Chapter 13, Problem 6E

To determine

Concept Introduction:

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

The comparison of two proposals given by partner.

Answer to Problem 6E

If there is $20\%$ increase in net income in every year then Mr. Witkowski’s proposal is acceptable. Otherwise, the proposal of two original partners would be better.

Explanation of Solution

As per Mr. Banyan and Mr. Schultz proposal:

Name	First year	Second year	Third year
Mr. Banyan	$\$1,12,500$	$\$1,35,000$	$\$1,62,000$
Mr. Schultz	$\$75,000$	$\$90,000$	$\$1,08,000$
Mr. Witkowski	$\$62,500$	$\$75,000$	$\$90,000$

As per Mr. Witkowski’s proposal:

Name	First year	Second year	Third year
Mr. Banyan	$\$1,22,500$	$\$1,37,667$	$\$1,55,667$
Mr. Schultz	$\$82,500$	$\$97,667$	$\$1,15,667$
Mr. Witkowski	$\$45,000$	$\$64,666$	$\$88,666$

In the first year:

The estimated profit of the company for the first year would be $=\$2,50,000$

It would be increase by $20\%$ in the next two subsequent years.

So, in the second year, the increased income is:

  $\begin{array}{c}\text{Increased profit}=\$2,50,000+\left(\$2,50,000\times 20\%\right)\\ =\$2,50,000+\$50,000\\ =\$3,00,000\end{array}$

And, in the third year, income is:

  $\begin{array}{c}\text{Increased profit}=\$3,00,000+\left(\$3,00,000\times 20\%\right)\\ =\$3,00,000+\$60,000\\ =\$3,60,000\end{array}$

Profit percentage of all the partners as follows:

Mr. Banyan $=45\%$

Mr. Schultz $=30\%$

Mr. Witkowski $=25\%$

Comparison for the first year where the income is $\$2,50,000$

As per Mr. Banyan and Mr. Schultz proposal:

Profit will be distributed to all partners in the above profit-sharing ratio i.e.

Partners	Computation	Income
Mr. Banyan	$\$2,50,000\times 45\%$	$\$1,12,500$
Mr. Schultz	$\$2,50,000\times 30\%$	$\$75,000$
Mr. Witkowski	$\$2,50,000\times 25\%$	$\$62,500$
Total		$\$2,50,000$

As per Mr. Witkowski’s proposal:

(Amount in $)

Heads of distribution	$$ Mr. Banyan	Mr. Schultz	Mr. Witkowski	Total
Salaries	$1,20,000$	$80,000$	$40,000$	$2,40,000$
Bonus (Note-   $1$)	-	-	$2,500$	$2,500$
Interest on capital (Note-   $2$)	$5,000$	$5,000$	$5,000$	$15,000$
Total	$1,25,000$	$85,000$	$47,500$	$2,57,500$
Loss (Note-   $3$)	$\left(2,500\right)$	$\left(2,500\right)$	$\left(2,500\right)$	$\left(7,500\right)$
Total	$1,22,500$	$82,500$	$45,000$	$2,50,000$

Note- $1$

Calculation of bonus for Mr. Witkowski:

Bonus is $5\%$ payable to Mr. Witkowski in excess of $\$2,00,000$ net income, up to $\$2,60,000$

Excess Income is:

  $\begin{array}{c}\text{Excess}=\$2,50,000-\$2,00,000\\ =\$50,000\end{array}$

So, bonus payable to Mr. Witkowski is:

  $\begin{array}{c}\text{Bonus}=\$50,000\times 5\%\\ =\$2,500\end{array}$

Note- $2$

Calculation of Interest on capital account:

Interest on capital account to be paid to partners at the rate of $10\%$ on minimum balance

So, interest on capital is:

  $\begin{array}{c}\text{Interest}=10\%of\text{ \$50,000}\\ \text{=\$5,000}\end{array}$

Note- $3$

Calculation of balance profit and loss to be allocated to partners

Loss balance is

  $\begin{array}{c}\text{Loss}=\$2,57,500-\$2,50,000\\ =\$7,500\end{array}$

So, this loss to be distributed to each partner equally

  $\begin{array}{c}\text{Share of loss}=\frac{\$7,500}{3}\\ =\$2,500\end{array}$

Comparison for the second year where the income is $\$3,00,000$

As per Mr. Banyan and Mr. Schultz proposal:

Profit will be distributed to all partners in the above profit-sharing ratio i.e.

Partners	Computation	Income
Mr. Banyan	$\$3,00,000\times 45\%$	$\$1,35,000$
Mr. Schultz	$\$3,00,000\times 30\%$	$\$90,000$
Mr. Witkowski	$\$3,00,000\times 25\%$	$\$75,000$
Total		$\$3,00,000$

As per Mr. Witkowski’s proposal:

(Amount in $)

Heads of distribution	$$ Mr. Banyan	Mr. Schultz	Mr. Witkowski	Total
Salaries	$1,20,000$	$80,000$	$40,000$	$2,40,000$
Bonus (Note-   $4$)	-	-	$7,000$	$7,000$
Interest on capital (Note-   $5$)	$5,000$	$5,000$	$5,000$	$15,000$
Total	$1,25,000$	$85,000$	$52,000$	$2,62,000$
Profit (Note-   $6$)	$12,667$	$12,667$	$12,666$	$38,000$
Total	$1,37,667$	$97,667$	$64,666$	$3,00,000$

Note- $4$

Calculation of bonus for Mr. Witkowski:

Bonus is $5\%$ payable to Mr. Witkowski in excess of $\$2,00,000$ net income, up to $\$2,60,000$ and including $10\%$ bonus in excess of $\$2,60,000$ income.

Second year income is $\$3,00,000$

So, bonus on excess income up to $\$2,60,000$

  $\begin{array}{c}\text{Bonus}=\$2,60,000-\$2,00,000\\ =\$60,000\\ =5\%\text{ of \$60,000}\\ \text{=\$3,000}\end{array}$ `

The bonus on excess income from $\$2,60,000$ to $\$3,00,000$

  $\begin{array}{c}\text{Bonus}=\$3,00,000-\$2,60,000\\ =\$40,000\\ =10\%\text{ of \$40,000}\\ \text{=\$4,000}\end{array}$

So, bonus payable to Mr. Witkowski is:

  $\begin{array}{c}\text{Bonus}=\$3,000+\$4,000\\ =\$7,000\end{array}$

Note- $5$

Calculation of Interest on capital account:

Interest on capital account to be paid to partners at the rate of $10\%$ on minimum balance

So, interest on capital is:

  $\begin{array}{c}\text{Interest}=10\%of\text{ \$50,000}\\ \text{=\$5,000}\end{array}$

Note- $6$

Calculation of balance profit and loss to be allocated to partners

Profit balance is:

  $\begin{array}{c}\text{Profit}=\$3,00,000-\$2,62,000\\ =\$38,000\end{array}$

So, this profit to be distributed to each partner equally

  $\begin{array}{c}\text{Share of profit}=\frac{\$38,000}{3}\\ =\$12,667\end{array}$

Comparison for the third year where the income is $\$3,60,000$

As per Mr. Banyan and Mr. Schultz proposal:

Profit will be distributed to all partners in the above profit-sharing ratio i.e.

Partners	Computation	Income
Mr. Banyan	$\$3,60,000\times 45\%$	$\$1,62,000$
Mr. Schultz	$\$3,60,000\times 30\%$	$\$1,08,000$
Mr. Witkowski	$\$3,60,000\times 25\%$	$\$90,000$
Total		$\$3,60,000$

As per Mr. Witkowski’s proposal:

(Amount in $)

Heads of distribution	$$ Mr. Banyan	Mr. Schultz	Mr. Witkowski	Total
Salaries	$1,20,000$	$80,000$	$40,000$	$2,40,000$
Bonus (Note-   $7$)	-	-	$13,000$	$13,000$
Interest on capital (Note-   $8$)	$5,000$	$5,000$	$5,000$	$15,000$
Total	$1,25,000$	$85,000$	$58,000$	$2,68,000$
Profit (Note-   $9$)	$30,667$	$30,667$	$30,666$	$92,000$
Total	$1,55,667$	$1,15,667$	$88,666$	$3,60,000$

Note- $7$

Calculation of bonus for Mr. Witkowski:

Bonus is $5\%$ payable to Mr. Witkowski in excess of $\$2,00,000$ net income, up to $\$2,60,000$ and including $10\%$ bonus in excess of $\$2,60,000$ income.

Second year income is $\$3,00,000$

So, bonus on excess income up to $\$2,60,000$

  $\begin{array}{c}\text{Bonus}=\$2,60,000-\$2,00,000\\ =\$60,000\\ =5\%\text{ of \$60,000}\\ \text{=\$3,000}\end{array}$ `

The bonus on excess income from $\$2,60,000$ to $\$3,60,000$

  $\begin{array}{c}\text{Bonus}=\$3,60,000-\$2,60,000\\ =\$1,00,000\\ =10\%\text{ of \$1,00,000}\\ \text{=\$10,000}\end{array}$

So, bonus payable to Mr. Witkowski is:

  $\begin{array}{c}\text{Bonus}=\$3,000+\$10,000\\ =\$13,000\end{array}$

Note- $8$

Calculation of Interest on capital account:

Interest on capital account to be paid to partners at the rate of $10\%$ on minimum balance

So, interest on capital is:

  $\begin{array}{c}\text{Interest}=10\%of\text{ \$50,000}\\ \text{=\$5,000}\end{array}$

Note- $9$

Calculation of balance profit and loss to be allocated to partners

The profit balance is:

  $\begin{array}{c}\text{Profit}=\$3,60,000-\$2,68,000\\ =\$92,000\end{array}$

So, this profit to be distributed to each partner equally

  $\begin{array}{c}\text{Share of profit}=\frac{\$92,000}{3}\\ =\$30,667\end{array}$