Example of Guarantee of Minimum Profit to a Partner

Ram, Sita, and Puja are partners sharing profit in the ratio 12:8:5. Puja is being guaranteed that her share of profit shall be a minimum of ₹50,000 p.a. and any deficiency shall be borne by Ram and Sita in their profit-sharing ratio. The Profit for the year ended 31st March 2021 was ₹2,00,000. Pass necessary Journal entries in the book of the firm and prepare the Profit and Loss Appropriation Account.

Solution:

Puja’s Share in the Profit of the firm= [Tex]2,00,000\times \frac{5}{25}=₹40,000[/Tex]
Minimum profit guaranteed to her= ₹50,000
Deficiency= 50,000 − 40,000= ₹10,000

Share of Deficiency of Borne by:

Ram:
Deficiency Amount payable= [Tex]10,000\times \frac{12}{20}=₹6,000[/Tex]

Sita:
Deficiency Amount payable= [Tex]10,000\times \frac{8}{20}=₹4,000[/Tex]

Distribution of the firm’s Profit among the partners as there is no guarantee:

Ram:
Profit Share=  [Tex]2,00,000\times \frac{12}{25}=₹96,000[/Tex]

Sita:
Profit Share=  [Tex]2,00,000\times \frac{8}{25}=₹64,000[/Tex]

Puja:
Profit Share=  [Tex]2,00,000\times \frac{5}{25}=₹40,000[/Tex]

Case II: When the actual share is more than the guaranteed amount

When the actual profit share of the Guaranteed partner is either equal to or more than the Guaranteed Amount, then under such circumstance no Deficiency arises. So, the profit of the firm is Distributed among the partners as if there is no clause for the guarantee of minimum profit.

Distribution of Profit among all the partners as if there is no Guarantee Arrangement: 

Illustration: 

Arun, Deepa, and Rahul are partners sharing profits in the ratio of 5:3:2. According to the Partnership Agreement, Rahul is to get the minimum amount of ₹10,000 as his share of profit every year. The Net Profit for the year ended 31st March’22 amounted to ₹60,000. Prepare the Profit and Loss Appropriation Account and pass necessary Journal entries in the book of the firm.

Solution:

Distribution of Profit among the Partners as if there is no Guarantee:

Arun:
Profit Share=  [Tex]60,000\times \frac{5}{10}=₹30,000[/Tex]

Deepa:
Profit Share=  [Tex]60,000\times \frac{3}{10}=₹18,000[/Tex]

Rahul:
Profit Share=  [Tex]60,000\times \frac{2}{10}=₹12,000[/Tex]

Guarantee of Minimum Profit to a Partner means that a partner has been assured to receive a minimum amount of profit (Guaranteed Amount). This further means that if in any year, the actual share of the profit of the guaranteed partner is less than the Guaranteed Amount, then the deficiency shall be covered by the partner providing the guarantee. The partner who has been assured to receive the guaranteed amount is called a ‘Guaranteed Partner’, and the partner or the partners giving such guarantee are called ‘Guaranteeing Partners’. Such assurance may be given by one or more or all the partners either in their profit-sharing ratio or in the ratio agreed upon by the partners.

Guarantee of Minimum Profit to a Partner can be understood in the following cases:

• When no information about the Guaranteeing Partner and the ratio in which the deficiency amount has to be borne is given: In this case, any deficiency in the Guaranteed Amount is borne by all the partners in their profit sharing ratio (Firm Guarantee).
• When the Guarantee is given by the specific partner: Under the situation where a specific partner provides the Guarantee of Minimum Profit to another Partner, then any deficiency in the Guaranteed Amount is borne by that specific partner only.
• When a Guarantee of Minimum Profit is given by all the partners in some specific ratio: Any deficiency in the Guaranteed Amount is borne by all the partners in the specific ratio agreed by all the partners (Personal Guarantee).