Chapter 1

PARTNERSHIP
FUNDAMENTALS
STUDY MATERIAL COMPILED BY
ABHISHEK KHANDELWAL
B.COM, M.COM, L.L.B, B.ED, CA (FINAL)

Meaning of partnership according to Indian Partnership Act 1932

According to Section4 of the Indian Partnership Act, 1932 :
"Partnership is the relationship between persons

(known as partners) who have agreed to the

share the profits of a business carried on by all or
any one of them acting for all
Please Note: - In case a partner take a decision on
behalf of all the partners in a firm and the
decision went wrong and firm incurs losses, even
in such case too the same shall be bourne by all
the partners of the firm

Features of Partnership as per Indian Partnership Act

1932
1) There must be at least two persons to form a valid partnership. Section 11
of The Indian Partnership Act, 1932 restrict the (maximum) number
of partners to 10 for carrying on banking business and 20 for
other kind of business.
2) Partnership comes into existence by an agreement (either
written or oral) among the partners. The written agreement among the
partners is termed as Partnership Deed.
3) A Partnership can be formed for the purpose of carrying business and
sharing the profits or losses of the business
4) An agreement between the partners must be aimed at sharing the
profits or losses of the business.
5) A partnership can be carried on by all or any one of them
acting for all.

Partnership :- General meaning and requirement

A partnership firm is a business organization which is incorporated

or started with an voluntary association of at least two or more

than two members
For a firm to be an partnership firm, there must be a
profit sharing ratio among the partners
Also all of the partners must be working for the business or any
one of them acting on behalf of all of the partners
Requirement of a partnership firm arises due to several reasons
a) To raise capital for exploiting various new ventures or opportunities

prevailing in the market to increase the profitability of the business.

b) To enhance skills in the organization, or induce fresh talent in
the firm for enhanced and competitive working
c) To capture new markets, etc by the way of mergers or acquisitions

Partnership Deed:- Meaning and requirement

It is a legal written document that contains the terms

and conditions decided among the partners relating to

the operations and working of the business and
distribution of profits thereof.
Although Indian Partnership Act do not prohibits a
partnership firm from operations due to non
registration of a partnership deed thats why a firm in
our country can operate into partnership without
getting itself registered
They can have a registered partnership deed or the
same can have an oral partnership deed

EFFECTS OF NON REGISTRATION OF PARTNERSHIP

DEED OTHER THAN ACCONTING PROCEDURES
In our country India registration of partnership deed is not mandatory

according to the partnership act 1932, but still it is always advisable to get
the partnership deed registered because in case a partnership deed is not
registered partners will lack the following:They can not sue any party regarding the transactions.
They cannot take salary, IOC, or any other benefits from the firm other than

the share of profits, that too will be shared equally.

In case of unregistered partnership firm no partner can exempt him/herself
from the unlimited liability associated with partnership business.
An unregistered partnership firm will always have to bear a lack of
confidence on their organisation in the eyes of creditors, or other
stakeholders. Even banks do not grants loans to such partnership firm since
any quarrel between partners may lead to problems in the working of the
business and repayments of the amounts due to the bankers or creditors or
stakeholders.

Must inclusions in a partnership deed

Name and address of the firm
Name and address of the partners
Capital employed by the partners
Interest on capital
Allowed drawings
Interest on drawings
Method for calculation of goodwill
Nature of business
Etc

(Note:- There are many items that are to be included in the partnership
deed when the same has to be registered, the above mentioned
enumerate only few of them as the same would be suffice for the
board exam preparation, also the same depends upon firm to firm and
partners to partners)

Rules applicable in the absence of partnership

deed ( Accounting and Working)
Profit sharing ratio will be EQUAL
No Interest on Capital will be allowed to the partners
No Interest on the drawings made by partners can be charged
No Salary / No Bonus / No Commission will be allowed to

any of the partners

Interest on Partners Loan will be provided with an Interest @
6% p.a.
No new partner can be admitted in the firm without the consent of

all of the partners

Any partner can participate in the management of the business as
well as the working
Any partner can check the books of accounts of the business

Accounts to be prepared for a Partnership firm

Journal
Ledger

(Not very often

Trial Balance
asked in Boards)
Trading and P&L Account
(P&L at times may be asked)
Profit and Loss Appropriation Account
New for us as
well as Very
Partners Capital Account
Important
Balance Sheet
Same as youve studied in class XI

Difference between Profit and loss and profit and loss appropriation
account

Basis P&L
Account

P&L App
Account

Nature of
transaction

Only those which are

charges against the profits

Only those which are app. against

the profits i.e. to be done in case of
profits only

When
prepared

After the preparation of

trading account

After the preparation of P&L

Account

Requirement

Has to be prepared anyways

there is a loss or profits

Prepared only in case of profits

Inclusions

Rent, electricity bills,

depreciation , etc

Salary to partners, Interest on

capitals, etc
Any payments made to partners
are recorded here

Types of Capital Accounts

Basis

Fixed Capital A/c

Fluctuating Capital A
ccounts

When
prepared

This account is prepared when This account is prepared when the

the amounts of capitals are
amounts of capitals can be altered
fixed i.e. cannot be changed
or modified or changed
except in case of permanent
alteration

Where to
show the
modifications

Modification in the capital is

shown in another account
prepared namely current account

All the modification relating to capitals

are shown in the capital account itself

No of accounts to be prepared here is

No of accounts Here two accounts are prepared
to be prepared a) Capital Account (which remains on thats partners capital account itself

Can capital go
negative

fixed)
b) Current Account ( where
alterations are recorded)

where all the modifications relating to

capitals are recorded

NO

YES

Differentiation as for what account is to be prepared for whom

Profit and loss Appropriation
Account

Prepared
with
respect to
the
FIRM
Expenses relating to the firm will be
DEBITED in this account as well as
incomes relating to firm will be
CREDITED in this account

Partners Capital Account

Prepared
with respect
to the
PARTNERS
Expenses relating to the
partners will be DEBITED in
this account as well as incomes
relating to partners will be
CREDITED in this account

Journal entries relating to Partnership relating to

Appropriation of Profits (with Concept)
Entry for
Interest on
Capital

With respect to firm

Since it is an expense to the firm,
firms a/c is Debited

P&L App

With respect to partners

Since it is an income to the
partner, their a/c Credited

a/c Dr
Interest on Capital a/c Dr.
To Interest on Capital a/c
To Partners Capital a/c

Since it is an expense to the firm,

Since it is an income to the
Salary /
firms a/c is Debited
partner, their a/c Credited
Bonus /
Sal/ Bonus/Comsn a/c Dr.
Commission P&L App a/c Dr
To Salary/Bonus/Commission a/c
To Partners Capital a/c

Interest on
Drawings

Since it is an income to the firm,

firms a/c credited

Interest on Drawings a/c Dr.

To P&L Appr. a/c

Distribution P&L Appropriation Account Dr.

of profits
To Partners Capital Account
( This is a direct transfer entry)

Since it is an Expense to the

partner, their a/c Debited

Partners Capital a/c Dr.

To Int. on Drawings
P&L App Account Dr.
To Partners Cap Account
( This is a direct transfer entry)

Specimen of a Profit and Loss Appropriation Account

Expenses made by
firm
To interest on capital
A:
B:

Amount

xxx

To Partners Salary /
Bonus/ Commission
A:
B:

xxx

To reserves (transferred
if any)

xxx

To Profits transferred to
capital Accounts
A:
xxx
B:

Income generated by
firm and b/d profit

Amount

By Profit and Loss

Account( profits transferred
from P&L Account)

xxx

By Interest on Drawings
A:
B:

xxx

Specimen of Partners Capital Account

Particulars
To Balance b/d
( in case of previous years
negative balance)

Particulars
By balance b/d
(in case previous years
balance)
By Bank/ Cash Account ( in
case of new business

To Drawings

By Interest on capital

To Interest on Drawings

By Salary/ Bonus/
Commission

To Accumulated losses
(P&L Acc, Advertisement
Suspense, Old Goodwill

By Profit and Loss App Acc

By Reserves (Accumulated
profits General Reserve, P&L
Acc, IFF, WCR)

Calculation of Interest on Drawings

Interest on drawings is basically the amount charged by the firm on

the amounts withdrew by the partners for their personal usage

Why is it charged

Since the money invested by the proprietor into the business is now
the funds of the firm and the same has to be used by the firm to
earn profits which are to be distributed among the partners only.
Now if a partner withdraw money for his/her own purpose the firm
is eligible to charge interest on such amount since the same now
belongs to the firm.
It can be calculated by three methods

a) Simple Method
b) Product Method
c) Average Period Method

Simple Method ( Although very rarely asked in

Boards)
It is the method wherein the amount of interest is

calculated on the basis of period for which money is

withdrew from the business
Formula for the calculation is as under
Amount of Drawing x Rate of interest x Time period for which
money is withdrew
100
12

Product Method
It is the method where the amounts of drawings are

multiplied by the period for which drawings were

done and after that following formula is applied
Total of (Amount of Drawing x Time Periods) x
100

Rate of interest x 1
12

Time periods are calculated from the date of drawing to

st March or
date of financial year closure, that may be 31st
December according to the question

the
st
31st

Average Period Method (Maximum asked in Boards)

This method is applicable only when

a) Amounts of drawings are equal, and

b) Time Period between each drawing is equal
Under the average period method interest on drawings is
charged/calculated for a fixed time period which is calculated by a
specific formula i.e.
Time left after first drawings + Time left after last drawing
2
Note:- These drawings as per our syllabus can be done either monthly, quarterly, in
a period of 6 months or in period of 9 months

We prefer to refer the following table for the calculation

of average period

Table showing the various average periods for

calculation of Interest on Drawings
Basis when
drawings are
made
Amount of
drawings to be
multiplied with

Monthly

Quarterly

In a period
of 6 months

In a period
of 9 months

12

Drawings done in
beginning of

6.5 months
(+0.5)

7.5 months
(+1.5)

3.5 months

5 months

Drawings done at
middle of

6 months
(1/2 of

6 months
(fixed)

3 months

4.5 months

Drawings done at
the end

5.5 months
(-0.5)

4.5 months
(-1.5)

2.5 months

4 months

This difference remains same with reference

to the period of 6 months and period of 9 months)

Difference between drawings against profits and

drawings against capital
Drawings against profits means
drawings are made out of the
profits earned by the firm
during the year.

Drawings against capital means

drawings made in excess of the
profits earned during the year
i.e. from capital.

These drawings do not reduce the

capitals of the partners, as these are
the drawings that are made against
the profits earned by the partners in
the due course of business

Such drawings reduce the capitals of

the partners

It is not considered while calculating

the interest on capital, because
drawings of profits do not lead to
reduction of capitals of the partners.

It is deducted before calculating

interest on capital as the same
reduces the amounts of capitals
invested by the partners

Interest on Capital
Partners provide the firm with a capital investment for

carrying on the business activities and at the same

time they expect a fixed rate of return onto their
capital investments in the firm.
The same is known is Interest on capital which is also
an expense for the firm and an income for the
partners and thats why the same has to be debited
to the Profit and Loss Appropriation Account
and credited to the Partners Capital Account.
Why do partners expect a fixed rate of return on
to their own amounts invested into the business
??

Provision relating to Interest on Capital

Cases

Treatment

When partnership deed do

not provides for Interest on
Capital

When Interest on Capital is not provided in the PARTNERSHIP

DEED, the same will not be given to partners as mention for the
same is not been made in the deed
Therefore, NO INTEREST ON CAPITAL

When partnership deed

provides for Interest on
Capital but silent regarding
its treatment

Case a) When sufficient profits are there

FULL INTEREST ON CAPITAL WILL BE PROVIDED
Case b) When firm is suffering from a loss
NO INTEREST ON CAPITAL WILL BE GIVEN
Case c) When firm has profits but the same are not sufficient
to meet the liability of Interest payable to partners
( IN SUCH CASE INTEREST WILL BE PAID TO PARTNERS
IN THE RATIO OF THEIR INTEREST ON CAPITALS)
(Most Important w.r.t. Board Practical Questions)

When partnership deed

Interest on capital will be provided to partners even in case of
provides Interest on Capital losses to the firm
as a charge Against Profits
Note:- Charge against profits refers to those expenses that
are compulsory to be paid, even in case of losses and the
same are shown in P&L Account not P&L Appropriation
Account

Difference between charge against profits and

appropriations against profits
Basis

Charge Against Profits

Appropriation Against profits

MEANING

Those expenses against

profits which are to be
provided compulsorily
irrespective of profits in the
firm or not

Those expense against profits which

are only made when there are
profits available in the firm for the
purpose of distribution

TREATMENT

The same has to be shown

in the P&L Account of the
partners and are to be
provided always

These are to be shown in the P&L

Appropriation Account of the
partners and are only provided
when profits are there for
distribution

EXAMPLE

Electricity/ Power Bill

Depreciation
Rent, Transfers to
Provisions, etc

Interest on Capital
Salary/ Bonus to partners
Distribution of profits
Transfer to Reserves, etc

REQUIREMENT

Has to be provided
irrespective of profits.

Provided only when profits are

there for the of distribution.

Treatment of Past Adjustments

Many times what happens is that partners while

preparing final books of accounts forgets to make

appropriations according to the partnership deed and the
same comes into notice after some years.
At that time it is not possible for the partners to remake
all the books of accounts already audited and checked
and also when the returns of the firm are already filed
In such case what a partnership firm can do is, it can
make a simple adjustment entry
Gaining Partners Capital a/c
Dr
To Sacrificing Partners Capital a/c

How is the amount calculated for making past adjustments

Amounts to be Paid (What was to be Given)

Less : Amounts Paid (What was given already)

Difference if positive will be CREDITED to the partners
capital account as the partner has sacrificed
(Amount to be given- Amount given) = + means that amount given to partner was
less than his share. Therefore the same must be compensated by other partners.

Difference if negative will be DEBITED to the partners

capital account as the partner has gained
(Amount to be given- Amount given) = - means that amount given to partner
was higher than his share. Therefore the same must be returned to the
partners whose share it was.

Guarantee of Profits to Partner

Guarantee of profits to a partner refers that a partner is

been provided with an assurance of minimum profits

solely by a partner or combination of partners
collectively
In several cases the guarantee of profits to the partners
is provided by the firm and the deficiency if any is met
by the other partners in their profit sharing ratio in the
absence of any information in the question
In such case such guarantee is met by the partners
guaranteeing in the ratio admitted by them and the
same is paid to the partner to whom guarantee was
made, in case of any deficiency.

Accounting treatment of Guarantee of Profits

In case any partner/ partners are guaranteed with a share of

profit and after the distribution of profit the amount is

deficit in his/ her account in such case the amount which is
guaranteed by the rest of the partners is credited to the
partner and the bearing of the same shall be taken by the
partners who have guaranteed for the same and the amount
of the share that the partner has to pay according to the
condition of reimbursement decided shall be debited to the
account of partner who is paying.
There is no separate entry for the same that shall be done
for the same, i.e. no separate accounting has to be done
The treatment to be done shall be done separately as a
working note or as a part of the question.

Important Points to be noted while calculations

1) Interest on capital is always calculated on the

opening capital of the partners, in case closing

capitals are given, opening capitals can be
calculated by using the following formula
)Capital at the End
Add :- 1. Drawings
2. Interest on Drawings
3. Losses during the Year
Less:- 1. Additional Capital Introduced
2. Profits during the year
Opening Capital (The amount on which Interest on
Capital is to be calculated)

Important Points to be noted while calculations

2) Interest on drawing is calculated on the basis of methods
discussed but in case no time period is mentioned in
question in such case interest on drawings will always be
calculated for 6 months.
3) Also interest on capital and interest on drawings will be
calculated on the basis of their period only when p.a. is
mentioned with the rate, otherwise interests will be calculated for
complete year irrespective of time mentioned.
4) Interest on partners loan is a charge against profits and the same
has to be recorded in the P&L account and in case rate of interest
on the same is not given the same shall be taken as 6% p.a.
5) In case the appropriations are higher than the amounts of
profits, in such case appropriations are to be distributed in the
ratio of appropriations itself

Thank You
Study Material Compiled by
Abhishek Khandelwal
B.Com, M.Com, L.L.B, B.Ed, CA (Final)