Notes:Accounting for Partnership Firms : Fundamentals

2
Accounting For Partnership Firms: Fundamentals
* Nature of partnership firms :-
Partnership is a relation of mutual trust and faith. Partnership accounts should present a true and fair
picture of the partnership business.

*Definition :-
It is a relationship between persons who have agreed to share the profit of a business. Carried on by
all or any of them acting for all (Sec.4 of Indian Partnership Act, 1932) .

* Characteristics of partnership
1. There must be at least two persons to form a partnership maximum 10 persons in banking business
and 20 persons in case of other business to form a partnership.
2. Partnership is an agreement between two or more persons.
3. Partners must agree to carry on business.
4. The agreement between the partners must be aimed at sharing the profits of the business.
5. Each partner is an agent as well as partner of the firm.
6. Each partner can participate in the conduct of business.
*Partnership Deed : It Contains 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 [fixed or fluctuating] to be contributed by each partner.
5. The rate of interest is to be allowed on capitals.
6. How much amount withdrawn by partners for personal use.
7. The rate of interest charged on partner’s drawingss.
8. Formula of valuation of goodwill in case of retirement or admission of a partner.
9. In which ratio profits or losses are to be divided among the partners.
10. Salary to any partner for the work done by him.
11. Accounting period of the firm. Yearly or half-yearly and the date on which accounts are to be
closed every year.
12. Safe custody of the books of accounts and other documents of the firm.
 13. Whether the firm’s books will be audited or not? If so, the mode of auditors appointment.
14. Date of commencement of the partnership.
15. The period for which the partnership has been established and the mode of dissolution of
partnership.
16. Whether decision in the case of garner vs. Murray is to apply in the case of insolvency of a
partner.
17. Account in the bank will be opened in firms name or in some partner’s name? Who will have
the right to sign 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.
20. In case of dispute among the partners. How the dispute will be solved?
* Importance of Partnership Deed
1. It regulates the rights, duties and liabilities of each partner.
2. It helps to avoid any misunderstanding amongst the partners.
3. Any dispute amongst the partners may be settled easily as the partnership deed may be readily
referred to .

* Rules Applicable in the Absence of Partnership Deed

1. Profits and Losses are to be shared equally irrespective of their capital contribution.
2. No intrest in capitals shall be allowed to the partners.
3. No interest is to be charged on drawingss.
4. Interest at the rate of 6% per annum is to be allowed on a partner’s loan to the firm.
5. No entitlement of salary to any partners.
6. Without the consent of all existing partners, No new partner can be admitted to the firm.
7. Each partner can participate in the conduct of business.
8. Each partner can inspect the books of firm and can take a copy of the same.
* The journal entries that are passed for various items Shown
in the profit and loss appropriation account are as follows :
1. Entry for Interest on Capital
(1) on allowing interest on capital

interest on capital A/c Dr

To partner’s capital a/c / current a/c.
(interest on capital at -----% p.a.)

(2) on closure of interest on capital A/c

 profit & loss appropriation A/c Dr
To interest on capital A/c

2. Entry for Interest on Drawingss

(1) on charging interest on drawingss

Partner’s capitals A/c /current a/c Dr

To interest on drawingss A/c
(Interest on drawingss at-----% p.a.)
(2) on closure of interest on drawingss A/c

Interest on drawingss A/c Dr

To profit & loss appropriation a/c

3. Entry for Salary or Commission Payable to a Partner

(1) on allowing salary or commission to a partner

Partner’s salary / commission A/c Dr

To partner’s capital A/c / current A/c

(2) on closure of salary or commission account

profit & loss appropriation A/c Dr

To partner’s salary / commission a/c.

4. Entry for Transferring a Part of Profit to Reserve:

Profit & loss appropriation A/c Dr
To reserve A/c

5. Entry for transfer of credit balance of profit & loss

appropriation A/c (being profit)

Profit & loss appropriation A/c Dr

To partner’s capital or current A/c

6. Entry for Transfer of debit balance of profit & loss

appropriation A/c (being loss)
Partner’s capital or current a/c Dr
To profit & loss appropriation A/c

Profit and Loss Appropriation Account

Dr.
Cr.
Particulars Rs Particulars Rs
 To Salary to Partners : X By Profit & Loss A/c
Y By Interest on Drawingss : X
To Commission to Partners : X Y
Y By Loss Transferred to Partner’s
To Interest on Partner’s Capital : X Capital or current a/c. : X
Y Y
To Reserve A/c
To Profit transferred to Partner’s
Capital or Current A/c : X
Y

Calculation of Interest on Drawingss :

Amount of Drawingss X Rate of interest X number of months
100 12

Proforma of Capital Accounts When the capitals are fixed

Partner’s Capital A/c.
Particulars A B C Particulars A B C

To Cash / Bank By balance b/d

a/c (permanent (opening
withdrawn of balance )
capital)
By case / bank
To balance c/d A/c (additional
(closing capital)
balance)

Partner’s Current Account

Particulars A B C Particulars A B C
To Balance b/d By Balance B/d
[In case of debit (In case of credit opening
opening balance] balance )
To Drawingss By Interest on Capital
To Interest on By Salary
Drawingss By Commission
To P&L A/c By P&L Appropriation
(Share of loss, in a/c
case of loss ) (Share of Profit, in case
To Balance c/d of profit)

When the capitals are fluctuating :

Partner’s Capital Account
Particulars A B C Particulars A B C
To Drawingss By Balance B/d
To Interest on (opening balance)
Drawingss By Cash / Bank a/c
To Profit and Loss (Additional capital)
A/c (In case of loss, By Interest on Capital
share of loss ) By Salary
To Balance c/d By Commission
By P&Lappropriation
(share of profit )

Distinction Between Fixed Capital Accounts and Fluctuating

Capital Accounts

Fixed Capital Accounts Fluctuating Capitals Accounts

1. The balance in capital account usually remains1.
unchanged except in extraordinary
circumstances. 2.
2. Partners have two accounts capital accounts 3.
and current accounts
3. All transactions relating to partner account are4.
not made in capital account but are entered in
separate current account.
4. This cannot show a negative balance.
The Balance of Capital accounts change in
time to time
Partners have only capital account ;
All transactions relating to partner account are
made in their capital accounts.
This can show a negative balance
 Calculation of Manager’s Commission on Net Profits
(1) on profits before charging such commission

Profit (before commission) X Rate of Commission

100

(2) on profits after charging such commission

Profit (before commission) X Rate of Commission

100 + Rate of Commission

Interest on Partner’s Loan to the Firm

Rate of Interest:
if their no agreement for the rate of interest, then charge interest on loan @ 6% per annum.

Nature of Interest: interest against partner’s loan allowed whether there are profit or not.
Accounting Treatment:
It is treated as a charge against the profits and hence interest on partner’s loan is debited to profit &
loss A/c and not to profit & loss appropriation A/c.

Interest on partner’s loan is recorded in “interest accrued account “.

1. Entries for interest on partner’s loan

.
(1) for providing interest on partner’s loan:
Interest on partner’s loan a/c Dr
To interest accrued a/c

(2) for closing the interest on partner’s loan :

P&L a/c Dr
To interest on partner’s loan a/c.

Distinction Between Charge Against Profit and Appropriation out

of Profit

S.No. Charge Against Profit Appropriation out of Profit

 1. It indicates expenses to be deducted from It indicates distribution of net profit to
profits while calculating net profit or loss. various heads.

2. It is debited to profit and loss account It is debited to profit and loss

appropriation account.

3. It is necessary to make charge against Appropriations are made only when

profits even if there is loss. there is profit.

Methods of calculating interest on drawingss:

1. Simple method
Interest on drawingss = Amount of drawingss X Rate of
Interest X Months
100 12
2. Product Method:
Interest on drawingss = Total of products X Rate of Interest X 1
100 12
3. Average Method:
Case (1) When Drawings is made in the beginning of every month: If the
drawings of equal amount
Average period = Time left after first drawings + Time left after last
drawings
2
= 12 Months + 1 Month = 6½ Months
2
Case (2) When Drawings are made at the end of every month:
Average period = Time left after first drawings + Time left after last
drawings
2
= 11 Months + 0 Month = 5½ Months
2

Case (3) When Drawings are made in middle or at any time during the
month: (middle)
 Average period = Time left after first drawings + time left after last
drawings
2
= 11.5 Months + 0.5 Month = 6 Months
2

Case (4) When drawings of equal amount are made in the beginning of
each quarter:
Average period = Time left after first drawings + Time left after last
drawings
2
= 12 Month + 3 month = 7½ Months
2
Case (5) When drawings of equal amount are made at the end of each
quarter:
Average period = Time left after first drawings + Time left after last
drawings
2
= 9 Months + 0 Month =4½ Months
2
Case (6) When drawings of equal amount are made during the middle of
each quarter:
Average period = Time left after first drawings + Time left after last
drawings
2
= 10.5 Months + 1.5 Months = 6 Months
2
Case (7) When drawings of equal amount are made only during a period
of 6 Months :
(i) In the beginning of each month:

Average period = 6 Months + 1 Month = 3½ Months

2
(ii) At the end of each month :

Average period = 5 Months + 0 Month = 2½ Months

2
(iii) In the middle of each month:
 Average period = 5½ Months + ½ Month = 3 Months
2

Case (8) When drawings of equal amount are made during 9

months.
(i) In the beginning of each month

Average period = Time left after first drawings + Time left after last
drawings
2
= 9 Months + 1 Month = 5 Months
2
 (ii) At the end of each month

Average period = Time left after first drawings + Time left after last
drawings
2
= 8 Months + 0 Month = 4 Months
2
(iii) In the middle of each month

Average period = Time left after first drawings + Time left after last
drawings
2
= 8.5 Months + 0.5 Month = 4.5 Months
2
Case (9) When the rate of interest is given without the word ‘per annum’
interest will be charged without considering time or date of
drawings.
1. Interest on Drawings is charged @ 10% per anum

Amount on Drawings X Rate of Interest X 6

100 12
2. Interest on Drawings is charged @ 10%

Amount on Drawings X Rate of Interest

100

* Adjustment in the Closed Accounts:

Accounts have been closed after the financial year, it is discovered that
there have been some errors or omission in the old accounts. In such
cases instead of altering the old accounts, and the signed balance sheet an
adjustment entry for such error or omission is made at the beginning of the
next year. Following adjustments are made:

1. When Interest on Capitals or Drawings may have been omitted.

2. When profits and losses have been distributed among the partner in a
wrong proportion.
3. When profit sharing ratio has been altered with effect from some past date.
4. When salary or commission payable to a partner has been omitted.

* Guarantee of Profit to a Partner :

Sometimes a partner is guaranteed that he shall get a certain minimum
amount of profits of the firm. Such a guarantee may be given either (i) any
one of the partners or (ii) by all other partners in a particular ratio. When the
profits of the firm are not adequate then the ‘excess’ paid to the guaranteed
partner should be charged to the partner who has given the guarantee.