Question

Need answers! Thank you! A new business client comes to your office. There are three owners of the business. The three individuals, Alan, Bob, and Carol, are thinking about forming a partnership. Alan is only investing $1 million in cash. He will not have anything to do with the daily activities of the business. Bob has had some experience in the business and will be responsible for the day-to-day operations of the business. Carol has a great deal of experience and many contacts within the business. She will be responsible for attracting new clients. Neither Bob nor Carol are investing cash into the partnership. During the first year of operation, the partnership generated a profit of $150,000. None of the partners received distributions during the year.

I. Allocation of Profits A. Explain how allocating the profits evenly between the partners would work. Consider the fairness to each of the partners in your response.

B. What would be the value of each partner’s capital account at the end of the year, given that the profits were allocated evenly among the three? Support your answer with quantitative data and an explanation of how you came to this conclusion.

C. Explain an alternative method of allocating the profits if 80% of the profits was given to the cash investor and the remaining amount was split evenly between the other two partners.

D. What would be the value of each partner’s capital account at the end of the year, given this alternative allocation method? Support your answer with quantitative data and an explanation of how you came to this conclusion.

Answer 1

A.It will certainly work ,if the partnership agreement between the three says so,ie. profits are to be shared equally amongst them.It all depends on the agreement ,either oral or in writing(depending on local legislations) & registered with appropriate authority, with details of sharing.

Carol is investing all her contacts ,which are the basis for origination of the business itself.

Alan has invested money.

Bob has invested his time, to run the business that was originated by Carol, with Alan's money .

So,it is only fair and proper that the profits were allocated evenly among the three.

B.Value of each partner’s capital account at the end of the year,
given that the profits were allocated evenly among the three
	Alan	Bob	Carol
Initial capital	1000000
Share of profits(1/3*150000)	50000	50000	50000
Capital at end of Year	1050000	50000	50000
C & D.Alternative method of allocating the profits if 80% of the profits was given to the cash investor and the remaining amount was split evenly between the other two partners.
	Alan	Bob	Carol
Initial capital	1000000
80% profits(80%*150000)	120000
Balance (150000-120000)/2		15000	15000
Capital at end of Year	1120000	15000	15000