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, 2019, 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 2019. 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, 2020, 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 2020 is reported as $100,000. Each partner withdraws the full amount that is allowed.

On January 1, 2021, 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 2021 is $99,000 with the partners again taking their full drawing allowance.

On January 1, 2022, 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

A. Let us assume that bonus method is used.

DATE	ACCOUNT TITLES	DEBIT($)	CREDIT($)
Jan 01,2019	Building	130000
	Equipment	140000
	Cash	60000
	To O'Donnell Capital		165000
	To Reese Capital		165000
Dec 31,2019	Reese Capital	26500
	To O'Donnell Capital		20500
	To Income Summary		6000

O'Donnell = (165000*10%) + $4000 = $ 20500

Jan 01,2020	Cash	26000
	O'Donnell Capital	4400
	Reese Capital	39600
	To Dunn Capital		70000

Dunn's Capital = $( 330000-6000+26000) * 20%= $70000

O'donnell capital = (70000-26000) * 10%= $4400

Reese capital = (70000-26000) * 90%= 39600

Dec,31,2020	O'Donnell Capital	27165
	Reese capital	14835
	Dunn Capital	10500
	To O'Donnell's drawings		27165
	To Reese's drawings		14835
	To Dunn's drawings		10500

O'donnell drawings= (165000+20500-4400)= 181100*15%= $ 27165 or $ 7000 whichever is higher

Reese drawings= (165000-26500-39600)= 98900*15%= $ 14835 or $ 7000 whichever is higher

Dunn drawings= 70000*15%= $ 10500 or $ 7000 whichever is higher

Dec,31,2020	Income summary	100000
	To O'Donnell capital		28110
	To Reese capital		43134
	To Dunn capital		28756

O'Donnell = $ (181100 *10%) + (100000*10%) = $ 18110 +10000 = $28110

Reese = $(100000-28110) *6/10 = 43134

Dunn= $(100000-28110) *4/10 = 28756

Jan 01,2021	Dunn's Capital	88256
	to Postner's capital		88256
	(70000-10500+28756)

Jan 31,2021	O'donnell capital	27307
	Reese capital	19080
	Postner capital	13238
	To O'donnell drawings		27307
	To Reese drawings		19080
	To Postner drawings		13238

O'donnell drawings= (181100+28110-27165)= 182045*15%= $ 27307 or $ 7000 whichever is higher

Reese drawings= (98900+43134-14835)= 127199*15%= $ 19080 or $ 7000 whichever is higher

Postner drawings= 88256*15%= $ 13238 or $ 7000 whichever is higher

Dec,31,2021	Income summary	99000
	To O'Donnell capital		28105
	To Reese capital		42537
	To Postner capital		28358

O'Donnell = $ (182045 *10%) + (99000*10%) = $ 18205 +9900 = $28105

Reese = $(99000-28105) *6/10 = 42537

Postner= $(99000-28105) *4/10 = 28358