ADVANCED ACCOUNTING
ADVANCED ACCOUNTING
12th Edition
ISBN: 9780357671221
Author: FISCHER
Publisher: CENGAGE L
Question
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Chapter 13, Problem 13.3P
To determine

Concept Introduction:

People start their own business and select the form of organization depending upon their need and kind of their business. Partnership is one form of organization. The allocation of profit and loss between the partners is based on the profit-sharing ratio given in the partnership deed and if no priority system is followed then profit and loss will be divided equally.

The best alternative for Mr. R.

Expert Solution & Answer
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Answer to Problem 13.3P

Preparation of the comparative schedule for the two alternatives as follows:

    Alternative oneAlternative two
    Payment datePresent valuePayment datePresent value
    March, 2016
    (for 2015)
    $15,78,704March, 2016
    (for 2015)
    $1,89,815
    March, 2017
    (for 2016)
    $1,16,941March, 2017
    (for 2016)
    $1,03,224
    March, 2018
    (for 2017)
    $1,16,941March, 2018
    (for 2017)
    $14,63,852
    Total$18,12,586$17,56,891

The return in alternative one is higher than the return in alternative two. Therefore, Mr. R will have to choose an alternative one.

Explanation of Solution

Alternative1:

Mr. R will receive his share of the current year 2015 on March 31, 2016 with a lump sum payment of $15,00,000 . Mr. R can invest the money at the rate of 8% p.a. compounded annually.

The profit distribution for 2015 is as follows:

    ComponentMr. ROther partners
    Salaries$1,25,000$3,00,000
    Bonus on income after bonus10%0%
    % of the remaining profit40%60%

The income for the year 2015, 2016 and 2017 is $5,50,000, $6,50,000 and $6,82,000 respectively.

    a. Computation of share of Mr. R in the current year profit (2015) .
    ParticularsMr. ROther partnersTotal
    Income (2015)$5,50,000
    Salaries$1,25,000$3,00,000$4,25,000
    Bonus (Note - 1)$50,000-$50,000
    Sub-total$1,75,000$3,00,000$4,75,000
    Remaining profit (Note - 2)$30,000$45,000$75,000
    Income allocation$2,05,000$3,45,000$5,50,000
  • Note - 1 : Calculation of bonus:
  •   Bonus=(Net income - Bonus)×10%Bonus=($5,50,000Bonus)×10%Bonus + 10% of Bonus = $5,50,000×10%110% Bonus = $55,000Bonus = $55,000110%Bonus = $50,000

  • Note - 2 : Calculation of profit share of Mr. R:
  • The remaining profit is $75,000 and his share is 40% . So, profit is:

      Profit=$75,000×40%=$30,000

    And, another partner’s share is:

      Share=$75,000$30,000=$45,000

    Therefore, the total share of income is $2,05,000 of Mr. R in the current year and lump sum compensation is $15,00,000 .

    Computation of present value cash flow in the financial year 2016, 2017 and 2018 at 8% compound interest as follows:

    Component201620172018Total
    Total income allocation in the previous year$2,05,000--$2,05,000
    The lump-sum payment$15,00,000--$15,00,000
    8% return on investment (Note - 3 ) -$1,36,400$1,47,312$2,83,712
    Total$17,05,000$1,36,400$1,47,312$19,88,712
    Present value index0.92590.85730.7938
    Net present value$15,78,704$1,16,941$1,16,941$18,12,586
  • Note - 3 : Computation of return on investment in the subsequent year at 8% compound interest as follows:
    YearInvestmentAmount of return
    March 31, 2017$17,05,000$1,36,400
    March 31, 2018$18,41,400($17,05,000+$1,36,400)$1,47,312

Therefore, the total income in the alternative one is $18,12,586 .

Alternative2:

Mr. R will receive his share of the current year 2015 . Share of profit of 2016 and 2017 on subsequent year in March 31 . And, as in March 31, 2018 he will receive a lump sum payment of $17,00,000 . Mr. R can invest the money at the rate of 8% p.a. compounded annually.

The profit distribution for 2015 is as follows:

    ComponentMr. ROther partners
    Salaries$80,000$3,00,000
    Bonus on income after bonus0%10%
    % of the remaining profit20%80%
    b. Computation of share of Mr. R in the current year profit 2017 .
    ParticularsMr. ROther partnersTotal
    Income (2016)$6,05,000
    Salaries$80,000$3,50,000$4,30,000
    Bonus (Note - 4)-$55,000$55,000
    Sub-total$80,000$4,05,000$4,85,000

    Remaining profit (Note - 5)
    $24,000$96,000$1,20,000
    Income allocation$1,04,000$5,01,000$6,05,000
  • Note - 4 : Calculation of bonus:
  •   Bonus=(Net income - Bonus)×10%Bonus=($6,05,000Bonus)×10%Bonus + 10% of Bonus = $6,05,000×10%110% Bonus = $60,500Bonus = $60,500110%Bonus = $55,000

  • Note - 5 : Calculation of profit share of Mr. R:
  • The remaining profit is $1,20,000 and his share is 20% . So, profit is:

      Profit=$1,20,000×20%=$24,000

    And, another partner’s share is:

      Share=$1,20,000$24,000=$96,000

    Computation of present value of March, 2017 :

    ComponentAmount
    Share from income allocation$1,04,000
    Return on proceeds (Note - 8)$16,400
    Total proceeds$1,20,400
    Present value index0.8573
    Present value$1,03,224

    Therefore, the present value is $1,03,224 .

    c. Computation of share of Mr. R in the current year profit 2018 .
    ParticularsMr. ROther partnersTotal
    Income (2016)$6,82,000
    Salaries$80,000$3,50,000$4,30,000
    Bonus (Note - 6)-$62,000$62,000
    Sub-total$80,000$4,12,000$4,92,000
    Remaining profit (Note - 7)$38,000$1,52,000$1,90,000
    Income allocation$1,18,000$5,64,000$6,82,000
  • Note - 6 : Calculation of bonus:
  •   Bonus=(Net income - Bonus)×10%Bonus=($6,82,000Bonus)×10%Bonus + 10% of Bonus = $6,82,000×10%110% Bonus = $68,200Bonus = $68,200110%Bonus = $62,000

  • Note - 7 : Calculation of profit share of Mr. R:
  • The remaining profit is $1,90,000 and his share is 20% . So, profit is:

      Profit=$1,90,000×20%=$38,000

    And, another partner’s share is:

      Share=$1,90,000$38,000=$1,52,000

    Computation of present value of March, 2018 :

    ComponentAmount
    Share from income allocation$1,18,000
    Duplication of capital investment $17,00,000
    Return on proceeds (Note - 8)$26,032
    Total proceeds$18,44,032
    Present value index0.7938
    Present value$14,63,852

    Therefore, the present value is $14,63,852 .

  • Note - 8 : Computation of return on investment in the subsequent year at 8% compound interest as follows:
  • YearInvestmentAmount of return
    March 31, 2017$2,05,000$16,400
    March 31, 2018$3,25,000($2,05,000+$1,20,000)$26,032

    Therefore, the present value in alternative two by adding all these is:

      PV=$1,89,815+$1,03,224+$14,63,852=$17,56,891

    So, the total cash flow in alternative two is $17,56,891 .

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