Accounting Final Exam - Question #2?

Question

Johnson and Smith are partners sharing profits & losses in a 3:2 ratio. Their capital balances are $10,000 and $20,00, respectively. The partners agree to admit Don for $10,000 for a 30% interest in the partnership. Smith's capital balance after admitting Don is......

a - $12,000
b - $19,200
c - $20,000
d - $20,800

Please help!!!

Answer 1

When a partnership share is bought for less than it is worth (discount), we need to account for the differences between the purchase price and the actual worth. The purchase price is $10k. The actual worth is $10k + $20k +$10K = $40k. If Don is getting a 30% share, theoretically he should pay in 0.3 x $40k or $12k, but he's asked to put in only $10k, i.e. Johnson and Smith are giving him a discount of $2k. Now Johnson and Smith must share the discount in the ratio 3:2. 3/5 of $2k is $1,200 (Johnson's share) and 2/5 of $2k is $800 (Smith's share). The journal entries would be:

Dr Cash $10,000
Dr Johnson, capital $1,200
Dr Smith, capital $800
Cr Don, capital $12,000

After admitting Don, Johnson's capital would be $10,000 less $1,200 or $8,800 and Smith's capital would be $20,000 less $800 or $19,200.

So the answer is (b) - $19,200