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141

Ch. 14Exercises

EXERCISE 14-1
(1)
Inventory..................................................................................
Accounts Receivable..........................................................
Warranty Obligations..........................................................
Pearson, Capital.................................................................
Murphy, Capital..................................................................
To adjust book values to market values.

58,000

Cash........................................................................................
Goodwill...................................................................................
Pearson, Capital.................................................................
Murphy, Capital..................................................................
Warner, Capital...................................................................
To record admission of Warner and recognition of goodwill.
If Warner contributes $84,000 for a 30% interest in capital,
this suggests a total new partnership value of $280,000.

84,000
56,000

18,000
10,000
18,000
12,000

33,600
22,400
84,000

(2) If the $56,000 of goodwill proved to be worthless, Warner would be charged 35% of
$56,000, or $19,600. However, the real harm to Warner would be that of having paid more
to enter the partnership than he/she should have. If the goodwill did not exist, then the
adjusted assets of the previous partners would have been $140,000 ($45,000 + $65,000 +
$30,000), which represents 70% of a total partnership value of $200,000. In that case,
Warner would have only paid $60,000 for a 30% interest in capital. Therefore, Warner
would have paid an extra $24,000 ($84,000 versus $60,000) for the goodwill that proved to
be worthless.
EXERCISE 14-3
(1) A sale by Freeman to another individual, as compared to a sale to the partnership, would
not affect Papes capital balance. Freeman's capital balance would merely be transferred at
book value to the other party's capital account.
(2) The $125,000 paid to Freeman relative to their capital balance of $80,000 represents a
bonus of $45,000 that is allocated between the remaining partners according to their
proportionate capital balances. Given that the remaining partners have equal proportionate
average capital balances, Papes capital balance would be reduced by $22,500 to a
balance of $17,500.
(3) The $45,000 over excess over Freemans capital balance represents two things: 1)
Freemans share of the appreciation in value of the recorded net assets and 2) Freemans
share of the total entity goodwill. The strict allocation and recognition of these two elements
to only Freeman would have no impact on Papes capital balance.
(4) Once again, the $45,000 over excess over Freemans capital balance represents two
things: 1) Freemans share of the appreciation in value of the recorded net assets and 2)
Freemans share of the total entity goodwill. If the partnership is going to recognize goodwill
traceable to the entire entity, then it would seem appropriate to recognize other net asset
appreciation that is traceable to the entire entity. The $45,000 represents Freemans 50%
interest in both of these elements and therefore, a total of $90,000 is traceable to the entire
partnerships interest in both of these elements. Accordingly, Pape should recognize as an

Ch. 14Exercises

142

increase in capital their 25% interest in the $90,000 of appreciation or $22,500 resulting in
an adjusted capital balance of $62,500 ($40,000 plus $22,500). The $22,500 would be
allocated as $10,000 (25% ($200,000 value of net assets less $160,000 book value of
assets) traceable to previously recognized net assets and $12,500 traceable to goodwill.
(5) Given the movement toward recognizing net assets at fair value, the method set forth in (4)
above would be preferable. It results in a more meaningful value of all of the assets,
tangible and intangible, held by the partnership. This in turn will result in more meaningful
metrics such as return on assets, return on equity, etc.
(6) If the current method were to be retained, it is imperative that the method for determining
"average capital" be clearly set forth. Is it a simple or a weighted average? What impact do
draws and loans have on the calculation, etc. Using just capital as a basis for allocation
seems rather narrow. Although a commercial construction may be capital intensive
(investment in equipment, etc.), a number of other factors might be more relevant to the
allocation of profits. Time spent by the partners and their varying functions might suggest
that salaries and bonuses might be more primary means of allocation with interest on
capital being used rather than proportionate capital balances. If these methods were
adopted, some percentages would have to be adopted to allocate remaining unallocated
amounts.

143

Ch. 14Exercises

EXERCISE 14-4
(1) The note payable has a market value greater than the book value that will reduce the net
asset value of the partnership by $15,000. However, the assets whose market values differ
from their book values will result in a $24,000 increase in the net asset value of the
partnership. The total net increase in the value is $9,000 ($24,000 less $15,000).
Petersens
interest in this net increase is $4,500 (50% $9,000), resulting in a suggested value for his
interest in the partnership of $104,500.
(2) If the value of Petersens interest before consideration of goodwill is $104,500 as set forth
above, then the difference between $130,000 and $104,500, or $25,500, represents
Petersens 50% interest in the value of goodwill. Therefore, the suggested value of goodwill
is $51,000.
(3) Both Jacobsen and Olsen would be acquiring equal interests in the net asset values
associated with Petersens interest; therefore, one would expect them to value these assets
at equal amounts. The critical factor relates to the voting interests acquired by each of the
remaining partners. If Jacobsen were to acquire half of Petersens interest along with half of
his voting rights, then Jacobsen would have a controlling voting interest in the partnership.
This may result in Jacobsen being motivated to pay more for her one-half than Olsen would
be willing to pay. All things being equal, having a controlling interest represents a control
premium, which is typically reflected in transaction prices.
(4) Based on the $104,500 value in item (1) above, a half interest in that would be $52,250.
Therefore, selling a half interest for $60,000 suggests that $7,750 represents Petersens
25% (one-half of a total 50% interest) interest in goodwill with an imputed total goodwill
value of $31,000. Prior to sale, Petersens capital balance would be increased by $4,500
per item (1) above plus the $7,750 goodwill traceable to the partial sale resulting in a total
of $112,250. After the sale for $60,000, Petersens capital balance would be reduced to
$52,250 ($112,250 less $60,000).
(5) In either case, Petersen should sell his interest for the same price. However, the ability for
him to collect the sales price may be a factor. The partnership itself may have a greater
ability to pay the sales price. The partnership may have a greater ability to borrow the
necessary funds for the purchase price due to its collateral position and operating cash
flows. Obviously, Petersen would be most interested in maximizing the value of his interest
and receiving a cash payment in the most timely and secure manner. The ability of a buyer
to pay, whether it is the partnership or an individual, is a critical factor to be considered. If
the partnership were to acquire Petersens interest, then Jacobsen could achieve a
controlling interest in the remaining partnership without using her personal funds.

Ch. 14Exercises

144

EXERCISE 14-5
(1)

(a)
(b)
(c)
(d)
(e)
(f)
(g)

Partnership
Fair market value of original partnership:
Assets at book value.........................
Liabilities at book value and fair
market value..................................
Book value of original partnership.....
Asset appreciation (depreciation)......
Net assets.........................................
Percent of new partnership represented
by the:
Investment of new partner.................
Fair value of the original partnership.
Fair value of new partnership
suggested by the fair value of
the original partnership [(b) (d)]...
Fair value of original partnership.......
Fair value of consideration that
should be conveyed by the
new partner [(e) (f)].....................

$ 500,000

$ 600,000

$ 800,000

(369,500)
$ 130,500
(50,000)
$ 80,500

(410,000)
$ 190,000
125,000
$ 315,000

(558,000)
$ 242,000
50,000
$ 292,000

30%
70%

(b)
(h)
(j)

20%
80%

$ 115,000
80,500

$ 420,000
315,000

$ 365,000
292,000

$ 34,500

$ 105,000

$ 73,000

(2)

(h)
(i)

25%
75%

Partnership
Amount of consideration to be conveyed:
Value of land.....................................
Value of cash....................................
Total consideration............................
Fair value of new partnership
suggested by the fair value of the
new partners investment [(h) (c)]
Fair value of the original
partnership.....................................
Investment of new partner.................
Adjusted value of new partnership
excluding goodwill [(d) + (h)]..........
If (i) exceeds (j), goodwill is
traceable to....................................
In the amount of [(i) (j)]...................
If (j) exceeds (i), goodwill is
traceable to....................................
In the amount of [(e) (j)]..................

$ 50,000
4,000
$ 54,000

$ 50,000
60,000
$ 110,000

$ 50,000
15,000
$ 65,000

$ 180,000

$ 440,000

$ 325,000

$ 80,500
54,000

$ 315,000
110,000

$ 292,000
65,000

$ 134,500

$ 425,000

$ 357,000

Original
Partners
$ 45,500

Original
Partners
$ 15,000
New
Partner
$ 8,000

145

Ch. 14Exercises

Exercise 14-5, Concluded

Proof:
Book value of original partnership.....
Asset appreciation (depreciation)......
Goodwill traceable to original
partnership.....................................
Goodwill traceable to new partner.....
(h) Investment of new partner.................
Total capital of new partnership.........
(c) New partners interest in capital........
New partners capital balance...........
(a)

$130,500
(50,000)

$190,000
125,000

45,500

$242,000
50,000

15,000

54,000
$180,000

30%
$ 54,000

110,000
$440,000

25%
$110,000

8,000
65,000
$365,000

20%
$ 73,000

EXERCISE 14-8
(1) Allocation of typical profits under the original partnerships agreement:

Salaries.................................
Bonus to A*...........................
Remaining profits..................
Total......................................

A
$30,000
12,000
10,000
$52,000

B
$30,000

C
$40,000

4,000
$34,000

6,000
$46,000

Cumulative
Total
$100,000
112,000
132,000

*Bonus = 10% (Net Income Bonus)


110% Bonus = 10% (Net Income)
110% Bonus = $13,200
Bonus = $12,000
Allocation of new partnership profits necessary to satisfy Bower:

Salaries.......................................
$130,000
Remaining profits*.......................
270,000
Bonus to Dawson**.....................
290,000
Total............................................

Cumulative
D

A
Total
$30,000

$30,000

$40,000

$30,000

42,000

14,000

42,000

42,000
20,000

$72,000

$44,000

$82,000

$92,000

*In order for Bower to increase his allocation by $10,000, he would need to receive a
$14,000 allocation based on the profit percentage. Therefore, the total amount of profit
subject to this allocation would be $140,000 ($14,000 divided by 10%).
**If the cumulative total of income allocated before the bonus to Dawson is $270,000, then
Dawson would be entitled to the $20,000 bonus under the revised partnership
agreement.

Ch. 14Exercises

146

(2) The fair value of the net assets of the original partnership is $56,000 ($530,000
$474,000). If Dawson acquires a 30% interest in the capital of the partnership, this would
mean that the fair value traceable to the original partnership would represent 70% of the
new partnerships total capital. Therefore, the total capital of the new partnership would be
$80,000 ($56,000 70%), and Dawson would have to pay $24,000 ($80,000 $56,000) for
a 30% interest in the new partnership.

147

Ch. 14Exercises

Exercise 14-8, Concluded


(3) If the partnership were liquidated as described, Bower would receive additional cash of
$88,200, determined as follows:
Noncash
Cash
Assets
Chambers
Beginning balances........ $
0 $ 680,000
60,000
Recognition of liability....
(1,200)
Vehicle transfer..............
(20,000)
(1,500)
Sales of assets...............
515,000 (660,000)
(43,500)
Payment of liabilities...... (434,000)
Balances........................ $ 81,000 $
0
13,800
Contribution of assets....
12,000
Allocation of deficit.........
(9,000)
Balances........................ $ 93,000 $
0
4,800

Offset Capital Balances


Liabilities

Arnold

Bower

$ 430,000

$ 50,000

$140,000

4,000

(2,000)

(800)

(2,500)

(16,000)*

(72,500)

(29,000)

(434,000)
$
0 $ (27,000) $ 94,200
12,000
15,000
$

*$15,000 fair value + (20% $5,000 book value vs. fair value) = $16,000

(6,000)
$ 88,200

Ch. 14Problems

148

PROBLEM 14-2
(1) Partner Bs capital balance will now be 80% of $30,000 or $24,000.
(2) The understatement of $25,000 is traceable to the original partnership and the total
partners capital would increase $25,000 to a revised total of $140,000. The $140,000
would represent 70% of a new suggested value of $200,000 ($140,000 divided by 70%).
Therefore, Partner D would be expected to contribute $60,000 of consideration ($200,000
less $140,000).
(3) The overstatement of $25,000 is traceable to the original partnership and the total partners
capital would decrease $25,000 to a revised total of $90,000. The $90,000 would represent
75% of a new suggested value of $120,000 ($90,000 divided by 70%). Therefore, Partner D
would be expected to contribute $30,000 of consideration ($120,000 less $90,000).

(4) The capital of the original partnership plus the contribution of the new partner would total
$181,000 of which Partner D would have a 30% interest or $54,300. Therefore, a bonus of
$11,700 ($66,000 less $54,300) would be allocated to the original partners. Partner Bs
interest in the bonus would be 30% or $3,510 resulting in a new capital balance of $33,510.
(5) The contribution of $66,000 represents a 30% interest in a partnership with a total value of
$220,000. Therefore, the value traceable to the original partnership must be $154,000
($220,000 less $66,000) of which $115,000 was previously recognized. This suggests
goodwill traceable to the original partnership of $39,000 ($154,000 $115,000) of which
30% is allocable to Partner B. Partner Bs revised capital balance would be $41,700
($30,000 plus 30% of $39,000).
(6) After the contribution of $70,000 the total capital of the new partnership would be $185,000
of which the new partner would have a 30% interest or $55,500 (30% times $185,000). This
suggests that a bonus of $14,500 ($70,000 $55,500) is traceable to the original partners.
Partner As interest in the bonus is $7,250 resulting in a revised capital balance of $77,250.
(7) The $25,000 understatement in value of the recognized assets is traceable to the original
partners and total partnership capital would increase to $140,000 ($115,000 plus $25,000).
Dividing the $140,000 by 70% (the original partners interest in the new partnership) would
suggest a value of $200,000. This would suggest that the new partner should pay $60,000
for a 30% interest in the partnership. However, the fact that the new partner is paying more
than that suggests that there is good will traceable to the original partnership and that the
new partners investment of $70,000 represents 30% of a total value of $233,333 ($70,000
divided by 30%). Comparing this total value of $233,333 against the revised original book
value of $140,000 and the investment of $70,000 results in goodwill of $23,333 ($233,333
$140,000 $70,000).
(8) The $25,000 understatement in value of the recognized assets is traceable to the original
partners and total partnership capital would increase to $140,000 ($115,000 plus $25,000).
Dividing the $140,000 by 70% (the original partners interest in the new partnership) would
suggest a value of $200,000. This would suggest that the new partner should pay $60,000
for a 30% interest in the partnership. However, the fact that the new partner is paying less

149

Ch. 14Exercises

than $60,000 suggests that the new partner is also contributing goodwill in the amount of
$35,000 ($60,000 $25,000).
(9) Adjusting the partnership for the $30,000 understatement in value would increase Bs
capital to $39,000 ($30,000 + 30% times $30,000). If B is paid $51,000 for their interest,
this suggests that $12,000 ($51,000 $39,00) represents Bs 30% interest in total entity
goodwill of $40,000 ($12,000 divided by 30%). After recording this information, As capital
balance would be $105,000 ($70,000 +50% times the $30,000 asset appreciation + 50% of
the $40,000 of goodwill).($145,000 ($115,000 + $30,000).

Ch. 14Problems

1410

PROBLEM 14-3
(1)
Pre-sale capital balance........................
Sale to Grossman..................................
Post-sale capital balance......................
(2)
Pre-sale capital balance........................
Recognize only decreases in the
value of existing assets.....................
Sale to Grossman..................................
Post-sale capital balance......................
(3)
Pre-sale capital balance........................
Recognize only decreases in the
value of existing assets.....................
Sale to partnership................................
Post-sale capital balance......................
(4)
Pre-sale capital balance........................
Recognize only decreases in the
value of existing assets.....................
Recognition of Zeigler's goodwill...........
Sale to partnership................................
Post-sale capital balance......................
(5)
Pre-sale capital balance........................
Recognize only decreases in the
value of existing assets.....................
Recognition of all suggested goodwill....
Sale to partnership................................
Post-sale capital balance......................
(6)
Pre-sale capital balance........................
Recognize all changes in the
value of existing assets.....................
Recognition of all suggested goodwill....
Sale to partnership................................
Post-sale capital balance......................

Grossman

Casper

$125,000
150,000
$275,000

$200,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

$200,000

(15,750)

Ziegler

Total

$ 150,000 $ 475,000
(150,000)

$
0 $ 475,000

(12,250)
143,000
$255,750

(7,000)
(35,000)
(143,000)

$
0 $ 440,000

$184,250

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(14,000)
(8,500)
$102,500

(14,000)
(7,000)
(35,000)
(8,500) (143,000) (160,000)
$177,500 $
0 $ 280,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(14,000)

(14,000)

(7,000)
(35,000)
17,000
17,000
(160,000) (160,000)
$
0 $ 297,000

$111,000

$186,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

(14,000)
34,000

(14,000)
34,000

(7,000)
(35,000)
17,000
85,000
(160,000) (160,000)
$
0 $ 365,000

$145,000

$220,000

Grossman

Casper

Ziegler

Total

$125,000

$200,000

$ 150,000

$ 475,000

8,000
12,000

8,000
12,000

$145,000

$220,000

4,000
20,000
6,000
30,000
(160,000) (160,000)
$
0 $ 365,000

Note: This problem provides an opportunity to discuss which of the above alternatives, if any, is
most appropriate. Consideration should be given to what is currently allowed by generally
accepted accounting principles.