Chapter 14, Problem 31P

a.

To determine

Prepare journal entries to record the preceding transactions on the assumption that the bonus method is used.

Explanation of Solution

Journal entries to record the preceding transactions on the assumption that the bonus method is used

Date	Accounts and Explanation	Post Ref.	Debit ($)	Credit ($)
2013
1-Jan	Building		$   52,000
	Equipment		$   16,000
	Cash		$   12,000
	Person R's Capital			$   40,000
	Person OD's Capital			$   40,000
	(To record the initial investment)
31-Dec	Person R's Capital		$   22,000
	Income Statement			$   10,000
	Person OD's Capital			$   12,000
	(To record the transfer of interest and partnership income to person D)
2014
1-Jan	Cash		$   15,000
	Person OD's Capital		$        300
	Person R's Capital		$     1,700
	Person TD's Capital			$   17,000
	(To record the admission of new partner)
31-Dec	Person OD's Capital		$   10,340
	Person R's Capital		$     5,000
	Person TD's Capital		$     5,000
	Person OD's Drawings			$   10,340
	Person R's Drawings			$     5,000
	Person TD's Drawings			$     5,000
	(To record the closing entry of drawings by reducing the amount from capital accounts)
31-Dec	Income Statement		$   44,000
	Person OD's Capital			$   16,940
	Person R's Capital			$   16,236
	Person TD's Capital			$   10,824
	(To record the allocation of net income)
2015
1-Jan	Person TD's Capital		$   22,824
	Person JP's Capital			$   22,824
	(To record the sale of person TD's share to person JP)
31-Dec	Person OD's Capital		$   11,660
	Person R's Capital		$     5,507
	Person JP's Capital		$     5,000
	Person OD's Drawings			$   11,660
	Person R's Drawings			$     5,507
	Person JP's Drawings			$     5,000
	(To record the closing entry of drawings by reducing the amount from capital accounts)
31-Dec	Income Statement		$   61,000
	Person OD's Capital			$   20,810
	Person R's Capital			$   24,114
	Person JP's Capital			$   16,076
	(To record the allocation of net income)
2016
1-Jan	Person JP's Capital		$   33,900
	Person OD's Capital		$        509
	Person R's Capital		$     2,881
	Cash			$   37,290
	(To record the withdrawal of person JP)

Table: (1)

Person OD is entitled to interest on capital of $8,000 which is 20% of $40,000. Person OD is entitled to have 15% of $10,000 which is $1,500 or $4,000. The larger amount is preferred so the larger amount is $4,000. Hence, total income for person OD is $12,000.

On January 1, 2014, a new partner person TD joined the firm by contributing cash of $15,000 with 20% interest in the firm. Partners are allowed to withdraw drawings as $5,000 or 20% of beginning capital balance of the year, whichever is larger. Net income for 2014 is $44,000 distributed among the partners after providing interest and salary in their profit sharing ratios.

The drawings are deducted from the capital balances of the partners.

On Jan 1, 2015, person TD sells his partnership to person JP. Person JP directly pays $46,000 to person TD. Drawings are reduced from capital balances and accounts are closed. Net income of $61,000 is distributed among the partners after deducting the salary and interest.

Person JP withdraws from the partnership and is paid the capital balance plus 10%. 10% is contributed by the partners in their profit sharing ratio.

Working note

Calculate total capital of the firm after the loss and new admission:

$\begin{array}{c}\text{Total}\text{capital}=\$80,000-\$10,000+\$15,000\\ =\$95,000-\$10,000\\ =\$85,000\end{array}$

Person TD has 20% share in the business.

Calculate the amount of share of person TD in the total capital:

$\begin{array}{c}\text{Share}\text{of}\text{person}\text{TD}=\$85,000\times 20\%\\ =\$17,000\end{array}$

Person TD is bringing $15,000 in cash. $2,000 of his share is contributed by all other partners in their profit sharing ratios.

Calculate distribution of bonus from the partners:

$\begin{array}{c}\text{Bonus}\text{share}\text{of}\text{person}\text{OD}=\$2,000\times 15\%\\ =\$300\\ \text{Bonus}\text{share}\text{of}\text{person}\text{R}=\$2,000\times 85\%\\ =\$1,700\end{array}$

Calculate the beginning capital balance for person OD:

$\begin{array}{c}\text{Beginning}\text{capital}\text{balance}\text{for}\text{person}\text{OD}=\text{Initial}\text{capital}+\text{Interest}\text{and}\text{salary}\\ -\text{Bonus}\text{to}\text{person}\text{TD}\\ =\$40,000+\$12,000-\$1,700\\ =\$52,000-\$300\\ =\$51,700\end{array}$

Calculate the amount of drawings of person OD:

$\begin{array}{c}\text{Drawings}=\$51,700\times 20\%\\ =\$10,340\end{array}$

Income allocation for the year 2014

Particulars	Person OD	Person R	Person TD	Total
Net income				$          44,000
Interest on capital	$       10,340			$          10,340
Net income after interest				$          33,660
Salary	$         6,600			$            6,600
Net income after salary				$          27,060
Distributed among partners		$        16,236	$       10,824	$          27,060
Total	$       16,940	$        16,236	$       10,824	$                   0

Table: (2)

Calculate ending capital balances of the partners in the year 2014:

Particulars	Person OD	Person R	Person TD	Total
Beginning balance	$    40,000	$  40,000		$    80,000
Interest and salary	$    12,000	$ (22,000)		$  (10,000)
Person TD's investment	$        (300)	$  (1,700)	$   17,000	$    15,000
Drawings	$   (10,340)	$  (5,000)	$   (5,000)	$  (20,340)
Income allocation	$    16,940	$  16,236	$   10,824	$    44,000
Ending balances	$    58,300	$  27,536	$   22,824	$  108,660

Table: (3)

Income allocation for 2015

Particulars	Person OD	Person R	Person JP	Total
Net income				$          61,000
Interest on capital	$       11,660			$          11,660
Net income after interest				$          49,340
Salary	$         9,150			$            9,150
Net income after salary				$          40,190
Distributed among partners		$        24,114	$       16,076	$          40,190
Total	$       20,810	$        24,114	$       16,076	$                   0

Table: (4)

Calculate ending capital balance of person JP:

$\begin{array}{c}\text{Ending}\text{capital}\text{balance}=\$22,824-\$5,000+\$16,076\\ =\$17,824+\$16,076\\ =\$33,900\end{array}$

b.

To determine

Prepare journal entries to record the preceding transactions on the assumption that the goodwill method is used.

Explanation of Solution

Journal entries to record the preceding transactions on the assumption that the goodwill method is used

Date	Accounts and Explanation	Post Ref.	Debit ($)	Credit ($)
2013
1-Jan	Building		$   52,000
	Equipment		$   16,000
	Cash		$   12,000
	Goodwill		$   80,000
	Person R's Capital			$   80,000
	Person OD's Capital			$   80,000
	(To record the initial investment)
31-Dec	Person R's Capital		$   30,000
	Income Statement			$   10,000
	Person OD's Capital			$   20,000
	(To record the transfer of interest and partnership income to person D)
2014
1-Jan	Cash		$   15,000
	Goodwill		$   22,500
	Person TD's Capital			$   37,500
	(To record the admission of new partner)
31-Dec	Person OD's Capital		$   20,000
	Person R's Capital		$   10,000
	Person TD's Capital		$     7,500
	Person OD's Drawings			$   20,000
	Person R's Drawings			$   10,000
	Person TD's Drawings			$     7,500
	(To record the closing entry of drawings by reducing the amount from capital accounts)
31-Dec	Income Statement		$   44,000
	Person OD's Capital			$   26,600
	Person R's Capital			$   10,440
	Person JP's Capital			$     6,960
	(To record the allocation of net income)
2015
1-Jan	Goodwill		$   26,588
	Person D's Capital			$     3,988
	Person R's Capital			$   13,560
	Person TD's Capital			$     9,040
	(To record the goodwill by purchase of person TD's share)
1-Jan	Person TD's Capital		$   46,000
	Person JP's Capital			$   46,000
	(To record the sale of person TD's share to person JP)
31-Dec	Person OD's Capital		$   22,118
	Person R's Capital		$   12,800
	Person JP's Capital		$     9,200
	Person OD's Drawings			$   22,118
	Person R's Drawings			$   12,800
	Person JP's Drawings			$     9,200
	(To record the closing entry of drawings by reducing the amount from capital accounts)
31-Dec	Income Statement		$   61,000
	Person OD's Capital			$   31,268
	Person R's Capital			$   17,839
	Person JP's Capital			$   11,893
	(To record the allocation of net income)
2016
1-Jan	Person JP's Capital		$   53,562
	Cash			$   53,562
	(To record the withdrawal of person JP)

Table: (5)

Working note

Calculate implied value of the business:

$\begin{array}{c}\text{Implied}\text{value}=\frac{\$15,000}{20\%}\\ =\$15,000\times \frac{100}{20}\\ =\frac{\$1,500,000}{20}\\ =\$75,000\end{array}$

Calculate total value of the business:

$\begin{array}{c}\text{Total}\text{value}=\$80,000+\$20,000+\$80,000-\$30,000\\ =\$100,000+\$50,000\\ =\$150,000\end{array}$

Calculate goodwill:

$\begin{array}{l}\$15,000+\text{Goodwill}=20\%\left(\$150,000+\$15,000+\text{Goodwill}\right)\\ \$15,000+\text{Goodwill}=20\%\left(\$165,000+\text{Goodwill}\right)\\ \$15,000+\text{Goodwill}=\$33,000+0.20\text{Goodwill}\\ \text{Goodwill}-0.20\text{Goodwill}=\$33,000-\$15,000\end{array}$

Now, goodwill is calculated as:

$\begin{array}{c}0.8\text{Goodwill}=\$18,000\\ \text{Goodwill}=\frac{\$18,000}{0.8}\\ \text{Goodwill}=\$22,500\end{array}$

Calculate the capital of person OD:

$\begin{array}{c}\text{Capital}\text{of}\text{person}\text{OD}=\$80,000+\$16,000+\$4,000\\ =\$100,000\end{array}$

Income allocation for the year 2014:

Particulars	Person OD	Person R	Person TD	Total
Net income				$          44,000
Interest on capital	$       20,000			$          20,000
Net income after interest				$          24,000
Salary	$         6,600			$            6,600
Net income after salary				$          17,400
Distributed among partners		$        10,440	$         6,960	$          17,400
Total	$       26,600	$        10,440	$         6,960	$                   0

Table: (6)

Calculate ending capital balances:

Particulars	Person OD	Person R	Person TD	Total
Beginning balance	$    80,000	$  80,000		$  160,000
Interest and salary	$    20,000	$ (30,000)		$  (10,000)
Person TD's investment			$   37,500	$    37,500
Drawings	$   (20,000)	$ (10,000)	$   (7,500)	$  (37,500)
Income allocation	$    26,600	$  10,440	$     6,960	$    44,000
Ending balances	$  106,600	$  50,440	$   36,960	$  194,000

Table: (7)

Calculate the excess amount paid by person JP:

$\begin{array}{c}\text{Excess}\text{amount}=\$46,000-\$36,960\\ =\$9,040\end{array}$

Now, person TD is getting the profit share of 40% of 85% which is 34%.

Calculate goodwill:

$\begin{array}{c}\text{Goodwill}=\frac{\$9,040}{34\%}\\ =\$9,040\times \frac{100}{34}\\ =\frac{\$904,000}{34}\\ =\$26,588\end{array}$

Goodwill is distributed to partners in their profit sharing ratio.

Calculate capital of person OD after goodwill:

$\begin{array}{c}\text{Capital}\text{of}\text{person}\text{OD}=\$106,600+\$3,988\\ =\$110,588\\ \text{Capital}\text{of}\text{person}\text{R}=\$50,440+\$13,560\\ =\$64,000\end{array}$

Now, capital of person JP after goodwill:

$\begin{array}{c}\text{Capital}\text{of}\text{person}\text{JP}=\$36,960+\$9,040\\ =\$46,000\end{array}$

Income allocation of the year 2015:

Particulars	Person OD	Person R	Person JP	Total
Net income				$          61,000
Interest on capital	$       22,118			$          22,118
Net income after interest				$          38,882
Salary	$         9,150			$            9,150
Net income after salary				$          29,732
Distributed among partners		$        17,839	$       11,893	$          29,732
Total	$       31,268	$        17,839	$       11,893	$                   0

Table: (8)