Chapter 12, Problem 2PA

### Financial Accounting

15th Edition
Carl Warren + 2 others
ISBN: 9781337272124

Chapter
Section

### Financial Accounting

15th Edition
Carl Warren + 2 others
ISBN: 9781337272124
Textbook Problem

# Dividing partnership incomeMorrison and Greene have decided to form a partnership. They have agreed that Morrison is to invest $150,000 and that Greene is to invest$50,000. Morrison is to devote one-half time to the business, and Greene is to devote full time. The following plans for the division of income are being considered: a. Equal division b. In the ratio of original investments c. In the ratio of time devoted to the business d. Interest of 6% on original investments and the remainder equally e. Interest of 6% on original investments, salary allowances of $40,000 to Morrison and$70,000 to Greene, and the remainder equally f. Plan (e), except that Greene is also to be allowed a bonus equal to 20% of the amount by which net income exceeds the total salary allowances InstructionsFor each plan, determine the division of the net income under each of the following assumptions: (1) net income of $115,000 and (2) net income of$200,000. Present the data in tabular form, using the following columnar headings:

To determine

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

Explanation

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

 Â Net Income Â Â Â Â Â Â Â Â  Â $1,15,000 Net Income Â$2,00,000 Â M G M G Plan (a) Â Â Â Â Income sharing ratio under this plan is equal. So, the ratio is 1:1 Â Â Â Â Distribution of Net Income (1:1) $57,500$57,500 $100,000$100,000 Plan (b) Â Â Â Â 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 Â Â Â Â Distribution of Net Income (3:1) $86,250$28,750 $150,000$50,000 Plan (c) Â Â Â Â 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 Â Â Â Â Distribution of Net Income (1:2) $38,333$76,667 $66,667$133,333 Plan (d) Â Â Â Â 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 Â Â Â Â Remaining Income (1:1) $51,500$51,500 $94,000$94,000 Net Income $60,500$54,500 $103,000$97,000 Plan (e) Â Â Â Â 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 Â Â Â Â Excess allowance over income (1:1) (2) -$3,500 -$3,500 Â Â Remaining Income (1:1) Â Â $39,000$39,000 Net Income $45,500$69,500 $88,000$112,000 Plan (f) Â Â Â Â Interest allowance (1) $9,000$3,000 $9,000$3,000 Salary allowance $40,000$70,000 $40,000$70,000 Bonus allowance (4) Â $1,000 Â$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 Â Â Â Â Excess allowance over income (1:1) (3) -$4,000 -$4,000 Â Â Remaining Income (1:1) Â Â $30,000$30,000 Net Income $45,000$70,000 $79,000$121,000

Table (2)

Calculation of Interest Allowances â€“ (1)

Interestâ€‰Allowanceâ€‰=â€‰â€‰(Capitalâ€‰balanceâ€‰Ã—â€‰6100)

Share of M:

â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‰â€‰â€‰â€‰â€‰â€‰â€‰â€‰â€‰â€‰Interestâ€‰AllowanceÂ ofâ€‹â€‰M}â€‰=â€‰â€‰($150,000â€‰Ã—â€‰6100)=â€‰$9,000

Share of G:

â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‹â€‰â€‰â€‰â€‰â€‰â€‰â€‰â€‰â€‰â€‰Interestâ€‰AllowanceÂ ofâ€‹â€‰G}â€‰=â€‰â€‰($50,000â€‰Ã—â€‰6100)=â€‰$6,000

Calculation of Excess Allowances â€“

Excessâ€‰Allowanceâ€‰=â€‰(Totalâ€‰interest+â€‰Totalâ€‰Salaryâ€‰â€‰â€‰â€‰â€‰â€‰+â€‰Bonusâ€‰-â€‰Netâ€‰Income)

Plan (e) - (2)

Excessâ€‰Allowanceâ€‰=â€‰($12,000+â€‰$110,000â€‰â€‰â€‰â€‰â€‰â€‰â€‰-â€‰\$115,000â€‰)

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