I would like to record about the key points of the US CPA exam content.
<Create and note the points based on mainly Becker’s workbook>
Bonus Method
- This method involves distributing (or charging) the difference between the fair value of the asset invested by the new partner and the new partnership’s capital balances among the existing partners when a new partner joins or an existing partner leaves.
- The difference between the invested asset and the granted capital balance is distributed (or charged) to the existing partners as a bonus.
- When a new partner joins: If the fair value of the asset invested by the new partner exceeds the capital balance granted, the difference is distributed as a bonus to the existing partners. If the fair value of the asset invested by the new partner is less than the capital balance granted, the difference is borne by the existing partners.
- Example: Assume existing partners A and B have capital balances of $60,000 and $20,000 respectively. A new partner, C, invests land worth $15,000 and is granted a 20% capital interest. The total capital balances of the new partnership will be $95,000 ($60,000 + $20,000 + $15,000). C’s capital balance will be 20% of $95,000, which is $19,000. The difference of $4,000 between the $15,000 fair value of the land and the $19,000 capital balance is distributed as a bonus to the existing partners A and B.
Goodwill Method
- This method involves recording goodwill to adjust the partnership’s capital balances when a new partner joins or an existing partner leaves.
- Goodwill is recorded based on the invested asset and allocated to the existing partners.
- When a new partner joins: The total fair value of the partnership is re-evaluated based on the new partner’s investment, and goodwill is recorded. This goodwill is allocated to the existing partners.
- Interest paid from Partner’s capital balance: the interest comes “out of” the profit, resulting in a loss, which is loss of the partnership company and the profit of partners.
- Example: Assume existing partners A and B have capital balances of $60,000 and $20,000 respectively. A new partner, C, invests $20,000 and is granted a 20% capital interest. The total fair value of the partnership will be $100,000 ($20,000 / 20%). Based on this value, goodwill of $20,000 ($100,000 – $60,000 – $20,000) is recorded. This goodwill is allocated to the existing partners A and B.
- Example: Under the partnership agreement, each partner has an equal initial capital balance accounted for under the goodwill method. the difference amount of the initial contributions between partners is recorded as Goodwill which is allocated to existing partners to make each initial capital balance as equal. For example, if one partner’s initial contribution amount is 60 and another partner’s contribution is 20, the 40 Goodwill is recorded, and it will be allocated to another partner’s contribution.
A partner’s retirement treatment
<Bonds Method>
- In the bonus method, goodwill is not recognized as an asset. Instead, any bonus paid to the retiring partner is directly deducted from the capital accounts of the remaining partners.
- Merits: Simplified Process: The accounting process is relatively simple and straightforward since goodwill is not recognized. Immediate Fair Distribution: Payments to the retiring partner are made immediately, ensuring a fair and prompt distribution. No Impairment Risk: Since goodwill is not recognized, there is no need for future impairment processing.
- Demerits: Lack of Actual Value Reflection: The actual market value and intangible assets of the company or partnership are not reflected in the financial statements. Capital Fluctuations among Partners: Payments to the retiring partner reduce the capital of the remaining partners, affecting the balance among them. Reduced External Credibility: Since goodwill is not recognized, the financial reports may lack credibility with external investors and business partners.
- Premise: There is a partnership consisting of Allen, Beck, and Chale. The capital balances are as follows: Allen’s capital balance: $50,000, Beck’s capital balance: $30,000, Chale’s capital balance: $20,000 The profit and loss sharing ratio is Allen: Beck= 5:3:2.
- Example: Allen is retiring from the partnership.
- New goodwill has been valued at $30,000. The cash settlement amount for Allen’s retirement is based on Allen’s capital balance plus the new goodwill allocated to Allen.
- Allen’s final capital balance: $50,000 (original capital) + $30,000 (Allen’s share of new goodwill) = $80,000
- Allocation of the bonus: $30,000 is deducted from Beck and Chale’s capital based on their profit-sharing ratios. Beck’s share = $30,000 * (3/5) = $18,000, Chale’s share = $30,000 * (2/5) = $12,000
- Journal Entry:
- Dr. Beck’s Capital $18,000
- Dr. Chale’s Capital $12,000
- Dr. Allen’s Capital $50,000
- Cr. Cash $80,000
<Goodwill Method>
- Under the goodwill method, goodwill is recorded as an asset, and all partners’ capital balances are adjusted, resulting in a change in the total net assets of the partnership.
- Goodwill is recorded as an asset, and all partners’ capital balances are adjusted upon Allen’s retirement.
- Recording of goodwill: Goodwill of $30,000 is recorded as an asset.
- Allocation of goodwill: The goodwill is allocated based on the ratio Allen:Beck= 5:3:2. Allen’s share = $30,000 * (5/10) = $15,000, Beck’s share = $30,000 * (3/10) = $9,000, Chale’s share = $30,000 * (2/10) = $6,000
- Dr. Goodwill $30,000
- Cr. Allen’s Capital $15,000
- Cr. Chale’s Capital $9,000
- Cr. Allen’s Capital $6,000
- Dr. Allen’s Capital $65,000
- Cr. Cash $65,000
- suppose a company successfully completes a new project, and the revenue from this project significantly exceeds the overall company revenue. When a partner who has made a substantial contribution to this success retires, the company evaluates his contribution and makes an additional payment. This payment reflects the intangible value (goodwill) generated by his contribution, resulting in an increase in the company’s goodwill.
- (Difference) The cash settlement amount for a departing partner differs between the bonus method and the goodwill method. The bonus method redistributes capital among the remaining partners, while the goodwill method adjusts capital accounts based on the overall valuation of the partnership. The choice between these methods depends on the partnership agreement and accounting policies.
- (Common) Sales of assets : The amount received from the sale of an asset corresponds to the capital value, so only the gain or loss on sale should be reflected in the reconciliation statement. In accounting for partnership withdrawal, dissolution or admission: The bonus method increases (or decreases) the individual partners accounts without changing total net assets of the partnership. Since the capital accounts of Beck and Chale decreased, goodwill was not recorded as an asset, but instead the bonus paid to Allen was charged against the capital accounts of the remaining partners. The goodwill method increases the individual partners accounts and also changes total net assets of the partnership.
- (Common) A loan from a partner to the partnership will be offset against the receivable and payable as a non-cash transaction.
