AHSEC - 12: Accounting for Partnership Firms including Goodwill Important Notes for MAY' 2021 Exam | Revised and Reduced Syllabus

Class 12 Accountancy Notes

Unit – 2: Accounting for Partnership Firms


Unit – 2: Accounting For Partnership Firms FOR 2021 EXAM

Q.1. Define the term “Partnership”, Partners, Firm and Firm name. What are essentials of partnership?

Ans: Partnership: 2004, 2010, 2011,

Partnership is an association of two or more person who agreed to do business and share profits and losses arises from it in an agreed ratio. The partners act both as agents and principals of the firm.

In India, Partnership firm is governed by the Indian Partnership Act 1932. Section 4 of this act defines partnership as: "The relationship between persons, who have agreed to share the profits of a business carried on by all or any one of them acting for all."

Partnership in this way is an agreement, between two or more persons to carry on legal business with profit motive, which is carried on by all or any one of them acting for all.

Partners, Firm and Firm name: The persons who have entered into a partnership with one another are individually called partners and collectively a firm. The name under which the business is carried is called firm name.

Essential (Characteristics) of Partnership: 2008, 2009, 2020

a)      Agreement: Partnership is the result of an agreement, either written or oral, between two or more persons. It arises from contract and not from status or process of law.

b)      Number of Persons: In a partnership firm there must be at least two people to form the business. Partnership Act 1932, does not specifies the maximum numbers of persons, but the Indian Company Act 2013, restricts the number of Partners to 100 for a partnership firm. But in case of limited liability partnership there is no maximum limit.

c)       Business: There must be a legal business. Business includes trade, vocation and profession.

d)      Profit-Sharing: The agreement between/amongst the partners must be to share profit or losses arise from the business.

e)      Agents and principals: The partners act both as agents and principals of the firm. Partnership firm can be carried on by all or any of them acting on behalf of all the partners.

f)       Separate legal entity: Partnership is a separate legal entity from the accounting point of view. But from the legal view point firm is not separate from its partners. If a firm is bankrupt, private estate of the partners is liable to meet firm’s obligations.

Q.2. What is Partnership Deed? What are its contents?                                1999, 2003, 2007, 2009, 2014, 2018, 2019

Ans: Partnership deed: Meaning

A partnership is formed by an agreement. This agreement may be oral or in writing. Though the law does not expressly require that the partnership agreement should be in writing, it is desirable to have it in writing. A written agreement, which contains the terms of partnership, as agreed to by the partners is called ‘Partnership Deed.’

Importance: It is a very important document of the firm which defines relationship amongst the partners. It is necessary to avoid disputes amongst the partners and can be presented in the court as evidence.

Contents (Clauses) of the Deed:

a)      Name and address of the firm.

b)      Names and addresses of the partners.

c)       Nature of Business.

d)      Amount of capital to be contributed by each partner.

e)      Profit or loss sharing ratio.

f)       Date of commencement of partnership.

g)      Interest of Capital, if provided the rate of interest must be specified.

h)      Partner’s salaries and commission, if provided.

i)        Interest on Drawings, if charged, the rate of interest should also be specified.

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ALSO READ (AHSEC ASSAM BOARD CLASS 12):

1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES

2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)

3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)

4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)

5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)

6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS

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Q.3. What are the rules to be followed in the absence of Partnership agreement between partners? 2000, 2002, 2009, 2011, 2014

Ans: According to Indian Partnership Act 1932 (sec. 4), the following provision are applicable in the absence of partnership deed:

a)      Profit Sharing Ratio: In the absence of partnership deed all partners will share Profit or losses in equal ratio.

b)      Interest on Capital: No interest will be given to any partner on his capital in the absence of partnership deed. In case, there is a partnership deed, which allows interest on capital, it will be allowed in case of profit but not in case of loss in the business.

c)       Interest on Drawings: No interest will be charged on drawing in the absence of partnership deed.

d)      Partner’s Salary/Commission: No salary or commission will be given to any partner in the absence of partnership deed.

e)      Interest on Partner’s Loan: Interest on partner’s loan will be given @ 6% p.a. Such interest is payable even if there are losses.

Q.4. Mention three Rights and Duties of Partners.           2009, 2014

Ans: Duties (Obligations) of a Partner: It is the duty of Partners:

a)      It is the duty of every partner to devote his full attention and time to the firm.

b)      It is the duty of every partner to act honestly for the benefit of the firm.

c)       It is the duty of every partner to not to carry similar business.

d)      Every partner must share losses of the firm.

e)      It is the duty of every partner to maintain secrecy and does not share business secrets with others.

Rights of a Partner:

a)      Every partner has a right to take part in the conduct and management of the business.

b)      Every partner has a right to be consulted in the matters of the partnership.

c)       Every partner has a right to share profits with others in the agreed ratio.

d)      Partners have a right of free access to all records, books of accounts and also to examine and copy them.

e)      Every partner has the right not to allow the admission of a new partner.

f)       Every partner has the right to retire from the firm after giving proper notice.

Q.5. What are various types of partners and partnership?

Ans: Types of Partners :

a)      Active partner: An active partner is a partner who gives capital, participates in management, shares the profits and losses and has unlimited liability.

b)      Sleeping partner or Dormant Partner: A Partner who do not take part in the business activities.

c)       Secret partner: A partner who has association with the firm but unknown to the public.

d)      Nominal partner: A partner who allows his name to be used by the firm is called nominal partner.

e)      Partner by estoppel: A person who by behaviour sets an impression to others that he/she is a partner of the firm.

f)       Partner by holding out: A person who is not a partner but allows himself to be represented as partner in a firm.

Kinds of Partnership:

Partnership firms are of two type’s viz., General Partnership and Limited Partnership.

1. General Partnership: In this case the liability of all the partners is unlimited. General Partnership can be further divided into two types i.e. (i) Partnership at Will, and (ii) Particular Partnership. These are explained as under:

(i) Partnership at will: When a partnership firm is constituted for unspecified period, it is known as Partnership at will. It can be dissolved by any partner by giving a notice indicating that he wants to withdraw his interest from the firm.

(ii) Particular partnership: As the very name suggests, this type of partnership is formed for conducting business of specific or temporary nature. The partnership comes to an end either on the accomplishment of the task for which the partnership was undertaken or on the expiry of the time period for which the firm was constituted.

2. Limited Partnership: Under this type of partnership some of the partners have unlimited liability while others have limited liability up to their individual share in the capital of the firm.

Q.6. What is Profit and Loss appropriation Account? Mention its purpose and features. Distinguish between profit and loss account and profit and loss appropriation account.                                2020

Ans: Profit or loss appropriation account: For the purpose of distribution of net profit between or amongst the partners, an additional account known as profit and loss appropriation accounts is prepared. This account is nominal in nature. It is prepared after profit and loss accounts to show the distribution of net profit amongst the partners after all appropriations. It is credited with net profit as shown by profit and loss account, interest on drawings and fines/penalty charged on partners and debited with interest on capital, partner’s salaries & commission and transfer to reserves. The balance of this account is distributed between/amongst the partners in their agreed profit sharing ratio.

Purpose of preparing profit and loss appropriation: In case of sole trade business, the whole of the net profit is credited to the proprietor’s capital and the capital account is debited for any drawings. But in case of partnership business, a separate account is needed for appropriation and distribution of profits between or amongst the partners. So, a new account is added after profit and loss account which is prepared only in case of partnership business. This account will show how the net profit of the business is being appropriated among partners.

Features of Profit and loss Appropriation account:

a) It is an extension of the profit and loss account.

b) It is a nominal account.

c) It is prepared by partnership firms only.

d) It is prepared as per the contents of partnership deed.

e) It shows the appropriation of profit for the accounting period.

Difference between Profit and loss account and Profit and loss appropriation account:

Profit and loss Account

Profit and loss appropriation account

1. It is prepared after trading account.

2. This account is prepared by every form of business organisation.

3. Items debited in profit and loss account are all expenses.

 

4. At the time of preparing this account, matching concept is followed.

5. This account is the basis of calculation of income tax.

1. It is prepared after profit and loss account.

2. This account is prepared by partnership firm only.

 

3. Items debited in profit and loss appropriation account are all appropriations.

4. At the time of preparing this account, no matching concept is followed.

5. This account is not the basis of calculation of income tax.

Q.7. What is fixed and fluctuating capital? Distinguish between them.  2007, 2020

Ans: In case of a partnership firm, a separate account is maintained for each partner to record various transactions between the firm and partners and to find the capital balance of each partner at the end of the year. This separate account is called partner’s capital account. A partnership firm can maintain the capital accounts of partners as fixed capital account method or Fluctuating capital Accounts method.

A) Fixed Capital Account method: Fixed capital means capital balance of the partners shall remain unchanged except in certain cases. When fixed capital method is followed, two accounts i.e., A Capital Account and a Current Account for each partner are maintained.

Capital Accounts: In case capital accounts are fixed, the opening and closing balances of capital accounts normally remain unchanged. But, if additional capital is introduced or drawings are made out of capital during the accounting year then closing capital will differ from opening capital. Fixed capital account always shows credit balance.

Current Accounts: When capital account is fixed, then current account is opened for each partner separately to record all the transactions, other than capital contribution and withdrawal of capital, between the firm and the partner. It is credited with partner’s salary, fees, bonus, commission, interest on capital, share in profits, partners’ share in reserves and goodwill and debited with Drawings out of profit, interest on drawings and share in losses. Current account of the partners may show both credit or debit balance.

B) Fluctuating Capital Account Method: Under fluctuating capital account method, only Capital account is maintained for each partner. Fluctuating capital method is normally followed for maintaining capital accounts in the absence of any instructions. Fluctuating capital accounts of partners means where in all the transactions relating to partners e.g. salary, fees ,commission, interest on capital, share in profits, goodwill, reserves, drawings etc., are recorded along with the opening balance of capital and additional capital introduced in the firm. In case of fluctuating capital accounts, current accounts of partners are not opened. The closing balances of partner’s capital account may show debit or credit balance.

Difference between fixed capital accounts and fluctuating capital Accounts:     2018

Basic of difference

Fixed Capital Account

Fluctuating Capital Accounts

1. Opening and Closing balance

Opening and Closing balances normally remains the same.

Opening and Closing balance changed due to adjustment in capital account.

2. Current account

Current accounts of partners are opened in this case.

Current accounts of partners are not opened in this case.

3. Adjustment relating to capital

All adjustment relating to partners capital accounts are made in current account.

All such adjustments are made in capital account itself.

4. Closing capital

The closing balance of capital account always shows a credit balance.

The closing balances of partner’s capital account may be debit or credit.

5. Number of Accounts

Two accounts i.e. capital and current account is maintained.

Only one account i.e. capital account is maintained.

6. Specific mention

If capital is fixed, then it should be specifically mentioned in the deed.

It is not necessary to be mentioned in the deed.

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ALSO READ (AHSEC ASSAM BOARD CLASS 12):

1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES

2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)

3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)

4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)

5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)

6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS

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Q. 8. Mention the adjustment entries for P/L appropriation account.                     1999, 2003, 2012,

Ans: Adjustment entries for P/L Appropriation account

Particulars

When Capitals are Fixed

When Capitals are Fluctuating

1. For Interest on Capital

(Adjustment Entries)

Interest on Capital A/c Dr.

Partner’s Current A/c Cr.

Interest on Capital A/c Dr.

Partner’s Capital A/c Cr.

Transferring interest of capital to p/l appropriation account

Profit and Loss Appropriation A/c Dr.

To Interest on Capital A/c

2. For Interest on Drawing

Partner’s Current A/c Dr.

Interest on Drawings A/c Cr.

Partner’s Capital A/c Dr.

Interest on Drawings A/c Cr.

Transferring interest of Drawings to p/l appropriation account

Interest on Drawings A/c    Dr.

To Profit and Loss Appropriation A/c

 

3. For Partner’s Salaries/ bonus /commission

Partner’s Salaries A/c Dr.

Partner’s Current A/c Cr.

Partner’s Salaries A/c Dr.

Partner’s Current A/c Cr.

Transferring interest of Partner’s salaries/bonus/commission to p/l appropriation account

Profit and Loss Appropriation A/c Dr.

To Partner’s salaries/bonus/commission A/c

4. Interest on Partner’s loan

Interest on Partner’s Loan A/c Dr.

Partner’s Loan A/c Cr.

Interest on Partner’s Loan A/c Dr.

Partner’s Loan A/c Cr.

Transferring interest on partner’s loan to profit and loss account

Profit and Loss Account Dr.

To Interest on Partner’s Loan A/c

5. Creation of reserve

Profit and Loss Appropriation A/c Dr

To General Reserve A/c

Q.11. What do you mean by Goodwill? What are its various types? Why it is valued?   2017, 2019

Ans: Goodwill: Goodwill is an intangible asset which indicates the value of the reputation of a firm. It comes into existence due to various favourable factors such as favourable location, efficient management, good quality of product and services etc. It is one factor which distinguishes an old established business from a new business. It can also be defined as the capacity of a business to earn extra income.

In the words of Eric L. Kohler “Goodwill is the present value of expected future profits in excess of a normal return on the investment in tangible assets.”

Types of Goodwill

Goodwill is mainly of two types:

1.       Purchased Goodwill

2.       Non-Purchased Goodwill

Purchased Goodwill: It is that goodwill which is acquired by making a payment. When one business is taken over by another business, the excess of purchase consideration over its net value (assets-liabilities) of the business which is taken over is termed to as purchased Goodwill. This type of goodwill is shown in the balance sheet.

Non Purchased Goodwill: Non Purchased Goodwill is an internally generated goodwill which arises because of favourable factors that a business possesses (e.g., favourable location, time factor and efficiency of management). This type of goodwill is not to be recognised as an asset hence not shown in balance sheet.

Situations/Reasons for Valuation of Goodwill                   2009, 2012, 2019

In case of a partnership firm, the need for valuation of goodwill may arise under the following circumstances:

a)      When a new partner is admitted,

b)      When a partner retires from the firm

c)       When a partner dies

d)      When there is a change in profit sharing ratio among partners,

e)      When the firm is sold as a going concern,

f)       When two or more firms amalgamated.

Q.12. What are various characteristics of goodwill? What are the factors affecting the value of goodwill?

Ans: Nature and Characteristics of Goodwill

a)      It is an intangible and not a fictitious asset.

b)      It indicates the capacity of a firm to earn extra income.

c)       It comes into existence due to various favourable factors such as favourable location, efficient management, good quality of product and services etc.

d)      It is difficult to ascertain the exact value of goodwill.

e)      It can be sold along with the sale of the business.

Factors affecting the value of Goodwill are:                       2007, 2019

a)      Skill in Management: If the management is capable and efficient, the firm will earn good profits and that will raise the value of goodwill.

b)      Location Factor: If the business is located at a favourable place, it can increase the volume of sales which correspondingly increases the value of goodwill.

c)       Quality: If the quality of goods and services are high, then there will be a ready market for the goods and the value of its goodwill will be high.

d)      Favourable Contracts: Sometimes, a firm enters into long term contracts for sale and purchase of goods at favourable prices. This will also affect profits and goodwill of the firm.

e)      Risk Involved: When the risk is less in the business it creates more goodwill but if the risk is more, it creates less goodwill.

f)       Market situation: If a firm deals in a product whose demand is higher than the supply, it will lead to a higher profit thereby increasing the value of goodwill of the firm.

Q.13. Explain various methods for valuation of Goodwill.                            2008, 2013, 2015, 2017

Ans: Methods of Valuation of Goodwill:

1)      Average/Simple Average profits method      2019

2)      Weighted average profit method

3)      Super profit method                              2012, 2019, 2020

1)      Average Profits Method: In this method, Actual maintainable profits of business over a number of years are taken into account. Actual maintainable profits earned over a number of years are totalled and average is determined by dividing total with number of years. The average profits so determined are multiplied by the number of year’s purchases to arrive at the value of goodwill.

For calculation of goodwill following steps are to be followed

1.       Calculate Actual maintainable profits with the help of following formula. Actual maintainable profits = Net Profit + Abnormal loss – Abnormal Gain – regular business expenses not considered in accounts.

2.       Calculate Average maintainable Profit = Total Actual maintainable profits /no of years.

3.       Calculate goodwill = Average maintainable Profit x no. of year’s purchase

2)      Weighted average method: This method is a modified version of average profit method. In this method each year profit is assigned a weight i.e. 1, 2, 3, 4 etc. Thereafter each year profit is multiplied by the weights so assigned and the sums of the products are calculated. The total of products is divided by the total of weights. As a result we find the weighted average profit. After this the value of goodwill is calculated by multiplying the weighted average profit with the agreed number of year’s purchase.

For calculation of goodwill following steps are to be followed:

1.       Total of Product of Profits: Sum of product of each year’s profit with weights.

2.       Weighted average profit = (Total of Product of Profits / Total of Weights)

3.       Value of goodwill  = Weighted average profit × number of year of purchase

3)      Super Profit Method: Super Profits means excess of actual average maintainable profits over normal Profit of a firm. Normal profits mean the profit which the firms could normally earns in a particular business. It is calculated by multiplying capital employed in the firm with normal rate of return. Goodwill under this method is calculated by multiplying super profit with the agreed number of year’s purchase.

Under this method, the following steps are to be followed for calculation of goodwill:

1.       Calculate average maintainable profit with the help of following formula: Total Actual maintainable profits /no of years.

2.       Calculate normal profit by multiplying capital employed with normal rate of return.

3.       Calculate super profit. Super profit is the excess of average maintainable profit over normal profit.

4.       Calculate the value of goodwill = super profit x no. of year’s purchase