Accounting for Partnership Firms: Fundamentals
A partnership is a relation between persons who agree to share the profits of a business carried on by all or any of them acting for all. Where the deed is silent, the Indian Partnership Act, 1932 supplies the default rules.
Rules when the deed is silent
- No interest on capital, no interest on drawings, no salary to any partner.
- Profits and losses are shared equally.
- Interest on a partner's loan to the firm is 6% per annum and is a charge against profit.
- Interest on capital is allowed only if the deed provides for it.
Profit and loss appropriation account
Begins with net profit, deducts interest on capital and partner's salary or commission, adds interest on drawings, and divides the balance in the profit-sharing ratio. Interest on capital is an appropriation, so if profits are insufficient it is restricted to the available profit in the ratio of interest due.
Worked example
A and B have capitals of ₹3,00,000 and ₹2,00,000. Profit is ₹1,80,000; interest on capital 10%; salary to B ₹30,000; profits shared equally. Interest: A ₹30,000, B ₹20,000. Salary ₹30,000. Remaining profit = 1,80,000 − 30,000 − 20,000 − 30,000 = ₹1,00,000, so ₹50,000 each. A receives ₹80,000 and B receives ₹1,00,000.
Traps
- Crediting interest on drawings to the appropriation account but forgetting to debit the partner's capital or current account.
- Charging partner's salary in the profit and loss account instead of appropriating it.
- Dividing profits equally when the deed specifies a ratio.
- Ignoring interest on a partner's loan, which is payable even without a deed.