Partners' Capital Accounts, Guarantee of Minimum Profit and Past Adjustments

Every partner's stake in the firm — capital contributed, share of profit, interest earned, salary due, drawings taken, interest charged on those drawings — has to be recorded somewhere. Partnership accounting allows the partners to choose between two different ways of doing this, called the Fixed Capital Method and the Fluctuating Capital Method. Both arrive at exactly the same final financial position for each partner; they differ only in how the bookkeeping is organised.

Under the Fixed Capital Method, each partner has two accounts: a Capital Account, which records only the capital actually contributed (and any further capital introduced or permanently withdrawn) and therefore normally stays unchanged year after year, and a separate Current Account, through which every other item — interest on capital, salary, commission, share of profit, drawings, and interest on drawings — is routed every year. Because it moves every year, the Current Account can show either a debit or a credit balance, and its balance is carried forward and shown separately from the fixed Capital Account balance in the Balance Sheet.

Under the Fluctuating Capital Method, there is only one account per partner — a single Capital Account through which every item passes: opening capital, additional capital, interest on capital, salary, share of profit, drawings, and interest on drawings. Because everything is recorded in the same account, its balance genuinely fluctuates (hence the name) from year to year, and unless a Partnership Deed specifically says capitals are to remain fixed, the Fluctuating Capital Method is the one applied by default.

Whichever method is used, the total net worth finally standing to a partner's credit is always identical — under the Fixed method it is simply split between the (unchanged) Capital Account and the Current Account balance, while under the Fluctuating method the same total appears as a single Capital Account balance. Illustrations 7 and 8 in this chapter work through the exact same set of figures under both methods so the equivalence can be checked directly.

Guarantee of a Minimum Profit

A partnership deed may guarantee that a particular partner's share of profit will never fall below a stated minimum amount in any year — commonly done for a newly admitted partner, a working partner whose contribution is otherwise hard to value, or a partner being given a smaller share as a concession. If, applying the normal profit-sharing ratio, that partner's actual share works out to be less than the guaranteed minimum, the shortfall (called the deficiency) is made good either by the firm as a whole or, more commonly, by one or more of the other partners in a ratio the deed specifies (often their own profit-sharing ratio). The guaranteed partner always receives exactly the guaranteed amount — no more — and the partner(s) bearing the guarantee have their own share correspondingly reduced by the deficiency they bear.

Past Adjustments …