Question

HOW WILL THE PROFITS BE SPLIT?

James J. Dewars has been the sole owner of a small CPA firm for the past 20 years. Now 52 years old, Dewars is concerned about the continuation of his practice after he retires. He would like to begin taking more time off now although he wants to remain active in the firm for at least another 8 to 10 years. He has worked hard over the decades to build up the practice so that he presently makes a profit of $180,000 annually.

Lewis Huffman has been working for Dewars for the past four years. He now earns a salary of $68,000 per year. He is a very dedicated employee who generally works 44 to 60 hours per week. In the past, Dewars has been in charge of the larger, more profitable audit clients whereas Huffman, with less experience, worked with the smaller clients. Both Dewars and Huffman do some tax work although that segment of the business has never been emphasized.

Sally Scriba has been employed for the past seven years with another CPA firm as a tax specialist. She has no auditing experience but has a great reputation in tax planning and preparation. She currently earns an annual salary of $80,000.

Dewars, Huffman, and Scriba are negotiating the creation of a new CPA firm as a partnership. Dewars plans to reduce his time in this firm although he will continue to work with many of the clients that he has served for the past two decades. Huffman will begin to take over some of the major audit jobs. Scriba will start to develop an extensive tax practice for the firm.

Because of the changes in the firm, the three potential partners anticipate earning a total net income in the first year of operations of between $130,000 and $260,000. Thereafter, they hope that profits will increase at the rate of 10 to 20 percent annually for the next five years or so.

How should this new partnership allocate its future net income among these partners?

Answer 1

Answer: