MANAGER BECOMING A PARTNER

ACCOUNTING FOR PARTNERSHIP FIRMS

LESSON - 8

MANAGER BECOMING A PARTNER

            In partnership firms the partners may mutually agree to appoint the manager of the firm as one of the firm's partner. If the manager is going to become a partner then there should be a certain calculation as the person being the manager and for becoming a partner of the firm should be made, this calculation will be done following the retrospective effect. Retrospective effect means the changes that the partners are going to make regarding the admission of the manager as a partner will apply from the past years also.

            In simple, the benefits the manager had received all the years and the benefits he was suppose to receive for being a partner all these years will be calculated and compared. Usually the benefits of being a partner would be more so in that case the deficiency amount will be compensated by the other partners as agreed and there is also a chance of the opposite, that is the benefits of being a manager may be more so in that case the manager will compensate the partners.

PROCEDURE FOR CALCULATING RETROSPECTIVE EFFECT:

Step 1 - Calculate the beneficial amount the partner would have received as a manager the firm.

Step 2 -  Calculate the beneficial amount the manager will receive if he is becoming the partner of the firm.

Step 3 -  Compare both step 1 and step 2 and determine the difference amount.

Step 4 - If in case the amount as per step 1 is more, that is the benefit he got as a manager is more then the manager has to compensate the difference amount to the partners.

JOURNAL ENTRY

            New partner (Manager) account         Dr.                 XXX

                To old partners account                                                             XXX

            (being the difference amount paid by the manager)

Step 5 - If in case the amount as per step 2 is more, that is the benefit he will receive as a partner is more then the difference amount will be compensated by the partner to the manager.

JOURNAL ENTRY

       Old partners account              Dr.                     XXX

           To new partner (manager) account                              XXX

            (being the difference amount compensated by the partners to the manager)

FORMAT TO FIND RETROSPECTIVE EFFECT

YEARS (1)	PROFIT OR LOSS (2)	SHARE AS MANAGER (3)		SHARE AS A PARTNER (4)		ADJUSTED PROFIT (5)
No of years the retrospective effect is to take place	Profit or loss of all those years                     TOTAL	He might receive salary, interest,   etc             TOTAL	Different items he receives as a manager should be shown   in separate columns    TOTAL	He might receive interest, commission, or any other appropriations            TOTAL	Different items he receives as a partner should be shown in separate columns           TOTAL	The actual profit from which the share as a partner has to be calculated   FORMULA: profit/loss + share as a manager - share as a partner    TOTAL = (2)+(3)-(4)

 

GUARANTEE OF PROFIT

ACCOUNTING FOR PARTNERSHIP FIRMS

LESSON - 7

GUARANTEE OF PROFIT

            A partner may be allowed for a minimum amount of profit at the end of the year even if the firm has earned less profit or no profit at all. One or more allowed partners may get their share of agreed profit even if the firm is not earning a profit that year this is called giving guarantee for a minimum amount of profit.

            What will happen if the firm is earning a more profit? Even then the guaranteed partner is benefited, that is he will get his share calculated from the more amount of profit, which will get him a higher amount. In both situations whether profit or loss the guaranteed partner will receive his share of profit without fail. The profit share of the partner is compared with the guaranteed amount of profit given by the partners, which ever amount is higher it should be given to the guaranteed partner.

PROFIT GUARANTEE IS GIVEN BY THREE ENTITIES:

1) All the partners

2) One or more partners

3) By the firm

1) PROFIT GUARANTEE GIVEN BY ALL THE PARTNERS:

            All the partners of the firm will agree to pay a guaranteed amount of profit to one or more partners. During the end of the financial year while appropriating the share of profits to all the partners,

if the guaranteed partner's share of profit is less than the guaranteed amount given by the partners then the deficit amount will be given by the guaranteeing partners as agreed.

            In case the actual profit of the guaranteed partner is more than the guaranteed amount then the higher amount of profit is given to him and the other partners have nothing to compensate. In simple, the guaranteed partner will get will get the higher amount either it is actual profit or it is his guaranteed profit.

JOURNAL ENTRIES:

1) For distribution of profit

Profit and loss appropriation a/c    Dr.             XXX

   To all the partner's capital a/c                                          XXX

(being the available profit distributed among the partners)

2) For the deficiency amount

Guaranteeing partner's capital a/c     Dr.             XXX

     To guaranteed partner's capital a/c                                  XXX

(being the deficit guaranteed amount given by the guaranteeing partners)

2) GUARANTEE OF PROFIT IS GIVEN BY ONE OR MORE PARTNERS:

            In this situation the procedure of providing guarantee to a partner is same as we have discussed above. The major change is that, in the above case the guarantee is provided by all the partners of the firm, so the deficit amount was shared among all the partners in their agreed ratio but in this situation either a particular partner or more partners are giving guarantee not all the partners of the firm so the deficiency amount will be compensated only by the guaranteeing partner or partners not by all the partners.

 

            The profit of the firm is shared as usual to all the partners and then the deficit amount will be compensated only by the guaranteeing partner to the guaranteed partners in the ratio as the have already agreed. The partners those who have not given any guarantee will not be affected in the process.

JOURNAL ENTRIES:

1) For distribution of profit 

Profit and loss appropriation a/c       Dr.               XXX

       To all the partner's capital a/c                                         XXX

    (being the profit distributed among the partners)

2) For the deficiency amount

                      Guaranteeing partners capital account         Dr.                            XXX

                                   To guaranteed partner's capital account                                                 XXX

                      (being the deficit amount guaranteed is compensated by the guaranteeing partners)

3) GUARANTEE OF PROFIT IS GIVEN BY THE FIRM:

           

             In the above two situations the partners of the firm where giving guarantee to another partners but in this case the firm itself is giving guarantee to partners. As the guarantee given by the firm becomes an duty for it to pay first, so this guaranteed amount to the partner is not calculated from the divisible profit but it is paid first and the remaining amount after the payment of the guaranteed amount is considered to be the divisible profit. The divisible profit will be shared by the remaining partners in their agreed ratio.

            If in case the firm incurs a loss that year? When there is a loss also the guaranteed partner will get his share of profit. The guaranteed amount will increase the loss of the firm as it has a duty to pay the guaranteed partner. The total loss (the loss of the firm and the guaranteed amount of the partner) will be shared by the remaining partners as they have agreed. In simple, first we can divide the firm's loss among all the partners and then the guaranteeing partners will compensate the guaranteed partner the loss he has shared and his guaranteed amount of profit.

JOURNAL ENTRIES

1) FOR DISTRIBUTION OF PROFIT

            Profit and loss appropriation account         Dr.                                 XXX

                To all the remaining partners capital account                                                       XXX

                To the guaranteed partner capital account                                                           XXX

            (being the profit distributed among the partners)

Note: The guaranteed amount is paid first and then the remaining amount of profit is shared between the partners)

2) IN CASE OF A LOSS

        1)         Partners capital accounts             Dr.                     XXX    (including the guaranteed partner)

                        To profit and loss account                                                     XXX

                    (being the amount of loss shared by the partners)

        2)         Guaranteeing partners capital account         Dr.                         XXX

                        To guaranteed partners capital account                                                         XXX

                    (being the deficit amount shared by the guaranteeing partners)

A PARTNER GIVING GUARANTEE OF MINIMUM EARNINGS TO THE FIRM 

            A partner may provide guarantee to the firm that he will be able to produce the guaranteed amount of earnings that year. If in case he fails, if he is not able to provide the firm with the guaranteed
amount of earnings then the deficiency amount which he failed to provide will be deducted from his capital account. 

JOURNAL ENTRIES

            Guaranteed partner capital account                 Dr.                         XXX (partner who promised a minimum earning to the firm)

                    To profit and loss appropriation account                                                 XXX

(being the deficit amount compensated by the guaranteed partner)

Note: Capital account and current in the journal entries should by used according to the capital accounts maintained by the firm.

ADJUSTMENTS OF PAST ERRORS IN PARTNERSHIP ACCOUNTS

ACCOUNTING FOR PARTNERSHIP FIRMS

LESSON - 6

ADJUSTMENTS OF PAST ERRORS

            After the firm prepares their financial statements of the accounting year sometimes there are chances of errors, omissions etc in the accounts prepared. These errors would have affected the capital accounts of the partners but spotted late. These errors committed should be rectified when it is spotted, but the errors are of historical in nature so we need to pass its rectifying entries to correct it. In partnership accounting these errors are rectified mostly through adjustment of partner's capital accounts. Rectification of these errors would either increase or decrease the capital accounts of the partners, that it may provide the partners with a profit or a loss.

TWO METHODS ARE FOLLOWED TO RECTIFY THE ERRORS:

            1) By passing a single adjustment entry to rectify all the errors (analytical table is prepared) or

            2) By passing adjustment entries for each error individually.

1) PREPARATION OF ANALYTICAL TABLE - single adjustment entry method

    

            All the errors committed in the previous years are taken in total, the errors may be of two possibilities in nature. The errors which increased (credited) the capital account and the errors which decreased (debit) the capital accounts of the partners. These errors will be reversed to rectify them. Out of the total error the net amount of all the errors is determined and a single rectifying journal entry is passed to correct the error committed.

            This procedure can be easily done with the help of preparing an table. This table is called analytical table. This table shows the net effect of all the errors and its effect on partners capital accounts.

FORMAT SAMPLE OF AN ANALYTICAL TABLE

ADJUSTMENT TABLE OR ANALYTICAL TABLE

Particulars	A Partners   Dr.                Cr.		B Partner   Dr.                 Cr.		C Partner   Dr.                 Cr.		Firm’s account   Dr.                 Cr.
Interest on capital .. given more .. given less   Interest on drawings .. taken more .. taken less   Salary/commission etc .. given more .. given less   Net profit or Net loss	XXX         XXX     XXX       XXX   Total	XXX     XXX         XXX   XXX     Total	XXX         XXX     XXX       XXX   Total	XXX     XXX         XXX   XXX     Total	XXX         XXX     XXX       XXX   Total	XXX     XXX         XXX   XXX     Total	XXX     XXX         XXX   XXX     Total	XXX         XXX     XXX       XXX   Total

            

             The result after balancing the table will show a difference in the Credit and Debit columns, this will be used to pass the rectifying entry by providing the information on whose capital account is to be debited and whose capital account is to be credited.

PROCEDURE TO FIND THE NET EFFECT

            Step 1 : An analytical table is a simple version of capital accounts of the partners, so according to the partners in the question columns should be prepared in the table.

            Step 2 : At the end after the partners capital accounts one column should be prepared for the firm, as the rectified changes that affect the partner's capital accounts will also be rectified in the firm's account.

            Step 3 : Now rectify the errors, any increase in amount should be credited and any decrease in the amount should be debited. The errors transactions which had wrongly increased or decreased the capital accounts of the partners should be treated in the opposite way to reverse the entries and rectify.

            Example : If any partner was given more amount (that is more amount was credited to him) so in order to rectify it we should decrease the amount given more than actual (it has to be debited) and same the opposite if a partner was given less amount (credited less) so now we have to give him his remaining amount (the balance amount credit to him again).

            Step 4 : After rectifying the errors any net profit or loss left will also be distributed among the partners.

            Step 5 : Finally balance the amount of each partner individually, this will show you which partner is to be debited and which partner is to be credited.

            Step 6 : Pass the single adjustment entry according to the Dr. and Cr. of the partners.

2) BY PASSING INDIVIDUAL JOURNAL ENTRIES TO RECTIFY:

            Each error committed will be rectified individually by passing journal entries for it under this method. In this method analytical table is not prepared instead journal entries are passed. The errors are rectified by opening profit and loss adjustment account. The errors are adjusted (debited or credited) through profit and loss adjustment account and finally profit and loss adjustment account is adjusted (debited or credited) to partners capital/current accounts respectively.

JOURNAL ENTRIES FOR RECTIFICATION OF ERRORS

1) Adjustment entries for the items which are to be CREDITED to the partner's capital account

            Profit and loss adjustment a/c                 Dr.                     XXX

                To partners capital/current a/c                                                                XXX

            (being previously omitted errors now rectified)

Example : 

            - Interest on capital was given less

            - Salary/interest on capital/commission etc omitted etc.

2) Adjustment entries for the items which are to be DEBITED to partners capital accounts

            Partners capital/current a/c                 Dr.                        XXX

               To profit and loss adjustment a/c                                                            XXX

            (being previously omitted errors now rectified)

Example : 

            - Interest on drawings omitted 

            - Salary/interest on capital etc was given more etc.

3) If net PROFIT out of the rectifications made

          

          Profit and loss adjustment a/c             Dr.                           XXX

                  To partners capital/current a/c                                                              XXX

          (Being profit on rectification credited to partners capital accounts)

4) If net LOSS out of the rectifications made

            Partners capital/current a/c                 Dr.                         XXX

                To profit and loss adjustment a/c                                                             XXX

            (Being loss on rectification debited to partners capital accounts)

CAPITAL ACCOUNTS OF PARTNERS

ACCOUNTING FOR PARTNERSHIP FIRMS

LESSON - 5

PARTNERS CAPITAL ACCOUNTS

            As business has a separate legal entity, that is the business and its owner are considered as two different entities. The partnership firm maintains the transaction details of its partners individually in an account named as capital account. Capital accounts shows the details of partner's transactions - the things he needs to receive (credited) and the things which reduces his payments (debited). Normally partner's capital account has a credit balance and it is shown in the liabilities side of the balance sheet, it is a due amount for the firm as it has to be paid back to the partners invested.

PARTNER'S CAPITAL ACCOUNT CAN BE MAINTAINED IN TWO WAYS:

1) FIXED CAPITAL  ACCOUNTS METHOD

            The firms which does not want its partner's capital accounts to be altered follows this method, in this method the capital invested by the partners remain same and unaltered by the functioning of the business. The transactions related to the functioning of the business will be entered in an another account.

 

            Under this method we need to prepare two accounts

            - Capital Account and 

            - Current Account 

            - CAPITAL ACCOUNT

            Partners capital account shows the money invested by the partners as capital. Usually capital account under fixed capital method shows the same balance every year as all the other transactions will be entered in another account. Only two types of transactions possibly affect this account under this method, they are:

            - Additional capital introduced during the year which will be credited to the account and

            - Capital withdrawn (drawings out of capital) during the year which will be debited to the account

            Capital accounts will always show a credit balance as there should be money left in the business to operate it year after year.

FORMAT OF CAPITAL ACCOUNT

Dr.                                                 PARTNERS CAPITAL ACCOUNT                                        Cr.

Particulars	A’s capital a/c - amount	B’s capital a/c - amount	Particulars	A’s capital a/c - amount	B’s capital a/c - amount
Any drawings (drawings out of capital)   Balance left	XXXX       XXXX          TOTAL	XXXX      XXXX          TOTAL	Capital invested   Any additional capital added	XXXX      XXXX           TOTAL	XXXX    XXXX            TOTAL

              

           - CURRENT ACCOUNT

            As the transactions related to the business operation are not entered in capital account under this method, it needs a separate account so all those transactions will be entered in an another account named current account. The transactions related to business operations like interest on capital, interest on drawings, salary, commission etc will be entered in this account. The transactions which are due to the partner has to be credited and the transactions for which the partner has to pay will be debited to the current account respectively. As current account records all the transaction both favorable and unfavorable, it may have a debit or credit balance.

            A credit balance in current shows the amount the firm needs to pay the partners, so it should be shown in the liabilities side of the balance sheet. A debit balance in the current account denotes the partner has used more money than that is available to him and he has to pay back to the firm, so it will be shown in the asset side of the balance sheet.

FORMAT OF CURRENT ACCOUNT

Dr.                                                PARTNERS CURRENT ACCOUNT                                    Cr.

Particulars	A’s capital a/c - amount	B’s capital a/c - amount	Particulars	A’s capital a/c - amount	B’s capital a/c - amount
Capital invested (it can be debit or credit balance)   Items partner needs to pay     . drawings (out of profit)     . interest on drawings     . any loss   Balance left (it can have debit or credit balance)	XXXX            XXXX    XXXX        XXXX       XXXX            TOTAL	XXXX             XXXX    XXXX      XXXX       XXXX          TOTAL	Capital invested (it can be credit or debit balance)   Items partner needs to receive     . interest on capital     . commission/ salary     . any profit   Balance left (it can have credit or debit balance)	XXXX              XXXX    XXXX      XXXX               TOTAL	XXXX             XXXX   XXXX       XXXX                TOTAL

 

Note : As current account records all the transaction related to the business operations, it may have a debit or credit balance.

2) FLUCTUATING CAPITAL ACCOUNTS METHOD

            If the firm wants to show all its transactions in a same account then this method is followed. Under this method all the transactions whether it is related to the partner's capital or to the business operations, all will be recorded under a same account. This method maintains only one account named

capital account to record it all transactions. Under fluctuating capital method capital account records transactions like additional capital, drawings, interest on capital, interest on drawings, salary, commission etc. All the transactions for which the partner has to receive amount will be credited and for which he needs to pay will be debited to the capital account

            Under fluctuating method capital account may have both debit or credit balance. If capital account has a debit balance then it has to be shown in the asset side of the balance sheet and if it has a credit balance then it has to be shown in the liabilities side of the balance sheet.

            Normally partnership firms follow fluctuating capital method so if the question does not state any particular method the student can follow fluctuating capital method.

FORMAT OF CAPITAL ACCOUNT under fluctuating capital method:

Dr.                                              PARTNERS CAPITAL ACCOUNT                                                    Cr.

Particulars	A’s capital a/c - amount	B’s capital a/c - amount	Particulars	A’s capital a/c - amount	B’s capital a/c - amount
Capital invested (it can be debit or credit balance)   Drawings made out of capital     Items partner needs to pay     . drawings (out of profit)     . interest on drawings     . any loss   Balance left (it can have debit or credit balance)	XXXX            XXXX            XXXX       XXXX    XXXX          XXXX             TOTAL	XXXX            XXXX              XXXX       XXXX    XXXX          XXXX           TOTAL	Capital invested (it can be credit or debit balance)   Additional capital introduced     Items partner needs to receive     . interest on capital     . commission/ salary     . any profit   Balance left (it can have credit or debit balance)	XXXX           XXXX          XXXX   XXXX   XXXX          XXXX              TOTAL	XXXX           XXXX              XXXX  XXXX  XXXX          XXXX              TOTAL