Keith Scott and David McPeek agreed to share the annual net incomes or losses of their partnership as follows: If the partnership earned a net income, the first $60,000 would be allocated 40% to Scott and 60% to McPeek to reflect the time devoted to the business by each partner. Income in excess of $60,000 would be shared equally. Also, the partners have agreed to share any losses equally.
1. Prepare a schedule showing how net income of $72,000 for 2014 should be allocated to the partners.
2. Sometime later in 2015, the partners discovered that $80,000 of accounts payable had existed on December 31, 2014, but had not been recorded. These accounts payable relate to expenses incurred by the business. They are now trying to determine the best way to correct their accounting records, particularly their capital accounts. McPeek suggested that they make a special entry crediting $80,000 to the liability account, and debiting their capital accounts for $40,000 each. Scott, on the other hand, suggested that an entry should be made to record the accounts payable and retroactively correct the capital accounts to reflect the balance that they would have had if the expenses had been recognized in 2014. If they had been recognized, the partnership would have reported a loss of $8,000 instead of the $72,000 net income.
a. Present the journal entry suggested by McPeek for recording the accounts payable and allocating the loss to the partners.
b. Give the journal entry to record the accounts payable and correct the capital accounts accord-
ing to Scott’s suggestion. Show how you calculated the amounts presented in the entry.
3. Which suggestion do you think complies with their partnership agreement? Why?