What is a partnership and a partnership deed?
A partnership is a relation between people who agree to share the profits of a business run by all of them, or by any of them acting for all. Each person is a partner; together they are the firm.
- At least 2 persons; at most 50 (Companies Rules).
- There must be an agreement and a business with a profit motive.
- Liability of partners is unlimited.
The written agreement is the partnership deed. It usually states: capital of each partner, profit-sharing ratio, interest on capital and drawings, salary or commission, and rules for admission, retirement and dissolution.
Rules of the Partnership Act 1932 when there is no deed
If there is no deed, or the deed is silent on a point, the Act applies:
- Profit and loss: shared equally.
- Interest on capital: not allowed.
- Interest on drawings: not charged.
- Salary or commission to a partner: not allowed.
- Interest on a partner's loan to the firm: 6% a year.
Tip: 6% on a loan is paid even if the firm has a loss, because it is a charge.
Fixed and fluctuating capital accounts
Fixed capital method: each partner has two accounts. The capital account shows only the capital brought in (and any extra capital or permanent withdrawal). A separate current account gets interest on capital, salary, commission, share of profit, drawings and interest on drawings. The capital account always has a credit balance; the current account can have a debit balance.
Fluctuating capital method: only one capital account; all the items above go into it, so its balance changes every year.
If the question says nothing, use the fluctuating method.
Profit and Loss Appropriation Account
First find the net profit in the Profit and Loss Account. Charges against profit come here: interest on a partner's loan, rent paid to a partner, manager's commission.
Then the P&L Appropriation Account shows how that profit is divided:
- Credit side: net profit b/d, interest on drawings.
- Debit side: interest on capital, partners' salary and commission, transfer to reserve, and the balance shared in the profit-sharing ratio.
Interest on capital and on drawings
Interest on capital = capital × rate × time. If capital changes in the year, find interest for each period. Interest on drawings on equal monthly drawings: at the start of each month use 6.5 months, in the middle 6 months, at the end 5.5 months (on the total).
When profit is too small
If the deed treats interest on capital as an appropriation and profit is less than the total interest, profit is shared in the ratio of interest. No interest is given in a loss.
Guarantee of profit to a partner
Sometimes a partner (often a new one) is promised a minimum profit. If his share is less, the shortfall (deficiency) is borne by:
- one partner, or
- all old partners in their profit ratio, or
- partners in an agreed ratio.
The entry: Guarantor's Capital/Current A/c Dr, To Guaranteed partner's Capital/Current A/c. A firm can also guarantee a minimum total profit.
Past adjustments
After accounts are closed, a mistake may be found: interest on capital was left out, or profit was shared in the wrong ratio. Instead of reopening the accounts, make one adjustment entry between partners' capital (or current) accounts.
- Make a table: what each partner should have got (interest, salary, profit).
- Subtract what each did get.
- A plus means credit that partner; a minus means debit. The totals must add to zero.
Key formulas and definitions
- Interest on capital = Capital × Rate × Time/12 (months)
- Interest on drawings (equal monthly, total D): start → D×r×6.5/12; middle → 6/12; end → 5.5/12
- Divisible profit = Net profit + Interest on drawings − Interest on capital − Salary − Commission − Reserve
- Commission as % of profit after commission = Profit × rate ÷ (100 + rate)
- Deficiency on guarantee = Guaranteed amount − Actual share
- No deed: equal sharing, no IoC, no salary, loan interest 6% p.a.
Worked examples
1. Asha and Bilal have capitals of ₹2,00,000 and ₹1,00,000. Interest on capital 10%, Bilal's salary ₹24,000, ratio 3:2. Net profit ₹1,20,000. Share the profit.
IoC: Asha ₹20,000, Bilal ₹10,000. Salary ₹24,000. Left: 1,20,000 − 30,000 − 24,000 = ₹66,000. Asha 3/5 = ₹39,600; Bilal 2/5 = ₹26,400.
2. C and D have no deed. C gave the firm a loan of ₹50,000. C's capital ₹1,00,000, D's ₹60,000. Profit before loan interest ₹43,000. C asks for 10% interest on capital and 12% on loan. Settle it.
Act applies: no interest on capital; loan interest 6%: 50,000 × 6% = ₹3,000 (charge). Profit left ₹40,000 shared equally: ₹20,000 each.
3. E withdrew ₹2,000 at the start of every month. Interest on drawings is 6% p.a. Find it.
Total drawings = ₹24,000. Start of month → 6.5 months. Interest = 24,000 × 6/100 × 6.5/12 = ₹780.
4. F's capital on 1 April was ₹1,00,000. On 1 October he added ₹40,000. Interest 8% p.a. Find interest for the year.
1,00,000 × 8% = ₹8,000 for full year; 40,000 × 8% × 6/12 = ₹1,600. Total ₹9,600.
5. Manager gets 10% commission on net profit after charging his commission. Profit before commission ₹66,000. Find his commission.
66,000 × 10/110 = ₹6,000.
6. G, H share 3:2. K is admitted for 1/6 share with a guarantee of ₹20,000. Profit ₹90,000. Deficiency borne by G and H in 3:2. Find final shares.
K gets 90,000 × 1/6 = 15,000; short ₹5,000. Rest 75,000 in 3:2 → G 45,000, H 30,000. Deficiency: G bears 3,000, H 2,000. Final: G 42,000; H 28,000; K 20,000.
7. P and Q (capitals ₹60,000 and ₹40,000, equal sharing) forgot 10% interest on capital after closing accounts. Pass the adjustment.
Should get: P 6,000, Q 4,000 (total 10,000). This 10,000 was shared equally instead: P −5,000, Q −5,000. Net: P +1,000, Q −1,000. Entry: Q's Capital A/c Dr ₹1,000, To P's Capital A/c ₹1,000.
8. X and Y share 2:1. Interest on capital is an appropriation: X ₹12,000, Y ₹6,000. Profit is only ₹9,000. Share it.
Profit < interest, so share in ratio of interest 12,000:6,000 = 2:1 → X ₹6,000, Y ₹3,000. Nothing more.
Common mistakes
- Putting interest on a partner's loan in the Appropriation Account. It is a charge and goes to the P&L Account.
- Giving interest on capital when there is no deed. The Act allows none.
- Recording drawings in the capital account under the fixed method. They go to the current account.
- In a past adjustment, passing one entry for each item. Net all items per partner into one entry.