<h5 id="11-nature-of-partnership">1.1 Nature of Partnership</h5> <ul> <li>Partnership is an agreement between two or more individuals to carry on a business and share its profits/losses.</li> <li>Minimum number of partners can be two, with a maximum of 50 (as per Indian Partnership Act 1932 and Companies Act 2013).</li> <li>Business agreement should be for carrying out a common goal, mutual agency and sharing of profits/losses are essential features.</li> <li>Mutual agency implies that every partner can participate in business affairs and can bind or be bound by other partners’ acts.</li> <li>Each partner is liable jointly and severally, with unlimited liability for the firm’s debts while being a partner.</li> </ul> <p>======</p> <h5 id="12-partnership-deed">1.2 Partnership Deed</h5> <ul> <li>Partnership is a result of agreement among partners, which can be oral or written.</li> <li>The agreement details, when in writing, is called ‘Partnership Deed’ containing aspects like business objective, partners’ capital contribution, and profit/loss sharing ratio.</li> <li>Partnership Deed contains partners’ names, firm’s main business, capital amount, accounting period, bank accounts operation, salaries, duties, and other business conduct rules.</li> <li>The Deed should be drafted as per ‘Stamp Act’ and preferably registered with the Registrar of Firms, with alterable clauses via partners’ consent.</li> <li>In absence of explicit agreement on certain matters, the Indian Partnership Act, 1932 provisions apply, including treatment of losses from insolvency.</li> </ul> <p>======</p> <h5 id="121-provisions-of-partnership-act-relevant-for-accounting">1.2.1 Provisions of Partnership Act Relevant for Accounting</h5> <ul> <li>If the partnership deed is silent, profits and losses are shared equally, no interest is given on capital contributed, no interest is charged on drawings, and interest on partner’s loan is given at 6% p.a.</li> <li>A partner can only get remuneration or salary if the deed provides for it.</li> <li>If a partner derives profit from the firm or competes with it, they must account for and pay the profit to the firm.</li> <li>A partnership can exist without a written agreement, but it is advisable to have one.</li> <li>The maximum number of partners in a firm is 50, unless it is a banking firm, in which case it is 10.</li> <li>The rate of interest on partner’s loan is not specified by the deed, it is 6% p.a. if the deed is silent.</li> </ul> <p>======</p> <h5 id="13-special-aspects-of-partnership-accounts">1.3 Special Aspects of Partnership Accounts</h5> <ul> <li>Partnership accounts are maintained similarly to sole proprietorship, with exceptions.</li> <li>The exceptions include: maintenance of Partners’ Capital Accounts, distribution of Profit and Loss among partners, adjustments for wrong profit appropriation in the past.</li> <li>These aspects are discussed in this chapter.</li> <li>Other aspects such as reconstitution of the partnership firm and dissolution of partnership firm are covered in subsequent chapters.</li> <li>Equations or formulae are not applicable in this text.</li> </ul> <p>======</p> <h5 id="14-maintenance-of-capital-accounts-of-partners">1.4 Maintenance of Capital Accounts of Partners</h5> <ul> <li>Transactions relating to partners are recorded in their capital accounts, with two methods of maintenance: fixed and fluctuating capital methods.</li> <li>Fixed capital method: capital remains fixed, all other items (share of profit, interest on capital, drawings, etc.) are recorded in separate Partner’s Current Account. This results in two accounts per partner, with the capital account on the liabilities side and current account balance (credit or debit) shown accordingly in the balance sheet.</li> <li>Fluctuating capital method: only one capital account per partner, with all adjustments (share of profit, interest on capital, drawings, etc.) recorded directly in the capital accounts, causing balance to fluctuate over time. This method is used in the absence of specific instructions.</li> <li>Fixed capital method proforma: Partner’s Capital Account (credit) and Partner’s Current Account (debit or credit).</li> <li>Fluctuating capital method proforma: Partner’s Capital Account (credit or debit).</li> </ul> <p>======</p> <h5 id="141-distinction-between-fixed-and-fluctuating-capital-accounts">1.4.1 Distinction between Fixed and Fluctuating Capital Accounts</h5> <ul> <li>The method involves maintaining two separate accounts for each partner: a ‘capital account’ and a ‘current account’.</li> <li>Transactions related to the deed, such as drawings, salary, and interest on capital, are posted in the current accounts and not in the capital accounts.</li> <li>Adjustments for these transactions are made in the capital accounts, causing the balance to fluctuate from year to year.</li> <li>The capital account balance remains unchanged unless there is an addition to or withdrawal of capital.</li> <li>Contrary to the original statement, the capital account may sometimes show a debit balance.</li> </ul> <p>======</p> <h5 id="15-distribution-of-profit-among-partners">1.5 Distribution of Profit among Partners</h5> <ul> <li>The profits and losses of a firm are distributed among partners in an agreed ratio, or equally if the partnership deed is silent.</li> <li>In sole partnership, profit or loss is transferred to the capital account of the proprietor.</li> <li>For partnership firms, adjustments such as interest on drawings, interest on capital, salary to partners, and commission to partners are necessary.</li> <li>A Profit and Loss Appropriation Account is prepared to determine the final figure of profit/loss to be distributed.</li> <li>The determined profit/loss is then distributed among partners in their agreed profit-sharing ratio.</li> </ul> <p>======</p> <h5 id="151-profit-and-loss-appropriation-account">1.5.1 Profit and Loss Appropriation Account</h5> <ul> <li>Profit and Loss Appropriation Account is an extension of the Profit and Loss Account, showing how profits are distributed among partners.</li> <li>It starts with the net profit/net loss as per Profit and Loss Account. Adjustments include interest on capital, drawings, salary, and commission.</li> <li>Interest on capital is credited to partners’ capital/current accounts and then transferred to Profit and Loss Appropriation Account.</li> <li>Interest on drawings is charged to partners’ capital accounts and then transferred to Profit and Loss Appropriation Account.</li> <li>Partner’s salary and commission are allowed to partner’s capital account and then transferred to Profit and Loss Appropriation Account.</li> <li>Shares of profit or loss after appropriations are distributed to partners’ capital/current accounts. No adjustments are made for losses.</li> </ul> <p>======</p> <h5 id="152-interest-on-capital">1.5.2 Interest on Capital</h5> <ul> <li>Interest on capital is only allowed if specifically agreed upon by partners.</li> <li>It is calculated with respect to the time period that the capital remained in business during a financial year.</li> <li>The rate of interest on capital is usually agreed upon at the start of the partnership.</li> <li>When there are additions or withdrawals of capital during the accounting period, the interest on capital is adjusted accordingly.</li> <li>In the absence of a specific provision in the Deed, no interest will be paid on the capital to the partners if the firm incurs a loss during the accounting year.</li> </ul> <p>======</p> <h5 id="153-interest-on-drawings">1.5.3 Interest on Drawings</h5> <ol> <li>For a partner, Govind, interest on drawings needs to be calculated for the amounts withdrawn during the year 2019-2020: April 30 (Rs. 6,000), June 30 (Rs. 4,000), September 30 (Rs. 8,000), December 31 (Rs. 3,000), and January 31 (Rs. 5,00</li> </ol> <p>======</p> <h5 id="16-guarantee-of-profit-to-a-partner">1.6 Guarantee of Profit to a Partner</h5> <ul> <li>In a firm, a new partner can be admitted with a guarantee of a minimum amount as his share of profits.</li> <li>This guaranteed amount is paid to the new partner if his share of profit based on the profit sharing ratio is less than the guaranteed amount.</li> <li>The deficiency in the guaranteed amount is borne by the guaranteeing partners in their profit sharing ratio.</li> <li>If only one partner gives the guarantee, the whole amount of deficiency is borne by that partner.</li> <li>The new profit sharing ratio is calculated based on the guaranteed share of the new partner and the remaining profit is shared between the old partners in their earlier profit sharing ratio.</li> </ul> <p>======</p> <h5 id="17-past-adjustments">1.7 Past Adjustments</h5> <ul> <li>After final accounts are prepared, omissions or errors in transactions recording might be found.</li> <li>These omissions can be in respect of interest on capitals, drawings, loans, salaries, commissions, or outstanding expenses.</li> <li>Adjustments can be made either through ‘Profit and Loss Adjustment Account’ or directly in the capital accounts.</li> <li>Example: Interest on capital not credited to partners’ accounts. Error can be rectified by passing a journal entry to charge interest to partners’ capital accounts.</li> <li>Another example: Omitting interest on drawings. Necessary adjusting journal entry can be passed to charge interest on drawings to the partner’s capital account.</li> </ul> <p>======</p>