Question

Irene Watts and John Lyon are forming a partnership to which Watts will devote one-half time and Lyon will devote full time. They have discussed the following alternative plans for sharing income and loss: (a) in the ratio of their initial capital investments, which they have agreed will be $42,000 for Watts and $63,000 for Lyon; (b) in proportion to the time devoted to the business; (c) a salary allowance of $6,000 per month to Lyon and the balance in accordance with the ratio of their initial capital investments; or (d) a salary allowance of $6,000 per month to Lyon, 10% interest on their initial capital investments, and the balance shared equally. The partners expect the business to perform as follows: year 1, $36,000 net loss; year 2, $90,000 net income; and year 3, $150,000 net income. Required: Complete the tables, one for each of the first three years, by showing how to allocate partnership income or loss to the partners under each of the four plans being considered. (Do not round intermediate calculations. Round final answers to the nearest whole dollar. Enter all allowances as positive values. Enter losses as negative values.)

Answer 1

Irene Watts and John Lyon

Allocation of Partnership Income or Loss under these plans:

(a) in the ratio of their initial capital investments, which they have agreed will be $42,000 for Watts and $63,000 for Lyon:

Year 1 Year 2 Year 3

Net Income / (Loss) ($36,000) $90,000 $150,000

Watts 40% (14,400) 36,000 60,000

Lyon 60% (21,600) 54,000 90,000

(b) in proportion to the time devoted to the business:

Year 1 Year 2 Year 3

Net Income / (Loss) ($36,000) $90,000 $150,000

Watts 1/3 (12,000) 30,000 50,000

Lyon 2/3 (24,000) 60,000 100,000

(c) a salary allowance of $6,000 per month to Lyon and the balance in accordance with the ratio of their initial capital investments:

Year 1 Year 2 Year 3

Net Income / (Loss) ($36,000) $90,000 $150,000

Less Salary (72,000) (72,000) (72,000)

Distributable Income/(Loss) (108,000) $18,000 $78,000

Watts 40% ($43,200) $7,200 $31,200

Lyon:

Salary 72,000 72,000 72,000

Distributable 60% (64,800) 10,800 46,800

Net share $7,200 $82,800 $118,800

(d) a salary allowance of $6,000 per month to Lyon, 10% interest on their initial capital investments, and the balance shared equally:

Year 1 Year 2 Year 3

Net Income / (Loss) ($36,000) $90,000 $150,000

Less Salary (72,000) (72,000) (72,000)

Less Interest on Capital (10,500) (10,500) (10,500)

Distributable Income/(Loss) (118,500) 7,500 67,500

Watts:

Interest on Capital 4,200 4,200 4,200

Distributable income 40% (47,400) 3,000 27,000

Share of profit or loss ($45,400) $7,200 $31,200

Lyon:

Salary 72,000 72,000 72,000

Interest on Capital 6,300 6,300 6,300

Income/Loss 60% (71,100) 4,500 40,500

Net share $7,200 $82,800 $118,800

Step-by-step explanation:

a) Data and Calculations:

Net Income of Loss:

Year 1 = $36,000 loss

Year 2 = $90,000

Year 3 = $150,000

Sharing plans:

a) Capital:

Watts $42,000 = $42,000/$105,000 = 40%

Lyon $63,000 = $63,000/$105,000 = 60%

b) Time devotion:

Watts 1 = 1/3 or 33%

Lyon 2 = 2/3 or 67%

c) a salary allowance of $6,000 per month to Lyon and the balance in accordance with the ratio of their initial capital investments:

Distributable Income / Loss:

Year 1 = ($36,000) - $72,000 = ($108,000)

Year 2 = $90,000 - $72,000 = $18,000

Year 3 = $150,000 - $72,000 = $78,000