Chapter 12, Problem 4AP

1.

To determine

Prepare three tables and complete the tables by showing the allocation of $450,000 net income to the partners.

Explanation of Solution

Partnership:

A partnership is an unincorporated form of business which is formed by an agreement, owned and managed mutually by two or more individuals, who invest their assets in the business and share the liabilities and profits among themselves.

Table is prepared as follows:

Income (Loss) sharing plan		Calculations	Partner  M	Partner  L	Partner  B	Total
(a)		$450,000 ( divided equally)	$150,000	$150,000	$150,000	$450,000
(b)		$450,000 (allocated according to the initial investments)	(1)$40,500	(2)$157,500	(3) $252,000
		Total allocated	$40,500	$157,500	$252,000	$450,000
(c)		Net income				$450,000
		Salary allowances	$80,000	$60,000	$90,000	($230,000)
		Balance of income				$220,000
		Interest allowances
		$\text{ 10\% x \$67,500}$	$6,750
		$\text{10\% x \$262,500}$		$26,250
		$\text{10\% x \$420,000}$			$42,000
		Total interest				($75,000)
		Balance of income				$145,000
		Balance allocated	(4)$29,000	(5)$58,000	(6)$58,000	(145,000)
		Balance of income				$0
		Shares of partners	$115,750	$144,250	$190,000

Table (1)

Note: Under plan (a) the net income of $450,000 is shared equally among the partners.

Working note:

Calculate the share of income and loss for Partner M in the ratio of their beginning capital investments under plan (a):

$\begin{array}{c}\begin{array}{l}\text{The}\text{share}\text{of}\text{income}\text{and}\\ \text{loss}\text{for}\text{Partner}\text{M}\end{array}\}\text{=}\frac{\text{Initial}\text{investment}\text{of}\text{Partner}\text{M}}{\text{Total}\text{investment}}\\ \text{=}\frac{\text{\$67,500}}{\text{\$750,000}}\\ \text{=}\text{\$40,500}\end{array}$ (1)

Calculate the share of income and loss for Partner L in the ratio of their beginning capital investments under plan (a):

$\begin{array}{c}\begin{array}{l}\text{The}\text{share}\text{of}\text{income}\text{and}\\ \text{loss}\text{for}\text{Partner}\text{L}\end{array}\}\text{=}\frac{\text{Initial}\text{investment}\text{of}\text{Partner}\text{L}}{\text{Total}\text{investment}}\\ \text{=}\frac{\text{\$262,500}}{\text{\$750,000}}\\ \text{=}\text{\$157,500}\end{array}$ (2)

Calculate the share of income and loss for Partner B in the ratio of their beginning capital investments under plan (a):

$\begin{array}{c}\begin{array}{l}\text{The}\text{share}\text{of}\text{income}\text{and}\\ \text{loss}\text{for}\text{Partner}\text{B}\end{array}\}\text{=}\frac{\text{Initial}\text{investment}\text{of}\text{Partner}\text{B}}{\text{Total}\text{investment}}\\ \text{=}\frac{\text{\$420,000}}{\text{\$750,000}}\\ \text{=}\text{\$252,000}\end{array}$ (3)

Calculate the balance of income allocated to Partner M under plan (c):

$\begin{array}{c}\begin{array}{l}\text{Balance}\text{of}\text{income}\\ \text{allocated}\text{to}\text{Partner}\text{M}\end{array})\text{=}\text{Balance}\text{of}\text{income}\text{×}\text{20\%}\\ \text{=}\text{\$145,000×}\text{20\%}\\ \text{=}\text{\$29,000}\end{array}$ (4)

Calculate the balance of income allocated to Partner L under plan (c):

$\begin{array}{c}\begin{array}{l}\text{Balance}\text{of}\text{income}\\ \text{allocated}\text{to}\text{Partner}\text{L}\end{array})\text{=}\text{Balance}\text{of}\text{income}\text{×}4\text{0\%}\\ \text{=}\text{\$145,000×}\text{40\%}\\ \text{=}\text{\$58,000}\end{array}$ (5)

Calculate the balance of income allocated to Partner B under plan (c):

$\begin{array}{c}\begin{array}{l}\text{Balance}\text{of}\text{income}\\ \text{allocated}\text{to}\text{Partner}\text{B}\end{array})\text{=}\text{Balance}\text{of}\text{income}\text{×}\text{40\%}\\ \text{=}\text{\$145,000×}\text{40\%}\\ \text{=}\text{\$48,000}\end{array}$ (6)

2.

To determine

Prepare a statement of partners’ equity showing the allocation of income to the partners if it is assumed that plan (c) is agreed among the partners.

Explanation of Solution

Statement of Partner’s equity:

The statement of partners’ equity reports the change in the capital accounts of partner’s during an accounting period. Additional investments, net income from income statement is added and drawings are deducted from the beginning balance of partners’ equity to get the ending balance of the partners’ equity.

Prepare statement of partners’ equity:

Partnership MLB
Statement of  Partners' Equity
For Year Ended December 31
Particulars	Person M	Person L	Person B	Total
Beginning capital balances	$0	$0	$0	$0
Add:
Investments by owners	$67,500	$262,500	$420,000	$750,000
Net income
Salary allowances	$80,000	$60,000	$90,000
Interest allowances	$6,750	$26,250	$42,000
Balance allocated	(8)($19,200)	(9)($38,400)	(10)($38,400)
Total net income	$67,550	$47,850	$93,600	$209,000
Total	$135,050	$310,350	$513,600	$959,000
Less partners'  withdrawals	($34,000)	($48,000)	($64,000)	($146,000)
Ending capital balances	$101,050	$262,350	$449,600	$813,000

Table (2)

Working note:

Calculate the balance of income:

$\begin{array}{c}\text{Balance}\text{of}\text{income}\text{=}\left[\begin{array}{l}\text{Total}\text{net}\text{income}-\left(\text{Salary}\text{allowance}\text{of}\text{Partners}\right)-\\ \left(\text{Interest}\text{allowance}\text{of}\text{partnets}\right)\end{array}\right]\\ \text{=}\left[\begin{array}{l}\text{\$209,000}-\left(\text{\$80,000+\$60,000+\$90,000}\right)-\\ \left(\text{\$6,750+\$26,250+\$42,000}\right)\end{array}\right]\\ \text{=}\text{\$96,000}\end{array}$ (7)

Calculate the balance of income allocated to Partner M:

$\begin{array}{c}\begin{array}{l}\text{Balance}\text{of}\text{income}\\ \text{allocated}\text{to}\text{Partner}\text{M}\end{array})\text{=}\text{Balance}\text{of}\text{income}\text{×}\text{20\%}\\ \text{=}\text{\$96,000}\text{(7)×}\text{20\%}\\ \text{=}\text{\$19,200}\end{array}$ (8)

Calculate the balance of income allocated to Partner L:

$\begin{array}{c}\begin{array}{l}\text{Balance}\text{of}\text{income}\\ \text{allocated}\text{to}\text{Partner}\text{L}\end{array})\text{=}\text{Balance}\text{of}\text{income}\text{×}4\text{0\%}\\ \text{=}\text{\$96,000 (7)×}\text{40\%}\\ \text{=}\text{\$38,400}\end{array}$ (9)

Calculate the balance of income allocated to Partner B:

$\begin{array}{c}\begin{array}{l}\text{Balance}\text{of}\text{income}\\ \text{allocated}\text{to}\text{Partner}\text{B}\end{array})\text{=}\text{Balance}\text{of}\text{income}\text{×}\text{40\%}\\ \text{=}\text{\$96,000 (7)×}\text{40\%}\\ \text{=}\text{\$38,400}\end{array}$ (10)

3.

To determine

Prepare journal entry to close the income summary, assuming that plan (c) is agreed among the partners and also close the withdrawals accounts.

Explanation of Solution

Prepare journal entry to close the income summary accounts:

Date		Account Title and Explanation	Debit ($)	Credit ($)
December 31		Income Summary	209,000
		Partner M, Capital		67,550
		Partner L, Capital		47,850
		Partner B, Capital		93,600
		(To close the income summary)

Table (3)

• Income summary is a component of partners’ equity and it is decreased which increases the value of partners’ equity. Therefore, debit income summary account by $209,000.
• Partner M, Capital is a component of partners’ equity and it is increased which decreases the value of partners’ equity. Therefore, credit Partner M, Capital account by $67,550.
• Partner L, Capital is a component of partners’ equity and it is increased which decreases the value of partners’ equity. Therefore, credit Partner L, Capital account by $47,850.
• Partner B, Capital is a component of partners’ equity and it is increased which decreases the value of partners’ equity. Therefore, credit Partner B, Capital account by $93,600.

Prepare journal entry to close the withdrawal accounts:

Date		Account Title and Explanation	Debit ($)	Credit ($)
December 31		Partner M, Capital	34,000
		Partner L, Capital	48,000
		Partner B, Capital	64,000
		Partner M, Withdrawals		34,000
		Partner L, Withdrawals		48,000
		Partner B, Withdrawals		64,000
		(To close withdrawals accounts)

Table (4)

• Partner M, Capital is a component of partners’ equity and it is decreased which increases the value of partners’ equity. Therefore, debit Partner M, Capital account by $34,000.
• Partner L, Capital is a component of partners’ equity and it is decreased which increases the value of partners’ equity. Therefore, debit Partner L, Capital account by $48,000.
• Partner B, Capital is a component of partners’ equity and it is decreased which increases the value of partners’ equity. Therefore, debit Partner B, Capital account by $64,000.
• Partner M, Withdrawals is a component of partners’ equity and it is increased which decreases the value of partner M’s equity. Therefore, credit Partner M, Withdrawals account by $34,000.
• Partner L, Withdrawals is a component of partners’ equity and it is increased which decreases the value of partner L’s equity. Therefore, credit Partner L, Withdrawals account by $48,000.
• Partner B, Withdrawals is a component of partners’ equity and it is increased which decreases the value of partner B’s equity. Therefore, credit Partner B, Withdrawals account by $64,000.