Chapter 14 Question 26 In the early part of 2015, the partners of Hugh, Jacobs,

Question

Chapter 14 Question 26

In the early part of 2015, the partners of Hugh, Jacobs, and Thomas sought assistance for a local accountant. They had begun a new business in 2014 but had never used an accountant's services.

Hugh and Jacobs began the partnership by contributing $150,000 and $100,000 in cash, respectively. Hugh was to work occasionally at the business, and Jacobs was to be employed full-time. They decided that year-end profits and losses should be assigned as follows:

1. Each partner was to be allocated 10 percent interest computed on the beginning capital balances for the period.

2. A compensation allowance of $5,000 was to go to Hugh with a $25,000 amount assigned to Jacobs.

3. Any remaining income would be split on a 4:6 basis to Hugh and Jacobs, respectively.

In 2014, revenues totaled $175,000, and expenses were $146,000 (not including the partners' compensation allowance). Hugh withdrew cash oc $9,000 during the year, and Jacobs took out $14,000. In addition, the business paid $7,000 for repairs made to Hugh's home and charged it to repair expense.

On January 1, 2015, the partnership sold a 15 percent interest to Thomas for $64,000 cash. This money was contributed to the business with the bonus method used for accounting purposes.

Answer the following questions:

a. Why was the original profit and loss allocation, as just outlined, designed by the partnership?

b. Why did the drawings for 2014 not agree with the compensation allowances provided for in the partnership agreement?

c. What journal enteries should the partnership have recorded on December 31, 2014?

d. What journal entry should the partnership have recorded on January 1, 2015?

Explanation / Answer

a. The profit and loss allocation was designed by the partnership as outline to compensate the partners for the difference in the capital employed by them and the time devoted by each partner to the partnership. H contributed more money to the partnership than J, but J worked full time whereas H was to work occasionally.

b. Drawings are not compensation allowances. Conpensation allowances are a return to the partners for the capital employed by them and the time devoted to the partnership. Drawings are in a way return of capital. Therefore, it is not necessary that the drawings should agree with the compensation allowances.  

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