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 $124,000 and equipment valued at $128,000 as well as $48,000 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 10 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 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 $11,000 during the first year of its operation. On January 1, 2020, Terri Dunn becomes a third partner in this business by contributing $19,000 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 5:5 basis between Reese and Dunn, respectively.

Partnership income for 2020 is reported as $94,000. 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 $145,000 directly to Dunn. Net income for 2021 is $94,000 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	124000
	Equipment	128000
	Cash	48000
	To O'Donnell Capital		150000
	To Reese Capital		150000
Dec 31,2019	Reese Capital	47000
	To O'Donnell Capital		36000
	To Income Summary		11000

O'Donnell = (150000*20%) + $6000 = $ 36000

Jan 01,2020	Cash	19000
	O'Donnell Capital	4260
	Reese Capital	38340
	To Dunn Capital		61600

Dunn's Capital = $( 300000-11000+19000) * 20%= $61600

O'donnell capital = (61600-19000) * 10%= $4260

Reese capital = (61600-19000) * 90%= 38340

Dec,31,2020	O'Donnell Capital	27261
	Reese capital	9699
	Dunn Capital	9240
	To O'Donnell's drawings		27261
	To Reese's drawings		9699
	To Dunn's drawings		9240

O'donnell drawings= (150000+36000-4260)= 181740*15%= $ 27261 or $ 7000 whichever is higher

Reese drawings= (150000-47000-38340)= 64660*15%= $ 9699 or $ 7000 whichever is higher

Dunn drawings= 61660*15%= $ 9240 or $ 7000 whichever is higher

Dec,31,2020	Income summary	94000
	To O'Donnell capital		45748
	To Reese capital		24126
	To Dunn capital		24126

O'Donnell = $ (181740 *20%) + (94000*10%) = $ 36348 +9400 = $45748

Reese = $(94000-45748) *5/10 = 24126

Dunn= $(94000-45748) *5/10 = 24126

Jan 01,2021	Dunn's Capital	76486
	to Postner's capital		76486
	(61600-9240+24126)

Jan 31,2021	O'donnell capital	30034
	Reese capital	11863
	Postner capital	11203
	To O'donnell drawings		30034
	To Reese drawings		11863
	To Postner drawings		11203

O'donnell drawings= (181740+45748-27261)= 200227*15%= $ 30034 or $ 7000 whichever is higher

Reese drawings= (64660+24126-9699)= 64660*15%= $ 11863 or $ 7000 whichever is higher

Postner drawings= 76486*15%= $ 11203 or $ 7000 whichever is higher

Dec,31,2021	Income summary	94000
	To O'Donnell capital		49445
	To Reese capital		22277
	To Postner capital		22278

O'Donnell = $ (200227 *20%) + (94000*10%) = $ 40045 +9400 = $49445

Reese = $(94000-49445) *5/10 = 22277

Postner= $(94000-49445) *5/10 = 22278