Accounting for Partnerships: Basic Concepts Chapter Notes | Accountancy Class 12 - Commerce PDF Download

Introduction

According to Section -4 of the Indian Partnership Act, 1932: “Partnership is the relations between two or more persons who have agreed to share the profits of a business carried on by all or any one of them acting for all”.

Partnerships are governed by a partnership agreement, which outlines the rights, responsibilities, and profit-sharing arrangements among the partners. 

Formation of Partnership:

• Partnerships can be formed through a formal agreement between the partners or through an implied agreement based on the conduct and actions of the parties involved.
• The formation process typically involves determining the contributions of each partner (e.g., capital, assets, skills) and establishing the terms of the partnership agreement.

Features of Partnership

1. Two or more persons: There must be at least two persons to form a valid partnership.
   The maximum number of partners cannot exceed the number of partners prescribed by the Companies Act 2013 which is 50 in any business, whether banking or non-banking.
2. Agreement Partnership comes into existence by an agreement (either written or oral among the partners. The written agreement among the partners is called Partnership Deed.
3. Existence of business and profit motive: A partnership can be formed to carry on legal business to earn profits. Joint ownership of some property by itself cannot be called a partnership.
4. Sharing of Profits: An agreement between the partners must be aimed at sharing the profits. If some persons join hands to run some charitable activity, it will not be called a partnership. Further, if a partner is deprived of his right to share the profits of the business, he cannot be called a partner.
5. A 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 concerning the firm's business.
6. Relationship of Principal and Agent: Each partner is an agent as well as a partner of the firm. An agent can bind the other partners by his acts and principles because the acts of the other partners can bind him.

Partnership Deed

• Since a partnership is the outcome of an agreement, all the partners must agree upon some terms and conditions. 
• Such terms and conditions may be either written or oral. 
• The law does not make it compulsory to have a written agreement. 
• However, to avoid all misunderstandings and disputes, it is always the best course to have a written agreement duly signed and registered under the Act.
• The partnership deed is a written agreement among the partners which contains the terms of the agreement. 
• It is also called ’ Articles of Partnership ’. A partnership deed should contain the following points:
  1.  Name and address of the firm as well as partners.
  2.  Name and addresses of the partners.
  3.  Nature and place of the business.
  4.  Duration, if any, of partnership.
  5.  Capital contribution by each partner.
  6.  Interest on capital.
  7.  Drawings and interest in drawings.
  8. Profit-sharing ratio.
  9.  Interest on loan.
  10.  Partner’s Salary/commission etc.
  11.  Method for valuation of goodwill and assets.
  12.  Accounting period of the firm and duration of partnership
  13.  Rights and duties of partners how disputes will be settled.
  14.  Decisions taken if some partner becomes insolvent.
  15.  Opening of Bank Account - whereas it will be in the name of firm or partners.

Benefits of Partnership Deed

1. It regulates the rights, duties and liabilities of each partner.
2. It helps to avoid any misunderstanding amongst the partners because all the terms and conditions of partnership have been laid down before hand in the deed.
3. Any dispute amongst the partners may be settled easily as the partnership deed may be readiy referred to.

Hence, it is always best course to have a written partnership deed duly signed by all the partners and registered under the Act.

Rules applicable in the absence of a partnership deed

Distribution of Profits among Partners

• Transactions of the partnership firm are recorded according to the principles of the Double­entry bookkeeping system, and as in the case of a sole proprietorship concern a partnership firm will also prepare Trading account, Profit & 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 profits of the partnership firm are divided amongst the partners.
• A Profit and Loss Appropriation Account is prepared to show the distribution of profits among partners as per the provision of Partnership Deed (or as per the provision of Indian Partnership Act, 1932 in the absence of Partnership Deed).
• It is an extension of Profit and Loss Account.
• It is a nominal account.
• It records entries for interest on capital, Interest on Drawings, Salary to the partner, and division of profits among the partners.

The Journal Entries regarding the Profit and Loss Appropriation Account are as follows:

1. For transfer of balance of Profit and Loss Account
   Profit and Loss A/c Dr.
   To Profit and Loss Appropriation A/c
2. For allowing Interest on capital
   Interest on Capital A/c       Dr.
   To Partner’s Capital/Current A/cs
   (Being interest on capital allowed @ % p.a.)
3. For transferring Interest on Capital to p&L appropriation A/c.
   Profit and Loss Appropriation A/c        Dr.
   To Interest on Capital A/c.
   (Being interest on capital transferred to p&L Appropriation A/c)
4. For allowing Salary or Commission to a partner:
   Partners Salary/Commission A/c            Dr.
   To Partner’s Capital/Current A/cs
   (Being salary/commission payable to a partner)
5. For transferring Partner’s Salary/Commission A/c to Profit and Loss Appropriation A/s:
   Profit and Loss Appropriation A/c      Dr.
   To Partner’s Salary/Commission A/c
6. For transfer of Reserves:
   Profit and Loss Appropriation A/c       Dr.
   To Reserve A/c
   (Being reserve created)
7. For charging interest on a partner’s drawings:
   Partner’s Capital/Current A/c.Dr.
   To Interest on Drawings A/c
   (Being interest on drawings charged @ % p.a.)
8. For transferring interest on drawings to Profit and Loss Appropriation A/c Interest on Drawings A/c    Dr.
   To Profit and Loss Appropriation A/c
   (Being interest on drawings transferred to P&L appropriation A/c)
9. For transfer to Profit (i.e. Credit Balance of Profit and Loss Appropriation Account
   Profit and Loss Appropriation A/cDr.
   To Partners Capital/Current A/cs
   (Being profits distributed among partners)

Specimen of Profit and Loss Appropriation Account 

Important Provisions of Partnership Act 

• In the absence of a specified profit-sharing ratio in the partnership deed, all partners will receive equal profits regardless of their capital distribution within the firm.
• No interest on capital will be payable if the partnership deed does not address the issue.
• Likewise, no interest will be charged on partners' drawings if not mentioned in the deed.
• If a partner has lent money to the firm for business purposes, they are entitled to receive interest at a rate of 6 percent per annum on the loan amount.
• Partners are not entitled to receive a salary or any other form of remuneration for participating in the firm's business unless explicitly stated in the partnership deed.
• Any profits obtained by a partner from firm transactions, use of firm property or connections, or the firm's name must be accounted for and returned to the firm.
• If a partner engages in a competing business, they must disclose and reimburse the firm for any profits made in that venture.

Special Aspects of Partnership Accounts 

• Partners' capital accounts can be managed using two approaches: the Fixed Capital Method and the Fluctuating Capital Method.
• Profit and loss sharing among partners is determined based on agreed-upon terms outlined in the partnership agreement.
• Any incorrect allocation of profits in previous periods is rectified through necessary adjustments.
• Reconstitution of the partnership firm involves changes in its structure, such as admission, retirement, or expulsion of partners.
• The dissolution of a partnership firm marks the termination of its operations and the settlement of its affairs, including the distribution of assets among partners.

Partner's Capital Accounts

A. Interest on Capital: An Appropriation of Profits:

B. Interest on Capital: As a Charge against Profits:
Interest on Capital is always allowed in full irrespective of amount of profits of losses.

Note:
Interest on Capital is always calculated on the OPENING CAPITAL.
Il’ Opening Capital is not given in the question, it should be ascertained as follows: 

Interest on Drawings

Interest on Drawing can be calculated using either Product Method or Direct Method (i.e. Short Cut Method)

Direct Method will be used only if all the following three conditions are satisfied:

1.  Amount should be same throughout the period
2.  Date of Drawings should be same throughout the period
3.  Drawings should be made regularly without any gap.

Value of T under Different circumstances will be as under:

Quarterly

INTEREST ON PARTNERS LOAN

If a partner has given loan to the firm, he is entittled to receive interest on such loan at an agreed rate.

It is a charge against profits. It is provided irrespective of profits or loss. It will also be provided in the absence of Partnership Deed @ 6% per annum.

The following entries are passed to record the interest on partner’s loan

1.  For allowing Interest on loan:

Interest on Partner’s Loan A/cDr.

To Partner’s Loan A/c

(Being interest on loan allowed @ % p.a.)

2.  For transferring Interest on Loan to Profit and Loss A/c:

Profit and Loss A/cDr.

To Interest on Loan A/c

(Being Interest on loan transferred to P & L A/c)

It is always DEBITED to Profit and Loss A/c Rent Paid to Partner.

Rent paid to a partner is also a charge against profits and it will also be

DEBITED to Profit and Loss A/c

Note: