Partnership Accounts Unit-II Lucknow University

 

Day-II

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FA UNIT- II

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An Overview of Indian Partnership

Partnership Accounts

Meaning of Partnership as per Section 4 of Indian Partnership Act, 1932

“Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.”

Nature: A partnership firm has no separate legal entity apart from the partners constituting it.

Partners, Firm and Firm Name: The persons who have entered into partnership with one another are individually called partners and collectively a firm. The name under which the business of the firm is carried on is called the firm name.

Essential Elements, Main Features or Characteristics of Partnership

1.  There must be two or more persons.

2.  There must be an agreement.

3.  There must be a lawful business.

4.  There must be sharing of profits of business.

5.   There must be a mutual agency, i.e., the business must be either carried on by all or any of them acting for all.

Partnership Deed: The document containing the terms and conditions of the agreement between/among partners, is known as the Partnership Deed. The Partnership Deed usually includes the following:

(i)               Name and address of the firm.

(ii)             Names and addresses of all partners.

(iii)          Date of commencement of partnership.

(iv)           Capital to be contributed by each partner.

(v)             Whether interest is to be allowed on capitals.

(vi)           Whether any partner is to be allowed salary.

(vii)        The profit-sharing ratio.

(viii)      The duties of each partner.

(ix)           Mode of settlement of accounts in case of retirement/death of a partner.

Benefits or Advantages of having a Partnership Deed

(i)               It facilitates functioning of the business.

(ii)             It is helpful in the settlement of all disputes arising among the partners.

(iii)          It helps to avoid misunderstandings among the partners.

Provisions Applicable in the Absence of Partnership Agreement/Partnership Deed

1.  Interest is not allowed on Partners’ Capitals or charged on Drawings.

2.    Partner is not entitled to salary or remuneration for the work done for the firm.

3.  Interest @ 6% p.a. is allowed on the loans advanced by any partner.

4.  Profit or loss is distributed equally among the partners.

Profit and Loss Appropriation Account is an extension of the Profit and Loss Account. The purpose of this account is to show how Net Profit is appropriated and distributed among the partners.

It is credited with Net Profit and interest on drawings.

It is debited with interest on capitals, salary or commission to partners as per the terms of Partnership Deed.

Its balance is transferred to the Partners’ Capital (or Current) Accounts in their agreed profit-sharing ratio (or equally if there is no agreed profit-sharing ratio).

Salary or Commission to a Partner: Salary or Commission to a partner is allowed if the Partnership Deed provides for it.

A: Commission as a percentage of the Net Profit before charging such commission = Net Profit before Commission × Rate of Commission /100

B: Commission as a percentage of Net Profit after charging such commission

= Net Profit before Commission × Rate of Commission /100 + Rate of Commission

 

Salary or commission to a partner being an appropriation of profits is transferred to the debit of the Profit and Loss Appropriation Account and not to the debit of the Profit and Loss Account.

·        Interest on Capital: Interest on capital is calculated on time basis, taking into consideration any additional capital introduced or any existing capital withdrawn.

·        Interest on Current Account: Interest on Current Account is allowed (in case of Credit Balance) and charged (in case of debit balance) on Opening Balance. It is allowed or charged if instructed in the question.

·        Interest on Drawings: If the Partnership Deed so provides, interest on drawings is charged from the partners. The interest so charged is credited to the Profit and Loss Appropriation Account and debited to the Partners’ Capital or Current Accounts.

·        If the date of Drawings is not given, the Interest on total Drawings is calculated for 6 months. Interest @ 10% without the word ‘per annum’ means interest is calculated without any reference to time period.

·        Interest on Partner’s Loan to the Firm: If a partner gives a loan to the firm, he is entitled to interest on such loan at an agreed rate of interest. If there is no agreement as to the rate of interest on loan, the partner is entitled to interest on loan @ 6% p.a. Interest on partner’s loan is a ‘charge’ against the profit and is credited to his/her Loan Account.

·        Interest on Loan by the Firm to a Partner: Firm is entitled to receive interest on loan given to a partner. However, the firm will charge interest on loan advanced to a partner only, if it is provided in the Partnership Deed or is agreed to charge interest along with the rate of interest among the partners. It is a gain to the firm and is credited to Profit and Loss A/c.

Methods of Maintaining Capital Accounts of Partners

The Partners’ Capital Accounts may be maintained according to Fixed Capital Method or Fluctuating Capital Method.

Fixed Capital Method: Under this method, the capital of partners remains unchanged except under special circumstances. In case of the fixed capital, two accounts are maintained for each partner, viz., (i) Fixed Capital Account and (ii) Current Account. All adjustments regarding drawings, interest on drawings, salary, interest on capital, commission and share of profit or loss are recorded in Current Account. The Fixed Capital Account cannot have a negative balance.

Fluctuating Capital Method: Capital Accounts are called fluctuating when the balances of Capital Accounts change with each transaction. All adjustments relating to interest on capital, drawings, salary and profit are recorded in the Capital Accounts. Under this method, only one account is opened for each partner, i.e., Capital Account.

In the absence of any instruction, Partners’ Capital Accounts are prepared following Fluctuating Capital Method.

·        Guarantee of Minimum Profit to a Partner: A partner may be guaranteed a minimum amount of his share in profits. Guarantee may be provided by one or some or all of the partners in an existing profit- sharing ratio or in some other agreed ratio. If in any year, the actual share of profit is less than the guaranteed amount, the deficiency is borne by the guaranteeing partners in their agreed ratio.

·        Past Adjustments: Sometimes after closing the accounts of a partnership firm for a certain period, certain omissions or errors may be discovered. For example, interest on capital or interest on drawings may have been omitted or interest has been calculated at a different rate than agreed, or profits may have been distributed in a different manner than agreed among the partners. Corrections of these errors are generally done through the Partners’ Capital Accounts by means of a single adjusting Journal entry. No attempt is made to reopen the accounts of the previous accounting period(s). Such adjustments are called past adjustments as these are related to past periods.

Distribution of Profits among Partners

 

Transactions of the partnership firm are recorded according to the principles of Double-entry book keeping system, and as in the case of a sole proprietorship concern a partnership firm will also prepare Trading account, Profit & Loss account and Balance Sheet at the end of every year. The only difference between accounting of a sole trader and partnership firm is that the profits of the partnership firm are divided amongst the 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 absence of Partnership Deed). It is an extension of profit and Loss Account. It is nominal account. It records entries for interest on capital, Interest on Drawings, Salary to the partner, and division of profits among the partners.

The Journal Entries regarding Profit and Loss Appropriation Account are as follows:

 

1.  For transfer of balance of Profit and Loss Account

Profit and Loss A/c Dr.

To Profit and Loss Appropriation A/c

 

2.  For Interest on Capital

For allowing Interest on capital Interest on Capital A/c

To Partner’s Capital/Current A/cs

(Being interest on capital allowed @ % p.a.)

 

2.  For transferring Interest on Capital to P&L appropriation A/c.

Profit and Loss Appropriation A/c Dr. To Interest on Capital A/c.

(Being interest on capital transferred to P&L Appropriation A/c)

 

3.  For Salary or Commission payable to a partner

i.  For allowing Salary or Commission to a partner: Partners Salary/Commission A/c Dr.

To Partner’s Capital/Current A/c

(Being salary/commission payable to a partner)

ii.   For transferring Partner’s Salary/Commission A/c to Profit and Loss Appropriation A/s:

Profit and Loss Appropriation A/c Dr. To Partner’s Salary/Commission A/c

4.  For transfer of Reserves:

Profit and Loss Appropriation A/c Dr.

To Reserve A/c

(Being reserve created)

 

5.  For Interest on Drawings:

1. 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.)

 

2.   For transferring interest on drawings to Profit and Loss Appropriation A/c Interest on Drawings A/c Dr.

To Profit and Loss Appropriation A/c

(Being interest on drawings transferred to P&L appropriation A/c)

 

6.  For transfer to Profit (i.e. Credit Balance of Profit and Loss Appropriation Account

Profit and Loss Appropriation A/c Dr.

To Partners Capital/Current A/c

(Being profits distributed among partners)

 

 

SPECIMEN OF PROFIT AND LOSS APPROPRIATION ACCOUNT

Profit and Loss Appropriation Account

For the year ending on                                       

 

Partner’s Capital Accounts

Partner’s Capital Accounts: It is an account which represents the partner’s interest 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 any of the following two methods.

1.  Fixed Capital Accounts

2.  Fluctuating Capital Accounts

 

1. Fixed Capital Accounts

Under this method the original capitals invested by the partners remain constant, unless additional capital is introduced by an agreement. All entries relating to drawings, interest on capitals, interest on drawings, salary to partner, share of profits/losses are made in separate account which is called as Current Account. Thus the following two accounts are maintained when capitals are fixed.

(i)  Capital Account

This account will always show a credit balance: Balance of Capital account remains fixed, it does not change every year that is why it is called fixed capital method and only the following two transactions are recorded in the Fixed Capital Accounts:

 

·        Permanent - Additional Capital Introduced

·        Permanent - Capital Withdrawn or Drawings out of Capital only

 

 

 

 

 

 

 

 

 

 

(ii)  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. All the Current Year’s adjustments are recorded in this account, that is why it is called Current account.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note:

1.  Debit balance of Current Account is shown in Assets side of Balance Sheet.

2.  Credits balance of Current Account A/c is shown in Liabilities side of balance Sheet.

3.  Balance of Fixed Capital Accounts are always shown in Liabilities side of Balance Sheet as it will be always be credit balance.

2. 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. In this method the capitals are not fixed.

 

In the absence of information, the Capital Accounts should be prepared by this method.

Partner’s Capital

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INTEREST ON CAPITAL

Interest on partner’s capital will be allowed only when it has been specifically mentioned in the partnership deed. If interest on capital is to be allowed as per the

 

 

 

 

 

 

 

 

 

 

In case of Losses	Interest on Capital is NOT ALLOWED
In cases of Sufficient Profits	Interest on Capital is ALLOWED IN FULL
In case of Insufficient Profits	Interest will be restricted to the amount of profit. Hence, profit will be distributed in the ratio of interest on capital of each partner.

2.  Credit Balance of his current account (if any).

3.  Share of Goodwill. (By gaining partners)

4.  Share of Reserves of Undistributed profits.

5.  His share in the profit on revaluation of assets and liabilities.

6.  Share in profits up to the date of Retirement/Death. (By p & L suspense A/c)

7.  Interest on capital if involved.

8.  Salary if any

 

Deduction from the above sum (to be debited to capital account)

 

1.  Debit balance of his current account (if any)

2.  Share of existing Goodwill to be written off.

3.  Share of accumulated loss.

4.  Drawing and interest on drawings (if any)

5.  Share of loss on account of Revaluation of assets and liabilities.

6.  His share of business loss up to the date of Retirement/Death (To p & L) suspense A/C)

 

Accounting Treatment

 

1.  Calculation of new profit sharing ratio and gaining ratio

2.  Treatment of goodwill.

3.  Evaluation a/c preparation with the adjustment in the respect of unrecorded assets /liabilities.

4.  Distribution of reserves and accumulated profits/loss.

5.  Ascertainment of share of profit/loss till the date of retirement. Death.

6.  Adjustment of capital if required.

7.  Settlement of the Accounts due to Retired/Deceased partner.

 

New profit Sharing Ratio & Gaining Ratio

 

New profit Sharing Ratio: it is the ratio in which the remaining partners share future profits after retirement/death.

 

2.   Gaining ratio is given which is different than the old ratio in this New share of continuing partner = has old share + gained from outgoing partner.

 

3.  If the new ratio is given the Gaining ratio = New Ratio -Old Ratio

 

 

 

 

TREATMENT OF GOODWILL

 

According to accounting standards – 10, Good will account can’t be raised as only purchased goodwill is recorded in books. Therefore only adjustment entry is done for goodwill

 

Steps to be followed

1.  When old good will appears in the books then first of all this is writer in the old ratio.

Remember Old Goodwill old Ratio

All Partner’s capital A/C     Dr. To Good Will A/c

 

2.  After written off of goodwill adjustment of retiring partner’s share goodwill will be made through the following journal entry.

Remaining Partner’s Capital, A/C Dr. (in gaining To Retiring/Deceased Partner’s Capital A/c

 

Retiring Partner’s Capital A/c Dr.

 

To Cash Bank A/c

 

2.  When the retiring partner is paid nothing in cash then the whole amount due is transferred to his loan A/c

Retiring Partner’s Capital A/c Dr. To retiring partner’s Loon A/c

3.  When Retiring Partner is partly paid in cash and the remaining amount in treated Loan.

Retiring Partner’s Capital A/c Dr. (Total Amount due) To Cash Bank A/c (Amount Paid)

To Retiring Partner’s Loan A/c (Amount of Loan)

 

Settlement of loan of the Retiring Partner

Loan of the retiring partner is disposed off accordingly of the pre decided term and conditions among the partners. Normally the Principal amount is paid in few equal instalments. In such cases interest is credited to the Loan A/c on the basic of the amount outstanding at the beginning of each year and the amount paid it debited to loan A/c.

The following Journal entries are done

a.  For interest on Loan. Interest A/c Dr.

To Retiring partner’s Loan A/c

b.  For the payment of instalment. Retiring Partner’s Loan A/c Dr.

To Cash/Bank A/c (including interest)

 

Adjustment of Capitals

At the time of retirement/death, the remaining partners may decide to adjust their capitals in their new profit sharing Ratio. Then

·  The sum of their capitals will be treated as the total capital of the new firm which will be divided in their New Profit Sharing Ratio.

·  Excess of Deficiency of capital in the individual capital A/c is calculated.

 

·   Such excess or shortage is adjusted by withdrawal or contribution in case or transferring to their current A/cs.

Journal Entries

 

(a)  For excess Capital withdrawn by the Partners Partner’s capital A/c Dr.

To Cash/Bank A/c

(b)  For deficiency, cash will be brought in by the partner Cash/Bank A/c  Dr.

To Partner’s capital A/c

 

DEATH OF A PARTNER

 

Accounting treatment in the case of death is same as in the case of return except the following:

1.  The deceased partners claim is transferred to his executer’s account.

 

2.  Normally the retirement takes place at the end of the Accounting pried but the death may occur at any time. Hence the claim of deceased  part shall  also include his share or pro2. Normally the retirement takes place at the end of the Accounting pried but the death may occur at any time. Hence the claim of deceased part shall also include his share or profit or loss, interest on capital drawings if any from the date of the last balance sheet to the date his death profit or loss, interest on capital drawings if any from the date of the last balance sheet to the date his death.

 

1. Calculation of profit/Loss for the intervening Period.

It is calculated by any one of the two methods given below:

 

a. On Time Basis: In this method proportionally profit for the time period is calculated either on the basis of last year’s profit or on basis of average

 

from this profit the deceased partner’s share of profit is calculated.

 

 

Dissolution of a firm: As per Indian Partnership Act, 1932: “Dissolution firm means termination of partnership among all the partners of the firm”

 

When a firm is dissolved, the business of the firm terminates. All the assets the firm are disposed off and all outsiders’ liabilities and partners’ loan and partner capital are paid.

Dissolution of Partnership: Dissolution of Partnership refers to terminal of  old partnership agreement (i.e., Partnership Deep) and a reconstruction the firm.

It may take place on

 

·   Change in profit sharing ratio among the existing partner:

·   Admission of a partner; and

·   Retirement of Death of partner.

 

It may or may not result into closing down of the business as the remount partners may decide to carry on the business under a new agreement.

Types of dissolution of firms: A Partnership firm can be dissolved in any the following ways:

 

(A) Without the intervention of the court:

(1)  When all partners agree to dissolve the firm (Sec. 40);

(2)  Compulsory Dissolution (Sec. 41)

(i)  When all or except but one partner of the firm become insolvent

(ii)  When business of the firm become unlawful.

(3)  On the happening of any of the following events: (Sec. 42)

(i)  On the insolvency of a partner.

(ii)  On the fulfilment of the objective of the firm for which the for was formed.

(iii)  On the expiry of the (period) for which the firm was formed.

(4)  By Notice (Sec. 43): When the duration of the partnership firm is a fixed and it is at will of the partners. Any partner by giving notice other partners can dissolve the firm.

 

(B)     Dissolution by order of the court (Sec. 44): A court on application by a partner may order the dissolution of the firm under the following circumstances:

 

(1)  When a partner has become of unsound mind.

(2)  When a partner has become permanently incapable of performing his duties as a partner.

(3)  When a partner is found quality of misconduct that may harm the partnership.

(4)  When a partner consistently and deliberately commits breach of partnership agreement.

(5) When a partner transfer whole of is interest in the business firm to a third party, without the consent of existing partners.

(6) When the court is satisfied that the partnership firm cannot be carried on except at a loss.

(7)  When the court finds that the dissolution of firm is justified and equitable.