Question

A new business client comes to your office. There are three owners of the business. The three individuals, Alan, Bob, and Carol, are thinking about forming a partnership. Alan is only investing $1 million in cash. He will not have anything to do with the daily activities of the business. Bob has had some experience in the business and will be responsible for the day-to-day operations of the business. Carol has a great deal of experience and many contacts within the business. She will be responsible for attracting new clients. Neither Bob nor Carol are investing cash into the partnership. During the first year of operation, the partnership generated a profit of $150,000. None of the partners received distributions during the year.

A. How do the payment of salary and the allocation of profit affect entries and the financial bottom line? Be sure to support your explanation with concrete examples.

B. How could the payment of salary and allocation of profit be a more effective method of splitting the company's profits for the three partners? Explain a scenario in which the three partners would be compensated fairly, and support your answer with logical reasoning.

C. What would be the value of each partner's capital account at the end of the year, given your proposed fair allocation method? Support your answer with quantitative data and an explanation of how you came to this conclusion.

Answer 1