Question

Larry Goldstein and Rafi Hassan created a partnership to produce software for online advertising. Goldstein was a lawyer and would handle all the legal matters, but Hassan was the technical whiz and would do all of the production and sales. Because most of the work would be done by Hassan, the partnership agreement specified that the yearly income would be split in a two-phase allocation. The first $100,000 of net income would be split among Goldstein and Hassan in a 1:4 ratio (one part to Goldstein, four parts to Hassan). Any net income above $100,000 would be split evenly. At the onset, both men contributed $200,000 to the partnership and made no withdrawals during the first year. The partnership earned $175,000 of net income in its first year. What is the closing balance in the owners' capital accounts?

Answer 1

Initial contribution by each partner = $200,000

Net income earned by the partnership in the first year = $175,000

Phase 1 allocation:

The first $100,000 of net income is split in a 1:4 ratio between Goldstein and Hassan.

Goldstein's share = 1 / (1 + 4) * $100,000 = $20,000

Hassan's share = 4 / (1 + 4) * $100,000 = $80,000

Phase 2 allocation:

Any net income above $100,000 is split evenly between Goldstein and Hassan.

Remaining net income = $175,000 - $100,000 = $75,000

Goldstein's share = $75,000 / 2 = $37,500

Hassan's share = $75,000 / 2 = $37,500

Now, let's calculate the closing balance in the owners' capital accounts:

Goldstein's capital account:

Initial contribution + Phase 1 allocation + Phase 2 allocation

$200,000 + $20,000 + $37,500 = $257,500

Hassan's capital account:

Initial contribution + Phase 1 allocation + Phase 2 allocation

$200,000 + $80,000 + $37,500 = $317,500

Therefore, the closing balance in Goldstein's capital account is $257,500, and the closing balance in Hassan's capital account is $317,500.