CHAPTER-1 ACCOUNTING FOR PARTNERSHIP BASIC CONCEPTS
INTRODUCTION You have already learnt the accounting procedure for sole trading concerns. Limitations of sole proprietorship 1.Limited financial resources 2.Limited managerial ability 3.Limited scope of expansion 4.Unlimited liability The need of partnership arose due to the limitations of sole proprietorship.
Definition As per section 4 of the Indian Partnership Act 1932,Partnership is the relationship between persons who have agreed to share the profits of a business carried on by all any of them acting for all. *Persons who enter into the partnership are individually called partners and collectively called a firm.
Features 1.Agreement/Deed The basis upon which the partnership is constituted is an agreement ,between the partners. The agreement should be for carrying on a lawful business. The agreement may be in oral or written form. 2.Two or more persons A minimum of two persons are required to form a partnership. The maximum number of persons in a partnership is limited to 10,in case of banking business and 20 if it is carrying on any other business.
3.Business The agreement should be for carrying on some business. Business include every trade,occupation or profession. The business must be legal. 4.Sharing of profits The objectives of partnership must be to earn profits and must be distributed among partners in an agreed ratio. In case of losses too are shared in the agreed ratio. 5.Business carried on by all or any of them acting for all. Each partner can participate in the conduct of business and act for the firm, as well as each partner is bound by the acts of
other partners. Thus a partner is both an agent and the principal.ie.,he is an agent when he makes the other partners liable for his acts. He is the principal when the other partners make him liable for their acts. This is based on mutual agency principle. Partnership Deed A written agreement which contains the terms and conditions of partnership is called Partnership deed. Contents of the Deed *Name of the firm *Name and address of all partners *Nature and place of the firm *Date of commencement of partnership. *Duration of partnership
*Amount of capital contributed or to be contributed by each partner.etc………………………………… Rules applicable in the absence of partnership deed 1.No interest on capital 2.No interest on drawings 3.No salary 4.No commission 5.Equal share in profits 6.6% interest on loan taken from a partner.
Proforma of capital account Cr. Dr.
A partner’s capital account normally shows credit balance. • However it can show a debit balance under certain circumstances, like excessive withdrawal etc……….. There are two methods of maintaining capital accounts of partners.(in partnership) 1.Fixed Capital Method 2.Fluctuating Capital Method
Fluctuating Capital Method In the fluctuating capiltal method, all adjustment like salary, commi- ssion,interest on capital etc..are show in the capital a/c itself. In the fluctuating capital method, there is only one a/c ie,capital a/c for each partner The balance of fluctuating capital a/c keep on changing from time to time. Fluctuating capital a/c normally shows a credit balance.
ILLUSTRATION 1 Arun and Balu entered into a partnersip business on 1st April 1998 .They have contributed capital of Rs.50000 and Rs.60000 respectively.They decided to share profits and lossessequally.According to the deed interest on capital is allowed at 6% per annum and Balu was entitled to get a salary of Rs.8000 per annum.During the year Balu withdrew Rs.6000 and Arun withdrew Rs.4000.Netprofit of the business after providing interest on capital and salary to Balu amounted to Rs.16000. Show the capital accounts of the partners. 1.When capitals are fixed 2.When capitals are flictuating
1.When capitals are fixed Dr Capital a/c Cr.
Current a/c Dr. Cr.
2.Fluctuating capital method Dr. Capital a/c Cr.
Profit and loss Appropriation a/c Profit and loss appropriation a/c is an extension of profit and loss account. It is prepared to show how net profit is distributed among the partners. Proforma of Profit and loss appropriation a/c Cr. Dr.
ILLUSTRATION 2 On 1st January 2000 ‘R’ and ‘S’ entered into a partnership contributing Rs.40000 and 30000 respectively,and sharing profit and losses in the ratio of 3:2.R is to be allowed a salary of Rs.6000 per year. Interest on capital is to be allowed at 6% per annum. During the year R withdrew Rs.3000 and S Rs.4000.Interst on the same being Rs.150 and Rs.240 respectively. The profit of the year before the above mentioned adjustments was Rs.12500. Pass the necessary entries relating to the appropriation of profit and prepare the profit and loss appropriation a/c and partner’s capital a/c.
P&L appropriation a/c Dr. Cr.
Interest on drawings Case 1 When drawings of a fixed amount are made in the beginning of every month, interest will be charged on the whole amount for 6 ½ months. Interest on drawings = total drawings X rate of interest X 61/2 100 12 Example A & B are partners in a firm. B withdrew Rs.5000 per month(in the beginning of the month).Calculate his interest on drawings for the preparations of final a/c, if it is charged @ 10%.
Total drawings = 5000 X 12 = 60000 Interest on drawings = total drawings X rate of interest X 6 ½ 12 100 = 60000 X 10 X6 ½ 100 12 =3250 Case 2 When drawings of a fixed amount are made at the end of the every month . Interest on drawings = total drawings X rate of interest X 5 ½ 100 12
Example A partner makes a drawings of Rs.1000 per month ( at the end of the every month ). Under the partnership deed interest is to be charged at 15% per annum. Calculate his interest on drawings. Total drawings=1000 X 12 = 12000 Interest on drawings = total drawings X rate of interest X 5 ½ 100 12 = 12000 X 15 X 5 ½ 100 12 =825
Case 3 When drawings are made in the middle of every month. Interest on drawings = total drawings X rate of interest X 6 ½ 100 12 Example A partner make a drawings of Rs.1000 per month. Under the partnership deed interest is to be charged @ 15% per annum. Calculate his interest on drawings. Interest on drawings = total drawings x rate of interest x 6 ½ 12 100 Product method ( In the case- different amounts withdrawn on different dates)
Goodwill Goodwill can be defined as “ the present value of a firm’s anticipated excess earnings” or as “ the capitalised value attached to the differential profit capacity of a business. *Goodwill is an intangible asset Factors determining Goodwill. 1.Conduct of business Goodwill of a business to a large extend, is attached with the quality of the goods it deals with and services it provides. Higher the quality more will be the goodwill or viceversa. 2.Location The location of a business firm is another factor affecting goodwill . Easy and convenient locations will attract more customers
Which eventually add to the goodwill of the firm. 3.Efficiency of the business If the management of the business is highly efficient , it will be able to maintain cost efficiency and productivity which will enhance profitability of the business and there by it’s goodwill. 4.Market condition Monopoly in the market restricts competition and helps the firm to earn higher profits which enhances it’s goodwill. 5.Special previlages The firm that enjoys special previlages like import license , uninterrupted supply of electricity, attractive trade marks etc………. brings goodwill to the firm.
Need for the valuation of goodwill 1.Change in the profit sharing ratio amongst the existing partners. 2. Admission of a new partner 3.Retirement of a partner 4.Death of a partner 5.Dissolution of a firm involves sale of business as a going concerns. 6. Amalgamation of firms. Methods of valuation of goodwill 1.Average profit method Under this method the value of goodwill is calculated at an agreed number of years purchase of the average profits for the past few years . At the time of the sale of an established business , the purchaser has to pay an extra amount for the value of
goodwill . This amount is equal to the profits he is likely to receive for the first few years .The goodwill ,there for , should be calculated by multiplying the past average profits by the number of years during which the anticipated profits are expected to accrue. Example The profits of a firm for the last six years are given . The partnership agreement provides the valuation of goodwill at 3 years purchase prince of the average profits of the last 6 years . Calculate the value goodwill . The profits of the firm were :-
Calculate the goodwill under average profits method ? ------------------------------------------ Goodwill = Average profits X no. of years purchased Average profit = Total profit No. of years = 60000+40000+50000+55000+45000+50000 6
= 300000 6 50000 ====== = Goodwill= Average profit x No. of years purchased = 50000 X 3 =150000 ======
2. Weighted average profit method Weighted average method is the modified version of simple average profit method for computing goodwill . Under this method each year profit is multiplied by the respective number of weights , based on the principle of earnings in the immediate past and earnings in the distant past . Example The profits of a firm for the last 5 years ending 31st March were as follows :-
Calculate the value of goodwill on the basis of 3 year purchased of weighted average profit. ------------------------------------------------------ Weighted average profit = Total of products for profits Total of weight Weighted average profit = Total of products for profits Total of weight
= 338000 15 = 22533 ====== Goodwill = Weighted average profit x number of years = 22533 x 3 = 67599 ====== 3. Super profit method Under super profit method , goodwill is calculated at a certain number of years purchase of the super profits of the business . Super profits means excess of actual profits over normal profit .
Example The average profit of the firm for the last 5 years 20000 and the capital invested in 130000 . The normal profits for the similar line of business is 10% . Calculate the amount of goodwill if it is 2 years purchase of super profit . --------------------------------------------- Normal profit = 10% of capital invested. ie ; = Normal profit = 130000 x 10 100 = 13000 ===== Average profit = 20000 Super profit = Average profit - normal profit = 20000 – 13000 =7000 ====
Goodwill = Super profit x Number of years purchased = 7000 x 2 = 14000 ===== 3 .Capitalization method Under this method the goodwill can be calculated in two ways . 1. By capitalizing the average profits. 2. By capitalizing the super profits. Capitalizing the average profit Here , expected future maintainable profits are estimate after providing for reasonable managerial remuneration . These expected future profits are capitalized on the basis of normal rate of return to find out the total value of business .
Example A business has earned average profits of Rs. 80000 during the last few years and the normal rate of return in similar type of business is 10% . Find out the value of goodwill by capitalization method , given that the assets of the firm amount to Rs. 600000 and liabilities to Rs.100000. ------------------------------------------ Capital of the firm = 600000 – 100000 = 500000 ====== Average profit = 80000 Normal rate of return = 10 100 80000 x 100 = 800000 ====== Goodwill = capitalized value – net asset = 800000 - 500000 = 300000 10
Capitalization of super profit Super profit are capitalized under this method . Example Calculate goodwill if :- The goodwill of a firm is estimated at three years purchase of the average profits of the last 5 years which are as follows:- 2. If the firms total capital employed is Rs. 100000 and the normal rate of return is 6%, the average profit for the last 5 years is Rs. 15000 and goodwill is estimated at 3 years purchase of super profits .
Remuneration given to partner was Rs.2000 /- . 3.Rama Bothers earn a net profit of Rs.25000 with a capital of Rs. 200000 . The normal rate of return in the business is 10%.Use capitalization of super profits method to value of the goodwill ------------------------------------------------ Average profit = (10000+15000+5000+8000 – 5000)/5 = 33000/5 = 6600 Goodwill = 6600 x 3 = 19800 2. Average profit = 15000 Remuneration to the partners =2000 Average actual profit =15000 – 2000= 13000 Normal profit = 100000 x 6/100 = 6000 Super profit = 13000 - 6000 = 7000 Goodwill=70000 x 3 = 21000
Normal profit = 200000 x 10/100 = 20000 Super profit= Average profit – normal profit = 25000 – 20000 = 5000 Goodwill = Super profit x 100/Normal rate of return =5000 x 100/10 =50000 ===== 4.Present value of super profit Here goodwill is estimated as the present value of the future super profits. This method is based on the principal of determining the present value of future cash flow. Example A firm has forecasted it’s future profit for five years as follows . 1st year - 100000 2nd year - 120000 3rd year - 80000 4th year - 110000 5th year - 130000
The total assets of the firms are Rs.1000000 and outside liabilities are Rs.300000 . The present value factor at 10% are as follows . Calculate value of goodwill. ----------------------------------------------------------------------
Goodwill = 27273+41320+7513+27320+37254 = 140680 ====== Past adjustments After closing the accounts of the firm , it may come to light that certain items were omitted or left out by mistake . In such a case necessary adjustment are carried out in the partners capital accounts . Profit and loss adjustment a/c is used for this purpose . we can also prepare a statement of adjustment to find out the net difference and pass a direct journal entry in the capital accounts.
Example The net profit of X , Y , and Z for the year ended March 31st 2006 was Rs.60000 and the same was distributed among them in their agreed ratio of 3:1:1 . It was subsequently discovered that the under mentioned transactions were not recorded in the books:- Interest on the capital at the rate 5% per annum. Interest on drawings amounting to X Rs. 700 , Y Rs. 500 and Z Rs.300 Partners salary :- X-Rs.1000 ,Y-Rs.1500 per annum The capital a/c of partners were fixed as X Rs.100000 , Y Rs.80000 and Z Rs.60000.Record the adjustment entry? ----------------------------------------------------------------
X’s capital a/cDr.2500 Y a/c 2400 Z a/c 100 ---------------------------------------------------------------------------------------
CREATED BY :- 1. DIVYA RAJ (Group member) 2. JINCY SUSAN SKARIA ( Group member) 3. JUBY SUSAN JAMES (Group member) 4. JULIE JOSE (Group member) 5. MEENU.H (Group leader )