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APPENDIX C
FORMS OF BUSINESS ORGANIZATIONS
Below are brief descriptions of each problem. These descriptions are accompanied by the estimated time (in
minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially
filled-in working papers.
Problems
C–1 Partnership Transactions
Students are required to calculate partners’ share of net income, determine the
effects of income taxes for partners, and prepare a statement of partners’
equity.
15 Easy
C–2 Analysis of Equity
Students must analyze the effects of stockholders’ investments, net income,
and dividends on stockholders’ equity.
15 Easy
C–3 Division of Partnership Income
Students are required to distribute net income to partners, including interest,
salaries, and residual amounts.
15 Easy
C–4 Hot Dog Shack
Students are required to demonstrate their understanding of partnership
accounts and the nature of partnership income.
30 Medium
C–5 The Top Hat, Inc.
Record typical equity transactions for a corporation and prepare a statement of
retained earnings.
25 Medium
C–6 Frontier Western Wear, Inc.
Make entries to record equity transactions for a corporation and close Income
Summary and Dividends accounts. Prepare the stockholders’ equity section of
a corporation’s balance sheet.
30 Medium
C–7 Wesson Corporation and Martin Industries
Prepare the stockholders’ equity section of the balance sheet of two different
corporations.
25 Easy
C–8 S & X Co.
Prepare entries to record owner’s equity transactions in a sole proprietorship
and in a corporation. Contrast the nature of net income for these two types of
business organizations.
45 Strong
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345
*C–9 Avery and Kirk
Formation of a partnership, journal entries, and a beginning balance sheet.
Entries to close the Income Summary account and drawing accounts.
20 Easy
*C–10 Comedy Today
Profit sharing under a variety of agreements. Includes fixed ratio; interest on
beginning capital accounts and fixed ratio for balance; salaries to partners,
interest on capital accounts, and balance in fixed ratio. Journal entry to close
the Income Summary account.
25 Medium
*C–11 Rothchild Furnishings, Inc.
Sharing of income in a partnership when partnership agreement provides for
salaries to partners, interest on invested capital, and balance in a fixed ratio.
Separate cases handling a loss, a small profit, and a large profit.
30 Medium
C–12 Prime Cuts—a Tax Planning Case
An individual has recently incorporated his business and is now being
“hammered” by the effects of double taxation. Students are to compute the
overall tax burden of the corporation compared to the former proprietorship
and to make tax planning recommendations. A very practical “eye opener” to
the importance of tax planning.
*C–13 Ramirez and Smith
Given the plans, personal backgrounds, and financial status of two individuals
planning a partnership, draft an income-sharing agreement that will provide an
equitable division of partnership income between them. Also, prepare a 2-year
schedule showing how the recommended plan will work out under forecasts
of earnings. Write a defense of the profit-sharing plan in the light of the
division of earnings over the 2-year period.
40 Strong
30 Medium
____________
*Supplemental Topic A, “Partnership Accounting—A Closer Look.”
346
© The McGraw-Hill Companies, Inc., 2005
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1. Neither the house nor the mortgage should appear in the financial statements of Hanson Sporting
Goods. The house is a personal asset of Hanson’s, not an asset in use in the business. Similarly, the
mortgage is a personal liability, not a debt incurred by the business entity. The business entity
principle requires that a business entity be regarded as separate from the other affairs of its
owner(s).
2. The primary advantages of the partnership form of organization are the opportunity to bring
together sufficient capital to carry on a business and the opportunity to combine the specialized
skills of a group of individuals. In comparison to a corporation, the partnership form of organization
has the advantages of ease of organization, freedom from regulation, and flexibility of action
afforded the owners. In addition, the partnership might be organized in a form that limits the
liability of the owners.
The primary disadvantages of the general partnership form of organization are the unlimited
liability and the mutual agency features. Unlimited liability means that any one partner may be held
liable for all the debts of the partnership if the other partners prove unable to contribute. Mutual
agency means that one partner may enter into agreements that are binding upon all the other
partners.
3. Mutual agency means that every partner in a partnership has the right to bind that partnership to
contracts.
4. There are two important reasons why this type of business would probably be organized as a limited
partnership rather than as a regular partnership. First, the 50 investors throughout the state could be
designated as limited partners, thus limiting their personal liability for any losses incurred by the
business to the amount of their investment. If the business were organized as a regular partnership,
each investor could be held personally liable for business losses of an unlimited amount. Most
passive investors would not participate in an investment which did not provide for an absolute limit
as to the amount of possible loss.
The second reason for organization as a limited partnership is to centralize responsibility for
managerial decision with the two experienced real estate developers, who would be the general
partners. As the 50 investors are scattered throughout the state, they clearly will not be actively
involved in the daily management of the business. Hence, it is both unnecessary and undesirable for
each of these investors to have the right to bind the partnership to contracts. A limited partnership
restricts this authority to the general partners.
5. Salaries of owner-managers are an expense deducted in arriving at the net income of a corporation,
but no such deductions are generally made in determining the net income of a partnership. Also,
corporate net income has been reduced by corporate income taxes, but no tax has been paid on
partnership net income, which is taxable to the partners personally.
6. Partner Reed must report her share of the net income, $39,000, not the amounts of cash or other
assets she withdraws from the business.
7. a. Owners’ liability for debts of the business. Partners are jointly and individually liable for the
debts of the partnership. A corporation, however, is responsible for its own debts; the
stockholders in a corporation are not personally liable for the debts of the business entity. Thus,
the amount of money which a stockholder might lose by investing in a corporation is limited to
the amount of his or her investment.
b. Transferability of ownership interest. A partnership interest can be transferred only if the
remaining partners are willing to accept the new person into the partnership; shares of stock in a
corporation are freely transferable.
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347
c. Continuity of existence. A partnership is terminated upon the resignation or death of any partner
or the admission of a new partner; transfers of shares of stock of a corporation do not affect the
existence of the corporate entity.
d. Federal taxation on income. A corporation is subject to federal income tax on its income, and
stockholders are also subject to a personal income tax on any amounts they receive as
dividends. A partnership is not a taxable entity, but the partners must pay personal taxes on
their share of income earned by the partnership, whether or not it is actually withdrawn by them
from the partnership.
8. The term double taxation refers to the fact that the income of a corporation is taxed at two levels.
First, the income of a corporation is subject to corporate income taxes, which must be paid by the
corporation. Second, if the corporation distributes its earnings as dividends to stockholders, the
stockholders must pay personal income taxes on the amounts they receive. This double taxation of
income is one of the principle disadvantages of the corporate form of business organization.
*9. Consideration should be given to differences in the contributions of the partners to the business in
terms of the amount or value of services rendered; the amount of capital invested; and the
reputation, personal credit standing, and seniority of the partners.
*10. One factor to be considered is that the salary allowance has first priority in the division of income
among the partners. A second factor is the difference in the share of the residual profits. Partner
Young must choose between a one-twelfth larger share of the profits, and a fixed-priority share of
$16,000. If he expects the partnership income to be large, he may prefer the larger share of the
profits; if he expects income to be modest or if there is considerable risk of incurring losses, he may
prefer the salary priority. He should take into account any salaries allowed to the other partners,
since the greater these salary allowances, the smaller the residual income to which his one-third
share will apply.
____________
*Supplemental Topic A, “Partnership Accounting—A Closer Look.”
348
© The McGraw-Hill Companies, Inc., 2005
SOLUTIONS TO PROBLEMS
PROBLEM C–1
PARTNERSHIP TRANSACTIONS
a. $60,000 ($180,000  1/3)
b. Each partner must report his share of net income of the partnership ($60,000) on his or her
personal income tax return.
c.
E-Z MANAUFACTURING COMPANY
Statement of Partners’ Equity
For the Year Ended December 31, 20__
Gonzales Todd
Yeager
Balances, January 1, 20__ ........................ $50,000 $ 60,000 $40,000
Add: Net income for the year ...................
60,000
60,000
60,000
Subtotals..................................................... $ 110,000 $120,000 $100,000
Less: Drawings ..........................................
25,000
23,000
30,000
Balances, December 31, 20__ ................... $85,000 $ 97,000 $70,000
Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al
Total
$150,000
180,000
$330,000
78,000
$252,000
349
PROBLEM C–2
ANALYSIS OF EQUITY
a. Additional investment $20,000 [$50,000 (ending capital stock balance)  $30,000 (beginning
capital stock balance)].
b. Net income $30,000 [$200,000 (ending retained earnings balance)  $180,000 (beginning retained
earnings balance) + $10,000 (dividends)].
c. The $200,000 represents the amount of the corporation’s earnings that have accumulated (not
been distributed to the stockholders) since the corporation was formed.
350
© The McGraw-Hill Companies, Inc., 2005
PROBLEM C–3
DIVISION OF PARTNERSHIP INCOME
*
Guenther
Net income to be divided ..............................................
Salary allowances to partners ...................................... $ 80,000
Income after salary allowances ...................................
Interest allowances on beginning capital:
15,000
Guenther ($100,000  15%) .....................................
Firmin ($80,000  15%) ...........................................
Total allocated as interest ....................................
Remaining income after salaries and interest ............
Allocated in a fixed ratio:
Guenther (60%) ........................................................
54,000
Firmin (40%).............................................................
Total share to each partner
$ 149,000
Firmin
$ 50,000
Net Income
$ 247,000
(130,000)
$ 117,000
12,000
(27,000)
$ 90,000
36,000
$ 98,000
(90,000)
$
-0-
____________
*Supplemental Topic A, “Partnership Accounting—A Closer Look.”
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351
30 Minutes, Medium
PROBLEM C–4
HOT DOG SHACK
a. $30,000 ($90,000  1/3), each partner’s share of net income of the partnership must be reported
on his income tax return.
b.
Hot Dog Shack
Statement of Partners’ Equity
For the Year Ended December 31, 20__
Beginning capital balance ...................................
Add: Net income ..................................................
Subtotal.................................................................
Less: Drawing ......................................................
Ending capital balance ........................................
Glen
$ 55,000
30,000
$85,000
15,000
$70,000
Chow
$60,000
30,000
$90,000
15,000
$75,000
West
$ 5,000
30,000
$35,000
30,000
$ 5,000
Total
$ 120,000
90,000
$ 210,000
60,000
$ 150,000
c. Assuming that each partner devoted the same amount of time to the business, Glen and Chow
would probably consider the profit-sharing agreement to be inequitable because they have much
larger investments in the business than does West.
d. Partnership net income should compensate partners for their services to the business, invested
capital, and risks of ownership. Therefore, in evaluating the adequacy of his or her share of
partnership net income, a partner should consider how much time he or she devotes to the
business, the amount of capital invested in the business, and the risks of the business, including
the risk that his or her personal assets may have to be used to satisfy the partnership’s creditors.
352
© The McGraw-Hill Companies, Inc., 2005
25 Minutes, Medium
PROBLEM C–5
THE TOP HAT, INC.
a.
General Journal
Jun
3
Cash
2 0 0 0 0
Capital Stock
Issued 1,000 shares of capital stock at $20 per share.
2 0 0 0 0
10 Dividends
Dividends Payable
Declared a dividend of $0.25 per share, payable June 23
($0.25  20,000 shares  $5,000).
5 0 0 0
23 Dividends Payable
Cash
To record payment of dividend declared June 10.
5 0 0 0
30 Income Summary
Retained Earnings
To close the Income Summary account into Retained Earnings.
5 0 0 0
5 0 0 0
6 0 0 0 0
30 Retained Earnings
Dividends
To close Dividends into Retained Earnings.
b.
6 0 0 0 0
5 0 0 0
5 0 0 0
THE TOP HAT, INC.
Statement of Retained Earnings
For the Month Ended June 30, 20__
Retained earnings, May 31
Net income for the month
Subtotal
Less: Dividends
Retained earnings, June 30
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$5 2 0 0 0
6 0 0 0
$5 8 0 0 0
5 0 0
$5 7 5 0 0
0
0
0
0
0
353
30 Minutes, Medium
PROBLEM C–6
FRONTIER WESTERN WEAR, INC.
a.
General Journal
2004
Jan 15 Cash
8 0 0 0 0 0
Capital Stock
Issued 40,000 shares of capital stock at $20 per share.
Dec 31 Income Taxes Expense
Income Taxes Payable
To accrue the income taxes for the year ($120,000  40%).
31 Income Summary
Income Taxes Expense
To close the Income Taxes Expense account.
b.
2005
Mar 15 Dividends
Dividends Payable
Declared a dividend of $0.50 per share, payable April 15
($0.50  40,000 shares  $20,000).
Apr 15 Dividends Payable
Cash
To record payment of dividend declared March 15.
c.
2005
Dec 31 Retained Earnings
Income Summary
To close the Income Summary account for a period with a
net loss.
31 Retained Earnings
Dividends
To close Dividends into Retained Earnings.
354
8 0 0 0 0 0
4 8 0 0 0
4 8 0 0 0
4 8 0 0 0
4 8 0 0 0
2 0 0 0 0
2 0 0 0 0
2 0 0 0 0
2 0 0 0 0
1 8 0 0 0
1 8 0 0 0
2 0 0 0 0
2 0 0 0 0
© The McGraw-Hill Companies, Inc., 2005
PROBLEM C–6
FRONTIER WESTERN WEAR, INC. (concluded)
d.
FRONTIER WESTERN WEAR, INC.
Partial Balance Sheet
December 31, 2005
Stockholders’ equity:
Capital stock
Retained earnings (computation below)
Total stockholders’ equity
Computation of retained earnings at December 31, 2005:
Income before income taxes—2004
Less: Income taxes expense
Retained earnings, December 31, 2004
Less: Dividends for 2005
Less: Net loss for 2005
Retained earnings, December 31, 2005
$8 0 0 0 0 0
3 4 0 0 0
$8 3 4 0 0 0
$1 2 0 0 0 0
4 8 0 0 0
$ 7 2 0 0 0
$ 2 0 0 0 0
1 8 0 0 0
Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al
$
3 8 0 0 0
3 4 0 0 0
355
25 Minutes, Easy
PROBLEM C–7
WESSON CORPORATION AND MARTIN INDUSTRIES
a.
WESSON CORPORATION
Partial Balance Sheet
December 31, 2005
Stockholders’ equity:
Capital stock
Retained earnings
Total stockholders’ equity
$2 5 0 0 0 0
2 1 0 0 0 *
$2 7 1 0 0 0
*$21,000   $32,000 (2003 loss)  $12,000 (2004 loss)
 $90,000 (2005 net income)  $25,000 (2005 dividend)
b.
MARTIN INDUSTRIES
Partial Balance Sheet
December 31, 2005
Stockholders’ equity:
Capital stock
Retained earnings
Total stockholders’ equity
$1 0 0 0 0 0 0
6 7 5 0 0 0 *
$1 6 7 5 0 0 0
*$675,000  $800,000  [5 years  (100,000 x $.25)]
356
© The McGraw-Hill Companies, Inc., 2005
45 Minutes, Strong
PROBLEM C–8
S & X CO.
a.
General Journal
(1)
Nov 9
Cash
1 5 0 0 0
Turner, Capital
To record additional investment by owner.
1 5 0 0 0
15 Turner, Drawing
Cash
To record withdrawal from business.
1 5 0 0
30 Turner, Drawing
Cash
To record withdrawal from business.
1 5 0 0
30 Turner, Drawing
Cash
To record withdrawal from business.
1 0 0 0
30 Turner, Capital
Turner, Drawing
To close the owner's Drawing account.
4 0 0 0
30 Income Summary
Turner, Capital
To close the Income Summary account to the Owner’s
Capital account.
5 0 0 0
1 5 0 0
1 5 0 0
1 0 0 0
(2)
b.
(1)
Nov
9 Cash
4 0 0 0
5 0 0 0
1 5 0 0 0
Capital Stock
To record additional investment by owner.
1 5 0 0 0
15 Salaries Expense
Cash
To record salary to Turner.
1 5 0 0
30 Dividends
Dividends Payable
To record declaration of a dividend payable on November 30.
1 0 0 0
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1 5 0 0
1 0 0 0
357
PROBLEM C–8
S & X CO. (concluded)
General Journal
Nov 30 Salaries Expense
Cash
To record salary to Turner.
30 Dividends Payable
Cash
To record the payment of the dividend declared on
November 30.
1 5 0 0
1 5 0 0
1 0 0 0
1 0 0 0
(2)
30 Income Taxes Expense
Income Taxes Payable
To accrue income taxes expense for November.
($2,000  30%  $600)
6 0 0
30 Income Summary
Income Taxes Expense
To close the Income Taxes Expense account into the Income
Summary account.
6 0 0
6 0 0
6 0 0
30 Income Summary
Retained Earnings
To close the Income Summary account.
1 4 0 0
30 Retained Earnings
Dividends
To close the Dividends account.
1 0 0 0
1 4 0 0
1 0 0 0
c. The net income differs for two reasons. First, the corporation is subject to income taxes, and this
is an expense that is not included in the accounts of the sole proprietorship. Second, payments for
services to Turner are considered to be salaries expense when the business is organized as a corporation. When the business is organized as a sole proprietorship, the payments are considered to
be withdrawals by the owner.
d. If the business is organized as a sole proprietorship, Turner will pay taxes on the net income of
the partnership ($5,000) through his individual income tax return. (This assumes that the net
income of the partnership is equal to its taxable income.)
If the business is organized as a corporation, Turner will pay taxes on his individual tax return on
the salaries received ($3,000), and the dividend received ($1,000) from the corporation.
358
© The McGraw-Hill Companies, Inc., 2005
20 Minutes, Easy
PROBLEM C–9
AVERY AND KIRK
a.
General Journal
July 1
Cash
Inventory
George Avery, Capital
To record Avery’s investment in the partnership.
1 Cash
Accounts Receivable
Inventory
Office Equipment
Accounts Payable
Dinah Kirk, Capital
To record Kirk’s investment in the partnership.
b.
3 0 0 0 0
5 6 0 0 0
8 6 0 0 0
9 4
7 9 6
1 2 8
9 0
0
0
0
0
0
0
0
0
2 4 8 0 0
8 6 0 0 0
AVERY AND KIRK
Balance Sheet
July 1, 20__
Assets
Cash
Accounts receivable
Inventory
Office equipment
$
3 9 4 0
7 9 6 0
6 8 8 0
9 0 0
$1 9 6 8 0
0
0
0
0
0
$
2 4 8 0 0
Liabilities & Partners’ Equity
Liabilities:
Accounts payable
Partners’ equity:
George Avery, capital
Dinah Kirk, capital
$ 8 6 0 0 0
8 6 0 0 0
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1 7 2 0 0 0
$1 9 6 8 0 0
359
PROBLEM C–9
AVERY AND KIRK (concluded)
c.
General Journal
June 30 Income Summary
George Avery, Capital
Dinah Kirk, Capital
To close the Income Summary account.
30 George Avery, Capital
Dinah Kirk, Capital
George Avery, Drawing
Dinah Kirk, Drawing
To close the partners’ drawing accounts.
360
7 4 0 0 0
3 7 0 0 0
3 7 0 0 0
3 1 0 0 0
3 1 0 0 0
3 1 0 0 0
3 1 0 0 0
© The McGraw-Hill Companies, Inc., 2005
25 Minutes, Medium
PROBLEM C–10
COMEDY TODAY
a.
Distribution of Net Income
(1) Fixed ratio
Net income to be divided
Abott (40%)
Martin (60%)
Total share to each partner
Abbott
Martin
Net Income
$
1 1 0 0 0 0
$
(1 1 0 0 0 0 )
– 0 –
$
1 1 0 0 0 0
$
(3 0 0 0 0 )
8 0 0 0 0
$
(8 0 0 0 0 )
– 0 –
$ 4 4 0 0 0
$ 4 4 0 0 0
$ 6 6 0 0 0
$ 6 6 0 0 0
(2) Interest on capitals, and fixed ratio
Net income to be divided
Interest allowances on beginning capitals:
Abbott ($80,000  15%)
Martin ($120,000 15%)
Total allocated as interest allowances
Remaining income after interest allowances
Allocated in a fixed ratio:
Abbott (50%)
Martin (50%)
Total share to each partner
$ 1 2 0 0 0
$ 1 8 0 0 0
4 0 0 0 0
$ 5 2 0 0 0
4 0 0 0 0
$ 5 8 0 0 0
$ 3 6 0 0 0
$ 5 6 0 0 0
(3) Salaries, interest, and fixed ratio
Net income to be divided
Salary allowances to partners
Income after salary allowances
Interest allowances on beginning capitals:
Abbott ($80,000  15%)
Martin ($120,000  15%)
Total allocated as interest allowances
Residual loss after salary and interest allowances
Allocated in a fixed ratio:
Abbott (50%)
Martin (50%)
Total share to each partner
$
$
1 1 0 0 0 0
(9 2 0 0 0 )
1 8 0 0 0
$
(3 0 0 0 0 )
(1 2 0 0 0 )
$
1 2 0 0 0
– 0 –
1 2 0 0 0
1 8 0 0 0
(6 0 0 0 )
$ 4 2 0 0 0
(6 0 0 0 )
$ 6 8 0 0 0
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361
PROBLEM C–10
COMEDY TODAY (concluded)
b.
General Journal
Journal entry to close Income Summary account
(Case 3 from part a above)
Income Summary
Abbott, Capital
Martin, Capital
To close the Income Summary account by crediting each
partner with the authorized salary and with interest on
invested capital by dividing the residual loss equally.
362
1 1 0 0 0 0
4 2 0 0 0
6 8 0 0 0
© The McGraw-Hill Companies, Inc., 2005
30 Minutes, Medium
PROBLESM C–11
ROTHCHILD FURNISHING’S, INC.
Partner
Axle
a. Net income to be divided
Salary allowances to partners $ 1
Income after salary allowances
Interest allowances on capital:
2
Axle ($180,000  12%)
Brandt ($140,000  12%)
Conrad ($80,000  12%)
Total allocated as interest
Remaining income after
salary and interest allowances
Allocated in a fixed ratio:
Axle (1/2)
19
Brandt (1/3)
Conrad (1/6)
Total share to each partner
$22
b. Net income to be divided
Salary allowances to partners $ 1
Loss after salary allowances
Interest allowances on capital:
2
Axle ($180,000  12%)
Brandt ($140,000  12%)
Conrad ($80,000  12%)
Total allocated as interest
Remaining loss after salary
and interest allowances
Allocated in a fixed ratio:
Axle (1/2)
(2
Brandt (1/3)
Conrad (1/6)
Total share to each partner
$ 1
c. Loss to be divided
Salary allowances to partners $ 1
Loss after salary allowances
Interest allowances on capital:
2
Axle ($180,000  12%)
Brandt ($140,000  12%)
Conrad ($80,000  12%)
Total allocated as interest
Remaining loss after salary
and interest allowances
Allocated in a fixed ratio:
Axle (1/2)
(8
Brandt (1/3)
Conrad (1/6)
Total share to each partner
$ (5
Division of Net Income
Partner
Brandt
0000
$
50000
Partner
Conrad
$
Net
Income
$526000
(88000)
$438000
28000
1600
16800
9600
(48000)
$
390000
$
(390000)
–0–
5000
130000
6600
$196800
65000
$102600
0000
$
$
$
50000
28000
$
95000
(88000)
7000
1600
16800
9600
(48000)
$
(41000)
$
41000
–0–
0500)
(13667)
1100
$
53133
$
(6833)
30767
0000
$
50000
$
28000
$
(32000)
(88000)
$(120000)
1600
16800
9600
(48000)
$(168000)
4000)
(56000)
2400)
$
10800
$
(28000)
9600
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$
168000
–0–
363
40 Minutes, Strong
PROBLEM C-12
PRIME CUTS
a. Several reasons why it might be advantageous for Weber to have incorporated his business
include:
 Limiting personal liability. For example, in the event that some customers are made ill by
tainted or spoiled meat, the business might incur a liability which could bankrupt the
company, but Weber’s personal assets would not be affected.
 As a corporation, it will be easier for Weber to raise additional equity capital to expand, or
also to sell some of the existing equity to other investors, without surrendering control.
 The corporate form gives the business more continuity of existence, which may assist the
company in hiring management and borrowing from creditors on a long-term basis.
 The corporate form could enable Weber to gradually transfer ownership interests in the
business to his children or other heirs.
b. Computation of income that Weber would have retained after income taxes if the business were
still organized as a sole proprietorship:
Income before taxes (also net income) ...............................................................................
Less: Personal income taxes paid by Weber on business income
($1,000,000  45%) ............................................................................................................
Amount retained by Weber after income taxes ................................................................
$1,000,000
450,000
$ 550,000
c. Computation of income retained by Weber after income taxes with the company
organized as a corporation:
Income before taxes .............................................................................................................
Less: Corporate income taxes (40%) .................................................................................
Net income of the business (and dividends received by Weber) .....................................
Less: Personal income taxes paid by Weber on dividend income
($600,000 45%) ................................................................................................................
Amount retained by Weber after all income taxes ..........................................................
$1,000,000
400,000
$ 600,000
270,000
$ 330,000
d. The term double taxation refers to the concept that corporate income is taxed at two separate
levels. First, this income is taxed to the corporation as it is earned, and second, these earnings are
taxed a second time—to the stockholders—when they are distributed in the form of dividends.
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PROBLEM C-12
PRIME CUTS (concluded)
e. There are many ways in which Weber could reduce this “tax bite.” In fact, his current strategies
are maximizing the adverse effects of “double taxation.” Weber should consider:
 Drawing as much salary as possible. His salary is a deductible expense to the corporation in
its computation of taxable income. While his salary will still be subject to personal income
taxes, this amount will be exempted from corporate income taxes. If, for example, he set his
salary at $200,000 (not unreasonable for a CEO of a successful business), he would reduce
the corporate income taxes by $80,000.
 Weber might organize the business as an S Corporation. This would eliminate the corporate
income tax altogether, resulting in the tax consequences described in b, above. The net tax
savings would amount to $220,000 ($670,000 in annual taxes, less the resulting $450,000).
 As Weber has “plenty of income from other sources,” he could leave the money in the
corporation—that is, stop declaring dividends. On an annual basis, this would eliminate the
$270,000 in personal income taxes that he currently is paying on his dividend income. Of
course, the money would then be in the corporation, and not immediately available to
Weber. When—and if—he takes this money out of the corporation, it will be subject to
personal income taxes.
Note to instructor: You may wish to expand upon this point to illustrate a potential benefit of the
preferential treatment given to capital gains. If Weber sells the company, any gain is taxed as a capital gain, not as ordinary income.
Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al
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30 Minutes, Medium
PROBLEM C-13
RAMIREZ AND SMITH
a. Income-sharing proposal:
Assuming that the present earning capacity of the two partners reflects the relative value of their
services to the new partnership, the difference in the value of their services should be recognized
by agreeing to a salary allowance of $48,000 per year for Ramirez and $30,000 per year for
Smith. There is also a difference in the amount of capital invested by the two partners. As 20% is
given as a fair rate of return for this type of investment, the difference in capital contributions
may be recognized by allowing each partner 20% interest on his invested capital. None of the
information in the problem suggests any reason why any residual profit or loss should be divided
unequally. Therefore, it seems reasonable for the partners to share 50:50 in any residual income
or loss.
b. (part b is on next page)
c. The preceding schedule shows that Partner Ramirez will have a $14,000 advantage over Partner
Smith in both years. In the first year Ramirez will be credited with income of $2,000 while Smith
will be charged with a loss of $12,000. (The difference between a $2,000 income and a $12,000 loss
is $14,000.) In the second year of the forecast, both partners will be credited with income, but
Ramirez’s share will be $14,000 greater than Smith’s share.
The $14,000 differential stems from the fact that under the terms of the income-sharing agreement, the annual value of Ramirez’s personal services is $18,000 greater than the value assigned
to services rendered by Smith. On the other hand, the value of the additional $20,000 capital invested by Smith causes Smith to earn $4,000 more “interest” than is allocated to Ramirez. The
salary differential of $18,000 exceeds the interest differential of $4,000 by $14,000, which as
pointed out above, is the annual advantage to Ramirez. This $14,000 per year advantage to
Ramirez will continue, regardless of changes in partnership income, as long as salaries and
interest on capitals remain at present levels. This income-sharing agreement thus meets the goals
of recognizing differences in the value of personal services and capital investments made available
to the business by each partner.
Note to instructor: Since students are asked to draw up their own income-sharing proposal, this is not
the only possible acceptable solution. For example, students might reasonably vary the rate of return
allowed on partners’ invested capital or find a reason for sharing residual profits on some basis other
than equally.
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© The McGraw-Hill Companies, Inc., 2005
PROBLEM C-13
RAMIREZ AND SMITH (concluded)
b.
RAMIREZ AND SMITH
Division of Partnership Net Income
Ramirez
First year:
Net income (loss) to be divided
Salary allowances to partners
Remaining income (loss) after salary allowances
Interest allowances on beginning capital balances:
Ramirez ($50,000  20%)
Smith ($70,000  20%)
Total allocated as interest allowances
Remaining income (loss) after salary and
interest allowances
Allocated in a fixed ratio:
Ramirez (50%)
Smith (50%)
Total share to each partner
Second year:
Net income (loss) to be divided
Salary allowances to partners
Remaining income (loss) after salary allowances
Interest allowances on beginning capital balances:
Ramirez ($50,000  20%)
Smith ($70,000  20%)
Total allocated as interest
Remaining income (loss) after salary and
interest allowances
Allocated in a fixed ratio:
Ramirez (50%)
Smith (50%)
Total share to each partner
Net
Income (Loss)
Allocated
Smith
$
$
4 8 0 0 0
$
3 0 0 0 0
$
(1 0 0 0 0 )
(7 8 0 0 0 )
(8 8 0 0 0 )
1 0 0 0 0
1 4 0 0 0
(2 4 0 0 0 )
$(1 1 2 0 0 0 )
(5 6 0 0 0 )
$
2 0 0 0
$
4 8 0 0 0
(5 6 0 0 0 )
$ (1 2 0 0 0 )
$
$
$
3 0 0 0 0
$
1 1 2 0 0 0
– 0 –
9 0 0 0 0
(7 8 0 0 0 )
1 2 0 0 0
1 0 0 0 0
1 4 0 0 0
(2 4 0 0 0 )
$
(1 2 0 0 0 )
$
1 2 0 0 0
– 0 –
(6 0 0 0 )
$
5 2 0 0 0
$
Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al
(6 0 0 0 )
3 8 0 0 0
367