What is Partnership Capital Account?
Partnership capital account is the account which contains all the transactions occurring between the partners and partnership firm like the initial contribution of capital in partnership, the interest of capital paid, drawings, the share of profit, and other adjustments and it is required in order to maintain proper accountability and transparency between the partners and the firm.
A business entity in which two or more persons doing business together agree to share the profits arising out of business in the pre-defined profit ratio as partners is called as the partnership firm. The partnership agreement can be oral as well as written. The profit-sharing can also be on the basis of capital contribution or as a mutually decided.
The accounts of the partnership firm differ from that or proprietorship as it also contains the partners’ capital account in which the capital contributed by partners and all the transactions between firm and partners are to be recorded. The partner’s capital account can be of two types, i.e., current account and fixed capital account. If the account is a fixed capital account, then the only capital contribution is to be credited, and all other transactions are to be recorded in the current account.
How to Calculate?
Usually the capital contribution depends upon the share of profits like if business of partnership firm requires the investment of $ 1,000,000 and there are four partners in the partnership firm and profit sharing ratio is equal then each partner’s contribution will be $ 250,000 ($ 1,000,000 /4) whereas if the profit sharing ratio is 2:5:1:2 then the capital contribution of partner A will be $ 200,000 ($ 1,000,000 * 2/10), partner B will be $ 500,000 ($ 1,000,000 * 5/10), partner C will be $ 100,000 ($ 1,000,000 * 1/10) and partner D will be $ 200,000 ($ 1,000,000 * 2/10).
Partners by the mutual decision, can contribute more or less, which may not be as per the profit sharing ratio, and sometimes, in partnership, one should contribute the capital, and others will invest the time and talent.
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The steps for calculating the partnership capital account are as under:
- Step #1 – Credit the capital account with the capital contributed by partners, the share of profit, remuneration of partners, interest on capital, any receipt or asset directly associated with the partner.
- Step #2 – Debit the capital account by drawings, any liability directly related to the partner, etc.
- Step #3 – Share of profit is to be distributed in the profit-sharing ratio before calculating closing capital.
- Step #4 – Closing capital is to be calculated by reducing the debits from the credits so as to calculate the effective capital contribution.
- Step #5 – The closing capital is to be transferred to the balance sheet as a partner capital account.
ABC and Co are the partnership firm with the three partners A, B, and C. Profit sharing ratio of each partner is equal, and the capital contribution of each partner is also equal. The total requirement of investment in the business is $ 300,000. The firm does not maintain a separate current account and all the transactions are to be recorded in the capital account itself. Other details are as under:
Draw the Partners Capital account and record the above transactions.
- Capital Contribution = $ 300,000 / 3 = $ 100,000
- Interest on Capital = $ 100,000 * 12% = $ 12,000 per partner.
- Profit Share =$75,000/3 =$25,000 per partner
- Transparency in the records is maintained through the capital account of partners.
- In the event of closure of business, the amount to be received or to be distributed to each partner can be easily determined.
- The liabilities of each partner can be easily fixed.
- Decisions can be easily taken to maximize the benefit to the firm because of transparent records.
- A partnership capital account can be presented and accepted as a legal document.
- With the transparency and clarity of accounts, it is easy to admit the new partner, or it gets easy to settle the account at the time of retirement of a partner.
- In case of partnership other than a limited liability partnership, the partners are jointly and severally responsible for the outside liabilities; hence the risk of one partner is transferred to other ones in their profit-sharing ratio and from the personal estate, if liabilities are more than assets and the partners capital account becomes of no value in this case as the capital account cannot be enforced for limited liability.
- As in most organizations, no separate current account is prepared; hence the basis of capital contribution gets changed with transactions.
- There are chances of conflict in case of a change in the basis of the capital.
A partnership capital account is an account in which all the transactions between the partners and the firm are to be recorded. With the preparation of the partnership capital account, it becomes easy to distribute the assets and liabilities to the partners and becomes easy to settle the account at the time of admission or retirement of partners.
But in case of partnership other than a limited liability partnership, the capital account becomes useless as the partners have to pay from the personal estate in case of assets are less than liabilities, and the capital account cannot be enforced for limitation of liability. The basis of the partnership can be changed with the transactions like salary, interest to partners, and this sometimes can create conflicts between the partners.
This has been a guide to What is a Partnership Capital Account & its Definition. Here we discuss the example of a partnership capital account and how to calculate along with advantages and disadvantages. You can learn more about from the following articles –