Kathy and Eddie formed the K & E partnership several years ago. Capital account balances on January 1, 2011, were as follows:

Kathy ..... $496,750

Eddie ..... $268,250

The partnership agreement provides Kathy with an annual salary of $10,000 plus a bonus of 5 percent of partnership net income for managing the business. Eddie is provided an annual salary of $15,000 with no bonus. The remainder is shared evenly. Partnership net income for 2011 was $30,000. Eddie and Kathy each invested an additional $5,000 during the year to finance a special purchase. Year-end drawing account balances were $15,000 for Kathy and $10,000 for Eddie.

REQUIRED

1. Prepare an income allocation schedule.

2. Create the journal entries to update the equity accounts at the end of the year.

3. Determine the capital balances as of December 31, 2011.