Before we dive into the accounting of a partnership firm, it is important that we learn the basics of partnership. The essentials that make a partnership are unique and valuable information before we learn accounting effects. Also, we will look at the basics of a partnership deed. Let us get started.
Nature of Partnership
When two or more persons join hands to set up a business and share its profits and losses it is called Partnership. Section 4 of the Indian Partnership Act 1932 defines partnership as 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’.
Partners are the persons who have entered into partnership individually with one another. Partners collectively are called ‘firm’. The essential features of the partnership are as follows.
Browse more Topics under Accounting For Partnership
- Distribution of Profit Among Partners
- Guarantee of Profit to a Partner, Past Adjustments and Final Accounts
- Special Aspects of Partnership Accounts and its Maintenance
Two or More Persons
There should be at least two persons coming together to form the partnership for a common goal. In other words, the minimum number of partners in a partnership firm can be two.
- For Banking Business, Partners must be less than or equal to 10.
- For Any Other Business, Partners must be less than or equal to 20.
- If the number of partners exceeds the limits, the partnership becomes illegal.
The partnership is an agreement between two or more persons who decided to do business and share its profits and losses. To have a legal relationship between the partners, the partnership agreement becomes the basis. The agreement can be in written form or oral form. An oral agreement is equally valid. But, preferably the partners should have a written agreement, in order to avoid disputes in future.
To carry on some business there should be an agreement. Mere co-ownership of a property does not amount to the partnership. The business must also be legal in nature, a partnership to carry out illegal business is not valid.
The business of a partnership firm may be carried on by all the partners or any of them acting for all. This statement has two important implications. First, to participate in the conduct of the affairs of its business, every partner is entitled. Second that a relationship of mutual agency between all the partners exists.
For all the other partners, each partner carrying on the business is the principal as well as the agent. He can bind other partners by his acts. And also is bound by the acts of other partners with regard to the business of the firm.
Sharing of Profit
The agreement between partners must be to share profits and losses of a business. Sharing of profits and losses is important. The partnership is not for the purpose of some charitable activity.
Liability of Partnership
Each partner is liable jointly with all the other partners. And also when is a partner, severally liable to the third party for all the acts done by the firm. Liability of the partner is not limited. This implies that for paying off the firm’s debts, his private assets can also be used.
Agreement to carry on a business between the partners, partnership comes into existence. The partnership agreement can be either oral or written. The Partnership Act does not require that the agreement must be in writing. But when the agreement is in written form, it is called ‘Partnership Deed’. Partnership deed should be duly signed by the partners, stamped & registered.
Partnership deed generally contains the following details:
- Names and Addresses of the firm and its main business;
- Names and Addresses of all partners;
- A contribution of the amount of capital by each partner;
- The accounting period of the firm;
- The date of commencement of partnership;
- Rules regarding an operation of Bank Accounts;
- Profit and loss sharing ratio;
- The rate of interest on capital, loan, drawings, etc;
- Mode of auditor’s appointment, if any;
- Salaries, commission, etc, if payable to any partner;
- The rights, duties, and liabilities of each partner;
- Treatment of loss arising out of insolvency of one or more partners;
- Settlement of accounts on the dissolution of the firm;
- Method of a settlement of disputes among the partners;
- Rules to be followed in case of admission, retirement, a death of a partner; and
- Any other matter relating to the conduct of business. Normally, all the matters affecting the relationship of partners amongst themselves are covered in partnership deed.
Q: Arti and Anita are partners in the firm without a partnership deed with a capital of Rs5,00,000 and Rs. 3,00,000 respectively. Arti wants to share the profits in the ratio of capitals. Whether the claim is valid, state with a reason.
Solution: In the absence the partnership deed, profits are shared equally between the partners, according to the Indian Partnership Act, 1932. So, the claim of Arti is not valid to share profits in the ratio of capitals.