What is Past Adjustment?
In several cases, when the final accounts of any firm have already been closed, various matters might be added on a later date or accidentally get left out. Such an erroneous account history can lead to disarray in the firm. To tackle this situation, one of the most common solutions opted by accountants is passing a past adjustment entry.
What do You mean by Past Adjustment in Partnership?
In Partnership Accounting, past adjustments are an essential entry in the Net Profit section under Profit and Loss Appropriation A/C of a firm. The Net Profit A/C of a firm denotes the overall profit distribution among all firm owners.
These adjustments can be done with reference to remuneration of partners and interest on drawings, interest on capital, etc. Sometimes the omissions or errors are observed after the preparation of financial statements and the distribution of profit among the partners in accordance with the profit sharing ratio determined in the company. In such situations, a new adjustment entry is passed for evaluating the errors because the existing entries are not changed.
Distribution of profit usually takes place in the given ratio and other terms and conditions accepted among those in partnership.
For example, if at a certain period of a financial year, a situation arose for which the distribution of profit had to be changed for the remainder of the fiscal year. In such situations, the final account of the company is not altered, but an adjustment entry is passed at the end of the current fiscal, or at the beginning of the following one.
Brush up your memory on profit sharing ratios and rectification of errors in profit and loss account with the following vital tips –
For example, A and B are partners in a firm sharing profits equally. Their capital account balances as on April 01, 2020 were Rs. 2,00,000 and Rs. 3,00,000 respectively. After the finalization of the books of accounts for the financial year ending March 31, 2021, it is found out that there has been omission of interest on capitals at the rate of 6% per annum, as agreed by the partners in the partnership indeed.
Hence, the amount of interest on capital that should be credited to the capital accounts of A and B-
A = Rs. 12,000 ( \[\frac{6}{100}\] x Rs. 2,00,000)
B = Rs. 18,000 ( \[\frac{6}{100}\] x Rs. 3,00,000)
What is a New Profit-Sharing Ratio?
A new profit-sharing ratio can be defined as a proportion of profit distribution accepted by both old and new owners of a firm (who are in a partnership). Key features of the profit distribution strategy in such cases –
New partners obtain their profit from the shares in profit from the old partners. In simple terms, former partners are required to forgo a portion of their profit in kindness for the new partners.
If the terms and conditions mentioned during initiation of such a partnership do not state how new partners gain their shares in profit, then it is to be assumed that the profit-sharing ratio has the final say in the distribution of profit.
Moreover, if the terms and conditions included a certain percentage of the share which would be granted to new partners, profit will be distributed accordingly.
The remaining profit will be shared among the old partners as per their proportions calculated from the new profit-sharing ratio.
These are the key points you need to refer to before solving the numerical questions on past adjustments in partnership accounts.
Q1. Arijit and Aritra own an agricultural shipping business. They share the profits of their company Go Green Ltd. at a ratio of 3:2. They took in partner Sujon during the middle of a fiscal year with a new partner who would receive \[\frac{1}{5^{th}}\] of the future profits. However, this important statement was ignored while distributing profits. What is the method for rectifying errors in profit and loss A/C of this firm?
Ans: So, as per this question, initially:
Arijit’s share of profit = 35 and Aritra’s share of profit = 25
Sujon will receive 15 of the overall profit, in that case remaining share = 1 - 15 = 45
So, Arijit’s share after Sujon came into partnership = 35 of 45= 1225
Similarly, Aritra’s share after Sujon came into partnership = 25 of 45= 825
Therefore, new profile sharing ratio = 1225 : 825 :15=12:8:5
Hence, profit generated by Go Green will be distributed among company partners Arijit, Aritra and Sujon in the ratio 12:8:5.
Different Types of Past Judgements in Partnership
There are various reasons behind companies and firms passing a past adjustment entry to resolve any discrepancies issued while distributing profits, forming the balance sheet, revising all journal entries etc.
Among those issues, the most common errors leading to such disagreements can be classified as two types –
Single Error
In such cases, an adjustment table is constructed where the rectified amount is mentioned along with the journal entry passed to resolve the error.
Multiple Errors
In such cases, a Profit and Loss Appropriate A/C is prepared, which falls under several components of the final account, where all the adjustments are noted along with working notes. A past adjustment entry is passed where the error is rectified.
This is done mainly to leave prior calculations and tabulations in the final account unaltered.
Consult this numerical which has been solved below to understand the fundamentals of making a past adjustment in accountancy.
The error or omission in past adjustment may be associated with interest on partner's loan, partner's salary, interest on drawings, interest on capital, or outstanding expenses. The error may also occur because of any changes made in the partnership between the partners or any retrospective in the accounting policies so followed.
Q2. Let us consider that Mainak and Arjun are partners in a business, sharing profits in 2:1 ratio, respectively. Few months into fiscal year 2019, they accept Riti as a partner with 25% share in profits with a guarantee that she will receive at least Rs. 60,000 as her share. Net profit for this business for the financial year of 2019 was Rs. 1,80,000. Prepare the past adjustment partnership account for this business.
Ans: As per the given information,
Riti’s share of profit = 25% = 14
Therefore, remaining share = 1 - 14=34
Arjun’s share of profit = 23 of 34 = 612
Similarly, Mainak’s share = 13 of 34 = 312
New profit-sharing ratio = 14 : 612 : 312=1:2:1 for Riti, Arjun and Mainak respectively.
Hence, profit distributed to Arjun = 24 of Rs. 1,80,000=Rs. 90,000
Similarly, profit distributed Mainak and Riti each = 14 of Rs. 1,80,000=Rs. 45,000
However, as per the terms, Riti should be receiving Rs. 60,000 as profits.
So, the remaining terms, i.e. Rs. (60,000 – 45,000) or a deficit of Rs. 15,000 will be borne by Arjun and Mainak as per the new profit ratio, which is 2:1.
Arjun’s net profit = Rs. 90,000 - (23 of Rs. 15,000) = Rs. 80,000
Mainak’s net profit = Rs. 45,000 - (13 of Rs. 15,000) = Rs. 40,000
The journal entry is given below –
Past Adjustment Entry
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The different conditions regarding guarantee of profit include, guarantee given by the partner to the firm, guarantee given by the firm to a partner, guarantee given by one partner to another partner, and simultaneous guarantee given by the firm to the partner and by the partner to the firm.
Distribution of Profits under Guarantee Arrangement
The following steps are involved in the distribution of profits under guarantee arrangement.
First, the actual share of profit/loss of the guaranteed partner is calculated.
Then, the guaranteed amount is calculated.
The amount of deficiency is calculated. Deficiency = Guaranteed Amount – Actual Share of Profit
The deficiency is distributed among the guaranteeing partners in their guaranteeing ratio.
The actual profits/losses is distributed among all the partners in their profit sharing ratio as if there is no guarantee arrangement.
The share of deficiency is recovered as per step 3 from the guaranteeing partners and credit is given for the same to the guaranteed partner.
FAQs on Past Adjustments in Accounting: Explained
1. What is meant by past adjustment?
A past adjustment refers to any correction made to rectify errors or omissions in previous accounting periods. These adjustments are necessary when mistakes like wrong profit distribution, incorrect capital amounts, or omitted transactions are discovered after the accounts have been finalized and closed. Past adjustments help ensure fairness among all partners or stakeholders by amending the records to reflect the correct financial positions retroactively. Making such corrections is vital for maintaining the integrity of financial statements. Past adjustment usually involves altering capital accounts or drawing accounts in accounting records to correct previous errors.
2. What is a passed adjustment in accounting?
In accounting, a passed adjustment refers to an error or required change that was not recorded or reflected in the accounts during the period it occurred but is later identified. This typically happens when accountants discover mistakes after the books have been closed, such as missed expenses or incomplete entries. Passed adjustments are important for accurate financial reporting and involve making proper entries in subsequent periods. The correction ensures that all partners or account holders receive their fair share of profits, losses, or interest, based on accurate numbers. Recognizing passed adjustments helps maintain trust and transparency in accounting practices.
3. How to solve past adjustments?
To solve past adjustments, you need to identify the error, calculate the correct amounts, and adjust the relevant accounts. The main steps involved are:
- Identify the mistake or omission in previous accounts.
- Determine the amount to be corrected for each partner or account holder.
- Pass a journal entry to adjust the capital or drawing accounts as needed.
By following these steps, you ensure that the error is rectified and the current accounts reflect accurate balances. Properly solving past adjustments maintains fairness and accuracy in accounting records.
4. What are the 4 types of adjustments?
In accounting, there are four main types of adjustments used to prepare correct financial statements. These adjustments help match income and expenses to the proper periods. The main types are:
- Accrued revenues: Recording income earned but not yet received.
- Accrued expenses: Recognizing expenses incurred but not yet paid.
- Deferred revenues: Revenues received in advance but not yet earned.
- Prepaid expenses: Expenses paid in advance for future periods.
Each type of adjustment ensures the financial statements reflect all relevant information for the reporting period. These adjustments, including past adjustment, help maintain accurate and fair records for a business.
5. Why are past adjustments necessary in partnership firms?
Past adjustments are crucial in partnership firms to correct errors related to profit sharing, interest on capital, drawings, salaries, or commissions discovered after closing the books. Without these adjustments, partners could be unfairly compensated based on incorrect records, affecting trust and long-term collaboration. Making past adjustments restores equality and accuracy by amending capital or current accounts as per agreed ratios. This practice safeguards transparency and ensures each partner receives their correct financial entitlements, helping maintain strong business relationships and legal compliance in partnership accounting.
6. What journal entry is used for past adjustments?
When a past adjustment is needed, a journal entry is made to amend the affected partners’ capital or current accounts. The partner who received excess amounts is debited, while the partner who received less is credited with the difference identified. The entry typically uses the following format: debit the account of the partner who owes money and credit the account of the partner due for compensation. This adjustment ensures all partners’ accounts accurately reflect their correct financial positions after the change. Accurate journal entries are essential for transparent accounting and fair partnership dealings.
7. What common errors lead to past adjustments?
Past adjustments address errors or omissions that occurred in previous accounting periods and were discovered later. Common causes include:
- Improper calculation or distribution of profits or losses
- Incorrect or missed entries for interest on capital, drawings, or partners’ salaries
- Omission of certain transactions
- Failure to follow partnership agreements precisely
Identifying these common errors early can minimize the need for extensive corrections later. Timely and accurate past adjustments help maintain the accuracy and reliability of partnership accounting records.
8. How does past adjustment differ from current year adjustment?
Past adjustments involve correcting errors from previous accounting periods, while current year adjustments deal with mistakes identified within the current period before accounts are finalized. Past adjustments often require retrospective entries and may affect capital or current accounts. In contrast, current year adjustments are made within the same accounting cycle, often before closing the books. Both processes aim to maintain accurate records, but the timing and methods of correction differ, with past adjustments needing greater care to ensure fairness among all stakeholders.
9. When should past adjustments be recorded in the books?
Past adjustments should be recorded as soon as an error or omission from a previous period is discovered, regardless of when the mistake occurred. Promptly making these corrections safeguards accuracy in accounting records and prevents complications in future financial statements. Recording past adjustments at the earliest ensures updated balances in partners’ accounts and compliant reporting. Waiting too long can cause confusion and legal complications, so immediate action is recommended to maintain clear and honest financial records.
