The Red and Blue partnership has been created to operate a law firm. The partners have been attempting to devise a fair system to allocate profits and losses. Red plans to work more billable hours each year than Blue. However, Blue has more experience and can charge a higher hourly rate. Red expects to invest more money in the business than Blue.
Build a spreadsheet that can be used to allocate profits and losses to these two partners each year. The spreadsheet should be constructed so that the following variables can be entered:
Net income for the year.
Number of billable hours for each partner.
Hourly rate for each partner.
Capital investment by each partner.
Interest rate on capital investment.
Profit and loss ratio.
Use this spreadsheet to determine the allocation if partnership net income for the current year is $200,000, the number of billable hours is 2,000 for Red and 1,500 for Blue, the hourly rate for Red is $20 and for Blue is $30, and investment by Red is $80,000 and by Blue is $50,000. Interest on capital will be accrued each year at 10 percent of the beginning balance. Any remaining income amount will be split 50–50.
Use the spreadsheet a second time but make these changes: Blue reports 1,700 billable hours, Red invests $100,000, and interest will be recognized at a 12 percent annual rate. How do these three changes impact the allocation of the $200,000?