Thirty years ago, five mechanics formed a partnership and established an automob

Question

Thirty years ago, five mechanics formed a partnership and established an automobile repair shop. Two of the partners, Decker and Groth, are now retiring. The other three partners, Farmer, Wang, and Lux, are continuing the partnership. The original agreement called for an equal division of income. The remaining partners plan to continue this arrangement. The following balance sheet is prepared for the partnership as of the retirement date:

$1,060,000

All partners agreed that Decker should receive $287,500 for his interest in the business and Groth should receive $187,500. Farmer proposed the bonus method for recording the retirements. Wang objects to this method and suggests the partial goodwill approach.

(a) Prepare the journal entry to record the retirements under the bonus method.

(b) Prepare the journal entry to record the retirements under the partial goodwill approach.

c) Why does Wang object to the bonus method of accounting?

Under the bonus method, Wang's capital balance is reduced to zero.

Under the bonus method, Wang must pay cash to the other remaining partners.

Under the bonus method, Wang pays more cash to the retired partners.

Under the bonus method, no goodwill is attributed to Wang.

(d) Regardless of the accounting method employed, what immediate problem for the business can you identify at the time of retirement?

The firm's total debts exceed the assets available to pay those debts.

The firm is insolvent.

The firm is not profitable.

The firm does not have sufficient cash to pay the retirees.

Cash $130,000 Accounts payable $175,000 Accounts receivable 210,000 Loan payable 100,000 Inventory of parts 120,000 Capital - Decker 250,000 Equipment, net 300,000 Capital - Groth 150,000 Building, net 210,000 Capital - Farmer 225,000 Land 90,000 Capital - Wang 25,000 Capital - Lux 135,000 Total assets $1,060,000 Total liabilities and capital

$1,060,000

Explanation / Answer

Journal Entry Under Bonus Method (A) Particular Dr. Amount($) Cr. Amount($) 1 Farmer's capital          25,000.00 Wang's capital          25,000.00 lux's Capital          25,000.00 Decker's capital        250,000.00 Groth's Capital        150,000.00 Cash    437,500.00 The retiring partners are paid 437500 in cash and their capital account of 400000(250000+150000) is cleared. The cost of the bonus paid to the retiring partner (75,000) is allocated between the remaining partners In there profit sharing ratio i.e. 1:1:1 Journal Entry Under Partial Goodwill Method (B) Particular Dr. Amount($) Cr. Amount($) Goodwill        161,000.00 Assets    1,060,000.00 Liabilities    275,000.00 Cash    437,500.00 Farmer's capital    169,500.00 Wang's capital    169,500.00 5,08,500 is divided in the ratio of lux's Capital    169,500.00 01:01:01 Under Partial Goodwill approach , goodwill is calculated as follows Total assests-total liabilities 1060000-275000= 785000 Share of retiring partner= 785000*2/5 = 314000 Less Cash to be paid Decker           287500                                   Groth              187500                                  Goodwill=      161000 (C) Wang Object to bonus method because his capital is reduced to zero($25000-$25000) (D) The Immediate problem is that firm doesn't have sufficient cash to pay to retirees.

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