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A capital account consists of the capital of partners and retained earnings. A partnership is an artificial person and a separate legal entity in case of LLPs. A partnership business also has a capital account which shows the capital and retained earnings of a firm, and in the this way, partners own a capital account. According to The Partnership Act 1932, the partnership deed contains a partnership clause stating the amount of capital a partner will bring to the partnership business.
Maintaining Of Capital Account Of Partners
Partners Capital account is an account that shows the total equity investment of a partner in the partnership business. Two methods can maintain a partner’s capital account:
- Fixed capital method
- Fluctuating capital method
Fixed Capital Method
Under the fixed capital Method, a partner’s capital does not change. It remains the same unless there is a permanent change in the capital, like bringing additional capital or withdrawing capital. Under this method, two types of accounts are made:
- Capital account: Capital account records the transactions related to introducing additional capital or withdrawal of capital.
- Current account: Current account records transactions related to interest on Drawings, profits , losses, adjustments etc.
Accounting treatment for Fixed Capital Method
- Interest on Capital is credited in each partner’s current account
- Retained earnings are credited in each partner’s current account
- Salary is credited in each partner’s current account
- Commission is credited in each partner’s current account
- Drawings is debited in each partner’s current account
- Loss is debited in each partner’s current account
Features of Fixed Capital Method
Certain features help in a distinction between Fixed and Fluctuating Capital Accounts. Those features are:
- Both partner’s current and capital account is made under Fixed Capital Method.
- The capital account always shows a credit balance. Current can show either credit or debit balance.
- Both capital and current account are shown in the balance sheet.
- It must be mentioned in the partnership deed.
- The capital remains unchanged.
Fluctuating Capital Method
Under Fluctuating Capital Account, the capital keeps changing with every bit of addition and withdrawal of capital. Only one account is made under Fluctuating Capital Account, which is a capital account for each partner. This capital account will record all the transactions related to interest received or paid on capital and drawings, salary and commission, and distribution of profit and losses among the partners.
Accounting treatment for Fluctuating Capital Account
- Interest on drawings is debited
- Drawings is debited
- Interest on capital is credited
- Retained earnings are credited
- Salary is credited
- Commission has credited
Features of Fluctuating Capital Account
Certain features help distinguish between Fixed and Fluctuating Capital Accounts. Those features are:
- Only the partner’s capital account is made.
- A capital account can show either a credit or debit balance.
- The only capital account is shown in the balance sheet.
- It is not a compulsion for it to be mentioned in the partnership deed.
- Its capital keeps on fluctuating.
The Distinction between Fixed and Fluctuating Capital Accounts
Basis | Fixed Capital Accounts | Fluctuating Capital Accounts |
Number of Accounts | Both partners’ current and capital accounts are made. | Only the partner’s capital account is made. |
Balance | A capital account always shows a credit balance. Current can show either credit or debit balance. | A capital account can show either a credit or debit balance. |
Balance sheet | Both capital and current account are shown in the balance sheet. | The only capital account is shown in the balance sheet. |
Partnership deed | It must be mentioned in the partnership deed. | It is not a compulsion to be mentioned in the partnership deed. |
Capital | It remains unchanged. | It keeps on fluctuating. |
Conclusion
According to The Partnership Act 1932, the partnership deed contains a partnership clause stating the amount of capital a partner will bring to the partnership business. Partners Capital account is an account that shows the total equity investment of a partner in the partnership business. Two methods can maintain a partner’s capital account:
- Fixed capital method
- Fluctuating capital method
