Accounting for partnership Firms

Chapter 1
Chapter overview
1.BASIC 2.PARTNERSHIP DEED 3.SPECIAL ASPECT

1. Meaning. 1. Meaning of Partnership Deed 1. Interest on Partners Loan

2. Features and characteristics 2. Content of Partnership deed 2. P&L Appropriation Accounts
3. Rights of partner 3. Importance of Partnership 3. Partners capital Accounts
Deed under fixed and fluctuating
4. Rule Applicable in the methods
Absence of Partnership Deed 4. Salary or Commission to
Partners
5. Interest on partners
Drawings
6. Interest on partners capitals
7. Past Adjustments
8. Guarantee pf profit

1.Basic

1.1 Meaning of Partnership

Partnership is an association between two and more persons who agree to do business and share its profits
and losses. The partners act both as gents and principals of the firm.
Definition of Partnership : Section 4 of the Indian Partnership Act, 1932, defines partnership as follow :
“ Partnership is the relation between persons who have agreed to share the profits of a business carried on by
all any of them acting for all “

1.2 Features and characteristics of partnership

Two or more  Atleast two person to form a partnership firm.

persons  All partner must be competent to contract.
 Maximum 50 member in a partnership firm.

Agreement  Partnership is the result of agreement.

 Either oral or written.
 Written agreement among partners is called Partnership deed.
Lawful Business  It form for Lawful Purpose or Business must be legal.
Profit motive  It can be formed for the purpose of carrying on some Business.
 With the intention of earning of profits .

Sharing of profits  Agreement between the partner must be aimed at sharing the profit of the
business.
 But it is not necessary that all partners should share the losses also.
 It may be agree between the partner that one or more of them shall not be
liable for losses.
Business carried  It means that each partner can participate in the conduct of business and
on by all or any of  Each partner is bound by the acts of other partner in respect to the business of
them acting for all the firm.

1.3 Right of Partners

1 Every partner has the right to share profits or losses with other partner in the agree ratio.
2 Every partner has the right to take part in the conduct of business.
3 Every partner has the right to inspect and have a copy of the books of account.
4 Every partner has right to disallow the admission of a new partner.
5 Every partner is the joint owner of the partnership property.
6 If partner gives loan to the firm, he has a right to receive interest at the agreed rate. If the rate of
interest is not agree, it is paid @6% rate.
7 Every partner has a right to retire from the firm after giving a proper notice.

2.Partnership Deed

Meaning  Partnership comes in existence by oral or written agreement

 To avoid any disputes it is better to have written agreement.
 This written agreement is knows as Partnership Deed.
Content of 1. Name and address of the firm
Partnership 2. Name and address of the Partners
deed 3. Type and Nature of business of the firm purpose to do
4. Amount of capital to be contributed by each partner and whether the capital
account will be fixed or fluctuating

5. Interest Whether interest is to be allowed on capitals. if so, rate of interest

on capital

6. Drawings how much amount the partner are entitled to withdraw from
personal accounts
7. Interest Whether interest will be charged on partners drawings. If so rate of
on interest
drawing
8. Profit Ratio in which profit or losses are to be divided among the partner
 sharing
ratio
9. Salary Whether any partner will be paid salary for the work done by him. If
so, how much?
10. Other  Method of goodwill in case of admission and retirement of
matters partner
 Accounting period of the firm
 Date of commencement of partnership
 Duration of partnership
 Settlement disputes whether the arbitrator will be appointed
Important of Law does not make it mandatory for every firm to make the partnership deed, it is desirable to
partnership have it due to the following Reasons:
Deed
a) It regulates the right, duties and Liabilities of each partner
b) Help to avoids any misunderstanding among the partner
c) Any dispute amongst the partners may be settled easily as the partnership deed
may be readily referred to.
Rule Applicable In the absence of a partnership deed or oral Agreement, or if the partnership deed is salient on
in the Absence certain point, the following provision of partnership of Partnership Act 1932 will be applicable:
of Partnership
Deed Profit sharing ratio Shared equally among partner irrespective of their capital
contribution
Interest on capital No interest on capital shall allowed,
If provision for IOC in partnership deed it will allowed only when
there is profit

Interest on drawing No interest is to be charged

Salary to a partner No partner is entitled to any salary or commission for taking part
in running the firms business

Interest on loan Rate @6% p.a is allowed whether the profit or not

Admission of a new Without the consent of all existing partners no new partner can
Partner be admitted to the firm

3.Special Aspect

3.1 Interest on Partner Loan

Meaning If any partner gives loans to the firm, he is entitled to receives interest at the agreed
rate of interest and specified in the partnership deed. Or
In case of absence of partnership deed rate of interest is 6% p.a on loan.

Nature of interest It is charged against profit, it means interest is allowed whether there is profit or not.
Accounting Interest on partner loan is Debited to profit & loss A/c and not to profit & loss
treatment Appropriation A/c because interest on partner loan is charged against the profit.

Journal entries For providing interest Interest on partners loan A/c…………………………Dr

on partner loan To Partner loan A/c
Or
To interest accrued A/c
For closing the Profit & Loss A/c ……………………………………………..Dr
interest on partner To interest on partner loan A/c
loan account
Note :- charge Against Profit v/s Appropriation of profit

Charge Against Profit Appropriation of profit

It deduction from revenue to determine the net It is distribution of net profit for the year among
profit and loss for the year the partner
In the event of loss also expenses that are a charge Appropriation is made when there is a profit
don profit are accounted
It debit to the profit and loss A/c It is debit to profit and loss appropriation A/c
It is done before appropriation of Profit It is done after accounting of all charge

3.2 Profit and Loss Appropriation Account

Meaning  Profit and Loss Appropriation Account is merely an extension of the Profit
and Loss Account of the firm
 It shows how the profits are appropriated or distributed among the
partners.
 All adjustments in respect of partner’s salary, partner’s commission,
interest on capital, interest on drawings, etc. are made through this
account.
 It starts with the net profit/net loss as per Profit and Loss Account.
Format of Profit and
Loss Appropriation Particular DR Particular CR
Accounts To salaries of Partners xxx By Profit and loss A/c xxx
(t/f from P&L A/c)
To commission to partners xxx By interest on drawing xxx

To interest on partners capital xxx

To Reserve A/c xxx

To Profit t/f to partners capital xxx

or current A/c

Journal entries Profit t/f from P&L A/c Profit & Loss A/c…………………………Dr
 to P&L Appropriation To Profit & Loss appropriation A/c

Loss t/f from P&L A/c Profit & Loss appropriation A/c .…. Dr
to P&L Appropriation To Profit & Loss A/c

Interest on capital 1) On allowing Interest on capital :

Interest on capital A/c ……………. DR
To Partners capital A/c

2) On closure of interest on capital A/c :

P&L Appropriation A/c ………………… DR
To Interest on capital A/c

Interest on Drawing 1) on charging interest on drawing :

Partner capital A/c …………………….. DR
To Interest on Drawing A/c

2) on closure of interest on drawin:

Interest on drawing A/c ……………… DR
To P&L Appropriation A/c

Salary or Commission 1) on allowing salary or commission to a partner:

payable to a partner
Partners salary A/c ……………………….. DR
Partner Commission A/c ….……………. DR
To Partners capital A/c

2) on closure of salary or commission A/c

P&L Appropriation A/c ………………….. DR
To Partner salary A/c
To Partner commission A/c

T/F a part of Profit to P&L Appropriation A/c ……………………………. DR

Reserve To Reserve A/c

T/f of credit balances P&L appropriation A/c ……………………………. DR

of P&L appropriation To Partners capital or Current A/c

Examples 1
A and B are the partner in a firm sharing profits and losses in ratio 3:2. Profit made by firm during the year i
Rs.1,37,000. Partners entitled to interest on capital @6 % p.a. and B is to be allowed a salary of Rs.5,000 per
month. Capital of A and B Rs.3,00,000 and Rs.1,50,000 respectively. Prepared profit and loss appropriation
A/c.
Solution:
Profit and Loss Appropriation Account of the firm
for the year ended ….
Particular Dr Particular Cr
To salary By net profit as per P&L A/c 1,37,000
A Nil
B (5,000 X 12 Month) 60,000
To interest on capital
A (3,00,000 X 6%) 18,000
B (1,50,000 X 6%) 9,000
To profit t/f to capital Account
A 30,000
B 20,000
(refer working note)
1,37,000 1,37,000

Working note:

Total net profit 1,37,000

Less:
Salary (60,000)
Interest on capital (18,000 + 9,000) (27,000)

Profit available to partners 50,000

50,000 distributed among A&B in ratio 3:2

A 50,000 X 3/5 = 30,000
B 50,000 X 2/5 = 20,000