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Methods of Capital Account Creation
Fluctuating Capital Account Method
Fixed Capital Account Method

(a) Fixed Capital Account
A firm prepares Fixed Account with very basic capital related transactions. Unlike the Capital account, under these repetitive capital related transactions does not affect the Capital balance. Like, Salary of employees, commission for employees, interest on capital, interest on drawings, etc.

The firm opens the account in the name of “Fixed Capital Account”. Initial Investment will appear on the credit side as the starting entry. Only 2 kinds of Capital related transactions can affect its balance :

(1) Addition of Capital

(2) Permanent Withdrawal of Capital

[Note: Sometimes even the Non-Permanent Withdrawals or Drawings are also included on the debit side of this account.]

(b) Current Account
It includes all the capital related transactions other than the initial investment of capital, addition of capital and withdrawal of capital. Hence, It mainly includes items such as :

1. Interest on Capital

2. Interest on Drawings

3. Salaries and other remuneration to employees

4. Commission to employees and even more.

Hence, by preparing this account, we can let the main capital of the business “fixed”. As a result of which there is no fluctuation at all. Hence, the firm will be able to find out the exact reasons behind the change.

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Revaluation of assets and liabilities

1. When revised value of assets and liabilities are shown in the books
Under this method, the assets and liabilities are shown at their revised values in the books and in the balance sheet which is prepared immediately after the admission of a partner. A Revaluation account is opened to record the increase or decrease in assets and liabilities. Revaluation account is also called Profit and loss adjustment account. It is a nominal account. Revaluation account is credited with increase in value of assets and decrease in the value of liabilities. It is debited with decrease in value of assets and increase in the value of liabilities. Unrecorded assets if any are credited and unrecorded liabilities if any are debited to the revaluation account. The profit or loss arising therefrom is transferred to the capital accounts of the old partners in the old profit sharing ratio. If the total of the credit side of the revaluation account exceeds the total of the debit side, the difference is profit on revaluation. If the total of the debit side of the revaluation account exceeds the total of the credit side, the difference is loss on revaluation.

2. When revised values of assets and liabilities are not shown in the books
Under this method, the assets and liabilities are shown at their original values and not at the revised values in the books and in the balance sheet which is prepared immediately after the admission of a partner. The net result of revaluation is adjusted through the capital accounts of the partners. A Memorandum revaluation account which is a temporary account is opened when the revised values are not to be shown in the books of accounts.

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Journal entries for Partner's Capital A/C

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Journal entries for Partner's Capital A/C

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Remaining Partners Capital A/c (Individually)                   Dr.

To Retiring Partners Capital A/c

(Being the share of retiring partner in revaluation profit adjusted in remaining partners capital in gaining ratio)
(i)  In case of Revaluation Loss

Remaining Partners Capital A/c (Individually)                   Dr.

To Retiring Partners Capital A/c

(Being the share of retiring partner in revaluation profit adjusted in remaining partners capital in gaining ratio)

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The following Journal entries are passed:

1] For the increase in the value of Assets
Assets A/c (Individually) Dr.

To Revaluation A/c

(Being increase in the value of assets on revaluation)

2] For a decrease in the value of Assets
Revaluation A/c Dr.

To Assets A/c (Individually)

(Being decrease in the value of assets on revaluation)

3] For an increase in the value of Liabilities
Revaluation A/c Dr.

To Liabilities A/c (Individually)

(Being increase in the value of liabilities on revaluation)

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Rajesh and Ramesh are partners sharing profits in the ratio 3:2. Raman is admitted as a new partner and the new profit sharing ratio is decided as 5:3:2. The following revaluations are made. Pass journal entries and prepare revaluation account.

a)     The value of building is increased by ₹ 15,000.

b)    The value of the machinery is decreased by ₹ 4,000.

c)     Provision for doubtful debt is made for ₹ 1,000.

Solution

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A and B are partners sharing profits in the ratio of 3 : 2 with capitals of Rs.50,000 and Rs. 30,000 respectively. Interest on capital is agreed @ 6% p.a.B is to be allowed an annual salary of Rs. 2,500. During 2006, the profits ofthe year prior to calculation of interest on capital but after charging B'ssalary amounted to Rs. 12,500. A provision of 5% of the profits is to bemade in respect of Manager's commission.Prepare an account showing the allocation of partners' capital account.
Solution

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Meaning: The partnership capital account is an Equity account in the accounting records of a partnership. It contains the following types of transactions:

• Initial and additional contributions by partners to the partnership, in the form of either cash or the market value of other types of assets.

• Profits and losses earned by the business, and distributed to the partners based on the provisions of the partnership agreement.

• Distributions to the partners

°The ending balance in the account is the undistributed balance to the partners as of the current date.°

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Accounting Treatment of Reserves, Undistributed Profits or Losses

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Accounting Treatment of Reserves, Undistributed Profits or Losses

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The new partner is not entitled to any share in undistributed profits or losses appearing in the balance sheet at the time of admission, as these are earned by the old partners. So, these should be transferred to old partners’ capital/current account.

Journal entries passed will be

(i) For Undistributed Profits ,

General Reserve A/c      Dr

Profit and Loss A/c         Dr

Workmen Compensation Fund A/c  Dr [Excess of reserve over actual liability]

Investment Fluctuation Fund A/c  Dr [Excess of reserve over the difference

between book value and market value]

Old Partners’ Capital/Current A/c         Dr [Old ratio]

(ii) For Undistributed Losses

To Old Partners’ Capital/Current A/c   [Old ratio]

To Profit and Loss A/c

To Deferred Revenue Expenditure A/c

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The account which is prepared to record changes in the value of assets and liabilities at the time of admission, retirement, death and change in profit sharing ratio is called revaluation account.