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

a	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.
Date	General Journal	Debit	Credit
01.01.2016	Building	$76,000
	Equipment	48000
	Cash	36000
	To O'Donnell Capital		80000
	To Steve Reese's capital		80000
31.12.2016	Steve Reese's capital	42000
	To O'Donnell capital		32000
	To Income Summary		10000
	(The allocation plan specifies that O'Donnell receives 20% in interest [or $16,000 based on $80,000 capital balance] plus $16000 more. The remaining $42,000 loss is assigned to Steve Reese.)
01.01.2017	Cash	24000
	O'Donnell Capital	3900
	Steve Reese's capital	15600
	To Terri Dunn capital		43500
	The total capital would be (160000-10000+24000) $174000 of which Terri's share is 25% of 174000 $43500
	O'Donnell Capital share - 20% of (43500-24000)	3900
	Steve Reese's capital share - 80% (43500-24000)	15600
31.12.2017	O'Donnell Capital	10810
	Steve Reese's capital	6000
	Terri Dunn capital	6000
	To O'Donnell, drawings		10810
	To Steve Reese's drawings		6000
	To Terri Dunn's drawings		6000
	(To close out drawings account for the year based on distributing 10% of each partner's beginning capital balances or $6000 whichiver is greater
	O'Donnell Capital(80000+32000-3900)	10810
	Steve Reese's capital(80000-42000-15600)	2240	6000	6000
	Terri Dunn capital	4350	6000	6000
31.12.2017	Income Summary	68000
	To O'Donnell Capital		35220
	To Steve Reese's capital		19668
	To Terri Dunn capital		13112
	(80000+32000-3900)*20%- O'Donnell	21620
	68000*20%	13600
		32780
01.01.2018	Terri Dunn capital	50612
	To Postner capital		50612
	(43500-6000+13112)
31.12.2018	O'Donnell Capital	13251
	Steve Reese's capital	6000
	Postner's capital	6000
	To O'Donnell, drawings		13251
	To Steve Reese's drawings		6000
	To Postner's drawings		6000
	O'Donnell Capital(80000+32000-3900-10810+35220)	13251
	Steve Reese's capital(80000-42000-15600-6000+19668)	3606.8	6000	6000
	Postner's capital	5061.2	6000
31.12.2018	Income Summary	69000
	To O'Donnell Capital		40302
	To Steve Reese's capital		17218.8
	To Postner's capital		11479.2
	O' Donnel share	13800
	Capital ((80000+32000-3900-10810+35220)	26502
		40302
01.01.2019	O'Donnell Capital(6209.12)*20%	1,241.82
	Steve Reese's capital (6209.12)*80%	4,967.30
	Postner's capital(50612+11479.20)	62,091.20		6209.12
	To Cash		68300.32
b)	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
Date	General Journal	Debit	Credit
01.01.2016	Building	$76,000
	Equipment	48000
	Cash	36000
	Goodwill	160000
	To O'Donnell Capital		160000
	To Steve Reese's capital		160000
31.12.2016	Steve Reese's capital	74000
	To O'Donnell capital		64000
	To Income Summary		10000
	(The allocation plan specifies that O'Donnell receives 20% in interest [or $32,000 based on $160,000 capital balance] plus $32000 more. The remaining $74,000 loss is assigned to Steve Reese.)
01.01.2017	Cash	24000
	Goodwill	47333.33
	To Terri Dunn capital		71333.33
	Goodwill will have to be calculated
	$24,000 + Goodwill =	25% (Current Capital + $24,000 + Goodwill)
	$24,000 + Goodwill =	25% ($310,000 + $24,000 + Goodwill)
	$24,000 + Goodwill =	$77500 + 0.25 Goodwill		77500
	0.75 Goodwill =	53500		24000
	Goodwill =	71333.33		53500
				71333.33
31.12.2017	O'Donnell Capital(160000+64000)	22400
	Steve Reese's capital(160000-74000)	8600
	Terri Dunn capital	7133.333
	To O'Donnell, drawings		22400
	To Steve Reese's drawings		8600
	To Terri Dunn's drawings		7133.33
31.12.2017	Income Summary	68000
	To O'Donnell Capital		58400
	To Steve Reese's capital		5760
	To Terri Dunn capital		3840
	(160000+64000)*20%- O'Donnell	44800
	68000*20%	13600
		58400
01.01.2018	Goodwill (105000-71333.33-7133.33+3840)	30373.34
	To O'Donnell Capital		6,074.67
	To Steve Reese's capital		14,579.20
	To Terri Dunn capital		9,719.47
01.01.2018	Terri Dunn capital	105000
	To Postner capital		105000
31.12.2018	O'Donnell Capital	26607.47
	Steve Reese's capital	9773.92
	Postner's capital	10500
	To O'Donnell, drawings		26607.47
	To Steve Reese's drawings		9773.92
	To Postner's drawings		10500
	O'Donnell Capital(160000+64000-22400+58400+6074.67)	26607.467
	Steve Reese's capital(160000-74000+14579.20+5760-8600)	9773.92
	Postner's capital(105000)*10%	10500
31.12.2018	Income Summary	69000
	To O'Donnell Capital		67,014.93
	To Steve Reese's capital		1,191.04
	To Postner's capital		794.03
	O' Donnel share	13800
	Capital (160000+64000-22400+58400+6074.67)	53214.934
		67014.934
01.01.2019	Goodwill	23823.5
	To O'Donnell Capital		4764.7
	To Steve Reese's capital		11435.28
	To Postner's capital		7623.52
	Postner will be paid(105000-10500+794.03)	95,294.03
		9,529.40
	Total	104,823.43
	Postner is being paid 9529.40 in excess of his share of 9529.40/0.40	23823.5
01.01.2019	Postner's capital	104823.433
	To Cash		104823.43