A new business client comes to your office. There arethree owners of the business. The three individuals, Alan, Bob, andCarol, are thinking about forming a partnership. Alan is onlyinvesting $1 million in cash. He will not have anything to do withthe daily activities of the business. Bob has had some experiencein the business and will be responsible for the day-to-dayoperations of the business. Carol has a great deal of experienceand many contacts within the business. She will be responsible forattracting new clients. Neither Bob nor Carol are investing cashinto the partnership. During the first year of operation, thepartnership generated a profit of $150,000. None of the partnersreceived distributions during the year.
Payment of Salary
A. Should the two partners who are working in thebusiness receive a salary? Why or why not? Be sure to support yourdecision with research and quantitative data.
B. If the two non-investors did receive a salary, howwould their capital account be affected? How would this impact apotential future liquidation or buyout? Be sure to thoroughlyexplain and support your answer.
C. Should the cash investor receive a higher share ofthe profits or other sharing options? Why or why not? Support youropinions with research and quantitative data.
D. If the cash investor did receive a salary, howwould his capital account be affected? How would this impact apotential future liquidation or buyout? Be sure to thoroughlyexplain and support your answer.
E. How do the payment of salary and the allocation ofprofit affect entries and the financial bottom line? Be sure tosupport your explanation with concrete examples.
F. How could the payment of salary and allocation ofprofit be a more effective method of splitting the company'sprofits for the three partners? Explain a scenario in which thethree partners would be all compensated fairly, and support youranswer with logical reasoning.
G. What would be the value of each partner's capitalaccount at the end of the year, given your proposed fair allocationmethod? Support your answer with quantitative data and anexplanation of how you came to this conclusion.
