What is Capital Ratio?

We know that the profits of a partnership firm are distributed among all the partners in an agreed ratio. But if the deed is silent regarding the profit sharing ratio, then profits are distributed equally among all the partners. However, at times, it may happen that the partners decide to share the profits and losses in the ratio of their capital balances and not in their profit sharing ratio. In such a situation, the capital ratio of the partners is to be ascertained. The calculation of the capital ratio depends on the following two situations.

  • Fixed Capital Balance (When there is no change in the Capital Balances)
  • Fluctuating Capital Balance (When there is a change in the Capital Balances i.e. when capital is withdrawn or introduced during the year)

Fixed Capital Balance

In this case, the capital balances of the partners remain the same throughout an accounting period. That is, in other words, the opening capital balance and the closing capital balance of the partner are equal. Therefore, in this case, the ratio can be computed either using the opening or closing capital balance. For example, if the capital balances of two partners A and B are Rs 90,000 and Rs 45,000, then the capital ratio is 2 : 1.

Example: A and B are the partners in a business with capitals of Rs 1,00,000 and Rs 80,000 as of January 01, 2011. Calculate their capital ratio.

Fluctuating Capital Balance

In this case, the capital balances fluctuate (or vary) during an accounting period. As a result, the closing and opening capital balances differ from each other. The capital balances vary because of withdrawals of capital (drawings) or the introduction of fresh capital during the year. In this case, the capital ratio is ascertained by the Weighted Average Method. In this method, weights are assigned to the capital balances as per the number of months it remained in the business.

For example, if Rs 50,000 remained in the business from January 01 to September 30, so the weight of 9 is assigned. After assigning the weights, the product is computed by multiplying capital balances with their respective weights. The sum total of products gives the total capital balances of the partners on which the capital ratio can be computed.

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