Introduction
When two or more people join hands to run a business and share its profits, the relationship is called a partnership. In this chapter, which opens the Class 12 Accountancy course, you learn how the accounts of such a firm differ from those of a sole proprietor. The Balance Sheet, trading and profit and loss account look almost the same; what changes is how the partners' capitals are maintained and how the profit is shared among them. Almost every later chapter (admission, retirement, death, dissolution) builds on the ideas learnt here, so this chapter is the foundation of the whole partnership unit.
Key Concepts
1.1 Nature of 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." Its essential features are:
Two or more persons – the maximum is 50, as prescribed by the Central Government under Section 464 of the Companies Act, 2013 (the Act allows the government to prescribe up to 100).Agreement – written or oral; partnership arises from contract, not from status.Business – the agreement must be to carry on a lawful business.Mutual agency – every partner is both an agent and a principal of the firm.Sharing of profit – partners agree to share profits (and losses).Liability – liability of partners is unlimited; they are jointly and severally liable.1.2 Partnership Deed
The written agreement is called the partnership deed. It usually covers: names and addresses of the firm and partners, nature of business, duration, capital contributed, profit sharing ratio, interest on capital and on drawings, salaries and commission, loans by partners, rules for admission, retirement and dissolution, and settlement of disputes.
Provisions when the deed is silent (Act applies):
Profits and losses are shared equally.No interest on capital is allowed.No interest on drawings is charged.Interest on a partner's loan is allowed @ 6% p.a.No salary or commission is allowed to any partner.Every partner has the right to take part in business and to inspect the books.1.3 Special Aspects of Partnership Accounts
The special aspects are: maintenance of capital accounts, distribution of profit or loss, adjustments for wrong appropriations of the past, and reconstitution and dissolution of the firm.
1.4 Maintenance of Capital Accounts
Fixed Capital Method – each partner has a Capital Account (only opening capital, additional capital and permanent withdrawal of capital) and a separate Current Account (interest on capital, salary, commission, share of profit, drawings, interest on drawings). The capital balance stays unchanged; the current account can show a debit or credit balance.Fluctuating Capital Method – only one Capital Account; all adjustments pass through it, so the balance keeps changing. This is the method followed when nothing is stated.1.5 Distribution of Profit among Partners
Appropriations are shown in the Profit and Loss Appropriation Account, an extension of the P&L Account. It is credited with net profit and interest on drawings; it is debited with interest on capital, salaries, commission and transfer to reserve; the balance is divided in the profit sharing ratio.
Interest on capital is an appropriation, allowed only out of profits. If profit is less than the interest due, the profit is distributed in the ratio of interest on capital; in case of loss, no interest is allowed. (If the deed treats it as a charge, it is allowed even in a loss.)Interest on drawings = Drawings × Rate × Average period ÷ 12. For equal monthly drawings, the average period is 6.5 months (beginning of month), 5.5 months (end) and 6 months (middle). For equal quarterly drawings it is 7.5 months (beginning) and 4.5 months (end). If dates are not given, interest is charged for 6 months on average.Partner's salary/commission are appropriations; a partner's loan interest is a charge against profit.1.6 Guarantee of Profit to a Partner
A new partner may be guaranteed a minimum amount of profit. Any deficiency is borne by the guaranteeing partners in the agreed ratio (in their profit sharing ratio if nothing is said), or by one partner alone if only he gives the guarantee.
1.7 Past Adjustments
Omissions or errors (interest on capital, interest on drawings, salary, wrong ratio) discovered after accounts are closed are corrected by a single adjustment entry through partners' capital/current accounts, often worked out through a statement of net effect or a Profit and Loss Adjustment Account.
Worked Examples
Example 1 – Interest on capital with additional capital (Illustration 1). Sameer and Yasmin had capitals of ₹15,00,000 and ₹10,00,000 and introduced ₹3,00,000 and ₹2,00,000 on 1 October (6 months before year-end). Interest @ 5% p.a.:
Sameer = 75,000 + 3,00,000 × 5% × 6/12 (7,500) = ₹82,500Yasmin = 50,000 + 2,00,000 × 5% × 6/12 (5,000) = ₹55,000Under the fixed capital method Sameer's Current A/c = 82,500 + salary 20,000 + commission 10,000 + profit 60,000 − drawings 30,000 − interest on drawings 1,800 = ₹1,40,700 (Cr.); Yasmin's = 55,000 + 7,000 + 40,000 − 20,000 − 1,200 = ₹80,800 (Cr.).
Example 2 – Interest on capital when profit is insufficient (Illustration 7). Anupam and Abhishek (3:2) have capitals of ₹1,50,000 and ₹2,00,000; interest @ 8% = 12,000 + 16,000 = ₹28,000. If profit is only ₹14,000, it is divided in the ratio of interest 12,000:16,000 = 3:4 → Anupam ₹6,000, Abhishek ₹8,000. If there is a loss, no interest is allowed.
Example 3 – Interest on drawings. Aashish withdraws ₹10,000 per month (₹1,20,000 a year); rate 8% p.a.
Beginning of each month: 1,20,000 × 8% × 6.5/12 = ₹5,200End of each month: × 5.5/12 = ₹4,400Middle of each month: × 6/12 = ₹4,800Satish withdraws ₹30,000 per quarter (₹1,20,000) @ 8%: beginning of quarter × 7.5/12 = ₹6,000; end of quarter × 4.5/12 = ₹3,600.
Example 4 – Guarantee (Madhulika, Rakshita, Kanishka; 2:3:1). Profit ₹1,20,000; Kanishka is guaranteed ₹25,000 but her share is only ₹20,000. Deficiency ₹5,000 is borne 2:3 → Madhulika ₹2,000, Rakshita ₹3,000. Final: Madhulika ₹38,000, Rakshita ₹57,000, Kanishka ₹25,000. If only Rakshita gave the guarantee: 40,000 / 55,000 / 25,000.
Example 5 – Guarantee (Illustration 10). Mohit and Rohan (2:1) admit Rahul for 1/4 share with a minimum of ₹50,000. Profit ₹1,60,000: Rahul's share 40,000, deficiency 10,000 borne 2:1. Mohit 80,000 − 6,667 = ₹73,333; Rohan 40,000 − 3,333 = ₹36,667; Rahul ₹50,000.
Example 6 – Past adjustment of interest on capital. Rameez and Zaheer (equal) with capitals ₹50,000 and ₹1,00,000; 6% interest (₹3,000 and ₹6,000; total ₹9,000) was omitted. Correct distribution would have reduced each partner's profit by ₹4,500. Net effect: Rameez +3,000 − 4,500 = −1,500; Zaheer +6,000 − 4,500 = +1,500.
Rameez's Capital A/c Dr ₹1,500
To Zaheer's Capital A/c ₹1,500
Similarly, when interest on drawings @ 10% was omitted for Nusrat, Sonu and Himesh (5:3:2; drawings 20,000, 15,000, 10,000 → interest 2,000, 1,500, 1,000; total 4,500 re-shared as 2,250, 1,350, 900):
Sonu's Capital A/c Dr ₹150
Himesh's Capital A/c Dr ₹100
To Nusrat's Capital A/c ₹250
Key-Facts Sheet
Partnership defined in Section 4, Indian Partnership Act, 1932.Maximum partners: 50 (Section 464, Companies Act, 2013).Deed silent: equal profit, no interest on capital/drawings, no salary, 6% on partner's loan.Fixed method: Capital A/c + Current A/c; fluctuating method: one Capital A/c.Interest on capital = appropriation; interest on partner's loan = charge.Monthly drawings: 6.5 / 6 / 5.5 months; quarterly: 7.5 / 4.5 months.Deficiency of guarantee borne by guarantors in agreed (or their profit sharing) ratio.Board Exam Focus
Frequent questions: silent-deed provisions (3 marks), distinguish fixed and fluctuating capital (3–4 marks), P&L Appropriation with guarantee (4–6 marks), interest on drawings on different dates, and past adjustment entries.
Answer outline 1 – "Distinguish between Fixed and Fluctuating capital." Number of accounts (two vs one); change in balance (fixed vs changing); adjustments recorded (current account vs capital account); credit/debit balance (current may be debit, capital generally credit); state that fluctuating is the default method.
Answer outline 2 – "Prepare P&L Appropriation A/c with guarantee." Compute appropriations first (interest on capital, salary, commission) → divisible profit → share each partner → compare guaranteed partner's share with minimum → transfer deficiency from guarantors in the stated ratio → show final shares on the debit side.
Answer outline 3 – "Omission of interest on capital – pass one adjustment entry." Prepare a table: amount that should be credited (interest), amount wrongly credited (profit re-shared), net effect; debit the partner with net excess and credit the one with net shortage.
Key Terms
Partnership – साझेदारीPartner – साझेदारFirm – फर्मPartnership Deed – साझेदारी संलेखMutual Agency – पारस्परिक एजेंसीUnlimited Liability – असीमित दायित्वFixed Capital – स्थिर पूँजीFluctuating Capital – परिवर्तनशील पूँजीCurrent Account – चालू खाताProfit and Loss Appropriation Account – लाभ-हानि विनियोजन खाताInterest on Capital – पूँजी पर ब्याजInterest on Drawings – आहरण पर ब्याजGuarantee of Profit – लाभ की गारंटीPast Adjustments – पिछले समायोजनProfit Sharing Ratio – लाभ विभाजन अनुपातCommon Mistakes
Allowing interest on capital or salary when the deed is silent.Allowing interest on capital in full when the profit is insufficient, or at all in a year of loss.Using 6 months for all drawings instead of 6.5 / 5.5 / 7.5 / 4.5 months as the dates demand.Showing interest on a partner's loan in the Appropriation Account instead of the P&L Account.Posting salary, drawings or profit to the Capital Account under the fixed capital method.Charging guarantee deficiency to all partners, including the guaranteed partner.Passing several entries for a past adjustment instead of the single net entry.