Accounting Treatment of Partner’s Capital Account in case of Retirement of a Partner (Fluctuating Capital)

A Partner’s Capital Account is a separate account that records all the transactions between the Partnership firm and the Partners in order to determine the share of each partner in the firm at the end of the accounting period. All the capital investments made by the partners are credited, and drawings are debited into the Capital Account. Similarly, the incomes and profits of the partners, like Interest on Capital, and Commission to partners are recorded on the Credit side of the capital Account, and the expenses/ losses, such as Interest on Drawings are debited. A Partner’s Capital ensures the accuracy and transparency of the firm’s accounting system.

Methods of maintaining Capital Account

The Capital Accounts can be maintained in the following two ways:

1. Fixed Capital Method: Under Fixed Capital Method, the initial capital introduced by the partners at the beginning is considered to be fixed throughout the span of the partnership firm, except for the introduction of additional capital, and permanent withdrawal of the capital (drawings). All other transactions like Interest on Capital, Interest on Drawings, Salary, Commission, Share of profit, etc., are recorded in a separate account known as a Current Account.

2. Fluctuating Capital Method: The capital balance of each of the partners goes on changing from time to time and is of fluctuating nature. The capital account under this method is affected by every transaction between the firm and the partners, such as Interest on Capital, Interest on Drawings, Salary, Commission, and so on.

Fluctuating Capital Method:

The capital balance of each of the partners under the Fluctuating method fluctuates continuously and keeps on changing from time to time, i.e., it is not fixed. This is because no separate account (Current Account) is prepared to record the income and expenses and profits/ losses of the partners. All the transactions related to, Interest on Capital, Interest on Drawings, Salary, Commission, Share of profit, etc., are recorded in the capital account itself. In case of no instruction is provided, the Fluctuating method should be used to prepare the Partner’s Capital Account.

Steps of Fluctuating Capital Method:

Under this method, to prepare the Capital Account the following steps are to be taken:

Step 1: A  Capital Account is prepared, and the initial capital invested by the partner is credited, and any additional investments made by the partners are also credited. Any drawings from the capital are recorded on the debit side of the capital account.

Step 2: All the Income and Profits of a partner, such as Interest on capital, the salary of the partner, the profit share of the partner, commission, etc., are recorded on the credit side of the Capital Account.

Step 3: All the expenses or liabilities related to the partner, such as Interest on drawings are debited to a Capital Account. 

Step 4: The profit and loss are distributed among the partners in their profit-sharing ratio. The profit is credited, and the loss is debited, respectively.

Step 5: At last, the closing capital of the partner is calculated by subtracting the debit side of the Capital Account from the credit side. The closing balance of the retiring partner is then paid or transferred to his Loan A/c, and the balance of the remaining partners is transferred to the Balance sheet as Partner’s Capital Account.

Formats (When the Capital is Fluctuating):

 

Illustration:

Blossom, Bubbles, and Buttercup were partners in the firm sharing profits and losses in a ratio of 3: 2: 1, respectively. Following is the Balance Sheet of their firm as on 31st March 2022:

 

Buttercup retired on 1st April 2022 under the followings terms:

1. The market price of the investment was ₹ 35,200, which was taken over by the retiring partner at the market value.
2. Goodwill of the firm was valued at ₹ 60,000.
3. The value of the Patent was reduced by ₹ 4,000 and a  Machinery by ₹ 10,000.
4. Provision for Doubtful Debts to be raised to 6%.
5. Amount Due to Buttercup is to be settled on the following basis:

• 50% amount to be paid at the time of retirement.
• 25% of the total amount is to be paid within one year.
• The rest of the balance is to be paid by a bill of exchange (without interest) having a due date of 3 months.

Prepare Revaluation Account, Partner’s Capital Account under Fluctuating Capital Method, and Balance Sheet of Blossom and Bubbles after the retirement of Buttercup.

Solution:

 

 

 

Working Notes:

1. Gaining Ratio of Blossom and Bubble = 3: 2 (There is no information about the New Profit-Sharing Ratio, it is presumed that share of the retiring partner is acquired by the remaining partner in their old profit-sharing ratio.)

2. Workmen Compensation Fund is to be created to an extent of ₹ 12,000 and so the balance is credited to the Partner’s Capital Account.

3. The investment Fluctuation Reserve is a provision created for a fall in the market price of the investment. Since, in the given question, the market value is more than the book value of the investment, the provision so created is credited to the Partner’s Capital Account.

4. Amount due to Buttercup = 58,000 (credit side of her capital A/c) − 40,000 (debit side of her capital A/c) =18,000. 

   Amount Payable at time of retirement = 50% of 18,000 = ₹ 9,000.

   Amount to be paid within one year (Buttercups’ Loan) = 25% of 18,000 = ₹ 4,500

   Amount to be paid as Bills Payable = ₹ 4,500.

5. Employee’s Provident Fund is a liability and not an accumulated profit, hence not distributed among the partners.