Accounting for Partnership Firms
Definition of Partnership
According to Section 4 of Partnership Act 1932 “ Partnership is relation between the persons who have agreed to share the profits of a business carried on by all or any of them acting for all”.
Essential Features of Partnership
(a) There must be two or more persons
(b) There must be Partnership agreement among partners
(c) There must be legal and lawful business
(d) There must be sharing of profits among partners
(e) There must be Principal-Agent relationship among partners.
Definition of Partnership Deed
Partnership deed is a document, which contains all terms and conditions of Partnership as agreed among partners.
Necessity of Partnership Deed
It is always considered better to make partnership agreement in writing as in case of disputes among partners it can be referred and used as evidence in the court of law.
Main contents of Partnership Deed from accounting point of view
(i) The ratio in which profit and losses will be shared by the partners.
(ii) The rate of interest on capital to be provided to the partners.
(iii) The rate of interest on drawings, if it is to be charged from partners on the drawings.
(iv) Rate of interest on loans and advances by partners to the firm.
(v) The amount of salary or commission payable to partner for any extra work done by him.
Main Provisions of Partnership Act in the absence of Partnership Deed
Main provisions of Partnership Act in the absence of partnership deed or when partnership deed is silent on certain matters:
(1) Profit and losses are shared equally among partners irrespective of their capital contributions
(2) No partner is entitled for interest on his capital contribution. If partnership deed provides for interest on capital, it is provided when there are profits. In case of losses no interest on capital is provided.
(3) Interest on partners’ drawing is not charged.
(4) No partner is entitled for any salary or remuneration.
(5) Interest on partners’ loan is provided @6% p.a.
Fixed Capital Method Vs Fluctuating Capital Method
Basis of Distinction Fixed Capital Method Fluctuating Capital Method
Number of Accounts In fixed capital method, two accounts are maintained for each partner i.e., capital accounts and current accounts In fluctuating capital method one account is maintained for each partners i.e., Capital account.
Change in Capital Account Balances In fixed capital method balances of partners capitals remain unchanged except under some special circumstances In fluctuating capital method balances of partners capitals fluctuate frequently.
Recording of Transactions In fixed capital method adjustments regarding interest on capital, interest on drawings, partners salaries and profits etc. are recorded in partners’ current accounts In fluctuating capital method all these adjustments are recorded in partners’ capital accounts.
Debit or Credit Balance In fixed capital method capital accounts never show negative or debit balance In fluctuating capital method capital accounts may show negative or debit balance.
Format of Partners’ Capital Accounts under Fluctuating Capital Method
Dr CAPITAL ACCOUNTS Cr
A B A B
Date Particulars Amt Amt. Date Particulars Amt Amt
To Drawings
To Cash/Bank A/c (withdrawal of excess capital)
To Interest on Drawings
To P & L Appropriation
Account (Loss transferred)
To Balance c/d
By Balance b/d or
(Opening balances)
By Cash/Bank A/c
(Capital introduced)
By Cash or Bank A/c
(additional capital introduced)
By Interest on Capital
By Salary/Comm. A /c
By P &L Appropriation A/c
(Profit transferred)
By Balance c/d
Format of Partners’ Capital Accounts and Current Accounts under Fixed Capital Method.
Dr CAPITAL ACCOUNTS Cr
A B A B
Date Particulars Amt. Amt. Date Particulars Amt. Amt.
To Cash or Bank A/c
(Withdrawal of Capital)
To Balance c/d
By Balance b/d or
(Opening balances)
By Cash/Bank A/c
(capital introduced)
By Cash/Bank A/c
(Fresh Capital introduced)
Dr CURRENT ACCOUNTS Cr
A B A B
Date Particulars Amt. Amt. Date Particulars Amt. Amt.
To Drawing A/c
To Int. on Drawings A/c
To P & L A/c (share of loss in case of loss)
To Balance c/d
By Balance b/d
By Int. on Capital A/c
By Salary A/c
By Commission A/c
By P & L App. A/c
(Share of profit in case of profit)
Meaning of Profit & Loss Appropriation Account
Profit & Loss Appropriation A/c is an extension to Profit & Loss A/c which is prepared to distribute business profits among partners.
Journal Entries for distribution of business profits
1. Transfer of profit:
Rs. Rs.
Profit and Loss A/c Dr.
To Profit and Loss Appropriation A/c
(Being Net Profit from Profit and Loss Account transferred to Profit and Loss Appropriation A/c)
2. For Interest on Capital:
Rs. Rs.
(i) Interest on Capital A/c Dr.
To Partners Capital/Current A/cs
(Being interest on Capital allowed to partners)
(ii) Profit and Loss Appropriation Account Dr.
To Interest on Capital Account
(Being interest on capital transferred to Profit and Loss App. A/c.)
3. For Partner’s Salaries or Commission
Rs. Rs.
(i) Salary or Commission A/c Dr.
To Partners Capital/Current A/cs
(Being salary or commission allowed to partner’s)
(ii) Profit and Loss Appropriation A/c Dr.
To Salary or Commission A/c
(Being interest on capital transferred to Profit and Loss App. A/c.)
4. For Interest on Drawings
Rs. Rs.
(i) Partners Capital/Current A/cs Dr.
To Interest on Drawings A/c
(Being interest on drawings charged from partners.)
(ii) Interest on Drawing A/c Dr.
To Profit and Loss Appropriation A/c
(Being interest drawings transferred to Profit and Loss App. A/c.)
5. For transfer to General Reserve
Profit and Loss Appropriation A/c Dr.
To General Reserve A/c
(Being interest transferred to General Reserve.)
6. Transfer of Remaining Profit to Partners
Profit and Loss Appropriation A/c Dr.
To Partners Capital/Current A/cs
(Being profit transferred to partner’s accounts in agreed ratio.)
Format of Profit & Loss Appropriation Account
Profit & Loss Appropriation Account .
Dr For the year ended.......................................... Cr
Particulars Amount Particulars Amount
To Interest on Capital
A xx
B xx
To Partners’ Salaries/ Comm.
A xx
B xx
To Reserve
To Profit transferred to :
A’s Capital /Current A/c xx
B’s Capital/Current A/c xx
By Net Profit as per Profit & Loss A/c
By Interest on Drawings
A xx
B xx
Calculation of Interest on Drawings
(1) Irregular drawings – When amount of each withdrawal is not same or time interval between each withdrawal is not equal. Simple method or Product method can be used to calculate interest on drawings.
(2) Regular drawings – When same amount is withdrawn in equal time intervals.
(a) When a fixed amount is drawn in the begining of each month of the year then interest on total drawings may be calculated for 6½ months.
(b) When a fixed amount is drawn in the middle of each month of the year then interest on total drawings may be calculated for 6 months.
(c) When a fixed amount is drawn at the end of each month of the year then interest on total drawings may be calculated for 5½ months.
(d) When a fixed amount is drawn in the begining of each quarter of the year then interest on total drawings may be calculated for 7½ months.
(e) When a fixed amount is drawn in the middle of each quarter of the year then interest on total drawings may be calculated for 6 months.
(f) When a fixed amount is drawn at the end of each quarter of the year then interest on total drawings may be calculated for 4½ months.
Note: In the absence of information of date of drawings, interest on drawing is calculated for 6 months.
Calculation of Commission payable on profits
(1) When commission is payable at a fixed percentage on profits before charging commission:
Profit before charging Commission × Rate of Commission
100
(2) When commission is payable at a fixed percentage on profits after charging commission:
Profit before charging Commission × Rate of Commission
100 +Rate of Commission
Guarantee of profit to a partner
Sometimes a partner is admitted into a firm with a guarantee of minimum share of profit in the business. Such guarantee may be given by old partners or one of the old partners individually. If in any year guaranteed partner’s normal share is less than his guaranteed share, the deficiency is borne by other partners on the basis of their agreement. Following journal entries may be recorded for treatment of guarantee to a partner:
(i) Profit & Loss Appropriation A/c Dr.
To Partners’ Capital A/cs
[Distribution of business profit in profit sharing ratio]
(ii) Other Partners’ Capital A/cs Dr.
To Guaranteed Partner’s Capital A/c
[Treatment of deficiency in guaranteed share in profit]
Past Adjustment
Sometimes, after preparation of final accounts of a partnership firm, it may be found that some omissions and errors have been committed while distributing profits among partners. Instead of reopening the final accounts an adjustment entry or entries are recorded to rectify the error. There are two methods to rectify these errors and omissions:
(i) Through Profit & Loss Adjustment Account
(ii) Directly through Partners’ Capital Accounts
Through Profit & Loss Adjustment Account
(a) Profit & Loss Adjustment A/c Dr.
To Partners’ Capital A/cs
[Entry for providing interest on capital, salary to partners, if omitted]
(b) Partners’ Capital A/cs Dr.
To Profit & Loss Adjustment A/c
[Entry for interest on drawings, if omitted]
(c) Partners’ Capital A/cs Dr.
To Profit & Loss Adjustment A/c
[Entry for loss on adjustment]
Directly through Partners’ Capital Accounts
(i) An adjustment table is to be prepared to calculate the adjustment entry
Particulars Dr. or Cr. Partner A
Rs. Partner B
Rs. Total
Rs.
Interest on Capital, if omitted
Partners’ Salary/Commission, if omitted
Interest on drawings, if omitted Cr.
Cr.
Dr. xxx
xxx
xxx xxx
xxx
xxx xxx
xxx
xxx
Net Amount Dr. or Cr. xxx xxx xxx
Total of net amount in profit sharing ratio Dr. or Cr. xxx xxx xxx
(ii) Adjustment Entry
Partners, Capital A/c Dr.
To Partners’ Capital A/c
[Adjustment entry for omissions of provisions of partnership deed]
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