PARTNERSHIPS – FORMATION, OPERATIONS, AND CHANGES

IN OWNERSHIP INTERESTS
Multiple Choice Questions

1. Under the Uniform Partnership Act, loans made by a partner to the

partnership are treated as

a. advances to the partnership for which interest shall be paid from the
date of the advance.
b. advances to the partnership that are carried in the partners' capital
accounts.
c. Accounts Payable of the partnership for which interest is paid.
d. advances to the partnership for which interest does not have to be paid.

2. A partner assigned his partnership interest to a third party. Which statement

best describes the legal ramifications to the assignee?

a. The assignment of the partnership interest does not entitle the assignee
to partnership assets upon a liquidation.
b. The assignment dissolves the partnership.
c. The assignee has the right to share in the management of the
partnership.
d. The assignee does not become a partner but has the right to share in
future partnership profits and to receive the proper share of partnership
assets upon liquidation.

3. In the Uniform Partnership Act, partners have

I. mutual agency.
II.unlimited liability.

a. I only.
b. II only.
c. I and II.
d. Neither I nor II.

4. Partnerships

a. are required to prepare annual reports.

b. are required to file income tax returns but do not pay Federal taxes.
c. are required to file income tax returns and pay Federal income taxes.
d. are not required to file income tax returns or pay Federal income taxes.

5. Langley invests his delivery van in a computer repair partnership with

McCurdy. What amount should the van be credited to Langley’s partnership
capital?
 a. The tax basis.
b. The fair value at the date of contribution.
c. Langley’s original cost.
d. The assessed valuation for property tax purposes.

Use the following information for questions 6, 7 and 8.

A summary balance sheet for the McCune, Nall, and Oakley partnership appears
below. McCune, Nall, and Oakley share profits and losses in a ratio of 2:3:5,
respectively.

Assets
Cash $ 50,000
Inventory 62,500
Marketable securities 100,000
Land 50,000
Building-net 250,000
Total assets $ 512,500

Equities
McCune, capital $ 212,500
Nall, capital 200,000
Oakely, capital 100,000
Total equities $ 512,500

The partners agree to admit Pavic for a one-fifth interest. The fair market value of
partnership land is appraised at $100,000 and the fair market value of inventory is
$87,500. The assets are to be revalued prior to the admission of Pavic and there is
$15,000 of goodwill that attaches to the old partnership.

6. By how much will the capital accounts of McCune, Nall, and Oakley increase,
respectively, due to the revaluation of the assets and the recognition of
goodwill?

a. The capital accounts will increase by $25,000 each.

b. The capital accounts will increase by $30,000 each.
c. $18,000, $27,000, and $45,000.
d. $20,000, $25,000, and $30,000.

7. How much cash must Pavic invest to acquire a one-fifth interest?

a. $117,500.
b. $120,500.
c. $146,875.
 d. $150,625.

8. What will the profit and loss sharing ratios be after Pavic’s investment?

a. 1:2:4:2.
b. 2:3:5:2.
c. 3:4:6:2.
d. 4:6:10:5.

Use the following information for questions 9, 10 and 11.

Albion and Blaze share profits and losses equally. Albion and Blaze receive salary
allowances of $20,000 and $30,000, respectively, and both partners receive 10%
interest on their average capital balances. Average capital balances are calculated at
the beginning of each month balance regardless of when additional capital
contributions or permanent withdrawals are made subsequently within the month.
Partners’ drawings are not used in determining the average capital balances. Total
net income for 2006 is $120,000.

Albion Blaze
January 1 capital balances $ 100,000 $ 120,000
Yearly drawings ($1,500 a month) 18,000 18,000
Permanent withdrawals of capital:
June 3 ( 12,000 )
May 2 ( 15,000 )
Additional investments of capital:
July 3 40,000
October 2 50,000

9. What is the weighted-average capital for Albion and Blaze in 2006?

a. $100,000 and $120,000.

b. $105,333 and $126,667.
c. $110,667 and $119,583.
d. $126,667 and $105,333.

10. If the average capital for Albion and Blaze from the above information is
$112,000 and $119,000, respectively, what will be the total amount of profit
allocated after the salary and interest distributions are completed?

a. $70,000.
b. $73,100.
c. $75,000.
d. $80,000.

11. If the average capital balances for Albion and Blaze are $100,000 and
$120,000, what will the final profit allocations for Albion and Blaze in 2006?

a. $50,000 and $70,000.

 b. $54,000 and $66,000.
c. $70,000 and $50,000.
d. $75,000 and $45,000.

Use the following information for questions 12 and 13.

Bloom and Carnes share profits and losses in a ratio of 2:3, respectively. Bloom and
Carnes receive salary allowances of $10,000 and $20,000, also respectively, and both
partners receive 10% interest based upon the balance in their capital accounts on
January 1. Partners’ drawings are not used in determining the average capital
balances. Total net income for 2006 is $60,000. If net income after deducting the
interest and salary allocations is greater than $20,000, Carnes receives a bonus of
5% of the original amount of net income.

Bloom Carnes
January 1 capital balances $ 200,000 $ 300,000
Yearly drawings ($1,500 a month) 18,000 18,000

12. What are the total amounts for the allocation of interest, salary, and bonus,
and, how much over-allocation is present?

a. $60,000 and $0.

b. $80,000 and $20,000.
c. $83,000 and $0.
d. $83,000 and $23,000.

13. If the partnership experiences a net loss of $20,000 for the year, what will be
the final amount of profit or (loss) closed to each partner’s capital account?

a. ($30,000) to Bloom and $10,000 to Carnes.

b. ($10,000) to Bloom and ($10,000) to Carnes.
c. ($8,000) to Bloom and ($12,000) to Carnes.
d. $10,000 to Bloom and ($30,000) to Carnes.

14. The XYZ partnership provides a 10% bonus to Partner Y that is based upon
partnership income, after deduction of the bonus. If the partnership's
income is $121,000, how much is Partner Y's bonus allocation?

a. $11,000.
b. $11,450.
c. $11,650.
d. $12,100.

15. Drawings

a. are advances to a partnership.

b. are loans to a partnership.
c. are a function of interest on partnership average capital.
 d. *are the same nature as withdrawals.

16. If the partnership agreement provides a formula for the computation of a

bonus to the partners, the bonus would be computed

a. next to last, because the final allocation is the distribution of the profit
residual.
b. before income tax allocations are made.
c. after the salary and interest allocations are made.
d. in any manner agreed to by the partners.

Use the following information for questions 17, 18 and 19.

Davis has decided to retire from the partnership of Davis, Eiser, and Foreman. The
partnership will pay Davis $200,000. Goodwill is to be recorded in the transaction
as implied by the excess payment to Davis. A summary balance sheet for the Davis,
Eiser, and Foreman partnership appears below. Davis, Eiser, and Foreman share
profits and losses in a ratio of 1:1:3, respectively.

Assets
Cash $ 75,000
Inventory 82,000
Marketable securities 38,000
Land 150,000
Building-net 255,000
Total assets $ 600,000

Equities
Davis, capital 160,000
Eiser, capital 140,000
Foreman, capital 300,000
Total equities $ 600,000

17. What goodwill will be recorded?

a. $40,000.
b. $120,000.
c. $160,000.
d. $200,000.

18. What partnership capital will Eiser have after Davis retires?

a. $100,000.
b. $140,000.
c. $180,000.
d. $220,000.
19. What partnership capital will Foreman have after Davis retires?

a. $240,000.
b. $300,000.
c. $360,000.
d. $420,000.

20. In a limited partnership, a general partner

a. is excluded from management.

b. is not entitled to a bonus at the end of the year.
c. has limited liability for partnership debit.
d. has unlimited liability for partnership debit.

Exercise 1

Cesar and Damon share partnership profits and losses at 60% and 40%, respectively.
The partners agree to admit Egan into the partnership for a 50% interest in capital
and earnings. Capital accounts immediately before the admission of Egan are:

Cesar (60%) $ 300,000

Damon (40%) 300,000
Total $ 600,000

Required:

1. Prepare the journal entry(s) for the admission of Egan to the partnership
assuming Egan invested $400,000 for the ownership interest. Egan paid the
money directly to Cesar and to Damon for 50% of each of their respective
capital interests. The partnership records goodwill.

2. Prepare the journal entry(s) for the admission of Egan to the partnership
assuming Egan invested $500,000 for the ownership interest. Egan paid the
money to the partnership for a 50% interest in capital and earnings. The
partnership records goodwill.

3. Prepare the journal entry(s) for the admission of Egan to the partnership
assuming Egan invested $700,000 for the ownership interest. Egan paid the
money to the partnership for a 50% interest in capital and earnings. The
partnership records goodwill.
Exercise 2

On February 1, 2005, Flores, Gilroy, and Hansen began a partnership in which

Flores and Hansen contributed cash of $25,000; Gilroy contribute property with a
fair value of $50,000 and a tax basis $40,000. Gilroy receives a 5% bonus of
partnership income. Flores and Hansen receive salaries of $10,000 each. The
partnership agreement of Flores, Gilroy, and Hansen provides all partners to receive
a 5% interest on capital and that profits and losses be divided of the remaining
income be distributed to Flores, Gilroy, and Hansen by a 1:3:1 ratio.

Required:

Prepare a schedule to distribute $25,000 of partnership net income to the partners.

Exercise 3

The profit and loss sharing agreement for the Quade, Reid, and Scott partnership
provides for a $15,000 salary allowance to Reid. Residual profits and losses are
allocated 5:3:2 to Quade, Reid, and Scott, respectively. In 2006, the partnership
recorded $120,000 of net income that was properly allocated to the partner's capital
accounts. On January 25, 2007, after the books were closed for 2006, Quade
discovered that office equipment, purchased for $12,000 on December 29, 2006, was
recorded as office expense by the company bookkeeper.

Required:

Prepare the necessary correcting entry(s) for the partnership.

Exercise 4

Evans, Fitch, and Gault operate a partnership with a complex profit and loss sharing
agreement. The average capital balance for each partner on December 31, 2006 is
$300,000 for Evans, $250,000 for Fitch, and $325,000 for Gault. An 8% interest
allocation is provided to each partner. Evans and Fitch receive salary allocations of
$10,000 and $15,000, respectively. If partnership net income is above $25,000, after
the salary allocations are considered (but before the interest allocations are
considered), Gault will receive a bonus of 10% of the original amount of net income.
All residual income is allocated in the ratios of 2:3:5 to Evans, Fitch, and Gault,
respectively.

Required:

1. Prepare a schedule to allocate income to the partners assuming that

partnership net income is $250,000.

2. Prepare a journal entry to distribute the partnership's income to the partners

(assume that an Income Summary account is used by the partnership).
Exercise 5

Required:

Using the information from Exercise 4 above:

1. Prepare a schedule to allocate income or loss to the partners assuming that the
partnership incurs a net loss of $36,000.

2. Prepare a journal entry to distribute the partnership's loss to the partners

(assume that an Income Summary account is used by the partnership).

Exercise 6

Grech, Harris, and Ivers have a retail partnership business selling personal
computers. The partners are allowed an interest allocation of 8% on their average
capital. Capital account balances on the first day of each month are used in
determining weighted average capital, regardless of additional partner investment or
withdrawal transactions during any given month. Drawings are disregarded in
computing average capital, but temporary withdrawals of capital that are debited to
the capital account are used in the average calculation. Partner capital activity for
the year was:

Capital accounts Grech Harris Ivers

Jan 1 balance $ 200,000 $ 300,000 $ 250,000
Feb 2 investment 50,000
Mar 6 investment 10,000 20,000
Apr 20 withdrawal ( 10,000 )
Jul 3 withdrawal
and investment ( 7,000 ) 10,000
Sep 29 investment 5,000 4,000 5,000
Nov 5 investment 5,000
Required:

Calculate weighted average capital for each partner, and determine the amount of interest
that each partner will be allocated.
Exercise 7

The profit and loss sharing agreement for the Sealy, Teske, and Ubank partnership
provides that each partner receive a bonus of 5% on the original amount of
partnership net income if net income is above $25,000. Sealy and Teske receive a
salary allowance of $7,500 and $10,500, respectively. Ubank has an average capital
balance of $260,000, and receives a 10% interest allocation on the amount by which
his average capital account balance exceeds $200,000. Residual profits and losses
are allocated to Sealy, Teske, and Ubank in their respective ratios of 7:5:8.

Required:

Prepare a schedule to allocate $88,000 of partnership net income to the partners.

Exercise 8

A summary balance sheet for the partnership of Ivory, Jacoby and Kato on December
31, 2006 is shown below. Partners Ivory, Jacoby and Kato allocate profit and loss in
their respective ratios of 9:6:10.

Assets
Cash $ 50,000
Inventory 75,000
Marketable securities 120,000
Land 80,000
Building-net 400,000
Total assets $ 725,000

Equities
Ivory, capital $ 425,000
Jacoby, capital 225,000
Kato, capital 75,000
Total equities $ 725,000

The partners agree to admit Lange for a one-tenth interest. The fair market value for
partnership land is $180,000, and the fair market value of the inventory is $150,000.

Required:

1. Record the entry to revalue the partnership assets prior to the admission of
Lange.
 2. Calculate how much Lange will have to invest to acquire a 10% interest.

3. If Lange paid $200,000 to the partnership in exchange for a 10% interest,

what would be the bonus that is allocated to each partner's capital account?

Exercise 9

A summary balance sheet for the Vail, Wacker Yang partnership on December 31,
2006 is shown below. Partners Vail, Wacker, and Yang allocate profit and loss in
their respective ratios of 4:5:7. The partnership agreed to pay partner Yang $227,500
for his partnership interest upon his retirement from the partnership on January 1,
2007. Any payments exceeding Yang’s capital balance are treated as a bonus from
partners Vail and Wacker.

Assets
Cash $ 75,000
Inventory 87,500
Marketable securities 60,000
Land 90,000
Building-net 150,000
Total assets $ 462,500

Equities
Vail, capital $ 212,500
Wacker, capital 112,500
Yang, capital 137,500
Total equities $ 462,500

Required:
Prepare the journal entry to reflect Yang’s retirement from the partnership.

Exercise 10

A summary balance sheet for the Almond, Brandt, and Clack partnership on
December 31, 2006 is shown below. Partners Almond, Brandt, and Clack allocate
profit and loss in their respective ratios of 2:1:1. The partnership agreed to pay
partner Brandt $135,000 for his partnership interest upon his retirement from the
partnership on January 1, 2007. The partnership financials on January 1, 2007 are:

Assets
Cash $ 75,000
Inventory 85,000
Marketable securities 60,000
Land 90,000
Building-net 150,000
Total assets $ 420,000

Equities
Almond, capital $ 210,000
Brandt, capital 105,000
Clack, capital 105,000
Total equities $ 420,000

Required:
Prepare the journal entry to reflect Brandt’s retirement from the partnership:
1. Assuming a bonus to Brandt.
2. Assuming a revaluation of total partnership capital based on excess payment.
3. Assuming goodwill to excess payment is recorded.

SOLUTIONS

Multiple Choice Questions

1. a
2. d
3. c
4. b
5. b
6. c The assets will be valued upward by $90,000 which, allocated on a
2:3:5 basis, yields $18,000 to McCune, $27,000 to Nall, and
$45,000 to Oakely.

7. d After the revaluation, the assets will be recorded at $602,500. If

Pavic is admitted for a one-fifth interest, the $602,500 represents
80% of the total implied capital. Dividing $602,500 by 80% gives a
total capitalization of $753,150 for which $150,625 is required from
Pavic for a 20% interest.

8. d Each of the original partners has given up 20% of their interest to

Pavic. Their profit and loss sharing ratios will therefore be 80% of
what they were before the admission of Pavic.

McCune 20% x 80% = 16%

Nall 30% x 80% = 24%
Oakely 50% x 80% = 40%
 Pavic = 20%

Expressed as: 4:6:10:5

9. c Albion: [($100,000 x 6) + ($88,000 x 1) +

($128,000 x 5)]/12 = $110,667

Blaze: [($120,000 x 5) + ($105,000 x 5) +

($155,000 x 2)]/12 = $119,583

10. b Capital: ($112,000 + $119,000)x(10%) = $23,100

Salary: ($20,000 + $30,000) = $50,000
Total: $23,100 + $50,000 = $73,100

11. b Albion: ($100,000 x 10%) + $20,000 + $24,000 = $54,000

Blaze: ($120,000 x 10%) + $30,000 + $24,000 = $66,000

12. b Interest: ($500,000 x 10%) = $50,000

Salary: ($10,000 + $20,000) = $30,000
Bonus: Condition not met = $0

Total allocations = $80,000 and over-allocations =

$80,000 - $60,000 = $20,000

13. b Bloom:
Interest allocation: $20,000
Salary allocation: $10,000

Carnes:
Interest allocation: $30,000
Salary allocation: $20,000

There is a total of $80,000 for positive allocations. To bring them

down to a $20,000 loss, a residual adjustment of ($100,000) is
needed which is allocated ($40,000) to Bloom and ($60,000) to
Carnes. After these amounts are assigned to the partners, each
partner’s capital account will be reduced by a net $10,000.

14. a B = .1x($121,000 - B)
B = $12,100 - .1B
1.1B = $12,100
B = $11,000

15. d
16. d
17. d
18. c
19. c
20. d

Exercise 1

Requirement 1

Goodwill 200,000
Cesar, capital 120,000
Damon, capital 80,000

Cesar, capital 210,000

Damon, capital 190,000
Egan, capital 400,000

If a $400,000 payment represents 50% of total capital, then twice that amount, or
$800,000, is the implied total capital including goodwill. If the present total capital is
$600,000, and the implied total capital is $800,000, the amount of goodwill to record
is $200,000. This goodwill is allocated 60% to Cesar and 40% to Damon.

After the first entry is posted, the balances in the Cesar and Damon capital accounts
will be $420,000 and $380,000, respectively. If one-half of each partner’s interest is
given to Egan, Cesar’s capital account is reduced by $210,000, and Damon’ capital
account is reduced by $190,000.

Requirement 2

Goodwill 100,000
Cash 500,000
Egan, capital 600,000

If we focus on the current capital of the partnership, $600,000, and say that it is
fairly valued, then, if it represents 50% of final capital after Egan’s investment, final
capital should be $1,200,000. Egan’s share of final capital will be $600,000, and, if
Egan invests $500,000 for this interest, there must be $100,000 of goodwill that is
allocated to Egan.

Requirement 3

Goodwill 100,000
Cesar, capital 60,000
Damon, capital 40,000

Cash 700,000
Egan, capital 700,000

If Egan invests $700,000 for a 50% interest, it implies that total partnership capital should
be $1,400,000. After Egan’s investment, total capital will be $1,300,000, and goodwill is
therefore $100,000. The goodwill is allocated to Cesar and Damon.
Exercise 2

Income Flores Gilroy Hansen

Net income $ 25,000
Bonus to Gilroy ( 1,250 ) $ 1,250
Salaries ( 20,000 ) $ 10,000 $ 10,000
Interest ( 5,000 ) 1,250 2,500 1,250
Residual loss ( 1,250 )
Loss allocation 1,250 $( 250 ) ( 750 ) ( 250 )
Allocation $ 0 $ 11,000 $ 3,000 $ 11,000

Exercise 3

1/25/07 Office Equipment 12,000

Quade, capital 6,000
Reid, capital 3,600
Scott, capital 2,400

Correction of journal entry error from 12/29/03. To record office

equipment and to adjust partner capital accounts.

Exercise 4

Requirement 1

Income Evans Fitch Gault

Net income $ 250,000
Bonus to Gault ( 25,000 ) $ 25,000
Salary allocation ( 25,000 ) $ 10,000 $ 15,000
Interest allocation ( 70,000 ) 24,000 20,000 26,000
Residual ( 130,000 ) 26,000 39,000 65,000
Final allocation $ 0 $ 60,000 $ 74,000 $ 116,000

Requirement 2

Income summary 250,000

Evans, capital 60,000
Fitch, capital 74,000
Gault, capital 116,000

Exercise 5

Requirement 1
 Loss Evans Fitch Gault
Net loss $ ( 36,000 )
Bonus to Gault ( 0 ) $ 0
Salary allocation ( 25,000 ) $ 10,000 $ 15,000
Interest allocation ( 70,000 ) 24,000 20,000 $ 26,000
Subtotal ( 131,000 ) 34,000 35,000 26,000
Residual allocation 131,000 ( 26,200 ) ( 39,300 ) ( 65,500 )
Totals $ 0 $ 7,800 $( 4,300 ) $( 39,500 )

Requirement 2

Fitch, capital 4,300

Gault, capital 39,500
Evans, capital 7,800
Income summary 36,000

Exercise 6

Grech
Jan, Feb $ 200,000 x 2 = $ 400,000
Mar 250,000 x 1 = 250,000
Apr, May, Jun, Jul 260,000 x 4 = 1,040,000
Aug, Sep 253,000 x 2 = 506,000
Oct, Nov, Dec 258,000 x 3 = 774,000
Total capital $ 2,970,000
Average capital $ 247,500
Interest allocation $ 19,800

Harris
Jan, Feb, Mar $ 300,000 x 3 = $ 900,000
Apr, May, Jun, Jul 320,000 x 4 = 1,280,000
Aug, Sep 330,000 x 2 = 660,000
Oct, Nov, Dec 334,000 x 3 = 1,002,000
Total capital $ 3,842,000
Average capital $ 320,167
Interest allocation $ 25,613

Ivers
Jan, Feb, Mar, Apr $ 250,000 x 4 = $ 1,000,000
May, Jun, Jul, Aug, Sep 240,000 x 5 = 1,200,000
Oct, Nov 245,000 x 2 = 490,000
Dec 250,000 x 1 = 250,000
Total capital $ 2,940,000
Average capital $ 245,000
Interest allocation $ 19,600

Exercise 7

Income Sealy Teske Ubank

Net income $ 88,000
Bonus ( 13,200 ) $ 4,400 $ 4,400 $ 4,400
Salary ( 18,000 ) 7,500 10,500
Interest ( 6,000 ) 6,000
Subtotal 50,800 11,900 14,900 10,400
Balance ( 50,800 ) 17,780 12,700 20,320
Totals $ 0 $ 29,680 $ 27,600 $ 30,720

Exercise 8

Requirement 1

The assets of the partnership must be adjusted to fair market value. Land will
increase by $100,000, and Inventory by $75,000. The profit and loss ratio elements
add up to 25. Partner Ivory will then be allocated 9/25 of the $175,000, etc.

Land 100,000
Inventory 75,000
Ivory, capital 63,000
Jacoby, capital 42,000
Kato, capital 70,000

Requirement 2

The partnership's total assets after revaluation are $900,000. If Lange acquires a
10% interest, it implies that the $900,000 represents 90% of the partnership’s value
after Lange's investment. Therefore, $900,000/90% = $1,000,000, and $1,000,000 x
10% = $100,000. The entry to record Lange’s investment would be:

Cash 100,000
Lange, capital 100,000

Requirement 3

Cash 200,000
Lange, capital 100,000
Ivory, capital 36,000
 Jacoby, capital 24,000
Kato, capital 40,000

Exercise 9

1/1/04 Yang, capital 137,500

Vail, capital ($90,000 x 4/9) 40,000
Wacker, capital ($90,000 x 5/9) 50,000
Cash 227,500

Exercise 10

Requirement 1

Almond and Clack give a bonus to Brand which reduces their capital in a 2 to 1
ratio.

Brandt, capital 105,000

Almond, capital 20,000
Clack, capital 10,000
Cash 135,000

Requirement 2

Revalue the total partnership capital to reflect the value at Brandt’s retirement’s
excess payment of $30,000.

Goodwill 60,000
Almond, capital 20,000
Clack, capital 10,000
Brandt, capital 30,000

Brandt, capital 135,000

Cash 135,000

Requirement 3

Add goodwill equal to the excess payment

Brandt, capital 105,000

Goodwill 30,000
Cash 135,000