Accounts Chapter 1 (Grade 12) PDF

Accounting for Partnership: Basic Concepts 1 LEARNING OBJECTIVES Y ou have learnt about the preparation of financial statements for a sole proprietary concern. As the...

Accounting for Partnership: Basic Concepts 1 LEARNING OBJECTIVES Y ou have learnt about the preparation of financial statements for a sole proprietary concern. As the business expands, one needs more capital and After studying this chapter, larger number of people to manage the business and you will be able to : share its risks. In such a situation, people usually Define partnership and adopt the partnership form of organisation. list its essential features; Accounting for partnership firms has it’s own Identify the provisions of peculiarities, as the partnership firm comes into the Indian Partnership existence when two or more persons come together Act 1932 that are relevant for accounting; to establish business and share its profits. On many Prepare partners’ capital issues affecting distribution of profits, there may not accounts under fixed and be any specific agreement between the partners. In fluctuating capital such a situation the provisions of the Indian methods; Partnership Act 1932 apply. Similarly, calculation Explain the distribution of interest on capital, interest on drawings and profit or loss among the partners and prepare the maintenance of partners capital accounts have their Profit and Loss own peculiarities. Not only that a variety of Appropriation Account; adjustments are required on the death of a partner Calculate interest on or when a new partner is admitted and so on. These capital and drawing under various situations; peculiar situations need specific treatment in Explain how guarantee accounting that need to be clarified. for a minimum amount The present chapter discusses some basic of profit affects the aspects of partnership such as distribution of profit, distribution of profits among the partners; maintenance of capital accounts, etc. The treatment of situations like admission of partner, retirement, Make necessary adjustments to rectify death and dissolution have been taken up in the the past errors in subsequent chapters. partners capital accounts; and 1.1 Nature of Partnership Prepare final accounts of a partnership firm; 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. Section 4 of the Indian Partnership Act 1932 defines partnership as the Rationalised 2023-24 2 Accountancy – Not-for-Profit Organisation and Partnership Accounts ‘relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all’. Persons who have entered into partnership with one another are individually called ‘partners’ and collectively called ‘firm’. The name under which the business is carried is called the ‘firm’s name’. A partnership firm has no separate legal entity, apart from the partners constituting it. Thus, the essential features of partnership are: 1. Two or More Persons: In order to form partnership, there should be at least two persons coming together for a common goal. In other words, the minimum number of partners in a firm can be two. There is however, a limit on their maximum number. By virtue of Section 464 of the Companies Act 2013, the Central Government is empowered to prescribe maximum number of partners in a firm but the number of partners can not be more than 100. The Central government has prescribed the maximum number of partness in a firm to be 50. 2. Agreement: Partnership is the result of an agreement between two or more persons to do business and share its profits and losses. The agreement becomes the basis of relationship between the partners. It is not necessary that such agreement is in written form. An oral agreement is equally valid. But in order to avoid disputes, it is preferred that the partners have a written agreement. 3. Business: The agreement should be to carry on some business. Mere co- ownership of a property does not amount to partnership. For example, if Rohit and Sachin jointly purchase a plot of land, they become the joint owners of the property and not the partners. But if they are in the business of purchase and sale of land for the purpose of making profit, they will be called partners. 4. Mutual Agency: The business of a partnership concern may be carried on by all the partners or any of them acting for all. This statement has two important implications. First, every partner is entitled to participate in the conduct of the affairs of its business. Second, that there exists a relationship of mutual agency between all the partners. Each partner carrying on the business is the principal as well as the agent for all the other partners. He can bind other partners by his acts and also is bound by the acts of other partners with regard to business of the firm. Relationship of mutual agency is so important that one can say that there would be no partnership, if the element of mutual agency is absent. 5. Sharing of Profit: Another important element of partnership is that, the agreement between partners must be to share profits and losses of a business. Though the definition contained in the Partnership Act describes partnership as relation between people who agree to share the profits of a business, the sharing of loss is implied. Thus, sharing of profits and Rationalised 2023-24 Accounting for Partnership : Basic Concepts 3 losses is important. If some persons join hands for the purpose of some charitable activity, it will not be termed as partnership. 6. Liability of Partners: Each partner is liable jointly with all the other partners and also severally to the third party for all the acts of the firm done while he is a partner. Not only that the liability of a partner for acts of the firm is also unlimited. This implies that his private assets can also be used for paying off the firm’s debts. 1.2 Partnership Deed Partnership comes into existence as a result of agreement among the partners. The agreement can be either oral or written. The Partnership Act does not require that the agreement must be in writing. But wherever it is in writing, the document, which contains terms of the agreement is called ‘Partnership Deed’. It generally contains the details about all the aspects affecting the relationship between the partners including the objective of business, contribution of capital by each partner, ratio in which the profits and the losses will be shared by the partners and entitlement of partners to interest on capital, interest on loan, etc. The clauses of partnership deed can be altered with the consent of all the partners. The deed should be properly drafted and prepared as per the provisions of the ‘Stamp Act’ and preferably registered with the Registrar of Firms. Contents of the Partnership Deed The Partnership Deed usually contains the following details: Names and Addresses of the firm and its main business; Names and Addresses of all partners; Amount of capital to be contributed by each partner; The accounting period of the firm; The date of commencement of partnership; Rules regarding operation of Bank Accounts; Profit and loss sharing ratio; Rate of interest on capital, loan, drawings, etc; Mode of auditor’s appointment, if any; Salaries, commission, etc, if payable to any partner; The rights, duties and liabilities of each partner; Treatment of loss arising out of insolvency of one or more partners; Settlement of accounts on dissolution of the firm; Method of settlement of disputes among the partners; Rules to be followed in case of admission, retirement, death of a partner; and Any other matter relating to the conduct of business. Normally, the partnership deed covers all matters affecting relationship of partners amongst themselves. However, if there is no express agreement on certain matters, the provisions of the Indian Partnership Act, 1932 shall apply. Rationalised 2023-24 4 Accountancy – Not-for-Profit Organisation and Partnership Accounts 1.2.1 Provisions of Partnership Act Relevant for Accounting The important provisions affecting partnership accounts are as follows: (a) Profit Sharing Ratio: If the partnership deed is silent about the profit sharing ratio, the profits and losses of the firm are to be shared equally by partners, irrespective of their capital contribution in the firm. (b) Interest on Capital: No partner is entitled to claim any interest on the amount of capital contributed by him in the firm as a matter of right. However, interest can be allowed when it is expressly agreed to by the partners. Thus, no interest on capital is payable if the partnership deed is silent on the issue. (c) Interest on Drawings: No interest is to be charged on the drawings made by the partners, if there is no mention in the Deed. (d) Interest on Loan: If any partner has advanced loan to the firm for the purpose of business, he/she shall be entitled to get an interest on the loan amount at the rate of 6 per cent per annum. (e) Remuneration for Firm’s Work: 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. Apart from the above, the Indian Partnership Act specifies that subject to contract between the partners: (i) If a partner derives any profit for him/her self from any transaction of the firm or from the use of the property or business connection of the firm or the firm name, he/she shall account for the profit and pay it to the firm. (ii) If a partner carries on any business of the same nature as and competing with that of the firm, he/she shall account for and pay to the firm, all profit made by him/her in that business. Test your Understanding – I 1. Mohan and Shyam are partners in a firm. State whether the claim is valid if the partnership agreement is silent in the following matters: (i) Mohan is an active partner. He wants a salary of Rs. 10,000 per year; (ii) Shyam had advanced a loan to the firm. He claims interest @ 10% per annum; (iii) Mohan has contributed Rs. 20,000 and Shyam Rs. 50,000 as capital. Mohan wants equal share in profits. (iv) Shyam wants interest on capital to be credited @ 6% per annum. 2. State whether the following statements are true or false: (i) Valid partnership can be formulated even without a written agreement between the partners; (ii) Each partner carrying on the business is the principal as well as the agent for all the other partners; (iii) Maximum number of partners can be 50; (iv) Methods of settlement of dispute among the partners can’t be part of the partnership deed; Rationalised 2023-24 Accounting for Partnership : Basic Concepts 5 (v) If the deed is silent, interest at the rate of 6% p.a. would be charged on the drawings made by the partner; (vi) Interest on partner’s loan is to be given @ 12% p.a., if the deed is silent about the rate. 1.3 Special Aspects of Partnership Accounts Accounting treatment for partnership firm is similar to that of a sole proprietorship business with the exception of the following aspects: Maintenance of Partners’ Capital Accounts; Distribution of Profit and Loss among the partners; Adjustments for Wrong Appropriation of Profits in the Past; Reconstitution of the Partnership Firm; and Dissolution of Partnership Firm. The first three aspects mentioned above have been taken up in the following sections of this chapter. The remaining aspects have been covered in the subsequent chapters. 1.4 Maintenance of Capital Accounts of Partners All transactions relating to partners of the firm are recorded in the books of the firm through their capital accounts. This includes the amount of money brought in as capital, withdrawal of capital, share of profit, interest on capital, interest on drawings, partner’s salary, commission to partners, etc. There are two methods by which the capital accounts of partners can be maintained. These are: (i) fixed capital method, and (ii) fluctuating capital method. The difference between the two lies in whether or not the transactions other than addition/withdrawal of capital are recorded in the capital accounts of the partners. (a) Fixed Capital Method: Under the fixed capital method, the capitals of the partners shall remain fixed unless additional capital is introduced or a part of the capital is withdrawn as per the agreement among the partners. All items like share of profit or loss, interest on capital, drawings, interest on drawings, etc. are recorded in a separate accounts, called Partner’s Current Account. The partners’ capital accounts will always show a credit balance, which shall remain the same (fixed) year after year unless there is any addition or withdrawal of capital. The partners’ current account on the other hand, may show a debit or a credit balance. Thus under this method, two accounts are maintained for each partner viz., capital account and current account, While the partners’ capital accounts shall always appear on the liabilities side in the balance sheet, the partners’ current account’s balance shall be shown on the liabilities side, if they have credit balance and on the assets side, if they have debit balance. The partner’s capital account and the current account under the fixed capital method would appear as shown in Fig.1.1. Rationalised 2023-24 6 Accountancy – Not-for-Profit Organisation and Partnership Accounts Partner’s Capital Account Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount (Rs.) (Rs.) Bank (permanent xxx Balance b/d xxx withdrawal of capital) (opening balance) Balance c/d xxx Bank (fresh capital xxx (closing balance) introduced) xxx xxx Partner’s Current Account Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount (Rs.) (Rs.) Balance b/d xxx Balance b/d xxx (in case of debit (in case of credit opening balance) opening balance) Drawings xxx Salary xxx Interest on drawings xxx Commission xxx Profit & Loss a/c xxx Interest on capital Profit & Loss xxx Appropriation Balance c/d xxx (share of profit) (in case of credit Balance c/d xxx closing balance) (in case of debit closing balance) xxxx xxxx Fig. 1.1: Proforma of Partner’s Capital and Current Account under Fixed Capital Method. (b) Fluctuating Capital Method: Under the fluctuating capital method, only one account, i.e. capital account is maintained for each partner. All the adjustments such as share of profit and loss, interest on capital, drawings, interest on drawings, salary or commission to partners, etc are recorded directly in the capital accounts of the partners. This makes the balance in the capital account to fluctuate from time to time. That’s the reason why this method is called fluctuating capital method. In the absence of any instruction, the capital account should be prepared by this method. The proforma of capital accounts prepared under the fluctuating capital method is given in Fig.1.2. Rationalised 2023-24 Accounting for Partnership : Basic Concepts 7 Partner’s Capital Account Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount (Rs.) (Rs.) Balance b/d (in case xxx Balance b/d (in case xxx of debitclosing of credit opening balance) balance) Drawings Bank (fresh xxx Interest on drawings xxx capital introduced) Profit and Loss xxx Salaries xxx A/c Interest on capital xxx (for share of loss) Profit and Loss xxx Balance c/d (in case xxx Appropriation of credit closing (for share of profit) balance) Balance b/d (in case xxx of debit closing balance) xxxx xxxx Fig. 1.2: Proforma of Partner’s Capital Account under Fluctuating capital Method. 1.4.1 Distinction between Fixed and Fluctuating Capital Accounts The main points of differences between the fixed and fluctuating capital methods can be summed up as follows: Basis of Distinction Fixed Capital Fluctuating Capital (i) Number of Under this method, two Each partner has one account, accounts separate accounts are i.e. capital account, under this maintained for each partner method viz., ‘capital account’ and ‘current account’. (ii) Items related Drawings, salary,interest All adjustments for drawings, to deed on capital,etc. are posted salary interest on capital, etc., (transfered) in the current are posted (transfered) in the accounts and not in the capital accounts, capital accounts. (iii) Fixed balance The capital account balance The balance of the capital remain unchanged unless account fluctuates from year there is addition to or to year withdrawal of capital. (iv) Credit balance The capital accounts The capital account always show a credit balance. may sometimes show a debit balance. Rationalised 2023-24 8 Accountancy – Not-for-Profit Organisation and Partnership Accounts 1.5 Distribution of Profit among Partners The profits and losses of the firm are distributed among the partners in an agreed ratio. However, if the partnership deed is silent, the firm’s profits and losses are to be shared equally by all the partners. You know that in the case of sole partnership the profit or loss, as ascertained by the profit and loss account is transferred to the capital account of the proprietor. In case of partnership, however, certain adjustments such as interest on drawings, interest on capital, salary to partners, and commission to partners are required to be made. For this purpose, it is customary to prepare a Profit and Loss Appropriation Account of the firm and ascertain the final figure of profit and loss to be distributed among the partners, in their profit sharing ratio. 1.5.1 Profit and Loss Appropriation Account Profit and Loss Appropriation Account is merely an extension of the Profit and Loss Account of the firm. It shows how the profits are appropriated or distributed among the partners. All adjustments in respect of partner’s salary, partner’s commission, interest on capital, interest on drawings, etc. are made through this account. It starts with the net profit/net loss as per Profit and Loss Account. The journal entries for preparation of Profit and Loss Appropriation Account and making various adjustments through it are given as follows: Journal Entries 1. Transfer of the balance of Profit and Loss Account to Profit and Loss Appropriation Account: (a) If Profit and Loss Account shows a credit balance (net profit): Profit and Loss A/c Dr. To Profit and Loss Appropriation A/c (b) If Profit and Loss Account shows a debit balance (net loss) Profit and Loss Appropriation A/c Dr. To Profit and Loss A/c 2. Interest on Capital: (a) For Allowing interest on capital: Interest on Capital A/c Dr. To Partner’s Capital/Current A/cs (individually) (b) For transferring interest on capital to Profit and Loss Appropriation Account: Profit and Loss Appropriation A/c Dr. To Interest on Capital A/c 3. Interest on Drawings: (a) For charging interest on drawings to partners’ capital accounts: Partners Capital/Current A/c’s (individually) Dr. To Interest on Drawings A/c (b) For transferring interest on drawings to Profit and Loss Appropriation Account: Interest on Drawings A/c Dr. To Profit and Loss Appropriation A/c Rationalised 2023-24 Accounting for Partnership : Basic Concepts 9 4. Partner’s Salary: (a) For Allowing partner’s salary to partner’s capital account: Salary to Partner A/c Dr. To Partner’s Capital/Current A/c’s (individually) (b) For transferring partner’s salary to Profit and Loss Appropriation Account: Profit and Loss Appropriation A/c Dr. To Salary to Partner’s A/c 5. Partner’s Commission: (a) For crediting commission allowed to a partner, to partner’s capital account: Commission to Partner A/c Dr. To Partner’s Capital/Current A/c’s (individually) (b) For transferring commission allowed to partners to Profit and Loss Appropriation Account. Profit and Loss Appropriation A/c Dr. To Commission to Partners Capital/Current A/c 6. Share of Profit or Loss after appropriations: (a) If Profit: Profit and Loss Appropriation A/c Dr. To Partner’s Capital/Current A/c’s (individually) (b) If Loss: Partner’s Capital/Current A/c (individually) To Profit and Loss Appropriation A/c Note: In case firm suffers a loss, no interest on capital, salary, remuneration is to be allowed to partners. The Proforma of Profit and Loss Appropriation Account is given as follows: Profit and Loss Appropriation Account Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Profit and Loss Profit and Loss xxx (if there is loss) xxx (if there is profit) Interest on Capital xxx Interest on Drawings xxx Salary to Partner xxx Partners’ Capital/Current Accounts xxx Commission to Partner xxx (distribution of Loss) Partners’ Capital/Current Accounts xxx (distribution of profit) xxxx xxxx Fig. 1.3: Proforma of Profit and Loss Appropriation Account Illustration 1 Sameer and Yasmin are partners with capitals of Rs.15,00,000 and Rs. 10,00,000 respectively. They agreed to share profits in the ratio of 3:2. Show how the following transactions will be recorded in the capital accounts of the partners in case: (i) the capitals are fixed, and (ii) the capitals are fluctuating. The books are closed on March 31, every year. Rationalised 2023-24 10 Accountancy – Not-for-Profit Organisation and Partnership Accounts Particulars Sameer Yasmin (Rs.) (Rs.) Additional capital contributed 3,00,000 2.00,000 on October, 2019 Interest on capital 5 % P.a 5 % P.a Drawings (during 2019-20) 30,000 20,000 Interest on drawings 1,800 1,200 Salary 20.000 Commission 10,000 7,000 Share in Profit 60,000 40,000 for the year 2019-20 Solution Fixed Capital Method Partner’s Capital Accounts Dr. Cr. Date Particulars L.F. Sameer Yasmin Date Particulars L.F. Sameer Yasmin Amount Amount Amount Amount (Rs.) (Rs.) (Rs.) (Rs.) Balance c/d 18,00,000 12,00,000 Balance b/d 15,00,000 10,00,000 Bank (Additional capital) 3,00,000 2,00,000 18,00,000 12,00,000 18,00,000 12,00,000 Partner’s Current Accounts Dr. Cr. Date Particulars J.F. Amount Amount Date Particulars J.F. Amount Amount (Rs.) (Rs.) (Rs.) (Rs.) Sameer Yasmin Sameer Yasmin Drawings 30,000 20,000 Interest on 82,500 55,000 Interest on 1,800 1,200 capital drawings Partner’s 20,000 7,000 1,40,700 80,800 salary Balance c/d 1,40,700 80,800 Commission 10,000 profit and loss 60,000 40,000 Appropriation 1,72,500 1,02,000 1,72,500 1,02,000 Rationalised 2023-24 Accounting for Partnership : Basic Concepts 11 Working Notes: Calculation of interest on capitals: Rs. Rs. 15,00,000 X 5% on Rs. 15,00,000 for 1 Year =5× = 75,000 100 3,00,000 6 5% on Rs. 3,00,000 for 6 months =5× = 7,500 100 12 82,500 10,00,000 Y 5% on Rs. 10,00,000 for 1 year =5× = 50,000 100 2,00,000 6 5% on Rs. 2,00,000 for 6 month =5× × = 5,000 100 12 55,000 Fluctuating Capital Method Dr. Partner’s Capital Accounts Cr. Date Particulars J.F. Amount Amount Date Particulars J.F. Amount Amount (Rs.) (Rs.) (Rs.) (Rs.) Sameer Yasmin Sameer Yasmin Drawings 30,000 20,000 Balance b/d 15,00,000 10,00,000 Interest on 1800 1200 Bank 3,00,000 2,00,000 Drawings Interest on 82,500 55,000 Balance c/d 19,40,700 12,80,800 capital Salary 20,000 7,000 Commission 10,000 - Profit and Loss appropriation 60,000 40,000 19,72,500 113,02,000 19,72,500 13,02,000 Do it Yourself 1. Soumya and Bimal are partners in a firm Sharing profits and losses in the ratio of 3:2. The balance in their capital and current accounts as on April 01, 2019 were as under: Soumya Bimal (Rs.) (Rs.) Capital Accounts 3,00,000 2,00,000 Current Accounts (Cr.) 1,00,000 80,000 The partnership deed provides that Soumya is to be paid salary @ Rs, 500 per month where as Bimal is to get a commission of Rs. 40,000 for the year. Interest on capital is to be credited at 6% p.a. The drawings of Soumya and Bimal for the year were Rs. 30,000 and Rs. 10,000 respectively. The net profit of the firm before making these adjustments was Rs, 2,49,000. Interest on Soumya’s drawings was Rs. 750 and Bimal’s drawings, Rs. 250. Prepare Profit and Loss Appropriation Account and Partner’s Capital and Current Accounts. Rationalised 2023-24 12 Accountancy – Not-for-Profit Organisation and Partnership Accounts 2. Soniya, Charu and Smita started a partnership firm on April 1, 2019. They contributed Rs, 5,00,000, Rs. 4,00,000 and Rs. 3,00,000 respectively as their capitals and decided to share profits and losses in the ratio of 3:2:1. The partnership deed provides that Soniya is to be paid a salary of Rs. 10,000 per month and Charu a commission of Rs. 50,000. It also provides that interest on capital be allowed @6% p.a. The drawings for the year were Soniya Rs. 60,000, Charu Rs. 40,000 and Smita Rs. 20,000. Interest on drawings was charged as Rs. 2,700 on Soniya’s drawings, Rs. 1,800 on Charu’s drawings and Rs. 900 on Smita’s drawings. The net amount of profit as per Profit and Loss Account for the year 2019-2020 is Rs. 3,56,600. (i) Record necessary journal entries. (ii) Prepare profit and loss appropriation account (iii) Show capital accounts of the partners. Illustration 2 Amit, Babu and Charu set up a partnership firm on April 1, 2019. They contributed Rs. 50,000, Rs. 40,000 and Rs. 30,000, respectively as their capitals and agreed to share profits and losses in the ratio of 3 : 2 :1. Amit is to be paid a salary of Rs. 1,000 per month and Babu, a Commission of Rs. 5,000. It is also provided that interest to be allowed on capital at 6% p.a. The drawings for the year were Amit Rs. 6,000, Babu Rs. 4,000 and Charu Rs. 2,000. Interest on drawings of Rs. 270 was charged on Amit’s drawings, Rs. 180 on Babu’s drawings and Rs. 90, on Charu’s drawings. The net profit as per Profit and Loss Account for the year ending March 31, 2020 was Rs. 35,660. Prepare the Profit and Loss Appropriation Account to show the distribution of profit among the partners. Solution Profit and Loss Appropriation Account Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Amits’ salary 12,000 Profit and Loss A/c (Net profit) 35,660 Babus’ commission 5,000 Interest on drawings: Interest on Capitals : Amit 270 Amit 3,000 Babu 180 Babu 2,400 Charu 90 540 Charu 1,800 7,200 Share of profit transferred to Capital accounts : Amit 6,000 Babu 4,000 Charu 2,000 12,000 36,200 36,200 Rationalised 2023-24 Accounting for Partnership : Basic Concepts 13 Illustration 3 Yadu, Madhu and Vidu are partners sharing profits and losses in the ratio of 2:2:1. There fixed capitals on April 01, 2019 were; Yadu Rs. 5,00,000, Madhu Rs. 4,00,000 and Vidhu Rs. 3,50,000. As per the partnership deed, partners are entitled to interest on capital @ 5% p.a., and Yadu has to be paid a salary of Rs. 2,000 per month while Vidu would be receiving a commission of Rs. 18,000. Net loss of the firm as per profit and loss account for the year ending March 31, 2019 amounted to Rs. 75,000 on the basis of above information prepare profit and loss appropriation account. Prepare profit and loss appropriation account for the year ending March 31, 2019. Solution Books of Yadu, Madhu and Vidu Profit and Loss Appropriation Account for the year ending March 31, 2019 Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Profit & Loss 75,000 Partners' Current account (Net Loss) (Distribution of Loss) Yadu 30,000 Madhu 30,000 Vidu 15,000 75,000 75,000 75,000 Illustration 4 Amitabh and Babul are partners sharing profits in the ratio of 3:2, with capitals of Rs. 50,000 and Rs. 30,000 respectively. Interest on capital is agreed @ 6% p.a. Babul is to be allowed an annual salary of Rs. 2,500. Manager is to be allowed commission Rs. 5,000. Amitabh has also given a Loan on April 01 , 2019 of Rs. 50,000 to the firm without any agreement. During the year 2019-20, the profits earned is Rs. 22,250. Prepare Profit and Loss Appropriation account showing the distribution of profit and the partners’ capital accounts for the year ending March 31, 2020. Rationalised 2023-24 14 Accountancy – Not-for-Profit Organisation and Partnership Accounts Solution Profit and Loss Appropriation Account Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Babul’s salary 2,500 Profit and Loss A/c 14,250 Interest on capital: (Net profit before Babul’s Amitabh 3,000 salary) Babul 1,800 Profit transferred to partner’s capital account; Amitabh 4,170 Babul 2,780 6,950 14,250 14,250 Amitabh’s Capital Account Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount 2020 (Rs.) 2019 (Rs.) Mar.31 Balance c/d 57,170 2019 Apr.01 Balance b/d 50,000 Mar.31 Interest on capital 3,000 Mar.31 Profit & Loss 4,170 Appropriation a/c 57,170 (share of profit) 57,170 Babul’s Capital Account Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount 2020 (Rs.) (Rs.) Mar.31 Balance c/d 37,080 2019 Apr.01 Balance b/d 30,000 Mar.31 Salary 2,500 Mar.31 Interest on capital 1,800 Profit & Loss 2,780 Appropriation a/c (share of profit) 37,080 37,080 Rationalised 2023-24 Accounting for Partnership : Basic Concepts 15 Working Notes: Profit and Loss Account Rs. Rs. Managers’ commission 5,000 Profit 22,250 Interest on Amitabh’s Loan 3,000 Test your Understanding – II 1. Raju and Jai commenced business in partnership on April 1, 2019. No partnership agreement was made whether oral or written. They contributed Rs. 4,00,000 and Rs. 1,00,000 respectively as capitals. In addtion, Raju advanced Rs. 2,00,000 as loan to the firm on October 1, 2019. Raju had met with an accident on July 1, 2017 and could not attend the business up to september 30, 2017. The profit for the year ended March 31, 2020 amounted to Rs, 50,600. Disputes have arisen between them on sharing the profits of the firm. Raju Claims: (i) He should be given interest at 10% p.a. on capital and so also on loan. (ii) Profit should be distributed in the proportion of capitals. Jai Claims: (i) Net profit should be shared equally. (ii) He should be allowed remuneration of Rs, 1,000 p.a. during the period of Raju’s illness. (iii) Interest on capital and loan should be given @ 6% p.a. State the correct position on each issue as per the provisions of the Partnership Act. 1932. 2. Reena and Raman are partners with capitals of Rs. 3,00,000 and Rs. 1,00,000 respectively. The profit for the year ended March 31, 2020 was Rs. 1,80,000, before paying rent for her personal building to be used as godown for firm to Reena payable at Rs. 5000 per month. Interest on capital is to be allowed at 6% p.a. Raman was entitled to a salary of Rs. 30,000 p.a. The drawings of partners were Rs. 30,000 and 20,000. The interest on drawings to be charged to Reena was Rs. 1,000 and to Raman, Rs. 500. Assuming that Reena and Raman are equal partners. State their share of profit after necessary appropriations. Note: Payment of Rent to Reena is an expense for the business. Hence, it is change against profits. 1.5.2 Interest on Capital No interest is allowed on partners’ capitals unless it is expressly agreed among the partners. When the Deed specifically provides for it, interest on capital is Rationalised 2023-24 16 Accountancy – Not-for-Profit Organisation and Partnership Accounts 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. Interest on capital is generally provided for in two situations: (i) when the partners contribute unequal amounts of capitals but share profits equally, and (ii) where the capital contribution is same but profit sharing is unequal. Interest on capital is calculated with due allowance for any addition or withdrawal of capital during the accounting period. For example, Mohini, Rashmi and Navin entered into partnership, bringing in Rs. 3,00,000, Rs. 2,00,000 and Rs. 1,00,000 respectively into the business. They decided to share profits and losses equally and agreed that interest on capital will be provided to the partners @10 per cent per annum. There was no addition or withdrawal of capital by any partner during the year. The interest on capital works out to Rs. 30,000 (10% on 30,000) for Mohini, Rs. 20,000 (10% on 2,00,000) for Rashmi, and Rs. 10,000 (10% on 1,00,000) for Navin. Take another case of Mansoor and Reshma who are partners in a firm and their capital accounts showed the balance of Rs. 2,00,000 and Rs. 1,50,000 respectively on April 1, 2019. Mansoor introduced additional capital of Rs. 1,00,000 on August 1, 2019 and Reshma brought in further capital of Rs. 1,50,000 on October 1, 2019. Interest is to be allowed @ 6% p.a. on the capitals. It shall be worked as follows:  6   6 8 For Mansoor  Rs. 2,00,000     Rs. 1,00,000     100   100 12  = Rs. 12,000 + Rs. 4,000 = Rs. 16,000  6   6 6 For Reshma  Rs. 1,50,000     Rs. 1,50,000     100   100 12  = Rs. 9,000+Rs. 4,500= Rs. 13,500 When there are both addition and withdrawal of capital by the partners during a financial year, the interest on capital is calculated as follows: (i) On the opening balance of the capital accounts of partners, interest is calculated for the whole year; (ii) On the additional capital brought in by any partner during the year, interest is calculated from the date of introduction of additional capital to the last day of the financial year. (iii) In case of withdrawal of capital, interest on capital will be calculated as: On opening capital from the beginning of the year till date of capital withdrawn and then on the reduced capital for the remaining time period. Alternatively, it can be calculated with respect of amount remained in business for the relevant period. Rationalised 2023-24 Accounting for Partnership : Basic Concepts 17 Illustration 5 Saloni and Srishti are partners in a firm. Their capital accounts as on April 01. 2019 showed a balance of Rs. 2,00,000 and Rs. 3,00,000 respectively. On July 01, 2019, Saloni introduced additional capital of Rs. 50,000 and Srishti, Rs. 60,000. On October 01 Saloni withdrew Rs. 30,000, and on January 01, 2020 Srishti withdraw, Rs. 15,000 from their capitals. Interest is allowed @ 8% p.a. Calculate interest payable on capital to both the partners during the financial year 2019–2020. Solution Statement Showing Calculation of Interest on Capital : For Saloni (Rs.) Rs.2, 00, 000  8  3 Interest on Rs. 2,00,000 for 3 months  = 4,000 100  12 Rs.2, 50, 000  8  3 Add : Interest on Rs. 2,50,000 for 3 months   5, 000 100  12 6 8 Add : Interest on Rs. 2,20,000 for 6 months  Rs.2, 20, 000    8,800 12 100 17,800 For Srishti (Rs.) 3 8 Interest on Rs. 3,00,000 for 3 months  Rs.3, 00, 000   = 6,000 12 100 8 6 Add : Interest on Rs. 3,60,000 for 6 months  Rs.3, 60, 000    14, 400 100 12 8 3 Add : Interest on Rs. 2,20,000 for 3 months  Rs.3, 45, 000   = 300 100 12 Rationalised 2023-24 18 Accountancy – Not-for-Profit Organisation and Partnership Accounts Sometimes opening capitals of partners may not be given. In such a situation before calculation of interest on capital the opening capitals will have to be worked out with the help of partners’ closing capitals by marking necessary adjustments for the additions and withdrawal of capital, drawings, share of profit or loss, if already shown in the capital accounts the partners. Illustration 6 Josh and Krish are partners sharing profits and losses in the ratio of 3:1. Their capitals at the end of the financial year 2015-2016 were Rs. 1,50,000 and Rs. 75,000. During the year 2015-2016, Josh’s drawings were Rs. 20,000 and the drawings of Krish were Rs. 5,000, which had been duly debited to partner’s capital accounts. Profit before charging interest on capital for the year was Rs. 16,000. The same had also been debited in their profit sharing ratio. Krish had brought additional capital of Rs. 16,000 on October 1, 2015. Calculate interest on capital @ 12% p.a. for the year 2015-2016. Solution Statement Showing Calculation of Capital at the Beginning Particulars Josh Krish Rs. Rs. Capital at the end 1,50,000 75,000 Add: Drawings during the year 20,000 5,000 1,70,000 80,000 Less: Share of profit (credited) 12,000 4,000 1,58,000 76,000 Less: Additional capital —- 16,000 Capital in the beginning 1,58,000 60,000 Interest on capital will be as 18,960 (12% of Rs. 1,58,000) for Josh and Rs. 960 for krish calculated as follows:  12   12 6  Rs. 60,000     Rs. 16,000    = Rs. 7,200 + Rs. 960 100   100 12  = Rs. 8,160. As clarified earlier, the interest on capital is allowed only when the firm has earned profit during the accounting year. Hence, no interest will be allowed during the year the firm has incurred net loss and if in a year, the profit of the firm is less than the amount due to the partners as interest on capital, the payment of interest will be restricted to the amount of profits. In that case, the profit will be effectively distributed in the ratio of interest on capital of each partner. Rationalised 2023-24 Accounting for Partnership : Basic Concepts 19 Illustration 7 Anupam and Abhishek are partners sharing profits and losses in the ratio of 3 : 2. Their capital accounts showed balances of Rs. 1,50,000 and Rs. 2,00,000 respectively on April 01, 2019. Show the calculation of interest on capital for the year ending December 31, 2020 in each of the following alternatives: (a) If the partnership deed is silent as to the payment of interest on capital and the profit for the year is Rs. 50,000; (b) If partnership deed provides for interest on capital @ 8% p.a. and the firm incurred a loss of Rs. 10,000 during the year; (c) If partnership deed provides for interest on capital @ 8% p.a. and the firm earned a profit of Rs. 50,000 during the year; (d) If the partnership deed provides for interest on capital @ 8% p.a. and the firm earned a profit of Rs. 14,000 during the year. Solution (a) In the absence of a specific provision in the Deed, no interest will be paid on the capital to the partners. The whole amount of profit will however be distributed among the partners in their profit sharing ratio. (b) As the firm has incurred losses during the accounting year, no interest on capital will be allowed to any partner. The firm’s loss will however be shared by the partners in their profit sharing ratio. Rs.. (c) Interest to Anupam @ 8% on Rs. 1,50,000 = 12,000 Interest to Abhishek @ 8% on Rs. 2,00,000 = 16,000 28,000 As the profit is sufficient to pay interest at agreed rate, the whole amount of interest on capital shall be allowed and the remaining profit amounting to Rs. 22,000 (Rs. 50,000 – Rs. 28,000) shall be shared by the partners in their profit sharing ratio. (d) As the profit for the year is Rs. 14,000, which is less than the amount of interest on capital due to partners, i.e. Rs. 28,000 (Rs. 12,000 for Anupam and Rs. 16,000 for Abhishek), interest will be paid to the extent of available profit i.e., Rs. 14,000. Anupam and Abhishek will be credited with Rs. 6,000 and Rs. 8,000, respectively. Effectively this amounts to sharing the firm’s profit in the ratio of interest on capital, i.e., 3:4. Rationalised 2023-24 20 Accountancy – Not-for-Profit Organisation and Partnership Accounts Test your Understanding – III 1. Rani and Suman are in partnership with fixed capitals of Rs, 80,000 and Rs. 60,000, respectively. During the year 2015-16, Rani withdrew Rs. 10,000 from her capital and Suman Rs. 15,000. Profits before charging interest on capital was Rs. 50,000. Rani and Suman shared profits in the ratio of 3:2. Calculate the amounts of interest on their capitals @ 12% p.a. for the year ended March 31, 2020. 2. Priya and Kajal are partners in a firm, sharing profits and losses in the ratio of 5:3. The balance in their fixed capital accounts, on April 1, 2019 were: Priya, Rs. 6,00,000 and Kajal, Rs. 8,00,000. The profit of the firm for the year ended March 31, 2020 was Rs, 1,26,000. Calculate their shares of profits: (a) when there was no agreement in respect of interest on capital, and (b) when there is an agreement that the interest on capital will be allowed @ 12% p.a. 1.5.3 Interest on Drawings The partnership agreement may also provide for charging of interest on money withdrawn out of the firm by the partners for their personal use. As stated earlier, no interest is charged on the drawings if there is no express agreement among the partners about it. However if the partnership deed so provides for it, the interest is charged at an agreed rate, for the period for which drawings have been made. Remained outstanding from the partners during an accounting year. Charging interest on drawings discourages excessive amounts of drawings by the partners. The calculation of interest on drawings under different situations is shown as here under. When Fixed Amounts was Withdrawn Every Month Many a time, a fixed amount of money is withdrawn by the partners, at equal time interval, say each month or each quarter. While calculating the time period, attention must be paid to whether the fixed amount was withdrawn at the beginning (first day) of the month, middle of the month or at the end (last day) of the month. If withdrawn on the first day of every month, interest on total amount will be calculated for 6ý½ months; if withdrawn at the end at every month, it will be calculated for 5½ months, and if withdrawn during the middle of the month, it will be calculated for 6 months. Suppose, Aashish withdrew Rs. 10,000 per month from the firm for his personal use during the year ending March 31, 2017. The calculation of average period and the interest on drawings, in different situations would be as follows: (a) When the amount is withdrawn at the beginning of each month: No. of months of 1 drawings + No. of month of last drawings Average Period = = 2 12+1 1 = 6 months. 2 2 Rationalised 2023-24 Accounting for Partnership : Basic Concepts 21 Interest on Drawings = = Rs. 5,200. (b) When the amount is withdrawn at the end of each month No. of months of 1 drawings + No. of months of last drawings Average Period = = 2 11+ 0 1 = 5 months 2 2 Interest on Drawings = = Rs. 4,400. (c) When money is withdrawn in the middle of the month When money is withdrawn in the middle of the month, nothing is added or deduced from the total period. No. of months of 1 drawings + No. of month of last drawings 11.5 + 0.5 Average Period = = = 2 2 6 months Interest on Drawings = = Rs. 4,800. When Fixed Amount is withdrawn Quarterly When fixed amount of money is withdrawn quarterly by partners, in such a situation, for the purpose of calculation of interest, the total period of time is ascertained depending on whether the money was withdrawn at the beginning or at the end of each quarter. If the amount is withdrawn at the beginning of each quarter, the interest is calculated on the total money withdrawn during the 12 + 3 year, for a period of seven and half months i.e., and if withdrawn at the 2 9+0 end of each quarter it will be calculated for a period of 4½ months, i.e., 2 Suppose Satish and Tilak are partners in a firm, sharing profits and losses equally. During financial year 2016–2017, Satish withdrew Rs. 30,000 quarterly. If interest is to be charged on drawings @ 8% per annum, the calculation of average period and interest on drawings will be as follows: Rationalised 2023-24 22 Accountancy – Not-for-Profit Organisation and Partnership Accounts (a) If the amount is withdrawn at the beginning of each quarter Statement Showing Calculation of Interest on Drawings Date Amount Time Period Interest (Rs.) (Rs.) 8 April 1, 2019 30,000 12 months 30,000 × ×1 100 = 2,400 9 8 July 1, 2019 30,000 9 months 30,000× × 12 100 = 1,800 6 8 Oct. 1, 2019 30,000 6 months 30,000× × 12 100 = 1,200 3 8 Jan. 1, 2020 30,000 3 months 30,000× × 12 100 = 600 Total 1,20,000 = Rs. 6,000 Alternatively, the interest can be calculated on the total amount withdrawn during the accounting year, i.e. Rs. 1,20,000 for a period of 7½ months (12+9+6+3)/4. as follows: 8 15 1 Rs. 1,20,000 × × × = Rs. 6,000. 100 2 12 (b) If the amount is withdrawn at the end of each quarter Statement Showing Calculation of Interest on Drawings Date Amount Time Period Interest (Rs.) (Rs.) 9´ 8 June 30, 2019 30,000 9 months 30,000 × 12 ´100 = 1,800 6 8 September 30, 2019 30,000 6 months 30,000 × × 12 100 = 1200 3 8 December 31, 2019 30,000 3 months 30,000 × × 12 100 = 6,000 March 31, 2020 30,000 0 months Total 1,20,000 = 3,600 Rationalised 2023-24 Accounting for Partnership : Basic Concepts 23 Alternatively, the interest can be calculated on the total amount withdrawn during the accounting year, i.e., Rs. 1,20,000 for a period of 4½ months (9 + 6 + 3 + 0)/4 months as follows: 8 9 1 = Rs. 1,20,000 × × × = Rs. 3,600 100 2 12 When Varying Amounts are Withdrawn at Different Intervals When the partners withdraw different amounts of money at different time intervals, the interest is calculated using the product method. Under the product method, for each withdrawal, the money withdrawn is multiplied by the period (usually expressed in months) for which it remained withdrawn during the financial year. The period is calculated from the date of the withdrawal to the last day of the accounting year. The products so calculated are totalled on the total of the products interest at the specified rate is calculated as under: 1 Total of products × Rate × 12 For example, Shahnaz withdrew the following amounts from her firm, for personal use during the year ending March 31, 2017. Calculate interest on drawings by product method, if the rate of interest to be charged is 7 per cent per annum. Date Amount (Rs.) April 1, 2019 16,000 June 30, 2019 15,000 October 31, 2019 10,000 December 31, 2019 14,000 March 1, 2020 11,000 Calculation of interest on drawings will be as follows: Statement Showing Calculation of Interest on Drawings Date Amount Time Period Product (Rs.) (Rs.) April 1, 2019 16,000 12 months 1,92,000 June 30, 2019 15,000 9 months 1,35,000 Oct. 31, 2019 10,000 5 months 50,000 Dec. 31, 2019 14,000 3 months 42,000 Mar. 1, 2020 11,000 1 month 11,000 Total 4,30,000 1 Interest = Sum of Products × Rate × 12 7 1 30100 = Rs. 4,30,000 × × = = Rs. 2,508 (approx.). 100 12 12 Rationalised 2023-24 24 Accountancy – Not-for-Profit Organisation and Partnership Accounts Illustration 8 John Ibrahm, a partner in Modern Tours and Travels withdrew money during the year ending March 31, 2020 from his capital account, for his personal use. Calculate interest in drawings in each of the following alternative situations, if rate of interest is 9 per cent per annum. (a) If he withdrew Rs. 3,000 per month at the beginning of the month. (b) If an amount of Rs. 3,000 per month was withdrawn by him at the end of each month. (c) If the amounts withdrawn were : Rs. 12,000 on June 01, 2019, Rs. 8,000; on August 31, 2019, Rs. 3,000; on September 30, 2019, Rs. 7,000, on November 30, 2019, and Rs. 6,000 on January 31, 2020. Solution (a) As a fixed amount of Rs. 3,000 per month is withdrawn at the beginning of the month, interest on drawings will be calculated for an average period of 61 2 months. 36,000 ´ 9 ´13 ´1 Interest on drawings = Rs. = Rs. 1,755 100 ´ 2 ´12 (b) As the fixed amount of Rs. 3,000 per month is withdrawn at the end of each month, interest on drawings will be calculated for an average period of 5 1 months. 2 Rs.36,000 ´ 9 ´11´1 = = Rs. 1,485 100 ´ 2 ´12 (C) Statements showing Calculation of Interest on Drawings 1 2 3 4 Date Amount Period (Interest) withdrawn (in months) (Rs.) (Rs.) 9 10 Jun. 1, 2019 12,000 10 12,000 × × = 900 100 12 9 7 Aug. 31, 2019 8,000 7 8,000 × × = 420 100 12 9 6 Sept. 30, 2019 3,000 6 3,000 × × = 135 100 12 9 4 Nov. 30, 2019 7,000 4 7,000 × × = 210 100 12 9 2 Jan. 31, 2020 6,000 2 6,000 × × = 90 100 12 Total Interest 1,755 Rationalised 2023-24 Accounting for Partnership : Basic Concepts 25 Illustration 9 Manu, Harry and Ali are partners in a firm sharing profits and losses equally. Harry and Ali withdrew the following amounts from the firm, for their personal use during 2019-2020. Date Harry Ali (Rs.) (Rs.) 2019 April, 01 5,000 7,000 July, 01 8,000 4,000 December, 01 5,000 5,000 March, 01, 2020 4,000 9,000 Calculate interest on drawings if the rate of interest to be charged is 10 per cent, and the books are closed on December 31 every year. Statement Showing Calculation of Interest on Drawings Harry Ali Amount Period Product Amount Period Product (Rs.) (in months) (Rs.) (Rs.) (in months) (Rs.) 5000 12 60,000 7,000 12 84,000 8000 9 72,000 4,000 9 36,000 5000 4 20,000 5,000 4 20,000 4000 1 4,000 10,000 1 10,000 1,56,000 1,50,000 Amount of Interest 1,56,000 ´10 ´1 Mannu = Rs. = Rs. 1,300 100 ´12 1,50,000 ´10 ´1 Ali = Rs. = Rs. 1,250 100 ´12 Do it Yourself 1. Govind is a partner in a firm. He withdrew the following amounts during the year 2015-16: (Rs.) April 30, 2019 6,000 June 30, 2019 4,000 Sept. 30, 2019 8,000 Dec. 31, 2019 3,000 Jan. 31, 2020 5,000 Rationalised 2023-24 26 Accountancy – Not-for-Profit Organisation and Partnership Accounts The interest on drawings is to be charged @ 6% p.a. The books are closed on March 31, every year. Calculate interest on drawing : 2. Ram and Syam are partners sharing profits/losses equally. Ram withdrew Rs. 1,000 p.m. regularly on the first day of every month during the year 2015-16 for personal expenses. If interest on drawings is charged @ 5% p.a. Calculate interest on the drawings of Ram. 3. Verma and Kaul are partners in a firm. The partnership agreement provides that interest on drawings should be charged @ 6% p.a. Verma withdraws Rs. 2,000 per month starting from April 01, 2019 to March 31, 2020. Kaul withdrew Rs, 3,000 per quarter, starting from April 01, 2019. Calculate interest on partner’s drawings. When Dates of Withdrawal are not specified When the total amount withdrawn is given but the dates of withdrawals are not specified, it is assumed that the amount was withdrawn evenly throughout the year. For example; Shakila withdrew Rs. 60,000 from partnership firm during the year ending March 31, 2020 and the interest on drawings is to be charged at the rate of 8 per cent per annum. For calculation of interest, the period would be taken as six months, which is the average period assuming, that amount is withdrawn evenly in the middle of the month, throughout the year. The amount of interest on drawings works out to be Rs. 2,400 as follows:  8 6  Rs.60,000    = Rs. 2,400 100 12  1.6 Guarantee of Profit to a Partner Sometimes a partner is admitted into the firm with a guarantee of certain minimum amount by way of his share of profits of the firm. Such assurance may be given by all the old partners in a certain ratio or by any of the old partners, individually to the new partner. The minimum guaranteed amount shall be paid to such new partner when his share of profit as per the profit sharing ratio is less than the guarnteed amount. For example, Madhulika and Rakshita, who are partners in a firm decide to admit Kanishka into their firm, giving her the guarantee of a minimum of Rs.25,000 as her share in firm’s profits. The firm earned a profit of Rs.1,20,000 during the year and the agreed profit sharing ratio between the partners is decided as 2:3:1. As per this ratio, Madhulika’s share in profit comes to Rs.40,000 (2/6 of Rs. 1,20,000); Rakshita, Rs. 60,000 (3/6 of Rs. 1,20,000) and Kanishka Rs. 20,000 (1/6 of Rs. 1,20,000). The share of Kanishka works out to be Rs.5,000 short of the guaranteed amount. This shall be borne by the guaranteeing partners Madhulika and Rakshita in Rationalised 2023-24 Accounting for Partnership : Basic Concepts 27 their profit sharing ratio, which in this case is 2:3, Madhulika’s share in the deficiency comes to Rs.2,000 (2/5 of Rs. 5,000), and that of Rakshita Rs.3,000. The total profit of the firm will be distributed among the partners as follows Madhulika will get Rs.38,000 (her share 40,000 minus share in deficiency Rs.2,000); Rakshita Rs.57,000 (60,000–3,000) and Kanishka Rs. 25,000 (Rs. 20,000 + Rs. 2,000 + Rs. 3,000). If only one partner gives the guarantee, say in the above case, only Rakshita gives the guarantee, the whole amount of deficiency (Rs.5,000) will be borne by her only. In that case profit distribution will be Madhulika Rs.40,000, Rakshita Rs. 55,000 (60,000–5,000) and Kanishka Rs. 25,000 (Rs. 20,000 + Rs. 5,000). Illustration 10 Mohit and Rohan share profits and losses in the ratio of 2:1. They admit Rahul as partner with 1/4 share in profits with a guarantee that his share of profit shall be at least Rs. 50,000. The net profit of the firm for the year ending March 31, 2015 was Rs. 1,60,000. Prepare Profit and Loss Appropriation Account. Solution Books of Mohit, Rohit and Rahul Profit and Loss Appropriation Account for the year ending..... Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Mohit’s capital Profit and Loss (Net profit) 1,60,000 (share of profit) 80,000 Less: Share in 6,667 73,333 deficiency Rohan’s capital (share of profit) 40,000 Less: Share in 3,333 36,667 deficiency Rahul’s capital (share of profit) 40,000 Add: Deficiency received from: Mohit 6,667 Rohan 3,333 50,000 1,60,000 1,60,000 Rationalised 2023-24 28 Accountancy – Not-for-Profit Organisation and Partnership Accounts Working Notes: The new profit sharing ratio after admission of Rahul comes to 2:1:1. As per this ratio the share of partners in the profit comes to: 2 Mohit = Rs. 1,60,000 × = Rs. 80,000 4 1 Rohan = Rs. 1,60,000 × = Rs. 40,000 4 1 Rahul = Rs. 1,60,000 × = Rs. 40,000 4 But, since Rahul has been given a guarantee of minimum of Rs. 50,000 as his share of profit. The deficiency of Rs. 10,000 (Rs. 50,000 – Rs. 40,000) shall be borne by Mohit and Rohan in the ratio in which they share profits and losses between themselves, viz. 2:1 as follows: Mohit’s share in deficiency comes to 2/3 × Rs. 10,000 = Rs. 6,667 Rohan’s share in deficiency comes to 1/3 × Rs. 10,000 = Rs. 3,333 Thus Mohit will get Rs. 80,000 – Rs. 6,667 = Rs. 73,333, Rohan will get Rs. 40,000–Rs. 3,333 = Rs. 36,667 and Rahul will get Rs. 40,000 + Rs. 6,667 + Rs. 3,333 = Rs. 50,000 in the profit of the firm. Calculation of new profit sharing ratio 1 1 3 The new partner Rahul’s share is. The remaining profit is 1 – = , to be shared 4 4 4 between Mohit and Rohan in the ratio of 2:1. 3 2 2 Mohit’s new share = ´ = 4 3 4 3 1 1 Rohan’s new share = ´ = 4 3 4 2 1 1 Thus, New profit sharing ratio comes to be : : or 2 : 1 :1. 4 4 4 Illustration- 11 Arun, Varun and Tarun were partners of a law firm sharing profits in the ratio of 5:3:2. Their partnership deed provided the following: (i) Interest on partners' capital @ 5% p.a. (ii) Arun guaranteed that he would earn a minimum annual fee of Rs. 6,00,000 for the firm. (iii) Tarun was guaranteed a profit of Rs. 2,50,000 (excluding interest on capital) and any deficiency on account of this was to be borne by Arun and Varun in the ratio of 2:3. During the year ending March 31, 2019, Arun earned a fee of Rs. 3,20,000 and net profits earned by the firm were Rs. 8,60,000. Partner's capital on April 01, 2018 were Arun - Rs. 30,00,000; Varun - Rs. 3,00,000 and Tarun- Rs. 2,00,000. Rationalised 2023-24 Accounting for Partnership : Basic Concepts 29 Prepare Profit and Loss Appropriation account and show your workings clearly. Solution Books of Arun, Varun and Tarun Profit and Loss Appropriation Account for the year ending March 31, 2019 Particulars Amount (Rs.) Particulars Amount (Rs.) Interest on Capital Profit & Loss 8,60,000 Arun - 15,000 (Net Profit) Varun - 15,000 Arun's Capital 2,80,000 Tarun - 10,000 40,000 Partners' Capital Accounts :- Arun 5,50,000 (-) Share in deficiency 12,000 5,38,000 Varun 3,30,000 (-) Share in deficiency 18,000 3,12,000 Tarun 2,20,000 + deficiency received from Arun 12,000 Varun 18,000 2,50,000 1,40,000 11,40,000 Working Notes :- Arun's deficiency of annual fee = Rs. 6,00,000 - Rs. 3,20,000 = Rs. 2,80,000 Tarun's deficiency in profits = Rs. 2,50,000 - Rs. 2,20,000 Rs. 30,000 to be borne by Arun & Varun in the ratio of 2:3 i.e. Rs. 12,000 and Rs. 18,000 respectively. Illustration 12 John and Mathew share profits and losses in the ratio of 3:2. They admit Mohanty into their firm to 1/6 share in profits. John personally guaranteed that Mohanty’s share of profit, after charging interest on capital @ 10 per cent per annum would Rationalised 2023-24 30 Accountancy – Not-for-Profit Organisation and Partnership Accounts not be less than Rs. 30,000 in any year. The capital provided was as follows: John Rs. 2,50,000, Mathew Rs. 2,00,000 and Mohanty Rs. 1,50,000. The profit for the year ending March 31,2015 amounted to Rs. 1,50,000 before providing interest on capital. Show the Profit & Loss Appropriation Account if new profit sharing ratio is 3:2:1. Solution Books of John and Mathew Profit and Loss Appropriation Account for the year ending..... Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Interest on capital Net profit 1,50,000 John 25,000 Mathew 20,000 Mohanty 15,000 60,000 Capital accounts shared info : John 45,000 Less: Share of deficiency 15,000 30,000 Mathew 30,000 Mohanty 15,000 Add: Deficiency 15,000 30,000 received from John 1,50,000 1,50,000 Working Notes: Profit after interest on capital is Rs. 90,000, which is to be distributed in the ratio of 3:2:1 as follows: John gets Rs. 45,000 (3/6 × Rs. 90,000), Mathew Rs. 30,000, Mohanty Rs. 15,000. Deficiency of Mohanty from the guaranteed profit of Rs. 15,000 will be borne by John. John will therefore get Rs. 45,000 – Rs. 15,000 = Rs. 30,000, Mathew Rs. 30,000 and Mohanty Rs. 30,000. Illustration 13 Mahesh and Dinesh share profits and losses in the ratio of 2:1. From January 01, 2014 they admit Rakesh into their firm who is to be given a share of 1/10 of the profits with a guaranteed minimum of Rs. 25,000. Mahesh and Dinesh continue to share profits as before but agree to bear any deficiency on account of guarantee to Rakesh in the ratio of 3:2 respectively. The profits of the firm for the year ending December 31, 2015 amounted to Rs. 1,20,000. Prepare Profit and Loss Appropriation Account. Rationalised 2023-24 Accounting for Partnership : Basic Concepts 31 Books of Mahesh and Dinesh Profit and Loss Appropriation Account for the year ending..... Dr. Cr. Particulars Amount Particulars Amount (Rs.) (Rs.) Capital Accounts: Net profit 1,20,000 (for share of profit) Mahesh 72,000 6/10 × 1,20,000 Less: Deficiency share 7,800 64,200 Dinesh 36,000 3/10 × 1,20,000 Less: Deficiency share 5,200 30,800 Rakesh 12,000 Add: Share of Deficiency from Mahesh 7,800 Dinesh 5,200 25,000 1,20,000 1,20,000 Working Notes: New profit sharing Ratio will be calculated as follows: 1 9 Rakesh to share 10 of the profits. The remaining profit will be shared by Mahesh 10 and Dinesh in the ratio of 2:1. 2 9 3 Mahesh’s share in profit will be ´ = 3 10 10 1 9 3 Dinesh’s share will be ´ = 3 10 10 3 3 1 The New ratio becomes : : or 6 : 3 : 1. 5 10 10 6 Mahesh’s share in profit = 1,20,000 × = Rs. 72,000, 10 Dinesh’s share in profit = Rs. 36,000, Rakesh’s share in profit = Rs. 12,000. Deficiency of Rakesh (Rs. 13,000) will be shared by Mahesh and Dinesh in the ratio of 3:2. Mahesh will bear 3 5 of 13,000, i.e. Rs. 7,800 and Rakesh, 2 5 of Rs. 13,000, i.e. Rs. 5,200. Thus, the profits of the firm will be shared as follows. Mahesh will get Rs. 72,000 – Rs. 7,800 = Rs. 64,200. Dinesh will get Rs. 36,000 – Rs. 5,200 = Rs. 30,800 Rakesh will get Rs. 12,000 + Rs. 7,800 + Rs. 5,200 = Rs. 25,000. Rationalised 2023-24 32 Accountancy – Not-for-Profit Organisation and Partnership Accounts Do It Yourself Kavita and Lalit are partners sharing profits in the ratio of 2:1. They decide to admit Mohan with share in profits with a guaranteed amount of Rs. 25,000. Both Kavita and Lalita undertake to meet the liability arising out of Guaranteed amount to Mohan in their respective profit sharing ratio. The profit sharing ratio between Kavita and Lalit does not change. The firm earned profits of Rs. 76,000 for the year 2006–07.Show the distribution of profit amongst the partners. 1.7 Past Adjustments Sometimes a few omissions or errors in the recording of transactions or the preparation of summary statements are found after the final accounts have been prepared and the profits distributed among the partners. The omission may be in respect of interest on capitals, interest on drawings, interest on partners’ loan, partner’s salary, partner’s commission or outstanding expenses. There may also be some changes in the provisions of partnership deed or system of accounting having impact with retrospective effect. All these acts of omission and commission need adjustments for correction of their impact. Instead of altering old accounts, necessary adjustments can be made either; (a) through ‘Profit and Loss Adjustment Account’, or (b) directly in the capital accounts of the concerned partners. This is explained with the help of following example. Rameez and Zaheer are equal partners. Their capitals as on April 01, 2015 were Rs. 50,000 and Rs. 1,00,000 respectively. After the accounts for the financial year ending March 31, 2016 have been prepared, it is discovered that interest at the rate of 6 per cent per annum, as provided in the partnership deed has not been credited to the partners’ capital accounts before distribution of profit. In this case, the interest on capital not credited to the partners’ capital accounts works out to be Rs. 3000 (6/100 × Rs. 50,000) for Rameez and Rs. 6,000 (6/100 × Rs. 1,00,000) for Zaheer. Had the interest on capital been duly provided, the firm’s profit would have reduced by Rs. 9,000. By this omission, the whole amount of profit as per Profit and Loss Account (without adjustment of Rs. 9,000) has been distributed among the partners in their profit sharing ratio, and the amounts of interest on capital have not been credited to their capital accounts. This error can be rectified in any of the following ways; (a) Through Profit and Loss Adjustment Account (i) Profit and Loss Adjustment A/c Dr. 9,000 To Rameez’s capital A/c 3,000 To Zaheer’s capital A/c 6,000 (Interest on capital) Rationalised 2023-24 Accounting for Partnership : Basic Concepts 33 (ii) Rameez’s capital A/c Dr. 4,500 Zaheer’s capital A/c Dr. 4,500 To Profit and Loss Adjustment A/c 9,000 (Loss on adjustment) (b) Directly in Partners’ Capital Accounts For direct adjustment in partners’ capital accounts first a statement to ascertain the net effect of omission on partners’ capital accounts will be worked out as follows and then the adjustment entries can be recorded. Statement Showing Net Effect of Omitting Interest on Capital Details Rameez Zaheer (Rs.) (Rs.) (i) Amount which should have been 3,000 (Cr.) 6,000 (Cr.) credited as interest on capital (ii) Amount actually credited by 4,500 (Dr.) 4,500 (Dr.) way of share of profit (Rs. 9,000 divided equally)— (iii) Difference between (i) and (ii) Dr. 1,500 Cr. 1,500 (Net effect) (Excess) (Short) The statement shows that Rameez has got excess credit of Rs. 1,500 while Zaheer’s account has been credited less by Rs. 1,500. In order to rectify the error Rameez’s capital account should be debited and that of Zaheer, credited with Rs. 1,500 by passing the following journal entry; journal entry. Rameez’s Capital A/c Dr. 1,500 To Zaheer’s Capital A/c 1,500 (Adjustment for omission of interest on capital) Illustration 14 Nusrat, Sonu and Himesh are partners sharing profits and losses in the ratio of 5 : 3 : 2. The partnership deed provides for charging interest on drawing’s @ 10% p.a. The drawings of Nusrat, Sonu and Himesh during the year ending March 31, 2015 amounted to Rs. 20,000, Rs. 15,000 and Rs. 10,000 respectively. After the final accounts have been prepared, it was discovered that interest on drawings has not been taken into consideration. Give necessary adjusting journal entry. Rationalised 2023-24 34 Accountancy – Not-for-Profit Organisation and Partnership Accounts Statement showing Net Effect of Omitting Interest on Drawings Particulars Nusrat Sonu Himesh Total (Rs.) (Rs.) (Rs.) Amount which should have been 2,000 1,500 1,000 4,500 debited by way of interest on (Dr) (Dr) (Dr) drawings Amount that should have been 2,250 1,350 900 4,500 credited by way of share of profit (Cr.) (Cr.) (Cr.) Required Adjustment Cr. 250 Cr. 150 Cr.100 (Short) (Excess) (Excess) Journal Entry for adjustment of interest on drawings would be: Sonu’s Capital A/c Dr. 150 Himesh’s Capital A/c Dr. 100 To Nusrat’s Capital A/c 250 (Adjustment for omission of interest on drawings) Do it Yourself 1. Gupta and Sarin are partners in a firm sharing profits in the ratio of 3:2. Their fixed capitals are: Gupta 2,00,000, and Sarin 3,00,000. After the accounts for the year are prepared it is discovered that interest on capital @10% p.a. as provided in the partnership agreement, has not been credited in the capital accounts of partners before distribution of profits. Record adjustment entry to rectify the error. 2. Krishna, Sandeep and Karim are partners sharing profits in the ratio of 3:2:1. Their fixed capitals are: Krishan Rs. 1,20,000, Sandeep 90,000 and Karim 60,000. For the year 2014-15, interest was credited to them @ 6% p.a. instead of 5% p.a. Record adjustment entries through P&L adjustments account. 3. Leela, Meera and Neha are partners and have omitted interest on capital @9% p.a. for three years ended March 31, 2013. Their fixed capitals on which interest was to be allowed throughout were: Leela Rs. 80,000, Meera Rs. 60,000 and Neha Rs. 1,00,000. Their profit sharing ratio during the last three years were: Year Leela Meera Neha 2015-16 2 2 2 2014-15 4 5 1 2013-14 1 2 2 Record adjustment entry. Terms Introduced in the Chapter Partnership Interest on Capital Partnership Firm Interest on Drawings Partnership Deed Average Period Rationalised 2023-24 Accounting for Partnership : Basic Concepts 35 Fixed Capital Account Profit and Loss Appropriation Fluctuating Capital Account Account Profit and Loss Adjustment Account Partner’s Current Account Summary 1. Definition of partnership and its essential features: Partnership is defined as “Relation between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all”. The essential features of partnership are : (i) To form a partnership, there must be at least two persons; (ii) It is created by an agreement; (iii) The agreement should be for carrying on some legal business; (iv) sharing of profits and losses; and (v) relationship of mutual agency among the partners. 2. Meaning and contents of partnership deed: A document which contains the terms of partnership as agreed among the partners is called ‘Partnership Deed’. It usually contains information about all aspects affecting relationship between partners, including objective of business, contribution of capital by each partner, ratio in which profit and losses will be shared by the partners, entitlement of part