Question

Steve Reese is a well-known interior designer in Fort Worth, Texas. He wants to start his own business and convinces Rob O’Donnell, a local merchant, to contribute the capital to form a partnership. On January 1, 2016, O’Donnell invests a building worth $62,000 and equipment valued at $36,000 as well as $32,000 in cash. Although Reese makes no tangible contribution to the partnership, he will operate the business and be an equal partner in the beginning capital balances.

To entice O’Donnell to join this partnership, Reese draws up the following profit and loss agreement:

• O’Donnell will be credited annually with interest equal to 10 percent of the beginning capital balance for the year.
• O’Donnell will also have added to his capital account 20 percent of partnership income each year (without regard for the preceding interest figure) or $4,000, whichever is larger. All remaining income is credited to Reese.
• Neither partner is allowed to withdraw funds from the partnership during 2016. Thereafter, each can draw $6,000 annually or 10 percent of the beginning capital balance for the year, whichever is larger.

The partnership reported a net loss of $10,000 during the first year of its operation. On January 1, 2017, Terri Dunn becomes a third partner in this business by contributing $25,000 cash to the partnership. Dunn receives a 25 percent share of the business’s capital. The profit and loss agreement is altered as follows:

• O’Donnell is still entitled to (1) interest on his beginning capital balance as well as (2) the share of partnership income just specified.
• Any remaining profit or loss will be split on a 6:4 basis between Reese and Dunn, respectively.

Partnership income for 2017 is reported as $62,000. Each partner withdraws the full amount that is allowed.

On January 1, 2018, Dunn becomes ill and sells her interest in the partnership (with the consent of the other two partners) to Judy Postner. Postner pays $95,000 directly to Dunn. Net income for 2018 is $66,000 with the partners again taking their full drawing allowance.

On January 1, 2019, Postner withdraws from the business for personal reasons. The articles of partnership state that any partner may leave the partnership at any time and is entitled to receive cash in an amount equal to the recorded capital balance at that time plus 10 percent.

1. Prepare journal entries to record the preceding transactions on the assumption that the bonus (or no revaluation) method is used. Drawings need not be recorded, although the balances should be included in the closing entries.

2. Prepare journal entries to record the previous transactions on the assumption that the goodwill (or revaluation) method is used. Drawings need not be recorded, although the balances should be included in the closing entries.

Answer 1

($65000+10%)+$ 4000 Loss from business 10000 01/01/2017 Cash O'Donnell's Capital (36250-25000)"20% Reese Capital (36250-25000)"80% 25000 2250 9000 Dunn Capital (14500025%) 36250 31/12/2017 Income 62000 O'Donell Capital (6200020%)+ (75500.2250)+10% Reese Capital (62000-12400)"60% Dunn Capital (62000-12400)"40%) 19725 29760 19840 01/01/2018 Dunn Capital 47160 Postner Capital (36250-6000+16910) 47160 31/12/2018 Income 74565 O'Donell's Capital (856501096) + (660002090) Reese Capital (66000-13200)"60% Postner Capital (66000-13200)"40% 21765 31680 21120 01/01/2019 Postner acpital O'Donell's Capital (6228"20%) Reese Capital (6228"40%) 62280 1246 4982 Cash 68508

BONUS METHOD Dale DebitCredit 62000 36000 32000 01/01/2016 Building Equipment Cash Rees Capital O'Donell Capital 65000 65000 31/12/2016 Reese Capital 20500 O'Donell Capital ($650001096)+54000 Loss from business 10500 10000 01/01/2017 Cash O'Donell's Capital (36250-25000)20% Reese Capital (36250-25000)"80% 25000 2250 9000 Dunn Capital (1450002596) 36250 31/12/2017 Income 62000 O'Donell Capital (620002090)+ (75500-2250)"10% Reese Capital (62000-12400)"60% Dunn Capital (62000-12400),40%) 19725 29760 19840 01/01/2018 Dunn Capital IF11 47160 Postner Capital (36250-6000+16910) 47160 31/12/2018 Income 74565 O'Donell's Capital (8565010%) + (6600020%) 21765

BONUS METHOD Dale DebitCredit 62000 36000 32000 01/01/2016 Building Equipment Cash Rees Capital O'Donell Capital 65000 65000 31/12/2016 Reese Capital 20500 O'Donell Capital ($650001096)+54000 Loss from business 10500 10000 01/01/2017 Cash O'Donell's Capital (36250-25000)20% Reese Capital (36250-25000)"80% 25000 2250 9000 Dunn Capital (1450002596) 36250 31/12/2017 Income 62000 O'Donell Capital (620002090)+ (75500-2250)"10% Reese Capital (62000-12400)"60% Dunn Capital (62000-12400),40%) 19725 29760 19840 01/01/2018 Dunn Capital IF11 47160 Postner Capital (36250-6000+16910) 47160 31/12/2018 Income 74565 O'Donell's Capital (8565010%) + (6600020%) 21765