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Adjustment of Partner's Capital

Last updated date: 23rd May 2024
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Partner's Capital

The partnership capital account can be defined as an equity account that is recorded in the accounting entry. The following are the types of transactions:

  • The initial and the subsequent contributions by the partners to the partnership firm, in the form of either cash or the market value of another kind of assets 

  • The profit and the losses are earned by the business and are allocated to the partners based on the provisions of the partnership agreement.  

  • Distributions done to the partners. 

The ending balance in the account is then undistributed balance to the partners as of the present date.

Type of Partnership Account

A partnership might maintain a single partnership capital account for all the working partners, with a supporting schedule that breaks down the capital account for each partner. Given that, it is easier over the long term to instead maintain the separate capital accounts within the accounting system for each and every partner. By doing this it will be a lot easier to determine the amount that is to be distributed to each partner in the time of liquidation of the business or the if a partner leaves, it then reduces the amount of discussion over the payments and the liabilities amongst the partners.

The liquidating payment is that a partner may eventually receive the termination of the business which does not necessarily equal the balance in the partnership capital account that is prior to the liquidation of the business. When the assets are being sold and the liabilities are settled, it is likely that the market values are going to vary from the amounts recorded in the partnership. This difference will be represented in the liquidation payment also.

Adjustment of Partner's Capital

The partners may agree that their capitals in a reconstituted firm will be in the proportion of the new profit-sharing ratio. 

Here, it welcomes two situations.

The new partner is required to bring the proportionate capital for his share of the profit. Also, the new partner’s capital is then calculated on the basis of the capital of the reconstituted firm or on the basis of the combined capitals of the old partners in the share of profit.

The old partners may decide to make their capital in the proportion to their new profit-sharing ratio. The old partner's capital is then calculated on the basis of the capital that is brought by the new partner for his share of profit. This deficiency or the excess in the old partner's capital account is to be adjusted through the current accounts or through cash which may be brought in or withdrawn by the partners.

While, on the death of a partner, the partnership ceases to exist. But this firm will not cease to exist as the remaining partners may decide to continue their partnership business. In the case of the death of a partner, the treatment of various items is similar to that at the time of retirement of the partner. After making all the necessary adjustments in the Partners Capital Account, the amount that is due to him is to be paid to his Legal Representative.

Adjustment of Partner’s Capital and Death of a Partner

When there is a death of a partner, we need to credit the following mentioned amounts in the Deceased Partner’s Capital Account:

  • Reserves or the Undistributed profits

  • Goodwill 

  • Profit on revaluation of the assets and the liabilities. 

  • Any loan that is given by the partner

  • The Joint Life Policy 

  • Share in the subsequent Profits

  • Interest on Capital

Also, we need to debit the following amounts:

  • Drawings by the deceased partner

  • Interest in his drawings

  • Loss of revaluation of the assets and liabilities.

  • Share in subsequent Losses of the entity.

Procedures to Calculate the Profit of a Deceased Partner

Time Basis

In this method, the assumption is that the profits are earned evenly throughout the year. We estimate the profit on the basis of the profit that is incurred in the last year.

Turnover or Sales Basis

In this method, we need to consider the profit also the total sales of the last year. Here, we estimate the profit up to the date of death of the partner on the basis of the sales that are of the last year.

After all these adjustments, the amount which is standing in the Deceased Partner’s Capital A/C is payable to the legal representative.

FAQs on Adjustment of Partner's Capital

Q1. What is meant by Equity Account?

Ans. Equity accounts are the financial representation of who is having ownership of a business. Equity can come from the payments to a business, by its owners, or from the residual earnings that are generated by a business. Because of the different sources of equity funds, the equity is stored in different types of accounts. 

All the equity accounts, with the exception of the treasury stock account, have natural credit balances. If the retained earnings account has a debit balance, this means that either a business has been experiencing losses or the business has issued dividends that were available through retained earnings. 

Q2. Define Profit Sharing Ratio.

Ans. The ratio where the profits or losses of a business are being shared. For a partnership, these profit-sharing ratios are required to be set out in the partnership agreement, which will show the amount, that is usually given as a percentage of the total profits, that is attributable to each of the partners.

The profit-sharing ratio is a ratio by which the profits and losses of a partnership are calculated. The profit-sharing ratio is decided by the partners and then recorded in the business agreement. This ratio represents the percentage of total profit, which is being attributed to every partner.

Q3. What is a Reconstituted Firm?

Ans. The partnership, as we know is the agreement between two or more persons who share the profits of a business that is carried on by all or any one of them acting for all. While any change in the existing agreement is known as the reconstitution of the partnership firm.