Calculation of interest on Capital, interest on capital and interest on drawings

Calculation of interest on Capital

Note: Interest on Capital will be allowed on Capital in the beginning unless and otherwise stated.

Calculation of Capital in the beginning:

Particulars	Amount
Capital at the end of the year Add: Drawings made during the year Add: Interest on drawings for the year (if any) Add: Capital withdrawn during the year Less: Additional Capital introduced during the year Less: Profit share earned during the year Less: Interest on capital for the year (if any) Less: Loss incurred during the year	xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx
Capital in the beginning of the year  (Opening Capital)	xxxxx

Calculation of Salary or Commission to Partners

·         When to Allow – Salary or Commission to a partner is to be allowed if the partnership agreement provides for the same.

·         Nature of Payment – Salary or Commission to a partner is an appropriation out of profits and not a charge against the profits. In other words. It is to be allowed only if there are profits.

·         Calculation:

Case 1. Commission as % of Net Profit before charging such Commission

                                          = Net Profit before Commission × Rate of Commission

                                                                                                             100

Case 2. Commission as % of Net Profit after charging such Commission

                                         = Net Profit before Commission ×  Rate of Commission         

                                                                                                 100 + Rate of Commission

 Calculation of Interest on Partners’ Loan to Firm

·         Rate of Interest – In case, any partner has given a loan to firm; he is entitled to an interest on such loan at an agreed rate of interest. If there is no agreement as to rate of interest on loan, partner is entitled to interest on loan @ 6% per annum [Sec 13 (d)].

·         Nature of Interest – It may be noted that such interest on loan is a charge against the profits. In other words, such interest is to be allowed whether there are profits or not.

 Calculation of Capital Ratio

Sometimes, the partners decide to share the profits and losses of the firm in the capital ratio. When the capitals are fixed, the profits and losses are shared in the ratio of fixed capitals. But when the capitals are fluctuating and partners introduce or withdraw capital during the year, the effective Capital Ratio is calculated with reference to the time period for which capital has been used in business.

 Treatment of Past Adjustments

If after the final accounts have been prepared and the profits have already been distributed, some omission or commission are found in respect of interest on capital, interest on drawings, interest on partners’ salary or commission or change in the provisions of partnership deed or change in the system of accounting is required, the necessary adjustment can made either through profit and loss adjustment account or directly through the capital accounts of the concerned partner.

Sometimes, after the accounts for the year have been made up, it comes to light that some matters are left out of consideration by mistake or have been omitted or allowed/ charged at a higher or lower rate, profits and losses have been distributed in one year or in several years among the partners in a wrong proportions, and so on.

Calculation of Guarantee of minimum profit to a partner

Sometimes a partner may be guaranteed a minimum amount of his share in Profit. Such a partner to whom such guarantee has been provided is called ‘Guaranteed Partners’. The partner(s) who has (have) given such guarantee is (are) called ‘Guaranting Partners’ Such minimum amount is called ‘Guaranteed Amount’. One or some or all of the partners in an existing profit sharing ratio or in some other agreed ratio may provide such guarantee. If in any year, the actual share of Profit of a Guaranteed Partner is less than the Guaranteed Amount, then the deficiency is borne by the Guaranteeing Partners in their agreed ratio.

The distribution of profits under guarantee arrangement consists of the following steps:

Step 1. Calculate the Actual Share of Profit/Loss of Guaranteed Partner.

Step 2. Calculate the amount of deficiency as follows:

                              Deficiency = Guaranteed Amount – Actual Share of Profit

Step 3. Distribute the deficiency among the guaranteeing partners in the guaranteeing ratio.

Step 4. Recover share of deficiency from the guaranteeing partners and give credit for the

 same to guaranteed partner.