CBSE Quick Revision Notes and Chapter Summary
Class-12 Accountancy
Chapter 1 - Basics of Partnership

Introduction

A business can be organised in the form of a sole proprietorship, a partnership firm or a company. In Sole​​ Proprietorship total capital is invested by only one person and only he is responsible for functioning and all the profits and losses. The main disadvantage of single ownership is that his all personal properties are always at risk and may be used for the​​ payment of the business liabilities. That's why the need of partnership takes place. In partnership loss is shared by all the partners while in single proprietorship only one person is suffering for all losses. The main advantage of partnership is that there are two or more persons to take the responsibility of business. All profits and losses are distributed among the partners. Partnership comes into existence out of agreement. The agreement may be written or oral among the partners. It is better to have a​​ written agreement among the partners to avoid the conflicts or disputes. Whenever there is dispute for the distribution of the profits among the partners, in such case Indian partnership act 1932 is applicable.

Meaning and Definition of Partnership

A partnership is formed by an agreement. Partnership agreement may be written or oral. The agreement should be to share the profits of the business. The firm’s business may be carried on by all the partners or any one of them acting for all. As per the law, it is not necessary to have a written agreement but to avoid the trouble in managing the affairs of the partnership firm, it is always advisable to have a written partnership deed which should be signed by all the partners.

Definition According to Section- 4 of the Indian Partnership Act, 1932 :

"Partnership is the relationship between persons who have agreed to the share the profits of a business carried on by al or any one of them acting for all"

Features/Characteristics of Partnership

• Two or More Persons :​​ A partnership business can be commenced with two or more partners. According to the Indian Companies Act, 1956, maximum number of persons in case of a banking business is 10 (Ten) and 20 (Twenty) in case of other business.

2.​​ Agreement Between the Partners​​ : A partnership is formed by an agreement. Partnership agreement can be written or oral. There is no fixed or compulsory law for the formation of written partnership agreement but in the absence of a written agreement partners may face difficulty in managing the affairs of the partnership firm. Therefore, to avoid the conflicts/disputes among the partners, it is also advisable to have a written partnership agreement.

• Lawful Business​​ : The agreement should be carrying on some legal business. Unlawful activities are not considered as partnership business.

Example 1​​ :​​ Vinod and Yuvraj purchased a piece of land jointly and sold after sometime at a profit. The profit earned from sale of land was shared by Vinod and Yuvraj Equally. It will not be treated as partnership business.

Example 2 :​​ David and John are partners doing smuggling and share the amount earned equally. It is not a partnership business.

• Sharing of Profits​​ : It is necessary to share the profits/losses of a​​ partnership business among the partners. A group of people doing some charitable activities, will not be termed as partnership. The ratio of sharing profits/losses should be determined by the agreement and in case if there is not partnership deed, in such​​ a situation profits/losses should be shared equally.

• Business Carried on by all or any of them acting for all: It is not necessary for all the

partners to participate in day-to-day activities of the business. A partnership business can be carried on by all​​ the partners or any one of them acting for all on behalf of other partners. In Acutal, partnership is based on the concept of Mutual Agency realtionship. A partner is both an agent and a principal because he binds other partners by his acts and in the same manner he is also bound by the acts of the other partners.

Meaning and Contents of Partnership Deed

A Partnership is formed by an agreement. This agreement may be written or oral. In actual, Partnership deed is a written agreement signed by all the partners. It is a document which contains all terms and conditions of partnership agreed by the partners. As we know that partnership is the result of agreement among the partners. The agreement may be written or oral. In absence of a written agreement, there may be dispute or conflicts among other partners regarding profits. Therefore, an agreement should be written and signed by all the partners. Partners can make changes in the clauses of partnership deed time to time with the consent of all partners.

Contents of partnership deed

The partnership deed usually contains the following particulars:

• Name of the Firm ; address of Firm ; its main Business

• Names and addresses of all partners

• Date of commencement of partnership

• Capital contributed by each​​ partners

• Ratios in which profits and losses are to be shared by the partners

• Salaries, commission, allowances payable to the partners

• Rights, duties and liabilities of the partners

• Duration of partnership, if any

• Mode of auditors appointment

• Accounting period of the firm

• Rules regarding the operation of bank account

• Loan given to the firm by a partner, interest on that loan payable to the partners

• Method of valuation of goodwill

• Rules to be followed in case of admission, retirement and death of a​​ partner

• Settlement of accounts at the time of dissolution

• Settlement of disputes among other partners

Advantages/Benefits of Partnership deed

• A written partnership deed plays important role in avoiding disputes and conflicts among the partners in future.

• A​​ writtten partnership deed can be used as an evidence in the court of law.

• Facilitates smooth functioning of business by avoiding misunderstanding

Provisions Affecting Accounting Treatment

In the absence of a written partnership deed or if the deed is​​ silent on certain matters, following provisions for the Indian Partnership Act, 1932 will be applicable:

Rights of partners

• Right to take part in management

• Right to inspect the books of accounts

• Right to share profits

• Right to be consulted about matters affecting the​​ partnership business

• Right to retire

Duties of partners

• He should be faithful to other partners

• He should share the losses of the firm

• To attend his duties diligently

• He should not compete with the firm

Preparation of Profit & Loss​​ Appropriation Account

In case of a partnership firm, all charge are shown in profit and loss account and all appropriations are shown in Profit and Loss Appropriation Account. The main purpose of preparing Profit and Loss Appropriation Account is 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 absesnce of Partnership Deed). It is an extension of Profit and Loss Acccount. It is a temporary account and​​ by nature it is a nominal account.

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

• When Profit from Profit and Loss Account is transferred to the P/L Appropriation A/c

Profit and Loss A/c Dr.

To Profit and Loss​​ Appropriation A/c (Being profit transferred to P & L Appropriation A/c)

• For Interest on Capital

• For allowing Interest on capital

Interest on Capital A/c

To Partners' Capital/Current A/cs (Being interest on capital allwoed @ %​​ p.a)

• For​​ transferring Interest on Capital to Profit and Loss Appropriation A/c:

Profit and Loss Appropriation A/c Dr.

To Interest on Capital A/c

(Being interest on capital transferre to P & L Appropriation A/c)

• For Salary of Commission payable to a partner

• For​​ allowing Salary or Commission to a partner :

Partner's Salary/Commission A/c Dr.

To Partner's Capital /Current A/cs (Being salary/commission payable to a partner)

• For transferring Partner's Salary/Commission A/c to Profit and Loss Appropriation A/c :

Profit and Loss appropriation A/c Dr.

To Partner's Salary/ Commission A/c

• For transfer of Reserves :

Profit and Loss Appropriation A/c Dr.

To Reserve A/c (Being reserve created)

• For Interest on Drawings :

• 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.)

• 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 Apprpriation A/c)

• For transfer to Profit (i.e. Credit Balance of Profit and Loss Appropriation Account:

Profit and Loss Appropriation A/c Dr.

To Partners Capital A/cs

(Being profit​​ distributed among partners)

Proforma of Profit and Loss Appropriation Account

Partners

Capital

Account

Preparation of Partners Capital Accounts

Partner's Capital Accounts : It is an account which represents the partner's interst in the​​ business.

In case of partnership business, a separate capital account is maintained for each partner. The capital accounts of partners may be maintained by following any of the following two methods:

(1)​​ Fixed Capital Accounts :​​ Under this method capitals​​ of the partners remain fixed. Capital accounts of the partners will show always Credit balances. Under This method mainly two

accounts are prepared i.e. Partners Capital Account and Partners Current Account. There are only two situations when fixed capitals of the partners may change :

Situation 1: When Additional Capital is introduced by the partners

Situation 2: When Some part of capital is withdrawn permanently by the partners

Only two items are shown in the credit side i.e. opening balance or​​ capital introduced by the partners and additional capital (if any) introduced by the partners.

In the debit side withdrawn of capital (permanently) and closing balance is shown.

Partners Capital Account

Partners Current Account

Note​​ :

• Debit balance of Current​​ Account is shown in Assets side of Balance Sheet.

• Credit balance of Current Account is shown in Liabilities side of Balance Sheet.

• Balance of Capital Accounts are always shown in Liabilities side of Balance Sheet as this account will always show a​​ credit balance when capital is fixed

(2)​​ Fluctuating Capital Accounts: Under this method only one account is prepared i.e. Partners Capital Account. It may show Debit or Credit balance.

Credit Side Items​​ :

• Balance of Capital or Capital Introduced by the partners

• Additional Capital (if any) contributed by the partners during the year

• Interest on capital (if any)

• Salary/Remuneration to the partners (if any)

• Commission/Bonus to the partners (if any)

• Share of Profit

Debit Side Items

• Withdrawl of capital (if any)

• Drawings made during the year (if any)

• Interest on drawings (if any)

• Share of loss (if any)

• Closing​​ balance

Partners Capital Account

INTEREST ON CAPITAL

Interest on​​ partners’ capital will be allowed only when it has been specifically mentioned in the partnership deed. Interest on Capital can be treated as either an Appropriation of profit or a charge against profits.

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 or losses

Journal Entries

• In case of sufficient profits

Profit and Loss Appropriation A/c Dr.

To Interest on Capital A/c

(Being interest on capital transferred to P & L​​ Appropriation A/c)

• In case of Insufficient Profits or Losses

Profit and Loss / Profit and Loss Adjustment A/c Dr.

To Interest on Capital A/c

(Being interest on capital transferred to P&LAdjustment A/c)

Note :

Interest on Capital is always​​ calculated on the opening capital. If Opening Capital is not given in the question, it should be ascertained as follows :

For additional capital interest is calculated for period for which​​ capital is utilised e.g if additional capital is introduced on 1s​​ October in firm where accounts are closed on 31st March.

Interest = Amount introduced x Rate/100 x 6/12 as money is utilised for 6 months

Interest on Drawings

Drawings means cash or​​ goods withdrawn from the business by the proprietor for personal use. It reduces the capital of the proprietor. Interest on drawings will be charged from the partner’s capital account, only if it is mentioned in the partnership deed. If partnership deed is​​ silent, no interest on drawings will be charged. According to the business entity concept interest on drawings will be treated as income for the business and loss for the partners.

Distinction between drawings against profit and drawings against capital

Methods for Calculation of​​ interest on drawings

• When a fixed amount is withdrawn by the partners after regular intervals and rate of interest is given in the question with the word per annum

• Step 1. Calculate average period :

  average period =​​ Time after first drawing + time​​ after last drawing

  2

  Step 2. Calculate interest on drawings :

  interest on drawings = Total drawings x Rate/100 x Average period

  When rate of interest is given without the word per annum

In such a case, Interest on Drawings is calculated with a flat rate irrespective of date of drawings.

• When Different amounts are withdrawn at different time intervals

We have the following two methods to calculate the amount of Interest on Drawing :

• Simple Interest Method

In this method, interest on drawing is​​ calculated for each amount of drawing indivdually of the basis of periods for which

• Product Method

In this method, the amounts of drawings are multiplied by the period for which it remained withdrawn during the period, Interest for 1 month is​​ calculated on the sum of these products.

• Half yearly Drawings for year when:

  • Drawings are made in the begnning of each period (half-year) Interest on drawing = Amount x Rate/100 x 9/12

  • Drawings are made in the middle of each period (half year)​​ Interes on drawing =

  Amount x Rate/100 x 6/12 

  Half Yearly Drawings

(c) Drawings are made at the end of each period (half year) Interest on drawing = Amount x Rate/100 x 3/12

For monthly drawings for 6 months

• Drawings are made in beginning of each​​ month Interst = Amount x Rate/100 x 3.5/12

• When drawings are made in the middle of each month Interest = Amount x Rate/100 x 3/12

When date of withdrawal is not specified

Sometimes date of withdrawal is not given in the question; amount withdrawn by the partners as drawings is given only. In such a case it is assumed that the amount is withdrawn at average basis or withdrawn evenly throughout the year and interest will be charged for the average period which will be assumed to be 6 months. It is assumed that amount is withdrawn in the middle of every month. The following formula will be used.

Interest on Drawings = Total Drawings x Rate/100 x 6/12

Important Points

• If amount is withdrawn in the beginning of each month, interest is calculated for 6​​ 1/4 months.

• If amount is withdrawn in the middle of each month, interest is calculated for 6 months.

• If amount is withdrawn at the end of each month, interest is calculated​​ for 5​​ 1/4 months.

• If amount is withdrawn in the beginning of each quarter, interest is calculated for 7​​ 1/4 months.

• If amount is withdrawn at the middle of each quarter, interest is calculated for 6 months.

• If amount is withdrawn at the end of each quarter, interest is calculated for 4​​ 1/4 months.

• When date of withdrawal is not given, it is mainly assumed to be in the middle of month.

• When different amounts are withdrawn at different intervals, product method is used for the calculation of​​ interest.

• In the absence of partnership deed or if partnership deed is there but silent about interest, No interest will be charged on drawings.

• Interest will be credited to P/L Appropriation Account and Debited to partners'

capital/current Account. 

Concept of Past Adjustment

Past Adjustments are concerned with the previous entries which were left out or ommitted or wrongly entered in the accounts. If, after preparation of Final Accounts of firm, it is found that some errors or omission in accounts has occurred than such errors or omissions are rectified in the next year by passing an adjustment entry.

A statement is prepared to ascertain the net effect of such errors or omissions on partner's capital/current accounts in the following manner.

Adustment Table

Now compare Step 1 and​​ Step 2 and decide Partner is gainer or sacrificing. After this make the following entry :

Gainer partner's A/c Dr.

To Sacrificing Partner's A/c

GUARANTEE OF PROFITS TO A PARTNER

Guarantee is an assurance given to the partner of the firm that at least a fixed amount shall be given to him/her irrespective of his/her actual share in profits of the firm. If actual share in profits is less than the guaranteed amount in that case the deficit amount shall be borne either by the firm or by any partner as the case may be.

Note :​​ Guarantee to a partner is given for minimum share in profits. If the actual share in profits is more than the minimum guaranteed amount then the actual profits will be allowed to the partner

Methods for Valuation of Goodwill Average Profit​​ Method

This method is based on the assumption that a new business firm will not be able to earn high profits in the first few years of its operations. That is why goodwill is valued at an agreed number of years purchase of the average profits of the past few years.

The profit earned by a Firm during​​ previous accounting periods on an average basis is called average profit. Goodwil is calculated on the basis of average profit due to future expectations of earning capacity of the firm.