ACCOUNTING FOR PARTNERSHIP FIRMS
Here are the fundamentals for ACCOUNTING FOR PARTNERSHIP FIRMS
DEFINITION OF PARTNERSHIP
Section 4 of the Indian Partnership Act,1932 states that
“Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all”
NATURE OF PARTNERSHIP
A Partnership firm is not a separate legal entity from its partners.
FEATURES OF PARTNERSHIP
Main features of partnership are:
- There must be 2 or more persons.
- There must be an agreement.
- There must be a lawful business.
- There must be sharing of profits of business.
- There must be a mutual agency ,i.e,business should be carried on by all or any of them acting for all.
The written document containing all the terms and conditions of agreement between partners is known as Partenrship Deed. It usually includes:
- Name and address of firm.
- Names and addresses of all partners.
- Date of commencement of partnership.
- Capital contributed by partners.
- Whether interest on capital to be allowed.
- Whether salary to partner allowed.
- Profit sharing ratio.
- Duties of partners.
- Methods of valuing goodwill in all cases.
- Mode of settlement of accounts in case of retirement/death.
ADVANTAGES OF HAVING PARTNERSHIP DEED
- Facilitates functioning of business.
- Helps in settlement of disputes among partners.
- Avoids misunderstandings among the partners.
PROVISIONS APPLICABLE IN ABSENCE OF PARTNERSHIP DEED
- Interest on capital is not allowed.
- Interest on drawings is not to be charged.
- Partners are not entitled for salary or remuneration.
- Interest on loan by partner is to be allowed @ 6%p.a .
- Profits or losses are shared equally by all partners.
METHODS OF MAINTAINING CAPITAL ACCOUNTS OF PARTNERS
- Fixed capital method- means capitals of partners remain unchanged except under special circumstances. Under this, two accounts for each partner i.e,
- Fixed Capital account
- Current account -all adjustments regarding drwaings,interest on drawings,salary,interest on capital,commission and share of profits or losses are made here.
- Fluctuating capital method- under this, only capital account for each partner is maintained. All transactions are recorded in this account only.
( if question is silent, partner’s capital should be assumed to be fluctuating.)
Salary or commission to a partner: commission is allowed if agreement says so.
- Commission as percentage of Net Profit before charging such commission = Net Profit before commission* rate of commission/100
- Commission as percentage of Net Profit before after such commission = Net Profit before commission* rate of commission/100+ rate of commission.
(salary or commission being an appropriation of profits is transferred to debit of profit and loss appropriation account).
- Interest on capital: taking into consideration any additional capital introduced or withdrawn existing capital, IOC is calculated on time basis. And is allowed only if provision says so. As interest is appropriation, it is provided through profit and loss appropriation.
- Interest on drawings: if partnership deed provides, interest on drawings is charged from partners. It is credited to profit and loss appropriation account and debited to partner’s capital or current accounts.
(if the date of drawings is not given, it is calculated for 6 months.)
- Interest on partner’s loan to the firm: when partner gives a loan to firm, he is entitled to get interest on such loan. If agreement does not exist, partner gets interest @ 6% p.a. it is debited to profit and loss account as it is charge against the profits.
These are made to rectify errors and omissions committed in the past by an adjustment entry in capital/current accounts of partners.
GUARANTEE OF MINIMUM PROFIT TO A PARTNER
Sometimes, partner is guaranteed a minimum amount of his share in profits. Such is provided by one or some or all partners in existing profit sharing ratio or some other. If in any year, actual share of profit is less than guaranteed amount, deficiency is borne by guaranteeing partners in agreed ratio.