Ch 9 AA Partnerships: Formation and Operation: Problems

Partnerships: Formation and Operation LO 9-1 1. Which of the following is not a reason for the popularity of partnerships as a legal form for businesses? a. Partnerships may be formed merely by an oral agreement. b. Partnerships can more easily generate significant amounts of capital. c. Partnerships avoid the double taxation of income that is found in corporations. d. In some cases, losses may be used to offset gains for tax purposes.

1. B

Partnerships: Formation and Operation LO 9-6 10. A partnership begins its first year with the following capital balances: Alfred, Capital.................. $50,000 Bernard, Capital.................. 60,000 Collins, Capital.................. 70,000 The articles of partnership stipulate that profits and losses be assigned in the following manner: • Each partner is allocated interest equal to 5 percent of the beginning capital balance. • Bernard is allocated compensation of $18,000 per year. • Any remaining profits and losses are allocated on a 3:3:4 basis, respectively. • Each partner is allowed to withdraw up to $5,000 cash per year. Assuming that the net income is $60,000 and that each partner withdraws the maximum amount allowed, what is the balance in Collins capital account at the end of that year? a. $70,800. b. $86,700. c. $73,500. d. $81,700.

10. D ASSIGNMENT OF INCOME ALFRED BERNARD COLLINS TOTAL Interest—5% of beginning capital $ 2,500 $ 3,000 $ 3,500 $ 9,000 Salary 18,000 18,000 Allocation of remaining income ($33,000 divided on a 3:3:4 basis) 9,900 9,900 13,200 33,000 Totals $12,400 $30,900 $16,700 $60,000 STATEMENT OF CAPITAL ALFRED BERNARD COLLINS TOTAL Beginning capital $50,000 $60,000 $70,000 $180,000 Net income (above) 12,400 30,900 16,700 60,000 Drawings (given) (5,000) (5,000) (5,000) (15,000) Ending capital $57,400 $85,900 $81,700 $225,000

Partnerships: Formation and Operation 11. A partnership begins its first year of operations with the following capital balances: Winston, Capital.................. $110,000 Durham, Capital 80,000 Salem, Capital.................. 110,000 According to the articles of partnership, all profits will be assigned as follows: • Winston will be awarded an annual salary of $20,000 with $10,000 assigned to Salem. • The partners will be attributed interest equal to 10 percent of the capital balance as of the first day of the year. • The remainder will be assigned on a 5:2:3 basis, respectively. • Each partner is allowed to withdraw up to $10,000 per year. The net loss for the first year of operations is $20,000 and net income for the subsequent year is $40,000. Each partner withdraws the maximum amount from the business each period. What is the balance in Winston's capital account at the end of the second year? a. $102,600. b. $104,400. c. $108,600. d. $109,200.

11. A ASSIGNMENT OF INCOME—YEAR ONE WINSTON DURHAM SALEM TOTAL Interest—10% of beginning capital $11,000 $ 8,000 $11,000 $30,000 Salary 20,000 0 10,000 30,000 Allocation of remaining loss ($80,000 divided on a 5:2:3 basis) (40,000) (16,000) (24,000) (80,000) Totals $(9,000) $ (8,000) $ (3,000) $(20,000) STATEMENT OF CAPITAL—YEAR ONE WINSTON DURHAM SALEM TOTAL Beginning capital $110,000 $80,000 $110,000 $300,000 Net loss (above) (9,000) (8,000) (3,000) (20,000) Drawings (given) (10,000) (10,000) (10,000) (30,000) Ending capital $ 91,000 $62,000 $ 97,000 $250,000 ASSIGNMENT OF INCOME—YEAR TWO WINSTON DURHAM SALEM TOTAL Interest—10% of beginning capital $ 9,100 $ 6,200 $ 9,700 $25,000 Salary 20,000 0 10,000 30,000 Allocation of remaining loss ($15,000 divided on a 5:2:3 basis) (7,500) (3,000) (4,500) (15,000) Totals $21,600 $3,200 $15,200 $ 40,000 STATEMENT OF CAPITAL—YEAR TWO WINSTON DURHAM SALEM TOTAL Beginning capital (above) $ 91,000 $62,000 $ 97,000 $250,000 Net income (above) 21,600 3,200 15,200 40,000 Drawings (given) (10,000) (10,000) (10,000) (30,000) Ending capital $102,600 $55,200 $102,200 $260,000

Partnerships: Formation and Operation LO 9-10 12. A partnership has the following capital balances: Allen, Capital.................. $60,000 Burns, Capital.................. 30,000 Costello, Capital.................. 90,000 Profits and losses are split as follows: Allen (20 percent), Burns (30 percent), and Costello (50 percent). Costello wants to leave the partnership and is paid $100,000 from the business based on provisions in the articles of partnership. If the partnership uses the bonus method, what is the balance of Burns's capital account after Costello withdraws? a. $24,000. b. $27,000. c. $33,000. d. $36,000.

12. A Costello receives a $10,000 bonus ($100,000 less $90,000 capital balance). This bonus is deducted from the two remaining partners according to their profit and loss ratio (2:3). A 60 percent (3/5) reduction is assigned to Burns which decreases that partner's capital balance from $30,000 to $24,000.

Partnerships: Formation and Operation At year-end, the Circle City partnership has the following capital balances: Manning, Capital.................. $130,000 Gonzalez, Capital.................. 110,000 Clark, Capital.................. 80,000 Freeney, Capital.................. 70,000 Profits and losses are split on a 3:3:2:2 basis, respectively. Clark decides to leave the partnership and is paid $90,000 from the business based on the original contractual agreement. LO 9-10 13. Using the goodwill method, what is Manning's capital balance after Clark withdraws? a. $133,000. b. $137,500. c. $140,000. d. $145,000.

13. D Clark receives an additional $10,000. Because Clark receives 20 percent of profits and losses, this allocation indicates total goodwill of $50,000. 20% of Goodwill = $10,000 Goodwill = $10,000 ÷ .20 = $50,000 Goodwill 50,000 Manning, capital (30%) 15,000 Gonzalez, capital (30%) 15,000 Clark, capital (20%) 10,000 Freeney, capital (20%) 10,000 The above entry raises Manning's capital from $130,000 to $145,000.

Partnerships: Formation and Operation At year-end, the Circle City partnership has the following capital balances: Manning, Capital.................. $130,000 Gonzalez, Capital.................. 110,000 Clark, Capital.................. 80,000 Freeney, Capital.................. 70,000 Profits and losses are split on a 3:3:2:2 basis, respectively. Clark decides to leave the partnership and is paid $90,000 from the business based on the original contractual agreement. 14. If instead the partnership uses the bonus method, what is the balance of Manning's capital account after Clark withdraws? a. $100,000. b. $126,250. c. $130,000. d. $133,750.

14. B Under the bonus method, Clark's excess payment is deducted from the remaining partners' capital accounts according to their relative profit and loss ratios, 3:3:2. Manning's balance is then $126,250 = $130,000 - $3,750. Manning, capital 3,750 Gonzalez, capital 3,750 Freeney, capital 2,500 Clark, capital 80,000 Cash 90,000

Partnerships: Formation and Operation William (40% of gains and losses).................. $220,000 Jennings (40%).................. 160,000 Bryan (20%).................. 110,000 LO 9-8 15. Darrow invests $270,000 in cash for a 30 percent ownership interest. The money goes to the original partners. Goodwill is to be recorded. How much goodwill should be recognized, and what is Darrow's beginning capital balance? a. $410,000 and $270,000. b. $140,000 and $270,000. c. $140,000 and $189,000. d. $410,000 and $189,000.

15. A The implied value of the company is $900,000 ($270,000 ÷ 30%). Because the money is going to the partners rather than into the business, the capital total is $490,000 before realigning the balances. Hence, goodwill of $410,000 is recognized based on the implied value ($900,000 - $490,000). This goodwill is assumed to represent unrealized business gains and is attributed to the original partners according to their profit and loss ratio. They will then each convey 30 percent ownership of the $900,000 partnership to Darrow for a capital balance of $270,000.

Partnerships: Formation and Operation William (40% of gains and losses).................. $220,000 Jennings (40%).................. 160,000 Bryan (20%).................. 110,000 LO 9-9 16. Darrow invests $250,000 in cash for a 30 percent ownership interest. The money goes to the business. No goodwill or other revaluation is to be recorded. After the transaction, what is Jennings's capital balance? a. $160,000. b. $168,000. c. $170,200. d. $171,200.

16. D Because the money goes into the business, total capital becomes $740,000 ($490,000 + $250,000). Darrow is allotted 30 percent of this total or $222,000. Because Darrow invested $250,000, the extra $28,000 is assumed to be a bonus to the original partners. Jennings will be assigned 40 percent of this extra amount or $11,200. This bonus increases Jennings' capital from $160,000 to $171,200.

Partnerships: Formation and Operation LO 9-1 2. How does partnership accounting differ from corporate accounting? a. The matching principle is not considered appropriate for partnership accounting. b. Revenues are recognized at a different time by a partnership than is appropriate for a corporation. c. Individual capital accounts replace the contributed capital and retained earnings balances found in corporate accounting. d. Partnerships report all assets at fair value as of the latest balance sheet date.

2. C

Partnerships: Formation and Operation LO 9-2 3. Which of the following best describes the articles of partnership agreement? a. The purpose of the partnership and partners' rights and responsibilities are required elements of the articles of partnership. b. The articles of partnership are a legal covenant and must be expressed in writing to be valid. c. The articles of partnership are an agreement that limits partners' liability to partnership assets. d. The articles of partnership are a legal covenant that may be expressed orally or in writing, and forms the central governance for a partnership's operations.

3. D

Partnerships: Formation and Operation LO 9-9 4. Pat, Jean Lou, and Diane are partners with capital balances of $50,000, $30,000, and $20,000, respectively. These three partners share profits and losses equally. For an investment of $50,000 cash (paid to the business), MaryAnn will be admitted as a partner with a one-fourth interest in capital and profits. Based on this information, which of the following best justifies the amount of MaryAnn's investment? a. MaryAnn will receive a bonus from the other partners upon her admission to the partnership. b. Assets of the partnership were overvalued immediately prior to MaryAnn's investment. c. The book value of the partnership's net assets was less than the fair value immediately prior to MaryAnn's investment. d. MaryAnn is apparently bringing goodwill into the partnership, and her capital account will be credited for the appropriate amount.

4. C Mary Ann's investment equals 1/3 of total capital ($50,000 ÷ $150,000). However, she receives only a 1/4 interest capital balance. One explanation for the difference is that the business assets are worth more than book value. To achieve agreement, the net assets could be valued upward to fair value with the adjustment credited to the original partners' capital accounts. Alternatively, a bonus could be credited to the original partners.

Partnerships: Formation and Operation LO 9-9 5. A partnership has the following capital balances: Arlo (50% of gains and losses).................. $120,000 Band (30%)..... 95,000 Carlyle (20%)..... 100,000 David is going to invest $105,000 into the business to acquire a 30 percent ownership interest. Goodwill is to be recorded. What will be David's beginning capital balance? a. $94,500. b. $105,000. c. $126,000. d. $135,000.

5. D Based on the new contribution, the company's implied value is $350,000 ($105,000 ÷ 30%) which is less than the capital balances ($315,000 in original capital plus $105,000 to be invested). Thus, either the assets are overvalued or the new partner is contributing goodwill in addition to a cash investment. Because the problem indicates that goodwill is recognized, goodwill must be computed. Note that the $105,000 is going into the business and, thus, increases capital. David's investment = 30% (Original capital plus David's investment) $105,000 + Goodwill = .30 ($315,000 + $105,000 + Goodwill) $105,000 + Goodwill = $126,000 + .30 Goodwill .70 Goodwill = $21,000 Goodwill = $30,000 David's investment (Capital) = $105,000 + $30,000 = $135,000

Partnerships: Formation and Operation LO 9-8 6. A partnership has the following capital balances: Carpenter (40% of gains and losses).................. $140,000 Dane (30%)..... 280,000 Elkhart (30%)..... 340,000 Krystal is going to pay a total of $240,000 directly to these three partners to acquire a 25 percent ownership interest from each. Goodwill is to be recorded. What is Dane's capital balance after the transaction? a. $210,000. b. $255,000. c. $340,000. d. $352,000.

6. B The implied value of the company is $960,000 ($240,000 ÷ 25%). Because the current capital total is only $760,000, goodwill of $200,000 must be recognized. Krystal's investment is paid directly to the partners and does not affect the capital total. Of the $200,000 in goodwill, 30 percent or $60,000 is attributed to Dane which brings that capital balance to $340,000. Because a 25% interest is conveyed to the new partner, Dane's balance decreases by 25% or $85,000—resulting in a new balance of $255,000.

Partnerships: Formation and Operation LO 9-9 7. The capital balance for Bolcar is $110,000 and for Neary is $40,000. These two partners share profits and losses 70 percent (Bolcar) and 30 percent (Neary). Kansas invests $50,000 in cash into the partnership for a 30 percent ownership. The bonus method will be used. What is Neary's capital balance after Kansas's investment? a. $35,000. b. $37,000. c. $40,000. d. $43,000.

7. B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new investment. As Kansas's portion is 30 percent, the capital balance becomes $60,000 ($200,000 × 30%). Because only $50,000 was paid, a bonus of $10,000 is taken from the two original partners based on their profit and loss ratios: Bolcar - $7,000 (70%) and Neary - $3,000 (30%). The reduction drops Neary's capital balance from $40,000 to $37,000.

Partnerships: Formation and Operation LO 9-9 8. Bishop has a capital balance of $120,000 in a local partnership, and Cotton has a $90,000 balance. These two partners share profits and losses by a ratio of 60 percent to Bishop and 40 percent to Cotton. Lovett invests $60,000 in cash in the partnership for a 20 percent ownership. The goodwill method will be used. What is Cotton's capital balance after this new investment? a. $99,600. b. $102,000. c. $112,000. d. $126,000.

8. B Total capital is $270,000 ($120,000 + $90,000 + $60,000) after the new investment. However, the implied value of the business based on the new investment is $300,000 ($60,000 ÷ 20%). Thus, goodwill of $30,000 must be recognized with the offsetting allocation to the original partners based on their profit and loss ratio: Bishop - $18,000 (60%) and Cotton $12,000 (40%). The increase raises Cotton's capital from $90,000 to $102,000.

Partnerships: Formation and Operation LO 9-9 9 The capital balance for Messalina is $210,000 and for Romulus is $140,000. These two partners share profits and losses 60 percent (Messalina) and 40 percent (Romulus). Claudius invests $100,000 in cash in the partnership for a 20 percent ownership. The bonus method will be used. What are the capital balances for Messalina, Romulus, and Claudius after this investment is recorded? a. $216,000, $144,000, $90,000. b. $218,000, $142,000, $88,000. c. $222,000, $148,000, $80,000. d. $240,000, $160,000, $100,000.

9. A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new investment. As Claudius' portion is to be 20 percent, the new capital balance would be $90,000 ($450,000 × 20%). Because $100,000 was paid, a bonus of $10,000 is being given to the two original partners based on their profit and loss ratio: Messalina - $6,000 (60%) and Romulus - $4,000 (40%). The increase raises Messalina's capital balance from $210,000 to $216,000 and Romulus's capital balance from $140,000 to $144,000.