In view of the coronavirus pandemic, we are making LIVE CLASSES and VIDEO CLASSES completely FREE to prevent interruption in studies

Accounting for partnership firms is just as important as accounting for any other business.  As a matter of fact, partnership firms are also business if the partnership firm is providing goods or/and services in exchange for money. This selling price always includes a profit margin. Hence, this feature of the partnership firm proves that it is also a business. However, like how every business should account its activities and transactions, so should the partnership firm. But accounting for partnership firms vary from the accounting the transactions of any other business form.

Before you understand the treatment of accounting for partnership firms, it is important to know all the fundamentals. Without the correct basics, it is difficult to treat the accounting books of partnership firms.

WHAT IS A PARTNERSHIP FIRM?

Unlike the sole proprietorship establishment, partnership firms have more than one decision maker. In other words, partnership firms involve two or more people. There are 4 main categories of partnership firms. The general partnership allows all partners to have unlimited liabilities. Whereas, the limited partnership allows partners to have limited liabilities against the obligation of the firm. There is also the partnership at will in which the partnership can be formed for an indefinite period of time. And the particular partnership is a partnership that is active for only a specific period of time. The particular partnership may last from a few days to only a few weeks. It can also deactivate upon the achievement of some goals as well.

In partnership firms, the profits made are proportionately distributed among the partners. Profit distribution ratios, however, decide the proportion of the profit that each partner receives. The Memorandum of Association (MOA) and the Article of Association (AOA) should state the profit sharing ratio of the partners.

Accordingly, the Memorandum of Association is a document that includes fundamental information about the firm. It provides clarity about the inception and incorporation of the partnership firm. Similarly, the Article of Association is a document that includes fundamental and an in-depth information about the governing rules of the firm. It provides clarity about the functioning and managerial decisions of the firm.

REQUIREMENTS OF ACCOUNTING FOR PARTNERSHIP FIRMS

Certain requisites should be present in order to be able to go ahead with accounting for partnership firms. A few such requisites are as follows.

  1. 2 or more people should be running the business. It is not a partnership firm if only 1 person is running the activities and business. In such a case, the accounting treatments vary because the firm is otherwise a sole proprietorship. Therefore, the primary requirement for accounting for partnership firms is to make sure that the firm is, in fact, a partnership firm.
  2. There should prevail a business idea or/and a profit motive. Since every business strives of maximizing its profits and providing qualitative goods/service. Hence, without the motive of making profits, it is difficult to account for partnership firms.
  3. There should be a binding agreement (partnership deed) that binds all the parties of the partnership firm. Usually, this agreement should be in writing. Because an oral agreement can often lead to a breach int he contract. Accounting for partnership firms is impossible if the partners of the firm are not binding on a mutual or legal contract.
  4. The partners should be willing to share the profits amongst themselves. The partnership firm is run wholly on trust, togetherness and hard work. Therefore, all the partners (whether active or dormant) should receive a share of the profits. Only in such a case is it possible to go ahead with accounting for partnership firms

WHAT IS A PARTNERSHIP DEED?

Partnership Agreement and Articles of Partnership are other names of the Partnership Deed. The Partnership Deed is an agreement that contains all the crucial information about the partnership firm and the partners. Since one of the major requisites for accounting for partnership firms is to have a binding contract, this deed is very important. The partnership deed is very important for the documentation and registration of the firm. Also, it is crucial to safeguard the interest of the business as well as its partners.

Although the law states that the partnership deed can be either oral or in writing, many partnership firms prefer it to be in legal writings. Many may mistake the partnership deed with the MOA and the AOA. But the Memorandum of Association and the Article of Association are important for the registration of the business. Whereas the partnership deed clarifies the details about the relationship that exists between the firm and the partners.

Some of the essential information that must be stated in the partnership deed is as follows.

  1. Name and address of the partnership firm
  2. The main business activity of the partnership firm
  3. Name and address of all the partners
  4. The accounting period of the firm (calendar period or financial period)
  5. The date of commencement of the partnership
  6. The rate of interest on the capital, loans or drawings etc
  7. Salaries, commisions and profit ratio amongst the partners
  8. Settlement of accounts on the dissolution of the firm
  9. The rights, duties and responsibilities of each partner
  10. Method of settling disputes that arise between the partners
  11. Rules during the admission, retirement or death of a partner(s)
  12. The treatment of loss
  13. The mode of auditor’s appointment

RULES APPLICABLE IN THE ABSENCE OF THE PARTNERSHIP DEED

A Partnership Deed is mandatory for every partnership firm. Not only does it prove its legality, but it also helps in various accounting operations. The partnership deed also plays an important role in the settlement of any disputes that arise among the partners. Moreover, the deed is a rulebook that helps in the smooth functioning of the partnership firm. However, some firms often decide to either draft its deed a little later or avoid the formation of the deed. In such a case, the rules for treating the business’s accounts change. Discussed below are the essential rules that are applicable in the absence of the partnership deed.

  • The profit sharing ratio is equal to all partners irrespective of their capital investment.
  • No partner receives any salary or commission. They only receive equal shares of the profit.
  • Partners do not have to pay any interest on capital.
  • No partner has to pay any interest on drawings.
  • Every partner is liable to pay 6% per annum as interests on loans.

PARTNER’S CAPITAL ACCOUNTS

In case of a partnership business, the partners must have separate capital accounts. The maintenance of these capital accounts varies from partner to partner. The maintenance of these capital accounts is crucial to go ahead with the accounting for partnership firms. However, there are 2 methods of maintaining partner’s capital accounts.

  1. Fixed Capital Account. Under this method, the original capital investments of the partners are kept constant. In case any additional capital is later introduced, this value will vary. Moreover, any entry relating to drawings, interest on capitals or interest on drawings are made in a separate account. This account is the capital account. Also, salary to partner and share of profits/losses are made here as well. Thus the maintenance of the capital account and the current account are crucial.
  2. Fluctuating Capital Account. Under this method, only the preparation of the current account is important. Also, the maintenance of current accounts for each and every partner is mandatory. The capital account may show a debit or credit balance and the balance of this account changes frequently from time to time. Therefore, it is called the Fluctuating Capital Account. Moreover, in this method, the capitals are not constant. In the absence of information, adoption of this method of treating capital accounts is a given rule.

To read more about the basics of accounting, you can refer this article!

Mock questions are too easy or too hard?

We adapt to your current skill level and rapidly raise it up.

+91
No thanks.

Request a Free 60 minute counselling session at your home

Please enter a valid phone number
  • Happy Students

    7,829,648

    Happy Students
  • Questions Attempted

    358,177,393

    Questions Attempted
  • Tests

    3,028,498

    Tests Taken
  • Doubts Answered

    3,020,367

    Doubts Answered