Chapter

Preparation of Financial Statements – Partnership

Meaning of Partnership

• When two or more persons join hands to set up a business and share its profits and losses, they are said to be
in partnership.

• Section 4 of the Indian 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 called individually, "partners" and
collectively "a firm", and the name under which their business is carried on is called the "firm-name".

• A partnership firm has no separate legal entity, apart from the partners constituting it.

Features of Partnership

1. Two or More Persons: In order to form partnership, there should be at least two persons coming together for
a common goal.
Minimum number of partners in a firm can be 2.
Minimum number of partners in a firm can be 50. [Rule 10 of The Companies (Miscellaneous) Rules,
2014]

2. Agreement: Partnership is the result of an agreement between two or more persons to do business and share
its profits and losses. It is not necessary that such agreement is in written form. An oral agreement is equally
valid.
Agreement means every promise and every set of promises, forming the consideration for each
other.
Contract is an agreement enforceable by law

3. Business: The agreement should be to carry on some business. Mere co- ownership of a property does not
amount to partnership. For example, if Rohit and Sachin jointly purchase a plot of land, they become the joint
owners of the property and not the partners. But if they are in the business of purchase and sale of land for
the purpose of making profit, they will be called partners.

Prepared by: Raman Luthra

Chartered Accountant
4. 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.
Every partner is entitled to participate in the conduct of the affairs of its business.
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.

5. Sharing of Profit: Another important element of partnership is that, the agreement between partners must be
to share profits and losses of a business.
Section13 Mutual Right and Liabilities - The Partnership Act, 1932. Subject to contract between the
partners -
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.
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.
Interest on Drawings: No interest is to be charged on the drawings made by the partners, if there is
no mention in the Deed.
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.
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:

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.
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.

6. 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.

Prepared by: Raman Luthra

Chartered Accountant
Trading and Profit and Loss Account

Trading Account
The trading account ascertains the result from basic operational activities of the business. The basic operational
activity involves the manufacturing, purchasing and selling of goods.

Profit and Loss Account

Profit & loss account is an account, representing the actual profit earned or loss sustained by the business during the
accounting period.
Trading and Profit and Loss Account of ABC for the year ended
March 31, XXXX
Dr. Cr.
Expenses/Losses Amount Revenues/Gains Amount
` `
Opening stock ..... Sales .....
Purchases .....
Wages .....
Carriage inwards/ .....
Freight inwards/cartage
Gross profit c/d1
Gross loss b/d2
xxx xxx
Gross loss c/d1 .....
Gross profit b/d .....
Rent/rates and taxes ..... Interest received .....
Salaries ..... .....
Repairs and renewals ..... Net loss2
Bad debts .....
Net profit2 (transferred to .....
capital account)
xxx xxx

1,2either of the items computed

Distribution of Profit among Partners

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.

Profit and Loss Appropriation Account

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.

Prepared by: Raman Luthra

Chartered Accountant
 Profit and Loss Appropriation Account
Dr. Cr.
Particulars Amount Particulars Amount
(Rs.) (Rs.)
Profit and Profit and xxx
Loss (if there xxx Loss (if there
is loss) is profit)
Interest on Capital xxx Interest on Drawings xxx
Salary to Partner xxx Partners’ Capital/Current
Commission to Accounts (distribution of Loss) xxx
Partner xxx
Partners’ Capital/Current
Accounts (distribution of xxx
profit)
xxxx xxxx

Maintenance of Capital Accounts of Partners

a) Fixed Capital Method: Under the fixed capital method, the capitals of the partners shall remain fixed unless
additional capital is introduced or a part of the capital is withdrawn as per the agreement among the partners.
All items like share of profit or loss, interest on capital, drawings, interest on drawings, etc. are recorded in a
separate account, called Partner’s Current Account.

Partner’s Capital Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
(Rs.) (Rs.)
Bank (permanent xxx Balance b/d xxx
withdrawal of (opening balance)
capital) xxx Bank (fresh capital xxx
Balance c/d introduced)
(closing balance)
xxx xxx

Partner’s Current Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
(Rs.) (Rs.)
Balance b/d xxx Balance b/d xxx
(in case of debit (in case of credit
opening balance) opening balance)
Drawings xxx Salary Commission xxx
Interest on xxx Interest on capital xxx
drawings Profit & xxx Profit & Loss
Loss a/c Appropriation xxx
Balance c/d (share of profit)
(in case of credit xxx Balance c/d
closing balance) (in case of debit closing xxx
balance)

xxxx xxxx

Prepared by: Raman Luthra

Chartered Accountant
 b) Fluctuating Capital Method: Under the fluctuating capital method, only one account, i.e. capital account is
maintained for each partner. All the adjustments such as share of profit and loss, interest on capital, drawings,
interest on drawings, salary or commission to partners, etc are recorded directly in the capital accounts of the
partner

Partner’s Capital Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
(Rs.) (Rs.)
Balance b/d (in xxx Balance b/d (in case xxx
case of debit of credit opening
closing balance) balance)
Drawings Bank (fresh xxx
Interest on xxx capital
drawings Profit and xxx introduced) xxx
Loss Salaries xxx
A/c Interest on capital xxx
(for share of loss) xxx Profit and Loss
Balance c/d (in Appropriation
case of credit (for share of profit) xxx
closing balance) Balance b/d (in case
of debit closing
balance)
xxxx xxxx

Balance Sheet

The balance sheet is a statement prepared for showing the financial position of the business summarising its assets
and liabilities at a given date. The assets reflect debit balances and liabilities (including capital) reflect credit balances.
It is prepared at the end of the accounting period after the trading and profit and loss account have been prepared. It
is called balance sheet because it is a statement of balances of ledger accounts that have not been transferred to trading
and profit and loss account and are to be carried forward to the next year with the help of an opening entry made in
the journal at the beginning of the next year.

Balance Sheet of as at March 31, 2XXX

Liabilities Amount Assets Amount

` `
Capital ..... Furniture .....
Add Profit ..... ..... Cash .....
Long-term loan ..... Bank .....
Short-term loan Goodwill .....
Sundry creditors ..... Sundry debtors .....
Bills payable Land and Buildings
Bank overdraft Closing stock

xxxx xxxx

Prepared by: Raman Luthra

Chartered Accountant
Multiple Choice Questions

1. [Question] X, Y and Z are partners in a firm. At the time of division of profits for the year, there was a dispute
between the partners. Profit before interest on loan was 6,000/-.
Y provided loan to the firm of INR 80,000/- and demanded interest of 20% p.a. There was no agreement on
this point. Calculate the amount payable to X, Y and Z respectively?

a) 2,000 to each partner

b) 2,000, 18,000 and 2,000 to X, Y and Z respectively
c) 2,000, 4,800 and 2,000 to X, Y and Z respectively
d) 600, 4,800 and 600 to X, Y and Z respectively
e) 400, 5,200 and 400 to X, Y and Z respectively

Answer: e.

2. [Question] On 1st January 2020, a partner advanced a loan of 1,00,000/- to the firm. In the absence of
agreement, Interest on loan for financial Year 19-20 will be?

a) Nil
b) 1,500/-
c) 3,000/-
d) 4,500/-
e) 6,000/-

Answer: b.

3. [Question] A and B are partners. According to profit and loss account, the net profit for the year is 2,00,000.
The total interest on partner’s drawing is 1000. A’s salary is 40,000 per year and B’s salary is 3,000 per month.
The net profit as per profit and loss appropriation account will be?

a) 1,23,000/-
b) 1,25,000/-
c) 1,56,000/-
d) 1,58,000/-
e) 2,01,000/-

Answer: b.

4. [Question] Drawing will be recorded ______ side of ________ account?

a) Credit, Partner’s Capital

b) Debit, Partner’s Capital
c) Credit, P&L Appropriation A/c
d) Debit, P&L Appropriation A/c
e) None of the above is correct.

Answer: b.

Prepared by: Raman Luthra

Chartered Accountant