Rodgers and Michael formed a partnership on January 2, 2017. Michael invested $1

Question

Rodgers and Michael formed a partnership on January 2, 2017. Michael invested $120,000 in cash. Rodgers invested land valued at $30,000, which he had purchased for $20,000 in 2005. In addition, Rodgers possessed superior managerial skills and agreed to manage the firm. The partners agreed to the following profit and loss allocation formula:

a.    Interest —8% on original capital investments.

b.   Salary — $5,000 a month to Rodgers.

c.    Bonus — Rodgers is to be allocated a bonus of 20% of net income after subtracting the bonus, interest, and salary.

d.   Remaining profit is to be divided equally.

At the end of 2017 the partnership reported net income before interest, salaries, and bonus of $168,000.

Calculate the amount of bonus to be allocated to Rodgers.

Explanation / Answer

Each partner’s initial investment in a partnership should be recorded at the fair market value of the assets at the date of their transfer to the partnership.

The value of the land contributed by Rodger will be taken as $30000.

Capiat balances:

Rodger : $30000

Michael : $ 120000

a) Interest on capital balances @ 8%:

Rodger = 8% * $30000 = $2400

Michael = 8% * $120000 = $9600

Total interest paid to partners = 2400+9600 = $12000

b) Salary:

Rodger: $5000 per month = $5000 x 12 = $60000 per year

c) Let bonus to Rodger be "B"

According to the condition:

B = 20% of [$168000 - ($12000 + $60000 + B)]

B = 20% of [96000 - B]

B = 20% of $96000 - 20% of B

B + 0.20B = $19200

1.20B = $19200

B = $19200 / 1.20 = $16000

The bonus to be paid to Rodger = $16000

Check:

Net profit after bonus, salary and interest = $168000 - $16000 - $60000 - $12000 = $80000

Bonus = 20% * 80000 = $16000

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