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, 2013, O’Donnell invests a building worth $56,000 and equipment valued at $24,000 as well as $20,000 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 20 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 2013. Thereafter, each can draw $5,000 annually or 10 percent of the beginning capital balance for the year, whichever is larger.

  

The partnership reported a net loss of $7,000 during the first year of its operation. On January 1, 2014, Terri Dunn becomes a third partner in this business by contributing $15,000 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 2014 is reported as $62,000. Each partner withdraws the full amount that is allowed.

On January 1, 2015, Dunn becomes ill and sells her interest in the partnership (with the consent of the other two partners) to Judy Postner. Postner pays $75,000 directly to Dunn. Net income for 2015 is $63,000 with the partners again taking their full drawing allowance.

On January 1, 2016, 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.

a.	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.

b. 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

Solution a:

Date	Particular	Debit	Credit
01-Jan-13	Cash	20000
	Building	56000
	Equipment	24000
	O’Donnell, Capital		50000
	Reese, Capital		50000
	(Being record of Assets contributed)
31-Dec-13	Reese, Capital	23000
	O’Donnell, Capital (50000*20%)+6000		16000
	Income Summary		7000
	(Being allocation of $7000 Loss to Partners)
	Clsoing capital = (1,00,000-7000)= 93000
01-Jan-14	Cash	15000
	O’Donnell, Capital    (27000-15000)*20%	2400
	Reese, Capital          (27000-15000)*80%	9600
	Terri Dunn , Capital   (93000+15000)*25%		27000
	(Being Assets contributed)
31-Dec-14	Income summary	64000
	O’Donnell, Capital (64000*20%)+(50000+16000-2400)*10%		19160
	Reese, Capital (64000-19160)*0.60		26904
	Terri Dunn , Capital (64000-19160)*0.40		17936
	(Being allocation of $64000 profit)
01-Jan-15	Terri Dunn , Capital	75000
	Judy Postner		75000
	(Being Judy acquired share of dunn)
31-Dec-15	Income summary	63000
	O’Donnell, Capital (63000*20%)+(50000+16000-                   2400+19160)*10%		20876
	Reese, Capital (63000-20876)*0.6		25274.4
	Judy Postner    (63000-20876)*0.4		16849.6
Solution b
Goodwill Method is used
	Particular	Debit	Credit
01.01.2016	Cash	20000
	Building	56000
	Equipment	24000
	Goodwill	100000
	O’Donnell, Capital		100000
	Reese, Capital		100000
	(Being Asset recorded)
31.12.2016	Reese, Capital	33000
	O’Donnell, Capital (1,00,000*20%)+6000		26000
	Income Summary		7000
	(To record allocation of $7000 Loss to Partners)
	(Being profit contributed)