Unit:I

Chapter:1

What are Fundamentals of Partnership Firms?

Partnership

According to Section 4 of the Indian Partnership Act, 1932, “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.

Features of Partnership

  • Two or More Persons: At least two persons must pool resources to start a partnership firm. The Partnership Act, 1932 does not specify any maximum limit on the number of partners.
  • Agreement: A partnership comes into being through an agreement between persons who are competent to enter into a contract.
  • Lawful Business: The partners can take up only legally blessed activities. Any illegal activity carried out by partners does not enjoy the legal sanction.
  • Profit Sharing: The partnership agreement must specify the manner of sharing profits and losses among partners. In the absence of any clause, profit and loss to be shared equally.
  • Agency Relationship: Generally speaking, every partner is considered to be an agent of the firm as well as her partners. Partners have an agency relationship among themselves.
  • Unlimited Liability: All partners are jointly and severally responsible for all activities carried out by the partnership.
  • Not a Separate Legal Entity: The firm does not have a personality of its own. The business gets terminated in case of death, bankruptcy or lunacy of any one of the partners.
  • Transfer of Interest: A partner cannot transfer his interest in the firm to outsiders unless all other partners agree unanimously.

A typical microsporangium is surrounded by 4 walls

Partnership Deed

Partnership deed is a partnership agreement between the partners of the firms which outlines the terms and conditions of the partnership between the partners.

Provisions Of The Indian Partnership Act, 1932 In The Absence Of Partnership Deed

Since there is no partnership deed, provisions of the Indian Partnership Act, 1932 will apply.

  • No interest on capital is payable to any partner.
  • No interest is chargeable on drawings made by the partner.
  • Interest on loan is payable at 6% per annum.
  • No remuneration is payable to any partner.
  • Profits should be distributed equally.
  • New partner cannot be admitted unless all the partners agree.

Difference Between Fixed And Fluctuating Capital Accounts

Basis Fixed Capital Account Fluctuating Capital Account
1. Number of Accounts Maintained Two accounts, viz., capital and current account. One account, viz., capital account.
2. Nature of Account/Balance Remains unaltered. Fluctuates.
3. Adjustments Adjustments like interest on capital, drawings, interest on drawings, etc. are made in the current accounts. Adjustments are made in the capital account itself.
4. Appearance in the balance sheet Both capital and current accounts appear. Only capital account appears.
5. Specific mention It should be specifically mentioned in the partnership deed. Not necessary.
6. Credit/Debit balance Fixed capital accounts alway show a credit balance. Fluctuating capital may sometimes show a debit balance.

Format Of Profit And Loss Appropriation Accounts

Dr.

Profit and Loss Appropriation Account for the year ended ................

Cr.

Particulars Amount
(₹)
Particulars Amount
(₹)
To Profit and loss A/c (Net loss transferred from profit and loss account) ××× By Profit and loss A/c (Net profit transferred from profit and loss account) ×××
To Interest on partners’ capital A/c ×××
To Partners’ salary A/c ××× By Interest on partners’ drawings A/c ×××
To Partners’ commission A/c ×××
To Reserve A/c ×××
To Partners’ capital/current A/c (Profit) ×××
××× ×××

Past Adjustments (Relating To Interest On Capital, Interest On Drawing, Salary And Profit Sharing Ratio)

Sometimes in partnership firms the books of accounts get closed but some mistakes or omissions take place. Thus, to rectify those errors and omissions adjustment entries are passed.

The errors or mistakes are on account of the following:

  • Divisible Profit wrongly distributed.
  • Certain Appropriations (IOC, Salary, Bonus and Commission) omitted or wrongly dealt (excess charged or short charged).
  • Interest on Drawings omitted or wrongly dealt. (Excess or Short)

These errors and omissions are rectified by adjusting the Capital Account of the affected partners by passing (a) a single adjustment entry, or (b) adjustment entries.

Goodwill

Goodwill is an intangible asset which is not visible or cannot be touched but can be purchased and traded and is real. The value of an enterprise’s brand name, solid consumer base, functional consumer associations, good employee associations and any patents or proprietary technology represent some instances of goodwill.

Need for Valuation

Valuation of goodwill may be due to any of the following reasons:

Sole-proprietorship Firm

Partnership Firm

A Company

  • Firm is sold
  • Firm is converted into a Company
  • Any new partner is taken
  • Any old partner retires
  • Any change in profit-sharing ratio
  • Any partner dies
  • Different firms are amalgamated

Factors Affecting The Value Of Goodwill

  • Location
  • Time
  • Nature of Business
  • Capital Required
  • Owner’s Reputation
  • Market Situation
  • The trend of Profit
  • The efficiency of Management
  • Special Advantages

Methods of Valuation of Goodwill

Goodwill is valued as per the method stated in Partnership Deed or as per the Method of Valuation agreed by the partners. Following three method are followed for valuing goodwill:

Average Profit Method

  • ➥ Simple Average Profit Method
  • ➥ Weighted Average Profit Method

Super Profit Method

Capitalisation Method

  • ➥ Capitalisation of Average Profit Method
  • ➥ Capitalisation of Super Profit Method

Average Profit Method

This method is divided into two sub division.

Simple Average Profit Method

In this process, goodwill evaluation is done by calculating the average profit by the number of years it is called years purchase. It can be calculated by using the formula. Goodwill = Average Profit × Number of years’ purchase

Weighted Average Profit Method

This technique is used when there is a change in profits and giving high importance to the present year’s profit. It is evaluated by using the formula.
Goodwill = Weighted Average Profit x Number of years’ purchase Weighted Average Profit = Sum of Profits multiplied by weights/Sum of weights

Super Profit Method

It is a surplus of expected future maintainable profits over normal profits. The goodwill is established by
evaluating super-profits by a specific number of the purchase year. It can be estimated by applying the
below formula.

Super Profit = Actual or Average Profit – Normal Profit

Goodwill = Super Profit × Number of years’ purchase

Normal Profit = (Average Capital Employed × Normal Rate of Return)/100

Capitalisation Method

Capitalisation method has two methods of calculating it.

Capitalisation of Average Profit Method

In this process, goodwill is measured by subtracting the original capital applied from the capitalised amount of the average profits based on the normal rate of return. The formula used is mentioned below.

Capitalised Value of Business = Average Profit ×100/Normal Rate of Return

Capital Employed (Net Assets) = Total Assets – Outside Liabilities
Goodwill = Capitalised Value of Business – Net Assets

Capitalisation of Super Profit Method

Here, the super profit is capitalised, and the goodwill is calculated. Super Profit = Actual or Average Profit – Normal Profit

Goodwill = Super Profits ×100/Normal Rate of Return