IPCC Paper I: Accounting Chapter No. 14

CA Shakuntala Chhangani .

} Partnership –General } Admission of a partner } Retirement and Death of a partner

General

} To understand the need for partnership and the meaning and features of the partnership ; } To understand the concept of partnership deed; } Applicability of Section 13 of Indian Partnership Act,

1932 when there is no partnership deed or the partnership deed is silent on the point; } To learn the techniques of maintaining profit and

loss appropriation account;

} To learn the methods of maintaining partners capital account; } To learn techniques for valuation of goodwill; } To learn calculation of interest on capital, interest on

Drawings, remuneration etc.. to the partners; } To learn accounting treatment in case of company

is the partner of the firm;

} To learn accounting treatment in case of change in the method of accounting from cash basis to accrual / mercantile basis; } To learn accounting treatment in case of change in

profit sharing ratio with retrospective effect; } To understand the concept of guaranteed partner; } Rectification of wrong distribution of profits.

} To cope with the increasing financial and managerial demands in the present day business world } Two or more persons may decide to ◦ Make a common pool of their resources ◦ Carry on the business Jointly ◦ Share the Profits in an agreed ratio

} This is known as Partnership

Definition U/s 4 of Indian Partnership Act, 1932 : } The term partnership is defined as “relation between persons who have agreed to

share the profits of a business carried on by all or any of them acting for all.”

ØMinimum no. of partners : 2 Partners ØMaximum no. of partners: ØPartnership Act is silent about maximum no. of members ØSection 11 of Companies Act, 1956 restricts maximum

no. of members to following in case of any association of persons unless registered under Companies Act , 1956 ØBanking Business: 10 ØAny Other Business: 20

} Partnership ◦ Is the result of an Agreement among Partners ◦ Does not arise by status or operation of law (Section 5).

} The agreement may be : ◦ Express or Implied ◦ Oral or Written

} Business must be in Existence ◦ Includes every ñ Trade ñ Profession or ñ Occupation.

} It implies that a partnership firm can not be formed to carry on a charitable work

} Profit making is the basic Intention of the Business } However, eventually, if the losses are incurred, it

will borne by the partners in agreed PSR. } If a Partner not share the Profits in a Firm, he is not

a partner. } However, sharing of loss by the member is not

necessary to become a partner (Guaranteed Partner)

} Every partner is liable for the acts of other partners of the firm done in the normal course of business. Every partner is a principal when he is bound by the acts of other partner. Similarly every partner is an agent when he binds other partners by his acts. } The relationship between the partners is that

of mutual agency. i.e. mutual faith and trust.

} A document which contains express written agreement between partners and properly stamped in the court of law is called a “partnership deed / agreement / articles of partnership” } It generally contains the following : ØName and address of the firm ØThe nature of business of the firm ØName and addresses of the partners and their

occupation

} Duration of the firm } Capital contribution by each partner and drawing

rights } Interest on capital / drawings / loans given by the

partners } Profit sharing ratio } Rights and duties of the partners inter se } Provisions relating to admission / retirement / death

of a partner

ØDispute settlement procedure ØSettlement of accounts of retiring or deceased

partner ØCalculation of share of profit in case of retirement or

death of a partner during the accounting year ØValuation of goodwill in case of retirement or death

of a partner during the accounting year § It helps to avoid disputes in future

} In the absence of an agreement (oral or written) between partners, provisions of section 13 of Indian Partnership Act, 1932, which are given below, shall apply : Ø Partner is not entitled to receive remuneration

(Section 13(a)) Ø Partners are entitled to share the profits equally

(section 13(b))

ØNo interest on capital (section 13(c)) Ø 6% interest on advances made by the partner to

the firm beyond his capital contribution (section 13(d))

} Records the transactions of the firm with the partners except rent paid to the partner. } Shows appropriation (distribution) of profits to

adjust the rights of the partners inter se } Items appearing in Profit and Loss

Appropriation A/c are also called below the line items (after tax).

Dr Profit and Loss Appropriation Account Cr. Rs. Rs.

To Interest on Capital A/c XX By net profit b/f XX

To Salary / commission to By Interest on drawings A/c XX

partner A/c XX

To Divisible net profit

transferred to Capital A/c

XX

XXX XXX

There are two methods of maintaining Capital Account under partnership: } Fixed Capital Method } Fluctuating Capital Method

} Capital Account is maintained at a fixed level } It is not allowed to fluctuate in the routine

course of business } All entries relating to interest on capital /

drawings, withdrawal of profits, share of profits, salary to partners etc are passed through a separate account called current A/c

Dr. Capital Account Cr.

Rs. Rs.

To Cash / Bank A/c XX By Balance B/f XX

(permanent withdrawal

of excess capital)

(capital Contribution till

last year

To Balance C/f

(year end capital bal.)

XX By Cash / Bank A/c

(fresh capital introduced)

XX

XXX XXX

Dr. Current Account Cr. Rs. Rs.

To Balance B/f XX By Balance B/f XX

To Drawings A/c XX By salary to partner A/c XX

To Interest on drawings A/c XX By Interest on Capital A/c XX

To Profit & Loss Appro. A/c XX By profit & Loss Appro. A/c XX

To Balance C/f XX By Balance C/f XX

XXX XXX

} Capital Account is allowed to fluctuate } All entries relating to share of profit,

remuneration to partner, Interest on capital / drawings, withdrawal of profits etc. are passed in capital account only. } No need to open a separate account i.e.

Current A/c

Dr. Capital Account Cr. Rs. Rs.

To Balance B/f XX By Balance B/f XX

To Drawings A/c XX By Interest on Capital A/c XX

To interest on Drawings By Salary to Partners’ A/c XX

To Profit and Loss Appropriation A/c (Loss)

XX By Profit and Loss Appropriation A/c (profit)

XX

To Balance C/f

XX

By Balance C/f XX

XXX XXX

Fixed Capital Method } Two accounts namely capital

account and current account are opened

} All entries relating to interest on capital / drawings, salary to partner share of profit / loss, withdrawal of profit are passed through Current A/c

} Capital account can never show Dr. balance

Fluctuating Capital Method } Only one account i.e. capital

account is required to be opened

} All entries relating to interest on capital / drawings, salary to partner share of profit / loss, withdrawal of profit are passed through Current A/c

} Capital account can show Dr. or credit balance

} Three partners A, B and C } Capital contribution Rs. 3,00,000, Rs. 2,00,000 and

Rs. 1,00,000 respectively } PSR equal } Interest on capital @ 10% } Profit for the year Rs. 1,20,000 } Profit appropriated by way of interest on capital Rs.

60,000 and the balance profit Rs. 60,000 shared equally

} Three partners A, B and C } Capital contribution Rs. 3,00,000, Rs. 2,00,000 and

Rs. 1,00,000 respectively } PSR is 3:2:1 } Interest on capital @ 10% } Profit for the year Rs. 1,20,000 } Profit appropriated by way of interest on capital Rs.

60,000 and the balance profit Rs. 60,000 shared in the ratio of 3:2:1

} Three partners A, B and C } Capital contribution Rs. 3,00,000, Rs. 2,00,000 and Rs.

1,00,000 respectively } PSR is equal } Interest on capital @ 10% } Profit for the year Rs. 48,000 } Each partner will get share of profit by way of interest

on capital to the extent of available profits in capital ratio i.e. A will get Rs. 24,000, B will get Rs. 16,000 and C will get Rs. 8,000 only

} Three partners A, B and C } Capital contribution Rs. 3,00,000, Rs. 2,00,000 and

Rs. 1,00,000 respectively } PSR is equal } Interest on capital @ 10% } Profit for the year Rs. 48,000 } There is a provision in the partnership deed that full

interest on capital is allowed even in case of insufficient profits

} Three partners A, B and C } Capital contribution Rs. 3,00,000, Rs. 2,00,000 and

Rs. 1,00,000 respectively } PSR is equal } Interest on capital @ 10% } Loss for the year Rs. 48,000

} What is actually interest on Capital ? } When to allow interest on capital ? } Why interest on capital is allowed ?

} In case the profit sharing ratio and capital ratio are the same, real division of profits is not affected even when interest on capital is not charged.

} Interest on capital is allowed only to the extent of available profits.

} However, the above limitation may be waived by partners by an agreement

} Partnership deed provides for interest on capital but does not stipulate the effect in case of loss, no interest on capital is allowed i.e. interest on capital is allowed only out of profits.

} Mr A had opening balance of capital Rs. 3,00,000 on 1.4.2010 } He introduced a further capital of Rs. 1,00,000 on

1.10.2010 } A withdrew the capital of Rs. 50,000 on 1.1.2011 } Interest on capital for the year ended 31.3.2011 will be : } 3,00,000 x 10% x 6/12 = Rs. 15,000 } 4,00,000 x 10% x 3/12 = Rs. 10,000 } 3,50,000 x 10% x 3/12 = Rs. 8,750

  33,750

} Interest on capital is calculated on time basis considering additional capital employed during the year and the capital withdrawn

} A distinction should always be made between

withdrawal in anticipation of profits and withdrawal of capital

} It is an expenditure for the firm and income for the concerned partner

} Accounting entry : (a) When interest on capital is due : Interest on Capital A/c Dr. XX To Partner’s Capital / Current A/c XX (b) Year end transfer entry : Profit and Loss Appropriation A/c Dr. XX To Interest on Capital A/c XX

Example 1 : } Ram and Shyam were partners sharing profits and

losses equally. Their capitals were Rs. 2,00,000 and Rs. 1,00,000 respectively. Partnership deed provides for interest on capital @ 6% per annum. The net profit before interest on capital was Rs. 50,000. show the distribution of profits among the partners.

Dr Profit and Loss Appropriation Account Cr. Rs. Rs.

To Interest on capital A/c: By net profit b/f 50,000

Ram 12,000

Shyam 6,000 18,000

To Capital A/c :

Ram 16,000

Shyam 16,000 32,000

50,000 50,000

Example 2 : } Ram and Shyam were partners sharing profits and

losses equally. Their capitals were Rs. 2,00,000 and Rs. 1,00,000 respectively. Partnership deed provides for interest on capital @ 6% per annum. The net profit before interest on capital was Rs. 15,000. show the distribution of profits among the partners.

Dr Profit and Loss Appropriation Account Cr.

Rs. Rs.

To Interest on capital A/c: By net profit b/f 15,000

Ram 10,000

Shyam 5,000 15,000

15,000 15,000

Example 3 : } Ram and Shyam were partners sharing profits and

losses in the ratio of 2:1. Their capitals were Rs. 2,00,000 and Rs. 1,00,000 respectively. Partnership deed provides for interest on capital @ 6% per annum. The net profit before interest on capital was Rs. 15,000. Show the distribution of profits among the partners.

Dr. Profit and Loss Appropriation Account Cr.

Rs. Rs.

To Interest on Capital A/c: By net profit b/f 15,000

Ram 10,000

Shyam 5,000 15,000

15,000 15,000

Example 4 : } In the above example, had there been no provision

in partnership deed regarding payment of interest on capital, there would have been no impact on distribution of profits which is shown as under :

Dr Profit and Loss Appropriation Account Cr.

Rs. Rs.

To Net divisible profits

transferred to Capital A/c:

By net profit b/f 15,000

Ram 10,000

Shyam 5,000 15,000

15,000 15,000

Example 5 : } In the above example, if the partners waive the

limitation of interest on capital to the extent of available profits only then the interest on capital will be allowed as under :

Dr. Profit and Loss Appropriation Account Cr.

Rs. Rs.

To Interest on Capital A/c By net profit b/f 15,000

Ram 12,000 By capital A/c :

Shyam 6,000 18,000 Ram 1,500

Shyam 1,500 3,000

18,000 18,000

} Interest on drawings is income for the firm and expenditure for the concerned partner. } It is paid by the partner to the firm for the

excess amount withdrawn. } Interest on drawings can be charged only if

provided by the partnership deed

Accounting Entry : (a) Interest on drawing charged : Partners’ capital / current A/c Dr. XX To Interest on drawings A/c XX (b) Year end Transfer entry : Interest on Drawings A/c Dr. XX To Profit and Loss Appropriation A/c XX

} Example 1 : Mr. A is a partner of XYZ and co. The partnership deed

provided for interest on drawings @ 8% per annum. Mr. A withdrew the following amount during the year :

1.4. 2011 Rs. 3,000 1.9.2011 Rs. 4,000 1.12.2011 Rs. 6,000 1.2.2012 Rs. 2,000 Calculate interest on drawings for the year ended

31.3.2012

Interest on drawings is calculated as under : Date Amount

withdrawn Outstanding

period Interest @ 8%

1.4.2011 3,000 12 months 3,000 x 8% x12/12 = 240 1.9.2011 4,000 7 months 4,000 x 8% x 7/12 = 187 1.12.2011 6,000 4 months 6,000 x 8% x 4/12 = 160 1.2.2012 2,000 2 months 2,000 x 8% x 2/12 = 26

613

Date Amount Outstanding Interest on withdrawn period drawings 1.4.2011 3,000 12 months 240 Date Amount Outstanding Product Interest on period drawings (1) (2) (3) (4) = (2)x(3) (4) x8%x1/12 1.4.2011 3,000 12 months 36,000 240

Interest on drawings can also be calculated by product method as under :

Date Amount withdrawn

Outstanding period

product

1.4.2011 3,000 12 months 36,000 1.9.2011 4,000 7 months 28,000 1.12.2011 6,000 4 months 24,000 1.2.2012 2,000 2 months 4,000

92,000

Interest on drawings = Total product x Interest % x 1/12 months / 52 weeks / 365 days = 92,000 x 8% x 1/12 = Rs. 613

} Withdrawals are made at the beginning of each month : Month Amount Outstanding Interest @ withdrawn period 12% p.a. January 10,000 6 months 600 February 10,000 5 months 500 March 10,000 4 months 400 April 10,000 3 months 300 May 10,000 2 months 200 June 10,000 1 month 100 Total 60,000 2,100

} Interest on = Total amount X Interest X Avg o/s period/ drawings withdrawn % 12 months = 60,000 x 12% x (6 + 1)/2 12 months = 60,000 x 12% x 3.5 / 12 = Rs. 2,100

} Withdrawals are made at the end of each month : Month Amount Outstanding Interest @ withdrawn period 12% p.a. January 10,000 5 months 500 February 10,000 4 months 400 March 10,000 3 months 300 April 10,000 2 months 200 May 10,000 1 months 100 June 10,000 0 month 00 Total 60,000 1,500

} Interest on = Total amount X Interest X Avg o/s period/ drawings withdrawn % 12 months = 60,000 x 12% x (5 + 0)/2 12 months = 60,000 x 12% x 2.5 / 12 = Rs. 1,500

} Withdrawals are made in the middle of each month : Month Amount Outstanding Interest @ withdrawn period 12% p.a. January 10,000 5.5 months 550 February 10,000 4.5 months 450 March 10,000 3.5 months 350 April 10,000 2.5 months 250 May 10,000 1.5 months 150 June 10,000 0.5 month 50 Total 60,000 1,800

} Interest on = Total amount X Interest X Avg o/s period/ drawings withdrawn % 12 months = 60,000 x 12% x (5.5 + 0.5)/2 12 months = 60,000 x 12% x 3 / 12 = Rs. 1,800

Hints : } If withdrawals are made at a fixed amount at the

beginning of each month, calculate interest on drawings for 6.5 months as under:

Total amount withdrawn X Interest % x 6.5/12 } If withdrawals are made at a fixed amount at the

end of each month, calculate interest on drawings for 5.5 months as under:

Total amount withdrawn X Interest % x 5.5/12

} If withdrawals are made at a fixed amount at the middle of each month or if the question specifies that withdrawals were made evening through out the year, calculate interest on drawings for 6 months as under:

Total amount withdrawn X Interest % x 6/12

} Example 2 : } A, B and C are partners sharing profit in the ratio of

4:2:3. Partners withdrew the following amounts during the year :

1) A Rs. 2,000 in the beginning of each month 2) B Rs. 3,000 at the end of each month 3) C Rs. 4,000 in the middle of each month You are required to calculate interest on drawings

@ 8% per annum.

} Solution : } Calculation of interest on drawings : 1) A = 24,000 X 8% X 6.5/12 = Rs. 1,040 2) B = 36,000 X 8% X 5.5/12 = Rs. 1,320 3) C = 48,000 X 8% X 6/12 = Rs. 1,920

} It is an expenditure for the firm and income for the concerned partner } Accounting entry : (a) When Remuneration to partner is due : Remuneration to Partner A/c Dr. XX To Partner’s Capital Current A/c XX (b) Year end transfer entry : Profit and Loss Appropriation A/c Dr. XX To Remuneration to Partner A/c XX

For your interest and patient hearing