Q.Read the following hypothetical situation and answer questions number 4 and 5 on the basis of the given information : Kavita, Savita and Madhu were partners in a firm with capitals of ₹ 6,00,000, ₹ 4,00,000 and ₹ 2,00,000 respectively. After providing interest on capital @ 10% p.a., the profits are divisible as follows : Kavita 1/3, Savita 1/2 and Madhu 1/6. Kavita personally guaranteed that Savita's share of profit after charging interest on capital would not be less than ₹ 1,00,000 in any year. The profit for the year ending 31st March, 2022 amounted to ₹ 3,00,000 before providing interest on capital. Savita's share of profit is short of the guaranteed amount by : (A) ₹ 40,000 (B) ₹ 70,000 (C) ₹ 20,000 (D) ₹ 10,000

Concept: Guarantee of Minimum Profit to a Partner

When an incoming partner is admitted with a guarantee of minimum profit, the firm promises that the new partner will receive at least a specified amount, regardless of what the profit-sharing ratio yields. If the new partner's share calculated by the agreed ratio falls short of the guaranteed amount, the deficiency must be borne by one or more of the existing partners.

The accounting treatment depends on who bears the guarantee. The question is silent on this point, which means we apply the default rule: the deficiency is borne by the old partners (here, John and Harry) in their old profit-sharing ratio. The new partner receives the guaranteed amount, and the remaining profit is distributed among all partners in the new ratio, but the old partners' shares are reduced to make up the shortfall.

The mechanics are straightforward:

1. Calculate Dinesh's share under the new profit-sharing ratio.
2. Compare it with the guaranteed amount.
3. If the calculated share is less, the deficiency is borne by John and Harry in their old ratio (2:1).
4. Adjust each partner's final share accordingly.

Determination of New Profit-Sharing Ratio

Dinesh is admitted for $\frac{1}{4}$ share. The remaining share for John and Harry together is:

John and Harry continue to share this $\frac{3}{4}$ in their old ratio of 2:1.

John's new share:

Harry's new share:

New profit-sharing ratio = John : Harry : Dinesh = $\frac{1}{2} : \frac{1}{4} : \frac{1}{4}$ = 2 : 1 : 1.

Calculation of Profit Distribution

Working Note 1: Dinesh's share as per new ratio

Net profit for the year = ₹2,80,000

Dinesh's share = $\frac{1}{4} \times 2,80,000 = ₹70,000$

Working Note 2: Guarantee shortfall

Guaranteed amount to Dinesh = ₹1,00,000

Dinesh's share as per ratio = ₹70,000

Deficiency = ₹1,00,000 – ₹70,000 = ₹30,000

This deficiency of ₹30,000 must be borne by John and Harry in their old ratio of 2:1.

Working Note 3: Deficiency borne by old partners

John's share of deficiency = $\frac{2}{3} \times 30,000 = ₹20,000$

Harry's share of deficiency = $\frac{1}{3} \times 30,000 = ₹10,000$

Working Note 4: Final distribution of profit

| Partner | Share as per new ratio (2:1:1) | Adjustment for guarantee | Final share | …

Concept: Guarantee of Minimum Profit to a Partner

When a partner is guaranteed a minimum profit, the firm first distributes profit in the normal profit-sharing ratio. If the guaranteed partner's share falls short of the guarantee, the deficiency must be made good. The question then becomes: who bears this deficiency?

Here, Boris is guaranteed ₹95,000. The deficiency (if any) is to be borne by Abhay and Chetan equally — meaning they share the burden 1:1, not in their original profit ratio. This is a specific arrangement among the partners.

The accounting treatment is straightforward:

1. Distribute the total profit (₹2,00,000) in the normal ratio 5:3:2.
2. Compare Boris's share with his guarantee.
3. If his share is less, calculate the deficiency.
4. Abhay and Chetan each contribute half the deficiency from their own shares to Boris.

The net effect is a transfer within the appropriation: Abhay's and Chetan's capital/current accounts are debited (reduced), and Boris's is credited (increased) by the deficiency amount, split equally between the two guarantors.

Solution

Working Note 1: Distribution of Profit in Normal Ratio (5:3:2)

Total profit = ₹2,00,000

Profit-sharing ratio = 5:3:2 (sum = 10)

• Abhay's share = $\frac{5}{10} \times 2,00,000 = ₹1,00,000$
• Boris's share = $\frac{3}{10} \times 2,00,000 = ₹60,000$
• Chetan's share = $\frac{2}{10} \times 2,00,000 = ₹40,000$

Working Note 2: Deficiency in Boris's Share

Boris is guaranteed ₹95,000, but his normal share is only ₹60,000.

Deficiency = ₹95,000 − ₹60,000 = ₹35,000

This ₹35,000 shortfall must be made good by Abhay and Chetan equally.

Working Note 3: Contribution by Abhay and Chetan

Since the deficiency is to be borne equally:

• Abhay's contribution = $\frac{35,000}{2} = ₹17,500$
• Chetan's contribution = $\frac{35,000}{2} = ₹17,500$

Working Note 4: Final Distribution of Profit

The adjustment is a pure transfer: Abhay and Chetan each give up ₹17,500 of their profit share, which is added to Boris's share to bring it up to the guaranteed ₹95,000. …

The question deals with the concept of 'Guarantee of Profit to a Partner'. This is a common arrangement in partnership firms where one or more partners are assured a minimum amount of profit, irrespective of the firm's actual earnings.

Concept of Guarantee of Profit

When a partner is guaranteed a minimum profit, it means that if their share of profit (calculated according to the profit-sharing ratio) falls short of the guaranteed amount, the deficiency must be made good. This deficiency can be borne by:

1. The firm (i.e., by all other partners in their profit-sharing ratio).
2. One specific partner.
3. A group of specific partners in an agreed ratio.

In this problem, Kavita has personally guaranteed that Savita's share of profit would not be less than ₹1,00,000. This means any deficiency in Savita's profit share will be borne solely by Kavita.

Accounting Treatment

The distribution of profit, including any guarantee adjustments, is shown in the Profit and Loss Appropriation Account.

1. First, all appropriations like interest on capital, salary, commission are provided.
2. The remaining profit is then distributed among partners according to their profit-sharing ratio.
3. At this stage, if any partner's share is less than their guaranteed amount, the deficiency is calculated.
4. This deficiency is then added to the guaranteed partner's share and deducted from the share of the partner(s) who gave the guarantee.

The journal entries for distributing profit and making good the guarantee deficiency would typically involve:

• For Interest on Capital:
  • Profit and Loss Appropriation A/c Dr.
    • To Partner's Capital/Current A/c (Individual partners) (Being interest on capital provided)
• For Distribution of Profit (including guarantee adjustment):
  • Profit and Loss Appropriation A/c Dr.
    • To Partner's Capital/Current A/c (Kavita's final share)
    • To Partner's Capital/Current A/c (Savita's final share)
    • To Partner's Capital/Current A/c (Madhu's final share) (Being profit distributed among partners after guarantee adjustment)

We will now proceed with the calculations and prepare the Profit and Loss Appropriation Account.

Working Notes

WN 1: Calculation of Interest on Capital

Interest on Capital is provided at 10% p.a. on the opening capitals.

• Kavita's Capital = ₹6,00,000
  • Interest on Kavita's Capital = ₹6,00,000 $\times$ 10% = ₹60,000
• Savita's Capital = ₹4,00,000
  • Interest on Savita's Capital = ₹4,00,000 $\times$ 10% = ₹40,000
• Madhu's Capital = ₹2,00,000
  • Interest on Madhu's Capital = ₹2,00,000 $\times$ 10% = ₹20,000
• Total Interest on Capital = ₹60,000 + ₹40,000 + ₹20,000 = ₹1,20,000

WN 2: Calculation of Profit available for distribution

The profit for the year before providing interest on capital was ₹3,00,000.

• Profit before Interest on Capital = ₹3,00,000
• Less: Total Interest on Capital (from WN 1) = ₹1,20,000
• Profit available for distribution = ₹1,80,000

WN 3: Distribution of Profit before Guarantee Adjustment

The profit-sharing ratio is Kavita 1/3, Savita 1/2, and Madhu 1/6.

To find a common ratio, we find the LCM of the denominators (3, 2, 6), which is 6.

• Kavita: 1/3 = 2/6
• Savita: 1/2 = 3/6
• Madhu: 1/6 So, the profit-sharing ratio is 2:3:1.

The profit available for distribution is ₹1,80,000 (from WN 2).

• Kavita's share = ₹1,80,000 $\times$ (2/6) = ₹60,000
• Savita's share = ₹1,80,000 $\times$ (3/6) = ₹90,000
• Madhu's share = ₹1,80,000 $\times$ (1/6) = ₹30,000

WN 4: Calculation of Deficiency and its Adjustment

Kavita guaranteed that Savita's share of profit after charging interest on capital would not be less than ₹1,00,000.

• Savita's share of profit (before guarantee adjustment, from WN 3) = ₹90,000
• Guaranteed minimum profit for Savita = ₹1,00,000 …

Concept: Guarantee of Profit by a Partner

When one partner guarantees a minimum share of profit to another partner, the guarantee operates after all appropriations (like interest on capital) have been made. If the guaranteed partner's share falls short of the guaranteed amount, the deficiency is borne by the guarantor partner from their own share.

The accounting treatment follows these steps:

1. Calculate interest on capital for all partners (this is an appropriation, debited to Profit & Loss Appropriation Account).
2. Determine divisible profit = Total profit − Interest on capital.
3. Distribute divisible profit in the agreed profit-sharing ratio.
4. Check the guarantee: Compare the guaranteed partner's share (profit share only, excluding interest) with the guaranteed minimum.
5. Adjust for deficiency: If there is a shortfall, the guarantor transfers the deficiency amount from their profit share to the guaranteed partner.

Solution

Working Note 1: Interest on Capital

Interest on capital @ 10% p.a.:

• Kavita: $\frac{10}{100} \times ₹6,00,000 = ₹60,000$
• Savita: $\frac{10}{100} \times ₹4,00,000 = ₹40,000$
• Madhu: $\frac{10}{100} \times ₹2,00,000 = ₹20,000$

Total Interest on Capital = ₹60,000 + ₹40,000 + ₹20,000 = ₹1,20,000

Working Note 2: Divisible Profit

Profit before interest on capital = ₹3,00,000

Less: Interest on capital = ₹1,20,000

Divisible Profit = ₹3,00,000 − ₹1,20,000 = ₹1,80,000

Working Note 3: Distribution in Profit-Sharing Ratio (before guarantee adjustment)

Profit-sharing ratio: Kavita 1/3, Savita 1/2, Madhu 1/6

• Kavita: $\frac{1}{3} \times ₹1,80,000 = ₹60,000$
• Savita: $\frac{1}{2} \times ₹1,80,000 = ₹90,000$
• Madhu: $\frac{1}{6} \times ₹1,80,000 = ₹30,000$

Working Note 4: Guarantee Adjustment

Savita's guaranteed minimum share of profit = ₹1,00,000

Savita's actual share (before guarantee) = ₹90,000

Deficiency = ₹1,00,000 − ₹90,000 = ₹10,000

Since Kavita has personally guaranteed Savita's profit, Kavita will bear this deficiency from her own share.

Working Note 5: Final Distribution of Profit (after guarantee adjustment)

The question deals with the concept of Guarantee of Profit to a Partner. This is an arrangement where one or more partners, or sometimes the firm itself, guarantees a minimum amount of profit to a specific partner for a given accounting period. If the actual share of profit (after all appropriations like interest on capital, salary, commission, etc.) falls short of the guaranteed amount, the deficiency is borne by the partner(s) who gave the guarantee, or by the firm in their profit-sharing ratio if the firm gave the guarantee.

In this scenario, Anu has personally guaranteed that Divya's share of profit, after allowing interest on capital, will not be less than ₹75,000. This means we first calculate the profit available for distribution, then distribute it among partners in their profit-sharing ratio, and then check if Divya's total income (interest on capital + share of profit) meets the guaranteed amount. If there's a shortfall, Anu's share of profit will be reduced by that amount, and Divya's share will be increased accordingly.

Let's proceed with the calculations and prepare the necessary accounts.

Working Notes

1. Calculation of Interest on Capital

Interest on Capital is allowed at 5% p.a. on the opening capital balances.

• Anu's Interest on Capital = ₹5,00,000 $\times$ 5/100 = ₹25,000
• Charu's Interest on Capital = ₹3,00,000 $\times$ 5/100 = ₹15,000
• Divya's Interest on Capital = ₹2,00,000 $\times$ 5/100 = ₹10,000
• Total Interest on Capital = ₹25,000 + ₹15,000 + ₹10,000 = ₹50,000

2. Calculation of Profit Available for Distribution (before guarantee adjustment)

Net Profit for the year = ₹2,00,000

Less: Total Interest on Capital = ₹50,000

Profit available for distribution = ₹2,00,000 - ₹50,000 = ₹1,50,000

3. Distribution of Profit (before guarantee adjustment)

The profit-sharing ratio is 2:1:2.

• Anu's Share = ₹1,50,000 $\times$ (2/5) = ₹60,000
• Charu's Share = ₹1,50,000 $\times$ (1/5) = ₹30,000
• Divya's Share = ₹1,50,000 $\times$ (2/5) = ₹60,000

4. Calculation of Divya's Guaranteed Amount and Deficiency

Divya's total income (before guarantee adjustment) = Interest on Capital + Share of Profit

• Divya's Interest on Capital = ₹10,000
• Divya's Share of Profit (before adjustment) = ₹60,000
• Total for Divya = ₹10,000 + ₹60,000 = ₹70,000

Guaranteed minimum profit for Divya = ₹75,000

Deficiency = Guaranteed Amount - Actual Total Income

Deficiency = ₹75,000 - ₹70,000 = ₹5,000

This answers question 9.

5. Adjustment for Deficiency

The deficiency of ₹5,000 is to be borne by Anu, as per the guarantee.

• Anu's final share of profit = Anu's share (before adjustment) - Deficiency borne by Anu = ₹60,000 - ₹5,000 = ₹55,000
• Divya's final share of profit = Divya's share (before adjustment) + Deficiency received by Divya = ₹60,000 + ₹5,000 = ₹65,000
• Charu's share of profit remains unchanged = ₹30,000

6. Verification of Divya's Final Guaranteed Profit

Divya's final total income = Interest on Capital + Final Share of Profit

= ₹10,000 + ₹65,000 = ₹75,000. This matches the guaranteed amount.

Solution: Profit and Loss Appropriation Account

Concept: Guarantee of Minimum Profit

Anu has personally guaranteed that Divya's share of profit — measured after interest on capital has been allowed to all partners — will not be less than ₹75,000. The steps are: allow interest on capital, distribute the remaining profit in the profit-sharing ratio, compare Divya's entitlement with the guarantee, and let the guarantor alone make good any deficiency.

Step 1 – Interest on Capital @ 5% p.a.

Step 2 – Divisible Profit

Net profit ₹2,00,000 − interest on capital ₹50,000 = ₹1,50,000.

Step 3 – Distribution in 2 : 1 : 2

Step 4 – Guarantee Check

Divya's total = interest ₹10,000 + share ₹60,000 = ₹70,000. Guaranteed minimum = ₹75,000. Deficiency = ₹5,000, borne wholly by Anu.

Step 5 – Final Distribution of the ₹1,50,000 Profit …