PARTNERSHIP

ESSENTIALS OF PARTNERSHIP
The law governing partnership is contained in the Partnership Act, 1932. Section 4 of the Act
defines partnership as "the relation between persons who have agreed to share the profits of a
business carried on by all or any of them acting for all".
The following are the essential elements of partnership:
1. There must be an agreement entered into by all the persons concerned.
2. The agreement must be to share the profits of a business.
3. The business must be carried on by all or any of them acting for all.
All these elements must be present before a partnership can come into existence. If any of
them is not present, there cannot be formed a partnership.
PARTNERSHIP AGREEMENT

 Partnership is the result of an agreement. The agreement among the partners which
sets out the terms on which they have agreed to form a partnership is called partnership
agreement.
 It may be in writing or by words of mouth or be implied from the course of conduct of
the parties. It is desirable to have the partnership agreement in writing to avoid future
disputes.
 The document in writing containing the various terms and conditions as to the
relationship of the partners to each other is called the 'partnership deed'. The following
clauses are normally included in partnership agreement.
1. Name under which business of the firm is to be carried on.
2. Nature of partnership business.
3. The capital of the firm and the proportion in which it is to be contributed by each partner.
4. Ratio in which profits and losses are to be shared by partners.
5. Rate at which interest is to be allowed on the capital and charged on the drawings.
6. Amount which each partner is allowed to withdraw in anticipation of profits from the
business for private expenses and the timing of such drawings.
7. Amount of salaries and other allowances if any payable to partners.
8. Commencement and duration of partnership.
9 Whether the capital accounts are to be fixed or fluctuating.
10. Valuation of goodwill at the time of retirement or death of a partner.
11. The method of ascertaining the amount due to the retiring partner or the representative of
a deceased partner at the time of retirement or death and the manner in which the amount
due will be paid.
12. Keeping of proper books of accounts and preparation of balance sheet.
13. Audit of the accounts of the firm and the manner of appointment of auditor.
14. Right and duties of partners.
15. Arbitration clause, laying down the procedure to be followed for the settlement of disputes
among the partners.
RIGHTS OF THE PARTNERS
1. Every partner has a right to take part in the conduct and management of the business.
2 Every partner has a right to be consulted and heard in all matters affecting the business of
partnership.
3 Every partner has the right to have access to and to inspect and copy any one of the books of
the firm.
4. The partners are entitled to share equally in the profits earned and shall contribute equally to
the losses sustained by the firm.
5. A partner making for the purpose of the business any payment or advance beyond the
amount of the capital he has agreed to subscribe, is entitled to interest thereon at the rate of
six per cent per annum.
6. A partner has the right not to allow the admission of a new partner.
DUTIES OF THE PARTNERS
1. Every partner is bound to attend diligently to his duties in the conduct of the business.
2. A partner is not entitled to receive any remuneration for taking part in the conduct of the
business.
3. A partner shall indemnify the firm for any loss caused to it by his willful neglect in the
conduct of the business of the firm.
 PROFIT & LOSS APPROPRIATION ACCOUNT

P&L Appropriation Account is prepared to show how the company appropriates or distributes
the profit earned during the year. It is an extension of Profit and loss a/c. It is prepared after the
preparation of profit and loss a/c at the end of every financial year.

The purpose is to allow the adjustments to be made to the profits so that the final income can
be divided among the partners per the agreed terms.

It is a nominal account, which means all the expense items of the firm are debited, and income
items are credited.

CAPITAL ACCOUNT

The partnership capital account is an equity account in the accounting records of a

partnership. It contains the following types of transactions:

 Initial and subsequent capital introduced by partners in the form of either cash or the
market value of other types of assets

 Share of profits and losses allocated to the partners through PL appropriation account

 Drawings of partners

The ending balance in the account is the undistributed balance to the partners as of the
current date.

EXAMPLE 1

The profits of Partnership AB Consultants for the year ending 31.12.X2 are £170,000. Capital
balances at 1.1.X2 are: Partner A, £140,000 and Partner B, £20,000. Interest on opening capital
is to be allocated at the rate of 10 per cent per annum. Partners’ salaries have been agreed in
the partnership agreement to be £10,000 and £25,000, respectively. Mr. A also provided loan to
business for £10,000 at the rate of 6% on 1.7.X2. The partners’ profit sharing ratio (PSR) is 3:2.
Drawings in the year for Partner A were £60,000 and £44,000 for Partner B. Interest on
drawings is 4.5%.

Required:

Prepare profit & loss appropriation account and the capital accounts of the partners A and B.
Answer:

PROFIT & LOSS APPROPRIATION ACCOUNT

A£ B£ TOTAL £
Profit for the year 170000
Less: interest on loan (10000 x6% x 6/12) (300)
Add: Interest on drawings
(60000 x4.5%) + (44000 x 4.5%) 4680
Adjusted profit 174380
Interest on capital 14000 2000 (16000)
Salaries 10000 25000 (35000)
Profit available for distributions 123380
Share in profits (3:2) 74028 49352
Closing balances at year end 98028 76352

CAPITAL ACCOUNTS

A£ B£ TOTAL £
Opening balance at start 140000 20000 160000
Profit & loss appropriation 98028 76352 174380
Drawings (60000) (44000) (104000)
Interest on drawings (2700) (1980) (4680)
Closing balance at year end 175328 50372 225700

EXAMPLE 2

A, B and C set up a partnership firm on 1.1.2017. They contributed Rs. 50,000, Rs. 40,000
and Rs. 30,000 respectively as their capitals and decided to share profit and loss in the
ratio of 3: 2: 1. The partnership deed provided that A is to be paid a salary of Rs. 1, 000 per
month and B a salary of Rs. 5,000 per year. It also provided that interest on capital be
allowed at 6% per annum. The drawings for the year were A Rs. 6,000, B Rs. 4,000 and C
Rs. 2,000. Interest on drawings was charged Rs. 270 on A's drawings Rs. 180 on B's
drawings and Rs. 90 on C's drawings. The net profit as per profit and loss account for the
year 2017 was Rs. 35,660.

Required:

Prepare profit & loss appropriation account of and the partner's capital accounts.
 PROFIT & LOSS APPROPRIATION ACCOUNT

A Rs B Rs C Rs TOTAL Rs
Net Profit for the year 35660
Interest on drawings 540
Adjusted profit 36200
Interest on capital 3000 2400 1800 (7200)
Salaries 12000 5000 0 (17000)
Profit available for distributions 12000
Share in profits (3:2:1) 6000 4000 2000
Closing balances at year end 21000 11400 3800

CAPITAL ACCOUNTS

A Rs B Rs C Rs TOTAL Rs
Opening balance 50000 40000 30000 120000
Profit & loss appropriation 21000 11400 3800 36200
Drawings (6000) (4000) (2000) (12000)
Interest on drawings (270) (180) (90) (540)
Closing balance at year end 64730 47220 31710 143660
ADMISSION OF PARTNER
In case additional capital or managerial hand or both are required in the course of expansion of
a business, it becomes usual to admit a new person into the business as a partner. If the
existing business is owned by a sole trader, it is converted into a partnership concern on the
admission of the new partner. A new partner in an already existing partnership can be admitted
with the consent of all the partners.
GOODWILL
'Goodwill of a business is the advantage, whatever it may be which a person gets by continuing
to carry on and being entitled to represent to the outside world that he is carrying on a
business, which has been carried on for some time previously'.
From the accountants view point, goodwill, in the sense of attracting customers has little
significance unless it is valuable in the sense of having a saleable value. To the accountant,
therefore, goodwill is an intangible but not a fictitious asset. The goodwill possessed by a firm
may be due to the following factors:
(a) The personal reputation of the partners.
(b) The reputation of the goods dealt in.
(c) Location of the business premises.
(d) Advantage available in regard to the supply of the materials etc.
(e) Possession of favorable contracts complete or partial monopoly etc.
(f) Possession of contented and efficient employees.
(g) Possession of trademarks, patents or well-known business name.
(h) Continuance of advertising campaigns.
(i) The maintenance of quality of the firm’s products and development of business with
changing conditions.
(j) Freedom from legislative restrictions.
GOODWILL ON ADMISSION
The treatment of Goodwill, when a person is admitted into the partnership will depend upon as
whether goodwill account exists or does not exist at the time when the new person is admitted
into the partnership concern.
The different methods for the treatment of goodwill in this case are:
1. PREMIUM METHOD
(a) The amount of goodwill is paid privately by the incoming partner to the old partners.
(b) The value of goodwill attributable to incoming partner's share of profit is brought in cash at
the amount is retained in the business.
(c) The value of goodwill attributable to incoming partner's share of profit is brought in cash
and the amount is withdrawn by the old partners.
II. REVALUATION METHOD
The incoming partner does not bring in the amount of goodwill in cash, but a goodwill account
raised in the books at full value.
III. MEMORANDUM REVALUATION METHOD
Incoming partner does not bring cash into the business for goodwill, a goodwill account is
raised in books at full value and is then immediately written off.
EXAMPLE 3 (Premium Method)
A and B are partners in a firm sharing profits and losses in there and Rs. 8,000 in admitted i the
firm for 1/5th share of profits. He is to bring in Rs. 30,000 as capital and Rs. 8,000 as his shares
Goodwill. Give necessary journal entries
(a) When the amount of Goodwill is retained in the business.
(b) When the amount of Goodwill is fully withdrawn.
(c) When 50% of the amount of Goodwill is withdrawn.
ANSWER (a)

Transaction Account Debit (Rs) Credit (Rs)

1 Cash 38000

C’s Capital 30000

Goodwill 8000

2 Goodwill 8000

A’s Capital 5000

B’s Capital 3000

(b)

Transaction Account Debit (Rs) Credit (Rs)

1 Cash 38000

C’s Capital 30000

Goodwill 8000

2 Goodwill 8000

A’s Capital 5000

B’s Capital 3000

3 A’s Capital 5000

B’s Capital 3000

Cash 8000

(c)

Transaction Account Debit (Rs) Credit (Rs)

1 Cash 38000

C’s Capital 30000

Goodwill 8000

2 Goodwill 8000

A’s Capital 5000

B’s Capital 3000

3 A’s Capital 2500

B’s Capital 1500

Cash 4000
EXAMPLE 4 (Revaluation Method)
A and B are partners sharing profits and losses in the ratio of 3: 2. They admit C into the
partnership with a 1/4 share in the future profits. C bring in Rs. 30,000 on account of capital but
is unable to bring in anything on account of goodwill. Goodwill of the firm is valued at two years
purchase of the average profits of the last three years. The profits of the last three years were
Rs. 8,000, Rs. 10,500 and Rs. 11,500. Make journal entries.
Solution:
Average profit= 30,000/3 = 10,000
Value of goodwill = 10000 x 2 = Rs. 20,000

Transaction Account Debit (Rs) Credit (Rs)

1 Cash 30000

C’s Capital 30000

2 Goodwill 20000

A’s Capital 12000

B’s Capital 8000

EXAMPLE 5 (Memorandum Revaluation Method)

A and B are partners sharing profits and losses in the ratio of 3: 2. They admit C into the
partnership with a 1/4 share in the future profits. C bring in Rs. 30,000 on account of capital but
is unable to bring in anything on account of goodwill. Goodwill of the firm is valued at two years
purchase of the average profits of the last three years. The profits of the last three years were
Rs. 8,000, Rs. 10,500 and Rs. 11,500. The goodwill is written off in the new profit and loss
sharing ratio between all partners. Calculate the new PL sharing ratio and pass journal entries.
Answer C’s share = 1/4
Remaining profit = 1 – 1/4 = 3/4
New share of A = 3/5 x 3/4 = 9/20
New share of B = 2/5 x 3/4 = 6/20
C’s share = 1/4 or 5/20
New PL sharing ratio = 9:6:5
Transaction Account Debit (Rs) Credit (Rs)

1 Cash 30000

C’s Capital 30000

2 Goodwill 20000

A’s Capital 12000

B’s Capital 8000

3 A’s Capital 9000

B’s Capital 6000

C’s Capital 5000

Goodwill 20000