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INTODUCTION TO PARTNERSHIP
According to Kimball and Kimball, “A partnership firm as it is often called, is then a
group of men who have joined capital or services for the prosecuting of some enterprise.”
Generally, Partnership means, the relation between two or more persons competent to
contract who have agreed to carry on business with a view to private gains.
According to Indian Partnership Act 1932, section 4,” Partnership I the relationship
between persons who have agreed to share the profits of the business carried on by all or
any of them acting for all.”
Here the persons who are entered into partnership with one another called individually
‘partners’ and collectively as ‘firm’.
As per partnership Act, there must be minimum two persons to form a partnership firm,
but regarding maximum number, the act is silent.

Chacteristics of Partnership
 Agreement: In order to run the business smoothly, it is necessary that there must be
an agreement between partners named “Partnership Deed”. May be in oral or
writing mode.
 Plurality of persons: Here, at least two persons are required. The maximum
number of persons is ten in case of firms having banking business and twenty in
case of other business.
 Lawful Business: It is essential that the partnership is formed for doing lawful
business to earn profits.
 Voluntary Association: A partnership is a voluntary association of individuals. The
partnership firm has no separate legal existence.
 Sharing of profits: It is essential that the partners share profits of the firm
according to predetermined ratio.
 Non-transferability: No partner can transfer his share in the partnership without
the prior consent of all other partners.
 Collective Management: The ownership is not separated form management. Each
partner is an owner and also a part of management.
 Act: The partnership business is governed by the Indian Partnership Act,1932.

The need for large amount of capital, better management, sharing risk
jointly and specialised knowledge gave rise to partnership firm.
[Advantages and Disadvantages of Partnership Firm]
Advantages:
 Easy to form: This is a suitable type of organisation requiring no legal formalities
and no formal documents.
 More funds: The resources of more than one person are available for the business.
 Greater managerial talent: The partners may be assigned duties according to their
talent. Every department may be managed and controlled by different partners.
 Promptness in decision making: The partners meet frequently a take prompt
decision.
 Sharing of risk: The risk is shared by partners. The burden of each partner will be
much less as compared to sole trade.
 Relationship between reword and work: The partners try to put more labour to earn
more profits. The more they work, the more will they get.
 More possibility of growth and expansion: Partnership concern has more
possibilities for expansion and growth of the business.
 Secrecy: A partnership concern is not expected to publish its profit and loss account
and balance sheet as is necessary for a joint stock company. They can keep the
business secrets to themselves.

Disadvantages:
 Unlimited liability: Here, partners are not only liable for their investments but their
private properties can also be taken for business liabilities.
 Limited resources: The business resources are limited to personal funds of the
partners.
 Lack of continuity: The partnership concern suffers from the uncertainty of
duration because, it can be dissolved at the time of death, lunacy or insolvency of a
partner.

 Mutual Distrust: It is difficult to maintain harmony among partners because they

may have different opinions and may not agree on certain matters.
  Lack of public faith: The accounts of partnership concerns are not published. So,
public is unaware of the exact position of the business.
 Lack of prompt decisions: All decisions are taken by the consent of partners. so
decision making process becomes time consuming.

Partnership Deed:
The document which contains the terms and conditions of partnership, as agreed among
the partners, is called ‘Partnership Deed’.
Contents of partnership Deed:
•Name, address and place of business of the firm.
•Name and address of all partners.
•Type of business that the firm shall carry on.
•Date of commencement of partnership.
•Amount of capital contribution by each partner.
•Ratio in which the profits or losses are to be shared.
•Rate of interest on capital.
•Rate of interest on drawings.
•Rate of interest on loan by a partner to the firm.
•The method of computation and treatment of goodwill on the reconstitution of a firm.
•The mode of settlement of accounts in case of dissolution.
•The date on which accounts shall be closed every year.
•Clear provisions about the rights and duties of partners.
•Maximum permissible drawings by each partner.
•Method of book-keeping – cash basis or accrual basis.
•Valuation of assets and liabilities in case of reconstruction.
•Method of settlement of dispute, if arises.
•Partner or partners who will be in change of operating bank account

When there is no partnership deed:

When there is no partnership deed or any agreement the relevant provisions of the Indian
Partnership Act,1932 would be applicable.
1.Sharing of profits and losses - Profits and losses are to be shared equally. (Sec 13)
2.Interest on capital - No interest is to be allowed on capital. (Sec 13c)
3.Interest on drawings. - No interest is to be charged on drawings.
4.Interest on loan given by a partner. - Interest @6% p.a. is to be allowed on
advances/loans. (Sec 13d)
5.Salary/Commission/Remuneration to a partner. - No remuneration fix taking part in the
conduct of business is to be allowed to any partner. (Sec 13 a)

FINAL ACCOUNTS OF PARTNERSHIP:

The final accounts of partnership business consist of the following:
•Manufacturing Account (in case of manufacturing concern).
•Trading and Profit & Loss Account.
•Profit and Loss Appropriation Account.
•Balance Sheet.

PROFIT AND LOSS APPROPRIATION ACCOUNT

This profit and loss account is one which is solely prepared for partnership firm.
After finding out the net profit as per the profit and loss account, the profit and loss
appropriation account is prepared to show how the net profit is distributed among the
partners.
Features:
•It is an extension of the profit and loss account.
•It is credited with net profits and interest on drawings.
•It is debited with interest on capitals, salary or commission to partners, if provided under
the terms of partnership deed.
•Transfer of profits to the General Reserve or specific reserve is also done through this
account.
•The balance of profit and loss appropriation account is transferred to the partner’s capital
or current account in their agreed profit sharing ratio.
Journal Entries Relating to Profit & Loss Appropriation Account:
1.Interest on capital (i) Interest on capital A/c……………. Dr
To partners capital (or current)
A/c(individually)
(Interest is allowed on partners’ capital)

(ii) Profit and Loss Appropriation A/c….

Dr
To Interest on capital A/c
[ Interest on capital is transferred to P&L.
(app) A/c]
Alternatively, only one entry may be
2.Interest on drawings passed, as follows,
Profit and Loss Appropriation A/c……. Dr
To Partners’ capital A/c(individually)
(i)Partner’s Capital (or current) A/c
(individually)……. Dr
 To Interest on drawing A/c
(Interest is charged on partner’s drawing)

(ii) Interest on drawings A/c ………. Dr

To Profit & Loss Appropriation A/c
3.Partner’s salary/commission [Interest on drawing is transferred to P&L.
(app)A/c]

(i)Partner’s salary/commission A/c…… Dr

To partners’ capital (or current)
A/c
(salary or commission is allowed to
partners)

(ii)Profit & Loss Appropriation A/c…. Dr

To partners salary/commission A/c
[salary or commission is transferred to
P&L.(app)A/c]

Specimen of Profit and Loss Appropriation Account:

Profit and Loss Appropriation Account of M/s AB Traders

Dr (for the year ended……) Cr
Particulars Amount Particulars Amount
(Rs) (Rs)
To Interest on capital By Profit and Loss A/c XXX
A XXX (Net profit)
B XXX XXX
To salary to partners XXX By Interest on Drawing
A XXX XXX
XXX B XXX
To bonus to partners
To commission or fees to partners XXX
To Reserve Fund XXX

To profit transferred to;

A’s capital*/current**A/c
XXX

B’s capital/current A/c

XXX
XXX
 XXX
XXX

*Under fluctuating capital method.

** Under fixed capital method.

SPECIAL ASPECTS OF PARTNERSHIP ACCOUNTS

The final accounts of a partnership firm is prepared in the same manner as that of a sole
proprietorship concern. But, there are certain typical issues that require special
consideration. These are:
1.Partners’ capital account
2.Interest on partner’s capital
3.Interest on partner’s drawing
4.Salary or commission to partner
5.Interest on partner’s loan
6.Past adjustments
7.Capital ratio
8.Guarantee of profit
Partners’ capital Account
In partnership the capital account of each partner is opened separately in their name.it may
be maintained according to the following two methods:
FIXED CAPITAL ACCOUNT METHOD
Here two accounts are opened for every partner viz, capital account and current account.
when capital accounts are fixed, the transactions between the firm and partners such as;
interest on capital, interest on drawings, salary, commission, fees, bonus, share of
profits/loses etc are recorded through current account. Normally partners current account
shows a credit balance but if the partners have drawn out more than their share, then it will
show a debit balance. Here capital account remains fixed.
FLUCTUATING CAPITAL ACCOUNT METHOD
Here only one account i.e. partner’s capital account is maintained. Besides the opening
capital introduced all the transactions between the firm and partners e.g. salary, fees,
bonus, goodwill etc are also recorded in this account. Capital balance fluctuate this capital
account is called fluctuating capital account.
Interest on capital
As pointed out earlier, interest is allowed on capital only when partnership deed provides
for it. It is allowed in such cases where partners’ capitals are disproportionate to the share
of profit taken by them and interest is allowed to compensate the partner contributing
excess relative capital.
JOURNALS;
i. For allowing interest on capital
Interest on capital A/c …..Dr
To partner’s capital/ current A/c
ii. For transferring interest on capital
Profit and loss Appropriation A/c …..Dr
To interest on capital A/c

PROVISION IN RESPECT OF INTEREST ON CAPITAL

1.If partnership deed is silent, no capital is allowed.
2.If deed provides for it and considers interest as an appropriation of profit
a.in case of loss – no interest on capital is allowed.
b.in case of sufficient profit, allow interest at the agreed rate.
c.in case of insufficient profit, interest shall be allowed upto the profit available in the
ratio of interest on capital.
3. if interest on capital is treated as a charge against profit, interest on capital will be
allowed whether there is profit or loss. In this case interest on capital will be shown in the
profit and loss account.

INTEREST ON DRAWINGS
Partners are sometimes allowed to draw either cash or goods from the business for their
personal use in anticipation of profit and also against their claim of salary, commission etc
here, journal entries,
i.For charging interest on drawing
partner’s capital/ current A/c….. Dr
To interest on drawings A/c
ii.For transferring interest on drawings to profit and loss appropriation account
Interest on drawings A/c …. Dr
To profit & Loss Appropriation A/c
Calculation of interest on Drawings
Case- I when date of drawings is not given
Interest on drawings is always calculated with reference to the period of drawing. So,
when dates of drawings are not given it is to be calculated on total drawings made during
the year for an average period of six months. Similarly, when the rate of interest is given
without mentioning the word “per annum”, interest will be calculated ignoring the time
factor.
Case-II when irregular amounts are drawn at different time periods
In this case care should be taken to determine the period of each withdrawl form the day it
occurs to the closing accounting date. Then use product method to calculate the total
interest on drawings.
Case- III when a constant amount is drawn at regular intervals
Accounting period Constant amounts are Period for which interest on
drawn drawings is calculated on
total drawings
12 months a. In the beginning of each 6.5 months
month
b. At the end of each month 5.5 months
c. In the middle of each 6 months
month

6 months a. In the beginning of each

month 3.5months
b. At the end of each month
c. In the middle of each 2.5months
month 3 months
12 months a.in the beginning of each 7.5 months
quarter
b.at the end of each quarter 4.5 months
c.in the middle of each 6 months
quarter
Salary, Commission, Fees, Bonus etc Payable to Partner
Salary or commission to partners is an appropriation out of profits and not a charge against
the profits. Salary or commission is paid to compensate partners for devoting more time or
for acquiring extra – ordinary skill.
i. Commission as a percentage of Net profit before charging such commission.
= Net profit before commission multiplied by Rate of commission/100
ii.Commission as a percentage of Net profit after charging such commission
= Net profit before commission multiplied by rate of commission/100+Rate of
commission
Accounting Treatment:
i.For salary, commission etc payable to partner.
Partner’s salary/ commission A/c ………… Dr
To partner’s capital A/c / Current A/c
ii.For transfer of commission etc to profit and loss appropriation A/c
Profit and Loss Appropriation A/c……... Dr
To partner’s salary/ commission A/c
Interest on loan given by partners
At times a firm borrows money from its partners to fulfil the requirement of additional
fund. On the borrowing amount the firm pays interest as mentioned in the deed. If the deed
is silent interest on such loan is allowed at 6% p.a with due regard to the period of
borrowing.
JOURNAL ENTRIES
i.when loan is given by a partner
cash/bank A/c ……. Dr
To partner’s loan A/c
ii. if interest on loan is paid
Interest on loan A/c ……. Dr
To cash/bank A/c
iii. when interest is due
Interest on loan A/c …… Dr
To partner’s loan A/c
iv. when interest on loan is transferred to profit and loss account
profit & loss A/c ……… Dr
To interest on loan A/c

Distribution of profits in capital ratio

Generally, partners share profits in the profit-sharing ratio mentioned in the partnership
deed. However, at times profits are to be shared in the capital ratio as per the direction
given in the question. In such a situation;
i. If capital account of partners are fixed: The profit is to be shared in their fixed capital
ratio.
ii. If capital account of partners are fluctuating: We have to calculate the capital ratio
giving due regard to the additional capital introduced and withdrawal of capital with
reference to time by applying product method.
Past Adjustment (Adjustment of incorrect distribution of profit)
Past adjustment may arise due to omission of interest on capital, interest on drawing,
salary or commission payable to partners, change in profit sharing ratio etc. Adjustment in
such a case is made by writing back the profit wrongly distributed and then making a fresh
appropriation on correct basis through profit and loss Appropriation Account.
PROCEDURE:
1.First calculate opening capital by adding drawings and deducting the share of profit.
2.Then prepare profit & loss Appropriation Account by writing back the profit already
distributed and making fresh distribution after correcting the errors and mistake.
3.Prepare correct capital accounts.

Guarantee of profit to a partner

Sometimes a partner is admitted to a partnership firm on the condition that he would be
given a minimum amount of profit. In such a case, he will be given the minimum amount
of profit as agreed upon or his share of profit as profit sharing ratio whichever is higher.
The guarantee may be given either by one partner or by all the old partners. The partner to
whom guarantee is given is termed as guaranteed partner while the partner giving such
guarantee is called guaranteeing partner. When guarantee is given by one or all partners in
the existing profit ratio is termed as firm guarantee. But if guarantee is given in a ratio
other than the existing profit sharing ratio, it is referred to as personal guarantee.
The rule of guarantee states that if the share of the guaranteed partner is less than the
guaranteed amount, the deficiency arising therefrom shall be borne by the guaranting
partners in the agreed ratio. In this case, transfer should be made from the share of profit
of the guaranteeing partner.
Journal entry:
Guaranteeing partner’s capital A/c ……... Dr
To Guaranteed partner’s Capital A/c

PROCEDURE:
1.Calculate share of profit of each partner in the profit-sharing ratio without considering
the guarantee clause.
2.If the share of the guaranteed partner is more than the amount of guarantee, no
adjustment is required.
3.If the guaranteed partner’s share falls short of the minimum amount, the deficiency is
made good by transferring profit from the share of the partners giving such guarantee.
4.If the guarantee is given by all partners, transfer of profit should be made from their
share in the agreed ratio. If the question is silent, the deficiency shall be borne by the
guaranteeing partners in their profit-sharing ratio.

PRACTICAL PROBLEM:
Aditya and Binita are partners in a firm sharing profits and losses equally. On April,2019
their capitals were Rs.3,00,000 and Rs.2,00,000 respectively. The partnership agreement
provides that;
I. Interest on capital to be allowed @ 6% per annum.
ii. Interest on Binita’s loan account of Rs.1,00,000 for the entire year.
iii. Transfer 10% of the distributable profits to reserve fund.
iv. Interest on drawings of partners @ 6% p.a.
Drawings of Aditya – Rs.50,000 and Binita – Rs.60,000
The profit and loss account of the firm showed a net profit of Rs.2,05,000 (before interest
on Binita’s loan) for the year ended 31 March,2020.
Prepare profit and loss A/c, profit and loss appropriation A/c and partner’s capital
accounts.

SOLUTION:
Dr. Profit and Loss Account Cr.
Particulars Amount Particulars Amount
(Rs.) (Rs.)
To Interest on loan 6,000 By Net profit 2,05,000
To Profit and Loss (App)
A/c 1,99,000
2,05,000 2,05,000

Profit and Loss Appropriation A/c for the year ended March 31, 2020
Dr.
Cr.
Particulars Amount (Rs.) Particulars Amount (Rs.)

To Interest on capital By Profit and Loss A/c 1,99,000

Aditya 18,000 - Net Profit
Binita 12,000 30,000
By Interest on drawings
To Reserve Fund 17,230 Aditya 1,500
(10% of 2,02,300 – Binita 1,800 3,300
30,000)

To share of profit
transferred to: `1,55,070
Aditya’scapitalA/c 77,535
Binita’s capital A/c
77,535
2,02,300 2,02,300

Partners Capital Account

Dr.
Cr.
Particulars Aditya Binita Particulars Aditya Binita

To Drawings A/c 50,000 60,000 By Balance b/d 3,00,000 2,00,000

To Interest on 1,500 1,800 By Int. on capital 18,000 12,000

drawings
By P & L Appr.
To Balance c/d 3,44,035 2,27,735 A/c 77,535 77,535

3,95,535 2,89,535 3,95,535 2,89,535

Working Notes:
1.Interest on partner’s loan has been allowed @ 6% per annum as there has been no
agreement. But it will to shown on the debit side of the profit & loss account.
2.As the date of drawing is not mentioned interest has been calculated for an average
period of 6 months.