Indian Partnership Act

Indian Partnership Act, 1932 Sec 4.
Definition of "partnership", "partner", "firm" and "firm name"

"Partnership" is 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. Persons who have entered into partnership with one another are called individually "partners" and collectively a "firm", and the name under which their business is carried on is called the "firm name".
Essential elements of Partnership

From the above definition of partnership, the essential elements of partnership can be understood as "Partnership" is 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.
persons
There should be at least two persons to form a partnership or partnership firm.
Restrictions on the number of persons

The maximum number of members that can exist in partnership is 10 in case of a firm carrying on banking business and 20 in case of any other business. This restriction is placed by the companies act and not the partnership act.
Companies Act, 1956
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Sec 11. Prohibition of associations and partnerships exceeding certain number

(1) No company, association or partnership consisting of more than ten persons shall be formed for the purpose of carrying on the business of banking, unless it is registered as a company under this Act, or is formed in pursuance of some other Indian Law. (2) No company, association or partnership consisting of more than twenty persons shall be formed for the purpose of carrying on any other business that has for its object the acquisition of gain by the company,
association or partnership, or by the individual members thereof, unless it is registered as a company under this Act, or is formed in pursuance of some other Indian law. (3) This section shall not apply to a joint family as such carrying on a business; and where a business is carried on by two or more " joint families, in computing the number of persons for the purposes of Sec 11 (1) and Sec 11 (2), minor members of such families shall be excluded. (4) Every member of a company, association or partnership carrying on business in contravention of this section shall be personally liable for all liabilities incurred in such business. (5) Every person who is a member of a company, association or partnership formed in contravention of this section shall be punishable with fine which may extend to ten thousand rupees.
who have agreed

There should be an agreement between those persons who are forming the partnership. The agreement is the foundation for the partnership. Partnerships can arise only from a contract and not status.
Indian Partnership Act, 193 Sec 5. Partnership not created by status

The relation of partnership arises from contract and not from status; and, in particular, the members of a Hindu undivided family carrying on a family business as such, or a Burmese Buddhist husband and wife carrying business as such, are not partners in such business.
the profits of a business

There should be a business carried on by the partnership and that too with an intention to make and share profits of that business. Therefore we can say "No Business No Partnership" as well as "No intention to share profits No Partnership" Though, no specific mention of sharing of losses is made, we consider that Sharing profits implies Sharing Losses also.
Indian Partnership Act, 1932

carried on by all or any of them acting for all
The business may be carried on by any one or more of the partners.
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Acting for all

This implies that a partner conducting the business should be understood as conducting the business on behalf of all the partners. Each partner would be responsible for the acts of the other partners in relation to the firm. As far as the outsiders are concerned, the partners and the firm are one and the same.
Mutual Agency [Principal Agent Relationship]
In his/her role as a partner, a person acts both as a principal as well as an agent. A partner is an agent for the acts that the he/she does on behalf of the firm, whereby he/she can bind the other partners for such acts. The other partners would be the principals for such acts. With regard to the acts of the other partners, he/she will act as the principal (since he as a partner is bound by the acts of the other partners on behalf of the firm) Where a partner cannot be made responsible for the acts of one or more other partners we cannot say they together form a partnership. This mutual agency is what really decides whether there is a partnership or not. Thus it is said the "Mutual Agency" is the real test of partnership.
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Sec 18. Partner to be agent of the firm

Subject to the provisions of this Act, a partner is the agent of the firm for the purpose of the business of the firm.
Partners
Persons who have entered into partnership with one another are called individually "partners".
Partnership
The relationship between the persons is called "partnership".
Firm
The partners are collectively called a "firm".
Firm Name
The name under which the partnership business is carried on is called the
Partnership is a form of business organisation. A business and its ownership are independent concepts. The idea that the actual business and the form of organisation that is owning it are different would help you in creating an understanding on the difference in accounting for partnership firms and other forms of business organizations. The same business may be owned by a "sole proprietor", a "partnership firm", a "co-operative society", a "company" or any other form of business organisation. Ascertaining the profit or loss is an idea related to the business. How the profit made is dealt with is an idea related to the form of business organisation. Thus the process of profit ascertainment (final accounting) for a business would be the same whatever may be the form of business organisation.
What's the difference?

The way the profits made by an organisation are shared is what is different from organisation to organisation. Taking a hypothetical case of a business owned by different types of business organisations, the process of ascertaining profits would be more or less the same but the process of dealing with profits made would be different from one form of business organisation to another.
The have an understanding on the difference in accounting where the same business is conducted by two different forms of business organisations, let us consider an example of a business being conducted by a sole proprietor "Mr. Narayanan" and another case of the same business being run by a partnership firm "M/S Mani and Murthy" who share the profits of the firm between them in the ratio 1 : 2.
Final Accounting Business Owned by a Sole Proprietor
Final Accounting
Trial Balance of M/s Wearall Textlies as on 31st March 2006 Debit Amount (in Rs) Credit Amount (in Rs)
1,00,000 15,000 25,000 1,50,000 25,000 3,20,000 50,000 3,000 1,51,000 45,000 38,000 4,61,000 4,61,000
Particulars
L/F
Capital Opening Stock Closing Stock Purchases Rent Paid Sales Wages Commission Received Assets Debtors Creditors
Total Dr
Trading and Profit and Loss a/c

Amount Particulars (in Rs) (in Rs) Amount Particulars (in Rs) Amount
Cr
Amount (in Rs)
To To To To
Opening Stock Purchases Wages Gross Profit
15,000 1,50,000 50,000 1,30,000
By Sales By Closing Stock
3,20,000 25,000
3,45,000
3,45,000
To Rent To Net Profit
25,000 1,08,000
By Gross Profit By Commission Received
1,30,000 3,000
1,33,000
1,33,000
Dr
Capital a/c
Cr
Amount Particulars (in Rs)
Amount (in Rs)
Amount (in Rs)
To Balance c/d
2,08,000
By Balance b/d By Net Profit
1,00,000 1,08,000
2,08,000
2,08,000
By Balance b/d
2,08,000
Recording Gross Profit and Net Profit

Should the posting relating to gross profit and net profit read "To P & L a/c" and "To Capital a/c" respectively. How is it that it shows "Gross Profit" and "Net Profit"
Explanation
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Journal in the books of M/s ____ for the period from __ to ____ Date
March 31st
V/R Particulars No. L/F (in Rs) (in Rs) Debit Amount Credit Amount
Trading a/c To Profit and Loss a/c [For the gross profit transferred to profit and loss account.]
Dr
1,30,000 1,30,000
March 31st
Profit and Loss a/c To Capital a/c
Dr
1,08,000 1,08,000
[For the net profit transferred to capital account.]
Dr

Cr
Amount (in Rs)
To Profit & Loss a/c
1,30,000
3,45,000
3,45,000
By Trading a/c To Capital a/c

1,08,000
1,30,000
1,33,000
1,33,000
The basic purpose of accounting is derivation of information The more information we need, the more accounting heads we have to create.
Journal in the books of M/s ____ for the period from __ to ____ Date
March 31st
Trading a/c To Gross Profit a/c [For the gross profit transferred to Gross Profit account.]
Dr
1,30,000 1,30,000
March 31st
Gross Profit a/c Profit and Loss a/c [For the gross profit transferred to profit and loss account.]
Dr
1,30,000 1,30,000
March 31st
Profit and Loss a/c Net Profit a/c
Dr
1,08,000 1,08,000
[For the net profit transferred to Net Profit account.] March 31st Net Profit a/c Capital a/c Dr 1,08,000 1,08,000
[For the net profit transferred to capital account.]
Dr

Cr
Amount (in Rs)
To Gross Profit
1,30,000
3,45,000
3,45,000
By Gross Profit a/c To Net Profit

1,08,000
1,30,000
1,33,000
1,33,000
Dr
Capital a/c
Amount Particulars (in Rs) (in Rs) Amount
Cr
Amount (in Rs)
To Balance c/d
2,08,000
By Net Profit
1,08,000
2,08,000
2,08,000
By Balance b/d
2,08,000
Dr
Gross Profit a/c

Cr
Amount (in Rs)
To Profit and Loss a/c
1,30,000
By Trading a/c
1,30,000
1,30,000
1,30,000
Dr
Net Profit a/c

Cr
Amount (in Rs)
To Capital a/c
1,08,000
By Profit and Loss a/c
1,08,000
1,08,000
1,08,000
Final Accounting Business Owned by the Partnership Firm
Assuming all other data to be the same and the capital of Rs. 1,00,000 is owned by the two partners Mani and Murthy as Rs. 30,000 and Rs. 70,000 respectively.
Trial Balance of M/s Wearall Textlies as on 31st March 2006 Particulars L/F Debit Amount Credit Amount
(in Rs)
Mani's Capital Murthy's Capital Opening Stock Closing Stock Purchases Rent Paid Sales Wages Commission Received Assets Debtors Creditors
(in Rs)
70,000 30,000
15,000 25,000 1,50,000 25,000 3,20,000 50,000 3,000 1,51,000 45,000 38,000 4,61,000 4,61,000
Total
The Trading and profit and loss account would be the same Net Profit = Rs. 1,08,000.
Dr

Cr
Amount (in Rs)
To To To To
Opening Stock Purchases Wages Gross Profit
15,000 1,50,000 50,000 1,30,000
By Sales By Closing Stock
3,20,000 25,000
3,45,000
3,45,000
To Rent To Net Profit c/d
25,000 1,08,000
By Gross Profit By Commission Received
1,30,000 3,000
1,33,000
1,33,000
To Net Profit (Mani) To Net Profit (Murty)
36,000 72,000
By Net Profit b/d
1,08,000
1,08,000
1,08,000
Distribution of Profits among Partners

Partners profit sharing ratio Mani : Murthy = 1 : 2 1 = 3 : 3 2
Partners share of profits = Firms profit Profit sharing proportion
1 Mani's Share = Rs. 1,08,000 3 = Rs. 36,000
2 Murthy's Share = Rs. 1,08,000 3

Rs. 72,000
Rs. 72,000
Dr
Partners Capital a/c's

Mani Particulars (in Rs) (in Rs) Murthy Particulars (in Rs) (in Rs) Mani Murthy
Cr
To Balance c/d
1,06,000
1,02,000
By Balance b/d
70,000
30,000
By Net Profit
36,000
72,000
1,06,000
1,02,000
1,06,000
1,02,000
By Balance b/d
1,06,000
1,02,000
The difference that you can notice is that the profit of Rs. 1,08,000 instead of getting into the account representing a single owner (capital account) is distributed among all the owners i.e. their respective capital accounts.
Is that all the difference !!!
Surely, not
If this is the only difference, then you have completed learning Partnership accounting. This example is given to make you understand that Capital and its related aspects differ for each form of business organisation. Therefore, learning about accounting for partnership firms involves learning about the various aspects related to Capital.
Appropriation
= Setting aside Money for a specific purpose
Factors of Production Returns

In economic terms, the four basic factors of production are Land, Labour, Capital and Organisation. Each of these factors would be compensated by sharing a part of the income earned. What they get is what is called the return for the factor.
Rent is the return for Land; Wages are the returns for Labour/Labor; Interest is the return for Capital; and Profits are the returns for the Organisation.
Thus profit earned by the partnership firm can be said to be the returns earned by the Organisation.
Organisation Partnership Firm

Land, Labour and Capital are factors of production which we see or feel. Organisation is an intangible factor that combines these three factors to achieve the intended objective. Organisation can therefore be understood as, the efforts made by those who have contributed capital. These efforts may take many different forms, some tangible and some intangible.
What Constitutes "Organisation" in a Partnership Firm

In a partnership firm, the efforts made by the partners who are the contributors of capital, represent the "Organisation". All these contributions, apart from the capital they contribute form the factor we call "Organisation". Partners contribution to the firm takes many different forms which may be tangible or intangible. Some of them are
Time
The partners spend their time and energy in working for the firm by looking after the day to day affairs of the firm.
Business Relations
The partners through their contacts in the society bring in customers which would result in more sales.
Intelligence
The partners use their intelligence and abilities at various situations like in solving problems faced by the firm, tiding over tough situations, overcoming competitions etc.
Why not Capital

We do not consider the Capital contributed by the partners since "Capital" itself is dealt with as a separate factor.
Varied Contributions of Partners towards the Organisation

Since no two human beings can be exactly of the same capabilities, the contributions made by the partners for the factor called organisation varies from partner to partner. Each partner contributes according to his/her abilities and possibilities.
Remunerating the Factors of Production in a Partnership Firm

Let us limit our idea to remunerating the two factors of production Capital and Organisation only.
Judicious Distribution of the Firms Profits

A, B and C are partners in a firm. The firm has made a profit of Rs. 3,00,000. What would be the judicious share of profits to be distributed to each partner A, B and C.
Share Equally
A, B and C sharing Rs. 1,00,000 each. This sounds prudent if the contributions of A, B and C towards the firm is the same in all respects. Say, A, B and C are of the same intelligence level, they work for the same time for the firm, they have contributed the same amount of Capital for the firm, they are having more or less the same contacts outside through which sales are generated, they have all withdrawn the same amounts of money for their personal uses (drawings) etc. In such a situation it would be appropriate to give each an equal share.
Equal Share not a Judicious share always

If we consider the following aspects we may have to agree that sharing the profits of the firm equally amongst partners may not be the judicious (best) way.
Unequal Capital Contributions

The Capital Contributed by A, B and C is Rs. 2,00,000, Rs. 75,000 and Rs. 1,00,000 respectively. Now, since A, B and C have contributed varied amounts of Capital towards the firm, it would not be appropriate to share the profits equally among them.
To Compensate Pay interest on Capital.

Compensate for the uneven contributions towards capital and then share the profits equally (if contributions of A, B and C towards the firm in all other respects is the same). Greater the Capital contributed, greater the interest earned. This would set right the difference in contributions in the form of capital. Profit equal to "Interest on Capital" payable to partners is first paid away and then the remaining profit can be shared equally.
Unequal time Spent

B works full time in the firm and A and C are passive partners. Now, since A, B and C have contributed varied amounts of time and energy towards the firm, it would not be appropriate to share the profits equally among them.
To Compensate Pay salary to Partner.

Compensate for the uneven contributions of time and energy towards the firm and then share the profits equally (if contributions of A, B and C towards the firm in all other respects is the same). The salary paid to B would be compensation for his greater contribution. Profit equal to "Salary to Partners" is first paid away and then the remaining profit can be shared equally.
Public Relations/Contacts
C has greater contacts in the outside world, a lot of customers are C's contacts. Now, the contribution of C towards the sales of the firm through his contacts is greater than that of A and B. Therefore, it would not be appropriate to share the profits equally among them.
To Compensate Pay Commission to Partner.

Compensate C for the greater contributions he has made towards the firm and then share the profits equally (if contributions of A, B and C towards the firm in all other respects is the same). The commission paid to C for sales made to customers who are his contacts would be compensation for his greater contribution. Profit equal to "Commission to Partners" is first paid away and then the remaining profit can be shared equally.
Drawings
The Drawings of A, B and C are respectively, Rs. 20,000, Rs. 2,000 and Rs. 15,000 respectively. Since Drawings
is nothing but capital being withdrawn, A and C have withdrawn greater amount of capital whereas B has withdrawn a lesser amount. This would result in A's and C's capital contribution being lesser and B's capital contribution being greater.
Remedy Charge Interest on Drawings.

Greater the drawings greater the interest payable by the partners. This would compensate the unevenness in drawings made by the partners.
Remunerating Organisation = Distributing Profits

As can be seen from the above explanation, Salary to Partners, Commission to Partners, etc., are all paid out of profits made. These are different methods of compensation for the contributions made by partners to the firm.
All
and
these
contributions
together
are
identified
as
"Organisation"
Remuneration for organisation is profit,

The payments for all these are nothing but methods of sharing profits
Profit Distribution Accounting Treatment

Consider the following information in relation to M/S ABC and CO., a partnership firm with A, B and C as partners.
Illustration : Problem
1. 2. 3. 4. 5. Net Profit - Rs. 3,74,000 Interest on Capital @ 5% - A : Rs. 10,000; B : Rs. 3,750 and C : Rs. 5,000 Salary to Partner - B : Rs. 24,000 Commission to Partner - C : Rs. 52,000 Interest on Drawings @ 5% - A : Rs. 1,000; B : Rs. 100 and C : Rs. 750
Illustration : Solution
Since Interest on Capital, Salary to Partners etc., are methods of distribution of profit, they are to be made after ascertaining profits. Thus the accounting for the distribution of profits is a process that follows the ascertainment of net profits. Assuming the distribution to have been made through Profit and Loss a/c, the P/L a/c and the Partners Capital accounts would be as below.
Dr
Amount Particulars (in Rs) To Net Profit
Profit and Loss a/c

3,74 ,000 21,33,000
Cr
Amount (in Rs) Amount (in Rs)
21,33,000
To A's Cap (int) To B's Cap (int) To C's Cap (int) To B's Cap (sal) To C's Cap (comm) To bal c/d (Distr Pr)
10,000 3,750 5,000 24,000 52,000 18,750 24,000 52,000 2,81,100 3,75,850
By By By By
Net Profit b/d A's Cap (int drw) B's Cap (int drw) C's Cap (int drw)
3,74,000 1,000 100 750 1,850
3,75,850
To A's Cap (Pr) To B's Cap (Pr) To C's Cap (Pr)
93,700 93,700 93,700 2,81,200 2,81,100
By bal b/d (Distr Pr)
2,81,100
2,81,100
Note
Distr.
Pr Distributable Profit; int. Drw Interest on Drawings; int Interest ; Sal Salary; Comm Commission; Pr Profit Share
The account is balanced a number of times to enable deriving information easily. Specifically, the
Distributable profit is carried down so that we can have the figure which is to be used for calculating the partners share of profits.

Partners profit sharing ratio A : B : C = 1 : 1 : 1 = 1 3 : 1 3 : 1 3
Partners Share of Profits = Distributable Profit Profit Sharing Proportion Therefore, 1 3 1 3 1 3
A's Share =
Rs. 2,81,100
Rs. 93,700
B's Share =
Rs. 1,08,000
Rs. 93,700
C's Share =
Rs. 2,81,100
Rs. 93,700
Rs. 2,81,100
Dr
Particulars

A (in Rs) To P&L (Int) To Drawings to Bal c/d
1,000 20,000 2,82,700
Cr
A Particulars (in Rs) By By By By By Bal b/d P&L (int) P&L (sal) P&L (com) P&L (pr)
2,00,000 10,000
B (in Rs)
100 2,000 1,94,350
C (in Rs)
750 15,000 2,34,950
B (in Rs)
75,000 3,750 24,000
C (in Rs)
1,00,000 5,000 52,000
93,700 3,03,700
93,700 1,96,450 1,94,3500
93,700 2,50,700 2,34,950
3,03,700
1,96,450
2,50,700
By Bal b/d
2,82,700
Ledger Postings Unavailability of information

If you interpret the ledger postings in the above P/L a/c and the Partners Capital a/c's you can find that all the postings in the Partners Capital a/c's read either "To P/L a/c" or "By P/L a/c" and in the "Profit and Loss a/c" read "To _ Capital a/c" or "By _Capital a/c". These postings can be interpreted as
In
"Profit
and
Loss extent of Rs.
a/c": __. a/c": a/c".
There is a transfer of credit balance to "_ Capital a/c" to the There is a transfer of debit balance to "_ Capital a/c" to the extent of Rs. __.
In
"_ Capital There is a transfer of a credit balance from There is a transfer of a debit balance from "Profit and Loss a/c".
"Profit
and
Loss
Since the natural flow is from the Profit and Loss account to the Capital account we would interpret it as From P/L a/c to __Capital a/c. Theoretically it is capable of being interpreted the other way also.
Information not available
Generally we would be able to identify the reason for a debit or credit by reading the posting itself. However, here it would be difficult to gather the information relating to all credits and debits that way, since all of them look similar. Thus, we would not be able to derive the information as to the reason for which the debits and credits are made. Though "To A's Cap (int)" seems to be creating the idea that the posting gives the information relating to the purpose for which the amount is being transferred, it is not so. It would not be practically possible to write down such details as (int), (sal), etc., more so in mechanised systems of accounting (using computers). [To understand this limitation read the posting as "To _ Capital a/c" only ignoring the wordings within the brackets].
Solution !!
To derive the information that we need we create additional account heads which work as controlling accounts.
The basic purpose of accounting is derivation of information The more information we need, the more accounting heads we need to maintain.
Charge Against Profits Vs. Appropriation of Profits
Appropriation = Setting aside Money for a specific purpose Charge = Financial liability
Classification of Debits to Profit and Loss account

The various items debited to the Profit and Loss a/c can be classified into two as
Charge Against Profit

Debits which represent an expenditure or loss. Salaries, Wages, Rent, Depreciation, Loss on Sale of Assets etc., are all charges against profits.
Appropriation of Profit
Debits which result in the profit being kept aside. Creation of reserves is an example of profit appropriation. Reserves are created by transferring credit balance (a certain amount of profit) from the profit and loss account to the reserve account.
Journal in the books of M/s Razmataz Chemicals for the period from __ to 31st December 2005 Date
1st to 30th
Profit and Loss a/c To General Reserve a/c [For the amount transferred to the general reserve.]
Dr
xxx xxx
The Profit and Loss account is debited both while profits are charged as well as when profits are appropriated. However, creation of a reserve is appropriation as it does not result in the profit being used up. It results in the profit being maintained/shown in two different accounts or profit being transferred to a different account.
Reserves are created by charging profits.
Creation of reserves is an appropriation of profits.
Interest on Capital, Salary, Commission etc., to Partners Appropriations

Distribution of profit to partners is appropriation of profits. It is to be understood as profit being kept aside to be given to the owners as a return for their contributions. "Interest on Capital", "Salary to Partners", etc., paid to partners are different methods adopted to compensate their varied contributions and thus ensure equitable distribution of profits. Therefore all these payments made to partners would also be appropriations of profits and not charge against profits.
Using Profit & Loss Appropriation a/c

To differentiate between charges and appropriations of profits being made to the profit and loss account, the P/L a/c is divided into two by creating a new account by name "Profit and Loss Appropriation a/c". The net profit is transferred to "P & L Appropriation a/c" and all the appropriations are made from this account. The same postings as above made using the "P & L Appropriation a/c" would be
Dr
Amount Particulars (in Rs) To P/L Appr (Net Profit) a/c
Profit and Loss a/c

3,74 ,000 21,33,000
Cr
Amount (in Rs) Amount (in Rs)
21,33,000
Dr
Particulars
Profit and Loss Appropriation a/c

Amount (in Rs) Amount Particulars (in Rs) By By By By P/L a/c (Net Profit) A's Cap (int drw) B's Cap (int drw) C's Cap (int drw) (in Rs)
1,000 100 750
Cr
Amount Amount (in Rs)
3,74,000
To A's Cap (int) To B's Cap (int) To C's Cap (int) To B's Cap (sal) To C's Cap (comm) To bal c/d (Distr Pr)
10,000 3,750 5,000 24,000 52,000 18,750 24,000 52,000 2,81,100 3,75,850
1,850
3,75,850
To A's Cap (Pr) To B's Cap (Pr) To C's Cap (Pr)
93,700 93,700 93,700 2,81,200 2,81,100
By bal b/d (Distr Pr)
2,81,100
2,81,100
Dr
A Particulars (in Rs) To P&L Appr (Int) To Drawings To Bal c/d
1,000 20,000 2,82,700

B (in Rs)
100 2,000 1,94,350
Cr
A B (in Rs)
75,000 3,750 24,000 52,000 93,700 3,03,700 93,700 1,96,450 1,94,3500 93,700 2,50,700 2,34,950
C Particulars (in Rs)

750 15,000 2,34,950
C (in Rs)
1,00,000 5,000
(in Rs) By By By By By Bal b/d P&L Appr P&L Appr P&L Appr P&L Appr
2,00,000
(int) (sal) (com) (pr)
10,000
3,03,700
1,96,450
2,50,700
By Bal b/d
2,82,700
What difference does using Appropriation a/c make ?

Using P & L Appropriation account would enable handling all the information relating to appropriation of profits through a separate account. But, when we come to reading the postings in the appropriation account as well as the Capital accounts, the only difference we can see is that "P & L a/c" is replaced by "P & L Appropriation a/c". Even after replacing the P & L a/c with the P & L appropriation a/c, we will not get the information as to the
reason for which the debits and credits are being made. The postings can be interpreted as
In
"Profit and Loss Appropriation a/c": There is a transfer of credit balance to "_ Capital a/c" to the extent of Rs. __. There is a transfer of debit balance to "_ Capital a/c" to the extent of Rs. __. "_ Capital a/c": There is a transfer of a credit balance from "Profit and Loss Appropriation a/c". There is a transfer of a debit balance from "Profit and Loss Appropriation a/c".
In
Only a Slight variation

A slightly different idea that the transfers are from profit and loss appropriation account and thus relate to profits distributed can be obtained. But for this, there is virtually no difference in the information available.
Deriving More/Clear Information
To derive the information that we need we create additional accounts.
Create Controlling a/c's

We create ledger accounts to enable us derive greater information. Apart from this these ledger accounts have no other purpose. While transferring an amount from account ONE to account TWO, we transfer it through this controlling/intermediary account. Thus we transfer the amount from account ONE to CONTROLLING account and from that account to TWO. This will result in the name of the CONTROLLING account appearing in postings made in both account ONE and TWO. The name used would be such that it provides the required information as to why the posting is appearing.
Explanation
Consider the journal entry for recording "Interest on Capital" through the "Profit and Loss Appropriation a/c"
1st to 30th
Profit & Loss Appropriation a/c To A's Capital a/c To B's Capital a/c To C's Capital a/c
Dr
18,750 10,000 3,750 5,000
[For the interest on capital payable to A, B and C transferred to their respective capital accounts.] Now,
A controlling account by name "Interest on Capital" would be created The interest on capital payable to partners as a whole would be transferred from the "Profit and Loss Appropriation a/c" to the "Interest on Capital a/c" and From the "Interest on Capital a/c" the interest payable to each partner is transferred to his/her Capital a/c.
The journal entries for recording these transactions would be
1st to 30th
Profit & Loss Appropriation a/c To Interest on Capital a/c
Dr
18,750 18,750
[For the interest on capital payable to partners.] 1st to 30th Interest on Capital a/c To A's Capital a/c To B's Capital a/c To C's Capital a/c Dr 18,750 10,000 3,750 5,000
[For the interest on capital payable to A, B and C transferred to their respective capital accounts.] If this is done the postings in the "Profit and Loss Appropriation a/c" would read "To Interest on Capital" and in the Partners Capital Accounts would read "By Interest on Capital". This would give a clear understanding on the entries that are posted. One should note that the "Interest on Capital a/c" being a controlling account is raised and written off immediately, thus having nil balance. If we assume presence of controlling accounts, we can use meaningful phrases to represent postings in ledger accounts.
Common Controlling accounts

The most common Controlling accounts used are
Interest on Capital
For recording Interest on Capital Payable to Partners
Interest on Drawings
For recording Interest on Drawings Charged to Partners
Salary (to Partners)

For recording Salary payable to partners
Commission (to Partners)

For recording Commission payable to partners
Brokerage (to Partners)

For recording Brokerage payable to partners
Share of Profits
For recording the share of distributable profits credited to partners.
Illustration
Postings in the "Profit and Loss Appropriation a/c" and the "Partners Capital Accounts" using the above controlling accounts would read
Dr
Particulars

Amount (in Rs) Amount Particulars (in Rs) By Net Profit b/d By Int on Drawings:
18,750 24,000 52,000 2,81,100
Cr
Amount (in Rs)
3,74,000
Amount (in Rs)
To Int on Cap:
A B C
To Salary to Partner:
10,000 3,750 5,000 24,000 52,000
A B C
1,000 100 750 1,850
B
To Commission to Partner:
C
To Distributable Profit c/d
3,75,850 3,75,850
To Profit Share:
By Distr Profit b/d

93,700 93,700 93,700 2,81,100
2,81,100
A B C
2,81,100
2,81,100
D r
A Particulars (in Rs) To Int on Draw To Drawings To Bal c/d
1,000 20,000 2,82,700

B (in Rs)
100 2,000 1,94,350
Cr
A B (in Rs)
75,000 3,750 24,000 52,000 93,700 3,03,700 93,700 1,96,450 1,94,3500 93,700 2,50,700 2,34,950
C Particulars (in Rs)

750 15,000 2,34,950
C (in Rs)
1,00,000 5,000
(in Rs) By By By By By Bal b/d Int on Cap Salary Commission Profit Share
2,00,000 10,000
3,03,700
1,96,450
2,50,700
By Bal b/d
2,82,700
Computerised Accounting
In manual accounting, in using meaningful phrases to derive greater information, we do not create the controlling (ledger) accounts as they are raised and immediately written off and their balances would ultimately be nil. We can assume that they have been created and the required entries have been passed through them without even creating them. However, in case of computerised accounting, if we intend to use such a facility, we need to create all those accounts which we identify as controlling accounts and ensure that the journal entries that are required (if the controlling accounts are used) are also recorded.
Partnership" is 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.
who have agreed

There should be an agreement between those persons who are forming the partnership. The
agreement is the foundation for the partnership. Partnerships can arise only from a contract and not status.

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Sec 5. Partnership not created by status

The relation of partnership arises from contract and not from status; and, in particular, the members of a Hindu undivided family carrying on a family business as such, or a Burmese Buddhist husband and wife carrying business as such, are not partners in such business.
Agreement may be Written or Oral

The contract/agreement that forms the basis of the relationship between the partners specifies the terms and conditions that bind the partners into the relationship. This agreement may be written or oral.
Written Agreement Partnership Deed

The agreement between the partners put down in writing forms the "Partnership Deed". It is a document containing the various aspects agreed upon by the partners. It is also called a "Partnership Agreement" or
"Articles of Partnership"
Contents of the Partnership Deed

The partnership generally covers/includes the following aspects
Names of the partners of the firm and their addresses Duration of Partnership Capital contribution of each Partner and aspects relevant to it like introduction of additional capital,
drawings that can be made etc.
Interests to be paid on Capital, Loans given by partners to the firm, charged on Drawings and the
relevant rates of interest
Aspects relating to salaries, commissions, etc., to be paid to partners The ratio in which the profits and losses are to be shared among partners Goodwill valuation methodology at the time of incorporating changes in the partnership. Rights and Duties of Partners inter se among themselves. Name of the Bank/Banks where the business banking accounts should be maintained and the
person/persons who are vested with the power to operate the accounts.
The person/persons responsible for accounting for the business transactions and the place where the
books of accounts are to be kept generally. To say in brief, everything that is relevant to the relationship between the partners forms part of the agreement. Even aspects relating to Arbitration (in case of disputes among themselves) etc., will be part of the agreement.
Role of Partnership Deed in Accounting

Any and every aspect relating to the partnership may be included in the "Partnership Deed". This deed forms the basis of any transaction involving the partners. Even accounting for partnership firms is a function that is to be carried on in accordance with the provisions in the "Partnership Deed". Salary to be paid to partners, profits to be shared among partners, interest on capital, interest on drawings, etc., are all to be decided based on the agreement between the partners (i.e. based on the partnership deed). Thus in accounting for transactions involving these, compliance with what is agreed upon should be ensured.
Where the Partnership Deed is silent

Where the partnership deed or the agreement between the partners is silent on any aspect that is to be decided based on that agreement, the provisions in the "Indian Partnership Act, 1932" apply.
Role of Partnership Act in Accounting

The following provisions affect the accounting treatments in the absence of an agreement in that respect.
Partners Share of Profits

In the absence of an agreement between the partners, they would share profits and losses equally among themselves (and not in the ratio of their capital contributions). If there is an agreement between the partners then the shares would be decided according to the agreement.
Separate Ratios for Profits and Losses

The partners may decide that profits be shared in a certain ratio and losses in another ratio.
Share in Profits Only

The partners may decide that one or more partners may share profits and will not have to share losses at all.
Share in Losses Only!!!

There is no provision for one or more partners may sharing only losses and not sharing any profits. Partnership would exist only where there is a business and the partners have agreed to share the profits of the business.
Indian Partnership Act, 1932 Sec 13. Mutual rights and liabilities
Subject to contract between the partners,-
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(b) the partners are entitled to share equally in the profits earned, and shall contribute equally to the losses sustained by the firm;
Remuneration to Partners
In the absence of an agreement between the partners, a partner is not entitled to receive any remuneration (salary, commission, brokerage etc.,) for the services rendered by him to the firm. If there is an agreement between the partners then the partner may receive such remuneration as agreed upon.
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(a) a partner is not entitled to receive remuneration for taking part in the conduct of the business;
Interest on Capital
In the absence of an agreement between the partners, a partner is not entitled to receive any interest on Capital even there is a variation in the profit sharing ratio and the capital contribution. If there is an agreement between the partners then interest is to be paid at the rates agreed upon.
Interest to be paid only out of Profits

Even where the agreement provides for payment of interest on capital, it will not be paid if there are losses.
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(c) where a partner is entitled to interest on the capital subscribed by him such interest shall be payable only out of profits
No specific mention is made about drawings in the act. Therefore, it is assumed that the provisions that are applicable for Capital would also be applicable for Drawings, whereby, In the absence of an agreement between the partners, a partner is not entitled to pay any interest on Drawings.
If there is an agreement between the partners then interest is to be charged at the rates agreed upon.
Interest on Partners Loans or Advances

In the absence of an agreement between the partners, a partner is entitled to receive interest at the rate of 6% p.a. on any payment or advance made beyond the amount of Capital he has to contribute. If there is an agreement between the partners then interest is to be paid at the rates agreed upon, .
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(d) a partner making, for the purposes of the business, any payment or advance beyond the amount of capital he has agreed to subscribe, is entitled to interest thereon at the rate of six per cent per annum;
Some Conventions followed in Accounting

In addition to the specific provisions available in the "Indian Partnership Act, 1932", a few other conventions are followed in solving problems involving partnerships.
Rate of Interest
Where the partners have agreed upon to pay interest on capital and/or charge interest on drawings but the agreement is silent as to the rate of interest to be paid or charged, we consider the rate of interest to be 6%. This may be based on the fact that in providing interest for advances, the act specifies 6% rate of interest. Since 6% is considered reasonable in one case it may be taken in other cases also.
Partners Relative's Loans

Practically, partner's relatives are outsiders for the firm and it would not be appropriate to think about them based on the agreement between parties. But where the information is missing and you have to make an assumption to go along with problem solving, you may apply the same rule that is applied to the partners advances to loans/advances made by the partners relatives also. This should be a last resort attempt only. Where there is no information relating to interest payment to partners relatives as well as the rate of interest, interest should be paid at the rate of 6%
Profit Sharing Ratio

By profit sharing ratio in a partnership firm, we mean the ratio in which the profits and losses of the firm are to be distributed amongst the partners. The basis for arriving at the ratio is the agreement between the partners. If there is a partnership deed, the ratio should be ascertained from the provisions in the partnership deed. In the absence of a partnership deed and where there is no indication as to the agreement between the partners in this aspect, it should be considered as equal
share for all partners. The ratio may be a specified as absolute values or it may be taken as the ratio fo their Capital account balances or it may be based on anything else as agreed upon by the partners. Deriving this ratio (if it is not given) would be one important requirement in problem solving.
Different Ratios for Profit Sharing and Loss Sharing

If the partners so agree, the Profit Sharing Ratio and the Loss Sharing Ratio may be different. There may be a partner who has a share in profits only but not in losses.
Share in Losses only !!

There cannot be a partner who has a share in losses only but not in profits. This is for the reason that there would be no partnership if there is no share in profits. "Partnership" is 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.
Expressing the Profit Sharing Ratio

The profit sharing ratio may be expressed in a number of different forms. Whatever may be the form in which the ratio is expressed it can always be converted to a form suitable to you.
Simple Ratio [Natural Numbers represent shares]

May, Day and Way are partners sharing profits in the in the ratio 1 : 3 : 4. Rewriting the ratio as below would aid in your calculations May : Day : Way = 1 : 3 : 4 = 1 8 : 3 8 : 4 8 [1 + 3 + 4 = 8]
This can be simplified further and written as
1 8
3 8
1 2
However, expressing the shares as ratios with a common denominator would be helpful.
Simple Ratio [Fractions represent shares]

Where the shares are represented by fractional numbers, one should always ensure that the sum of the fractional parts adds up to 1.
Like Fractions represent shares

Fractions with the same denominator are like fractions. Ramu, Damu and Mamu share profits in the ratio 2 9 : 3 9 : 4 9
Check
2 + 3 + 4 = 2+3+4
9 = 9 9
=1 Sum of Like Fractions = Sum of Numerators Common Denominator
Just check up whether the numerators are adding (2 + 3 + 4) up to the common denominator (9) or not.
Note
To be cautious make it a habit to write down the ratio in fractional form if the shares are given as natural numbers and vice versa so that you can check this aspect as well as have a form useful for calculations.
Unlike Fractions represent shares

Fractions without a common denominator are unlike fractions Goon, Doon and Moon share profits in the ratio 1 2 , 1 3 , and 1 4
Sum of Unlike Fractions =
Sum of (Product of the fraction and the LCM of the denominators) LCM of the Denominators 1 2 1 3 1 4
( Thus, 1 2 + 1 3 + 1 4 =
12) + (
12) + ( 12
12)
[LCM of denominators i.e. 2, 3, 4 is 12]
6+4+3 12 13 12
What to do in such cases

If you find that the fractions representing shares of partners are not adding up to 1, you have to derive the actual ratio using the given fractions. 1 2 1 2 1 3 1 4 1 3 1 4
Goon : Doon : Moon =
12 :
12 :
12
[Multiplying all the terms of the ratio with the same number (the LCM of denominators 2, 3, 4 i.e. 12) will not change the ratio.] =6:4:3 = 6 : 4 : 3 [6 + 4 + 3 = 13]
13
13
13
This represents the ratio of profit sharing between partners and is in a form suitable for calculations.
Try this
A father left his property to be shared by his three sons as follows : 1/2 to the youngest, 1/3 to the middle and 1/6th to the eldest son. They were struck up with the problem of sharing the 17 horses in their stable. They approached their fathers best friend and asked him to help them out. He thought about it and asked them to take one of his horses, include it in the horses to be shared and then share the horses (along with the one he gave). The sons did so and finally were left with 1 horse which they returned to its rightful owner. How did this happen? This is a small problem that lets you understand the above concept.
Interest on Capital
Interest on Capital is to be paid
Only when agreed upon

Interest on Capital is to be paid to partners only if it is specifically agreed upon. If there is no mention regarding this, in the partnership agreement (deed), then no interest need be paid.
Only out of profits

Interest is to be paid only out of profits. Where there is a loss, no interest should be paid on capital, even if the partnership agreement provides for the same.
@ 6% if rate is not mentioned

Where the partnership deed provides for payment of interest on capital and it does not mention the rate of interest to be paid, it is a convention to pay interest @ 6% p.a.
On What Balance is Interest Paid

Interest is paid on capital for the reason that it has been used for the purpose of the partnership business. The balance in Capital account unless where it is fixed, keeps fluctuating on account of a number of reasons, thus making it difficult to assess the amount of capital employed in the business. There would be a change on account of appropriations made at the end of the accounting period like salary to partners, commission to partners, etc. Even during the course of the accounting period, the balances may change on account of additional capital introduced, capital withdrawn, etc., In the absence of appropriate information, it is a convention that interest is paid on the opening balances in Capital Accounts. In problem solving we will come across these situations.
Opening Balance known

Where the Capital a/c balances at the beginning of the accounting period are known and there is no
change in the balance through out the period, the interest is calculated on the opening balance.
Closing Balance and Appropriations at the end known

Where the Capital a/c balances at the end are known and the changes at the end of the accounting period that have affected the account are also known, the opening balance in the capital accounts is ascertained and interest is calculated thereon using the information relating to the changes.
Closing balance and all transactions known

Where the Capital a/c balances at the end are known and the changes over the accounting period as well as those at the end of the accounting period are known, the capital account balances at various points of time (when changes take place) and the period for which the capital has been utilised is ascertained and interest is calculated thereon.
Closing balance known

Where the Capital a/c balances at the end are known and no other information is available, or where the information relating to transactions affecting the capital account are known without the information relating to the date/period of occurrence, we calculate the interest based on the closing balance.
Interest on Drawings is to be charged
Only when agreed upon

Interest on Drawings is to be charged to partners only if it is specifically agreed upon. If there is no mention in the partnership agreement regarding this, no interest need be charged.
@ 6% if rate is not mentioned

Where the partnership deed provides for charging interest on drawings and it does not mention the rate of interest to be charged, it is a convention to charge interest @ 6% p.a.
Calculating Interest on Drawings

Interest is charged on drawings for the reason that the amount has been withdrawn by the partners without allowing it for being used for the purpose of the business. In the absence of appropriate information, it is a convention that the interest on drawings is calculated on the "Drawings a/c" balance at the end. In problem solving we will come across these variations.
Closing Balance known

Where the Drawings a/c balances at the end of the accounting period are known and there is no information relating to the time of drawing, interest is calculated on the closing balance.
Amount and Dates of Drawings are known
Drawings made during the period and the dates on which the drawings have been made are known. Since the period for which the withdrawn amounts are used is known, interest is calculated based on the amount drawn and the period of use.
Drawings made at regular intervals

Where the Drawings are made at regular intervals, all the drawings are converted to an equivalent of drawings for a specified period and interest is calculated thereon.
Salary to Partners
Salary is to be paid to partners only if it is specifically agreed upon. If there is no mention in the partnership agreement then no salary need be paid.
Commission to Partners
Commission is to be paid to partners only if it is specifically agreed upon. If there is no mention in the partnership agreement then no commission need be paid.
Methods of Expressing Commission

Commissions may be calculated on a number of bases, as a % of Sales, as a % of Gross Profit, as a % of Net Profit, as a % of Purchases, etc., depending on the reason for which the commission is being paid and the agreement between the partners. There are two basic methods of expressing commission as a % of something else. Let us consider Commission being calculated as a % of Net Profit as an example.
Before Charging Such Commission

This is the normal calculation. Where there is no specific mention of the method, this is what we assume.
Eg: "8% of Net Profits (Rs. 1,25,000)".

"8% of Net Profits (Rs. 1,25,000) before charging such commission". Commission = Rs. 1,25,000 8% = Rs. 10,000
After Charging Such Commission

Under this method, the commission is expressed as a certain % of something after charging such commission.
Eg: "8% of Net Profits (Rs. 1,25,000) after charging such commission".
8% after charging such commission
The commission should work out to 8% of the amount remaining after charging the commission to the
net profit i.e. reducing the commission from the net profit.
Finding Net Profit after Charging Commission (without knowing the commission)
Let the commission be Rs. x (Using Net Profit = Rs. 1,25,000) Net Profit after charging commission = Net Profit Commission
= Rs. 1,25,000 Rs. x = Rs. (1,25,000 x) Therefore, Commission = 8% of Net Profits after charging such commission Commission = Net Profit after Charging Commission 8% Rs. x = Rs. (1,25,000 x) 8 100
Rs. x = Rs. (1,25,000 x) 25x = (1,25,000 x) 2 25x = (1,25,000 2) (2x) 25x + 2x = 2,50,000 27x = 2,50,000 x= 2,50,000 27
2 25
x = 9,259.26
Verify
Net Profit after charging such commission = Rs. 1,25,000 Rs. 9,259,26 = Rs. 1,15,740,74 Commission = Net Profit after charging such commission 8% = 1,15,740.74 8% = Rs. 9,259.26
Formula for Calculating Commission after Charging Such Commission

From the above calculations, we can derive a formula that would be easier to remember and use Commission = Net Profit after Charging Commission 8% Rs. x = Rs. (1,25,000 x) 100x = (1,25,000 x) 8 100x = (1,25,000 8) (8x) 100x + 8x = (1,25,000 8) 108x = (1,25,000 8) x= 1,25,000 8 108 8 100 + 8 8 100
x = 1,25,000
Commission = Net Profit before Charging such Commission
Commission % 100 + Commission %
x% of Net Profit Before charging such commission = Net Profits before charging commission x%
After charging such commission = Net Profit before charging such commission
x 100 + x
Example
25% of net profits
Before charging such commission = Net Profits before charging such commission 25% After charging such commission = Net Profit before charging such commission
25 100 + 25
Partners Capital Accounts
The first difference we can notice, between accounting for sole proprietary form of business organisation and partnership form of business organisation is with regard to capital and its related aspects. In place of a single capital account, we see as many capital accounts as there are partners. In manual accounting and during the learning process, we prepare the partners capital accounts in a columnar form instead of showing each ledger account separately, to enable easier understanding.
Fluctuating Capital Accounts
Interest on Capital, Salaries to Partners, Interest on Drawings, Commission to Partners, Partners Share of Profits are all amounts that belong to the partners. By Convention we credit/debit all these amounts relating to partners to their capital accounts. This would result in the balance in the Partners getting altered.

Since the capital account balances changes (fluctuates) with the regular transactions relating to capital, the Capitals accounts maintained under this method are known as "Fluctuating Capital Accounts". By convention this is the normal method adopted for maintaining capital accounts in problem solving, unless there is an instruction to the contrary.
Dr
A Particulars (in Rs) B

C Particulars (in Rs) (in Rs) (in Rs) (in Rs) A B C
Cr
(in Rs)
To Int on Draw To Drawings
1,000 20,000
100 2,000
750 15,000
By By By By
Bal b/d Int on Cap Salary Commission
2,00,000 10,000
75,000 3,750 24,000
1,00,000 5,000 52,000
To Bal c/d
2,82,700
1,94,350
2,34,950
By Profit Share
93,700
93,700
93,700
3,03,700
1,96,450
2,50,700
3,03,700
1,96,450
2,50,700
By Bal b/d
2,82,700
1,94,3500
2,34,950
Capital Accounts : Affected by Capital Natured & Revenue Natured Transactions

Since all the transactions which affect the capital accounts are dealt with using the same capital account, we can say that Capital accounts are affected by transactions of both Capital Nature as well as Revenue Nature.
Fixed Capital Accounts
Why another Type

Profits (revenue) increase capital. Capital also increases when additional capital is brought in by the partner. Under the fluctuating capital account system, the capital account gets affected by transactions of both capital and revenue nature. Thus both these transactions are recorded using the same capital account. If the organisation intends to obtain the information relating to the Capital account balance on account of Capital natured transactions and Revenue Natured transactions separately, a separate Capital accounts needs to be maintained to record the revenue natured transactions.

Where there is a need for greater information in relation to capital, the total information is divided into two areas and separate ledger accounts are maintained in relation to each area. This gives information relating to long term and short term aspects separately. The transactions relating to the partners are classified as capital and current natured. In recording the transactions which are of current nature, a separate account by name "__ (Partners) Current a/c" is used instead of the "__ (Partners) Capital a/c". Any transaction that relates to the appropriation of profits, drawings, etc., is considered current natured and is recorded through the Current accounts. Those transactions which relate to bringing in and taking out capital are considered capital natured and are recorded through the Capital accounts. Capital Accounts have a fixed balance unless capital is either withdrawn or additional capital is contributed. Since the capital account balance is more or less fixed, this method is called "Fixed Capital Method"
Drawings Current/Capital
Regular drawings as agreed upon among partners are also treated to be transactions of current nature and are thus recorded through the current accounts. This is on the premise that, as the firm keeps making profits, the partners would be entitled to withdraw and use some of the profits for their necessities. Where there is a specific instruction to treat drawings as capital i.e. to be debited to the Capital accounts, it would
have to be done accordingly. The same information as shown in the capital accounts would appear as below if fixed capital accounts are maintained.
Dr

Cr
(in Rs)
To Bal c/d
2,00,000
75,000
1,00,000
By Bal b/d
2,00,000
75,000
1,00,000
2,00,000
75,000
1,00,000
2,00,000
75,000
1,00,000
By Bal b/d
2,00,000
75,000
1,00,000
Dr
Partners Current a/c's

Cr
(in Rs)
To Bal b/d To Int on Draw To Drawings To Bal c/d
1,000 20,000 1,82,700
100 2,000 1,19,350
750 15,000 1,34,950
By By By By By
Bal b/d Int on Cap Salary Commission Profit Share
10,000
3,750 24,000
5,000 52,000
93,700
93,700
93,700
1,03,700
1,21,450
1,50,700
1,03,700
1,21,450
1,50,700
By Bal b/d
82,700
1,19,350
1,34,950
Calculation of Interest on Capital
The capital account balance considered for calculation of interest on capital is dependent on the method adopted for maintaining the capital accounts.

Where the Capital Accounts are being maintained under "Fixed Capital Accounts" method, interest on capital is to be paid on the balances in the capital accounts. Interest on Current account balances is not considered unless there is a specific instruction regarding the same.
Where the Capital Accounts are being maintained under "Fluctuating Capital Accounts" method, interest on capital is to be paid on the balances in the capital accounts as that is the only account that is related
Opportunity Cost/Loss
Any decision that involves a choice between two or more alternatives has an opportunity cost/loss involved. Opportunity Cost/Loss is the amount that is foregone by taking up a particular alternative. The opportunity loss related to an alternative (choice) is the value of the utility that would have been derived had the other alternative
been chosen. Say, Mr. A with the amount of capital he has, can either do a business or invest in fixed deposits in banks. The opportunity loss
related to the option of investing in the business is the income he might earn from it. related to the option of depositing in the bank is the interest he might get on the deposit.
In taking up an option one has to consider the opportunity loss relating to other options. An option is chosen only if the value of utility one derives out of it is greater than the opportunity loss on account of the others. Opportunity cost/loss is expressed in relative terms also. The opportunity loss of an option is the difference between the utility/value of the option with the highest utility and the utility/value of that option itself.
Partners in a Firm Opportunity Loss
The contributions made by partners to the firm takes various forms like contribution of assets (cash, Motor Vehicles, Buildings etc) towards capital, their time and energy by working in the firm, their personal contacts by generating sales through them, their selling abilities etc., In contributing these assets or services to the firm, the partners personally incur an opportunity cost/loss which they will consider before employing them for the firm.
where the partner is investing capital he/she would be thinking of the earnings they might get if that capital is employed elsewhere; where he/she is employing his/her time as a working partner, he/she would be thinking of his/her earning if he/she employs the same time elsewhere.
Each and every contribution of the partner has an opportunity loss attached to it for the partner.
Need for Guarantee
In situations of the sort mentioned here, partners may ask for a guarantee from one or more other partners so that they would not be at loss (because they opted for this alternative)
Where a partner is participating in a partnership firm, he/she needs to be compensated at the minimum, to the extent of his/her opportunity loss for the contribution made to the firm. Otherwise he/she may be desisted from contributing to the firm. Where a partner is very much sure that he can employ what he/she is contributing to the firm elsewhere in a more profitable manner, why should he/she invest them for the firm, unless there is some sort of assurance for the returns they get by contributing to the firm? When a person is getting into a partnership agreement, he/she will be conscious of his/her own abilities as well as the limitations of his/her other partners. Moreover, he/she would be measuring his/her opportunity cost/loss in becoming a partner.
All Partners Cannot be the Guaranteed

One or more partners can be given the guarantee. Since, there should be at least one partner who is giving the guarantee, not all the partners cannot be the guaranteed.
All Partners Cannot be the Guarantors
One or more partners can give the guarantee. Since, there should be at least one partner who is being guaranteed, not all the partners cannot be the guarantors. There should be at least one who is giving and one who is guaranteed, thus eliminating the chance of all the partners being either guarantors or the guaranteed in such cases.
Guarantee To One Partner
A Case
A, B and C are partners in a firm sharing profits and losses in the ratio 5/10, 3/10 and 1/10 respectively. There is a proposal to take in Mr. M as a partner giving him a 1/10th share of profits. Mr. M is willing to join as a partner only if he is guaranteed that his annual share of profits would be not less than Rs. 20,000.
Effect of the Guarantee

If Mr. M is to get his guaranteed share the firm should make an annual profit of at least Rs. 2,00,000 (1/10th of 2,00,000 = 20,000). If the profit is lesser, then the existing partners should forego their share to ensure that Mr. M gets his guaranteed share of profits. If the profit is more than Rs. 2,00,000, the guarantee does not affect the share of other partners. The guarantee may be given by one or more partners. Conditions where the guarantee is given
By only One Partner

Though the existing partners believe that Mr. M's admission as a partner would enable them to make greater profits, only Mr. A is willing for the guarantee proposal asked for by Mr. M. The other partners say that they would not mind admitting Mr. M if the burden of guarantee is taken up by Mr. A. If Mr. M gets into the firm, Mr. A would be relieved of some of his responsibilities. Moreover, admitting Mr. M would be beneficial in all ways to the firm and post admission, the firm would make profits required to ensure the minimum asked for by Mr. M. Thus Mr. A gives the guarantee.
By Two or More Partners

All the partners except Mr. B are willing to admit Mr. M giving him the guarantee required. Thus the required guarantee is given by Mr. A and Mr. C.
By the Firm
All the partners are willing to admit Mr. M giving him the guarantee. Thus the required guarantee is given by all the partners (other than the guaranteed). Such a guarantee is called guarantee by the firm.
Guarantee To Two or More Partners
The guarantee may also be given to two or more partners, but not all the partners. Guarantee to all the partners does not carry any sense (who gives the guarantee then?) Even in such a case we may come across one partner giving the guarantee, two or more other partners (but not all) giving the guarantee and all other partners (i.e. the firm) giving the guarantee.
What Constitutes the Guarantee Amount?
The difference between the amount guaranteed and the amount that a guaranteed partner would get if the guarantee is not brought into force, is what we call the shortfall. To ascertain the shortfall we need to calculate the guaranteed amount and to calculate the guaranteed amount we need the information relating to Guarantees. The guaranteed amount may consist of (relate to)
Distributable Profits only

The guaranteed amount would consist of (relatable to) distributable profits only.
Eg: Mr. M is guaranteed an annual profit of Rs. 50,000 by Mr. A and Mr. C.
[The guarantee here is related to distributable profits only.]
Distributable Profits + Other Appropriations

The guaranteed amount would consist of other profit appropriations like salary to partner, commission to partner also.
Eg: Mr. M is guaranteed by the firm that his share of income including his salary and interest on capital
would be not less than Rs. 50,000 per anum. [The guaranteed amount is related to distributable profits, salary to partners and interest on capital. These three incomes received by Mr. M should add up to a minimum of Rs. 50,000 as per the guarantee.]
Shortfall Amount
To ascertain the shortfall,
The appropriations are to be made between partners as if there are no guarantees. Subsequently, the amount received by the guaranteed partner/partners is to be calculated taking into consideration the terms of the guarantee. [The terms of guarantee enable us to understand what constitutes the guaranteed amount]. The difference between the amount received and the amount guaranteed is what we call the shortfall amount.
Shortfall Who Bears it and in what proportion?
The shortfall on account of the guarantee would have to be borne by one or more partners as agreed upon by them. Where the guarantee is given
By only One Partner

That partner who gives the guarantee would have to bear the total shortfall.
By Two or More Partners

All the partners who have given the guarantee would bear the shortfall in a proportion agreed upon between them and in the ratio of their profit sharing in the absence of any agreement regarding this.
By the Firm
All the partners except the partners who have the guarantee would share the shortfall in the ratio agreed upon between them and in the ratio of their profit sharing in the absence of any agreement regarding this
Methods for making good the Shortfall
After ascertaining the shortfall, the next step is to decide upon how to account for the shortfall. The following methods can be adopted for making good the shortfall.
I :: useful in all cases

This method is capable of being used in all cases. The steps to be followed for making good the shortfall under this method are. 1. 2. 3. 4. Appropriate the profits normally (ignoring the guarantee) Find the Shortfall in guarantee based on the terms of guarantee. Ascertain the share of each of the guarantors in the shortfall. [This is the amount that each partner should contribute for making good the shortfall to one or more other partners having the guarantee.] Make the adjustment for making good the shortfall, by taking from the guarantors and giving to the guaranteed.
II :: Where the firm is the Guarantor

Where the firm (all the partners other than the guaranteed) is the guarantor and they share the shortfall in the ratio of their profit sharing, 1. Distribute the guaranteed amounts first to the partners who have the guarantee. This should be so done only if the profits of the firm are such that a normal distribution of profits would result in a shortfall. 2. Appropriate the remaining profits among the guarantors in the ratio of profit sharing inter se among themselves.
This method would be the simplest when there are no appropriations of profits like interest on capital, salary to
partners etc. Where there are appropriations, this method may be avoided (though theoretically this may be adopted in certain cases).
Accounting Treatment
Accounting treatment is nothing but recording the transactions in accounting terms. Thus it is dependent on the method we follow for making good the shortfall of guarantee.
Method I
There are two ways the transactions under this method can be accounted for
Recording all the Transactions The basic purpose of accounting is derivation of information The more information we need, the more accounting heads we need to maintain.
If we intend to have a clear idea of every transaction relating to appropriations and guaranatees, we consider the transactions in detail. In such a case the following transactions are recorded in the books of accounts
Record all appropriations of profits (ignoring the fact that there is some guarantee). [Such appropriations include Salary to Partners, Commission to Partners, Interest on Capital, Interest on Drawings charged etc.]
Record sharing of distributable profit remaining after such appropriations in the profit sharing ratio interse between the partners Record the entry for taking amounts from the guarantors and giving to the guaranteed for making good the shortfall, thus completing the adjustment for guarantee.
Accounting in this manner, provides the maximum possible information in relation to guarantees.
Recording all appropriations separately and adjusted Profit Shares

If the organisation does not need detailed information relating to the adjustments to be made for making good the shortfall in guarantee but needs the detailed information relating to appropriations, it can pass separate entries for appropriations other than profit share and a single entry for recording the net amount appropriated among partners after making the adjustments for guarantees to their profit shares. A statement is prepared to ascertain the net amount to be credited/debited to partners after making adjustments for guarantees.
Recording a Single Transaction for all appropriations and adjusted profit shares together
If the organisation does not need detailed information relating to the appropriations made among partners as well as the adjustments made for guarantees, it can pass a single entry for recording the net amount
appropriated among partners. A statement is prepared to ascertain the net amount to be credited/debited to partners and a single entry is recorded for this net amount. This would amount to recording the net effect of all the entries passed when accounting is done in a detailed manner.
Illustration A Problem
Ram, Shyam and Kabir share profits and losses in the ratio of 3 : 2 : 3. As from 1st January 20x7 they admit Chand and Robert who are to have one-tenth share each of the profits with a guaranteed minimum share of distributable profit of Rs. 15,000 each. Ram, Shyam and Kabir agree to suffer any excess over 1/10th going to Chand and Robert in the ratio of 2 : 2 : 1 respectively. The new profit sharing ratio among partners being Ram : Shyam : Kabir : Chand : Robert = 3 : 2 : 3 : 1 : 1. The profits of the firm in respect of the year are Rs. 1,50,000 and the following appropriations have to be made:
Interest on Capital Ram: Rs. 8,000; Shyam: Rs. 7,000; Robert: Rs. 4,000 Interest on Drawings Kabir : Rs. 2,000; Chand: Rs. 4,000; Salary to Partners Shyam : Rs. 7,000; Robert: Rs. 10,000;
Illustration Working Notes
Particulars
Net Profit () Interest on Capital () Salary to Partners (+) Interest on Drawings
Firm/Total
1,50,000 19,000 17,000 + 6,000
Ram
Shyam
Kabir
Chand
Robert
+ 8,000
+ 7,000 + 7,000 2,000 4,000
+ 4,000 + 10,000
() Distributable Profits
1,20,000 1,20,000
+ 8,000 + 36,000
+ 14,000 + 24,000
2,000 + 36,000
4,000 + 12,000
+ 14,000 + 12,000
Total Appropriations
+ 44,000
+ 38,000
+ 34,000
+ 8,000
+ 26,000
Appropriations would result in the profit available with the firm getting reduced and the amount in the partners capital/current account getting increased.

Partners Profit Sharing Ratio
Ram : Shyam : Kabir : Chand : Robert = 3 : 2 : 3 : 1 : 1 = 3 : 2 : 3 : 1 : 1
10
10
10
10
10
Share of Distributable Profits

Partners Share of Profits = Distributable Profit Profit Sharing Proportion 3 Therefore, Ram's Share = Rs. 1,20,000 10 = Rs. 36,000
2 Shyam's Share = Rs. 120,000 10 = Rs. 24,000
3 Kabir's Share = Rs. 1,20,000 10 = Rs. 36,000
1 Chand's Share = Rs. 1,20,000 10 = Rs. 12,000
1 Robert's Share = Rs. 1,20,000 10

Rs. 1,20,000
= Rs. 12,000
Adjustment for Guarantees

Particulars
(a) Guaranteed Amounts : + 15,000 Profit Share + 15,000 30,000
Ram
Shyam
Kabir
Chand
Robert
Total
Total
+ 15,000
+ 15,000
+ 30,000
(b) Actual Earnings : 12,000 Profit Share 12,000 24,000
Total
12,000
12,000
24,000
Shortfall [(a) (b)] * Shortfall made good
+ 3,000 2,400 2,400 1,200
+ 3,000
+ 6,000 6,000
Net Effect
2,400
2,400
1,200
+3,000
+3,000
Note
Shortfall is to be calculated only if (a) > (b).
Distribution of Shortfall among Partners

Shortfall Sharing Proportion
Ratio in which Partners share the shortfall Ram : Shyam : Kabir = 2 : 2 : 1 2 = 5 : 5 2 : 5 1
Share of Shortfall
Partners Share of Shortfall = Amount of Shortfall Sharing Proportion 2 Therefore, Ram's Share = Rs. 6,000 5 = Rs. 2,400
2 Shyam's Share = Rs. 6,000 5 = Rs. 2,400
1 Kabir's Share = Rs. 6,000 5

Rs. 6,000
= Rs. 1,200
Illustration Solution (Method I)
The transactions to be recorded under this method would be
Appropriation of profits towards [Journal Entries
Hide/Show
Interest on Capital Salary to Partners
Journal in the books of M/s __ for the period from ____ to _____ Date
March 31st
Profit and Loss Appropriation Dr a/c To Interest on Capital a/c To Salary to Partners a/c [For the amount appropriated towards interest on capital and salaries payable to partners.]
36,000 19,000 17,000
March 31st
Interest on Capital a/c To Ram's Capital a/c To Shyam's Capital a/c To Robert's Capital a/c [For the interest on capital distributed to partners.]
Dr
19,000 8,000 7,000 4,000
March 31st
Salary to Partners a/c To Shyam's Capital a/c To Robert's Capital a/c [For the Salary distributed to partners.]
Dr
17,000 7,000 10,000
Adjustment for Interest on Drawings [Journal Entries
Hide/Show
March 31st
Interest on Drawings a/c To Profit and Loss Appropriation a/c
Dr
6,000 6,000
[For the amount chargeable to partners towards interest on drawings.] March 31st Kabir's Capital a/c Dr Chand's Capital a/c Dr To Interest on Drawings a/c [For the Interest on Drawings 2,000 4,000 6,000
charged to partners.]
Appropriation of Distributable Profits [Journal Entries
Hide/Show
March 31st
Profit and Loss Appropriation Dr a/c To Distributable Profits a/c [For the amount of distributable profits.]
1,20,000 1,20,000
March 31st
Distributable Profits a/c To Ram's Capital a/c To Shyam's Capital a/c To Kabir's Capital a/c To Chand's Capital a/c To Robert's Capital a/c [For the distributable profits shared among partners.]
Dr
1,20,000 36,000 24,000 36,000 12,000 12,000
Adjustment for making good the shortfall among partners [Journal Entries
Hide/Show
March 31st Ram's Capital a/c Shyam's Capital a/c Kabir's Capital a/c To Guarantee Shortfall a/c
Dr Dr Dr
2,400 2,400 1,200 6,000
[For the shortfall in amounts guaranteed made good by ram, shyam and kabir.] March 31st Guarantee Shortfall a/c To Chand's Capital a/c To Robert's Capital a/c Dr Dr Dr 6,000 3,000 3,000
[For the shortfall in amounts guaranteed made good to
chand and rahim.]
D r
C r
(in Rs)
To Int on Cap:
8,000
By Net Profit b/d By Int on Drawings:

2,000 19,000
1,50,000
Ram Shyam Robert

7,000 4,000 7,000 10,000 17,000 1,20,000
Kabir Chand
4,000
6,000
Shyam Robert
<>
1,56,000
1,56,000
To Profit Share:
36,000
By Distr Profit b/d

24,000 36,000 12,000 12,000 1,20,000
1,20,000
Ram Shyam Kabir Chand Robert
1,20,000
1,20,000
Dr
Ram Particulars (in Rs) (in Rs) (in Rs) Shyam Kabir

Chand (in Rs) Robert Particulars (in Rs) (in Rs) (in Rs) (in Rs) (in Rs) Ram Shyam Kabir Chand
Cr
Robert (in Rs)
To Int on Drawings To Guarantee Shortfall To Bal c/d
2,400
2,400
2,000 1,200
4,0000
By By By By By
Bal b/d Interest on Cap Partners Salary Profit Share Guarantee Shortfall
8,000 36,000
7,000 7,000 24,000
36,000
12,000 3,000
4,000 10,000 12,000 3,000
By Bal b/d
Illustration Solution (Alternative)
Where the organisation does not intend to maintain the detail relating to guarantee, the journal entries relating to shortfall can be eliminated by making adjustments for shortfall and then appropriating the distributable profits.
Ascertaining Adjusted Distributable Profits
A statement for ascertaining the net distributable profits after making adjustments for shortfall.
Particulars
Ram
Shyam
Kabir
Chand
Robert
Total
Distributable Profits : Shortfall made good
+ 36,000 2,400
+ 24,000 2,400
+ 36,000 1,200
+ 15,000 + 3,000
+ 15,000 + 3,000
1,20,000 0
Net Distribution
+ 33,600
+ 21,400
+ 34,800
+ 15,000
+ 15,000
1,20,000
If this method is followed, the adjusted distributable profits are distributed to partners as share of profits and no additional entries need to be passed regarding making good the shortfall. All the other entries would be the same as in the above case.
Dr

Amount Particulars (in Rs) (in Rs) Amount Particulars (in Rs) (in Rs) Amount Amount
Cr
To Int on Cap:
8,000
By Net Profit b/d By Int on Drawings:

2,000 19,000
1,50,000
Ram Shyam Robert

7,000 4,000 7,000 10,000 17,000 1,20,000
Kabir Chand
4,000
6,000
Shyam Robert
<>
1,56,000
1,56,000
To Profit Share:
33,600
By Distr Profit b/d

21,400 34,800 15,000 15,000 1,20,000
1,20,000
1,20,000
1,20,000
Dr

Cr
Robert (in Rs)
To Int on Drawings To Bal c/d
2,000
4,0000
By By By By
Bal b/d Interest on Cap Partners Salary Profit Share
8,000 36,000
7,000 7,000 24,000
36,000
12,000
4,000 10,000 12,000
By Bal b/d
The information relating to shortfall in guarantee and how it is made good would not be available from accounting.
Short cut for a specific case

Where the firm guarantees to make good the shortfall and the guarantors (partners other than the guaranteed) agree to make good the shortfall by contributing in their profit sharing ratios inter se between them, this procedure can be adopted. In such cases, we don't even need to think of the adjustments to be made. Pay off the partners having the guarantee, the amount guaranteed first from the distributable profits and then distribute the remaining profits among the remaining partners in their profit sharing ratio. That would take care of the adjustment to be made.
Illustration Solution (Using only One Entry)
This method (the least advised) can be used where the organisation's information needs are minimal and it does not intend to maintain any information relating to appropriations and guarantees.
Calculation of Net amounts to be appropriated

Particulars Ram Shyam Kabir Chand Robert Total
Total appropriations Shortfall made good
+ 44,000 2,400
+ 38,000 2,400
+ 34,000 1,200
+ 8,000 + 3,000
+ 26,000 + 3,000
Net Distribution
+ 41,600
+ 35,600
+ 32,800
+ 11,000
+ 29,000
Dr
C r
(in Rs)
To Profit Share:
41,600
By Net Profit b/d

35,600 32,800 11,000 29,000 1,20,000
1,20,000
1,20,000
1,20,000
Dr

Cr
Robert (in Rs)
To Bal c/d
By Bal b/d By Profit Share
41,600
35,600
32,800
11,000
29,000
Past Adjustments Classification

Adjustments in accounts of the partnership firm may be needed whenever something relating to the past period has to be corrected. These are needed on account of a number of reasons like, the partners deciding to change the inter relationship between themselves with retrospective effect, identification of past period errors, etc. For the purpose of their treatment in accounting, these past adjustments can be classified into two
Re-appropriations
The adjustments pertaining to the past periods which involve appropriations only i.e. those whose correction/adjustment would influence Nominal a/c's and/or Partners Capital/Current a/c's only.
Adjustments
The adjustments pertaining to the past periods which involve adjustments i.e. those whose correction/adjustment would influence Real a/c's, Personal a/c's other than Partners Capital a/c's.
Re-Appropriations
We know that "Interest on Capital", "Salary to Partners", "Commission to Partners", etc., are all appropriations of profits. A mistake with regard to appropriations arises in cases where there are (a) Errors in calculations of the appropriable amounts, and (b) Accounting errors i.e. errors in recording or posting these transactions. An error in relation to appropriation of profits would result in an error in the amount that is debited/credited to the Partners Capital a/c's. Where such errors are subsequently identified they need to be corrected by re-appropriation of profits already appropriated. These re-appropriations would influence only the Partners Capital a/c's. Re-appropriation can be understood as taking back the amount that has been erroneously distributed and distributing the correct amounts again. The re-appropriations to be made may pertain to profits relating to a single accounting period or two or more accounting periods.
Profit and Loss Re-Appropriation a/c

To give a clear understanding as to the reason for which the recordings are being done, we use a separate account to deal with these transactions of re-appropriations. We name the account "Profit and Loss ReAppropriation a/c". This account is sometimes named "Profit and Loss Adjustment a/c" or "Profit and Loss ReAdjustment a/c".
Radha, Nimmi and Bindu are partners in a firm sharing profits and losses in the ratio 1 : 3 : 2. They had made a profit of Rs. 2,40,000 during the last accounting period. They were entitled to a salaries of Rs. 8,000, Rs. 10,000 and Rs. 12,000 respectively. The profits after charging their salaries was distributed among the partners in their profit sharing ratio. It was later discovered that the following appropriations have not been taken into consideration while distributing the profits.
Commission of Rs. 8,000 payable to Bindu Interest on Fixed Capitals payable to Radha, Nimmi and Bindu as Rs. 5,000, Rs. 6,000 and Rs. 5,000
respectively.
Interest on Drawings chargeable to Radha, Nimmi and Bindu as Rs. 1,000, Rs. 1,500 and Rs. 500
respectively. You are required to make adjustments for the above and set right the accounts.

Appropriations and Profits Share (already done) Total
(a) Net Profit (b) Appropriations: Salary to Partners Total (b) (c) Distributable Profits (a) (b) (d) Share of Distributable Profit (e) Total Appropriations 2,40,000 30,000 30,000 + 2,10,000 2,10,000 (2,40,000) + 8,000 + 8,000 + 35,000 + 43,000 + 10,000 + 10,000 + 1,05,000 + 1,15,000 + 12,000 + 12,000 + 70,000 + 82,000
Radha
Nimmi
Bindu
Distribution of Profits among Partners Profit Sharing Ratio

Radha : Nimmi : Bindu = 1 : 3 : 2 = 1 6 : 3 6 : 2 6
Share of Distributable Profits

Partners Share of Profits = Distributable Profit Profit Sharing Proportion 1 6 3 6 2 6
Therefore, Radha's Share = Rs. 2,10,000
Rs. 35,000
Nimmi's Share = Rs. 2,10,000
= Rs. 1,05,000
Bindu's Share = Rs. 2,10,000
Rs. 70,000
Rs. 2,10,000
Appropriations and Profits Share (that should have been done) Total
(a) Net Profit (b) Appropriations: Salary to Partners Commission to Partners Interest on Capital Interest on Drawings Total (b) (c) Distributable Profits (a) (b) (d) Share of Distributable Profits (e) Total Appropriations 2,40,000 30,000 8,000 16,000 + 3,000 51,000 + 1,89,000 1,89,000 (2,40,000) + 8,000 + 5,000 1,000 + 12,000 + 31,500 + 43,500 + 10,000 + 6,000 1,500 + 14,500 + 94,500 + 1,09,000 + 12,000 + 8,000 + 5,000 500 + 24,500 + 63,000 + 87,500
Radha
Nimmi
Bindu
Distribution of Profits among Partners Share of Distributable Profits

Partners Share of Profits = Distributable Profit Profit Sharing Proportion 1 6 3 6 2 6
Therefore, Radha's Share = Rs. 1,89,000
= Rs. 31,500
Nimmi's Share = Rs. 1,89,000
= Rs. 94,500
Bindu's Share = Rs. 1,89,000
= Rs. 63,000
Rs. 1,89,000
Illustration Solution (Re-appropriation)

Under this method for re-appropriating profits, all the amounts that have been appropriated earlier would be redrawn and the appropriation would be made appropriately in full again. This gives the maximum possible information regarding the re-appropriations and is requires the maximum entries to be recorded. Re-appropriating profits in the above illustration needs us to record the following transactions.
The total amounts that were appropriated to the partners earlier are brought back. [Journal Entries
Hide/Show
March 31
st
V/R Particulars No. L/F
Debit Amount (in Rs)
Credit Amount (in Rs)
Radha Capital a/c Nimmi Capital a/c Bindu Capital a/c To Profit/Loss Re-
Dr Dr Dr
43,000 1,15,000 82,000 2,40,000
appropriation a/c [For the amount profits appropriated earlier in an erroneous manner brought back from the partners capital accounts.]
The profits are appropriated in the correct manner again . [Journal Entries
Hide/Show
March 31
st
Profit/Loss ReDr appropriation a/c To Interest on Capital a/c To Salary to Partners a/c To Commission to Partners a/c [For the amount of profits appropriated towards interest on capital, salaries, commission payable to partners.]
54,000 16,000 30,000 8,000
March 31st Interest on Drawings a/c To Profit/Loss Reappropriation a/c
Dr
3,000 3,000
[For the interest on drawings chargeable to partners.] March 31st Interest on Capital a/c To Radha Capital a/c To Nimmi Capital a/c To Bindu Capital a/c [For the interest on capital appropriated to partners.] March 31st Salary to Partners a/c To Radha Capital a/c To Nimmi Capital a/c To Bindu Capital a/c [For the salary to partners appropriated to partners.] March 31st Commission to Partners a/c To Bindu Capital a/c [For the commisson to partners appropriated to partners.] March 31st Radha Capital a/c Dr 1,000 Dr 8,000 8,000 Dr 30,000 8,000 10,000 12,000 Dr 16,000 5,000 6,000 5,000
Nimmi Capital a/c Bindu Capital a/c To Interest on Drawings a/c
Dr Dr
1,500 500 3,000
[For the interest on drawings charged to partners.] March 31st Profit/Loss Reappropriation a/c To Distributable Profits a/c Dr 1,89,000 1,89,000
[For the profit that can be appropriated as distributable profits.] March 31st Distributable Profits a/c To Radha Capital a/c To Nimmi Capital a/c To Bindu Capital a/c Dr 1,89,000 35,000 1,05,000 70,000
[For the distributable profits shared among partners in their profit sharing ratio.]
D r

Amount Particulars (in Rs) To Salary To Partners: (in Rs) By Appr. brought back:
8,000 10,000 12,000 5,000 6,000 5,000 8,000 16,000 8,000 1,89,000 30,000
C r
Amount Amount (in Rs) (in Rs)
Amount Particulars
Radha Nimmi Bindu

To Interest on Capital:
Radha Nimmi Bindu

By Int on Drawings:
43,000 1,15,000 82,000 1,000 1,500 500 3,000 2,40,000
Radha Nimmi Bindu

To Comm. to Partner:
Radha Nimmi Bindu
Bindu
2,43,000 2,43,000
To Profit Share: Radha Nimmi Bindu
By Distr Profit b/d

43,500 1,09,000 87,500 1,89,000 1,89,000
1,89,000
1,89,000
Illustration Solution (Alternative)

Where there are appropriations that have been correctly done earlier, they may be left out of the process of reappropriation thereby reducing the transactions to be dealt within in th process of re appropriation. Under this method, only those amounts which pertains to erroneous appropriations would be withdrawn from the partners and would be re appropriated. Taking the case of Salary paid to partners, the amounts appropriated as salary from the profits is correct and to that extent no adjustment need be made. But in withdrawing the total amount appropriated and re-appropriating them again we are undoing and redoing the transaction which may be avoided. Thus, the transaction relating to the appropriation of salaries is ignored and the rest of the amount that has been appropriated to the partners is withdrawn from their accounts.
The transactions to be dealt with would be as follows
Amount distributed as share of profits earlier is brought back from the partners capital accounts
[Journal Entries
Hide/Show
March 31
st
Radha Capital a/c Nimmi Capital a/c Bindu Capital a/c To Profit/Loss Reappropriation a/c
Dr Dr Dr
35,000 1,05,000 70,000 2,10,000
[For the amount profits appropriated earlier to the extent they are erroneous brought back from the partners capital accounts.]
But for the amount withdrawn from the partners capital accounts, this entry is the same as the one
recorded in the above method.
Statement for Ascertaining Amounts to be withdrawn

Total
Share of Distributable Profit Total Amount to be withdrawn + 2,10,000 + 2,10,000
Radha
35,000 35,000
Nimmi
1,05,000 1,05,000
Bindu
70,000 70,000
The amounts that have not been appropriated earlier and those which have been appropriated earlier in
an erroneous manner and have been withdrawn are re-appropriated now and the remaining profit is shared among partners in their profit sharing ratio [Journal Entries Hide/Show]
March 31
st
Profit/Loss Re-appropriation a/c To Interest on Capital a/c To Commission to Partners a/c
Dr
54,000 16,000 8,000
[For the amount of profits appropriated towards interest on capital, commission payable to partners.] March 31st Interest on Drawings a/c To Profit/Loss Reappropriation a/c [For the interest on drawings chargeable to partners.] March 31st Interest on Capital a/c Dr 16,000 Dr 3,000 3,000
To Radha Capital a/c To Nimmi Capital a/c To Bindu Capital a/c [For the interest on capital appropriated to partners.] March 31st Commission to Partners a/c To Bindu Capital a/c
5,000 6,000 5,000
Dr
8,000 8,000
[For the commisson to partners appropriated to partners.] March 31st Radha Capital a/c Dr Nimmi Capital a/c Dr Bindu Capital a/c Dr To Interest on Drawings a/c [For the interest on drawings charged to partners.] March 31st Profit/Loss Re-appropriation a/c To Distributable Profits a/c [For the profit that can be appropriated as distributable profits.] March 31st Distributable Profits a/c To Radha Capital a/c To Nimmi Capital a/c To Bindu Capital a/c Dr 1,89,000 35,000 1,05,000 70,000 Dr 1,89,000 1,89,000 1,000 1,500 500 3,000
[For the distributable profits shared among partners in their profit sharing ratio.]
Statement for Appropriation of withdrawn amounts

Total
(a) Amount Withdrawn (b) Appropriations Commission to Partners Interest on Capital Interest on Drawings Total (b) (c) Distributable Profits (a) (b) (d) Share of Distributable Profits (e) Total Appropriations 2,10,000 8,000 16,000 + 3,000 21,000 + 1,89,000 1,89,000 (2,10,000) + 5,000 1,000 + 4,000 + 35,000 + 43,000 + 6,000 1,500 + 4,500 + 1,05,000 + 1,15,000 + 8,000 + 5,000 500 + 12,500 + 70,000 + 82,000
Radha
Nimmi
Bindu
All the entries recorded here would be the same as the ones recorded earlier, the only exception being the
absence of transactions that have been dealt with properly in the first case and which have been ignored at the time of withdrawing appropriated amounts from the partners capital accounts. [Salary to Partners here]
Dr
Particulars

Amount (in Rs) To Interest on Capital: Amount Particulars (in Rs) By Appr. brought back:
5,000 6,000 5,000 8,000 16,000 8,000 1,89,000
Cr
Amount (in Rs)
Amount (in Rs)
Radha Nimmi Bindu

Radha Nimmi Bindu

By Int on Drawings:
35,000 1,05,000 70,000 1,000 1,500 500 3,000 2,10,000
Bindu
Radha Nimmi Bindu

By Distr Profit b/d
2,43,000
2,43,000 1,89,000
To Profit Share: Radha Nimmi Bindu
43,500 1,09,000 87,500 1,89,000 1,89,000 1,89,000
Illustration Solution (Modified Alternative)

The method of withdrawing the amounts related to erroneous appropriations only can be modified to withdraw only a part of the share of profits appropriated. In the above illustration, share of profits to the extent of Rs. 2,10,000 have been withdrawn and in reappropriating share of profits to the extent of Rs. 1,89,000 have been distributed to partners. There has been no change in the ratio of profit sharing among partners. Thus it amounts to (a) withdrawing the 1,89,000 and redistributing the amounts as have been withdrawn and (b) withdrawing the remaining 21,000 (2,10,000 1,89,000) and redistributing it in a different manner. The redistribution process can be further simplified by withdrawing only the amount of Rs. 21,000 required for being redistributed in a different manner. The amount to be withdrawn can be ascertained from the reappropriation to be made.
Statement for Appropriation of withdrawn amounts Total

(1) Appropriations to be made Commission to Partners Interest on Capital Interest on Drawings Total (1) Amount to be withdrawn
Radha
Nimmi
Bindu
8,000 16,000 + 3,000 21,000 + 21,000
+ 5,000 1,000 + 4,000 3,500
+ 6,000 1,500 + 4,500 10,500
+ 8,000 + 5,000 500 + 12,500 7,000
Share of Amounts to be withdrawn from partners

Partners Share of Amount to be withdrawn = Amount to be withdrawn Profit Sharing Proportion 1 6 3 6
Therefore, Radha's Share =
Rs. 21,000
Rs. 3,000
Nimmi's Share =
Rs. 21,000
Rs. 10,500
Bindu's Share =
Rs. 21,000 2
Rs. 7,000
6
Rs. 21,000
Dr
Particulars

Amount (in Rs) To Interest on Capital: Amount Particulars (in Rs) By Appr. brought back:
5,000 6,000 5,000 8,000 16,000 8,000
Cr
Amount (in Rs)
Amount (in Rs)
Radha Nimmi Bindu

Radha Nimmi Bindu

By Int on Drawings:
3,500 10,500 7,000 1,000 1,500 500 3,000 21,000
Bindu
Radha Nimmi Bindu

24,000
24,000
Illustration Solution (Using a Single Journal Entry)

The objective of error rectification is to set right the position rather than to re do everything. Therefore, if the firm wishes to ensure that the position is set right and does not wish to have the information relating to all the adjustments made during re-appropriation, then a single journal entry for the net effect would be recorded in place of all the above transactions. The net effect can be ascertained if we know what has been recorded and what should have been recorded.
Statement for ascertainment of Adjustment to be made Total

(1) Past Appropriation (withdrawn) (2) Re-Appropriation (to be made) Net Effect + 2,40,000 2,40,000 0
Radha
43,000 + 43,500 + 500
Nimmi
1,15,000 + 1,09,000 6,000
Bindu
82,000 + 87,500 + 5,500
March 31
st
Nimmi Capital a/c To Radha Capital a/c To Bindu Capital a/c [For the adjustment made to capital accounts to make good the errors in appropriations.]
Dr
6,000 500 5,000
Adjustments in accounts of the partnership firm may be needed whenever something relating to the past period has to be corrected. These are needed on account of a number of reasons like, the partners deciding to change the inter relationship between themselves with retrospective effect, identification of past period errors, etc. For the purpose of their treatment in accounting, these past adjustments can be classified into two
Re-appropriations
The adjustments pertaining to the past periods which involve appropriations only i.e. those whose correction/adjustment would influence Nominal a/c's and/or Partners Capital/Current a/c's only.
Adjustments
The adjustments pertaining to the past periods which involve adjustments i.e. those whose
correction/adjustment would influence Real a/c's, Personal a/c's other than Partners Capital a/c's.
Adjustments Error Rectification
We know that "Interest on Capital", "Salary to Partners", "Commission to Partners", ... are all appropriations of profits. Not taking the interest, salary, commission etc., into consideration, recording wrong amounts, distributing the distributable profit in a wrong proportion are some examples of these mistakes in appropriations. When there is an error with regard to these appropriations, it would influence the amount that is being distributed to the partners (i.e. the amount that is ultimately credited to the partners capital accounts). But, where there are errors that are to be rectified either relatting to the current or the past periods, whose rectification effects Real and other personal accounts care should be taken to ensure that all the relevant accounts are adjusted apart from making adjustments in the capital accounts with regard to the net effect of these adjustments.
Profit and Loss Adjustment a/c
To give a clear understanding as to the reason for which the recordings are being done, we use a separate account to deal with these adjustment transactions. We name the account "Profit and Loss Adjustment a/c". This account in general is used whenever there are adjustments to be made of unconventional nature.
"Me", "You" and "They" are partners in a firm sharing profits and losses in the ratio 5 : 3 : 2. The following is the information relevant to the partners as on 31st December 20x4:
Me
Capital (as on 1st Jan 20x4) 1,00,000
You
1,50,000
They
2,00,000
Drawings during the year
15,000
20,000
20,000
1,000
4,000
2,000
The draft accounts showed a net profit of Rs. 4,00,000 before making adjustments for interest on capital @10% per anum and the interest on drawings. While checking the records they have noticed the following: i. A machinery costing Rs. 50,000 purchased during 20x3 was debited to Repairs Account. 10% depreciation on reducing balance (on the last day of the accounting period) method is provided on plant and
ii. iii.
machinery. The interest on fixed deposit due to the firm Rs. 4,000 was used by "They" for his personal expenses. It is decided that the method of recording Special Fee in the books was to be changed from "Cash Basis" to "Accrual Basis". The fees still receivable stood at Rs.18,000.
Make necessary adjustments to incorporate the above aspects and Appropriate the profits of the firm.
The journal entries for rectifying the errors would be
Statement for calculation of adjustments to be made

[+ Debit and Credit]
Machinery
(i) Machinery a/c Dr To P&L adj (Repairs) a/c Depreciation for 20x3 P&L adj (Depriciation) a/c Dr To Machinery a/c Depreciation for 20x4 P&L (Depriciation) a/c Dr To Machinery a/c (ii) They's Drawings a/c Dr To P&L (Int on FD) a/c (iii) Interest Receivable a/c Dr To P&L (Interest) a/c Net Effect + 40,500 + 50,000
Int Rec
Drawings
P&L adj
P&L
50,000
+ 5,000 5,000
+ 4,500 4,500 + 4,000 4,000 + 18,000 18,000 + 18,000 + 4,000 45,000 17,500
Journal Entries
Whatever may be the adjustment you have to make, it would be very easy if you can think of the journal entry to be recorded to incorporate/rectify the same. If asset accounts are influenced by the adjustments made, care should be taken to check the influence of the adjustment on the calculation of depreciation both during the previous as well as the current periods.
Methods for incorporating the adjustments

Even here the number of entries recorded would depend on the need for information. Greater the information you need, greater the account heads we maintain and greater the entries that we record. There are basically two methods we can adopt for recording the adjustments. 1.
Recording
all
All the entries for transactions as they appear in the statement above can be recorded, thereby giving
complete information. Simplification to an extent can be done by writing simple/complex compound entries (clubbing the entries) for deprectioin etc. 2.
Single
Journal
Entry
The objective of rectification of errors is to correct the position rather than to re do everything. Therefore, if the firm wishes to ensure that the position is corrected without having to re-do everything, then a single journal entry for the Net Effect [as above] would be recorded.
Direct Ledger Accounts Precautions

We generally get accustomed to preparing the key ledger accounts as part of problem solving, especially in chapters like Consignments, Joint Ventures, Partnership Accounts etc. If we are preparing the ledger accounts directly, we should be careful enough to ensure that the effect of all the above adjustments in incorporated in the relevant accounts. Preparation of the above statement would thus be helpful either way. If you are writing the journal entries it works as a working note. If you are preparing the ledgers directly, you can ensure that all accounts which are influenced are taken care of.
Illustration Solution [Recording All]
All the transactions that appear in the statement are recorded and they are posted to the respective ledger accounts. Since the balances of the "Machinery a/c" and "Interest Receivable a/c" are not know, postings in those accounts may be ignored.
Ledger Accounts
Dr Profit and Loss Adjustment a/c Cr
Particulars
To Machinery a/c To Net adj c/d
Particulars

50,000
45,000 By Machinery a/c
50,000 To Share of Net Adj: By Net Adj b/d "Me" 22,500 "You" 13,500 "They" 9,000 45,000 45,000
50,000 45,000
45,000
Dr Profit and Loss a/c Cr
Particulars
To Machinery a/c To Net Profit c/d [To appropriation a/c]
Particulars

4,00,000 18,000 4,000
4,500 By Net Profit b/d By Interest Receivable 4,17,500 By They's Drawings
4,22,000 Dr Profit and Loss Appropriation a/c Cr
4,22,000
Particulars
To Interest on Capital: "Me" "You" "They" To Distributable Profit c/d
Particulars

4,17,500 1,000 4,000 2,000
10,000 15,000 20,000
By Net Profit b/d By Int on Drawings: "Me" 45,000 "You" "They" 3,79,500 4,24,500
7,000
4,24,500 By Distr Profit b/d 3,79,500
To Profit Share: "Me" "You" "They"
1,89,750 1,13,850 75,900 3,79,500 3,79,500 3,79,500
Dr Partners Drawings a/c's Cr
Particulars
Me You They Me You They Particulars (in Rs) (in Rs) (in Rs) (in Rs) (in Rs) (in Rs)
To Bal b/d 15,000 20,000 20,000 By Bal c/d 15,000 20,000 24,000 To P&L adj 4,000 15,000 20,000 24,000 To Bal b/d 15,000 20,000 24,000 Dr Partners Capital a/c's Cr 15,000 20,000 24,000
Particulars
Me
You
They
Particulars
Me
You
They
(in Rs)
To Int on Dr To Drawings To Bal c/d 1,000 15,000
(in Rs)
4,000 20,000
(in Rs)
(in Rs)
(in Rs)
(in Rs)
2,000 By Bal b/d 1,00,000 1,50,000 2,00,000 24,000 By Int on Cap 10,000 15,000 20,000 By P&L adj 22,500 13,500 9,000 2,82,700 1,94,350 2,34,950 By Profit Share 1,89,750 1,13,750 75,900 3,03,700 1,96,450 2,50,700 By Bal b/d Dr Machinery a/c Cr 3,03,700 1,96,450 2,50,700 2,82,700 1,94,3500 2,34,950
Date Particulars J/F
Amount Date (in Rs)
Particulars
J/F
Amount (in Rs)

5,000 4,500
To P&L adj Total
50,000
By P&L adj a/c By P&L a/c Total
Dr Interest Receivable a/c Cr
Date
Particulars
J/F
Amount Amount Date Particulars J/F (in Rs) (in Rs)
To P&L adj a/c Total
18,000 Total
Illustration Solution [Recording Net Adjustment]
The Net Effect of the various adjustments is recorded using a single journal entry and the rest of the appropriations is done as earlier.
The Difference
The difference would be in the information available with regard to corrections or adjustments. The information available in the machinery account is reduced when we record the net effect. There would be no difference in the profit and loss appropriation account and the partners capital accounts.
Journal Entries
Journal in the books of M/s _____ for the period from ____ to _____
Date
V/R No.
Particulars
L/F
Debit Amount Credit Amount (in Rs) (in Rs)

40,500 18,000 4,000 45,000 17,500
March 31st Machinery a/c Dr Interest Receivable a/c Dr They's Drawings a/c Dr To P & L adj a/c To P & L a/c [For the net effect of rectification of errors.]
Ledger a/c's
Dr Profit and Loss Adjustment a/c Cr
Particulars
Particulars

45,000
To Share of Net Adj: By Mach,...a/c's "Me" 22,500 "You" 13,500 "They" 9,000 45,000 45,000
45,000
Dr Profit and Loss a/c Cr
Particulars
To Net Profit c/d [To appropriation a/c]
Particulars

4,00,000 17,500 17,500
4,17,500 By Net Profit b/d By Mach,...a/c's 17,500
Dr Profit and Loss Appropriation a/c Cr
Particulars
To Interest on Capital: "Me" "You" "They" To Distributable Profit c/d
Particulars

4,17,500 1,000 4,000 2,000
10,000 15,000 20,000
By Net Profit b/d By Int on Drawings: "Me" 45,000 "You" "They" 3,79,500
7,000
4,24,500 To Profit Share: "Me" "You" "They" By Distr Profit b/d 1,89,750 1,13,850 75,900 3,79,500 3,79,500
4,24,500 3,79,500
3,79,500
Dr Partners Drawings a/c's Cr
Particulars
Me You They Me You They Particulars (in Rs) (in Rs) (in Rs) (in Rs) (in Rs) (in Rs)
To Bal b/d 15,000 20,000 20,000 By Bal c/d 15,000 20,000 24,000 To P&L adj 4,000 15,000 20,000 24,000 To Bal b/d 15,000 20,000 24,000 Dr Partners Capital a/c's Cr 15,000 20,000 24,000
Particulars
To Int on Dr To Drawings To Bal c/d
Me (in Rs)
1,000 15,000
You (in Rs)

4,000 20,000
They (in Rs)
Particulars
Me (in Rs)
You (in Rs)
They (in Rs)
2,000 By Bal b/d 1,00,000 1,50,000 2,00,000 24,000 By Int on Cap 10,000 15,000 20,000 By P&L adj 22,500 13,500 9,000 2,82,700 1,94,350 2,34,950 By Profit Share 1,89,750 1,13,750 75,900 3,03,700 1,96,450 2,50,700 By Bal b/d Dr Machinery a/c Cr 3,03,700 1,96,450 2,50,700 2,82,700 1,94,3500 2,34,950
Date Particulars J/F

Total
To P&L adj Total
40,500
Dr Interest Receivable a/c Cr
Date
Particulars
J/F
To P&L adj a/c Total
18,000 Total

Indian Partnership Act

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Indian Partnership Act

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Indian Partnership Act, 1932 Sec 4.

Definition of "partnership", "partner", "firm" and "firm name"

Essential elements of Partnership

Restrictions on the number of persons

Companies Act, 1956

Sec 11. Prohibition of associations and partnerships exceeding certain number

who have agreed

Indian Partnership Act, 193 Sec 5. Partnership not created by status

the profits of a business

Indian Partnership Act, 1932

Acting for all

Mutual Agency [Principal Agent Relationship]

Indian Partnership Act, 1932

Sec 18. Partner to be agent of the firm

What's the difference?

Final Accounting Business Owned by a Sole Proprietor

Trading and Profit and Loss a/c

Opening Stock Purchases Wages Gross Profit

15,000 1,50,000 50,000 1,30,000

By Sales By Closing Stock

To Rent To Net Profit

By Gross Profit By Commission Received

Amount Particulars (in Rs)

Amount Particulars (in Rs)

Amount (in Rs)

Amount (in Rs)

By Balance b/d By Net Profit

Recording Gross Profit and Net Profit

Profit and Loss a/c To Capital a/c

[For the net profit transferred to capital account.]

Trading and Profit and Loss a/c

To Profit & Loss a/c

By Trading a/c To Capital a/c

Profit and Loss a/c Net Profit a/c

[For the net profit transferred to capital account.]

Trading and Profit and Loss a/c

By Gross Profit a/c To Net Profit

Gross Profit a/c

To Profit and Loss a/c

Net Profit a/c

By Profit and Loss a/c

Final Accounting Business Owned by the Partnership Firm

Trading and Profit and Loss a/c

Opening Stock Purchases Wages Gross Profit

15,000 1,50,000 50,000 1,30,000

By Sales By Closing Stock

To Rent To Net Profit c/d

By Gross Profit By Commission Received

To Net Profit (Mani) To Net Profit (Murty)

By Net Profit b/d

Distribution of Profits among Partners

Partners share of profits = Firms profit Profit sharing proportion

1 Mani's Share = Rs. 1,08,000 3 = Rs. 36,000

2 Murthy's Share = Rs. 1,08,000 3

Partners Capital a/c's

Is that all the difference !!!

Factors of Production Returns

Organisation Partnership Firm

What Constitutes "Organisation" in a Partnership Firm

Why not Capital

Varied Contributions of Partners towards the Organisation

Remunerating the Factors of Production in a Partnership Firm

Judicious Distribution of the Firms Profits