Partnership Accounts
By Asok Nadhani
21.1 Partnership
As per Indian
Partnership Act, 1932, Partnership is the relation between two or more persons,
who have agreed to share the profits and losses of a business carried on by all
or any of them acting for all. Partners entering into a partnership are
individually called Partners and the collective
entity is called a firm.
21.1.1
Characteristics of Partnership
i)
It is an association of two or more persons.
ii)
There should be an agreement entered into by all persons
concerned. Though normally a partnership agreement is recorded in writing, it
may be real. However, to register a partnership agreement, it must be in
writing.
iii)
There is an agreement ratio which is used to share
profit or loss of the business and in the absence of any instruction, the
profits or losses must be shared equally between the partners.
21.1.2
Registration of Partnership Firm
The Registration of
Partnership Firm is not compulsory. The partners may submit an application in
the prescribed form giving the details of the business along with the
prescribed fees and this application form must be signed and verified by each
and every partner’s or by his authorized agent.
21.2 Partnership Deed
a)
The important terms of partnership as agreed by the
partners is (called the Partnership Deed) recorded in a document.
b)
Important changes of partnership deed: A
partnership deed should specify about:
i)
The amount of capital contributed by the partners.
ii)
The rate of interest on capital, drawings and loan.
iii)
The ratio in which profits and losses are to be
shared between the partners.
iv)
Salary and remuneration payable to partners.
v)
Method of valuation of Goodwill on introduction, retirement
or death of a partner.
vi)
Treatment of losses arising out of the insolvency
of a partner.
vii)
Preparation of Accounts and its Audit.
c)
Applicability of Partnership Act, 1932:
If there is no
partnership deed, or the partnership deed is silent on any point, provisions of
Indian Partnership Act, 1932 would be applicable, which lays down the following
guidelines:
i)
Equal share in profit or loss for all partners.
ii)
Partners are not entitled to any remuneration or
salary for the conduct of business.
iii)
No interest on capital to be allowed.
iv)
No interest on drawing.
v)
Loans or advances made to the firm carries interest
@ 6% p.a.
21.3 Partners’ Accounts
Normally Partners Account
means Capital Accounts, Current Accounts and Drawings Accounts of the partners,
but sometimes, Interest Accounts and Partners Loan Accounts are also included
in it.
21.3.1 Partners’ Capital Account: Partners’ Capital Account may be maintained under
the following two methods.
21.3.1.1 Fixed Capital: In this method, the partners are not allowed to change
their capital except in extraordinary circumstances. If fixed capital is
changed by partners’ agreement, additional capital introduced or withdrawn will
be recorded in Capital A/c.
Partners’
Capital Account (Fixed)
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Dr.
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Cr.
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Date
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Particulars
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Rs.
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Date
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Particulars
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Rs.
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To Cash A/c
(Capital withdrawn)
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By Balance b/d
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To Balance c/d
(Closing balance)
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By Cash A/c
(Additional capital
introduced)
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21.3.1.2 Fluctuating Capital: In this method, the
balance of capital accounts do not remain constant, but fluctuate frequently, normally
all the entries relating to drawings, interest on drawings, interest on
capital, salary or commission, share in profits or losses, etc are recorded in
Capital A/c.
Partners’
Capital Account (Fluctuating)
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Dr.
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Cr.
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Date
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Particulars
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Rs.
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Date
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Particulars
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Rs.
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To Drawings A/c
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By Balance b/d
(Opening balance)
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To Interest on drawings A/c
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By Interest on capital A/c
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To P&L
Appropriation A/c (loss)
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By Salary A/c.
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By Partner’s Commission A/c
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By Interest on Loan A/c
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To Balance c/d
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By P&L
Appropriation A/c (Profit)
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21.3.1.3 Difference between
Fixed Capital and Fluctuating Capital
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Serial Number
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Basis
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Fixed Capital
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Fluctuating Capital
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1.
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Meaning
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Capital remains fixed as
mutually agreed by the partners.
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Capital changes due to
any transactions relating to partner.
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2.
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Number of Accounts
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Apart from Partners
Capital A/c, Partner’s other Accounts are also maintained (like Current A/c).
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Only one account
maintained I.e. Partners Capital A/c, in respect of each partner.
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3.
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Adjustment entries
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Under this method,
adjustment entries like drawings, interest on capital or interest on
drawings, salary, share in profit or loss, etc. are recorded in current
account (not in capital accounts).
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All adjustment entries
relating to partners are recorded in their capital a/c.
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4.
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Change in Balance
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The Balance does not
change except in special circumstances.
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The Balance goes on
changing on every transaction with partner.
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5.
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Nature and Presentation
of Balance Sheet.
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Capital A/c always shows
credit balance, Balances of Partner’s Other A/c’s are shown separately in the
Balance Sheet.
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Only one account is
maintained and its balances shown in Balance Sheet.
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21.3.2 Current Account: Under fixed
capital method, a separate account is opened called Current Account. It is
credited with amount of the share of profit of the partner, interest on
capital, remuneration of the partner etc. and debited with drawings of the
partner, interest on drawings of the partner, amount of shares of loss of the
firm which is bear by the partner etc.
Partners’
Current Account
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Dr.
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Cr.
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Date
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Particulars
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Rs.
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Date
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Particulars
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Rs.
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To Balance b/d
(Opening balance, if Dr.
balance)
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By Balance b/d
(Opening balance)
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To Drawings A/c
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By Interest on capital A/c
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To Interest on drawings A/c
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By Salary A/c.
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To P&L
Appropriation A/c (loss)
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By Partner’s Commission A/c
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To Balance c/d
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By Interest on Loan A/c
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By P&L
Appropriation A/c (Profit)
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21.3.3 Drawings Account: Even when Current Account is there, a separate
account for drawing may be opened, in which drawings made by the partners are
recorded. At the end of the year, balance of drawings account is transferred
either to Current Account or to Capital Account as the case may be.
For example, when partners
withdraw goods:
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Drawings A/c (Partner A/c)
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Dr.
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To Purchase A/c.
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When a Partner
withdraws money for Personal Purpose:
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Drawings A/c (Partner A/c)
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Dr.
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To Cash A/c.
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Under no
circumstances, Drawings should be shown in Profit and Loss Account.
21.3.4 Partners’ Loan Account: This account is for all sorts of Loan (given to or
taken by) of partners.
i)
When firm takes loan from its partner:
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Cash or Bank A/c
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Dr.
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To Loan A/c (Partner A/c).
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ii)
When Loan is paid back by the firm to Partner,
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Loan A/c (Partner A/c)
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Dr.
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To Cash or Bank A/c.
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If no rate of
interest on partner’s loan is mentioned in partnership agreement, it is paid @
6% p.a. Payment of partner’s loan has a priority over his Capital.
21.3.5 Partners’ Interest Account: A firm may open an Interest Account for each
partner, for interest on capital and loan of the partner. At the end of the
year, balance of this account is transferred to Current Account.
21.3.6 Profit and Loss Appropriation Account: Adjustment entries of interest on capital, interest
on drawings, salary etc., may either be shown in Profit and Loss account or a
separate Profit and Loss Appropriation is prepared. Entries regarding interest
on capital, interest on drawings, salary and share in profit or loss will be
recorded through Profit and Loss Appropriation A/c.
21.3.6.1 Journal entries
relating to Profit & Loss Appropriation A/c
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1.
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For Interest on Capital
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(a)
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On allowing Interest on
Capital A/c
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Interest on Capital A/c
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Dr.
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To Partner’s Capital /
Current A/c
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(Interest on Capital allowed to Partners)
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(b)
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On Closure of Interest on
Capital A/c
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Profit and Loss Appropriation A/c
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Dr.
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To Interest on Capital A/c
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(Interest on Capital
transferred to Profit & Loss Appropriation A/c)
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Note:
In
place of above two entries only one entry may also be passed as follows:
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Profit & loss Appropriation A/c
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Dr.
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To Partner’s Capital A/c
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(Interest on Capital allowed to Partners)
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2.
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For Interest on Drawings
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(a)
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On charging Interest on
Drawings A/c
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Partner’s Capital / Current A/c
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Dr.
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To Interest on Drawings
A/c.
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(Interest charged on
Partner’s Drawings)
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(b)
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On Closure of Interest on
Drawings A/c
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Interest on Drawing A/c
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Dr.
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To Profit and Loss
Appropriation A/c
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(Interest on Drawings transferred to Profit & Loss Appropriation
A/c.)
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Note:
In
place of above two entries, only one entry may also be passed as follows:
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Partner’s Capital A/c
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Dr.
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To Profit & Loss
Appropriation A/c
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(Interest charged on Drawings of Partners)
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3.
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For Partner’s Salary or
Commission
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(a)
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On allowing Salary or
Commission
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Salary or Commission to Partners A/c
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Dr.
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To Partner’s Capital /
Current A/c
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(Salary or Commission paid
to Partners)
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(b)
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On Closure of Salary or
Commission to Partners A/c.
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Profit and Loss Appropriation A/c
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Dr.
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To Salary or Commission to
Partners A/c.
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(Salary or commission
transferred)
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4.
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For transfer to Reserve
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Profit and Loss Appropriation A/c
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Dr.
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To Reserve A/c.
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(Transfer to reserve)
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5.
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For transfer to Credit
Balance (If Profit)
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Profit and Loss Appropriation A/c
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Dr.
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To Partner’s Capital (or
Current) A/c.
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(Net profit distributed among partners.)
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21.3.7 Interest on Drawing
The interest is calculated at a fixed rate percent
from the date of drawing till the last day of the accounting period. If
interest on drawing is calculated on monthly basis, then following point should
be remembered.
(i)
If
a partner draws a fixed amount at the beginning of each month, interest on total
drawing will be calculated on the whole amount for 6.5 months.
(ii)
If
a partner draws a fixed amount at the end of each month, interest on total
drawing will be calculated on the whole amount for 5.5 months.
(iii) If a partner draws a fixed amount in the
mid of the month, interest on total drawing will be calculated on the whole
amount for 6 months.
Example: (Interest on
Drawings)
Suppose A, K & N are equal partners.
A withdraws Rs.1,000 at the beginning of each month.
K withdraws Rs.1,000 at the end of each month.
N withdraws Rs.1,000 in the mid of the month.
Rate of interest on drawing is 10% p.a. Show how the interest on
drawing will be calculated.
Solution:
A withdraws
at the beginning of each month, so
interest on drawing will be -
Rs. (1000 x 12) x
10% x 6.5/12 = Rs.650
K withdraws
Rs.1,000 at the end of each month,
so interest on drawing will be -
Rs. (1000 x 12) x
10% x 5.5/12 = Rs.550
N withdraws
Rs.1,000 in the mid of the month so
interest on drawing will be -
Rs. (1000 x 12) x
10% x 6/12 = Rs.600
These rates are arrived in the following way:
Calculation
of the interest of drawings:
A withdraws at the beginning of each month, so for the 1st month he will
pay interest for 12 months on his withdrawal amount i.e. Rs.1,000. Similarly for
the 2nd month he will pay interest for 11 months and so on.
Sum of the months based on beginning of each month for
12 months = (12+11+10 +9 +8 +7+6+5+4+3+2+1) month’s = 78 months. So effective
average period = 78/12 = 6.5 months.
So, the interest of drawing’s = Rs. {1,000 x 6.5 x 10%} = Rs.650
K withdraws Rs.1,000 at the end of each month, so for the 1st
month he will pay interest for 11 months on his withdrawal amount i.e.
Rs.1,000. Similarly for the 2nd month he will pay interest for 10
months and so on.
Sum of the months based on end of each month = (11 + 10
+ 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1+ 0) month’s = 66 months.
So effective average period = 66/12 = 5.5 months.
So, the interest of
drawing’s = Rs.{1,000 x 5.5 x 10%} = Rs.550
N withdraws Rs.1,000 in the mid of the month, so for the 1st month he will
pay interest for 11.5 months on his withdrawal amount i.e. Rs.1,000. Similarly
for the 2nd month he will pay interest for 10.5 months and so on.
Sum of the months based on mid of the month = (11.5+10.5+9.5+8.5+7.5+6.5+5.5+4.5+3.5+2.5+1.5+.5)
month’s =72 months. So effective average period = 72/12 = 6 months.
So, the interest of
drawing’s= Rs.{1,000 x 6 x 10%} = Rs.600
21.4 Practical Problems
Example 1: (Distribution of
profit when Partnership deed is silent)
Ram, Rahim and karim are
partners in a firm. They have no agreement in respect of profit-sharing ratio,
Interest on capital, interest on loan advanced by partners and remuneration
payable to partners. In the matter of distribution of profit they have put
forward the following claims:
(i)
Ram, who has contributed maximum capital, demands
interest on capital at 10% p.a. and share of profit in the capital ratio. But
Rahim and Karim do not agree.
(ii)
Rahim has devoted full time for running the
business and demands salary at the rate of Rs.500 p.m. But Ram and Karim do not
agree.
(iii)
Karim demands interest on loan of Rs.2,000 advanced
by him at market rate of interest @ 12% p.a.
How shall you settle the
dispute and prepare Profit and Loss Appropriation Account after transferring
10% of the divisible profit to Reserve. Net profit before taking into account
any of the above claims amounted to Rs.45,000 at the end of the first year of
their business.
[C.U
B. Com (Hons.)-1994]
Solution:
There is no partnership
deed. Therefore, the following provisions of The Indian Partnership Act are to
be applied:
(i)
No interest on capital is payable to any partner.
Therefore, Ram is not entitled to interest on capital.
(ii)
No remuneration is payable to any partner. Therefore,
Rahim is not entitled to any salary.
(iii)
Interest on loan is payable @ 6% p.a. Therefore,
Karim is to get interest @ 6% p.a. on Rs.2,000.
(iv)
The profits should be distributed equally.
Profit
and Loss Appropriation Account
For
the year ended ……..
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Dr.
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Cr.
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Particulars
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Rs.
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Particulars
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Rs.
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To Interest on Karim Loan A/c
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By Profit and Loss A/c
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(6 % of Rs.2,000 )
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120
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(Net Profit)
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45,000
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To Reserve A/c
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10% of Rs.(45,000 – 120)
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4,488
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To Partners’ Capital A/c:- (Share of Profit) [Note]
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Ram:- (1/3rd of
Rs.40,392)
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Rs.13,464
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Rahim:- (1/3rd
of Rs.40.392)
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Rs.13,464
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Karim:- (1/3rd
of Rs.40,392)
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Rs.13,464
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40,392
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45,000
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45,000
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Note: Profit after transfer of reserve = Rs.45,000
– (Rs.120 + Rs.4,488) = Rs.40,392. it will be divided among partners in their
profit sharing ratio.
Example
2 :( Fluctuating Capital)
On 1st January, 2010,
A, B and C enter into partnership contributing Rs.5,00,000, Rs.2,60,000 and Rs.2,40,000
respectively and sharing profits and losses in the ratio of 5:3:2. B and C are
entitled to a salary of Rs.16,000 and Rs.14,500 respectively per year. Interest
on capital is allowed at 5% p.a. 6% interest is charged on drawings.
During the year, A withdrew
Rs.40,000. B Rs.25,000 and C Rs.15,000.
Interest on drawing being :
A – Rs.2,250; B – Rs.1,125; and C – Rs.725. Profit in 2010 before the above mentioned
adjustments was Rs.1,42,800.
Show how the profit is
distributed and also prepare the Capital Accounts, if they were fluctuating.
[I.C.W.A
(Inter) – Dec.1995, Adapted]
Solution:
Working Notes:
1.
Calculation of
Interest on Capital
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Rs.
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A -on Rs.
5,00,000@ 5% p.a.
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25,000
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B- on Rs.
2,60,000 @ 5 % p.a.
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13,000
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C- on Rs.
2,40,000 @ 5% p.a.
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12,000
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50,000
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Profit and Loss Appropriation Account
For the year ended
31.12.2010
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Dr.
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Cr.
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Particulars
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Rs.
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Particulars
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Rs.
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To Interest on Capital A/c:- (W.N
1)
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50,000
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By Profit and Loss A/c
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1,42,800
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To Partners’ Salaries A/c:-
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(Net Profit)
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B -
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Rs.16,000
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By Interest on Drawings A/c:-
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C -
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Rs.14,500
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30,500
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A -
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Rs.2,250
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To Partners’ Capital A/c:- (Share of Profit)
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B -
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Rs.1,125
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A- (66,400 x 5/10)
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Rs.33,200
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C -
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Rs.725
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4,100
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B- (66,400 x 3/10)
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Rs.19,920
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C- (66,400 x 2/10)
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Rs.13,280
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66,400
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1,46,900
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1,46,900
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Partners’
Capital Accounts
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Dr.
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Cr.
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Date
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Particulars
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A
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B
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C
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Date
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Particulars
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A
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B
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C
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31.12.10
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To Drawings A/c
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40,000
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25,000
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15,000
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1.1.2010
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By Bank A/c (cash
introduced)
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5,00,000
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2,60,000
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2,40,000
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,,
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To Interest on Drawings
A/c
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2,250
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1,125
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725
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31.12.10
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By Interest on Capital A/c
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25,000
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13,000
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12,000
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,,
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To Balance c/d
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5,15,950
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2,82,795
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2,64,055
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,,
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By Partners’ Salary A/c
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-
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16,000
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14,500
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,,
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By P& L App. A/c(Share
of Profit)
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33,200
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19,920
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13,280
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5,58,200
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3,08,920
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2,79,780
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5,58,200
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3,08,920
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2,79,780
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Example
3:( Fixed and Fluctuating Capital)
A, B and C are partners in a
firm with capital of Rs.1,00,000, Rs.80,000 and Rs.40,000 respectively. They
share profits and losses as:
(i)
Up to Rs.20,000, in the ratio of 5:3:2;
(ii)
Above Rs.20,000, equally.
The net profit of the firm
for the year ended 31st December, 2009 amounted to Rs.80,400
and the drawings of the partners were: A – Rs.12,000, B – Rs.10,000 and C –
Rs.6,000.
You are required to prepare
the Profit and Loss Appropriation Account for the year ended 31.12.2009 and
Capital Accounts of the partners assuming:
(a)
Partners capitals are fixed
(b)
Partners’ capitals are fluctuating,
The following
adjustments should be made
1.
Interest on partners’ capitals to be paid @ 10%
p.a.
2.
Interest on drawings to be charged @ 5% p.a.
3.
A to receive salary of Rs.6,000 p.a.
4.
B and C to get commission @ 5% each on the net
profit.
Solution:
|
1.
Calculation of
Interest on Capital
|
2.
Calculation of
Interest on Drawing
(Assumed equal
monthly drawings at mid of each month)
|
3. Calculation of Partners’ Commission
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|||
|
|
Rs.
|
|
Rs.
|
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Rs.
|
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A - On Rs.1,00,000 @ 10% p.a.
|
10,000
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A - On Rs.12,000 @ 5% p.a. for 6 months
|
300
|
B - On
Rs.80,400 @ 5% p.a.
|
4,020
|
|
B - On Rs.80,000 @ 10% p.a.
|
8,000
|
B
- On Rs.10,000 @ 5% p.a. for 6 months
|
250
|
C - On
Rs.80,400 @ 5% p.a.
|
4,020
|
|
C - On
Rs.40,000 @ 10% p.a.
|
4,000
|
C
- On Rs. 6,000 @ 5% p.a. for 6 months
|
150
|
|
|
|
|
22,000
|
|
700
|
|
8,040
|
Profit
and Loss Appropriation Account
For
the year ended 31.12.2009
|
Dr.
|
|
|
|
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Cr.
|
|
Particulars
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Rs.
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Rs.
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Particulars
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Rs.
|
Rs.
|
|
To Interest on Capital
A/c:- (Wn.1)
|
|
22,000
|
By Profit and Loss A/c (Net
Profit)
|
|
80,400
|
|
|
|
|
By Interest on Drawings
A/c (w.n-2)
|
|
700
|
|
To Partners’ Salary A/c:-
A
|
|
6,000
|
|
|
|
|
To Commission A/c:- (Wn.3)
|
|
8,040
|
|
|
|
|
To Partners’ Capital A/c:-
(Share of Profit) (Wn.4)
|
|
|
|
|
|
|
A -
|
18,353
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|
|
|
|
|
B -
|
14,353
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|
|
|
|
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C -
|
12,354
|
45,060
|
|
|
|
|
|
|
81,100
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|
|
81,100
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a)
Fixed Capital Method:
Partners’
Capital Accounts
|
Dr.
|
|
|
|
|
|
|
|
|
Cr.
|
|
Date
|
Particulars
|
A
|
B
|
C
|
Date
|
Particulars
|
A
|
B
|
C
|
|
31.12.09
|
To Balance c/d
|
1,00,000
|
80,000
|
40,000
|
1.1.09
|
By Balance b/d
|
1,00,000
|
80,000
|
40,000
|
Partners’
Current Accounts
|
Dr.
|
|
|
|
|
|
|
|
|
Cr.
|
|
Date
|
Particulars
|
A
|
B
|
C
|
Date
|
Particulars
|
A
|
B
|
C
|
|
31.12.09
|
To Drawings A/c
|
12,000
|
10,000
|
6,000
|
31.12.09
|
By interest on Capital A/c (Wn.1)
|
10,000
|
8,000
|
4,000
|
|
,,
|
To Interest on Drawings A/c(w.n-2)
|
300
|
250
|
150
|
,,
|
By Partners’ Salary A/c
|
6,000
|
-
|
-
|
|
,,
|
To Balance c/d
|
22,053
|
16,123
|
14,224
|
,,
|
By Partners’ Commission A/c (Wn.3)
|
-
|
4,020
|
4,020
|
|
|
|
|
|
|
,,
|
By P&L Appro. A/c (W.n 4)
|
18,353
|
14,353
|
12,354
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34,353
|
26,373
|
20,374
|
|
|
34,353
|
26,373
|
20,374
|
(b)
Fluctuating Capital Method:
Partners’
Capital Accounts
|
Dr.
|
|
|
|
|
|
|
|
|
Cr.
|
|
Date
|
Particulars
|
A
|
B
|
C
|
Date
|
Particulars
|
A
|
B
|
C
|
|
31.12.09
|
To Drawings A/c
|
12,000
|
10,000
|
6,000
|
1.1.09
|
By Balance b/d
|
1,00,000
|
80,000
|
40,000
|
|
,,
|
To Interest on Drawings A/c(w.n-2)
|
300
|
250
|
150
|
31.12.09
|
By interest on Capital A/c (Wn.1)
|
10,000
|
8,000
|
4,000
|
|
,,
|
To Balance c/d
|
1,22,053
|
96,123
|
54,224
|
,,
|
By Partners’ Salary A/c
|
6,000
|
-
|
-
|
|
|
|
|
|
|
,,
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By Partners’ Commission A/c (Wn.3)
|
-
|
4,020
|
4,020
|
|
|
|
|
|
|
,,
|
By P&L Appro. A/c (W.n 4)
|
18,353
|
14,353
|
12,354
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,34,353
|
1,06,373
|
60,374
|
|
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1,34,353
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1,06,373
|
60,374
|
4.
Calculation of
Share of Profit
|
|
A
|
B
|
C
|
|
Up to Rs. 20,000 in the ratio (5:3:2)
|
10,000
|
6,000
|
4,000
|
|
Above Rs.20,000 equally. Rs.(45,060 – 20,000) = Rs.25,060 will be
shared equally.
|
8,353
|
8,353
|
8,354
|
|
|
18,353
|
14,353
|
12,354
|
21.5
Goodwill
i)
Goodwill is an intangible asset. It is represents
extra earning capacity of the firm and value of reputation of the firm.
ii)
Normally goodwill is recorded in the books only
when consideration in money or money’s worth has been paid for it. As a matter
of financial prudence, goodwill is written off over a period of time though
many enterprises prefer to retain it as an asset.
21.5.1
Methods of valuation of Goodwill
There are four methods for
valuation of goodwill
1.
Average profit basis,
2.
Super profit basis,
3.
Annuity basis,
4.
Capitalization basis.
21.5.1.1 Average Profit Basis: In this case,
the profits of the past few years are averaged and adjusted for expected change
in future.
i) Calculate
average profit on the basis of the past few years’ profits after having adjusted
for any expected change in future. Average may be simple or weighted.
ii) Goodwill =
Average Profit x No. of years purchase
of average profit
Example: Profits of a partnership
firm for the last five years were Rs.25, 000, Rs.35,000, Rs.50,000, Rs.65,000
and Rs.75,000. The simple average profit per year is (Rs.2,50,000 / 5) =
Rs.50,000. However, a clear increasing trend is noticed and therefore average
profit may be arrived at by assigning appropriate weights as shown below:
|
1
|
2
|
3
|
4
|
|
Year
|
Profit (Rs.)
|
Weight
|
Weighted Profit (Rs.)
|
|
1
|
25,000
|
1
|
25,000
|
|
2
|
35,000
|
2
|
70,000
|
|
3
|
50,000
|
3
|
1,50,000
|
|
4
|
65,000
|
4
|
2,60,000
|
|
5
|
75,000
|
5
|
3,75,000
|
|
|
|
15
|
8,80,000
|
So, Weighted
Average Profit = Rs.8,80,000/15 = Rs.58, 667.
(i) If Goodwill is
valued at three years’ purchase of profit, then in this case the value of
goodwill is Rs.58,667 x 3 = Rs.1,76,000(approx) (as per Weighted Average).
(ii) Rs.50,000 x 3 =
Rs.1,50,000 (as per Single Average).
21.5.1.2 Super Profit Basis:
a) Super Profit
means, excess profit that can be earned by a firm over and above the normal
profit usually earned by similar firms under similar circumstances. In this
method, goodwill is valued on the basis of super profits earned by firm.
b) The Steps of
computation are as follows :-
i)
Calculation of Average Profits.
ii)
Calculation of Normal
profits.
Normal profits = Capital Employed x Normal rate of profit /100.
iii)
Calculation of Super profits.
Super Profits = Actual Average Profits – Normal
Profits.
iv)
Valuation of Goodwill
Goodwill = Super Profits x No. of years’ purchased.
Example: A firm earned profits as
follows in last three years :-
|
1st year
|
7,200
|
|
2nd year
|
8,400
|
|
3rd year
|
9,600
|
Capital employed
is Rs.40,000 and normal rate of return is 12% p.a. Calculation of goodwill on
the basis of 2 year’s purchase of super profits is shown below.
Solution: Average Profits = Rs.(7,200
+ 8,400 + 9,600) /3 years. = Rs.(25,200 / 3) = Rs.8,400.
Normal Profits =
Capital employed x Normal rate of profit /100
= Rs.40,000 x (12/100) = Rs.4,800.
Super Profit =
Average profit – Normal Profit = Rs.(8,400 – 4,800) = Rs.3,600.
Goodwill = Rs. 3,600x
2 years = Rs.7,200
21.5.1.3 Annuity Basis: If a firm is making super
profits, the period (in years) the firm will continue to get this super profit
is estimated. Present value of super profits for such period is found out by
Annuity Method applying Annuity rate from Annuity Table.
Goodwill = Super Profit x Present Value of Rs.1 by Annuity Method.
Example: Capital employed Rs.2,00,000;
Normal rate of profit is 10%; Present value of
annuity of Rs.1 for 3 years at 10% is Rs.2.48685. Average profit for 3 years is
Rs.24,000. Find out goodwill by Annuity Method.
Solution:
|
|
Rs.
|
|
Average Profit
|
24,000
|
|
Less:
|
20,000
|
|
Super Profit
|
4,000
|
Goodwill as per Annuity
Method = Rs.4,000 x 2.48685 = Rs.9947.4
21.5.1.4 Capitalization basis: Under this
method, goodwill is valued on the basis of capitalized value of business or total
value of business. Capitalized value of business means the value which a buyer
of business will be ready to pay for a particular business.
Example: Future maintainable profits
are Rs.25,000, normal Profit rate is 20% and capital employed is Rs.1,00,000
Capitalized value
of business = (Further maintainable profits x 100) /Normal
rate
= Rs.25,000
x (100/20)
=
Rs.1,25,000
|
Capitalized value of
business
|
1,25,000
|
|
Less: Capital employed
|
1,00,000
|
|
Value of
goodwill
|
25,000
|
If capitalized
value of business is less than capital employed, value of goodwill will be nil.
21.5.2 Hidden Goodwill
In some cases,
value of goodwill may not be specified. It will be calculated with reference to
the total capital of the firm and the profit sharing ratio in the following
way-
Example:
A and B are partners with
capitals of Rs.10, 000 and Rs.20, 000 respectively and sharing profits equally.
They admitted C as their partner with one-fourth profits of the firm on the
payment of Rs.12, 000. The amount of hidden goodwill is
Solution:
Calculation of Hidden
Goodwill:
C brings Rs. 12,000 for its
¼ th share.
Therefore, total capital of
the firm is= Rs. 12,000 x 4 = Rs.48,000 (taking C’s capital as base)
Old partners’ capital should
be = Rs.(48,000 – 12,000)= Rs. 36,000
But their combined capital
is Rs. 30,000
So, Hidden goodwill=
Rs.(36,000- 30,000)= Rs.6,000.
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