Any decision that involves a choice between two or more mutually exclusive alternatives has an opportunity cost or loss involved.

Opportunity Cost

Opportunity Cost is the value or utility that is foregone by taking up a particular alternative. It is the value of the utility that would have been derived had the best of the rest of the alternatives been chosen.

Option	Expected Utility	Opportunity Cost
Investing in a Business	50,000	60,000
Making a Fixed Deposit	40,000	60,000
Investing in Mutual Funds	45,000	60,000
Buying Land	60,000	50,000

Optimally, the option with the least opportunity cost is preferable.

Opportunity Loss

Opportunity Loss is the value or utility that is foregone by taking up a particular alternative. It is the difference between the value of the utility and its opportunity cost.

Option	Expected Utility	Opportunity Cost	Opportunity Loss
Investing in a Business	50,000	60,000	10,000
Making a Fixed Deposit	40,000	60,000	20,000
Investing in Mutual Funds	45,000	60,000	15,000
Buying Land	60,000	50,000	-10,000

Optimally, the option with the least opportunity loss is preferable.

The contributions made by partners to the firm take various forms like contribution of assets (cash, Motor Vehicles, Buildings etc) towards capital, their time and energy by working in the firm, their personal contacts by generating sales through them, their selling abilities etc.,

In contributing these assets or services to the firm, the partners personally incur an opportunity cost/loss which they will consider before employing them for the firm.

• where the partner is investing capital he/she would be thinking of the earnings they might get if that capital is employed elsewhere;
• where he/she is employing his/her time as a working partner, he/she would be thinking of his/her earning if he/she employs the same time elsewhere.

Each and every contribution of the partner has an opportunity cost loss attached to it unless they are sitting idle.

In situations of the sort mentioned here, partners may ask for a guarantee from one or more other partners so that they would not be at loss by employing their resources for the firm.

• Where a partner is participating in a partnership firm, he/she needs to be compensated at the minimum, to the extent of his/her opportunity loss for the contribution made to the firm. Otherwise he/she may be desisted from contributing to the firm.
• Where a partner is very much sure that he can employ what he/she is contributing to the firm elsewhere in a more profitable manner, why should he/she invest them for the firm, unless there is some sort of assurance for the returns they get by contributing to the firm?
• When a person is getting into a partnership agreement, he/she will be conscious of his/her own abilities as well as the limitations of his/her other partners. Moreover, he/she would be measuring his/her opportunity cost/loss in becoming a partner.

All Partners Cannot be the Guaranteed

In the context of a particular guarantee, one or more partners can be given the guarantee. Since, there should be at least one partner who is giving the guarantee, not all the partners can be the guaranteed.

All Partners Cannot be the Guarantors

In the context of a particular guarantee, one or more partners can give the guarantee. Since, there should be at least one partner who is being guaranteed, not all the partners can be the guarantors.

There should be at least one who is giving and one who is guaranteed, thus eliminating the chance of all the partners being either guarantors or the guaranteed in such cases.

A Partner can be a guarantor and a guaranteed

One or more partners can be both the guarantor and guaranteed at the same time. A partner may guarantee one or more other partners and at the same time get a guarantee from one or more other partners

Guarantee to One Partner

A, B and C are partners in a firm sharing profits and losses in the ratio 5 : 3 : 2. They now decide to admit Mr. M as a partner giving him ${\frac{1}{10}}^{th}$ share and taking among themselves ${\frac{5}{10}}^{th},{\frac{3}{10}}^{th}and{\frac{1}{10}}^{th}$ respectively. Mr. M was willing to join as a partner only if he is guaranteed that his annual share of profits would be not less than 20,000.

Effect of the Guarantee

If Mr. M is to get his guaranteed annual share, the firm would have to make an annual profit of at least 2,00,000 ( ${\frac{1}{10}}^{th}$ of 2,00,000 = 20,000). If the profit is lesser, then the existing partners should forego their share to ensure that Mr. M gets his guaranteed share of profits. If the profit is more than 2,00,000, the guarantee does not affect the share of other partners.

The guarantee may be given by one or more partners.

• Guarantee by one Partner

  On admitting Mr. M, the firm would benefit in a number of ways. Specifically Mr. A would be getting a major relief on Mr. M sharing some of his responsibilities.

  Mr. B and Mr. C were reluctant to agree to the guarantee proposal put forward by Mr. M. Mr. A, since he would be benefiting directly and being confident that the firm would make enough profits to ensure the minimum share asked for by Mr. M, has agreed to guarantee Mr. M on his own.

  Thus Mr. A guarantees Mr. M's minimum share. The burden of guarantee has to be borne by Mr. A.

• Guarantee by two Partners

  Mr. B is reluctant to agree to the guarantee proposal put forward by Mr. M. Mr. A and Mr. C being confident that Mr. M's admission is beneficial to the firm in every way, together agree to guarantee Mr. M.

  The burden of guarantee has to be borne by Mr. A and Mr. B together.

• Guarantee by the Firm

  Since all partners feel that admitting Mr. M would be benefiting the firm in all ways, they all agree to the minimum guarantee asked for by Mr. M.

  The burden of guarantee has to be borne by all the partners together. In such a situation, Mr. M is said to have been guaranteed by the firm.

Guarantee to two or more Partners

Guarantee to two or more partners would have be viewed similarly. The guarantee may be given by

• only one partner
• two or more partners
• the firm, i.e. all the partners together.

All appropriations as we see in partnership accounting are arrangements made to ensure an equitable distribution of profits based on the various contributions made by partners to the firm. As such the amount guaranteed may relate to

• Distributable Profits only

  Eg : Mr. M is guaranteed an annual profit of 50,000 by Mr. A and Mr. C.

  Share of profits received by Mr. M should be a minimum of 50,000.

• Distributable Profits and other Appropriations

  The guaranteed amount, apart from share of profits, may consist of other profit appropriations like salary to partner, commission to partner etc.

  Eg : Mr. M is guaranteed by the firm that his share of income including his salary and interest on capital would be not less than 50,000 per anum.

  Distributable profits, salary to partners and interest on capital received by Mr. M should add up to a minimum of 50,000 as per the guarantee.

Shortfall

The difference between the amount guaranteed and the amount that a guaranteed partner would get if the guarantee is not brought into force, is what we call the shortfall.

The terms of guarantee enable us to understand what constitutes the guaranteed amount and thereby calculate the guaranteed amount and the shortfall that has to be made good if any.

Who bears the shortfall and in what proportion?

Who bears the burden of shortfall is dependent on who has given the guarantee.

Where there is only one partner who has given the guarantee, the total burden inevitably has to be borne by that partner only.

Where two are more partners have given the guarantee or the firm has given the guarantee, the proportion in which the burden of shortfall is borne by the partners is dependent on the agreement between them. In problem solving, where there is no mention of the proportion, we assume that they share the burden in proportion to the profit sharing ratio inter se between them.

Calculations

To ascertain the shortfall, make a working notes in a format similar to the one given below

Working Notes (Profit Appropriations)

Particulars	Firm	A	B	C	D	E
a) Net Profit b) Interest on Capital c) Salary to Partners d) Interest on Drawings	+ 150 − 19 − 17 + 6	+ 8	+ 7 + 7	− 2	− 4	+ 4 + 10
e) Distributable Profits	+ 120 − 120	+ 8 + 36	+ 14 + 24	− 2 + 36	− 4 + 12	+ 14 + 12
f) Total Appropriations		+ 44	+ 38	+ 34	+ 8	+ 26
Guarantee g) Guaranteed Amount h) Distributed (b) + (e) (c) + (e)			− 35 + 31			− 25 + 22
i) Shortfall (g) − (h) j) Shortfall Made Good		− 5	− 4 + 4		− 2	− 3 + 3
k) Adjusted Distributable Profit (e) + (j) l) Net Appropriated (f) + (j)	− 120 − 150	+ 31 + 44	+ 28 + 42	+ 36 + 34	+ 10 + 6	+ 15 + 29

1. calculate appropriations and shares of distributable profits.
2. Calculate the guaranteed amounts based on the terms of the guarantee.
3. Calculate the shortfall.
4. Calculate the shortfall to be made good by each partner based on the agreement between them.
5. Take from the guarantor and give to the guaranteed.
6. Calculate the adjusted distributable profit and net appropriation if needed.

Note

The amount in the Firm column against k) and l) is to indicate the total amount being distributed and appropriated respectively. Please do not interpret it as a sum of the above columns.

useful in all cases

This working note provides all the detailed information required to account for the transactions relating to appropriation and enforcing guarantee. It would be useful in all cases, whatever may be the method of accounting we follow for incorporating the information relating to the guarantee.

Where the firm is the Guarantor

Where the firm (all partners other than the guaranteed) is the guarantor and they share the burden of making good the shortfall in the ratio of their profit sharing inter se between them, and the organisation's information needs are minimal, the following procedure may be followed to give effect to the guarantee.

Working Notes (Profit Appropriations)

Particulars	Firm	A	B	C	D	E
a) Net Profit b) to guaranteed partners	+ 150 − 60		+ 35			+ 25
c) to other partners	+ 90 − 90	+ 36	+ 35	+ 36	+ 18	+ 25
d) Final Appropriations	− 150	+ 36	+ 35	+ 36	+ 18	+ 25

1. distribute the share of profits to the guaranteed partners by giving away the guaranteed amounts to them.
2. distribute the rest of the profits to the remaining partners in the ratio of profit sharing inter se between them.

Note

The amount in the Firm column against (d) Final Appropriations is to indicate the total amount being appropriated which would be the net profit. Please do not interpret it as a sum of the above columns.

Ensure that there is a Shortfall

Ascertain if the guarantee is needed to be enforced or not.

This method can be adopted, when the profits are

• not enough to cover the guarantee

  guarantee has to be enforced

• exactly equal to cover the guarantee.

  guarantee would be met and there would be no profits in excess of the ones required to meet the guarantee.

If the profits are more than the ones required to cover the guarantee, the guaranteed partners would be entitled to a share that would be more than the guaranteed amounts. Thus using this method would give an erroneous distribution as the guaranteed partners are shared only the amount equal to their guaranteed amount instead of a higher share to which they are entitled.

The accounting treatment we adopt is dependent on the information needs of the organisation.

• Complete information

  If we need the accounting system to reveal all the information relating to all appropriations and making good the shortfall, then all transactions are to be recorded separately.

  Working Notes (Profit Appropriations)

  Particulars
  a) Net Profit b) Interest on Capital ✔ c) Salary to Partners ✔ d) Interest on Drawings ✔
  e) Distributable Profits ✔
  f) Total Appropriations
  Guarantee g) Guaranteed Amount h) Distributed (b) + (e) (c) + (e)
  i) Shortfall (g) − (h) j) Shortfall Made Good ✔
  k) Adjusted Distributable Profit (e) + (j) l) Net Appropriated (f) + (j)

  The ones ticked from the working table represent transactions. The rest are entries to help our calculations.

• Minimal information

  If the organisation requires only the minimal information, it can choose to record the net or amount being appropriated and record a single journal entry for that amount which would take care of all the appropriations and adjustments for guarantees.

  Working Notes (Profit Appropriations)

  Particulars	Firm	A	B	C	D	E
  i) Net Appropriated (f) + (j) ✔	− 150	+ 44	+ 42	+ 34	+ 6	+ 29

  If this method is adopted, then the only the information relating to total appropriations would be required for recording the journal entry.

  Where the firm is the Guarantor

  The working note used in cases where the firm is the guarantor, enables us to pass only a single journal entry whose information is picked from f) Final Appropriations.

  Working Notes (Profit Appropriations)

  Particulars	Firm	A	B	C	D	E
  d) Final Appropriations	− 150	+ 36	+ 35	+ 36	+ 18	+ 25

• Minimal information revealing shortfall

  The organisation may intend to maintain minimal information and at the same time have the information reveal that there was a shortfall and it has been made good. In such a case we need to record two transactions.

  One for the total appropriations of profits normally and the other for making good the shortfall.

  Working Notes (Profit Appropriations)

  Particulars	Firm	A	B	C	D	E
  f) Total Appropriations ✔		+ 44	+ 38	+ 34	+ 8	+ 26
  j) Shortfall Made Good ✔		− 5	+ 4		− 2	+ 3
  i) Net Appropriated (f) + (j)	− 150	+ 44	+ 42	+ 34	+ 6	+ 29

  This cannot be thought of if the firm is the guarantor and we have adopted the second method for working notes as that provides the information relating to final appropriations only.

Ram, Shyam and Kabir share profits and losses in the ratio of 3 : 2 : 3. As from 1st January 20_7 they admit Chand and Robert who are to have one-tenth share each of the profits with a guaranteed minimum share of distributable profit of 15,000 each. Ram, Shyam and Kabir agree to suffer any excess over ${\frac{1}{10}}^{th}$ going to Chand and Robert in the ratio of 2 : 2 : 1 respectively.

The new profit sharing ratio among partners being Ram : Shyam : Kabir : Chand : Robert = 3 : 2 : 3 : 1 : 1.

The profits of the firm in respect of the year are 1,50,000 and the following appropriations have to be made:

• Interest on Capital : Ram: 8,000; Shyam: 7,000; Robert: 4,000
• Interest on Drawings : Kabir : 2,000; Chand: 4,000;
• Salary to Partners : Shyam : 7,000; Robert: 10,000;

Working Notes (Profit Appropriations)

Particulars	Firm	Ram	Shyam	Kabir	Chand	Robert
a) Net Profit b) Interest on Capital c) Salary to Partners d) Interest on Drawings	+ 1,50,000 − 19,000 − 17,000 + 6,000	+ 8,000	+ 7,000 + 7,000	− 2,000	− 4,000	+ 4,000 + 10,000
e) Distributable Profits	+ 1,20,000 − 1,20,000	+ 8,000 + 36,000	+ 14,000 + 24,000	− 2,000 + 36,000	− 4,000 + 12,000	+ 14,000 + 12,000
f) Total Appropriations		+ 44,000	+ 38,000	+ 34,000	+ 8,000	+ 26,000
Guarantee g) Guaranteed Amount h) Distributed (e)					− 15,000 + 12,000	− 15,000 + 12,000
i) Shortfall (g) − (h) j) Shortfall Made Good		− 2,400	− 2,400	− 1,200	− 3,000 + 3,000	− 3,000 + 3,000
k) Adj. Distributable Profits (e) + (j) l) Net Appropriated (f) + (j)	− 1,20,000 − 1,50,000	+ 33,600 + 41,600	+ 21,600 + 35,600	+ 34,800 + 32,800	+ 15,000 + 11,000	+ 15,000 + 29,000

Information relating to interest on capital, salary to partners and interest on drawings is available from the information provided.

Appropriations would result in the profit available with the firm getting reduced and the amount in the partners capital/current account getting increased.

Partners share of distributable profits

Partners Profit Sharing Proportions

Ram : Shyam : Kabir : Chand : Robert	=	3 : 2 : 3 : 1 : 1
	=	$\frac{3}{10}:\frac{2}{10}:\frac{3}{10}:\frac{1}{10}:\frac{1}{10}$

Share of Distributable Profits

Partners Share of Profits = Distributable Profit × Profit Sharing Proportion

Ram's Share	:	$1,20,000\times \frac{3}{10}$	=	36,000
Shyam's Share	:	$1,20,000\times \frac{2}{10}$	=	24,000
Kabir's Share	:	$1,20,000\times \frac{3}{10}$	=	36,000
Chand's Share	:	$1,20,000\times \frac{1}{10}$	=	12,000
Robert's Share	:	$1,20,000\times \frac{1}{10}$	=	12,000
				1,20,000

Distribution of Shortfall among Partners

Shortfall Sharing Proportion

Ram : Shyam : Kabir	=	2 : 2 : 1
	=	$\frac{2}{5}:\frac{2}{5}:\frac{1}{5}$

Share of Shortfall

Partners share of shortfall = Amount of shortfall × Shortfall sharing proportion

Ram's Share	:	$6,000\times \frac{2}{5}$	=	2,400
Shyam's Share	:	$6,000\times \frac{2}{5}$	=	2,400
Kabir's Share	:	$6,000\times \frac{1}{5}$	=	1,200
				6,000

The transactions to be recorded under this method would be

1. Interest on Capital
2. Salary to Partners
3. Interest on Drawings
4. Distributable Profits
5. Shortfall Made Good

Journal

Profit and Loss Appropriation a/c

DrCr
Particulars	Amount	Particulars	Amount
To Interest on Capital To Salary to Partners To Distributable Profit	19,000 17,000 1,20,000	By Net Profit By Interest on Drawings	1,50,000 6,000
	1,56,000		1,56,000

Intermediary Accounts

Preparation of these accounts is generally not expected in examination conditions.

Partners Capital a/c's

DrCr
Particulars	Ram	Shyam	Kabir	Chand	Robert	Particulars	Ram	Shyam	Kabir	Chand	Robert
To Interest on Drawings To Guarantee Shortfall To Balance c/d	– 2,400 –	– 2,400 –	2,000 1,200 –	4,000 – –	– – –	By Balance b/d By Interest on Capital By Salary to Partners By Profit Share By Guarantee Shortfall	– 8,000 – 36,000 –	– 7,000 7,000 24,000 –	– – – 36,000 –	– – – 12,000 3,000	– 4,000 10,000 12,000 3,000
	–	–	–	–	–		–	–	–	–	–
						By Balance b/d	–	–	–	–	–

The only transaction recorded in the books is that of net appropriation .

Journal

Particulars		Amount (Dr)	Credit (Cr)
Profit and Loss Appropriation a/c To Ram's Capital a/c To Shyam's Capital a/c To Kabir's Capital a/c To Chand's Capital a/c To Robert's Capital a/c	Dr	1,50,000	41,600 35,600 32,800 11,000 29,000
[For the net amounts distributable to partners after taking into consideration all appropriations, guarantees and making good the shortfall in guarantees.]

Profit and Loss Appropriation a/c

DrCr
Particulars	Amount	Particulars	Amount
To Ram's Capital To Shyam's Capital To Kabir's Capital To Chand's Capital To Robert's Capital	41,600 35,600 32,800 11,000 29,000	By Net Profit	1,50,000
	1,50,000		1,50,000

Partners Capital a/c's

DrCr
Particulars	Ram	Shyam	Kabir	Chand	Robert	Particulars	Ram	Shyam	Kabir	Chand	Robert
To Balance c/d	–	–	–	–	–	By Balance b/d By Profit and Loss Appropriation	– 41,600	– 35,600	– 32,800	– 11,000	– 29,000
	–	–	–	–	–		–	–	–	–	–
						By Balance b/d	–	–	–	–	–

Masking Guarantee

The information relating to guarantees may be masked from being revealed by the ledger accounts in two ways.

• Make adjustments between partner capitals

  The guarantee shortfall may also be recorded as a direct transfer between partners capital accounts in which case the postings in the partners capital account show that an amount has been transferred from the guarantor's account to the guaranteed account masking the reason why the transfer was made.

  Journal

  Particulars		Amount (Dr)	Credit (Cr)
  Ram's Capital a/c Shyam's Capital a/c Kabir's Capital a/c To Chand's Capital a/c To Robert's Capital a/c	Dr Dr Dr	2,400 2,400 1,200	3,000 3,000
  [For the shortfall in amounts guaranteed made good by ram, shyam and kabir adjusted to their capitals.]

  If the organisation needs the additional information that the transfer is on account of a guarantee shortfall being made good to be revealed by the ledger posting, it has to use an intermediary account by some relevant name as 'Guarantee Shortfall a/c' to which the shortfall is transferred from the guarantor's accounts and from which the shortfall made good is transferred to the guaranteed's accounts. This has been shown in the solution giving complete information.

• Make adjustments to distributable profits

  The adjustment to be made for making good the shortfall may be made to the distributable profits before it is distributed. This will also mask the information relating to shortfall from being revealed by the partner's capital accounts.

  No entries are recorded relating to guarantee and making good the shortfall. The amounts of distributed profits would get affected, whereby they would not be in the profit sharing proportions.

  Journal

  Particulars		Amount (Dr)	Credit (Cr)
  Distributable Profits a/c To Ram's Capital a/c To Shyam's Capital a/c To Kabir's Capital a/c To Chand's Capital a/c To Robert's Capital a/c	Dr	1,50,000	33,600 21,600 34,800 15,000 15,000
  [For the net distributable profits distributable to partners after adjusting the shortfall in guarantees.]

These two methods would only mask the information relating to the shortfall being made good and information relating to all other appropriations is contained in the partners capital accounts or distributable profits accounts.