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 $102,000 and equipment valued at $92,000 as well as $46,000 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 10 percent of partnership income each year (without regard for the preceding interest figure) or $5,000, 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 $9,000 annually or 15 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 $15,000 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 6:4 basis between Reese and Dunn, respectively.

Partnership income for 2017 is reported as $76,000. 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 $120,000 directly to Dunn. Net income for 2018 is $77,000 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

1) without revaluation of Goodwill

As on 1st January, 2016

a) For Capital Bought in by Donnell

In. $

Debit Credit

Building A/c Dr. 102000

Equipment A/c Dr. 92000

Cash A/c Dr. 46000

To Rob O' Donnell Capital A/c - 240000

(Being Capital Introduced)

b) Reese being equal opening capital balance partner

Goodwull A/c Dr. 240000

To Reese Capital A/c - 240000

(Being Goodwill of Reese is recorded as Capital)

c)Year end Entry - Transfer of Net loss to Capital Balances

Rob O' Donnell Capital A/c Dr. 5000

Reese Capital A/c Dr. 5000

To Profit and Loss A/c - 10000

(Being Net Loss arised transferred to Capital A/c s')

d)Annual Interest Entry

Interest On capital A/c Dr. 48000

To Rob O' Donnell Capital A/c - 48000

(Being Interest On Capital is transferred)

As on 1st January, 2017

a) cash bought in by Teri Dunn

Cash A/c Dr. 15000

To Terri Dunn Capital A/c - 15000

(Being Capital Bought in)

b)Change in Profit Sharing Ratio(PSR)

Let total profit of Firm be 1

Share of Terri Dunn is 20% of 1 i.,e

Therefore remaining Proft = 1-1/5=4/5

Therefore New PSR is

Donnell 1/2 * 4/5 = 4/10

Reese 1/2 * 4/5 = 4/10

Dunn 1/2 * 2/2 =2/10

Therefore 4:4:2 is New PSR

c)Year end Entry - Transfer of Net Income to Capital Balances

1. Interest on Capital A/c Dr. 56600   

Profit and Loss A/c Dr. 7600

To Rob O' Donnell Capital A/c 64200

(Being Interest on opening capital(240000-5000+48000) and 15% of 76000 is transferred to Capital A/c)

​​ ​​​​​2. Profit and Loss A/c Dr. 68400

To Reese Capital A/c   - 41040

To Terri Dunn Capital A/c - 27360

(Bieing Net Income transferred to Capital A/c)

3. Rob O' Donnell Capital A/c Dr. 42450

Reese Capital A/c Dr. 36000

Terri Dunn Capital A/c Dr. 9000

To Drawings A/c - 86700

(Being Drawings made)

As on 1st January, 2018

Terri Dunn is replaced with Judy Postner with same Capital as amount is directly given to Dunn by postner without firms Interruption.

a)Year end entries

1. Interest on Capital A/c Dr. 60950   

Profit and Loss A/c Dr. 7700

To Rob O' Donnell Capital A/c 68650   

(Being Interest on opening capital(283000+56600+7600+42450 and 15% of 77000 is transferred to Capital A/c)

2. Rob O' Donnell Capital A/c Dr. 45712.5

Reese Capital A/c Dr. 35250

Poster Capital A/c Dr. 9000

  (Being Drawings made)

As on 1st January, 2019

Poster withdraws from Partnership

Therefore ,

Poster Capital A/c Dr. 105288

To Cash A/c - 57288

To Goodwill A/c - 48000

(Being Cash = 10% of 52080-closing bal. and goodwill distributed)