Partnership Account

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Meaning of Partnership

Partnership Account, As the business expands, one needs more capital and a bigger number of individuals to manage the business and share its risks. when two or more persons close to establishing business and share its profits. On many issues affecting the distribution of profits, there might not be any specific agreement between the partners. Calculation of capital interest & interest on drawings and maintenance of partners capital accounts have their own peculiarities. Not only that a spread of adjustments are required on the death of a partner or when a replacement partner is admitted then on.

Nature of Partnership

When two or more persons join hands to line up a business and share its profits and losses, they’re said to be in partnership Account. As per act Section, 4 of the Indian Partnership 1932 defines partnership because the relation between persons who have agreed to share the profits or loss of a business born by all or any of them. The name under which the business is carried is named the ‘firm’s name’. A partnership firm has no separate legal entity, aside from the partners constituting it. Thus, the essential features of partnership are:

1. Two or More Persons

So as to make a partnership, there should be a minimum of two persons coming together for a standard goal. The minimum number of partners during a firm are often two. a limit on their maximum number. Section 464 of the businesses Act 2013, the Central Government is prescribed a maximum number of partners during a firm but the number of partners can not be more than 100. The Central government has prescribed the utmost number of partners during a firm to be 50 under Rule 10 of the businesses (Miscellaneous) Rules, 2014, So, a partnership firm cannot have more than 50 partners.

2. Agreement

A partnership is that the results of an agreement between two or more persons to try to business and share its profits and losses. The agreement becomes the idea of the connection between the partners. That such agreement is in written form and oral agreement is equally valid. But so as to avoid disputes, it’s preferred that the partners have an agreement.

3. Business

The agreement should be to hold on to some business. Mere co-ownership of a property doesn’t amount to a partnership. For example, if Partners jointly purchase a plot of land, they become the joint owners of the property and not the partners. But if they’re within the business of purchase and sale of land for the aim of creating a profit, they’re going to be called partners.

4. The Mutual Agency

The partnership concern may be borne by all the partners or any of them acting for all. This statement has two important implications. Normally, that there exists a relationship of mutual agency between all the partners. Each partner carrying on the business is that the principal also because the agent for all the opposite partners. He can bind other partners by his acts and is also bound by the acts of other partners with reference to the business of the firm. The relationship of the mutual agency is so important that one can say that there would be no partnership if the element of mutual agency is absent.

5. Sharing of Profit

Another important element of the partnership is that the agreement between partners must be to share the profits and losses of a business. Though the definition contained within the Partnership Act describes the partnership because the relationship between people that comply with share the profits of a business, the sharing of loss is implied. Thus, sharing of profits and losses is important.

6. Liability of Partnership

Each partner is liable jointly with all the opposite partners and also severally to the third party for all the acts of the firm done while he is a partner. The liability of a partner for acts of the firm is additionally limited. That his private assets also can be used for paying off the firm’s debts.

Partnership Deed

The partnership comes into existence as a result of an agreement among the partners. The agreement can be either oral or written. The Partnership Act doesn’t require that the agreement must be in writing. But wherever it’s in writing, the document, which contains the terms of the agreement is named ‘Partnership Deed’. It generally contains the small print about all the aspects affecting the connection between the partners including the target of business, the contribution of capital by each partner, ratio during which the profits and therefore the losses are going to be shared by the partners and entitlement of partners to interest on capital, interest on the loan, etc. The clauses of the partnership deed are often altered with the consent of all the partners. The deed should be properly drafted and ready as per the provisions of the ‘Stamp Act’ and preferably registered with the Registrar of Firms. be used for paying off the firm’s debts.

Provisions Relevant for Accounting

The important provisions affecting are as follows:

(a) Share 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, regardless of their capital contribution to the firm.

(b) Interest on Capital

No partner is entitled to say any interest on the quantity of capital contributed by him within the firm as a matter of right. However, interest is often allowed when it’s expressly agreed to by the partners. Thus, no interest on capital is payable if the partnership deed is silent on the difficulty. The interest is payable only out of the profits of the business and not if the firm incurs losses during the amount.

(c) Interest on Drawings

No interest is to be charged on the drawings made by the partners if there is no declare in the Deed.

(d) Interest on Advances

If any partner has advanced some money to the firm exceeding the amount of his capital for the purpose of business, he shall be allowed to get an interest on the amount of 6 per cent per annum.

(e) Remuneration for Firm’s Work

No partner is entitled to get a salary or other remuneration for taking part in the conduct of the business of the firm unless there is a provision for an equivalent within the Partnership Deed.

The Indian Partnership Act specifies that subject to a contract between the partners:
(i) If a partner derives any profit for him/herself from any transaction of the firm or from the utilization of the property or business connection of the firm, he/she shall account for the profit and pay it to the firm.
(ii) If a partner carries on any business of an equivalent nature as and competing thereupon of the firm, he/she shall account for and pay to the firm, all profit made by him/her in that business.

Special Aspects of Partnership Accounts

Accounting treatment for a partnership firm is similar to that of a sole proprietorship business with the exception of the following aspects:
• Maintenance of Partners’ Capital Accounts;
• Distribution of Profit and Loss among the partners;
• Adjustments for the Wrong Appropriation of Profits in the Past;
• Reconstitution of the Partnership Firm;
• Dissolution of Partnership Firm.

Maintenance of Capital Accounts of Partners

All transactions concerning partners of the firm are recorded within the books of the firm through their capital accounts. This includes the quantity of cash brought in as capital, withdrawal of capital, the share of profit, interest on capital, interest on drawings, partner’s salary, commission to partners, etc. There are two methods by which the capital accounts of partners are often maintained. The difference between the 2 lies in whether or not the transactions aside from the addition/withdrawal of capital are recorded within the capital accounts of the partners.

(a) Fixed Capital Method

In the fixed capital method, the capitals of the partners shall remain fixed unless additional capital is introduced or a neighbourhood of the capital is withdrawn as per the agreement among the partners. All items like a share of profit or loss, interest on capital, drawings, interest on drawings, etc. are recorded during a separate account, called Partner’s accounting.

The partners’ capital accounts will always show a credit balance, which shall remain an equivalent (fixed) year after year unless there’s any addition or withdrawal of capital. The partners’ account, on the other hand, may show a debit or a credit balance. Thus under this method, two accounts are maintained for every partner viz., capital account and accounting, 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 a credit balance and on the assets side if they have a debit balance.

(b) Fluctuating Capital Method

Under the fluctuating capital method, just one account, i.e. capital account is maintained for each partner. All the adjustments like a share of profit and loss, interest on capital, drawings, interest on drawings, salary or commission to partners, etc are recorded directly within the capital accounts of the partners. This makes the balance in the capital account fluctuate from time to time. That’s the rationale why this method is known as fluctuating capital method.

The distinction between Fixed and Fluctuating Capital Accounts

Basis of Distinction Fixed Capital Account Fluctuating Capital Account
( i ) Number of Accounts Under this method, two separate accounts are maintained for each partner viz. ‘capital account’ and ‘current account’. Each partner has one account i.e. capital account, under this method.
( ii ) Adjustments Adjustments for drawings salary, interest on capital, etc. are made within the current accounts and not within the capital accounts. All adjustments for drawings, salary interest on capital, etc., are made within the capital accounts,
( iii ) Fixed Balance Capital account balance remains unchanged unless there’s an addition to or withdrawal of capital. Capital account balances fluctuated from year to year.
( iv ) Credit Balance The capital accounts always show a credit balance. The capital account may sometimes show a debit balance.

Distribution of Profit among Partners

The profits and losses are distributed among the partners in an agreed ratio. In the case of a partnership, certain adjustments like interest on drawings, interest on capital, salary to partners, and commission to partners are required to be made. For this purpose, it’s customary to organize a Profit and Loss Appropriation Account of the firm and ascertain the ultimate figure of profit and loss to be distributed among the partners, in their share ratio.

Profit and Loss Appropriation Account

The profit and Loss Appropriation Account is simply an extension of the Profit and Loss Account of the firm. It shows how the profits are appropriated among the partners. All entries in respect of partner’s salary, partner’s commission, interest on capital, interest on drawings, etc. are made through this account. It starts with internet profit/net loss as per Profit and Loss Account is transferred to the present account.

Calculation of Interest on Capital

No interest is allowed on partners’ capitals unless it’s expressly agreed upon among the partners. When the Deed specifically provides for it, interest on capital is credited to the partners at the agreed rate with regard to the period of time that the capital remained in business during a financial year. Interest on capital is usually provided for in two situations: (i) when the partners contribute unequal amounts of capitals but share profits equally, and (ii) where the capital contribution is the same but profit sharing is unequal.

Interest on capital is calculated with due allowance for any addition and withdrawal of capital during the accounting period. for instance, Ram, Shyam and Gopal entered into a partnership, bringing in Rs. 3,00,000, Rs. 2,00,000 and Rs. 1,00,000 respectively into the business. They decided to share profits and losses equally and agreed that interest on capital is getting to be provided to the partners @10 per cent once a year. That was no addition or withdrawal of capital by any partner during the year. The interest on capital works bent Rs. 30,000 (10% on 30,000) for Ram, Rs. 20,000 (10% on 2,00,000) for Shyam, and Rs. 10,000 (10% on 1,00,000) for Gopal.

Take another case of Mansi and Rashmi who are partners during a firm and their capital accounts showed the balance of Rs. 2,00,000 and Rs. 1,50,000 respectively on April 1, 2016. Mansi introduced additional capital of Rs. 1,00,000 on Lammas, 2016, and Rashmi brought in further capital of Rs. 1,50,000 on October 1, 2016. Interest is to be allowed @ 6% p.a. on the capitals. It shall be worked as follows:

For Mansi ( Rs. 2,00,000 x 6/100) + ( Rs.1,00,000 x 6/100 x 8/12)

= Rs.12,000+Rs. 4,000= Rs. 16,000

For Rashmi ( 1,50,000 x 6/100) + ( Rs. 1,50,000 x 6/100 x 6/12)

= Rs. 9,000+Rs. 4500 = Rs. 13,500

When there are both addition and withdrawal of capital by partners during a financial year, the interest on capital is calculated as follows:
(i) On the opening balance of the capital accounts of partners, interest is calculated for the entire year;
(ii) On the extra capital brought in by any partner during the year, interest is calculated from the date of introduction of additional capital to the Judgment Day of the financial year.
(iii) On the quantity of capital withdrawn (other than usual drawings) during the year interest for the amount from the date of withdrawal to the Judgment Day of the financial year is calculated and deducted from the entire interest calculated under
points: (i) and (ii) above. Alternatively, it can be calculated with respect to the amounts that remained invested for the relevant periods.

Interest on Drawings

The partnership agreement can also provide for the charging of interest on money withdrawn out of the firm by the partners for his or her personal use. if the partnership deed so provides for it, the interest is charged at an agreed rate, for the amount of money that remained outstanding from the partners during an accounting year. Charging interest on drawings deflated excessive amounts of drawings by the partners.

The calculation of interest on drawings under different situations is hereunder.

When Fixed Amounts is Withdrawn Every Month

Many a time, a hard and fast amount of cash is withdrawn by the partners, at an equal interval, say monthly or each quarter. While calculating the period of time, attention must be paid as to if the fixed amount was withdrawn at the start (first day) of the month, middle of the month or at the end of the month. If withdrawn on the first day of every month, interest on the total amount will be calculated for 6½ months; if withdrawn at the end of every month, it will be calculated for 5½ months, and if withdrawn during the centre of the month, it’ll be calculated for six months.

When Fixed Amount is withdrawn Quarterly

When a fixed amount of money is withdrawn quarterly by partners, in such a situation, for the purpose of calculation of interest, the total period of time is ascertained depending on whether the cash was withdrawn at the start or at the top of every quarter. If the quantity is withdrawn at the start of every quarter, the interest is calculated on the entire money withdrawn during the year, for a period of seven and half months and if withdrawn at the end of each quarter it will be calculated for a period of 4½ months.

When Varying Amounts are Withdrawn at Different Intervals

When the partners withdraw different amounts of cash at different time intervals, the interest is calculated using the merchandise method. Under the merchandise method, for every withdrawal, the cash withdrawn is multiplied by the amount (usually expressed in months) that remained withdrawn during the fiscal year. The period is calculated from the date of the withdrawal to the Judgment Day of the accounting year. The products so calculated are totalled and interest for 1 month at the required rate is figured out, on the entire of the products.

When Dates of Withdrawal are not specified
When the entire amount withdrawn is given but the dates of withdrawals aren’t specified, it’s assumed that the quantity was withdrawn evenly throughout the year. For example; Shakila withdrew Rs. 60,000 from partnership firm during the year ending March 31, 2015, and therefore the interest on drawings is to be charged at the speed of 8 per cent once a year. For calculation of interest, the amount would be taken as six months, which is that the average period assuming, that quantity is withdrawn evenly within the middle of the month, throughout the year.

Guarantee of Profit to a Partner

Sometimes a partner is admitted into the firm with a guarantee of a particular minimum amount by way of his share of profits of the firm. Such assurance could also be given by all the old partners during a certain ratio or by any of the old partners, individually to the new partner.

The minimum guaranteed amount shall be paid to such a replacement partner when his share of profit as per the profit-sharing ratio is a smaller amount than the guaranteed amount.

For example, Madhulika and Rakshita, who are partners during a firm plan to admit Kanishka into their firm, giving her the guarantee of a minimum of Rs.25,000 as her share in the firm’s profits. The firm earned a profit of Rs.1,20,000 during the year and therefore the agreed share ratio between the partners is set as 2:3:1. As per this ratio, Madhulika’s share in profit involves Rs.40,000 (2/6 of Rs. 1,20,000); Rakshita, Rs. 60,000 (3/6 of Rs. 1,20,000) and Kanishka Rs. 20,000 (1/6 of Rs. 1,20,000). The share of Kanishka works bent be Rs.5,000 in need of the guaranteed amount. This shall be borne by the guaranteeing partners Madhulika and Rakshita in their share ratio, which during this case is 2:3, Madhulika’s share within the deficiency involves Rs.2,000 (2/5 of Rs. 5,000), and that of Rakshita Rs.3,000. The total profit of the firm will be distributed among the partners as follows Madhulika will get Rs.38,000 (her share 40,000 minus share in deficiency Rs.2,000); Rakshita Rs.57,000 (60,000–3,000) and Kanishka Rs. 25,000 (Rs. 20,000 + Rs. 2,000 + Rs. 3,000).

If just one partner gives the guarantee, say within the above case, only Rakshita gives the guarantee, the entire amount of deficiency (Rs.5,000) are going to be borne by her only. In that case, profit distribution are going to be Madhulika Rs.40,000, Rakshita Rs. 55,000 (60,000–5,000) and Kanishka Rs. 25,000 (Rs. 20,000 + Rs. 5,000).

Past Adjustments

Sometimes a few errors in the recording of transactions or the preparation of summary statements are found after the final accounts are prepared and the profits distributed among the partners. The error could also be in respect of interest on capitals, drawings, partners’ loan, partner’s salary, partner’s commission and outstanding expenses. There can also be some changes within the provisions of partnership deed or system of accounting having an impression with retrospective effect. All these acts of error and commission need adjustments for correction of their impact. Instead of altering old accounts, necessary adjustments are often made either; (a) through ‘Profit and Loss Adjustment Account’, or (b) directly within the capital accounts of the concerned partners.

This is explained with the assistance of the subsequent example.

Rameez and Zaheer are equal partners. Their capitals as of April 01, 2015, were Rs. 50,000 and Rs. 1,00,000 respectively. After the accounts for the fiscal year ending March 31, 2016, have been prepared, it’s discovered that interest at the speed of 6 per cent once a year, as provided within the partnership deed has not been credited to the partners’ capital accounts before distribution of profit. In this case, the interest on capital not credited to the partners’ capital accounts works bent be Rs. 3000 (6/100 × Rs. 50,000) for Rameez and Rs. 6,000 (6/100 × Rs. 1,00,000) for Zaheer.

By this omission, the whole amount of profit as per the Profit and Loss Account (without adjustment of Rs. 9,000) has been distributed among the partners in their share ratio, and therefore the amounts of interest on capital haven’t been credited to their capital accounts.

Final Accounts

The final accounts of a partnership firm are prepared within the same way as those prepared for a sole trading concern with only one difference which relates to the distribution of profit among the partners. After preparing the Trading and Profit and Loss Account, internet profit or net loss is transferred to an account called Profit and Loss Appropriation Account as discussed.

As you know, all adjustments in respect of interest on capital, interest on drawings, partner’s salary, partners’ share of profit and loss, interest on partner’s loan, etc. are made from the Profit and Loss Appropriation Account. This is done in order to distinguish between the results of operations of the business and the distribution of the profit among the owners.

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