Partnership Accounts

1. Introduction and Formation

A partnership is a business relationship between two or more persons (usually between 2 and 20) carrying on a business in common with a view to profit. The legal framework is guided by the Partnership Act of 1890.

The Partnership Deed

This is the internal agreement governing the relationship between partners. In the absence of an agreement, the Partnership Act provides that:

• Profits and losses are shared equally.
• No interest is allowed on capital.
• No interest is charged on drawings.
• No salaries or remuneration for partners.
• Interest at 5% per annum is allowed on loans made by partners to the firm.

2. Financial Statements in Partnership

Profit and Loss Appropriation Account

After calculating the Net Profit in the Trading, Profit and Loss Account, the Appropriation Account is prepared to show how the profit is distributed. Key items include:

• Interest on Capital: Reward for investing capital.
• Partners' Salaries: Reward for active participation.
• Interest on Drawings: Charged to discourage excessive withdrawals.
• Share of Profit/Loss: The residual amount shared in the agreed ratio.

Capital and Current Accounts

Partners maintain two main types of accounts:

• Fixed Capital Account: The capital remains constant. All adjustments (interest, salaries, share of profit) are recorded in a separate Current Account.
• Fluctuating Capital Account: All entries are made in the Capital Account, causing the balance to change constantly.

3. Admission and Retirement

When a new partner joins or an old one leaves, the business is technically dissolved and a new one formed. Key steps include:

• Revaluation of Assets and Liabilities: A Revaluation Account is opened. Profit/Loss on revaluation is shared among old partners in their old profit-sharing ratio.
• Goodwill: This represents the reputation of the business. It can be valued using the Average Profit or Super Profit methods.

4. Dissolution of Partnership

Dissolution occurs when the business is wound up. A Realization Account is prepared to:

• Record the sale of assets.
• Pay off liabilities.
• Determine the final profit or loss on winding up.

The Garner vs. Murray rule states that if a partner is insolvent and cannot pay their debit balance, the deficiency is shared by the solvent partners in the ratio of their last agreed capital.

5. Conversion to a Company

A partnership may convert to a limited liability company. A Realization Account is used to close the partnership books. The difference between the Purchase Consideration (price paid by the company) and the net book value of assets taken over is profit/loss on conversion.