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Accounting for Partnership: Basic Concepts

Accounting for Partnership: Basic Concepts

Action PlanNotesQuestionsMock-Test
Study Action Plan (Sorted by Difficulty)
Partnership Deed and Provisions
Accuracy: 68%
Total Attempted116
Total Correct79
Total Incorrect37
Difficulty Level:
Medium
Past Adjustments in Partnership
Accuracy: 69%
Total Attempted45
Total Correct31
Total Incorrect14
Difficulty Level:
Medium
Partnership Accounting
Accuracy: 71%
Total Attempted147
Total Correct105
Total Incorrect42
Difficulty Level:
Medium
Interest on Capital and Drawings
Accuracy: 77%
Total Attempted77
Total Correct59
Total Incorrect18
Difficulty Level:
Low
Profit and Loss Appropriation Account
Accuracy: 78%
Total Attempted147
Total Correct115
Total Incorrect32
Difficulty Level:
Low
Guarantee of Profit to a Partner
Accuracy: 79%
Total Attempted95
Total Correct75
Total Incorrect20
Difficulty Level:
Low

Learning Objectives

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Learning Objectives

  • Define partnership and list its essential features;
  • Identify the provisions of the Indian Partnership Act 1932 that are relevant for accounting;
  • Prepare partners' capital accounts under fixed and fluctuating capital methods;
  • Explain the distribution of profit or loss among the partners and prepare the Profit and Loss Appropriation Account;
  • Calculate interest on capital and drawing under various situations;
  • Explain how guarantee for a minimum amount of profit affects the distribution of profits;
  • Make necessary adjustments to rectify the past errors in partners' capital accounts;
  • Prepare final accounts of a partnership firm.

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Revision Notes & Summary

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Accounting for Partnership: Basic Concepts

1. Learning Objectives

After studying this chapter, you will be able to:
  • Define partnership and list its essential features;
  • Identify the provisions of the Indian Partnership Act 1932 that are relevant for accounting;
  • Prepare partners' capital accounts under fixed and fluctuating capital methods;
  • Explain the distribution of profit or loss among the partners and prepare the Profit and Loss Appropriation Account;
  • Calculate interest on capital and drawing under various situations;
  • Explain how guarantee for a minimum amount of profit affects the distribution of profits;
  • Make necessary adjustments to rectify the past errors in partners' capital accounts;
  • Prepare final accounts of a partnership firm.

2. Nature of Partnership

  • Definition: When two or more persons join hands to set up a business and share its profits and losses, they are said to be in partnership.
  • Legal Reference: Section 4 of the Indian Partnership Act 1932 defines partnership.

3. Partnership Deed

  • Definition: The document containing terms of the partnership agreement is called the 'Partnership Deed'.
  • Contents: It generally includes:
    • Names and addresses of the firm and its main business;
    • Names and addresses of all partners;
    • Amount of capital contributed by each partner;
    • Accounting period of the firm;
    • Date of commencement of partnership;
    • Rules regarding operation of bank accounts;
    • Profit and loss sharing ratio;
    • Rate of interest on capital, loan, drawings, etc.;
    • Salaries, commission, etc., payable to any partner;
    • Rights, duties, and liabilities of each partner;
    • Treatment of loss arising out of insolvency of one or more partners;
    • Method of settlement of disputes among partners.

4. Accounting Methods

4.1 Fixed Capital vs. Fluctuating Capital

Basis of DistinctionFixed CapitalFluctuating Capital
Number of accountsTwo separate accounts: capital and current account.One account for capital.
Items related to deedDrawings, salary, interest on capital are posted in current accounts.All adjustments are posted in capital accounts.
Fixed balanceCapital account balance remains unchanged unless there is an addition or withdrawal.Balance fluctuates from year to year.
Credit balanceAlways shows a credit balance.May show a debit balance.

5. Distribution of Profits

  • Profit and Loss Appropriation Account: An additional account prepared to show distribution of profit and loss among partners.
  • Calculation of Interest on Capital: Interest on capital is calculated based on the time period for which the capital remained in business.

6. Treatment of Guarantees

  • If a partner is guaranteed a minimum amount of profit, any deficiency is made good by the guaranteeing partners in the agreed ratio.

7. Past Adjustments

  • Necessary adjustments can be made in the partner's capital accounts through the Profit and Loss Adjustment Account to rectify omissions or commissions.

8. Final Accounts Preparation

  • The final accounts of a partnership firm are similar to those of a sole proprietary concern, with the addition of the Profit and Loss Appropriation Account.
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Practice Test – MCQs, True/False

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Multiple Choice Questions

A.

Interest is calculated on the total amount withdrawn for the entire year.

B.

Interest is calculated on each withdrawal separately.

C.

Interest is not charged if the amount is fixed.

D.

Interest is only charged if the partner agrees.
Correct Answer: B

Solution:

When a partner withdraws a fixed amount regularly, interest is calculated on each withdrawal separately, considering the time period it remained withdrawn.

Chapter Concept:

Profit and Loss Appropriation Account

A.

The partner with the highest capital

B.

The partner with the lowest capital

C.

The partners who gave the guarantee

D.

The firm as a whole
Correct Answer: C

Solution:

The deficiency is borne by the partners who provided the guarantee, in their profit sharing ratio or as agreed.

Chapter Concept:

Partnership Accounting

A.

Rs. 5,000

B.

Rs. 3,000

C.

Rs. 7,000

D.

Rs. 2,000
Correct Answer: A

Solution:

Partner A's share of the profit is Rs. 20,000. Since he is guaranteed a minimum of Rs. 25,000, he will receive a deficiency of Rs. 5,000 to meet the guaranteed amount.

Chapter Concept:

Partnership Deed and Provisions

A.

The partner with the highest capital contribution

B.

All partners in their profit-sharing ratio

C.

The partner(s) who guaranteed the minimum profit

D.

The partner with the lowest capital contribution
Correct Answer: C

Solution:

If a partner is guaranteed a minimum profit and the firm's profit is insufficient, the deficiency is borne by the partner(s) who provided the guarantee.

Chapter Concept:

Profit and Loss Appropriation Account

A.

Interest is calculated for 6 months.

B.

Interest is calculated for 6.5 months.

C.

Interest is calculated for 5.5 months.

D.

Interest is calculated for 12 months.
Correct Answer: B

Solution:

When a fixed amount is withdrawn at the beginning of each month, interest on the total amount is calculated for 6.5 months.

Chapter Concept:

Partnership Accounting

A.

60,00060,000

B.

55,00055,000

C.

50,00050,000

D.

45,00045,000
Correct Answer: A

Solution:

Interest on capital is calculated as: Partner X: 250,000×10%=25,000250,000 \times 10\% = 25,000, Partner Y: 200,000×10%=20,000200,000 \times 10\% = 20,000, Partner Z: 150,000×10%=15,000150,000 \times 10\% = 15,000. Total interest = 25,000+20,000+15,000=60,00025,000 + 20,000 + 15,000 = 60,000.

Chapter Concept:

Profit and Loss Appropriation Account

A.

The profit belongs to the partner

B.

The profit must be shared equally among all partners

C.

The partner must account for the profit and pay it to the firm

D.

The profit is used to reduce the firm's debts
Correct Answer: C

Solution:

If a partner derives any profit from the use of the firm's property, he/she must account for the profit and pay it to the firm.

Chapter Concept:

Partnership Deed and Provisions

A.

The deficiency is ignored.

B.

The deficiency is borne by the partner himself.

C.

The deficiency is borne by the existing partners in their profit-sharing ratio.

D.

The deficiency is borne by the partner with the highest capital contribution.
Correct Answer: C

Solution:

The deficiency is borne by the existing partners in their profit-sharing ratio if a partner is guaranteed a minimum profit share.

Chapter Concept:

Partnership Accounting

A.

Interest is charged at 10% per annum

B.

No interest is charged on drawings

C.

Interest is charged at the bank's prevailing rate

D.

Interest is charged at 5% per annum
Correct Answer: B

Solution:

If the partnership agreement does not specify interest on drawings, no interest is charged.

Chapter Concept:

Profit and Loss Appropriation Account

A.

Deficiency is borne by all partners equally.

B.

Deficiency is borne by the partner giving the guarantee.

C.

Deficiency is borne by the old partners in their profit sharing ratio.

D.

Deficiency is not covered and the partner receives Rs. 40,000.
Correct Answer: C

Solution:

The deficiency of Rs. 10,000 is borne by the old partners in their profit sharing ratio.

Chapter Concept:

Partnership Accounting

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Accounting for Partnership: Basic Concepts

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True or False

Correct Answer: False

Solution:

If the partnership deed is silent, no interest on capital is payable to partners. Interest on capital is only credited if it is expressly agreed upon by the partners.

Chapter Concept :

Profit and Loss Appropriation Account

Correct Answer: True

Solution:

Adjustments for omissions or errors in partnership accounts can be rectified either by using a Profit and Loss Adjustment Account or by directly adjusting the capital accounts of the partners.

Chapter Concept :

Past Adjustments in Partnership

Correct Answer: True

Solution:

According to the Indian Partnership Act, a partnership agreement can be oral or written. However, a written agreement is preferred to avoid disputes.

Chapter Concept :

Partnership Deed and Provisions

Correct Answer: False

Solution:

The Indian Partnership Act, 1932 does not require the partnership agreement to be in writing; an oral agreement is equally valid.

Chapter Concept :

Partnership Deed and Provisions

Correct Answer: True

Solution:

According to the provisions of the Partnership Act, if the partnership deed does not specify the profit-sharing ratio, the profits and losses are to be shared equally among the partners.

Chapter Concept :

Profit and Loss Appropriation Account

Correct Answer: True

Solution:

If a partner is guaranteed a minimum profit share and the actual profit share is less than the guaranteed amount, the deficiency is borne by the other partners in their agreed profit-sharing ratio.

Chapter Concept :

Guarantee of Profit to a Partner

Correct Answer: True

Solution:

Adjustments for past errors or omissions can be made directly in the capital accounts of the partners instead of altering old accounts.

Chapter Concept :

Past Adjustments in Partnership

Correct Answer: True

Solution:

Interest on capital is credited to the partners at the agreed rate with reference to the time period for which the capital remained in business during a financial year. It is only allowed when the partnership deed specifically provides for it.

Chapter Concept :

Interest on Capital and Drawings

Correct Answer: True

Solution:

According to the provisions of the Indian Partnership Act, 1932, if the partnership deed is silent on the profit-sharing ratio, profits and losses are shared equally, regardless of the capital contribution.

Chapter Concept :

Partnership Accounting

Correct Answer: False

Solution:

No partner is entitled to get salary or other remuneration for taking part in the conduct of the business of the firm unless there is a provision for the same in the Partnership Deed.

Chapter Concept :

Partnership Accounting

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