Partnership Account: Firm Basics

Partnership Account

• A partnership involves business carried on by all or any one of them acting on behalf of everyone involved
• The partnership involves an agreement entered into by all individuals concerned
• A partnership requires the existence of some kind of business
• Within a partnership, there is unlimited liability for all partners
• Partnerships are an association of two or more persons
• Partnerships involve the sharing of profits and losses of the business
• As per Section 4 of the Partnership Act, 1932, partnership is defined as the relation between persons who have agreed to share the profit of a business carried on by all or any of them acting for all.

Accounts of partnership firm

• Trading and Profit, and Loss Account and Balance Sheet are components of partnership firms
• The Profit and Loss Appropriation Account is a component of partnership firms
• Capital accounts of a partner can be determined by either the fixed capital method or fluctuating capital method

Features of a Partnership

• The relation of partnership arises from contract between parties and not from status as it happens in case of HUF (Hindu Undivided Family)
• A formal or written agreement is not necessary to create a partnership.
• A partnership can exist only for business
• Section 2 (b) of Indian Partnership Act, 1932 states that business includes every trade, occupation, and profession
• Parties concerned must agree to share business profits
• Section 4 of Indian Partnership Act, 1932 does not insist upon sharing of losses, meaning a provision for sharing of loss is not necessary.
• Mutual agency means business is carried on by all or any of them acting for all
• Thus, if the person carrying on the business acts not only for themselves, but for others as principals and agents, they are partners.

Number of partners

• The minimum number of partners you can have is two
• The maximum number of partners you can have is 50 as per Section 464 of the Companies Act, 2013
• No association or partnership consisting of more than 100 number of persons as may be prescribed can be formed for carrying on any business
• Rule 10 of Companies (incorporation) Rules 2014 specifies the limit as 50, meaning the max number member is 50

Limited Liability Partnership

• A Limited Liability Partnership (LLP) is viewed as an alternative corporate business proposal that provides the benefits of limited liability
• LLPs permit members the flexibility of organizing their internal structure as a partnership, which is based on a mutually arrived agreement
• The LLP will be a separate legal entity, liable to the full extent of its assets
• The liability of the partners is limited to their agreed contribution in the LLP which may be tangible or intangible, or both tangible and intangible in nature
• No partner is liable on account of the independent or unauthorized actions of other partners or their misconduct
• The liabilities of the LLP and partners who are found to have acted with intent to defraud Creditors or for any fraudulent purpose are unlimited for all or any of the debts or other liabilities of the LLP
• The main benefit in an LLP is that it is taxed as a partnership, but has the benefits of being a corporate, or more significantly, a juristic entity with limited liability
• An LLP has the special characteristic of being a separate legal personality distinct from its partners
• The LLP is à body corporate in nature.
• The Limited Liability Partnerships (LLPs) in India were introduced by the Limited Liability Partnership Act, 2008
• The Limited Liability Partnership Act lays down the law for the formation and regulation of Limited Liability Partnerships.
• Limited liability partnership is defined as a partnership formed and registered under the Act
• Limited liability partnership agreement means any written agreement between the partners of the limited liability partnership or between the limited liability partnership and its partners
• Any individual or body corporate may be a partner in a limited liability partnership, as per the LLP Act
• An individual is barred from becoming a partner of a limited liability partnership if he or she has been found to be of unsound mind by a Court of competent jurisdiction and the finding is in force, is an undischarged insolvent, or has applied to be adjudicated as an insolvent and his application is pending.
• Every limited liability partnership must have at least two partners.
• If at any time the number of partners of a limited liability partnership is reduced below two and the limited liability partnership carries on business for more than six months while the number is so reduced, the person who is the only partner of the limited liability partnership during the time that it so carries on business after those six months and has the knowledge of the fact that it is carrying on business with him alone, shall be liable personally for the obligations of the limited liability partnership incurred during that period.

Distinction between an ordinary partnership firm and an LLP

• An ordinary partnership allows individual partners to come and go, not so for LLPs
• In a partnership, a firm cannot own assets, but in a LLP they can
• Partnerships have unlimited liability to its members
• Limited liability partnerships have limited liability for their members
• Partnerships are each others agents but in a LLP they are only agents for the firm, not each other

Main clauses requried in a Partnership Deed

• Name of the firm and the partners are required in a partners deed
• Commencement and duration of business are required in a partners deed
• Amount of capital to be contributed by each partner is required in a partners deed
• Amount to be allowed to each partner as drawings and the timings of such drawings are required in a partners deed
• Rate of interest to be allowed to each partner on their capital and on their loan to the firm, and to be charged on their drawings;
• The ratio in which profits or losses are to be shared
• Variation to mutual agreed upon rights and duties of the partner
• Procedure for valuing the good will

Rules in the Absence of Partnership Deed

• No partner has the right to a salary
• No interest is to be allowed on capital
• No interest is to be charged on the drawings
• Interest at the rate of 6% per annum is to be allowed on a partner's loan to the firm
• Profits and losses are to be shared equally
• In the absence of an agreement, the interest and salary payable to a partner will be paid only if there is profit.

Powers of Partners

• Powers include buying and selling of goods, receiving payments on behalf of the firm and giving valid receipt
• Include drawing cheques and drawing, accepting and endorsing bills of exchange and promissory notes in the name of the firm
• Include borrowing money on behalf of the firm with or without pledging the inventories-in-trade and engaging servants for the business of the firm

Accounts

• The Partnership Act does not specify any format for the preparation of accounts of a Partnership Firm, and thus accounts are prepared as per the basic rules of partnership accounts
• There is not much difference between the accounts of a partnership firm and that of sole proprietorship (provided there is no change in the firm itself)
• The only difference to be noted is that instead of one Capital Account there will be as many Capital Accounts as there are partners
• When a partner takes money out of the firms for their domestic purpose, either his Capital Account can be debited or a separate account named as Drawings Account can be opened in his name, and the account may be debited
• A Trial Balance of a partnership firm, may contain Capital Accounts of partners as well as Drawings Accounts
• Finally, the Drawings Account of a partner may be transferred to his Capital Account so that a net figure is available
• Generally the Drawings Account or Current Account (as it is usually called) remains separate

Profit and Loss Appropriation Account

• During the course of business, a partnership firm will prepare a Trading Account and a Profit and Loss Account at the end of every year.
• The final accounts of a sole proprietorship concern will not differ from the accounts of a partnership firm.
• The Profit and Loss Account will show the profit earned by the firm or loss suffered by it
• This profit or loss has to be transferred to the Capital Accounts of partners according to the terms of the Partnership Deed or according to the provisions of the Indian Partnership Act (if there is no Partnership Deed or if the Deed is silent on a particular point).

Two methods of accounting

• Fluctuation, in which no current account is maintained and all such transactions and events are passed through capital accounts.
• Fixed, in which initially capital is contributed by the partners

Interest on capital

• If capitals are fluctuating and current accounts, if capitals are fixed, amount of interest is debited to interests on capital accounts and credited to capital accounts
• Credit the capital (or current) account of the partner concerned and debit the profit and loss appropriation account

Guarantee of Minimium Profit

• One partner can enjoy the right to have a minimum amount of profit in a year as per the terms of the partnership agreement
• Deficiency share of profit is shared by the remaining partners

Capital Ratio

• Partners may agree to share profits and losses in this ratio
• profits will be shared in the ratio of given capitals if capitals are fixed
• capitals for the purpose of ratio would be determined with reference to time on weighted average if fluctuation occurs

Valuation of Goodwill

• Goodwill is the value of reputation of a firm in respect of profits expected in future over and above the normal rate of profits
• Valuation is required upon change in profit sharing ratio, admission of partner, retirement, dissolution

Methods of Valuation of Goodwill

• Average profit =total profit/number of years
• goodwill = average profit X no. of year's purchase
• Super Profit is average profit - normal profit
• goodwill = super profit X number of years