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 –

1. 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. 

2. 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.

3. 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. 

4. 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.

1. First, the actual share of profit/loss of the guaranteed partner is calculated.

2. Then, the guaranteed amount is calculated.

3. The amount of deficiency is calculated. Deficiency = Guaranteed Amount – Actual Share of Profit

4. The deficiency is distributed among the guaranteeing partners in their guaranteeing ratio.

5. The actual profits/losses is distributed among all the partners in their profit sharing ratio as if there is no guarantee arrangement.

6. 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.