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, 2016, O’Donnell invests a building worth $76,000 and equipment valued at $48,000 as well as $36,000 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 20 percent of partnership income each year (without regard for the preceding interest figure) or $7,000, whichever is larger. All remaining income is credited to Reese.
• Neither partner is allowed to withdraw funds from the partnership during 2016. Thereafter, each can draw $6,000 annually or 10 percent of the beginning capital balance for the year, whichever is larger.

The partnership reported a net loss of $10,000 during the first year of its operation. On January 1, 2017, Terri Dunn becomes a third partner in this business by contributing $24,000 cash to the partnership. Dunn receives a 25 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 2017 is reported as $68,000. Each partner withdraws the full amount that is allowed.

On January 1, 2018, Dunn becomes ill and sells her interest in the partnership (with the consent of the other two partners) to Judy Postner. Postner pays $105,000 directly to Dunn. Net income for 2018 is $69,000 with the partners again taking their full drawing allowance.

On January 1, 2019, 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

DATE		JOURNAL		DEBIT	CREDIT
1.1.16		Building		76000
		Equipment		48000
		cash		36000
			o donnell, capital		80000
			reese , capital		80000
31.12.16		reese, capital		33000			The allocation plan specifies that O'Donnell receives 20% in interest [or $16,000 based on $80,000 capital balance] plus $7,000 more [Because that amount exceeds 20% of the profits from the period]. The remaining $33,000 loss is assigned to Reese.
			o donnell, capital		23000
			income summary		10000
1.1.17		cash		24000
		o donnell, capital		4900			New investment by Dunn brings total capital to $194,000 after 2013 loss [$180,000 ? $10,000 + $24,000]. Dunn's 25% interest is $48,500 [$194,000 × 25%] with the extra $24,500 coming from the two original partners [allocated between them according to their profit and loss ratio
		reese , capital		19600
			Dunn capital		48500
31.12.2017		o donnell, capital		9810			capital balance of o donnell			98100
		reese , capital		6000
		Dunn capital		6000
			o donnell, drawings		9810
			reese , drawings		6000
			Dunn drawings		6000
									o donnell		reese		dunn
31.12.2017		Income summary		68000			Interest (20% of $98,100 beginning capital balance)		19620
			o donnell, capital		33220
			reese , capital		20,868		20% of $68,000 income		13600
			Dunn capital		13912		60:40 spilt of remaining $34,780 income				20,868		13912
							Total		33220		20,868		13912
1.1.18		Dunn, capital		56412
			Postner capital		56412
31.12.18		o donnell, capital		12151			capital balance (31.12.17)
		reese , capital		6000
		Postner capital		6000			o donnell	121510
			o donnell, drawing		12151		reese	42,268
			reese , drawing		6000		postner	56412
			Postner drawing		6000

31.12.18		Income summary		69000					o donnell		reese		postner
			o donnell, capital		38102		Interest (20% of $121510 beginning capital balance)		24302
			reese , capital		18,539
			Postner capital		12359		20% of $69000 income		13800
							60:40 spilt of remaining $30,898 income				18,539		12359
							Total		38102		18,539		12359