Capital Accounts – Fixed vs Fluctuating Methods

Introduction

In a partnership, we need track how much the firm owes to each partner. Unlike a sole proprietor (Capital A/c), partners have multiple transactions with the firm: Salary, Interest, Drawings, Profit Share. There are two methods to record these: Fixed Capital Method and Fluctuating Capital Method.

1. Fluctuating Capital Method (Default)

Under this method, generally only one account is maintained for each partner: Partner's Capital A/c.

• All adjustments (Capital introduction, Salary, Interest, Profit, Drawings) are passed through this single account.
• Result: The balance of capital fluctuates from year to year.

Format: Partner's Capital A/c

2. Fixed Capital Method

Under this method, the capital is kept "Fixed" or intact. Two accounts are maintained:

1. Partner's Capital A/c:
   • Records ONLY permanent Capital Introduction or Capital Withdrawal.
   • Balance remains constant unless fresh capital is added.
2. Partner's Current A/c:
   • Records all "fluctuating" items: Salary, Interest, Drawings, Profit Share.
   • This account can have a Debit or Credit balance.

Why use this?

It helps partners distinguishes between their Original Investment (Fixed) and their Annual Earnings (Current).

Comparison: Fixed vs Fluctuating

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Accounting Treatment (Journal Entries)

1. Interest on Capital

• Interest on Capital A/c ...Dr
• To Partner's Capital/Current A/c (Being interest allowed to partner)

2. Salary to Partner

• Partner's Salary A/c ...Dr
• To Partner's Capital/Current A/c

3. Closure (Transfer to P&L Appropriation)

• P&L Appropriation A/c ...Dr
• To Interest on Capital A/c
• To Partner's Salary A/c

Exam Notes: Writing the Answer

Question: "Distinguish between Fixed and Fluctuating Capital Accounts." (5 Marks)

Model Answer:

1. Number of Accounts: In Fixed method, two accounts (Capital & Current) are maintained. In Fluctuating, only one (Capital) is maintained.
2. Adjustments: Items like drawings, salary, and interest are recorded in the Current A/c in the Fixed method, whereas they are merged into the Capital A/c in the Fluctuating method.
3. Balance: The Capital Account balance remains unchanged in the Fixed method (unless permanent addition/withdrawal), whereas it changes every year in the Fluctuating method.
4. Presentation: Fixed Capital always shows a Credit balance. Fluctuating Capital may show a Debit balance due to heavy losses or drawings.

Note: If the question is silent, always assume Fluctuating Capital Method.

Quiz Time! 🎯

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