PARTNERSHIP ACCOUNTS – FUNDAMENTALS
BCOM(MARGHAM PUBLICATION), CLASS 12th,
CMA(PAPER-5: STUDY NOTE 6), CA, CS, UGC NET/SET
INTRODUCTION
According to Section -4 of the Indian
Partnership Act, 1932:
“Partnership is the relations between
two or more persons who have agreed to share the profits of a business carried
on by all or any one of them acting for all”
Features of Partnership
1. Two or more persons: There must
be at least two persons to form a valid partnership. The maximum number of
partners cannot exceed the number of partners prescribed by Companies Act, 2013
which is 50 in any business whether banking or non- banking.
2. Agreement: Partnership comes into
existence by an agreement (either written or oral among the partners. The
written agreement among the partners is called Partnership Deed.
3. Existence of business and profit
motive: A partnership can be formed for the purpose of carrying on
legal business with the intention of earning profits. A joint ownership of some
property by itself cannot be called a partnership.
4. Sharing of Profits: An agreement
between the partners must be aimed at sharing the profits. If some persons join
hands to run some charitable activity, it will not be called partnership. Further,
if a partner is deprived of his right to share the profits of the business, he
cannot be called as partner.
5. Business carried on by all or any of them
acting for all: It means that each partner can participate in the
conduct of business and each partner is bound by the acts of other partners in
respect to the business of the firm.
6. Relationship of Principal and Agent: Each
partner is an agent ad well as a partner of the firm. An agent, because he can
bind the other partners by his acts and principal, because he himself can be
bound by the acts of the other partners.
Partnership Deed
Since partnership is the outcome of an agreement, it is
essential that there must be some terms and conditions agreed upon by all the
partners. Such terms and conditions mat be either written or oral. The law does
not make it compulsory to have a written agreement. However, in order to avoid
all misunderstandings and disputes, it is always the best course to have a
written agreement duly signed and registered under the Act.
The partnership deed is a written agreement among the
partners which contains the terms of agreement. It is also called ‘ Articles of
Partnership’. A partnership deed should contain the following points:
- Name
and address of the firm as well as partners.
- Name
and addresses of the partners.
- Nature
and place of the business.
- Duration,
if any of partnership.
- Capital
contribution by each partner.
- Interest
on capital.
- Drawings
and interest on drawings.
- Profit
sharing ratio.
- Interest
on loan.
- Partner’s
Salary/commission etc.
- Method
for valuation of goodwill and assets.
- Accounting
period of the firm and duration of partnership
- Rights
and duties of partners how disputes will be settled.
- Decisions
taken if some partner becomes insolvent.
- Opening
of Bank Account – whereas it will be in the name of firm or partners.
- Rules
to be followed in case of admission & Settlement of accounts or
retirement or death of partner.
- Revaluation
of assets & liabilities, if any to be done.
- Method
of recording of firm’s accounts
- Auditing
- Date
of commencement of partnership
Benefits of Partnership Deed
(1) It regulates the rights, duties and liabilities of each
partner.
(2) It helps to avoid any misunderstanding amongst the
partners because all the terms and conditions of partnership have been laid
down beforehand in the deed.
(3) Any dispute amongst the partners may be settled easily
as the partnership deed may be readily referred to.
Hence, it is always best course to have a written
partnership deed duly signed by all the partners and registered under the Act.
Absence of Partnership Deed
If there is no partnership deed or when there is no express
statement in the partnership deed,
then the following provisions of the Act will apply:
(i) Remuneration to partners
No salary or remuneration is allowed to any partner.
[Section 13(a)]
(ii) Profit sharing ratio
Profits and losses are to be shared by the partners equally.
[Section 13(b)]
(iii) Interest on capital
No interest is allowed on the capital. Where a partner is
entitled to interest on capital
contributed as per partnership deed, such interest on
capital will be payable only out of
profits. [Section 13(c)]
(iv) Interest on loans advanced by partners to the firm
Interest on loan is to be allowed at the rate of 6 per cent
per annum. [Section 13(d)]
(v) Interest on drawings
No interest is charged on the drawings of the partners.
Illustration on No Partnership Deed
A, B, C and D are partners in a firm. There is no partnership
deed. How will you deal with the
following?
(i) A has contributed maximum capital. He demands interest
on capital at 12% per annum.
(ii) B has withdrawn ` 1,000 per month. Other partners ask B
to pay interest on drawings
@ 10% per annum to the firm. But, B does not agree to it.
(iii) Loan advanced by C to the firm is ` 10,000. He demands
interest on loan @ 9% per
annum. A and B do not agree with this.
(iv) D demands salary at the rate of ` 5,000 per month as he
spends full time for the business.
B and C do not agree with this.
(v) A demands the profit to be shared in the capital ratio.
But, B, C and D do not agree.
Solution:
Since there is no partnership deed, provisions of the Indian
Partnership Act, 1932 will apply.
(i) No interest on capital is payable to any partner.
Therefore, A is not entitled to interest
on capital.
(ii) No interest is chargeable on drawings made by the
partner. Therefore, B need not pay
interest on drawings.
(iii) Interest on loan is payable at 6% per annum. Therefore,
C is to get interest at 6% per
annum on ` 10,000.
(iv) No remuneration is payable to any partner. Hence, D is
not entitled to salary.
(v) Profits should be distributed equally.
Accounts of Partnership:
1.
Interest on Capital
Interest on capital is allowed to
compensate partners for contributing capital to the firm in excess of profit-sharing
ratio.
Interest on capital is credited to the
partners at the agreed rate with reference to the time period for which the
capital remained in business during a financial year.
The two situations
under which interest on capital is generally provided are:
- When
the partner contributes unequal amounts of capital but shares profits.
- When
capital contribution is the same but the share of profits is unequal.
Accounting Treatment for Interest on
Capital
Interest on capital is considered as an
expense for the business and is added to the owner’s capital, which increases
the overall capital of the owner in the business. Two accounts are involved in
the accounting for interest on capital which is Capital A/c and Interest on
Capital A/c.
The following journal entries are made to
account for interest on capital
Interest on Capital A/c Dr.
To Capital A/c
Calculation of Interest of Capital:
Interest on capital is to be calculated on the capitals at
the beginning for the relevant period. If there is any additional capital
introduced or capital withdrawn during the year, it will cause change in the
capitals and interest is to be calculated proportionately on the changed
capitals for the relevant period.
Interest on capital is generally calculated on the opening balance of Partner’s capital. If the opening capital is not given it is to be calculated with those items which have been added to the capital and adding those items which have been subtracted.
Accounting Treatment for Interest on Drawings:
The amount withdrawn by the partners for
personal use is termed as drawings. It is the amount which withdrawn against
profit. It is the temporary withdrawn made, which is to be returned by the
partners with interest.
Interest on drawings is the amount of
interest paid by the partners, calculated with reference to the time period for
which the money was withdrawn.
➢ It is an income for the firm
and hence is credited to the Profit and Loss Appropriation
Account.
➢ It is an expense to the
partners, hence is debited to the Partner’s Capital Account.
➢ Interest on drawing is charged
from the partners, if it mentioned in the Partnership Deed.
1.
For charging interest on a partner’s drawings:
Partner’s Capital/Current A/c.Dr.
To Interest on Drawings A/c
(Being interest on drawings charged @ %
p.a.)
2. For transferring interest on drawings to
Profit and Loss Appropriation A/c
Interest on Drawings A/cDr.
To Profit and Loss Appropriation A/c
(Being interest on drawings transferred to
P&L appropriation A/c)
Calculation of interest on drawings
Interest on drawings can be computed by
following either direct method or product method. Also, if the partners
withdraw fixed amount at fixed time interval, interest on drawings may be
calculated on the basis of the average period method. Based on the dates of drawings
and the number of drawings, different methods can be followed for calculating
interest on drawings.
(i) Direct method
Interest is calculated on drawings for the
period from the date of drawings to the date of closing date of the accounting
year. The following formula is used to compute the interest on drawings:
Interest on drawings = Amount of drawings x
Rate of interest x Period of interest
Period of interest refers to the period
from the date of drawings to the closing date of the accounting year. This
method is suitable when different amounts are withdrawn at different time
intervals.
(ii) Product method
Under product method, interest is
calculated on the total of the products, that is, the product of number of
drawings and the period for which the amount remained withdrawn. If the product
is calculated in terms of months, then interest is calculated on the total of
products at the rate per month. If the product is calculated in terms of days,
then interest is calculated on the total of products at the rate per day. This
method can be used in all situations as an alternative to direct method.
The procedure for calculating interest on
drawings under product method is as follows:
a)
Multiply each amount withdrawn by the relevant period (in months) to
find out the individual product.
b)
Find out the sum of all the individual products.
c)
Calculate interest at the prescribed rate for one month by using the
following formula.
Interest on drawings = Sum of products x
Rate of interest p.a. × 1/12
Tutorial Note
If the period of interest is taken in days,
each amount withdrawn is to be multiplied by the relevant period (in days) to
find out the individual product and the following formula is to be used to find
out the interest on drawings.
Interest on drawings = Sum of products x
Rate of interest p.a. ×1/365
(iii) Average period method
If the partners withdraw fixed amount
at fixed time interval, interest on drawings may be calculated on the basis of
the average period. Fixed time interval refers to withdrawal made monthly,
quarterly, half-yearly, once in 2 months and once in 4 months.