Guarantee of Profits in Partnership Accounts

What is the meaning of Guarantee of Profits

When one or more partners give guarantee of minimum profits to one or more partners then this is guarantee of profits in partnership accounts. Suppose A, B and C are partners. C is given a guarantee that in any year his share of profits will never be less than Rs 1 Lakh. Now if C's share of profits in an year is Rs 80000 only then the deficiency of Rs 20000 (100000-80000) will be borne by A and B. Please note that the guarantee is always given for a minimum amount of profits

Types of Guarantee

• Guarantee in partnership can be of three types
  • Guarantee of profits by one of more partners to one or more other partners
  • Guarantee of profits by one of more partners to the firm
  • Guarantee of earnings given by one of more partners to the firm

Guarantee of profits by one of more partners to one or more other partners

This is the most common type of guarantee and most of the question are from this only

What will happen if Actual Profit share > guaranteed profit share

In such case the guaranteed partner will be given his actual share of profits as per his normal profit sharing ratio and no deficiency arises. hence the remaining partners also gets their normal profit share as per profit sharing ratio

What happens if Guaranteed profit share > Actual profit share does not come

• In such a case the partners who have given guarantee will bear the deficiency either :
  • If question is silent then in their mutual profit sharing ratio. Example - A, B and C are sharing profits in the ratio of 5:4:1. C is given minimum profit guarantee of Rs 5 Lakhs. Deficiency if any will be borne by A and B in the ratio of 5:4 which is their mutual profit sharing ratio
  • If Question gives a separate ratio for bearing the deficiency then deficiency will be borne in such ratio. Example - A, B and C are sharing profits in the ratio of 5:4:1. C is given minimum profit guarantee of Rs 5 Lakhs. Deficiency if any will be borne by A and B in the ratio of 1:1. In this case deficiency will be borne in the ratio of 1:1 and not 5:4
  • If only a single partner has given guarantee then he alone will bear the deficiency and no ratio is required

What will be Journal entries

Example - Suppose A and B have given guarantee of minimum profits to C

• First pass normal profit appropriation entry (with actual profit share)
• Profit and Loss Approrpriation A/c Dr..
  • To A Capital/Current A/c
  • To B Capital/Current A/c
  • To C Capital/Current A/c
• Then pass entry for deficiency
• A Capital/Current A/c Dr..
• B Capital/Current A/c Dr..
  • C Capital/Current A/c

Note : If the firm follows fixed capital method then current A/c will be used. if the firm follows fluctuating capital method then partner capital A/c will be used.

Types of language in guarantee questions

Example 1 - C's profit share will be minimum Rs 1 Lakh.

Answer - In this case the guarantee amount will considered after all the appropriations i.e. interest on capital, salary and commission

Example 2 - C's profit share including interest on capital will be Rs …………

Answer - In this case the guaranteed amount will be calculated including the interest on capital

Example 3 - C's profit share including interest on capital but excluding salary will be Rs ………….

Answer - In this case the guaranteed amount will be calculated including the interest on capital but excluding salary paid to the partner

Similarly there can be different types of combinations of various appropriations while calculating the guaranteed amount.

Is the guaranteed amount annual

Yes the guaranteed amount is annual. Example - A gives guarantee to B of minimum profits of Rs 5 Lakhs annually. If the firm works for less than one year due to newly started business during the year or closure of business during the year then the guaranteed amount will be calculated proportionately for the period the firm has actually run.

Example - A gave guarantee to C of Rs 84000 profits for the year. The firm started its business on 01-Sep-2023.Find appropriation of profits for the year ended 31-Mar-2024.

Answer - The guarantee amount will not be Rs 1 Lakh. But it will be Rs 84000 * 7/12 = Rs 49000

Can guarantee result into a loss for the partner giving guarantee

Yes. The partner giving guarantee can incur loss due to bearing deficiency even though the firm earned profits.

Example - A, B and C are partners sharing profits in the ratio of 2:2:1. A is guaranteed minimum profits of Rs 160000 per annum. Net Profit for the year ended 31-Mar-20XX is Rs 100000.

Answer - In this case

Please note that in the above example even though the firm earned profits of Rs 1 Lakhs but B and c ended with a loss due to guarantee given to A and consequently meeting the deficiency out of their share of profits.

What happens if minimum profit guarantee is given to newly admitted partner

The process in this case is exactly the same. Only one additional step in the beginning will be calculate the new profit sharing ratio after the admission of new partner. Once new ratio is calculated then individual partners profit share can be calculated and guarantee deficiency adjusted (if any)

Guarantee of minimum profits given by a partner to the firm

In such a case deficiency if any will be written on the credit side of profit and loss appropriation A/c as " By Guaranteering partner capital A/c". The combined profits including the deficiency amount given by partner to firm will be appropriated and rest of the process of appropriation will be same with no difference.

Journal entry :

• Partner Capital/Current A/c Dr..
  • To Profit and Loss Appropriation A/c

Minimum earnings guaranteed by a partner

First we need to understand the difference between earning and profits. Earnings are basically sales and when we deduct expenses from sales(earnings) then we get profit. Earnings term is usually used for sales in services business like doctors, engineers, advocates, etc. All the cases discussed above were related to guarantee of profits.

But a partner can also give a earnings guarantee to the firm.

Example - A, B and C are three partners into the legal advisory business. A gives guarantee to the firm that he will earn a minimum fees of Rs 10 Lakhs for the firm. Now if A earns fees of Rs 8 Lakhs only for the firm then he will pay Rs 2 Lakhs to the firm.

In the profit and loss appropriation A/c Rs 2 Lakhs will be shown on the credit side under 'By A' Capital A/c'. Rest of the process of preparing the profit and loss appropriation A/c will be same.

Journal entry :

• Partner Capital/Current A/c Dr..
  • To Profit and Loss Appropriation A/c

Graphic Summary of Guarantee adjustments in partnership

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