Chapter 12, Problem 2PA

To determine

Determine division of net income of $115,000 and $200,000 under different plans.

Answer to Problem 2PA

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 $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

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