Accountancy Class 12: Partnership Firms

• Accountancy for Class 12 covers partnership firms, which are business structures where two or more individuals agree to share in the profits or losses of a business.

Partnership

• A partnership is defined as the relationship between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.
• The main features of a partnership include: Agreement, Association of two or more persons, Profit Sharing, Mutual Agency and Lawful Business.
• The Indian Partnership Act, 1932 governs partnerships in India.

Partnership Deed

• A partnership deed is a written agreement among the partners that outlines the terms and conditions of the partnership.
• Typical contents of a partnership deed include: Names and addresses of the firm and partners, Nature of business, Date of commencement, Duration of Partnership, Profit and loss sharing ratio, Capital contribution, Interest on capital and drawings, Salaries and/or commissions, and Dispute resolution mechanisms.
• If a partnership deed is silent on certain aspects, the provisions of the Indian Partnership Act, 1932 apply.
• According to the Partnership Act, in the absence of a partnership deed, profits and losses are to be shared equally, no interest is allowed on capital, no interest is charged on drawings, no salary or remuneration is paid to partners, and interest at 6% per annum is allowed on loans advanced by a partner to the firm.

Capital Accounts

• There are two methods for maintaining partners' capital accounts: Fixed Capital Method and Fluctuating Capital Method.
• Under the Fixed Capital Method, the capital of the partners remains constant except under circumstances such as introduction of additional capital or withdrawal of capital. All transactions like share of profit or loss, interest on capital, drawings, etc. are recorded in a separate account called 'Partners' Current Account'.
• Under the Fluctuating Capital Method, all transactions are recorded directly in the partners' capital accounts. Thus, capital balances fluctuate. There is no current account.

Profit and Loss Appropriation Account

• The Profit and Loss Appropriation Account is an extension of the Profit and Loss Account.
• It shows how the net profit or net loss of the firm is distributed among the partners.
• Items typically recorded in the Profit and Loss Appropriation Account include: Interest on capital, Partner's salaries or commissions, Transfer to reserves, and Division of profit or loss.

Accounting for Partnership Transactions

• Interest on Capital: It is calculated on the opening balance of the capital account. If the partnership deed provides for interest on capital, it is debited to the Profit and Loss Appropriation Account and credited to the partner's capital or current account.
• Partner's Salary/Commission: If a partner is entitled to a salary or commission, it is also debited to the Profit and Loss Appropriation Account and credited to the partner's capital or current account.
• Interest on Drawings: Drawings are the amounts withdrawn by partners for personal use. Interest on drawings is charged if provided in the partnership deed. It is credited to the Profit and Loss Appropriation Account and debited to the partner's capital or current account.

Goodwill

• Goodwill is an intangible asset representing the reputation of the firm and its ability to earn higher profits compared to other firms in the same industry.
• Factors affecting goodwill include: Efficiency of management, Favorable location, Quality of products, Customer relations, and Market situation.
• Methods for valuing goodwill are: Average Profits Method, Super Profits Method, and Capitalization Method (Capitalization of Average Profits or Capitalization of Super Profits).
• Average Profits Method: Goodwill is calculated by multiplying the average of past years' profits by an agreed number of years' purchase.
• Super Profits Method: Super profits are the excess of actual average profits over the normal profits. Goodwill is calculated by multiplying the super profits by an agreed number of years' purchase.
• Capitalization Method: Goodwill is determined by capitalizing either average profits or super profits.
• When there is a change in the profit-sharing ratio among existing partners, one or more partners gain, and one or more partners lose, thus requiring an adjustment for goodwill. The gaining partner(s) compensate the losing partner(s) for the share of goodwill.

Reconstitution of a Partnership Firm

• Reconstitution of a partnership firm occurs when there is a change in the existing agreement among the partners.
• Modes of reconstitution include: Change in profit-sharing ratio, Admission of a new partner, Retirement of a partner, Death of a partner and Amalgamation of firms.

Admission of a Partner

• When a new partner is admitted, the existing partnership firm is reconstituted.
• Adjustments required on admission of a partner: Change in profit-sharing ratio, Accounting for goodwill, Revaluation of assets and reassessment of liabilities and Adjustment of accumulated profits and losses.
• The new partner brings in capital as per the agreed terms.
• The sacrificing ratio is the ratio in which the old partners agree to sacrifice their share of profit in favor of the new partner.
• The new profit-sharing ratio is calculated considering the old ratio and the sacrifice made by the old partners.

Retirement/Death of a Partner

• When a partner retires or dies, the partnership firm is reconstituted.
• The retiring/deceased partner is entitled to his/her share of capital, share of goodwill, share of accumulated profits or losses, interest on capital, salary (if any), and share in the revaluation of assets and liabilities.
• The amount due to the retiring/deceased partner is usually paid off in installments or transferred to a loan account if immediate payment is not possible.
• In case of death of a partner, the amount due is paid to his/her legal representatives.

Dissolution of a Partnership Firm

• Dissolution of a partnership firm means the termination of the partnership agreement among all the partners.
• Dissolution can occur through: Agreement, Compulsory dissolution, On the happening of certain events, By notice, or By order of the court.
• On dissolution, the assets of the firm are realized, and the liabilities are paid off.
• A Realization Account is prepared to record the realization of assets and settlement of liabilities.
• The final balance in the Realization Account represents the profit or loss on realization, which is distributed among the partners in their profit-sharing ratio.