[greenjuice]

Help everyone!

I’m almost done with chapter 10 except there’s one question really confuses me.

Chapter 10 Becker Simulation-#6 Question#4

Here’s the question:

On January 1, Year 1, Johnson (J), Smith (S), and Henry (H) formed a legal services partnership. Initially, J contributed $12,000,000, S contributed $18,000,000, and H contributed $30,000,000 for a partnership profit and loss sharing ratio of 20%, 30%, and 50%, respectively. As part of the original partnership agreement, the partnership will pay H an annual salary of $100,000 for overseeing daily business activity. In addition, the partners agreed H should receive a 10% guaranteed bonus of any partnership profits prior to distributing any earnings to the individual partners. The partnership will pay interest of 2% on the partners’ capital balances at each fiscal year end. The partnership generated net profit of $4,000,000 during its first year of operations.

At the beginning of Year 2 the partnership admitted Cunningham (C) as an additional partner. As part of the agreement, Cunningham provided a capital contribution of $20,000,000 in return for a 20% partnership interest.

In the third quarter of Year2, S decided to withdraw from the partnership. The partnership determined that the fair value of the partnership’s assets was 110,000,000 and the adjusted profit/loss ratios for J, S, H and C were now 15%, 25%, 40$ and 20% respectively.

Question#4: What is the amount paid to S upon withdrawal from the partnership in Year 2 assuming the goodwill method is used? Assume there was no change to the partner’s capital accounts after admitting C at the beginning of Year 2.

Here’s the solution of Q4:

Original S capital balance 18,000,000

Add: Admission of Partner C 6,000,000

Asset Adjustment of FMV to S captial 2,500,000 (110,000,000-100,000,000)*25%

Payoff to S partner=26,500,000

Where did the 100,000,000 come from?

Anyone could help me out here?

[taxgeek83]

It's been a bit, but I think this your explanation (someone correct me if I'm wrong):

The $100,000,000 is the FMV of the partnership at the time of C's buy-in. C bought in for $20,000,000 which gave C a 20% interest; $20,000,000/20% = $100,000,000.

[greenjuice]

Thank you! This has helped a lot!

[Author]

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