Partnership Accounts: Revisions & Profit Guarantees

• This content will discuss partnership account revisions with a focus on fundamental concepts and problem-solving
• It will also cover the topic of guarantee of profits for partnerships

Partnership Accounts Overview

• Partnership accounts involve a book focused on the financial activities of partnerships
• Unlike sole proprietorships, partnerships involve multiple owners (minimum 2, maximum 50)
• Key considerations include how profits are calculated, divided, and whether partners receive extra compensation like salaries or commissions

Comparison to Sole Proprietorship Accounting

• In class 11, accounts were created for sole proprietorships
• The sole proprietorship's books included
  • Trading Account: Resulting in Gross Profit
  • Profit and Loss (P&L) Account: Resulting in Net Profit
  • Balance Sheet: where net profit was added to capital

Chapter Breakdown in Partnership Accounting

• Fundamentals: It contains the basics, like interest on capital and partnership deeds
• Goodwill:
• Change in Profit Sharing Ratio: How accounts change when profit distribution changes
• Admission of a New Partner:
• Retirement/Death of a Partner:
• Dissolution: The end of the partnership firm

Board Exam Relevance

• These partnership topics account for 36 marks of an 80-mark paper

Partnership Deed

• Partnership accounts require careful division of profits and decision-making
• This involves things like each partner's capital contribution and if they will receive a salary
• Decisions are commonly written down in a "Partnership Deed"
• The "partnership deed’ is a document specifying such terms and conditions of a partnership

Rules in Absence of Partnership Deed

• When there isn't a pre-existing partnership deed, the following rules apply
  • Profits and losses are distributed equally regardless of each partner's capital contribution or work
  • No interest on capital for partners' investments in the business
  • No interest charged on drawings (withdrawals) made by partners
  • If the firm takes a loan from a partner it will be repaid at a rate of 6% per annum
  • No bonuses, commissions, or extra salary are given out

Key Accounts in Partnership

• Profit and Loss (P&L) Appropriation Account
• Partners' Current Account
• Partners' Capital Account

Profit and Loss (P&L) Appropriation Account Explained

• The P&L Appropriation Account is an extension of the regular P&L account that is made to calculate Net Profit
• After the account is created, this will be converted into a capital account to track individual funds
• It classifies as a nominal account
• Here expenses are put on the debit side, and total income and gains are put on the credit side

P&L Procedure

• The Net Profit is transferred initially from the P&L account
• The Net Profit is transferred to P&L Appropriation initially
• The firm may then earn from partner activities, such as interest on drawings, this gets credited
• Against that, the firm distributes funds like Interest Of Capital, Salary, Bonuses and Commissions on the debit side

P&L Reserve and Balance

• Following expenses, a firm must set aside a "reserve", this gets debited- This is money that's set aside for the future
• What remains is then known as “Divisible Profit”

The Importance of The Capital Account

• It is essential to track what each partner earns, similar to how a capital account is made to see the increase or decrease of capital, as the divisible profit is technically capital

Capital Account Procedure

• Start with "Opening Capital’ under "Balance, Brought Down" on the credit side, which credits increases to the partner Partners can add more capital, which is called "Additional Capital"
• To then deduct from that, put "Capital Withdrawn" on the debit side, which debits decreases to the funds
• To further credit their funds, put "Interest on Capital”, “Salary, Bonus, Commission” and “Divisible Profit” on the credit side
• To further debit the money available, use interest on drawings
• The account is closed when there is a "Closing Capital” balance

Forms of Capital Accounts

• The capital side is considered "Fluctuating", and so the account can have money added and subtracted from it
• To avoid mixing these funds, the procedure can also consider it "Fixed", This entails using two separate accounts- A "Capital Account", where capital is recorded and kept separate, and a "Current Account", where profit sharing will be recorded separately

Differences Between Capital and Current Account

• The Capital account tracks capital- Open, additional investments and any withdrawals
• The Current account tracks profits- Interest, bonuses, commissions, profit-sharing and drawings

Calculating Interests on Capital Note

• Interest on Capital should always be calculated with respect to "Opening Capital"’, i.e capital available at the start of the accounting period it should not consider capital from later on.
• For example, 1 Lakh from April 1 till the end of the year will yield interest, but any capital you add at a later date may not Interest can be yielded when added later, however, for only the period that it is available

Interest on Capital Example Calculation

• If X introduced ₹10 Lakh on April 1, and then removed ₹4 Lakh after 6 months, one must calculate the interest on the initial amount, and then calculate the interest on the second period If interest is 10%, then the first 6 months will yield ₹50,000, i.e half of the one lakh it yields per year. Then, for the next 6 months, calculate the interest on ₹6 Lakh, yielding ₹30,000. Add the interest to get ₹80,000

Interests on Drawings Examples

• The key is to always calculate the interest relative to the period of time the amount was out of the account
• A number of withdrawals will require separate calculation for each

Interests of Drawings: Simple Vs Product Method

• For Interests on Drawings, there exist a Simple Method and a Product Method
• The Simple method entails calculating interests every time a withdrawal is made
• The Product method has a special formula to quickly calculate these interests. Use the following steps:
  • List out all the drawings separately
  • List out the period of time each drawing was out of the account
  • Multiply the time with the drawings respectively to get a "Product"
  • Add the values of the Products to get a "Sum of Products"
  • Use the Formula, "Sum Of product * Rate/100 * 1/12)

INTEREST ON DRAWINGS SPECIAL CASES

• When the "Amount of Drawings" and the "Time Period of Drawings" are the same, there are shortcuts for calculation
• Time Period of Drawings being the same refers to amounts being drawn on the same basis, like same date of every quarter
• On the other hand, Amount of Drawings must also be the same amount every period

INTEREST ON DRAWINGS SHORTCUT FORMULA

• Calculations are simplified by multiplying total drawings with the interest rate and then multiplying it with a periodic term

SIMPLE/PRODUCT METHOD ALWAYS WORKS

• Simple and product methods always work if there is no short cut. Use these if you are ever confused

Time Period Calculation Formula

Time Period = ( First Time Period + Last Time Period ) / 2 This is used to calculate the time period when amounts are same

Term "Per Annum"- Interest on Drawings Note

• Always make sure that Interest of Drawings include the term "Per Annum" to ensure it uses the full formula Missing this step and this formula may yield highly different amounts

Chart Against Profits

• All deductions from Net Profit are first paid out, and whatever profit is left is then distributed
• In that sense, certain expenses do not have an impact on firm losses, for example, Interests on Loans, Rent and Salaries

Apropriation Out Of Profits

• Other expenses may only be paid out out of the Net Profit available. I.e Interest On Capital, Partner Salaries
• These adjustments are usually paid to partners
• They will be cancelled if there is no profit available

Manager's Commission v Partner's Commissions

• A manager’s commission is a charge from the company, so there shouldn't be an exception for a partner's compensation.
• They can't be cancelled if there is a loss, they have to be paid, whereas with charges against appropriation, a partner's commission is an exception

Firm Loan From Partner v Loan Given By Firm To Partner

• Firm Loan From Partner has an interest that needs to be paid, so it will go on the debit side Loan Given By Firm To Partner can be counted as an interest that will be received, so its income can go on the credit side

Loan: Deed and Interest Considerations

• If there is a deed, the interest will be paid as per the deed. If there is no deed, interest will be paid at 6% per annum
• On the other hand, if there is a case where interest on loans are to be paid out and there is no deed, then there interest is 0%

Past Adjustment

• In a partnership, there may be an adjustment that was necessary, but it was missed, it is only corrected when the error is discovered
• This can then be corrected in an adjustment period
• There can also be an error in amounts that are added, this will all be corrected
• In such a case, this error can be balanced for by giving the error back to the company

Past Adjustments: Types of Errors

• 3 types of errors can occur
  • The partnership is supposed to be assigned something, but was forgotten
  • Amounts are entered are incorrect
  • Distribution of profits is done incorrectly

Basic Past Adjustments Concepts

• The basis of whether a financial decision is helpful or not is dependent on the balance of expenses of losses that are on the debit side, and gains and profits on the credit side
• When a company is credited against its profit, then that represents an increase in their profit
• When a company is debited against its profit, then that represents a loss in their profit
• If anything benefits the partner, there must be a debit.

Important Rule

• Credit is addition and debit is subtraction because their roles vary
• If the partnership firm is credited, then the same must be debited to the partner, its reverse

Calculating Interest on Capital: Key Factor

• Capital is added to the credit side, and from there will yield interest on the credit side

Importance of Drawings

• Note that Capital Withdrawn to Capital, while Drawings are of the profit the partner has, this is a simple calculation
• Both occur on the debit side. The net effect on capital is the same

Drawings: Product Short Cut Method Example

• For a faster approach, consider the method that combines the products for you. Formula: Total of Products * Rate / 100 * ( 1/12 )
• First, each drawings amount must be multiplied with the time period each was out of the account
• The total amount must be multiplied with Rate/100, per year
• A Time Component of * ( 1/12 ) must be factored

Product Method Time Periods Example

• If you are asked to list all events that take place at he "end" of a month, remember the date of the end ( Like with Feb, will there be Feb 28 or Feb 29? )

Common Interest Note: No Need for Time

• If the word "Per Annum" is not given, a Time Period will not be needed

Guarantee of Profits

• Guarantee means a certain amount of profit can be assigned
• An important amount, a good amount can be assured

Guarantee: Partner vs Firm vs Partner-to-Partner

• In order for this to work properly, a partner may have committed to an amount. A Partnership-Firm can commit to one another, etc.. This can either be in writing or verbal.
• As the guarantee is usually in writing, if there is a conflict, the law often steps in- They will first look for the partnership deed. If there is not one, then the default rules will apply

Partnership Commitment Types: P to F

• Here, Partner To Firm commitment occurs
  • One example can be the partner assures the other partners that a product will be high value but did not deliver it. In which his income is lowered if it is made on the short run, and he gets a lot more income if the company does well on the long run.
  • Always a Partner-To-Firm relationship because, as a boss, they are saying that they themselves will be more fruitful for the company. They do not need to compare themselves with their peers- Just how good they can do for their company! As such, if the product turns out to be a dud, they may have to sell personal assets to make up for that promise

Partnership Commitment Types: F to P

• Firm to Partner In this case, the firm tells one of the partners that a certain return is guaranteed
• This is a partnership relationship for two particular types
  • Relationship with the Company
    • Partnership with each other, based on specified ratios

If someone commits an action, in accordance to all rules, that person must be assured of whatever is the final goal

Guarantee and Specified Ratio

• in the absence of the ratio being specified, the average profit is distributed, similar to those where there is no Deed

Guarantee Summary- Order Matters!

• When you do find what to do, then the partner and the company with follow it through, to make sure the last partner gets their cut.
• This can lead to situations where the partnership is not a partnership
• The idea is the same that as long as they are a member of accounting, they must ensure that they get the specified amounts.

Goodwill

• Good Will is essentially the reputation that a partnership firm has acquired overtime
• Because of this, you may want some Good Will
  • The reason that you may choose to purchase that Goodwill is the promise of the original person’s work

Categories of Good Will

• Purchasing Goodwill occurs when you purchase that goodwill when you buy the company
  • This type occurs directly on the balance books
• You can self generate your good will, meaning over an extended period of time, the company and members have developed good will
  • This type does not occur on the books

Goodwill Calculations

Goodwill is calculated in certain cases

• Proportions Change
• Admissions
• Retirements
• Passing Away
• Agreements

5 Goodwill Calculations Listed

• A few examples are
  • Average Profit Mathod
  • Super Profit Method
  • The Weighted Averaging Method
  • Capitalization of average profits per year
  • Capitalization of super profits

Avereage Profit Method

• In the "Average Profit" method, the goodwill is calculated according to your current earnings and sales You basically see the average amount you sell relative to other years
• To calculate Good Will = Average Profit / Number of Years

Average Profit Calculation and "Adjustments”

• Avereage Profit = Sum of Profits / Number of Years The Sum of profits takes Adjustments into account with the below chart

Average Profit: Abnormal Loss Adjustments

• Abnormal loss is an accident or bad occurence that reduces overall annual profit. So these should be added back to the calculation

Average Profit: Abnormal Gain Adjustments

• Abnormal Gains are, simply put, a type of “one trick pony”
  • They will not always happen- So these should be subtracted from the average.
  • Examples may include selling a product at a profit, the product will sell and it will not be available.

Calculation for “Revenue - Capital-“

• “Revenue - Capital” This is, put simply, an expense being booked at capital

Adjustments chart and calculations using REVENUE

• To correct, you would have to reduce the profits because if a revenue is not recorded then the revenue books are wrong
• Then “add back” the depreciation values because the amounts are now more stable due to the adjustment
• When Revenue is wrongly marked as Capital, this means Capital was wrongly marked as Revenue. This calls for the opposite action with adjustment with reverse signs

Close and Open Stocking Adjustments Chart"

• Closing Stock- Is over-valued, meaning less Profit due to miscalculated expenses
  • Therefore this should be subtracted
• Opening Stock- Is conversely, to profit, meaning expenses get affected due to over or under valuations
  • So closing stock is directly related, and opening shares are just less The opening rate gets added back, while the closing stocks are lessened

Weighted Average Formula

• To find the Goodwill score under the Weighted Averaging Method, there is Goodwill amount that can be used

• Total of products * rate / 100 * 1/12

• In this method *1/12, which is used often, needs to factor in the cost to save time and cost

Ratio of Profit to Loss, No Extra Info

• As this goes per usual, the profit is known, since there are no new shares. So these numbers should then equal.

Good Will and Super Averaging- More details

• You are trying to find the good will score by dividing by the number of returns given or the period being considered If the period is not being factored in it will result in some changes to the total score

Average Profit, 4-5 Years, Same Way to do it

• No matter how well you do it, if it has a lower percentage factor than that was previously assessed, then it can create quite a huge negative result in calculations

More Math with Goodwill

• The super average was used to determine that the company is performing in the super tier There are 4 calculations that can be made for goodwill, there are a few methods available too

Super Profit Calulation

• In order to assess this, you will need to be given the actual values of the goodwill or rate to apply for the calculation

Super Profit Math

• Super Profit = Average Profit / Normal Profit Normal profit is calculated Capital / NRR / 100
• To find the score the good will, you use normal formulas, but must use the rates per 100 to accurately rate the good will
• By assessing the different aspects of the good will, it can have a more appropriate rate assigned to it to determine a more appropriate rate

Capitalizing Scores

• When capital is increased, and profits aren't then that might mean the capitalization was used
• “Total value - Capital Employed”, while the Super Profit uses that as well with minor differences

Capital Employed

• You can capitalize on Super Profit by using profit/NRR/100, this requires prior numbers, while the other does not

Admission: Share Percentages Note

• Admissions are where members come together from separate entities. Percentages may vary quite a bit and thus proper tracking will then occur. It begins with assessing the percentage and other share related metrics

New Profit Shares: Notes Before Dividing

New Profit Scores are those that now have to be split among people. These require notes because those will have to be assessed for

One Key Note- When You Lose, It's a Chain Recation

It must be remembered that if you make an adjustment on one year make sure to carry over and make the same adjustment per every year that it affects, One mistake can create chain side effects- It is always correct to ask for help if needed

Gaining the Upper Hand.

We now find, on the other hand, the side we use often

• These new, smaller, amounts are a direct consequence of your previous numbers. These are for the calculations that we see every day. By always being aware of the numbers we have to come to know, we should start to make sure that they do equal the correct number to save time and effort later on!

After That Profit: Short

We know that when we make an error, it's an iterative process- One step leads to another. Make sure you are being careful and doing the due diligence required to make the most proper checks needed. There will also be others to look for when you do make mistakes

This is a Game- Plan accordingly, follow through.

In the real world, you don't have to follow the linear equation to get a reward. The main factor I do like, with you reading, is keeping it slow and steady.

What's What

The new ratio or percentage you may want to take May often be too hot or too cold for you. You may often have to make a change to what you do.

Next Stop, Number 3.

So you will then apply your number by following the ratio It then happens that the money goes where it needs to go. But again if that does not workout then

But This is When It Has To Stop.

This is for when an emergency hits and must use a time saver, A shortcut- If need be. There is no other behavior.

• However, the game is about to change to its highest degree For you will need not only be knowing of money But if other types of assets, a new reality.

This Will Take A Load Off Of You.

We will now learn of those of accounts of loans. For this is something that all accounting professionals own.

• From receiving and giving interest is what we have to see For to master giving and seeing is the next degree.

• We use money out of the debt in the debt side So that it balances with the company's amount of pride.

• You show who takes out the credit and who decides its fate For that money with them at this time You must ask when you receive the money at a rate.

• Don't get confused with the terms as we go down these steps For the terms which will come are where knowledge has been kept.

• A high probability is here, to check what you understand from that. For one step here miscalculated will set the trap.

We Don't Miss, Ever.

How many students say that as they make silly errors in tests. Yet there are only so many silly errors that should pass.

• In such cases you learn how much it works on you, For when you come back like a bullet in the test That is as important as when you go through.

• But this is your time, to prepare, So you may make the most efficient choices, And to have the right equipment and devices, And to have the best teacher! Because he cares!

Now Remember To Be Fair.

For you will want to be fair, all the time. And for that it will result well over time.

• Because what will come through may be a change Will the people that were from the former get the range.

• Now the people that have had more of the game You will need to try extra hard to put them in the hall of fame.

• Now, remember there will be some with better qualities Some must be helped as some have some high causalities.

• This is where the old accounts fall by the way For here, not for the old, but the new, is where we stay.

The End

• All will go as said.

Explore partnership account revisions, covering key concepts and problem-solving techniques. Understand the differences between partnership and sole proprietorship accounting. It will also discuss profits & guarantee of profits for partnerships.