — $80,400 | —$80,0001,200 3,000$84,200 | —$50,000667 — $50,667 | —$50,0002,000 6,000$58,000 | $35,000—8,933 — $43,933 | ——$26,800 6,000$32,800 |
** Under the new bonus provision, only $10,000 (= $175,000 – $35,000 – $80,000 – $50,000) of income remains to be allocated via interest on capital balances. The maximum amount to be allocated via interest is $30,000 [= (.04 x $30,000) + (.04 x $50,000) + (.2 x $134,000) = $1,200 + $2,000 + $26,800], Bill’s share of the $10,000 is therefore $400 [= $10,000 x ($1,200/$30,000)], Al’s is $667 [= $10,000 x ($2,000/$30,000)] and Hillie’s is $8,933 [= $10,000 ($26,800/$30,000)].
This approach leads to a shift in income away from Bill and Al and toward Hillie. Although the shifts shown in the above table may not seem very large, Hillie’s income share rises by 34% in 2014.
P14.4 Income Allocations: Schedule of Changes in Capital Accounts
Capital balances at beginning of year
Added to Sills’ capital account during the years was the income share (interest + salary + bonus + share of residual). Withdrawn from Sills’ account was the income share plus $15,000. Thus, the net withdrawal from Sills’ account was $15,000. By using the end of year balance in the account, we can compute the beginning balance. The same logic applies to calculating Perez’s beginning capital account balance.
| Sills: | |
| End of year balance | $ 5,000 |
| Plus net withdrawal | 15,000 |
| Beginning balance | $ 20,000 |
| Perez: | |
| End of year balance | $ 80,000 |
| Less net addition | (10,000) |
| Beginning balance | $ 70,000 |
| Lamke: | |
| Total capital balance at beginning of year | $120,000 |
| Less other partners’ balances ($20,000 + $70,000) | (90,000) |
| Beginning balance | $ 30,000 |
b.
Silverstone Partnership
Schedule of Changes in Capital Accounts
For the Year Ended December 31, 2013
| Lamke | Perez | Sills | |
| Capital balances, January 1 | $30,000 | $ 70,000 | $20,000 |
| Allocation of net income: | |||
| Interest (1) | 1,500 | 3,500 | 1,000 |
| Salaries | 15,000 | 20,000 | 10,000 |
| Bonus (2) | – | – | 9,600 |
| Residual profit (3) | 11,800 | 11,800 | 11,800 |
| Balance after distributions | 58,300 | 105,300 | 52,400 |
| Withdrawals (4) | 3,300 | 25,300 | 47,400 |
| Ending Balance | $55,000 | $ 80,000 | $ 5,000 |
(1) Interest payments to partners
| Capital Balance Beginning of year | Times 5% | Interest Paid | |
| Lamke | $30,000 | x .05 | $1,500 |
| Perez | 70,000 | x .05 | 3,500 |
| Sills | 20,000 | x .05 | 1,000 |
| $6,000 |
(2) Bonus to Sills
| Income before salaries and bonus | $90,000 |
| Plus interest | 6,000 |
| Income before salaries, bonus and interest | 96,000 |
| Times 10% | x .1 |
| Bonus | $ 9,600 |
(3) Income after salaries, bonus, and interest
| Income before salaries, bonus and interest | $96,000 | |
| Less interest | (6,000) | |
| Less salaries: | ||
| Lamke | $15,000 | |
| Perez | 20,000 | |
| Sills | 10,000 | (45,000) |
| Less bonus to Sills | (9,600) | |
| Income after salaries, bonus, and interest | $35,400 |
Each partner is allocated $35,400/3 = $11,800.
(4) Drawings by partners
| Lamke: | (given) | $ 3,300 |
| Perez: | Total distribution less $10,000 retained = $3,500 + $20,000 + $11,800 – $10,000 = | 25,300 |
| Sills: | Total distribution plus $15,000 = $1,000 + $10,000 + $9,600 + $11,800 + $15,000 = | 47,400 |
P14.5 Financial Statement Effects of Partnership Expansion
The alternatives affect the amounts of assets and equities, not liabilities. Alternatives 2 and 3 look good because debt is a small part of the capital structure (and total assets) and cash and the quick ratio [= (cash + receivables)/accounts payable] are highest. This may be offset by the presence of additional other assets (probably goodwill) which produce greater depreciation and possible impairment charges that exceed the additional earnings generated.
The principal red flag involves the very large portion of total assets represented by other assets. What is the composition of other assets? To the extent that goodwill is included, as it undoubtedly is in alternatives 3 and 4, impairment losses can cause a drag on earnings without corresponding earning power. Remember, the partnership group is the same, with the same talents, whether or not goodwill is recorded.
In each alternative, Ingalls has the same 20% of total capital. Ingalls’ capital represents the greatest percentage of total assets in #3. Yet in #4, Ingalls acquires the 20% capital interest for $12,000 (rather than $40,000) cash. Either of these alternatives is probably preferred to the other two although we cannot determine how much cash was paid in the personal transaction #1.
| Dr. (Cr.) | ||||
| CashOther assetsCapital – GrahamCapital – HydeCapital – Ingalls | #1 ––10,0006,000(16,000) | #2 40,000–(12,000)(4,000)(24,000) | #3 40,00080,000(60,000)(20,000)(40,000) | #4 12,0008,000––(20,000) |
#1: Personal transaction between Ingalls, Graham and Hyde.
#2: Bonus to old partners.
#3: Goodwill to old partners [$80,000 = $40,000/.2 – ($50,000 + $30,000 + $40,000)]
#4: Goodwill to new partner [$8,000 = ($50,000 + $30,000)/.8 – ($50,000 + $30,000 + $12,000)]
P14.6 Investment Club: Admission and Income Allocation
Because the Club maintains its books on a cost basis, unrealized gains and losses are not reflected in the capital accounts of existing partners. However, the gains and losses that occurred prior to the admission of Grant and Lee are attributable to the old partners. In joining the Club, Grant and Lee must therefore invest an amount that is equivalent to the current value of a proportionate share of Club equity.
Grant and Lee must each invest $7,000, as shown below:
| Current value of Club equity: | |
| Cash | $ 3,200 |
| Fair market value of securities | 122,800 |
| Total | $126,000 |
Equity value per partner = $126,000/18 = $7,000.
Allocation of 2014 income to partners:
| Total | Grant | Lee | 18 Old Partners | |
| Dividends | $4,200 | $210 | $210 | $3,780 |
| Gain on Security A: | ||||
| Prior to January 1, 2014 | 3,600 | 0 | 0 | 3,600 |
| After January 1, 2014 | 2,000 | 100 | 100 | 1,800 |
| Loss on Security B: | ||||
| Prior to January 1, 2014 | (1,800) | 0 | 0 | (1,800) |
| After January 1, 2014 | (1,000) | (50) | (50) | (900) |
| Total | $7,000 | $260 | $260 | $6,480 |
Gains and losses that occurred prior to January 1, 2014 are attributable to the 18 old partners. Gains and losses since January 1, 2014 are attributable to all 20 partners ($260 = .05 x ($4,200 + $2,000 – $1,000).
To answer this question, we calculate the capital accounts of the partners after the sale of the portfolio. Certain other calculations are required first.
- Cost of portfolio at time of sale:
| Cost at December 31, 2014 | $ 78,300 |
| Less cost of securities sold in 2014 | (14,000) |
| Plus cost of securities bought in 2014 | 40,000 |
| Cost of portfolio at time of sale | $ 104,300 |
- Gain on sale of portfolio:
| Selling price | $ 228,000 |
| Cost (per (1) above) | (104,300) |
| Gain | $ 123,700 |
- Amount of unrealized gain prior to January 1, 2014:
| Fair market value of portfolio at January 1, 2014 | $122,800 | |
| Less: January 1, 2014 FMV of securities sold in 2014 | (15,800) | |
| Remaining FMV at December 31, 2014 | $ 107,000 | |
| Cost of portfolio at January 1, 2014 | 78,300 | |
| Less: Cost of securities sold in 2014 | (14,000) | |
| Remaining cost at December 31, 2014 | (64,300) | |
| Remaining pre-January 1, 2014 gain | $ 42,700 |
- Amount of gain accrued after January 1, 2014:
| Total gain, per (2) above | $123,700 |
| Gain accrued prior to January 1, 2014, per (3) | (42,700) |
| Gain accrued after January 1, 2014 | $ 81,000 |
- Total assets of Club at dissolution:
| Cash: | |
| Balance at January 1, 2014 | $ 3,200 |
| Invested by Grant and Lee | 14,000 |
| Invested during 2014 (20 x $500) | 10,000 |
| Proceeds from 2014 sale of securities | 16,800 |
| Received from 2014 dividends | 4,200 |
| Invested in new securities during 2014 | (40,000) |
| Cash balance at December 31, 2014 | 8,200 |
| Proceeds from 2015 sale of securities | 228,000 |
| Total assets at dissolution | $236,200 |
Partners’ capital accounts at time of dissolution:
| Total | Grant | Lee | 18 Old Partners | |
| Capital at January 1, 2014 | $ 81,500 | $ 81,500 | ||
| Invested by Grant and Lee | 14,000 | $ 7,000 | $ 7,000 | 0 |
| Invested during 2014 | 10,000 | 500 | 500 | 9,000 |
| 2014 income allocation (see c.) | 7,000 | 260 | 260 | 6,480 |
| Capital at December 31, 2014 | $112,500 | $ 7,760 | $ 7,760 | $ 96,980 |
| Allocation of remainingpre-2014 gain | 42,700 | 0 | 0 | 42,700 |
| Allocation ofpost-January 1, 2014 gain | 81,000 | 4,050 | 4,050 | 72,900 |
| Capital at time of dissolution | $236,200 | $11,810 | $11,810 | $212,580 |
Thus, Grant and Lee each received $11,810 and the 18 old partners as a group received $212,580.
P14.7 Admission – Various Cases
Case 1
- Since the goodwill account did not change, but total capital balances did change, the bonus method was used to account for Lansing’s admission.
- Lansing invested $50,000 in assets other than cash in the partnership. A bonus to the existing partners of $15,000 (to Simpson, $7,500 and to Scott, $7,500) accounted for the changes in Simpson’s and Scott’s capital balances.
- Lansing’s percentage of ownership is 29% (rounded). $35,000/($42,500 + $42,500 + $35,000) = .29
Case 2
- Neither the bonus nor goodwill method was used to account for the admission of Lansing.
- Lansing purchased Scott’s interest in the partnership. It is impossible to determine the amount that Lansing paid Scott. The transaction occurred between Lansing and Scott as individuals. The only effect on partnership books is to transfer the capital account from Scott to Lansing.
- Lansing’s percentage of ownership is 50% = $35,000/($35,000 + $35,000)
Case 3
- Since the goodwill account did not change, but total capital balances did change, the bonus method was used to account for Lansing’s admission.
- Lansing invested $10,000 cash in the partnership. A bonus to the new partner of $10,000 (from Simpson, $5,000 and from Scott, $5,000) accounted for Lansing’s total capital balance of $20,000.
- Lansing’s percentage of ownership is 25%. $20,000/($30,000 + $30,000 + $20,000) = .25
Case 4
- Since the goodwill account changed, the goodwill method was used to account for Lansing’s admission.
- Lansing invested tangible net assets of $40,000 (assets of $90,000 and liabilities of $50,000). Also, $20,000 of goodwill to the new partner accounts for Lansing’s capital balance of $60,000.
- Lansing’s percentage of ownership is 46% (rounded). $60,000/(35,000 + 35,000 + 60,000) = .46.
Case 5
- Since the goodwill account changed, the goodwill method was used to account for Lansing’s admission.
- Lansing invested $20,000 in the partnership. Also goodwill to existing partners of $10,000 (to Simpson, $5,000 and to Scott, $5,000) was recognized.
- Lansing’s percentage of ownership is 20%. $20,000/($40,000 + $40,000 + $20,000) = .20.
P14.8 Retirement of Two Partners
a.
| Capital ‑ Dewitt | 50,000 | ||
| Capital ‑ Galax | 40,000 | ||
| Capital ‑ Farber | 7,500 | ||
| Capital ‑ Wayne | 7,500 | ||
| Capital ‑ Lane | 7,500 | ||
| Cash and other assets | 112,500 |
To record retirement of Dewitt and Galax under the bonus method.
Total paid $112,500
Total capital of retirees 90,000
Total bonus 22,500
Divided among partners / 3
Portion met by each remaining partner $ 7,500
b.
| Goodwill | 22,500 | ||
| Capital ‑ Dewitt | 12,500 | ||
| Capital ‑ Galax | 10,000 |
To record goodwill prior to retirement of Dewitt and Galax.
| Dewitt | Galax | |
| Payment | $62,500 | $50,000 |
| Capital balance | 50,000 | 40,000 |
| Goodwill attributable to retiree | $12,500 | $10,000 |
| Capital ‑ Dewitt | 62,500 | ||
| Capital ‑ Galax | 50,000 | ||
| Cash and Other Assets | 112,500 |
To record retirement of Dewitt and Galax under the goodwill method.
c.
Under the bonus method of accounting for retirement, Wayne’s capital balance is reduced to zero. This is likely his objection to the procedure.
In either case, the firm does not have sufficient cash to pay the retirees. Certainly some cash is also needed for operating expenses so that depleting the cash account would be unwise. A simple solution would be to pay retirees in installments over a period of several years.
P14.9 Retirement – Various Cases
Case 1
- Since the goodwill account did not change, but total capital balances did change, the bonus method was used to account for Goldsmith’s retirement.
- Goldsmith was paid $30,000 upon retirement. A bonus to the remaining partners of $10,000 ($5,000 each) was recorded.
Case 2
- The goodwill method (partial goodwill approach) was used to account for Goldsmith’s retirement.
- Goldsmith was paid $50,000 upon retirement. Goodwill of $10,000 was recognized before retirement and attributed only to Goldsmith.
Case 3
- Neither the bonus nor goodwill method was used to account for Goldsmith’s retirement.
- Flint purchased Goldsmith’s interest in the partnership. It is impossible to tell what Flint paid Goldsmith. The transaction occurred between Flint and Goldsmith as individuals. The only effect on partnership books is to transfer the capital account from Goldsmith to Flint.
Case 4
- Neither the bonus nor goodwill method was used to account for Goldsmith’s retirement. (The problem states that no bonus was recorded in this case.)
- Goldsmith received assets with fair market value of $45,000. Assets were written up to $145,000 with the partners sharing the gain equally. Then $45,000 of assets were distributed to Goldsmith.
Case 5
- The goodwill method (total goodwill approach) was used to account for Goldsmith’s retirement.
- Goldsmith was paid $50,000 upon retirement. Goodwill of $30,000 was recognized before retirement and assigned equally to each partner.
P14.10 Financial Statement Effects of Retirement/Admission
Goodwill currently accounts for about 39% (= 800/2,068) of the firm’s total assets and represents 79% [= 800/(270 + 195 + 547)] of the partners’ capital. In fact, if goodwill is subtracted to get “tangible net worth,” total liabilities/total assets exceeds .83 [= (47 + 209 + 600 + 200)/(2,068 – 800)]. Any additional goodwill under the goodwill method of retirement will increase goodwill’s significance as a part of total assets. Because goodwill is considered a soft, perhaps worthless asset, additional goodwill tends to devalue the balance sheet.
Under the bonus method of retirement, $80,000 in capital will be transferred from the other partners to Mills before Mills’ capital account is eliminated. Existing goodwill remains unchanged. The net effect is to reduce partners’ capital by $80,000 and accentuate the presence of debt in the firm’s capital structure.
If you include in the calculation the additional $350,000 debt incurred to pay Mills and exclude the goodwill, total liabilities/total assets approaches 1.11 [= (47 + 209 + 600 + 200 + 350)/(2,068 – 800)] under both methods!
b.
Because the $350,000 exceeds Mills’ capital balance of $270,000, partial goodwill is $80,000 and total goodwill is $400,000 (= 80,000/.2). The following entries record the goodwill and Mills’ retirement.
| Goodwill | 400,000 | ||
| Capital – Mills | 80,000 | ||
| Capital – Sinclair | 80,000 | ||
| Capital – Other Partners | 240,000 |
To record goodwill of $400,000, assigning it to the partners
in accordance with their income-sharing percentages.
| Cash | 350,000 | ||
| Notes Payable–1st National Bank | 350,000 |
| Capital–Mills | 350,000 | ||
| Cash | 350,000 |
At this point, total capital amounts to $1,062,000 (= 195,000 + 80,000 + 547,000 + 240,000); it will be $1,112,000 after Luh’s $50,000 investment. Thus Luh invests $50,000 for a 10% interest in $1,112,000, or $111,200. Under the bonus method of admission, Luh’s bonus is $61,200 (= 111,200 – 50,000), charged $15,300 (25%–the income-sharing ratio of Sinclair and the other partners remains 1:3) to Sinclair and $45,900 (75%) to the other partners.
Under the goodwill method of admission, we have goodwill to the new partner (50,000 < 111,200) of $68,000 [= (1,062,000/.9) – (1,062,000 + 50,000)]. The pro-forma balance sheets appear next.
Moore, Mills, Sinclair & Co.
Pro-forma Balance Sheets
After Mills’ Retirement and Luh’s Admission
| Bonus Method | Goodwill Method | |
| Cash and cash equivalents | $ 228,000 | $ 228,000 |
| Accounts receivable–clients | 430,000 | 430,000 |
| Notes receivable–Sinclair | 100,000 | 100,000 |
| Prepayments | 60,000 | 60,000 |
| Fixed assets, net | 500,000 | 500,000 |
| Goodwill, net | 1,200,000(1) | 1,268,000(4) |
| $2,518,000 | $2,586,000 | |
| Trade payables | $ 47,000 | $ 47,000 |
| Accrued liabilities | 209,000 | 209,000 |
| Notes payable – 1st National Bank | 950,000 | 950,000 |
| Notes payable – Moore | 200,000 | 200,000 |
| Capital – Luh | 111,200 | 118,000 |
| Capital – Sinclair | 259,700(2) | 75,000(5) |
| Capital – other partners | 741,100(3) | 87,000(6) |
| $2,518,000 | $2,586,000 |
(1) 1,200,000 = 800,000 + 400,000 recognized upon retirement
(2) 259,700 = 195,000 + 80,000 – 15,300
(3) 741,100 = 547,000 + 240,000 – 45,900
(4) 1,268,000 = 800,000 + 400,000 + 68,000 (= 118,000 – 50,000) from Luh’s admission
(5) 275,000 = 195,000 + 80,000
(6) 787,000 = 547,000 + 240,000
The resulting pro-forma balance sheets are not very different. Total assets and total capital are larger by the additional $68,000 of goodwill arising when Luh is admitted by the goodwill method. Using the comparisons made in Requirement 1, we see that:
| Bonus Method | Goodwill Method | |
| Goodwill/Total Assets | .477 | .490 |
| Total Liabilities/Total Assets | .558 | .544 |
Thus the two pro-forma balance sheets have about the same degree of healthiness (or sickliness). Leverage is slightly worse under the bonus method whereas the soft goodwill is slightly more significant component of total assets under the goodwill method.
P14.11 Partnership Admission and Liquidation
The amount, in present value terms, to be received by each partner is as follows:
| Reitmyer ($200,000 + .4 x ($1,200,000 – $700,000)) | $400,000 |
| Simon ($150,000 + .4 x ($1,200,000 – $700,000)) | 350,000 |
| Trybus ($70,000 + .2 x ($1,200,000 – $700,000)) | 170,000 |
| Total | $920,000 |
In this situation, the properties are sold for $1,200,000. After paying the $300,000 of liabilities, there is $920,000 (= $900,000 from sale transaction plus $20,000 existing cash) to be divided by the partners, in a 4:4:2 ratio. These transactions occur immediately, and no present value calculations are required.
The amount, in present value terms, to be received by each partner is as follows:
| Reitmyer | $266,170 |
| Simon | 266,170 |
| Trybus | 256,170 |
| Total | $788,510 |
In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for ten years; this has a present value of $245,784 (= $40,000 x present value of annuity factor, 10 years, 10% = $40,000 x 6.1446). A final payment of $1,000 is made to each partner at the end of year 10, which has a present value of $386 (= $1,000 x present value factor, 10 years, 10% = $1,000 x .3855). Thus the present values of the amounts received by each partner are:
| Reitmyer | Simon | Trybus | |
| Initial payment | $ 20,000 | $ 20,000 | $ 10,000 |
| Present value of ten years’ salary | 245,784 | 245,784 | 245,784 |
| Present value of final payment | 386 | 386 | 386 |
| Total | $266,170 | $ 266,170 | $256,170 |
Because all partners receive the same salary, note that Trybus fares better under this arrangement than under the immediate sale, while the other two partners receive less.
The amount, in present value terms, to be received by each partner is as follows:
| Reitmyer | $239,680 |
| Simon | 239,680 |
| Trybus | 154,550 |
| Total | $633,910 |
In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for two years; this has a present value of $69,420 (= $40,000 x present value of annuity factor, 2 years, 10% = $40,000 x 1.7355). The properties are sold for $950,000 at the end of the fourth year. After paying the $400,000 of liabilities, there is $550,000 to be divided by the partners. The present value of the net proceeds is $375,650 (= $550,000 x present value factor, 4 years, 10% = $550,000 x .6830).
Thus the present values of the amounts received by each partner are:
| Reitmyer | Simon | Trybus | |
| Initial payment | $ 20,000 | $ 20,000 | $ 10,000 |
| Present value of two years’ salary | 69,420 | 69,420 | 69,420 |
| Present value of sale proceeds | 150,260 | 150,260 | 75,130 |
| Total | $239,680 | $ 239,680 | $154,550 |
The amount, in present value terms, to be received by each partner is as follows:
| Reitmyer | $266,166 |
| Simon | 266,166 |
| Trybus | 256,166 |
| Total | $788,498 |
In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for five years; this has a present value of $151,632 (= $40,000 x present value of annuity factor, 5 years, 10% = $40,000 x 3.7908). The remaining five year’s of salary are then prepaid, at the end of year 5. The discounted value of these payments is $151,632 per partner (= $40,000 x present value of annuity factor, 5 years, 10% = $40,000 x 3.7908), and the present value is $94,148 (= $151,632 x present value factor, 5 years, 10% = $151,632 x .6209). The final payment of $1,000 is also prepaid to each partner at the end of year 5, which has a present value of $386 (= $1,000 x present value factor, 5 years, 10% = $1,000 x .6209 = $621; this amount discounted to the present is $386 = $621 x present value factor, 5 years, 10% = $621 x .6209).
Thus the present values of the amounts received by each partner are:
| Reitmyer | Simon | Trybus | |
| Initial payment | $ 20,000 | $ 20,000 | $ 10,000 |
| Present value of five years’ salary | 151,632 | 151,632 | 151,632 |
| Prepayment of five years’ salary | 94,148 | 94,148 | 94,148 |
| Prepayment of final payment | 386 | 386 | 386 |
| Total | $266,166 | $ 266,166 | $256,166 |
Note that, except for a small rounding error in the discount factors, this outcome is identical to requirement b. The acceleration of the payments makes no difference in present value terms.
e.
The amount, in present value terms, to be received by each partner is as follows:
| Reitmyer | $ 444,828 |
| Simon | 444,828 |
| Trybus | 298,230 |
| Total | $1,187,886 |
In this situation, $50,000 is received immediately and divided among the partners in a 4:4:2 ratio. The annual salary of $40,000 is received by each partner for five years; this has a present value of $151,632 (= $40,000 x present value of annuity factor, 5 years, 10% = $40,000 x 3.7908). The election of the buyout requires the partners to pay the Ushers $250,000 (= $50,000 x 5). The present value of this payment is $155,225 (= $250,000 x present value factor, 5 years, 10% = $250,000 x .6209). This payment would be divided among the partners in a 4:4:2 ratio. The properties are sold for $2,000,000 at the end of the fifth year. After paying the $650,000 of liabilities, there is $1,350,000 to be divided by the partners. The present value of the net proceeds is $838,215 (= $1,350,000 x present value factor, 5 years, 10% = $1,350,000 x .6209). Thus the present values of the amounts received by each partner are:
| Reitmyer | Simon | Trybus | |
| Initial payment | $ 20,000 | $ 20,000 | $ 10,000 |
| Present value of five years’ salary | 151,632 | 151,632 | 151,632 |
| Buyout payment made to Ushers* | (62,090) | (62,090) | (31,045) |
| Present value of sale proceeds | 335,286 | 335,286 | 167,643 |
| Total | $444,828 | $ 444,828 | $298,230 |
* Total is $155,225.
P14.12 Partnership Liquidation – Safe Payments
November
| Cash on hand | $30,000 |
| Cash from sale | 8,000 |
| $38,000 |
Since $40,000 is owed to creditors (to be paid in December) no cash can be distributed to partners.
December
| Cash at beginning of month | $38,000 |
| Cash from sale (= (.85 x $14,000) + $3,100) | 15,000 |
| Payments to outside creditors | (40,000) |
| Cash available for distribution | $13,000 |
Assuming a total loss on all remaining assets, there will be a loss of $26,000 on sale of equipment. Since no relationship was specified in the agreement, partners share the loss equally. Ogleby’s loan account is added to her capital balance.
| Able | Bowen | Cratz | Ogleby | |
| Capital balance, Nov. 2 | $16,000 | $ 7,000 | $ 3,000 | $28,000 |
| Loss realized in November* | (2,125) | (2,125) | (2,125) | (2,125) |
| Loss realized in December** | (1,625) | (1,625) | (1,625) | (1,625) |
| 12,250 | 3,250 | (750) | 24,250 | |
| Assumed loss on remaining assets | (6,500) | (6,500) | (6,500) | (6,500) |
| 5,750 | (3,250) | (7,250) | 17,750 | |
| Allocate deficiencies | (5,250) | 3,250 | 7,250 | (5,250) |
| $ 500 | $ 0 | $ 0 | $12,500 |
Distribute $500 to Able and $12,500 to Ogleby.
* Loss of $3,500 (= $4,000 – $7,500) on fixtures and loss of $5,000 (= $4,000 – $9,000) on equipment, total loss for November $8,500.
** Loss of $2,100 (= $11,900 – $14,000) on supplies and $4,400 (= $3,100 – $7,500) on fixtures, total loss for December $6,500
January
Cash available for distribution = $4,500.
| Able | Bowen | Cratz | Ogleby | |
| Capital balance before December distribution | $12,250 | $ 3,250 | $ (750) | $24,250 |
| December cash distribution | (500) | _____ | ____ | (12,500) |
| 11,750 | 3,250 | (750) | 11,750 | |
| Loss realized in January*** | (375) | (375) | (375) | (375) |
| 11,375 | 2,875 | (1,125) | 11,375 | |
| Assumed loss on remaining assets | (5,000) | (5,000) | (5,000) | (5,000) |
| 6,375 | (2,125) | (6,125) | 6,375 | |
| Allocate deficiencies | (4,125) | 2,125 | 6,125 | (4,125) |
| $ 2,250 | $ 0 | $ 0 | $ 2,250 |
Distribute $2,250 to Able and $2,250 to Ogleby.
*** Loss of $1,500 (= $4,500 – $6,000) on equipment in January.
P14.13 Partnership Liquidation – Safe Payments
| Dodge (40%) | Edsel (25%) | Ford (20%) | Harley (15%) | Total | ||
| Capital | $ 71,000 | $ 42,000 | $ 53,000 | $ 9,000 | $175,000 | |
| Partners’ loans | 80,000 | (25,000) | -0- | -0- | 55,000 | |
| Combined capital | 151,000 | 17,000 | 53,000 | 9,000 | 230,000 | |
| January transactions: | ||||||
| Loss– inventory return | (600) | (375) | (300) | (225) | (1,500) | |
| Loss – inventory sale | (6,000) | (3,750) | (3,000) | (2,250) | (15,000) | |
| Loss – equipment sale | (12,800) | (8,000) | (6,400) | (4,800) | (32,000) | |
| Liquidation expenses | (2,200) | (1,375) | (1,100) | (825) | (5,500) | |
| January 31 capital | 129,400 | 3,500 | 42,200 | 900 | 176,000 | |
| Less: | ||||||
| Reserved cash | (8,000) | (5,000) | (4,000) | (3,000) | (20,000) | |
| Potential loss – accounts receivable | (16,800) | (10,500) | (8,400) | (6,300) | (42,000) | |
| Potential loss on land | (12,000) | (7,500) | (6,000) | (4,500) | (30,000) | |
| Potential loss on truck | (14,800) | (9,250) | (7,400) | (5,550) | (37,000) | |
| 77,800 | (28,750) | 16,400 | (18,450) | 47,000 | ||
| Allocation of Edsel’s and Harley’s deficiencies | (31,467) | 28,750 | (15,733) | 18,450 | -0- | |
| January 31 safe payment | $ 46,333 | $ -0- | $ 667 | $ -0- | $ 47,000 | |
| Dodge (40%) | Edsel (25%) | Ford (20%) | Harley (15%) | Total | ||
| January 31 Capital | $ 129,400 | $ 3,500 | $ 42,200 | $ 900 | $ 176,000 | |
| Less: payment to partners | (46,333) | -0- | (667) | -0- | (47,000) | |
| February transactions: | ||||||
| Loss on truck | (2,800) | (1,750) | (1,400) | (1,050) | (7,000) | |
| Transfer of truck | (30,000) | -0- | -0- | -0- | (30,000) | |
| Accounts written off | (10,800) | (6,750) | (5,400) | (4,050) | (27,000) | |
| Liquidation expenses | (1,200) | (750) | (600) | (450) | (3,000) | |
| February 28 capital | 38,267 | (5,750) | 34,133 | (4,650) | 62,000 | |
| Less: | ||||||
| Reserved cash | (4,000) | (2,500) | (2,000) | (1,500) | (10,000) | |
| Potential loss on land | (12,000) | (7,500) | (6,000) | (4,500) | (30,000) | |
| 22,267 | (15,750) | 26,133 | (10,650) | 22,000 | ||
| Allocation of Edsel’s and Harley’s deficiencies | (17,600) | 15,750 | (8,800) | 10,650 | -0- | |
| February 28 safe payment | $ 4,667 | $ -0- | $ 17,333 | $ -0- | $ 22,000 | |
| February 28 capital | $ 38,267 | $ (5,750) | $ 34,133 | $ (4,650) | $ 62,000 | |
| Less: payment to partners | (4,667) | -0- | (17,333) | -0- | (22,000) | |
| March transactions: | ||||||
| Gain on land sale | 38,000 | 23,750 | 19,000 | 14,250 | 95,000 | |
| Liquidation expenses | (3,200) | (2,000) | (1,600) | (1,200) | (8,000) | |
| March 31 capital and safe payment | $ 68,400 | $ 16,000 | $ 34,200 | $ 8,400 | $127,000 |
P14.14 Close Books and Prepare Cash Distribution Plan
a.
| Capital Accounts | ||||
| A (.2) | B (.3) | C (.5) | Total | |
| Preclosing balances per books | $80,000 | $51,000 | $30,000 | $161,000 |
| Deduct drawings | (30,000) | (15,000) | (10,000) | (55,000) |
| Income allocation: | ||||
| Salaries | 20,000 | 30,000 | – | 50,000 |
| Residual | 4,000 | 6,000 | 10,000 | 20,000 |
| Postclosing balances | $74,000 | $72,000 | $30,000 | $176,000 |
| Postclosing balances | $ 74,000 | $ 72,000 | $ 30,000 | $176,000 |
| Add loan payable to C | – | – | 20,000 | 20,000 |
| Preliquidation balances | 74,000 | 72,000 | 50,000 | $196,000 |
| Divide by income-sharing % | .2 | .3 | .5 | |
| Standardized capital | 370,000 | 240,000 | 100,000 | |
| Equalize A and B | (130,000) | – | – | |
| 240,000 | 240,000 | 100,000 | ||
| Equalize A, B and C | (140,000) | (140,000) | – | |
| $100,000 | $100,000 | $100,000 | ||
| Convert equalization adjustments | 26,000 | – | – | 26,000 |
| Convert equalization adjustments | 28,000 | 42,000 | – | 70,000 |
Cash Distribution Plan
First $69,000 to creditors
Next $26,000 to A
Next $70,000 to A and B in 2:3 ratio
Any further amount A, B and C in 2:3:5 ratio
Because cash of $55,000 is already available, only $14,000 must be realized from the other assets to liquidate the liabilities. If $14,000 is realized, the loss on the other assets is $196,000 (= 210,000 – 14,000). As expected, this loss equals the total preliquidation capital of $196,000. When allocated to the partners in their 2:3:5 income-sharing ratio, and assuming no additional investments are made, each capital account will be driven to zero.
P14.15 Analysis of Liquidation Scenario
There appears to be inadequate control over cash receipts. An opportunity to steal cash exists when a single individual is responsible for collecting the coins and depositing them. (Note: An actual case arose in Northeastern Pennsylvania when a police officer who emptied parking meters unsupervised was accused of stealing the proceeds). This opportunity, coupled with Green’s worsening personal financial situation, may have presented a temptation that Green found difficult to resist. If so, this may explain the observed decrease in operating cash flow.
With 24 monthly payments of $500 each remaining, the present value at .0075 per month (equivalent to 9% annually) is $10,945 (= 21.8891 x $500). Thus the partners are better off by paying the $10,000 to cancel the lease.
To use the cash distribution plan methodology, we must first close the books and allocate the income. Net income of $6,000 (= $25,000 – $13,000 – $6,000) is allocated $3,600 (60%) to Green and $2,400 (40%) to Blue. Thus the capital position of the partners prior to liquidation is:
| Green | Blue | Total | |
| Capital accounts per trial balance | $ 5,000 | $ 4,850 | $ 9,850 |
| Income allocation | 3,600 | 2,400 | 6,000 |
| Addition of loan payable to Blue | 0 | 11,000 | 11,000 |
| $ 8,600 | $18,250 | $26,850 | |
| To standardize, divide by income % | .60 | .40 | |
| Standardized capital balance | 14,333 | 45,625 | |
| Equalize Green and Blue | 0 | (31,292) | |
| $14,333 | $14,333 | ||
| Convert equalization adjustment ($31,292 x .4) | $12,517 |
Therefore, the cash distribution plan is:
First $11,350 to creditors (includes $10,000 lease buyout).
Next $12,517 to Blue.
Any further amount to Green and Blue in a 3:2 ratio.
Green might be better off staying with it (and, if stealing, stop to eliminate any suspicions Blue may have) because sale of the equipment, supplies and prepayments (total net book value $25,500) must realize $21,567 (= $11,350 + $12,517 – $2,300) before Green will receive will receive anything.
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