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Problem 12-2A: Allocating partnership income and loss; sequential years L.O. P2 Irma
Watts and John Lyon are forming a partnership to which Watts will devote one-half time
and Lyon will devote full time. They have discussed the following alternative plans for
sharing income and loss: (a) in the ratio of their initial capital investments, which they
have agreed will be $42,000 for Watts and $63,000 for Lyon; (b) in proportion to the time
devoted to the business; (c) a salary allowance of $6,000 per month to Lyon and the
balance in accordance with the ratio of their initial capital investments; or (d) a salary
allowance of $6,000 per month to Lyon, 10% interest on their initial capital investments,
and the balance shared equally. The partners expect the business to perform as follows:
Year 1, $36,000 net loss; Year 2, $90,000 net income; and Year 3, $150,000 net income.
Required: Complete the tables, one for each of the first three years, by showing how to
allocate partnership income or

Preliminary calculations
Plan (a) & Plan (c) Percentages based on initial investments
Watts = $42,000/$105,000 = 40%
Lyon = $63,000/$105,000 = 60%

Plan (b) Percentages based on time

Watts = 0.5/1.5 = 33 1/3%
Lyon = 1.0/1.5 = 66 2/3%

Plan (c) & Plan (d) Salary allowance

Lyon= 12 x $6,000 = $72,000

Plan (d) Interest allowances

Watts = 10% x $42,000 = $ 4,200
Lyon= 10% x $63,000 = $ 6,300

Income (Loss) Year 1

Sharing Plan Calculations Watts Lyon

(a) 40% x $36,000 loss...................................................

$(14,400)
60% x $36,000 loss................................................... $(21,600)

(b) 33 1/3% x $36,000 loss.............................................

$(12,000)
 66 2/3% x $36,000 loss............................................. $(24,000)

(c) Salary allowance...................................................... $ 72,000

40% x ($36,000 loss + $72,000 salary).................... $(43,200)
60% x ($36,000 loss + $72,000 salary).................... ________ (64,800)
Totals.........................................................................
$(43,200) $ 7,200

(d) Salary allowance...................................................... $ 72,000

Interest allowances..................................................
$ 4,200 6,300
50% x ($36,000 loss + $72,000
salary + $10,500 interest)...................................... (59,250) (59,250)
Totals.........................................................................
$(55,050) $ 19,050

Income (Loss) Year 2

Sharing Plan Calculations Watts Lyon

(a) 40% x $90,000 income..............................................

$36,000
60% x $90,000 income.............................................. $54,000

(b) 33 1/3% x $90,000 income........................................

$30,000
66 2/3% x $90,000 income........................................ $60,000

(c) Salary allowance...................................................... $72,000

40% x ($90,000 income - $72,000 salary)................... $ 7,200
60% x ($90,000 income - $72,000 salary)................... _______ 10,800
Totals.........................................................................
$ 7,200 $82,800

(d) Salary allowance...................................................... $72,000

Interest allowances.................................................. $ 4,200 6,300
50% x ($90,000 income - $72,000
salary - $10,500 interest)....................................... 3,750 3,750
Totals.........................................................................
$ 7,950 $82,050

Income (Loss) Year 3

Sharing Plan Calculations Watts Lyon

(a) 40% x $150,000 income............................................

$60,000
 60% x $150,000 income............................................ $ 90,000

(b) 33 1/3% x $150,000 income......................................

$50,000
66 2/3% x $150,000 income...................................... $100,000

(c) Salary allowance...................................................... $ 72,000

40% x ($150,000 income - $72,000 salary)............. $31,200
60% x ($150,000 income - $72,000 salary)............. _______ 46,800
Totals.........................................................................
$31,200 $118,800

(d) Salary allowance...................................................... $ 72,000

Interest allowances.................................................. $ 4,200 6,300
50% x ($150,000 income - $72,000
salary - $10,500 interest).......................................33,750 33,750
Totals.........................................................................
$37,950 $112,050