Problem 1:

Characteristics of a partnership and proper organization form. A client is seeking your advice on how to organize a new business. The client is propos¬ing to acquire several single-story residences and convert them into group homes for the elderly. Each home would house eight elderly individuals, and the homes would be staffed 24 hours a day. Residents would receive housing, food, and daily-planned activities for a monthly fee. Group homes are licensed by the state and are closely monitored. Such homes do not provide any direct health care to the residents. The client plans to have an active role in the organization and management of the homes and is seeking another individual or two to provide necessary cap¬ital as passive investors. It is anticipated that the homes will operate at a loss for the first 12 to 18 months. The client hopes to open two group homes for each of the next four years and then sell his interest in the business. Your client is interested in organizing the company as a partnership and wants to know how that might affect him and other potential partners.

Identify and discuss some of the characteristics of a partnership of which your client should be aware.

Problem 2:

Allocation of profits and determination of withdrawals. Sandburg and Williams are the owners of a partnership that manufactures commercial lighting fixtures. Profits are allocated among the partners as follows:

Sandburg was divorced as of the beginning of 20X5 and as part of the divorce stipulation agreed to the following:
1. The spouse is to receive annual distributions traceable to years 20X5 and 20X6. The annual distribution is to be the greater of $100,000 or 25% of base earnings.
2 Base earnings are defined as net income of the partnership less: (a) salaries traceable to Sand-burg and Williams of $75,000 and $125,000, respectively, and (b) bonus to Sandburg as stated subject to the limitation that it not exceed $50,000.
3. Sandburg's spouse would receive a distribution from the partnership on August 31 of each current year and on February 28 of each subsequent year. The August 31 target distribution is $50,000. If the August distribution is less than $50,000, Sandburg's spouse will receive one-half year's interest on the deficiency at the rate of 10% per year. The following distribu¬tion on February 28 must be of an amount such that the two distributions equal the required distribution traceable to the calendar year just ended plus any interest associated with the August distribution.
4. All distributions to Sandburg's spouse are to be considered as a withdrawal of capital by Sandburg.
5. Aside from distributions to Sandburg's spouse, Sandburg's annual withdrawals cannot exceed $125,000.
6. Upon sale or dissolution of the partnership prior to February 28, 20X6, Sandburg's spouse would receive 50% of the net realizable value of Sandburg's partnership capital.
7. On February 28, 20X7, Sandburg's spouse will receive an additional final distribution equal to 50% of the sum of Sandburg's capital balance as of December 31, 20X6, less the amount of the February 20X7 distribution as called for by item (3) above.

Capital balances at the beginning of 20X5 were $180,000 and $125,000, respectively, for Sandburg and Williams. Activity related to the partnership during 20X5 and 20X6 is as follows:

20X5                  20X6

Partnership net income ......................................................................

Distribution to Sandburg's spouse: ......................................................

February 28

August 31

Distributions to Sandburg:

June 30.......................................................................................

September 30 .............................................................................

Distributions to Williams:

June 30.......................................................................................

September 30 .............................................................................  

$750,000             $700,000

 to be determined

40,000                 50,000

60,000               125,000

65,000                         0

30,000               300,000

90,000                 20,000

Prepare a schedule to determine the total amount of the distributions due Sandburg's spouse as of February 28, 20X7. Note that the solution requires one to determine the amount of the February 20X6 distribution to Sandburg's wife.

Problem 3

Decision to admit a new partner, profit allocation. Thomas and Purnell are general partners in a partnership along with four limited partners. Ten percent of partnership profit is allocated to each of the limited partners, and the balance of the profits is allocated to Thomas and Purnell as follows:

1. Salaries of $40,000 and $60,000 to Thomas and Purnell, respectively.

2. A bonus to Thomas of 10% of sales in excess of $1,200,000.

3. A bonus to Purnell of 5% of net income after the bonus.

4. Remaining profits to be allocated 60% and 40%, respectively, to Thomas and Purnell.

The general partners have been approached by Wiggins, who has significant experience in the area of foreign sales and is seeking admission to the partnership. Wiggins is confident that she can generate significant increases in sales and that any capital needed to finance the expansion will be raised and guaranteed by her. Furthermore, Wiggins is proposing that the existing profit agreement be modified as follows:

1. Wiggins will be allocated a salary of $40,000.

2. A bonus to Wiggins of 15% of all international sales in excess of $500,000.

3. Thomas's bonus will be limited to domestic sales only.

4. Remaining profits to be allocated 40%, 40%, and 20% to Thomas, Purnell, and Wiggins, respectively.

The limited partners are in favor of admitting Wiggins, noting that their opportunities for increased profits would be improved. However, Thomas and Purnell are concerned that unless sales and profits grow significantly, they will receive a smaller allocation of profits than they did before Wiggins. Without Wiggins, the partnership is projecting domestic sales and profits of $1,450,000 and $280,000, respectively, for the next year. Thomas and Purnell feel that if their interest in profits increases by $16,000 and $24,000, respectively, they will be inclined to admit Wiggins as a partner.

Assume that Wiggins is able to generate $700,000 of additional foreign sales which include a 40% gross profit margin and that the general and administrative expenses associated with this increase are 15% of such sales. Prepare an analysis for Thomas and Purnell that summarizes their profit allocation with and without Wiggins.