0CHAPTER 1
Accounting for Partnership Firms Fundamentals
According to Section4 of the Indian Partnership Act, 1932: "Partnership is the relationship between persons who have agreed to the share the profits of a business carried on by all or any one of them acting for all"
Features of Partnership:
- There must be at least two persons to form a valid partnership. Section 11 of the Indian Partnership Act, 1932 restrict the (maximum) number of partners to 10 for carrying on banking business and 20 for other kind of business.
- Partnership comes into existence by an agreement (either written or oral)among the partners. The written agreement among teh partners is called Partnership Deed.
- A Partnership can formed for the purpose of carrying at sharing the profits or losses of the business
- An agreement between the partners must be aimed at sharing the profits or losses of the business.
- A partnership can be carried on by all or any one of them acting for all.
Partnership Deed: The partnership deed is a written agreement among the partners which contains
the terms of agreement. A partnership deed should contain the following points:
- Name and address of the firm.
- Name and addresses of the partners.
- Nature of the business
- Terms of Partnership
- Capital contribution by each partner.
- Interest on capital
- Drawings and interest on drawings.
- Profit sharing ratio
- Interest on loan.
- Partner's Salary/commission etc.
- Method for valuation of goodwill
- Accounting period of the firm
- Rights and duties of partners.
Benefits of Partnership deed:
- Helps to avoid dispute in future
- It is an evidence in the court
- Facilitates functioning of business by avoiding misunderstanding
Rules applicable in the absence of partnership deed:
- Profit sharing Ratio Equal
- Interest on Capital No Interest on Capital is to be allowed to any Partner
- Interest on Drawings No interst on Drawings is to be charged from any Partner
- Salary on Commission to Not Alloweda Partner
- Interest on loan by a Partner Interest is allowed @6% per annum
Distribution of profits among partners: A Profit and Loss Appropriation Account is prepared to show the distribution
of profits among partners as per the provision of Partnership Deed (or as per the provision of Indian Partnership Act, 1932 in the absesnce of Partnership Deed). It is an extension of Profit and Loss Acccount. It is nominal account.
The Journal Entries regarding Profit and Loss Appropriation Account are as follows:
- For transfer of balance of Profit and Loss Account Profit and Loss A/c Dr. To Profit and Loss Appropriation A/c (Being net profit transferred to P & L Appropriation A/c)
- For Interest on Capital :
- For allowing Interest on capital. Interest on Capital A/c. To Partners' Capital/Current A/cs (Being interest on capital allwoed @ ___ % p.a).
- For transferring Interest on Capital to Profit and Loss Appropriation. Profit and Loss Appropriation A/c Dr. To Interest on Capital A/c .(Being interest on capital transferre to P & L Appropriation A/c)
- For Salary of Commission payable to a partner
- For allowing Salary or Commission to a partner: Partner's Salary/Commission A/c Dr. To Partner's Capital /Current A/cs (Being salary/commission payable to a partner).
- For transferring Partner's Salary/Commission A/c to Profit and Loss. Appropriation A/c: Profit and Loss appropriation A/c Dr. To Partner's Salary/ Commission A/c
- For transfer of Reserves: Profit and Loss Appropriation A/c Dr. To Reserve A/c (Being reserve created)
- For Interest on Drawings :
- For charging interest on a partner's drawings: Partner's Capital/Current A/c Dr. To Interest on Drawings A/c (Being interest on drawings charged @ ____%p.a.)
- For transferring Interest on drawings to Profit and Loss Appropriation A/c : Dr. Interest on Drawings A/c. To Profit and Loss Appropriation A/c (Being interest on drawings transferred to P & L Apprpriation A/c).
- For transfer to Profit (i.e. Credit Balance of Profit and Loss). Profit and Loss Appropriation A/c Dr. To Partners Capital A/cs (Being profits distributed among partners).
Specimen of profit and loss appropriation account:
- Profit and Loss Appropriation Account
- For the year ending on ________________
- Dr. Cr.
- Particulars ` Particulars `
- To Interest on Capital By Profit Loss A/c
- A (Net Profits transferred from B P& L A/c)
- To Partner's Salary/ By Interst on Drawings
- Commission A
- To Reserves B
- To Profits transferred to capital A/c of : A to B
Partner's Capital Accounts : It is an account which represents the partner's interst in
the business. In case of partnership business, a separate capital account is maintained for each
partner. The capital accounts of partners may be maintained by following any of the
following two methods:
- Fixed Capital Accounts
- Fluctuating Capital Accounts
Fixed Capital Accounts: Under this method the following two accounts are maintained:
- Capital Account: This account will always show a credit balance. Balance of Capital account remains fixed and only the following two transactions are recorded in the Fixed Capital. Accounts: 1. Additional Capital Introduced 2. Capital Withdrawn or Drawings out of Capital. Dr. Partner's Capital A/cs Cr. X Y X Y Particulars "Particulars" To Cash/ Bank A/c By Balance b/d (Capital Withdrawn) (Opening Cr. Balance). To Balance c/d By Cash/Bank A/c (Closing balance) (Additional Capital Introduced)
- Current Account: The Current account may show a debit or credit balance. All the usual adjustments such as Interest on Capital, partner's salary/commission, drawings (out of profits), interest on drawings and share in profits or losses etc. are recorded in this account Dr. Partner's Capital A/cs Cr. X Y X Y Particulars "Particulars". To Balance b/d By Balance b/d (Opening Dr. Balance) (Opening Cr. Balance). To Drawings By Interest on Capital (out of Profits) By Partner's Salary or To Interest on Drawings Commission. To Profit and Loss A/c By Profit and Loss (Share in losses) Appropriation A/c To Balance c/d (Share in Profits) (Closing credit Balance) By Balance c/d Closing Dr. Balance. Note :
- Debit balance of Current Account is shown in Assets side of Balance Sheet.
- Credit balance of Current Account is shown in Liabilities side of Balance Sheet.
- Balance of Capital Accounts are always shown in Liabilities side of Balance Sheet as this account will always show a credit balance when capital is fixed
Fluctuating Capital Accounts : In this method only one account, i.e, Capital Account of each and every partner is prepared and all the adjustment such as interest on capital, interest on drawings etc. are recorded in this account. Under this method, Capital account may show a debit or credit balance and the balance of this account changes frequently from time to time therefore it is called fluctuating Capital Account Dr. Partner's Capital A/cs Cr. X Y X Y
Particulars "Particulars". To Balance b/d By Balance b/d (Opening Dr. Balance) (Opening Cr. Balance). To Cash/Bank A/c By Cash/ Bank A/c (Capital Withdrawn) (Additional Capital To Drawings Intoduced) (out of profits). By Interest on Capital
To Interest on Drawings By Partner's Salary or To Profit and Loss A/c Commission (Share in losses) By Profit and Loss
To Balance c/d Appropriation A/c (Closing credit Balance) (Share in Profits). By Balance c/d (Closing Dr. Balance).
Interest On Capital: Interest on partners’ capital will be allowed only when it has been specifically mentioned in the partnership deed. Interest on Capital can be treated as either:
- An Appropriation of profit or
- A Charge against profits
Interest on Capital: An Appropriation of Profits: In Case of Losses Interest on Capital is not allowed. In case of sufficient profits interest on capital is allowed in full. In case of Insufficient Profits Interest on Capital is allowed only to the extent of profits in the ratio of interest on capital of each partner.
Interest on Capital: As a Charge against Profits: Interest on Capital is always allowed in full irrespective of amount of profits or losses.
