Question

Gray, Stone, and Lawson open an accounting practice on January 1, 2016, in San Diego, California, to be operated as a partnership. Gray and Stone will serve as the senior partners because of their years of experience. To establish the business, Gray, Stone, and Lawson contribute cash and other properties valued at $420,000, $390,000, and $195,000, respectively. An articles of partnership agreement is drawn up. It has the following stipulations:

• Personal drawings are allowed annually up to an amount equal to 10 percent of the beginning capital balance for the year.
• Profits and losses are allocated according to the following plan:

1. A salary allowance is credited to each partner in an amount equal to $7 per billable hour worked by that individual during the year.
2. Interest is credited to the partners’ capital accounts at the rate of 12 percent of the average monthly balance for the year (computed without regard for current income or drawings).
3. An annual bonus is to be credited to Gray and Stone. Each bonus is to be 10 percent of net income after subtracting the bonus, the salary allowance, and the interest. Also included in the agreement is the provision that there will be no bonus if there is a net loss or if salary and interest result in a negative remainder of net income to be distributed.
4. Any remaining partnership profit or loss is to be divided evenly among all partners.

Because of financial shortfalls encountered in getting the business started, Gray invests an additional $9,400 on May 1, 2016. On January 1, 2017, the partners allow Monet to buy into the partnership. Monet contributes cash directly to the business in an amount equal to a 20 percent interest in the book value of the partnership property subsequent to this contribution. The partnership agreement as to splitting profits and losses is not altered upon Monet’s entrance into the firm; the general provisions continue to be applicable.

The billable hours for the partners during the first three years of operation follow:

	2016	2017	2018
Gray	1,870	3,900	2,110
Stone	1,650	2,400	1,830
Lawson	3,400	1,590	1,520
Monet	0	1,400	1,790

The partnership reports net income for 2016 through 2018 as follows:

2016	$	97,000
2017		(41,400)
2018		224,000

Each partner withdraws the maximum allowable amount each year.

1. Determine the allocation of income for each of these three years. (picture format below, complete table for all three years)

2. Prepare in appropriate form a statement of partners’ capital for the year ending December 31, 2018. (picture format below)

Income Allocation-2016 Gra Stone Lawson Totals Salary allowance Interest Bonus Remainder to allocate Income allocation

Answer 1

Part A

Income Allocation—2016

	Gray	Stone	Lawson	Total
Salary allowance	13090	11550	23800	48440
Interest	51152	46800	23400	121352
Bonus	0	0	0	0
Remaining loss	(24264)	(24264)	(24264)	(72792)
Profit allocation	39978	34086	22936	97000

Explanation:

	Gray	Stone	Lawson	Total
Salary allowance	13090 (1870*7)	11550 (1650*7)	23800 (3400*7)	48440
Interest	51152 ((420000*12%*4/12)+(429400*12%*8/12))	46800 (390000*12%)	23400 (195000*12%)	121352
Bonus	0	0	0	0
Remaining loss (97000-48440-121352 = -72792)	(24264) (-72792/3)	(24264) (-72792/3)	(24264) (-72792/3)	(72792)
Profit allocation	39978	34086	22936	97000

Bonus is not applicable here because salary and interest would necessitate a negative bonus

	Gray	Stone	Lawson	Total
Beginning contributions	420000	390000	195000	1005000
Added Investment	9400	0	0	9400
Profit allocation	39978	34086	22936	97000
Drawing (10% of beginning capital)	(42000)	(39000)	(19500)	100500
Ending balances	427378	385086	198436	1010900

Monet's Investment = 20%* ($1010900 + Monet's Investment)

0.80 Monet's Investment   = 202180

Monet's Investment   = 252725

Part A

Income Allocation—2017

	Gray	Stone	Lawson	Monet	Total
Salary allowance	27300	16800	11130	9800	65030
Interest	51285	46210	23812	30327	151634
Bonus	0	0	0	0	0
Remaining loss	(64516)	(64516)	(64516)	(64516)	(258064)
Loss allocation	14069	(1506)	(29574)	(24389)	(41400)

Explanation:

	Gray	Stone	Lawson	Monet	Total
Salary allowance	27300 (3900*7)	16800 (2400*7)	11130 (1590*7)	9800 (1400*7)	65030
Interest	51285 (427378*12%)	46210 (385086*12%)	23812 (198436*12%)	30327 (252725*12%)	151634
Bonus	0	0	0	0	0
Remaining loss (-41400-65030-151634) = -258064	(64516) (-258064/4)	(64516) (-258064/4)	(64516) (-258064/4)	(64516) (-258064/4)	(258064)
Loss allocation	14069	(1506)	(29574)	(24389)	(41400)

	Gray	Stone	Lawson	Monet	Total
Beginning contributions	427378	385086	198436	252725	1263625
Loss allocation	14069	(1506)	(29574)	(24389)	(41400)
Drawing (10% of beginning capital)	(42738)	(38509)	(19844)	(25273)	(126364)
Ending balances	398709	345071	149018	203063	1095861

Part A

Income Allocation—2018

	Gray	Stone	Lawson	Monet	Total
Salary allowance	14770	12810	10640	12530	50750
Interest	47845	41409	17882	24368	131503
Bonus	3479	3479			6958
Remaining profit	8697	8697	8697	8698	22610
Profit allocation	74791	66395	37219	45595	224000

Explanation:

	Gray	Stone	Lawson	Monet	Total
Salary allowance	14770 (2110*7)	12810 (1830*7)	10640 (1520*7)	12530 (1790*7)	50750
Interest	47845 (398709*12%)	41409     (345071*12%)	17882 (149018*12%)	24368 (203063*12%)	131503
Bonus	3479	3479			6958
Remaining profit (224000-50750-131503-6958) = 34789	8697	8697	8697	8698	22610
Profit allocation	74791	66395	37219	45595	224000

Bonus = 20% (Net income – Salary – Interest – Bonus)

B = 0.2 ($224000 – $50750 – $131503 – B)

B = 0.2 ($41747 – B)

B = $8349.40 – .2B

     1.2 B = $8349.40

B = $6958 (or $3479 per person)

Part B

GRAY, STONE, LAWSON and MONET

Statement of partner’s capital

For the year ending December 31, 2018

	Gray	Stone	Lawson	Monet	Total
Beginning balances	398709	345071	149018	203063	1095861
Profit allocation	74791	66395	37219	45595	224000
Drawings (10% of beginning capital)	(39871)	(34507)	(14902)	(20306)	-109589
Ending balances	433629	376959	171335	228352	1210275