WELCOME
CHAPTER-1
ACCOUNTING FOR PARTNERSHIP
BASIC CONCEPTS
INTRODUCTION
You have already learnt the accounting
procedure for sole trading concerns.
Limitations of sole proprietorship
1.Limited financial resources
2.Limited managerial ability
3.Limited scope of expansion
4.Unlimited liability
The need of partnership arose due to the
limitations of sole proprietorship.
Definition
As per section 4 of the Indian Partnership Act
1932,Partnership is the relationship between
persons who have agreed to share the profits of a
business carried on by all any of them acting for all.
*Persons who enter into the partnership are
individually called partners and collectively called
a firm.
Features
1.Agreement/Deed
The basis upon which the partnership is constituted is an
agreement ,between the partners. The agreement should be for
carrying on a lawful business. The agreement may be in oral or
written form.
2.Two or more persons
A minimum of two persons are required to form a
partnership. The maximum number of persons in a
partnership is limited to 10,in case of banking business and
20 if it is carrying on any other business.
3.Business
The agreement should be for carrying on some business. Business
include every trade,occupation or profession. The business must
be legal.
4.Sharing of profits
The objectives of partnership must be to earn profits and must
be distributed among partners in an agreed ratio. In case of
losses too are shared in the agreed ratio.
5.Business carried on by all or any of them acting for all.
Each partner can participate in the conduct of business and act
for the firm, as well as each partner is bound by the acts of
other partners. Thus a partner is both an agent and the
principal.ie.,he is an agent when he makes the other partners
liable for his acts. He is the principal when the other partners
make him liable for their acts. This is based on mutual agency
principle.
Partnership Deed
A written agreement which contains the terms and conditions of
partnership is called Partnership deed.
Contents of the Deed
*Name of the firm
*Name and address of all partners
*Nature and place of the firm
*Date of commencement of partnership.
*Duration of partnership
*Amount of capital contributed or to be contributed by each
partner.etc…………………………………
Rules applicable in the absence of partnership deed
1.No interest on capital
2.No interest on drawings
3.No salary
4.No commission
5.Equal share in profits
6.6% interest on loan taken from a partner.
Proforma of capital account
Cr.
Dr.
Particulars
a a
m m
a a Particulars
m m
a a a
m m m
a
m
Drawings
X X
X
X
Balance b/d
X X
X
X
Interest on
drawings
X X
X
X
Cash
X X
X
X
Share of loss
X X
X
X
Salary
X X
X
X
Commission
X X
X
X
Interest on loan given to
Firm
X X
X
X
Interest on capital
X X
X
X
Share of profit
X X
X X
X
X
X
X
X X
X
X
•A partner’s capital account normally shows credit
balance.
• However it can show a debit balance under certain
circumstances, like excessive withdrawal etc………..
There are two methods of maintaining capital
accounts of partners.(in partnership)
1.Fixed Capital Method
2.Fluctuating Capital Method
Fixed Capital Method
Fluctuating Capital Method
In the fixed capital method all adjustments like salary,commission,interest
on capital,profit etc are shown in current account.
In the fluctuating capiltal method,
all adjustment like salary, commission,interest on capital etc..are
show in the capital a/c itself.
In the fixed capital method there are
two account to be prepared for each
partner.Capital a/c & Current a/c
In the fluctuating capital method,
there is only one a/c ie,capital a/c
for each partner
The balance of fixed capital a/c does
not change in general circumstances.
The balance of fluctuating capital
a/c keep on changing from time to
time.
Capital a/c normally shows credit balance while current a/c can show a credit or debit balance.
Fluctuating capital a/c normally
shows a credit balance.
ILLUSTRATION 1
Arun and Balu entered into a partnersip business on 1st
April 1998 .They have contributed capital of Rs.50000
and Rs.60000 respectively.They decided to share profits
and lossess equally.According to the deed interest on
capital is allowed at 6% per annum and Balu was entitled
to get a salary of Rs.8000 per annum.During the year
Balu withdrew Rs.6000 and Arun withdrew
Rs.4000.Netprofit of the business after providing interest
on capital and salary to Balu amounted to Rs.16000.
Show the capital accounts of the partners.
1.When capitals are fixed
2.When capitals are flictuating
1.When capitals are fixed
Dr
Cr.
Capital a/c
particulars
Arun
Balu
Balance c/d
50000 60000
Particulars
Arun
Balu
cash
50000
60000
50000
60000
50000
60000
50000 60000
Balance b/d
Current a/c
Dr.
particulars
Arun
Balu
particulars
Cr.
Aru Balu
n
Drawings
4000
6000
Share of
profit
800
0
800
0
Interest on
capital
300
0
360
0
Salary
Balance c/d
7000
1360
0
1100
0
1960
0
Balance b/d
800
0
110
00
196
00
700
0
136
00
2.Fluctuating capital method
Dr.
Capital a/c
particulars
Arun Bal
u
Drawings
4000 600 Cash
0
Balance c/d
Cr.
particulars
Arun
Balu
5000
0
6000
0
Share of
profit
8000
8000
Interest on
capital
3000
3600
Salary
-------
8000
6100
0
7960
0
5700
0
7360
0
5700 736
0
00
6100 796
0
00
Balance b/d
Profit and loss Appropriation a/c
Profit and loss appropriation a/c is an
extension of profit and loss account. It is prepared to show
how net profit is distributed among the partners.
Proforma of Profit and loss appropriation a/c
Cr.
Dr.
Particulars
Am
Particulars
Am
Interest on capital
XXX
Netprofit b/d
XXX
Salary
XXX
Interest on
drawings
XXX
Commission
XXX
Loss
XXX
Reserve
XXX
Profit
XXX
XXXX
XXXX
ILLUSTRATION 2
On 1st January 2000 ‘R’ and ‘S’ entered into
a partnership contributing Rs.40000 and 30000 respectively,and
sharing profit and losses in the ratio of 3:2.R is to be allowed a
salary of Rs.6000 per year. Interest on capital is to be allowed at
6% per annum. During the year R withdrew Rs.3000 and S
Rs.4000.Interst on the same being Rs.150 and Rs.240 respectively.
The profit of the year before the above mentioned adjustments
was Rs.12500.
Pass the necessary entries relating to the appropriation of profit
and prepare the profit and loss appropriation a/c and partner’s
capital a/c.
Dr.
P&L appropriation a/c
Cr.
Am
Particulars
Am
Particulars
R’s salary
6000
Net profit b/d
12500
Interest on capital
(2400+1800)
4200
Interest on
drawings150+240
390
Capital a/c
R-1614
S-1076
2690
12890
12890
Interest on drawings
Case 1
When drawings of a fixed amount are made in the beginning of
every month, interest will be charged on the whole amount for 6 ½
months.
Interest on drawings = total drawings X rate of interest X 61/2
100
12
Example
A & B are partners in a firm. B withdrew Rs.5000 per month(in the
beginning of the month).Calculate his interest on drawings for the
preparations of final a/c, if it is charged @ 10%.
Total drawings = 5000 X 12 = 60000
Interest on drawings = total drawings X rate of interest X 6 ½
100
12
= 60000 X 10 X 6 ½
100
12
=3250
Case 2
When drawings of a fixed amount are made at the end of the every
month .
Interest on drawings = total drawings X rate of interest X 5 ½
100
12
Example
A partner makes a drawings of Rs.1000 per month ( at the end of
the every month ). Under the partnership deed interest is to be charged
at 15% per annum. Calculate his interest on drawings.
Total drawings=1000 X 12 = 12000
Interest on drawings = total drawings X rate of interest X 5 ½
100
12
= 12000 X 15 X 5 ½
100
12
=825
Case 3
When drawings are made in the middle of every month.
Interest on drawings = total drawings X rate of interest X 6 ½
100
12
Example
A partner make a drawings of Rs.1000 per month. Under the
partnership deed interest is to be charged @ 15% per annum.
Calculate his interest on drawings.
Interest on drawings = total drawings x rate of interest x 6 ½
100
12
Product method
( In the case- different amounts withdrawn on
different dates)
Date
Amount
Period
product
January 31
3600
11
39600
March 31
2400
9
21600
June 30
4800
6
28800
August 31
1200
4
4800
October 30
6000
2
12000
Total
106800
Interest on drawings = Total of product X 1/12 X 5/100
= 445
Goodwill
Goodwill can be defined as “ the present value of a firm’s anticipated
excess earnings” or as “ the capitalised value attached to the
differential profit capacity of a business.
*Goodwill is an intangible asset
Factors determining Goodwill.
1.Conduct of business
Goodwill of a business to a large extend, is attached with the
quality of the goods it deals with and services it provides. Higher the
quality more will be the goodwill or viceversa.
2.Location
The location of a business firm is another factor affecting
goodwill . Easy and convenient locations will attract more customers
Which eventually add to the goodwill of the firm.
3.Efficiency of the business
If the management of the business is highly efficient , it will
be able to maintain cost efficiency and productivity which will
enhance profitability of the business and there by it’s goodwill.
4.Market condition
Monopoly in the market restricts competition and helps the
firm to earn higher profits which enhances it’s goodwill.
5.Special previlages
The firm that enjoys special previlages like import license ,
uninterrupted supply of electricity, attractive trade marks etc……….
brings goodwill to the firm.
Need for the valuation of goodwill
1.Change in the profit sharing ratio amongst the existing
partners.
2. Admission of a new partner
3.Retirement of a partner
4.Death of a partner
5.Dissolution of a firm involves sale of business as a going
concerns.
6. Amalgamation of firms.
Methods of valuation of goodwill
1.Average profit method
Under this method the value of goodwill is calculated
at an agreed number of years purchase of the average profits for
the past few years . At the time of the sale of an established
business , the purchaser has to pay an extra amount for the value of
goodwill . This amount is equal to the profits he is likely to receive
for the first few years .The goodwill ,there for , should be calculated
by multiplying the past average profits by the number of years
during which the anticipated profits are expected to accrue.
Example
The profits of a firm for the last six years are given .
The partnership agreement provides the valuation of goodwill at 3
years purchase prince of the average profits of the last 6 years .
Calculate the value goodwill . The profits of the firm were :-
Year
Profits
1992
60000
1993
40000
1994
50000
1995
55000
1996
45000
1997
50000
Calculate the goodwill under average profits method ?
-----------------------------------------Goodwill = Average profits X no. of years purchased
Average profit = Total profit
No. of years
= 60000+40000+50000+55000+45000+50000
6
= 300000
6
= 50000
======
Goodwill= Average profit x No. of years purchased
= 50000 X 3 =150000
======
2. Weighted average profit method
Weighted average method is the modified version of
simple average profit method for computing goodwill . Under this method
each year profit is multiplied by the respective number of weights , based
on the principle of earnings in the immediate past and earnings in the
distant past .
Example
The profits of a firm for the last 5 years ending 31st March
were as follows :Year
Profits
Weight
1999
18000
1
2000
22000
2
2001
30000
3
2002
24000
4
2003
18000
5
Calculate the value of goodwill on the basis of 3 year purchased of
weighted average profit.
-----------------------------------------------------Weighted average profit = Total of products for profits
Total of weight
Year
Profits
Weight
Product(profi
t x weight)
1999
18000
1
18000
2000
22000
2
44000
2001
30000
3
90000
2002
24000
4
96000
2003
18000
5
90000
------------------- ------------------15
338000
Weighted average profit = Total of products for profits
Total of weight
= 338000
15
= 22533
======
Goodwill = Weighted average profit x number of years
= 22533 x 3 = 67599
======
3. Super profit method
Under super profit method , goodwill is calculated at
a certain number of years purchase of the super profits of the
business .
Super profits means excess of actual profits over
normal profit .
Example
The average profit of the firm for the last 5 years
20000 and the capital invested in 130000 . The normal profits for
the similar line of business is 10% . Calculate the amount of
goodwill if it is 2 years purchase of super profit .
--------------------------------------------Normal profit = 10% of capital invested.
ie ; = Normal profit = 130000 x 10
100
= 13000
=====
Average profit = 20000
Super profit = Average profit - normal profit
= 20000 – 13000
=7000
====
Goodwill = Super profit x Number of years purchased
= 7000 x 2
= 14000
=====
3 .Capitalization method
Under this method the goodwill can be calculated in two
ways .
1. By capitalizing the average profits.
2. By capitalizing the super profits.
Capitalizing the average profit
Here , expected future maintainable profits are
estimate after providing for reasonable managerial remuneration .
These expected future profits are capitalized on the basis of
normal rate of return to find out the total value of business .
Example
A business has earned average profits of Rs. 80000
during the last few years and the normal rate of return in similar type
of business is 10% . Find out the value of goodwill by capitalization
method , given that the assets of the firm amount to Rs. 600000 and
liabilities to Rs.100000.
-----------------------------------------Capital of the firm = 600000 – 100000
= 500000
======
Average profit = 80000
Normal rate of return = 10
100
80000 x 100 = 800000
10 ======
Goodwill = capitalized value – net asset
= 800000 - 500000 = 300000
Capitalization of super profit
Super profit are capitalized under this method .
Example
Calculate goodwill if :1. The goodwill of a firm is estimated at three years purchase of the
average profits of the last 5 years which are as follows:Year
Profits
1999
10000
2000
15000
2001
5000
2002
5000(loss)
2003
8000
2. If the firms total capital employed is Rs. 100000 and the normal rate
of return is 6%, the average profit for the last 5 years is Rs. 15000 and
goodwill is estimated at 3 years purchase of super profits .
Remuneration given to partner was Rs.2000 /- .
3.Rama Bothers earn a net profit of Rs.25000 with a capital of Rs.
200000 . The normal rate of return in the business is 10%.Use
capitalization of super profits method to value of the goodwill
------------------------------------------------
1. Average profit = (10000+15000+5000+8000 – 5000)/5
= 33000/5 = 6600
Goodwill = 6600 x 3 = 19800
2. Average profit = 15000
Remuneration to the partners =2000
Average actual profit =15000 – 2000= 13000
Normal profit = 100000 x 6/100 = 6000
Super profit = 13000 - 6000 = 7000
Goodwill=70000 x 3 = 21000
Normal profit = 200000 x 10/100 = 20000
Super profit= Average profit – normal profit
= 25000 – 20000 = 5000
Goodwill = Super profit x 100/Normal rate of return
=5000 x 100/10 =50000
=====
4.Present value of super profit
Here goodwill is estimated as the present value of the
future super profits. This method is based on the principal of
determining the present value of future cash flow.
Example
A firm has forecasted it’s future profit for five years as follows .
1st year - 100000
2nd year - 120000
3rd year - 80000
4th year - 110000
5th year - 130000
The total assets of the firms are Rs.1000000 and outside liabilities
are Rs.300000 . The present value factor at 10% are as follows .
Year
1
2
Present value
factor
0.9091 0.8264
3
4
5
0.7513
0.6830
0.6209
Calculate value of goodwill.
---------------------------------------------------------------------Year
1
2
3
4
5
Profit
100000
120000
80000
110000
130000
Normal
profit
70000
70000
70000
70000
70000
Super
profit
30000
50000
10000
40000
60000
Super
profit x
pvf
27273
41320
7513
27320
37254
Goodwill = 27273+41320+7513+27320+37254
= 140680
======
Past adjustments
After closing the accounts of the firm , it may come to light
that certain items were omitted or left out by mistake . In such a
case necessary adjustment are carried out in the partners capital
accounts . Profit and loss adjustment a/c is used for this purpose .
we can also prepare a statement of adjustment to find out
the net difference and pass a direct journal entry in the capital
accounts.
Example
The net profit of X , Y , and Z for the year ended March 31st 2006 was
Rs.60000 and the same was distributed among them in their agreed
ratio of 3:1:1 . It was subsequently discovered that the under
mentioned transactions were not recorded in the books:1. Interest on the capital at the rate 5% per annum.
2. Interest on drawings amounting to X Rs. 700 , Y Rs. 500 and Z
Rs.300
3. Partners salary :X-Rs.1000 ,Y-Rs.1500 per annum
The capital a/c of partners were fixed as X
Rs.100000 , Y Rs.80000 and Z Rs.60000.Record the adjustment
entry?
----------------------------------------------------------------
Adjusted Profit and loss appropriation a/c
Particulars
Interest on capital
X
5000
Y
4000
Z
3000
Salary
X
Y
1000
1500
Profit transferred
to capital a/c
X-28200
Y-9400
Z-9400
Am
Particulars
Am
Net profit b/d
60000
12000
2500
Interest on
drawings X-700
Y-500
Z-300
1500
47000
61500
======
61500
======
Statement showing adjustment
Particulars
X
Y
Z
Amount which should
have been credited
28200
9400
9400
1500
------------
4000
------------14900
3000
------------12400
500
-------------
300
--------------
14400
12000
------------2400
12100
12000
-------------100
Amount which should
have been credited to the
capital a/c
Salary –
1000
Interest on
capital
--5000
------------34200
Less, Amount which
should have been debited
Interest on
drawings 700
------------Amount actually reserved
Amount actually credited
33500
36000
------------2500
X’s capital a/cDr.2500
Y a/c
Z a/c
2400
100
---------------------------------------------------------------------------------------
CREATED BY :1. DIVYA RAJ
(Group member)
2. JINCY SUSAN SKARIA ( Group member)
3. JUBY SUSAN JAMES (Group member)
4. JULIE JOSE
(Group member)
5. MEENU.H
(Group leader )
THANK YOU…..