Solution manual advanced accounting 9e by hoyle ch14

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CHAPTER 14
PARTNERSHIPS: FORMATION AND OPERATION
Chapter Outline
I.

Business organizations that are formed legally as partnerships, although they are not always
as visible as corporations, still proliferate throughout this country especially in the legal,
medical, and accounting professions.
A. Advantages of the partnership format include ease of creation and the absence of the
double taxation effect inherent to the income earned by a corporation and distributed to
its owners.
B. Partnerships, however, rarely grow to a significant size (when compared with large
corporate organizations) primarily because of the unlimited liability being assumed by
each general partner.
C. Alternative legal formats have been created over the years to combine the benefits of
corporations and partnerships such as S corporations, limited liability partnerships, and
limited liability companies.

II. Partnership accounting and the capital accounts
A. The distinctive aspects of partnership accounting center on the capital accounts
maintained for each individual partner.
B. The basis of accounting for these capital balances is the Articles of Partnership
agreement which establishes provisions for initial investments, withdrawals, admission of
a new partner, retirement of a partner, etc.
C. The actual contribution made by the partners to the business should be recorded at fair
market value. A problem arises, however, when a contribution is truly intangible such as
a particular expertise or an established client base.
1. In the bonus method, only identifiable assets are valued and recorded. The capital
account balances are then aligned to indicate the percentage of the actual

contributions being made by each partner.
2. In the goodwill method, the amount being contributed and the corresponding
percentage of the initial capital balance are used to calculate the value of the
business and the presence of goodwill, a figure which is physically recorded as an
intangible asset.
III. Allocation of income
A. At the end of each fiscal period, the revenue and expense accounts must be closed out
with the resulting income figure being assigned to the individual capital accounts.
B. The method of allocating income to the capital accounts should be established within the
Articles of Partnership.

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1. The partners can simply assume an equal division of profits and losses.
2. The partners, however, can select any method that is designed to arrive at an
equitable allocation. Such factors as the amounts of capital invested, the time
worked in the business, and the degree of business expertise may all serve to
influence the assignment of income.
IV. Accounting for partnership dissolution
A. Over time, the identity of the individuals within a partnership can change through
admission of a new partner or the death, retirement, or withdrawal of a present partner.
B. Each change in composition serves to dissolve the original partnership usually so that a
new partnership can be formed to continue the business. Thus, dissolution does not

necessarily affect the operations of the business.
C. Admission of a new partner.
1. A new partner will often buy all (or a portion) of the interest owned by one or more of
the present partners.
a. The capital account balances can simply be reclassified to reflect the identity of
the new ownership.
b. As an alternative, all accounts may be adjusted to fair market value with the price
paid being used as the basis for calculating any goodwill.
2. A new partner can also be admitted by a direct contribution to the partnership
business.
a. The bonus (or no revaluation) method records the identifiable assets being
contributed at fair market value. The new partner’s capital is set equal to a
prearranged percentage or amount. The remaining capital balances are then
aligned based on profit and loss percentages.
b. The goodwill (or revaluation) approach initially adjusts all assets and liabilities of
the partnership to fair market value and records goodwill based on the amount
being paid (which is used to calculate the implied value of the business).
D. Withdrawal of a partner
1. The final asset distribution to an individual should be based on the agreement
established in the Articles of Partnership and will often vary in amount from that
partner's ending capital balance.
2. The difference between the amount paid and the final capital balance can simply be
recorded as an adjustment to the remaining partners' capital accounts in the same
manner as the bonus method.
3. As an alternative, all accounts can be adjusted to fair value with the amount of
payment being used as the basis for computing goodwill.

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Learning Objectives
Having completed Chapter 14 of this textbook, "Partnerships: Formation and Operation,"
students should be able to fulfill each of the following learning objectives:
1. Discuss the advantages and disadvantages of organizing a business as a partnership
instead of as a corporation including such factors as the ease of formation, taxation effects,
and the unlimited liability of the partners.
2. Describe the purpose of an Articles of Partnership and list specific items that should be
included in this agreement.
3. Prepare the journal entry to record the initial capital investment made by a partner when
either cash or another asset is being contributed.
4. Use both the bonus method and the goodwill method to record a capital investment made
by a partner who is contributing an attribute such as a specific expertise or an established
clientele.
5. Understand the impact that the allocation of income earned by a partnership has on the
individual capital balances.
6. Allocate income to partners when interest and/or salary factors are included.
7. Discuss the meaning of a partnership dissolution and understand that a dissolution will often
have little or no effect on the operations of the partnership business.
8. Prepare journal entries to record the acquisition by a new partner of a current partner's
interest. These entries should be made both as a reclassification as well as by means of the
goodwill approach.
9. Prepare journal entries to record a new partner's admission by a contribution made directly
to the partnership. These entries should be made both by the bonus method as well as by
the goodwill method.

10. Prepare journal entries to record the withdrawal of a current partner. These entries should
be made by the bonus method, the goodwill method, or a modified method whereby assets
and liabilities are revalued but no goodwill is recognized.

Answers to Discussion Questions
What Kind of Business is This?
The owners of this business face a common problem: they have started operations without
giving serious consideration to the legal formation of the company. The accountant now needs
to spell out for them the advantages and disadvantages of creating a partnership versus a

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corporation or some other type of legal form. Eventually, the owners must make this decision
but they should consider all of the relevant factors before arriving at their choice.
The accountant should discuss the following issues with the two owners:
—Ease of formation. A formal partnership can be created by the writing of an Articles of
Partnership. If the allocation of income and the contributions by the partners have already
been resolved, the development of this document should be relatively simple. Forming a
corporation can be a more difficult task but the degree of difficulty does depend on individual
state laws. Normally, the documents to be completed are more complicated although that is
not necessarily so. The accountant should explain the specific procedures that apply to
partnerships in the state where the business is organized and conducts its operations.
—Business liabilities. In a partnership, either partner may be held liable for all business debts.

Thus, if liabilities escalate and the business fails, each partner does risk the possible loss of
an enormous sum. The same problem would not exist in a corporation where owners and the
business are considered separate entities. For the owners, potential losses are, in
corporations, normally limited to the amount being invested. However, in many small, newly
created, corporations, the owners are required to personally guarantee any loans. Therefore,
to an extent, the concept of unlimited liability may actually be present in either case. The
partners should forecast the amount of debts that will be incurred and the possible outcome if
the business would happen to fail.
—Lawsuits. Some businesses are more susceptible to lawsuits than others. A florist, for
example, would seem to have less risk than a pharmaceutical company. The concept of
personal liability for business debts becomes especially important in a business with a high
possibility of litigation and resulting losses. In a business with such a risk, creating a
corporation to protect the personal property of the stockholders would appear to be a wise
move. The owners of a partnership might become personally responsible for losses created
by a business mistake or accident. Obviously, this need for responsibility is recognized in
states that prohibit doctors, lawyers, accountants, and the like from incorporating. This is a
primary reason for such states to allow licensed professionals to operate LLPs.
—Taxation. In a partnership, all income is allocated to the owners immediately and they are
taxed on this amount. Double-taxation is avoided. A corporation pays an income tax and any
dividends are then taxed again when collected by the owners. Therefore, traditionally,
partnerships are viewed as having a tax advantage. The accountant should also mention to
the partners other possible tax factors that may affect their decision. For example, in small
corporations, double taxation may not be a problem. If salaries paid to the owners are
reasonable and approximate the company's profits so that no dividends are distributed, only
one tax is paid in either case. As another issue, if a partnership suffers a loss (which often
happens when companies begin operations), that loss is passed to the partners and can be
used to reduce other taxable income. However, in a corporation, losses are carried back and
forward to reduce other taxable income that is earned by the business, possibly delaying the
benefits of the loss. As mentioned in the textbook, the owners should consider forming an S
Corporation—a business that is incorporated but still taxed as a partnership.

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—Bankruptcy. If the business should ever fail and have to be liquidated, losses of a partnership
are passed directly to the owners to reduce taxable income immediately. For a corporation,
the loss is a capital loss to the stockholders which can only offset their own capital gains or
be deducted at the rate of $3,000 per year. Thus, if a large loss is incurred, the tax benefits
may not be realized for years into the future.
—Growth potential. Traditionally, corporations have more growth potential than do partnerships.
Ownership interests can be easily transferred. The limitation on liability encourages
ownership by individuals who cannot participate in the management of the company.
Partnerships are more restricted in adding new owners. Partnerships usually have to entice
individuals who are willing to work in the business in order to obtain additional capital.
Therefore, the accountant may want to address the following questions in advising these
clients:
 What amount of time and energy is involved in becoming incorporated?
 How much profit or loss is anticipated from the operations of this business in the
foreseeable future?
 How much debt will the new business incur?
 Will this debt be guaranteed by the owners?
 How much salary do the owners anticipate withdrawing from the business?
 What are the chances of incurring lawsuits?
 What is the possibility that the business will fail?

 How large do the owners expect this business to grow? Do they anticipate the need
for new owners and new capital?
 Does the creation of an S Corporation apply to this particular business?
How Will the Profits Be Split?
This case is designed to point up the difficulty of designing a profit-sharing arrangement that is
fair to all parties. Currently, these three individuals have incomes totaling an amount in excess
of the first year income that is expected. Thus, the adopted plan will have an immediate impact
on them. The reduction of income must be absorbed by the partners in some equitable manner.
In addition, the income is projected to increase relatively fast so that the agreed-upon method
needs to reward all participants properly over time.
Dewars has built up the firm and still handles the bigger clients although he plans to reduce his
workload over the next few years. Thus, one method of compensation would be to credit him
with interest on the capital built up in the business. However, if that number alone is used, it will
tend to escalate even if his work hours are reduced. For this reason, Dewars' share of the
profits could also be based in some way on the number of hours that he works. According to the
information presented, this number will probably shrink over the years, reducing the profits
allocated to Dewars. Thus, this partner might be given interest equal to 10 percent of his capital
balance and $50 for each hour worked.

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Huffman is contributing a significant number of hours to the firm but tends to work on the
smaller jobs. A possible allocation technique would be to give this partner a per hour allocation

but one that is somewhat smaller than Dewars. For example, Huffman could receive an income
allocation of $30 per hour to begin. That number could then be programmed to escalate over
the years as Huffman starts to take over the bigger jobs.
Scriba's role is to develop a tax practice within the firm. Consequently, one suggestion would be
to credit her capital account with a percentage of the tax revenues (20 percent, for example)
each year. In that way, she benefits by the amount of business that she is able to bring to the
organization. During the first years, though, she may have trouble getting the new part of this
business to generate significant revenues. Thus, the partners may want to set a minimum figure
for her income allocation. She could be credited, as an example, with 20 percent of tax
revenues but not less than $50,000.
Many answers to this question are possible. The above is just a simple suggestion based on the
facts presented in the case. Income allocation techniques are usually designed to reward the
partners for the attributes that they bring to the organization. Even with the above system,
percentages would still be necessary to assign any remaining profit or loss. If the partners are
not totally satisfied with the system as designed, the percentages could be weighted or adjusted
to reward any partner not being properly compensated.

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Answers to Questions
1. The advantages of operating a business as a partnership include the ease of formation and
the avoidance of the double taxation effect that inherently reduces the profits distributed to
the owners of a corporation. In addition, since the losses of a partnership pass, for tax

purposes, directly through to the owners, partnerships have historically been used
(especially in certain industries) to reduce or defer income taxes.
Several disadvantages also accrue from the partnership format. Each general partner, for
example, has unlimited liability for all debts of the business. This potential liability can be
especially significant in light of the concept of mutual agency, the right that each partner has
to create liabilities in the name of the partnership. Because of the risks created by unlimited
liability and mutual agency, the growth potential of most partnerships is severely limited. Few
people are willing to become general partners in an organization unless they can maintain
some day-to-day contact and control over the business.
Further discussion of these issues can be found in the Answer to the first Discussion
Question that appears above.
2. Specific partnership accounting problems center in the equity (or capital) section of the
balance sheet. In a corporation, stockholders' equity is divided between earned capital and
contributed capital. Conversely, for a partnership, each partner has an individual capital
account that is not differentiated according to its sources. Virtually all accounting issues
encountered purely in connection with the partnership format are related to recording and
maintaining these capital balances.
3. The balance in each partner's capital account measures that partner's interest in the book
value of the business’ net assets. This figure arises from contributions, earnings, drawings,
and other capital transactions.
4. A Subchapter S corporation is formed legally as a corporation so that its owners enjoy
limited legal liability and easy transferability of ownership. However, if a company qualifies
and becomes a Subchapter S Corporation, it will be taxed in virtually the same manner as a
partnership. Hence, income will be taxed only once and that is to the owners at the time that
it is earned by the corporation.
Use of this designation is quite restricted. To qualify as a Subchapter S Corporation, a
company can only have one class of stock and must have no more than 100 owners. These
owners can only be individuals, estates, certain tax-exempt entities, and certain types of
trusts. Most corporations that do not qualify as Subchapter S Corporations are automatically
Subchapter C Corporations. These entities are also corporations but they pay income taxes

when the income is earned. Additionally, the owners are liable for a second income tax
when dividends are distributed to them. Thus, the income earned by a Subchapter C
Corporation faces the double taxation effect commonly associated with corporations.
5. In a general partnership, each partner can have unlimited liability for the debts of the
business. Therefore, a partner may face a significant risk, especially in connection with the
actions and activities of other partners. However, general partnerships are easy to form and
often serve well in smaller businesses where all partners know each other. The major
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advantage of a general partnership is that all income earned by the business is only taxed
once when earned by the business so that no second tax is incurred when distributions are
made to owners.
A limited liability partnership (LLP) is very similar to a general partnership except in the
method by which a partner’s liability is measured. In an LLP, the partners can still lose their
entire investment and be held responsible for all contractual debts of the business such as
loans. However, partners cannot be held responsible for damages caused by other
partners. For example, if one partner carelessly causes damage and is sued, the other
partners are not held responsible.
A limited liability company can now be created in certain situations. This type of organization
is classified as a partnership for tax purposes so that the double-taxation effect is avoided.
However, the liability of the owners is limited to their individual investments like a Subchapter
C Corporation. Depending on state law, the number of owners is not restricted in the same
manner as a Subchapter S Corporation so that there is a greater potential for growth.

6. The Articles of Partnership is a legal agreement that should be created as a prerequisite for
the formation of a partnership. This document defines the rights and responsibilities of the
partners in relation to the business and in relation to each other. Thus, it serves as a
governing document for the partnership. The Articles of Partnership may contain any
number of provisions but should normally specify each of the following:
a.
b.
c.
d.
e.

Name and address of each partner
Business location
Description of the nature of the business
Rights and responsibilities of each partner
Initial investment to be made by each partner along with the method to be used for
valuation
f. Specific method by which profits and losses are to be allocated
g. Periodic withdrawals to be allowed each partner
h. Procedure for admitting new partners
i. Method for arbitrating partnership disputes
j. Method for settling a partner's share in the business upon withdrawal, retirement, or
death
7. To give fair recognition to noncash contributions, all assets donated by the partners (such
as land or inventory) should be recorded by the partnership at their fair values at the date of
investment. However, for taxation purposes, the partner’s book value is retained.
8. In forming a partnership, one or more of the partners may be contributing some factor (such
as an established clientele or an expertise) which is not viewed normally as an asset in the
traditional accounting sense. In effect, the partner will be receiving a larger capital balance
than the identifiable contributions would warrant.

The bonus method of recording this transaction is to value and record only the identifiable
assets such as land and buildings. The capital accounts are then aligned to recognize the
proportionate interest being assigned to each partner's investment. If, for example, the

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capital balances are to be equal, they are set at identical amounts that correspond in total to
the value of the identifiable assets.
As an alternative, the amounts contributed along with the established capital percentages
can be used to determine mathematically the implied total value of the business and the
presence of any goodwill brought into the business. This goodwill is recognized at the time
that the partnership is created so that the amount can be credited to the appropriate partner.
9. The Drawing account measures the amount of assets that a particular partner takes from
the business during the current period. Often, only regularly allowed distributions are
recorded in the Drawing account with larger, more sporadic withdrawals being recorded as
direct reductions to the partner's capital balance.
10. At the end of each fiscal year, when revenues and expenses are closed out, some
assignment must be made of the resulting income figure since a partnership will have two or
more capital accounts rather than a single retained earnings balance. This allocation to the
capital accounts is based on the agreement established by the partners preferably as a part
of the Articles of Partnership.
11. The allocation process can be based on any number of factors. The actual assignment of
income should be designed to give fair and equitable treatment to each of the partners.

Often, an interest factor is used to reward the capital investment of the partners. A salary
allowance is utilized as a means of recognizing the amount of time worked by an individual
or a certain degree of business expertise. The allocation process can be further refined by a
ratio that is either divided evenly among the partners or weighted in favor of one or more
members.
12. If agreement as to the allocation of income has not been specified, an equal division among
all partners is presumed. If an agreement has been reached for assigning profits but no
mention is made concerning losses, the assumption is made that the same method is
intended in either case.
13. The dissolution of a partnership is the breakup or cessation of the partnership. Many
reasons can exist for a partnership to dissolve. One partner may withdraw, retire, or die. A
new partner may be admitted to the partnership. The original partnership terminates
whenever the identity of the individuals serving as partners has changed.
Dissolution, however, does not necessarily lead to the liquidation of the business. In most
cases, but not all, a new partnership is formed which takes over the business. Such
dissolutions are no more than changes in the composition of the ownership and should not
affect operations.
14. A new partner can join a partnership by acquiring part or all of the interest of one or more of
the present partners. This transaction is carried out with the individual partners directly and
not with the partnership. A new partner may also enter through a contribution to the
business. In such cases, the investment is made to the partnership rather than to the
individuals.
15. In selling an interest in a partnership, three rights are conveyed to the new owner:
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a. The right of co-ownership of the business property;
b. The right to a specified allocation of profits and losses generated by the partnership's
business; and
c. The right to participate in the management of the business.
No problem exists in selling or assigning the first two of these rights. However, the right to
participate in management decisions can only be transferred with the consent of all partners.
16. Any goodwill being recognized in a capital transaction that is allocated to the original
partners is based on the profit and loss ratio. The amount is assumed to represent
unrealized gains in the value of the business. To determine the amount of goodwill, the
implied value of the business as a whole must be calculated based on the price being paid
for a portion by the new partner. The difference between this implied value and the total
capital is assumed to be goodwill or some other adjustment to asset value.
17. Allocating goodwill to an entering partner may be necessary for several reasons. One of the
most common is that the partner is bringing to the partnership an attribute that is not an
asset in the traditional accounting sense. For example, a new partner with an excellent
business reputation might be credited with goodwill at the time of entrance. Other factors
such as an established clientele or a professional expertise can justify attributing goodwill to
the new partner. The partnership might make this same concession to an entering partner if
cash is urgently needed by the business and a larger share of the capital has to be offered
as an enticement to generate the new investment.
18. Book values in most cases measure historical cost expenditures which often have
undergone years of allocation and changes in value. For this reason, book value will
frequently fail to mirror or even resemble the actual worth of a business. In addition, the
goodwill that is assumed to be present in a business as a going concern is not a factor that
is always reflected within book values. Therefore, distributing partnership property to a
withdrawing partner based on book value would not necessarily be fair. Hence, the Articles
of Partnership should spell out a method by which an equitable settlement can be achieved.

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Answers to Problems
1. B
2. C
3. C Mary Ann's investment is equal to 1/3 of the total capital ($50,000/$150,000).
However, she is receiving a smaller capital balance, only a 1/4 interest. One
explanation for this difference is that the business assets may be worth
more than book value. To achieve agreement, the net assets could be
valued upward to fair value with the adjustment recorded to the capital
accounts of the original partners. As an alternative, a bonus could be
credited to the original partners.
4. D The implied value of the company based on the new contribution is only
$233,333 ($70,000/30%) which is below the total of the capital balances
($280,000 in original capital plus $70,000 to be invested). Thus, either the
assets are overvalued or the new partner is also contributing goodwill.
Since the problem indicates that goodwill is being recognized, that figure
must be computed. Note that the $70,000 is going into the business and,
thus, increases capital.
Danville's investment
$70,000 + Goodwill
$70,000 + Goodwill
.70 Goodwill

Goodwill
Danville's Investment (Capital)

=
=
=
=
=
=

30% (Original Capital Plus Danville's Investment)
.30 ($280,000 + $70,000 + Goodwill)
$105,000 + .30 Goodwill
$35,000
$50,000
$70,000 + $50,000 or $120,000

5. C The implied value of the company is $800,000 ($200,000/25%). Since the
current capital total is only $600,000, goodwill of $200,000 must be
recognized. Oscar's investment is going to the partners so that it does not
affect the capital total directly. Of the $200,000 in goodwill, 30 percent or
$60,000 is attributed to Jethro which brings that capital balance to
$260,000. Since a 25 percent interest is being conveyed to the new partner,
Jethro's balance will then decrease by 25% or $65,000—a drop to $195,000.
6. B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new
investment. As Kansas's portion is to be 30 percent, the capital balance
would be $60,000 ($200,000 × 30%). Since only $50,000 was paid, a bonus
of $10,000 must be taken from the two original partners based on their
profit and loss ratio: Bolcar – $7,000 (70%) and Neary – $3,000 (30%). The
reduction drops Neary's capital balance from $40,000 to $37,000.

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7. 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.
8. A Total capital is $450,000 ($210,000 + $140,000 + $100,000) after the new
investment. As Claudius's portion is to be 20 percent, the new capital
balance would be $90,000 ($450,000 × 20%). Since $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.
9. D ASSIGNMENT OF INCOME—2007
Interest—10% of
beginning capital ..............
Salary ......................................
Allocation of remaining income
($6,000 divided on a 3:3:4 basis)
Totals ...........................

ARTHUR

BAXTER

CARTWRIGHT

TOTAL

$ 6,000
20,000

$ 8,000

$10,000
20,000

$24,000

1,800
$ 7,800

1,800
$29,800

2,400
$12,400

6,000
$50,000

ARTHUR

BAXTER

$60,000
7,800
(5,000)
$62,800

$80,000
29,800
(5,000)
$104,800

STATEMENT OF CAPITAL—2007
Beginning capital ...................
Net income (above) ................
Drawings (given) ...................
Ending capital ........................

CARTWRIGHT

TOTAL

$100,000 $240,000
12,400
50,000
(5,000) (15,000)
$107,400 $275,000

10. A ASSIGNMENT OF INCOME—YEAR ONE
WINSTON

Interest—10% of
beginning capital ..............
$11,000
Salary ...................................... 20,000
-0Allocation of remaining loss
($80,000 divided on a 5:2:3 basis) (40,000)
Totals ...........................
$(9,000)

DURHAM

SALEM

TOTAL

$ 8,000
10,000

$11,000
30,000

$30,000

(16,000)
$ (8,000)

(24,000) (80,000)
$ (3,000) $(20,000)

STATEMENT OF CAPITAL—YEAR ONE
WINSTON

Beginning capital ...................
Net loss (above) .....................
Drawings (given) ...................
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$110,000
(9,000)
(10,000)

DURHAM

$80,000
(8,000)
(10,000)

SALEM

TOTAL

$110,000 $300,000
(3,000) (20,000)
(10,000) (30,000)

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Ending capital ...................

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$ 91,000

$62,000

$ 97,000 $250,000

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10. (continued)
ASSIGNMENT OF INCOME—YEAR TWO
WINSTON

Interest—10% of
beginning capital ..............
$ 9,100

Salary ...................................... 20,000
-0Allocation of remaining loss
($15,000 divided on a 5:2:3 basis)
(7,500)
Totals ...........................
$21,600

DURHAM

SALEM

TOTAL

$ 6,200
10,000

$ 9,700
30,000

$25,000

(3,000)
$3,200

(4,500) (15,000)
$15,200 $ 40,000

STATEMENT OF CAPITAL—YEAR TWO
Beginning capital (above) .....
Net income (above) ................

Drawings (given) ...................
Ending capital ...................

WINSTON

DURHAM

$ 91,000
21,600
(10,000)
$102,600

$62,000
3,200
(10,000)
$55,200

SALEM

TOTAL

$ 97,000 $250,000
15,200
40,000
(10,000) (30,000)
$102,200 $260,000

11. A A $10,000 bonus is paid to Costello ($100,000 is paid rather than the
$90,000 capital balance). This bonus is deducted from the two remaining
partners according to their profit and loss ratio (2:3). A reduction of 60

percent (3/5) is assigned to Burns or a decrease of $6,000 which drops that
partner’s capital balance from $30,000 to $24,000.
12. D Craig receives an additional $10,000. Since Craig is assigned 20 percent of
all profits and losses, this allocation indicates total goodwill of $50,000.
20% of Goodwill = $10,000
.20 G = $10,000
G = $10,000/.20
G = $50,000
Montana is assigned 30% of all profits and losses and would, therefore,
record $15,000 of this goodwill, an entry that raises this partner's capital
balance from $130,000 to $145,000.
13. A The implied value of the company is $900,000 ($270,000/30%). Since 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 must be 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.

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14. D Since 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.
15. (10 Minutes) (Compute capital balances under both goodwill and bonus
methods)
a. Goodwill Method
Implied value of partnership ($80,000/40%) .................
Total capital after investment ($70,000 + $40,000 + $80,000)
Goodwill .........................................................................

$200,000
190,000
$ 10,000

Goodwill to Hamlet (7/10) ..............................................

$

7,000

Goodwill to MacBeth (3/10) ...........................................

$ 3,000

Hamlet, capital (original balance plus goodwill) .........

$ 77,000

MacBeth, capital (original balance plus goodwill) ......

$ 43,000

Lear, capital (payment) (40% of total capital) ..............

$ 80,000

b. Bonus Method
Total capital after investment ($70,000 + 40,000 + $80,000)
Ownership portion—Lear .............................................
Lear, capital ...................................................................

$190,000
40%
$ 76,000

Bonus payment made by Lear ($80,000 – $76,000) ......

$

4,000

Bonus to Hamlet (7/10) ..................................................

$

2,800

Bonus to MacBeth (3/10) ...............................................

$

1,200

Hamlet, capital (original balance plus bonus) .............

$ 72,800

MacBeth, capital (original balance plus bonus) ..........

$ 41,200

Lear, capital (40% of total capital) ................................

$ 76,000

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16. (15 Minutes) (Prepare journal entries to record admission of new partner under
both the goodwill and the bonus methods)
Part a.
Total capital is $300,000 ($85,000 + $60,000 + $55,000 + $100,000) after the

new investment. As Sergio's portion is 25 percent, this partner's capital
balance would be $75,000. Since $100,000 was paid, a bonus of $25,000 is
given to the three original partners based on their profit and loss ratio:
Tiger—$12,500 (50%), Phil—$7,500 (30%), and Ernie—$5,000 (20%).
Cash .........................................................................
Sergio, Capital .....................................................
Tiger, Capital .......................................................
Phil, Capital .........................................................
Ernie, Capital .......................................................

100,000
75,000
12,500
7,500
5,000

Part b.
Total capital is $260,000 ($85,000 + $60,000 + $55,000 + $60,000) after the
new investment. As Sergio's portion is to be 25 percent, this partner's
capital balance would be $65,000. Because only $60,000 was paid, a bonus
of $5,000 is taken from the three original partners based on their profit and
loss ratio: Tiger—$2,500 (50%), Phil—$1,500 (30%), and Ernie—$1,000
(20%).
Cash .........................................................................
Tiger, Capital ............................................................
Phil, Capital ..............................................................
Ernie, Capital ............................................................
Sergio, Capital .....................................................

60,000

2,500
1,500
1,000
65,000

Part c.
Total capital is $272,000 ($85,000 + $60,000 + $55,000 + $72,000) after the
new investment. However, the implied value of the business based on the
new investment is $288,000 ($72,000/25%). Consequently, goodwill of
$16,000 must be recognized with the offsetting allocation to the original
partners based on their profit and loss ratio: Tiger—$8,000 (50%), Phil—
$4,800 (30%), and Ernie—$3,200 (20%).
Goodwill ...................................................................
Tiger, Capital .......................................................
Phil, Capital .........................................................
Ernie, Capital .......................................................
Cash ..........................................................................
Sergio, Capital .....................................................
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16,000
8,000
4,800
3,200
72,000
72,000

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17. (16 Minutes) (Determine capital balances after admission of new partner using
both goodwill and bonus methods)
Part a.
Total capital is $490,000 ($200,000 + $120,000 + $90,000 + $80,000) after the
new investment. However, the implied value of the business based on the
new investment is only $444,444 ($80,000/18%). According to the goodwill
method, this situation indicates that the new partner must be bringing
some intangible attribute to the partnership other than just cash. This
contribution must be computed algebraically and is recorded as goodwill
to the new partner.
G's Investment = .18 ($200,000 + $120,000 + $90,000 + G's Investment)
$80,000 + Goodwill = .18 ($410,000 + $80,000 + Goodwill)
$80,000 + Goodwill = $88,200 + .18 Goodwill
.82 Goodwill = $8,200
Goodwill = $10,000
The above goodwill balance indicates that Grant's total investment is
$90,000 (cash of $80,000 and goodwill of $10,000). A $90,000 contribution
raises the total capital to $500,000 so that Grant does, indeed, have an 18
percent interest ($90,000/$500,000).
CAPITAL BALANCES:
Nixon ....................................................................
Hoover .................................................................
Polk ....................................................................
Grant ....................................................................

$200,000

120,000
90,000
90,000

Part b.
Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after the
new investment. As Grant's portion is to be 20 percent, this partner's
capital balance will be $102,000. Since only $100,000 was paid, a bonus of
$2,000 is taken from the three original partners based on their profit and
loss ratio: Nixon—$1,000 (50%), Hoover—$400 (20%), and Polk—$600
(30%).
CAPITAL BALANCES
Original

Nixon ....................
Hoover ..................
Polk ......................
Grant ....................
Total ................

$200,000
120,000
90,000
-0-

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Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

Investment

100,000

Bonus

$(1,000)
( 400)
( 600)
2,000

Total

$199,000
119,600
89,400
102,000
$510,000

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18. (8 Minutes) (Record admission of new partner and allocation of new income)
Part a.
Total capital is $336,000 ($150,000 + $110,000 + $76,000) after the new
investment. However, the implied value of the business based on the new
investment is $380,000 ($76,000/20%). Consequently, goodwill of $44,000
must be recognized with the offsetting allocation to the original two
partners based on their profit and loss ratio: Com—$26,400 (60%) and

Pack—$17,600 (40%).
Goodwill ...............................................................
Com, Capital ...................................................
Pack, Capital ..................................................
Cash ....................................................................
Hal, Capital .....................................................

44,000
26,400
17,600
76,000
76,000

Part b.

Interest .................................
Remaining loss .....................
Income allocation ...........

Com
$17,640
(1,000)
$16,640

Pack
$12,760
(600)
$12,160

Hal

$7,600
(400)
$7,200

Total
$38,000
(2,000)
$36,000

King
$
-030,000
(6,000)
$24,000

Lane
$
-045,000
(6,000)
$39,000

Total
$18,000
90,000
(18,000)
$90,000

19. (5 Minutes) (Allocation of income to partners)
Jones
Bonus (20%) .........................

$18,000
Interest (15% of average capital) 15,000
Remaining loss ($18,000) ...
(6,000)
Income assignment .............
$27,000

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20. (15 Minutes) (Allocate income and determine capital balances)
ALLOCATION OF INCOME
Interest (10%)
Salary
Remaining income (loss):
$ 23,600
(12,600)
(51,000)
$(40,000)
Totals

Purkerson
Smith
$ 6,600 (below) $ 4,000

18,000
25,000

(16,000)
$ 8,600

(8,000)
$21,000

Traynor
$ 2,000
8,000

Totals
$12,600
51,000

(16,000)

(40,000)

$(6,000)

$23,600

CALCULATION OF PURKERSON'S INTEREST ALLOCATION
Balance, January 1—April 1 ($60,000 × 3)
Balance, April 1—December 31 ($68,000 × 9)
Total ................................................................................
Months ............................................................................

Average monthly capital balance .................................
Interest rate ....................................................................
Interest allocation (above) ............................................

$180,000
612,000
$792,000
 12
$ 66,000
× 10%
$ 6,600

STATEMENT OF PARTNERS' CAPITAL
Purkerson

Beginning balances ..............
Additional contribution ........
Income (above) .....................
Drawings ($1,000 per month)
Ending capital balances ........

$60,000
8,000
8,600
(12,000)
$64,600

Irwin/McGraw-Hill
Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

Smith

$40,000
-021,000
(12,000)
$49,000

Traynor

Totals

$20,000 $120,000
-08,000
(6,000)
23,600
(12,000)
(36,000)
$ 2,000 $115,600

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21. (30 Minutes) (Allocate income for several years and determine ending capital
balances)
INCOME ALLOCATION—2009
Left
Interest (12% of beginning capital) $2,400

Salary
12,000
Remaining income/loss:
$(30,000)
(15,600)
(20,000)
$(65,600)
(19,680)
Totals
$(5,280)

Center
$ 7,200
8,000

Right
$ 6,000
-0-

Total
$ 15,600
20,000

(32,800)
$(17,600)

(13,120)
$(7,120)

(65,600)

$(30,000)

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2009

Beginning balances ...........
Income allocation ..............
Drawings ............................
Ending balances ...........

Left
$20,000
(5,280)
(10,000)
$ 4,720

Center
$60,000
(17,600)
(10,000)
$32,400

INCOME ALLOCATION—2010
Left
Center
Interest(12% of beginning capital above) *$566
$3,888
Salary .................................
12,000
8,000
Remaining income/loss:

$20,000
(8,400)
(20,000)
$(8,400)
(2,520)
(4,200)
Totals .................
$10,046
$7,688
*Rounded

Right
Total
$50,000 $130,000
(7,120)
(30,000)
(10,000)
(30,000)
$32,880 $ 70,000

Right
$3,946
-0-

Total
$ 8,400
20,000

(1,680)
$2,266

(8,400)
$20,000

STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2010

Beginning balances (above)
Additional investment .......
Income allocation ..............
Drawings ............................
Ending balances ...........

Irwin/McGraw-Hill
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Left
$ 4,720
-010,046
(10,000)
$ 4,766

Center
$32,400
-07,688
(10,000)
$30,088

Right
$32,880
12,000

2,266
(10,000)
$37,146

Total
$70,000
12,000
20,000
(30,000)
$72,000

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21. (continued)
INCOME ALLOCATION—2011
Left
Center
Interest (12% of beginning capital
above)* ..........................
$ 572
$ 3,611
Salary ..................................
12,000
8,000
Remaining income:
$40,000

(8,640)
(20,000)
$11,360 ........................
2,272
4,544
Totals ........................
$14,844
$16,155

Right

Total

$4,457
-0-

$ 8,640
20,000

4,544
$9,001

11,360
$40,000

*Rounded
STATEMENT OF PARTNERS' CAPITAL—DECEMBER 31, 2011
Left
Center
Right

Total
Beginning balances (above)
$ 4,766
$30,088
$37,146
$72,000
Income allocation
14,844
16,155
9,001
40,000
Drawings
(10,000)
(10,000)
(10,000)
(30,000)
Ending balances
$ 9,610
$36,243
$36,147
$82,000

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22. (12 Minutes) (Determine capital balances after retirement of a partner using
both the goodwill and the bonus approaches)
a. Harrison receives an additional $30,000 about the capital balance. Since
Harrison is assigned 20 percent of all profits and losses, this extra
allocation indicates total goodwill of $150,000, which must be split among
all partners.
20% of Goodwill = $30,000
.20 G = $30,000
G = $150,000
CAPITAL BALANCES AFTER WITHDRAWAL
Original Balance

Lennon
McCartney
Harrison
Starr
Total

$230,000
190,000
160,000
140,000

Goodwill

Withdrawal Final Balance

$45,000
45,000

30,000
30,000

$275,000
235,000
-0170,000
$680,000

$(190,000)

b. A $50,000 bonus is paid to Lennon ($280,000 is paid rather than the $230,000
capital balance). This bonus is deducted from the three remaining partners
according to their relative profit and loss ratio (3:2:1). A reduction of 50
percent (3/6) is assigned to McCartney or a decrease of $25,000 which drops
this partner's capital balance from $190,000 to $165,000. A reduction of 33.3
percent (2/6) is assigned to Harrison or a decrease of $16,667 which drops this
partner's capital balance from $160,000 to $143,333. A reduction of 16.7
percent (1/6) is assigned to Starr or a decrease of $8,333 which drops this
partner's capital balance from $140,000 to $131,667.

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23. (45 Minutes) (Discussion of P&L allocations and admission of a new partner)

a. The interest factor was probably inserted to reward Page for contributing
$50,000 more to the partnership than Childers. The salary allowance gives
an additional $15,000 to Childers in recognition of the full-time (rather than
part-time) employment. The 40:60 split of the remaining income was
probably negotiated by the partners based on other factors such as
business experience, reputation, etc.
b. The drawings show the assets removed by a partner during a period of
time. A salary allowance is added to each partner's capital for the year
(usually in recognition of work done) and is a component of net income
allocation. The two numbers are often designed to be equal but agreement
is not necessary. For example, a salary allowance might be high to
recognize work contributed by one partner. The allowance increases the
appropriate capital balance. The partner might, though, remove little or no
money so that the partnership could maintain its liquidity.
c. Page, Drawings ........................................................
5,000
Repair Expense ...................................................
(To reclassify payment made to repair personal residence.)
Page, Capital .............................................................
Childers, Capital .......................................................
Page, Drawings (adjusted) .................................
Childers, Drawings .............................................
(To close drawings accounts for 2008.)

13,000
11,000

Revenues ..................................................................
Expenses (adjusted by first entry) .....................
Income Summary ................................................

(To close revenue and expense accounts for 2008.)

90,000

5,000

13,000
11,000

59,000
31,000

Income Summary .....................................................
31,000
Page, Capital .......................................................
11,000
Childers, Capital ..................................................
20,000
(To close net income to partners' capital–see allocation plan shown below.)
Allocation of Income
Page
Childers
Interest (10% of beginning balance)
$ 8,000
$ 3,000
Salary allowances
5,000
20,000
Remaining income (loss):
$31,000

(11,000)
(25,000)
$ (5,000)
(2,000) (40%)
(3,000) (60%)
$11,000
$20,000
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23. (continued)
d. Total capital (original balances of $110,000 plus 2008
net income less drawings) .................................
Investment by Smith ................................................
Total capital after investment ..................................
Ownership portion acquired by Smith ....................
Smith, capital ............................................................
Amount paid .............................................................
Bonus paid by Smith—assigned to original partners

$117,000
43,000
$160,000
20%

$ 32,000
43,000
$ 11,000

Bonus to Page (40%) ................................................

$4,400

Bonus to Childers (60%) ..........................................

$6,600

Cash .........................................................................
Smith, Capital (20% of total capital) ...................
Page, Capital .......................................................
Childers, Capital ..................................................

43,000

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32,000
4,400
6,600

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24. (40 Minutes) (Reporting a change in the composition of a partnership)
a. Exact amount of investment can only be computed algebraically:
E Investment = 25% (Original Capital + E Investment)
El = .25 ($270,000 + El)
El = $67,500 + .25 El
.75 El = $67,500
E Investment = $90,000
b. Implied value of partnership ($36,000/10%) .............
Total capital after investment by E ($270,000 + $36,000)
Goodwill ....................................................................
Allocation of Goodwill:
A (30%) ...............................................................
B (10%) ...............................................................
C (40%) ...............................................................
D (20%) ...............................................................
Total ................................................................

$360,000
306,000
$ 54,000
$16,200
5,400
21,600
10,800
$54,000

CAPITAL BALANCES
Original balances

Goodwill (above)
Investment
Capital balances

A
$20,000
16,200
-0$ 36,200

B
$40,000
5,400
-0$45,400

C
$ 90,000
21,600
-0$111,600

D
$120,000
10,800
-0$130,800

E
$-0-036,000
$36,000

c. Since E's investment of $42,000 is less than 20% of the resulting capital
($312,000). E is apparently bringing some other attribute to the partnership

(goodwill) that must be computed:
E Investment = 20% (Original Capital + E Investment)
$42,000 + Goodwill = .20 ($270,000 + $42,000 + Goodwill)
$42,000 + Goodwill = $62,400 + .20 Goodwill
.80 Goodwill = $20,400
Goodwill = $25,500
E's investment is, therefore, $42,000 in cash and $25,500 in goodwill for a total
capital balance of $67,500; the other capital accounts remain unchanged. Note
that E's capital of $67,500 is 20% of the new total capital $337,500 ($270,000 +
$67,500).

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