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Accounting For Partnership Firms: Fundamentals
Nature of partnership firms:Partnership is a relation of mutual trust and faith. Partnership accounts should present a
true and fair picture of the partnership business.
Definition:It is a relationship between persons who have agreed to share the profit of a business.
Carried on by all or any of them acting for all (Sec.4 of Indian Partnership Act, 1932) .
Characteristics of partnership
1.

There must be at least two persons to form a partnership maximum 10 persons in

banking business and 20 persons in case of other business to form a partnership.
2.
Partnership is an agreement between two or more persons.
3.
Partners must agree to carry on business.
4.
The agreement between the partners must be aimed at sharing the profits of the
business.
5.
Each partner is an agent as well as partner of the firm.
6.
Each partner can participate in the conduct of business.
Partnership Deed:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.

It Contains following points:

The name and address of the firm;
Names and addresses of the partners.
The type and nature of the business the firm proposes to do.
Amount of capital [fixed or fluctuating] to be contributed by each partner.
The rate of interest is to be allowed on capitals.
How much amount withdrawn by partners for personal use.
The rate of interest charged on partners drawings.
Formula of valuation of goodwill in case of retirement or admission of a partner.
In which ratio profits or losses are to be divided among the partners.
Salary to any partner for the work done by him.
Accounting period of the firm. Yearly or half-yearly and the date on which accounts are
to be closed every year.
Safe custody of the books of accounts and other documents of the firm.
Whether the firms books will be audited or not? If so, the mode of auditors appointment.
Date of commencement of the partnership.
The period for which the partnership has been established and the mode of dissolution of
partnership.
Whether decision in the case of garner vs. Murray is to apply in the case of insolvency of
a partner.
Account in the bank will be opened in firms name or in some partners name? Who will
have the right to sign the cheques ?
Rules to be followed in case of admission of a partner.

20.
Rules to be followed while settling the accounts on retirement.
21.
In case of dispute among the partners. How the dispute will be solved?
Importance of Partnership Deed
1.
It regulates the rights, duties and liabilities of each partner.
2.
It helps to avoid any misunderstanding amongst the partners.
3.
Any dispute amongst the partners may be settled easily as the partnership deed may be
readily referred to.
Rules Applicable in the Absence of Partnership Deed
1.
Profits and Losses are to be shared equally irrespective of their capital contribution.
2.
No interest in capitals shall be allowed to the partners.
3.
No interest is to be charged on drawings.
4.
Interest at the rate of 6% per annum is to be allowed on a partners loan to the firm.
5.
No entitlement of salary to any partners.
6.
Without the consent of all existing partners, No new partner can be admitted to the firm.
7.
Each partner can participate in the conduct of business.
8.
Each partner can inspect the books of firm and can take a copy of the same.
The journal entries that are passed for various items Shown in the profit and loss
appropriation account are as follows:
1.
(1)

Entry for Interest on Capital

on allowing interest on capital
interest on capital A/c
Dr
To partners capital a/c / current a/c.
(interest on capital at -----% p.a.)

(2)

on closure of interest on capital A/c

profit & loss appropriation A/c
To interest on capital A/c

Dr

2. Entry for Interest on Drawings

(1)

on charging interest on drawings

Partners capitals A/c /current a/c Dr
To interest on drawings A/c
(Interest on drawings at-----% p.a.)

(2)

on closure of interest on drawings A/c

Interest on drawings A/c

Dr

To profit & loss appropriation a/c

3. Entry for Salary or Commission Payable to a Partner
(1)

on allowing salary or commission to a partner

Partners salary / commission A/c Dr
To partners capital A/c / current A/c

(2)

on closure of salary or commission account

profit & loss appropriation A/c
Dr
To partners salary / commission a/c.

4. Entry for Transferring a Part of Profit to Reserve:

Profit & loss appropriation A/c
To reserve A/c

Dr

5. Entry for transfer of credit balance of profit & loss appropriation A/c (being profit)
Profit & loss appropriation A/c
Dr
To partners capital or current A/c
6. Entry for Transfer of debit balance of profit & loss appropriation A/c (being loss)
Partners capital or current a/c
Dr
To profit & loss appropriation A/c
Profit and Loss Appropriation Account
Dr.
Particulars
To Salary to Partners : X
Y
To Commission to Partners : X
Y
To Interest on Partners Capital : X
Y
To Reserve A/c
To Profit transferred to Partners
Capital or Current A/c : X
Y

Cr.
Rs

Particulars
By Profit & Loss A/c
By Interest on Drawingss : X
Y
By Loss Transferred to Partners
Capital or current a/c. : X
Y

Rs

Calculation of Interest on Drawings:

Amount of Drawings X Rate of interest
100

X number of months
12

Proforma of Capital Accounts When the capitals are fixed

Particulars

Partners Capital A/c.

C
Particulars

To Cash /
Bank a/c
(permanent
withdrawn of
capital)

By balance b/d
(opening
balance )
By case / bank
A/c (additional
capital)

To balance c/d
(closing
balance)

Partners Current Account

Particulars
To Balance b/d
[In case of debit
opening balance]
To Drawings
To Interest on
Drawings
To P&L A/c
(Share of loss, in
case of loss )
To Balance c/d

Particulars
By Balance B/d
(In case of credit opening
balance )
By Interest on Capital
By Salary
By Commission
By P&L Appropriation
a/c
(Share of Profit, in case
of profit)

When the capitals are fluctuating:

Particulars

Partners Capital Account

B
C
Particulars

To Drawingss
To Interest on
Drawingss
To Profit and
Loss A/c (In case
of loss, share of
loss )
To Balance c/d

By Balance B/d
(opening balance)
By Cash / Bank a/c
(Additional capital)
By Interest on Capital
By Salary
By Commission
By P&Lappropriation
(share of profit )

Distinction Between Fixed Capital Accounts and Fluctuating Capital Accounts

Fixed Capital Accounts
1. The balance in capital account usually
remains unchanged except in
extraordinary circumstances.

Fluctuating Capitals Accounts

1. The Balance of Capital accounts change
in time to time
2. Partners have only capital account ;

2. Partners have two accounts capital

accounts and current accounts

3. All transactions relating to partner

account are made in their capital
accounts.

3. All transactions relating to partner

account are not made in capital account
but are entered in separate current
account.

4. This can show a negative balance

4. This cannot show a negative balance.

Calculation of Managers Commission on Net Profits

(1) on profits before charging such commission
Profit (before commission) X Rate of Commission
100
(2) on profits after charging such commission
Profit (before commission) X

Rate of Commission
100 + Rate of Commission

Interest on Partners Loan to the Firm

Rate of Interest:

If there is no agreement for the rate of interest, then charge interest on loan
@ 6% per annum.

Nature of Interest:

interest against partners loan allowed whether there are profit or not.

Accounting Treatment:

It is treated as a charge against the profits and hence interest on

partners loan is debited to profit & loss A/c and not to profit &
loss appropriation A/c.

Interest on partners loan is recorded in interest accrued account .

1.

Entries for interest on partners loan

(1)

for providing interest on partners loan:

Interest on partners loan a/c
Dr
To interest accrued a/c

(2)

for closing the interest on partners loan :

P&L a/c
Dr
To interest on partners loan a/c.

Distinction Between Charge Against Profit and Appropriation out of Profit

S.No.

Charge Against Profit

Appropriation out of Profit

1.

It indicates expenses to be deducted from

profits while calculating net profit or loss.

It indicates distribution of net profit to

various heads.

2.

It is debited to profit and loss account

It is debited to profit and loss

appropriation account.

3.

It is necessary to make charge against

profits even if there is loss.

Appropriations are made only when

there is profit.

Methods of calculating interest on drawings:

1.
Simple method
Interest on drawings = Amount of drawings
2.

Product Method:
Interest on drawings

Total of products

X Rate of Interest
100
X

Rate of Interest
100

Months
12

X 1
12

3.

Average Method:

Case (1):

When Drawings is made in the beginning of every month: If the drawings of

equal amount

Average period = Time left after first drawings + Time left after last drawings
2
= 12 Months + 1 Month
= 6 Months
2
Case (2):
When Drawings are made at the end of every month:
Average period = Time left after first drawings + Time left after last drawings
2
= 11 Months + 0 Month
= 5 Months
2
Case (3):

When Drawings are made in middle or at any time during the month:
(middle)

Average period = Time left after first drawings + time left after last drawings
2
= 11.5 Months + 0.5 Month = 6 Months
2
Case (4):

When drawings of equal amount are made in the beginning of each quarter:

Average period = Time left after first drawings + Time left after last drawings
2
= 12 Month + 3 month = 7 Months
2
Case (5) When drawings of equal amount are made at the end of each quarter:
Average period = Time left after first drawings + Time left after last drawings
2
= 9 Months + 0 Month =4 Months
2
Case (6): When drawings of equal amount are made during the middle of each quarter:
Average period = Time left after first drawings + Time left after last drawings
2
= 10.5 Months + 1.5 Months = 6 Months
2
Case (7): When drawings of equal amount are made only during a period of 6 Months:
(i) In the beginning of each month:
Average period = 6 Months + 1 Month = 3 Months
2

(ii) At the end of each month :

Average period = 5 Months + 0 Month = 2 Months
2
(iii) In the middle of each month:
Average period = 5 Months + Month = 3 Months
2
Case (8):
(i)

When drawings of equal amount are made during 9 months.

In the beginning of each month

Average period = Time left after first drawings + Time left after last drawings
2
= 9 Months + 1 Month
= 5 Months
2
(ii) At the end of each month
Average period = Time left after first drawings + Time left after last drawings
2
= 8 Months + 0 Month = 4 Months
2
(iii) In the middle of each month
Average period = Time left after first drawings + Time left after last drawings
2
= 8.5 Months + 0.5 Month
= 4.5 Months
2
Case (9):
When the rate of interest is given without the word per annum interest will
be charged without considering time or date of drawings.
1.
Interest on Drawings is charged @ 10% per anum

2.

Amount on Drawings X Rate of Interest X 6

100
12
Interest on Drawings is charged @ 10%

Amount on Drawings X Rate of Interest

100
Adjustment in the Closed Accounts:
Accounts have been closed after the financial year, it is discovered that there have been some
errors or omission in the old accounts. In such cases instead of altering the old accounts, and the
signed balance sheet an adjustment entry for such error or omission is made at the beginning of
the next year. Following adjustments are made:

1.

When Interest on Capitals or Drawings may have been omitted.

2.

When profits and losses have been distributed among the partner in a wrong proportion.

3.

When profit sharing ratio has been altered with effect from some past date.

4.

When salary or commission payable to a partner has been omitted.

Guarantee of Profit to a Partner :

Sometimes a partner is guaranteed that he shall get a certain minimum amount of profits of the
firm. Such a guarantee may be given either (i) any one of the partners or (ii) by all other partners
in a particular ratio. When the profits of the firm are not adequate then the excess paid to the
guaranteed partner should be charged to the partner who has given the guarantee.

ADMISSION OF A PARTNER
Reconstitution of a Partnership Firm:
Admission of a Partner
A new partner is needed into the business due to the following reasons:1. When more capital is needed for the expansion of the business.
2. When a competent and experienced person is needed for the efficient running of the
business.
3. To increase the goodwill and reputation of the business by taking a reputed and renowned
person into the partnership.
4. To encourage a capable employee by taking him into the partnership.
Following Adjustments are needed at the time of the admission of a new partner :1. Calculation of new profit sharing ratio.
2. Accounting treatment of goodwill.
3. Accounting treatment for revaluation of Assets and Liabilities.
4. Accounting treatment of reserves and accumulated profits.
5. Adjustment of capitals on the basis of new profit sharing ratio.
Calculation of New Profit Sharing Ratio:
1.
When only the ratio of new partner is given in the question, then in the absence of any
instructions. It is presumed that the old partner will continue to share the remaining profits in the
same ratio in which they were sharing before the admission of a new partner.
2.
The new partner purchases his share of profit from the old partners equally. In such
cases the new profit sharing ratios of the old partners will be as certained by deducting the
sacrifice made by them from their existing share of profits.
New Profit Ratio = Old Ratio - Sacrifice
3.
The new partner purchases his share of profit from the old partners in particular ratio. In
such cases the new profit sharing ratio of the old partners will be calculated after deducting the
sacrifice made by a partner from his existing share of profit.
New Profit Ratio = Old Ratio - Sacrifice

4. When the old partners surrender a particular fraction of their share in favour of the new
Partner then:
Surrendering Share =
Surrendered Share X Old Ratio.
New Ratio
=
Old Ratio - Surrendering Share.
Sacrifice Ratio
=
Old Ratio - New Ratio.
Accounting Treatment of Goodwill on the Admission of a Partner:
1. When the amount of goodwill (premium) is paid privately.
:No Entry
2. When the new partner brings his share of goodwill (premium) in cash:
a.)

When the amount of goodwill/ premium brought in by the new partner is retained
in the business:i.)
Cash/ Bank A/c
Dr.
To goodwill A/c
ii.)

b.)

Goodwill A/c
Dr (in sacrifice ratio)
To Old partners capital A/c

When goodwill/premium brought in by the new partner is withdrawn by the old

partners:i.)
Old Partners capital A/c
Dr.
To Cash / Bank A/c

When goodwill already appears in the books and new partners brings his share of
goodwill/premium in cash:First of all the existing goodwill account will have to be written off. For this purpose old
partners capital accounts are debited in old ratio and goodwill account is credited.
Old partners capital A/c
To goodwill A/c

Dr.
(in old ratio)

Remaining entries remains same for bring goodwill in cash.

* When the new partner does not bring his share of goodwill/premium in cash:New partners current A/c

Dr. (from his share of goodwill)

To old partners capital A/c

(in sacrifice ratio)

* When goodwill already appears in the books and new partner does not bring his share of
goodwill/premium in cash:i.)

Old partners capital A/c

Dr.
To goodwill A/c (in old ratio)

ii.)

New partners current A/c

Dr.
To old partners capital A/c (in sacrifice ratio )

* When new partner brings in only a part of his share of goodwill:i.)

Cash/bank A/c
To goodwill A/c

Dr.

ii.)

Goodwill A/c
Dr.
New partners current A/c
Dr.
To Old partners capital A/c (in sacrifice ratio)

Revaluation of assets & liabilities :Revaluation account :Account which is prepared to record changes in the value of assets & liabilities at time of
admission, retirement, death and change in profit ratio of existing partners. Proforma of
Revaluation Account is given below :Revaluation Account
Particulars
To Decrease in value of assets
To Increase in value of liabilities
To Unrecorded liabilities
To Profit on revaluation
transferred to partners capital
accounts (in old ratio)

Amoun
t

Particulars
By Increase in value of assets
By Decrease in value of liabilities
By unrecorded assets
By loss on revaluation
transferred to partners capital
accounts (in old ratio)

Amount

Particulars
To drawings
To interest on
drawings
To profit & loss (Share
of loss)
To revaluation A/c
(share of loss)
To balance c/d

Partners Capital Account

B
C
Particulars
By balance b/d
By cash/bank A/c
By interest on capital
By salary
By commission
By P&L appropriation
A/c (share of profit)
By revaluation A/c
(share of profit)

i.) For decrease in the value of assets & increase in the value of Assets / unrecorded Assets:1.
2.
3.

Revaluation A/c
To assets A/c

Dr.
(decrease )

Assets A/c
To revaluation A/c

Dr.

Unrecorded assets A/c

To revaluation A/c

Dr.

(increase)

ii.) For increase / decrease of liabilities or unrecorded liabilities :1.

2.
3.

Revaluation A/c.
To liabilities A/c

Dr.

Liabilities A/c
Dr.
To Revaluation A/c

(increase )
(decrease)

Revaluation A/c
Dr
To unrecorded liabilities A/c

iii.) Revaluation A/c shows profit or loss :1.

Revaluation A/c.
Dr.
To Old partners capital A/c

2.

Old partners capital A/c. Dr.

To revaluation A/c

(in profit)
(in old ratio)
(in loss)
(in old ratio)

Accounting treatment of reserves and accumulated profits or losses:i.)

For distributing reserves and accumulated profits among old partners in old ratio General reserve A/c
Dr.
Reserve A/c
Dr.
P&L A/c {cr. Balance} Dr.
To old partners capital a/c / current a/c.

ii.)

For distributing accumulated losses among old partners in old ratioOld partners capital A/c Dr.
To P&L A/c { Dr. balance}

iii.) For distributing surplus of specific funds:Workmens compensation fund A/c

Dr.
Investment fluctuation fund A/c
Dr.
To Old Partners Capital a/c. / Current a/c.
* Adjustment of old partners capital accounts on the basis of new partners capital:i.) If the existing capital of any partner is less then his newly calculated capital:Bank A/c / Partners Current a/c.
Dr.
To Old Partners Capital A/c.
ii) If the existing capital of any partner is more than his newly calculated capital :
Old Partners Capital A/c.
Dr.
To Bank A/c. / Partners Current A/c.