Partnership accounting


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Partnership accounting

  1. 1. Prepared by: Khurram Shehzad
  2. 2. 1. Definition of Partnership1.Types of Partnership2.Essential Feature of Partnership3.Partnership Deeds4.Partner Capital Account under Fixed &Fluctuating Method5.Distribution of Profit6.Past Adjustment7.Changing in Profit Sharing ration8.SWOT analysis9.Conclusion
  3. 3. Definition of Partnership : The Partnership Act, 1932 defines partnership as "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“. Types of Partnership : 1-General Partnership 2-Limited Partnership 3-Limited Liability Partnership 1-General Partnership: A general partnership involves two or more owners carrying out a business purpose. General partners share equal rights and responsibilities in connection with management of the business, and any individual partner can bind the entire group to a legal obligation.2- Limited Partnership:A limited partnership allows each partner to restrict his / her personal liability to the amount ofhis or her business investment. Not every partner can benefit from this limitation at least oneparticipant must accept general partnership status, exposing him or herself to full personalliability for the businesss debts and obligations. The general partner retains the right to controlthe business, while the limited partner does not participate in management decisions. Bothgeneral and limited partners benefit from business profits.
  4. 4. 3- Limited Liability Partnership:Limited liability partnerships (LLP) retain the tax advantages of the general partnershipform, but offer some personal liability protection to the participants. Individual partnersin a limited liability partnership are not personally responsible for the wrongful acts ofother partners, or for the debts or obligations of the businessThe Partnership Act, 1932 defines partnership as "the relation between persons who haveagreed to share the profits of a business carried on by all or any of them acting for all". Basedon this definition, the essential features of partnership are as follows:1-Two or more persons2- Agreement between the partners3- Business4- Sharing of profits5- Business carried on by all or any of them acting for all.1-Two or more persons:To form a partnership, there must be at least two persons. There is, however, a limit on themaximum number of persons who constitute a partnership firm. It should not exceed 10 if thefirm is carrying on a banking business and 20 if it is engaged in any other business.
  5. 5. 2-Agreement between the partners:A partnership is created by an agreement. It is neither created by operation of law as in thecase of Hindu Undivided Family nor by status. The agreement forms the basis of economicrelationship amongst the partners. The agreement can be written or oral.3- Business:The agreement should be for carrying on some legal business. A joint ownership of someproperty by itself does not constitute partnership. However, the joint ownership of theproperty may be used for forming the partnership in order to pursue the businessobjectives for which the partnership is formed. 4- Sharing of profits:The agreement should be to share the profits of the business. If some persons join handsto carry on some charitable activity, it will not be termed as partnership. Of course, theratio in which the partners will share the profits is determined by the agreement or inthe absence of the agreement; it is shared equally amongst the partners.5- Business carried on by all or any of them acting for all.The firms business may be carried on by all the partners or any one of them acting forall. This means that partnership is based on the concept of mutual agency relationship. Apartner is both an agent (he can, by his acts, bind the other partners) and a principal (heis bound by the acts of other partners). The implication of this is that partner bindsothers and others bind him in the same way
  6. 6. Partnership Deed: 1-Meaning 2-Contents of Partnership Deed 3-Provisions Affecting Accounting Treatment Meaning:A partnership is formed by an agreement. This agreement may be written or oral.Though the law does not expressly require that there should be an agreement in writingbut the absence of a written agreement may be a source of trouble in managing theaffairs of the partnership firm. Therefore, a Partnership deed should be written, assentedand signed by all the partners. Contents of Partnership Deed: The partnership deed usually contains the following particulars: • Name of the firm; •Names and addresses of all partners; •Nature and place of the business; •Date of commencement of partnership; •Duration of partnership, if any; •Amount of capital contributed or to be contributed by each partner; •Rules regarding operation of bank accounts; •Ratio in which profits are to be shared;
  7. 7. • Interest, if any, on partners capital and drawings: • Interest on loan by the partners(s) to the firm; • Salaries, commissions, etc. if payable to any partner(s); • The safe custody of the books of accounts and other documents of the firm; • Mode of auditors appointment, if any; • Rules to be followed in case of admission, retirement, death, of a partner; • Settlement of accounts on dissolution of the firm; • Mode of settlement of disputes among the partners.Normally, a partnership deed covers all matters relating to the mutual relationshipamongst the partners. But if the deed is silent on certain matters or in the absence ofany deed or an express agreement, the relevant provisions of the Partnership Act shallbecome applicable. It is, therefore, necessary to know the provisions of the Act, whichhave a direct bearing on the accounting treatment of certain items. These are as follows:
  8. 8. 1. Profit Sharing 2. Interest on Capital 3. Interest on Loan 4. Interest on Drawings 5. Remuneration to Partners1-Profit Sharing:The partners shall share the profits of the firm equally irrespective of their capitalcontributionInterest on Capital:No interest is allowed to partners on the capital contributed by them. Where, however,the agreement provides for interest on capital, such interest is payable only out of theprofits of the business. In other words, if there are losses, interest on capital will not beallowed even if the agreement so provides.
  9. 9. 3-Interest on Loan:If any partner, apart from his share of capital, advances money to the firm as a loan, he isentitled to interest on such amount at the rate of 6 per cent per annum. Such interestshall be paid even out of the assets of the firm. This means that interest on loan shall bepaid even if there are losses. Implying, thereby, that it is a charge against the revenues. 4- Interest on Drawings: No interest will be charged on drawings made by the partners. 5-Remuneration to Partners No partner is entitled to any salary or commission for participating in the business of the firm. It should be remembered that the above rules are applicable only in the absence of any provision to the contrary in the partnership agreement.
  10. 10. Partner Capital AccountIn case of partnership firm, the transactions relating to partners are recorded in theirrespective capital accounts. Normally, each partners capital account is preparedseparately. two methods by which the capital accounts of partners can be maintained There are 1- Fluctuating Capital Method 2- Fixed Capital Method. Fluctuating Capital MethodUnder the fluctuating capital method, only one account, the capital account for eachpartner is maintained. It records all items affecting partners account like interest oncapital, drawings, interest on drawings, salary, commission, and share of profit or lossin the capital account itself. As a result of these, the balance in the capital accountkeeps on fluctuating.
  11. 11. Partner Capital Account: Dr. Cr. Date Particulars J.F Amount Date Particular J.F Amount .   Drawings *** Opening balance *** Interest on Drawings *** Addition to capital *** Share of loss Interest on capital *** *** Withdrawal of capital Salary Closing balance *** Commission/Bonus *** *** Share of profit ***   Total *** Total *** 2-Fixed Capital MethodUnder the fixed capital method, the capitals of the partners shall remain fixed unlesssome additional capital is introduced or some amount of capital is withdrawn by anagreement among the partners. Hence, all items like interesting capital, drawings,interest on drawings, salary, commission, and share of profit or loss are not to beshown in the capital accounts. For all these transactions, a separate account calledPartners Current Account is opened.
  12. 12. Dr. Cr.Date Particulars J.F Amount Date Particular J.F Amount .  Withdrawal of capital *** Opening balance *** Closing balance *** Addition to *** capital  Total *** Total ***Dr. Cr. Date Particulars J.F Amount Date Particular J.F Amount.   Drawings *** Opening balance *** Interest on Drawings *** Addition to capital *** Share of loss Interest on capital *** *** Withdrawal of capital Salary Closing balance *** Commission/Bonus *** *** Share of profit ***   Total *** Total ***
  13. 13. In case of partnership firm, the net profit (after charging the interest on capital,partners salary and commission and after taking into account the interest on drawings)is to be shared by all the partners in the agreed profit sharing ratio. As stated earlier, inthe absence of any specific agreement to this effect, the profit is to be distributedequally among the various partners. Profit and Loss Appropriation Account Dr. Cr. Date Particular J.F Amount Date Particular J.F Amount   Net Loss (If Loss) *** Net Profit (if Profit) *** Interest on Capital *** Interest on Drawing *** Partner’s Salary *** Share of Loss (if loss) *** Partner’s Commission *** Reserve (Transfer) *** Share of Profit (If Profit) ***   Total *** Total ***
  14. 14. If the partnership agreement specifically provides for the payment of the interest on the capital contributed by the partners, the same has to be allowed. Interest to be allowed on capital is to be calculated with respect to the time, rate and amount. Partners Capital (individually) A/ Dr. Profit and Loss Adjustment A/C (Cr.) For Example:Ali and Hamza are partners in a firm. Their capital accounts showed the balance on Jan 1, 2008 as Rs.20,000 and Rs. 15,000 respectively. During the year, Ali introduced additional capital of Rs.10,000 onMay 1,2000 and Hamza brought in further capital of Rs.15,000 on July 1, 2008. Hamza withdrew Rs.5,000 from her capital on October 1, 2000. Interests allowed @ 6% p.a. on the capitals. Calculate theinterest to be paid on the capital. Particular Ali Hamza 1. Interest on capital balance on Jan 1, 2008 1200                Ali – (20,000×6/100)           Hamza –(15,000×6/100) 900 2-Add : Interest on additional capital:           Ali-(10,000×6/100×8/12) 400          Hamza –(15,000×6/100×6/12) 450 3-Less: Interest on capital withdrawn           Hamza – (5000×3/12×6/100) (75)   Total Interest Payable 16,00 1,275
  15. 15. Calculation of Interest on Drawings:Interest on drawings is to be charged from the partners, if the same has been specifically provided inthe partnership deed. Interest on drawings is to be calculated with reference to the time period forwhich the money was withdrawn. Example:Suppose, Assad is a partner who withdrew Rs. 20,000 on October 1, 2008. Interest on drawings ischarged @ 10% per annum. The calculation of interest will be as follows: 20,000 x 10/100 x 3/12 = Rs.500 Past Adjustments:Sometimes, after the final accounts have been prepared and the partners capital account are closed, itis found that certain items have been omitted by mistake or have been wrongly treated. Suchomissions and commissions usually relate to the interest on capital, interest on drawings, salary topartners, etc. In such a situation, necessary adjustments have to be made in the partners capitalaccount through an account called Profit and Loss Adjustment Account. The following procedure may be helpful in recording necessary adjustments:. 1-Adjusting entries Interest on Capital: Profit and Loss Adjustment a/c (Dr.) Partners Capital a/c (individually) (Cr.)
  16. 16. Partners Capital (individually) a/c Dr. Profit and Loss Adjustment a/c (Cr.)Example (Past adjustments)Irfan and Rizwan are partners in a firm sharing profits equally. Their capital accounts as on December 31, 2000showed balances of Rs. 60,000 and Rs. 50,000 respectively. After taking into account the profits of the year 2000,which amounted to Rs 20,000, it was subsequently found that the following items have been left out while preparingthe final account of the year ended 2000(i) The partners were entitled to interest on capitals @ 6% p.a.(ii) The drawings of Irfan and Rizwan for the year 2000 were Rs.8,000 and Rs.6,000 respectively. The interest ondrawings was also to be charged @ 5% p.a.(iii) Irfan was entitled to salary of Rs.5,000 and Rizwan, a commission of Rs.2,000 for the whole year. It was decidedto make the necessary adjustments to record the above omissions. Give the necessary journal entries and preparethe profit and loss adjustment account and Partners capital accounts. Partners’ capital at the beginning:   Irfan Rizwan Capital at the end 60,000 50,000 Less: Share of Profit (10,000) (10,000) Total Before Drawing 50,000 40,000 Add: Drawings  8,000 6,000 Capital at the beginning 58,000 46,000 Interest on Capital Interest on Drawings Irfan : 58,000 × 6/100 = Rs. 3,480 Irfan: 8,000 x 5/100 x 6/12 = Rs.200 (5% P.a for 6th Month) Rizwan : 46,000 × 6/100 = Rs. 2,760 Rizwan: 6,000 x 5/100 x 6/12 = Rs.150 (5% P.a for 6th Month)
  17. 17. Adjusting Entries Date Particular L.F Amount (Dr.) Amount (Cr.)Dec,31 Profit and Loss Adjustment a/c 6240  Irfan Capital a/c 3840  Rizwan Capital a/c 2760  (Amount of interest on capital )    // Irfan Capital a/c 200  Rizwan Capital a/c 150  Profit and Loss Adjustment a/c 350  (Amount of interest on drawings )      // Profit and Loss Adjustment a/c 5,000  Irfan Capital a/c 5,000  (Amount of salary )      // Profit and Loss Adjustment a/c 2,000  Rizwan Capital a/c 2,000  Amount of Interest)      // Irfan Capital a/c 6,445 Rizwan Capital a/c 6,445 Profit and Loss Adjustment a/c 12,890 (Amount of Loss on Adjustment ) Profit and Loss Adjustment Account for the year ended December 31, 2000 Particular Amount Particular Amount Capital (Interest on capital) Capital (Interest on Drawing) Irfan       3480 Irfan 200 Rizwan   2760 6,240 Rizwan 150 350 Irfan Capital (Salary) 5,000 Capital (Loss on adjustments) Rizwan capital (Commission ) 2,000 Irfan 6,445 12,890 Rizwan 6,445 Total 13240 Total 13,240
  18. 18. Sometimes, the partners of a firm may agree to change their existing profit sharing ratio.As a result of this, some partners will gain in future profits while others will lose. In sucha situation, the partner who gains by the change in the profit sharing ratio mustcompensate the partner who has made the sacrifice because this effectively amounts toone partner buying the share of profits from another partner.
  19. 19. Introduction:Global Business Network was established in 1999, deals with cellular phone. There aretwo partners, have equal capital investment and profit ratio. Strength:1-Number of Partner is limited 2-Easy Monitoring 3-Vision, goal and objectives can defined easily4-Less paper work 5-Tax Advantage
  20. 20. Weakness: 1-Limited Capital 2-Legal Liability for paying firm debts Threat:   1-Risks to the partners for dissolution of firm Conclusion:By this we conclude that certain rights and duties are specified in a Indianpartnership act 1932 which regulate the proper functioning of firm and withoutwhich a firm cannot be run.