Question

Why are my questions not answered? I am waiting and waiting and desperately need it done.

Here:

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. Profits for the year = $150000

Share of Profit of Alan = $150000*1/3 = $50000

Share of Profit of Bob = $150000*1/3 = $50000

Share of Profit of Carol = $150000*1/3 = $50000

In my opinion, Allocation of profits on an evenly basis is a better method. Though Bob and Carol are not contributing any cash or initial capital towards business but they are investing their time and efforts and bringing their hard earned experience to gain customers and conduct efficient business. Aan in turn is only investing initial capital of $1 million and then acting as a sleeping partner. Therefore it would not be appropriate to Increase the share of Alan on the basis of capital invested.

B. When the profits of the year are distributed evenly among the partners, the capital accounts of the partners at the end of years stood as follows:

Capital Account of Alen = $1000000 + $50000(share of Profit) = $1050000

Capital Account of Bob   = $50000(share of Profit) = $50000

Capital Account of Carey = $50000(share of Profit) = $50000

As Bob and Carey did not contribute any initial capital therefore their capital at the end is their share of profit only.

C. If 80% of the profits was given to the cash investor and the remaining amount was split evenly between the other two partners

Profits for the year = $150000

Share of Profit of Alan = $150000*80% = $120000

Share of Profit of Bob = $(150000-120000)*1/2 = $15000

Share of Profit of Carol = $150000-120000)*1/2 = $15000

In a business, Capital is the main constituent. But alone capital cannot make a business success. Efficient manpower with skills and experience is also required as an important constituent for the success of a business. In the present case allocating 80% of the profits to Alan just because he has contributed cash is unfair. By this, both Bob and Carol would be demotivated and discouraged to continue in partnership. In lieu of profits they should be given some extra benefits and compensations like commision and salaries etc.

D. If 80% of the profits was given to the cash investor and the remaining amount was split evenly between the other two partners

Capital Account of Alen = $1000000 + $120000(share of Profit) = $1120000

Capital Account of Bob   = $15000(share of Profit) = $15000

Capital Account of Carey = $15000(share of Profit) = $15000

As Bob and Carey did not contribute any initial capital therefore their capital at the end is their share of profit only.