Commerce

Interest on Partner’s Capital | Past Adjustment | Guarantee of Profit

INTEREST ON PARTNER’S CAPITAL  

1. When Capitals of partners are different but profit-sharing ratio is equal. 

If a partner invests more capital as compared to other partners and the profit-sharing ratio 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.

2. When Capitals of partners are not same and profit-sharing ratio is also not equal. 

Partners investing less capital may get more share of profit and partners investing more capital may get less share of profit. 

3. 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 the partner investing more capital gets more share of profit.

PROVISION RELATED TO IOC

Cases: 

1.  When the partnership deed does not exist or partnership deed does not have a clause as to interest on capital.   
   •     →  interest on capital is not allowed

2.  When the partnership deed provides for interest on capital as a charge.
   • → interest on capital is allowed whether there is profit or loss

3.  When the partnership deed provides for interest on capital but is silent as to the treatment of interest as a charge or appropriation. 
   • → interest on capital is considered to be appropriation of profit interest on capital is allowed only if there is profit there are three possible situations:

(i) In case of loss interest on capital is not allowed.

(ii)In case of profit  before interest is equal to or more than the interest:-  interest on capital is allowed at the agreed rate. 

(iii)  In case of profit before interest is less than the interest:-  interest is allowed only to the extent of profit in the ratio of interest on capital of each partner. 

Interest on capital when profit available for appropriation is inadequate:

The profit of the form may be less than the amount of total interest on capital allowable to the partners in such a situation, interest on Capitals of the partners is calculated and the profit is distributed among the partners in the ratio of interest on capital.

PAST ADJUSTMENT

1. When single adjustment entry is passed : 

A single adjustment entry is passed for the net amount of all the past adjustments.

2. When adjustment  entries are passed in place of a single journal entry : 

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

                          To Partners’ Capital/Current A/cs

(Being the 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

                             To Profit and Loss Adjustment A/c

(Being the 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

                            To Partners Capital/Current A/cs

(Being the profit on adjustment credited to Partners’ Capital/Current Accounts)

            (b) For Loss

                      Partners’ Capital/Current A/cs.

                            To Profit and Loss Adjustment A/c

(Being the loss on adjustment transferred to Partners’ Capital/Current Accounts)

Note: If capitals of the partners are fixed, adjustment entries are passed through Partners

GUARANTEE OF PROFIT

 1. Guarantee of profit by all the remaining partners  

                  When all the remaining partners guarantee that the guaranteed partner shall be given a minimum amount of profit.

ACCOUNTING ENTRY 

1.  On distributing the profit as if there is guarantee agreement 

                  Profit and Loss appropriation a/c        …Dr 

                           To A’s partners capital a/c

2.  On charging deficiency to guaranteed partner  

                  Guarantee partner capital a/c.             …Dr

                      To Guaranteed partner capital a/c

2. Guarantee of profit by one or more of the existing or old partners 

         When one or more than one of the existing or old partner’s guarantee a minimum profit to another partner, the adjustments are made through the partners capital account. 

©  Guarantee of minimum profit to a partner in case of loss 

Distribute loss among the partners in their profit sharing ratio.  then the 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 proper sharing ratio or to the debit of the partner who has guaranteed minimum profit to the guaranteed partner. 

OR

Directly,  give the guaranteed amount to the guaranteed partner and distribute the loss of the firm plus the amount given to the guaranteed partner among the rest of the partners or who has guaranteed minimum profit to the partner.   

© Guarantee of profit by the firm

It’s the same as the guarantee of all the partners as guarantee of profit to a partner means that the partners other than the guaranteed partner shall share the balance profit after profit equal to guarantee that amount is credited to the guaranteed partners capital account or current account.

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