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Chapter 12: Problem 3

Candace Hassell and Abby Lawson formed a partnership, investing \(\$ 240,000\) and \(\$ 80,000\), respectively. Determine their participation in the year's net income of \(\$ 200,000\) under each of the following independent assumptions: (a) no agreement concerning division of net income; (b) divided in the ratio of original capital investment; (c) interest at the rate of \(15 \%\) allowed on original investments and the remainder divided in the ratio of \(2: 3\); (d) salary allowances of \(\$ 50,000\) and \(\$ 70,000\), respectively, and the balance divided equally; (e) allowance of interest at the rate of \(15 \%\) on original investments, salary allowances of \(\$ 50,000\) and \(\$ 70,000\), respectively, and the remainder divided equally.

Short Answer

Expert verified
(a) $100,000 each; (b) Candace $150,000, Abby $50,000; (c) Candace $96,800, Abby $103,200; (d) Candace $90,000, Abby $110,000; (e) Candace $102,000, Abby $98,000.

Step by step solution

01

No Agreement on Division

When there is no agreement concerning the division of net income, it is assumed that the profits are shared equally. Therefore, the net income of \( \\(200,000 \) will be divided between Candace and Abby equally. \[ \text{Candace's Share} = \frac{200,000}{2} = \\)100,000 \]\[ \text{Abby's Share} = \frac{200,000}{2} = \$100,000 \]
02

Division by Capital Investment Ratio

The division is based on their original capital investments. The ratio of Candace's and Abby's investments is \( 240,000 : 80,000 \) which simplifies to \( 3:1 \). Net income is divided in this ratio.\[ \text{Candace鈥檚 Share} = \frac{3}{3+1} \times 200,000 = \frac{3}{4} \times 200,000 = \\(150,000 \]\[ \text{Abby鈥檚 Share} = \frac{1}{3+1} \times 200,000 = \frac{1}{4} \times 200,000 = \\)50,000 \]
03

Division with Interest and Fixed Ratio

Calculate 15% interest on the original investments. Then divide the remainder of the profit in the ratio 2:3.Interest:\[ \text{Candace's Interest} = 0.15 \times 240,000 = \\(36,000 \]\[ \text{Abby's Interest} = 0.15 \times 80,000 = \\)12,000 \]Remaining Profit:\[ \text{Remaining Profit} = 200,000 - (36,000 + 12,000) = 152,000 \]Division in 2:3 ratio:\[ \text{Candace鈥檚 Remaining Share} = \frac{2}{2+3} \times 152,000 = \frac{2}{5} \times 152,000 = \\(60,800 \]\[ \text{Abby鈥檚 Remaining Share} = \frac{3}{2+3} \times 152,000 = \frac{3}{5} \times 152,000 = \\)91,200 \]Final Shares:\[ \text{Candace's Total} = 36,000 + 60,800 = \\(96,800 \]\[ \text{Abby's Total} = 12,000 + 91,200 = \\)103,200 \]
04

Division with Salary Allowances

Allocate salary allowances first and then divide the remaining profit equally.Salary Allowances:\[ \text{Candace鈥檚 Salary} = \\(50,000 \]\[ \text{Abby鈥檚 Salary} = \\)70,000 \]Remaining Profit:\[ \text{Remaining Profit} = 200,000 - (50,000 + 70,000) = 80,000 \]Equal Division of Remaining Profit:\[ \text{Candace鈥檚 Share of Remainder} = \frac{80,000}{2} = \\(40,000 \]\[ \text{Abby鈥檚 Share of Remainder} = \frac{80,000}{2} = \\)40,000 \]Final Shares:\[ \text{Candace's Total} = 50,000 + 40,000 = \\(90,000 \]\[ \text{Abby's Total} = 70,000 + 40,000 = \\)110,000 \]
05

Combination of Interest, Salaries, and Equal Division

First calculate 15% interest on investments, then allocate salary allowances. Divide any remaining profit equally.Interest:\[ \text{Candace's Interest} = 0.15 \times 240,000 = \\(36,000 \]\[ \text{Abby's Interest} = 0.15 \times 80,000 = \\)12,000 \]Salary Allowances:\[ \text{Candace's Salary} = \\(50,000 \]\[ \text{Abby's Salary} = \\)70,000 \]Remaining Profit:\[ \text{Total Allocated before Remainder} = 36,000 + 12,000 + 50,000 + 70,000 = 168,000 \]\[ \text{Remaining Profit} = 200,000 - 168,000 = 32,000 \]Equal Division of Remaining Profit:\[ \text{Candace鈥檚 Share of Remainder} = \frac{32,000}{2} = \\(16,000 \]\[ \text{Abby鈥檚 Share of Remainder} = \frac{32,000}{2} = \\)16,000 \]Final Shares:\[ \text{Candace's Total} = 36,000 + 50,000 + 16,000 = \\(102,000 \]\[ \text{Abby's Total} = 12,000 + 70,000 + 16,000 = \\)98,000 \]

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Profit Distribution
In partnership accounting, profit distribution refers to how the net income of a partnership is divided among partners. It is crucial to agree on a method of allocation to ensure fairness and transparency. If no agreement is made, profits are typically shared equally.
The aim is to align the distribution with each partner's input, such as their capital contribution, effort, or role in the partnership. This concept is important because it can affect partners' satisfaction and motivation, ultimately impacting the partnership's success.
Capital Investment Ratio
When partners invest different amounts of capital into a business, it's common to distribute profits based on the capital investment ratio.
This ratio reflects each partner's financial contribution to forming the partnership. For example, if one partner invests three times as much as another, they may receive a proportionately larger share of the profits. To calculate this, determine the ratio by dividing the investment amounts, simplify the ratio, and then apply it to the net income. This method ensures that partners are rewarded in line with their initial financial investment, promoting equity within the business.
Salary Allowances
Salary allowances are predetermined amounts that partners can receive as compensation for their work in the partnership. This approach recognizes partners' roles and responsibilities, differentiating between capital invested and efforts made. To calculate the distribution, first allocate the agreed salary allowances to each partner. Afterward, any remaining profit is shared according to an agreed method, often split equally or based on another specified ratio. Salary allowances are especially useful when partners contribute significantly different amounts of time or expertise. They ensure that effort and involvement are acknowledged financially, which aids in maintaining commitment and morale.
Interest on Investments
Interest on investments involves providing partners with a return on their initial capital contributions before distributing remaining profits. This method is another way to reward partners proportional to their financial risk. To implement this, calculate interest at the agreed rate (for instance, 15%) on each partner's initial investment. Deduct this interest from the total profit, and then distribute any remaining profit using a chosen method, such as equally or via a separate ratio. This approach ensures that partners are compensated for the opportunity cost of investing their capital into the partnership. It is an incentive to encourage investment and financial commitment within the partnership.

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Most popular questions from this chapter

Sixty-year-old Jasmine Howard retired from her computer consulting business in Boston and moved to Florida. There she met 27-year-old Dawn Patel, who had just graduated from Eldon Community College with an associate degree in computer science. Jasmine and Dawn formed a partnership called J\&D Computer Consultants. Jasmine contributed \(\$ 25,000\) for startup costs and devoted one-half time to the business. Dawn devoted full time to the business. The monthly drawings were \(\$ 2,000\) for Jasmine and \(\$ 4,000\) for Dawn. At the end of the first year of operations, the two partners disagreed on the division of net income. Jasmine reasoned that the division should be equal. Although she devoted only one-half time to the business, she contributed all of the startup funds. Dawn reasoned that the income-sharing ratio should be \(2: 1\) in her favor because she devoted full time to the business and her monthly drawings were twice those of Jasmine. Can you identify any flaws in the partners' reasoning regarding the incomesharing ratio?

Ben Bowman and Savannah Mapes formed a limited liability company with an operating agreement that provided a salary allowance of \(\$ 75,000\) and \(\$ 60,000\) to each member, respectively. In addition, the operating agreement specified an income-sharing ratio of 3:2. The two members withdrew amounts equal to their salary allowances. a. Determine the division of \(\$ 188,000\) net income for the year. b. Provide journal entries to close the (1) income summary and (2) drawing accounts for the two members.

Pryor and Lester are partners, sharing gains and losses equally. They decide to terminate their partnership. Prior to realization, their capital balances are \(\$ 12,000\) and \(\$ 8,000\), respectively. After all noncash assets are sold and all liabilities are paid, there is a cash balance of \(\$ 16,000\). a. What is the amount of a gain or loss on realization? b. How should the gain or loss be divided between Pryor and Lester? c. How should the cash be divided between Pryor and Lester?

Casey Fisher and Logan Baylor formed a partnership in which the partnership agreement provided for salary allowances of \(\$ 40,000\) and \(\$ 35,000\), respectively. Determine the division of a \(\$ 20,000\) net loss for the current year.

Jason Bradley and Abdul Barak, with capital balances of \(\$ 26,000\) and \(\$ 35,000\), respectively, decide to liquidate their partnership. After selling the noncash assets and paying the liabilities, there is \(\$ 76,000\) of cash remaining. If the partners share income and losses equally, how should the cash be distributed?
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