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 $130,000 and equipment valued at $140,000 as well as $60,000 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 10 percent of partnership income each year (without regard for the preceding interest figure) or $4,000, 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 $7,000 annually or 15 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 $26,000 cash to the partnership. Dunn receives a 20 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 $100,000. 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 $99,000 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	130000
		Equipment	140000
		Cash	60000
		O'Donnell, Capital ((130000+140000+60000)*1/2)		165000
		Reese, Capital ((130000+140000+60000)*1/2)		125000
		(To record initial investment of assets by partners)
2	12/31/16	Reese, Capital	26500
		O'Donnell, Capital (165000*10%)+4000		20500
		Income Summary		6000
		(To record the distribution of net income to partners)
3	1/1/17	Cash	26000
		O'Donnell, Capital (44000*10%)	4400
		Reese, Capital (44000*90%)	39600
		Dunn, Capital		70000
		(To record the admittance of Dunn into the partnership)
4	12/31/17	O'Donnell, Capital (165000+20500-4400)*15%	27165
		Reese, Capital ((165000-26500-39600)*15%)	14835
		Dunn, Capital (70000*15%)	10500
		O'Donnell, Drawings		27165
		Reese, Drawings		14835
		Dunn, Drawings		10500
		(To record entry to close drawings account)
5	12/31/17	Income Summary	100000
		O'Donnell, Capital		28110
		Reese, Capital		43134
		Dunn, Capital		28756
		(To record the distribution of net income to partners)
6	1/1/18	Dunn, Capital	88256
		Postner, Capital		88256
		(To record the admittance of Postner into the partnership)
7	12/31/18	O'Donnell, Capital (182045*15%)	27307
		Reese, Capital (127199*15%)	19080
		Postner, Capital (88256*15%)	13238
		O'Donnell, Drawings		27307
		Reese, Drawings		19080
		Postner, Drawings		13238
		(To record entry to close drawings account)
8	12/31/18	Income Summary	99000
		O'Donnell, Capital		28105
		Reese, Capital		42537
		Dunn, Capital		28358
		(To record the distribution of net income to partners)
9	1/1/19	Postner, Capital (47160-6000+17694)	103376
		O'Donnell, Capital (9107*20%)	1034
		Reese, Capital (9107* 80%)	9304
		Cash (103376*(1+10%))		113714
		(To record the final distribution to Postner)

Part B

No.	Date	General journal	Debit	Credit
1	1/1/16	Building	130000
		Equipment	140000
		Cash	60000
		Goodwill	330000
		O'Donnell, Capital		330000
		Reese, Capital		330000
		(To record initial investment of assets by partners)
2	12/31/16	Reese, Capital	43000
		O'Donnell, Capital (330000*10%)+4000		37000
		Income Summary		6000
		(To record the distribution of net income to partners)
3	1/1/17	Cash	26000
		Goodwill	111500
		Dunn, Capital		137500
		(To record the admittance of Dunn into the partnership)
4	12/31/17	O'Donnell, Capital (330000+37000)*15%	55050
		Reese, Capital (330000-43000)*15%	43050
		Dunn, Capital (137500*15%)	20625
		O'Donnell, Drawings		55050
		Reese, Drawings		43050
		Dunn, Drawings		20625
		(To record entry to close drawings account)
5	12/31/17	Income Summary	100000
		O'Donnell, Capital		46700
		Reese, Capital		31980
		Dunn, Capital		21320
		(To record the distribution of net income to partners)
6	1/1/18	Goodwill (175000-138195)/36%	102236
		O’Donnell Capital (102236*10%)		10224
		Reese, Capital (102236*54%)		55207
		Postner, Capital (102236*36%)		36805
		(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 ((358650+10224)*15%)	55331
		Reese, Capital ((275930+55207)*15%)	49671
		Postner, Capital (175000*15%)	26250
		O'Donnell, Drawings		55331
		Reese, Drawings		49671
		Postner, Drawings		26250
		(To record entry to close drawings account)
9	12/31/18	Income Summary	99000
		O'Donnell, Capital		46787
		Reese, Capital		31328
		Dunn, Capital		20885
		(To record the distribution of net income to partners)
10	1/1/19	Goodwill ((169635*10%) =16964/36%)	47122
		O'Donnell, Capital (10%)		4712
		Reese, Capital (54%)		25446
		Postner, Capital (36%)		16964
		(To record the goodwill indicated by the withdrawl of postner)
11	1/1/19	Postner, Capital	186599
		Cash (169635*(1+10%))		186599
		(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 $16500 based on $165,000 capital balance] plus $4,000 more [since that amount is greater than 10% of the profits from the period]. The remaining $26500 loss is assigned to Reese.)

1/1/17 - New investment by Dunn brings total capital to $145,000 after 2008 loss [$(165000+165000) – $6,000 + $26,000]. Dunn's 20% interest is $70000 [$350000 × 20%] with the extra $44000 (70000-26000) 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 15% of each partner's beginning capital balances or 7000 whichever is more

Net income distribution

	O'Donnell	Reese	Dunn
Interest (165000+20500-4400)*10% beginning capital balance)	18110
10% of $100000 income	10000
60:40 spilt of remaining $71890 (100000-18110-10000) Income		43134	28756
Total	28110	43134	28756

Capital Balances as of December 31, 2017:

	O'Donnell	Reese	Dunn
Initial 2016 investment	165000	165000
2016 net loss allocation	20500	(26500)
Dunn's investment	(4400)	(39600)	70000
2017 drawings	(27165)	(14835)	(10500)
2017 net income allocation	28110	43134	28756
12/31/17 balances	182045	127199	88256

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 15% of each partner's beginning capital balances or 7000 whichever is more.

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

	O'Donnell	Reese	Dunn
Interest (10% of 182045 beginning capital balance)	18205
10% of $99000 income	9900
60:40 spilt of remaining $70895 (99000-18205-9900) Income		42537	28358
Total	28105	42537	28358

1/1/19 - Postner's capital = 103376 (88256-13238+28358). Extra 10338 (10%*103376) payment is deducted from the two remaining partners' capital accounts in ratio of 10%:90%

O'Donnell, Capital = 10%*10338 = 1034

Reese, Capital = 90%*10338= 9304

Part B

1/1/16- Reese is credited with goodwill of $330,000 to match O'Donnell's investment.

12/31/16 - The allocation plan specifies that O'Donnell will receive 10% in interest [or $33000 based on $330,000 capital balance] plus $6,000 more [since that amount is greater than 10% of the profits from the period]. The remaining $43000 loss is assigned to Reese.)

1/1/17

Current capital = total capital by two partners – net loss = 330000+330000-6000 = 654000

26000+goodwill = 20%*(current capital+26000+goodwill)

26000+goodwill= 20%*(654000+26000+goodwill)

26000+goodwill =20%*(680000+goodwill)

26000+goodwill=136000*0.20goodwill

0.80 goodwill = 110000

Goodwill = 137500

Dunn contributes cash and goodwill.

Net income distribution

	O'Donnell	Reese	Dunn
Interest (10% of $((330000+37000)) beginning capital balance)	36700
10% of $100000 income	10000
60:40 spilt of remaining $34300 (100000-36700-10000) Income		31980	21320
Total	46700	31980	21320