Silent Partnership Agreement on Equipment

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					                                                 20
      PARTNERSHIPS:
  FORMATION AND OPERATION
      LEVEL OF       TIME
                    DIFFICULTY (MINUTES)
REVIEW QUESTIONS
EXERCISES
      20-1 Dividing the profit or loss: Partnership agreement is silent                Simple 5
      20-2 Dividing the profit or loss: Performance features and ratio                 Simple 5
      20-3 Dividing the profit or loss: Ratio and salary allowances             Simple 10
 20-4 Dividing the profit or loss: Ratio, salary allowances, and imputed
                interest on capital              Simple 10
 20-5 Dividing the profit or loss: Ratio, salary allowances, and imputed
                interest on capital—Order of priority specified          Simple 10
      20-6 Recording initial capital contributions               Moderate       10

PROBLEMS
      20-1 Dividing profits: Interest on capital, bonuses, and salary allowances             Simple 15
 20-2 Dividing profits: Revision of profit-sharing agreement—prior period
                adjustments             Complex         60
 20-3 Combining two partnerships: Recording the
                initial capital contributions           Moderate        40
 20-4 Combining three sole proprietorships: Dividing the profit for the
                first year of operations                Moderate        50
      20-5 Converting from cash to accrual basis               Moderate       60
      20-6 Preparing worksheets to determine current trial balance            Moderate       60

                                    U THINKING CRITICALLY U
CASES
      20-1    Planning for settlement in the event of a partner’s death        Simple 5
      20-2    Preparing the partnership agreement               Simple 5
      20-3    Dividing profits and losses               Simple 5
      20-4    Recording the initial capital contributions               Simple 5
      20-5    Selecting the form of business organization               Simple 10

EXERCISES FOR APPENDIX 20A
      20A-1 Determination of each partner’s tax basis                 Moderate       10
      20A-2 Subsequent changes in each partner’s tax basis            Moderate       10
20-2 •     ADVANCED ACCOUNTING: Concepts and Practice


                                        ASSIGNMENT MATERIAL
REVIEW QUESTIONS
         1.       In a general partnership, each partner has unlimited personal liability with respect to debts
incurred by the partnership. In other words, a partner’s personal assets cannot be insulated from partnership
creditors.
         2.       A partnership is an association of two or more persons who contribute money, property, or
services as co-owners of a business, the profits and losses of which are shared in an agreed-upon manner.
     3. In a limited partnership, at least one partner must be a general partner. All other partners have only their
     invested capital at risk—not their personal assets as well.
     4. In a limited liability partnership, each partner is not personally liable to the partnership creditors for the
     actions of his or her other partners.
     5. Because partnerships are governed by state laws, partnership agreements should comply with state laws.
     To achieve this objective, the services of an attorney are usually necessary.
     6. A well-written partnership agreement is a guide to the partners regarding their relationship and
     consequences under the UPA and any allowable variations to which the partners have agreed.
     7. The following major items should be included in a partnership agreement: (a) essential legal provisions;
     (b) the name, place, formation date, business purpose, and duration of the business; (c) a list of assets
     contributed by each partner and the related agreed-upon valuations; (d) the partnership’s basis of accounting
     and its year-end; (e) the profit and loss sharing formula and drawing rights; and (f) provisions for settling
     with a partner who withdraws.
     8. No. The accounting pronouncements of the FASB and its predecessor organizations are intended
     primarily for publicly owned corporations, which must follow GAAP.
     9. The most common features structured into a profit and loss sharing agreement are (a) salary allowances,
     (b) interest imputed on capital balances, and (c) bonuses based on performance factors.
     10. Technically, no. Many partnerships call certain cash distributions to partners salaries and record them as
     such; however, salaries can be paid only to employees—not to owners.
     11. Examples of performance criteria are (a) chargeable hours, (b) total billings, (c) write-offs, (d)
     promotional and civic activities, and (e) profits in excess of specified levels.
     12. With a drawing account, a partnership can record cash withdrawals in a specially designated account for
     each partner. A drawing account maintains a cumulative total of such withdrawals. Drawing accounts are
     primarily for convenience and are not absolutely necessary.
     13. Loans from a partner are treated like any other loan. Partners’ loans are entitled to bear interest.
     14. When the potential for subsequent adjustments arises from activities that occurred before the revision
     date, the use of the old profit and loss sharing formula may better achieve equity among the partners.
     15. Partnerships commonly deviate from GAAP in the following areas: (a) the use of the cash basis instead of
     the accrual basis, (b) the use of prior period adjustments, (c) the use of current values instead of historical
     cost (usually in connection with a change in ownership), and (d) the recognition of goodwill (usually in
     connection with a change in ownership).
     16. No. A partnership’s financial statements should be consistent with its organizational form. The
     partnership form of organization requires appropriate disclosures regarding the nature of this form of
     organization—for example, that the individual partners pay income taxes and the partnership does not.


                                                  EXERCISES
E 20-1 (Estimated time: 5 minutes)
Requirement 1:
When the partnership agreement is silent regarding the division of profits and losses, the RUPA provides for
profits and losses to be shared equally.
                                                               Partnerships: Formation and Operation   • 20-3

E 20-1 (continued)
Requirement 2:
Income Summary                     40,000
     Capital, Reed                               20,000
     Capital, Wright                             20,000

E 20-2 (Estimated time: 5 minutes)
Requirement 1:

Allocated to
                         Total     Monte Carlo
     Total profit        $160,000
     Bonus:
      30% of ($280,000 – $200,000)             (24,000)       $24,000
      30% of [$160,000 – (50% of $280,000)]                   (6,000)          $ 6,000
     Residual profit            $130,000
     Allocate 50:50             (130,000)       65,000 65,000
                  $ -0-         $89,000$71,000

Requirement 2:
Income Summary                     160,000
     Capital, Monte                              89,000
     Capital, Carlo                              71,000

E 20-3 (Estimated time: 10 minutes)
Requirement 1:
a.

Allocated to
                         Total     Bunn Frye
  Total profit           $30,000
Salary allowance                 (10,000)             $10,000
 Residual Profit         $20,000
Allocate 70:30           (20,000)       $14,000 6,000
                 $ -0-   $14,000 $16,000

b.

Allocated to
                         Total     Bunn Frye
  Total profit           $ 6,000
Salary allowance                 (10,000)                 $10,000
 Residual Profit         $(4,000)
Allocate 70:30             4,000 $(2,800)         (1,200)
                         $ -0-    $(2,800)               $ 8,800
20-4 •     ADVANCED ACCOUNTING: Concepts and Practice


E 20-3 (continued)
Requirement 1: (continued)

c.

Allocated to
                          Total     Bunn Frye
  Total profit            $(10,000)
Salary allowance                   (10,000)             $10,000
 Residual Profit          $(20,000)
Allocate 70:30              20,000       $(14,000)       (6,000)
                 $    -0-         $(14,000)     $ 4,000
Requirement 2:
a. Income Summary                   30,000
         Capital, Bunn                       14,000
         Capital, Frye                       16,000
b. Income Summary                   6,000
   Capital, Bunn                    2,800
         Capital, Frye                       8,800
c. Capital Bunn                     14,000
         Capital, Frye                       4,000
         Income Summary                               10,000

E 20-4 (Estimated time: 10 minutes)
Requirement 1:
a.

Allocated to
                          Total     Agee Begee
   Total profit           $98,000
Salary allowance                    (55,000)          $33,000$22,000
Interest on capital                 (18,000)          6,000 12,000
 Residual Profit          $25,000
Allocate 60:40            (25,000)      15,000 10,000
                          $ -0- $54,000               $44,000
b.

Allocated to
                          Total     Agee Begee
   Total profit           $ 58,000
Salary allowance                  (55,000)        $33,000$22,000
Interest on capital                (18,000)       6,000 12,000
 Residual Profit          $(15,000)
Allocate 60:40               15,000         (9,000)       (6,000)
                          $ -0-           $30,000                $28,000
                                                                  Partnerships: Formation and Operation   • 20-5

E 20-4 (continued)
Requirement 1: (continued)
c.

Allocated to
                         Total Agee         Begee
   Total profit          $ (27,000)
Salary allowance                 (55,000)            $ 33,000 $ 22,000
Interest on capital                 (18,000)            6,000 12,000
 Residual Profit         $(100,000)
Allocate 60:40             100,000             (60,000) (40,000)
                         $ -0-           $(21,000)      $(6,000)
Requirement 2:
a. Income Summary                  98,000
         Capital, Agee                      54,000
         Capital, Begee                              44,000
b. Income Summary                  58,000
         Capital, Agee                      30,000
         Capital, Begee                              28,000
c. Capital, Agee                   21,000
   Capital, Begee                  6,000
         Income Summary                              27,000

E 20-5 (Estimated time: 10 minutes)
Requirement 1:
a.

Allocated to
                         Total     Agee Begee
   Total profit          $98,000
Salary allowance                (55,000)        $33,000$22,000
Interest on capital              (18,000)       6,000 12,000
   Residual Profit              $25,000
Allocate 2:1             (25,000)         15,000 12,000
                         $ -0- $54,000                  $44,000
b.

Allocated to
                         Total     Agee Begee
   Total profit          $58,000
Salary allowance                  (55,000)           $33,000$22,000
 Available for Interest on Capital                   $ 3,000
1/6 ($3,000 ÷ $18,000) × $6,000          (1,000)     1,000
1/6 ($3000 ÷ $18,000) × $12,000                       (2,000)       ______   2,000
                $ -0- $34,000$24,000

     c. In this case, the partnership agreement is vague. An argument can be made for allocating the loss equally
     pursuant the RUPA because the partnership agreement is silent with respect to losses. Alternatively, we could
20-6 •   ADVANCED ACCOUNTING: Concepts and Practice


  presume that losses were intended to be shared in the residual profit-sharing ratio. In these cases, the
  accountant should seek clarification from each partner.
                                                                Partnerships: Formation and Operation   • 20-7

E 20-5 (continued)
Requirement 2:
a. Income Summary            98,000
          Capital, Agee             54,000
          Capital, Begee                   44,000
       b.       Income Summary             58,000
          Capital, Agee             34,000
          Capital, Begee                   24,000

E 20-6 (Estimated time: 10 minutes)
Requirement 1:
Capital contribution of Booker:
Cash            80,000
Machinery and Equipment                 50,000
       Capital, Booker                  130,000
Capital contribution of Page:
Cash            20,000
Machinery and Equipment                 60,000
Building                 240,000
       Loan Payable                     100,000
       Capital, Page                    220,000

Requirement 2:
                        Booker Page Total
Cash contributed                 $80,000$20,000$100,000
  Noncash assets contributed:
    Machinery and equipment               50,000 60,000 110,000
    Building           _______             240,000         240,000
               $130,000          $320,000         $450,000
  Adjustment to basis for liabilities of $40,000 assumed by
   Booker (40% of $100,000)                 40,000         (40,000)     _______
      Basis            $170,000           $280,000       $450,000

                                                 PROBLEMS
P 20-1 (Estimated time: 15 minutes)
Requirement 1:
                        Total Horn Sax
  Total profit          $200,000
  ($20,000 ÷ $50,000) × $200,000                  (80,000)      $80,000
  ($30,000 ÷ $50,000) × $200,000                  (120,000)     ______ $120,000
    Division of profits        $ -0-              $80,000$120,000
20-8 •     ADVANCED ACCOUNTING: Concepts and Practice


P 20-1 (continued)
Requirement 2:
                        Total    Horn Sax
Total profit             $200,000
  ($26,000 ÷ $50,000) × $200,000            (104,000)     $104,000
  ($24,000 ÷ $50,000) × $200,000             (96,000)     _______         $96,000
     Division of profits        $ -0-       $104,000      $96,000

Calculation of average capital balances:
                        Horn Sax
  January             $20,000$30,000
  February            28,000 30,000
  March               28,000 30,000
  April      28,000 25,000
  May        28,000 25,000
  June       24,000 25,000
  July       24,000 20,000
  August              24,000 20,000
  September           24,000 20,000
  October             24,000 15,000
  November            31,000 15,000
  December              29,000         33,000
             $312,000         $288,000
             ÷      12        ÷     12
   Average Capital Balances          $ 26,000      $ 24,000

Requirement 3:
                        Total    Horn Sax
Total profit             $200,000
  ($30,000 ÷ $40,000) × $200,000            (150,000)     $150,000
  ($10,000 ÷ $40,000) × $200,000              (50,000)    _______              50,000
     Division of profits        $ -0-       $150,000      $50,000

Requirement 4:
                        Total    Horn Sax
Total profit             $200,000
  Bonus: 20% of ($200,000 – $150,000)              (10,000)         $ 10,000
  Residual profit               $190,000
  Allocate 50:50                (190,000)     95,000       95,000
     Division of profits        $ -0-       $105,000      $95,000
                                                                                           Partnerships: Formation and Operation                   • 20-9

P 20-1 (continued)
Requirement 5:
                                   Total       Horn Sax
Total profit             $200,000
  Salary allowances             (80,000)      $45,000$35,000
  Interest on average capital:
     10% of $26,000             (2,600) 2,600
     10% of $24,000                (2,400)            2,400
  Residual profit               $115,000
  Allocate 50:50                (115,000)       57,500        57,500
     Division of profits        $ -0- $105,100        $96,000

P 20-2 (Estimated time: 60 minutes)
Requirement 1:
Profit for 2006, per books .............................................................................................................    $145,000
  Increase 2003 cost of sales for understatement of 12/31/02 inventory ......................................                               (8,000)
  Decrease 2003 cost of sales for understatement of 12/31/03 inventory .....................................                                18,000
  Increase depreciation expense .....................................................................................................          (5,000)
Correct Profit for 2006 .................................................................................................................   $150,000
                                               Division of Correct Profit—2006
                                   Total Archer Bowes Cross
  Total profit           $150,000
  Salary allowances               (55,000)        $20,000$20,000$15,000
  Bonuses: ($150,000 – $110,000 = $40,000)
   20% of $40,000                 (8,000) 8,000
   20% of $40,000                 (8,000)         8,000
   10% of $40,000                    (4,000)                      4,000
      Residual Profit             $ 75,000
      Allocate 35:35:30            (75,000)         26,250 26,250 22,500
                $ -0-             $54,250$54,250$41,500
Requirement 2:
                                                    Approach 1
                         Archer Bowes Cross Total
  Correction for $15,000 ($7,000 + $8,000) adjustment for 2005:
   40% for bonuses to Bowes and Cross                      $3,000 $3,000         $ 6,000
   60% in profit and loss–sharing ratio             3,600 3,600 $1,800 9,000
                $6,600 $6,600 $1,800 $15,000
  Correction for $(7,000) adjustment for 2004:
   Profit and loss ratio is used since bonus is not applicable           (2,800) (2,800) (1,400) (7,000)
  Net Correction                  $3,800 $3,800 $ 400 $ 8,000
20-10 •      ADVANCED ACCOUNTING: Concepts and Practice


P 20-2 (continued)
Requirement 2: (continued)

                                                     Approach 2
                                                    a
Profit for 2005, per books              $110,000
  Decrease 2005 cost of sales for overstatement of 12/31/04 inventory              7,000
  Decrease 2005 cost of sales for understatement of 12/31/06 inventory                 8,000
Correct Profit for 2006                 $125,000
                                     Division of Correct Profit—2005
                         Total Archer Bowes Cross
    Total profit        $125,000
    Salary allowances          (35,000)            $15,000         $15,000         $ 5,000
    Bonuses ($125,000 – $90,000 = $35,000)                   (14,000)      7,000   (20%) 7,000   (20%)
      Residual Profit          $ 76,000
    Allocate 40:40:20            76,000             30,400           30,400         15,200
                 $ -0-         $52,400             $52,400          $20,200
a
For 2005, the incorrectly reported profit was more than $90,000 and the corrected profit is also more than
$90,000. Therefore, 40% of the change is allocated as bonus, 60% in the profit and loss sharing ratio.
                                    Division of Incorrect Profit—2005
                         Total Archer Bowes Cross
    Total profit          $110,000
    Salary allowances              (35,500)        $15,000         $15,000          $ 5,000
    Bonuses ($110,000 – $90,000 = $20,000)                    (8,000)         4,000         (20%) 4,000 (20%)
     Residual Profit               $ 67,000
    Allocate 40:40:20                (67,000)       26,800           26,800          13,400
                  $ -0-            $45,800         $45,800         $18,400
    Difference between correct allocation and
     incorrect allocation of profits               $ 15,000        $6,600           $6,600         $1,800
    Adjustment required for 2005           $ 15,000        $6,600           $6,600          $1,800
                                   a
    Adjustment required for 2004                      (7,000)      (2,800) (2,800) (1,400)
    Adjustment Required at 1/1/06                  $ 8,000         $3,800           $3,800         $ 400
a
The residual profit and loss sharing ratio can be used for 2004 because the bonus provision was not used since
profits did not exceed $90,000.
Adjusting entry required as of 1/1/06:
 Inventory               8,000
      Capital, Archer                     3,800
      Capital, Bowes                      3,800
      Capital, Cross                      400
    To adjust capital balances at 1/1/06 for prior period errors.
                                                            Partnerships: Formation and Operation   • 20-11

P 20-3 (Estimated time: 40 minutes)
Requirement 1:
                        Altoe & Bass Sopra & Tennor
  Cash         20,000                 15,000
  Accounts Receivable         100,000                150,000
     Allowance for Uncollectibles                    5,000                         15,000
  Merchandise Inventory               175,000                140,000(1)
  Land         30,000                 42,000
  Buildings and Equipment             64,000 (2)             100,000(3)
  Prepaids             5,000                  7,000
     Accounts Payable                 40,000                        64,000
     Notes Payable                    70,000                        75,000
     Accrued Liabilities                      30,000                        46,000
     Capital, Alto                    99,000
     Capital, Bass                    150,000
     Capital, Sopra                                                 80,000
     Capital, Tennor                                                174,000

  (1) $119,000 ÷ 85% = $140,000.
  (2) 80% of $80,000.
  (3) 80% of $125,000.

  Summary of changes to carrying values:
              Altoe & Bass Sopra & Tennor
   Increase allowance for doubtful accounts            $(3,000)       $ (9,000)
   Increase land                5,000 7,000
   Increase inventory                  21,000
   Increase buildings and equipment            8,000 36,000
   Increase accounts payable                   (4,000)
   Increase accrued liabilities        ______ (1,000)
     Net Increase               $10,000$50,000
  Allocate to:
   Altoe                $ 4,000(40%) Sopra              $15,000(30%)
   Bass                   6,000(60%) Tennor               35,000     (70%)
              $10,000                         $50,000
Requirement 2:
                        Altoe Bass    Sopra Tennor
  Profit sharing percentage                 20%          30%             15%        35%
  Capital balances per requirement 1, a total of
   $503,000             $99,000$150,000           $80,000$174,000
  Capital balances required using profit and loss
   sharing percentages
   20% of $503,000              100,600
   30% of $503,000                       150,900
   15% of $503,000                                75,450
   35% of $503,000              ______ ______ ______ 176,050
     Capital to Be Contributed or (Withdrawn)                   $ 1,600 $ 900$(4,550)        $ 2,050
20-12 •     ADVANCED ACCOUNTING: Concepts and Practice


P 20-4 (Estimated time: 50 minutes)
Requirement 1:
Billings               $120,000
Expenses (excluding depreciation and bad debts expense but including the
 excess rent)          $29,350
Add — Bad debts expense not properly chargeable to capital accounts
 (50% of $1,600)               800
 Depreciation expense:
   Old equipment (10% of $13,000)              1,300
   New equipment (10% of 5,000 × ½)                250 31,700
      Profit for 2003                  $ 88,300
Requirement 2:
                                                           Total           Arby   Bobb    Carlos
Mack
  Total profit           $88,300
  Excess rent to be absorbed by Carlos           900                   $(900)
  Percentage of billings
    Arby—20% of $44,000                  (8,800) $8,800
    Bobb—20% of $24,000                  (4,800)         $4,800
    Carlos—20% of $22,000                (4,400)                 4,400
    Mack—20% of $18,000                    (3,600)                            $ 3,600a
     Residual profit             $67,600
    Arby—40%             (27,040)        27,040
    Bobb—35%                     (23,660)                23,660
    Carlos—25%                    (16,900)       ______ ______ 16,900______
                $ -0- $35,840$28,460$20,400$ 3,600
  a
    Total expenses per above             $31,700
    Less—Excess rent             (900)
  Bad debts charged to income                  (800)
    Apportionable Expenses               $30,000
    Apportionable expenses               $ 30,000        =         25%
    Total fees           $120,000
    New fees after April 1               $24,000
    Less—Pro rata share of expenses, at 25%                (6,000)
      Basis for Computing Mack’s 20%             $18,000
Requirement 3:
                   Statement of Partners’ Capital for the Year Ended December 31, 2006
                       Arby             Bobb           Carlos        Mack     Total
Balances, 1/1/06               $20,600$10,600$21,800           $53,000
+ Net income for 2003          35,840 28,460 20,400 $3,600 88,300
  - Withdrawals                (5,200) (4,400) (5,800) (2,500) (17,900)
  - Write-off of receivables contributed                 (1,200)        (450)       ______ _____
    (1,650)
  Balances, 12/31/06           $50,040$34,210$36,400$1,100 $121,750
Note: The receivables contributed by Arby and Bobb that were uncollectible are chargeable to the capital
     accounts because their collectibility was guaranteed.
                                                              Partnerships: Formation and Operation    • 20-13

    The excess rent of $900 is a proper expense in determining profits because it represents the actual cost of
using the facilities. By agreeing to absorb this portion of the rent expense, Carlos has effectively included this
item in the profit and loss sharing formula.
20-14 •      ADVANCED ACCOUNTING: Concepts and Practice


P 20-5 (Estimated time: 60 minutes)

                                      Arfee, Barker, and Chow
                      Worksheet to Adjust to Accrual Basis at December 31, 2006
                                                                    Unadjusted
                      Adjusted
                                    Trial Balance      Adjustments                     Trial Balance_
                  Debit   Credit          Debit   Credit     Debit Credit
Cash           10,000                                              10,000
Accounts receivable             40,000                                               40,000
Inventory               26,000                                              26,000
Land           9,000                                               9,000
Buildings               50,000                                              50,000
Accumulated depreciation                          2,000                                                2,000
Equipment               56,000           4,400    (3)                       60,400
Accumulated depreciation                          6,000                     (3)    880                 6,880
Goodwill                5,000                             (5)      5,000
Accounts payable                         55,000                                               55,000
Allowance for future inventory losses                     3,000    3,000    (2)
Arfee, Capital                  40,000   290      (4)     (1)      400               40,870
                                2,500    (5)      (2)     1,500
                                                  (3)     1,760
Barker, Capital                  60,000 334       (4)     (1)      120               60,242
                                 1,500 (5)        (2)     900
                                                  (3)     1,056
Chow, Capital                    30,000 20        (1)     (2)      600               29,928
                                 356    (4)       (3)     704
                                 1,000 (5)
Prepaid insurance                                 700     (1)                        700
Advances from customers                                                     (1)      200               200
Allowance for doubtful accounts                                                      (4)      980              980
                196,000196,00014,100                      14,100 196,100196,100

See the following pages for explanation of entries, formal journal entries, and related supporting computations.

Explanation of adjusting entries:
 (1) To recognize prepayments and accruals at 12/31/06.
 (2) To eliminate reserve for inventory losses.
 (3) To capitalize equipment expensed and recognize depreciation thereon.
 (4) To establish allowance for doubtful accounts at 12/31/06.
 (5) To write off goodwill recorded during the year.
                                                                                            Partnerships: Formation and Operation                       • 20-15

P 20-5 (continued)
Adjusting journal entries and related supporting computations:
                                                                          Entry (1)
Prepaid Insurance ....................................................................................................................           700
Capital, Chow .........................................................................................................................          20
     Advances from Customers .............................................................................................                                200
     Capital, Arfee .................................................................................................................                     400
     Capital, Barker ......................................................................................................                               120
   To adjust for year-end prepayments and accruals.

Computation of effect on income for 2006 and 2005:
                       Increase (Decrease)
                             Income
                                                                                                                                          2006         2005
   Prepaid insurance:
   12/31/05             $ (650)                 $ 650
     12/31/06           700
   Advances from customers:
     12/31/05           1,100                   (1,100)
     12/31/06           (200)
   Accrued interest payable:
     12/31/05              450                   (450)
     Totals             $1,400                  $(900)

Distribution of increase (decrease) in income:
                         Arfee Barker Chow Total
    Decrease in 2005 income (distributed equally)                                                $(300) $(300) $(300) $(900)
    Increase in 2006 income (distributed 5:3:2)           700                                      420    280 1,400
      Net Increase (Decrease) in Capital Account Balances                                               $ 400 $ 120 $ (20) $ 500

                                                   Entry (2)
Reserve for Inventory Losses            3,000
      Capital, Arfee (50%)                      1,500
      Capital, Barker (30%)                     900
      Capital, Chow (20%)                       600
   To eliminate reserve for inventory declines.
The inventory reserve was established in 2005. Thus the new (2005) profit-sharing ratio of 5:3:2 was used.

                                                                             Entry (3)
Equipment               4,400
         Accumulated Depreciation                       880
         Capital, Arfee (50%)                    1,760
         Capital, Barker (30%)                   1,056
         Capital, Chow (20%)                     704
1To capitalize equipment improperly expensed in 2005 and to correct related
2 accumulated depreciation. (Accumulated depreciation = $4,400 × 10% × 2 = $880.)
3 The $3,520 net effect on income is distributed 5:3:2.
20-16 •     ADVANCED ACCOUNTING: Concepts and Practice


P 20-5 (continued)
                                                    Entry (4)
Capital, Arfee          290
  Capital, Barker               334
  Capital, Chow                 356
          Allowance for Doubtful Accounts                        980
    To establish allowance for doubtful accounts at 12/31/02 as follows:
       Current accounts ($40,000 × 85%) × 2% =           $680
       Past due accounts ($40,000 × 15%) × 5%           =           300
          Total          $980

Computation of effect on income for 2006 and 2005:
                       Increase (Decrease)
                       Income
                                                                                                2006   2005
2005 accounts written off in 2003              $1,000 $(1,000)
  2005 provision for uncollectibles ($4,000 × 5%)             200          (200)
  2006 provision for uncollectibles              (980) ______
    Total               $ 220 $(1,200)

Distribution of increase (decrease) in income:
                         Arfee Barker Chow Total
  Decrease in 2005 income of $1,200 (distributed equally)                  $(400) $(400) $(400) $(1,200)
  Increase in 2006 income of $220 (distributed 5:3:2)             110        66      44     220
    Net Increase (Decrease) in Capital Account Balances                    $(290) $(334) $(356) $ (980)

                                                    Entry (5)
Capital, Arfee (50%)            2,500
  Capital, Barker (30%)                 1,500
  Capital, Chow (20%)           1,000
         Goodwill                       5,000
 To write off goodwill recorded in 2005 (distributed 5:3:2).
                                                                                                     Partnerships: Formation and Operation   • 20-17

P 20-6 (Estimated time : 60 minute)
                                                                 Pace & Runn
                                               Worksheet to Reflect Transactions 1/1/06 to 6/30/06
                       Trial Balance           Income
                                                             12/31/05                 Adjustments                          Statement          Balance
  Sheet_
               Debit Credit Debit Credit Debit Credit Debit Credit
Cash           10,000          81,737 (1)      (2)     86,600                   5,137
Account receivable—Trade              8,000            600    (2)      (1)      40,000                     18,575
                               49,400 (3)      (4)     175
                               750    (11)
Allowance for bad debts               600      175     (4)     (5)     494                                 919
Merchandise inventory          35,000          2,500   (8)                                        37,500
Prepaid insurance              150                             (9)     70                         80
Automobiles             7,800         7,200    (2)     (6)     1,800                     13,200
Accumulated depreciation—autos                         4,250   1,800   (6)      (7)      1,600                          4,050
Furniture and fixtures         2,200                                                              2,200
Accumulated depreciation—F & F                        650                       (7)      110                            760
Accounts payable                      13,800   45,000 (2)      (11)    49,950                              18,750
Bank loan payable                     8,000    16,000 (2)      (1)     17,000                              9,000
Accrued liabilities                   200      34     (10)                                                 166
Capital, Pace                  17,500 5,000    (2)                                                12,500
Capital, Runn                  18,150 3,000    (2)                                                12,650
                 _____ _____ 2,500 (2)
                 63,150 63,150
Prepaid interest                      283    (1)     (12)   208                          75
Employee receivables                         300     (2)                                          300
Sales                                        (1)     25,000            74,400
                                             (3)     49,400
Cost of sales                         49,200 (11)    (8)    2,500      46,700
General expenses                             7,000 (2)      (10)       34     6,966
Bad debt expenses                            494     (5)                      494
Depreciation expense                         1,710 (7)                        1,710
Insurance expense                            70      (9)                      70
Interest expense                      208    (12)                      208
Gain on sale of auto                         _ _ ___        (1)        20                20
                              274,961                274,96156,148     74,420
Net income for the period
 (to be divided equally)                                                     18,272                        18,272
                                                               74,420 74,420 77,067 77,067
20-18 •      ADVANCED ACCOUNTING: Concepts and Practice


Note: See following page for computations in support of entries (3), (5), (7), (11), and (12).
                                                                                   Partnerships: Formation and Operation                        • 20-19
P 20-6 (continued)
Computations in support of selected adjusting entries:
                                      Entry (3) Determination of Credit Sales
Beginning trade receivables .............................................................................................................   $ 8,000
Sales on account (forced amount) ....................................................................................................         49,400
Cash collections ($40,000 – $600)...................................................................................................         (39,400)
  Ending Trade Receivables ...........................................................................................................      $ 18,000
Entry (5) Determination of Addition to Bad Debt Allowance
Credit sales as determined in entry (3).............................................................................................        $49,400
                                  1%
     Required Addition to Bad Debt Allowance .............................................................................                  $      494

  Entry (7) Determination of Depreciation Expense
Old automobiles . . . . . . . . . . $6,000 ÷   3  ×                                         ½ yr.       =      $1,000
New automobiles . . . . . . . . .     $7,200 ÷ 3  ×                                         ¼ yr.       =         600          $1,600
Furniture ands fixture. . . . . .     $2,200 ÷ 10 ×                                         ¼ yr.       =                         110
                                                                                                                                            $1,710

                                                 Entry (11) Determination of Purchases
Beginning accounts payable
                                                                                                                                            $13,800
+ Purchases (forced amount)
                                                                                                                                                49,950
- Cash payments
                                                                                                                                            (45,000)
Ending Accounts Payable
                                                                                                                                            $18,750

                                            Entry (12) Determination of Prepaid Interest
Face amount of 5/1/06, note payable
                                                                                                                                            $ 9,000
Cash proceeds
                                                                                                                                                 8,850
    Discount
                                                                                                                                            $     150
Notes is for 4 months; 2 months have expired
                                                                                                                                            ×       ½
    Prepaid Interest at 6/30/06                           $       75

                                                                   U CASES U
C 20-1 (Estimated time: 5 minutes)
―Cross-purchase agreements‖ are commonly used to facilitate the settlement with the estate of the deceased
partner (and to give control to the surviving owner). Such arrangements are usually structured as follows:
         a.      The partners buy life insurance policies on each others’ lives, naming themselves as
beneficiaries. (By personally paying the premiums, rather than having the partnership do so, the full cash
amount is received tax free, allowing the full amount to be available to purchase the deceased partner’s
interest.)
20-20 •      ADVANCED ACCOUNTING: Concepts and Practice
    b. In writing, the partners agree to purchase the deceased partner’s interest at a set price (usually equal to
    the amount of the life insurance). In turn, the estate of the deceased partner is obligated to sell the deceased
    partner’s interest to the surviving partner at the set price.
     Cross-purchase agreements should be in writing. In many cases, the partners have had oral agreements and
life insurance policies. When a partner died, however, the surviving partner made a much lower offer to the
estate of the deceased partner on a ―take-it-or-leave-it basis.‖ The result is that the surviving spouse or the
estate winds up receiving much less than had been planned on.
                                                              Partnerships: Formation and Operation      • 20-21
C 20-2 (Estimated time: 5 minutes)
Overall, this request is outside the accountant’s realm of expertise. The accountant should suggest that the
partners have an attorney review the partnership agreement. Although certain omissions may be readily
apparent to the accountant (such as not specifying the basis of accounting, the year-end, or the sharing of
profits and losses), the accountant should make it quite clear to the client that accountants can make such a
review only as it pertains to accounting matters.

C 20-3 (Estimated time: 5 minutes)
The accountant should not advise partners how to share profits and losses. In this case, the accountant’s role is
limited to demonstrating how certain features can be included in the profit and loss sharing formula and how
they operate under hypothetical situations. The partners should decide which features they want to include.

C 20-4 (Estimated time: 5 minutes)
Requirement 1:
Hye’s preference for the current market value per the property tax assessment notice over the market value per
the independent appraisal (presumably because it is more objectively determinable) is unsupportable. Both
appraisals involve subjective determinations. In many cases, current market values per property tax assessment
notices lag behind the true current market values, which is evidently the case here.
    Lowe’s argument for using the $100,000 historical cost ―so that Lowe’s tax basis carries over to the
partnership‖ implies that the tax basis does not carry over if the land is recorded at other than $100,000. This is
erroneous. Regardless of the amount at which the land is recorded, the tax basis of $100,000 carries over to
the partnership.
    The fact that an objective, verifiable transaction has not occurred is irrelevant. The accountant should point
out the inequity that would result to Lowe if the land is recorded at less than $150,000. On the sale of the land,
Hye would share in any appreciation that occurred before the formation of the partnership. (If the land is
recorded at $150,000, the partnership agreement should specify that the first $50,000 of gain on a subsequent
sale of the land should be allocated to Lowe for income tax–reporting purposes.)

Requirement 2:
Theoretically, the fact that the land is sold two years later for $140,000 should not change your answer in
requirement 1. In retrospect, however, it appears to have been wise to include a provision in the partnership
agreement that in the event of subsequent sale of the land for less than $150,000 (but not less than $100,000),
the loss is to be charged to Lowe’s capital account—unless it can be determined that the loss occurred because
of a specific subsequent event such as a change in zoning laws or government possession of the land through
exercise of eminent domain powers.

C 20-5 (Estimated time: 10 minutes)
         1.       Personal liability. The corporation’s key characteristic is the limited liability of its owners.
Except in a limited number of cases, an investor has no liability beyond his or her capital investment. An
exception is made when less than par is paid for stock issued by the corporation. A general partnership does
not protect the partners against liability for the firm’s debts.
         2.       Borrowing capacity. Because general partners are personally liable for the entity’s debts, a
general partnership, to the extent of the general partners’ assets, can ordinarily obtain a greater amount of
credit, other things being equal. If the financial position of the corporation is such that it does not justify a
given loan, however, the borrowing capacity of the corporation can be increased by having the principal
stockholders or officers, or both, guarantee the loan.
20-22 •      ADVANCED ACCOUNTING: Concepts and Practice
C 20-5 (continued)
         3.       Operating a multistate business. A corporation must qualify to do business in a foreign
jurisdiction (that is, a state other than the state in which it was incorporated). Partnerships, on the other hand,
are generally not subject to such requirements. It is therefore usually less complicated to operate a multistate
business in the partnership form, limited or general.
         4.       Income tax considerations. The major difference between taxation of a partnership compared
with that of a corporation is that the partnership is not recognized as a taxable entity, and the corporation is a
separate taxable entity.
     The partnership pays no taxes. Instead, its income or loss is passed through the partnership to the
individual partners in accordance with the partnership agreement regarding the sharing of income and losses.
The corporation, on the other hand, pays a tax on its ordinary income at the applicable corporate rate.
     In choosing between the partnership and corporate forms of business organization, investors who also
intend to operate the business should consider the tax rates of a corporation in relation to the individual tax
rates of the investors. Except for reasonable compensation for services rendered, investor operators often retain
all income in the business for expansion. If the corporate tax rate(s) is (are) less than the investors’ personal
rates, it may be possible to pay less taxes in the short run, retaining more income for business expansion. In
these situations, dividends are often not contemplated, even though the accumulated earning tax problem must
be considered and dealt with appropriately.

                           REVIEW QUESTIONS FOR APPENDIX 20A
         1.       The purpose of tracking a partner’s tax basis is to compute the taxable gain or loss upon the
sale of the partner’s interest.
         2.       Adjusted tax basis essentially means historical cost less any depreciation previously allowed
(actually deducted) or allowable (what could have been deducted if the asset had been used in a business) for
income tax reporting purposes.
         3.       A partner’s capital account balance cannot be used to determine that partner’s tax basis
because the tax laws are not structured around a partner’s equity as reflected in the general ledger.
         4.       a. Contributions—Increase tax basis.
                  b. Distributions—Decrease tax basis.
                  c. Profits—Increase tax basis.
                  d. Losses—Decrease tax basis.
                  e. Partnership borrowings—Increase tax basis.
                  f. Repayments of partnership debt—Decrease tax basis.
         5.       Partnership loans result in an increase in partners’ tax bases because their substance is the
equivalent of personal cash contributions because the partners are personally responsible for such loans.
         6.       Partnerships do not have net operating loss carrybacks or carryforwards because they are not
taxable entities. When a partner’s share of a partnership’s loss for a given year exceeds the excess of the
partner’s nonbusiness income over nonbusiness deductions, however, this net amount is a net operating loss
that can be carried back three years and then forward seven years on the partner’s individual income tax return.
         7.       When a partner contributes into a partnership an asset that has a fair value more than the
partner’s cost of that asset, no step-up in basis is allowed for tax-reporting purposes. Accordingly, the partner
does not report a gain on his or her individual return.
         8.       When a partner contributes liabilities into a partnership, it results in increasing the tax bases of
the partners (the profit and loss sharing ratio is used to allocate the increase among the partners).
                                                                                           Partnerships: Formation and Operation                           • 20-23
                                                  EXERCISES FOR APPENDIX 20A
E 20A-1 (Estimated time: 10 minutes)
Requirement 1:
                          Evers Glade Marsh Total
    Adjusted tax basis of assets contributed
     Cash                 $50,000              $ 50,000
     Accounts receivable          20,000              20,000
     Land                         $30,000      30,000
     Equipment            ______ ______ $20,000 20,000
                 $70,000$30,000$20,000$120,000
    Adjustment to tax basis for liabilities assumed
     40% of $10,000                4,000            (4,000)
     30% of $10,000                ______ 3,000 (3,000)                                              _______
       Basis             $74,000$33,000$13,000$120,000

Requirement 2:
Accounts receivable ...........................................................................................................................
.............................................................................................................................................. $20,000
Land ...................................................................................................................................................
................................................................................................................................................ 30,000
Equipment ..........................................................................................................................................
................................................................................................................................................ 20,000

Requirement 3:
To record Evers’ contribution:
 Cash          50,000
    Accounts Receivable                                        20,000
         Capital, Evers                                        70,000
  To record Glade’s contribution:
    Land                40,000
         Capital, Glade                                        40,000
  To record Marsh’s contribution:
    Equipment           25,000
         Note Payable—Equipment                                                         10,000
         Capital, Marsh                                        15,000

Requirement 4:Proceeds:
 Cash distribution (in liquidation of capital balance)                                                 $40,000
 Relief of responsibility for liabilities (30% × $10,000) ...................................................................
3,000
     Total Proceeds ............................................................................................................................
.............................................................................................................................................. $43,000
 Tax basis ..........................................................................................................................................
33,000
     Taxable Gain ..............................................................................................................................
.............................................................................................................................................. $10,000
20-24 •     ADVANCED ACCOUNTING: Concepts and Practice
E 20A-2 (Estimated time: 10 minutes)
Requirement 1:
                       Reed   Storey Teller
Beginning tax basis           $50,000$35,000$65,000
+ Capital contributions       18,000 10,000 4,000
  - Capital withdrawals              (6,000) (12,000)             (5,000)
  + Profit              11,000 11,000 11,000
  Ending Tax Basis            $73,000$44,000$75,000

Requirement 2:
                         Reed Storey Teller
Ending tax basis, per above               $73,000$44,000$75,000
  + Increase in liabilities (allocate equally)            8,000     8,000   8,000
  Ending Tax Basis                $81,000$52,000$83,000

  Note: The purchase of equipment by the partnership is irrelevant.

  E 20A-3 (Estimated time: 5 minutes)

  c. Capital Account Balance …$70,000 ($50,000 cash contribution + $30,000 equipment contribution [FV]
                                        - $10,000 note payable = $70,000


     Tax basis………………….. $71,000 ($50,000 cash contribution + $25,000 equipment contribution
                                 [HC] = $75,000; $75,000 -$4,000 ($10,000 note payable x 40%)
                                 = $71,000

				
DOCUMENT INFO
Description: Silent Partnership Agreement on Equipment document sample