Question

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 ye

E. How do the payment of salary and the allocation of profit affect entries and the financial bottom line? Be sure to support your explanation with concrete examples. [ACC-405-01]

F. How could the payment of salary and allocation of profit be a more effective method of splitting the company’s profits for the three partners? Explain a scenario in which the three partners would all be compensated fairly, and support your answer with logical reasoning. [ACC-405-03]

G. What would be the value of each partner’s capital account at the end of the year, given your proposed fair allocation method? Support your answer with quantitative data and an explanation of how you came to this conclusion. [ACC-405-01

Answer 1

E. The profit sharing ration is not given therefore the profit can be shared in the equal ratio. In the given question the amount of the salary to be given to each partner is not mentioned, therefore there will not be any impact of salary. If the salary paid to partner the same is given to partners person account and the fund of the firm will got reduced.

If, the profit is shared in equal ratio the income for the first year $ 150000 will be shared equally to Alan, Bob, and Carol.

i.e. $ 50000 to each partner. The same will be credited to capital account and the amount will be available with the firm as capital.

F. Alan is investing $1 million in cash but, 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.

Hence, all three are contributing to the firm in visible or invisible form. Therefore the profit should be shared in equal ratio.

salary should be given to Bob and Carol, because they are contributing in day to day activity and handling the business.

Interest on capital should be given to Alan, as he has contributed cash in the firm.

G. the value of each partner’s capital account at the end of the year will be as follows, if the first year profit is shared in equal ration.

Alan = ($150000+$50000) = $200000

Bob = $50000

Carol = $50000