Accounting for Partnership Firms – Basic Concepts

A partnership is a form of business organisation where two or more persons agree to carry on a business together with the aim of earning profit and sharing it among themselves. It is governed by the Indian Partnership Act, 1932.

Definition

According to Section 4 of the Indian 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."

• Key elements of a valid partnership:
• Two or more persons (minimum 2, maximum 50 as per Companies Act, 2013)
• Agreement (oral or written, but written is preferred — called Partnership Deed)
• Lawful business
• Sharing of profits (losses are also shared unless agreed otherwise)
• Mutual agency — every partner acts as an agent of the firm and of other partners

Partnership Deed

• A Partnership Deed (also called Articles of Partnership) is a written agreement among partners. It contains:
• Name and address of the firm and partners
• Nature and place of business
• Capital contributed by each partner
• Profit and loss sharing ratio (PSR)
• Interest on capital, drawings, and loans
• Salary/commission to partners (if any)
• Rules for admission, retirement, death of a partner
• Procedure for dissolution

Provisions in the Absence of Partnership Deed

• If no deed exists (or the deed is silent on a matter), the Indian Partnership Act, 1932 applies:
• Profit/Loss shared equally
• No interest on capital
• No salary or commission to partners
• Interest on loan by a partner @ 6% p.a.
• Interest on drawings — nil

Capital Accounts of Partners

Partners may maintain capital accounts in two ways:

• 1. Fixed Capital Method:
• Capital Account — remains fixed (only permanent changes recorded)
• Current Account — records drawings, interest on capital, salary, share of profit/loss

• 2. Fluctuating Capital Method:
• Only one account per partner; all entries (capital, drawings, P&L) go here
• Balance fluctuates every year

Profit and Loss Appropriation Account

• After calculating net profit in the P&L Account, the profit is distributed among partners through the Profit and Loss Appropriation Account. Items on the debit side:
• Interest on Capital (to partners)
• Partner Salary / Commission
• Transfer to reserves (General Reserve, etc.)

• Items on the credit side:
• Net Profit (transferred from P&L A/c)
• Interest on Drawings (from partners)

Remaining balance = Divisible Profit, shared in the agreed ratio.

Interest on Drawings

• If the deed provides for interest on drawings, it is charged to partners:
• Simple interest on specific amounts
• If equal monthly drawings of Rs D at the start of each month: Interest = D x 12 x rate/100 x 6.5/12
• If equal monthly drawings at the end of each month: Interest = D x 12 x rate/100 x 5.5/12
• If equal monthly drawings in the middle of each month: Interest = D x 12 x rate/100 x 6/12

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· Steps: · Net Profit = Rs 1,20,000
Less: Interest on Capital (A) = Rs 8,000
Less: Interest on Capital (B) = Rs 6,000
Less: Salary to A = Rs 12,000
Total Appropriations = Rs 26,000
Divisible Profit = 1,20,000 - 26,000 = Rs 94,000
A gets 94,000/2 = Rs 47,000 and B gets Rs 47,000.

· Steps: · Total parts = 3+2+1 = 6
X = (3/6) x 90,000 = Rs 45,000
Y = (2/6) x 90,000 = Rs 30,000
Z = (1/6) x 90,000 = Rs 15,000

· Steps: · Since there is no partnership deed, provisions of the Indian Partnership Act apply — no interest on capital is allowed. P and Q will share profits equally regardless of capital contribution.

· Steps: · Total drawings = 5,000 x 12 = Rs 60,000
Interest = 60,000 x 6/100 x 6.5/12 = Rs 1,950
(6.5 months is the average time because the first drawing is outstanding for 12 months and the last for 1 month; average = (12+1)/2 = 6.5)

· Dr side: · Drawings Rs 30,000; Balance c/d Rs 34,000 · Cr side: · Salary Rs 24,000; P&L Appropriation (Profit) Rs 40,000
Total both sides = Rs 64,000. Closing credit balance = Rs 34,000.

· Interest on Capital: · A = 1,50,000 x 8% = Rs 12,000; B = 1,00,000 x 8% = Rs 8,000; C = 50,000 x 8% = Rs 4,000; Total = Rs 24,000.
Remaining profit = 60,000 - 24,000 = Rs 36,000
Shared 2:2:1: A = 14,400; B = 14,400; C = 7,200

| Basis | Fixed Capital | Fluctuating Capital |
|---|---|---|
| Number of accounts | Two (Capital + Current) | One (Capital only) |
| Capital balance | Remains fixed | Changes every year |
| Entries for P&L, drawings | In Current A/c | In Capital A/c |
| When used | Usually in large firms | Smaller firms |