Q.Ashok, Brijesh and Cheena are partners sharing profits and losses in the ratio of 2: 2: 1. Ashok and Brijesh have guaranteed that Cheena share in any year shall be Rs. 20,000. The net profit for the year ended March 31, 2017 amounted to Rs. 70,000. Prepare Profit and Loss Appropriation Account.
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Start your 14-day free trial to unlock the full solution →Cheena's guaranteed minimum share is ₹20,000; the actual share as per the 2:2:1 ratio on ₹70,000 profit is only ₹14,000, so Ashok and Brijesh bear the ₹6,000 deficiency in their profit-sharing ratio (2:2 = 1:1). Final distribution: Ashok ₹25,000, Brijesh ₹25,000, Cheena ₹20,000.
Concept First: Guarantee of Profit
A guarantee of profit is a promise by one or more partners (the guarantors) that a specific partner (the beneficiary) will receive a minimum amount of profit in a given year. If the beneficiary's share, calculated normally according to the profit-sharing ratio, falls short of the guaranteed amount, the deficiency is borne by the guarantor partners.
The key accounting treatment is this: the deficiency is not a separate expense or charge against profit. Instead, it is an adjustment to the distribution of the net profit. The Profit and Loss Appropriation Account first distributes the profit in the agreed ratio (2:2:1). Then, the deficiency is transferred from the guarantors' capital accounts to the beneficiary's capital account. In the Appropriation Account itself, we show the final, adjusted shares directly.
The rule is simple: the total profit distributed must equal the net profit (₹70,000). The guarantee merely reshuffles the shares among the partners. Ashok and Brijesh, having given the guarantee, will bear the shortfall in their own profit-sharing ratio (which is 2:2, or equally).
Solution: Profit and Loss Appropriation Account
Profit and Loss Appropriation Account
for the year ended March 31, 2017
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|---|---|---|
| To Profit transferred to: | By Net Profit (as per P&L A/c) | 70,000 | |
| Ashok's Capital A/c | 25,000 | ||
| Brijesh's Capital A/c | 25,000 | ||
| Cheena's Capital A/c | 20,000 | ||
| 70,000 | 70,000 |
Working Notes
Working Note 1: Calculation of Partners' Share in the Ratio of 2:2:1
Total Profit = ₹70,000
Ratio = Ashok : Brijesh : Cheena = 2 : 2 : 1 (Sum of ratios = 5)
- Ashok's share = 2/5 x ₹70,000 = ₹28,000
- Brijesh's share = 2/5 x ₹70,000 = ₹28,000
- Cheena's share = 1/5 x ₹70,000 = ₹14,000
Working Note 2: Calculation of Deficiency in Cheena's Guarantee
- Guaranteed minimum to Cheena = ₹20,000
- Actual share of Cheena (as per ratio) = ₹14,000
- Deficiency = ₹20,000 - ₹14,000 = ₹6,000
Working Note 3: Sharing of Deficiency between Ashok and Brijesh
The deficiency of ₹6,000 is to be borne by Ashok and Brijesh in their profit-sharing ratio, which is 2:2, i.e., equally. …
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