Explain briefly the meaning of a guarantee of minimum profit.

A Partner (or partners) may be guaranteed minimum share of profit from the business. It is the minimum profit that the guaranteed partner (or Parnters0 will get.

Thus, if the guaranteed partner’s share of profit is more than the guaranteed profit, he will get actual share of profit and not the guaranteed profit.

The profit may be guaranteed to an existing or incoming (new) partner by:

a) all the remaining partners in an agreed ratio, or

b) One or more of the existing or old partners.

Let’s understand it in brief.

a) Guarantee of Profit by all the Remaining Partners

When all the remaining partners (i.e, other than the guaranteed partner), guarantee that the guaranteed partner (or partners) shall be given a minimum amount of profit, following steps are followed:

Step 1: Share of profit as per profit sharing ratio is determined

Step 2: Minimum guaranteed profit is determined

The higher of the amount calculated as per Step 1 and 2 is payable to the guaranteed partner.

If the share of profit is less than the guaranteed amount, the different in the amount of profit is borne by the remaining partners in the agreed ratio.

Where agreed ratio is not given the deficit is borne by them in their profit sharing ratio.

Note:- Minimum guaranteed profit minus share of profit of the guaranteed partner is called deficit.

For example:-

There are 3 partners A, B and C sharing profits in 3:2:1. The C is given minimum guaranteed profits ₹ 12,000. The profit for the year is ₹ 60,000.

The share of C in the profit is ₹ 10,000.

The deficit of X in share of profit is 12,000 – 10,000 = ₹ 2,000.

The deficit 2,000 will be borne by A and B in their profit sharing in 3:2.

Thus A, will bear 2,000 * 3/5 = ₹ 1200

B, will bear 2,000 * 2/5 = ₹ 800

b) Guarantee of Profit by one or more of the Existing or old Partners

When one of the existing or old partners (in some cases more than one partner) guarantee minimum profit, the adjustment is made through the Partner’s Capital Accounts.

The Step followed are:

Step – 1: Distribute the profit among the partners in their profit sharing ratio.

Step – 2: If share of profit of the guaranteed partner is less than the minimum guaranteed profit the difference is deducted from the share of profit of the partner (or partners) who has guaranteed and it is added to the share of profit of the guaranteed partner.

Note:- When two or more partners guarantee, the shortfall (deficiency) is shared by them in the agreed ratio or in their profit sharing ratio, if the agreed ratio is not given.

For example:-

There are three partners A, B and C sharing profits in 3:2:1. C is given minimum guarantee in profit ₹ 12,000 by A. The profit for the year is ₹ 60,000.

The C’s share in profit is ₹ 10,000

The deficiency of c’s in profit is 12000 – 1000 = ₹ 2,000.

The ₹ 2,000 will be borne by A.

The final profit of A would be as follows

60000 * 3/6 – 2,000 = ₹ 28,000