IPCC Paper I: Accounting Chapter No.

14

CA Shakuntala Chhangani .
 Partnership –General
 Admission of a partner
 Retirement and Death of a partner
General
 To understand the need for partnership and the
meaning and features of the partnership ;
 To understand the concept of partnership deed;
 Applicability of Section 13 of Indian Partnership Act,
1932 when there is no partnership deed or the
partnership deed is silent on the point;
 To learn the techniques of maintaining profit and
loss appropriation account;
 To learn the methods of maintaining partners capital
account;
 To learn techniques for valuation of goodwill;
 To learn calculation of interest on capital, interest on
Drawings, remuneration etc.. to the partners;
 To learn accounting treatment in case of company
is the partner of the firm;
 To learn accounting treatment in case of change in
the method of accounting from cash basis to
accrual / mercantile basis;
 To learn accounting treatment in case of change in
profit sharing ratio with retrospective effect;
 To understand the concept of guaranteed partner;
 Rectification of wrong distribution of profits.
 Tocope with the increasing financial and
managerial demands in the present day
business world
 Two or more persons may decide to
◦ Make a common pool of their resources
◦ Carry on the business Jointly
◦ Share the Profits in an agreed ratio
 This is known as Partnership
Definition U/s 4 of Indian Partnership Act, 1932 :
 The term partnership is defined as
“relation between persons who have agreed to
share the profits of a business carried on by all
or any of them acting for all.”
 Minimumno. of partners : 2 Partners
 Maximum no. of partners:
Partnership Act is silent about maximum no. of members
Section 11 of Companies Act, 1956 restricts maximum
no. of members to following in case of any association of
persons unless registered under Companies Act , 1956
Banking Business: 10
Any Other Business: 20
 Partnership
◦ Is the result of an Agreement among Partners
◦ Does not arise by status or operation of law (Section 5).
 The agreement may be :
◦ Express or Implied
◦ Oral or Written
 Business must be in Existence
◦ Includes every
 Trade
 Profession or
 Occupation.
 It implies that a partnership firm can not be formed
to carry on a charitable work
 Profit making is the basic Intention of the Business
 However, eventually, if the losses are incurred, it
will borne by the partners in agreed PSR.
 If a Partner not share the Profits in a Firm, he is not
a partner.
 However, sharing of loss by the member is not
necessary to become a partner (Guaranteed
Partner)
 Every partner is liable for the acts of other
partners of the firm done in the normal course
of business. Every partner is a principal when
he is bound by the acts of other partner.
Similarly every partner is an agent when he
binds other partners by his acts.
 The relationship between the partners is that
of mutual agency. i.e. mutual faith and trust.
 A document which contains express written
agreement between partners and properly stamped
in the court of law is called a “partnership deed /
agreement / articles of partnership”
 It generally contains the following :
 Name and address of the firm
 The nature of business of the firm
 Name and addresses of the partners and their
occupation
 Duration of the firm
 Capital contribution by each partner and drawing
rights
 Interest on capital / drawings / loans given by the
partners
 Profit sharing ratio
 Rights and duties of the partners inter se
 Provisions relating to admission / retirement / death
of a partner
 Dispute settlement procedure
 Settlement of accounts of retiring or deceased
partner
 Calculation of share of profit in case of retirement or
death of a partner during the accounting year
 Valuation of goodwill in case of retirement or death
of a partner during the accounting year
 It helps to avoid disputes in future
In the absence of an agreement (oral or written)
between partners, provisions of section 13 of
Indian Partnership Act, 1932, which are given
below, shall apply :
 Partner is not entitled to receive remuneration
(Section 13(a))
 Partners are entitled to share the profits equally
(section 13(b))
 No interest on capital (section 13(c))

 6% interest on advances made by the partner to

the firm beyond his capital contribution (section
13(d))
 Records the transactions of the firm with the
partners except rent paid to the partner.
 Shows appropriation (distribution) of profits to
adjust the rights of the partners inter se
 Items appearing in Profit and Loss
Appropriation A/c are also called below the
line items (after tax)
Dr Profit and Loss Appropriation Account Cr.
Rs. Rs.

To Interest on Capital A/c XX By net profit b/f XX

To Salary / commission to By Interest on drawings A/c XX

partner A/c XX

To Divisible net profit

transferred to Capital A/c XX

XXX XXX
There are two methods of maintaining Capital
Account under partnership:
 Fixed Capital Method
 Fluctuating Capital Method
 Capital Account is maintained at a fixed level
 It is not allowed to fluctuate in the routine
course of business
 All entries relating to interest on capital /
drawings, withdrawal of profits, share of
profits, salary to partners etc are passed
through a separate account called current A/c
Dr. Capital Account Cr.
Rs. Rs.

To Cash / Bank A/c XX By Balance B/f XX

(permanent withdrawal (capital Contribution till

of excess capital) last year

To Balance C/f XX By Cash / Bank A/c XX

(year end capital bal.) (fresh capital introduced)

XXX XXX
 Dr. Current Account Cr.
Rs. Rs.
To Balance B/f
XX By Balance B/f XX

To Drawings A/c XX By salary to partner A/c XX

To Interest on drawings A/c XX By Interest on Capital A/c XX

To Profit & Loss Appro. A/c XX By profit & Loss Appro. A/c XX

To Balance C/f XX By Balance C/f XX

XXX XXX
 Capital Account is allowed to fluctuate
 All entries relating to share of profit,
remuneration to partner, Interest on capital /
drawings, withdrawal of profits etc. are
passed in capital account only.
 No need to open a separate account i.e.
Current A/c
Dr. Capital Account Cr.
Rs. Rs.
To Balance B/f XX By Balance B/f XX

To Drawings A/c XX By Interest on Capital A/c XX

To interest on Drawings By Salary to Partners’ A/c XX

To Profit and Loss XX By Profit and Loss

Appropriation A/c (Loss) Appropriation A/c (profit) XX

To Balance C/f XX By Balance C/f XX

XXX XXX
 Fixed Capital Method
 Two accounts namely capital
account and current account
are opened
 All entries relating to interest
on capital / drawings, salary
to partner share of profit /
loss, withdrawal of profit are
passed through Current A/c
 Capital account can never
show Dr. balance
Fluctuating Capital Method
 Only one account i.e. capital
account is required to be
opened
 All entries relating to interest
on capital / drawings, salary
to partner share of profit /
loss, withdrawal of profit are
passed through Current A/c
 Capital account can show
Dr. or credit balance
 Three partners A, B and C
 Capital contribution Rs. 3,00,000, Rs. 2,00,000 and
Rs. 1,00,000 respectively
 PSR equal
 Interest on capital @ 10%
 Profit for the year Rs. 1,20,000
 Profit appropriated by way of interest on capital Rs.
60,000 and the balance profit Rs. 60,000 shared
equally
 Three partners A, B and C
 Capital contribution Rs. 3,00,000, Rs. 2,00,000 and
Rs. 1,00,000 respectively
 PSR is 3:2:1
 Interest on capital @ 10%
 Profit for the year Rs. 1,20,000
 Profit appropriated by way of interest on capital Rs.
60,000 and the balance profit Rs. 60,000 shared in
the ratio of 3:2:1
 Three partners A, B and C
 Capital contribution Rs. 3,00,000, Rs. 2,00,000 and Rs.
1,00,000 respectively
 PSR is equal
 Interest on capital @ 10%
 Profit for the year Rs. 48,000
 Each partner will get share of profit by way of interest
on capital to the extent of available profits in capital
ratio i.e. A will get Rs. 24,000, B will get Rs. 16,000 and
C will get Rs. 8,000 only
 Three partners A, B and C
 Capital contribution Rs. 3,00,000, Rs. 2,00,000 and
Rs. 1,00,000 respectively
 PSR is equal
 Interest on capital @ 10%
 Profit for the year Rs. 48,000
 There is a provision in the partnership deed that full
interest on capital is allowed even in case of
insufficient profits
 Three partners A, B and C
 Capital contribution Rs. 3,00,000, Rs. 2,00,000 and
Rs. 1,00,000 respectively
 PSR is equal
 Interest on capital @ 10%
 Loss for the year Rs. 48,000
 What is actually interest on Capital ?

 When to allow interest on capital ?

 Why interest on capital is allowed ?

 In case the profit sharing ratio and capital ratio are the
same, real division of profits is not affected even when
interest on capital is not charged.
 Interest on capital is allowed only to the extent of
available profits.
 However, the above limitation may be waived by partners
by an agreement
 Partnership deed provides for interest on capital but
does not stipulate the effect in case of loss, no interest
on capital is allowed i.e. interest on capital is allowed only
out of profits.
 Mr A had opening balance of capital Rs. 3,00,000 on
1.4.2010
 He introduced a further capital of Rs. 1,00,000 on
1.10.2010
 A withdrew the capital of Rs. 50,000 on 1.1.2011
 Interest on capital for the year ended 31.3.2011 will be :
 3,00,000 x 10% x 6/12 = Rs. 15,000
 4,00,000 x 10% x 3/12 = Rs. 10,000
 3,50,000 x 10% x 3/12 = Rs. 8,750
 33,750
 Interest on capital is calculated on time basis
considering additional capital employed during the
year and the capital withdrawn

 A distinction should always be made between

withdrawal in anticipation of profits and withdrawal
of capital
 It is an expenditure for the firm and income for the
concerned partner

 Accounting entry :
(a) When interest on capital is due :
Interest on Capital A/c Dr. XX
To Partner’s Capital / Current A/c XX

(b) Year end transfer entry :

Profit and Loss Appropriation A/c Dr. XX
To Interest on Capital A/c XX
Example 1 :
 Ram and Shyam were partners sharing profits and
losses equally. Their capitals were Rs. 2,00,000
and Rs. 1,00,000 respectively. Partnership deed
provides for interest on capital @ 6% per annum.
The net profit before interest on capital was Rs.
50,000. show the distribution of profits among the
partners.
Dr Profit and Loss Appropriation Account Cr.

Rs. Rs.

To Interest on capital A/c: By net profit b/f 50,000

Ram 12,000

Shyam 6,000 18,000

To Capital A/c :

Ram 16,000

Shyam 16,000 32,000

50,000 50,000
Example 2 :
 Ram and Shyam were partners sharing profits and
losses equally. Their capitals were Rs. 2,00,000
and Rs. 1,00,000 respectively. Partnership deed
provides for interest on capital @ 6% per annum.
The net profit before interest on capital was Rs.
15,000. show the distribution of profits among the
partners.
Dr Profit and Loss Appropriation Account Cr.
Rs. Rs.

To Interest on capital A/c: By net profit b/f 15,000

Ram 10,000

Shyam 5,000 15,000

15,000 15,000
Example 3 :
 Ram and Shyam were partners sharing profits and
losses in the ratio of 2:1. Their capitals were Rs.
2,00,000 and Rs. 1,00,000 respectively. Partnership
deed provides for interest on capital @ 6% per
annum. The net profit before interest on capital was
Rs. 15,000. Show the distribution of profits among
the partners.
Dr. Profit and Loss Appropriation Account Cr.
Rs. Rs.

To Interest on Capital A/c: By net profit b/f 15,000

Ram 10,000

Shyam 5,000 15,000

15,000 15,000
Example 4 :
 In the above example, had there been no provision
in partnership deed regarding payment of interest
on capital, there would have been no impact on
distribution of profits which is shown as under :
Dr Profit and Loss Appropriation Account Cr.
Rs. Rs.

To Net divisible profits By net profit b/f 15,000

transferred to Capital A/c:

Ram 10,000

Shyam 5,000 15,000

15,000 15,000
Example 5 :
 In the above example, if the partners waive the
limitation of interest on capital to the extent of
available profits only then the interest on capital will
be allowed as under :
 Dr. Profit and Loss Appropriation Account Cr.
Rs. Rs.

To Interest on Capital A/c By net profit b/f 15,000

Ram 12,000 By capital A/c :

Shyam 6,000 18,000 Ram 1,500

Shyam 1,500 3,000

18,000 18,000
 Interest on drawings is income for the firm
and expenditure for the concerned partner.
 It is paid by the partner to the firm for the
excess amount withdrawn.
 Interest on drawings can be charged only if
provided by the partnership deed
Accounting Entry :
(a) Interest on drawing charged :
Partners’ capital / current A/c Dr. XX
To Interest on drawings A/c XX

(b) Year end Transfer entry :

Interest on Drawings A/c Dr. XX
To Profit and Loss Appropriation A/c XX
 Example 1 :
Mr. A is a partner of XYZ and co. The partnership deed
provided for interest on drawings @ 8% per annum. Mr. A
withdrew the following amount during the year :
1.4. 2011 Rs. 3,000
1.9.2011 Rs. 4,000
1.12.2011 Rs. 6,000
1.2.2012 Rs. 2,000
Calculate interest on drawings for the year ended
31.3.2012
Interest on drawings is calculated as under :
Date Amount Outstanding Interest @ 8%
withdrawn period
1.4.2011 3,000 12 months 3,000 x 8% x12/12 = 240
1.9.2011 4,000 7 months 4,000 x 8% x 7/12 = 187
1.12.2011 6,000 4 months 6,000 x 8% x 4/12 = 160
1.2.2012 2,000 2 months 2,000 x 8% x 2/12 = 26
613
Date Amount Outstanding Interest on
withdrawn period drawings
1.4.2011 3,000 12 months 240

Date Amount Outstanding Product Interest on

period drawings
(1) (2) (3) (4) = (2)x(3) (4) x8%x1/12
1.4.2011 3,000 12 months 36,000 240
Interest on drawings can also be calculated
by product method as under :
Date Amount Outstanding product
withdrawn period
1.4.2011 3,000 12 months 36,000
1.9.2011 4,000 7 months 28,000
1.12.2011 6,000 4 months 24,000
1.2.2012 2,000 2 months 4,000
92,000

Interest on drawings = Total product x Interest % x 1/12 months

/ 52 weeks / 365 days
= 92,000 x 8% x 1/12
= Rs. 613
 Withdrawals are made at the beginning of each month :
Month Amount Outstanding Interest @
withdrawn period 12% p.a.
January 10,0006 months 600
February 10,0005 months 500
March 10,0004 months 400
April 10,0003 months 300
May 10,0002 months 200
June 10,0001 month 100
Total 60,000 2,100
 Interest on = Total amount X Interest X Avg o/s period/
drawings withdrawn % 12 months
= 60,000 x 12% x (6 + 1)/2
12 months
= 60,000 x 12% x 3.5 / 12
= Rs. 2,100
 Withdrawals are made at the end of each month :
Month Amount Outstanding Interest @
withdrawn period 12% p.a.
January 10,0005 months 500
February 10,0004 months 400
March 10,0003 months 300
April 10,0002 months 200
May 10,0001 months 100
June 10,0000 month 00
Total 60,000 1,500
 Interest on = Total amount X Interest X Avg o/s period/
drawings withdrawn % 12 months
= 60,000 x 12% x (5 + 0)/2
12 months
= 60,000 x 12% x 2.5 / 12
= Rs. 1,500
 Withdrawals are made in the middle of each month :
Month Amount Outstanding Interest @
withdrawn period 12% p.a.
January 10,0005.5 months 550
February 10,0004.5 months 450
March 10,0003.5 months 350
April 10,0002.5 months 250
May 10,0001.5 months 150
June 10,0000.5 month 50
Total 60,000 1,800
 Interest on = Total amount X Interest X Avg o/s period/
drawings withdrawn % 12 months
= 60,000 x 12% x (5.5 + 0.5)/2
12 months
= 60,000 x 12% x 3 / 12
= Rs. 1,800
 Hints :
 If withdrawals are made at a fixed amount at the
beginning of each month, calculate interest on
drawings for 6.5 months as under:
Total amount withdrawn X Interest % x 6.5/12
 If withdrawals are made at a fixed amount at the
end of each month, calculate interest on
drawings for 5.5 months as under:
Total amount withdrawn X Interest % x 5.5/12
 Ifwithdrawals are made at a fixed amount at
the middle of each month or if the question
specifies that withdrawals were made evening
through out the year, calculate interest on
drawings for 6 months as under:
Total amount withdrawn X Interest % x 6/12
 Example 2 :
 A, B and C are partners sharing profit in the ratio of
4:2:3. Partners withdrew the following amounts
during the year :
1) A Rs. 2,000 in the beginning of each month
2) B Rs. 3,000 at the end of each month
3) C Rs. 4,000 in the middle of each month
You are required to calculate interest on drawings
@ 8% per annum.
 Solution :
 Calculation of interest on drawings :
1) A = 24,000 X 8% X 6.5/12 = Rs. 1,040
2) B = 36,000 X 8% X 5.5/12 = Rs. 1,320
3) C = 48,000 X 8% X 6/12 = Rs. 1,920
 It is an expenditure for the firm and income for the concerned
partner
 Accounting entry :
(a) When Remuneration to partner is due :
Remuneration to Partner A/c Dr. XX
To Partner’s Capital Current A/c XX

(b) Year end transfer entry :

Profit and Loss Appropriation A/c Dr. XX
To Remuneration to Partner A/c XX
 What is goodwill?
1) Goodwill is the reputation of the business
quantified in terms of money.
2) Goodwill is the extra profit earning capacity of the
business as compared to the other entities in the
same industries.
3) In case of liquidation, goodwill is the excess of the
selling price of the business over its net assets.
 When is the goodwill valued in case of partnership?
 In case of partnership, goodwill is valued in the
following situations :
a) When there is a change in PSR
b) When a new partner is admitted to partnership
c) When a partner retires from partnership
d) When a partner dies
e) When the firm sells its business
 Methods of valuation of goodwill :
a) Average Profit Method
b) Super Profit Method
c) Capitalisation Method
d) Annuity Method
 y

a b
No. of
profit

years
purchase

o
years x
Average Profit Method :
 Under this method, goodwill is calculated on the basis
of average profit of the business. The calculation is
shown below :
Step 1: Calculate average profits: Total profits/ No. of yrs

Step 2: Calculate goodwill : Average Profits x No. of yrs.

purchase
 Example 1 :
The profits of the last five years are Rs. 85,000, Rs.
90,000, Rs. 70,000, Rs. 1,00,000 and Rs. 80,000
respectively. Find value of Goodwill if it is calculated
on average profits of last five years on the basis of
3 years purchase.
Solution :
Average Profits = Total Profits / no. of years

(85,000+90,000+70,000+1,00,000+80,000)
5 years
= Rs. 85,000
Goodwill = Average Profits x no. of years purchase
= 85,000 x 3 years
= Rs. 2,55,000
 Rising or falling trend in profits:
Step 1: Calculate Weighted Profit (WP) as under:
Years Profit (Rs.) Weights Product (WP)
(1) (2) (3) (4) = (2) x (3)

Step 2: Weighted Average Profits (WAP) =

Total Product x Total Weights

Step 3: Calculate Goodwill = WAP x No. of years

purchase
 Example 2:
The profits of the last five years (2001 to 2005) are
Rs. 75,000, Rs. 80,000, Rs. 85,000, Rs. 90,000 and
Rs. 1,00,000 respectively. Find value of Goodwill if
it is calculated on average profits of last five years
on the basis of 3 years purchase.
 Solution :
Step 1: Calculate WP
Year Profit (Rs.) Weight Product
2001 75,000 1 75,000
2002 80,000 2 1,60,000
2003 85,000 3 2,55,000
2004 90,000 4 3,60,000
2005 1,00,000 5 5,00,000
Total 15 13,50,000
Step 2 : Calculate weighted Average Profits :

= Total product
Total Weights
= 13,50,000
15
= Rs. 90,000
Step 3 : Calculate Goodwill : WAP x No. of yrs Purchase
= 90,000 x 3 years
= Rs. 2,70,000
(b) Super Profit Method :
 Under this Method, Goodwill is calculated as under:

Step 1 : Calculate capital employed (CE) :

Total assets – all outside liabilities – Non-trade
investments
Step 2 : Calculate Normal Profit (NP) :
CE x normal rate of return %
Step 3 : Calculate Average Profit (If reqd.):
Total Profits / No. of years
Step 4 : Calculate Super Profit (SP) :
Average / Actual Profit – NP
Step 5 : Goodwill : SP x No. of years purchase
 Example 3 :
The profits of the last five years are Rs. 85,000, Rs.
90,000, Rs. 70,000, Rs. 1,00,000 and Rs. 80,000
respectively. Total assets are Rs. 6,00,000 whereas
outside liabilities amount to Rs. 2,00,000. Normal
rate of return is 15%. Find value of Goodwill on the
basis of 2 years purchase of super profits based on
the average of five years.
Solution :
Step 1 : Capital Employed : 6,00,000 – 2,00,000
: Rs. 4,00,000
Step 2 : Normal Profit (NP) : 4,00,000 x 15%
: Rs. 60,000
Step 3 : Average Profit :
(85000+90000+70000+100000+80000) / 5
Rs. 85,000
Step 4 : Super Profits : 85,000 – 60,000
: Rs. 25,000
Step 5 : Goodwill : 25,000 x 2 years purchase
: Rs. 50,000
Capitalisation Method :
Under this method, goodwill is calculated as under :
Goodwill : Super Profit .
Normal Rate of return %
Or
Goodwill: Average / Actual Profits – Capital Employed
Normal rate of return %
 Example 4 :
Find the goodwill of the firm using capitalization
method from the following information :
Total capital employed in the firm Rs. 8,00,000
Reasonable rate of return 15%
profits for the year Rs. 12,00,000
 Solution :
Goodwill: Average / Actual Profits – Capital Employed
Normal rate of return %

: 12,00,000 – 8,00,000
15%

: 80,00,000 – 8,00,000

: Rs. 72,00,000
Annuity Method :
Under this method, Goodwill is calculated as under :
Goodwill : SP x Annuity Factor (Discounted value of
future cash flows)
 Example :
The profits and losses for the last years are 2007-08
losses Rs. 10,000, 2008-09 losses Rs. 2,500, 2009-10
profits Rs. 98,000 and 2010-11 Rs. 76,000.The
average capital employed in the business is Rs.
2,00,000. The rate of interest expected from capital
invested is 12%. The remuneration of partners is
estimated to be Rs. 1,000 pm. Calculate the value of
goodwill on the basis of four years purchase of super
profits based on annuity of four years. Take discounting
rate as 10%.
Solution :
Step 1. Capital employed = Rs. 2,00,000
Step 2. Normal profit = 2,00,000 x 12%
= Rs. 24,000
Step 3. Average Profits = Total Profits / no. of years
-10,000 - 2,500+98,000+76,000
4 years
= Rs. 40,375
Step 4. Super Profit = Avg / actual profit – Normal Profit
– remuneration to partners
= 40,375 – 24,000 – 12,000
= Rs. 4,375
Step 5 . Goodwill = Super Profit X Annuity factor
= 4,375 X 3.1699
= Rs. 13,868

 Partnership may have natural as well as artificial
partners
 No specific provisions in Companies Act but implied
provisions do exist
 The object clause of the memorandum must confer
such power
 Can a partnership firm become the member of a co.
?
NO
 In the books of the Co  In the books of the firm
1. Capital contributed by
the co.:
Investment A/c Dr. Bank A/c Dr.
To Bank A/c To Partner’s Capital A/c
2. Withdrawal of capital :
Bank A/c Dr. Partner’s Capital A/c Dr.
To Investment A/c To Bank A/c
3. Interest on Capital:
Investment A/c Dr. Interest on Capital A/c Dr.
To Interest on Capital A/c To Partner’s Capital A/c

4. Share of profit :
Investment A/c Dr. Profit and Loss Appropriation
To Share of profit from A/c Dr.
firm A/c To Partner’s Capital A/c
5. Interest on Drawings:
Interest on Drawings A/c Dr. Partner’s Capital A/c Dr.
To Investment A/c To Interest on Drawings A/c

6. Share of Loss :
Share of Loss from firm A/c Partner’s Capital A/c Dr.
Dr. To Profit and Loss
To Investment A/c Appropriation A/c
7. Interest on Drawings
transferred to Profit and Loss
A/c :
Profit and Loss A/c Dr.
To Interest on Drawings A/c
8. Interest on Capital &Share of
profit transferred to Profit and
Loss A/c:
Interest on Capital A/c Dr.
Share of profit from the firm A/c Dr.
To Profit & Loss A/c
Interest on Drawings transferred to
Profit and Loss Appropriation A/c :
Interest on Drawings A/c Dr.
To Profit & Loss Appropriation A/c
Interest on Capital transferred to
Profit and Loss Appropriation A/c:
Profit and Loss Appropriation A/c Dr.
To Interest on Capital A/c
Example 1 :
X, Y Ltd. And Z Ltd. Are partners of X & Co. The partnership deed provided that :
a) The working partner Mr. X is to be remunerated at 15% of the net profits after charging his
remuneration but before charging interest on capital and provision for taxation.
b) Interest is to be provided on capital @ 15% p.a.
c) Balance profits after making provision for taxation is to be shared in the ratio of 1:2:2 by the three
partners
During the year ended 31.3.2012 :
1) The net profit before tax and before making any payment to partners amounted to Rs. 6,90,000
2) Interest on capitals at 15% per annum amounted to :
3) Rs. 60,000 for X, Rs. 1,50,000 for Y Ltd and Rs. 1,80,000 for Z Ltd. The capitals have remained
unchanged during the year.
4) Provision for tax is to be computed at 40% of the “Total Income” of the firm. The total income has
been computed at Rs. 1,95,000.
You are asked by :
A. The firm to pass the closing entries in relation to the above;
B. Y Ltd. to pass the entries in its books pertaining to its income from the firm and show the investment
in partnership account as it would appear in its ledger;
C. Z Ltd. to show, how the above information will appear in its financial statements for the year.; and
D. Mr. X to show working, if any, in relation to the above.
 Solution :
D. Remuneration to Mr. X :
Profit before charging X’s remuneration,
Interest on capital & Provision for tax 6,90,000 (115%)
(-) X’s remuneration ? (15%)
Profit after charging X’s remuneration but
Before charging interest on capital and
Provision for taxation ? (100%)
Remuneration to X = profit before charging rem etc. X rate of rem.
100 + rate of rem.
= 6,90,000 x 15
115
= Rs. 90,000
A. In the books of the firm :
Closing entries as on 31.3.2012
Particulars L.F Debit Credit
. (Rs.) (Rs.)
Profit and Loss A/c Dr. 78,000
To Provision for taxation A/c 78,000
(Being provision made for taxation @
40% of total income of Rs. 1,95,000)

Profit and loss A/c Dr. 6,12,000

To Profit and Loss Appropriation A/c 6,12,000
(being net profit after tax transferred to
Profit and Loss Appropriation A/c)
Remuneration to X A/c Dr. 90,000
To X’s Capital A/c 90,000
(Being remuneration to X provided)

Interest on Capital A/c Dr. 3,90,000

To X’s Capital A/c 60,000
To Y Ltd’s Capital A/c 1,50,000
To Z Ltd’s Capital A/c 1,80,000
(Being Interest on Capital provided)

Profit and Loss Appropriation A/c Dr. 4,80,000

To Remuneration to X A/c 90,000
To Interest on Capital A/c 3,90,000
(Being remuneration to X and interest
on capital transferred to profit and Loss
appropriation A/c)
Profit and Loss Appropriation A/c Dr. 1,32,000
To X’s Capital A/c 26,400
To Y Ltd’s Capital A/c 52,800
To Z Ltd’s Capital A/c 52,800
(Being balance profit transferred to
partners’ capital A/c in 1:2:2)
 B. In the books of Y Ltd. :
Journal Entries
Particulars L.F. Debit Credit
(Rs.) (Rs.)
Investment in partnership A/c Dr. 2,02,800
To Interest on capital A/c 1,50,000
To Share of profit A/c 52,800
Being interest on capital @ 15% and
share of profit from the firm recorded)

Interest on Capital A/c Dr. 1,50,000

Share of profit A/c Dr. 52,800
To Profit and Loss A/c 2,02,800
(being interest on capital and share of
profit from the partnership firm
transferred to profit and Loss A/c)
 Dr. Investment in Partnership Account Cr.
Rs. Rs.

To Balance b/f 10,00,000

(1,50,000/15%)

To Interest on capital A/c 1,50,000

To share of profit A/c 52,800 By Balance b/f 12,02,800

12,02,800 12,02,800
C. Extracts of Financial statements of Z Ltd.
Profit and Loss Account for the year ended 31.3.2012
Other income : Rs.
Income from partnership :
Interest on capital 1,80,000
Share of profit 52,800
2,32,800
Extracts of schedule of investments forming part of Balance sheet as on
31.3.2012 :
31.3.2012 31.3.2011
Investment in Partnership 14,32,800 12,00,000
(1,80,000/15%)

Partners capitals as on 31.3. Share of profit

31.3.12 31.3.11 * 31.3.12 31.3.11
X 5,76,400 4,00,000 1/5 1/5
Y Ltd. 12,02,800 10,00,000 2/5 2/5
Z Ltd. 14,32,800 12,00,000 2/5 2/5

* Opening capitals = Interest on Capital / 15%

 Change in the method of accounting without any change in
PSR :
1) Make the adjustments to record accrued income (Asset
A/c) or Outstanding liability (Liability A/c) through
revaluation A/c / profit and Loss Adjustment A/c OR
2) Pass the following entry to record the same :
Accrued Income A/c Dr.
To Outstanding Liability A/c
(The difference will be transferred to partners capital A/c
in PSR)
Example :
The partnership accounts of A,B and C sharing the profit and losses in the ratio of
2:2:1 were maintained on cash basis right from its formation on 1.4.2009. now the
partners decided to change into mercantile basis. Following details are given in
this respect :
31.3.10 31.3.11 31.3.12 31.3.13
Outstanding Salary 2,000 2,000 3,000 4,000
Prepaid insurance 1,500 3,000 4,000 6,000
Interest accrued but
Not received 2,000 4,000 6,000 8,000
Rent recd. In advance 3,000 6,000 9,000 12,000
Profit as per P/L A/c 10,500 20,500 30,500 40,500
Pass the necessary adjustment entry.
 Adjustment Entry :
Prepaid insurance A/c Dr. 6,000
Accrued Interest A/c Dr. 8,000
A’s Capital A/c Dr. 800
B’s Capital A/c Dr. 800
C’s Capital A/c Dr. 400
To Outstanding Salary A/c 4,000
To Rent recd. In Advance A/c 12,000
(Being entry passed for conversion from cash to
mercantile basis)
Dr. Revaluation Account Cr.
Rs. Rs.

To Outstanding Salary A/c 4,000 By Prepaid insurance A/c 6,000

To rent recd. In Adv. A/c 12,000 By Accrued Interest A/c 8,000

By Capital A/c (Rev. Loss)

A 800

B 800

C 400 2,000

16,000 16,000
Steps to be followed :
Take back the already distributed profits from the date the
change is effective in old PSR by passing the entry :
Capital A/c Dr. XX
To Profit and Loss Adjustment A/c XX
Redistribute the profits in new PRS by passing the entry :
Profit and Loss Adjustment A/c Dr. XX
To Capital A/c XX

Goodwill to be paid by gaining partner to sacrificing partner

Example :
The firm of A, B and C existed for some years PRS being 2/5, 2/5 and 1/5
respectively. C, however, feels that this arrangement has not been satisfactory to
him and requires to be placed on the same basis as regards profits as A and B. he
further wants that this arrangement shall apply not only to future profits but also
retrospectively to the profits of the past three years, which were Rs. 26,000, Rs.
22,100 and Rs. 25,805. A and B have no objection to this. Goodwill as on the date
of change in PSR was Rs. 81,000.
Show the adjustment account and the capital account of the firm after giving effect
to the above arrangements, assuming that immediately after the distribution of the
last year’s profits, the capital accounts stood as under :
A Rs. 52,000
B Rs. 39,000
C Rs. 27,430
Dr. Profit and Loss Adjustment Account Cr.
Rs. Rs.

To capital A/c : By capital A/c :

A 24,635 A 29,562

B 24,635 B 29,562

C 24,635 73,905 C 14,781 73,905

73,905 73,905
 Goodwill Adjustment required :
A B C
Goodwill raised 32,400 cr. 32,400 cr. 16,200 cr.
(Old PSR 2:2:1)
Goodwill w/off 27,000 dr. 27,000 dr. 27,000 dr.
(New PRS 1:1:1)
Net Effect 5,400 cr. 5,400 cr. 10,800 dr.
Dr. Capital Account Cr.
A B C A B C
Rs. Rs. Rs. Rs. Rs. Rs.

To P/L Adj A/c 29562 29562 14781 By Bal. b/f 52000 39000 27430

To A and B’s -- -- By P/L Adj 24365 24365 24365

Capital A/c 10800 A/c

To Balance c/f 52203 39203 26214 By C’s capital 5400 5400 --

A/c

81765 68765 51795 81765 68765 51795

 Steps to be followed :
1) Take back the already distributed profits
2) Make the rectification adjustments
3) Redistribute the recalculated profits in new PRS
Example :
The firm of A, B and C existed for some years PRS being 2/5, 2/5 and 1/5 respectively. C, however, feels
that this arrangement has not been satisfactory to him and requires to be placed on the same basis as
regards profits as A and B. he further wants that this arrangement shall apply not only to future profits
but also retrospectively to the profits of the past three years, which were Rs. 26,000, Rs. 22,100 and Rs.
25,805. A and B have no objection to this.
They further agree that in making such adjustment, regard should be had to Rs. 6,500 value of goods
which had been charged to profits but which actually were taken privately by B and Rs. 3,900 of office
furniture for which no account had been opened in the books but charged to profit and Loss A/c. plant
and machinery of the firm had not been depreciated over past years and it was estimated that the total
of the amounts which should have been written off was Rs. 9,035.
It was further agreed that after adjustment, the capital were to be equalised without, however, increasing
or reducing the total capital of the firm.
Show the adjustment account and the capital account of the firm after giving effect to the above
arrangements, assuming that immediately after the distribution of the last year’s profits, the capital
accounts stood as under :
A Rs. 52,000
B Rs. 39,000
C Rs. 27,430
Dr. Profit and Loss Adjustment Account Cr.
Rs. Rs.

To Plant and mach. A/c 9,035 By Capital A/c :

To Capital A/c : A 29,561

A 25,090 B 29,561

B 25,090 C 14,781 73,905

C 25,090 75,270 BY B’s Capital A/c 6,500

By Office equipments A/c 3,900

84,305 84,305
 Dr. Capital Account Cr.
A B C A B C
Rs. Rs. Rs. Rs. Rs. Rs.

To P/L Adj A/c 29562 29562 14781 By Bal. b/f 52000 39000 27430

To P/L Adj A/c -- 6500 -- By P/L Adj 25090 25090 25090

A/c

To Bank A/c 8051 -- -- By Bank A/c -- 11449 1737

(Bal. figure) (Bal. figure)

To Balance c/f 39477 39477 39476

77090 75539 54257 77090 75539 54257

 Change in the method of accounting along with change
in PSR with retrospective effect :
 The following steps will be taken :
1. Open a separate account called “Profit & Loss
Adjustment A/c”
2. Take back the already distributed profits from the
date the change in PRS is effective by passing the
entry :
Partners Capital A/c Dr.
To Profit and Loss Adjustment A/c
3. Take back / redistribute the effect of the accrued
income and outstanding expenses of the year
preceding the year from which change is effective
in the old PRS
4. Make the adjustment for Accrued income,
Outstanding expenses, interest on capital /
drawings or any other error by passing the entry :

Profit & Loss Adjustment A/c Dr. XX

To Interest on Capital A/c XX
To outstanding Expenses A/c XX
OR
 Accrued Income Account Dr. XX
Interest on drawings A/c Dr. XX
To Profit and Loss Adjustment A/c XX

5. Redistribute the newly calculated correct profits

Profit and Loss Adjustment A/c Dr. XX
To Partners capital A/c XX
 Example :
X and Y are partners in a business started in 2008 sharing profits
and losses in the ratio of 5:4. after the accounts for the calender
year 2011 were made up and their proportionate shares taken
note of in their individual accounts, they decided to share profits
and losses equally retrospectively for and from the year 2011. It
was also discovered that in ascertaining the result in prior years,
certain adjustments, details of which are given below, had not
been noticed :
2008 2009 2010 2011
Rs Rs. Rs. Rs.
Profit as per accounts 72,000 78,000 90,000 1,08,000
Income not taken into account 5,400 4,500 3,600 6,300
Expenses not provided for 9,000 6,000 10,800 7,200

On 31.12.2010, Reserves stood at Rs. 54,000. Capitals of X and Y

Rs. 1,26,000 and Rs. 96,000 respectively on 31.12.2011.
Dr. Profit and Loss Adjustment Account Cr.
Rs. Rs.
To outstanding By Capital A/c :
Expenses A/c 7,200 X 60,000
Y 48,000 1,08,000
To Capital A/c : By Capital A/c :
X 57,150 (10,800 – 3,600)
Y 57,150 1,14,300 X 4,000
Y 3,200 7,200
By Accrued income A/c 6,300
1,21,500 1,21,500
 Dr. Capital Account Cr.
X Y X Y
Rs. Rs. Rs. Rs.
To P/L Adj A/c 60,000 48,000 By Bal. b/f 1,26,000 96,000
To P/L Adj A/c 4,000 3,200 By Reserves A/c 30,000 24,000
To Bal. c/f 1,49,150 1,25,950 By P/L Adj A/c 57,150 57,150
2,13,150 1,77,150 2,13,150 1,77,150
 Three Ram, Shyam and Ravan formed a firm of
Chartered Accountants with PSR 1:1:1
 Losses year 1 Rs. 3,00,000, year 2 Rs. 6,00,000
and year 3 Rs. 12,00,000
 Guaranteed me minimum Rs. 4,00,000 per annum
with PRS 1:1:1:1
 Let us now assume that I Joined the firm
 If there is a loss of Rs. 10,00,000 after my joining the firm
 My share will be? Loss Rs.2,50,000(10,00,000x1/4)
 No?, I will get Rs. 4,00,000 as minimum guaranteed profit
 If there is a profit of Rs. 10,00,000 then how much I will get? Rs. 2,50,000
(10,00,000x1/4)
 No, again I will get Rs. 4,00,000 as minimum guaranteed profit
 If the profit is Rs. 20,00,000, how much I will get ? Is it Rs. 4,00,000 or Rs.
5,00,000 (20,00,000 x ¼)?
 No, Now I will get Rs. 5,00,000
 Who will bear the loss due to extra amount paid to me over and above my
share of profit ?
 The partner giving the guarantee
 In which ratio ? Agreed ratio or PRS
 How much amount the guaranteed partner gets?
 Higher of minimum guaranteed profit or his share of
profit
 Who will bear the deficiency ?
 Partner/s giving the guarantee.
 Deficiency will be borne in which ratio?
 In the agreed ratio or PSR.
 Example 1:
Ram and Shyam shared profits and Losses in the
ratio of 5:4. They admitted Ravan as 1/5 partner
with a guaranteed profit of Rs. 28,000. The profit of
the firm for the year was Rs. 1,00,000. Prepare
profit and Loss Appropriation A/c showing
distribution of profit.
Dr Profit and Loss Appropriation A/c Cr.
Rs. Rs.

To Capital A/c : By Net profit b/f 1,00,000

Ram [(1,00000 -
20,000) x 5/9]-
8,000 x 5/9 40,000

Shyam [(1,00000 - 32,000

20,000) x 4/9)] –
8,000 x 4/9
Ravan 28,000

1,00,000 1,00,000
 Example :
Ram and Shyam shared profits and Losses in the
ratio of 3:2. They admitted Ravan as 1/5 partner
with a guaranteed profit of Rs. 28,000. The profit of
the firm for the year was Rs. 1,00,000. Prepare
profit and Loss Appropriation A/c showing
distribution of profit if the excess paid to Ravan is to
be borne by Ram only
Dr Profit and Loss Appropriation A/c Cr.
Rs. Rs.

To Capital A/c : By Net profit b/f 1,00,000

Ram [(1,00000 -
20,000) x 3/5)]-
8,000 or b/f 40,000

Shyam [(1,00000 - 32,000

20,000) x 2/5)]

Ravan 28,000

1,00,000 1,00,000
 Example :
Ram and Shyam shared profits and Losses in the
ratio of 3:2. They admitted Ravan as 1/5 partner
with a guaranteed profit of Rs. 28,000. The profit of
the firm for the year was Rs. 1,00,000. Prepare
profit and Loss Appropriation A/c showing
distribution of profit if the excess paid to Ravan is to
be borne by Ram and Shyam equally
Dr Profit and Loss Appropriation A/c Cr.
Rs. Rs.
To Capital A/c : By Net profit b/f 1,00,000
Ram [(1,00000 -
20,000) x 3/5)]-
4,000 or b/f 44,000

Shyam [(1,00000 -
20,000) x 2/5) ]-
4,000 28,000

Ravan 28,000
1,00,000 1,00,000
For your interest and patient hearing