14-1.

A partnership is an incorporated association of two or more persons to pursue a

business for profit as co-owners.

True / False

Wrong. The correct answer is false. A partnership is an unincorporated form of

business.

14-2. A written contract is necessary for the legal formation of a partnership.

True / False

Wrong. The correct answer is false. Oral agreements are also binding. However,
written agreements are preferred.

14-3. Partnerships are subject to income taxes.

True / False

You answered correctly! Each partner's share of income, as reported on their

individual income tax forms, is subject to income taxes. The income of the partnership is
not subject to income taxes.

14-4. Partners can agree to limit the power of negotiating contracts for the partnership
to any one or more of the partners. Such an agreement is binding on all outsiders,
whether or not they know it exists.

True / False

Wrong. The correct answer is false. Such an agreement is binding only on outsiders
who know that such an agreement exists. Outsiders unaware of such an agreement
have the right to assume each partner has normal agency powers for the partnership.

14-5. If Partner A contributes cash of $20,000 to the partnership of A and B, and Partner
B contributes a building valued at $30,000 to the partnership, the investments become
joint property of both partners.

True / False

You answered correctly! Partnership assets are owned jointly by all partners.

14-6. A general partnership may consist of limited partners and general partners.

True / False
You answered correctly! A general partnership consists of general partners only. In a
general partnership all partners have unlimited liability for partnership debts, and all
have mutual agency.

14-7. Limited partners are liable for any debt that cannot be paid through the resources
of the partnership.

True / False

Wrong. The correct answer is false. Limited partners have limited liability—limited to
the extent of their investment in the partnership. Limited partners have no personal
liability for debts of a limited partnership.

14-8. General partners are included in limited partnerships.

True / False

You answered correctly! Because of the limited liability accorded to limited partners,
creditors are protected, to a degree, when the limited partnership has at least one
general partner (one with unlimited liability).

14-9. If Partner A invested twice as much as Partner B, and there are only two partners,
the income must be divided in a ratio of 2:1, respectively.

True / False

Wrong. The correct answer is false. While investments and time spent are commonly
used as the basis for the allocation of profits and losses, partners can and do select
other criteria for allocating profits and losses.

14-10. If partners agree to a method of sharing net income, but say nothing about net
losses, losses are shared in the same way as net income.

True / False

You answered correctly! Unless a method of sharing net losses is spoken to

separately, the agreement for profit distribution will be used for both income and losses.

14-11. When a partnership agreement provides for the division of earnings based on
time spent and investment balances, the resulting amounts may be treated by the
partners as deductible salary expenses and interest expenses in determining the net
income of the partnership.

True / False
You answered correctly! Partners are not employees of the partnership, and they
cannot pay themselves interest on capital balances. The allocated amounts of salaries
and interest must be treated as allowances (a means of dividing net income or net loss).

14-12. In the purchase of partnership interest, the capital accounts of the exiting
partner(s) will be reduced.

True / False

Wrong. The correct answer is true. In a purchase of interest, the new partner is given
credit for the portion capital he/she is buying from each exiting partner whose capital
account is reduced accordingly. The cash or other assets given do not become property
of the partnership. A purchase of interest is a personal transaction between the seller
and buyer.

14-13. With a 100% purchase of the interest of a partner, a new partner has all the
rights of the remaining partner(s) .

True / False

Wrong. The correct answer is false. The new partner does not have a voice in
management until being admitted as a partner. The amount of interest purchased has
no bearing on the issue of a voice in management. An investment in a partnership is a
transaction between the new partner and the partnership.

14-14. The capital of an existing partnership is $160,000 after Keith invested $40,000 in
the partnership. Keith is entitled to 25% (1/4) of the income or loss of the partnership.

True / False

Wrong. The correct answer is false. The division of income or loss is a separate
matter on which the partners must agree. The ratio of capital investments is not the only
criteria used for the division of partnership income or loss.

14-15. When the current value of the partnership is greater than the recorded amounts
of equity, the bonus resulting from a purchase of interest is given to the old partner(s).

True / False

Wrong. The correct answer is true. When the current value of the partnership is
greater than the recorded amounts of equity, the old partners would receive proportional
credit for any bonus resulting from the purchase of interest.

14-16. The withdrawal of a partner from a partnership may result in an increase in the
capital accounts of the remaining partners.
True / False

Wrong. The correct answer is true. Should a withdrawing partner accept less than the
recorded value of his or her equity, the difference (excess) is divided proportionately
between the remaining partners according to their profit and loss agreement.

14-17. There is more than one reason for giving a withdrawing partner assets of value
greater than the withdrawing partner's recorded equity.

True / False

Wrong. The correct answer is true. First, the recorded equity may be understated.
Second, the remaining partners may agree to remove the exiting partner by giving
assets of value greater than the partner's recorded equity.

14-18. The death of a partner will require that all noncash assets are sold for cash, all
liabilities are paid, and remaining cash be distributed to the estate of the dead partner
on the basis of the partnership income and loss agreement.

True / False

You answered correctly! A partner's death dissolves the partnership, it is not a cause
for liquidation. A deceased partner's estate is entitled to receive his or her partnership
equity. The partnership contract should contain provisions for settlement in the event
the death of a partner.

14-19. Partners will share gains and losses on liquidation in their capital investment
ratio.

True / False

Wrong. The correct answer is false. Gains and losses on liquidation are shared in
accordance with the partnership agreement on the division of income and loss.

14-20. A capital deficiency occurs when a partner has insufficient equity to cover his or
her share of losses resulting from liquidation.

True / False

You answered correctly! A capital deficiency can arise from liquidation losses,
excessive withdrawal before liquidation, or recurring losses in prior periods. If a partner
with a capital deficiency is unable to pay the deficiency to the partnership, the remaining
partners must absorb the deficiency.
Chapter 14: Partnerships: Formation and
Operation

1. Which one of the following is a reason for the popularity of partnerships as a legal
form for businesses?
A. Partnerships avoid the double taxation of income that is found in
corporations.
B. Partnerships need only be formed by an oral agreement.
C. In some cases, losses may be used to offset gains for income tax
purposes.
D. Partners in partnerships are not subject to unlimited liability.
E. Partnerships avoid mutual agency.

2. Marea and Ashley began a partnership on January 4, 2001. Marea invested cash of
$90,000 as well as inventory costing $8,000, but with a current appraised value of
$10,000. Ashley contributed land with a $30,000 book value and a $65,000 fair market
value. The partnership also accepted responsibility for a $5,000 note payable owed in
connection with the land. The partners agreed to begin operations with equal capital
balances.
Assuming that the bonus method was used by this partnership, what was Marea's initial
capital balance?
A. $ 61,500
B. $ 80,000
C. $ 82,500
D. $100,000
E. $ 81,000

3. Marea and Ashley began a partnership on January 4, 2001. Marea invested cash of
$90,000 as well as inventory costing $8,000, but with a current appraised value of
$10,000. Ashley contributed land with a $30,000 book value and a $65,000 fair market
value. The partnership also accepted responsibility for a $5,000 note payable owed in
connection with the land. The partners agreed to begin operations with equal capital
balances.
Assuming that the goodwill method was used by this partnership, what is the amount of
goodwill and the amount of Ashley's initial capital balance?
A. Goodwill = $ 15,000, Ashely's Initial Capital Balance = $ 80,000
B. Goodwill = $ 45,000, Ashely's Initial Capital Balance = $ 90,000
C. Goodwill = $ 20,000, Ashely's Initial Capital Balance = $ 65,000
D. Goodwill = $ 40,000, Ashely's Initial Capital Balance = $100,000
E. Goodwill = $ 30,000, Ashely's Initial Capital Balance = $ 85,000

4. The partnership of Albert and Beach decided to admit Collins as a partner with a 25%
interest. Collins invested $50,000 in cash into the partnership. Albert's and Beach's
capital accounts and their profit and loss sharing ratios are shown below:

If the partnership used the goodwill method, how much goodwill should be recognized
by this transaction?
A. $80,000
B. $50,000
C. $45,000
D. $25,000
E. $30,000

5. The partnership of Albert and Beach decided to admit Collins as a partner with a 25%
interest. Collins invested $50,000 in cash into the partnership. Albert's and Beach's
capital accounts and their profit and loss sharing ratios are shown below:

If the partnership used the goodwill method, what would be the capital balances for
Albert, Beach, and Collins after Collins' investment was recorded?
A. Albert = $92,000, Beach = $58,000, Collins = $50,000
B. Albert = $82,500, Beach = $45,000, Collins = $42,500
C. Albert = $98,000, Beach = $52,000, Collins = $50,000
 D. Albert = $94,000, Beach = $49,000, Collins = $57,000
E. Albert = $91,000, Beach = $50,000, Collins = $59,000

6. The partnership of Albert and Beach decided to admit Collins as a partner with a 25%
interest. Collins invested $50,000 in cash into the partnership. Albert's and Beach's
capital accounts and their profit and loss sharing ratios are shown below:

If the partnership used the bonus method, what would be the capital balances for Albert,
Beach, and Collins after Collins' investment was recorded?
A. Albert = $92,000, Beach = $58,000, Collins = $50,000
B. Albert = $82,500, Beach = $45,000, Collins = $42,500
C. Albert = $98,000, Beach = $52,000, Collins = $50,000
D. Albert = $94,000, Beach = $49,000, Collins = $57,000
E. Albert = $91,000, Beach = $50,000, Collins = $59,000

7. A partnership was formed on January 5, 2001 with the following capital balances:

The Articles of Partnership stipulated that profits and losses are assigned as follows:

Net income of $150,000 was earned by the business in 2001.

Assuming that each partner withdraws the maximum amount, how much income is
allocated to Donald in 2001?
A. $73,000
B. $33,000
C. $22,000
D. $55,000
E. $81,000
8. A partnership was formed on January 5, 2001 with the following capital balances:

The Articles of Partnership stipulated that profits and losses are assigned as follows:

Net income of $150,000 was earned by the business in 2001.

Assuming that each partner withdraws the maximum amount, what is each partner's
capital account balance at the end of 2001?
A. Curtis = $132,000, Donald = $223,000, Edward = $265,000
B. Curtis = $213,000, Donald = $132,000, Edward = $275,000
C. Curtis = $112,000, Donald = $213,000, Edward = $295,000
D. Curtis = $122,000, Donald = $233,000, Edward = $265,000
E. Curtis = $145,000, Donald = $200,000, Edward = $275,000

9. As of December 31, 2001, the Manhattan Co. partnership had the following capital
balances:

Profits/Losses are split on a 4:3:2:1 basis, respectively. Adams decided to leave the
partnership and was paid $324,000 from the business based on the original contractual
agreement.
If the goodwill method is applied, what is the total amount of goodwill?
A. $50,000
B. $72,000
C. $21,000
D. $80,000
E. $89,000

10. As of December 31, 2001, the Manhattan Co. partnership had the following capital
balances:
Profits/Losses are split on a 4:3:2:1 basis, respectively. Adams decided to leave the
partnership and was paid $324,000 from the business based on the original contractual
agreement.
If the goodwill method is applied, what is the capital for Scott after Adams' withdrawal?
A. $425,000
B. $432,000
C. $416,000
D. $475,000
E. $437,000

11. The following condensed balance sheet is presented for the partnership of Cooke,
Dorry, and Evans who share profits and losses in the ratio of 4:3:3, respectively.

Assume that Fisher is going to pay $300,000 to the partnership for her 25% interest.
Using the goodwill method, what will Dorry's capital balance be after admitting Fisher?
A. $ 290,000
B. $ 63,000
C. $ 263,000
D. $ 360,000
E. $1,200,000

12. The following condensed balance sheet is presented for the partnership of Cooke,
Dorry, and Evans who share profits and losses in the ratio of 4:3:3, respectively.
Assume that Fisher is going to pay $300,000 to the individual partners for a 25%
interest. Using the bonus method, what will Fisher capital balance be?
A. $ 75,000
B. $ 300,000
C. $ 235,000
D. $ 172,500
E. $ 247,500

John and Jerry

are both
lawyers. They
form a law
partnership. The
articles of
partnership
specify that the
firm may
engage in any
business that is
lawful within
the United
States. Two
weeks after the
partnership is
formed Jerry
goes out and,
without John's
knowledge,
buys a $20,000
computer
system for the
partnership.
John refuses to
allow
partnership
assets to be
used to pay the
$20,000. The
business that
sold the
computer
system to Jerry
sues the
partnership in
court and wins
the case. This
situation is an
application of
which
partnership
characteristic?
Unlimited liability.
A)
No federal income taxation of partnerships.
B)
Limited life.
C)
Mutual agency.
D)
None of the above.
E)

2
Which two characteristics are true of partnerships?
(1) They are subject to federal income taxation and (2) they do not have
A) limited life.
(1) They are not subject to federal income taxation and (2) they have
B) unlimited life.
(1) They are not subject to federal income taxation and (2) they have limited
C) life.
(1) They are not subject to federal income taxation and (2) they do not have
D) limited life.
None of the above.
E)

3
Which set of characteristics is true of limited partners?
 (1) Limited partners may participate in the daily operations of the
A) partnership, and (2) they have unlimited liability.
(1) Limited partners may not participate in the daily operations of the
B) partnership, and (2) they have unlimited liability.
(1) Limited partners may participate in the daily operations of the
C) partnership, and (2) they have limited liability.
(1) Limited partners may not participate in the daily operations of the
D) partnership, and (2) they have limited liability.

None of the above.

E)

4
Which two features characterize limited liability companies?
The members (1) have limited liability, and (2) do not participate in the
A) daily operations of the company.
The members (1) have unlimited liability, and (2) do not participate in the
B) daily operations of the business.
The members (1) have unlimited liability, and (2) do participate in the daily
C) operations of the company.
The members (1) have limited liability, and (2) do participate in the daily
D) operations of the company.
None of the above.
E)

5
Two partners share profits and losses in a ratio of 60:40. The first partner is
given a salary allowance of $20,000 while the second partner is given a salary
allowance of $25,000. The partners are also given an interest allowance equal to
10% of their initial capital account balances. Their initial capital account
balances were $30,000 for the first partner and $50,000 for the second partner. If
net income for the period is $60,000, how much will be allocated to each of the
partners?
$30,000 to the first partner and $30,000 to the second partner.
A)
$36,000 to the first partner and $24,000 to the second partner.
B)
$27,200 to the first partner and $32,800 to the second partner.
C)
$32,800 to the first partner and $27,200 to the second partner.
D)
None of the above.
E)
6
What are the acceptable methods of admitting a new partner into a partnership?
The incoming partner buys the entire interest directly from an existing
A) partner.
The incoming partner buys part of an existing partner's interest directly from
B) the existing partner.
The incoming partner buys part of the existing partnership interest directly
C) from two or more existing partners.
The incoming partner buys his or her interest directly from the partnership.
D)
All of the above methods are acceptable.
E)

7
An interest in a partnership is considered to be a capital asset under our federal
tax laws. When such an interest is sold at a gain, the gain is taxable. When such
an interest is sold at a loss, the loss is usually deductible for tax purposes.
Incoming partner Thane purchases all of existing partner Maryam's partnership
interest for $50,000. At this time, the balance in Maryam's capital account is
$35,000. The partnership agrees to accept Thane as a partner. How much gain or
loss will Maryam have for tax purposes and what will be the balance in Thane's
capital account immediately after she is admitted to the partnership?
Maryam has a $15,000 loss and Thane has an initial capital balance of
A) $50,000.
Maryam has a gain of $15,000 and Thane has an initial capital balance of
B) $50,000.
Maryam has a loss of $15,000 and Thane has an initial capital balance of
C) $35,000.
Maryam has a gain of $15,000 and Thane has an initial capital balance of
D) $35,000.
None of the above.
E)

8
A partnership consists of four partners: Joe, Susan, Ray, and Tom who share
profits and losses in the percentages of 20%/25%/30%/25%. The current
balances in their respective capital accounts are $22,000, $30,000, $44,000, and
$50,000. Incoming partner Dan buys 50% of Joe's interest for $15,000 and he
also buys 50% of Ray's interest for $25,000. These transactions take place
directly between Dan, Joe, and Ray. How much will be credited to Dan's capital
account?
$66,000.
 A)
$33,000.
B)
$40,000.
C)
$36,000.
D)
None of the above.
E)

9
Partners A and B have existing capital balances of $30,000 and $40,000 and
share profits and losses in a ratio of 70%/30%. Incoming partner C invests
$40,000 for a 25% interest in profits and losses. How much will be credited to
the capital account of the incoming partner?
$40,000.
A)
$10,000.
B)
$27,500.
C)
$30,000.
D)
None of the above.
E)

10
Partners A and B have existing capital balances of $50,000 and $70,000 and
share profits and losses in a ratio of 60%/40%. Incoming partner C invests
$58,000 for a 30% interest in profits and losses. Any difference between what is
invested by partner C will be treated as a bonus to or from the existing partners.
How will the bonus be handled?
$2,760 will be debited to Partner A's capital account and $1,840 will be
A) debited to Partner B's capital account.
$1,840 will be credited to Partner A's capital account and $2,760 will be
B) credited to Partner B's capital account.
$2,760 will be credited to Partner A's capital account and $1,840 will be
C) credited to Partner B's capital account.
$4,600 will be credited to C's capital account.
D)
None of the above.
E)
11
ABC Partnership has four partners who share profits and losses equally. On
December 1, 2009, the balances in the partner's capital accounts were: $40,000,
to Partner A; $50,000 to Partner B; $30,000 to Partner C; and $80,000 to Partner
D. Partner C wishes to retire from the partnership. After due negotiations with
the partners, the partnership agrees to pay Partner C $39,000 for his interest.
What will the balances in the capital accounts of A, B, C, and D after the
payment is made to C?
A = $40,000; B = $50,000; C = $0; and D = $80,000.
A)
A = $37,000; B = $47,000; C = $0; and D = $77,000.
B)
A = $43,000; B = $53,000; C = $0; and D = $83,000
C)
A = $40,000; B = $50,000; C = $30,000; and D = $80,000.
D)
None of the above.
E)

12
The ABCD partnership has sold all of its assets and has paid off all of its debts
just prior to final liquidation. The partners share profits and losses in a ratio of
15%/20%/25%/40%. Partner B, the 20% partner, has a deficit in his capital
account of $60,000 and is personally insolvent. How much of B's capital
deficiency will Partner D have to absorb?
$20,000.
A)
$60,000.
B)
$24,000.
C)
$30,000.
D)
None of the above.
E)

13
Three people form a new partnership. The first one contributes $19,000 in cash.
The second one contributes a piece of land on which a building suitable for the
partnership's purposes is constructed. The book values of the land and building
as recorded on the second person's books are $20,000 and $100,000, but the
present fair market values are $25,000 and $190,000, respectively. There is a
$60,000 mortgage payable on the building, which the partnership is willing to
assume. The third person contributes a used automobile which has a book value
 of $5,000 and a fair market value of $9,000. There is a small note payable on the
automobile of $2,000, which the partnership agrees to assume. At what amounts
will the land, building, and automobile be recorded on the books of the
partnership?
$20,000, $100,000, and $5,000.
A)
$20,000, $100,000, and $9,000.
B)
$25,000, $190,000, and $9,000.
C)
$25,000, $190,000, and $7,000.
D)
None of the above.
E)

14
Three people form a new partnership. The first one contributes $19,000 in cash.
The second one contributes a piece of land on which a building suitable for the
partnership's purposes is constructed. The book values of the land and building
as recorded on the second person's books are $20,000 and $100,000, but the
present fair market values are $25,000 and $190,000, respectively. There is a
$60,000 mortgage payable on the building, which the partnership is willing to
assume. The third person contributes a used automobile which has a book value
of $5,000 and a fair market value of $9,000. There is a small note payable on the
automobile of $2,000, which the partnership agrees to assume. What amount
will be credited to each partner's capital account after these contributions have
been made?
$19,000, $120,000, and $5,000.
A)
$19,000, $60,000, and $3,000.
B)
$19,000, $155,000, and $7,000.
C)
$48,000, $48,000, and $48,000.
D)
None of the above.
E)

15
XYZ Partnership's equity at the end of 2009 totaled $350,000 ($122,500 from X,
$70,000 from Y, and $157,500 from Z.) For the year ended December 31, 2010,
net income is $60,000 ($21,000 allocated to X, $12,000 allocated to Y, and
$27,000 allocated to Z.) Year-end total partnership equity is $375,000 ($131,250
from X, $75,000 from Y, and $168,750 from Z.) Compute the individual partner
return on equity ratio for Partner Y.
80.0%
A)
14.1%
B)
82.8%
C)
16.6%
D)
Partner Y did not have a return on equity.
E)