1 answer

Steve Reese is a well-known interior designer in Fort Worth, Texas. He wants to start his...

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 $108,000 and equipment valued at $60,000 as well as $42,000 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 10 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 $7,000, 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 $8,000 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 $75,000. 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 $115,000 directly to Dunn. Net income for 2018 is $74,000 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.

Required:

1. Prepare journal entries (9 total) 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.

Journal entries to be prepared:

a. record the initial investment of assets by partners

b. record the redistribution of net income to partners

c. record the admittance of Dunn into the partnership.

d. Record entry to close drawings accounts.

e. Record the distribution of net income to partners.

f. Record the admittance of Postner into the partnership.

g. Record entry to close drawings accounts

h. Record the distribution of net income to partners.

i. Record the cash paid to the withdrawing partner.

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.

Journal entries to be prepared:

a. Record the initial investment of assets by partners

b. Record the redistribution of net income to partners

c. Record the admittance of Dunn into the partnership.

d. Record entry to close drawings accounts.

e. Record the distribution of net income to partners.

f. Record the goodwill indicated by the purchase of Dunn's interest.

g. Record the admittance of Postner into the Partnership.

h. Record entry to close drawings accounts.

i. Record the distribution of net income to partners.

j. Record the goodwill indicated by the withdrawal of Postner.

k. Record the final distribution to Postner


Answers

Date Account Title Ref Debit ($) Credit ($)
1-1-2016 Building $ 108,000
Equipment $ 60,000
Cash $ 42,000
O' Donnell, Capital $ 105, 000
Reese, Capital $ 105,000
12-31-2016 Reese, Capital $ 27,500
O' Donneel, Capital $ 17,500
Income Summary $ 10,000

O' Donneel = ($105,000 * 10%) + $ 7,000

= $ 10,500 + $ 7,000 = $17,500

1-1-2017 Cash $ 15,000
O' Donneel, Capital $ 2,800
Reese, Capital $ 25,200
Dunn, Capital $ 43,000

DUnn = ( $210,000 - $10,000 + $ 15,000)*20%

= $ 43,000

O' Donnel = ($43,000 - $15,000)*10% = $ 2,800

Reesee = ($43,000 - $ 15,000)* 90% = $ 25,200

12-31-2017 O' Donneel, Drawings $ 17,955
Reesee, Drawings $ 8,000
Dunn, Drawings $ 8,000
O' Donneel, Capital $ 17,955
Reesee, Capital $ 8,000
Dunn, Capital $ 8,000

O' doneell = {($105,000 + 17,500 - 2800)*15%} or $ 8000 w.e.h

= $ 17,955

Reesee = {(105,000 - 27,500 - 25,200)*15%} or $8,000 w.e.h

= $ 8,000

Dunn = (43,000 *15%) or $ 8,000 w.e.h

= $ 8,000

w.e.h = which ever is higher

12-31-2017 Income Summary $ 75,000
O' Donneel, Capital $ 19,470
Reesee, Capital $ 33,318
Dunn, Capital $ 22,212

O' Donneel = (119,700 * 10%) + (75,000 *10%)

= $ 19,470

Reesee = (75,000 - 19,470) * 6 / 10 = $ 33,318

Dunn = (75,000 - 19,470) *4 / 10 = $ 22,212

1-1-2018 Dunn, Capital $ 57,212
Postner, Capital $ 57,212
(43,000 - 8,000 + 22,212 = 57,212)
31-12-2018 O' Donneel, Drawings $ 18,182
Reesee, Drawings $11,642
Postner, Drawings $ 8,582
O' Donneel, Capitla $ 18,182
Reesee, Capital $ 11,642
Postner, Capital $ 8,582

O' Donnell = [(119,700 + 19,470 - 17,955)*15%] or $ 8000 w.eh

= $ 18,182

Reesee = [(52,300 + 33,318 - 8000)*15%] or $8,000 w.e.h

= $ 11,642

Postner = 57,212 * 15% or $ 8,000 w.e.h

= $ 8,582

12-31-2018 Income Summary $ 74,000
O' Donnel, Capital $19,521
Reesee, Capital $ 32,687
Postner, Capital $21,792

O' Donnel = (121,215 *10%) + (74,000 *10%)

= 19,521

Reesee = (74,000 - 19,521)*6 / 10 = 32,687

Postner = (74,000 - 19,521) * 4 / 10 = 21,792

1-1-2019 Postner, Capital $70,422
O' Donneel, Capital $704
Reesee, Capital $ 6,338

Postner = 57,212 - 8,582 + 21,792 = 70,422

O' DOnnell = (70,422 *10%) *10% = 704

Reesee = (70, 422 * 10%) *90% = 6,338

.

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