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 $58,000 and equipment valued at $28,000 as well as $24,000 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 15 percent of partnership income each year (without regard for the preceding interest figure) or $7,000, 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 $5,000 annually or 20 percent of the beginning capital balance for the year, whichever is larger.

The partnership reported a net loss of $8,000 during the first year of its operation. On January 1, 2017, Terri Dunn becomes a third partner in this business by contributing $10,000 cash to the partnership. Dunn receives a 20 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 5:5 basis between Reese and Dunn, respectively.

Partnership income for 2017 is reported as $64,000. 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 $75,000 directly to Dunn. Net income for 2018 is $64,000 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

Bonus Method is used
		Debit	Credit
01.01.2016	Cash	24000
	Building	58000
	Equipment	28000
	O’Donnell, Capital		55000
	Reese, Capital		55000
	(To record Assets contributed)
31.12.2016	Reese, Capital	20500
	O’Donnell, Capital		12500
	Income Summary		8000
	(To record allocation of $8000 Loss to Partners)
01.01.2017	Cash	10000
	O’Donnell, Capital	2240
	Reese, Capital	20160
	Terri Dunn , Capital		32400
	(To record Assets contributed)
31.12.2017	Income summary	64000
	O’Donnell, Capital		13526
	Reese, Capital		25237
	Terri Dunn , Capital		25237
	(To record allocation of $8000 Loss to Partners)
01.01.2018	Terri Dunn , Capital	75000
	Judy Postner		75000
Goodwill Method is used
		Debit	Credit
01.01.2016	Cash	24000
	Building	58000
	Equipment	28000
	Goodwill	110000
	O’Donnell, Capital		110000
	Reese, Capital		110000
	(To record Assets contributed)
31.12.2016	Reese, Capital	26000
	O’Donnell, Capital		18000
	Income Summary		8000
	(To record allocation of $8000 Loss to Partners)