The net profit of X, Y and Z for the year ended March 31, 2020 was Rs. 60,000 and the same was distributed amo

Numerical Questions · Q37

Q. The net profit of X, Y and Z for the year ended March 31, 2020 was Rs. 60,000 and the same was distributed among them in their agreed ratio of 3: 1: 1. It was subsequently discovered that the under mentioned transactions were not recorded in the books:

(i) Interest on Capital @ 5% p.a.

(ii) Interest on drawings amounting to X Rs. 700, Y Rs. 500 and Z Rs. 300.

(iii) Partner's Salary: X Rs. 1000, Y Rs. 1500 p.a. The capital accounts of partners were fixed as: X Rs. 1,00,000, Y Rs. 80,000 and Z Rs. 60,000. Record the adjustment entry.

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Concept understanding — Partnership Profit Distribution Rules

Partnership Capital Accounting — A First Look

Think of a partnership like a group of friends pooling money to start a roadside food stall. Each friend brings in some cash — that’s their capital. But unlike a simple piggy bank, a partnership needs a clear record of who put in how much, because profits (and losses) are shared in a fixed ratio, and partners may withdraw money, lend extra funds, or take a salary.

That record is what Partnership Capital Accounting is about.

What It Really Means

In accounting, capital is the amount a partner contributes to the firm. But it’s not just a one-time number. Over time, a partner’s capital changes due to:

Additional capital introduced
Drawings (money or goods taken out)
Share of profit or loss
Interest on capital, interest on drawings, partner’s salary, commission

The Capital Account of each partner tracks all these changes. It answers: What does the firm owe to this partner at any point?

Why It Matters

Without proper capital accounting, you cannot:

Determine each partner’s claim on the firm’s assets
Calculate interest on capital correctly
Prepare the Profit and Loss Appropriation Account
Settle accounts when a partner retires or dies

The NCERT textbook emphasises that capital accounts are personal accounts of the partners — they show the firm’s liability towards each partner.

Two Methods of Maintaining Capital Accounts

The NCERT Class 12 Accountancy textbook (Part II, Chapter 2) describes two methods:

1. Fixed Capital Method

Under this method, the capital account remains constant (except when additional capital is introduced or capital is withdrawn permanently). All other transactions — share of profit, drawings, interest, salary — are recorded in a separate Current Account.

Note

In the Fixed Capital Method, the Capital Account shows only the permanent capital. The Current Account shows the fluctuating balance.

2. Fluctuating Capital Method

Here, all transactions are recorded directly in the Capital Account. The capital balance changes every year.

Accounting Treatment — Which Account is Debited/Credited

Let’s take the most common entries. I’ll show the journal entry first, then explain.

Entry 1: Capital Introduced

When a partner brings in cash or assets:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Cash/Bank A/c	Dr.	xxx
	To Partner’s Capital A/c			xxx

Why? Cash comes in (asset increases — debit), and the firm’s liability to the partner increases (capital is a liability — credit).

Entry 2: Drawings

When a partner withdraws cash or goods for personal use:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Partner’s Capital/Current A/c	Dr.	xxx
	To Cash/Bank/Purchases A/c			xxx

Why? The firm’s liability to the partner decreases (debit the capital/current account), and cash or goods go out (credit).

Entry 3: Interest on Capital

This is an appropriation of profit. The formula (as per NCERT) is:

Interest on Capital = Capital × Rate of Time × Time (in months)/12

Journal entry:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Interest on Capital A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Then, at the end of the year, Interest on Capital is transferred to the Profit and Loss Appropriation Account:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Profit and Loss Appropriation A/c	Dr.	xxx
	To Interest on Capital A/c			xxx

Entry 4: Partner’s Salary

If the partnership deed allows a salary:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Salary to Partner A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Again, this is transferred to the Profit and Loss Appropriation Account.

Entry 5: Share of Profit

At the end of the year, after all appropriations, the remaining profit is distributed:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Profit and Loss Appropriation A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Formats as per NCERT

Format of Capital Account (Fluctuating Method)

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The error is that the profit was distributed without first adjusting for interest on capital, interest on drawings, and partners’ salaries. These items must be accounted for before profit is shared. The adjustment entry corrects the partners’ current accounts (since capitals are fixed) by transferring the net effect of the omitted items.

Step 1 – Calculate the net effect of omitted items

Item	X (₹)	Y (₹)	Z (₹)	Total (₹)
Interest on Capital @ 5% (Cr.)	+5,000	+4,000	+3,000	+12,000
Interest on Drawings (Dr.)	–700	–500	–300	–1,500
Partner’s Salary (Cr.)	+1,000	+1,500	—	+2,500
Net credit (omitted benefit)	+5,300	+5,000	+2,700	+13,000

These net amounts should have been credited to the partners before distributing the profit of ₹60,000.

Step 2 – What was actually done?

The profit of ₹60,000 was distributed in the ratio 3:1:1.

X got: ₹60,000 × 3/5 = ₹36,000
Y got: ₹60,000 × 1/5 = ₹12,000
Z got: ₹60,000 × 1/5 = ₹12,000

Step 3 – What should have been done?

First, deduct the total net credit (₹13,000) from the profit to get the distributable profit:

₹60,000 – ₹13,000 = ₹47,000.

Then distribute ₹47,000 in the ratio 3:1:1:

X: ₹47,000 × 3/5 = ₹28,200
Y: ₹47,000 × 1/5 = ₹9,400
Z: ₹47,000 × 1/5 = ₹9,400

Now add back each partner’s net credit to get the correct total credit:

X: ₹28,200 + ₹5,300 = ₹33,500
Y: ₹9,400 + ₹5,000 = ₹14,400
Z: ₹9,400 + ₹2,700 = ₹12,100

Step 4 – Compare actual vs. correct credit

Partner	Actually credited (₹)	Should be credited (₹)	Difference (₹)
X	36,000	33,500	–2,500 (excess)

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The adjustment entry is: X’s Current A/c Dr. ₹2,500; To Y’s Current A/c ₹2,400; To Z’s Current A/c ₹100. This corrects the profit distribution after accounting for omitted interest on capital, interest on drawings, and partners’ salaries.

Concept and Accounting Treatment

When a partnership’s net profit is distributed without recording certain appropriations (like interest on capital, interest on drawings, or salary), the distribution is wrong. The correct approach is to first compute what the profit should have been after all appropriations, then compare it with what was actually distributed. The difference is adjusted through the partners’ current accounts (since capital accounts are fixed).

The key rule: Appropriations are a charge against profit (salary, interest on drawings) or an appropriation of profit (interest on capital). They must be recorded before distributing the remaining profit in the agreed ratio. Here, the profit was distributed in the ratio 3:1:1 without these items, so we need to find the net effect on each partner’s share.

Solution: The Adjustment Entry

Date	Particulars	Debit (₹)	Credit (₹)
March 31, 2020	X’s Current A/c	2,500
	To Y’s Current A/c		2,400
	To Z’s Current A/c		100
	(Being adjustment for omitted appropriations)

Working Notes

1. Compute the Correct Net Profit After Appropriations

First, determine the total effect of the omitted items on the profit.

Interest on Capital (5% p.a.):

X: 5% of ₹1,00,000 = ₹5,000
Y: 5% of ₹80,000 = ₹4,000
Z: 5% of ₹60,000 = ₹3,000
Total interest on capital = ₹12,000

Interest on Drawings (credited to profit):

X: ₹700
Y: ₹500
Z: ₹300
Total interest on drawings = ₹1,500

Partners’ Salary (charge against profit):

X: ₹1,000
Y: ₹1,500
Total salary = ₹2,500

Correct Profit for Distribution:

Original net profit: ₹60,000
Add: Interest on drawings (credited to P&L) = +₹1,500
Less: Interest on capital (appropriation) = –₹12,000
Less: Partners’ salary (charge) = –₹2,500
Correct divisible profit = ₹60,000 + ₹1,500 – ₹12,000 – ₹2,500 = ₹47,000

2. Compute What Each Partner Should Have Received

The correct divisible profit of ₹47,000 is distributed in the ratio 3:1:1.

X’s share = 3/5 × ₹47,000 = ₹28,200
Y’s share = 1/5 × ₹47,000 = ₹9,400
Z’s share = 1/5 × ₹47,000 = ₹9,400

But each partner also receives salary and interest on capital (these are separate from the divisible profit share). So the total amount each partner should get is:

X: Salary ₹1,000 + Interest on capital ₹5,000 + Profit share ₹28,200 = ₹34,200
Y: Salary ₹1,500 + Interest on capital ₹4,000 + Profit share ₹9,400 = ₹14,900
Z: Interest on capital ₹3,000 + Profit share ₹9,400 = ₹12,400

Also, each partner owes interest on drawings (this reduces what they actually take home). So net entitlement:

X: ₹34,200 – ₹700 = ₹33,500
Y: ₹14,900 – ₹500 = ₹14,400
Z: ₹12,400 – ₹300 = ₹12,100

3. Compute What Was Actually Distributed

The original profit of ₹60,000 was distributed in ratio 3:1:1 without any appropriations. So each partner received:

X: 3/5 × ₹60,000 = ₹36,000
Y: 1/5 × ₹60,000 = ₹12,000
Z: 1/5 × ₹60,000 = ₹12,000

4. Find the Difference (Adjustment Required)

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Q.The net profit of X, Y and Z for the year ended March 31, 2020 was Rs. 60,000 and the same was distributed among them in their agreed ratio of 3: 1: 1. It was subsequently discovered that the under mentioned transactions were not recorded in the books:

Concept and Accounting Treatment

Solution: The Adjustment Entry

Working Notes

1. Compute the Correct Net Profit After Appropriations

2. Compute What Each Partner Should Have Received

3. Compute What Was Actually Distributed

4. Find the Difference (Adjustment Required)

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