ACCOUNTING FOR PARTNERSHIP FIRMS

CHAPTER – 1 FUNDAMENTALS
INTRODUCTION:
A business can be organized in the form of a Sole Proprietary Concern, a Partnership
Firm or a Joint Stock Company. The basic accounting procedure is same in all the above said
business organizations. There are certain limitations for a sole proprietorship. In a sole trading
concern only one man invests capital, undertakes risks involved in the business and controls the
whole affairs of the business. But one man’s capital, skill, controlling, and risk taking capacity are
generally limited. Therefore some persons may combine and enter in to an agreement to form a
partnership. There are certain special features in the accounts of a Partnership Firms.
1. Distribution of profits.
2. Maintenance of separate capital accounts.
3. Adjustment for wrong appropriation of profit in the past.
4. Reconstitution of Partnership firms.
5. Dissolution of Partnership firms.
DEFINITION:
Section 4 of the Indian Partnership Act, 1932, defines partnership as follows:
“Partnership is a relation between persons who have agreed to share the profits of a business
carried on by all or any of them acting for all.”
Main features or essential elements or characteristics of a partnership firm.
1. No. of persons:
There must be at least two persons to form a partnership. Partnership Act does not specify
the maximum number of persons, but Section 464 of the Indian Companies Act, 2013, restricts the
number of partners to 50. [Rule 10 of the Companies (Miscellaneous) Rules, 2014]
2. Agreement:
Partnership is the result of an agreement. It must come in to existence by an agreement
and not by the operation of law. Such an agreement can be either oral or in writing. The
agreement forms the basis of mutual rights and duties of partners.
3. Sharing of Profits:
The agreement between the partners must be aimed at sharing the profits of the business.
Any agreement for charitable purpose cannot be a partnership. Sharing of profit implies sharing of
losses also.
4. Business:
A partnership is formed to do a lawful business. Business includes trade, vocation and
profession.
5. Relationship of Principal and agent:
Each partner is agent as well as a partner of firm. An agent, because he can bind the other
partners by his acts and a principal, because he himself can be bound by the acts of the other
partners.
6. Unlimited liability:
The liability of partners of a firm is unlimited. This means that there is no distinction
between partner’s private properties and business properties as far as the firm’s creditors are
concerned.

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7. Registration:
The registration of partnership business is not compulsory as per law. Registration is in the
interest of the firm; so the firm preferably be registered.
8. Business carried on by all or any of them acting for all:
It means that each partner can participate in the conduct of business and each partner is
bound by the acts of other partners in respect to the business of the firm.
RIGHTS OF A PARTNER:
1. Every partner has the right to share the profits or losses with other partners in the agreed
ratio.
2. Every partner has the right to take part in the conduct of the business.
3. Every partner has the right to be consulted in the matters related to a partnership business.
4. Every partner has the right to inspect and have a copy of the books of accounts.
5. Every partner has the right to disallow the admission of a new partner.
6. Every partner is the joint owner of the partnership property.
7. If a partner has given loan to the firm, he has the right to receive interest at agreed rate. If
the rate of interest is not agreed, it is paid @6% p.a.
8. If a partner incurs expenses or makes payment on behalf of the firm, he has a right to be
indemnified by the firm.
9. Every partner has a right to retire from the firm after giving a proper notice.
PARTNERSHIP DEED:
Since partnership is the outcome of an agreement, it is essential that there must be some
terms and conditions agreed upon by all the partners. Such terms and conditions may be either
oral or written. The law does not make it compulsory to have a written agreement. However, in
order to avoid all misunderstandings and disputes, it is always the best course to have a written
agreement duly signed and registered under the Act. Such a written document which contains the
terms of agreement is called ‘Partnership Deed’. It is also called ‘Articles of Partnership’. The
partnership deed contains the following points:
1. The name and address of the firm.
2. Names and addresses of the partners.
3. The type and nature of the business, the firm proposes to do.
4. Amount of capital to be contributed by each partner and whether the capital accounts will
be Fixed or Fluctuating.
5. Interest on Capital: Whether interest is to be allowed on capitals. If so, rate of interest.
6. Drawings: how much amount the partners are entitled to withdraw for personal use.
7. Interest on drawings: whether interest will be charged on partner’s drawings. If so, rate of
interest.
8. Profit sharing ratio: the ratio in which profits or losses are to be divided among the
partners.
9. Salary: whether any partner will be paid salary for the work done by him.
10. Goodwill: Method of valuation of goodwill in case of admission or retirement of a partner.
11. Accounting period of the firm: The period after which the final accounts of the firm are to
be prepared. Whether yearly or half-yearly and the date on which accounts are to be closed
every year.
12. Method of recording of firm’s accounts and the safe custody of the books of accounts and
other documents of the firm.

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 13. Auditing: Whether the firm’s books will be audited or not. If so, the mode of auditor’s
appointment.
14. Date of commencement of partnership.
15. Duration of partnership: the period for which partnership has been established and the
mode of dissolution of partnership.
16. Use of the decision of Garner Vs Murray: Whether decision in the case of Garner Vs Murray
is to apply in case of insolvency of a partner.
17. Bank accounts: Whether the account in the bank will be opened in Firm’s name or in some
partner’s name. Who will have the right to sign in the cheques.
18. Rules to be followed in case of admission of a partner.
19. Rules to be followed while settling the accounts on retirement: The manner in which the
amount due on the retirement or death of a partner will be calculated and the manner in
which it will be paid.
20. Settlement of disputes: in case of dispute among the partners, how the dispute will be
solved. Whether arbitrator will be appointed.
RULES APPLICABLE IN THE ABSENCE OF PARTNESHIP DEED:
In the absence of partnership deed or if the partnership deed is silent on a certain
point, the following provisions of Partnership Act, 1932 will be applicable:
1. Profit Sharing Ratio: Profits and losses of the firm are to be shared equally irrespective of
their capital contribution.
2. Interest on Capital: No interest on capital shall be allowed to the partners. If there is a
provision for the interest on capitals in the Partnership Deed, it will be allowed only when
there is a profit.
3. Interest on Drawings: No interest is to be charged on drawings.
4. Salary to a partner: No partner is entitled to a salary or commission for taking part in
running a firm’s business.
5. Interest on Loan: Interest @ 6% per annum is to be allowed on a partner’s loan to the firm.
Such interest shall be paid even if there are losses to the firm.
6. Admission of a partner: without the consent of all the existing partners no new partner can
be admitted to the firm.
7. Partner’s capital accounts shall be fluctuating.
8. Each partner can participate in the conduct of the business.
9. Each partner can inspect the books of the firm and can take a copy of the same.
It should be remembered that partners may change any of the above
provision by coming to a common agreement.
RECORDING OF PARTNERSHIP TRANSACTIONS:
Transactions of the partnership firm are recorded according to
principles of Double Entry System, and as in the case of a Sole Proprietary Concern, a Partnership
Firm will also prepare Trading Account, Profit and 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 profit of the partnership firm are divided among the partners. Usually, for this purpose, the
profits as per Profit and Loss Account is transferred to a newly opened account, namely ‘Profit and
Loss Appropriation Account’.

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 1. PROFIT AND LOSS APPROPRIATION ACCOUNT:
Profit and Loss Appropriation Account is an extension to Profit and Loss
Account and is prepared to show, how net profit has been distributed among the partners. This
account is credited with net profit and interest on drawings and debited with interest on capital,
salary and commission to partners, transfer to reserve etc. These items are treated separately
without mixing up with General Trading Account. Profit calculated after taking into consideration,
all these items, is called “Divisible Profit”. The balance in Profit and Loss Appropriation Account is
divided among partners in their profit sharing ratio. Each partner’s share of profit is credited to his
Capital Accounts or Current Accounts as the case may be. If there is a loss, the share of the same is
debited either in Capital or Current Account.
Profit and Loss Appropriation Account of……………… for the year ended ……………………….
Dr. Cr.
Particulars Amount Particulars Amount
To, Profit and Loss A/c* By, Profit and Loss A/c
(Loss transferred from P&L (Profit transferred from P&L xxxxxxxx
A/c) xxxxxxxx A/c)
To, Partner’s salary By Interest on drawings
X: ………………… X: …………………
Y: ………………… xxxxxxxx Y: ………………… xxxxxxxx
To, Interest on capital By Partners Capital/Current
X: ………………… A/c
Y: ………………… xxxxxxxx X: …………………
To, Partner’s Commission xxxxxxxx Y: ………………… xxxxxxxx
X: …………………
Y: …………………
To, Reserve A/c xxxxxxxx
To, Partners Capital/Current
A/c
X: …………………
Y: ………………… xxxxxxxx
xxxxxxxx xxxxxxxx
*Either of two will exist.
Note: always remember that amount payable to partner (except interest on loan and Rent) such as
interest on capital (if not specified to be charge), salary, commission etc. are appropriation of
profit.
JOURNAL ENTRIES FOR THE PREPARATION OF PROFIT AND LOSS APPROPRIATION ACCOUNT:

1. To transfer the Net Profit:

Profit and Loss A/c Dr.
To Profit and Loss Appropriation A/c
To transfer Net Loss:
Profit and Loss Appropriation A/c Dr.
To Profit and Loss A/c

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 2. To Interest on Capital:
(a) Interest on Capital A/c Dr.
To Partner’s Capital/Current A/c
(b) Profit and Loss Appropriation A/c Dr.
To Interest on Capital A/c
3. For Partners Salary:
(a) Partner’s Salaries A/c Dr.
To Partner’s Capital/Current A/c
(b) Profit and Loss Appropriation A/c Dr.
To Partner’s Salaries A/c
4. For Partners Commission:
(a) Partner’s Commission A/c Dr.
To Partner’s Capital/Current A/c
(b) Profit and Loss Appropriation A/c Dr.
To Partner’s Commission A/c
5. For Interest on Drawings:
(a) Partner’s Capital/Current A/c Dr.
To Interest on Drawings A/c
(b) Interest on Drawings A/c Dr.
To Profit and Loss Appropriation A/c
6. For transfer to Reserve
Profit and Loss Appropriation A/c Dr.
To Reserve A/c
7. For transfer of balance in P&L Appropriation A/c (Being profit):-
P&L Appropriation A/c Dr.
To Partner’s Capital/Current A/c
2. CAPITAL ACCOUNTS OF THE PARTNERS:
The transactions relating to the sole proprietor are recorded in his
capital account. Similarly, in case of partnership firm, the transactions relating to the
partners should also be recorded in their respective Capital Accounts. Normally, each
partner’s capital accounts are prepared separately but these accounts can also be prepared
in a tabular form.
Capital Accounts of the partners may be maintained in any one of the
following methods:
(A) Fixed Capital Accounts:-
Under this system the original capitals invested by partners remain constant,
unless additional capital is introduced by an agreement or withdrawal is made from the existing
capital. In other words, capitals of the partners are not allowed to change during the life-time of
business except in extra-ordinary circumstances. When Fixed capital method is adopted, all entries
relating to drawings, interest on capitals, interest on drawings, salary to a partner, share of profit
or loss etc., are made in a newly-opened account for each partner. This account is called Current
Account. Thus, the following two accounts will be prepared separately when the capitals are fixed:

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Dr. PARTNER’S CAPITAL ACCOUNT Cr.
Date Particulars A B Date Particulars A B
To Cash /Bank A/c xxxxx xxxxx By Balance b/d xxxxx xxxxx
(Permanent (Opening Balance)
withdrawal of By Cash/Bank A/c
Capital) (Additional Capital) xxxxx xxxxx
To Balance c/d xxxxx xxxxx
(Closing Balnce)
xxxxx xxxxx xxxxx xxxxx

Dr. PARTNER’S CURRENT ACCOUNT Cr.

Date Particulars A B Date Particulars A B
To Balance b/d xxxxx xxxxx By Balance b/d xxxxx xxxxx
(In case of debit (In case of credit
opening balance) opening balance)
To Drawings A/c xxxxx xxxxx By Interest on xxxxx xxxxx
To Interest on capital A/c
drawings A/c xxxxx xxxxx By Salary A/c xxxxx xxxxx
To P&L A/c By Commission A/c xxxxx xxxxx
(Share of loss, in By P&L
case of loss) xxxxx xxxxx Appropriation A/c xxxxx xxxxx
To Balance c/d xxxxx xxxxx (Share of Profit)
xxxxx xxxxx xxxxx xxxxx
(B) Fluctuating Capital Accounts:-
When the capitals need not be fixed, the balances of capital accounts go on
changing from time to time. The reason is that no separate current accounts are maintained, but
all the entries relating to drawings, interest on capitals, interest on drawings, salary to a partner,
share of profit or loss etc., are recorded in the Capital Account itself. In the absence of any
instruction, the capital accounts should be prepared under Fluctuating Capital Method.
Dr. PARTNER’S CAPITAL ACCOUNT Cr.
Date Particulars A B Date Particulars A B
To Drawings A/c Xxxxx Xxxxx By Balance b/d xxxxx xxxxx
(Drawings against (Opening balance)
profit) By Cash / Bank A/c
To Cash / Bank A/c xxxxx xxxxx (Additional Capital) xxxxx xxxxx
(Drawings against By Interest on
Capital) capital A/c xxxxx xxxxx
To Interest on By Salary A/c xxxxx xxxxx
drawings A/c xxxxxx xxxxxx By Commission A/c xxxxx xxxxx
To P&L A/c By P&L
(Share of loss, in Appropriation A/c
case of loss) xxxxx xxxxx (Share of Profit in xxxxxx xxxxx
To Balance c/d xxxxx xxxxxx case of profit)
xxxxx xxxxx xxxxx xxxxx

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DISTINCTION BETWEEN PROFIT AND LOSS ACCOUNT AND PROFIT AND LOSS
APPROPRIATION ACCOUNT:-
Sl.No PROFIT AND LOSS ACCOUNT Sl.No PROFIT AND LOSS APPROPRIATION ACCOUNT
1. It is prepared after Trading Account and 1. It is prepared after Profit and Loss
hence starts with the Gross profit Account and hence starts with the net
disclosed by Trading Account. profit disclosed by Profit and Loss
Account.
2. It is prepared to ascertain Net profit or 2. It is prepared to distribute the net
Net loss. profit of the year among the partners.
3. This account has neither opening balance 3. This account may have opening as well
nor closing balance. as closing balances.
4. Expenses debited to this account are 4. Items debited to this account are
charge against profits. appropriation of profits.
5. This account is not prepared on the basis 5. This account is prepared on the basis of
of partnership agreement, except for partnership agreement.
interest on loan from partners.
6. Matching Principle (Matching of revenue 6. Matching Principle is not followed while
against expenses) is followed while preparing this account.
preparing this account.

DISTINCTION BETWEEN CHARGE AGAINST PROFIT AND APPROPRIATION OUT OF PROFIT:-

Sl.No BASIS CHARGE AGAINST PROFIT APPROPRIATION OUT OF PROFIT

1. Nature It indicates expenses to be deducted It indicates distribution of net profit to
from profits while calculating net various heads.
profit or loss.
2. Recording It is debited to Profit and Loss A/c. It is debited to Profit and Loss
Appropriation A/c.
3. Necessary It is necessary to make charges Appropriations are made only when
or not against profits even if there is loss. there is profit.
4. Example Interest on partner’s loan and rent Interest on Capital, Partner’s salary etc.
paid to a partner.

DISTINCTION BETWEEN FIXED CAPITAL ACCOUNTS AND FLUCTUATING CAPITAL ACCOUNTS:

Sl.No BASIS FIXED CAPITAL ACCOUNTS FLUCTUATING CAPITAL ACCOUNTS

1. Change in When the Capitals are fixed, the When the capitals are fluctuating, the
Capital balances in capital accounts usually balances in capital Accounts go on
remain unchanged during the life changing from time to time.
time of the business, except when
capital is introduced or withdrawn
permanently.
2. Number of When capitals are fixed, each When the capitals are fluctuating, each
accounts partner has two accounts, namely, partner has only one account, namely,
Capital Account and a Current Capital Account.

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 Account.
3. Recording When the capitals are fixed, In this case all transactions relating to
of transactions relating to drawings, partners are made directly in the capital
Transactions interest on capital, interest on accounts itself.
drawings, salary, share of profit or
loss etc., are not made in Capital
accounts but are entered in
separate Current Accounts.
4. Negative Fixed capital account can never Fluctuating capital account can show a
balance show a negative balance. Always negative balance. Means may show a
shows Credit balance. debit balance.

DISTINCTION BETWEEN DRAWINGS AGAINST PROFIT AND DRAWINGS AGAINST CAPITAL:-

Sl.No DRAWINGS AGAINST PROFIT DRAWINGS AGAINST CAPITAL

1. Drawings against profit means drawings Drawings against capital means drawings made
made out of profits earned by the firm in excess of profits.
during the year.
2. Such drawings do not reduce the capital of Such drawings reduce the capital of the firm.
the firm.
3. It is not considered while calculating It is deducted from capital while calculating
interest on capital. interest on capital.

Limited Liability Partnership:- (LLP)

Limited Liability partnership (LLP) is a business vehicle, which came in to existence
with the enactment of Limited Liability Partnership Act, 2008. The compliance of LLP is under the
Registrar of Companies. The main features of LLP are:-
1. Name of the LLP is approved by the Registrar of Companies.
2. LLP comes in to existence by entering in to an agreement by the partners which defines their
respective duties and responsibilities and also their profit-sharing ratio.
The agreement is then filed with Registrar of Companies.
3. Unlike in the case of partnership, liability of the partners is limited to the extent of their
capital.
4. At least two persons should be appointed as ‘Designated Persons’, one of whom must be a
partner.
5. LLP must file a ‘Solvency Certificate’ with the Registrar of Companies every year.
6. An LLP is a body corporate formed and incorporated under this Act.
7. It is legal entity separate from that of its partners.
8. An LLP shall have perpetual succession.
9. Any change in the partners of an LLP shall not affect the existence, rights or liabilities of the
LLP.
10. Indian Partnership Act, 1932 shall not apply to an LLP.

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DISTINCTION BETWEEN AN ORDINARY PARTNERSHIP FIRM AND AN LLP
No. Basis of
Partnerships LLPs
distinction
1. Applicable Law Indian Partnership Act,1932. The Limited Liability Partnership
Act, 2008.
2. Registration Optional. Compulsory with Registrar of
Companies.
3. Creation Created by an agreement. Created by Law.
4. Body corporate Body corporate cannot become a Body corporate can become its
partner. partner.
5. Separate legal It is not a separate legal entity. It is a separate legal entity.
entity
6. Perpetual Partnerships do not have perpetual It has perpetual succession and
succession succession. individual partners may come and
go.
7. Number of Minimum 2 and maximum 50. Minimum 2 but no maximum limit.
partners
8. Ownership of Firm cannot own any asset. The LLP as an independent entity
assets The partners own the assets of the can own assets.
firm.
9. Liability Unlimited. Limited to the extent of their
contribution towards LLP.

SOME IMPORTANT NOTES:-

1. MANAGER’S COMMISSION:-
Sometimes manager is to be allowed a certain percentage of net profit
as his commission. In the absence of information, manager’s commission will be calculated on
profit before any adjustment is made according to partnership deed, i.e., before adjustments
in respect of partner’s salary, interest on capital etc. Manager’s commission is a charge against
profit and not an appropriation of profit. Hence it is debited to Profit and Loss A/c and not in
the Profit and Loss Appropriation A/c.
2. INTEREST ON PARTNER’S LOAN TO THE FIRM:-
Rate of Interest:- If a partner has given loan to the firm, he is entitled to receive interest on
such loan at an agreed rate of interest. However, if there is no agreement as to the rate of
interest, he is entitled to receive interest on loan @6% p.a.
Nature of interest:- Interest on partner’s loan is a charge against profit and hence, such
interest is allowed whether there are profits or not.
Accounting treatment:- It is treated as a charge against profit and hence interest on
partner’s loan is debited to Profit & Loss A/c and not to P&L Appropriation A/c.
It must be noted that interest on partner’s loan is not credited to Partner’s
Capital or Current A/c. It is credited to his Loan A/c.
The following entries are passed for interest on partner’s loan:
(a) For providing Interest on Partner’s loan:
Interest on Partner’s Loan A/c Dr.
To Partner’s Loan A/c
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 (b) For closing the Interest on Partner’s Loan A/c:
Profit and Loss A/c Dr.
To Interest on Partner’s Loan A/c
3. RENT PAID TO A PARTNER:-
Like interest on partner’s loan, rent paid to partner is also treated as a
charge against profit and not an appropriation out of profit and hence it should be debited to
Profit and Loss A/c and not to P&L Appropriation A/c and Credited to Partner’s Current A/c in
case of Fixed capital system or to Partner’s Capital A/c when Capitals are fluctuating.
Rent paid to a partner is an expense incurred for using the property.
Hence, it is a charge against profit and will be debited to P&L A/c, even if the firm incurs a loss.

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