CHAPTER 1
ACCOUNTING FOR PARTNERSHIP
BASIC CONCEPTS
A business can be organised in the
LEARNING OBJECTIVES form of a sole proprietorship, a
After studying this chapter you will be partnership firm or a company.
able to : Earlier, you have studied how to
l Define partnership and list its essential prepare Profit and Loss Account and
features;
Balance Sheet of a sole proprietor.
l Explain the meaning and list the
contents of partnership deed; If one man was intelligent enough
l Recognise the relevant provisions of the and commanded all the resources
Indian Partnership Act 1932, as that he needed and also the
applicable to accounting in the absence
necessary power to do everything,
of any provision to the contrary in the
partnership agreement; he would have carried on his
l Prepare partners' capital account under business as an individual. Alas, this
fixed and fluctuating capital method; is not true in life. Every man needs
l Distribute profit or loss among the help from others and this is true in
partners and prepare profit and loss
appropriation account;
business which requires huge
l Explain how guarantee of a minimum resources for the ongoing expansion
amount of profit to a partner is treated programmes. Therefore, one of the
in the books of accounts; inevitable ways is to for m
l Carry out past adjustments; partnership by joining hands with
l Explain the meaning of goodwill and
person(s) who can complement the
methods of its evaluation;
l Describe the accounting implications efforts by bringing in the necessary
of change in profit sharing ratio; and intellectual as well as financial
l Explain 'joint life policy' in relation to capital. This chapter is devoted to
partnership accounts. the basic aspects of partnership
accounting dealing with the
, 2 ACCOUNTANCY
preparation of Profit and Loss Account and Balance Sheet of a partnership firm.
Although the basic accounting procedure is similar in all cases, there are certain
special features in the accounts of a partnership firm. In the case of a partnership
firm, for example, the special features relate to the distribution of profits, the
maintenance of capital accounts and the adjustments required when the firm is
reconstituted. In this chapter, we shall study the nature of partnership and
discuss the basic aspects of partnership accounts like preparation of capital
accounts, distribution of profits amongst partners and change in the profit-
sharing ratio of the existing partners along with preparation of Profit and Loss
Account and Balance Sheet of the partnership firm.
1.1 Nature of Partnership
The sole proprietorship has its limitations such as limited capital, limited
managerial ability and limited risk-bearing capacity. Hence, when a business
expands or when it is to be set up on a scale, which needs more capital and
involves more risk, two or more persons join hands to run it. They agree to
share the capital, the management, the risk and profits of the business. Such
mutual economic relationship based on a written or an oral agreement amongst
these persons is termed as 'partnership'. The persons who have entered into
partnership are individually known as 'partners' and collectively as 'firm'.
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". Based on this definition, the essential
features of partnership are as follows:
1. Two or more persons : To form a partnership, there must be at least two
persons. There is, however, a limit on the maximum number of persons
who constitute a partnership firm. It should not exceed 10 if the firm is
carrying on a banking business and 20 if it is engaged in any other business.
2. Agreement between the partners : A partnership is created by an agreement.
It is neither created by operation of law as in the case of Hindu Undivided
Family nor by status. The agreement forms the basis of economic
relationship 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 some property by itself does not constitute partnership.
However, the joint ownership of the property may be used for forming the
partnership in order to pursue the business objectives for which the
partnership is formed.
,ACCOUNTING FOR PARTNERSHIP — BASIC CONCEPTS 3
4. Sharing of profits : The agreement should be to share the profits of the
business. If some persons join hands to carry on some charitable activity,
it will not be termed as partnership. Of course, the ratio in which the
partners will share the profits is determined by the agreement or in the
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 firm's business
may be carried on by all the partners or any one of them acting for all. This
means that partnership is based on the concept of mutual agency
relationship. A partner is both an agent (he can, by his acts, bind the other
partners) and a principal (he is bound by the acts of other partners). The
implication of this is that partner binds others and others bind him in the
same way. Further implication of this is that each partner is entitled to
participate in the conduct of business affairs and act for and on behalf of
the firm.
1.2 Partnership Deed
1.2.1 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 writing but the absence of a written agreement may be a source
of trouble in managing the affairs of the partnership firm. Therefore, a
partnership deed should be written, assented and signed by all the partners.
1.2.2 Contents of Partnership Deed
The partnership deed usually contains the following particulars:
l Name of the firm;
l Names and addresses of all partners;
l Nature and place of the business;
l Date of commencement of partnership;
l Duration of partnership, if any;
l Amount of capital contributed or to be contributed by each partner;
l Rules regarding operation of bank accounts;
l Ratio in which profits are to be shared;
l Interest, if any, on partners' capital and drawings;
, 4 ACCOUNTANCY
l Interest on loan by the partners(s) to the firm;
l Salaries, commissions, etc. if payable to any partner(s);
l The safe custody of the books of accounts and other documents of
the firm;
l Mode of auditor's appointment, if any;
l Rules to be followed in case of admission, retirement, death, of a partner;
l Settlement of accounts on dissolution of the firm; and
l Mode of settlement of disputes among the partners.
1.2.3 Provisions Affecting Accounting Treatment
Normally, a partnership deed covers all matters relating to the mutual
relationship amongst the partners. But if the deed is silent on certain matters
or in the absence of any deed or an express agreement, the relevant provisions
of the Partnership Act shall become applicable. It is, therefore, necessary to
know the provisions of the Act, which have a direct bearing on the accounting
treatment of certain items. These are as follows:
1. Profit Sharing : The partners shall share the profits of the firm equally
irrespective of their capital contribution.
2. Interest 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 the profits of the business.
In other words, if there are losses, interest on capital will not be allowed
even if the agreement so provides.
3. Interest on Loan : If any partner, apart from his share of capital, advances
money to the firm as a loan, he is entitled to interest on such amount at the
rate of 6 per cent per annum. Such interest shall be paid even out of the
assets of the firm. This means that interest on loan shall be paid 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.
ACCOUNTING FOR PARTNERSHIP
BASIC CONCEPTS
A business can be organised in the
LEARNING OBJECTIVES form of a sole proprietorship, a
After studying this chapter you will be partnership firm or a company.
able to : Earlier, you have studied how to
l Define partnership and list its essential prepare Profit and Loss Account and
features;
Balance Sheet of a sole proprietor.
l Explain the meaning and list the
contents of partnership deed; If one man was intelligent enough
l Recognise the relevant provisions of the and commanded all the resources
Indian Partnership Act 1932, as that he needed and also the
applicable to accounting in the absence
necessary power to do everything,
of any provision to the contrary in the
partnership agreement; he would have carried on his
l Prepare partners' capital account under business as an individual. Alas, this
fixed and fluctuating capital method; is not true in life. Every man needs
l Distribute profit or loss among the help from others and this is true in
partners and prepare profit and loss
appropriation account;
business which requires huge
l Explain how guarantee of a minimum resources for the ongoing expansion
amount of profit to a partner is treated programmes. Therefore, one of the
in the books of accounts; inevitable ways is to for m
l Carry out past adjustments; partnership by joining hands with
l Explain the meaning of goodwill and
person(s) who can complement the
methods of its evaluation;
l Describe the accounting implications efforts by bringing in the necessary
of change in profit sharing ratio; and intellectual as well as financial
l Explain 'joint life policy' in relation to capital. This chapter is devoted to
partnership accounts. the basic aspects of partnership
accounting dealing with the
, 2 ACCOUNTANCY
preparation of Profit and Loss Account and Balance Sheet of a partnership firm.
Although the basic accounting procedure is similar in all cases, there are certain
special features in the accounts of a partnership firm. In the case of a partnership
firm, for example, the special features relate to the distribution of profits, the
maintenance of capital accounts and the adjustments required when the firm is
reconstituted. In this chapter, we shall study the nature of partnership and
discuss the basic aspects of partnership accounts like preparation of capital
accounts, distribution of profits amongst partners and change in the profit-
sharing ratio of the existing partners along with preparation of Profit and Loss
Account and Balance Sheet of the partnership firm.
1.1 Nature of Partnership
The sole proprietorship has its limitations such as limited capital, limited
managerial ability and limited risk-bearing capacity. Hence, when a business
expands or when it is to be set up on a scale, which needs more capital and
involves more risk, two or more persons join hands to run it. They agree to
share the capital, the management, the risk and profits of the business. Such
mutual economic relationship based on a written or an oral agreement amongst
these persons is termed as 'partnership'. The persons who have entered into
partnership are individually known as 'partners' and collectively as 'firm'.
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". Based on this definition, the essential
features of partnership are as follows:
1. Two or more persons : To form a partnership, there must be at least two
persons. There is, however, a limit on the maximum number of persons
who constitute a partnership firm. It should not exceed 10 if the firm is
carrying on a banking business and 20 if it is engaged in any other business.
2. Agreement between the partners : A partnership is created by an agreement.
It is neither created by operation of law as in the case of Hindu Undivided
Family nor by status. The agreement forms the basis of economic
relationship 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 some property by itself does not constitute partnership.
However, the joint ownership of the property may be used for forming the
partnership in order to pursue the business objectives for which the
partnership is formed.
,ACCOUNTING FOR PARTNERSHIP — BASIC CONCEPTS 3
4. Sharing of profits : The agreement should be to share the profits of the
business. If some persons join hands to carry on some charitable activity,
it will not be termed as partnership. Of course, the ratio in which the
partners will share the profits is determined by the agreement or in the
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 firm's business
may be carried on by all the partners or any one of them acting for all. This
means that partnership is based on the concept of mutual agency
relationship. A partner is both an agent (he can, by his acts, bind the other
partners) and a principal (he is bound by the acts of other partners). The
implication of this is that partner binds others and others bind him in the
same way. Further implication of this is that each partner is entitled to
participate in the conduct of business affairs and act for and on behalf of
the firm.
1.2 Partnership Deed
1.2.1 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 writing but the absence of a written agreement may be a source
of trouble in managing the affairs of the partnership firm. Therefore, a
partnership deed should be written, assented and signed by all the partners.
1.2.2 Contents of Partnership Deed
The partnership deed usually contains the following particulars:
l Name of the firm;
l Names and addresses of all partners;
l Nature and place of the business;
l Date of commencement of partnership;
l Duration of partnership, if any;
l Amount of capital contributed or to be contributed by each partner;
l Rules regarding operation of bank accounts;
l Ratio in which profits are to be shared;
l Interest, if any, on partners' capital and drawings;
, 4 ACCOUNTANCY
l Interest on loan by the partners(s) to the firm;
l Salaries, commissions, etc. if payable to any partner(s);
l The safe custody of the books of accounts and other documents of
the firm;
l Mode of auditor's appointment, if any;
l Rules to be followed in case of admission, retirement, death, of a partner;
l Settlement of accounts on dissolution of the firm; and
l Mode of settlement of disputes among the partners.
1.2.3 Provisions Affecting Accounting Treatment
Normally, a partnership deed covers all matters relating to the mutual
relationship amongst the partners. But if the deed is silent on certain matters
or in the absence of any deed or an express agreement, the relevant provisions
of the Partnership Act shall become applicable. It is, therefore, necessary to
know the provisions of the Act, which have a direct bearing on the accounting
treatment of certain items. These are as follows:
1. Profit Sharing : The partners shall share the profits of the firm equally
irrespective of their capital contribution.
2. Interest 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 the profits of the business.
In other words, if there are losses, interest on capital will not be allowed
even if the agreement so provides.
3. Interest on Loan : If any partner, apart from his share of capital, advances
money to the firm as a loan, he is entitled to interest on such amount at the
rate of 6 per cent per annum. Such interest shall be paid even out of the
assets of the firm. This means that interest on loan shall be paid 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.
