Chapter – 2

Accounting for Partnership – Basic concept

Partnership The relationship between persons who have agreed to share the profit of a business carried on by all or any of them acting for all. Partnership deed: It is a written document containing the terms of partnership as agreed to by the partners Rules applicable in the absence of partnership deed 1. 2. 3. 4. 5.

Profit sharing ratio – equally Interest on capital – not entitled Interest on drawings – not entitled Remuneration to partners – not entitled Interest on loan – 6%

Partner’s capital account: a) Fixed capital i. Capital account ii. Current account ( all adjustment are shown in here) b) Fluctuating capital i. Capital account ( all adjustment shown in capital account itself)

Profit and loss appropriation account This is extension of profit and loss account to record partner’s adjustment items and is prepared to show how net profit has been distributed among the partners Profit and loss appropriation account Net loss Interest on capital: AXXX BXXX Partners salary Partners commission Reserve If profit: AXXX BXXX

XXXX

XXXX XXXX XXXX XXXX

Net profit Interest on drawings: AXXX BXXX

XXXX

XXXX

If loss: XXXX

AB-

XXX XXX

XXXX Calculation of interest on capital Case 1: when there is no addition to or withdrawn from capital during the year

XXXX XXXX

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Accounting for partnership – basic concept

Interest on capital = opening capital * rate /100 Case 2: when there is addition to capital The following steps must be followed a) Find the opening capital b) Calculate interest on capital using formula of case 1 c) Calculate interest on additional capital Interest on capital = additional capital * rate/100 * date /12 Case 3: When there is withdrawn out of capital The following steps must be followed. a) Calculate interest on capital on opening capital from the beginning of the year to the date of withdrawn b) Calculate the new capital c) Calculation of interest on capital on new capital Case 4: If opening balance is not given Capital at the end of the year

XXXX

Add: Drawings Interest on drawings Share of loss, if any

XXXX XXXX XXXX

Less: Salary Commission Additional capital Share of profit

XXXX XXXX XXXX XXXX

Opening capital

XXXX XXXX

(XXXX) XXXX

Calculation of interest on drawings Case 1: Amount of withdrawal, rate of interest, date given: Interest on drawings = drawings amount * rate/100 * date /12 Case 2: Amount, rate of interest are given but date not given Interest on drawings = drawings amount * rate/100 * 6 /12 Case 3: Amount withdrawal in every month a) In the beginning of every month Interest on drawings = drawings amount * rate/100 * 6.5 /12 b) In the middle of every month

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Accounting for partnership – basic concept

Interest on drawings = drawings amount * rate/100 * 6 /12 c) In the end of every month Interest on drawings = drawings amount * rate/100 * 5.5 /12 Case 4: different amount withdraw in the different interval Interest on drawings = sum of product * rate/100 * 1 /12

Guarantee of profit to the partners Sometime on admission of a new partner, the existing partners may give an assurance to the incoming partners that he shall be given minimum amount of profit irrespective of firm actual profit Guarantee of profit can be given in 2 way 1. All other partners bear deficiency 2. One partner bear the deficiency

Past adjustment Sometime after the final account for the year have been made up and partners capital is prepared it may be found that certain items are left out by mistake or wrongly treated. Such errors and omission usually relates to a) Interest on capital b) Salary to partners

c) Interest on drawings d) Commission or remuneration to the partners

In operation terms it implies that there has occurred wrong allocation of profit among the partner. So necessary adjustment have to be carried out in partner’s capital account or current account through an account called profit and loss adjustment account Journal entries 1) If the item like salary, commission, interest on capital etc. have been omitted P & L adjustment a/c dr To partners capital account 2) If interest on drawings has been omitted Partners capital a/c dr To P/L adjustment account 3) If profit arise after closing the profit and loss adjustment account P/L adjustment a/c dr To partners capital account 4) If loss Partners capital a/c dr To P/L adjustment a/c

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Accounting for partnership – basic concept

Goodwill It is the value of reputation of the firm in respect of profit in future over and above and normal profit. Goodwill can be defined as the present value of the firm anticipated excess earning. Need for the valuation of goodwill 1) 2) 3) 4) 5) 6)

Change in profit sharing ratio Admission of partner Retirement of existing partner Death of a partner Dissolution Amalgamation of 2 firm

Methods of valuation of goodwill a) b) c) d)

Average profit method Weighted average profit method Super profit method Capitalization method i. Capitalization of average profit ii. Capitalization of super profit e) Present value of super profit

Average profit method I. II. III.

Find out the total profit Find the average profit ( total profit / no.of year) Calculate goodwill by multiplying average profit by no.of year purchased Goodwill = Average profit * no. of year purchased

Weighted average profit method i. ii. iii. iv.

Weights are assigned to each year profit Each year profit is multiplied by respective weight to find the value of product Find out the total of product Find the weighted average profit WAP = sum of product/ Total weight v. Find the goodwill Goodwill = WAP * no .of year purchase

Super profit method i. ii.

Find out the average profit Find out normal profit

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Accounting for partnership – basic concept

iii. iv.

Normal profit = Capital employed * NRR/ 100 (NRR – Normal Rate of Return) Find the super profit Super profit = Average profit – Normal profit Find the goodwill Goodwill = Super profit * no. of year purchased

Capitalisation of average profit i. ii. iii. iv.

Find out the average profit Capitalize the average profit Total Value of Business = Average profit * 100 / NRR Calculate net asset of the firm Net Asset = Total asset (excluding goodwill) - outside liability Find the goodwill Goodwill = T.V.B - Net Asset

Capitalisation of super profit i. ii. iii. iv.

Find out the average profit Calculate Normal profit Normal profit = Capital employed * NRR/ 100 Calculate super profit Super profit = Average profit – Normal profit Calculate Goodwill Goodwill = Super profit * 100 / NRR

Distinction between fixed capital and fluctuating capital Fixed capital Two accounts are prepared i.e. capital account and current account

Fluctuating capital One account is prepared i.e capital account

Adjustment relating to interest on capital, salary, commission etc are made in the current account

All adjustment are made in the capital account

The balance of fixed capital account does not change

The balance of fluctuating capital account keeps on changing

Fixed capital account always shows credit balance

Fluctuating capital account may have credit or debit balance

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