In partnership firms, the capital account of a partner may be maintained either as a Fixed Capital Account or a Fluctuating Capital Account. Both of these represent two different ways in which the amount owed to a partner may be determined at the end of a financial year. In this blog, we have discussed the meaning of these two methods (along with formats) and their differences.
What is a Fixed Capital Account?
A Fixed Capital Account method is a method wherein two accounts are prepared for each partner, i.e. (a) Partner’s Capital Account and (b) Partner’s Current Account. A Partner’s Capital Account is used to record only the capital of the partner. For recording all other transactions of the partners relating to drawings, interest on capital, commission, salary, the share of profit or loss, etc., a Partner’s Current Account is prepared.
Thus, capital accounts are not touched at all in this method, and debits and credits for interest on capital, interest on drawings, profits, losses, drawings, and other items are made in separate accounts known as current or drawings accounts of partners. It is only when new (or additional) capital is introduced that the capital account is credited, and when capital is permanently withdrawn, it is debited.
If no capital is added or withdrawn during the year, the capital account does not change and it remains fixed throughout the year. Hence, the name “Fixed Capital Account” is used in this case.
What is a Fluctuating Capital Account?
Contrary to the fixed capital account method that maintains two separate accounts for each partner, the fluctuating capital method has only one composite account to record all transactions of a partner. Rather than having a Partner’s Capital Account and a Partner’s Current Account separately, only one account called the “Partner’s Capital Account” is maintained.
In other words, profits or losses, drawings, interest on capital, interest on drawings, salary (to partners), commission, new capital introduced, and so on can all be recorded in the capital accounts, just as they appear in a sole proprietorship business. Because the balances of these capital accounts continue to fluctuate due to various debits and credits, they are referred to as Fluctuating Capital Accounts. There is no need to keep separate current accounts in this method because all transactions that pass via current accounts pass through capital accounts.
Formats of Accounts maintained under Fixed Capital and Fluctuating Capital methods
Given below are illustrative formats of capital and current accounts when fixed or fluctuating capital methods are used:
When capital accounts are fluctuating:
When capital accounts are fixed:
Transactions of profits or losses, interest on capital, interest on drawings, salary (to partners), commission, etc. are first entered through the Profit and Loss Appropriation Account and thereafter, transferred to the capital/current accounts of respective partners. The Profit and Loss Appropriation Account is merely an extension of the P/L Account. It is credited with net profit and interest on drawings, debited for adjustments like interest on capital, salary, commission, etc., and then determines the final profit/loss to be distributed.
How do Fixed and Fluctuating Capitals differ from each other?
From the above discussion, the main points of difference between Fixed Capital and Fluctuating Capital Accounts can be put together as follows:
- Under the fixed capital method, two accounts of each partner are maintained, i.e., the Capital Account and the Current Account. Whereas under fluctuating capital method, only one account of each partner, i.e., the Capital Account is maintained.
- In the case of the fixed capital account method, except when capital is introduced or permanently withdrawn, the balance in the capital account remains the same. In contrast, when fluctuating capital account method is used, the balance in the capital account varies every year due to profits/losses, drawings, interest on capital, interest on drawings, etc.
- Under the fixed capital method, all adjustments on account of profits/losses, drawings, salary, commission, interest on capital, interest on drawings, etc. are done in the current account. Whereas under fluctuating capital method, all adjustments in respect of these items are done in the capital accounts of partners.
- In the case of the fixed capital account method, the capital account would normally always show a plus or credit balance while the current account may show a debit (negative) balance. Contrary to this, the fluctuating capital account may sometimes have a debit or negative balance.
- Fluctuating capital method is more commonly used in preparing the partners’ capital accounts.
- If a partnership firm adopts the fixed capital method, the same has to be specified in the partnership deed. However, there is no such requirement when fluctuating capital method is used.
|Basis of difference||Fixed Capital method||Fluctuating Capital method|
|Number of accounts||Two: Capital Account and Current Account||One: Capital Account|
|Balance in the capital account||Fixed||Changes every year|
|Adjustments for interest on capital, drawings, salary, the share of profit/loss, etc.||Done in Current Account||Done in Capital Account|
|Nature of balance of capital||Credit balance||Might be debit or credit|
|Shown on which side of the Balance Sheet||Capital Account balances: usually on the liabilities side; Current Account balances: either on the liabilities side (if Cr. Balance) or on the assets side (if Dr. balance)||Capital Account balances: either on the liabilities side (if Cr. Balance) or on the assets side (if Dr. balance)|
|Partnership deed||Must be specified||Not required to specify|
You might also like: