Moore, Mills, Sinclair & Co. (MMS) is a rapidly-growing regional CPA firm. It actively recruits new staff accountants at major colleges and universities and aggressively pursues exceptional partners and near-partners at other CPA firms. Concurrently, MMS's founders have been retiring. Moore left last year and Mills and Sinclair are contemplating retiring soon. Prior to retirement of Mills and Sinclair, who each have a 20 percent share in profits and losses, the firm's condensed balance sheet appears as follows:
MOORE, MILLS, SINCLAIR & CO. Balance Sheet December 31, 2013
Cash and cash equivalents$ 178,000
Accounts receivable-clients430,000
Notes receivable-Sinclair100,000
Prepayments60,000
Fixed assets, net500,000
Goodwill, net800,000
Total assets$2,068,000
Trade payables$47,000
Accrued liabilities209,000
Notes payable-1 st National Bank600,000
Notes payable-Moore200,000
Capital-Mills270,000
Capital-Sinclair195,000
Capital-Other Partners547,000
Total liabilities and capital$2,068,000
After some discussion, the firm agrees to pay Mills $350,000 upon retirement, intending to borrow the cash to do so from 1st National Bank. Shortly thereafter, Luh, a highly competent and entrepreneurial information systems specialist, is offered a 10 percent interest in capital and profits for a $50,000 cash investment.
Required
a. Discuss the ways in which the methods of accounting for the retirement could weaken the above balance sheet, and illustrate with calculations.
b. Suppose Mills' retirement is accounted for by the total goodwill method. After Mills' retirement is recorded by the total goodwill approach, prepare pro-forma balance sheets for MMS that reflect Luh's admission under the two alternative admission methods.
c. Briefly describe the principal differences between the two balance sheets in part b. Which seems to portray the healthier firm? Why?