Advanced Accounting

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Mr. White (invested $20,000) and Mr. Black (invested $10,000) are in a partnership to run a marketing firm. They share profits and losses in the ratio of 2:1, which is also the ratio of their initial investment in the business. Mr. White manages the office but Mr. Black gets all of the contracts for the firm. It is his high profile that gets the contracts for the firm. At the end of the year, the firm has reported net income of $300,000, which was allocated in the ratio of 2:1, ($200,000 for Mr. White, and $100,000 for Mr. Black). On Dec 31, 20XX, Mr. White’s capital balance was $150,000 and Mr. Black’s capital balance was $100,000. Mr. White has withdrawn more cash from the business than his partner Mr. Black.

On Jan 15th, Mr. White discovered that the net income for the previous year was understated by $60,000. Mr. Black tells Mr. White that this net income of $60,000 should be shared in the proportion of their current capital balances. (Mr. White = 150,000/$250,000 = 60% = $36,000; Mr. Black = $100,000/$250,000 = 40% = $24,000). But Mr. White feels that the additional income should be shared in the ratio of 2:1 ($60,000 x 2/3 = $40,000 Mr. White; $60,000 x 1/3 = $20,000 Mr. Black).

Who is correct? Why?

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