All about fixed and fluctuating capital accounts

In a commercial partnership, a capital account might be either fixed or fluctuating, depending on the circumstances. This article will discuss the two types of partners’ capital accounts and write the difference between fixed and fluctuating capital systems.

What is the difference between the working of a fixed capital account and fluctuating capital one?

A capital account is a general ledger account that reflects some particular activities, such as the proprietor’s investment in his own firm, the total amount of earnings, company costs, and so on.

The partner’s capital account is the one that keeps track of all transactions involving the partnership company and its partners. It is generated after the accounting period to calculate the partners’ share of the business. It records all aspects of the partner’s business, from their original capital investment through their portion of the firm’s earnings.

The partner’s capital account is intended to improve openness and accuracy between the company and its partners, as well as among partners. The account is credited with capital investments and debited withdrawals. Similarly, the partners’ income and profits are recorded on the capital account’s credit side, while their costs and losses are debited.

The capital account can be kept in two ways:

• Fixed capital account;
• Fluctuating capital account.

But what is the difference between fixed capital and fluctuating capital methods? Let’s discuss both of them individually.

Fixed capital method

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The original capital introduced by the partners is regarded as fixed throughout the firm’s lifecycle, save for additional capital introduced and irreversible withdrawal of the funds (drawings).

The fixed capital account strategy involves creating two accounts for each partner:

• The partner’s capital account, which records the partner’s capital, extra capital, and permanent withdrawals.
• Partner’s current account. A separate account called current is set up to record other transactions such as interest on capital, salary, commission, profit share, withdrawals, division of losses or profits, and so on. It is credited/debited by the transactions with the company other than the one directly relating to the capital account.

As a result, the capital account is unaffected. If no funds are removed or contributed during the fiscal year, the account remains stable and the same.

Fluctuating capital method

The capital balance of each partner changes continually and is not fixed under the fluctuating method of keeping partners’ capital accounts. The reason for such constant volatility is that no separate (current) account is established to record the partners’ revenue, spending, and profits/losses.

Every item of business, such as interest on capital, drawings, salaries, commissions, profit shares, and so on, is documented in the partner’s capital account. All modifications resulting in a capital reduction are recorded on the account’s debit side, and the ones that result in its increase are reported on the credit side.

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What is the difference between fixed and fluctuating capitals?

Let’s state the four main differences between fixed capital and fluctuating capital:

• The fixed capital technique requires each partner to keep two accounts, the сapital and the current. In contrast, the fluctuating capital technique maintains only one account for each partner.
• All adjustments for profits/losses, draws, salaries, commission, interests on capital and drawings, and so on are made in the current account when using the fixed capital method. Alternatively, under the fluctuating capital one, all adjustments are made in the partners’ capital accounts.
• Except when capital is added or permanently removed, the balance in the capital account remains constant when using the fixed capital account approach. When the fluctuating capital method is employed, the capital account balance changes every year owing to profits/losses, withdrawals, interest on capital, interest on drawings, and so on.
• In the case of the fixed capital account system, the capital account should always display a positive or credit balance, but the current account may show a negative or debit level. In contrast, the fluctuating capital account may occasionally have a debit or negative balance.

You can even better understand the difference between the fixed capital and fluctuating capital methods by reading the data in the table below:

Note! If you are from India, you can read a similar table about the differences between fixed capital and fluctuating capital accounts in Hindi here.

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The bottom line

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A partner’s total capital includes both their initial investment and accrued interest. However, in practice, it is easier to separate the initial investment (the capital account) from the partnership’s trading activity profits (the current account).

The partners’ capital changes as a result of fluctuations in the capital account. Aside from the original investment and its withdrawal, all other capital-related activities, such as salary, and interest on capital and withdrawals, are recorded in the current account. It is not constant and undergoes frequent adjustments.