Accounting for Partnership Firms: Fundamentals and Goodwill
This section covers Accounting for Partnership Firms: Fundamentals and Goodwill. BSEB tests the partnership deed, appropriation of profit, capital and current accounts, and valuation of goodwill at admission, retirement and death.
Core rules
- In the absence of a deed, the Indian Partnership Act, 1932 applies: profits and losses are shared equally; no interest on capital or drawings and no partner salary is allowed; interest on a partner’s loan is 6% p.a.
- Profit is appropriated through Profit and Loss Appropriation Account: interest on capital, salary/commission, interest on drawings, reserve, then divisible profit.
- Fixed-capital systems keep capital accounts unchanged and record adjustments in current accounts.
- Goodwill methods: average profit × number of years’ purchase; super profit × years’ purchase; capitalisation of average or super profit.
Worked example
Average profit of the last three years is ₹90,000. Capital employed is ₹5,00,000 and the normal rate of return is 12%. Normal profit = ₹5,00,000 × 12% = ₹60,000. Super profit = ₹90,000 − ₹60,000 = ₹30,000. Goodwill at three years’ purchase = ₹30,000 × 3 = ₹90,000. If an abnormal loss of ₹15,000 was included in one year’s profit, it must be added back before averaging.
Traps
Use capital employed, not total assets, when computing normal profit. Remove abnormal gains/losses and non-recurring items before averaging. At admission, premium for goodwill is credited to old partners in sacrificing ratio; if goodwill is raised in the books, it is credited to old partners in old ratio. Do not charge interest on drawings without an agreement.