Partnership accounting tutorial pdf

The accounting treatment for these kinds of compensation is beyond the scope of this article. Join Now. Basics of partnership accounting Part I. Income allocation in partnership accounting. Previous Page. Related accounting tutorials and articles. Basics of partnership accounting Part II. XXX take note that it is now credited to the drawing accounts. There are errors in the recording or even underrecording or overrecording or misrecording or non recording of financial transaction more particularly affecting profit and loss accounts in the past years which were uncover during the current year.

Since the net income or net loss during those years were not accurate , the capital accounts are likewise not accurate HENCE a correction has to be made. What are the example of these errors. When an inventory was overvalued at the end of the year, that means the inventory account was overdebited and the cost of sales was over credited, in this case the net profit is overstated because the cost of sales becomes smaller than it should be. Similarly when the inventory was understated, the cost of sales is overdebited thereby decreasing the net profit.

When a sales was made but no entry to record the receivable and sales account, the profit and loss decreases. What is difficult here is how the inventory errors are to be corrected. The periodic inventory method is where an actual count is taken and the proper costing is done. Last year the inventory was counted and there are 4 units at 3. Unfortunately This year let us say, there is transaction, just to simply the matter, but again an inventory was counted and the count is expectedly to be 4 units at 3.

So that this year , the cost of sales is overstated by It must be first check whether those errors in previous years were not corrected the following year , if it is already adjusted the following year , there is no need to adjust.

There are three system that would bring their capital balance to their sharing ratio 1. THE FIRM shall pay the partner whose capital did not changed and charged or debited to the capital account of the other partners. ISSUE: 1. A, B partners with the following capital movement during the year. I repeat, when bonus is treated as expense the , the bonus is computed based on net income before bonus.

If bonus is treated as distribtution of profit then bonus computed based on net income after bonus. A to receive salary of 10, and B 6, chargeable to expense. C to receive minimum of 5, , D to receive minimum of 12, Partner's Commission i Commission is an expense for the firm and a gain to the partner.

Reserve 6. The undermentioned trial balance was extracted from their books on December 31, Trial Balance as on December 31, Rs. The following adjustments are to be made: 1. The value of stock on December 31, was Rs.

Write off Rs. Particulars Amount Particulars Amount Rs. They contributed Rs. The partnership deed provided that Ajit is to be paid a salary of Rs. The drawings for the year were: Ajit Rs. Interest on drawings Rs. The net amount of profit as per the profit and loss account for the year ended was Rs.

You are required to record the necessary journal entries relating to appropriation of profit and prepare the profit and loss appropriation account and the partners' capital accounts. Debit Credit Amount Amount Rs. The balance in their capital and current accounts as on January1, were as under : Pawan Purna Rs. Capital Account 30, 20, Current Account Cr. The drawings of Pawan and Purna for the year were Rs.

The net profit of the firm before making these adjustments was Rs. Prepare the Profit and Loss Appropriation Account and the partners' capital and current accounts. Pawan Purna Date Particulars J. Pawan Purna F. Pawan Purna Rs. Interest to be allowed on capital is to be calculated with respect to the time, rate and amount.

Generally, following points are to be borne in mind while calculating the interest on capital: 1. Normally, interest on the opening balance at the beginning of the year is allowed for the whole accounting year. If additional capital is invested during the year, interest for the relevant period is calculated. If part of the capital is withdrawn during the year, interest on the part of the capital that was invested for the whole year, interest is calculated for the whole year and it is added with the amount of interest that is calculated on the remaining capital that was invested for the relevant period.

For example, Anmol has Rs. In the middle of the year he withdrew Rs. Illustration 5 Interest on Capital Mansoor and Reshma are partners in a firm. Their capital accounts showed the balance on Jan 1, as Rs. During the year, Mansoor introduced additional capital of Rs.

Reshma withdrew Rs. Calculate the interest to be paid on the capital. Interest on drawings is to be calculated with reference to the time period for which the money was withdrawn.

Following may be the possibilities requiring the different calculations of interest when: 1 Amount, rate of interest and date of withdrawal is given: Suppose, Johnson is a partner who withdrew Rs. The calculation of interest will be as follows: 10 3 Rs. The calculation of interest will be as follows: 10 6 Rs. Hence, interest is charged for the average of the period of the year, i. For example, Sonu withdraws Rs. In this case, interest on drawings will be calculated as follows : Statement of Calculation of Interest on Drawings 1 2 3 4 5 Date Amount Rs.

He withdrew the following amounts during the year : Rs. Assuming the accounting year closes on December 31each year, interest on drawings to be debited to Rajesh shall be worked out as follows : 1 2 3 4 Date Amount Rs. Period Months Product Rs. In that case also, we shall arrive at the same amount of interest. Illustration 7 Interest on drawings Amit and Sonu are partners sharing profits equally.

Amit withdrew Rs. Period for which money has Product Rs. The calculation of the average period depends upon the fact whether the fixed amount is withdrawn on the first day of every month or the last day of every month. Hence, the interest on drawings can also be calculated by applying the average period formula. During the year ended, December 31, , Maneesh withdrew Rs. Calculate interest on the partners' drawings. There may be two situations : a Guarantee to one partner by others the firm, b Guarantee to a partner by another partner individually.

Such a guarantee may be given to an existing partner or to a new partner at the time of admission. Such guaranteed amount shall be paid to partner when his share of profit, as calculated, according to his profit sharing ratio is less than the guaranteed amount. The deficiency of such guaranteed amount will be borne by the other partner's in their profit sharing or agreed ratio as the case may be. Example, Soni and Mita are partners and they decide to admit Mary into the partnership firm.

The profit sharing ratio is agreed as with a guaranteed amount of Rs. For the year ended , the business earns a profit of Rs. Mary's share works out to Rs. This is Rs. Hence, Mary will get Rs. They admit Printer as a partner with a guarantee that his share of profits shall not be less than Rs. Profits are to be shared in the proportion of The total profits for the year ended were Rs.

Prepare the profit and loss appropriation account showing the division of the profits for the year. Since Printer has been guaranteed a minimum amount of Rs. In illustration 9, all the three partners have agreed to guarantee Printer for the minimum share of profit.

Hence, these three divided the Printer's share in the ratio of Suppose Mouse alone agrees to guarantee Printer then profit distribution will be as follows : Mouse's share Rs.

Kim undertook to meet the liability arising out of the guaranteed amount to Mohit. The profit sharing ratio between Kim, Lal and Mohit will be The firm earned profit of Rs. You are required to prepare Profit and Loss Appropriation Account and show the distribution of profit amongst the partners. Hence, there is a shortfall of Rs 6, This amount will be borne by Kim. Such omissions and commissions usually relate to the interest on capital, interest on drawings, salary to partners, etc.

In such a situation, necessary adjustments have to be made in the partners' capital account through an account called Profit and Loss Adjustment Account. The following procedure may be helpful in recording necessary adjustments : 1. If, interest on capital is one of the items of omissions, then first ascertain the partners' capital at the beginning. This can be done by deducting partners' share of current year's profit from their capitals at the end and adding their drawings thereto.

Work out the amounts of omitted items that are to be credited to partners' capital accounts such as interest on capital, salaries to partners, etc. Work out the balance of the Profit and Loss Adjustment Account. The credit balance of the Profit and Loss Adjustment Account reflects the profit and the debit balance, the loss.

This is to be distributed among the partners. The balance of the Profit and Loss Adjustment Account as worked out in point 4 above be transferred to the partners' capital accounts in their profit sharing ratio. Thus, the Profit and Loss Adjustment Account will stand closed. Illustration 11 Past adjustments Asha and Bony are partners in a firm sharing profits equally. Their capital accounts as on December 31, showed balances of Rs. After taking into account the profits of the year , which amounted to Rs 20,, it was subsequently found that the following items have been left out while preparing the final account of the year ended It was decided to make the necessary adjustments to record the above omissions.

Give the necessary journal entries and prepare the profit and loss adjustment account and Partners' capital accounts. Solution 1 Partners capital at the beginning Asha Bony Rs. Capital at the end 60, 50, Less: Share of Profit 10, 10, Rs. Asha's Bony's Date Particulars J. Asha's Bony's Rs. Amount credited 8, 4, Interest on capital, salary and commission Amount debited 6, 6, Interest on drawings and share of loss Cr.

This helps the business to earn more profits as compared to a newly set up business. In accounting, the monetary value of such advantage is known as 'goodwill'. It is regarded as an intangible asset. In other words, goodwill is the value of the reputation of a firm in respect of the profits expected in future over and above the normal profits.

Thus, goodwill exists only when the firm earns super profits. Any firm that earns normal profits or is incurring losses has no goodwill. Nature of Business : A firm that produces high value added products or having a stable demand is able to earn more profits and therefore has more goodwill.

Location : If the business is centrally located or is at a place having heavy customer traffic, the goodwill tends to be high. Efficiency of Management : A well-managed concern usually enjoys the advantage of high productivity and cost efficiency. This leads to higher profits and so the value of goodwill will also be high. Market situation : The monopoly condition or limited competition enables the concern to earn high profits which leads to higher value of goodwill.

Special Advantages : The firm that enjoys special advantages like import licences, low rate and assured supply of electricity, long-term contracts for supply of materials, well-known collaborators, patents, trade marks, etc. But, in case of a partnership firm it may also arise in the following circumstances: 1. Change in the profit sharing ratio amongst the existing partners; 2. Admission of a new partner; 3. Retirement of a partner; 4. Death of a partner; 5. Dissolution of a firm which involves sale of business as a going concern; and 6.

Amalgamation of firms. Average Profits Method : Under this method, the goodwill is valued at agreed number of 'years' purchase of the average profits of the past few years. It is based on the assumption that a new business will not be able to earn any profits during the first few years of its operations. Hence, the person who purchases a running business must pay in the form of goodwill a sum which is equal to the profits he is likely to receive for the first few years.

The goodwill, therefore, should be calculated by multiplying the past average profits by the number of years during which the anticipated profits are expected to accrue. For example, if the past average profits of a business works out at Rs. Illustration 12 Goodwill The profit for the last five years of a firm were as follows year Rs. Calculate goodwill of the firm on the basis of 4 years purchase of 5 years average profits. Solution Year Profit Rs. The profits for the last five years were as follows : Year Rs.

Year ending Profit Rs. March 31 4,00, including an abnor mal gain of Rs. Solution Calculation of average maintainable profits. Year ended Profit Rs. Weighted Average Profit Method : This method is a modified version of the earlier method. Under this method each year's profit is multiplied by the respective number of weights i.

Thereafter, the weighted average profit is multiplied by the agreed number to find out the value of goodwill. It is applicable when the profit shows a rising or falling trend. Solution Year Profit ended 31 March Rs. The profit of the last four years were : Rs. The weights assigned to each year are : ; 2; 3 and You are supplied the following information : i On September 1, a major plant repair was undertaken for Rs.

Solution Calculation of adjusted profit Rs. Given Profits 20, 24, 20, 30, Less Management Cost 4, 4, 4, 4, 15, 20, 15, 25, Add Capital expenditure charged to revenue - - 6, - 15, 20, 21, 25, Less unprovided depreciation - - 15, 20, 21, 24, Less over valuation of closing stock - 2, - - 15, 17, 21, 24, Add over value of opening - - 2, - stock Adjusted Profit 15, 17, 23, 24, Calculation of weighted average profits : Year Profit Weight Product Rs.

Super Profits Method : The basic assumption in the average profits method of calculating goodwill is that, if a new business is set up, it will not be able to earn any profits during the first few years of its operations. Hence, the person who purchases an existing business has to pay in the form of goodwill a sum equal to the total profits he is likely to receive for the first 'few years'.

It is also contended that the buyer's real benefit does not lie in total profits; it is limited to such amounts of profits which are in excess of the normal return on capital employed in similar business. Therefore, it is desirable to value, goodwill on the basis of the excess profits and not the actual profits. The excess of actual profits over the normal profits is termed as super profits. The Normal profits will work out at Rs.