Accountancy · Ch 2 — Accounting for Partnership: Basic Concepts
Past Adjustments
Past Adjustments
Concept: Why Past Adjustments Are Needed
After the final accounts are prepared and profits have been distributed among partners, it is common to discover that some items were omitted or incorrectly recorded. These could be:
- Interest on capital not credited to partners
- Interest on drawings not charged to partners
- Interest on a partner's loan not accounted for
- Partner's salary or commission not provided
- Outstanding expenses not recorded
- Changes in the partnership deed or accounting system that have a retrospective effect
Instead of reopening and altering the old accounts (which is impractical), the necessary correction is made through an adjustment — either (a) through a Profit and Loss Adjustment Account, or (b) directly in the capital accounts of the concerned partners. This is explained with the help of the following example.
Example: Rameez and Zaheer are equal partners. Their capitals as on April 1, 2015 were ₹50,000 and ₹1,00,000 respectively. After the accounts for the year ending March 31, 2016 had been prepared, it was discovered that interest @ 6% p.a., as provided in the partnership deed, had not been credited to the partners' capital accounts before distribution of profit.
The interest on capital not credited works out to ₹3,000 (6% of ₹50,000) for Rameez and ₹6,000 (6% of ₹1,00,000) for Zaheer. Had it been provided, the firm's profit would have been reduced by ₹9,000. By this omission, the whole profit (without the ₹9,000 adjustment) was distributed among the partners in their profit-sharing ratio, and the interest on capital was never credited. This error can be rectified in either of the following ways.
(a) Through Profit and Loss Adjustment Account
First the omitted interest is credited to the partners through the Profit and Loss Adjustment Account, and then the resulting adjustment loss is shared among the partners in their profit-sharing ratio.
(i) Record the omitted interest on capital:
| Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|
| Profit and Loss Adjustment A/c Dr. | 9,000 | ||
| To Rameez's Capital A/c | 3,000 | ||
| To Zaheer's Capital A/c | 6,000 | ||
| (Interest on capital) |
(ii) Distribute the adjustment loss equally (their profit-sharing ratio):
| Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|
| Rameez's Capital A/c Dr. | 4,500 | ||
| Zaheer's Capital A/c Dr. | 4,500 | ||
| To Profit and Loss Adjustment A/c | 9,000 | ||
| (Loss on adjustment) |
(b) Directly in Partners' Capital Accounts
Under this method the Profit and Loss Adjustment Account is avoided. Instead, a statement is prepared to ascertain the net effect of the omission on each partner's capital account, and then a single adjusting entry is passed.
Statement Showing Net Effect of Omitting Interest on Capital
| Details | Rameez (₹) | Zaheer (₹) |
|---|---|---|
| (i) Amount which should have been credited as interest on capital | 3,000 (Cr.) | 6,000 (Cr.) |
| (ii) Amount actually credited by way of share of profit (₹9,000 divided equally) | 4,500 (Dr.) | 4,500 (Dr.) |
| (iii) Difference between (i) and (ii) — Net effect | Dr. 1,500 (Excess) | Cr. 1,500 (Short) |