Accounting for Partnership: Basic Concepts — Notes

Partnership (Indian Partnership Act, 1932): a relation between persons who agree to share the profits of a business carried on by all of them or by any of them acting for all.

Features: two or more persons (maximum 50, under the Companies Act, 2013 and its rules); an agreement, oral or written; a lawful business; sharing of profits; mutual agency; unlimited liability. Registration of a firm is optional.

Partnership deed: the written agreement. It usually covers the names of the firm and partners, nature and duration of business, capitals, profit-sharing ratio, interest on capital, drawings and loans, salaries and commission, accounting rules, and rules for admission, retirement, death, goodwill, disputes and dissolution.

When the deed is silent (the Act applies):

• profits and losses shared equally;
• no interest on capital; no interest on drawings;
• no salary or commission to any partner;
• interest on a partner's loan at 6% per annum, a charge against profit.

Fixed capital method: two accounts per partner.

• Capital account: opening capital, additional capital (credit), capital permanently withdrawn (debit). Always a credit balance.
• Current account: interest on capital, salary, commission, share of profit (credit); drawings, interest on drawings, share of loss (debit). May have a debit balance.

Fluctuating capital method: one capital account per partner records all these items; its balance changes every year. Use it when a question names no method.

Finding opening capital from closing capital: closing capital + drawings + interest on drawings + share of loss − share of profit − interest on capital − salary − commission − additional capital = opening capital.

Charges (Profit and Loss Account): interest on a partner's loan, rent paid to a partner, salaries of employees. Allowed even in a loss.

Appropriations (Profit and Loss Appropriation Account): interest on capital, salary and commission to partners, transfer to reserve, shares of profit. Allowed only out of profit.

Format: credit net profit and interest on drawings; debit interest on capital, salary, commission and reserve; the balance (divisible profit) is credited to partners in the profit-sharing ratio.

Interest on capital:

• on opening capital for the year; on additional capital from its date; reduced for capital withdrawn from its date;
• deed silent: none;
• appropriation, enough profit: full interest;
• appropriation, profit short: the whole profit is shared in the ratio of interest due;
• appropriation, loss: no interest;
• charge: full interest debited to the Profit and Loss Account, even if it causes a loss.

Interest on drawings is charged only if the deed provides; it is credited to the appropriation account and debited to the partner.

• Equal amounts at regular intervals: interest = total drawings × rate ÷ 100 × average period ÷ 12.
• Average period: monthly 6½ / 6 / 5½ months (beginning / middle / end); quarterly 7½ / 6 / 4½; half-yearly 9 / 6 / 3.
• Dates not given: 6 months.
• Unequal amounts or dates (product method): multiply each amount by the months left to the year end, add the products, and charge interest for one month on the total.

Salary and commission to partners are appropriations, payable only if the deed provides.

• Commission on profit before charging it = profit × rate ÷ 100.
• Commission on profit after charging it = profit × rate ÷ (100 + rate).

Guarantee to a partner: a partner is promised a minimum share. Divide the profit normally; if the share is below the minimum, the deficiency is borne by:

• the firm: all other partners in their mutual profit-sharing ratio;
• one partner: that partner alone;
• some partners: in the ratio they agreed.

In the appropriation account the guaranteed partner is shown with the minimum and the guarantors with their reduced shares (or the deficiency is passed by an entry: guarantor's capital Dr., to guaranteed partner's capital).

Guarantee to the firm: a partner promises that the firm will earn at least a stated profit. The shortfall is brought in by that partner (debited to his capital, credited to the appropriation account) and the full guaranteed profit is divided among all partners.

The firm's total profit is never changed by a guarantee to a partner.

Errors or omissions found after the accounts are closed (interest on capital or drawings, salary, commission, wrong profit-sharing ratio) are corrected without reopening the accounts.

Method:

1. For each partner, list what should have been credited (+) or debited (−).
2. Deduct what was actually credited (reverse the profit wrongly shared).
3. Find the net effect; the net effects of all partners total zero.
4. Pass one entry: debit the partners who lose, credit those who gain (current accounts if capitals are fixed, capital accounts if fluctuating).

If only an appropriation such as interest on capital is omitted, the same total is taken back from the partners in the profit-sharing ratio.

Goodwill is the value of a firm's reputation that lets it earn more than a normal profit. It is an intangible asset (not fictitious) and cannot be sold apart from the business. Under Accounting Standard 26, only purchased goodwill is recorded.

Factors: nature of business, location, efficiency of management, market situation, special advantages (patents, licences, contracts), period in business.

Valuation (use normal profits: add back abnormal losses, remove non-recurring gains, deduct a fair salary for unpaid partner work):

• Average profit: goodwill = average profit × number of years' purchase.
• Weighted average profit: weighted average = sum of (profit × weight) ÷ sum of weights; × years' purchase.
• Super profit: normal profit = capital employed × normal rate ÷ 100; super profit = average profit − normal profit; goodwill = super profit × years' purchase.
• Capitalisation of average profit: capitalised value = average profit × 100 ÷ normal rate; goodwill = capitalised value − capital employed.
• Capitalisation of super profit: goodwill = super profit × 100 ÷ normal rate.

Capital employed = total assets (excluding goodwill and fictitious assets) − outside liabilities.