Study Material & Notes-Partnership Fundamentals – Sample page

Study Material & Notes for the Chapter 2

Partnership - Fundamentals

I.   PARTNERSHIP BASICS

A.  Partnership-Definition

          The Indian Partnership Act 1932, Section 4   

      “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.”

  • Relation between persons
  • Who have agreed (written/oral)
  • To share the profits (losses)…business with a motive to earn profits
  • Of a business…legal business (theft/cheating, scam)
  • Carried on by all or
  • Any of them acting for all
B.  Nature of Partnership
Table 2.1.B1.1
C. Nature of Partnership
  • To share profits in an agreed ratio
  • To take part in the conduct of the business
  • Right to be consulted
  • Right to inspect the books of accounts
  • Right to retire from the firm
  • To disallow admission of new partners (Imp).
  • Example 40 partners, want to admit new partner, one partner says No
D. Contents of Partnership Deed
  • Partnership agreement is the mutual understanding on which Partners decide to do a legal business to earn profits.
  • It may be oral or written.
  • The written, signed and registered version of the agreement is also called partnership deed
  • Deed is optional/non mandatory/non compulsory but recommended
  • Profit will be distributed/apportioned as per the agreement
  • Agreement once made needs to be honoured in all the conditions
  • The Partnership Deed may contains basically two types of matters:
  • Management related matters
  • Money related matters
Table 2.1.D1.1
     E. Provisions relevant for Accounting
Table 2.1.E1.1
F. Interest on Loan given by Partner
  • Is a charge against profit (accrued even if no Profits)
  • Interest rate is as provided in the Partnership deed
  • If no partnership deed or not provided in partnership deed – @6% p.a.
  • Interest = Amount of Loan X Rate of Interest X Time
  • Interest is credited to Partner Loan Account (and not to Partner Capital/Current A/C)
Journal Entry
Table 2.1.F1.1
G. Rent Payable to Partner
  • Is a charge against profit (accrued even if no Profits)
  • Charge since rent is paid for using property for business purpose
  • Rent is credited to Rent Payable Account (and not to Partner Capital/Current A/C) Capital/Current A/C)
Journal Entry
Table 2.1.G1
H. Remuneration to Partner – Salary/Commission
  • Payable only if provided in the partnership deed
  • If loss – it is not payable, If sufficient profits – Fully allowed
  • If insufficient profits – Profits are distributed in the ratio of Salary/Commission to be allowed

  • Salary/Commission is credited to Partner’s Capital/Current Account
Journal Entry
Table 2.1.H1

II.   INTEREST ON CAPITAL AND DRAWINGS

A. Interest on Capital
  • Interest is computed on time proportion basis, number of days capital deployed in Firm
  • Interest is computed only on Opening Capital, Additional Capital & drawings against capital
  • Interest is not computed on Profit/Loss
  • Interest on Capital= Amount of capital X Rate of Interest X Time
  • If only Closing Capital is given, interest cannot be computed on Closing capital
  • We need to find out Opening Capital and capital additions/deletions
  • If Opening Capital is not given prepare Capital A/C or use formula
    • Opening Capital=Closing Capital + Loss + Drawings- Profit – Additional Capital
  • Prepare Ledger Account as per the below format
Partner Capital Account
For the year ended …………………….
Table 2.2.A1,1
Journal Entry
Table 2.2.A2
B. Interest on Drawings
  • Product Method (unequal amount withdrawn at different dates)
  • Simple Method – Interest is computed for each drawing separately using simple interest formula:

Formula 2_1.3

  •  Product Method – Interest is computed for each drawing separately using simple interest formula:

Formula 2_2.2.2

             Product = Each Drawing x No. of Months till Financial year end

  • Average Period Method (Uniform drawings & uniform time internal)
  • Two prerequisites / condition of using this method
    • Uniform/Similar time intervals…monthly, quarterly, half-yearly etc.
    • Uniform/Similar amounts on each interval say 1000, 5000, 10000 etc.

Formula 2_3.1 Formula 2_4.1

Important to Note:
  • If date of withdrawal is not given, the interest on total drawings for the year is calculated for six months on the average basis
  • When rate of interest is given without the word ‘per annum’ interest is charged without considering the time factor.
Journal Entry
Table 2.2.B1

III. PROFIT & LOSS APPROPRITATION ACCOUNT

Table 2.3.1
Profit & Loss Account
Table 2.3.2.1
Profit & Loss Appropriation Account
Table 2.3.3.1
Appropriation > Available Profits

Profit is distributed in the ratio of appropriations to be made, determined as follows:

  • Determine the amount payable as appropriation to each partner as per the Partnership deed (e.g. Salary, commission, interest on capital)
  • Total the amount of appropriations for each partner separately
  • The ratio of total appropriations amongst partners becomes the ratio for distribution of available profits among the partners

IV. FIXED AND FLUCTUATING CAPITAL

Capital Accounts
A. Fixed Capital
  • Partners’ Capital Accounts
  • Partners’ Current Accounts
B. Fluctuating Capital
  • Partners’ Capital Accounts
A. Fixed Capital Ledgers
Partners’ Capital Accounts
Table 2.4.A1.1
Partners’ Current Accounts
Table 2.4.A2.1
B. Fluctuating Capital Ledgers
Partners’ Capital Accounts
Table 2.4.B1.1
C. Difference between Fixed & Fluctuating Capital Methods
Table 2.4.C1

In the absence of any information, always prepare fluctuating A/C

V. PAST ADJUSTMENT

Table 2.5.1
Method-1 When net impact is routed through partners accounts Process Steps
  1. Prepare an analytical table in the following format
Table 2.5.2.1
  1. Benefits to partners are mentioned on credit side of respective Partner column and on the debit side of firm and vice versa
  2. Total of columns designated to firm will give Firm’s net profit/loss
  3. Distribute the profit/loss in profit sharing ratio
  4. Sum partners columns and compute difference of total debit and total credit
  5. If net difference is debit, that partner’s capital account will be debited and vice versa 
Journal Entry
Table 2.5.3
Method-2 Adjustment entry for each adjustment
Table 2.5.4

VI. GUARANTEE OF PROFITS

A. Definitions
Table 2.6.A1
B. Type of Guarantees
Table 2.6.B1
C. Order of applying Guarantees

In case in a question two or more Guarantees are to be applied then this order is to be followed

  1. By Partner To Firm
  2. By Firm to Partner
  3. By Partner to Another Partner(s)

When beneficiary’s actual share of profit is more than the guaranteed amount, then his share of profit is given to him, not guaranteed amount of profit.  

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