Accounting for PartnershipAccounting for Partnership

Basics of PartnershipBasics of Partnership

Meaning of a partnership firm

As per the Indian Partnership Act, 1932

“The relationship between persons who have agreed to share the profit of a business

carried on by all or any of them acting for all”

Key features

An association of two or more persons

An agreement entered into by all persons concerned

Existence of a business

The carrying on of such business by all or any one of them acting for all

Sharing of profits and losses of the business

Unlimited liability of all partners

Partnership Agreement and Deed

Every partnership should have an agreement which may be oral or written (written

agreement is preferred)

Registration of an agreement is not compulsory. When registered, the partnership

agreement is called as Partnership Deed

Non registration restricts the partners or the firm from taking any legal action

If the Partnership Deed is silent on any point, the provisions of the Partnership Act will

apply

For example, if the profit sharing ratio is silent, the partners will share the profits

equally as per the Partnership Act

Contents of a Partnership Deed

Name of the firm and the partners Salary payable to partners

Commencement and duration of business Method of valuing goodwill on the on admission, retirement, death etc

Amount of capital to be contributed by each partner Procedure by which a partner may retire and the method of payment of his dues

Amount to be allowed to each partner as drawings and the timings of such drawings

Basis of the determination of the executors of a deceased partner and the method of payment

Rate of interest on capital, drawings and loan Treatment of losses arising out of the insolvency of a partner

Profit sharing ratio Procedure to be allowed for settlement of disputes among partners

Microsoft Office Word 97 - 2003 Document

Position if partnership agreement is silent

2

No partner has right to

receive salary

No payment of interest in

capital or charging

interest on drawings

Interest on loan/ advance

given by partner to carry

6% interest p.a

Profits and losses to

be shared equally

2

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Profit and Loss Appropriation Account

Special feature of Partnership Accounts

Prepared in addition to the normal Profit and Loss Account

Once profit/ loss from business as per the usual method is arrived at, the profit/ loss,

instead of being transferred to Balance Sheet is transferred to P&L Appropriation A/c

Entries to be passed in P&L Appropriation Account

Salary to partner

Interest on capital

Interest on drawings

Interest on loan

Drawings do not appear in P&L Appropriation A/c as it is a Balance Sheet item

1. For salary/ interest on capital/ loan to be paid to partner

P&L Appropriation A/c -Dr To Partner’s Capital A/c

2. For interest to be charged on drawings

Partner’s Capital A/c -Dr To P&L Appropriation A/c

Problem 1

A and B start business on 1st January, 2009, with capitals of Rs. 30,000 and Rs.

20,000. According to the Partnership Deed, B is entitled to a salary of Rs. 500 per

month and interest is to be allowed on capitals at 6% per annum. The remaining

profits are to be distributed amongst the partners in the ratio of 5:3. During 2009

the firm earned a profit, before charging salary to B and interest on capital

amounting to Rs. 25,000. During the year A withdrew Rs. 8,000 and B withdrew

Rs. 10,000 for domestic purposes. Rate of interest on drawings is 5%

Prepare the Profit and Loss Appropriation Account and Capital Accounts of

Partners. Assume calendar year.

Problem 2

Ram, Rahim and Karim are partners in a firm. They have no agreement in respect of profit- sharing ratio, interest on capital, interest on loan advanced by partners and remuneration payable to partners. In the matter of distribution of profits they have put forward the following claims: 1.Ram, who has contributed maximum capital demands interest on capital at 10% p.a. and share of profit in the capital ratio

2.Rahim has devoted full time for running the business and demands salary at the rate of Rs. 500 p.m.

3.Karim demands interest on loan of Rs. 2,000 advanced by him at the market rate of interest which is 12% p.a.

Valuation of GoodwillValuation of Goodwill

Which will you choose?

Bangalore-Mysore cost

Mercedes Benz – Rs 200

Ordinary – Rs 100

Methods of Goodwill calculation

2

Average profit basis Super Profit basis

Annuity basis Capitalisation basis

2

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Problem 4

The Firm earned profits during 2006-2009 as follows:

Year Profit (Rs)

2006 1,20,000

2007 1,25,000

2008 1,30,000

2009 1,50,000

Capital employed Rs 5,00,000. Rate of normal profit is 20% which can also be

assumed as the interest rate. Goodwill is valued at 3 years purchase. Find out

goodwill under all methods.

Calculation of Sacrificing and Gain ratio

New Ratio – Old Ratio = Gain Ratio (if positive) or Sacrificing Ratio (if negative)

Admission of a partnerAdmission of a partner

Admission- Basics

When a new partner is admitted, the firm is said to be reconstituted

A new balance sheet must be drawn up on the date of admission

Entry for appreciation or depreciation of assets should be passed

Unrecorded asset or liability should be brought into books

Goodwill, if any, must be valued and reserves must be shared

For the purposes of the admission of a new partner, ‘Revaluation A/c’ is drawn up

Profit/ loss from Revalution A/c must be shared between old partners in their old

profit sharing ratio

The same approach is also applicable for Retirement and Death

The following will be entries which would be passed during admission

New partners share of goodwill credited to sacrificing partners in sacrificing ratio

Share of revaluation profits or losses

Share of Reserve

Capital brought in by new partner

Revaluation Account

Opened specially during reconstitution of a firm (admission, death, retirement)

Contains amounts on account of bringing the balance sheet of the firm up-to date

Also known as ‘Profit and Loss Adjustment A/c’

Journal Entries

1. Revaluation A/c -Dr To Assets A/c (decrease in assets) To Liabilities A/c (increase in liability)

2. Asset A/c -Dr (increase in asset)Liability A/c -Dr (decrease in liability)

To Revaluation A/c

3. Revaluation A/c -Dr (in case of profit on revaluation) To Old Partners Capital A/c

(in old profit sharing ratio)

4. Old Partners Capital A/c -Dr (in case of loss on revaluation) To Revaluation A/c

(in old profit sharing ratio)

Problems

A and B were partners sharing profits and losses in the ratio 3:2. On January 1,2009, they admitted C as a third partner for 1/5th Share in profits on the following terms: He is to pay Rs. 25,000 as his capital and Rs. 10,000 as his share of goodwill

The new profits sharing ratio will be 5:3:2

The assets are to be revalued as under

•Building Rs 25,000 (Current Value Rs 18,000)•Plant and Machinery Rs 13,000 (Current Value Rs 15,000)•Stock Rs 10,000 (Current Value Rs 12,000)•Debtors Rs 11,000 (Current Value Rs 10,000)

Give journal entries for the above and draw up relevant ledger accounts

Problems

A and B are partners in a firm, sharing profits and losses in the ratio of 3:2. The Balance Sheet of A and B as on 1.1.2009 was as follows

‘C’ was admitted to the firm on the above date on the following terms: He is admitted for 1/6 share in the future profits. He is to introduce capital of Rs. 25,000. The new profit sharing ratio of A, B and C will be 3:2:1 respectively. ‘C’ is unable to bring in cash for his share of goodwill, and they decided to adjust his share of goodwill amounting to Rs 7,500 though the partner’s capital accounts. Furniture is to be written down by Rs. 870 and stock to be depreciated by 5%. A provision is required for debtors @ 5% for bad debts. The value of buildings having appreciated is to be brought upto Rs. 29,200. The value of investments is increased by Rs. 450. It is found that the creditors included a sum of Rs. 1,400, which is not to be paid off.

Liabilities Rs Assets RsCapital A/c’s:

A’s CapitalB’s CapitalReservesSundry creditorsBills payableBank overdraft

44,00036,0003,000

12,9004,1006,000

BuildingFurnitureStock In TradeSundry Debtors 35,000Less: Provision (200)InvestmentsCash

26,0005,800

21,40034,8002,500

15,500

Total 1,06,000 Total 1,06,000

Retirement- Basics (same as admission)

When a partner retires, the firm is said to be reconstituted

A new balance sheet must be drawn up on the date of retirement

Entry for appreciation or depreciation of assets should be passed

Unrecorded asset or liability should be brought into books

Goodwill, if any, must be valued and reserves must be shared

For the purposes of the retirement of a partner, ‘Revaluation A/c’ is drawn up

Profit/ loss from Revalution A/c must be shared between old partners in their old

profit sharing ratio

A retiring partner will get the following on retirement:

His share of goodwill borne by continuing partners in gain ratio

Share of revaluation profits

Share of Reserve

Capital balance

Revaluation Account (same as admission)

Opened specially during reconstitution of a firm

Contains amounts on account of bringing the balance sheet of the firm up-to date

Also known as ‘Profit and Loss Adjustment A/c’

Journal Entries

1. Revaluation A/c -Dr To Assets A/c (decrease in assets) To Liabilities A/c (increase in liability)

2. Asset A/c -Dr (increase in asset)Liability A/c -Dr (decrease in liability)

To Revaluation A/c

3. Revaluation A/c -Dr (in case of profit on revaluation) To Old Partners Capital A/c

(in old profit sharing ratio)

4. Old Partners Capital A/c -Dr (in case of loss on revaluation) To Revaluation A/c

(in old profit sharing ratio)

Problems

Liabilities Rs Assets Rs

Capital A/c’s:A’s CapitalB’s CapitalReservesSundry creditors

20,00015,00015,0007,500

Plant and MachineryStock In TradeSundry Debtors BankCash

20,00016,00015,0006,000500

Total 57,500 Total 57,500

A and B are partners in a business sharing profits and losses in the ratio 3:2. Their balance sheet as on 1st January, 2009 is given below:

B retires from the business owing to illness and A takes it over. The following was agreed upon:

(1) The goodwill of the firm is valued at Rs. 25,000.(2) Depreciate Plant & Machinery by 7.5% and stock by 15%.(3) Doubtful debts provision is raised against debtors at 5% and a discount reserve against creditors at 2%.

Calculate the amount payable to retiring partner.