Question

James J. Dewars has been the sole owner of a small CPA firm for the past 20 years. Now 52 years old, Dewars is concerned about the continuation of his practice after he retires. He would like to begin taking more time off now although he wants to remain active in the firm for at least another 8 to 10 years. He has worked hard over the decades to build up the practice so that he presently makes a profit of $180,000 annually.

Lewis Huffman has been working for Dewars for the past four years. He now earns a salary of $68,000 per year. He is a very dedicated employee who generally works 44 to 60 hours per week. In the past, Dewars has been in charge of the larger, more profitable audit clients whereas Huffman, with less experience, worked with the smaller clients. Both Dewars and Huffman do some tax work although that segment of the business has never been emphasized.

Sally Scriba has been employed for the past seven years with another CPA firm as a tax specialist. She has no auditing experience but has a great reputation in tax planning and preparation. She currently earns an annual salary of $80,000.

Dewars, Huffman, and Scriba are negotiating the creation of a new CPA firm as a partnership. Dewars plans to reduce his time in this firm although he will continue to work with many of the clients that he has served for the past two decades. Huffman will begin to take over some of the major audit jobs. Scriba will start to develop an extensive tax practice for the firm.

Because of the changes in the firm, the three potential partners anticipate earning a total net income in the first year of operations of between $130,000 and $260,000. Thereafter, they hope that profits will increase at the rate of 10 to 20 percent annually for the next five years or so.

How should this new partnership allocate its future net income among these partners?

Answer 1

The problem provides three practitioners with varied periods of experience and working hours. The proposition may thus be summarised as below:
i.James J Dewars - 20 years’ practice – 180,000 income annually
ii.Lewis Huffman - 4 years’ experience- 68,000 income annually
iii.Sally Scriba - 7 years’ experience- 80,000 income annually
Now, James wishes to cut down on his working hours even though he still intends to continue to remain in practice for the next 8-10 years. Similarly, Lewis works for around 44-60 hours per week. Nothing in the problem specify to the working hours of Scriba.
Furthermore, with James wanting to cut down on his practice a large portion of the audit work would be handled by Lewis. On the other hand Sally will develop an extensive tax practice in her core area of tax planning.
In this light, the three have joined to form a partnership firm. The exercise before us is to frame the proportion in which the income of this firm is to be divided considering the factors specified above.
We are taking Sally’s case as the mean as the problem does not mention anything about her inclination to work more or less and that she would be developing the practice which has been her specialisation. So, taking that into account there would not be any change in the proportion of her income in the new firm.
Lewis’s share would 30% more than his current income due to two factors: his ability to put in more working hours and the handling of the audit practice from James. Similarly, James’ share would be 70% of his current income as he would be cutting down on his working hours.