Partnership General Part 1

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In sole proprietorship we have only one owner. All earnings and losses of the business flow directly to the owner, and the business is not taxed as a separate entity. Accounting method is easy. But when it comes to partnership firm, we follow all accounting procedures but we need some special treatment in order to distribute profits or losses as per partnership agreement. Those special treatments include appropriation of Profits and treatment of good will etc.

Partnership Definition:

According to Indian Partnership Act 1932 – “Partnership relation between persons who have agreed to share profits of business carried on by all or any of them acting for all”.

Characteristics of Partnership:

  • Agreement: A partnership is formed by an agreement which could be either oral form or written form (written form is known as Partnership Deed). It describes terms and conditions of Partnership like sharing of Profits or Losses, Interest rates on Capital or Drawings, Salaries etc.

  • Number of Persons: To form a Partnership we need minimum of two people. Maximum number of people for banking business is 10 and for non-banking business 20.

  • Business Activity: Partnership firm is a profit-based business and it should work as per law of the country.

  • Sharing of Profits: As per the agreed ratio mentioned in Partnership deed.

  • Mutual Agency: Each partner will be responsible and liable for the acts of all other partners.

  • Unlimited Liability: The liability of partners of partnership firm is Unlimited. If the assets are insufficient to pay off the debts, personal properties of partners will be used to clear the debts.

  • Management: All partners have equal rights to manage business. They can manage different activities as for mutual understanding. Sometimes some partners may not participate in management (act as sleeping partner) and other partners will work on behalf of them.

  • Transferability of Share: No partner can transfer his/her share to any one including his/her family member without the consent of all other partners.

In the Presence of Partnership Deed:

It is written form of agreement basis of Partnership. It clearly states about terms and conditions regarding many things. Every partnership firm can prepare their own terms and conditions. It helps in settling of disputes raised among partners.

Contents of Partnership Deed:

  • Name and address of the partnership firm and each partner

  • Nature and objectives of the business

  • Capital contribution by each partner

  • Ratio in which profits is to be shared

  • Rate of Interest on capital if allowed

  • Salary or any other remuneration to partners, if allowed

  • Rate of interest on loans and advances by a partner to the firm

  • Drawings of partners and interest thereon, if any

  • Method of valuation of goodwill and revaluation of assets and liabilities on the reconstitution of the partnership i.e. on the admission, retirement or death of a partner

  • Settlement of disputes by arbitration

  • Settlement of accounts at the time of retirement or death of a partner

  • Circumstances in which the firm can be dissolved

  • Settlement of accounts at the time of dissolution of a firm

In the Absence of Partnership Deed:

If there is no written document of partnership deed, the provisions of Partnership Act become applicable. These provisions are as follows –

  1. Distribution of Profits: Partners are entitled to share profits equally.

  2. Interest on Capital: Interest on Capital is not allowed.

  3. Interest on Drawings: Not applicable

  4. Interest on partner’s loan: A Partner is allowed interest @ 6% per annum on the amount of loan given to the firm by him/her.

  5. Salary or remuneration for Management: Partners are not entitled to get any salary or commission for managing business activities.

Capital Account Meaning and Preparation in Partnership Firms:

Partners contribute their capital for partnership firm. And capital account is being maintained for every partner. The capital account could be of two kinds

Fixed Capital Account:

  • Under Fixed Capital Account we maintain two separate accounts for every partner. One is Capital Account to describe capital contribution and another one is Current Capital Account to record all other items related to capital.

  • All adjustments are recorded in Current account.

  • Capital Account shows credit balance and normally remains unchanged except under special circumstances.

Fluctuating Capital Account:

  • Basically, this is prepared if there absence of any information. Under this we maintain only one Capital Account and all capital and capital related information will be recorded in the same account.

  • Adjustments are recorded directly in the capital accounts and the balance of capital account could be either debit balance or credit balance and it fluctuates time to time.

Accounting Treatment of Interest on Capital:

  • Interest on Capital is an expense to firm and the rate of interest paid is based on agreement rate in partnership deed.

  • Basically, interest is paid on opening balance of partner capital A/c, if any capital added in between interest will be paid for the amount used in business during period.