Accounting Treatment of Partner’s Capital Account in case of change in Profit Sharing Ratio (Fixed Capital)

Capital is the amount contributed by the partners in the firm. Partner’s capital shows equity in a partnership that is owned by specific partners. It records the initial and subsequent contribution made by each partner and also the withdrawal made by the partner. Partner’s Capital Account shows the ownership interest in the firm by each partner of the firm. Partner’s Capital Account can either be fixed or fluctuating. It records all the transactions related to the partnership firm and the partners. All the initials transaction and share profit or loss made by the firm, and also the gains or revenue and loss incurred by the firm are recorded in the share of each partner in their capital account.

Methods of Maintaining Capital Account

1. Fixed Capital Method: Fixed Capital means that the capital of the partners is affixed and stationery. Capital of the partners does not change with every transaction and remains the same. It changes only when there is additional capital introduced or drawings are made(withdrawal of capital) by the partner. Two separate accounts are maintained- Partner’s Capital Account and Partner’s Current Account. Partner’s Capital Account is credited with capital contributed and additional capital introduced and debited with withdrawal made by the partner. Partner’s Current Account is debited or credited by the transaction with the firm other than the one directly relating to Capital Account.

2. Fluctuating Capital Method: Fluctuating Capital means that the capitals of the partners fluctuate and are irregular. Capital of the partners changes with every transaction and does not remain the same. Only one capital account is maintained under fluctuating capital method. All the transactions of the partners are recorded under one head separately in the name of each partner, i.e., Partner’s Capital Account. The account is debited or credited by the transactions with the firm relating to the partner.

Meaning of Fixed Capital Method:

Fixed Partner’s Capital Accounts Method is the method of maintaining capital accounts of a firm under which the amount of capital of each partner is fixed and only changes in case of a permanent increase or permanent decrease in the capital. There is an increase in capital when additional capital is introduced into the firm by the partner and a permanent decrease in capital when the concerned partner withdraws from his capital. Under this method, two accounts are maintained:

1. Partner’s Capital Account: The Capital Account records only those transactions that are related to capital or change in the capital (Additional Capital and Drawings). In the capital account, the capital brought in by the partner is credited, and any drawing is debited.

2. Partner’s Current Account: A separate account known as a Current Account or Drawings Account is opened to record all the other transactions related to partners, such as Interest on capital, Interest on drawings, salary, Profit/loss share, etc. Any income or profit of the partner is credited, and any expense or loss is debited to the current account.

Steps of Maintaining Fixed Capital Method:

Step 1: First, prepare a Capital Account, and credit the initial and subsequent capital contribution by the partner. Any drawings from the capital are recorded on the debit side of the capital account.

Step 2: Then prepare a Current Account. All the Receipts related to partners are recorded on the credit side of the current account, such as Interest on capital, the salary of the partner, the profit share of the partner, commission, and so on.

Step 3: The debit side of a current account records all the expenses or liabilities related to the partner, such as Interest on drawings.

Step 4: The profit up to the date of reconstitution is distributed according to the old profit-sharing ratio. The profit is credited, and the loss is debited, respectively.

Step 5: Then, the closing capital of the partner is calculated by subtracting the debit side of the current account from the credit side. The closing balance is then transferred to a Balance sheet as a partner capital account.

Format of Fixed Capital Method:

** denotes that the balance of the Current A/c can be either Debited or Credited.

Illustration:

Sarika, Vartika, and Nandani were partners sharing profits and losses in the ratio 2:2:1. Their Balance Sheet as on 31^st March 2021 is as follows:

From 1^st April 2022, they decided to alter the profit sharing ratio to 5:3:2. It is also decided that:

1. 20% Depreciation should be charged on Fixed Assets.
2. Creditors amounting to ₹50,000 were not to be paid.
3. Provision of 5% on Debtors and Bills Receivables be made for doubtful debts.
4. Furniture to be valued at ₹2,00,000.
5. It is found that an expense of ₹10,000 is still outstanding.

Pass necessary journal entries. Also, prepare Revaluation A/c, Partner’s Capital and Current A/c, and the new Balance Sheet of the firm. 

Solution:

Journal Entries