Change in Profit sharing ratios among the existing partners

 

·         Any change in existing agreement of partnership is reconstitution of the firm. As a result, existing agreement comes to an end and new agreement comes into existence. But, the firm continues.

·         A firm is reconstituted in the event of-

(i)     Change in the profit-sharing ratio among the existing partners.

(ii)     Admission of a new partner or partners.

(iii)    Retirement of a partner.

(iv)    Death of a partner.

(v)     Amalgamation of two or more partnership firms.

·         Accounting of Goodwill-

A.     When Goodwill is adjusted through Partners` Capital Accounts

B.     When Goodwill is raised and written off

Note- Unless stated otherwise, partners` capitals should be assumed to be fluctuating.

C.     When Existing Goodwill is written off

·         Accounting of Reserves, Accumulated Profits and Losses-

(i)  For transfer of Reserves and Accumulated Profits:

(ii)  For transfer of Accumulated Losses:

(iii) When claim for compensation does not exist:

(iv) When claim for compensation is equal to amount of workmen compensation reserve:

(v)  When claim for compensation is less than the amount of workmen compensation reserve:

(vi)  When claim for compensation is more than the amount of workmen compensation reserve:

(vii)  When market value of investments is equal to book value:

(viii) Fall in value of investments is equal to Investment Fluctuation Reserve:

(ix)  Fall in value of investments is less than Investment Fluctuation Reserve:

(x)   Fall in value of investments is more than Investment Fluctuation Reserve:

(xi)  When market value of Investments is higher than Book Value:

·         Adjustment of Reserves, Accumulated Profits and Losses through Partners` Capital Accounts, When these are to be retained in the books.

·         Calculate Net Effect of Reserves, Accumulated Profits and Losses.

·         In case of positive net effect:

·         In case of negative net effect:

·         Specimen of Revaluation Account:

·         Adjustment of Capitals-

      Sometimes, reconstitution of partnership firm may also require that capital of partners be reconstituted in their profit sharing ratio so adjustment in capitals is also required. Following steps are followed:

(i) Prepare capital accounts of partners` by adjusting their old capital accounts.

(ii) Calculate total capital of new firm. (if not given)

(iii) Allocate firm’s capital in new profit sharing ratio.

(iv) Find surplus/deficit in each partner’s capital accounts.

(v)  Adjust surplus/deficiency in capital in cash or by opening partners` current account if they have fixed capital.  

Accounting for Partnership Firms- Fundamentals

 

·         The partnership is an association of two or more persons who have agreed to run the business and share its profit.

 

·         The Indian Partnership Act is silent about the maximum number of partners, however, the Indian Companies Act, 2013 limits the number of partners to 50 [Sec. 464 along with rule no. 10 of Companies (Miscellaneous) Rule, 2014].

 

·         Following persons cannot be admitted as a partner:

(i)         Persons of unsound mind/ lunatic.      (ii)        Insolvent persons.

(iii)       Any individual disqualified by law.   (iv)       Minor in normal course.

 

·         According to provision of Partnership Act, 1932 [Sec.30] a minor can be admitted as a partner for the benefit of partnership with the consent of all the existing partners.

 

·         Partners are agents as well as principals.

 

·         The partnership is the result of an agreement, either written or oral. The agreement among partners if written is termed as ‘Partnership Deed’.

 

·         It is not essential but desirable to have a Partnership Deed. In case Partnership Deed does not exist or where exist but it does not have a clause to this effect, provisions of the Indian Partnership Act, 1932 will apply.

 

·         The provisions of the Indian Partnership Act, 1932:

·         Profit and Loss Appropriation Account is a nominal account. It is an extension of Profit and Loss Account to depict the appropriation of profit among the partners. It is prepared by partnership firms.

·         Charge against profit means that it is an expense for the firm and is paid whether the firm earns profit or incurs loss. Appropriation of profit means that they are allowed, if the firm earns profit during the year.

·         Interest on Loan by Partner, Rent Payable to a Partner and Manager’s Commission etc., are charge against profit. It is debited to Profit and Loss Account.

 

·         Specimen of the Profit and Loss Appropriation Account

Profit and Loss Appropriation Account

For the year ended……

 

·         Interest on Loan by the Partner-

Interest on loan by partner is credited to his Loan Account and not to his Capital Account. Journal entries passed are:

(i) To provide interest on Loan by Partner:

            Interest on Loan by Partner A/c                     Dr.

                  To Loan by Partner A/c

(ii) To close the Interest on Loan by Partner A/c:

            Profit and Loss A/c                                         Dr.

                  To Interest on Loan by Partner A/c

 

Interest on Loan by the firm to Partner-

A firm may give loan to a partner. It will charge interest on the loan given at the rate agreed among the partners. If the Partnership Deed does not provide for charging interest on loan given or agreement to charge interest does not exist, interest is not charged on the loan given.

If interest is charged on loan by the firm to a partner, interest is transferred to the credit of Profit and Loss Account and debit to Partner’s Capital Account or Partner’s Current Account. Journal entries are:

(i) For charging interest on Loan to Partner:

            Partner’s Capital/Current A/c                         Dr.

                  To Interest on Loan to Partner A/c

(ii) For transfer of Interest on Loan to Partner A/c:

            Interest on Loan to Partner A/c                      Dr.

                  To Profit and Loss A/c

 

·         Appropriations are more than available profit- In this situation, profit available for distribution among partners is distributed in the ratio of appropriation to be made.

 ·         Fixed Capital Accounts Method

 ·         Fluctuating Capital Accounts Method

• Remuneration (Salary or Commission) to Partners-

(i) Percentage of Net Profit or Distributable Profit before charging commission:

Net profit or distributable profit before commission x Rate of Commission / 100

(ii) Percentage of Net Profit or Distributable Profit after charging commission:

Net profit or distributable profit before commission x Rate of Commission /  100 + Rate of Commission

• Interest on Capital-

Interest on capital is allowed to a partner to compensate for contributing capital to the firm in excess of the profit sharing ratio. Interest on partner`s capital is computed at the rate of interest mentioned in Partnership Deed with reference to time period. Thus, interest on capital is allowed on the opening balance of the Partners` Capital. If further capital is introduced by a partner or is withdrawn by a partner, interest is calculated with reference to time period of use of capital in the business.

In case opening capital is not given, it is calculated as follows:

(a) When capitals are fixed-

(b) When capitals are fluctuating-

# Either loss or profit will appear at a time.

·         Interest on drawings is calculated for drawings against profit. Drawings against capital is not considered for calculating interest on drawings. Two cases of calculating interest on drawings are:

Case -1 When drawings are made at irregular period or of different amounts.

1. Simple Method- In this method, interest on drawing is calculated separately on each amount of drawing, from the date of drawing till the date of accounting period. Interest on each amount of drawing is calculated with the help of following formula:

2. Product Method-In this method, the amount of drawings is multiplied with the number of months or number of days it is drawn. The product so obtained is totaled and interest is calculated thereon for one month if the period is in months and for one day, if the period taken is in days.

Case-2 When drawings are made of same amount at regular intervals.

Note: 

·         If date of withdrawal is not given, the interest on total drawings for the year is calculated for Six Months on the basis of time.

·         When rate of interest is given without the word ‘per annum’, interest is charged without considering the time factor.

Past Adjustments- Sometimes, after the final accounts have been prepared and the partners` capital accounts are closed, it is found that certain items have been omitted by mistake or have been wrongly treated. These omissions and errors are rectified by two ways:

(a) Pass an adjustment entry.        

(b) Pass adjustments entries through ‘Profit and Loss Adjustment Account’.

 

Guarantee of Profits- Guarantee is an assurance that an existing partner or an incoming partner will not get his share of profit less than guaranteed amount. It means that, in case his share of profit is less than the guaranteed profit, then he will be compensated for the deficit.

Such a guarantee may be given either by:

(a) All other partners in an agreed ratio.  

(b) One or more of the existing or old partners.

If the question is silent about the burden of guarantee, then the deficiency is borne by the remaining partners in their profit-sharing ratio.