Accounting for Partnership Firms: Fundamentals
Structure of the accounts
A partnership prepares a Profit and Loss Account (to find operating profit) and then a Profit and Loss Appropriation Account, which shows distribution rather than expense: interest on capital, partners' salary or commission, interest on drawings (a credit), transfer to reserve, and the divisible profit. With fixed capital accounts, all such adjustments pass through the partners' Current Accounts; with fluctuating capitals they pass through the Capital Accounts themselves.
Rules to memorise
- Interest on capital is an appropriation, not a charge against profit. It is not allowed when there is a loss unless the deed permits it.
- Interest on drawings depends on time: equal monthly drawings at the beginning of each month give an average period of 6.5 months, mid-month 6 months, end of month 5.5 months.
- In the absence of a deed: no interest on capital, no interest on drawings, no salary, profits shared equally, and 6% p.a. interest on a partner's loan - this last one is a charge against profit.
Worked example
X and Y share profits 1:1. Capitals ₹5,00,000 and ₹3,00,000; interest on capital 10% p.a.; interest on drawings ₹6,000 and ₹4,000; profit before appropriation ₹1,20,000. Divisible profit = 1,20,000 − 80,000 (interest on capital) + 10,000 (interest on drawings) = ₹50,000, so ₹25,000 each. X's Current Account receives 50,000 + 25,000 − 6,000 = ₹69,000.
Marks-losing traps
- Debiting interest on capital to the Profit and Loss Account.
- Computing interest on drawings on the closing balance instead of on amount × time.
- Charging a partner's salary to Profit and Loss rather than to Appropriation.
- Crediting interest on drawings to Profit and Loss instead of to the Appropriation Account.