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 $120,000 and equipment valued at $120,000 as well as $40,000 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 20 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 $7,000 annually or 10 percent of the beginning capital balance for the year, whichever is larger.

The partnership reported a net loss of $9,000 during the first year of its operation. On January 1, 2017, Terri Dunn becomes a third partner in this business by contributing $53,000 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 $90,000. 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 $180,000 directly to Dunn. Net income for 2018 is $150,000 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

Dear Student,

If any doubts, then feel free to ask

Part A

Date	Account titles and explanation	debit	Credit
1/1/16	Building	120000
	Equipment	120000
	Cash	40000
	O'Donnell, Capital		140000
	Reese, Capital		140000
12/31/16	Reese, Capital	41000
	O'Donnell, Capital (140000*20%)+4000		32000
	Income Summary		9000
1/1/17	Cash	53000
	O'Donnell, Capital (20%)	5600
	Reese, Capital (80%)	22400
	Dunn, Capital		81000
12/31/17	O'Donnell, Capital (140000+32000-5600)*10%	16640
	Reese, Capital (140000-41000-22400)*10%	7660
	Dunn, Capital (81000*10%)	8100
	O'Donnell, Drawings		16640
	Reese, Drawings		7660
	Dunn, Drawings		8100
12/31/17	Income Summary	90000
	O'Donnell, Capital		51280
	Reese, Capital		23232
	Dunn, Capital		15488
1/1/18	Dunn, Capital	88388
	Postner, Capital		88388
12/31/18	O'Donnell, Capital (201040*10%)	20104
	Reese, Capital (92232*10%)	9223
	Postner, Capital (88388*10%)	8839
	O'Donnell, Drawings		20104
	Reese, Drawings		9223
	Postner, Drawings		8839
12/31/18	Income Summary	150000
	O'Donnell, Capital		70208
	Reese, Capital		47875
	Postner, Capital		31917
1/1/19	Postner, Capital (88388-8839+31917)	111466
	O'Donnell, Capital (20%)	2229
	Reese, Capital (80%)	8918
	Cash (111466*1.10)		122613

Part B

No.	Date	General journal	Debit	Credit
1	1/1/16	Building	120000
		Equipment	120000
		Cash	40000
		Goodwill	280000
		O'Donnell, Capital		280000
		Reese, Capital		280000
2	12/31/16	Reese, Capital	69000
		O'Donnell, Capital (280000*10%)+4000		60000
		Income Summary		9000
3	1/1/17	Cash	53000
		Goodwill	130667
		Dunn, Capital		183667
4	12/31/17	O'Donnell, Capital (280000+60000)*10%	34000
		Reese, Capital (280000-69000)*10%	21100
		Dunn, Capital (183667*10%)	18367
		O'Donnell, Drawings		34000
		Reese, Drawings		21100
		Dunn, Drawings		18367
5	12/31/17	Income Summary	90000
		O'Donnell, Capital		86000
		Reese, Capital		2400
		Dunn, Capital		1600
6	1/1/18	Goodwill (180000-166900)/32%	40938
		O’Donnell Capital (40938*20%)		8188
		Reese, Capital (40938*48%)		19650
		Postner, Capital (40938*32%)		13100
7	1/1/18	Dunn, Capital	180000
		Postner, Capital		180000
8	12/31/18	O'Donnell, Capital ((392000+8188)*10%)	40019
		Reese, Capital ((192300+19650)*15%)	21195
		Postner, Capital (180000*10%)	18000
		O'Donnell, Drawings		40019
		Reese, Drawings		21195
		Postner, Drawings		18000
9	12/31/18	Income Summary	150000
		O'Donnell, Capital		110038
		Reese, Capital		23977
		Dunn, Capital		15985
10	1/1/19	Goodwill ((177985*10%) =17799/32%)	55622
		O'Donnell, Capital (20%)		11124
		Reese, Capital (48%)		26699
		Postner, Capital (32%)		17799
11	1/1/19	Postner, Capital	195784
		Cash (177985*(1+10%))		195784
		(To record final distribution to Postner.)

Part A

1/1/16 - To record initial investment of assets by partners. Assets recorded at fair value with two equal capital balances

12/31/16 - The allocation plan specifies that O'Donnell will receive 20% in interest [or $28000 based on $140,000 capital balance] plus $4,000 more [since that amount is greater than 20% of the profits from the period]. The remaining $41000 loss is assigned to Reese.)

1/1/17 - New investment by Dunn brings total capital to $145,000 after 2008 loss [$(140000+140000) – $9,000 + $53,000]. Dunn's 25% interest is $81000 [$324,000 × 25%] with the extra $28000 (81000-53000) coming from the two original partners [allocated between them according to their profit and loss ratio].)

12/31/17 - To close out drawings accounts for the year based on distributing 10% of each partner's beginning capital balances or 7000 whichever is more

Net income distribution

	O'Donnell	Reese	Dunn
Interest (20% of $((140000+32000-5600)) beginning capital balance)	33280
20% of $90000 income	18000
60:40 spilt of remaining $38720 (90000-33280-18000) Income		23232	15488
Total	51280	23232	15488