O’Malley and O’Reilly formed a partnership on 1 July 2019 to run an information systems consultancy business by investing $400 000 and $360 000 respectively. Both partners work similar hours in the business.

O’Reilly has a Masters degree in information systems and 5 years’ experience in the workforce.

O’Malley has an undergraduate degree and has worked for 3 years; she has invested money inherited from her parents. On 1 January 2020 O’Malley invested an additional $40 000 cash as a capital contribution.

On 1 May 2020 O’Malley and O’Reilly withdrew $50 000 each in cash in expectation of profits for the current year ended 30 June 2020. They had not drawn up a partnership agreement so are not sure how the profits of $120 000 should be distributed to each partner. You have been asked to decide the most appropriate way to divide the profit, and a number of alternative scenarios are provided for you to consider:

1. no suggestions have been made by the partners 

2. the partners suggest distributing the profits in the ratio of the original capital balances 

3. the partners suggest that O’Malley receives a salary of $40 000 and O’Reilly receives a salary of $60 000 to reflect his greater qualifications and experience, with interest of 5% on ending capital balances, and the remainder distributed evenly between the partners.

Required

(a) Calculate the amount of profit distribution to each partner under each scenario. Which scenario is most favourable to O’Malley and to O’Reilly?

(b) Given the capital commitments and expertise of each partner, which scenario is the most appropriate for the partnership agreement?

(c) What recommendations would you make for any proposed partnership agreement in the event that the partnership incurs a loss for the year?