Capital Accounts of the Partner: Fixed Capital Method
The Partner’s Capital Account is an account that records all the transactions between the Partnership firm and the partners to evaluate the partners’ share in the firm (Partners’ investment) at the end of the accounting period. The partners’ capital account is adequately maintained to ensure transparency and accuracy between the firm and the partners and among the partners.
Methods of maintaining Capital Account:
The Capital Account can be maintained in either of the two ways mentioned below:
1. Fixed Capital Method: Under Fixed Capital Method, the initial capital introduced by the partners at the beginning is considered to be fixed throughout the lifespan of the firm, except in the event of Additional capital introduced and permanent withdrawal of the capital (drawings).
2. Fluctuating Capital Method: Under this method, the capital balance of each of the partners fluctuates continuously and is not fixed. The capital account is affected by each and every transaction between the firm and the partners.
Fixed Capital Method:
Under the fixed method of maintaining partners’ capital accounts, the initial capital invested by the partners remains constant throughout the lifetime of the business. The capital is affected only when additional capital is introduced by the partner or the capital is withdrawn by the partner. Under this method, two accounts are prepared:
- Capital Account: The Capital Account records only those transactions that are related to capital or change in the capital (Additional Capital and Drawings). In the capital account, the capital brought in by the partner is credited and any drawing is debited.
- Current Account: A separate account known as a Current Account or Drawings Account is opened to record all the other transactions related to partners, such as Interest on capital, Interest on drawings, salary, Profit/loss share, etc. Any income or profit of the partner is credited, and any expense or loss is debited to the current account.
Steps of Fixed Capital Method:
The preparation of a capital account under the Fixed Capital Method involves the following steps:
Step 1: Firstly, prepare a Capital Account, and credit the initial and subsequent capital contribution by the partner. Any drawings from the capital are recorded on the debit side of the capital account.
Step 2: Then prepare a Current Account. All the Receipts related to partners are recorded on the credit side of the current account, such as Interest on capital, the salary of the partner, the profit share of the partner, commission, and so on.
Step 3: The debit side of a current account records all the expenses or liabilities related to the partner, such as Interest on drawings.
Step 4: The profit is distributed according to the profit sharing ratio. The profit is credited, and the loss is debited, respectively.
Step 5: Then the closing capital of the partner is calculated by subtracting the debit side of the current account from the credit side. The closing balance is then transferred to a Balance sheet as a partner capital account.
Formats (When the capital is fixed):
** denotes that the balance of Current A/c can be either Debit or Credit.
X and Y are partners in the firm sharing profits and losses in the ratio of 1:1 with a capital contribution of ₹5,00,000 and ₹3,60,000, respectively on 1st April, 2021. On 1st July, 2021, they decided that their capital should be ₹4,00,000 each. Necessary adjustments in the capital were made by withdrawing or introducing cash. The Partnership Deed provides for the followings:
- Interest on Capital to be paid to each partner @8% p.a.
- X is entitled to get an annual salary of ₹ 8,000 and Y is allowed a monthly salary of ₹1,600. It was found that Y withdraws his monthly salary regularly.
- The manager of the firm is entitled to a commission of 10% of the profit before any adjustment.
- The Net Profit for the year ending 31st March, 2022 before charging interest on Capital and salary was ₹1,60,000.
Prepare the Profit and Loss Appropriation Account and the Partners’ Capital Account under Fixed Capital Method.
1. Calculation of Interest on Capital:
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