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Note for Partnership - P by Placement Factory

  • Partnership - P
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Introducton to Partnership Accounts Learning objectives After studying this unit, you will be able to : ♦♦ Understand the features of a partnership firm and the need for a Partnership Deed. ♦♦ Understand the points to be covered in a Partnership Deed regarding accounts. ♦♦ Learn the technique of maintaining Profit and Loss Appropriation Account. ♦♦ Familiarize with the two methods of maintaining Partners’ Capital Accounts, namely Fixed Capital Method and Fluctuating Capital Method. ♦♦ Note that Capital Account balance as per Fluctuating Capital method is just equal to the sum of the balances of Capital Account and Current Account as per Fixed Capital Method. ♦♦ Learn how to arrive at the corrected net profit figure which is to be taken to be Profit and Loss Appropriation Account after rectification of errors. Rectification of errors may be necessary to arrive at the net profit of the partnership and preparing Profit and loss Appropriation Account. ♦♦ Learn that interest on capital and drawings, salaries/commissions are to be shown in the Profit and Loss Appropriation Account and not in the Profit and Loss Account. Also learn that drawings by partners will not appear in the Appropriation Account.  1. Introduction  An individual i.e., a sole proprietor may not be in a position to cope with the financial and managerial demands of the present day business world. As a result, two or more individuals may decide to pool their financial and non-financial resources to carry on a business. The preparation of final accounts of sole proprietors have already been discussed in chapter 6. The final accounts of partnership firms including basic concepts of accounting for admission of a partner, retirement and death of a partner have been discussed in succeeding units of this chapter.  2. Definition and Features of Partnership  The Indian Partnership Act defines partnership as “the relationship between persons who have agreed to share the profit of a business carried on by all or any of them acting for all.” The essential features of partnership are : 1. 2. 3. 4. 5. 6. An association of two or more persons; An agreement entered into by all persons concerned; Existence of a business; The carrying on of such business by all or any one of them acting for all; and Sharing of profits of the business (including losses). Unlimited liability of all partners. The persons who enter into such an agreement are called partners and the business is called a firm. 8.2 © The Institute of Chartered Accountants of India COMMON PROFICIENCY TEST

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 3. Limited Liability Partnership  The Indian Partnership Act of 1932 provides for a general form of partnership which is the most prevalent form in India, but, over time the general form of partnership has lost its charm because of the inherent disadvantages in it, the most important shortcoming is the unlimited liability of all partners for business debts and legal consequences, regardless of their holding, as the firm is not a legal entity. General partners are also jointly and severally liable for tortuous acts of copartners. Each partner has the exposure of their personal assets being appropriated and liquidated to meet partnership dues. With the growth of the Indian economy, the role played by its entrepreneurs as well as its technical and professional manpower has been acknowledged internationally. Entrepreneurship, knowledge, risk and capital may be combined to provide a further impetus to India’s economic growth.  In this background, a need has been felt for a new corporate form that would provide an alternative to the traditional partnership, with unlimited personal liability on the one hand, and, the statute-based governance structure of the limited liability company on the other. This would enable professional expertise and entrepreneurial initiative to combine, organize and operate in flexible, innovative and efficient manner. The Government felt that with Indian professionals increasingly transacting with or representing multi-nationals in international transactions, the extent of the liability they could potentially be exposed to, is extremely high. Hence, in order to encourage Indian professionals to participate in the international business community without apprehension of being subject to excessive liability, the need for having a legal structure like the LLP is encouraged. The Limited Liability Partnership (LLP) is viewed as an alternative corporate business proposal that provides the benefits of limited liability but allows its members, the flexibility of organizing their internal structure as a partnership, which is based on a mutually arrived agreement. The LLP will be a separate legal entity, liable to the full extent of its assets, with the liability of the partners being limited to their agreed contribution in the LLP which may be of tangible or intangible nature or both tangible and intangible in nature. No partner would be liable on account of the independent or un-authorized actions of other partners or their misconduct. The liabilities of the LLP and partners who are found to have acted with intent to defraud Trade payables or for any fraudulent purpose shall be unlimited for all or any of the debts or other liabilities of the LLP. The main benefit in an LLP is that it is taxed as a partnership, but has the benefits of being a corporate, or more significantly, a juristic entity with limited liability. An LLP has the special characteristic of being a separate legal personality distinct from its partners. The LLP is a body corporate in nature. However, in the chapter the scope of discussion has been restricted to Partnership accounts as per the Indian Partnership Act, 1932 only.  4. Main clauses in a partnership deed  From the accounting point of view, the main thing is that relations among the partners will be governed by mutual agreement. The agreement is known as Partnership Deed which is to be Fundamentals of accounting © The Institute of Chartered Accountants of India 8.3

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Introducton to Partnership Accounts properly stamped. It should be comprehensive to avoid disputes later on. It is usual therefore, to find the following clauses in a Partnership Deed which may or may not be registered. 1. Name of the firm and the partners; 2. Commencement and duration of business; 3. Amount of capital to be contributed by each partner; 4. Amount to be allowed to each partner as drawings and the timings of such drawings; 5. Rate of interest to be allowed to each partner on his capital and on his loan to the firm, and to be charged on his drawings; 6. The ratio in which profits or losses are to be shared; 7. Whether a partner will be allowed to draw any salary; 8. Any variations in the mutual rights and duties of partners; 9. Method of valuing goodwill on the occassions of changes in the constitution of the firm ; 10. Procedure by which a partner may retire and the method of payment of his dues; 11. Basis of the determination of the executors of a deceased partner and the method of payment; 12. Treatment of losses arising out of the insolvency of a partner; 13. Procedure to be allowed for settlement of disputes among partners; 14. Preparation of accounts and their audit. Registration of the firm is not compulsory, but non-registration restricts the partners or the firm from taking any legal action. Often there is no written Partnership Deed or, if there is one, it may be silent on a particular point. In that case the relevant sections of the Partnership Act will apply. If on any point the Partnership Deed contains a clause, it will hold good; otherwise the provisions of the Act relating to the questions will apply.  5. Powers of partners  The Partners are supposed to have the power to act in certain matters and not to have such powers in others. In other words, unless a public notice has been given to the contrary, certain contracts entered into by a partner on behalf of the partnership, even without consulting other partners are binding and the provisions of the Act relating to the question will apply. In case of a trading firm, the implied powers of partners are the following: (a) Buying and selling of goods; (b) Receiving payments on behalf of the firm and giving valid recepit; (c) Drawing cheques and drawing, accepting and endorsing bills of exchange and promissory notes in the name of the firm; (d) Borrowing money on behalf of the firm with or without pledging the inventories-in-trade; (e) Engaging servants for the business of the firm. 8.4 © The Institute of Chartered Accountants of India COMMON PROFICIENCY TEST

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In certain cases an individual partner has no power to bind the firm. This is to say that third parties cannot bind the firm unless all the partners have agreed. These cases are : (a) Submitting a dispute relating to the firm arbitration; (b) Opening a bank account on behalf of the firm in the name of a partner; (c) Compromise or relinquishment of any claim or portion of claim by the firm; (d) Withdrawal of a suit or proceeding filed on behalf of the firm; (e) Admission of any liability in a suit or proceedings against the firm; (f) Acquisition of immovable property belonging to the firm; (g) Entering into partnership on behalf of the firm. The rights, duties and power of partners can be changed by mutual consent. Students should remember that in the absence of any agreement to the contrary; 1. no partner has the right to a salary, 2. no interest is to be allowed on capital, 3. no interest is to be charged on the drawings, 4. interest at the rate of 6% is to be allowed on a partner’s loan to the firm, and 5. profits and losses are to be shared equally. Note : In the absence of an agreement, the interest and salary payable to a partner will be paid only if there is profit.  6. Accounts  There is not much difference between the accounts of a partnership firm and that of sole proprietorship (provided there is no change in the firm itself). The only difference to be noted is that instead of one Capital Account there will be as many Capital Accounts as there are partners. If, for instance, there are three partners; A, B, and C, then there will be a Capital Account for each one of the partners; A’s Capital Account will be credited by the amount contributed by him as capital and similarly B’s and C’s Capital Accounts will be credited with the amounts brought in by them respectively as capital. When a partner takes money out of the firms for his domestic purpose, either his Capital Account can be debited or a separate account, named as Drawings Account, can be opened in his name and the account may be debited. In a Trial Balance of a partnership firm, therefore, one may find Capital Accounts of partners as well as Drawings Accounts. Finally the Drawings Account of a partner may be transferred to his Capital Account so that a net figure is available. But, often the Drawings Account or Current Account (as it is usually called) remains separate. 6.1 Profit and Loss Appropriation : During the course of business, a partnership firm will prepare Trading Account and a Profit and Loss Account at the end of every year. This is done exactly on the lines already given in the chapter 6. This is to say that final accounts of a sole proprietorship concern will not differ from the accounts of a partnership firm. The Profit and Loss Account will show the profit earned by the firm or loss suffered by it. This profit or loss has to be transferred to the Capital Accounts of partners according to the terms of the Partnership Deed or according Fundamentals of accounting © The Institute of Chartered Accountants of India 8.5

Lecture Notes