Chapter 12, Problem 12.2APR

To determine

Partnership

It is that form of organization which is owned and managed by two or more persons who invest and share the profits and losses according to a pre-determined ratio.

To determine: The division of net income of $115,000 and $200,000 under different plans.

Answer to Problem 12.2APR

Solution:

The division of net income of $115,000 and $200,000 under different plans is as follows:

		Net Income              $1,15,000		Net Income              $2,00,000
	Plans	M	G	M	G
a	Equal division	$57,500	$57,500	$100,000	$100,000
b	In the ratio of original investment	$86,250	$28,750	$150,000	$50,000
c	In the ratio of time devoted to the business	$38,333	$76,667	$66,667	$133,333
d	Interest of 6% on original investments and remainder equally	$60,500	$54,500	$103,000	$97,000
e	Interest of 6% on original investments, salary allowances of $40,000 to M and $70,000 to G, and the remainder equally	$45,500	$69,500	$88,000	$112,000
f	Plan (e) except that G is also to be allowed a bonus equal to 20% of the amount by which net income exceeds the total salary allowances.	$45,000	$70,000	$79,000	$121,000

Table (1)

Explanation of Solution

Working Notes for determining the division of net income between partner M and G under different plans:

	Net Income           $1,15,000		Net Income  $2,00,000
	M	G	M	G
Plan (a)
Income sharing ratio under this plan is equal. So, the ratio is 1:1
Distribution of Net Income (1:1)	$57,500	$57,500	$100,000	$100,000
Plan (b)
Income sharing ratio under this plan is the ratio of original investment by M and G i.e. $1, 50,000 & $50,000 respectively. So, the ratio is 3:1
Distribution of Net Income (3:1)	$86,250	$28,750	$150,000	$50,000
Plan (c)
Income sharing ratio under this plan is the ratio of time devoted by M and G i.e. 1/2 time & full time respectively. So, the ratio is 1:2
Distribution of Net Income (1:2)	$38,333	$76,667	$66,667	$133,333
Plan (d)
Interest allowance (1)	$9,000	$3,000	$9,000	$3,000
Income sharing ratio under this plan is equal. Any income left after allowing interest on capital will be distributed equally. So, the income sharing ratio is 1:1
Remaining Income (1:1)	$51,500	$51,500	$94,000	$94,000
Net Income	$60,500	$54,500	$103,000	$97,000
Plan (e)
Interest allowance (1)	$9,000	$3,000	$9,000	$3,000
Salary allowance	$40,000	$70,000	$40,000	$70,000
Any excess income or loss left after deducting interest and salary allowance will distributed among partners equally. So, the income or loss sharing ratio is 1:1
Excess allowance over income (1:1) (2)	-$3,500	-$3,500
Remaining Income (1:1)			$39,000	$39,000
Net Income	$45,500	$69,500	$88,000	$112,000
Plan (f)
Interest allowance (1)	$9,000	$3,000	$9,000	$3,000
Salary allowance	$40,000	$70,000	$40,000	$70,000
Bonus allowance (4)		$1,000		$18,000
Any excess income or loss left after deducting interest and salary allowance will distributed among partners equally. So, the income or loss sharing ratio is 1:1
Excess allowance over income (1:1) (3)	-$4,000	-$4,000
Remaining Income (1:1)			$30,000	$30,000
Net Income	$45,000	$70,000	$79,000	$121,000

Table (2)

Calculation of Interest Allowances – (1)

$\text{Interest}\text{Allowance}\text{=}\left(\text{Capital}\text{balance}\text{×}\frac{\text{6}}{\text{100}}\right)$

Share of M:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Interest}\\ \text{Allowance of}\text{}\text{M}\end{array}\}\text{=}\left(\text{\$150,000}\text{×}\frac{\text{6}}{\text{100}}\right)\\ \text{=}\text{\$9,000}\end{array}$

Share of G:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Interest}\\ \text{Allowance of}\text{}\text{G}\end{array}\}\text{=}\left(\text{\$50,000}\text{×}\frac{\text{6}}{\text{100}}\right)\\ \text{=}\text{\$6,000}\end{array}$

Calculation of Excess Allowances –

$\text{Excess}\text{Allowance}\text{=}\left(\begin{array}{l}\text{Total}\text{interest+}\text{Total}\text{Salary}\\ \text{+}\text{Bonus}\text{-}\text{Net}\text{Income}\end{array}\right)$

Plan (e) - (2)

$\begin{array}{c}\text{Excess}\text{Allowance}\text{=}\left(\begin{array}{l}\text{\$12,000+}\text{\$110,000}\\ \text{-}\text{\$115,000}\end{array}\right)\\ \text{=}\text{\$7,000}\end{array}$

Profit sharing ratio of M and G = 1:1

Share of M:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{G}\end{array}\}\text{=}\left(\text{\$7,000}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$3,500}\end{array}$

Share of G:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{G}\end{array}\}\text{=}\left(\text{\$7,000}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$3,500}\end{array}$

Plan (f) - (3)

$\begin{array}{c}\text{Excess}\text{Allowance}\text{=}\left(\begin{array}{l}\text{\$12,000+}\text{\$110,000}\\ \text{+}\text{\$1,000}\text{-}\text{\$115,000}\end{array}\right)\\ \text{=}\text{\$8,000}\end{array}$

Profit sharing ratio of M and G = 1:1

Share of M:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{M}\end{array}\}\text{=}\left(\text{\$8,000}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$4,000}\end{array}$

Share of G:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{G}\end{array}\}\text{=}\left(\text{\$8,000}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$4,000}\end{array}$

Calculation of Bonus Allowances (4)

$\text{Bonus}\text{Allowance}\text{=}\left(\begin{array}{l}\text{Net}\text{Income}\text{-}\\ \text{Salary}\text{Allowance}\end{array}\right)\text{×}\frac{\text{20}}{\text{100}}$

When Net income = $115,000

$\begin{array}{c}\text{Bonus}\text{Allowance}\text{=}\left[\begin{array}{l}\text{\$115,000}\text{-}\\ \left(\text{\$40,000}\text{+}\text{\$70,000}\right)\end{array}\right]\text{×}\frac{\text{20}}{\text{100}}\\ \text{=\$1,000}\end{array}$

When Net income = $200,000

$\begin{array}{c}\text{Bonus}\text{Allowance}\text{=}\left[\begin{array}{l}\text{\$200,000}\text{-}\\ \left(\text{\$40,000}\text{+}\text{\$70,000}\right)\end{array}\right]\text{×}\frac{\text{20}}{\text{100}}\\ \text{=\$18,000}\end{array}$