Reference no: EM133044587

Question - Exiting partners under the bonus method and liquidation. Midway Construction was a partnership owned by Davis, Murray, and Clay with yearend 2013 capital balances of $50,000, 80,000, and $70,000, respectively. Davis and Murray each received an annual salary of $100,000. Clay was primarily involved in sales and received a salary of $70,000 and a bonus of 20% of net income after salaries. All remaining profits were allocated equally among the partners. In the event of insufficient income or operating losses, each provision of the agreement would be satisfied to whatever extent possible given the order of salaries, interest, bonus, and percentages. Salaries are distributed at the end of each calendar quarter, and Clay's bonus is distributed at the end of the first month subsequent to year-end. Eighty percent of all other allocated income (income other than salary and bonus) is distributed to the partners at the end of the first quarter subsequent to year-end. During 2013, the partnership had net income of $450,000 and proceeded to construct a number of spec homes during 2014.

Unfortunately, during 2014, interest rates increased, and the economy experienced a significant slowdown, resulting in partnership income of only $300,000. In order to improve cash flows, on January 1, 2015, Rayburn made a capital contribution to the partnership of $59,000 cash and received a 50% interest in capital. Rayburn would receive a profit allocation equal to interest of $5,900 in 2015 and a 10% profit percentage. In 2016, Rayburn would receive interest of 10% on average capital, before allocation of 2016 profits, and a 10% profit allocation. The previous partners' profit and loss agreement was modified to provide for salaries at one-half of previous levels, none of which were to be distributed, and profit percentages of 30% each. All other aspects of the previous profit-sharing agreement remained in effect. During the year 2015, conditions worsened, and the partnership reported income of $142,000. At year-end 2015, Davis sold its capital interest to the partnership in exchange for $49,400 and received no further distributions. At the beginning of 2016, Murray loaned the partnership $50,000 with the necessary loan documents providing for interest at the rate of 6%. The profit-sharing agreement for 2013 was completely changed to simply provide for interest on capital to Rayburn as previously set forth and all remaining profits to be allocated 40%, 40%, and 20% for Murray, Clay, and Rayburn, respectively. The only withdrawal to take place during 2016 was the distribution of Clay's 2015 bonus.

The partnership could no longer sustain the economic downturn, and the decision was made to liquidate the partnership after having reported net income of $110,000 during the first six months of 2016. At the beginning of the liquidation process, the partnership had $15,000 in cash and liabilities, excluding loans from partners, of $84,000. Noncash assets of the partnership were liquidated as follows:

1. On August 1, 2016, assets with a book value of $220,000 were sold for $180,000.

2. On September 1, 2016, assets with a book value of $70,000 were sold for $82,000.

Prior to any further liquidation of assets, all available cash other than $10,000 held for future expenses was to be distributed to the partners on September 15, 2016.

1. Prepare a schedule analyzing the partners' capital prior to liquidation of the partnership. Assume use of the bonus method to record all changes in the ownership structure of the partnership.

2. Prepare a schedule of cash payments on September 15, 2016, of the liquidation, showing how the available cash was distributed. Supporting calculations should be in good form.