XII year accounting Notes

Accounting for Partnership – Basic Concepts

A business can be organized in different forms.

1. Sole Proprietorship
2. Partnership
3. Company

 The major limitations of Sole proprietorship form of business is

- Limited Capital

- Limited Managerial ability

- and Limited risk bearing capacity

Making business a partnership firm is one way to overcome the above limitations.

The basic accounting formalities to be followed in partnership accounting is similar  to that of sole proprietorship business. Ie., the preparation of profit and loss A/c and Balance sheet. But it differs in the following areas.

1. Distribution of profits among the partners
2. Maintenance of capital accounts and
3. Regarding adjustments when the firm is reconstituted.

So the question what is a Partnership is relevant here!

Indian Partnership Act 1932 defines Partnership as “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”

The persons who have entered into partnership individually are known as partners and collectively as ‘Firm’.

Features:

1. To or more persons.

There must be at least 2 persons to form a partnership. Maximum limit is 10 for banking business and 20 for any other business.

2. Agreement between partners.

A partnership is always based on an agreement, without which there won’t be any partnership business. Agreement can be oral or written.

3. Business.  The partnership business should be for carrying on some legal business

4. Sharing of profits.  The agreement must be for sharing the profits of the

business. The ration in which the profits are to shared must be clearly stated in the partnership. In the absence of a ratio the profits will be shared equally.

5. Business must be carried on by all or any one of them acting for all.

Here the partnership is based on the concept of mutual agency relationship. Ie., a partner is both an agent( he can, by his acts, bind other partners) and a Principal(bound by the acts of other partners).

Partnership deed

A partnership agreement is formed by an agreement. This agreement can be oral or written. If it is written it is called Partnership Deed. But law doesn’t say that the agreement should be in the written form. But it is always advisable to be in the written form in order to avoid the future conflicts and confusions.

Assignment:

You along with your friends joined hands to form a partnership business. Prepare a partnership deed which contains all the details of your agreement.

Provision in the Act if there is no Partnership Deed or Deed is silent on the following aspects:

1.      Profit sharing: The partners will share profits equally if there is no ratio for profit sharing is stated in the partnership deed irrespective of their capital contribution.

2.      Interest on Capital: No interest on capital will be given to the partners if the Partnership deed is silent about it. Interest on capital will be given only out of profits but not out of losses even if the deed provides so.

3.      Interest on Loan: Partners are entitled to interest @ 6 % per annum for the loan given by them to the firm, other than the capital. They are entitled to get this interest even if the firm in loss.

4.      Interest on Drawings: No interest can be charged if the deed is silent is charged in this respect.

5.      Remuneration to partners (salary): No partners are entitled to any salary or commission for participating in the business.

Partners Capital Accounts

All transactions relating to the partners are recorded in their respective capital accounts. There are 2 methods of maintaining capital accounts of partners.

1.      Fluctuating Capital Method

2.      Fixed Capital Method

Fluctuating Capital Method

Under this method only one capital account is maintained for each partner. All items affecting the partner’s accounts like interest on capital, drawings, interest on drawings, salary, commission, share of profit etc is recorded in this account.

Fixed Capital Method

Under this method 2 accounts are maintained for each partner.

1. Capital Account
2. Current Account

Capital account will remain fixed, unless some additional capital is introduced or some capital is withdrawn from the business. All other items such as interest on capital, drawings, interest on drawings, salary, commission, share of profit etc is recorded in the current accounts of partners. Here it should be noted that the current account balance will fluctuate year after year but the capital account will almost remain fixed.

Difference between Fluctuating capital method and fixed capital method

Sl.no	Fluctuating capital	Fixed capital
1	Only one a/c is maintained	Two a/c are maintained ie., Capital a/c and current a/c
2..	Fluctuates year after year	Capital a/c almost remains fixed, but current a/c will change
3.	All adjustments are done in this a/c. Ie., Interest on capital, interest on drawings, drawings, share of profit etc	All adjustments like Interest on capital, interest on drawings, drawings, share of profit etc are done in current account.
4.	Usually firm maintains their capital a/c under this method.	It should be specifically mentioned in the partnership deed to maintain this type of capital account

DISTRIBUTION OF PROFIT OR LOSS AMONG PARTNERS

The profit ascertained from profit and loss a/c is taken into another account named PROFIT AND APPROPRIATION ACCOUNT.

PROFIT AND APPROPRIATION ACCOUNT:

This is an extension of profit and loss account. All amounts due to partners and due from partners, transfer to reserve etc are recorded in this account. So PROFIT AND LOSS APPROPRIATION ACCOUNT is prepared to show how net profit is distributed among the partners. In this account net profit, interest on drawings etc is credited and salary, commission, interest on capital etc is debited. The balance available will be distributed among the partners in the agreed ratio.

Journal Entries:

1. For transfer of net profit:

                 

Profit and loss A/c                                          Dr

                        Profit and loss Appropriation A/c

For transfer of net loss:

Profit and loss Appropriation A/c                   Dr

                        Profit and loss A/c

      

2. Interest on capital:

Interest on capital A/c                                     Dr

            Partners Capital A/c

                        (Interest on capital provided in capital a/c)

                        Profit and loss Appropriation A/c                   Dr

                                    Interest on capital

                        (Interest transferred to Profit and loss Appropriation A/c)

3. Partners salary:

                 

                   Partner’s salary A/c                                        Dr

                              Partner’s capital

                  (Salary due to a partner)

                 

                  Profit and loss appropriation A/c                    Dr

                              Partner’s salary

                  (Salary transferred to profit and loss appropriation A/c)

4. Partners Commission:

Partners commission A/c                                 Dr

            Partner’s capital

(Commission due to a partner)

                        Profit and loss Appropriation A/c                   Dr

                                    Partners Commission

                        (Commission transferred to profit and loss appropriation A/c)

5. Interest on drawings:

                  Partner’s capital A/c                                        Dr

                              Interest on drawings

                  Interest on drawings A/c                                Dr

                              Profit and loss Appropriation A/c

Proforma of profit and loss account:

Profit and loss Appropriation A/c

Particulars	Amount	Particulars	Amount
Profit and Loss A/c(Net loss) Salary Commission Interest on capital Capital A/c(Profit)	Xxxx Xxxx Xxxx Xxxx xxxx	Profit and loss A/c (Net profit) Interest on drawings Capital accounts(Loss)	Xxxx Xxxx Xxxx
	xxxx		xxxxx

Calculation of Interest on Capital:

Interest on capital is generally calculated on the opening balance of partner’s capital accounts, if partnership deed provides for it. Calculation is done depending upon the amount and the duration (period).

For Eg:

Raju started business on 01/01/2008 with a capital of Rs.20000. If the accounts will be closed on 31/12/2008, then interest will be calculated for 1year.

Suppose he starts business only on 01/06/2008, then interest will be calculated for 6 months only, if the accounts are closed on 31/06/2008.

 Interest on Drawings:

Interest on drawings may be charged if partnership deed provides for it. The interest is calculated for the period from date of withdrawal to date of closing.

Guarantee of profit to a partner:

Sometimes a new partner or existing partner is guaranteed a minimum amount as share of profit by other partners. The guaranteed partner is entitled to receive the guaranteed share or actual share whichever is higher. But if in any year if the actual profit is less than the guaranteed amount then the other partners must compensate the shortage.