 Hello, and welcome to this session. This is Professor Fahad. In this session, we would look at an example of admitting a new partner. We're going to be using the bonus as well as the goodwill method. This is part five of five of my partnership recording. It means there are prerequisites to this session. This topic is covered in advanced accounting as well as the CPA exam, the far section. Please connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,500 plus accounting, auditing, finance, and tax lectures. Please like my lectures, click on the like button, share them, put them in the playlist, let the world know about them. On my website, farhatlectures.com, not only you can access the lectures, you can access the lectures plus quizzes, multiple choice, true, false exercises, which is something like the exercise I'm going to be working today. And if you're studying for your CPA, CMA exam, I have sections for that and I have 2,000 plus CPA questions. If you're looking to work with a study body, study body appell that the CO is an artificial driven study body platform that match you with someone who's studying for the CPA, the CFA, or any other exam you are looking to study for. So what's the prerequisite? Well, we have four prior sessions about partnership. The link is in the description if you're interested, if you want to look at the prior link. So in this session, we will work an example. So we'll work with a partnership example. We have A and B has agreed to form a partnership. Both of them already had the proprietorship and those assets were, and those assets were going to be combined to form a partnership. The fair value of Abel and the Baker are below. So we're going to see them. So the first thing you want to know this is they did not specify the sharing, like what's the capital, what's the, what's the capital structure? Well, if they don't, it means it's 50, 50, okay? So Abel's going to contribute 5,000 cash, Baker 20,000 cash inventory. Abel's going to contribute 5,000. Baker will contribute 40,000 land, 50,000 for Abel, nothing for Baker building. Abel's going to contribute a building. Also they're going to each one of them can contribute a piece of equipment, one for 10,000, one for 20,000. However, Abel's assuming there's a liability against one of the assets could be the building, we don't care, the building, the land or the equipment. There's a liability. So let's first compute the net contribution for each. So notice Abel, if we add all the assets, minus the liabilities will give us a net contribution of 90,000. Baker contributed all assets, the net contribution is 80,000. So the first thing you want to see is that their total contribution in total equal to 170,000, 170,000. So this is what's giving in the problem. Now let's assume we're going to be using the bonus method, the bonus method to, to journalize the form of this partnership. What is the bonus method? The bonus method means basically one of the partners will be receiving more than their share and the other partner. Obviously they're going to take it from the other partner. Okay. Now you might be asking, why with the bonus method work? Well, if you look at the numbers here, Abel contributed more than Baker, but they're going to have everything 50-50. So simply put, Abel's going to have to give up 5,000 and that 5,000 is going to go to Baker. So this way they have, let me just do this. So since they're going 50-50, Abel's going to lose 5,000 of their capital and it's going to go to Baker. And now they both will start a capital of 85,000. They will both start capital of 85,000. Once again, one of them will have to give up loses some capital and the other one will win. This is what the bonus method is. Okay. And if we have 170 divided by 2 will give us 85,000. So the capital is 85,000. Okay. So basically A is given up 5,000. Now you might be saying, why would they give up 85,000? Because maybe B has some special skills that they are not quantifiable. Simply put, they cannot be translated into cash or inventory or whatever. So Abel said, look, just join the partnership. I'll give you a bonus $5,000 for those skills. So just in case you're wondering why. So what entry would the partnership do on the day of the formation? They contributed cash of 25,000. We'll debit cash. We debit inventory. They both contributed inventory of 45,000. We contributed a land. I believe one of them contributed a land building and they both contributed equipment. So those are the debits. Then the partnership assumed the liability of 10,000. Then their capital balance is 85,000 and 85,000. Simply put, I told you they're going to split the partnership 50-50. But remember, A gave up $5,000, which went to B as the partner that received that bonus. So this is the bonus method. The other method is the goodwill method. What is the goodwill method? Basically the goodwill method is basically what we're saying is if we are contributing money to a partnership and if we're contributing money and we're going to be receiving a certain percentage of that partnership, we can find how much as the partnership is worth. So Able, if you remember Able contributed $90,000. Able contributed $90,000 and Able is going to get 50%. We're going to go with Able, not with Baker because we'll go with the larger number. So Able, if Able is willing to pay $90,000 for 50% of the partnership, what does that tell us? It tells us that if we take $90,000 divided by 0.5 or 0.50 or 50%, let me show you. And if you watch Shark Tank, this is what they do the first thing when somebody asks them for money, they want to know what's the total value of the company. If you divide it by 0.5, we'll find out that the total value of the company is 100, the partnership is $180,000. So for the goodwill method, first we want to find out how much is the value of the company? Well, if Able is willing to pay $90,000 for 50%, it means the company is worth $180,000. That's the implied value. That's the implied value. It's worth $180,000. Now remember, the implied value was $180,000, but together, one contributed $80,000, one contributed $90,000. That's their net contribution. So the actual equity is $170,000, but the implied, it should be $180,000. It means they have other assets, again, other assets, other resources that they're not quantifiable. We cannot put them on the books. What do we call them? We call them goodwill. So the first thing is we want to know what's the implied equity. The implied equity is $180,000, and we have if the implied equity is $180,000, but they only contributed $170,000. It means there's an additional goodwill for the company of $10,000. That's the additional goodwill. Now, let's look at the journal entry now. They contributed cash $25,000 together. They contributed inventory $45,000 together. One of the able-contributed land, able-contributed the building, able-contributed an equipment, both of them contributed equipment of worth of $30,000. Those are the debits. Now we're going to add, this is the goodwill method. We are going to debit the account goodwill for $10,000. They contributed a liability of $10,000. We have to absorb the liability. The partnership will have to absorb the liability. Ables capital is $90. Baker's capital is $90. Why $90,000? Because remember, it's $50,000, $50,000 partnership. Okay, $50,000, $50,000 partnership. So of the implied value is $180,000. If we're going to go $50,000, $50,000, each one of them will get $90,000, $90,000. Okay? Simply put, if you really think about it, if you really think about it, Baker got a kick in a sense. Baker received an additional, so Baker received an additional $10,000 because Baker only contributed $80,000. If you remember Baker contribution, let me just show you what Baker contribution was. Baker contribution is only $980,000, but their capital is $90,000. Okay? So this is the goodwill method. Okay? Is there a third method? Yes, there is a third method. And what's the third method? Basically, the third method is there is no goodwill and no bonus. So simply put, what we do is this. So the goodwill method with the exact method or sometimes in the CPA exam, they say no goodwill, no bonus. We debit all the assets for what they are. We credit the liabilities for what they are. Able balance will be $90,000 and Baker balance will be $80,000. So that's the exact thing that they contributed and that's the exact numbers in the journal entries. So there is no bonus, no goodwill for anyone. This is the third method. Now, the other thing I want to tell you under the bonus method, we basically adjust the capital balance, the right side under the goodwill method. What's going to happen is we're going to be adjusting the debit side or the left balance of the entry. Okay? Now, let's take a look further at this example and assume they're going to be allocating net income based on this setup. First of all, Able will get 8% of their beginning equity capital, which is $90,000. Baker will get 10%. Then Able will get a $25,000 salary allowance. Baker will get a $15,000 salary allowance. And anything left is distributed $50,50. And let's assume for the sake of illustration and the first year of operation, the partnership made $60,000. So simply put, how are we going to allocate? How are we going to allocate the $60,000? Simply put, when we debit income summary, because we need to allocate this account, we need to debit income summary. So the partnership made a profit of $60,000. We need to debit income summary, credit A capital, credit B capital. Okay? The total of $60,000. But how are we going to allocate this? Well, guess what? We're going to go ahead and follow what they agreed upon. First, we're going to start with Able. Okay? Let's start with Able. Able, $90,000 of capital times 0.08. They're going to be allocated, I'm sorry, $85,000, not $80,000. $85,000 times 0.08 times 0.08. That's going to give us $6,804 Able, $6,800. And for Baker, it's $85,000 times 10%. So far, we allocated $15,300. So we have $60,000. So far, we allocated $15,300. Now we're going to allocate the remainder. The remainder is salary, $25,000 for Able, $15,000 to Baker. So far, so we allocated up to $60,000 and additional $40,000. And what's left, whatever that left is, what's left is, what's the remainder? The remainder is $4,700. The remainder is allocated $50,50. The remainder is allocated $50,50. Okay? And therefore, Able, we're going to allocate to Able. We're going to credit Able's account. Well, $34,150. We're going to credit Baker's account $25,850. So that's the journal entry in total. We allocated $60,000 of income to each Able, $34,150 and Baker, $25,850 based on their agreement. Now, let's assume that the partnership had an income of only $20,000. Simply put, how do we allocate the $20,000? Guess what? We're going to follow exact same procedures. Although we're going to have a negative balance, we keep on going. $85,000 times 8%, $6,800. $85,000 times 10%, $8,500. So far, we allocated $15,300. Now, we're going to allocate of salaries, $25,000 and $15,000 as they agreed. Now, we're up to $40,000. What's going to happen is this. Now, we have $55,300, okay? But in reality, we only have, we allocated $55,300, but in reality, we only have $20,000 of income. What does that mean? It means we still have $35,300 as a negative balance. As a negative balance. So what do we do with the negative balance? We allocate the negative balance $50,50 and let's see. It's going to work. So of the $35,300, we allocate $17,000. This is negative $650 to A, $17,650 to B. Then we run the allocation. After we subtract the negatives, A's balance should increase by $14,150. B's balance should increase by $5,850. Together, they will get $20,000. Simply put, the entry will be income summary, debit income summary, $20,000, credit A's capital, $14,150, credit B's capital, $58,50. That's the entry. Now, if you want to work additional exercises or additional problems, similar to this one, please visit my website where you can subscribe and have access to more exercises. If you're studying for your CPA exam, that's a great investment. If you're a college student, that's a great supplement to your courses. Good luck, study hard and stay motivated.