10 Partnership Accounts
10.1 Meaning of Partnership
Partnership is the second-oldest form of business organisation, sitting between the sole proprietorship (one owner) and the company (separate legal person). Indian law defines it through 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.”
The persons who enter into partnership are individually called partners and collectively a firm; the name under which they conduct the business is the firm name (maheshwari2022?; grewal2023?).
Five essential features follow from the statutory definition.
| Essential | Working content |
|---|---|
| Two or more persons | Minimum 2; maximum 50 (Companies Act 2013, Rule 10) |
| Agreement | Express or implied; written deed is preferred |
| Lawful business | Carried on with profit motive |
| Sharing of profits | Profit (and loss) shared in agreed ratio |
| Mutual agency | Each partner is agent and principal of the others |
10.2 The Partnership Deed
A partnership deed is the written agreement laying out the rights and duties of partners. It is not legally compulsory under the 1932 Act but is invariably advised. Where the deed is silent on a matter, the default rules of the Act apply.
| Item | Default rule |
|---|---|
| Profit-sharing | Equal among partners |
| Interest on capital | None |
| Interest on drawings | None |
| Interest on partner’s loan to firm | 6 per cent per annum |
| Salary or commission to a partner | None |
The interest on a partner’s loan at 6 per cent is a charge against profit — it is paid even if the firm has incurred a loss.
10.3 Capital Accounts of Partners
Partners’ capital can be maintained on one of two systems.
| Dimension | Fixed capital | Fluctuating capital |
|---|---|---|
| Number of accounts per partner | Two — Capital and Current | One — Capital |
| What goes into Capital A/c | Only original capital and additions/withdrawals of capital | All routine entries |
| What goes into Current A/c | Drawings, interest on capital, salary, share of profit | Not applicable |
| Capital balance | Generally constant | Changes every year |
| Recommended for | Stable partnerships | Most informal partnerships |
10.4 Profit and Loss Appropriation Account
The Profit and Loss Account computes net profit. The Profit and Loss Appropriation Account shows how that profit is distributed among partners.
| Debit side (appropriations) | Credit side (sources) |
|---|---|
| Interest on Capital | Net Profit transferred from P&L |
| Salary to partners | Interest on Drawings |
| Commission to partners | |
| Reserve / General reserve transfer | |
| Share of Profit to partners (residual) |
A partner’s salary, commission and interest on capital are appropriations of profit, not charges against profit — they are paid only out of available profit.
10.4.1 Worked example
A and B are partners with capitals of ₹4,00,000 and ₹2,00,000. The deed allows interest on capital at 10 % p.a., a salary of ₹60,000 to B, and profits to be shared 3 : 2. Net profit before appropriation is ₹2,00,000.
| Item | Amount (₹) |
|---|---|
| Net profit | 2,00,000 |
| Less: Interest on capital — A (₹4,00,000 × 10 %) | − 40,000 |
| Less: Interest on capital — B (₹2,00,000 × 10 %) | − 20,000 |
| Less: Salary to B | − 60,000 |
| Distributable profit | 80,000 |
| Share — A (3/5) | 48,000 |
| Share — B (2/5) | 32,000 |
A’s total credit = 40,000 + 48,000 = ₹88,000. B’s total credit = 20,000 + 60,000 + 32,000 = ₹1,12,000.
10.5 Goodwill
Goodwill is the value of the firm’s reputation — its ability to earn supernormal profit. It is intangible but real. Three valuation methods recur in the syllabus (maheshwari2022?).
| Method | Formula | Note |
|---|---|---|
| Average Profit Method | Goodwill = Average profit × Number of years of purchase | Simplest |
| Super Profit Method | Super profit = Average profit − Normal profit; Goodwill = Super profit × Years | Better; uses normal return on capital |
| Capitalisation Method | Goodwill = Capitalised value of average (or super) profit − Net assets | Most refined |
Normal profit equals normal rate of return × capital employed. Super profit is the excess actually earned.
10.6 Admission of a Partner
When a new partner is admitted, four adjustments are required.
- New profit-sharing ratio is decided.
- Sacrificing ratio of old partners is calculated: \(\text{Sacrifice} = \text{Old share} - \text{New share}\).
- Goodwill is brought in or adjusted, distributed to old partners in the sacrificing ratio.
- Revaluation of assets and liabilities is carried out through a Revaluation Account; gains or losses are shared in the old profit-sharing ratio.
Existing reserves and accumulated profits are also transferred to old partners’ capital accounts in the old ratio.
| Concept | When used | Formula | Distributed to |
|---|---|---|---|
| Sacrificing ratio | Admission of partner | Old share − New share | Computes goodwill compensation to old partners |
| Gaining ratio | Retirement / death | New share − Old share | Computes goodwill compensation by remaining partners |
10.7 Retirement and Death of a Partner
The pattern mirrors admission with the direction reversed.
- New profit-sharing ratio is set among continuing partners.
- Gaining ratio of remaining partners is calculated.
- The retiring (or deceased) partner’s share of goodwill is credited to him by debiting remaining partners in the gaining ratio.
- Revaluation of assets and liabilities is carried out; gains/losses shared in old ratio.
- Reserves and accumulated profits are credited to all partners in old ratio.
- The retiring partner’s capital balance is settled — paid in cash, transferred to his loan account, or both.
- On death, the deceased partner’s representative is also entitled to a share of profits up to date of death (computed on a time basis or on the basis of the previous year’s turnover) and the proceeds of any Joint Life Policy.
10.8 Dissolution of a Partnership Firm
Section 39 distinguishes dissolution of partnership (a partner leaves; firm continues) from dissolution of firm (entire business is wound up). On dissolution of the firm, all assets are realised and liabilities discharged; partners’ accounts are settled.
| Mode | Statutory basis |
|---|---|
| By agreement | Section 40 |
| Compulsory dissolution | Section 41 — insolvency, illegality |
| Dissolution on the happening of certain contingencies | Section 42 — death, expiry of term, completion of venture |
| Dissolution by notice (partnership at will) | Section 43 |
| Dissolution by court | Section 44 — insanity, misconduct, breach |
The accounting treatment runs through three accounts: a Realisation Account (records sale of assets and discharge of liabilities), Partners’ Capital Accounts (closed by transfer of profit/loss on realisation) and a Cash/Bank Account (closed by final settlement).
10.8.1 Garner v. Murray rule
If, at the time of dissolution, a partner’s capital account shows a deficiency and that partner is insolvent, the deficiency is borne by the solvent partners in the ratio of their capitals (specifically, the capitals standing on the date of dissolution, after revaluation but before realisation entries) — not in the profit-sharing ratio. The rule comes from the English case Garner v. Murray (1904) and is followed in Indian textbooks (maheshwari2022?).
| Order | Application |
|---|---|
| 1 | Pay outside creditors |
| 2 | Repay partner’s loan to firm |
| 3 | Repay partners’ capitals |
| 4 | Distribute residual surplus among partners in profit-sharing ratio |
10.9 Limited Liability Partnership (LLP)
Introduced by the Limited Liability Partnership Act, 2008, an LLP is a body corporate with perpetual succession. Partners’ liability is limited to their agreed contribution. The LLP has at least two designated partners, of whom at least one must be an Indian resident. LLP accounts and audit are governed by the LLP Act and rules. The LLP is therefore a hybrid — partnership in flexibility, company in legal form.
10.10 Exam-Pattern MCQs
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| Matter | Default rule | ||
| (i) | Profit sharing | (a) | None |
| (ii) | Interest on capital | (b) | 6 per cent per annum |
| (iii) | Interest on partner's loan | (c) | Equal among partners |
| (iv) | Salary to a partner | (d) | None |
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| Method | Formula | ||
| (i) | Average Profit Method | (a) | Capitalised value of profits − Net assets |
| (ii) | Super Profit Method | (b) | Average profit × Years of purchase |
| (iii) | Capitalisation Method | (c) | Super profit × Years of purchase |
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| Event | Account | ||
| (i) | Salary paid to a partner | (a) | Realisation Account |
| (ii) | Revaluation of fixed assets on admission | (b) | P&L Appropriation Account |
| (iii) | Sale of assets on dissolution | (c) | Revaluation Account |
| (iv) | Distribution of a year's profit among partners | (d) | P&L Appropriation Account |
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| Case / Rule | Content | ||
| (i) | Garner v. Murray | (a) | Distinction between dissolution of partnership and dissolution of firm |
| (ii) | Section 13 | (b) | Default rules in absence of a deed |
| (iii) | Section 39 | (c) | Insolvent partner's deficiency borne by solvent partners in capital ratio |
| (iv) | Section 48 | (d) | Order of application of funds on dissolution |
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- Partnership = relation between persons who have agreed to share profits of a business carried on by all or any of them acting for all (Section 4).
- Min 2 partners, max 50 (Companies Act 2013, Rule 10).
- Section 13 defaults: profits equal, no interest on capital or drawings, 6 % p.a. on partner’s loan, no salary or commission.
- Capital systems: Fixed (Capital + Current A/c) vs Fluctuating (only Capital A/c).
- P&L Appropriation A/c distributes profit; salary/commission/interest on capital are appropriations, not charges.
- Goodwill methods: Average Profit, Super Profit, Capitalisation.
- Sacrificing ratio = Old − New (admission). Gaining ratio = New − Old (retirement/death).
- Dissolution: open Realisation Account, close partners’ capitals, settle through Cash A/c. Section 48 order: creditors → partners’ loans → capitals → residual surplus.
- Garner v. Murray (1904): insolvent partner’s deficiency borne by solvent partners in capital ratio, not profit ratio.
- LLP Act 2008: hybrid form; min 2 designated partners; one must be Indian resident.