A Partner’s Capital Account shows the amount invested by each partner in a partnership firm. It records the partner’s contributions, withdrawals, share of profit, and share of loss. This account represents each partner’s ownership interest in the business and may be fixed or fluctuating.
Methods of Maintaining Capital Account
Fixed Capital Method: Fixed Capital means that the capitals of the partners are affixed and they are stationary. The capital of the partners does not change with every transaction and remains the same. It changes only when there is additional capital introduced or drawings are made(withdrawal of capital) by the partner. Two separate accounts are maintained- Partner's Capital Account and Partner's Current Account. Partner's Capital Account is credited with capital contributed and additional capital introduced and debited with withdrawal made by the partner. Partner's Current Account is debited or credited by the transaction with the firm other than the one directly relating to Capital Account.
Fluctuating Capital Method: Fluctuating Capital means that the capitals of the partners fluctuate and are irregular. The capitals of the partners change with every transaction and do not remain the same. Only one capital account is maintained under fluctuating capital method. All the transactions of the partners are recorded under one head separately in the name of each partner i.e. Partner's Capital Account. The account is debited or credited by the transactions with the firm relating to the partner.
Meaning of Fluctuating Capital
It means the balance of a partner’s capital account keeps changing over time. In this method, all items like additional capital, drawings, interest on capital, salary, commission, share of profit or loss, etc., are recorded directly in the Capital Account. No separate Current Account is prepared, so the capital balance increases or decreases continuously.
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 deceased partner is credited, and any additional investments made by the partner is 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 the deceased 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 deceased partner, such as Interest on drawings are debited to the Capital Account.
Step 4: The profit and loss are distributed to the deceased partners in his/her 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 deceased partner is then paid by transferring it to his Executor A/c.
Format (When the Capital is Fluctuating)
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Illustration:
Tuli, Seems and Reta are partners in the firm, sharing profit and loss in the ratio of 2:2:1. The Balance Sheet of the firm on 31st March 2022 was as follows:
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Seema died on 31st June, 2022. The following decisions were taken by the remaining partner:
1. Land and Building will be appreciated by 10%, and Furniture will be depreciated by 5%.
2. From Provision on Debtors ₹1,500 were good.
3. There is a liability of ₹1,300 included in Sundry Creditors that will not arise.
4. Goodwill of the firm to be valued on 3 years purchase of last 2 years average profit. Profit for 2020-21 was ₹7,500 and for 2021-22 was ₹5,000.
5. An outstanding Salary of ₹1,200 and accrued income of ₹2,000 are to be brought into books of accounts.
6. Profit from 1st April 2021 till the date of death of the partner was ₹4,500.
7. Remaining Partner's decided to share the future profit-sharing ratio to be 3:2.
8. The Fixed Capital Method is to be converted into Fluctuating Capital Method by transferring the balance of the Partner's Current A/c to the respective Partner's Capital A/c.
Prepare Revaluation Account, Partner's Capital Account, and Balance Sheet of the Firm after the above adjustment after the death of the partner.
Solution:
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Workings:
1. Calculation of Gaining Ratio:
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2. Calculation of Seema's share in Goodwill:
Average Profit of last two years =
= ₹6,250
Goodwill = Average profit X 3 years purchase
= ₹6,250 x 3
= ₹18,750
Retiring Partner Share of Goodwill = Value of Goodwill on the date of retirement x Retiring partner's share in the firm
Seema's Share of Goodwill =
= ₹7,500
3. Calculation of the deceased partner's share in profit till the date of death:
Profit on the date of death of partner =₹4,500
Share in profit =
Seema's share in profit =₹1,800