Problem 10 - Accounting

Question

Lia Wu and Becca Sims are partners who share in the income equally and have capital balances of \(\$ 150,000\) and \(\$ 62,500\), respectively. Wu, with the consent of Sims, sells onethird of her interest to Kara Oliver. What entry is required by the partnership if the sales price is (a) \(\$ 40,000\) ? (b) \(\$ 60,000\) ?

Step-by-Step Solution

Answer

(a) Credit Oliver and debit Wu for \( \$50,000 \). (b) Same entry, as Wu's gain is personal.

Step 1: Understanding the Partnership Capital

Initially, Lia Wu and Becca Sims have capital balances of \( \\(150,000 \) and \( \\)62,500 \), respectively. They share in the income equally, meaning both partners have an equal stake in the partnership profits and losses.

Step 2: Calculate Wu's Capital to be Transferred

Lia Wu decides to sell one-third of her interest. Her total capital is \( \\(150,000 \). One-third of this amount is calculated as follows: \( \text{One-third of } \\)150,000 = \frac{1}{3} \times 150,000 = \$50,000 \). This is the capital amount Kara Oliver will receive from Wu's total capital.

Step 3: Transaction Entry for Sales Price (a) \( \$40,000 \)

When Wu sells her one-third interest for \( \\(40,000 \), Kara pays less than the book value of what she receives (\( \\)50,000 \)). Therefore, Wu incurs a loss. The entry to record this in the partnership books is: \[\text{Credit Kara Oliver's Capital: } \\(50,000\] \[\text{Debit Lia Wu's Capital: } \\)50,000\] Where Lia Wu's capital reduces by \( \$50,000 \) representing the loss.

Step 4: Transaction Entry for Sales Price (b) \( \$60,000 \)

When Wu sells her one-third interest for \( \\(60,000 \), Kara pays more than the book value of what she receives (\( \\)50,000 \)). Therefore, Wu gains. The entry to record this in the partnership books is: \[\text{Credit Kara Oliver's Capital: } \\(50,000\] \[\text{Debit Lia Wu's Capital: } \\)50,000\] The additional \( \$10,000 \) is Wu’s personal gain and does not affect the partnership record.

Key Concepts

Income Sharing in Partnerships

Partnerships often involve multiple partners who agree on how to share income or losses. In the case of Lia Wu and Becca Sims, the partners have chosen to share income equally. This means that any profit or loss generated by the partnership will be divided equally between the two partners.
This is expressed in their partnership agreement, and it determines how much of the profit each partner receives or how much loss each bears.

• This equal sharing is based on their agreement and not necessarily on the amount of capital each has contributed.
• Understanding the income sharing ratio is crucial for all partners as it affects how much return each partner will get from the business.
• It also affects decision-making and financial planning within the partnership.

Every partnership may have a different income-sharing agreement depending on the needs and contributions of the partners.

Capital Balance Adjustments

Capital balances in partnerships reflect each partner’s stake and responsibility in the business. Any changes in these balances, such as a partner selling part of their interest, require adjustments.
In Lia Wu's case, when she sells one-third of her interest, it affects her capital balance:

• Lia's initial capital balance is $150,000.
• She sells one-third of her interest, which amounts to $50,000.
• The sale means subtracting this amount from her capital balance, affecting the overall distribution of capital in the partnership.

After the sale, the new partner’s capital balance needs crediting for the amount of the interest they acquire. This action ensures that the capital structure remains accurately represented in the financial records.

Partnership Interest Sale

Selling a partnership interest involves transferring a portion of one partner's stake to another party. When Lia Wu decides to sell one-third of her interest, Kara Oliver steps in to buy it.
Here's what happens during such a transaction:

• If Kara pays $40,000 for the interest, which is less than its book value of $50,000, Wu incurs a $10,000 loss. The partnership records this transaction by crediting Kara's capital with $50,000 and debiting Wu's with the same amount.
• If Kara pays $60,000, more than the book value, Wu makes a $10,000 gain. However, the partnership only records the book value of $50,000 for both the debit and credit entries.

Selling a partnership interest like this does not alter the partnership's net assets but adjusts how those assets are distributed among the partners.