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NCERT Class 12 Accountancy Chapter 1 Accounting for partnership: Basic Concepts
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Accounting for partnership: Basic Concepts
Chapter: 1
| PART – I |
1. Define partnership deed.
Ans: Partnership comes into existence as a result of agreement among the partners. The agreement can be either oral or written. The Partnership Act does not require that the agreement must be in writing. But wherever it is in writing, the document, which contains terms of the agreement is called ‘Partnership Deed’.
2. Why is it considered desirable to make the partnership agreement in writing?
Ans: partnership is the result of an agreement between two or more persons to do business and share profit and losses. As per partnership Act 1932, it is not necessary that a partnership agreement must be in writing but still it is written form. Because today there are very good relationships among partners but in the future there may be disputes regarding any issue. A written partnership agreement will help in avoiding disputes and misunderstanding among the partners. In order to avoid disputes, it is preferred that the partners have a written agreement. In this way a written partnership deed is more desirable than the oral agreement.
3. List the items which may be debited or credited in capital accounts of the partners when:
(i) Capitals are fixed.
Ans:
| Debited item | Credited item |
| Drawings by the partners. | Interest on capital. |
| Interest in drawings. | Salary or commission to partners. |
| Share of loss. | Share of profit. |
| Expenses or payment made by partners. | Any other contribution made by partner, |
(ii) Capitals are fluctuating.
Ans:
| Debited item | Credited item |
| Drawings by the partners. | Initial capital introduced by partners. |
| Interest in drawings. | Additional capital introduced by partners. |
| Share of loss. | Interest on capital. |
| Withdrawals of capital. | Salary or commission to partners. |
| Share of profit. | |
| Any other income or receipts on behalf of the partner. |
4. Why is Profit and Loss Appropriation Account prepared?
Ans: Profit and Loss Appropriation Account is merely an extension of the Profit and Loss Account of the firm. It shows how the profits are appropriated or distributed among the partners. All adjustments in respect of partner’s salary, partner’s commission, interest on capital, interest on drawings, etc. are made through this account. It starts with the net profit/net loss as per Profit and Loss Account.
5. Give two circumstances under which the fixed capitals of partners may change.
Ans: The two circumstances under which the fixed capitals of partners may change:
(i) Additional Capital Contribution.
(ii) Permanent Withdrawal of Capital.
6. If a fixed amount is withdrawn on the first day of every quarter, for what period the interest on the total amount withdrawn will be calculated?
Ans: If the amount is withdrawn at the beginning of each quarter, the interest is calculated on the total money withdrawn during the year, for a period of seven and half months.
7. In the absence of Partnership deed, specify the rules relating to the following:
(i) Sharing of profits and losses.
Ans: The profits and losses of the firm are distributed among the partners in an agreed ratio. However, if the partnership deed is silent, the firm’s profits and losses are to be shared equally by all the partners.
(ii) Interest on partner’s capital.
Ans: No interest is allowed on partners’ capitals unless it is expressly agreed among the partners. When the Deed specifically provides for it, interest on capital is credited to the partners at the agreed rate with reference to the time period for which the capital remained in business during a financial year.
Interest on capital is generally provided for in two situations:
(a) when the partners contribute unequal amounts of capital but share profits equally. and
(b) where the capital contribution is the same but profit sharing is unequal.
(iii) Interest on Partner’s drawings.
Ans: The partnership agreement may also provide for charging of interest on money withdrawn out of the firm by the partners for their personal use. As stated earlier, no interest is charged on the drawings if there is no express agreement among the partners about it. However if the partnership deed so provides for it, the interest is charged at an agreed rate, for the period for which drawings have been made.
(iv) Interest on Partner’s loan.
Ans: In the absence of a partnership deed, the firm will allow a partner to lend money to the firm at a rate of 6% interest.
(v) Salary to a partner.
Ans: In case the partnership deed is silent. The partners will share profits and losses equally. No partner shall be allowed salary.
| Long Answer Questions |
1. What is meant by partnership? Explain its chief characteristics? Explain.
Ans: Partnership Act 1932 defines partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all’. Persons who have entered into partnership with one another are individually called ‘partners’ and collectively called ‘firm’. The name under which the business is carried is called the ‘firm’s name’. A partnership firm has no separate legal entity, apart from the partners constituting it.
The essential features/ Characteristics of partnership are:
(i) Two or More Persons: In order to form partnership, there should be at least two persons coming together for a common goal. In other words, the minimum number of partners in a firm can be two. There is however, a limit on their maximum number. By virtue of Section 464 of the Companies Act 2013, the Central Government is empowered to prescribe maximum number of partners in a firm but the number of partners can not be more than 100. The Central government has prescribed the maximum number of partners in a firm to be 50.
(ii) Agreement: Partnership is the result of an agreement between two or more persons to do business and share its profits and losses. The agreement becomes the basis of relationship between the partners. It is not necessary that such agreement is in written form. An oral agreement is equally valid. But in order to avoid disputes, it is preferred that the partners have a written agreement.
(iii) Business: The agreement should be to carry on some business. Mere co ownership of a property does not amount to partnership.
(iv) Mutual Agency: The business of a partnership concern may be carried on by all the partners or any of them acting for all. This statement has two important implications. First, every partner is entitled to participate in the conduct of the affairs of its business. Second, that there exists a relationship of mutual agency between all the partners. Each partner carrying on the business is the principal as well as the agent for all the other partners. He can bind other partners by his acts and also is bound by the acts of other partners with regard to business of the firm. Relationship of mutual agency is so important that one can say that there would be no partnership, if the element of mutual agency is absent.
(v) Sharing of Profit: Another important element of partnership is that, the agreement between partners must be to share profits and losses of a business. Though the definition contained in the Partnership Act describes partnership as relation between people who agree to share the profits of a business, the sharing of loss is implied. Thus, sharing of profits and losses is important. If some persons join hands for the purpose of some charitable activity, it will not be termed as partnership.
(vi) Liability of Partners: Each partner is liable jointly with all the other partners and also severally to the third party for all the acts of the firm done while he is a partner. Not only that the liability of a partner for acts of the firm is also unlimited. This implies that his private assets can also be used for paying off the firm’s debts.
2. Discuss the main provisions of the Indian Partnership Act 1932 that are relevant to partnership accounts if there is no partnership deed.
Ans: Provisions of Partnership Act Relevant for Accounting The important provisions affecting partnership accounts are as follows:
(a) Profit Sharing Ratio: If the partnership deed is silent about the profit sharing ratio, the profits and losses of the firm are to be shared equally by partners, irrespective of their capital contribution in the firm.
(b) Interest on Capital: No partner is entitled to claim any interest on the amount of capital contributed by him in the firm as a matter of right. However, interest can be allowed when it is expressly agreed to by the partners. Thus, no interest on capital is payable if the partnership deed is silent on the issue.
(c) Interest on Drawings: No interest is to be charged on the drawings made by the partners, if there is no mention in the Deed.
(d) Interest on Loan: If any partner has advanced loan to the firm for the purpose of business, he/she shall be entitled to get an interest on the loan amount at the rate of 6 per cent per annum.
(e) Remuneration for Firm’s Work: No partner is entitled to get salary or other remuneration for taking part in the conduct of the business of the firm unless there is a provision for the same in the Partnership Deed.
Apart from the above, the Indian Partnership Act specifies that subject to contract between the partners:
(i) If a partner derives any profit for him/her self from any transaction of the firm or from the use of the property or business connection of the firm or the firm name, he/she shall account for the profit and pay it to the firm.
(ii) If a partner carries on any business of the same nature as and competing with that of the firm, he/she shall account for and pay to the firm, all profit made by him/her in that business.
3. Explain why it is considered better to make a partnership agreement in writing.
Ans: A written partnership agreement ensures the smooth functioning of the business of the partnership firm. It also helps in settling the disputes among the partners.It gives you and your business partners a clear understanding of the rules and arrangements applying to your business relationship. when the partnership deed is written since it helps to avoid any future conflict and is also useful for tax purposes and registration of the partnership firm.In the Partnership agreement, the partners are equally responsible for the debt of an organisation. As per partnership Act 1932, it is not necessary that a partnership agreement must be in writing but still it is written form. Because today there are very good relationships among partners but in the future there may be disputes regarding any issue. A written partnership agreement will help in avoiding disputes and misunderstanding among the partners.
4. Illustrate how interest on drawings will be calculated under various situations.
Ans:
Interest on drawings = Rs.1,20,000x8x13x1 / 100x2x12 = 5,200.
(c) When money is withdrawn in the middle of the month When money is withdrawn in the middle of the month, nothing is added or deducted from the total period.
Average Period = No. of months of 1 drawings + No. of month of last drawings /2
= 11.5 + 0.5 /2 = 6 months.
Interest on drawing = Rs 1,20,000x8x6x1/ 100×12 = Rs. 4,800.
5. How will you deal with a change in profit sharing ratio among existing partners? Take imaginary figures to illustrate your answer.
Ans: Sometimes the existing partners may decide to change the profit sharing ratio then some partners gain at the cost of other partners.This involves accounting for goodwill, revaluation of assets and liabilities, and adjusting the capital accounts of the partners. In other words one partner gains and the other one sacrifices equal to the gain. In case of partnership, however, certain adjustments such as interest on drawings, interest on capital, salary to partners, and commission to partners are required to be made. For this purpose, it is customary to prepare a Profit and Loss Appropriation Account of the firm and ascertain the final figure of profit and loss to be distributed among the partners, in their profit sharing ratio.
The following journal entry is passed Example X, Y and Z are partners in a firm sharing profit and loss in 3:2:1 ratio. They decide to share profit and loss equally in future. On date the books of the firm show Rs.3,00,000 as general reserve profit on evaluation of Plant and Machinery Rs.50.000. The following adjustment entry is passed through the capital accounts without affecting the books of accounts.Hence in the above example. X gains at the cost of Y. so the Y needs to be compensated by X with the amount of Rs.50.000. The following adjustment entry is passed.
