Chapter 1 Accounting For Partnership Basic Concepts
Chapter 1 Accounting For Partnership Basic Concepts
Chapter 1 Accounting For Partnership Basic Concepts
Meaning
● Partnership is an association between two or more persons who agree to do business and
share its profits and losses.
● Partnership is a business relationship among two or more persons to share profits and
losses of the business, carried on by all or any of them acting for all.
Definition:
i. Two or more persons: To form a partnership, there must be at least 2 partners who are
competent to contract and who are not minor, persons of unsound mind and persons
disqualified by any law. The maximum number of the partners in the firm cannot exceed
50 vide Rule 10 of the Companies Rules, 2014 as prescribed by the Central Government.
ii. Agreement: It is a legal document signed by all the partners. A written agreement
containing the terms and conditions of partnership and because of which the partnership
comes into existence is known as Partnership Deed.
iii. Lawful Business: A partnership is formed to do a lawful business which includes trade,
vocation and profession. Any type of charitable institution running as a not-for-profit
organization will not be considered as a business.
iv. Profit-Sharing: A partnership agreement specifies how the profits and losses of the firm
will be shared by the partners.
v. Business can be carried on by all or any of the Partners Acting for All: Since, the
partners are the agents as well as principals of the firm, such business of the partnership
firm can be carried on by all or any of the partners acting for all.
Rights of Partners:
(1)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
Partnership Deed:
A written document containing the terms and conditions of partnership and because of which
the partnership comes into existence is known as Partnership Deed. It is a legal document signed
by all the partners and has the following clauses:
i. Description of the Partners: It contains names, description and addresses of the partners.
ii. Description of the Firm: It contains name and address of the firm.
iii. Principal Place of Business: It contains address of the principal place of business.
iv. Nature of Business: It specifies the nature of business that the firm shall carry on.
v. Commencement of Partnership: Date of commencement of partnership is specified in this
clause.
vi. Capital Contribution: It mentions the amount of capital that each partner contributes
whether capital accounts are fixed or fluctuating.
vii. Interest on Capital: It specifies the interest on capital if such interest is allowed to be paid.
viii. Interest on Drawings: It specifies the rate of interest on drawings if such interest is
charged on drawings.
ix. Profit-Sharing Ratio: It specifies the ratio in which the profits and losses of the firm are
shared by the partners.
x. Interest on Loan: It specifies the rate of interest paid on the loan by the partner to the
(2)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
firm.
xi. Remuneration to Partners: It specifies the amounts of salary, commission, etc. payable to
the partners.
xii. Valuation of Goodwill: It specifies the method by which the goodwill of the firm will be
valued in the event of reconstitution of the partnership.
xiii. Valuation of Assets: It specifies the manner in which assets of the firm shall be valued in
the event of reconstitution of the partnership.
xiv. Settlement of Accounts: It specifies the manner in which the accounts of the partner(s)
shall be settled in case of partners' retirement or death or in the event of dissolution of
the firm.
xv. Accounting Period: It specifies the date on which accounts of the firm are closed every
year.
xvi. Rights and Duties of Partners: It specifies the rights and duties of the partners.
xvii. Duration of Partnership: It specifies whether the partnership is for a specified period or
for a venture or at will.
xviii. Bank Account Operation: It specifies how the bank accounts should be operated; whether
by any of the partners or jointly by all partners.
xix. Death of a Partner: It specifies whether the firm will continue or dissolve in the event of
death of a partner.
xx. Settlement of Disputes: It specifies how the disputes among the partners shall be settled,
if any arises.
(3)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
Provisions of the Indian Partnership Act, 1932 shall be applicable when there is no Partnership
Deed or if the Partnership Deed is silent. Following are the matters for which provisions of this
Act shall be applicable, if the partnership deed is silent on the same:
i. Sharing of Profits/Losses: Profits/Losses are shared equally by the partners.
ii. Interest on Capital: No such interest on capital is allowed to partners.
iii. Interest on Drawings: No such interest on drawings is charged from partners.
iv. Interest on Advance/Loan by a Partner: Interest shall be paid at the rate of 6%p.a. Such
interest shall be payable even if there is a loss from business as it is a charge against profit.
v. Remuneration to Partners: No partner shall be paid such remuneration as salary,
commission, etc. if the partnership deed is silent on such matter.
vi. Liabilities of Partners: Subject to agreement among the partners:
a. Profit from a similar business: In case if a partner earns profit from a business that is
similar to that of the firm in competition with the firm, then such profit earned from such
business shall be paid to the firm.
b. Profit earned for self from firm's business: In case if the partner earns profit for self from
any business transaction of the firm or from the use of firm's property or business
connection, the profit so earned shall be paid to the firm.
i. Section 30: A minor may be admitted for the benefit of partnership if all the partners
agree.
ii. Section 31: A person may be admitted as a partner either with the consent of all the
existing partners or in accordance with an express agreement among the partners.
iii. Section 32: A partner may retire from the firm either with the consent of all the other
partners or in accordance with an express agreement among the partners.
iv. Section 69: Registration of the firm is optional and not compulsory.
v. Section 35: Unless otherwise agreed by the partners in the Partnership Deed, a firm is
dissolved on the death of a partner.
Meaning: An LLP is a corporate business vehicle that enables professional expertise and
entrepreneurial initiative to combine and operate in flexible, innovative and efficient manner,
providing benefits of limited liability while allowing its members the flexibility for organizing
their internal structure as a partnership.
(4)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
Characteristics:
i. Separate Legal Entity: An LLP has a separate legal entity and therefore, LLP and its
partners are distinct from each other.
ii. Minimum Capital: Such minimum capital of an LLP is not specified and therefore, the
partners of the LLP decide how much capital will be contributed by each partner.
iii. Minimum Number of Members: A minimum of 2 members are required to establish an
LLP who shall also be the Designated Partners and shall have Director Identification
Number (DIN). There is no limit on the maximum number of partners.
iv. Audit is not mandatory: Audit of an LLP is not compulsory except for the following:
a. If the contributions of the LLP exceeds Rs.25 Lakhs or
b. If the annual turnover of the LLP exceeds Rs.40 Lakhs.
Meaning:
i. It is the interest payable by the firm to the partner for the loan given by the partner to the
firm.
ii. The rate of interest on partners' loan is specified in the Partnership Deed.
iii. If the Partnership Deed is silent, interest shall be paid @6%p.a. on loan.
Profit of the firm is distributed among the Partners through the Profit and Loss Appropriation
Account. It is important to understand the meaning and the specimen of such Profit and Loss
Appropriation Account explained as follows:
Meaning of Profit and Loss Appropriation Account: Such Profit and Loss Appropriation Account
is an extension of the Profit and Loss Account and therefore, the credit balance of the Profit and
Loss Account is transferred to Profit and Loss Appropriation Account. Such amount is then
(5)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
*In case of Fluctuating Capital Method, Profit will be transferred to Partners' Capital Accounts.
In case of Fixed Capital Method, Profit will be transferred to Partners' Current Accounts.
Difference between Profit and Loss Account and Profit and Loss
Appropriation Account:
(6)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
In case where the total amount of appropriations is more than the amount of profit available,
profit available for distribution among the partners is distributed in the ratio of appropriation to
be made. The ratio of such appropriation is determined as follows:
i. Calculate the amount of appropriation payable to each partner as per the Partnership
Deed (ignoring the profit available for distribution among partners) like the salary,
commission and interest on capital, etc.
ii. Calculate the total amount of appropriation (as per step (i) above) for each partner
separately.
iii. Calculate the ratio of the Appropriations (as per step (ii) above) to be made to each
partner.
iv. Lastly, ratio calculated in (iii) above shall be the ratio in which available profits shall be
distributed among the partners.
v. It is important to note that no particular item like salary, commission, interest on capital,
(7)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
Following are some of the issues that require special treatment at the time of preparing the
financial statements of the firm.
Partners' Capital Accounts: In a partnership firm, separate Capital Accounts are maintained for
each partner as each of the partners is the owner and has separate transactions with the firm.
These Partners' Capital Accounts can be maintained by following any of the 2 methods:
i. Fixed Capital Accounts Method: In this method, the capital amount invested by each of the
partner in the firm remains fixed or unaltered, unless a partner introduces additional capital
or withdraws out of his or her capital. Such fixed capital is recorded in the Capital Account
and for recording all transactions other than transactions related to capital such as
drawings, interest on capital, interest on drawings, salary, commission, share of
profit/losses, etc. Current Accounts are maintained in addition to the Capital Accounts.
Specimen for the 2 accounts maintained under Fixed Capital Method is as follows:
salary, commission, interest on capital, interest on drawings, share of profits or losses, etc.
are recorded in this Capital Account only. This method is followed for maintaining Capital
Accounts and therefore, in the absence of any instructions, this method should be followed
for maintaining the Partners' Capital Accounts.
Specimen for the account maintained under Fluctuating Capital Method is same as follows:
(9)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
amounts are withdrawn at irregular intervals. Again this method can be used in 2 ways
namely, as simple method and product method.
i. Simple Method: In this method, interest is calculated on each single drawing amount.
For such calculation, period for which the amount has been utilised is to be
considered.
ii. Product Method: In this method, amount of drawings is multiplied with the number of
months or number of days it has been used. After this, the product so obtained is
totaled and the interest is calculated thereon for one month (when period is
considered in months) or for 1 day (when period is considered in days). Formula is as
follows:
Interest = [Total of product × (Rate of Interest ÷ 100) × (1 ÷ 12)] , in case period is in
terms of months,
Interest = [Total of product × (Rate of Interest ÷ 100) × (1 ÷ 365)] , in case period is in
terms
of days
b. Average Period Method: Interest on drawings is calculated using this method when:
a. there are regular drawings or
b. the amount of drawings is uniform and the time interval between the 2 drawings is
uniform. Formula is as follows:
Interest = ]Total drawings × (Rate of Interest ÷ 100) × (Average Period ÷ 12)], where
Average Period = (Months left after first drawings + Months left after last drawings) ÷
2
Journal Entries to record interest on drawings are as follows:
i. In case of Fixed Capital Accounts:
a. Partners' Current A/cs ... Dr.
To Interest on Drawings A/c
(Being the interest charged on partners' drawings)
b. Interest on Drawings A/c ... Dr.
To Profit and Loss Appropriation A/c
(Being the interest on drawings transferred to Profit and Loss Appropriation A/c)
Alternatively: only one entry can be passed in place of above 2 entries as follows:
Partners' Current A/cs ... Dr.
To Profit and Loss Appropriation A/c
(Being the interest charged on drawings of partners)
(11)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
... Dr.
To Profit and Loss Appropriation A/c
(Being the interest on drawings transferred to Profit and Loss Appropriation A/c)
Alternatively: only one entry can be passed in place of above 2 entries as follows:
Partners' Capital A/cs ... Dr.
To Profit and Loss Appropriation A/c
(Being the interest charged on drawings of partners)
(12)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
It is possible that even after the books of accounts of the partnership firm are closed, some
errors and omissions still exist. Such errors and omissions are to be rectified by adjusting the
Capital Accounts of the affected partners by:
i. passing an adjustment entry: Here, a single adjustment entry is passed for the net amount
of all past adjustment. An analytical table can be prepared for determining net effect of the
past adjustments and passing the adjustment entry.
ii. passing adjustment entries: Here, separate entry is to be passed for every adjustment. In
this case, analytical table to determine the net effect is not prepared. Entries are passed for
each and every error or omission by debiting or crediting Profit and Loss Adjustment
Account which is then closed by debiting or crediting with the corresponding credit or debit
to the Partners' Current Accounts or Capital Accounts.
Accounting Entries to be passed when separate adjustment entries are passed through Profit
and Loss Adjustment Account:
i. Entry for the items which are to be credited to the Partners' Capital/Current
Accounts:
Profit and Loss Adjustment A/c ... Dr.
To Partners' Capital/Current A/cs
(Being the adjustment made for previously omitted, now recorded)
ii. Entry for the items which are to be debited to the Partners' Capital/Current
Accounts:
Partners' Capital/Current A/cs ... Dr.
To Profit and Loss Adjustment A/c
(Being the adjustment made for previously omitted, now recorded)
b. For Loss:
Partners' Capital/Current A/cs... Dr.
To Profit and Loss Adjustment A/c
(16)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
If at any time partners of the firm decide to admit the Manager as a partner with retrospective
effect, profits for those years, interest paid on loan, etc. is to be adjusted to give effect to the
terms of partnership. This can be done by passing either a single adjustment entry or by passing
separate entries for each adjustment. Net effect of these adjustments can be determined with
the help of following steps:
Guarantee of Profit:
At the time of admission of a partner, it is possible that the new partner is admitted in the firm
with minimum guaranteed profits from the business. It means that the guaranteed partner shall
get the minimum guaranteed profit even if the guaranteed partner's or new partner's share of
profit is less than the guaranteed amount.
When profit is guaranteed to an existing or incoming partner, it can be done in 2 ways as follows:
i. Profit may be guaranteed by all the remaining partners in an agreed ratio: In this case,
following steps are followed :
Step 1: Share of profit as per profit sharing ratio is determined, and
Step 2: Minimum guaranteed profit is determined.
Step 3: Higher of the above two amounts (in step 1 and step 2) is given to the guaranteed
partner.
Step 4: If the share of profit is less than the guaranteed amount, the difference in the
amount of profit ( i.e., minimum guaranteed profit - share of profit of the guaranteed
partner) is borne by the remaining partners in the agreed ratio and where the agreed ratio is
not given such difference is borne by the partners in their profit sharing ratio.
ii. Profit may be guaranteed by one or more of the existing or old partners: In this case,
following steps are to be followed:
Step 1: Amount of profit is to be distributed among the partners as per their profit sharing
(17)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
ratio.
Step 2: In case 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.
Step 3: When two or more partners guarantee, the shortfall (deficiency) is shared by them in
the agreed ratio or in their profit sharing ratio as the case may be.
Accounting treatment of Guarantee of minimum profit to a partner in
case of Loss:
In case where the firm is incurring losses and minimum guaranteed profit is to be paid to the
partner who has been guaranteed minimum profit, adjustment will be made through
Partners' Capital Accounts as follows:
a) Loss is distributed among the partners in their profit-sharing ratio.
b) Capital Account of the guaranteed partner is credited with the guaranteed minimum profit
plus amount of loss.
c) The amount credited to the guaranteed partner's Capital Account is then debited to the
remaining partners in their profit sharing ratio or to the debit of the partner who has
guaranteed minimum profit.
This is a situation where, a partner (or partners) may guarantee minimum earnings to the firm
and/or guarantee a profit to the firm. In such case, any shortfall in earnings is debited to the
concerned Partner's (Partners') Capital Accounts or Current Accounts.
(18)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
(19)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
Important Questions
Multiple Choice questions-
Question 1. Partnership deed may be _______
(a) oral
(b) written
(c) duplicate
(d) either written or oral
Question 2. If no agreement is made by partners then interest on loan will be given @
_________
(a) 5% p.a.
(b) 6% p.a.
(c) no interest
(d) 7% p.a
Question 3. Profit will be divided in ________ in the absence of partnership deed.
(a) 1 : 1
(b) 2 : 1
(c) 1 : 2
(d) equal ratio
Question 4. In a partnership, liability of all partners is _________
(a) unlimited
(b) limited
(c) according to capital
(d) decided by company act
Question 5. Maximum number of partners in a partnership firm can be ________
(a) 50
(b) 20
(c) 100
(d) no limit
Question 6. When there is no partnership deed then provisions of partnership act ________
will be applicable.
(20)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
(a) 1956
(b) 1912
(c) 1932
(d) 1949
Question 7. Liability of a partner in LLP is ________
(a) limited
(b) unlimited
(c) not defined in the law
(d) limited to the capital only
Question 8. Provisions of Table _______ are applicable in the absence of partnership deed.
(a) A
(b) B
(c) C
(d) D
Question 9. In the absence of any provision interest on capital will be calculated for _________
(a) 6 months
(b) 1 year
(c) 1 month
(d) no interest
Question 10. Minimum number of partners in a partnership are ________
(a) 5
(b) 7
(c) 2
(d) 10
Very Short Questions-
1. Dev withdrew ₹ 10,000 on 15th day of every month. Interest on drawings was to be
charged @ 12% per annum. Calculate interest on Dev’s drawings.
2. Amit, a partner in a partnership firm withdrew ₹ 7,000 at the beginning of each quarter.
For how many months would interest on drawings be charged?
3. Partners of ABC Corporation have agreed that D, a minor, should be admitted as a partner
in the firm. What will be the liability of D?
(21)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
4. X, Y, and Z are partners in a firm. The firm had adopted the fixed capital method. Mention
the account in which the interest on capital will be recorded:
5. A partnership deed provides for the payment of interest on capital but there was a loss
instead of profits during the year 2010-11. Will the interest on capital be allowed?
6. Where is interest on a partner’s loan debited to Profit and Loss Account or Profit and Loss
Appropriation Account?
7. Is interest on a partner’s loan is payable even in case of loss to the firm?
8. Net profit of a firm is ₹ 30,000, partners’ salary is ₹ 12,000, and interest on capital is ₹
20,000. Mention the amount of partners’ salary and interest on capital which should be
debited to the Profit and Loss Appropriation Account if both items are treated as
appropriation.
9. Ram and Shyam are partners sharing profits/losses equally. Ram withdrew ₹ 1,000 p.m.
regularly on the first day of every month during the year 2013-14 for personal expenses. If
interest on drawings is charged @ 5% p.a. Calculate interest on the drawings of Ram.
10.Himanshu withdraws ₹ 2,500 at the end of each month. The partnership deed provides
for charging the interest on drawings @ 12% p.a. Calculate interest on Himanshu’s
drawings for the year ending 31st December 2013.
Short Questions-
1. Define Partnership Deed.
2. Why it is considered desirable to make the partnership agreement in writing.
3. Why is Profit and Loss Adjustment Account prepared? Explain.
4. Give two circumstances under which the fixed capitals of partners may change.
5. If a fixed amount is withdrawn on the first day of every quarter, for what period the
interest on total amount withdrawn will be calculated?
6. In the absence of partnership deed, specify the rules relating to the following:
(i) Sharing of profits and losses.
(ii) Interest on partner’s capital.
(iii) Interest on Partner’s drawings.
(iv) Interest on Partner’s loan
(v) Salary to a partner.
Long Questions-
1. What is partnership? What are its chief characteristics? Explain.
2. Discuss the main provisions of the Indian Partnership Act, 1932 that are relevant to
(22)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
10.
Short Answers-
1. A partnership deed also referred to as a partnership agreement, is a document of
importance that contains the details of all the rights and responsibilities of the concerned
parties involved in a business. It helps in preventing any kind of disputes or disagreements
that can arise between partners over their role on the business and the associated
benefits from the partnership in the firm.
2. According to the Partnership Act, 1932, having a Partnership deed in writing is not
mandatory. However, it is a safe option to have it in writing as it helps avoid any kind of
disputes that may arise between partners of a firm in future. It also helps resolution of
any kind of disputes as a written partnership that is signed by all the partners is suitable
for use as an evidence in the court of law.
3. It is prepared for the following reasons:
(24)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
i. For recording transactions, errors or omissions which may be left while preparing the
final accounts.
ii. To act as a account for distributing profit and loss between partners.
iii. To accommodate for changes in partnership deed.
4. Following circumstances lead to change in fixed capital of partners:
i. Introducing fresh capital in the firm by a partner with consent from other partners.
ii. When a portion of capital is withdrawn with consent of partners.
5. When there is withdrawal of money on first day of each quarter. Then the corresponding
interest is calculated for a period of seven and half months on the total amount that is
withdrawn.
6.
i. Sharing of profits and losses: If a partnership deed is absent, then the profit sharing
ratio should be equal among all partners, as per Partnership Act, 1932.
ii. Interest on Partner’s capital: If partnership deed is absent, then as per Partnership
Act, 1932, the partners are not entitled to interest earned on capital.
iii. Interest on Partner’s drawings: If partnership deed is absent, then as per Partnership
Act, 1932, in event of drawing money it shall be charged to the partners.
iv. Interest on Partner’s loan: If partnership deed is absent then the partner is eligible for
a 6% interest on loan to the firm.
v. Salary to a partner: In case of absence of partnership deed, the partners are not
eligible for any salary, any salary whatsoever if paid will be as appropriation of profit
(in case there is profit).
Long Answers-
1. According to Section 4 of the Partnership Act, 1932 a partnership is defined as “an
agreement between two or more persons who have mutually agreed to share profits or
losses that will be carried by all or any one of them acting for all”. The individuals who
setup the business jointly are called as partners and all the partners collectively are
known as firm.
Following are the important characteristics of a partnership firm:
i. Number of partners: The minimum number of persons to form a partnership is 2 and
the maximum is 50 as per Companies Rules Act, 2014. Any more than the specified
limit makes partnership illegal.
ii. Partnership Deed: A partnership deed is necessary document that contains all the
terms of the partnership and the details about contribution of each partner towards
the firm. It should be in written format as it helps in resolving disputes between
(25)
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS
01
(27)