Accounting of Partnership – Easy guide for FY 22-23

Accounting of Partnership – Easy guide for FY 2022-2023 is a attempt to help in Accounting & book keeping guide for all partnership firms out there. This article will address most of the questions related to accounting, Income Tax and partnership Act of Partnership firms. For additional questions drop comments.

Table of Contents

Explain Partnership and its key attributes

Partnership

Partnership is governed by Indian Partnership Act, 1932. Other Names are Firm/Partner/Firm Name. It is defined as a relation between 2 or more persons who have come together to conduct business and share profits of the said business. The business may be conducted by one on behalf of all partners.

Key attributes of a Partnership

The above definition gives us key attributes of a partnership which are as follows:

Two or more persons collaboration : A partnership is formed by 2 or more persons, 2 being the minimum number of partners required to form partnership. The maximum number of partners is not defined in Partnership Act. As per Companies Act, 2013 Section 464 maximum partner limit is capped at 100. However, in Companies (Miscellaneous) Rule, 2014 the maximum limit is 50. To conclude the maximum limit is currently kept at 50, if this limit exceeds the partnership becomes illegal.
Profit/Loss Sharing : The profits and losses from business of partnership will be distributed as defined in the partnership deed.
Partnership Deed : There must be a agreement written or verbal between the partners. A written agreement is call Partnership Deed and same has to be registered as per respective state laws.
Jointly & Severally Liable : All the partners are jointly and severally liable for all the acts done by each of them for there partnership business. The words “Jointly and Severally” simply means that legally any act done by a partner, resulting in liability which shall be borne by all of the partners.

Is Partnership firm a separate person ?

As per Income Tax Act, 1961 a partnership firm is a separate person who is liable to obtain a PAN in Firm’s Name and file Income Tax return. From legal point of view partnership firm is not a separate legal entity, partners will be jointly and severally liable for all the Act on behalf of firm.

Book keeping/ Accounting of Partnership Firm

Accounting of Partnership firm is more or less similar to any other accounting of any business. The additional account which is prepared in Partnership firms is a “Profit and Loss Appropriation Account”, all the entries related to distribution of Firm’s profit/Loss among partners in agreed ratio is distributed here. Profit and Loss Appropriation account is addendum to Profit and Loss Account.

Few additional accounts which are commonly used in Accounting of Partnership are as follows:

Profit & Loss Appropriation Account
Capital Accounts of Partners
Interest on Partners Drawings (As per agreed terms in Partnership Deed)
Interest on Partners Capital (As per agreed terms in Partnership Deed)
Salary or Commission to Partners (As per agreed terms in Partnership Deed)
Interest on Partners Loan (As per agreed terms in Partnership Deed)

Partnership Deed

A crucial documents which abides partners of the firm. All the relevant terms related to profit and loss sharing, salary/commission of partners, initial capital contributions, Interest on partners capital/drawings, Rights and Duties of partners, retirement/death/admission of partners, dissolution of partnership firms are defined in Partnership Deed

The most important thing is to get the Partnership Deed Registered. To obtain registration reach out to our professionals at taxledgeradvisor.

The Deed has to printed on Stamp Value as per respective state laws. It has to be duly signed by partners, 2 witnesses and then notarized by registered Stamp vendor.

The Partnership Deed envisages following details

Business Activity
Place of business
Name of business
Duration of Partnership business
Capital contribution of partners

Profit sharing Ratio
Management of the firm
Rights and duties of Partner
Operation of Bank Account
Borrowing power of firm
Books of Accounts maintenance and audit
Admission and Retirement of Partner – Procedures, settlement, goodwill money
Death of Partner – Procedures, settlement, goodwill money
Arbitration in case of dispute between the partners.
Insolvency of Partner case

For cases wherever Partnership Deed is silent, provision of Partnership Act, 1932 comes to rescue and same can be referred.

Partnership Act, 1932 link >> https://www.mca.gov.in/Ministry/actsbills/pdf/Partnership_Act_1932.pdf

Profit and Loss Appropriation Account – Accounting of Partnership

All the entries related to distribution of Firm’s profit/Loss among partners in agreed ratio is distributed here. Profit and Loss Appropriation account is addendum to Profit and Loss Account

Format of the Profit and Loss Appropriation Account is given below.

Profit and Loss Appropriation Account

For the year Ended as on _________

Dr Cr

Particulars	Amount	Particulars	Amount
To Profit and Loss Account (Loss)	xxx	By Profit and Loss Account (Profit)	xxx
To Interest on Partner’s Capital	xxx	By Interest on Partner’s Drawing	xxx
To Partners Salary	xxx
To Partners Commission	xxx
To reserve & surplus	xxx
To profit transferred to Partners Account	xxx
Total	xxxx	Total	xxxx

Profit & Loss Appropriation Account

Please Note:

If partners Commission is based on turnover/revenue or purchases then same becomes part of Profit and Loss Account and if commission is based on profit then it becomes part of Profit and Loss Appropriation Account.
Following are the items of Profit and Loss A/c Interest on Partner’s Loan and advance Manager Commission Rent Paid to a partner

Profit and Loss Account

For the year Ended as on ______________

Particulars	Amount	Particulars	Amount
To Interest on Partner’s Loan	xxx	By Revenue/Sales	xxx
To Manager Salary/Commission	xxx
To rent paid to partner	xxx
To reserve & surplus	xxx
To profit transferred to Profit and Loss Appropriation Account	xxx
Total	xxxx	Total	xxxx

Profit & Loss Account

Capital Account of Partner and and Interest thereon – Accounting of Partnership

Capital Account of Partner:

Methods have been defined in Accounting to maintain Capital Account of Partner.

Two methods to maintain Capital Account of Partners are :

Fluctuating Capital method
Fixed Capital method

If partnership deed is silent, then fluctuating capital method is used. This method is most commonly used method.

Fluctuating Capital method – Accounting of Partnership

As the name suggests fluctuating capital method, a single account is present partners capital account. Opening Capital is taken and all adjustment related to Interest on Partners Capital, Interest on Partner drawings, salary/remuneration to partners are passed in the same account.

Fixed Capital method – Accounting of Partnership

As the name suggests fixed capital method, two accounts are present.

They are as follows:

Partners’ Capital Account
Partners’ Current Account

1. Partners’ Capital Account: – Only two transactions additional capital introduced in business or capital withdrawn from business are recorded in this account.

2. Partners’ Current Account:- Other adjustments related to Interest on Partners Capital, Interest on Partner drawings, salary/remuneration to partners are passed in this account.

Interest on capital – Accounting of Partnership

Calculation of Interest on Capital: Interest on capital is calculated at the pre-defined rate with period for which capital has been used in the business. Interest on capital will be calculated on opening balance of capital account. Interest on capital is also allowed if any capital is introduced during the year.

Certain times closing capital is given then for the purpose of calculating “interest on capital” opening capital will find out

When Capital is fixed

Particulars	Partner A	Partner B
Opening Capital	xxx	xxx
Less: Capital Withdrawn	–	–
Add: Capital Introduced	+	+
Closing Capital	xxx	xxx

Calculation in case of Fixed Capital

When Capital is Fluctuating

Accounting Treatment of Interest on Capital

Particular Case	Rules Applicable
1. Interest in Capital is not agreed in Partnership Deed	Deduction of Interest on capital not allowed in fluctuating method
2. Terms of Interest on Capital is provided as “CHARGE” in Partnership Deed	Deduction of Interest on capital allowed in fluctuating method. The deduction is allowed even in case of loss
3. Terms of Interest in Capital is provided in Partnership Deed. But no description of whether same will be as a “CHARGE” or “APPROPRIATION“	Deduction of Interest on capital allowed in fluctuating method. However, no deduction is allowed in case of loss.

Capital is fluctuating case

Interest on Drawings – Accounting of Partnership

Interest on Drawings will only be deducted if terms of same is clearly defined in Partnership Deed. No deduction of Interest on drawings is same is not defined in Partnership Deed.

Calculation of Interest on Drawings

Methods are defined in Accounting for calculation of Interest on Drawings. Let us understand more about them below:

PRODUCT METHOD – Simple Method in which Interest on drawing will be calculated on each Date of withdrawn.

Date of Withdrawal	Amount (A)	Period (Date of Withdrawal to year end date)(B)	Product (A * B)

Total			xxx

Interest on Drawings = Sum of Product × Rate of Interest × Time

AVERAGE PRICE METHOD – Average Period Method ideally can be used in only one situation i.e. when amount and time gap between 2 drawings are same.

Accounting Treatment – Interest on drawings is profit or gain to the Firm and credited to the Profit & Loss Appropriation Account. On the other hand, interest on drawings is a loss to the partner and debits to his Current/Capitals Account.

Interest Payment on Partner’s Loan – Accounting of Partnership

Rate of Interest

Whenever a Partner gives loan to its Firm, interest may be charged by Partner at a rate as agreed upon in Partnership Deed. However, if Deed is silent as regards to Rate of Interest, Income tax allows such interest expenditure @ 6% p.a.

Nature of such Interest on Loan

Interest expenditure is in nature of “CHARGE” against profit and it has to be allowed no matter whether there is loss or profit in firm.

Accounting Treatment of this Interest on Loan

As discussed above, Interest expenditure is in nature of “CHARGE” against profit and hence, same goes on Debit side of Profit and Loss Account.

Salary/Commission withdrawn by Partners – Accounting of Partnership

When salary/commission is allowed ?

Salary/commission is allowed only in one case i.e. when the same is agreed upon in Partnership Deed.

Nature of Payment of Salary/Commission

Salary/Commission being “APPROPRIATION” out of profits is passed to Profit and Loss Appropriation account. If no Profit, then no salary/commission is allowed.

Calculation

Multiple ways can be decided to calculate commission. The method must be clearly defined in Partnership Deed. Let us discuss few below:

A case where commission has to be given from Net profit before tax before commission.
Another case where commission has to be given from Net profit before tax after commission.
Other possible case being, commission paid as a percent of either Sales or Purchases or some other terms as may be agreed.

Accounting of Partnership

For the first 2 cases, commission being “APPROPRIATION” out of profit is passed to Profit and Loss Appropriation Account.

For the 3rd case, commission being “CHARGE” out of profit is passed to Profit and Loss Account.

FAQs

Our professionals addressing some of the FAQs below :

1. What is basic accounting for partnership ?

A detail discussion has been done above in article on Profit and Loss appropriation account and Profit and Loss Account of Partnership Firm.

2. What are 2 types of partnership ?

The most common type of partnership is general partnerships. Over the recent years Limited Liability Partnership concept was introduced by enacting LLP Act, 2008. To conclude 2 types of partnerships are:

General Partnership
Limited Liability Partnership

3. What are 4 key elements of partnership ?

Refer key attributes of Partnership above.

4. What is partnership ratio of profit ?

Usually, the profit sharing ratio or partnership ratio of profit is 50:50. However it may vary and same will be agreed upon in Partnership Deed.

5. What is capital ratio in partnership ?

Usually, the capital ratio is 50:50. However it may vary and same will be agreed upon in Partnership Deed.

6. How profit and loss is shared in partnership ?