Guarantee of Profit to a Partner –
When a new partner is admitted to the partnership firm, he/she becomes eligible to share the profits earned by the firm in the agreed profit sharing ratio.
For eg – A and B are partners in a firm and they admitted C as a new partner as they wanted to expand their managerial expertise. Together A, B and C decided to share profits in the ratio of 3:2:1. During the year, the firm earned Rs 60,000 as profits. As per the agreement, the share of partner A = Rs 30,000 (3/6 of Rs 60,000), B = Rs 20,000 (2/6 of Rs 60,000), and C = Rs 10,000 (1/6 of Rs 60,000).
But in certain situations, a new partner can be admitted to the firm with a guarantee that he/she shall receive a minimum amount in the form of profits of the firm. This minimum amount is known as the guarantee of profit to a partner.
This assurance of guarantee of profit to a partner may be given either by –
a) collectively all the existing (old) partners in a specified ratio or,
b) by one of the existing (old) partners.
This concept of guarantee of profit to a partner comes into play when the share of profit of the new partner calculated on the basis of agreed profit sharing ratio is short of the minimum amount guaranteed.
Situation 1 – If guarantee of profit to a partner was given collectively by all the old partners –
A and B are partners in a firm and they decided to admit C as a new partner. Together A and B gave a guarantee of a minimum profit of Rs 20,000 to C. The agreed profit sharing ratio of the three partners is 3:2:1 and the firm earned Rs 60,000 as profits during the year.
As per the agreement, the share of partner A = Rs 30,000 (3/6 of Rs 60,000), B = Rs 20,000 (2/6 of Rs 60,000), and C = Rs 10,000 (1/6 of Rs 60,000).
To calculate the amount that is short of the guaranteed amount, the following formula is used.
Deficit = Profits guaranteed – Profits calculated as per Profit sharing ratio
In the above example, Deficit = Rs 20,000 – Rs 10,000
Therefore, we can see that share of C in profits is short by Rs 10,000 that what was guaranteed. This difference shall be made good by the old partners in their profit sharing ratio, i.e., 3:2.
Share of old partners in deficiency –
A = Rs 6,000 (3/5 of Rs 10,000)
B = Rs 4,000 (2/5 of Rs 10,000)
So, revised share of profits of old partners would be calculated by using the formula given below –
Share of profits of old partners = Profits calculated as per profit sharing ratio – Share in deficiency
Now, the division of profits between the partners would be as follows –
A = Rs 30,000 – Rs 6,000 = Rs 24,000
B = Rs 20,000 – Rs 4,000 = Rs 16,000
C = Rs 10,000 + Rs 6,000 + Rs, 4000 = Rs 20,000
Situation 2 – If one partner decides to give guarantee of profit to a partner –
Following the above example, if instead of both A and B, only A decides to give guarantee to C of a minimum profit of Rs 20,000. Then the whole amount of deficiency of Rs 10,000 would be met by A only.
Distribution of profit in that case would be –
A = Rs 30,000 – Rs 10,000 = Rs 20,000
B = Rs 20,000 – NIL = Rs 20,000
C = Rs 10,000 + Rs 10,000= Rs 20,000
Conclusion – At times, a new partner can be admitted to the partnership firm with a guarantee of minimum amount as the share of profits. Any difference between the amount guaranteed and profits distributed as per profit sharing ratio would be compensated by the old partners.