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.