Evaluating alternative profit allocation formulas. Banyan and Schultz operate a residential construction firm as a partnership and are considering admitting Witkowski as a partner. Witkowski has recently attended a seminar on the formation and management of partnerships and is proposing that the profit-sharing arrangement of the new partnership include a number of variables as follows:
a. Banyan, Schultz, and Witkowski receive salaries of $120,000, $80,000, and $40,000, respectively.
b. Witkowski receives a bonus of 5% on all income in excess of $200,000 and up to and including $260,000 and a bonus of 10% on income in excess of $260,000.
c. All partners are to maintain a minimum capital balance of $50,000 and will receive interest on this balance at the rate of 10% on the minimum balance.
d. Any residual amounts of profit are to be divided equally between the partners.
e. If profits are not adequate to complete the above provisions, no order of priority is to be followed.
Banyan and Schultz had been sharing profits per their profit and loss ratios of 60% and 40%, respectively, and had proposed to Witkowski that the new partnership allocate profits per the profit and loss ratios of 45%, 30%, and 25% for Banyan, Schultz, and Witkowski, respectively. The original partners are not convinced that Witkowski’s proposal is worth the trouble. Furthermore, they are concerned that they will not fare as well under Witkowski’s proposal as compared to their proposal. Banyan and Schultz believe that the new partnership should generate income of $250,000 in its first year and grow by 20% in each of the two subsequent years in large part due to the admission of Witkowski as a partner.
Assuming that the new partnership were to adopt Witkowski’s proposed agreement for a 3-year period, prepare a schedule to compare the Witkowski proposal against that being proposed by the original partners.
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