Guarantee of Profit to a Partner

A guarantee is a promise made to a firm’s partner that he or she would receive at least a certain amount regardless of his or her actual participation in the firm’s profits. If the firm’s actual share of profits is less than the guaranteed amount, the deficit will be borne by the firm or any of its partners, as the case may be. A guarantee to a partner is issued in exchange for a minimum profit share. If the actual profit share exceeds the minimum promised amount, the partner will be entitled to keep the entire profit.

Features of Guarantee of Profit to a Partner 

• A guarantee of a specified amount of profit is sometimes given by a partner in exchange for his/her share of the business profits. It is a set amount that must be paid by the partner who is provided such a guarantee.
• If the partner’s profit share is less than the promised profit share, the partner will be granted the guaranteed profit share.
• The partner or partners who have guaranteed the profit in an agreed-upon ratio method are responsible for the shortfall. One or all of the partners in an existing ratio, or a different ratio, may furnish the guarantee.
• A guaranteed partner is a partner to whom a minimum profit guarantee is granted.

If the actual profit share falls short of the specified amount, the gap will be absorbed by the Firm or one of its partners, depending on the situation. A Firm will make various ‘adjustments’ in this situation. The firm will give the partner the actual profit share if the real profit share surpasses the minimum guarantee amount.

Past Adjustments

Several times, once a firm’s final accounts have been closed, other issues may be added at a later date or mistakenly left out. Such a twisted account history might put the Firm in disarray. Passing a past adjustment entry is one of the most typical strategies used by accountants to deal with this scenario.

Examples of Guarantee of Profit to a Partner

Example 1 – Guarantee by all partners of the firm:

The firm first records the guaranteed return to the partners in the Profit and Loss Appropriation Account in this situation. The remaining profit is then distributed among the remaining partners in their remaining proportions.

Consider the following scenario:

A, B, and C are partners in a business that share profit and loss in a 2:2:1 ratio. A and B have agreed that C’s profit will never be less than Rs.20,000 in any given year. For the fiscal year ending March 31, 2022, the net profit was Rs.60,000.

The value of C’s 1/5th share, Rs.60,000, is less than Rs.20,000 which is the guaranteed amount. As a result, he must be compensated with Rs.20,000, and the remaining partners (A and B) would split the remaining profit of Rs.40,000 according to their profit-sharing ratios (2:2 or 1:1). 

Example 2 – Guaranteed by a single partner

In this instance, the profit deficit is determined first for the partner who received the guarantee. The deficit is then subtracted from the share of the partner who provided the assurance.

Consider the following scenario

Assume that in the first example, only A provides the guarantee to C, the modifications are as follows:

C’s share is less than the minimum guarantee. As a result, he/she will receive the guaranteed amount, but there will be no impact on B’s profits this time because the guarantee is provided only by A. As a result, the adjustments (deductions) for the profit deficit (Rs.8,000) will only be made from A’s share.

Example 3 – Other Partners Guarantee, but Deficiency Occurs in a Specific Ratio

In this situation, the profit shortfall is shared among the other partners in a predetermined ratio and not the remaining profit-sharing ratio.

Conclusion

A partner may be recruited to the firm with a minimum profit guarantee, which means that if his/her profit share is less than the guaranteed profit share, he/she will be paid the guaranteed profit share. The difference between the guaranteed profit and the actual profit is borne by the partner or partners who have ensured the profit in the agreed-upon ratio. The following conditions apply to profit guarantees: 

(i) The firm’s guarantee to a partner.

(ii) A guarantee is given by one partner to another.

(iii) The partner’s guarantee to the firm.

(iv) The firm’s simultaneous guarantee to the partner and the partner’s guarantee to the firm.