Chapter 14 Advanced Solutions

CHAPTER 14 PARTNERSHIPS: FORMATION AND OPERATIONAnswers to Questions1. The advantages of operating a business as a partnership include the ease of formation and the avoidance of the double taxation effect that inherently reduces the profits distributed to the owners of a corporation. In addition, since the losses of a partnership pass, for tax purposes, directly through to the owners, partnerships have historically been used (especially in certain industries) to reduce or defer income taxes. Several disadvantages also accrue from the partnership format. Each general partner, for example, has unlimited liability for all debts of the business. This potential liability can be especially significant in light of the concept of mutual agency, the right that each partner has to create liabilities in the name of the partnership. Because of the risks created by unlimited liability and mutual agency, the growth potential of most partnerships is severely limited. Few people are willing to become general partners in an organization unless they can maintain some day-to-day contact and control over the business. Further discussion of these issues can be found in the Answer to the first Discussion Question that appears above. 2. Specific partnership accounting problems center in the equity (or capital) section of the balance sheet. In a corporation, stockholders' equity is divided between earned capital and contributed capital. Conversely, for a partnership, each partner has an individual capital account that is not differentiated according to its sources. Virtually all accounting issues encountered purely in connection with the partnership format are related to recording and maintaining these capital balances. 3. The balance in each partner's capital account measures that partner's interest in the book value of the business net assets. This figure arises from contributions, earnings, drawings, and other capital transactions. 4. A Subchapter S corporation is formed legally as a corporation so that its owners enjoy limited legal liability and easy transferability of ownership. However, if a company qualifies and becomes a Subchapter S Corporation, it will be taxed in virtually the same manner as a partnership. Hence, income will be taxed only once and that is to the owners at the time that it is earned by the corporation. Use of this designation is quite restricted. To qualify as a Subchapter S Corporation, a company can only have one class of stock and must have no more than 100 owners. These owners can only be individuals, estates, certain tax-exempt entities, and certain types of trusts. Most corporations that do not qualify as Subchapter S Corporations are automatically Subchapter C Corporations. These entities are also corporations but they pay income taxes when the income is earned. Additionally, the owners are liable for a second income tax when dividends are distributed to them. Thus, the income earned by a Subchapter C Corporation faces the double taxation effect commonly associated with corporations.

5. In a general partnership, each partner can have unlimited liability for the debts of the business. Therefore, a partner may face a significant risk, especially in connection with the actions and activities of other partners. However, general partnerships are easy to form and often serve well in smaller businesses where all partners know each other. The major advantage of a general partnership is that all income earned by the business is only taxed once when earned by the business so that no second tax is incurred when distributions are made to owners. A limited liability partnership (LLP) is very similar to a general partnership except in the method by which a partners liability is measured. In an LLP, the partners can still lose their entire investment and be held responsible for all contractual debts of the business such as loans. However, partners cannot be held responsible for damages caused by other partners. For example, if one partner carelessly causes damage and is sued, the other partners are not held responsible. A limited liability company can now be created in certain situations. This type of organization is classified as a partnership for tax purposes so that the double-taxation effect is avoided. However, the liability of the owners is limited to their individual investments like a Subchapter C Corporation. Depending on state law, the number of owners is not restricted in the same manner as a Subchapter S Corporation so that there is a greater potential for growth. 6. The Articles of Partnership is a legal agreement that should be created as a prerequisite for the formation of a partnership. This document defines the rights and responsibilities of the partners in relation to the business and in relation to each other. Thus, it serves as a governing document for the partnership. The Articles of Partnership may contain any number of provisions but should normally specify each of the following: a. b. c. d. e. Name and address of each partner Business location Description of the nature of the business Rights and responsibilities of each partner Initial investment to be made by each partner along with the method to be used for valuation f. Specific method by which profits and losses are to be allocated g. Periodic withdrawals to be allowed each partner h. Procedure for admitting new partners i. Method for arbitrating partnership disputes j. Method for settling a partner's share in the business upon withdrawal, retirement, or death 7. To give fair recognition to noncash contributions, all assets donated by the partners (such as land or inventory) should be recorded by the partnership at their fair values at the date of investment. However, for taxation purposes, the partners book value is retained. 8. In forming a partnership, one or more of the partners may be contributing some factor (such as an established clientele or an expertise) which is not viewed normally as an asset in the traditional accounting sense. In effect, the partner will be receiving a larger capital balance than the identifiable contributions would warrant.

The bonus method of recording this transaction is to value and record only the identifiable assets such as land and buildings. The capital accounts are then aligned to recognize the proportionate interest being assigned to each partner's investment. If, for example, the capital balances are to be equal, they are set at identical amounts that correspond in total to the value of the identifiable assets. As an alternative, the amounts contributed along with the established capital percentages can be used to determine mathematically the implied total value of the business and the presence of any goodwill brought into the business. This goodwill is recognized at the time that the partnership is created so that the amount can be credited to the appropriate partner. 9. The Drawing account measures the amount of assets that a particular partner takes from the business during the current period. Often, only regularly allowed distributions are recorded in the Drawing account with larger, more sporadic withdrawals being recorded as direct reductions to the partner's capital balance. 10. At the end of each fiscal year, when revenues and expenses are closed out, some assignment must be made of the resulting income figure since a partnership will have two or more capital accounts rather than a single retained earnings balance. This allocation to the capital accounts is based on the agreement established by the partners preferably as a part of the Articles of Partnership. 11. The allocation process can be based on any number of factors. The actual assignment of income should be designed to give fair and equitable treatment to each of the partners. Often, an interest factor is used to reward the capital investment of the partners. A salary allowance is utilized as a means of recognizing the amount of time worked by an individual or a certain degree of business expertise. The allocation process can be further refined by a ratio that is either divided evenly among the partners or weighted in favor of one or more members. 12. If agreement as to the allocation of income has not been specified, an equal division among all partners is presumed. If an agreement has been reached for assigning profits but no mention is made concerning losses, the assumption is made that the same method is intended in either case. 13. The dissolution of a partnership is the breakup or cessation of the partnership. Many reasons can exist for a partnership to dissolve. One partner may withdraw, retire, or die. A new partner may be admitted to the partnership. The original partnership terminates whenever the identity of the individuals serving as partners has changed. Dissolution, however, does not necessarily lead to the liquidation of the business. In most cases, but not all, a new partnership is formed which takes over the business. Such dissolutions are no more than changes in the composition of the ownership and should not affect operations. 14. A new partner can join a partnership by acquiring part or all of the interest of one or more of the present partners. This transaction is carried out with the individual partners directly and not with the partnership. A new partner may also enter through a contribution to the business. In such cases, the investment is made to the partnership rather than to the individuals.

15. In selling an interest in a partnership, three rights are conveyed to the new owner: a. The right of co-ownership of the business property; b. The right to a specified allocation of profits and losses generated by the partnership's business; and c. The right to participate in the management of the business. No problem exists in selling or assigning the first two of these rights. However, the right to participate in management decisions can only be transferred with the consent of all partners. 16. Any goodwill being recognized in a capital transaction that is allocated to the original partners is based on the profit and loss ratio. The amount is assumed to represent unrealized gains in the value of the business. To determine the amount of goodwill, the implied value of the business as a whole must be calculated based on the price being paid for a portion by the new partner. The difference between this implied value and the total capital is assumed to be goodwill or some other adjustment to asset value. 17. Allocating goodwill to an entering partner may be necessary for several reasons. One of the most common is that the partner is bringing to the partnership an attribute that is not an asset in the traditional accounting sense. For example, a new partner with an excellent business reputation might be credited with goodwill at the time of entrance. Other factors such as an established clientele or a professional expertise can justify attributing goodwill to the new partner. The partnership might make this same concession to an entering partner if cash is urgently needed by the business and a larger share of the capital has to be offered as an enticement to generate the new investment. 18. Book values in most cases measure historical cost expenditures which often have undergone years of allocation and changes in value. For this reason, book value will frequently fail to mirror or even resemble the actual worth of a business. In addition, the goodwill that is assumed to be present in a business as a going concern is not a factor that is always reflected within book values. Therefore, distributing partnership property to a withdrawing partner based on book value would not necessarily be fair. Hence, the Articles of Partnership should spell out a method by which an equitable settlement can be achieved.

Answers to Problems 1. B 2. C 3. C Mary Ann's investment is equal to 1/3 of the total capital ($50,000/$150,000). However, she is receiving a smaller capital balance, only a 1/4 interest. One explanation for this difference is that the business assets may be worth more than book value. To achieve agreement, the net assets could be valued upward to fair value with the adjustment recorded to the capital accounts of the original partners. As an alternative, a bonus could be credited to the original partners. 4. D The implied value of the company based on the new contribution is only $233,333 ($70,000/30%) which is below the total of the capital balances ($280,000 in original capital plus $70,000 to be invested). Thus, either the assets are overvalued or the new partner is also contributing goodwill. Since the problem indicates that goodwill is being recognized, that figure must be computed. Note that the $70,000 is going into the business and, thus, increases capital. Danville's investment $70,000 + Goodwill $70,000 + Goodwill .70 Goodwill Goodwill Danville's Investment (Capital) = = = = = = 30% (Original Capital Plus Danville's Investment) .30 ($280,000 + $70,000 + Goodwill) $105,000 + .30 Goodwill $35,000 $50,000 $70,000 + $50,000 or $120,000

5. C The implied value of the company is $800,000 ($200,000/25%). Since the current capital total is only $600,000, goodwill of $200,000 must be recognized. Oscar's investment is going to the partners so that it does not affect the capital total directly. Of the $200,000 in goodwill, 30 percent or $60,000 is attributed to Jethro which brings that capital balance to $260,000. Since a 25 percent interest is being conveyed to the new partner, Jethro's balance will then decrease by 25% or $65,000a drop to $195,000. 6. B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new investment. As Kansas's portion is to be 30 percent, the capital balance would be $60,000 ($200,000 30%). Since only $50,000 was paid, a bonus of $10,000 must be taken from the two original partners based on their profit and loss ratio: Bolcar $7,000 (70%) and Neary $3,000 (30%). The reduction drops Neary's capital balance from $40,000 to $37,000. 7. B Total capital is $270,000 ($120,000 + $90,000 + $60,000) after the new investment. However, the implied value of the business based on the new investment is $300,000 ($60,000/20%). Thus, goodwill of $30,000 must be recognized with the offsetting allocation to the original partners based on

their profit and loss ratio: Bishop $18,000 (60%) and Cotton $12,000 (40%). The increase raises Cotton's capital from $90,000 to $102,000. 8. A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new investment. As Claudius's portion is to be 20 percent, the new capital balance would be $90,000 ($450,000 20%). Since $100,000 was paid, a bonus of $10,000 is being given to the two original partners based on their profit and loss ratio: Messalina $6,000 (60%) and Romulus $4,000 (40%). The increase raises Messalina's capital balance from $210,000 to $216,000 and Romulus's capital balance from $140,000 to $144,000. 9. D ASSIGNMENT OF INCOME2007ARTHUR BAXTER CARTWRIGHT TOTAL

Interest10% of beginning capital ............... Salary........................................ Allocation of remaining income ($6,000 divided on a 3:3:4 basis) Totals ............................ STATEMENT OF CAPITAL2007

$ 6,000 20,000 1,800 $ 7,800ARTHUR

$ 8,000 1,800 $29,800BAXTER

$10,000 20,000 2,400 $12,400CARTWRIGHT

$24,000 6,000 $50,000TOTAL

Beginning capital .................... Net income (above) ................. Drawings (given) ..................... Ending capital .........................

$60,000 7,800 (5,000) $62,800WINSTON

$80,000 29,800 (5,000) $104,800DURHAM

$100,000 $240,000 12,400 50,000 (5,000) (15,000) $107,400 $275,000SALEM TOTAL

10. A ASSIGNMENT OF INCOMEYEAR ONE Interest10% of beginning capital ............... $11,000 Salary........................................20,000 -0Allocation of remaining loss ($80,000 divided on a 5:2:3 basis) (40,000) Totals ............................ $(9,000) STATEMENT OF CAPITALYEAR ONEWINSTON DURHAM SALEM TOTAL

$ 8,000 10,000 (16,000) $ (8,000)

$11,000 30,000

$30,000

(24,000) (80,000) $ (3,000) $(20,000)

Beginning capital .................... Net loss (above) ...................... Drawings (given) ..................... Ending capital ....................

$110,000 (9,000) (10,000) $ 91,000

$80,000 (8,000) (10,000) $62,000

$110,000 $300,000 (3,000) (20,000) (10,000) (30,000) $ 97,000 $250,000

10. (continued) ASSIGNMENT OF INCOMEYEAR TWOWINSTON DURHAM SALEM TOTAL

Interest10% of beginning capital ............... $ 9,100 Salary........................................20,000 -0Allocation of remaining loss ($15,000 divided on a 5:2:3 basis) (7,500) Totals ............................ $21,600 STATEMENT OF CAPITALYEAR TWOWINSTON

$ 6,200 10,000 (3,000) $3,200DURHAM

$ 9,700 30,000

$25,000

(4,500) (15,000) $15,200 $ 40,000SALEM TOTAL

Beginning capital (above) ...... Net income (above) ................. Drawings (given) ..................... Ending capital ....................

$ 91,000 21,600 (10,000) $102,600

$62,000 3,200 (10,000) $55,200

$ 97,000 $250,000 15,200 40,000 (10,000) (30,000) $102,200 $260,000

11. A A $10,000 bonus is paid to Costello ($100,000 is paid rather than the $90,000 capital balance). This bonus is deducted from the two remaining partners according to their profit and loss ratio (2:3). A reduction of 60 percent (3/5) is assigned to Burns or a decrease of $6,000 which drops that partners capital balance from $30,000 to $24,000. 12. D Craig receives an additional $10,000. Since Craig is assigned 20 percent of all profits and losses, this allocation indicates total goodwill of $50,000. 20% of Goodwill = $10,000 .20 G = $10,000 G = $10,000/.20 G = $50,000 Montana is assigned 30% of all profits and losses and would, therefore, record $15,000 of this goodwill, an entry that raises this partner's capital balance from $130,000 to $145,000. 13. A The implied value of the company is $900,000 ($270,000/30%). Since the money is going to the partners rather than into the business, the capital total is $490,000 before realigning the balances. Hence, goodwill of $410,000 must be recognized based on the implied value ($900,000 $490,000). This goodwill is assumed to represent unrealized business gains and is attributed to the original partners according to their profit and loss ratio. They will then each convey 30 percent ownership of the $900,000 partnership to Darrow for a capital balance of $270,000.

14. D Since the money goes into the business, total capital becomes $740,000 ($490,000 + $250,000). Darrow is allotted 30 percent of this total or $222,000. Because Darrow invested $250,000, the extra $28,000 is assumed to be a bonus to the original partners. Jennings will be assigned 40 percent of this extra amount or $11,200. This bonus increases Jennings capital from $160,000 to $171,200. 15. (10 Minutes) (Compute capital balances under both goodwill and bonus methods) a. Goodwill Method Implied value of partnership ($80,000/40%) .................. Total capital after investment ($70,000 + $40,000 + $80,000) Goodwill ............................................................................ Goodwill to Hamlet (7/10) ............................................... Goodwill to MacBeth (3/10) ............................................ Hamlet, capital (original balance plus goodwill) .......... MacBeth, capital (original balance plus goodwill) ....... Lear, capital (payment) (40% of total capital) ............... b. Bonus Method Total capital after investment ($70,000 + 40,000 + $80,000) Ownership portionLear ................................................ Lear, capital ...................................................................... Bonus payment made by Lear ($80,000 $76,000)...... Bonus to Hamlet (7/10) .................................................... Bonus to MacBeth (3/10) ................................................. Hamlet, capital (original balance plus bonus) .............. MacBeth, capital (original balance plus bonus) ........... Lear, capital (40% of total capital) ................................. $200,000 190,000 $ 10,000 $ 7,000

$ 3,000 $ 77,000 $ 43,000 $ 80,000 $190,000 40% $ 76,000 $ $ $ 4,000 2,800 1,200

$ 72,800 $ 41,200 $ 76,000

16. (15 Minutes) (Prepare journal entries to record admission of new partner under both the goodwill and the bonus methods) Part a. Total capital is $300,000 ($85,000 + $60,000 + $55,000 + $100,000) after the new investment. As Sergio's portion is 25 percent, this partner's capital balance would be $75,000. Since $100,000 was paid, a bonus of $25,000 is given to the three original partners based on their profit and loss ratio: Tiger$12,500 (50%), Phil$7,500 (30%), and Ernie$5,000 (20%). Cash ............................................................................ Sergio, Capital ....................................................... Tiger, Capital ......................................................... Phil, Capital ........................................................... Ernie, Capital ......................................................... 100,000 75,000 12,500 7,500 5,000

Part b. Total capital is $260,000 ($85,000 + $60,000 + $55,000 + $60,000) after the new investment. As Sergio's portion is to be 25 percent, this partner's capital balance would be $65,000. Because only $60,000 was paid, a bonus of $5,000 is taken from the three original partners based on their profit and loss ratio: Tiger$2,500 (50%), Phil$1,500 (30%), and Ernie$1,000 (20%). Cash ............................................................................ Tiger, Capital .............................................................. Phil, Capital ................................................................. Ernie, Capital .............................................................. Sergio, Capital ....................................................... 60,000 2,500 1,500 1,000 65,000

Part c. Total capital is $272,000 ($85,000 + $60,000 + $55,000 + $72,000) after the new investment. However, the implied value of the business based on the new investment is $288,000 ($72,000/25%). Consequently, goodwill of $16,000 must be recognized with the offsetting allocation to the original partners based on their profit and loss ratio: Tiger$8,000 (50%), Phil $4,800 (30%), and Ernie$3,200 (20%). Goodwill ..................................................................... Tiger, Capital ......................................................... Phil, Capital ........................................................... Ernie, Capital ......................................................... Cash ............................................................................. Sergio, Capital ....................................................... 16,000 8,000 4,800 3,200 72,000 72,000

17. (16 Minutes) (Determine capital balances after admission of new partner using both goodwill and bonus methods) Part a. Total capital is $490,000 ($200,000 + $120,000 + $90,000 + $80,000) after the new investment. However, the implied value of the business based on the new investment is only $444,444 ($80,000/18%). According to the goodwill method, this situation indicates that the new partner must be bringing some intangible attribute to the partnership other than just cash. This contribution must be computed algebraically and is recorded as goodwill to the new partner. G's Investment = .18 ($200,000 + $120,000 + $90,000 + G's Investment) $80,000 + Goodwill = .18 ($410,000 + $80,000 + Goodwill) $80,000 + Goodwill = $88,200 + .18 Goodwill .82 Goodwill = $8,200 Goodwill = $10,000 The above goodwill balance indicates that Grant's total investment is $90,000 (cash of $80,000 and goodwill of $10,000). A $90,000 contribution raises the total capital to $500,000 so that Grant does, indeed, have an 18 percent interest ($90,000/$500,000). CAPITAL BALANCES: Nixon ...................................................................... Hoover .................................................................... Polk ...................................................................... Grant ...................................................................... $200,000 120,000 90,000 90,000

Part b. Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after the new investment. As Grant's portion is to be 20 percent, this partner's capital balance will be $102,000. Since only $100,000 was paid, a bonus of $2,000 is taken from the three original partners based on their profit and loss ratio: Nixon$1,000 (50%), Hoover$400 (20%), and Polk$600 (30%). CAPITAL BALANCESOriginal Investment Bonus Total

Nixon ..................... Hoover ................... Polk ........................ Grant ...................... Total .................

$200,000 120,000 90,000 -0-

100,000

$(1,000) ( 400) ( 600) 2,000

$199,000 119,600 89,400 102,000 $510,000

18. (8 Minutes) (Record admission of new partner and allocation of new income) Part a. Total capital is $336,000 ($150,000 + $110,000 + $76,000) after the new investment. However, the implied value of the business based on the new investment is $380,000 ($76,000/20%). Consequently, goodwill of $44,000 must be recognized with the offsetting allocation to the original two partners based on their profit and loss ratio: Com$26,400 (60%) and Pack $17,600 (40%). Goodwill.................................................................. Com, Capital ..................................................... Pack, Capital .................................................... Cash ...................................................................... Hal, Capital ....................................................... Part b. Interest .................................. Remaining loss...................... Income allocation ........... Com $17,640 (1,000) $16,640 Pack $12,760 (600) $12,160 Hal $7,600 (400) $7,200 Total $38,000 (2,000) $36,000 44,000 26,400 17,600 76,000 76,000

19. (5 Minutes) (Allocation of income to partners) Jones Bonus (20%) .......................... $18,000 Interest (15% of average capital) 15,000 Remaining loss ($18,000) ... (6,000) Income assignment .............. $27,000 $ King -030,000 (6,000) $24,000 $ Lane -045,000 (6,000) $39,000 Total $18,000 90,000 (18,000) $90,000

20. (15 Minutes) (Allocate income and determine capital balances) ALLOCATION OF INCOME Interest (10%) Salary Remaining income (loss): $ 23,600 (12,600) (51,000) $(40,000) Totals Purkerson Smith $ 6,600 (below) $ 4,000 18,000 25,000 Traynor $ 2,000 8,000 Totals $12,600 51,000

(16,000) $ 8,600

(8,000) $21,000

(16,000) $(6,000)

(40,000) $23,600

CALCULATION OF PURKERSON'S INTEREST ALLOCATION Balance, January 1April 1 ($60,000 3) Balance, April 1December 31 ($68,000 9) Total .................................................................................. Months............................................................................... Average monthly capital balance ................................... Interest rate ...................................................................... Interest allocation (above) .............................................. STATEMENT OF PARTNERS' CAPITALPurkerson Smith Traynor Totals

$180,000 612,000 $792,000 12 $ 66,000 10% $ 6,600

Beginning balances ............... Additional contribution ......... Income (above) ...................... Drawings ($1,000 per month) Ending capital balances........

$60,000 8,000 8,600 (12,000) $64,600

$40,000 -021,000 (12,000) $49,000

$20,000 $120,000 -08,000 (6,000) 23,600 (12,000) (36,000) $ 2,000 $115,600

21. (30 Minutes) (Allocate income for several years and determine ending capital balances) INCOME ALLOCATION2009 Left Interest (12% of beginning capital) $2,400 Salary 12,000 Remaining income/loss: $(30,000) (15,600) (20,000) $(65,600) (19,680) Totals $(5,280) Center $ 7,200 8,000 Right $ 6,000 -0Total $ 15,600 20,000

(32,800) $(17,600)

(13,120) (65,600) $(7,120) $(30,000)

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2009 Beginning balances ............ Income allocation ............... Drawings .............................. Ending balances ............ Left $20,000 (5,280) (10,000) $ 4,720 Center $60,000 (17,600) (10,000) $32,400 Right Total $50,000 $130,000 (7,120) (30,000) (10,000) (30,000) $32,880 $ 70,000 Right $3,946 -0Total $ 8,400 20,000

INCOME ALLOCATION2010 Left Center Interest(12% of beginning capital above) *$566 $3,888 Salary .................................. 12,000 8,000 Remaining income/loss: $20,000 (8,400) (20,000) $(8,400) (2,520) (4,200) Totals................... $10,046 $7,688 *Rounded

(1,680) $2,266

(8,400) $20,000

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2010 Beginning balances (above) Additional investment ........ Income allocation ............... Drawings .............................. Ending balances ............ Left $ 4,720 -010,046 (10,000) $ 4,766 Center $32,400 -07,688 (10,000) $30,088 Right $32,880 12,000 2,266 (10,000) $37,146 Total $70,000 12,000 20,000 (30,000) $72,000

21. (continued) INCOME ALLOCATION2011 Left Center Interest (12% of beginning capital above)* ............................ $ 572 $ 3,611 Salary ................................... 12,000 8,000 Remaining income: $40,000 (8,640) (20,000) $11,360......................... 2,272 4,544 Totals......................... $14,844 $16,155 *Rounded STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2011 Left Center Right Total Beginning balances (above) $ 4,766 $30,088 $37,146 $72,000 Income allocation 14,844 16,155 9,001 40,000 Drawings (10,000) (10,000) (10,000) (30,000) Ending balances $ 9,610 $36,243 $36,147 $82,000 Right $4,457 -0Total $ 8,640 20,000

4,544 $9,001

11,360 $40,000

22. (12 Minutes) (Determine capital balances after retirement of a partner using both the goodwill and the bonus approaches) a. Harrison receives an additional $30,000 about the capital balance. Since Harrison is assigned 20 percent of all profits and losses, this extra allocation indicates total goodwill of $150,000, which must be split among all partners. 20% of Goodwill = $30,000 .20 G = $30,000 G = $150,000 CAPITAL BALANCES AFTER WITHDRAWALOriginal Balance Goodwill Withdrawal Final Balance

Lennon McCartney Harrison Starr Total

$230,000 190,000 160,000 140,000

$45,000 45,000 30,000 30,000

$(190,000)

$275,000 235,000 -0170,000 $680,000

b. A $50,000 bonus is paid to Lennon ($280,000 is paid rather than the $230,000 capital balance). This bonus is deducted from the three remaining partners according to their relative profit and loss ratio (3:2:1). A reduction of 50 percent (3/6) is assigned to McCartney or a decrease of $25,000 which drops this partner's capital balance from $190,000 to $165,000. A reduction of 33.3 percent (2/6) is assigned to Harrison or a decrease of $16,667 which drops this partner's capital balance from $160,000 to $143,333. A reduction of 16.7 percent (1/6) is assigned to Starr or a decrease of $8,333 which drops this partner's capital balance from $140,000 to $131,667.

23. (45 Minutes) (Discussion of P&L allocations and admission of a new partner) a. The interest factor was probably inserted to reward Page for contributing $50,000 more to the partnership than Childers. The salary allowance gives an additional $15,000 to Childers in recognition of the full-time (rather than part-time) employment. The 40:60 split of the remaining income was probably negotiated by the partners based on other factors such as business experience, reputation, etc. b. The drawings show the assets removed by a partner during a period of time. A salary allowance is added to each partner's capital for the year (usually in recognition of work done) and is a component of net income allocation. The two numbers are often designed to be equal but agreement is not necessary. For example, a salary allowance might be high to recognize work contributed by one partner. The allowance increases the appropriate capital balance. The partner might, though, remove little or no money so that the partnership could maintain its liquidity. c. Page, Drawings ........................................................... 5,000 Repair Expense ..................................................... (To reclassify payment made to repair personal residence.) Page, Capital ............................................................... Childers, Capital ......................................................... Page, Drawings (adjusted) ................................... Childers, Drawings ............................................... (To close drawings accounts for 2008.) Revenues ..................................................................... Expenses (adjusted by first entry) ...................... Income Summary .................................................. (To close revenue and expense accounts for 2008.) 13,000 11,000 13,000 11,000 90,000 59,000 31,000 5,000

Income Summary ........................................................ 31,000 Page, Capital ......................................................... 11,000 Childers, Capital .................................................... 20,000 (To close net income to partners' capitalsee allocation plan shown below.) Allocation of Income Page Childers Interest (10% of beginning balance) $ 8,000 $ 3,000 Salary allowances 5,000 20,000 Remaining income (loss): $31,000 (11,000) (25,000) $ (5,000) (2,000) (40%) (3,000) (60%) $11,000 $20,000

23. (continued) d. Total capital (original balances of $110,000 plus 2008 net income less drawings) ................................... Investment by Smith .................................................. Total capital after investment ................................... Ownership portion acquired by Smith ..................... Smith, capital .............................................................. Amount paid ................................................................ Bonus paid by Smithassigned to original partners Bonus to Page (40%) .................................................. Bonus to Childers (60%) ............................................ Cash ............................................................................ Smith, Capital (20% of total capital) ................... Page, Capital ......................................................... Childers, Capital ....................................................

$117,000 43,000 $160,000 20% $ 32,000 43,000 $ 11,000 $4,400 $6,600 43,000 32,000 4,400 6,600

24. (40 Minutes) (Reporting a change in the composition of a partnership) a. Exact amount of investment can only be computed algebraically: E Investment = 25% (Original Capital + E Investment) El = .25 ($270,000 + El) El = $67,500 + .25 El .75 El = $67,500 E Investment = $90,000 b. Implied value of partnership ($36,000/10%)............. Total capital after investment by E ($270,000 + $36,000) Goodwill ...................................................................... Allocation of Goodwill: A (30%) ................................................................. $16,200 B (10%) ................................................................. 5,400 C (40%) ................................................................. 21,600 D (20%) ................................................................. 10,800 Total .................................................................. $54,000 CAPITAL BALANCES Original balances Goodwill (above) Investment Capital balances A $20,000 16,200 - 0$ 36,200 B $40,000 5,400 - 0$45,400 C $ 90,000 21,600 - 0$111,600 D $120,000 10,800 - 0$130,800 E $-0-036,000 $36,000 $360,000 306,000 $ 54,000

c. Since E's investment of $42,000 is less than 20% of the resulting capital ($312,000). E is apparently bringing some other attribute to the partnership (goodwill) that must be computed: E Investment = 20% (Original Capital + E Investment) $42,000 + Goodwill = .20 ($270,000 + $42,000 + Goodwill) $42,000 + Goodwill = $62,400 + .20 Goodwill .80 Goodwill = $20,400 Goodwill = $25,500 E's investment is, therefore, $42,000 in cash and $25,500 in goodwill for a total capital balance of $67,500; the other capital accounts remain unchanged. Note that E's capital of $67,500 is 20% of the new total capital $337,500 ($270,000 + $67,500).

24.(continued) d. Total capital after investment ($270,000 + $55,000) Amount acquired by E ............................................... E's capital balance ..................................................... E's payment ................................................................. Bonus being given to E ............................................. Bonus from: A (10%) ................................................................. B (30%) ................................................................. C (20%) ................................................................. D (40%) ................................................................. CAPITAL BALANCES A B C $20,000 $40,000 $90,000 -0-0-0(1,000) (3,000) (2,000) $19,000 $37,000 $88,000 $ 90,000 112,500 $ 22,500 $7,500 7,500 7,500 $1,000 3,000 2,000 4,000 D $120,000 -0(4,000) $116,000 $325,000 20% $ 65,000 55,000 $ 10,000

$10,000 E $-055,000 10,000 $65,000

Original balances Investment Bonus (above) Capital balances

e. C's capital balance C's collection (125%) Bonus being paid to C Bonus from: A (1/3) B (1/3) D (1/3)

$22,500 C D $ 90,000 $120,000 22,500 (7,500) (112,500) - 0$ -0- $112,500

CAPITAL BALANCES A B Original balances ................. $20,000 $40,000 Bonus (above) ...................... (7,500) (7,500) Payment ................................ - 0- 0Capital balances ................... $12,500 $32,500

25. (55 Minutes) (Allocation of income to the partners and determination of capital balances) ALLOCATION OF INCOME2008 Boswell Johnson Salary (8 months) ................. $8,000 $-0Remaining $3,000 ................. 1,200 (40%) 3,000 Totals ............................... $9,200 $1,800 Total $ 8,000 $11,000

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2008 Boswell Johnson Total Beginning Balances ($114,000 Invested capital split evenly market value used for assets) $57,000 $57,000 $114,000 Income allocation (above) ... 9,200 1,800 11,000 Drawings ............................... - 0- 0- 0Ending balances ............. $66,200 $58,800 $125,000 WALPOLE INVESTMENT JANUARY 1, 2009 Walpole's $54,000 investment increases total capital to $179,000. Walpole is credited with a 40% interest or $71,600. According to the problem, the excess $17,600 is a bonus from the original partners. Of this amount, $10,560 is allocated from Johnson (60%) and $7,040 from Boswell (40%). ALLOCATION OF INCOME2009 Boswell Salary ..................................... $12,000 Remaining $8,000 loss ($28,000 $36,000) ............................ (960) Totals .......................... $11,040 Johnson $-0(3,840) $(3,840) Walpole $24,000 (3,200) $20,800 Total $36,000 (8,000) $28,000

STATEMENT OF PARTNERS' CAPITALDECEMBER 31, 2009 Beginning balances ............. Walpole's contribution ........ Income allocation (above) ... Drawings ............................... Ending balances ............. Boswell $66,200 (7,040) 11,040 (5,000) $65,200 Johnson $58,800 (10,560) (3,840) (5,000) $39,400 Walpole Total $ -0- $125,000 71,600 54,000 20,800 28,000 (10,000) (20,000) $82,400 $187,000

26.(continued) ADMISSION OF POPEJANUARY 1, 2010 Pope's payment was made directly to the partners. Therefore, neither goodwill nor a bonus need be recognized. Instead, 10% of each capital balance shown above will be reclassified to Pope. The journal entry would be as follows: Boswell, Capital ............................................................... Johnson Capital ............................................................... Walpole, Capital ............................................................... Pope, Capital ............................................................... ALLOCATION OF INCOME2010Boswell Johnson Walpole Pope Total

6,520 3,940 8,240 18,700

Salary

$12,000 Remaining $400 income 54 Totals $12,054

$-0162 $162

$24,000 144 $24,144

$9,600 40 $9,640

$45,600 400 $46,000

STATEMENT OF PARTNERSHIP CAPITALDECEMBER 31, 2010 Beginning balances Admission of Pope Allocation of income (above) Drawings Ending balances Boswell Johnson $65,200 $39,400 (6,520) (3,940) 12,054 (5,000) $65,734 162 (5,000) $30,622 Walpole $82,400 (8,240) 24,144 (10,000) $88,304 Pope $-018,700 Total $187,000 -0-

9,640 46,000 (4,000) (24,000) $24,340 $209,000

26. (60 Minutes) (Allocate income and prepare a statement of partners' capital) a. Income Allocation2009 Gray Salary allowance ($8 per billable hour) $13,680 Interest (see Note A) 25,928 Bonus (not applicable because salary and interest would necessitate a negative bonus) -0Remaining loss (split evenly): $ 65,000 (35,600) (58,328) $(28,928) (9,643) Profit allocation $29,965 Stone $11,520 21,600 -0Lawson $10,400 10,800 -0Totals $35,600 58,328 -0-

(9,643) $23,477

(9,642) $11,558

(28,928) $65,000

Note A: Interest for Stone and Lawson is calculated at 12% of their beginning capital balances ($180,000 and $90,000, respectively) while for Gray the computation is based on a $210,000 balance for 4/12 of the year and $219,100 for the remaining 8/12. Capital Account Balances1/1/09 12/31/09 Beginning contributions Added Investment Profit allocation (from above) Drawing (10% of beginning balances) Ending balances Gray $210,000 9,100 29,965 (21,000) $228,065 Stone $180,000 -023,477 (18,000) $185,477 Lawson $90,000 -011,558 (9,000) $92,558 Totals $480,000 9,100 65,000 (48,000) $506,100

Prior to developing the information for 2010, a computation of Monet's investment must be made: Monet's Investment = 25% ($506,100 + Monet's Investment) Ml = $126,525 + .25 Ml .75 Ml = $126,525 Ml = $168,700

26. a. (continued) Income Allocation2010 Gray Salary allowance ($8 per billable hour) $14,400 Interest (12% of beginning capital balances for the year) 27,368 Bonus (not applicable) -0Remaining loss (split evenly): $ (20,400) (46,960) (80,976) $(148,336) (37,084) Loss allocation $ 4,684

Stone $ 12,000 22,257 -0-

Lawson $ 11,040 11,107 -0-

Monet $ 9,520 20,244 -0-

Totals $ 46,960 80,976 -0-

(37,084) $(2,827)

(37,084) $(14,937) Lawson $92,558 (14,937) (9,256) $68,365 Lawson $10,480

(37,084) $ (7,320) Monet $168,700 (7,320) (16,870) $144,510 Monet $12,640

(148,336) $(20,400) Totals $674,800 (20,400) (67,480) $586,920 Totals $ 51,120

Capital Account Balances 1/1/10 12/31/10 Gray Stone Beginning balances $228,065 $185,477 Loss allocation (from above) 4,684 (2,827) Drawings (10% of beginning balances) (22,806) (18,548) Ending balances $209,943 $164,102 Income Allocation2011 Gray Salary allowance ($8 per billable hour) $15,040 Interest (12% of beginning capital balances for the year) 25,193 Bonus (see Note B) 2,604 Remaining profit split evenly: $152,800 (51,120) (70,430) (5,208) $ 26,042 6,510 Profit allocation $49,347 Stone $12,960

19,692 2,604

8,204 -0-

17,341 -0-

70,430 5,208

6,510 $41,766

6,511 $25,195

6,511 $36,492

26,042 $152,800

26. a. (continued) Note B: 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 = 20% (Net income Salary Interest Bonus) B = .2 ($152,800 $51,120 $70,430 B) B = .2 ($31,250 B) B = $6,250 .2B 1.2 B = $6,250 B = $5,208 (or $2,604 per person) Capital Account Balances 1/1/11 12/31/11 Gray Stone Beginning balances $209,943 $164,102 Profit allocation (from above) 49,347 41,766 Drawings (10% of beginning balances) (20,994) (16,410) Ending balances $238,296 $189,458 b. GRAY, STONE, AND LAWSON Statement of Partners' Capital For Year Ending December 31, 2009 Beginning balances Added Investment Profit allocation Drawings Ending balances Gray $210,000 9,100 29,965 (21,000) $228,065 Stone $180,000 -023,477 (18,000) $185,477 Lawson $90,000 -011,558 (9,000) $92,558 Totals $480,000 9,100 65,000 (48,000) $506,100 Lawson $68,365 25,195 (6,837) $86,723 Monet $144,510 36,492 (14,451) $166,551 Totals $586,920 152,800 (58,692) $681,028

27. (40 Minutes) (Recording admission and retirement of partners using both the bonus and goodwill methods) a. Porthos, Capital .......................................................... 35,000 D'Artagnan, Capital ............................................... 35,000 (To reclassify half of Porthos's capital balance to reflect transfer of interest to D'Artagnan.) b. Goodwill ................................................................. 50,000 Athos, Capital (50%) ............................................ 25,000 Porthos, Capital (30%) ......................................... 15,000 Aramis, Capital (20%) .......................................... 10,000 (To record goodwill based on $250,000 implied value of partnership [$25,000/10%]. Since current capital is only $200,000 [the $25,000 goes directly to the partners], goodwill of $50,000 has to be recorded and allocated using profit and loss ratio.) Athos, Capital (10% of balance) ................................ 10,500 Porthos, Capital (10% of balance) ............................ 8,500 Aramis, Capital (10% of balance) .............................. 6,000 D'Artagnan, Capital................................................ 25,000 (To reclassify 10% of each partner's capital to reflect transfer of interest to D'Artagnan.) c. Cash ............................................................................ 30,000 D'Artagnan, Capital (10% of total capital)........... 23,000 Athos, Capital (50% of excess payment) ............ 3,500 Porthos, Capital (30% of excess payment) ........ 2,100 Aramis, Capital (20% of excess payment) .......... 1,400 (To record $30,000 payment by D'Artagnan which increases total capital to $230,000. D'Artagnan is credited for only 10% of that balance with the extra $7,000 payment being recorded as a bonus to the original partners.) d. Cash ............................................................................ 30,000 Goodwill ...................................................................... 70,000 D'Artagnan, Capital ............................................... 30,000 Athos, Capital (50% of goodwill) ........................ 35,000 Porthos, Capital (30% of goodwill) .................... 21,000 Aramis, Capital (20% of goodwill) ....................... 14,000 (To record D'Artagnan's contribution to the partnership. The $30,000 payment for 10% interest indicates a $300,000 value for the business although the capital balances would only increase to $230,000. The $70,000 difference is recorded as goodwill, an amount assigned to the original partners.)

27. (continued) e. Cash ............................................................................. 12,222 Goodwill . .................................................................... 10,000 D'Artagnan, Capital ............................................... 22,222 To record investment by D'Artagnan. The implied value of the investment as a whole would be only $122,220 ($12,222/10%). Since the capital balances are well in excess of this figure, D'Artagnan is apparently bringing some other factor (goodwill) into the partnership. This goodwill can be computed as follows: $12,222 + Goodwill = 10% (Original Capital + $12,222 + Goodwill) $12,222 + Goodwill = 10% ($200,000 + $12,222 + Goodwill) $12,222 + Goodwill = $21,222 + .10 Goodwill .90 Goodwill = $9,000 Goodwill = $10,000 f. Goodwill ...................................................................... 80,000 Athos, Capital (50%) ............................................. 40,000 Porthos, Capital (30%) .......................................... 24,000 Aramis, Capital (20%) ........................................... 16,000 (To record goodwill of $80,000 based on $280,000 appraisal of business.) Aramis, Capital ........................................................... 66,000 Cash ...................................................................... 66,000 (To distribute cash to retiring partner based on final capital balance.)

28. (75 Minutes) (Recording of changes in the composition of a partnership including allocation of income) a. 1/1/08 Building ....................................................... 52,000 Equipment.................................................... 16,000 Cash ............................................................. 12,000 O'Donnell, Capital ................................. 40,000 Reese, Capital ....................................... 40,000 (To record initial investment. Assets recorded at fair value with two equal capital balances.)

12/31/08 Reese, Capital ............................................ 22,000 O'Donnell, Capital ................................. 12,000 Income Summary .................................. 10,000 (The allocation plan specifies that O'Donnell will receive 20% in interest [or $8,000 based on $40,000 capital balance] plus $4,000 more [since that amount is greater than 15% of the profits from the period]. The remaining $22,000 loss is assigned to Reese.) 1/1/09 Cash ............................................................. 15,000 O'Donnell, Capital (15%) ............................ 300 Reese, Capital (85%) .................................. 1,700 Dunn, Capital ......................................... 17,000 (New investment by Dunn brings total capital to $85,000 after 2008 loss [$80,000 $10,000 + $15,000]. Dunn's 20% interest is $17,000 [$85,000 20%] with the extra $2,000 coming from the two original partners [allocated between them according to their profit and loss ratio].)

12/31/09 O'Donnell, Capital ...................................... 10,340 Reese, Capital ............................................ 5,000 Dunn, Capital .............................................. 5,000 O'Donnell, Drawings.............................. 10,340 Reese, Drawings ................................... 5,000 Dunn, Drawings .................................... 5,000 (To close out drawings accounts for the year based on distributing 20% of each partner's beginning capital balances [after adjustment for Dunn's investment] or $5,000 whichever is greater. O'Donnell's capital is $51,700 [$40,000 + $12,000 $300]) 12/31/09 Income Summary ....................................... 44,000 O'Donnell, Capital ................................. 16,940 Reese, Capital ....................................... 16,236 Dunn, Capital ......................................... 10,824 (To allocate $44,000 income figure for 2009 as determined below.) 28. a. (continued) O'Donnell Reese Dunn Interest (20% of $51,700

beginning capital balance)........ 15% of $44,000 income ................... 60:40 spilt of remaining $27,060 income ........................................ Total .................................................. Capital Balances as of December 31, 2009: Initial 2008 investment .................... 2008 profit allocation ...................... Dunn's investment .......................... 2009 drawings ................................. 2009 profit allocation ...................... 12/31/09 balances ............................ 1/1/10

$10,340 6,600 $16,940 O'Donnell $40,000 12,000 (300) (10,340) 16,940 $58,300 $16,236 $16,236 Reese $40,000 (22,000) (1,700) (5,000) 16,236 $27,536 22,824 22,824 $10,824 $10,824 Dunn $17,000 (5,000) 10,824 $22,824

Dunn, Capital .............................................. Postner, Capital .................................... (To reclassify balance to reflect acquisition of Dunn's interest.)

12/31/10 O'Donnell, Capital ...................................... Reese, Capital ............................................ Postner, Capital .......................................... O'Donnell, Drawings ............................. Reese, Drawings ................................... Postner, Drawings ................................ (To close out drawings accounts for the year based on 20% of beginning capital balances [above] or $5,000 [whichever is greater].)

11,660 5,507 5,000 11,660 5,507 5,000

12/31/10 Income Summary........................................ 61,000 O'Donnell, Capital ................................. Reese, Capital ....................................... Postner, Capital .................................... (To allocate profit for 2010 determined as follows) Interest (20% of $58,300 beg. capital) 15% of $61,000 income ............. 60:40 split of remaining $40,190 Totals................................ $16,076 O'Donnell $11,660 9,150 ______ Reese $24,114 $20,810

20,810 24,114 16,076 Postner $16,076 $24,114

28. a. (continued) 1/1/11 Postner, Capital .......................................... O'Donnell, Capital (15%) ............................ Reese, Capital (85%) .................................. Cash ....................................................... (Postner's capital is $33,900 [$22,824 $5,000 + $16,076]. Extra 10% payment is deducted from the two remaining partners' capital accounts.) b. 1/1/08 Building........................................................ Equipment ................................................... Cash ............................................................. Goodwill ...................................................... O'Donnell, Capital ................................. Reese, Capital ....................................... (To record initial capital investments. Reese is credited with goodwill of $80,000 to match O'Donnell's investment.)

33,900 509 2,881 37,290

52,000 16,000 12,000 80,000 80,000 80,000

12/31/08 Reese, Capital ............................................ O'Donnell, Capital ................................. Income Summary .................................. (Interest of $16,000 is credited to O'Donnell [$80,000 20%] along with a base of $4,000. The remaining amount is now a $30,000 loss that is attributed entirely to Reese.) 1/1/09 Cash ............................................................. Goodwill ...................................................... Dunn, Capital ......................................... (Cash and goodwill being contributed by Dunn are recorded. Goodwill must be calculated algebraically.)

30,000 20,000 10,000

15,000 22,500 37,500

$15,000 + Goodwill = 20% (Current Capital + $15,000 + Goodwill) $15,000 + Goodwill = 20% ($150,000 + $15,000 + Goodwill) $15,000 + Goodwill = $33,000 + .2 Goodwill .8 Goodwill = $18,000 Goodwill = $22,500

28. b. (continued) 12/31/09 O'Donnell, Capital ...................................... 20,000 Reese, Capital ............................................ 10,000 Dunn, Capital .............................................. 7,500 O'Donnell, Drawings.............................. Reese, Drawings ................................... Dunn, Drawings .................................... (To close out drawings accounts for the year based on 20 % of beginning capital balances: O'Donnell$100,000, Reese $50,000, and Dunn$37,500.) 12/31/09 Income Summary ....................................... 44,000 O'Donnell, Capital ................................. Reese, Capital ....................................... Dunn, Capital ......................................... (To allocate $44,000 income figure as follows) O'Donnell Interest (20% of $100,000 beginning capital balance) 15% of $44,000 income 60:40 split of remaining $17,400 Totals $20,000 6,600 $26,600 $10,440 $10,440 Reese $80,000 (30,000) (10,000) 10,440 $50,440 Reese

20,000 10,000 7,500

26,600 10,440 6,960 Dunn

$6,960 $6,960 Dunn $37,500 (7,500) 6,960 $36,960

Capital balances as of December 31, 2009: O'Donnell Initial 2008 investment . . . $ 80,000 2008 profit allocation ..... 20,000 Additional investment .... 2009 drawings ................. (20,000) 2009 profit allocation ..... 26,600 12/31/09 balances ........... $106,600 1/1/10

Goodwill ...................................................... 26,588 O'Donnell, Capital (15%) ...................... 3,988 Reese, Capital (51%) ............................ 13,560 Dunn, Capital (34%) .............................. 9,040 (To record goodwill indicated by purchase of Dunn's interest.)

In effect, profits are shared 15% to O'Donnell, 51% to Reese (60% of the 85% remaining after O'Donnell's income), and 34% to Dunn (40% of the 85% remaining after O'Donnell's income). Postner is paying $46,000, an amount $9,040 in excess of Dunn's capital ($36,960). The additional payment for this 34% income interest indicates total goodwill of $26,588 ($9,040/34%). Since Dunn is entitled to 34% of the profits but only holds 19% of the total capital, an 28. b. (continued)

implied value for the company as a whole cannot be determined directly from

the payment of $46,000. Thus, goodwill can only be computed based on the excess payment. 1/1/10 Dunn, Capital ................................................... Postner, Capital .......................................... (To reclassify capital balance to new partner.) 46,000 46,000

12/31/10 O'Donnell, Capital ............................................ 22,118 Reese, Capital .................................................. 12,800 Postner, Capital ............................................... 9,200 O'Donnell, Drawings .................................. 22,118 Reese, Drawings ........................................ 12,800 Postner, Drawings ..................................... 9,200 (To close out drawings accounts for the year based on 20% of beginning capital balances [after adjustment for goodwill].) 12/31/10 Income Summary ............................................. O'Donnell, Capital ...................................... Reese, Capital ............................................ Postner, Capital .......................................... To allocate profit for 2010 as follows: O'Donnell Interest (20% of $110,588 beginning capital balance) 15% of $61,000 income ........ 60:40 spilt of remaining $29,732 ............................. Totals................................ $11,893 Capital Balances as of December 31, 2010: 12/31/09 balances ................. Adjustment for goodwill ...... Drawings................................ Profit allocation..................... 12/31/10 balances.................. O'Donnell $106,600 3,988 (22,118) 31,268 $119,738 Reese $50,440 13,560 (12,800) 17,839 $69,039 Postner $36,960 9,040 (9,200) 11,893 $48,693 $22,118 9,150 $17,839 $31,268 $11,893 $17,839 61,000 31,268 17,839 11,893 Reese Postner

Postner will be paid $53,562 (110% of the capital balance) for her interest. This amount is $4,869 in excess of the capital account. Since Postner is only entitled to a 34% share of profits and losses, the additional $4,869 must indicate that the partnership as a whole is undervalued by $14,321 (4,869/34%). Only in that circumstance would the extra payment to Postner be justified: 28. b. (continued) 14,321

1/1/11 Goodwill .................................................................

O'Donnell, Capital (15%) ................................. Reese, Capital (51%) ....................................... Postner, Capital (34%) .................................... (To recognize implied goodwill.) 1/1/11 Postner, Capital ..................................................... Cash ................................................................. (To record final distribution to Postner.) 53,562

2,148 7,304 4,869

53,562