Walker, Hayes, and Leaky began a small manufacturing company organized as a partnership. The partnership has operated

Question:

Walker, Hayes, and Leaky began a small manufacturing company organized as a partnership. The partnership has operated for the past two years with reported annual net income averaging $220,000 and an allocation of such income as follows:

1. Salaries toWalker and Hayes of $90,000 each and a salary to Leaky of $70,000.

2. Bonuses to each partner of 5% of net income before bonuses.

3. Remaining profits are to be allocated equally among the partners.

The partners had initially agreed to review the allocation of profits after the first two years of operations, based on changing business opportunities. Leaky is proposing to invest another $125,000 into the partnership at the beginning of the second quarter of the third year of operations. Leaky believes that this injection of capital and their newly designed machined products will significantly increase reported net income in the third year of operations. However, Leaky has been encouraged by an outside investor to set up a second partnership with the investor and allocate profits as follows:

1. Salary of $60,000 to Leaky.

2. Interest at 5% on the $125,000 of needed capital that would be invested by the outside party.

3. Remaining profits allocated 80% to Leaky and the balance to the outside investor. Leaky would prefer to continue his involvement in the current partnership, but believes that the partnership's allocation of profits would have to be modified in order for them to reject the offer from the outside investor. Furthermore, Leaky believes that in the long run his investment of capital and new products will benefit all of the partners in the future, through expanded customer awareness of the company and its products. Leaky is proposing the following as a basis for continuing their involvement with the current partnership:

1. Salaries to all partners of $90,000.

2. Interest on capital of 5% of the weighted-average capital balance.

3. Mandatory investments of $15,000 of additional capital by each partner at the beginning of the third quarter and no withdrawals of capital during the third year of operations. Capital balances at the end of the second year were $40,000, $30,000, and $60,000 for Walker, Hayes, and Leaky, respectively.

4. An allocation of remaining profits, such that Leaky's allocation of total net income would be equal to his allocation of profits under the previous agreement, plus 100% of the profit he would have had if he had formed a partnership with the outside investor. The other two partners would continue to share remaining profits equally between themselves.

Hayes is a client of yours and has come to you seeking your advice. Hayes is concerned that Leaky's proposed profit-sharing agreement will result in Hayes having less of a profit allocation, than what he would have had if Leaky had not brought the capital and new product designs into the existing partnership. Hayes believes that the existing partnership would have had a net income of approximately $253,000 in its third year of operations. If Leaky had brought in the capital and product designs, net income would have been a minimum of $100,000 more and more likely $150,000 more.

Prepare a schedule that would help Hayes decide what course of action to take.

Partnership
A legal form of business operation between two or more individuals who share management and profits. A Written agreement between two or more individuals who join as partners to form and carry on a for-profit business. Among other things, it states...
Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question

Advanced Accounting

ISBN: 978-1305084858

12th edition

Authors: Paul M. Fischer, William J. Tayler, Rita H. Cheng

Question Posted: