Methods of maintaining capital accounts of partners

Methods of maintaining capital accounts of partners

Amount invested by partners in the partnership business is called partners’ capital. Capital may be contributed by a partner in cash or in the form of assets, etc. For each partner, a separate capital account is maintained. Capital accounts of partners of a firm may be maintained by following two methods: (i) Fixed capital method and (ii) Fluctuating capital method.

1. Fixed capital method

Under fixed capital method, the capital of the partners is not altered and it remains generally fixed. Two accounts are maintained for each partner namely (a) Capital account and (b) Current account. The transactions relating to initial capital introduced, additional capital introduced and capital permanently withdrawn are entered in the capital account and all other transactions are recorded in the current account.

(a) Partners’ capital account

Capital account is credited with the original amount of capital introduced by a partner into the business and any additional capital introduced by him/her in the subsequent years. The account is debited with the amount of capital permanently withdrawn by a partner from the business. No other items are debited or credited to this account. Capital account will always show credit balance under this method. The balance of capital account remains the same unless any additional capital is introduced or capital is permanently withdrawn.

(b) Partners’ current account

Partners’ current account is prepared for recording all transactions between the partner and the firm other than initial capital introduced, additional capital introduced and capital permanently withdrawn. This account is credited with interest on capital, partner’s salary or commission and share of profit to the partner. This account is debited with drawings, interest on drawings and share of loss of the partner. As a result, the balance in this account changes periodically. Current account may show either credit balance or debit balance.

Credit balance is the amount due to the partner from the firm. It is shown on the liabilities side of the balance sheet. Debit balance is the amount due from the partner to the firm. It is shown on the assets side of the balance sheet.

Illustration 2

From the following information, prepare capital accounts of partners Shanthi and Sumathi, when their capitals are fixed.

Solution

Illustration 3

Bragathish and Naresh are partners who maintain their capital accounts under fixed capital method. From the following particulars, prepare capital accounts of partners.

Solution

2. Fluctuating capital method

Under this method, only capital account is maintained for each partner. All the transactions between the partner and the firm are recorded in the capital account. This account is credited with initial and additional capital introduced by the partner, interest on capital, partner’s salary or commission and share of profit of the partner. The account is debited with capital withdrawn, drawings, interest on drawings and share of loss of the partner. As a result, the balance in this account goes on fluctuating periodically. Under this method, the partner’s capital account may show either credit balance or debit balance.

Format of capital account under fluctuating capital method

Illustration 4

From the following information, prepare capital accounts of partners Mannan and Sevagan, when their capitals are fluctuating.

Solution

3. Differences between fixed capital method and fluctuating capital method

Following are the differences between fixed capital method and fluctuating capital method of maintaining capital accounts of partners: