Guarantee of Profit to a Partner
Read everything you need to know about the guarantee of profit to a partner. Understand how the profit is shared among the partners.
Izhar Ahmad20 Dec, 2023
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A guarantee of profit is when one or more partners or, in some cases, the company itself promises to make a certain amount of money. The person who makes the guarantee of profit is the one who has to keep this promise. Basically, it means a set minimum amount that is a guarantee of profit to a partner.
If the actual share of profits is less than the promised amount, the company or the partner in question must pay the difference. When this happens, the company will make a number of changes. On the other hand, if the partner's actual share of income is higher than the guaranteed minimum, the company will give them the extra profits.What is Guarantee of Profit?
A guarantee of profit is an assurance from one or more partners or, in some cases, the company itself that it will pay a certain amount of money. The company that is giving this promise is responsible for keeping it. In easier words, it means a set minimum amount that is assured for the person who is getting the guarantee of profit.Also Read- Issue and Redemption of Debentures
Features of Guarantee of Profit
Given below we have provided the features of guarantee of profit:- A partner may offer a specific profit guarantee in return for a share in the business profits. This predetermined amount is obligatory for the partner receiving the guarantee.
- If the partner's share in profits falls below the promised amount, they are entitled to the guaranteed profit share.
- The partner or partners committing to the profit guarantee, following an agreed-upon ratio method, bear responsibility for any shortfall. This guarantee can be provided by one or all partners, maintaining the existing ratio or opting for a different one.
- A partner designated as guaranteed is one who is assured a minimum profit.
Procedure for Calculating Profit Amount Under Guarantee of Profit to a Partner
- Determine the Guaranteed Partner's actual share in the firm's profit or loss for the relevant accounting period.
- Compare the Guaranteed Amount with the Guaranteed Partner's actual profit/loss share to identify any shortfall.
- Allocate the deficient amount among the Guaranteeing Partners based on the agreed Guaranteeing Ratio.
- Allocate the firm's profit/loss among all partners according to the Profit-Sharing Ratio, disregarding the Guarantee of Minimum Profit.
- Recover the deficient share from the Guaranteeing Partners and credit the amount to the Guaranteed Partner.
Also Read- Difference Between E-Commerce and E-Business
Different Cases of Guarantee of Profit to a Partner
There are generally the following cases of guarantee of profit to a partner:Guarantee by the Firm or by All the Partners of the Firm
Firm or Partners' Collective Guarantee of Profit to a Partner and Historical Adjustments with Exemplification In this situation, the firm initially records the assured amount for the partner in the Profit and Loss Appropriation Account. Subsequently, it allocates the remaining profit among the other partners based on their respective ratios. For instance: X, Y, and Z are partners in a firm dividing profits and losses in the ratio 3:3:2. X and Y have pledged to ensure that Z's annual profit will not fall below Rs.25,000. The net profit for the fiscal year ending March 31, 2019, amounted to Rs.75,000. Prepare the Profit and Loss Appropriation Account. Z's 2/8 share of Rs.75,000 is less than Rs.25,000 (the guaranteed amount). Therefore, Z is entitled to Rs.25,000, and the remaining partners (X and Y) will distribute the remaining profit of Rs.50,000 in their respective profit-sharing ratio (3:3 or 1:1).Guarantee by One Partner Only
In this scenario, the initial step involves computing the profit deficiency for the partner who receives the guarantee. Subsequently, this deficit is subtracted from the share of the partner providing the guarantee. For instance: Consider the previous example; however, let's assume that in this case, only partner X offers the guarantee to partner Z. The adjustments would unfold as follows: Once again, Z's share falls short of the guaranteed amount. Consequently, Z will receive the guaranteed sum. Notably, in this instance, Q's profits remain unaffected as the guarantee is extended solely by X. Therefore, the adjustment (deduction) for the profit deficiency (Rs.6,250) will be made from X's share exclusively.Looking for the Best Commerce Coaching?
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Past Adjustments
In a firm, certain situations may arise, such as accounting errors, entry omissions, or retrospective changes in profit-sharing ratios, leading to the need for adjustments. Let's examine two distinct scenarios:Single Error Situation:
In the event of a single error, an adjustment table is created, and a corrective journal entry is recorded to rectify the specific mistake.Multiple Errors Situation:
When dealing with multiple errors, the firm revisits the preparation of the Profit and Loss Appropriation (a component of the final account) by generating working notes and a dedicated table. Subsequently, the necessary journal entry is executed to address the cumulative errors.Guarantee of Profit to a Partner FAQs
What exactly is a partner's guarantee?
A guarantee given to a partner signifies that the partner will get a specified minimum profit. and any deficiencies will be covered by the other partner.
Who guarantees a profit to a partner?
The guarantee can be provided by the previous partners in a predetermined ratio or by each of the former partners individually to the new partner or an associate.
What is hidden goodwill?
The value of goodwill that is not indicated at the time of a partner's admission is referred to as hidden goodwill.
What exactly is the sacrificing ratio?
The difference between the old and new ratios of the former partners called the sacrificing ratio. In other terms, the sacrificing ratio is the ratio in which the existing partners of a partnership business give up their profit share in favor of the new partner.
How do you determine partner profit?
To calculate the value of one share, divide the total profit by the sum of the ratio values. To calculate each partner's individual profit share, multiply the value of one share by their ratio value.
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