Guarantee of Profit to a Partner, Past Adjustments

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.

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Different Cases of Guarantee

1. Guarantee by the Firm or by All the Partners of the Firm

In this case, firstly the firm enters the guaranteed amount to the partner in the Profit an Loss Appropriation Account. Then, it distributes the remaining profit among the remaining partners in their remaining ratio.

For Example:

P, Q, and R are partners in a firm sharing profit and loss in the ratio 2:2:1. P and Q have guaranteed that R’s profit in any year shall not be less than Rs.20000. The Net profit for the year ended 31st March 2018 was Rs.60,000. Prepare Profit and Loss Appropriation Account.

Profit and Loss Appropriation A/c

Date	Particulars	Amount	Date	Particulars	Amount
31.03.2018	To P’s Capital A/c	20,000	31.03.2018	By Net Profit (transferred from P&L A/c)	60,000
	To Q’s Capital A/c	20,000
	To R’s Capital A/c	20,000
		60,000			60,000

Working Notes:

R’s 1/5 share of Rs.60000 is less than Rs.20000 (guarantee amount). Hence, he must be paid Rs.20000 and the remaining partners (P and Q) will share the remaining profit of Rs.40000 in their respective profit sharing ratio (2:2 or 1:1).

2. Guarantee by One Partner Only

Under this case, firstly the deficiency of profit is calculated for the partner who has received the guarantee. Then, this deficiency is deducted from the share of the partner who has given the guarantee.

For Example:

Now let’s assume, in the first example, if only P gives the guarantee to R then the adjustments will be like:

Profit and Loss Appropriation A/c

Date	Particulars	Amount	Date	Particulars	Amount
31.03.2018	To P’s Capital A/c	16,000	31.03.2018	By Net Profit	60,000
	To Q’s Capital A/c	24,000
	To R’s Capital A/c	20,000
		60,000			60,000

Working Notes:

Here also, R’s share is less than the guaranteed amount. Hence, he will get the guaranteed amount but this time there will not be any effect on the profits of Q as the guarantee is given by P only. So, the adjustments (deduction) of deficiency of profit (Rs.8,000) will be from P’s share only.

3. Guarantee by Other Partners but Deficiency is Borne in a Specified Ratio

Under this case, the deficiency of profit is borne by other partners in a pre-determined ratio (not the remaining profit sharing ratio).

Past Adjustments

There are certain circumstances in a firm when due to some reasons like an error in accounting, an omission of a entry, change in profit sharing ratio with retrospective effect, etc. Now we will look into the different adjustments in 2 different cases.

1. When there is only a single error: Under this case, an adjustment table is made and an adjusting journal entry is made to rectify the error. For 2. When there are multiple errors
2. When there are multiple errors:  In this case, the firm prepares the Profit and Loss Appropriation (part of final account) once again in working notes along with the special table. Afterward, we will make a necessary journal entry.

Solved Question for You

Question: P, Q, and R are partners in a firm with Capitals of Rs.200000, Rs.400000 and Rs.600000 respectively. Profit sharing ratio is 3:2:1. Interest on Capital @8% p.a. After the preparation of the final accounts, the firm finds out that the interest on capital was given @6% p.a. Give rectifying journal entry.

Answer:

Partners	Debit	Credit	Net
P	12,000	4,000	Dr. 8,000
Q	8,000	8,000
R	4,000	12,000	Cr. 8,000
Total	24,000	24,000

Here, firstly the excess of interest on capital (@2% p.a.) is credited to all the partners. Now, we know that interest on capital reduces the distribution of remaining profit. So, this total excess of interest on capital is debited to all the partners in their respective profit sharing ratio. The net amount (Debit-Credit or Credit-Debit) is noted and rectifying journal entry is made thereof

Date	Particulars	L.F.	Amount (Dr.)	Amount (Cr.)
	P’s Capital A/c                     Dr.		8,000
	To R’s Capital A/c			8,000
	(Being the rectification of interest of capital done with an increase of 2%p.a.)