LoginGet started

Accounting for Partnership firms- Fundamentals | ONE SHOT | Class 12 Accounts Half Yearly & Boards

Sunil Panda-The Educator・94 minutes read

The text outlines the fundamentals of partnerships, including definitions, legal requirements, profit-sharing arrangements, and the importance of a partnership deed to clarify responsibilities and liabilities among partners. It also emphasizes the financial aspects of partnerships, such as interest on capital and drawings, and provides examples of profit distribution and how to handle various scenarios in partnership operations.

Insights

  • The class emphasizes the foundational aspects of partnerships, ensuring students understand key concepts necessary for both exams and real-world applications, highlighting the importance of grasping every detail involved in partnership structures.
  • Partnership is legally defined as a profit-sharing relationship between two or more individuals, as per the Partnership Act of 1932, which outlines the minimum and maximum number of partners allowed, thus shaping the legal framework for business collaborations.
  • Partners are subject to unlimited liability, meaning their personal assets can be used to settle business debts, contrasting with Limited Liability Partnerships (LLPs) that offer some protection to partners' personal assets, showcasing the varying levels of risk involved in different partnership structures.
  • The text underscores the significance of a partnership deed, which, while not mandatory, is crucial for clarifying terms such as profit-sharing, responsibilities, and dispute resolution among partners, preventing potential conflicts and misunderstandings.
  • Financial management within partnerships is complex, involving detailed calculations for interest on capital, drawings, and profit distribution, all of which must be accurately tracked to ensure fair compensation and compliance with partnership agreements.

Get key ideas from YouTube videos. It’s free

Recent questions

  • What is a partnership in business?

    A partnership in business is a formal arrangement where two or more individuals collaborate to operate a business and share its profits. This relationship is governed by the Partnership Act, which outlines the legal framework for partnerships, including the responsibilities and rights of each partner. Partnerships can vary in structure, but they typically require a minimum of two partners and can have up to 50, as per regulations. The essence of a partnership lies in the mutual agreement to work together towards a common business goal, sharing both the risks and rewards that come with it.

  • How do I calculate interest on drawings?

    To calculate interest on drawings, you need to know the total amount withdrawn, the interest rate, and the time period for which the money was drawn. The formula used is: Total Drawings × Rate × Time Period. If the withdrawals are made at different times, you may need to calculate the interest for each withdrawal separately and then sum them up. For example, if a partner withdraws a fixed amount monthly, you can use the average time factor to determine the interest accurately. This ensures that the financial implications of personal withdrawals are accounted for in the partnership's financial statements.

  • What is a partnership deed?

    A partnership deed is a legal document that outlines the terms and conditions of a partnership agreement between partners. While it is not mandatory, having a partnership deed is highly recommended as it provides clarity on various aspects such as profit-sharing ratios, responsibilities of each partner, and procedures for resolving disputes. The deed serves as a reference point in case of disagreements and helps prevent misunderstandings by clearly defining each partner's rights and obligations. Without a partnership deed, the Partnership Act may apply, which could lead to equal profit sharing and other default provisions that may not align with the partners' intentions.

  • What are the liabilities of partners?

    Partners in a partnership have unlimited liability, meaning they are personally responsible for the debts and obligations of the business. This implies that if the partnership incurs debts or faces legal claims, the personal assets of the partners can be used to settle those debts. Unlike limited liability companies, where personal assets are protected, partners must be aware that their financial exposure is significant. This aspect of partnership can be a double-edged sword, as it encourages partners to be diligent in their business dealings but also poses a risk to their personal finances.

  • How are profits shared in a partnership?

    Profits in a partnership are typically shared according to the terms outlined in the partnership deed. If no specific sharing ratio is mentioned, profits are usually divided equally among partners. The sharing ratio can be influenced by various factors, including the capital contributions of each partner, their roles in the business, and any agreements made regarding salaries or interest on capital. It is essential for partners to agree on a clear profit-sharing arrangement to avoid disputes and ensure that each partner feels fairly compensated for their contributions to the business.

Related videos

Summary

00:00

Understanding Partnership Fundamentals and Liabilities

  • The class focuses on the fundamentals of partnership, covering all essential concepts from start to finish, ensuring students grasp every detail for examinations and practical applications.
  • Partnership is defined as a relationship where two or more individuals share profits from a business, as outlined in the Partnership Act of 1932, Section 4.
  • The minimum number of partners required to form a partnership is two, while the maximum limit is set at 50, as prescribed by the Central Government under the Companies Act, 2014.
  • A partnership must involve a business with a profit motive; non-profit organizations cannot form partnerships due to their lack of profit generation.
  • Mutual agency means that all partners are liable for each other's actions; if one partner makes a mistake, the others share the liability and profits.
  • A partnership deed, while not mandatory, is recommended to outline terms, including partner details, profit-sharing, and dispute resolution, ensuring clarity among partners.
  • Partners have unlimited liability, meaning personal assets can be sold to cover business debts, unlike limited liability companies where personal assets are protected.
  • Limited Liability Partnerships (LLPs), established under the LLP Act of 2000, combine features of partnerships and companies, providing limited liability to partners.
  • The partnership deed should include essential details such as the business name, partner contributions, profit-sharing ratios, and the duration of the partnership.
  • Key financial considerations include interest on partners' loans, salaries for managing partners, and any rent paid for using personal assets in the business, which affect net profit calculations.

13:51

Partnership Profit Distribution and Regulations

  • Three items must be subtracted from net profit: interest on drawings, partner's salary, and commission reserve, which should be noted in the comment section.
  • If there is a loss, it should be recorded at the beginning, and interest on drawings will be accounted for again.
  • Divisible profit is transferred to partners' capital or current accounts based on the sharing ratio; if no ratio is provided, profits are divided equally.
  • In case of a larger debit side, the class will buy divisible loss, which is transferred to partners' capital or current accounts.
  • The partnership deed is crucial; if absent, the Partnership Act 1932 applies, mandating equal profit sharing without interest on capital or salaries.
  • Partners' loans to the firm earn 6% interest unless specified otherwise in the deed; if silent, the firm does not pay interest on loans to partners.
  • If the deed specifies salaries or interest on capital, these must be paid from profits, but not exceeding the total profit available.
  • For example, if Ram, Shyam, and Payal share profits in a 2:2:1 ratio from a total profit of Rs 25,000, their shares must be calculated accordingly.
  • If interest on capital is charged, it must be fully paid even in loss situations; otherwise, it is not paid if not specified in the deed.
  • Losses incurred by a partner must be returned to the firm, and any profits made from gambling or similar activities must also be shared among partners.

25:46

Partnership Conflicts Without Written Agreement

  • Amar, Lalit, and Charu are partners without a written partnership deed, leading to confusion about profit sharing and responsibilities in their business operations.
  • Amar claims a 10% interest on his capital investment, but Lalit and Charu disagree, stating that without a deed, no interest is entitled.
  • Lalit requests a salary for his hard work, but the silent deed means no partner can claim a salary, regardless of their contributions.
  • Charu demands interest on a loan of ₹50,000 at 12%, but the silent deed limits it to 6%, as per partnership law.
  • Amar withdrew ₹10,000 for personal use, categorized as drawings, which do not accrue interest due to the silent deed.
  • The capital ratio among partners is established based on their investments: Amar (₹5 lakhs), Lalit (₹10 lakhs), and Charu (₹15 lakhs), resulting in a ratio of 1:2:3.
  • Lalit wishes to admit his son Inder into the partnership, but Charu objects, emphasizing that all partners must consent to any new admission.
  • Drawings are defined as withdrawals for personal use, and partners must account for interest on these drawings based on the partnership agreement.
  • Interest on drawings is calculated using the formula: Total Drawings × Rate × Time Period, with specific time factors depending on when withdrawals occur.
  • For unequal withdrawals, the product method is used to calculate interest, requiring careful tracking of amounts and withdrawal dates for accurate results.

37:50

Interest Calculations for Monthly Withdrawals

  • Withdrawals were made until September 30, with a total of ₹24,000 drawn over 6 months at an interest rate of 5%.
  • The time factor for calculating interest is determined by the formula: (Time left after first drawing + Time left after last drawing) / 2.
  • For the first withdrawal, the time factor is calculated as 3.5 months for the last withdrawal on September 30, leading to a time factor of 3.5/12.
  • If ₹6,000 is withdrawn every month for 6 months, the total interest calculation uses the average time factor of 3.5, 3, and 2.5 months.
  • A special case involves two partners withdrawing ₹10,000 monthly for 6 months, with interest calculated at 10% for the year ending March 31, 2024.
  • The total amount withdrawn over 6 months is ₹60,000, with the time factor calculated as 99.5/12 for interest purposes.
  • Green and Orange partners withdraw fixed amounts monthly, with interest on drawings calculated at 8% for the year.
  • The monthly drawing for Green is calculated using the formula: (Total drawing amount * Time factor) / 100, resulting in ₹5,000.
  • Salary and commission calculations must consider whether they are annual or monthly, with multipliers applied accordingly (e.g., quarterly = 4, semi-annually = 2).
  • Interest on capital for partners A, B, and C is calculated based on their respective withdrawals and the interest rate of 10%, totaling ₹11,750 for the year.

51:57

Commission and Profit Sharing in Partnerships

  • The text discusses commission calculations, emphasizing that class one receives commission for each step, with weak children having one point at fault but the rest being correct.
  • A net profit of ₹75,000 is established, with instructions to subtract various amounts, including ₹1 lakh and ₹2 lakhs, to determine divisible profit.
  • The divisible profit calculation involves adding ₹75,000 and ₹11,700, resulting in ₹76,700, from which multiple amounts are subtracted to find the final divisible profit.
  • The sharing ratio of profits among partners A, B, and C is mentioned, with a silent assumption that they share equally unless stated otherwise.
  • Two methods for creating partners' capital accounts are introduced: the fixed method and the fluctuating method, with the fluctuating method being the default if unspecified.
  • In the fixed method, partners' capital balances remain unchanged, while the current account can fluctuate, with specific formats for each method provided.
  • The fluctuating method involves only one account for partners' capital, where balances can vary, and includes details on additional capital contributions and withdrawals.
  • An example is given where partners A and B have capital of ₹5 lakh and ₹3 lakh, respectively, with a profit-sharing ratio of 3:1 and a net profit of ₹5 lakh.
  • Interest on capital is calculated at 6%, resulting in ₹30,000 for A and ₹18,000 for B, while A receives a commission of ₹60,000 based on ₹30 lakh in sales.
  • The text concludes with instructions on handling drawings and commissions, noting that if interest on drawings is not specified, it is considered zero.

01:07:24

Capital Account Management and Profit Distribution

  • Subtract 120 and add 5 to get 105; then divide 15810 by the total, removing profit and distributing capital accordingly.
  • Create a capital account with an opening balance of Rs. 5 lakh for partner A and Rs. 3 lakh for partner B, including drawings.
  • Record drawings: A's Rs. 80,000 and B's Rs. 60,000; total salaries amount to Rs. 18,000, with B receiving Rs. 6,600.
  • Calculate commission: A and B each receive Rs. 60,000; ensure commissions are recorded in their respective capital accounts.
  • The profit-sharing ratio is 3:1; calculate divisible profit as 316190, with A receiving 3/4 and B receiving 1/4.
  • Total divisible profits: A's share is Rs. 237,144.2, while B's share is Rs. 79,048; ensure these amounts are accurately recorded.
  • For past adjustments, correct errors by passing a single general entry to amend previous mistakes without recreating accounts.
  • Identify errors and omissions: reverse incorrect entries and provide correct figures, ensuring accurate representation in capital accounts.
  • In a scenario with partners Mohan, Suhan, and Adit, their capital accounts are Rs. 2 lakh, Rs. 1 lakh, and Rs. 1 lakh, respectively.
  • Adjust interest on capital from 8% to 5%; reverse the incorrect entry and provide the correct amount in the partners' capital accounts.

01:23:13

Calculating Opening Capital and Partner Interest

  • Calculate opening capital using the formula: Closing Capital - Profits + Drawings. This is essential for determining financial standing at the start of the period.
  • Interest on capital is calculated based on the opening balance of the partners' capital accounts, ensuring accurate financial reporting and partner compensation.
  • If a partner has a debit balance in their capital account, they do not receive interest on that amount, as interest is only applicable to positive balances.
  • For example, if a partner has a capital of ₹5,00,000, they earn interest; if they have a debit balance of ₹3,00,000, they earn no interest.
  • To find opening capital, subtract profits and add drawings to the closing capital, ensuring all financial movements are accounted for accurately.
  • In a scenario with partners Manoj and Nitin, if their closing capital is ₹90,000 and ₹80,000, and drawings are ₹40,000 and ₹20,000, calculate accordingly.
  • Interest on capital is typically set at 10%, so if the capital is ₹1,00,000, the interest would be ₹10,000, impacting overall profit distribution.
  • If interest on drawings is not charged, it must be noted as an omission in accounts, affecting the final financial statements.
  • Partners can guarantee profits to each other, ensuring that if one partner falls short, the others compensate for the deficiency based on their profit-sharing ratio.
  • For example, if partner B is guaranteed ₹60,000 but only earns ₹40,000, partners A and C must cover the ₹20,000 deficiency in their profit-sharing ratio of 3:1.

01:37:58

Partnership Profit Distribution and Salaries Explained

  • The partnership capital is divided in the ratio of 4:3:2, with interest on capital set at Rs 8 per unit, totaling Rs 120,000 for the partners Asghar, Chaman, and Dholu.
  • Chaman receives a monthly salary of Rs 7,000, while Dholu earns Rs 10,000, leading to annual salaries of Rs 84,000 and Rs 120,000 respectively, across four quarters.
  • The net profit of Rs 42,000 is calculated after accounting for total salaries and interest, with a final divisible profit of Rs 180,000 distributed based on the 4:3:2 ratio.
  • Dholu's guaranteed profit is Rs 60,000 annually, with a minimum requirement of Rs 110,000 when including his salary, leading to a deficiency of Rs 10,000 covered by the partner Python.
  • The calculation of profits excludes interest and salaries, ensuring clarity in profit distribution, with partners receiving their shares based on the agreed ratios and guarantees.
Channel avatarChannel avatarChannel avatarChannel avatarChannel avatar

Try it yourself — It’s free.