Accountancy · Ch 2 — Accounting for Partnership: Basic Concepts
Guarantee of Profit to a Partner
Guarantee of Profit to a Partner
Guarantee of Profit to a Partner
When a new partner is admitted into a firm, the existing partners sometimes give a guarantee that the new partner will receive a minimum amount as his share of the firm's profits. This guarantee is a promise to make up any shortfall if the new partner's actual share of profit falls below the guaranteed amount.
The guarantee can be given in two ways:
- By all the old partners jointly — in which case any deficiency is borne by them in their agreed profit-sharing ratio
- By one old partner individually — in which case that single partner bears the entire deficiency
The key point is that the guaranteed partner always receives at least the minimum amount. If his share of profit as per the profit-sharing ratio is less than the guaranteed amount, the deficiency is made up by the guaranteeing partners.
How the Deficiency is Calculated and Distributed
The process works in three steps:
- Calculate each partner's share of profit according to the new profit-sharing ratio
- Compare the new partner's share with the guaranteed amount — the difference is the deficiency
- The guaranteeing partners bear this deficiency in the agreed ratio (either their profit-sharing ratio or a separate ratio specified in the guarantee)
The deficiency is borne by the guaranteeing partners in the ratio in which they share profits between themselves, not in the new profit-sharing ratio that includes the new partner.
Example 1: Guarantee by All Old Partners
Madhulika and Rakshita (sharing 2:3) admit Kanishka with a 1/6 share and guarantee her minimum ₹25,000. Firm profit is ₹1,20,000.
Step 1 — Shares as per ratio (2:3:1):
- Madhulika: 2/6 × ₹1,20,000 = ₹40,000
- Rakshita: 3/6 × ₹1,20,000 = ₹60,000
- Kanishka: 1/6 × ₹1,20,000 = ₹20,000
Step 2 — Deficiency: ₹25,000 − ₹20,000 = ₹5,000
Step 3 — Borne by Madhulika and Rakshita in 2:3:
- Madhulika bears: 2/5 × ₹5,000 = ₹2,000
- Rakshita bears: 3/5 × ₹5,000 = ₹3,000
Final distribution:
- Madhulika: ₹40,000 − ₹2,000 = ₹38,000
- Rakshita: ₹60,000 − ₹3,000 = ₹57,000
- Kanishka: ₹20,000 + ₹2,000 + ₹3,000 = ₹25,000
Example 2: Guarantee by One Partner Only
If only Rakshita gives the guarantee, the entire deficiency of ₹5,000 is borne by her alone.
Final distribution:
- Madhulika: ₹40,000 (unchanged)
- Rakshita: ₹60,000 − ₹5,000 = ₹55,000
- Kanishka: ₹20,000 + ₹5,000 = ₹25,000
Accounting Treatment in the Profit and Loss Appropriation Account
The Profit and Loss Appropriation Account shows the net profit on the credit side. On the debit side, each partner's final share is shown after adjusting for the deficiency.
The deficiency is not a separate expense — it is simply a reallocation of profits among partners. The guaranteeing partners' capital accounts are reduced, and the guaranteed partner's capital account is increased by the same amount.
Summary of Key Points
- The guaranteed partner always receives at least the minimum amount
- The deficiency is the shortfall between the guaranteed amount and the partner's share as per the profit-sharing ratio …