PARTNERSHIP ACCOUNTS- ADJUSTMENTS

SAVITA MAHENDRU

ASST LECTURER IN COMMERCE�HRMMV

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SPECIAL ASPECTS OF PARTNERSHIP ACCOUNTS:

Following are some of the issues that require special treatment at the time of preparing the financial statements of the firm.

• Partners’ Capital Accounts: In a partnership firm, separate Capital Accounts are maintained for each partner as each of the partners is the owner and has separate transactions with the firm. These Partners’ Capital Accounts can be maintained by following any of the 2 methods:

i. Fixed Capital Accounts Method: In this method, the capital amount invested by each of the partner in the firm remains fixed or unaltered, unless a partner introduces additional capital or withdraws out of his or her capital. Such fixed capital is recorded in the Capital Account and for recording all transactions other than transactions related to capital such as drawings, interest on capital, interest on drawings, salary, commission, share of profit/losses, etc. Current Accounts are maintained in addition to the Capital Accounts.

ii. Fluctuating Capital Accounts Method: In this method, only one account is maintained which is the Capital Account. All the transactions related to the addition or withdrawal of capital, salary, commission, interest on capital, interest on drawings, share of profits or losses, etc. are recorded in this Capital Account only. This method is followed for maintaining Capital Accounts and therefore, in the absence of any instructions, this method should be followed for maintaining the Partners’ Capital Accounts.

SALARY OR COMMISSION (REMUNERATION) TO PARTNERS:�

1. In order to compensate the partners for looking after the business, the firm pays salary or commission to the partners.
2. Such salary or commission can be allowed to the partners only if the Partnership Deed allows it to be paid.
3. Such amount paid to the partners is an appropriation of profit and not a charge against the profit. Therefore, it can be paid only if the firm is making profits during the year.
4. Salary to partners is normally stated as an amount, whereas, Commission to partners is normally stated as a percentage of profit where the profit considered can be either before commission or after commission.
5. Formula for computing commission under the 2 methods is as follows:
1. Percentage of Net Profit before charging Commission: �Net Profit before commission * Rate of commission /100
2. Percentage of Net Profit after charging Commission:
3. Net Profit (before commission)* Rate of Commission /(100+Rate of Commission)

vi. Accounting treatment:

Salary or Commission, is an appropriation of profit, therefore, accounting treatment will be as follows:

1. On allowing Salaries/Commissions to Partners:

Partners’ Salaries/Commissions A/c …Dr.

To Partners’ Current A/cs (when capitals are fixed)

To Partners’ Capital A/cs (when capitals are fluctuating)

b. On closure of Salaries/Commissions A/cs:

Profit and Loss Appropriation A/c …Dr.

To Partners’ Salaries/ Commissions A/c

INTEREST ON PARTNERS’ DRAWINGS:

1. Drawings are the amounts that are withdrawn, in cash or in kind, by partners for their personal use.
2. These drawings can be out of capital or profits. When the amount withdrawn is a part of capital, it is referred to as drawings out of capital. While drawings out of profits are the amounts withdrawn against profit earned during the year.
3. If the Partnership Deed provides for charging interest on such amounts withdrawn by the partners against profits, such interest is termed as interest on drawings.
4. It is important to note that such interest is not charged on the drawings that are made against capital.
5. Such Interest charged on Drawings is credited to the Profit and Loss Appropriation Account and debited to Partners’ Capital Accounts or Partners’ Current Accounts.
6. Calculation of such interest is to be done taking into consideration the time from the date of withdrawal till the end of the financial year.

METHODS OF CALCULATING INTEREST ON DRAWINGS:

There are 2 methods of calculating interest on drawings which are explained as follows:

a. Product Method: This method is used when drawings of same amount or different amounts are withdrawn at irregular intervals. Again this method can be used in 2 ways namely, as simple method and product method.

i. Simple Method: In this method, interest is calculated on each single drawing amount. For such calculation, period for which the amount has been utilised is to be considered.

ii. Product Method: In this method, amount of drawings is multiplied with the number of months or number of days it has been used. After this, the product so obtained is totaled and the interest is calculated thereon for one month (when period is considered in months) or for 1 day (when period is considered in days).

b. Average Period Method: Interest on drawings is calculated using this method when:

a. there are regular drawings or

b. the amount of drawings is uniform and the time interval between the 2 drawings is uniform. �

• Interest on Partners’ Capitals:

i. In order to compensate a partner for contributing capital to the firm in excess of the profitsharing ratio, firm pays such interest on partner’s capital.

ii. In case any amount is contributed by the partner to the firm in the form of additional capital during the year, interest on such additional capital is allowed for the period it has remained in business.

iii. In case if any amount of capital is withdrawn by the partner during the year, no interest is allowed on the capital amount withdrawn.

• Important provisions relating to Interest on Capital:
• If there is no Partnership Deed or there is no clause in the deed as to interest on capital: Interest on Capital is not allowed.
• If the Partnership Deed provides for interest on capital but is silent as to the treatment of interest as a charge or appropriation: Interest on capital is treated as appropriation of profit. Such interest is payable only if the firm is making profits. Following are possible situations:
• In case of loss: No interest is allowed.
• In case of profit, where profit before interest is equal to or more than the interest: Interest is allowed at the agreed rate.
• In case of profit, where profit before interest is less than the interest: Interest is allowed only to the extent of profit in the ratio of interest on capital of each partner.

iii. If the Partnership Deed provides for interest as a charge (i.e., to be allowed whether there are profits or loss): Interest on capital is allowed whether there is profit or loss

ACCOUNTING TREATMENT WHEN A MANAGER IS ADMITTED AS PARTNER WITH RETROSPECTIVE EFFECT:

If at any time partners of the firm decide to admit the Manager as a partner with retrospective effect, profits for those years, interest paid on loan, etc. is to be adjusted to give effect to the terms of partnership. This can be done by passing either a single adjustment entry or by passing separate entries for each adjustment. Net effect of these adjustments can be determined with the help of following steps:

Step 1. Calculate the amount paid as remuneration to the Manager.

Step 2. Calculate the amount which should be allowed to the Manager on becoming a partner.

Step 3. Compare the amounts calculated in step 1 and step 2. If the amount in step 2 is more, it is credited to his account and debited to old partners in their old profit sharing ratio. If the amount in step 1 is more, it is debited to his account and credited to Old Partners’ Capital Accounts, in their old profit sharing ratio.