Question

Steve Reese is a well-known interior designer in Fort Worth, Texas. He wants to start his own business and convinces Rob O’Donnell, a local merchant, to contribute the capital to form a partnership. On January 1, 2016, O’Donnell invests a building worth $104,000 and equipment valued at $96,000 as well as $50,000 in cash. Although Reese makes no tangible contribution to the partnership, he will operate the business and be an equal partner in the beginning capital balances.

To entice O’Donnell to join this partnership, Reese draws up the following profit and loss agreement:

• O’Donnell will be credited annually with interest equal to 10 percent of the beginning capital balance for the year.
• O’Donnell will also have added to his capital account 20 percent of partnership income each year (without regard for the preceding interest figure) or $6,000, whichever is larger. All remaining income is credited to Reese.
• Neither partner is allowed to withdraw funds from the partnership during 2016. Thereafter, each can draw $9,000 annually or 10 percent of the beginning capital balance for the year, whichever is larger.

The partnership reported a net loss of $6,000 during the first year of its operation. On January 1, 2017, Terri Dunn becomes a third partner in this business by contributing $40,000 cash to the partnership. Dunn receives a 25 percent share of the business’s capital. The profit and loss agreement is altered as follows:

• O’Donnell is still entitled to (1) interest on his beginning capital balance as well as (2) the share of partnership income just specified.
• Any remaining profit or loss will be split on a 6:4 basis between Reese and Dunn, respectively.

Partnership income for 2017 is reported as $78,000. Each partner withdraws the full amount that is allowed.

On January 1, 2018, Dunn becomes ill and sells her interest in the partnership (with the consent of the other two partners) to Judy Postner. Postner pays $175,000 directly to Dunn. Net income for 2018 is $78,000 with the partners again taking their full drawing allowance.

On January 1, 2019, Postner withdraws from the business for personal reasons. The articles of partnership state that any partner may leave the partnership at any time and is entitled to receive cash in an amount equal to the recorded capital balance at that time plus 10 percent.

1. Prepare journal entries to record the preceding transactions on the assumption that the bonus (or no revaluation) method is used. Drawings need not be recorded, although the balances should be included in the closing entries.

2. Prepare journal entries to record the previous transactions on the assumption that the goodwill (or revaluation) method is used. Drawings need not be recorded, although the balances should be included in the closing entries.

Answer 1

Part A

No.	Date	General journal	Debit	Credit
1	1/1/16	Building	104000
		Equipment	96000
		Cash	50000
		O'Donnell, Capital ((104000+96000+50000)*1/2)		125000
		Reese, Capital ((104000+96000+50000)*1/2)		125000
		(To record initial investment of assets by partners)
2	12/31/16	Reese, Capital	24500
		O'Donnell, Capital (125000*10%)+6000		18500
		Income Summary		6000
		(To record the distribution of net income to partners)
3	1/1/17	Cash	40000
		O'Donnell, Capital (31000*20%)	6200
		Reese, Capital (31000*80%)	24800
		Dunn, Capital		71000
		(To record the admittance of Dunn into the partnership)
4	12/31/17	O'Donnell, Capital (125000+18500-6200)*10%	13730
		Reese, Capital ((125000-24500-24800)*10%) = 7570 or 9000 (whichever is greater)	9000
		Dunn, Capital (71000*10%) = 7100 or 9000 (whichever is greater)	9000
		O'Donnell, Drawings		13730
		Reese, Drawings		9000
		Dunn, Drawings		9000
		(To record entry to close drawings account)
5	12/31/17	Income Summary	78000
		O'Donnell, Capital		29330
		Reese, Capital		29202
		Dunn, Capital		19468
		(To record the distribution of net income to partners)
6	1/1/18	Dunn, Capital	81468
		Postner, Capital		81468
		(To record the admittance of Postner into the partnership)
7	12/31/18	O'Donnell, Capital (152900*10%)	15290
		Reese, Capital (95902*10%) = 9590 or 9000 whichever is larger	9590
		Postner, Capital (81468*10%) = 8147 or 9000 whichever is larger	9000
		O'Donnell, Drawings		15290
		Reese, Drawings		9590
		Postner, Drawings		9000
		(To record entry to close drawings account)
8	12/31/18	Income Summary	78000
		O'Donnell, Capital		31500
		Reese, Capital		27900
		Dunn, Capital		18600
		(To record the distribution of net income to partners)
9	1/1/19	Postner, Capital (47160-6000+17694)	91068
		O'Donnell, Capital (9107*20%)	1821
		Reese, Capital (9107* 80%)	7286
		Cash (91068*(1+10%))		100175
		(To record the final distribution to Postner)

Part B

No.	Date	General journal	Debit	Credit
1	1/1/16	Building	104000
		Equipment	96000
		Cash	50000
		Goodwill	250000
		O'Donnell, Capital		250000
		Reese, Capital		250000
		(To record initial investment of assets by partners)
2	12/31/16	Reese, Capital	37000
		O'Donnell, Capital (250000*10%)+6000		31000
		Income Summary		6000
		(To record the distribution of net income to partners)
3	1/1/17	Cash	40000
		Goodwill	84667
		Dunn, Capital		124667
		(To record the admittance of Dunn into the partnership)
4	12/31/17	O'Donnell, Capital (250000+31000)*10%	28100
		Reese, Capital (250000-37000)*10%	21300
		Dunn, Capital (124667*10%) = 8333	12467
		O'Donnell, Drawings		28100
		Reese, Drawings		21300
		Dunn, Drawings		12467
		(To record entry to close drawings account)
5	12/31/17	Income Summary	78000
		O'Donnell, Capital		43700
		Reese, Capital		20580
		Dunn, Capital		13720
		(To record the distribution of net income to partners)
6	1/1/18	Goodwill (175000-125920)/32%	153375
		O’Donnell Capital (153375*20%)		30675
		Reese, Capital (153375*48%)		73620
		Postner, Capital (153375*32%)		49080
		(To record the goodwill indicated by the purchase of Dunn’s interest)
7	1/1/18	Dunn, Capital	175000
		Postner, Capital		175000
		(To record the admittance of Postner into the partnership)
8	12/31/18	O'Donnell, Capital ((296600+30675)*10%)	32728
		Reese, Capital ((212280+73620)*10%)	28590
		Postner, Capital (175000*10%)	17500
		O'Donnell, Drawings		32728
		Reese, Drawings		28590
		Postner, Drawings		17500
		(To record entry to close drawings account)
9	12/31/18	Income Summary	78000
		O'Donnell, Capital		48328
		Reese, Capital		17803
		Dunn, Capital		11869
		(To record the distribution of net income to partners)
10	1/1/19	Goodwill ((169369*10) =16937/32%)	52928
		O'Donnell, Capital (20%)		10586
		Reese, Capital (48%)		25405
		Postner, Capital (32%)		16937
		(To record the goodwill indicated by the withdrawl of postner)
11	1/1/19	Postner, Capital	186306
		Cash (169369*(1+10%))		186306
		(To record final distribution to Postner.)

Explanation:

Part A

1/1/16 - To record initial investment of assets by partners. Assets recorded at fair value with two equal capital balances

12/31/16 - The allocation plan specifies that O'Donnell will receive 10% in interest [or $12500 based on $125,000 capital balance] plus $6,000 more [since that amount is greater than 20% of the profits from the period]. The remaining $24500 loss is assigned to Reese.)

1/1/17 - New investment by Dunn brings total capital to $145,000 after 2008 loss [$(125000+125000) – $6,000 + $40,000]. Dunn's 25% interest is $71000 [$284,000 × 25%] with the extra $31000 (71000-40000) coming from the two original partners [allocated between them according to their profit and loss ratio].)

12/31/17 - To close out drawings accounts for the year based on distributing 10% of each partner's beginning capital balances or 9000 whichever is more

Net income distribution

	O'Donnell	Reese	Dunn
Interest (10% of $((125000+18500-6200)) beginning capital balance)	13730
20% of $78000 income	15600
60:40 spilt of remaining $48670 (78000-13730-15600) Income		29202	19468
Total	29330	29202	19468

Capital Balances as of December 31, 2017:

	O'Donnell	Reese	Dunn
Initial 2016 investment	125000	125000
2016 net loss allocation	18500	(24500)
Dunn's investment	(6200)	(24800)	71000
2017 drawings	(13730)	(9000)	(9000)
2017 net income allocation	29330	29202	19468
12/31/17 balances	152900	95902	81468

1/1/18 -Reclassification of capital balance to reflect acquisition of Dunn's interest

12/31/18 - To close out drawings accounts for the year based on distributing 10% of each partner's beginning capital balances or 9000 whichever is more.

12/31/18 - To allocate net income for 2018 determined as follows

	O'Donnell	Reese	Dunn
Interest (10% of 159000 beginning capital balance)	15900
20% of $78000 income	15600
60:40 spilt of remaining $46500 (78000-15900-15600) Income		27900	18600
Total	31500	27900	18600

1/1/19 - Postner's capital = 91068 (81468-9000+18600). Extra 9107 (10%*91068) payment is deducted from the two remaining partners' capital accounts in ratio of 20%:80%

O'Donnell, Capital = 20%*9107 = 1821

Reese, Capital = 80%*9107= 7286

Part B

1/1/16- Reese is credited with goodwill of $250,000 to match O'Donnell's investment.

12/31/16 - The allocation plan specifies that O'Donnell will receive 10% in interest [or $25000 based on $250,000 capital balance] plus $6,000 more [since that amount is greater than 20% of the profits from the period]. The remaining $37000 loss is assigned to Reese.)

1/1/17

Current capital = total capital by two partners – net loss = 250000+250000-6000 = 494000

40000+goodwill = 25%*(current capital+40000+goodwill)

40000+goodwill= 25%*(494000+40000+goodwill)

40000+goodwill =25%*(534000+goodwill)

40000+goodwill=133500*0.25goodwill

0.75 goodwill = 93500

Goodwill = 124667

Dunn contributes cash and goodwill.

Net income distribution

	O'Donnell	Reese	Dunn
Interest (10% of $((250000+31000)) beginning capital balance)	28100
20% of $78000 income	15600
60:40 spilt of remaining $34300 (78000-28100-15600) Income		20580	13720
Total	43700	20580	13720