Special Aspects of Partnership Accounts

  PARTNERS’ CAPITAL ACCOUNTS | ACCOUNTANCY

A partnership firm has more than one owners (partners) and Capital Account is maintained for each partner separately. It is so because each partner has separate transactions with the firm. For example, if Atul, Amit, and Akhil are three partners in a firm, there shall be three Capital Accounts, one each for Atul, Amit, and Akhil.

PARTNERS’ CAPITAL ACCOUNTS

The Partners’ Capital Accounts may be maintained by following either:

(i) Fixed Capital Accounts Method; or

(ii) Fluctuating Capital Accounts Method.

Fixed Capital Accounts Method

Fixed Capital means capital invested by each partner in the firm remains fixed or unaltered, unless a partner introduces additional capital or withdraws out of his or her capital. When Fixed Capital Accounts Method is followed, two accounts, i.e., a Capital Account and a Current Account for each partner are maintained.

Capital Account 

Capital Account of each partner continues to show same balance year after year and changes only if additional capital is introduced, which is credited to Capital Account, withdrawal is made out of capital, which is debited to the Capital Account.

Current Account

Current Account is maintained to record transactions other than transactions of capital such as drawings against profit, interest allowed on capital, interest charged on drawings, salary or commission payable to a partner, share of profits/losses. As a result, the balance of Current Account fluctuates with every transaction with the partner.

Current Account of each partner is debited by the amount of:

(i) his drawings against profit;

(ii) interest on drawings;

(iii) share of loss; and

(iv) transfer of amount to Capital Account.

Note: Please note that Drawings against Capital is debited to Partner’s Capital Account.

Similarly, Current Account of each partner is credited by the amount of:

 (i) interest on Capital; 

(ii) remuneration (Salary or commission); 

(iii) share of Profit; and 

(iv) transfer of amount from Capital Account.

 It should be kept in mind that Partner’s Current Account may have a credit or debit balance. The balances of Partners’ Capital Accounts are shown in the liabilities side of the Balance Sheet, as that much amount is due to them. Credit balance in Current Account is shown in the liabilities side and debit balance in the assets side of the Balance Sheet.

Outline of the two accounts maintained under the Fixed Capital Accounts Method are:

Capital Account Current Account

Fluctuating Capital Accounts Method

Under Fluctuating Capital Accounts Method only one account namely ‘Capital Account’ is
maintained for each partner.

All transactions of a partner (e.g., capital introduced or withdrawn), salary or commission
allowed, interest allowed on capital, drawings (against profit), interest charged on drawings,
share of profit or loss, etc., are transferred to his Capital Account. As a result, balance in the
Capital Account fluctuates with every transaction.

Capital Accounts having credit balances are shown in the liabilities side while Capital Accounts
having debit balances are shown in the assets side of the Balance Sheet.

Fluctuating Capital Accounts Method is normally followed for maintaining Capital Accounts.

In the absence of any instruction or information, it is assumed that Fluctuating Capital Accounts Method is followed for maintaining the Partners’ Capital Accounts.

Outline of the Capital Account under Fluctuating Capital acounts Method is as follows:

Partner's Capital acounts

Pictorial Depiction of Methods of Maintaining
Partners’ Capital Accounts with Items Debited and Credited

Difference between Capital Account and Current Account

Difference between Capital Account and Current Account

Remuneration (Salary or Commission) to Partners

Remuneration (Salary or Commission) to Partners | Accounting Treatment

 Remuneration (Salary or Commission) is allowed to the partners for looking after the business of the firm. It is allowed only if the Partnership Deed provides to allow it. Stating differently, if
the Partnership Deed does not exist or if it exists but does not provide for allowing salary and
commission, it is not allowed.

Nature

Salary or commission to partners is allowed only if the Partnership Deed allows it and also if
the firm earns profit during the year. Salary or commission to a partner is an appropriation of
profit and not a charge against profit.

Salary payable to each partner is normally stated as an amount. But, Commission payable to a partner is stated as a percentage of profit, which may be allowed to the partners either:

(i) as a percentage of net profit or distributable profit before charging commission; or
(ii) as a percentage of net profit or distributable profit after charging a commission.
Commission, under the two methods, is computed as follows:

(i) Percentage of Net Profit or Distributable Profit before charging Commission:
Net Profit or Distributable Profit (before Commission) × Rate of Commission %
100
(ii) Percentage of Net Profit or Distributable Profit after charging Commission:
Net Profit or Distributable Profit (before Commission) × Rate of Commission %
100 + Rate of Commission

Accounting Treatment

Remuneration (Salary or Commission) to partners, an appropriation of profit, is
transferred to the Profit and Loss Appropriation Account. Journal entries passed are:

(i) On Allowing Remuneration (Salaries or Commission) to Partners:

Partners’ Salaries/Commission A/c ...Dr.
To Partners’ Current A/cs                     [When Capitals are fixed]
To Partners’ Capital A/cs                      [When Capitals are fluctuating]

(ii) On Closure of Remuneration (Salaries or Commission) A/cs:

Profit and Loss Appropriation A/c ...Dr.
To Partners’ Salaries/Commission A/c

Intrest on Partners'  Capitals

 Intrest on Partners'  Capitals

Interest on Capital is allowed to compensate a partner for contributing capital to the firm in excess of the profit-sharing ratio. Like interest on drawings, it is also calculated at the agreed rate with reference to the time capital has been used in the business. Thus, interest on capital is allowed on the opening balance of the partner’s capital.

Additional Capital: If additional capital is introduced during the year, interest is allowed on it from the date additional capital is introduced till the end of the accounting year.

Withdrawal of Capital: If capital is withdrawn by a partner during the year and interest is allowed on capital, interest is not allowed on the amount withdrawn from the date of withdrawal of capital till the end of the accounting year.

Reasons or justification for allowing interest on capital are:

(i) When Capitals of partners are different but profit share is equal. If a partner invests

more capital as compared to other partners and profit share is equal, interest paid on

capital compensates him or her for more investment. In case interest on capital is not

paid, share in profit of a partner investing more capital will be equal to share of profit

of partners investing less capital.

(ii) When Capitals of partners are not same and profit share is also not equal. In this

case, partners investing less capital may get more share of profit and partners investing

more capital may get less share of profit.

(iii) Capital increases the earning capacity of the firm. Capital is the most important

component of business. Capital helps in efficient conduct of business activities and therefore

earning more profits. It is because of this reason that interest on capital is allowed.

At the same time, where profit is shared by the partners in the proportion of their capitals, interest on capital should not be allowed because partner investing more capital gets more share of profit.

The provisions relating to interest on capital are given below:

PROVISION RELATING TO INTEREST ON CAPITAL

Journal entries to record interest on capital are:

Journal entries to record interest on capital are:

Interest on Capital when Profit Available for Appropriation is Inadequate

Profit of the firm may be less than the amount of interest on capitals allowable to the partners

and interest on capital is an appropriation. In this situation, interest on capitals of the partners is calculated and the profit is distributed among the partners in the ratio of interest on capital.

In case, along with interest on capital, appropriation is to be made for salary, commission, etc.,

to partners, total amount of appropriations for each partner is determined and amount of profit

is distributed among the partners in the ratio of the appropriations to be made to each partner.

Following illustration will bring more clarity

Opening Capital:

Interest on capital is allowed on Opening Capital of the partner. If a partner

has neither introduced additional capital nor withdrawn it during the year, closing balance

of the Capital Account of the previous year is the opening balance in the Capital Account of the Current Year. In case opening capital is not given, it needs to be determined to calculate interest on capital. It is determined by adding the items which have already been deducted (e.g., Share of Loss, Drawings, Interest on Drawings) and by deducting the items which have already been added to the capital (e.g., Additional Capital, Interest on Capital, Profit already credited). It is calculated as follows:

(a) When Capitals are fixed:

CALCULATION OF OPENING CAPITAL

(b) When Capitals are fluctuating:

When Capitals are fluctuating:

Alternatively, Opening Capital can be calculated as Balancing Figure by preparing Capital Account of each partner as follows:

PARTNER’S CAPITAL ACCOUNT

Accounting: An introduction

Intrest on Partners' Drawings

Drawings mean the amount withdrawn, in cash or in kind, by partners for their personal use.
Drawings may be out of capital or against profit. Both are discussed below:

 Intrest on Partners' Drawings

Drawings against Capital

Drawings against capital is withdrawal of amount out of his or her capital in the firm. Drawings
against capital is debited to his or her Capital Account. It means that the capital is reduced by
the amount withdrawn.
Interest on capital is allowed on capital for the period it is used in business. As a result of
drawings against capital, interest on capital is not allowed to a partner on withdrawn amount.
For example, Anmol (partner) has capital of ` 5,00,000 on 1st April, 2019. He withdraws
` 1,00,000 on 1st October, 2019 out of his capital. If the Partnership Deed allows interest on
capital @ 10% p.a., Anmol will get interest of ` 45,000 on capital for the year ended 31st March,
2020, calculated as follows:
On ` 5,00,000 @ 10 p.a. for 6 months (1st April, 2019 to 30th September, 2019)    25,000
On ` 4,00,000 (i.e., ` 5,00,000 – ` 1,00,000) @ 10% p.a. for 6 months
(1st October, 2019 to 31st March, 2020) `                                                                 20,000
Total Interest                                                                                    25000+20000=  45,000

Drawings against Profit

Drawings against profit means drawings by a partner against his or her expected share of profit for the year. Drawings against profit is debited to Drawings Account and not to the Capital Account of the partner. Actual share of profit of a partner is known at the end of the year and is the date when it becomes due to the partner. Since, withdrawal is earlier than it is due, the firm charges interest for the period amount is withdrawn by the partner.

Difference between Drawings Against Capital and Drawings Against Profit

Difference between Drawings Against Capital and Drawings Against Profit

Interest is charged on drawings against expected profit if the Partnership Deed provides for

charging interest on drawings. Interest charged on drawings is transferred to Profit and Loss

Appropriation Account and debited to Partners’ Capital Accounts (in case of Fluctuating Capital Accounts Method) or Partners’ Current Accounts (in case of Fixed Capital Accounts Method).

Journal entries passed for interest on drawings are:.

 Partner’s Capital/Current A/c ...Dr.

 To Interest on Drawings A/c

 (Interest charged on drawings)

 Interest on Drawings A/c ...Dr.

 To Profit and Loss Appropriation A/c

 (Interest on Drawings transferred)

Interest on amount of drawings is charged on the amount of drawings from the date of

withdrawal (drawing) till the end of the financial year.

Calculation of Interest on Drawings

Drawings by a partner may be broadly divided into:

(i) Irregular Drawings: It means drawings of same amount or different amounts at irregular

intervals; and

(ii) Regular Drawings: It means drawings of same amount at regular intervals.

Interest on Drawings when drawings are made at irregular period or of different amounts,

Product Method of calculating interest is followed. And when drawings are made of same

amount at regular intervals, interest on drawings is calculated using Average Period Method.

The two methods of calculating interest on drawings are:

I. Product Method; and

II. Average Period Method.

Both the methods are discussed below:

I. Product Method: When unequal amount is withdrawn at different dates or when there is

irregular drawings, interest on drawings is calculated with the help of Simple Method or

Product Method.

Simple Method: Under this method, interest on drawings is calculated for the period the

amount is drawn. The interest is calculated with reference to each drawing.

Product Method: Under this method, the amount of drawings is multiplied with the

number of months or number of days (as the case is) it is drawn. The product so obtained

is totalled and interest is calculated thereon for one month, if the period taken is in

months and for one day, if the period taken is in days.

II. Average Period Method: This method is used when there is regular drawings or when:

(a) the amount of drawings is uniform; and

(b) the time interval between the two drawings is also uniform.

 The formula for calculating interest on drawings under this method is:

Important Note: If the date of drawings is not given and Accounting period is less than

6 months, then the Interest on Total Drawings is calculated for half of the accounting period.

Remember: Interest on drawings is an income for the firm and hence is credited to Profit and Loss Appropriation Account. On the other hand, interest on drawings is a loss to the partner and is debited to his Capital Account (in case of Fluctuating Capitals) or Current Account (in case of Fixed Capitals)

The Journal entries to record interest on drawings are:

The Journal entries to record interest on drawings

At the time of calculating interest on drawings, remember the following:

1. When a partner withdraws fixed amount in the beginning of every month, interest is

charged on the total amount of drawings for 6½ months at an agreed rate per annum.

2. When a partner withdraws fixed sum in the middle of every month, interest is charged on

the total amount of drawings for 6 months at an agreed rate per annum.

3. When a partner withdraws fixed sum at the end of every month, interest is charged on

the total amount of drawings for 5½ months at an agreed rate per annum.

4. When a partner withdraws fixed sum in the beginning of each quarter, interest is charged

on the total amount of drawings for a period of 7½ months at an agreed rate per annum.

5. When a partner withdraws fixed sum in the middle of each quarter, interest is charged on

the total amount of drawings for a period of 6 months at an agreed rate per annum.

6. When a partner withdraws fixed sum at the end of each quarter, interest is charged on the

total amount of drawings for a period of 4½ months at an agreed rate per annum.

7. When a partner withdraws unequal amount on different dates, interest is calculated using

Simple Method or Product Method.

8. When dates of drawings are given and the interest is to be charged at an agreed rate per

annum, interest is calculated on the basis of time.

9. If date of withdrawal is not given, the interest on total drawings for the year is calculated

for six months on the average basis.

10. When rate of interest is given without the word ‘per annum’, interest is charged without

considering the time factor.

PAST ADJUSTMENTS (ADJUSTMENTS FOR INCORRECT APPROPRIATIONS OF PROFITS IN PAST) AFTER CLOSING THE BOOKS

Sometimes after closing the accounts of a partnership firm, i.e., preparing the financial statements, some errors or omissions in the accounts of the earlier years are noticed. For example, interest on capital or drawings is omitted, allowed or charged at higher or lower rate, profits or losses are distributed among the partners in a wrong ratio and so on. These errors and omissions are rectified by adjusting the Capital Accounts of the affected partners by passing (a) an adjustment entry, or (b) adjustment entries.

(A) When an Adjustment Entry (Single Adjustment Entry) is passed: In this case, net effect of the errors is determined and an adjustment entry is passed by debiting and crediting the Partners’ Capital/Current Accounts.

Alternatively, a table can be prepared by following the below specified procedure for determining the net effect of the past adjustments and passing the adjustment entry:

Step 1: Prepare an analytical table with one column for particulars, one for each partner separately and one for the firm. The columns for the partners and the firm are divided into two parts—debit and credit. An outlay of the Analytical Table is as follows:

*In case of fixed capitals

Step 2: Calculate interest on capital earlier omitted. Place interest due to individual

Partners in their respective credit columns and total interest so omitted in the

debit column of the firm (as it is an expense for the firm).

Step 3: Calculate interest on drawings earlier omitted to be considered. Place interest due

from individual partners in their respective debit columns and total interest so

omitted in the credit column of the firm (as it is an income for the firm).

Step 4: Repeat the process for any other expense or income omitted.

Step 5: Find out balance of the columns designed for the firm. This will disclose net profit

or net loss.

Step 6: Divide profit or loss (as per Step 5 above) among the partners in their profit-sharing ratio.

Step 7: Find the balance of each partner separately. In case one partner has debit balance,

the other partner must have credit balance of the same amount.

Step 8: Pass Adjustment Journal entry with the amounts determined as per Step 7.

Note: If adjustments are to be made for more than one year, then ascertain the consolidated position and then pass the required Journal entry.

(B) When Adjustment Journal Entries (in Place of one Adjustment Entry) are passed: In this situation, analytical table to determine the net effect of all the adjustments is not prepared

instead Journal entries are passed for each error or omission by debiting or crediting

Profit and Loss Adjustment Account. After passing the entries for adjustment of errors

and omissions, Profit and Loss Adjustment Account is closed by debiting or crediting (as

the situation is) with the corresponding credit or debit to the Partners’ Current Accounts,

if Fixed Capital Accounts Method is followed or Partners’ Capital Accounts, if Fluctuating

Capital Accounts Method is followed.

Accounting Entries

Following Journal entries shall be passed through Profit and Loss Adjustment Account:

(i) Adjustment entries for the items which are to be credited to the Partners’ Capital/Current Accounts:

Profit and Loss Adjustment A/c ...Dr.

 To Partners’ Capital/Current A/cs

(Adjustment made for previously omitted, now recorded)

(ii) Adjustment entries for the items which are to be debited to the Partners’ Capital/Current Accounts:

Partners’ Capital/Current A/cs ...Dr.

 To Profit and Loss Adjustment A/c

(Adjustment made for previously omitted, now recorded)

(iii) For Net Profit/Loss due to above adjustments:

(a) For Profit

Profit and Loss Adjustment A/c ...Dr.

 To Partners’ Capital/Current A/cs

(Profit on adjustment credited to Partners’ Capital/Current Accounts)

(b) For Loss

Partners’ Capital/Current A/cs ...Dr.

 To Profit and Loss Adjustment A/c

(Loss on adjustment transferred to Partners’ Capital/Current Accounts)

Note: If capitals of the partners are fixed, adjustment entries are passed through Partners’ Current Accounts. 

GUARANTEE OF PROFIT

A new partner (or partners) may be admitted in the firm with minimum guaranteed profit

from the business. The profit may be guaranteed to an existing or incoming (new) partner by:

(a) all the remaining partners in an agreed ratio; or

(b) one or more of the existing or old partners.

When the guaranteed partner’s or new partner’s share of profit is more than the guaranteed amount, his actual share of profit is given to him instead of the guaranteed amount of profit.

(a) Guarantee of Profit by all the Remaining Partners

When all the remaining partners (i.e., other than the guaranteed partner), guarantee that

the guaranteed partner (or partners) shall be given a minimum amount of profit, following

steps are followed:

Step 1: Share of profit as per profit-sharing ratio is determined, and

Step 2: Minimum guaranteed profit is determined.

The higher of the above two amounts (amounts calculated as per Step 1 and Step 2) is given to

the guaranteed partner. If the share of profit is less than the guaranteed amount, the difference

in the amount of profit, i.e., minimum guaranteed profit minus share of profit of the guaranteed

partner (called ‘deficit’) is borne by the remaining partners in the agreed ratio and where the

agreed ratio is not given the deficit is borne by them in their profit-sharing ratio.

Accounting Entries

1. On Distributing the Profit as if there is no Guarantee Agreement:

 Profit and Loss Appropriation A/c ...Dr.

To All Partners’ Capital A/cs

2. On Charging Deficiency to Guaranteeing Partner(s):

 Guaranteeing Partners’ Capital A/cs ...Dr.

To Guaranteed Partner’s Capital A/c

(b) Guarantee of Profit by one or more of the Existing or Old Partners

When one of the existing or old partners (in some cases more than one partner) guarantee

minimum profit, the adjustment is made through the Partners’ Capital Accounts. Following steps

are to be followed:

Step 1: Distribute the profit among the partners as per their profit-sharing ratio.

Step 2: If share of profit of the guaranteed partner is less than the minimum guaranteed profit

the difference is deducted from the share of profit of the partner (or partners) who

has guaranteed and it is added to the share of profit of the guaranteed partner.

When two or more partners guarantee, the shortfall (deficiency) is shared by them in the agreed

ratio or in their profit-sharing ratio as the case may be.

Accounting treatment of Guarantee of minimum profit to a partner in case of Loss

It is possible that the firm has incurred loss but minimum guaranteed profit is to be paid to the

partner who has been guaranteed minimum profit. In such case, adjustment is made through

Partners’ Capital Accounts in the following manner:

(i) Distribute loss among the partners in their profit-sharing ratio.

(ii) Capital account of the guaranteed partner is credited with guaranteed minimum

profit plus the amount of loss. This amount is debited to remaining partners in their

profit-sharing ratio or to the debit of the partner who has guaranteed minimum profit. 

Minimum Earnings Guaranteed by a Partner

A partner may guarantee minimum fee or specified amount that the firm shall earn by his

efforts. Shortfall, if any is borne by the partner guaranteeing the fee or amount specfied. For

example, Rohit, a partner guarantees the firm that he shall bring only additional fee of ` 1,00,000

in a year but is able to bring only ` 90,000 as fee. The shortfall of ` 10,000 will be debited to his

Capital Account (in case of fixed capitals) or Current Account (in case of fluctuating capitals).

Also, Read This

Accounting: An introduction

Accounting Concepts

Accounting for Partnership Firms - Fundamentals

PARTNERS’ CAPITAL ACCOUNTS | ACCOUNTANCY