Accounting for Partnership: Basic Concepts

Accounting for Partnership: Basic Concepts

Class 12th 

Notes by Sahil Swe

Introduction 

You have learnt about the preparation of financial statements for a sole proprietary concern. As the business expands, one needs more capital and larger number of people to manage the business and share its risks. In such a situation, people usually adopt the partnership form of organisation. Accounting for partnership firms has its own peculiarities, as the partnership firm comes into existence when two or more persons come together to establish business and share its profits. On many issues affecting distribution of profits, there may not be any specific agreement between the partners. In such a situation the provisions of the Indian Partnership Act 1932 apply. Similarly, calculation of interest on capital, interest on drawings and maintenance of partners capital accounts have their own peculiarities. Not only that a variety of adjustments are required on the death of a partner or when a new partner is admitted and so on. These peculiar situations need specific treatment in accounting that need to be clarified.

The present chapter discusses some basic aspects of partnership such as distribution of profit, maintenance of capital accounts, etc. The treatment of situations like admission of partner, retirement, death and dissolution have been taken up in the subsequent chapters.

Objectives:

· the past errors in partners’ capital accounts; and

· Prepare final accounts of a partnership firm;

Meaning and Definition of Partnership:

A partnership, is a business relationship between/among two or more persons to share profits and losses of the business, carried on by all or any of them acting for all.

1.1 Nature of Partnership

Partnership, from the legal viewpoint, is not a separate legal entity from its partners since firm’s debts are payable from personal assets of the partners, if the firm is unable to repay its liabilities.

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 relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.

The following points highlight the  essential features or Characteristics of Partnership:

1.  Two or More Persons: There must be at least two persons to form a partnership and all such persons must be competent to contract. According to Indian Contract Act, 1872, every person except the following is competent to contract:

   · (a) Persons of unsound mind, and

   · (b) Persons disqualified by any law.

2. Agreement: Partnership comes into existence by an agreement, either written or oral. It is the basis of relationship among partners, which may be for a particular venture, for a period or at will. The written agreement among the partners is known as Partnership Deed.

3. Business: A partnership is established for a business.

4. Profit Sharing: The agreement between/among the partners should be to share profits and losses of the business.

5. Business can be Carried on by All or Any of the Partners Acting for All: Business of the partnership can be carried on by all the partners, or by any of them acting for all the partners

6. Number of Persons: There must be at least two persons to form a partnership. (Limit of 50).

7. Mutual Agency: The business can be carried on by all the partners or by any one of them acting on behalf of all. Every partner is an agent of the firm and of the other partners.

8. Unlimited Liability: 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.

9. No Separate Legal Entity: A partnership firm is not a separate legal entity distinct from its partners. The firm and the partners are considered the same in the eyes of the law.

10. Business Motive: The purpose must be to carry on a business and share its profits. Engaging in charitable activities does not constitute a partnership.

Rights of Partners:

1. Every partner has the right to participate in the management of the business.

2. Every partner has the right to be consulted about the business matters.

3. Every partner has the right to inspect the books of account and have a copy of it.

4. Every partner has the right to share profits and losses in the agreed ratio. In case profit-sharing ratio is not agreed, profits and losses are shared equally as is provided in the Partnership Act, 1932.

5. If a partner has advanced loan, he has the right to receive interest thereon at an agreed rate of interest. In case the rate of interest is not agreed, interest is paid at the rate provided in the Indian Partnership Act, 1932, which is 6% p.a.

6. A partner has the right to take decisions in the interest of the business.

7. A partner has the right not to allow the admission of a new partner.

8. After giving notice, a partner has the right to retire from the firm.