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FUNDAMENTALS OF PARTNERSHIP
As the business expands, one needs more capital and larger number of people to manage the business and share its risks. In such a situation, people usually adopt the partnership form of organisation. Accounting for partnership firms has it’s own peculiarities, as the partnership firm comes into existence when two or more persons come together to establish business and share its profits.
Partnership is governed by The Partnership Act,1932. . Section 4 of the Indian 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’.
PARTNERS & PARTNERSHIP FIRM
Persons who have entered into partnership with one another are individually called ‘partners’ and collectively called ‘firm’. The name under which the business is carried is called the ‘firm’s name’.
A partnership firm has no separate legal entity, apart from the partners constituting it.
Thus, the essential features of partnership are:
1. Two or More Persons:
In order to form partnership, there should be at least two persons coming together for a common goal. In other words, the minimum number of partners in a firm can be two. There is however, a limit on their maximum number. If a firm is engaged in the banking business, it can have a maximum of ten partners while in case of any other business, the maximum number of partners can be twenty.
2. Agreement:
Partnership is the result of an agreement between two or more persons to do business and share its profits and losses. The agreement becomes the basis of relationship between the partners. It is not necessary that such agreement is in written form. An oral agreement is equally valid. But in order to avoid disputes, it is preferred that the partners have a written agreement.
3. Business:
The agreement should be to carry on some business. Mere co-ownership of a property does not amount to partnership.
For example, if Xand Y jointly purchase a plot of land, they become the joint owners of the property and not the partners. But if they are in the business of purchase and sale of land for the purpose of making profit, they will be called partners.
4. Mutual Agency:
The business of a partnership concern may be carried on by all the partners or any of them acting for all. This statement has two important implications. First, every partner is entitled to participate in the conduct of the affairs of its business. Second, that there exists a relationship of mutual agency between all the partners. Each partner carrying on the business is the principal as well as the agent for all the other partners. He can bind other partners by his acts and also is bound by the acts of other partners with regard to business of the firm. Relationship of mutual agency is so important that one can say that there would be no partnership, if the element of mutual agency is absent.
5. Sharing of Profit:
Another important element of partnership is that, the agreement between partners must be to share profits and losses of a business. Though the definition contained in the Partnership Act describes partnership as relation between people who agree to share the profits of a business, the sharing of loss is implied. Thus, sharing of profits and losses is important. If some persons join hands for the purpose of some charitable activity, it will not be termed as partnership.
6. Liability of Partnership:
Each partner is liable jointly with all the other partners and also severally to the third party for all the acts of the firm done while he is a partner. Not only that the liability of a partner for acts of the firm is also unlimited. This implies that his private assets can also be used for paying off the firm’s debts.
Partnership Deed:
Partnership comes into existence as a result of agreement among the partners. The agreement can be either oral or written. The Partnership Act does not require that the agreement must be in writing. But wherever it is in writing, the document, which contains terms of the agreement is called ‘Partnership Deed’.
The clauses of partnership deed can be altered with the consent of all the partners. The deed should be properly drafted and prepared as per the provisions of the ‘Stamp Act’ and preferably registered with the Registrar of Firms.
Contents of the Partnership Deed
The Partnership Deed usually contains the following details:
• Names and Addresses of the firm and its main business;
• Names and Addresses of all partners;
• Amount of capital to be contributed by each partner;
• The accounting period of the firm;
• The date of commencement of partnership;
• Rules regarding operation of Bank Accounts;
• Profit and loss sharing ratio;
• Rate of interest on capital, loan, drawings, etc;
• Mode of auditor’s appointment, if any;
• Salaries, commission, etc, if payable to any partner;
• The rights, duties and liabilities of each partner;
• Treatment of loss arising out of insolvency of one or more partners;
• Settlement of accounts on dissolution of the firm;
• Method of settlement of disputes among the partners;
• Rules to be followed in case of admission, retirement, death of a partner; and
• Any other matter relating to the conduct of business. Normally, the partnership deed covers all matters affecting relationship of partners amongst themselves. However, if there is no express agreement on certain matters, the provisions of the Indian Partnership Act, 1932 shall apply.
Provisions Relevant for Accounting-
The important provisions affecting partnership accounts are as follows:
a. Profit Sharing Ratio:
If the partnership deed is silent about the profit sharing ratio, the profits and losses of the firm are to be shared equally by partners, irrespective of their capital contribution in the firm.
b. Interest on Capital:
No partner is entitled to claim any interest on the amount of capital contributed by him in the firm as a matter of right. However, interest can be allowed when it is expressly agreed to by the partners. Thus, no interest on capital is payable if the partnership deed is silent on the issue. Further the interest is payable only out of the profits of the business and not if the firm incurs losses during the period.
c. Interest on Drawings:
No interest is to be charged on the drawings made by the partners, if there is no mention in the Deed.
d. Interest on Loan:
If any partner has advanced some money to the firm beyond the amount of his capital for the purpose of business, he shall be entitled to get an interest on the amount at the rate of 6 per cent per annum.
e. Remuneration for Firm’s Work:
No partner is entitled to get salary or other remuneration for taking part in the conduct of the business of the firm unless there is a provision for the same in the Partnership Deed.
Apart from the above, the Indian Partnership Act specifies that subject to contract between the partners:
Special Aspects of Partnership Accounts
Accounting treatment for partnership firm is similar to that of a sole proprietorship business with the exception of the following aspects:
• Maintenance of Partners’ Capital Accounts;
• Distribution of Profit and Loss among the partners;
• Adjustments for Wrong Appropriation of Profits in the Past;
• Reconstitution of the Partnership Firm; and
• Dissolution of Partnership Firm.
Maintenance of Capital Accounts of Partners
There are two methods by which the capital accounts of partners can be maintained. These are:
fixed capital method, and
fluctuating capital method.
The difference between the two lies in whether or not the transactions other than addition/withdrawal of capital are recorded in the capital accounts of the partners.
1. Fixed Capital Method:
Under the fixed capital method, the capitals of the partners shall remain fixed unless additional capital is introduced or a part of the capital is withdrawn as per the agreement among the partners. So There are two types of accounts to be made-
All items like share of profit or loss, interest on capital, drawings, interest on drawings, etc. are recorded in a separate accounts, called Partner’s Current Account.
The partners’ capital accounts will always show a credit balance, which shall remain the same (fixed) year after year unless there is any addition or withdrawal of capital. The partners’ current account on the other hand, may show a debit or a credit balance.
Dr Partner’s Capital Account Cr
Date
Particular
JF
Amount
To bank
((permanent withdrawal of capital)
To Balance c/d
(closing balance)
By Balance b/d
(Opening Balance)
By Bank ( Fresh Capital introduced)
Dr Partner’s Current Account Cr
To Balance b/d
(in case of debit opening bal,)
To Drawings
To Interest on drawings
To Profit & Loss
Appropriation
(for share of loss)
(in case of credit
closing balance)
opening balance)
By Salary
By Commission
By Interest on capital
By Profit & Loss
(share of profit)
By Balance c/d
(In case of debit closing Balance)
Under the fluctuating capital method, only one account, i.e. capital account is maintained for each partner. All the adjustments such as share of profit and loss, interest on capital, drawings, interest on drawings, salary or commission to partners, etc are recorded directly in the capital accounts of the partners. This makes the balance in the capital account to fluctuate from time to time. That’s the reason why this method is called fluctuating capital method.
DrPartner’s Capital AccountCr.
Distribution of Profit among Partners
The profits and losses of the firm are distributed among the partners in an agreed ratio. However, if the partnership deed is silent, the firm’s profits and losses are to be shared equally by all the partners.
Profit and Loss Appropriation Account
Profit and Loss Appropriation Account is merely an extension of the Profit and Loss Account of the firm. It shows how the profits are appropriated or distributed among the partners. All adjustments in respect of partner’s salary, partner’s commission, interest on capital, interest on drawings, etc. are made through this account. It starts with the net profit/net loss as per Profit and Loss Account is transfered to this account
The Proforma of Profit and Loss Appropriation Account is given as follows
DrProfit and Loss Appropriation AccountCr
Profit and Loss
(if there is loss)
Interest on Capital
Salary to Partner
Commission to Partner
Interest on Partner’s LoanPartners’ Capital Accounts (distribution of profit)
if there is profit)
Interest on Drawings
Partners’ Capital
(distribution of loss)
Calculation of Interest on Capital
No interest is allowed on partners’ capitals unless it is expressly agreed among the partners. When the Deed specifically provides for it, 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
Interest on capital is calculated with due allowance for any addition or withdrawal of capital during the accounting period.
The partnership agreement may also provide for charging of interest on money withdrawn out of the firm by the partners for their personal use. As stated earlier, no interest is charged on the drawings if there is no express agreement among the partners about it. However if the partnership deed so provides for it, the interest is charged at an agreed rate, for the period money remained outstanding from the partners during an accounting year. Charging interest on drawings discourages excessive amounts of drawings by the partners.
By: NIHARIKA WALIA ProfileResourcesReport error
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