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Study Note 4.2, Page 169-197

Study Note 4.2, Page 169-197

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02/14/2012

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169
Financial Accounting
4.2. APPROPRIATION OF PROFITS
INTRODUCTION
According to section 4 of the Partnership Act, 1932 a Partnership is “the relation betweenpersons who have agreed to share the profits of a business carried on by all or any one of themacting for all.If we analyse the definition we find three basic element of a Partnership :(1)It arises out of an agreement made by two or more persons;(2)The agreement is made regarding sharing profits of a business;(3)Such business is carried on by all or any one of them acting for all.(a)Partnership is the result of an agreement. It does not arise from status.(b)The agreement may be either verbal or in writing. There should be some terms andconditions binding the Partnership.(c)The existing law does not enforce that the terms of the Partnership must be in writ-ing. If written, the agreement is known as Deed or Articles of Partnership.(d)For the formation of a Partnership more then one person is requires. For a bankingbusiness the maximum number of Partners is 10, in other businesses it is 20.
Partnership Deed
Mode of Appropriation : Among other details the deed contains the mode of appropriation of profits (or losses) specially regarding interest on partners capitals, salary or commission, etc.payable to partners and the profit-sharing ratio.In the absence of deed the following guidelines should be followed :1.Every Partner should share profits equally [ Section 13 (b)].2.No interest is to be allowed on Partners’ capitals [ Section 13 (c)].3.No interest should be charged on the drawings of the Partners.4.No salary is to be allowed to any partner.5.Interest on advances made by partners should be provided @ 6% per annum. [Section13(d)].6.Every partner should be to have equal share in the property of the Partnership as perSection 14.
Some Important Considerations
Partners’ Capitals
(a)Where the Partners decide and the agreement provides, the Capitals Accounts of the Part-ners remain unchanged over years. In that case the Capital Accounts show the original
 
Financial Accounting
170
PARTNERSHIP ACCOUNTING
amounts invested by the Partners as capitals unless some change (like change in capitalRatio etc.) takes place. The Capitals are called Fixed Capitals.Partners’ Current Accounts are opened and used for recording subsequent trans actionsbetween the Partner and the firm for salary/commission to Partners, Interest on PartnersCapitals, their drawings and interests on drawings, share of profit/loss and interest onloans/advances given by Partners to the firm. Where Capitals are Fixed, Current Ac-counts serve as the appendix.(b)Where there is no agreement to keep Capitals fixed over years, untried regarding Part-ners’ drawings, Salary/Commission/Interest on Capital and share profit/loss are recordedthrough the Partners’ Capital Accounts. As a result, the Capitals undergo changes fromperiod to period and are called Fluctuating Capitals.(c)If any Partner gives any amount as Loan or Advance to the firm separately, Partners LoanAccounts are opened and maintained. Interest on Loan may be transferred to Loan Ac-count or to Current Account (if any).(d)A separate Drawings Account may be maintained to record withdrawals made by thepartners from the firm. On the closing date of a financial period, the balance of the Draw-ings Account is transferred to Capital Account or to Current Account (if capitals are fixed).One must remember also that,(i)A Capital represents a liability. The balances of fixed capitals should always be creditbalances. The balances of Current Accounts may be credit balances or debit balances (Wherea partners’ drawings exceed his share of profits/interests etc).(ii)The balances of Fluctuating capital may be credit or debit balances.(iii)Capitals of partners may not be as per their profit sharing ratio.(iv)A partner may contribute his capitals in cash and also in the form of any other asset in-cluding goodwill. If he brings in any liability his Capital = Assets brought in – Liabilitiesbrought in = Net Assets brought in.
Guaranteed Partnership
In a Partnership, there may be special agreement by virtue of which a Partner may get theguarantee of earning a minimum amount of profit.This guarantee may be given by one partner in particular or by the firm. It is given generally toencourage a junior partner or any sincere clerk of the business inducted to the benefits of Partnership.(a)Guarantee given by one Partner :(i)The appropriation of profit should be made in the general course by applying theexisting profit sharing ratio.(ii)The minimum amount guaranteed is to be decided.
 
171
Financial Accounting
(iii)In case the guaranteed amount (ii) is more, the excess should be deducted from theshare of profit of the Partner given guarantee and calculated under (i) above.The some amount should be added with the original share of profit of the Partner to whom theguarantee has been given.
Illustration 1 :
X and Y are Partners sharing profit as 5:3. Z is the clerk of their business getting a salary of Rs.500 p.m. and a commission of 5% of the net profit after deducting his salary and commission.Now, X guarantee that Z be made a Partners with 1/10
th
share of profit and nothong clse. If theannual profits is Rs. 1,32,000.
Steps :
(i)General Application of Profit Zs Share as clerk :Rs.Salary 500 * 12 6,000Commission 5/105 of [1,32,000 6,000]6,00012,000Balance of profit 1,20,000 Shared as : X =5/8 x 1,20,000 = Rs. 75,000 ;Y = 3/8 x 1,20,000 = Rs. 45,000(ii)Minimum guaranteed share of Z = 1/10
th
of Rs. 1,32,000 = Rs. 13,200(ii)Shortfall = Rs. 13,200 – Rs. 12,000 = Rs. 1200 to be deducted from share and added with Z’sshare.Final appropriation should be –Rs.X : Rs. 75,000 Rs. 120073,800Y :45,000Z : Rs. 12,000 + Rs. 1200 13,2001,32,000Xs Capital / Current A/c Dr. 1,200To Z’s Capital / Current A/c 1,200(Being Guaranteed share of profits provided
Guarantee given by firm :
(i)The share of profit of the guaranteed Partner is to be calculated according to the profit –sharing ratio.(ii)His minimum guaranteed amount is ascertained.(iii)The higher of (i) and (ii) is given or credited to him.(iv)The remaining profits are shared among the remaining Partners in their remaining ratio.If the minimum guaranteed amount is more, the shortfall may be agreed to be in a ratio spe-cially agreed upon.

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