Fluctuating Capital Accounts:

In this method only one single account is prepared. The balances of the capital accounts keep on changing.

 In the absence of any instruction in the question, the Capital Accounts need to be prepared by Fluctuating Capital Accounts Method.

 Methods of preparation of Capital Accounts

Capital Accounts (When capitals are fluctuating)

Particulars	Partner A	Partner B	Particulars	Partner A	Partner B
To balance b/d (in case of debit opening balance)	₹	₹	By balance b/d (in case of credit opening balance)	₹	₹
To Drawings	₹	₹	By Interest on Capital	₹	₹
To Interest on Drawings	₹	₹	By Salary	₹	₹
To P&L A/C (in case of loss, distributed in the profit sharing ratio)	₹	₹	By Commission	₹	₹
To balance c/d (closing balance,  when the credit side is more than the debit side)	₹	₹	By P&L Appropriation A/C ( in case of profit, distributed in the  profit sharing ratio)	₹	₹
			By Cash/Bank A/C (Additional Capital brought)	₹	₹
			By balance c/d (closing balance,  when the debit side is more than the credit side)	₹	₹
TOTAL	₹₹	₹₹	TOTAL	₹₹	₹₹

 

Notes:

• • ⎫All the items that increase the capital account balances, go on the credit side. And, the items that reduce the balances of the capital accounts, go on the debit side.
  • ⎫If a partner brings anything in kind (asset), then, the credit side of the capital account will be credited with the Asset's name and its value. For example, if a partner brings a Machine as Capital worth ₹50,000, then the Capital account will be credited as: By Machinery A/C in the particulars column and ₹50,000 in the amount column.

Profit and Loss Appropriation Account

 

Particulars	₹	Particulars	₹
To Profit and Loss A/c (Net Loss transferred from Profit and Loss Account)	₹	By Profit and Loss A/C (Net Profit transferred from Profit and Loss Account)	₹
To Interest on Capitals: A_____₹_______ B_____₹_______	₹	By Interest on Drawings: A_____₹_______ B_____₹_______	₹
To Partner's Salaries	₹
To Partner's Commissions	₹
To Reserves (Specific or General reserve)	₹
To Profit transferred to: A's Capital A/C (A's Current A/C) B's Capital A/C (B's Current A/C)	₹
TOTAL	₹₹	TOTAL	₹₹

 

• • ⎫There are only 7 entries that go in the P&L Appropriation A/c.
  • ⎫It is a Nominal Account.
  • ⎫Things to be paid to a partner is entered on the Debit side.
  • ⎫NOTE: Whenever calculating interest on any item or the amount of salary, etc. do see whether it is per month (p.m.) or per annum (p.a.) in the question.
  • ⎫NOTE: In case of loss to a firm, Profit and Loss Appropriation A/C will not be prepared and the losses will be distributed through Profit and Loss Account.
  • ⎫In items like Interest on Capital, do read the question carefully, and ascertain whether the item is an appropriation out of profits or a charge against profits.

 

Calculation of Interest on Capital

Hence, as we can see answers from both the methods is the same. In exams, you can use any method of your choice to calculate the interest on capital.

Interest on Capital is always calculated on Opening Capital. If Closing Capital is given, you need to calculate Opening capital first.

Calculation of Manager's Commission on Net Profits:

• 1. If commission is provided on profits before charging such commission:

Say, the profit is ₹1,21,000 before charging such commission and the manager is to be paid commission @10% on the profit before charging such commission, then the commission will be= 1,21,000 X 10/100 =  ₹12,100

• 1. If commission is provided on profits after charging such commission:

Say, the profit is ₹1,21,000 before charging such commission and the manager is to be paid commission @10% on the profit after charging such commission, then the commission will be =

1,21,000 X 10/(100+10) = 1,21,000 X 10/110 = ₹11,000

 Appropriations of Net Profit

 Example AP.1

 A and B are 2 partners in a firm. As per the partnership deed, the partners are to get salary of ₹10,000 and ₹15,000 p.a. Also, the interest on capital @10% comes out to be ₹5,000 and ₹10,000. Total Net Profit for the year is ₹25,000.

 

SOLUTION:

Total Appropriations to A: 10,000+5,000=15,000

Total Appropriations to B: 15,000+10,000=25,000

Hence, TOTAL= 15,000+25,000=40,000 > 25,000 (the net profit available for distribution)

 

Now, the ratio of the appropriations= A:B = 15,000:25,000= 3:5

Net Profit= ₹25,000

 

Now, Net profit will be distributed in 3:5 =

 

=> A= ₹25,000 X 3/8 = ₹9,375

=> B= ₹25,000 X 5/8 = ₹15,625

 

Rent paid to partner:

It is a charge against profit and hence it should be debited to Profit and Loss Account and credited to rent payable account.

 

Rent paid to a partner is an expense incurred for using the property. Hence, it is a charge against profits and will be debited to Profit and Loss A/C, even if the firm incurs a loss.

 

 

Interest on Partner's Loan:

Rate on Interest: If a partner has advanced loan to the partnership firm, he will be entitled to receive Interest on Loan on the loan amount at the agreed rate of interest.

 

However, if there is no agreement as to the rate of interest, he is entitled to receive interest on loan @6% per annum.

 

Nature of Interest: It is a charge against profit and hence interest on partner's loan is debited to Profit and Loss A/C, even if the firm incurs a loss.

 

The following entries are passed to record interest on loan:

1. 1. For providing Interest on Partner's Loan:

Interest on Partner's Loan A/C       Dr.

To Partner's Loan A/C

ii)    For closing the Interest on Partner's Loan A/C:

Profit & Loss A/C                               Dr.

To Interest on Partner's Loan A/C

 

Interest on Loan taken by a Partner from the Firm:

 

Nature of Interest: Interest on Loan taken by a partner is a gain (since this income does not occur on regular and continuous basis) for the firm. Interest on loan taken by a partner is credited to Profit and Loss A/C.

 

Accounting treatment:

The following entries are passed to record interest on loan:

• 1. For charging Interest on Loan to a partner:

Partner's Capital/Current A/C       Dr.

        To Interest on Partner's Loan A/C

• 1. For closing the Interest on Partner's Loan A/C:

Interest on Partner's Loan A/C      Dr.

To Profit and Loss Account

 

 

Methods of Calculating Interest on Drawings

• 1. Simple Method:

Interest on Drawings= Amount of Drawings X Rate of interest/100 X Months/12

 

• 1. Product Method:

First of all the products are computed by multiplying the each set of drawings from its duration. Then, the different products are added and the interest is calculated on the Total of products so arrived at for one month.

Interest on Drawings= Total of products X Rate of interest/100 X 1/12

 

• • When a partner makes monthly drawings on regular intervals, we need to calculate Average Period then which is as follows:

Average Period = (Time left after first drawing+ Time left after last drawing)/2

Therefore, Interest on Drawings= Total Drawings X Rate of interest/100 X Average period/12

 

• • Note: Average Period is to be used only when:

• • All amounts of drawings are equal, AND
  • The time gap between drawings is equal.

 

For example: When the drawings are of equal amount and are made during middle of each quarter:

Here, it is given that the amount of drawings is equal and the time interval between two drawing is equal (i.e. 3 months).

Hence, Average Period will be=  (Time left after first drawing+ Time left after last drawing)/2

= (10.5 months+ 1.5 months)/2= 6 months

 

 

Past Adjustments (Adjustments in Closed Accounts)

 

As previously learnt in 11th standard, if a wrong entry is passed, we can't modify it. We have to rectify it by passing a new entry so that the net effect comes out to be like the correct entry.

Here also, similar concept is used. Sometimes, wrong entries are passed regarding to the amount of interest or any other item to be given to the partner, or sometimes, the entry is passed in wrong partner's account. In these cases, there arises a need of a rectifying entry. This process of correcting the past entries is known as Past Adjustments.

The following are the types of errors that may occur:

1. 1. Interest on Capitals or Drawings may get omitted.
   2. Interest or Salary may be credited to wrong partner's account.
   3. Profits and Losses have been distributed among the partners in a wrong proportion.
   4. When salary or commission payable to a person has been omitted.
   5. When the profit sharing ratio gets changed with a retrospective effect (i.e. with effect from some past date).

 

These errors or omissions may be rectified in two ways:

• 1. By passing a single adjustment entry with the net effect of the errors and omissions (99% of the questions will be solved with this method), OR
  2. By passing separate adjustment entries for each error and omission.

 

Guarantee of Profit to a Partner

 

Guarantee means the surety of a particular amount of profits by one or more partners and in some cases by the firm, where the burden of guarantee is borne by the party providing such a guarantee. In other words, it is a minimum fixed amount for the partner who is given such a guarantee.

If the actual share in profits is less than the guaranteed amount then the deficit amount shall be borne either by the firm or by any partner as the case may be. There are many ‘Adjustments’ which a firm will do in such a case. If the actual share in profits is more than the minimum guarantee amount then the firm will provide the actual profits to the partner.