Meaning of Partnership * A partnership firm is an association of two or more persons to carry on a legal business and share its profits or losses. The persons who join hands together to do a business are individually known as partners and collectively a firm.¢ According to Sec 4 of the Indian Partnership Act, 1932, "the term partnership is the relation between two or more persons who have agreed to share the profit of the business carried on by all or any of them acting for allEssential elements of Partnership e1, At least two persons: There must be at least two persons to form a Partnership and all such persons must be competent to contract. e2, Agreement: There must be an agreement to form a partnership. This agreement can be oral or written. e3, Legal Business: An agreement should be for the purpose of carrying on the business or profession. The business to be carried on by the Partners should be legal.* 04. Profit Sharing: The agreement between the partners must be to share the profits or losses of the business in the particular ratio. e5 Mutual agency: There should be a mutual agency relationship among the partners. ‘Mutual Agency' relationship means that each partner is both an agent and the principal. Each partner is an in the sense that he can bind the other partners by his acts done. 6. Number of partners: The minimum limit of the partners in a firm is two and maximum number of partners in a banking firm should be 10 and in the other firm should be 20.Meaning of Partnership Deed * As stated above a partnership is formed by an agreement. This agreement can be oral or written. Though the law does not expressly require that there should be an agreement in writing but the absence of written agreement may be the source of problem in managing the affairs of the partnership firm.Contents of Partnership deed 1. Name of the firm. 2. Name and addresses of all the partners. 3. Nature and place of the business. 4. Duration of partnership. 5. Date of commencement of partnership. 6. Amount of capital contributed by each partners. 7. Ratio in which profits and losses are to be shared.8. Interest on partner's capital and drawings. 9. Interest on loan by the partner to the firm. 10. Salary, Commission, etc. if any payable to a partner. 11. Method of computation and treatment of Goodwill on the reconstitution of the firm. 12. Mode of settlement of accounts in case of retirement/death of a partner. 13. Mode of settlement of accounts in case of dissolution of the firm.Rules in the absence of the Partnership Deed * (i) The partners will share the profits and losses in the equal ratio. * (ii) Interest on loan will be given @ 6% p.a. to the partners. * (iii) No interest is allowed to partners on the capital invested by them.* (iv) No partner .is ta get any remuneration such as salary, commission etc for participating in the business. * (v) No interest will be charged on drawings made by the partners.ee ee ee ee ee Meaning of Profit and Loss Appropriation Account: * Profit and Loss Appropriation Account is an extension of Profit and Loss Account that is prepared to distribute the net profit among the partners. All adjustments relating to partners like interest on capital, interest on drawings, commission to partners etc. are made in this Account.Purpose of Profit & Loss Appropriation Account: * The main purpose of preparing Profit & Loss Appropriation Account of a Partnership concern is to calculate and distribute the divisible Profit & Loss. The Income Tax Act and the audit rule does not permit the partnership firm to consider the amount as business expenditure which is payable to the partnersProfit & Loss Appropriation Account To Transfer to Reserve To interest on Capital A xX 8 008 c xxx To Partner's Salary To Bonus/Commission to PartnerAccounting Treatment Ttems Accounting Entries Capital contributed in cash Dr. Cash Cr.__ Partners’ Capital Accounts Share of profits Dr. Profit and Loss Appropriation Cr.__ Partners’ Current Accounts. Share of losses Dr. Partners’ Current Accounts Cr. Profit and Loss Appropriation Interest on capital Dr. Profit and Loss Appropriation Partners’ salaries | __Cr,__ Partners’ Current Accounts | Dr. Cr. Profit and Loss Appropriation Partners’ Current AccountItems Interest on partners’ loan Accounting entries Dr Profit and loss appropriation Cr Partners’ current Partners’ drawings Dr Partners’ current Cr Partners Drawings Interest on drawings Dr Partners’ current Cr Profit and loss appropriationMethods of Maintaining Capital Accounts of the Partners * The partner's Capital Accounts are maintained according to Fluctuating Capital Method or Fixed Capital Method.Fluctuating Capital Method ¢ Under fluctuating capital method, only one account viz. capital account for each partner is maintained and all the transactions relating to a partner are recorded in his capital account. As a result, the balance in the Capital Account keeps on fluctuating.PARTNER'S CAPITAL A/C Particular To balance b /f To cash/bank A/c ( withdrawl } To drawings To interest on drawings To Profit & Loss A/c (share of loss) To balance c/f eee oon teen eeee Particular By balance b/f By cash/bank (additional capital) By interest on capital By salary By Commission By P&L Appropriation A/c (share of profits) By balance c/f teee esee tees sees see8Fixed Capital Account: * Under Fixed Capital method, two accounts viz. capital account and current account for each partner are maintained. The transactions relating to introduction or withdrawal of capital are recorded in Capital Account and other transactions like interest on capital, salary, interest on drawings, drawings are recorded in Current Account.Dr. Particular To cash/bank A/c (withdrawal) To balance c/f Partner's Capital Account Particular By balance b/f By cash/bank (additional capital) By balance ¢/f tone teen tees Cr.Partner's Current Account Cr. Particular Rs. Particular Rs. **** By balance b/f **** By interest on capital By salary By Commission **** By P&L Appropriation A/c (share *e** | of profits) By balance c/f To balance b/f To drawings To interest on drawings To Profit & Loss A/c (share of loss) To balance c/f teesDistinction between Fixed Capital Method and Fluctuating Capital Method ‘Change in Capital No of accounts Adjustments of drawings etc. Negative Balance txea Laprai metnoa ructuating Laprtai metnoa The capital remains unchanged except in The capital fluctuates quite frequently from some special circumstances period to period ‘Two accounts are maintained viz: capital One account is prepared i.e. capital account. account and current account All adjustments of drawings, salary etc All adjustments of drawings, salary etc are are done in capital account done in current account Fixed Capital Account can never show a_ Fluctuating Capital Account can show a negative balance. negative balance.Basis Need DIFF. B/W CAPITAL AND CURRENT A/C Capital Account Current Account Capital Account is opened in the case Current account is prepared only in case of fluctuating capital method and fixed _ fixed capital method. capital method Nature of accountCapital account in fixed capital method Current account fluctuates from year to Accounting treatment Balance of account remains fixed from year to year. year. Amount invested by the partner isto Transactions such as drawings, salary, and be recorded. interest on capital are recorded. Capital account in fixed method show Current account can show a credit or debit only credit balance. balanceBasis Debited Part Interest Drawings against capital It is debited in capital account It is a part of capital It is considered in calculation of interest on capital It reduces capital Drawings against profits It is debited in drawings account It is a part of expected profits It is not considered in calculating the interest on capital It does not reduce capital.Need Nature of account ‘Accounting treatment Balance of account Capital Account is opened in the case Current account is prepared only in case o fluctuating capital method and fixed _fixed capital method. capital method Capital account in fixed capital Current account fluctuates from year to method remains fixed from yearto year. year. Amount invested by the partner isto Transactions such as drawings, salary, and be recorded. interest on capital are recorded. Capital account in fixed method show Current account can show a credit or debit only credit balance. balanceCalculation of Interest on drawings: * The drawings are usually made by the partners at regular intervals. Thus, the interest on drawings is calculated with reference to the time period involved. It can be worked out by any one of the following methods:1. When dates of drawings are not given ° (i) Average period method. \f the dates of drawings are not given, the interest on drawings is calculated on the average basis on the total amount of drawings made during the accounting period for half of the accounting period. It is based on the assumption that the amounts were drawn evenly through out the accounting year. Formula: * Interest on drawings = Total drawings x Rate/100 x 6/12(ii) Average rate of interest method or when drawings are made irrespective of the time period: Sometimes the average rate of interest is given in the question, in such a case; itis assumed that the rate of interest is already half on the basis of 6 months. Thus, time will not be considered. Formula: Interest on drawings = Total drawings x Average Rate/100. When dates of drawings are given: (i) | Product Method: When different amounts are withdrawn at different intervals, the interest will be calculated with the help of product method. In this each amount of drawings is multiplied with number of days/months (from the date of drawings to the date of final accounts) to find out the product and then products are totaled. Interest is calculated on total product at the rate of interest for one month or one day. Formula: Interest on drawings = Total of Product x Rate/100 x 1/365 or 1/12* (ii) Monthly/quarterly drawings method:\f uniform amount is withdrawn at each time and the interval between two withdrawals also is uniform. In such a case interest on drawings is calculated with monthly drawings method. Time period in this method is calculated as follows:In that case there will be following cases: ° When drawings are for 12 months period At the beginning of each month = Total drawings x Rate/100 x 6.5/12 At the end of every month = Total drawings x Rate/100 x 5.5/12 At the middle of every month = Total drawings x Rate/100 x 6/12When drawings are for 6 months period * oAtthe beginning of each month = Total drawings x Rate/100 x 3.5/12 * oAtthe end of every month = Total drawings Rate/100 x 2.5/12 * oAtthe middle of every month = Total drawings x Rate/100 x 3/12When drawings are made quarterly during the period * o Atthe beginning of each quarter = Total drawings x Rate/100 x 7.5/12 * oAtthe end of every quarter = Total drawings x Rate/100 x 4.5/12Interest on Partner's Capital: * Interest on capital is to be allowed to the partners if the same is provided in the partnership deed and is allowed at the given rate with reference to time period for which the capital has been used in the business. . Formula: Interest on capital = Amount of Capital x Rate/100 x TimeCase 1. if the partnership agreement is silent for interest on capital. 2. if the partnership agreement provides for interest on capital but is silent as to treatment of interest as a charge or appropriation. 3. Hf the partnership agreement provide for interest on capital as a charge. Provision No Interest on capital will be allowed. Interest on capital will be allowed only if there are profits (a) In case of loss - No interest on capital will be allowed (b) Profit > Interest - Full interest on capital (c) Profit < Interest -Profit will be given capital ratio Full interest on capital will be provided whether there is profit or loss.Salary or Commission to a Partner ° Salary or Commission to a partner is to be allowed if the partnership agreement provides for the same. These are allowed only if there are profits.* Calculation- Commission may be allowed as a percentage of Net Profits before charging such commissions or after charging such commissions. * 1. Commission as % of Net Profit before charging such Commissions = Net profit before commission x Rate of commission/100 * 2. Commission as % of Net Profit after charging such Commissions = Net profit before commission x Rate of commission/100 + Rate of CommissionAccounting Treatment Salary or Commission to a partner being an appropriation out of profits shall be transferred to the debit of P& L Appropriation A/c and credit of the Partner's Capital A/c.Interest on Partner's Loan to a Firm * Rate of Interest- In case any partner has given loan to the firm; he is entitled to interest on such loan at an agreed rate of interest. If there is no agreement as to the rate of interest on loan, the partner is entitled to rate of interest on loan @ 6% per annum. * Interest on loan is debited to P& L A/c and is credited to the Partner's Loan A/c.Guarantee of minimum profit to a partner * Sometimes a partner may be guaranteed a minimum amount of his share in Profit. Such a partner to whom such guarantee has been provided is called guaranteed partner and the partner who had given such guarantee is called guaranteeing partner. Such minimum amount is called guaranteed amount.STEPS: * Step1: Calculate the Actual share of Profit/Loss of Guaranteed Partner for the given accounting period. ¢ Step2: Calculate the amount of deficiency as follows: Deficiency = Guaranteed amount - Actual share of profits ¢ Step 3: Distribute the amount of deficiency among the guaranteeing partners in their guaranteed ratio.* Step 4: Distribute the actual profit/loss among all the partners in their profit sharing ratio as if there is no guarantee arrangement. * Step5: = Recover share of deficiency (as per step 3) from the guaranteeing partners and give credit for the same to the guaranteed partner.