ACCOUNTING FOR PARTNERSHIP FIRMS-FUNDAMENTALS
Accounting Process in Partnership
According to Section 4 of the Partnership Act 1932 “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”
Features of partnership Firm
1) Association of two or more persons: There must be at least two persons and maximum of 50 persons to form a partnership and they must be competent to contract.
2) Partnership Agreement or Deed: There must be an agreement among partners to form a partnership. It can be written or oral.
3) Legal Business: The business of the partnership firm must be a legally allowed business.
4) Sharing of Profits or Losses: The partners must share profits or losses in a certain ratio.
5) Mutual Agency: The partners mutually take part in daily routine work or the work may be carried on by one or more partners on behalf of the other partners. Every partner is legally liable for the acts of all other partners, whether he is taking part in the activities of the firm or not.
6) Unlimited Liability: Partners' liability to the third parties is unlimited. If there are losses, and the firm is not able to pay its debts fully, then all the partners shall be jointly and severally liable to pay the debts of the firm to an unlimited extent.
Partnership Deed: The document, which contains terms of the agreement, is called' Partnership Deed'. It generally contains the details about all the aspects affecting the relationship between the partners including the objective of business, contribution of capital by each partner, ratio in which the profits and the losses will be shared by the partners and entitlement of partners to interest on capital, interest on loan, etc.
Provisions of Partnership Act, 1932 in the absence of Partnership Deed:
(a) Profit Sharing Ratio: If the partnership deed is silent about the profit sharing ratio, the profits and losses of the firm are to be shared equally by partners.
(b) Interest on Capital: No interest on capital is payable if the partnership deed is silent on the issue.
(c) Interest on Drawings: No interest is to be charged on the drawings made by the partners, if there is no mention in the Deed.
(d) Interest on Advances: If any partner has advanced some money to the firm beyond the amount of his capital for the purpose of business, he shall been titled to get an interest on the amount at the rate of 6 percent per annum.
(e) Remuneration for Firm's Work: No partner is entitled to get salary or other remuneration for taking part in the conduct of the business of the firm.
Fixed and Fluctuating Capital Accounts of Partners
There are two methods by which the capital accounts of partners can be maintained. These are: (i) fixed capital method, and (ii) fluctuating capital method.
Fixed Capital Method: Under the fixed capital method, the capitals of the partners shall remain fixed unless additional capitalis introduced or a part of the capital is with drawn as per the agreement among the partners. All items likes hare of profit or loss, interest on capital, drawings, interest on drawings, etc. are recorded in separate accounts, called Partner's Current Account. The partners' capital accounts will always show a credit balance, which shall remain the same (fixed) year after year unless there is any addition or withdrawal of capital. The partners' current account on the other hand, may show a debit or a credit balance. Thus under this method, two accounts are maintained for each partner viz., capital account and current account, While the partners' capital accounts shall always appear on the liabilities side in the balance sheet, the partners' current account's balance shall be shown on the liabilities side, if they have credit balance and on the assets side, if they have debit balance.
The partner's capital account and the current account under the fixed capital method would appear as shown below:
Dr. Partner’s Capital Account Cr.
Date
|
Particulars
|
J.F.
|
Amount
(Rs.)
|
Date
|
Particulars
|
J.F.
|
Amount
(Rs.)
|
To Bank A/c(permanent withdrawal of capital)
To Balance c/d
(closing balance)
|
xxx
xxx
|
By Balance b/d
(opening balance)
By Bank A/c
(fresh capital introduced)
|
xxx
xxx
| ||||
Date
|
xxx
|
xxx
|
Dr. Partner’s Current Account Cr.
Date
|
Particulars
|
J.F.
|
Amount
(Rs.)
|
Date
|
Particulars
|
J.F.
|
Amount
(Rs.)
|
To Drawings
To Interest on drawings
To Profit and Loss
Appropriation A/c (for share of loss) To Balance c/d
|
xxx xxx xxx xxx xxx
|
By Balance b/d
By Salaries/Commission
By Interest on capital
By Profit and Loss
Appropriation A/c
(for share of profit)
|
xxx xxx xxx xxx xxx
| ||||
Date
|
xxx
|
xxx
|
Fluctuating Capital Method: Under the fluctuating capital method, only one account, i.e. capital account is maintained for each partner. All the adjustments such as share of profit and loss, interest on capital, drawings, interest on drawings, salary or commission to partners, etc. are recorded directly in the capital accounts of the partners. This makes the balance in the capital account to fluctuate from time to time. That's the reason why this method is called fluctuating capital method. In the absence of any instruction, the capital account should be prepared by this method. The proforma of capital accounts prepared under the fluctuating capital method is given below:
Dr. Partner’s Capital Account Cr.
Date
|
Particulars
|
J.F.
|
Amount
(Rs.)
|
Date
|
Particulars
|
J.F.
|
Amount
(Rs.)
|
To Drawings
To Bank (permanent withdrawal of capital)
To Interest on drawings
To Profit and Loss
Appropriation A/c (for share of loss)
To Balance c/d
|
xxx xxx
xxx xxx
|
By Balance b/d
By Bank (fresh capital introduced)
By Salaries/Commission
By Interest on capital
By Profit and Loss
Appropriation A/c
(for share of profit)
|
xxx
xxx xxx xxx
| ||||
Date
|
xxxx
|
xxxx
|
Distribution of Profit among Partners
The profits and losses of the firm are distributed among the partners in an agreed ratio. However, if the partnership deed is silent, the firm's profits and losses are to be shared equally by all the partners.
You know that in the case of sole partnership the profit or loss, as certained by the profit and loss account is transferred to the capital account of the proprietor. In case of partnership, however, certain adjustments such as interest on drawings, interest on capital, salary to partners, and commission to partners are required to be made. For this purpose, it is customary to prepare a Profit and Loss Appropriation Account of the firm and as certain the final figure of profit and loss to be distributed among the partners, in their profit sharing ratio.
The Proforma of Profit and Loss Appropriation Account is given as follows:
Dr. Profit and Loss Appropriation Account Cr.
Particulars
|
Amount
(Rs.)
|
Particulars
|
Amount
(Rs.)
|
To Profit and Loss A/c (if there is loss)
To Interest on Capital A/c
To Salary/Commission to Partner A/c
To General Reserve A/c
To Partners' Cap A/cs or
Current A/cs (Distribution of Profit)
|
xxx xxx xxx xxx
|
By Profit and Loss A/c (if there is profit)
By Interest on Drawings
By Partners' Cap A/cs or Current A/cs
(distribution of loss)
|
xxx xxx xxx
|
xxxx
|
xxxx
|
*Note: Interest on partner's loan is to be treated as a charge against profits.
Past Adjustments
If after closing the accounts for the year it is the discovered that some errors have been committed, then these errors have to be rectified. Some adjustment entries have to be passed to rectify the error. The entries are made through Profit & Adjustment A/c. These entries are to rectify the errors committed in past, therefore, they are known as 'Past Adjustments'. Generally the following types of errors are committed:
(i) Interest on Capital and on Drawings have been omitted.
(ii) Interest on Capital and on Drawings have been provided at higher or lower rates than the rates agreed in the Deed.
(iii) Salary or commission to partners either not given or a higher or lower amount has been given.
(iv) Profit shared in a wrong ratio.
Adjustment Chart
Particulars
|
A
|
B
|
C
|
Total
|
+ Interest on Capital
|
+
|
+
|
+
|
+
|
+ Partner's Salary/Commission
|
+
|
+
|
+
|
+
|
- Interest on Drawings
|
–
|
–
|
–
|
-
|
Excess profit taken back in their P&L sharing ratio
|
-
|
-
|
-
|
–
|
–
|
–
|
–
| ||
+
|
–
|
+
|
* Assumed that there are three partners A, B and C.
* Assumed that all errors are related to omission
* + means Cr the partner's capital A/c
* - means Dr the partner's capital A/c
*
(i) Interest on Capital and on Drawings have been provided at higher or lower rates than the rates agreed in the Deed
(ii) Salary or commission to partners either a higher or lower amount has been given.
Guarantee of Profit to a Partner
Guarantee of profit means a minimum amount of profit to be paid to a partner. This amount shall be given to him if his share of profit is lower than the guaranteed amount. The deficit shall be borne either by one of the old partners or by all the old partners in a particular agreed ratio. If there is no agreement, then in their old profit sharing ratio, if his actual share of profit is more than the guaranteed amount, then, he will be given his actual share of profit. He gets the guaranteed amount or the actual share of profit, whichever is higher. (a) Guarantee given by all partners
(i) Compare the amount of guarantee and his actual share of profit. If guaranteed amount is more than his actual share of profit, then the guaranteed amount will be debited to profit and loss Appropriation Account and the partner's account will be credited with the guaranteed amount.
(ii) The deficiency shall be shared by other partners in their profit sharing ratio.
(b) Guarantee given by One Partner only
First calculate his share of profit. Compare it with the guaranteed amount. The amount of deficiency is to be charged from the partner who gave guarantee.
(c) Guarantee given to a partner by other partners in a ratio different from their profit sharing ratio
Distribute profit among all the partners in the profit sharing ratio. Work out the amount of deficiency by comparing it with the guaranteed amount and his actual share of profit. The other partners will bear the deficiency in an agreed new ratio.
IMPORTANT QUESTION PDF
IMPORTANT QUESTION PDF
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