Problem 17 - Accounting

Question

Luke Gilbert is to retire from the partnership of Gilbert and Associates as of March 31, the end of the current fiscal year. After closing the accounts, the capital balances of the partners are as follows: Luke Gilbert, \(\$ 245,000\); Marissa Cohen, \(\$ 125,000\); and Tyrone Cobb, \(\$ 140,000\). They have shared net income and net losses in the ratio of \(3: 2: 2\). The partners agree that the merchandise inventory should be increased by \(\$ 24,000\), and the allowance for doubtful accounts should be increased by \(\$ 5,800\). Gilbert agrees to accept a note for \(\$ 200,000\) in partial settlement of his ownership equity. The remainder of his claim is to be paid in cash. Cohen and Cobb are to share equally in the net income or net loss of the new partnership. Journalize the entries to record (a) the adjustment of the assets to bring them into agreement with current market prices and (b) the withdrawal of Gilbert from the partnership.

Step-by-Step Solution

Answer

Adjust inventory and allowance accounts, then record Gilbert's withdrawal as a note and cash payment.

Step 1: Adjust Inventory Value

The merchandise inventory needs to be increased by \( \\(24,000 \). This increase is distributed according to the old profit-sharing ratio of \( 3:2:2 \) for Gilbert, Cohen, and Cobb. To calculate the change in each partner's capital account, divide the increase in inventory by the sum of the ratio's parts \( 3+2+2 = 7 \), then multiply by each partner's share. - Increase in inventory: \( \\)24,000 \)- Gilbert's share: \( \frac{3}{7} \times \\(24,000 = \\)10,286 \)- Cohen's share: \( \frac{2}{7} \times \\(24,000 = \\)6,857 \)- Cobb's share: \( \frac{2}{7} \times \\(24,000 = \\)6,857 \)The journal entry is:Inventory: Debit \( \\(24,000 \)Luke Gilbert, Capital: Credit \( \\)10,286 \)Marissa Cohen, Capital: Credit \( \\(6,857 \)Tyrone Cobb, Capital: Credit \( \\)6,857 \).

Step 2: Adjust Allowance for Doubtful Accounts

The allowance for doubtful accounts needs to be increased by \( \\(5,800 \). This increase will also be distributed according to the profit-sharing ratio of \( 3:2:2 \). Divide \( \\)5,800 \) by 7, then multiply by each partner's share:- Increase in allowance: \( \\(5,800 \)- Gilbert's share: \( \frac{3}{7} \times \\)5,800 = \\(2,486 \)- Cohen's share: \( \frac{2}{7} \times \\)5,800 = \\(1,657 \)- Cobb's share: \( \frac{2}{7} \times \\)5,800 = \\(1,657 \)The journal entry is:Allowance for Doubtful Accounts: Credit \( \\)5,800 \)Luke Gilbert, Capital: Debit \( \\(2,486 \)Marissa Cohen, Capital: Debit \( \\)1,657 \)Tyrone Cobb, Capital: Debit \( \$1,657 \).

Step 3: Calculate Adjusted Capital Balances

After adjusting for inventory and the allowance for doubtful accounts, calculate the new capital balances.- Adjusted capital for Gilbert: \( \\(245,000 + \\)10,286 - \\(2,486 = \\)252,800 \)- Adjusted capital for Cohen: \( \\(125,000 + \\)6,857 - \\(1,657 = \\)130,200 \)- Adjusted capital for Cobb: \( \\(140,000 + \\)6,857 - \\(1,657 = \\)145,200 \)

Step 4: Record Withdrawal of Luke Gilbert

Luke Gilbert withdraws from the partnership by accepting a \( \\(200,000 \) note, with the remaining \( \\)52,800 \) to be paid in cash.The journal entry is:Luke Gilbert, Capital: Debit \( \\(252,800 \)Notes Payable: Credit \( \\)200,000 \)Cash: Credit \( \$52,800 \).

Step 5: Final Capital Balances for Remaining Partners

Since Luke Gilbert has withdrawn from the partnership, only Cohen and Cobb remain. Their capital balances are unaffected from Gilbert's departure aside from the runtime adjustments, as noted in Step 3.- Cohen's final capital balance: \( \\(130,200 \)- Cobb's final capital balance: \( \\)145,200 \)

Key Concepts

Journal Entries

Journal entries are essential in accounting, providing a formal record of a transaction. In the scenario of a partnership like Gilbert and Associates, journalizing the entries helps document adjustments and changes in partnership capital.

When an adjustment is needed, for instance, like increasing merchandise inventory by $24,000, a journal entry is made to reflect a debit to inventory and credits to the capital accounts of the partners based on their profit-sharing ratio. Similarly, adjustments to the Allowance for Doubtful Accounts require journal entries that show a credit to the allowance and debits to each partner's capital account.

Steps in recording journal entries include:

• Identifying the accounts affected by the transaction.
• Determining the type of adjustment: whether to debit or credit the accounts.
• Referencing the correct amount for each entry based on the partner's profit-sharing agreement.

By completing these steps, the journal entries accurately reflect the financial changes resulting from partner agreements. Proper journal entries ensure transparency and accuracy in financial records.

Capital Account Adjustment

Capital account adjustments are crucial when a partner retires, as seen in Gilbert's case. These adjustments reflect changes in the net worth of each partner due to asset revaluation or changes in liabilities like the provision for doubtful accounts.

In the given example, as partners agree on an increase in merchandise inventory and allowance for doubtful accounts, these adjustments affect capital accounts:

• For an increase in inventory, the partners’ capital accounts are credited according to their profit-sharing ratios of 3:2:2, reflecting their share of increased assets.
• For an increase in the allowance for doubtful accounts, their accounts are debited, indicating each partner’s share of the additional liability.

Formula for determining each partner’s adjustment: takes the total adjustment amount, divides by the sum of ratio parts, and multiplies by the individual partner's share.

These calculations ensure each partner’s capital account is correctly adjusted to reflect their share of the partnership's current market value.

Profit-Sharing Ratio

The profit-sharing ratio in a partnership agreement dictates how income or loss is divided among partners, playing a crucial role in financial transactions like withdrawals or asset revaluations.

In partnerships, the profit-sharing ratio often reflects each partner’s contribution to and risk in the business. For Gilbert and Associates, the profit-sharing ratio of 3:2:2 means Gilbert receives a larger share compared to the other partners, which affects all financial decisions, such as asset adjustments or when a partner withdraws.

To illustrate, when adjusting for an increased inventory or doubtful accounts, this ratio dictates the portion charged or credited to each capital account. Understanding this ratio is key for uniformity in financial reporting and equitably honoring the partnership agreement.

• Ensure all partners agree on the ratio beforehand to avoid disputes.
• Apply ratios consistently in each financial adjustment for fairness.

This transparency helps maintain trust and clear understanding between partners, particularly crucial during significant changes like a partner’s retirement.