Question

Thirty years ago, five mechanics formed a partnership and established an automobile repair shop. Two of the partners, Decker and Groth, are now retiring. The other three partners, Farmer, Wang, and Lux, are continuing the partnership. The original agreement called for an equal division of income. The remaining partners plan to continue this arrangement. The following balance sheet is prepared for the partnership as of the retirement date:

Cash	$130,000	Accounts payable	$175,000
Accounts receivable	210,000	Loan payable	100,000
Inventory of parts	120,000	Capital - Decker	250,000
Equipment, net	300,000	Capital - Groth	150,000
Building, net	210,000	Capital - Farmer	225,000
Land	90,000	Capital - Wang	25,000
		Capital - Lux	135,000
Total assets	$1,060,000	Total liabilities and capital	$1,060,000

All partners agreed that Decker should receive $287,500 for his interest in the business and Groth should receive $187,500. Farmer proposed the bonus method for recording the retirements. Wang objects to this method and suggests the partial goodwill approach.

(a) Prepare the journal entry to record the retirements under the bonus method.

(b) Prepare the journal entry to record the retirements under the partial goodwill approach.

c) Why does Wang object to the bonus method of accounting?

Under the bonus method, Wang's capital balance is reduced to zero.

Under the bonus method, Wang must pay cash to the other remaining partners.

Under the bonus method, Wang pays more cash to the retired partners.

Under the bonus method, no goodwill is attributed to Wang.

(d) Regardless of the accounting method employed, what immediate problem for the business can you identify at the time of retirement?

The firm's total debts exceed the assets available to pay those debts.

The firm is insolvent.

The firm is not profitable.

The firm does not have sufficient cash to pay the retirees.

Answer 1

Journal Entry Under Bonus Method

(A)

Particular

Dr. Amount($)

Cr. Amount($)

1

Farmer's capital

25,000.00

Wang's capital

25,000.00

lux's Capital

25,000.00

Decker's capital

250,000.00

Groth's Capital

150,000.00

Cash

437,500.00

The retiring partners are paid 437500 in cash and their capital account of 400000(250000+150000) is cleared.

The cost of the bonus paid to the retiring partner (75,000) is allocated between the remaining partners In there profit sharing ratio i.e. 1:1:1

Journal Entry Under Partial Goodwill Method

(B)

Particular

Dr. Amount($)

Cr. Amount($)

Goodwill

161,000.00

Assets

1,060,000.00

Liabilities

275,000.00

Cash

437,500.00

Farmer's capital

169,500.00

Wang's capital

169,500.00

5,08,500 is divided in the ratio of

lux's Capital

169,500.00

01:01:01

Under Partial Goodwill approach , goodwill is calculated as follows

Total assests-total liabilities

1060000-275000= 785000

Share of retiring partner= 785000*2/5 = 314000

Less

Cash to be paid Decker           287500

Groth              187500

Goodwill=      161000

(C)

Wang Object to bonus method because his capital is reduced to zero($25000-$25000)

(D)

The Immediate problem is that firm doesn't have sufficient cash to pay to retirees.