Question

Gray, Stone, and Lawson open an accounting practice on January 1, 2016, in San Diego, California, to be operated as a partnership. Gray and Stone will serve as the senior partners because of their years of experience. To establish the business, Gray, Stone, and Lawson contribute cash and other properties valued at $390,000, $360,000, and $180,000, respectively. An articles of partnership agreement is drawn up. It has the following stipulations: - Personal drawings are allowed annually up to an amount equal to 10 percent of the beginning capital balance for the year. - Profits and losses are allocated according to the following plan: 1. A salary allowance is credited to each partner in an amount equal to $7 per billable hour worked by that individual during the year. 2. Interest is credited to the partners’ capital accounts at the rate of 12 percent of the average monthly balance for the year (computed without regard for current income or drawings). 3. An annual bonus is to be credited to Gray and Stone. Each bonus is to be 10 percent of net income after subtracting the bonus, the salary allowance, and the interest. Also included in the agreement is the provision that there will be no bonus if there is a net loss or if salary and interest result in a negative remainder of net income to be distributed. 4. Any remaining partnership profit or loss is to be divided evenly among all partners. Because of financial shortfalls encountered in getting the business started, Gray invests an additional $8,600 on May 1, 2016. On January 1, 2017, the partners allow Monet to buy into the partnership. Monet contributes cash directly to the business in an amount equal to a 20 percent interest in the book value of the partnership property subsequent to this contribution. The partnership agreement as to splitting profits and losses is not altered upon Monet’s entrance into the firm; the general provisions continue to be applicable. The billable hours for the partners during the first three years of operation follow: 2016 2017 2018 Gray 1,890 3,600 2,060 Stone 1,620 2,100 1,800 Lawson 3,100 1,560 1,490 Monet 0 1,370 1,760 The partnership reports net income for 2016 through 2018 as follows: 2016 $ 101,000 2017 (38,400) 2018 243,000 Each partner withdraws the maximum allowable amount each year. A. Determine the allocation of income for each of these three years. B. Prepare in appropriate form a statement of partners’ capital for the year ending December 31, 2018.

Answer 1

2016
	Gray	Stone	Lawson	Total
Billable hours (A)	1,890	1,620	3,100	6,610
Rate per hour (B)	7	7	7	7
Salary allowance (C=A*B)	13,230	11,340	21,700	46,270
average monthly balance (D)	395,733	360,000	180,000	935,733
	(390000*4/12)+(398600*8/12)
Rate of Interest ('E)	12%	12%	12%	12%
Interest (F=D*E)	47,488	43,200	21,600	112,288
Net Income	101000
Less: Salary Allowance	46270
Less: Interest on Partner's Capital	112288
Less: Bonus	0
Profit /(Loss to be distibuted) (G)	-57558
No bonus is being paid for 2016 as the salary and interest result in negative rainder of net income
	Gray	Stone	Lawson	Total
Beginning Capital Balance for 2016	390,000	360,000	180,000	930,000
Add: Investment	8,600	-	-	8,600
Add:Salary allowance	13,230	11,340	21,700	46,270
Add:Interest	47,488	43,200	21,600	112,288
Less:Loss (57558/3)	-                                                 19,186	-                        19,186	-    19,186	-         57,558
Less:Drawings (10%)	-                                                 39,000	-                        36,000	-    18,000	-         93,000
Ending Capital Balance for 2016	401,132	359,354	186,114	946,600
Monet's Investment = 20% ($946600 + Monet's Investment)
Ml = $189320 + .20 Ml		189320
.80 Ml = $189320		236650
Ml = $236650

2017
	Gray	Stone	Lawson	Monet	Total
Billable hours (A)	3,600	2,100	1,560	1,370	8,630
Rate per hour (B)	7	7	7	7	7
Salary allowance (C=A*B)	25,200	14,700	10,920	9,590	60,410
average monthly balance (D)	401,132	359,354	186,114	236,650	1,183,250
Rate of Interest ('E)	12%	12%	12%	12%	12%
Interest (F=D*E)	48,136	43,122	22,334	28,398	141,990
Net Income	-38400
Less: Salary Allowance	60,410
Less: Interest on Partner's Capital	141,990
Less: Bonus	0
Profit /(Loss to be distibuted) (G)	-240800
No bonus is being paid for 2017 as there is net loss
	Gray	Stone	Lawson	Monet	Total
Beginning Capital Balance for 2017	401,132	359,354	186,114	236,650	1,183,250
Add: Investment	-	-	-	-	-
Add:Salary allowance	25,200	14,700	10,920	9,590	60,410
Add:Interest	48,136	43,122	22,334	28,398	141,990
Less:Loss (240800/4)	-                                                 60,200	-         60,200	-         60,200	-         60,200	-           240,800
Less:Drawings (10%)	-                                                 40,113	-         35,935	-         18,611	-         23,665	-           118,325
Ending Capital Balance for 2017	374,155	321,041	140,556	190,773	1,026,525

2018
	Gray	Stone	Lawson	Monet	Total
Billable hours (A)	2,060	1,800	1,490	1,760	7,110
Rate per hour (B)	7	7	7	7	7
Salary allowance (C=A*B)	14,420	12,600	10,430	12,320	49,770
average monthly balance (D)	374,155	321,041	140,556	190,773	1,026,525
Rate of Interest ('E)	12%	12%	12%	12%	12%
Interest (F=D*E)	44,899	38,525	16,867	22,893	123,183

The bonus to Gray and Stone can only be derived algebraically. Since each of the two partners is entitled to 10% of net income as defined, the total bonus is 20% and can be computed as follows:
Bonus = 10% (Net income – Salary – Interest – Bonus)
B = .1 ($243000 – $49770 – $123183 – B)
B = .1 ($70047 – B)
B = $7004.7 – .1B
1.1 B = $7004.7
B = $6368 (or $3184 per person)

Net Income	243000
Less: Salary Allowance	49,770
Less: Interest on Partner's Capital	123,183
Less: Bonus	6368
Profit /(Loss to be distibuted) (G)	63679

B.

Statement of Partners' Capital
Dec 31, 2018
	Gray	Stone	Lawson	Monet	Total
Beginning Capital Balance for 2018	374,155	321,041	140,556	190,773	1,026,525
Add: Investment	-	-	-	-	-
Add:Salary allowance	14,420	12,600	10,430	12,320	49,770
Add:Interest	44,899	38,525	16,867	22,893	123,183
Add: Bonus	3,184	3,184	-	-	6,368
Add: Profit (63679/4)	15,920	15,920	15,920	15,920	63,679
Less:Drawings (10%)	-    37,415	-    32,104	-    14,056	-    19,077	-     102,653
Ending Capital Balance for 2018	415,161	359,166	169,717	222,828	1,166,873