Chapter 12, Problem 2PA

To determine

Determine the division of net income of $105,000and $180,000 under different plans.

Explanation of Solution

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.

The division of net income of $105,000and $180,000 under different plans is as follows:

		Net Income              $1,15,000		Net Income              $180,000
	Plans	M	A	M	A
a	Equal division	$52,500	$52,500	$90,000	$90,000
b	In the ratio of original investment	$78,750	$26,250	$135,000	$45,000
c	In the ratio of time devoted to the business	$35,000	$70,000	$60,000	$120,000
d	Interest of 12% on original investments and remainder equally	$58,500	$46,500	$96,000	$84,000
e	Interest of 12% on original investments, salary allowances of $30,000 to M and $64,000 to G, and the remainder equally	$41,500	$63,500	$79,000	$101,000
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.	$40,400	$64,600	$70,400	$109,600

Table (1)

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

	Net Income           $1,15,000		Net Income  $180,000
	M	A	M	A
Plan (a)
Income sharing ratio under this plan is equal. So, the ratio is 1:1
Distribution of Net Income (1:1)	$52,500	$52,500	$90,000	$90,000
Plan (b)
Income sharing ratio under this plan is the ratio of original investment by M and A i.e. $1, 40,400 & $40,400 respectively. So, the ratio is 3:1
Distribution of Net Income (3:1)	$78,750	$26,250	$135,000	$45,000
Plan (c)
Income sharing ratio under this plan is the ratio of time devoted by M and A i.e. 1/2 time & full time respectively. So, the ratio is 1:2
Distribution of Net Income (1:2)	$35,000	$70,000	$60,000	$120,000
Plan (d)
Interest allowance (1)	$18,000	$6,000	$18,000	$6,000
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)	$40,500	$40,500	$78,000	$78,000
Net Income	$58,500	$46,500	$96,000	$84,000
Plan (e)
Interest allowance (1)	$18,000	$6,000	$18,000	$6,000
Salary allowance	$30,00	$64,000	$30,000	$64,000
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)	-$6,500	-$6,500
Remaining Income (1:1)			$31,000	$31,000
Net Income	$41,500	$63,500	$79,000	$101,000
Plan (f)
Interest allowance (1)	$18,000	$6,000	$18,000	$6,000
Salary allowance	$30,000	$64,000	$30,000	$64,000
Bonus allowance (4)		$2,200		$17,200
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)	-$7,600	-$7,600
Remaining Income (1:1)			$22,400	$22,400
Net Income	$40,400	$64,000	$70,400	$109,600

Table (2)

Calculation of Interest Allowances – (1)

$\text{Interest}\text{Allowance}\text{=}\left(\text{Capital}\text{balance}\text{×}\frac{12}{\text{100}}\right)$

Share of M:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Interest}\\ \text{Allowance of}\text{}\text{M}\end{array}\}\text{=}\left(\text{\$150,000}\text{×}\frac{12}{\text{100}}\right)\\ \text{=}\text{\$18,000}\end{array}$

Share of A:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Interest}\\ \text{Allowance of}\text{}\text{A}\end{array}\}\text{=}\left(\text{\$50,000}\text{×}\frac{\text{12}}{\text{100}}\right)\\ \text{=}\text{\$6,000}\end{array}$

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)

$\begin{array}{c}\text{Excess}\text{Allowance}\text{=}\left(\begin{array}{l}\text{\$24,000+}\text{\$94,000}\\ \text{-}\text{\$105,000}\end{array}\right)\\ \text{=}\text{\$13,000}\end{array}$

Profit sharing ratio of M and A = 1:1

Share of M:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{M}\end{array}\}\text{=}\left(\text{\$13,000}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$6,500}\end{array}$

Share of A:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{A}\end{array}\}\text{=}\left(\text{\$13,000}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$6,500}\end{array}$

Plan (f) - (3)

$\begin{array}{c}\text{Excess}\text{Allowance}\text{=}\left(\begin{array}{l}\text{\$24,000+}\text{\$94,000}\\ \text{+}\text{\$2,200}\text{-}\text{\$105,000}\end{array}\right)\\ \text{=}\text{\$15,200}\end{array}$

Profit sharing ratio of M and A = 1:1

Share of M:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{M}\end{array}\}\text{=}\left(\text{\$15,200}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$7,600}\end{array}$

Share of A:

$\begin{array}{c}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\text{}\begin{array}{l}\text{Excess}\\ \text{Allowance of}\text{}\text{A}\end{array}\}\text{=}\left(\text{\$15,200}\text{×}\frac{\text{1}}{\text{2}}\right)\\ \text{=}\text{\$7,600}\end{array}$

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 = $105,000

$\begin{array}{c}\text{Bonus}\text{Allowance}\text{=}\left[\begin{array}{l}\text{\$105,000}\text{-}\\ \left(\text{\$30,000}\text{+}\text{\$64,000}\right)\end{array}\right]\text{×}\frac{\text{20}}{\text{100}}\\ \text{=\$2,200}\end{array}$

When Net income = $180,000

$\begin{array}{c}\text{Bonus}\text{Allowance}\text{=}\left[\begin{array}{l}\text{\$180,000}\text{-}\\ \left(\text{\$30,000}\text{+}\text{\$64,000}\right)\end{array}\right]\text{×}\frac{\text{20}}{\text{100}}\\ \text{=\$17,200}\end{array}$