CHAPTER- 1

Accounting of Partnership: Basic Concepts

 Meaning/Definition of Partnership
As per the Partnership Act of 1932, “Partnership is a relationship between two or
more persons who have agreed to share profits and losses from the partnership
business carried by all or any one of them acting for all”.

 Features or Characteristics of Partnership- Minimum two persons are required to

form a partnership.
 As per Rule (10) of Companies (Miscellaneous) Rules Act 2014, the
maximum number of partners permissible is 50.
 Agreement between the partners of a partnership business can be either
written or oral.
 Partnership is formed to carry out business.
 Each partner carrying out business is a principle as well as an agent for all
other partners.
 Liability of partners is not limited to the extent of their capital. Each partner is
liable jointly with all the other partners and also severally to the third party
for all the acts of the firm.

 Partnership Deed
It is a document containing the details about partners and agreement among all the
partners of a partnership firm. It includes agreement on profit sharing ratio, salaries,
commission of partners, interest provided on partner’s capital and drawings and
interest on loan given or taken by the partners, etc.

 Content of a Partnership Deed

A partnership deed provides the following information and agreements: Objective of
business of the firm
 Name and address of the firm
 Name and address of all partners
 Profit and loss sharing ratio
 Contribution to capital by each partner
 Rights, types of roles and duties of partners
  Duration of partnership
 Rate of interest on capital, drawings and loans
 Salaries, commission, if payable to partners.
 Settlement of disputes amongst partners
 Rights and Duties of partners
 Rules regarding admission, retirement, death and dissolution of the firm, etc.

 Importance of Partnership Deed

 It provides information about rights, duties and obligations determined among
the partners.
 It can be produced as evidence in the court of law to settle disputes among the
partners.
 It provides information regarding distribution of profit and regarding the
presentation of Partners’ Capital Accounts.

 Provision in Absence of Partnership Deed

In absence of partnership deed, the following rules are applied. If profit sharing ratio
is not mentioned in the deed, then profit and loss are shared equally among the
partners.
 If interest on capitals is not mentioned in the deed, then no interest shall be
allowed on partners’ capital.
 If interest of drawings is not mentioned in the deed, then no interest shall be
charged on partners’ drawings.
 If interest on the partners’ loans and advances to firm is not mentioned in the
deed, then interest shall be paid at 6% p.a. even, if the firm incurred loss.
 If salary and commission to partners are not mentioned in the deed, then no
salary or commission will be allowed to any partner.

 Profit and Loss Appropriation Account

 It is an extension of Profit and Loss Account.

 It is prepared to show how the profit available for appropriation has been
appropriated among different items such as, interest on capitals, partners’
 remunerations in the form of salary, commissions, etc. It is nominal account
in nature.

 In case of partnership the items of profit due partners such as, interest on
capitals, partners’ remunerations in the form of salary, commissions, are
debited and the items due from partners such as interest on partners’
drawings, Net Profit are credited to the Profit and Loss Appropriation
Account.

 Specimen of the Profit and Loss Appropriation Account

Profit and Loss Appropriation Account

Amount Amount
Particulars Particulars
Rs Rs
Interest on Capitals: Profit and Loss
X (Net Profit for appropriation after
Y adjusting the items of charge
Partner’s Salary: against profit e.g. interest on
X partners loan, manager’s
Y commission, etc.)
Partner’s Commission: Interest on Drawings:
X X
Y Y
Reserve
Profit transferred to (Balancing Figure)
X’s Capital/Current A/c
Y’s Capital/Current A/c

Note: If in the question interest on loan, managers’ commission, outstanding

expenses, accrued income, etc. are mentioned and Profit before charging these
items is given, then there are following two ways of treatment.
 By preparing Profit and Loss Adjustment Account, followed by Profit and
Loss Appropriation Account, or

 By showing profit net of these items on the credit side of the Profit and Loss
Appropriation Account (deducting these items from the Profit).
Example
A and B are equal partners in a partnership business with their capital balances as
on January 01, 2011 are Rs 1,20,000 and Rs 80,000 respectively. Interest on their
capitals amounted to Rs 6,000 and Rs 4,000, Salary to A and B amounted to Rs
2,000 p.a. and Rs 1,500 p.a., interest on the loan forwarded by A to the firm
amounted to Rs 5,000 and the profit earned during the year amounted to Rs 90,000.
Prepare Profit and Loss Appropriation Account to show the appropriation of the
profit.

Solution:
This question can be solved by either of the following two ways.
First Way
Profit and Loss Adjustment Account
Amount Amount
Particulars Particulars
Rs Rs
Interest on A’s Loan 5,000 Profit 90,000

Profit transferred to Profit and 85,000

Loss Appropriation Account
(Balancing Figure)

90,000 90,000

Profit and Loss Appropriation Account

Amount Amount
Particulars Particulars
Rs Rs
Interest on Capitals: Profit and Loss 85,000
A 6,000 (Net Profit for
B 4,000 10,000 appropriation after
Partner’s Salary: adjusting interest on A’s
A 2,000 loan)
B 1,500 3,500
Profit transferred to:
(Balancing Figure)
A’s Capital/Current A/c 35,750
B’s Capital/Current A/c 35,750 71,500
85,000 85,000
 Alternative Method
Profit and Loss Appropriation Account
Amount Amount
Particulars Particulars
Rs Rs
Interest on Capitals: Profit and Loss 85,000
A 6,000 (90,000 – 5,000)
B 4,000 10,000
Partner’s Salary:
A 2,000
B 1,500 3,500
Profit transferred to:
(Balancing Figure)
A’s Capital/Current A/c 35,750
B’s Capital/Current A/c 35,750 71,500
85,000 85,000

 Difference between Profit and Loss and Profit and Loss Appropriation Account
Profit and Loss Appropriation
Points of Difference Profit and Loss Account
Account
Objective It is prepared to ascertain profit It is prepared to show the
earned and expenses and loss appropriation of profit.
incurred from the main course of
business.
Partnership Agreement Items in this account may or may Items in this account are shown as
not be related to the partnership per the partnership agreement.
agreement.
Matching concept It prepared by following the It is prepared by following
matching concept partnership agreement.
Started with It begins with Gross Profit or It begins with Net Profit (Net
Gross Loss. Loss) or the opening balance that
is available for appropriation.

 Partner’s Capital Account

There are two methods of presenting Partners’ Capital Accounts.
 Fixed Capital Account
 Fluctuating Capital Account
 Fixed Capital Account: It is prepared to show the capital contribution and drawings
made (withdrawal of capital) by the partners during an accounting period. The fixed
capital balances remain unaffected by the items of appropriation such as, interest on
capital, share of profit, etc. The following are the two accounts that are prepared
when the Partner’s Capital Accounts are presented by Fixed Capital Account
Method.
 Partners’ Capital Account- This account records the opening capital
balances and closing capital balances. If any fresh capital is introduced during
the accounting period, then it is credited to this account and if any withdrawal
of capital is made then it is debited to this account.

Partner’s Capital Account

Dr. Cr.
Particulars A B Particulars A B
Cash/Bank Balance b/d
(Withdrawal of capital) (Opening Balance)

Balance c/d Cash/Bank

(Closing Balance) (Additional capital)

 Partners’ Current Account- Under Fixed Capital Account Method, besides

the Partners’ Capital Account, a separate account, i.e. Partners’ Current
Account is prepared to show the items of appropriation received by the
partners and charged from the partners.
Partners’ Current Account
Dr. Cr.
Particulars A B Particulars A B
Balance b/d Balance b/d
(In case of debit balance) (In case of credit balance)
Drawings Interest on Capital
Interest on Drawings Partners Salary
Profit and Loss (Loss- if any) Commission
Profit and Loss Appropriation
(Profit)
Balance c/d Balance c/d
(If credit is more than debit) (If debit is more than credit)
 Fluctuating Capital Accounts Method:
Under this method, no separate account is prepared to show the items of
appropriation and drawings etc. In this method, only one account is prepared, i.e.
Partners’ Capital Account.

 Format of Fluctuating Partners Capital Account

Partners Capital Account
Dr. Cr.
Particulars A B Particulars A B
Balance b/d Balance b/d
(In case of debit balance) (Opening balance)
Drawings Cash/Bank
Interest on Drawings (Additional capital)

Profit and Loss (Loss- if any) Interest on Capital

Partners Salary
Commission
Profit and Loss Appropriation
(Profit)
Balance c/d (If credit is more than debit) Balance c/d
(If debit is more than credit)

 Drawings: The amount withdrawn in cash or in form other asset by the partners.

 Interest on Drawings: Interest on Drawings will be charged at the rate prescribed

partnership or orally decided (agreed) by the partners at the time of formation of
partnership.

Treatment of Interest on Drawings

Partners’ Capital A/c Dr.
OR
Partners’ Current A/c Dr. (If capital is fixed)
To Interest on Drawings A/c
(Interest charged on partners’ drawings)

Interest on Drawings A/c Dr.

To Profit and Loss Appropriation A/c
(Interest on drawings transferred to Profit and Loss Appropriation A/c)
 Alternative Method
Partners’ Capital A/c Dr.
OR
Partners’ Current A/c Dr.
To Profit and Loss Appropriation A/c
(Interest charged on partners’ drawings)

 Interest on Capital:
Where will be allowed on capital where rate of interest is given in partnership deed
agreed among the partners at the time of formation of partnership.

Accounting Treatment:
Interest on Capital A/c Dr.
To Partners’ Capital A/c
OR
To Partners’ Current A/c (If capital are fixed)
(Interest on capital allowed to partners)

Profit and Loss Appropriation A/c Dr.

To Partner on Capital A/c

Alternative Method
Profit and Loss Appropriation A/c Dr.
To Partners’ Capital A/c
OR
To Partners’ Current A/c (If Capital are fixed)
(Interest allowed on partners’ capital)

 Calculation of Interest on Partner’s Capital

When there is no change in the capital balances

Example:
A and B are the partners in a business their capital as on January 01, 2012 were Rs
1,00,000 and Rs 80,000 respectively.
A B
Capital 1,00,000 80,000
Interest on Capital:
6
A = 1,00,000   Rs 6,000
100
6
B = 80,000   Rs 4,800
100

When capital is withdrawn or fresh capital is introduced during the year

Example:
A B
Opening Balances (January 01, 2012) Rs 1,00,000 Rs 80,000
Drawings (July 01, 2012) Rs 20,000 –
Additional Capital Introduced (July 01, 2012) – Rs 20,000
Additional Capital Introduced (October 01, 2012) Rs 30,000 –

Solution:
Simple Interest Method
Interest on A’s Capital
Capital
During 2012 Months Product
Balances
6 6
From Jan. 01 to June 30 1,00,000 6 1,00,000    Rs 3,000
100 12
6 3
From July 01 to Sep. 30 80,000 3 80,000   = Rs 1,200
100 12
6 3
From Oct. 01 to Dec. 31 1,10,000 3 1,10,000   = Rs 1,650
100 12
Total Interest Rs 5,850

Interest on B’s Capital

Capital
During 2012 Months Product
Balances
6 6
From Jan. 01 to June 30 80,000 6 80,000    Rs 2,400
100 12
6 6
From July 01 to Dec. 31 1,00,000 6 1,00,000    Rs 3,000
100 12
Total Interest Rs 5,400
 Product Method
Interest on A’s Capital
Capital
During 2012 Weights Product
Balances
From Jan. 01 to June 30 1,00,000 6 Rs 1,00,000 × 6 = Rs 6,00,000
From July 01 to Sep. 30 80,000 3 Rs 80,000 × 3 = Rs 2,40,000
From Oct. 01 to Dec. 31 1,10,000 3 Rs 1,10,000 × 3 = Rs 3,30,000
Sum of Product Rs 11,70,000
6 1
Interest on A's Capital = 11,70,000    Rs 5,850
100 12

Interest on B’s Capital

Capital
During 2012 Weights Product
Balances
From Jan. 01 to June 30 80,000 6 Rs 80,000 × 6 = Rs 4,80,000
From July 01 to Dec. 31 1,00,000 6 Rs 1,00,000 × 6 = Rs 6,00,000
Sum of Product Rs 10,80,000

6 1
Interest on B's Capital = 10,80,000    Rs 5,400
100 12

 In case the question specifies that the profit is to be distributed among the partners in
the ratio of their capital balances, then we need to determine the capital ratio.

Example: When there is no change in the capital balances during the year
A and B are the partners in a business with capitals of Rs 1,00,000 and Rs 80,000 as
on January 01, 2012.
A B
Capital 1,00,000 80,000
Capital Ratio 5:4
 Example: When capital is withdrawn or fresh capital is introduced during the year
A B
Opening Balances
Rs 1,00,000 Rs 80,000
(January 01, 2012)
Drawings
Rs 20,000 –
(July 01, 2012)
Additional Capital Introduced (July
– Rs 20,000
01, 2012)
Additional Capital Introduced
Rs 30,000 –
(October 01, 2012)

Solution: Calculation of Capital Ratio

A’s Capital
During 2012 Weights Product
Balances
From Jan. 01 to June 30 1,00,000 6 Rs 1,00,000 × 6 = Rs 6,00,000
From July 01 to Sep. 30 80,000 3 Rs 80,000 × 3 = Rs 2,40,000
From Oct. 01 to Dec. 31 1,10,000 3 Rs 1,10,000 × 3 = Rs 3,30,000
Total 12 Rs 11,70,000

B’s Capital
During 2012 Weights Product
Balances
From Jan. 01 to June 30 80,000 6 Rs 80,000 × 6 = Rs 4,80,000
From July 01 to Dec. 31 1,00,000 6 Rs 1,00,000 × 6 = Rs 6,00,000
Total 12 Rs 10,80,000

A B
Total Weights 11,70,000 : 10,80,000
Capital Ratio 117 : 108

 Partner’s Salary and Commission: Salary and commission will be allowed to the
partners only if it is mentioned in the partnership deed.

Accounting Treatment:
Partners’ Salary A/c Dr.
Partners’ Commission A/c Dr.
To Partners’ Capital A/c
OR
To Partners’ Current A/c (If capital are fixed)
(Salary and Commission allowed to partners)

Profit and Loss Appropriation A/c Dr.

 To Partners’ Salary A/c
To Partners’ Commission A/c
(Partners’ Salary and Commission transferred to Partners’ Capital Account)

Alternative Method
Partners’ Salary A/c Dr.
Partners’ Commission A/c Dr.
To Partners’ Capital A/c
OR
To Partners’ Current A/c (If capital are fixed)
(Salary and commission allowed to partners)

 Interest on Partner’s Loan

Accounting Treatment
Interest on Partner’s loan A/c Dr.
To Partner’s Loan A/c
(Interest allowed on partners’ loan)

Profit and Loss A/c Dr.

To Interest on Partner’s Loan A/c
(Interest on partners loan transferred to Profit and Loss Account)

 Past Adjustment or Adjustments after Closing Accounts

Some errors and omissions are detected after closing the accounts. The effect of
these errors and commission can be rectified and adjusted by directly through
Partner’s Capital Account by passing an adjusting Journal entry.

Example
A and B are partners sharing profits and losses equally. At the end of the year, it was
found that the books of the accounts were closed without providing interest on
capitals of A and B of Rs 2,000 and Rs 1,500 and without charging interest on
drawings of Rs 200 and Rs 150.
Adjust the omitted items by passing adjusting Journal entries.

Solution:
Journal Entry
Debit Credit
Particulars L.F. Amount Amount
Rs Rs
B’s Capital A/c Dr. 225
To A’s Capital A/c 225
(Interest on capital and drawings adjusted)

Working Note:
A B Total
Interest on capital 2,000 1,500 = 3,500
Less: Interest on Drawings (200) (150) = (350)
Profit should have been distributed 1,800 1,350 3,150
Less: Profit wrongly distributed (1,575) (1,575) (3,150)
225 (225) NIL

Example
Saint and Kabir are partners sharing profits and losses in the ratio 3:2. On January
01, 2011, their capital balances stood at Rs 2,40,000 and Rs 2,00,000 respectively.
After closing the books of accounts on December 31, 2011, it was found that
interest on capital was allowed at 12% p.a. instead of 10% p.a. Pass the necessary
Journal entry for adjustment of interest on capital.

Solution:
Journal Entry
Debit Credit
Particulars L.F. Amount Amount
Rs Rs
Kabir’s Capital A/c Dr. 480
To Saint’s Capital A/c 480
(2% excess interest on capital adjusted)
 Working Note:
Saint Kabir Total
2% Interest on Capital (excess distributed) (4,800) (4,000) = (8,800)
Right distribution of 8,800 (3:2) 5,280 3,520 = 8,800
Adjustment of Profit in Capital Accounts (480) 480 NIL

 Guarantee of Profit to Partner

Example
1
A and B were partners sharing profits and losses equally. They admitted C for rd
3
share of profit on the condition that C will get a minimum profit of Rs 10,000 and if
any deficiency exists, then it will be equally borne by both A and B. The profit
earned during the year amounts to Rs 24,000. Prepare Profit and Loss Appropriation
Account to show the appropriation of profit among the partners.

Solution
Profit and Loss Appropriation Account
Dr. Cr.
Amount Amount
Particulars Particulars
Rs Rs
Profit transferred to Capital Account Profit and Loss (Net profit) 24,000
A 8,000 – 1,000 7,000
B 8,000 – 1,000 7,000
C 8,000 + 2,000 10,000
24,000 24,000
 1
C’s share of profit  24, 000   8, 000
3
But C was guaranteed a minimum profit of Rs 10,000, so the deficiency in C’s
share of profit = 10,000 – 8,000 = Rs 2,000
A and B both will equally bear the deficiency in C’s share.
1
A will bear  2, 000   Rs1, 000
2
1
B will bear  2, 000   Rs1, 000
2
C’s share of profit = Rs 8,000 + Rs 1,000 + Rs 1,000 = Rs 10,000s