Basic Concepts of Partnership - Class 12 Partnership Accounts Fundamental

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Topic Covered

  1. Meaning of Partnership
  2. Essential Elements (Main Features) of Partnership
  3. Essential Elements (Main Features) of Partnership
  4. Benefits or Advantages of having a Partnership Deed
  5. Provisions Applicable in the Absence of Partnership Agreement/Partnership Deed
  6. Interest on Loan by Partner’s to the Firm
  7. Interest on Loan by the Firm to Partners
  8. Rent Paid or Payable to Partner
  9. Manager’s Commission

1.   Meaning of Partnership

“Partnership is 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.”

2.   Essential Elements (Main Features) of Partnership

  1. There must be two or more persons.
  2. There must be an agreement.
  3. There must be lawful business.
  4. There must be sharing of profits of business.
  5. There must be a mutual agency, i.e., the business must be either carried on by all or any of them acting for all.

3.   Partnership Deed

The document containing the terms and conditions of the agreement between partners is known as the Partnership Deed. The Partnership Deed usually includes the following:

  1. Name and address of the firm.
  2. Names and addresses of all partners.
  3. Date of commencement of partnership.
  4. Capital to be contributed by each partner.
  5. Whether interest is to be allowed on capitals.
  6. Whether any partner is to be allowed salary.
  7. Profit-sharing Ratio among partners.
  8. The rights and duties of each partner.
  9. Method of valuation of goodwill in case of admission or retirement or death of a partner.
  10. Mode of settlement of accounts in case of retirement/death of a partner or dissolution of the firm.

4.   Benefits or Advantages of having a Partnership Deed

  1. It facilitates functioning of the business.
  2. It is helpful in the settlement of disputes arising among partners.
  3. It helps in avoiding misunderstandings among the partners.

5.   Provisions Applicable in the Absence of Partnership Agreement/Partnership Deed

  1. Interest is not allowed on Partners’ Capitals
  2. Interest is not charged on drawings.
  3. Partner is not entitled to salary or remuneration for the work done for the firm.
  4. Interest @ 6% p.a. is allowed on the loans by any partner.
  5. Interest is not charged on Loan by the firm to a partner.
  6. Profits or losses are divided equally among the partners.
  7. New partners cannot be admitted, unless all the partners agree.

6.   Interest on Loan by Partner’s to the Firm

  • If a partner gives a loan to the firm, he is entitled to an interest on such loan at an agreed rate of interest.
  • If there is no agreement as to the rate of interest on loan, the partner is entitled to interest on loan @ 6% p.a.
  • Interest on Loan is a charge against the profit.
  • It should be debited to Profit and Loss Account.
  • If interest is not paid yet, it should be interest amount should be credited to Interest Payable Account.

Rationale

Why Interest on Loan by the firm to the partner is not credited to his Capital Account?

  • Because it is paid to the partner as a lender and not as a partner; and
  • If interest is credited to his Capital Account and interest is allowed on Capital, it means interest will also be paid on unpaid interest on loan

Explanation

  • Loan by a partner is repayable on dissolution before repayment of capital to partners.
  • Interest must be payable @ 6% p.a. on loan and not on capital if deed is silent.

7.   Interest on Loan by the Firm to Partners

  • If firm given loan to a partner, interest will be charged on the loan at the agreed rate.
  • Interest is not charged on such loan if Partnership deed is silent.
  • Because, the Partnership Act, 1932 does not prescribe the rate of interest on loan given by the firm to partner.
  • Interest charged on loan by the firm to a partner is transferred to credit of Profit and Loss account and debit of Partners Capital Account.
  • Journal Entries

8.   Rent Paid or Payable to Partner

  • Rent paid to partner, like interest on loan by a partner, is a charge against the profit and not an appropriation of profit.
  • It is, therefore, debited to Profit and Loss Account and credited to Rent Paid /Payable Account.
  • If rent is not paid during the year but is payable, it should be credited to Rent Payable Account and not to Partner’s Capital Account.

Rationale

  • Rent Payable is a current liability being an expense.
  • If the rent payable is credited to Partner’s Capital Account and interest is payable on capital, it means interest will be paid on the amount of rent also.
  • Journal Entries

9.   Manager’s Commission

  • Manager’s Commission to be calculated on corrected Net Profit of Profit and Loss Account.
  • If the question is silent, it should be kept in mind that manager’s commission is a charge against the profit.
  • The Commission amount is transferred to debit of Profit & Loss Account.
  • Commission may be paid as
  1. a fixed amount or
  2. a percentage of Net Profit or
  3. partly as fixed amount and partly as percentage of Net Profit        

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