2

Accounting for Partnership Firms

- Fundamentals

Learning Objectives
After studying this Chapter. you should be able to understand

.Nature of Partnership Firm

Definition and Main Features of Partnership
.Partnership Deed-Meaning, Importance
Methods of Preparing Capital Accounts of Partners under Fixed and
Fluctuating Capital Methods
Division ofProfit among Partners
Profit and Loss Appropriation Account

PastAdjustments
Guarantee of Minimum Profit to a Partner

Introduction : - There are certain limitations of a sole trader. In a sole trading

concern only one man invests capital,
undertakes the risk involved in the business and
and
controls the whole affairs of the business. But one man's capital, skill, controlling
combine and
risk taking capacity are generally limited. Therefore, some persons may
enter into an agreement to form a partnership.
order to maintain this trust, it
Partnership is a relation of mutual trust and faith. In
maintained in an honest, accurate and
is necessary that the partnership accounts be
a true and fair picture of the
equitable manner. Partnership accounts should present
to study the definition of
partnership business. For this purpose it is necessary of the
partnership as given in the Partnership Act and the relevant provisions
Partnership Act which affect the partnership accounts.
Nature of Partnership Firm
firm is treated as a separate business
As per Accounting viewpoint, partnership
a partnership firm is
entity distinct from its partners. However, as per legal viewpoint,
not a separate legal entity. In other words, it has no
existence separate from its partners.

tmeans that in case of bankruptcy of the partnership

firm, private estates of the
partners would be liable to meet the firm's debts.
Indian Partnership Act, 1932, defines
Definition of Partnership: Section 4 ofthe
partnership as follows:
 RMS

agreemem
he esalt af
an
Partnershe

can be
Prefit
Motne
-rerstip
iere
Etence of Basiness3ad busaness
h the
Don ofeaming rosa
od
carmce
carang
oe soE
soE property s e l f e alien
jous oanersihup ot
use

rusrness a s t
be legai. A
e
nartneersi
ageee
betaeeE
E partners
ProfitsThe hands to nue some
4 Sharing ef pErsOes jou
basiness. if SOmE oftis
shaning he prois
of the
Furter. d2 partaerS ved ot
deprived his nT
aot be called
partnership. B t I is Do
actviy.it wl E Czed a parmET.
business. he c a m i
share he proits of the be aed betmeen the n e -
stare the iosses aso. li may
should
ha al partimers
liabie for iosses.
them shal sot be
e r more of is an agem as m .
and Ageaf: Each partner
5 Reiationship of Principal as as n
can buzd tne other pertners by
of the firm An agent beczuse he
princial other partnes
be bimself be bound by the acts of the
can
a principal, because

6. Besiness carried on by all or any

acting for al : - ii meas t cat
ofthem
and each partner is bound by
partnercan participate in the condact of business
fim
od other pertners in respect to the business of the
fim has no separae ensnce i
7. Na Separate Existence - A partnership the tim will be enioreanie
its memabers t means that all agreements entered wih
agains each partner separzely and jointiy.

Partnership cann come into existence in the absnce of any one of the ahne

mentioned cssemtiai features

Rights ofa Partner:
Every parterhas the night to share profits or losses with other partnes
ageed rati.
2 Every partner has the right to take part in the conduact of the businessS
Every partcr has the right to be consulted in the marters related to partners
basinecss
4 Fvery partner has the nght to inspect and have a copy of he
accots
Every partrer has a right to disallow the admission of a new partier
6. Fvery partnet is the joint owner of the partnership property
cCOUNTING FOR PARTNERSHIP FIRMS FUNDAMENTALS 23
7, If a partner has given loan to the
firm, he has a
agrecd rate. If the rate of interest is not agreed, it isright receive interest at
to
paid (a6% p.a.
8. If a partner incurs expenses or makes
on bechalf of the tim, he has a
right to be indemnified by the firm. payment
9. Every partner has a right to retire from the fim after
giving a proper notice
Limited Liability Partnership (LLP)
The Limited Liability Partnerships
(LLPs) in India came into existenee with the
enactment of "Limited L.1ability Partnership Act, 2008' which lay down the law for the
formation and regulation of Limited Liability Partnerships.
Definition: 'Limited Liability Partnership" means a partnership formed and
registered under this Act.
Nature of Limited Liability Partnership (LLP)
(A LLP is a body corporate formed and incorporated under this Act.
(in It is legal entity separate from that of its partners.
(iin) A LLP shali have perpetual succession.
(iv) Any change in the partners of a LLP shall not affect the existence, rights or
liabilities of the LILP.
Indian Partnership Act, 1932 shall not aply to a LLP.
Distinction between an Ordinary Partnership Firm and an LLP
Basis of Partnerships LLP
Distinction
1. Applicable Indian Partnership Act, 1932. The Limited Liability Partnership
Law Act, 2008.
Registration Optional Compulsory with Registrar of
Companies
Creation Created by an Agreement Created by Law
Body Body Corporate cannot Body Corporate can become its
Corporate become a partner. partner.
Separate Legal I t is not a separate legal entity. It is a separate legal entity.
Entity
6. Perpetual Partnerships do not have It has perpetual succession and
succession perpettual succession. individual partners may come and
go.
Number of Minimum 2 and Maximum Minimum 2 but no maximum
Partners 50 limit.
8. Ownership of Fim cannot own any asset. The LLP as an independent entity
Assets The partners own the assets of can own assets.
the firm.
9. Liability Unlimited. Limited to the extent of their
contribution towards LLP.

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
may be either oral or written. The law does not make it compulsory to have a written
 ACCOUNTING FOR PARTNEH.
UNUA
misunderstandin
dings and dispuAites. it i
m i s u n d e r s t a n d i n g s
and. AMENT
avoid all
avord ail
2.4 der to andregisto
andregistered under the ho
duly signed
order.
However,
in
greement iss ca
agreement
called
agreement.

course
to have
a
wriften

contains the tcrms ofagn C Part

partnership der
the best
Such a
written document

also
which

called'Articles of
Partnership'.
The nership deed
hould contcomaa
shoul
Deed'. t is
thefollowing points
of the firm.
name and address
(1) The
addresses of the partners.
Names and
(2) business the firnm proposes
to do.
nature of the
(3) The type and
each partner and

(4) Amount of capital

to be
contributed by
t

whether the
accounts will be
fixed or fluctuating.
capital
:-Whether interest is to be allowed on capital.
(5) Interest on Capitals
the rate of interest.

6) Drawings- How much

amount the partners are entitled to withdras
personal use.
(7)Interest on Drawings- Whether interest will be charged on partner
drawings. If so, the rate of interest.
(8) Profit Sharing Ratio :-The ratio in which profits or losses are to be
divided
among the partners.
(9) Salary:-Whether any partner will be paid salary for the work done
lf so, how much? by him
(10) Goodw ill- Method of valuation of
retirement of a partner. goodwill in case of admission or

(11) Accounting Period of the Firm :-The

of the firm are to be period after which the final accounts
which accounts are
prepared. Whether ycarly or half-yearly and the date on
be closed
to
every year.
(12) Method of recording of firm's
accounts and the safe
accounts and other
documents of the firm. of the books of custody
(13) Auditing:-Whether the
of auditor's appointment. firm's books will be audited or
not? If so, the mode
(14) Date of Commencement
of
(15) Duration of partnership.
established andpartnership
the mode of
The period for which the
(16) Use of
the
decision of dissolution of
Garner vspartnership. partnership has been
of Garner vs
(17) Bank Accounts
Murray- Whether decision in
Murray is to apply in the
case of the case
in some :-Whether the account in theinsolvency
of a
name or partner.
partner'
(18) Rules to be followed s name? Who will have bank will be opened in firm's
in case of
(19) Rules to be followed the right to
while
admission of a sign the cheques
manner in which the settling the partner.
be calculated amount due on the Accounts on
and
(20) Settlement of the manner in which it retirement
will
or
death of a Retirement:-The
Disputes-
dispute will be solved. In case
of paid.be partner
will
dispute
Whether arbitrator will among the
be
appointed?partners, how the
 ACCOUNTING FOR PARTNE RSHIp FIRMS
HUNDAMNIALS
Impertance of Partnership Deed

Though, the law does not make it mandatory (computry) for every firm lu
ha Ye
,nurtnership deed, it is desirable to have it due to the following reasoavs
) t regulates the rights, duties and liabilities of cach partner
(ii) It helps to avod any misunderstanding amongst the partnerv hecause all he
terms and conditions of partnership have been laid down hefore hand in the
deed.
(ii) Any dispule amongst the partners may be settled casily as the parinership
deed may be readily referred to.
Hence, it is always the best course to have a written partnership deed duly signed
by all the partners and registered under the

Rules Applicable in the Absence of Partnership Deed

In the absence of a Partnership Deed or Verbal agreement, orif the Partnership
Decd is silent on a certain point, the following provisions of Partnership Act, 1932
:-
will be applicable
(1)Profit-Sharing Ratio -Profits and Losses are to be shared equally
irrespective of their capital contribution.
on Capital- No interest on Capitals shall be allowed to the
(2)Interest
partners. Ifthere is a provision for the interest on capitals in the partnership
deed, it will be allowed only when there is a profit.
(3) Interest on Drawings-No interest is to be charged on drawings.

is entitled to any salary orcommission for

(4) Salary to a Partner:- No partner
taking part in running the firm's business.
Loan:- Interest at the rate of 6% per annum is to be allowed on
(5) Interest on
Such interest shall be paid even if there are losses
a partner's loan to the firm.
to the firm.

(6) Admission of a New Partner-Without

the consent of all existing partners
firm.
no new partner can be admitted to the
business.
(7) Each partner can participate in the conduct of
take of the same.
inspect the books of firm and copy can a
(8) Each partner can
any ofthe above provisions by
It should be remembered that partners may change
Coming to a common agreement.

Transactions
Recording of Partnership of
recorded according to the principles
Transactions of the partnership firm are
concern a partnership

double-entry system, and as in the case of a sole proprietorship Sheet at

Balance
Profit & Loss Account and
lim will also prepare Trading Account, of a sole trader and
The only diflerence between accounting
the end of every year. the
are divided among
firm is that the profits of the partnership firm
partnership Loss Account is
and
partners. Usually, for this profits as per Profit
purpose, the Appropriation
Profit and Loss
transterred to a newly-opened account, namely
 PARTNERSHIP FIRMS
A C C O U N T I N G
FOR FUNDAN
6 capital,
drawing, salary to
interest on
drawi

for
interest on
in th
only in
will be passedonly
that
ccount.
parth
andentries
Ancount'

division of
Pofitand
pnfts
Loss
among
the partners

Appropriation
Account showing the
distribu A
distribution of pr ASTSpeci
eEime
of
ACCOUNT
helow LOSS
APPROPRIATION

PROFITAND ended...
for theyear
Parliculars
Fancia
Loss A/c
By Profit &
Fe Salares of
Parmers (Net Profit transferred from
to Partners
Te Commission P&LA/c)
Partner's Capitals
To lnterest on By Interest on Drawings:
A
B
To Reserve Ac

To Profittransfermed to:
A'sCapital Ac
(or 4's Current A/c)
F'sCapital Alc
(or B's Current A/c)

The journal entries that are passed for various items shown in the above Profit and
Loss Appropriation Account are as follows:
1. Entry for transfer of Net Profit to Profit & Loss Appropriation Account:
Profit and Loss Alc
Dr.
To Profit
and
(Net Profit transferred)
Loss Appropriation A/Nc
2. Entry for Interest on Capital:
i) On allowing Interest on
Interest on Capital A/Vc
Capital
To Partner's
Capital Alc Dr.
(Interest on Capital at...% p.a.)
(ii) On closure of
Interest on Capital A/c
Interest on
capital is closed
by transferring it to the debit
Appropriation A/c, this is expenses
as
for the firm. The side of Profit & Loss
Profit&Loss
To
Appropriation A/c entry will be :
Interest on
Capital A/e Dr.
3. Entry for Interest on Drawings
(i) OnCharging Interest Drawings
Partner's Capital A/eon
To Interest on
Drawings A/c Dr.
(i) On closure of
Interest on Drawings A/c
Interest on
Drawings is closed by transferring it to the
Appropriation as this is income 1or the firm.
A/c, credit side of Profit & Loss
The entry will
be:
 ACCOUNTING FOR PARTNERSHIP FIRMS
Interest on Drawings A/c FUNDAMENTALS 27
To Profit & Loss Dr
Entry for Salary or Commission Appropriation A/c
Payable to a Partner :
(n On allowing salary or Commission
Partner's Salary/Commission AWc to a partner
Partner's Capital Alc
To Dr
(in On closure of salary or
commission account
Salary or Commission payable to a
side of Profit and Loss Appropriation partner closed by transferring it to the debit
is
entry will be: as Account, these are
expenses for the firm. The
Profit & Loss Appropriation A/c
To Partner's Salary/Commission A/c Dr.

5. Entry for transferring a part of profit to Reserve:

Profit& Loss Appropriation A/c
To Reserve A/c Dr.
6. Entry for transfer of Credit balance of Profit & Loss
profit) Appropriation A/c (being
Profit & Loss Appropriation A/c
To Partner's Capital Dr.
or Current A/cs
Features of Profit and Loss Appropriation Account
1. It is
prepared just after the Profit and Loss Account. Hence, it is an extension
of Profit and Loss Account.
2. It is prepared only by partnership firms.
3. It is Nominal Account.
a

4. It shows how the net

profit for the accounting period is appropriated
(distributed) among partners.
the
5. Entries in this account are made
giving effect to the Partnership Deed and/or
the Indian Partnership Act, 1932.

Distinction between Profit & Loss Account and Profit & Loss
Appropriation Account
Basis of Profit&Loss Account Profit & LoSs Appropriation
Distinction Account
i. Stage of It is prepared after Trading It is prepared after Profit and Loss
Preparation Account and hence starts with the Account and hence starts with the
gross profit disclosed by Trading net profit disclosed by Profit &
Account. Loss Account.
2 Objective It is prepared to ascertain net It is prepared to distribute the
profit or net loss. divisible profit of the year among
the partners.
3.
Opening Closing This account has neither opening This account may have opening
Balance balance nor closing balance. as well as closing balances.
 FOH'ARINE RStHI
FUEMS
UNIDAME
8
ACCOUNING

debited to thisaeount
pwnsew debited this acemn
NIAS
in

Expenses are appropriatiott of

harge against pevtits
profite
Appropriatio arecharye account is ne

Partnership
This account is not repared o
This uareal
rship| hasis ot partuership agre om the
the basvis
Agrevement for interest on
agnvement, escept
oan from arters.
(i.e. matching| Matching principle is
Matching Matching principle is| while
followed while ros
preparing
agninst expenses)
Principle of revenuewhile prepauring thisj account this
followed
account

Attention

a partner, salary, commiSsion, interest on Canital

such as
Any amount payable toPartner's Loan and rent payable to a partner) is treated a
etc. (except interest on
appropriation of profit and not a charge against profit. Hence, these items ar are
Profit & Loss A/c
dehited to Profit & Loss Appropriation A/c instead of

Distinction between Charge Against Prolit and Approprition out of Profit

Basis of Charge Against Profit Appropriation Out of Prof

Distinction
Nature It indicates expenses to be It indicates distribution of net
deducted from profits while profit to various heads.
calculating net profit or loss.
2 Recording It is debited to Profit and Loss It is debited to Profit and Loss
Account. Appropriation Account.
3. Necessary or It is necessary to make charges Appropriations are made only
not against profits even ifthere is when there is profit.
loss.

Example Interest on partner's loan and Interest on capital, partner's

rent paid to a partner, salary etc.

ILLUSTRATION 1.
Arti and Bharti are partners in firm
a
sharing profits
in the ratio of 3 2. The
following trial balance was extracted from their books as at 31st March, 2020:
TRIAL BALANCE
as at 3/st March, 2020
Dr Balances
Cr. Balances
Opening Stock
Purchases 36,000 Sales 940,000
Returns Inwards 6,20,000 Retums Outwards 4,000
Sundry Debtors 12,000 Sundry Creditors 43,000
Computer 1,25,000 Interest 1,000
Rent (for 11 months) 50,000 Arti's Capital 3,00,000
Salary to Staf 22,000 Bharti's Capital 150,00
and & Building 1,20,000
Vages
3,52,000
16.000
 OR PA
ACCOUNTING FOR PARTNERSHIP FIRMS FUNDAMENTALS

(erneral Chrges 30,000

'ashat Barnk 25,000
Arti's Drawings 20,000
Bharti's Deawings 10,000
14,38,000 4.38.000

prepare the Trading, Profit and Ioss Account and Prolit and
Youare required toAccount
for the year ended 31st March, 2020 and a Balance
Loss Appropríation
aus
heet as on that date, taking into account the following adjustments

Stock om 3Ist March, 2020 was valued at ?60,000

()Rent for the month ot March 2020 has not been paid
20%.
(ii) Depreciate Computer by
() Bharti is to be allowed a salary of 75,000 per month and partners are entitled
to interest on Capital @ 6% p.a.

OLUTION: TRADING AND PROFIT& LOSS ACcOUNT OF THE FIRM

for the year ended 31st March. 2020 Cr.
Dr
Particulars Particulars
To Opening Stock 36,000 By Sales 9,40,000
To Purchases 6,20,000 Less: Returns Inwards 12,000 9,28,000
Less: Returms Outwards 4,000 6,16,000 By Closing Stock 60,000
To Wages 16,000
To Gross Profit c/d 3,20,000
9,88,000 9,88,000
To Rent 22,000 By Gross Profit b/d 3.,20,000
Add Outstanding By Interest 1,000
(22,00011) 2,000 24,000
To Salary to Staff 1,20,000
To General Char 30,000
To Depreciation on Computer 10,000
To Net Profit transferred to
Profit&Loss Appropriation
A/c 1,37,000
3,21,000 3.21,000
PROFIT AND LOSS APPROPRIATION ACCOUNT
Dr. for the year ended 31st March, 2020 Cr.
Particulars Particdars
To Bharti's Salary 60,000 By Profit& Loss A/c
ToInterest on Capital: (Net Profit) 1,37,000
Arti 18,000
Bharti 9,000 27,000
ToProfit transferred to