Accounting for Partnership: Basic Concepts

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Accounting for Partnership

Accountancy is the primary subject you must study to kick-start your career in the business world. Class 12th accountancy familiarises students studying commerce with maths or commerce without maths with the basic concepts of accounting, presentation and preparation of financial statements and helps develop the skills essential for accounting. In this blog, we will summarise the second chapter in Class 12 Accountancy, i.e. Accounting for Partnership: Basic Concepts for a quick revision!

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Partnership and Features

According to the chapter accounting for partnership, a partnership is defined as a relationship between two or more people who come together to establish a business and share its profits and losses. According to the Indian Partnership Act, a partnership is defined as a relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. There are certain features shared by all partnerships:

  • Two or More Persons: A firm to be called a partnership must have two or more partners. According to Section 464, Companies Act 2013, the Central Government has the power to set a maximum number of partners in any partnership. The maximum number is 50.
  • Agreement: Any partnership requires an agreement that forms the relationship between two or more people. The agreement can be oral or written even though the latter is preferable to avoid conflict in the future. 
  • Business: The intent of business is crucial to any partnership. 
  • Mutual Agency: A crucial aspect of a partnership, it implies that all partners have the right to participate in the business affairs of the firm.
  • Sharing Profits: All firms/partnerships have an agreement to share all profits and losses.
  • Liability of Partners: All partners are liable for the actions of the partnership, this means that any or every partner’s personal assets can be used to pay off debts accrued by the partnership.

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Partnership Deed

A partnership deed refers to the written agreement signed and verified by all the partners of a firm as per the chapter accounting for partnership. The partnership agreement can be in oral or written format and it is a partnership deed when:

  • The document is written with the consent of all partners.
  • It contains the terms of the agreement and all the relevant details like names of the partners, objective & nature of the business, profit and loss sharing ratio, capital given by every partner, accounting period, date of commencement, etc.
  • It is a partnership deed when it is drafted according to the Stamp Act and registered with the Registrar of Firms.  

Provisions of the Indian Partnership Act

Here are some provisions of the Indian Partnership Act as mentioned in the chapter accounting for partnership that apply to the partnership deeds. They are: 

  • Profit-Sharing Ratio: The profit and losses are equally divided amongst all partners if the partnership deed does not state otherwise.
  • Interest on Capital: Partners cannot claim interests on the capital contributed by them if the partnership deed does not specify it.
  • Interest on Drawings: There can be no interest in drawings made by partners.
  • Interest on Loans: If any partner has given a loan to the partnership firm, then she/he can claim interest on the same at a 6% rate per annum.
  • Remuneration of Firm’s Work: Partners are not entitled to get a salary unless it is otherwise stated in the partnership deed.

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Special Aspects of Partnership Accounts

According to accounting for partnership, there are certain aspects of partnership accounts that set them apart from other businesses:

Maintenance of Capital Accounts of Partners

  • The transactions in the capital accounts of all the partners must be maintained and recorded by the firm. The accounts contain a record of capital contribution and withdrawal, the share of profits, interest on capital, interest on drawings, etc. 
  • There are two ways to maintain capital accounts; fixed capital method and fluctuating capital method.
  • Under the fixed capital method, two accounts are maintained for each partner. The two accounts are a capital account and a current account. The former shows partners’ capital contribution while other items like profit, interest, and salary are recorded under the current account. The initial capital is fixed unless there is some addition or withdrawal.
  • Under the fluctuating capital method, only one account is maintained, i.e. capital account, and the amount keeps on fluctuating because it records all items.  

Distribution of Profit among Partners

  • We already know that the profit and loss are equally divided amongst all partners according to the Partnership Act of India unless the partnership deed provides a specific ratio. Hence, to distribute the profit and loss, firms prepare the Profit and Loss Appropriation Account.
  • A profit and loss appropriation account is similar to a profit and loss account. The objective of the account is to appropriate profits after making adjustments with respect to other items like the partner’s salary, commission, interest on drawings etc. 

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Format of Profit and Loss Appropriation Account

The chapter accounting for partnership mentions that there is a particular format of profit and loss appropriation account. Tabulated below is the format for the same. 

ParticularsAmount ParticularsAmount
Profit & loss
(If there is a loss)
Profit & loss
(If there is a profit)
Interest on capitalInterest on drawings
Salary to PartnerPartners’ Capital
and current
account(distribution of loss)
Commission to Partner
Partners’ Capital and
current account
(distribution of profit)

Interest on Capital

Generally, partners do not receive any interest in the capital contribution made to the firm according to accounting for partnership. If the deed states that interest must be credited, it is given at an agreed rate. There are two circumstances under which interest is given. When the contribution to capital is more and the profits are divided equally, and two, when the contribution is equal, and profit-sharing is unequal.  

Interest on Drawing

Just as there is no interest charged on the capital, there is no interest charged on drawing the capital unless the deed explicitly says so. Interest is often charged on drawings to discourage partners from withdrawing their capital for personal use. 

There are different ways to calculate interest for different time periods under which capital is withdrawn:

  • When the amount is withdrawn at the beginning of each month: 
    Average Period = No. of months of 1 drawings + No. of months of last drawings/ 2 
  • When the amount is withdrawn at the end of each month 
    Average Period = No. of months of 1 drawings + No. of months of last drawings/ 2
  • When money is withdrawn in the middle of the month
  • Average Period = No. of months of 1 drawing + No. of months of last drawings
    Similarly, when the amount is withdrawn on a quarterly basis, then the interest is calculated based on whether the money was withdrawn at the beginning or at the end of the quarter.

Guarantee of Profit to a Partner

Sometimes, all partners or old partners guarantee a minimum account of profit to a new partner when their share of profit is less than the profit-sharing ratio as per the chapter on accounting for partnership. The difference is either borne by all partners or the ones who gave the guarantee.

Past Adjustments

In the last part of the chapter on accounting for partnership, there is mention of past adjustments. Often, certain discrepancies are revealed after the final accounts have been prepared and profits appropriated. Discrepancies can be adjusted through a profit and loss adjustment account or by making changes in the capital accounts of the partners.

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This is where we end our notes on Accounting for Partnership: Basic Concepts! Hopefully, these notes were great for a quick revision. For more exciting educational content, follow Leverage Edu on Facebook, Quora and Linkedin.

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