Question

The Distance Plus partnership has the following capital balances at the beginning of the current year:

Tiger (50% of profits and losses)	$	75,000
Phil (20%)		45,000
Ernie (30%)		60,000

Each of the following questions should be viewed independently.

1. If Sergio invests $60,000 in cash in the business for a 20 percent interest, what journal entry is recorded? Assume that the bonus method is used.

2. If Sergio invests $40,000 in cash in the business for a 20 percent interest, what journal entry is recorded? Assume that the bonus method is used.

3. If Sergio invests $50,000 in cash in the business for a 20 percent interest, what journal entry is recorded? Assume that the goodwill method is used.

Note: there is one JE for A to record the admission of new partner under bonus method, one JE for B, to record the admission of new partner under bonus method, and 2 JE's for C, the first to record the entry for goodwill allocation, during the admission of a new partner and the second to record the investment made by the new partner in the business.

Answer 1

A) Total capital after admission of Sergio = Tiger's Capital+Phil's Capital+Ernie's Capital+Sergio's Investment

= $75,000+$45,000+$60,000+$60,000 = $240,000

Share of Sergio in capital = Total capital after admission*Sergio's share

= $240,000*20% = $48,000

The share of Sergio is $48,000 but cash invested by him is $60,000, hence the excess of $12,000 (60,000-48,000) is bonus which will be allocated to existing partners in their existing profit sharing ratio (i.e 50:20:30).

Journal Entry (Amounts in $)

Account Titles and Explanations	Debit	Credit
Cash	60,000
Tiger's Capital (12,000*50%)		6,000
Phil's Capital (12,000*20%)		2,400
Ernie's Capital (12,000*30%)		3,600
Sergio's Capital		48,000
(To record the amount invested by Sergio under bonus method)

B) Total capital after admission of Sergio = Tiger's Capital+Phil's Capital+Ernie's Capital+Sergio's Investment

= $75,000+$45,000+$60,000+$40,000 = $220,000

Share of Sergio in capital = Total capital after admission*Sergio's share

= $220,000*20% = $44,000

The share of Sergio is $44,000 but cash invested by him is $40,000, hence the deficit of $4,000 (44,000-40,000) will be allocated to existing partners in their existing profit sharing ratio (i.e 50:20:30).

Journal Entry (Amounts in $)

Account Titles and Explanations	Debit	Credit
Cash	40,000
Tiger's Capital (4,000*50%)	2,000
Phil's Capital (4,000*20%)	800
Ernie's Capital (4,000*30%)	1,200
Sergio's Capital		44,000
(To record the amount invested by Sergio under bonus method)

C) Under the goodwill method, the amount of goodwill invested by the new partner is calculated and allocated to existing partners in their existing profit sharing ratio.

Total Par value of Capital = Sergio's Investment/Sergio's share of interest

= $50,000/20% = $250,000

Total capital after admission of Sergio = Tiger's Capital+Phil's Capital+Ernie's Capital+Sergio's Investment

= $75,000+$45,000+$60,000+$50,000 = $230,000

Goodwill Amount = Par Value of Capital - Total capital after admission of Sergio

= $250,000 - $230,000 = $20,000

The goodwill of $20,000 will be recorded and allocated to existing partners in their existing profit sharing ratio.

Journal Entries (Amounts in $)

Account Titles and Explanations	Debit	Credit
Goodwill	20,000
Tiger's Capital (20,000*50%)		10,000
Phil's Capital (20,000*20%)		4,000
Ernie's Capital (20,000*30%)		6,000
(To record and allocate the goodwill)
Cash	50,000
Sergio's Capital		50,000
(To record the amount invested by Sergio)