Ch:2 Accounting for Partnsership – Basic Concepts

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Partnership

The relationship between persons who have agreed to share the profit of a business carried on by all or any of them acting for all.

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General Features

1-Number of persons- minimum -2,  Maximum- 100

2-Agreement/deed – it may be written or oral

3- Business must be lawful and profit seeking

4- Sharing of profit as per agreed ratio.

5- Business carried on by all or any of them acting for all

6- Utmost good faith.

7- unlimited liability

8- No separate legal existence

Partnership deed

     It is a written document containing the terms of partnership as agreed to by the partners.

Contents of Partnership deed

• Name of the firm
• Name and address of partners
• Nature & place of business
• Date of commencement of business
• Duration if any
• Division of profit or loss
• Interest on capital or drawings
• Interest on partners loan
• Salaries,commission etc

Provisions of Partnership Act Relevant for Accounting
Rules applicable in the absence of partnership deed

1. Profit sharing ratio – The profits and losses of the firm are to be shared equally by partners

2. Interest on capital –  No partner is entitled to claim any interest on the amount of capital

3. Interest on drawings – No interest is to be charged on the drawings made by the partners.

4. Remuneration to partners – No partner is entitled to get salary or other remuneration for taking part in the conduct of the business

5. Interest on loan – : If any partner has advanced loan to the firm for the purpose of business, he/she shall be entitled to get an interest t at the rate of 6%per annum.

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Capital  Accounts of Partners

All transactions relating to partners of the firm are recorded in the books of the firm through their capital accounts. This includes the amount of money brought in as capital, withdrawal of capital, share of profit, interest on capital, interest on drawings, partner’s salary, commission to partners, etc

Methods of maintaining Partner’s capital accounts:

1. Fixed capital method and   
2. Fluctuating capital method

A – Fixed capital Method

     Under this method , the original capital invested by partners remains fixed unless some additional capital is introduced or capital withdrawn.Hence all items other than capital are not  to be shown in capital account.For all those items are shown in a separate “Current account”. Thus each partner will have two accounts,   

1.  Capital account                 
2. Current account ( all adjustments are shown in Partners current a/c

Proforma –Under Fixed capital Method

B – Fluctuating capital Method

Under Fluctuating capital method ,only one account – Capital Account for each partner is maintained.Adjustment in respect of additional capital, drawings, interest on capital,salary, commission, share of profit or loss are made directly in capital account.since the capital balance of partners fluctuating year to year.  

Distribution of profit/loss among partners

Profit and loss appropriation account

This is an extension of profit and loss account to record partner’s adjustment items and is prepared to show how net profit has been distributed among the partners

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Partner’s Drawing A/c

Withdrawal by a partner in the form of money or money’s worth from a firm in anticipation of profit is called Drawings.It is a personal account.

Journal entry
 Partner’s  Drawings A/c Dr
To cash/Purchase A/c

At the end of accounting period,drawing account is closed by transfer to Partner’s Capital/Current A/c.       

                    Partner’s Capital/Current A/c Dr
  To Partner’s Drawing A/c

Note:If some amount is withdrawn from capital,it is recorded in capital A/c,not in Drawings A/c

                   Partner’s capital A/c Dr
   To Cash/Bank A/c

Interest on capital

The Interest on capital is paid to the partners as a compensation for their capital contribution to the firm.If they invested this amount out side the business ,it would have a normal rate of interest and if some partners contributed more amount disproportionate to their profit sharing rights , they will be at an advantageous position.

• Interest on capital is a an expense for the firm and gain for partners individually. It is to be allowed only if the partnership deed provides for it.
• No interest on capital is payable if the firm is working at a loss.

Journal Entries

1. To provide interest on on capital                                      

Interest on capital A/c    Dr
To Partners capital A/c(Individually)

2. To close the Interest on capital Account

P&L Appropriation A/c      Dr
To Interest on capital A/c

Interest on capital = Capital X Rate X Period for which amount remained in the   business.

Case – 1 – When there is no addition to or withdrawal from capital during the year  

 Interest is calculated for whole year on the opening capital

Interest on capital=Opening capital X Rate X 12/12(Period)

Case-2 When there is additional capital contribution during the accounting year

Interest on capital = For Opening capital     – Full year

                                    For Additional capital  –  On the date to the end of the financial year.

Ex: Opening capital of Mr. A is 50,000,Rate of interest is 10%, he brought additional capital on july31 Rs.20000

Interest on capital =  For opening    capital       50000 X10100X 1212 =  5000 (For 12 months)

        For additional capital       20000 X10100 X12  5     = 833  (for 5 months)
Interest on capital due to Mr.A is (5000+833) Rs 5833

Case – 3

If opening balance of capital Account is not given 

Case – 4    When there is withdrawal out of capital(From) during  the year

Interest on capital  = On opening capital up to the date of withdrawal

        On capital after withdrawing for the remaining period.

Ex: Opening capital of Mr. A is 50,000,Rate of interest is 10%,he withdraw capital on july31 Rs.20000

 Interest on capital =  For opening    capital     50000 X10100X 712 =  2916 (For 7 months, full amount)

        For remaining capital     30000 X10100 X 512    = 1250  (for 5 months, after withdrawal)

Interest on capital due to Mr.A is (2916+1250) Rs 4166

Interest on Drawings

Interest is to be charged on the withdrawal made by partners if it has been specifically mentioned in the Partnership deed.It is an Income for the firm(Credited to P&L Appn: A/c) and expense of each partner(Debited to each partner’s capital A/c)

Journal entries

1-to charge interest on drawings 

Partner’s capital A/c Dr (Individually)   
            To interest on drawings A/c

2-To close Interest on drawings A/c

Interest on Drawings A/c Dr 
            To P& L Appn: A/c

Different ways of computing Interest on Drawings

1 – Amount,Rate, Date are given

Interest drawings = Total drawings X Rate X Period           Ex: 36000 X 10100  x712 

2 – Date of withdrawal not given ; Amount, Rate are given

If the date of drawings is not given,it may be assumed that drawings were made evenly throughout the year.In such a case interest should be for Six months

Interest drawings = Total drawings X Rate X  6/12 

3 – Product Method-Different amounts withdrawn at different intervals

The date of drawings and different amounts withdrawn are clearly stated the interest may be calculated with the help of “ Product method”

Steps

a-Calculate the time period, withdrawal period to closing period   ( 1-3-2018   to 31-12-2018,  10 months)

b-Multiply the amount with the period, Amount  X period,this is called “Product” (  20000 x 10 = 200000)

c-Add up the various product 

d-Calculate the Interest for one month on the Sum of product.  

Interest on Drawings = Sum of Product X Rate X 1/12

4 – Fixed Amount withdrawn every month

If a partner withdraws a fixed amount at regular intervals, the interest on drawings can be calculated on the basis of average period. It depends upon whether the fixed amount is withdrawn on the first day,middle or end of the each month or quarter

Guarantee of Profit to a Partner

Sometimes, on admission of a new partner, the existing partners may give an assurance to the incoming partner that he shall be given a minimum amount of profit irrespective of the firm’s actual profit.The newly admitted partner enjoys the privilege of getting the guaranteed profit.The deficiency is borne by all other partners in their Profit sharing Ratio.

Steps

1. Distribute the profit to all partners as per profit sharing ratio.
2. Calculate the deficiency or guaranteed partner ( Agreed amount – actual profit share)
3. Deduct the share of deficiency from other partner’s profit share ( deficiency X PSR of remaining partner’s only)
4. and add all the amounts to guaranteed partners share of profit.

Ex: A,B and C, Profit sharing ratio is 2:3:1, C is guaranteed profit of Rs 15,000, Profit for the year Rs 60,000

1. Profit share               A = 60000 X 26 = 20000

B  = 60000 X 3/6  = 30000

C =  60000 X 1/6   = 10000

1. Deficiency of C 5000   (15000- 10000=5000)
2. Share of deficiency borne by  A= 5000 X 2//5 = 2000

Share of deficiency borne by  B= 5000 X 3/5 = 3000

1. New share of Profit    A = 20000 – 2000 = 18000

       New share of Profit    B = 30000 – 3000 = 27000

       New share of Profit    C = 10000 + 2000+3000 = 15000

Past Adjustments

Sometimes a few omissions or errors are found in partnership accounts after final accounts have been prepared and the profits distributed among t he partners.The omission in respect of Interest on capital,salary,commission etc. All these need adjustments for correction instead of altering old accounts by way of 

1. Through “P&L Adjustment A/c”  or
2. Directly in the capital A/c of partners.

• Through P&L Adjustment A/c ( Ex :Interest on Capital )

Journal Entry

Right Entry  

P&L Adjustment    A/c Dr   9000
         To    A’s capital A/C             3000   
        To    A’s capital A/C             6000

(interest on capital is credited to capital a/cs)

Correction Entry

A’s capital A/C             4500
B’s capital A/C             4500
        To   P&L Adjustment    A/c Dr   9000 

(The amount debited to capital accounts in PSR, which are credited wrongly before)

• Directly partners Capital Accounts

For direct adjustment in partners capital account prepare a statement to ascertain the net effect of omission on partners capital account.

In order to rectify this error :-

A’s capital A/c   Dr     1500 
        To B’s capital A/c            1500

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