Question

Irene Watts and John Lyon are forming a partnership to which Watts will devote one-half time and Lyon will devote full time. They have discussed the following alternative plans for sharing income and loss: (a) in the ratio of their initial capital investments, which they have agreed will be $31,500 for Watts and $38,500 for Lyon; (b) in proportion to the time devoted to the business; (c) a salary allowance of $2,250 per month to Lyon and the balance in accordance with the ratio of their initial capital investments; or (d) a salary allowance of $2,250 per month to Lyon, 11% interest on their initial capital investments, and the balance shared equally. The partners expect the business to perform as follows: year 1, $18,000 net loss; year 2, $45,000 net income; and year 3, $75,000 net income.

Answer 1

Year 1
Plan A		Watts		Lyon	Total
Net Income /(Loss)					(18,000)
Balance allocated in proportion to initial investment	18,000*(31,500/70,000)	(8,100)	18,000*(38,500/70,000)	(9,900)	18,000
Balance of income / (loss)					nil
Share to the Partners		(8,100)		(9,900)	(18,000)
Plan B		Watts		Lyon	Total
Net Income/(Loss)					(18,000)
Balance allocated in proportion to time devoted	18,000*(0.5/1.5)	(6,000)	18,000*(1/1.5)	(12,000)	18,000
Balance of income / (loss)					nil
Share to the Partners		(6,000)		(12,000)	(18,000)
Plan C		Watts		Lyon	Total
Net Income/ (Loss)					(18,000)
Salary allowances			2,250*12	27,000	(27,000)
Balance of income/ (Loss)					(45,000)
Balance allocated in proportion of initial investment	45,000*(31,500/70,000)	(20,250)	45,000*(38,500/70,000)	(24,750)	45,000
Balance of Income/ (Loss)					nil
Share of the Partners (Salary + Balance Allocated)		(20,250)		2,250	(18,000)
Plan D		Watts		Lyon	Total
Net Income/ (Loss)					(18,000)
Salary Allowance			2,250*12	27,000	(27,000)
Balance of income/ (Loss)					(45,000)
Interest Allowances	31,500*11%	3,465	38,500*11%	4,235	(7,700)
Balance of income/(Loss)					(52,700)
Balance allocated Equally	52,700/2	(26,350)	52,700/2	(26,350)	52,700
Balance of Income/(Loss)					nil
Share of the partners (Salary+Interest+Balance allocated)		(22,885)		4,885	(18,000)

Year 2
Plan A		Watts		Lyon	Total
Net Income					45,000
Balance allocated in proportion to initial investment	45,000*(31,500/70,000)	20,250	45,000*(38,500/70,000)	24,750	(45,000)
Balance of income					nil
Share to the Partners		20,250		24,750	45,000
Plan B		Watts		Lyon	Total
Net Income					45,000
Balance allocated in proportion to time devoted	45,000*(0.5/1.5)	15,000	45,000*(1/1.5)	30,000	(45,000)
Balance of income					nil
Share to the Partners		15,000		30,000	45,000
Plan C		Watts		Lyon	Total
Net Income					45,000
Salary allowances			2,250*12	27,000	(27,000)
Balance of income					18,000
Balance allocated in proportion of initial investment	18,000*(31,500/70,000)	8,100	18,000*(38,500/70,000)	9,900	(18,000)
Balance of Income					nil
Share of the Partners (Salary + Balance Allocated)		8,100		36,900	45,000
Plan D		Watts		Lyon	Total
Net Income/ (Loss)					45,000
Salary Allowance			2,250*12	27,000	(27,000)
Balance of income/ (Loss)					18,000
Interest Allowances	31,500*11%	3,465	38,500*11%	4,235	(7,700)
Balance of income/(Loss)					10,300
Balance allocated Equally	10,300/2	5,150	10,300/2	5,150	(10,300)
Balance of Income/(Loss)					nil
Share of the partners (Salary+Interest+Balance allocated)		8,615		36,385	45,000

Year 3
Plan A		Watts		Lyon	Total
Net Income					75,000
Balance allocated in proportion to initial investment	75,000*(31,500/70,000)	33,750	75,000*(38,500/70,000)	41,250	(75,000)
Balance of income / (loss)					nil
Share to the Partners		33,750		41,250	75,000
Plan B		Watts		Lyon	Total
Net Income/(Loss)					75,000
Balance allocated in proportion to time devoted	75,000*(0.5/1.5)	25,000	75,000*(1/1.5)	50,000	(75,000)
Balance of income / (loss)					nil
Share to the Partners		25,000		50,000	75,000
Plan C		Watts		Lyon	Total
Net Income/ (Loss)					75,000
Salary allowances			2,250*12	27,000	(27,000)
Balance of income/ (Loss)					48,000
Balance allocated in proportion of initial investment	48,000*(31,500/70,000)	21,600	48,000*(38,500/70,000)	26,400	(48,000)
Balance of Income/ (Loss)					nil
Share of the Partners (Salary + Balance Allocated)		21,600		53,400	75,000
Plan D		Watts		Lyon	Total
Net Income/ (Loss)					75,000
Salary Allowance			2,250*12	27,000	(27,000)
Balance of income/ (Loss)					48,000
Interest Allowances	31,500*11%	3,465	38,500*11%	4,235	(7,700)
Balance of income/(Loss)					40,300
Balance allocated Equally	40,300/2	20,150	40,300/2	20,150	(40,300)
Balance of Income/(Loss)					nil
Share of the partners (Salary+Interest+Balance allocated)		23,615		51,385	75,000