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1. CH : 1
ACCOUNTING FOR
PARTNERSHIP FIRM –
FUNDAMENTALS

2. Meaning of Partnership
• A partnership firm is an
association of two or more
persons to carry on a legal
business and share its profits or
losses. The persons who join
hands together to do a business
are individually known as partners
and collectively a firm.

3. .
• According to Sec 4 of the Indian
Partnership Act, 1932, "the term
partnership is the relation between
two or more persons who have
agreed to share the profit of the
business carried on by all or any of
them acting for all

4. Essential elements of Partnership
•1. At least two persons: There must be at
least two persons to form a partnership and all
such persons must be competent to contract.
•2. Agreement: There must be an agreement
to form a partnership. This agreement can be oral
or written.
•3. Legal Business: An agreement should be
for the purpose of carrying on the business or
profession. The business to be carried on by the
partners should be legal.

5. .
• •4. Profit Sharing: The agreement between the
partners must be to share the profits or losses of
the business in the particular ratio.
• •5 Mutual agency: There should be a mutual
agency relationship among the partners. 'Mutual
Agency' relationship means that each partner is
both an agent and the principal. Each partner is
an in the sense that he can bind the other
partners by his acts done.
6. Number of partners: The minimum limit of the
partners in a firm is two and maximum number of
partners in a banking firm should be 10 and in the
other firm should be 20.

6. Meaning of Partnership Deed
• As stated above a partnership is formed by an
agreement. This agreement can be oral or
written. Though the law does not expressly
require that there should be an agreement in
writing but the absence of written agreement
may be the source of problem in managing
the affairs of the partnership firm.

7. Contents of Partnership deed
• 1.Nameof the firm.
• 2.Nameand addressesof allthepartners.
• 3.Natureandplace ofthebusiness.
• 4.Durationof partnership.
• 5.Dateof commencementof partnership.
• 6.Amountofcapitalcontributedby each partners.
• 7.Ratioin which profitsandlosses are tobe shared.

8. • 8.Intereston partner's capitalanddrawings.
• 9.Intereston loan by thepartner to thefirm.
• 10.Salary, Commission,etc.if any payableto a partner.
• 11.Methodof computationandtreatmentof Goodwillon the
reconstitutionofthe firm.
• 12.Mode ofsettlementofaccounts in case ofretirement/deathof
a partner.
• 13.Mode ofsettlementofaccounts in case ofdissolution ofthe
firm.

9. Rules in the absence of the Partnership Deed
• (i) The partners will share the profits and
losses in the equal ratio.
• (ii) Interest on loan will be given @ 6% p.a.
to the partners.
• (iii) No interest is allowed to partners on
the capital invested by them.

10. .• (iv) No partner .is toget any
remuneration such as salary, commission
etc for participating in the business.
• (v) No interest will be charged on
drawings made by the partners.

11. Meaning of Profit and Loss Appropriation
Account:
• Profit andLoss AppropriationAccountis an
extension ofProfit and Loss Accountthat is
prepared to distribute the net profit amongthe
partners. Alladjustments relating to partners like
interest oncapital, interest ondrawings,
commissionto partners etc. are made inthis
Account.

12. Purpose of Profit & Loss Appropriation Account:
• Themainpurpose of preparing Profit& Loss Appropriation
Account of a Partnershipconcern is to calculate and distribute
thedivisible Profit & Loss. The Income Tax Act and the audit
rule does notpermit thepartnership firm to consider the
amountas business expenditurewhich is payable to the
partners

14. AccountingTreatment
Items Accounting Entries
Capital contributed in cash Dr. Cash
Cr. Partners’ Capital Accounts
Share of profits Dr. Profit and Loss Appropriation
Cr. Partners’ Current Accounts
Share of losses Dr. Partners’ Current Accounts
Cr. Profit and Loss Appropriation
Interest on capital Dr. Profit and Loss Appropriation
Cr. Partners’ Current Accounts
Partners’ salaries Dr. Profit and Loss Appropriation
Cr. Partners’ Current Account

15. Items Accounting entries
Interest on partners’ loan Dr Profit and loss
appropriation
Cr Partners’ current
Partners’ drawings Dr Partners’ current
Cr Partners Drawings
Interest on drawings Dr Partners’ current
Cr Profit and loss
appropriation

16. Methods ofMaintaining Capital Accounts of
the Partners
•The partner's Capital Accounts are
maintained according to Fluctuating
Capital Method or Fixed Capital
Method.

17. Fluctuating Capital Method
• Under fluctuating capital method, only
one account viz. capital account for
each partner is maintained and all the
transactions relating to a partner are
recorded in his capital account. As a
result, the balance in the Capital
Account keeps on fluctuating.

18. PARTNER’S CAPITAL A/C
Particular Rs. Particular Rs.
To balance b / f
To cash/bank A/c (
withdrawl ]
To drawings
To interest on drawings
To Profit & Loss A/c (share
of loss)
To balance c/f
****
****
****
****
****
****
By balance b/f
By cash/bank (additional capital)
By interest on capital
By salary
By Commission
By P&L Appropriation A/c (share of
profits)
By balance c/f
****
****
****
****
****
****
****
**** ****
Dr. Partner's Capital Account Cr.

19. Fixed Capital Account:
• Under FixedCapitalmethod, two accountsviz. capital
accountand current accountfor each partner are
maintained.The transactions relatingto introduction
or withdrawalof capital arerecorded in Capital
Account and other transactionslikeinterest oncapital,
salary,interest ondrawings, drawings are recorded in
Current Account.

20. ,
Particular Rs. Particular Rs.
To cash/bank A/c
(withdrawal)
To balance c/f
****
****
By balance b / f
By cash/bank (additional
capital)
By balance c/f
****
****
****
**** ****
Dr. Partner's Capital Account Cr.

21. .
Particular Rs. Particular Rs.
To balance b/f
To drawings
To interest on drawings
To Profit & Loss A/c
(share of loss)
To balance c/f
****
****
****
****
****
By balance b/f
By interest on capital
By salary
By Commission
By P&L Appropriation A/c (share
of profits)
By balance c/f
****
****
****
****
****
****
**** ****
Dr. Partner's Current Account Cr.

22. ,
Basis Fixed Capital Method Fluctuating Capital Method
Change in Capital The capital remains unchanged except in
some special circumstances
The capital fluctuates quite frequently from
period to period
No of accounts Two accounts are maintained viz: capital
account and current account
One account is prepared i.e. capital account.
Adjustments of
drawings etc.
All adjustments of drawings, salary etc
are done in capital account
All adjustments of drawings, salary etc are
done in current account
Negative Balance Fixed Capital Account can never show a
negative balance.
Fluctuating Capital Account can show a
negative balance.
Distinction betweenFixed Capital Methodand Fluctuating Capital Method

23. Basis Capital Account Current Account
Need Capital Account is opened in the case
fluctuating capital method and fixed
capital method
Current account is prepared only in case of
fixed capital method.
Nature of accountCapital account in fixed capital method
remains fixed from year to year.
Current account fluctuates from year to
year.
Accounting
treatment
Amount invested by the partner is to
be recorded.
Transactions such as drawings, salary, and
interest on capital are recorded.
Balance of
account
Capital account in fixed method show
only credit balance.
Current account can show a credit or debit
balance
Following are some of the differences between Capital Account and Current Account
DIFF. B/W CAPITAL AND CURRENT A/C

24. Basis Drawings against capital Drawings against profits
Debited It is debited in capital account It is debited in drawings account
Part It is a part of capital It is a part of expected profits
Interest It is considered in calculation of
interest on capital
It is not considered in calculating the
interest on capital
Effect It reduces capital It does not reduce capital.

25. .
Basis Capital Account Current Account
Need Capital Account is opened in the case
fluctuating capital method and fixed
capital method
Current account is prepared only in case of
fixed capital method.
Nature of
account
Capital account in fixed capital
method remains fixed from year to
year.
Current account fluctuates from year to
year.
Accounting
treatment
Amount invested by the partner is to
be recorded.
Transactions such as drawings, salary, and
interest on capital are recorded.
Balance of
account
Capital account in fixed method show
only credit balance.
Current account can show a credit or debit
balance

26. Calculation ofInterest ondrawings:
• The drawings are usually made by
the partners at regular intervals.
Thus, the interest on drawings is
calculated with reference to the time
period involved. It can be worked out
by any one of the following methods:

27. 1. When dates of drawings are not given
• (i) Averageperiodmethod:Ifthe datesofdrawings arenot
given, theintereston drawings iscalculatedon theaverage basis
on thetotalamountof drawings madeduring theaccounting
periodfor halfof theaccounting period.Itis basedon the
assumptionthatthe amountsweredrawn evenly through out the
accounting year.
Formula:
• Interest on drawings= Total drawings× Rate/100×
6/12

28. .(ii) Averagerateofinterestmethodorwhendrawingsare
madeirrespective ofthetimeperiod:Sometimestheaverage
rate of interestis given in thequestion, in such a case; it is
assumed thatthe rate of interest is already halfon thebasis of
6 months.Thus, timewill notbe considered.
• Formula: Interest on drawings = Total
drawings × Average Rate/100
•

29. When dates of drawings are given:
• (i) Product Method: When different amounts are
withdrawn at different intervals, the interest will be
calculated with the help of product method. In this each
amount of drawings is multiplied with number of
days/months (from the date of drawings to the date of
final accounts) to find out the product and then products
are totaled. Interest is calculated on total product at the
rate of interest for one month or one day.
• Formula: Interest on drawings = Total of Product ×
Rate/100 × 1/365 or 1/12

30. .
• (ii) Monthly/quarterlydrawingsmethod:If
uniformamount is withdrawn at each time and
the interval between two withdrawals also is
uniform.In such a case interest ondrawings is
calculated with monthlydrawings method. Time
periodinthis methodis calculated as follows:

31. In that case there will be following cases:
• Whendrawingsarefor12monthsperiod
At the beginningof each month= Total drawings × Rate/100 ×
6.5/12
At the endof every month= Total drawings × Rate/100 × 5.5/12
At the middleof every month= Total drawings × Rate/100×
6/12

32. When drawings are for 6 months
period
• o At the beginning of each month = Totaldrawings×
Rate/100 × 3.5/12
• o At the end of every month = Totaldrawings×
Rate/100 × 2.5/12
• o At the middle of every month = Totaldrawings×
Rate/100 × 3/12

33. When drawings are made quarterly
during the period
• o Atthe beginningof eachquarter =Total
drawings×Rate/100×7.5/12
• o Atthe end ofeveryquarter= Total
drawings×Rate/100×4.5/12

34. Interest on Partner's Capital:
• Intereston capital is to be allowed to thepartners if thesame
is provided in the partnership deed and is allowed at thegiven
rate with reference to timeperiod for which thecapital has
been used in thebusiness.
• Formula:Interestoncapital=AmountofCapital×
Rate/100×Time

35. Case Provision
1. If the partnership agreement is
silent for interest on capital.
No interest on capital will be allowed.
2. If the partnership agreement
provides for interest on capital but is
silent as to treatment of interest as a
charge or appropriation.
Interest on capital will be allowed only
if there are profits
(a) In case of loss - No interest on
capital will be allowed
(b) Profit > Interest - Full interest on
capital
(c) Profit < Interest -Profit will be given
capital ratio
3. If the partnership agreement
provide for interest on capital as a
charge.
Full interest on capital will be provided
whether there is profit or loss.

36. Salary or Commission to a Partner
• Salary or Commission to a partner is to
be allowed if the partnership agreement
provides for thesame.Theseare allowed
only if there are profits.

37. .
• Calculation-Commissionmaybeallowedas a percentageofNet
Profitsbefore charging such commissionsor aftercharging such
commissions.
• 1. Commissionas % of NetProfitbeforechargingsuch
Commissions
=Netprofitbeforecommissionx Rateof
commission/100
• 2. Commissionas % of NetProfitafterchargingsuch
Commissions
=Netprofit beforecommissionx Rateofcommission/100
+Rateof Commission

38. Accounting Treatment
Salary or Commission to a partner being an
appropriation out of profits shall be
transferred to the debit of P& L
Appropriation A/c and credit of the
Partner's Capital A/c.

39. Interest on Partner's Loan to a Firm
• Rate of Interest- In case any partner has
given loan to the firm; he is entitled to interest
on such loan at an agreed rate of interest. If
there is no agreement as to the rate of
interest on loan, the partner is entitled to rate
of interest on loan @ 6% per annum.
• Interest on loan is debited to P& L A/c and is
credited to the Partner's Loan A/c.

40. Guarantee of minimumprofit to a partner
• Sometimes a partner may be guaranteed a
minimum amount of his share in Profit. Such a
partner to whom such guarantee has been
provided is called guaranteed partner and the
partner who had given such guarantee is
called guaranteeing partner. Such minimum
amount is called guaranteed amount.

41. STEPS:
• Step 1: Calculate the Actual share of
Profit/Loss of Guaranteed Partner for the
given accounting period.
• Step 2: Calculate the amount of deficiency
as follows:
Deficiency = Guaranteed amount -
Actual share of profits
• Step 3: Distribute the amount of deficiency
among the guaranteeing partners in their
guaranteed ratio.

42. .• Step 4: Distribute the actual
profit/loss among all the partners in their
profit sharing ratio as if there is no
guarantee arrangement.
• Step 5: Recover share of deficiency
(as per step 3) from the guaranteeing
partners and give credit for the same to
the guaranteed partner.

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