PARTNERSHIP – GENERAL

Profit & loss Appropriation Account

The profit & Loss Account is being prepared to know the profit earned or loss incurred in the accounting period but the profit & loss appropriation account is being prepared to show the distribution of the profit, as revealed by the Profit & loss account among the partners. The profit & loss appropriation account is prepared in the following form in case of the partnership firm:

PROFIT & LOSS APPROPRIATION ACCOUNT

PARTCULARS	AMOUNT	PARTICULARS	AMOUNT
To Salaries A B To Interest on capital A B To Commission A B To Profit A B To Balance c/d		By Profit & loss account By Interest on drawings A B

The above Account has been prepared assuming that there is two partners.

The Balance carried down represent that the part of profit earned during the year which is not distributed among the partners and retained in the business for the future use and this balance will appear in the Balance sheet.

Interest on capital

As per Indian Partnership Act, 1932 a partner is not entitled to interest on capital unless otherwise provided by the agreement i.e a partner is entitled to interest on capital if authorised by the agreement. The treatment of interest on capital under different circumstances are as follow:

Situations	Treatment
1. If the partnership agreement provides for interest on capital but is silent as to the treatment of interest as a charge or appropriation.	¨ Interest on capital will be treated as appropriation and will be allowed only when there is profit. 1. In case of loss – No Interest on capital will be allowed 2. In case profit before interest is less than the interest payable on the capital. – Profit will be distributed in the ratio of Interest on capital , which each partner would have entitled to had there been sufficient profit.
If the partnership agreement provides for treatment of interest on capital as a charge.	Full interest will be credited to the account of the partner even if there is loss before interest. Morever the interest will form part of the Profit & loss account and will not be part of the Profit & loss Appropriation account

Calculation of the Interest on Capital:

Calculation of Interest on capital is based on the two factors:

1. Rate of Interest

2. The period for which capital has been employed in the business.

FIXED CAPITAL ACCOUNT	FLUCTUTATING CAPITAL ACCOUNT
In this case interest on capital will calculated on the opening balance ( of the fixed capital account) for the full year and on the additional capital from the date it was introduced till the end of the year	In this case first of all opening balance will be calculated Then, interest on capital will calculated on the opening balance for the full year and on the additional capital from the date it was introduced till the end of the year

In case of fluctuating capital account the opening balance of the capital will be calculated from the closing capital as follow:

Opening capital = Closing capital +Drawings – Distribution of the profit (either by way of salary or commission or profit sharing) + Interest on drawings – Fresh capital Introduced.

Q1. A & B are sharing profit and losses in the ratio of 1:1. Their opening capital account balances
are Rs. 30,000 and Rs. 20,000 respectively. Show how interest on capital @ 10% p.a will be
treated in the following situations:

a. If the partnership agreement provides for the interest on capital but silent as to the treatment of the same in the books of the accounts:

there is profit of Rs. 6,000
there is loss of Rs. 2,000
there is profit of Rs. 5,000
there is profit of Rs. 3,000

b. If the partnership agreement provides for the interest on capital and this interest is to be treated as charge against profit.

there is profit of Rs. 6,000
there is loss of Rs. 2,000
there is profit of Rs. 5,000
there is profit of Rs. 3,000

Ans 1(a)

1. A – Interest on Capital Rs. 3000 & Profit Rs. 500 , B - Interest on Capital Rs. 2000 & Profit Rs.
500

2. No interest on Capital . Loss to each partner Rs. 1000

3. Interest on Capital A- Rs. 3000 & B – Rs. 2000

4. Profit of Rs. 3000 will be distributed between A & B in Capital ratio i.e 3:2 ( Rs. 1800 & Rs. 1200 to A & B respectively)

Ans 1(b)

1. A – Interest on Capital Rs. 3000 & Profit Rs. 500 , B - Interest on Capital Rs. 2000 & Profit Rs.
500.

2. Interest on Capital A – Rs. 3000 & B – Rs. 2000. Loss of Rs. 3500 to each partner

3. Interest on Capital A- Rs. 3000 & B – Rs. 2000

4. Interest on Capital A – Rs. 3000 & B – Rs. 2000. Loss to each partner Rs. 1000.

Q2. A & B are sharing profit and losses equally and their capital account balances at the beginning
       of the year was Rs. 40,000 and 30,000 respectively. During the year (mid of the year) both had
       introduced the additional capital of Rs. 10,000 each. The partnership agreement provides for the
       interest on capital @ 10%. Prepare a Profit & loss appropriation account assuming that there is
       profit of Rs. 4,000.

{Profit of Rs. 4000 will be divided between A & B in 9:7}

Q3. X and Y are partners sharing profit & losses in the ratio 3:2.During the year they had earned the
profit of Rs.50,000 which they had distributed as follow:

Salary to each partner – Rs. 1000 p.m. to each partner

Profit of Rs. 15,000 in the ratio of 3:2

Balance profit carried forward to the Balance sheet.

Their drawings during the year were as follow: Rs 7000 by X and Rs. 9000 by Y

They had also introduced the additional capital as follow:

X – Rs 10,000 on 1.4.99

Y - Rs. 10,000 on 1.10.99

Calculate the interest on capital @ 10% under the following two cases, assuming that accounting year is calendar year:

1. When partner are maintaining the fixed capital account and closing Balances of their fixed
capital account are as follow:

X – Rs. 60,000

Y- Rs. 60,000

2. When partner are maintaining the Fluctuating capital account and closing Balances of their
capital account are as follow:

X – Rs. 60,000

Y- Rs. 60,000

Ans.

1. When Fixed Capital accounts are being maintained

Calculation of the opening Capital

X Y

Closing Capital 60000 60000

Less: additional capital 10000 10000

Opening Capital 50000 50000

Interest on Capital:-

‘—On opening Capital 5000 5000

‘--- On Additional capital 750 250

5750 5250

2. When Fluctuating Capital are being Maintained:-

Calculation of the opening Capital

X Y

Closing capital 60000 60000

Less: additional Capital 10000 10000

Less: Salary 12000 12000

Less: Profit 10000 5000

Add: Drawings 7000 9000

35000 42000

Interest on Capital:-

‘—On opening Capital 3500 4200

‘--- On Additional capital 750 250

4250 4450

Interest on Drawings

As per Indian Partnership Act, 1932 a partner is not liable to pay to interest on drawings unless otherwise provided by the agreement i.e a partner is liable to pay to interest on drawings if authorised by the agreement.

Treatment of Interest on drawings

It is shown in the credit side of the profit & loss appropriation account and debited to the partner’s capital or current account, as the case may be, by means of the following journal entry

Partner’s Capital or Current Account - Dr.

To Profit & loss Appropriation Account

Calculation of the Interest on Drawings

The amount of the interest n drawings is based on the following two factors:

1. Rate of Interest

2. The period for which amount of the business is being used by the partners.

Interest on drawings are generally calculated on the basis of the product method which is being explained as follow with the help of the example:

Suppose a partner withdraw amount as follow:

1.5.99 Rs. 5000

1.7.99 Rs. 4000

1.9.99 Rs.4000

1.11.99 Rs. 4000

Calculate the interest on drawings @ 10%, assuming the accounting year to be Calendar year

Date Amount (A) Period for which amount was (B) Product

Used by the partner i.e ( from (A x B)

Date of drawing till the end of the

Year)

1.5.99 5000 8 months 40,000

1.7.99 4000 6 months 24,000

1.9.99 4000 4 months 16,000

1.11.99 4000 2 months 8,000

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88,000

Interest on drawings = Product x rate of interest for one month

= 88,000 x 10% x 1/12

= 733.33

Note: We have taken interest for one month because while calculating the product we have taken the No. of months. Had we taken the No. of days in the calculation of the product ,then while calculating interest we will take rate of interest for 1 day i.e rate of interest /365.

The logic of the product method is explained as follow:

On the basis of the following data interest will be calculated as follow:

(5000 x 8/12 x 10%) +( 4000 x 6/12 x 10%) + (4000 x 4/12 x 10%) + (4000 x 2/12 x 10%)

Taking (1/12 x 10%) as common factor in the above equation

[ (5000 x 8) + ( 4000 x 6) + (4000 x 4)+ ( 4000 x 2) ] x 10% x 1/12

[40,000 + 24,000 + 16,000 + 8,000 ] x 10% x 1/12

88,000 x 10% x 1/12

Hence same result is obtained as obtained under the product method.

IF the same amount is regular withdrawn each month during the year then interest on drawings will be calculated as follow:

¨ If drawings are made at the beginning of the month =

Total drawings x 6.5/12 x rate of Interest

¨ If drawings are made at the mid of the month =

Total drawings x 6./12 x rate of Interest

¨ If drawings are made at the end of the month =

Total drawings x 5.5/12 x rate of Interest

If it is given that same amount is regularly withdrawn each month, then it will be assumed that the amount is withdrawn during the mid of the year.

Commission on profit

Commission on the profit will paid to the partner only when the partnership agreement provides so

Treatment of Commission on profit

Commission on profit is treated as a appropriation of profit and the amount of commission is debited to Profit & loss appropriation account and credited to the partner’s capital and current account by means of the following journal entry;

Profit & loss Appropriation A/c – Dr.

To Partner’s capital or current account

Calculation of the Commission on profit

The Commission may be based on the Profit before charging Commission or Profit after charging Commission

¨ Commission on the Profit before charging Commission =

Profit x Rate of Commission

100

¨ Commission on the Profit after charging Commission =

Profit x Rate of Commission

100 + Rate of Commission

Here, profit is taken as per the requirement of the question which may be the Profit as per Profit & loss Account or Profit after all appropriation except commission or profit after some appropriation.

Q 4. A & B are partners sharing profit & losses in the ratio of 3 :2 and they earned the profit of Rs.
1,00,000 for the financial year 1998-99. The partners are entitled to the following:

Salary to A – Rs.30,000 p.a

Salary to B – Rs. 25,000 p.a

Commission to A – Rs. 10% of the profit

Commission to B – 25% of the profit after charging his commission

Balance profit in the profit sharing ratio.

Prepare profit &loss appropriation account.

Ans:

Profit & loss Appropriation A/c

Particulars	Amount	Particulars	Amount
To Salary A B To Commission A B To Net Profit A B	30,000 25,000 10,000 20,000 9,000 6,000 -------------------- 1,00,000	By Profit & loss A/c	1,00,000 -------------------- 1,00,000

Capital Ratio

The partnership agreement provides the ratio in which profit will be distributed among the partners and in the absence of the any ratio in the partnership agreement the profits are share equally. But sometimes the agreement may provide that profits are to be share in the capital Ratio

Capital ratio does not mean the ratio of capital either at the beginning or ratio of capital at the end rather capital ratio is calculated with reference to the time period for which capital has been used in the business

While calculating capital ratio a permanent introduction of capital into the business and permanent withdrawl of the capita from the business is taken into consideration, normal monthly drawings are often ignored.

Q6. A & B are partners sharing profit & losses in the ratio of capital Ratio. They are following

calendar year as their accounting year and their capital at the beginning of the year was Rs.
80,000 and Rs. 40,000 respectively. Calculate the capital ratio from the following details:

Date of transaction	Capital Introduced ( A)	Capital Introduced (B)	Capital withdrawn (A)	Capital withdrawn (B)
1^st April 1^st July 1^st September 1^st October 1^st November	- 10,000 - - 3,000	5,000 - 6,000 8,000 -	10,000 - - 2000 -	- 5000 - - 1500

PAST ADJUSTMENTS

If after the preparation of the final accounts some errors or omission is noticed partner desire to give effect to such errors or omission through their capital accounts rather to alter and reopened the final accounts. Such errors and omission are usually the following:

a. Omission of Interest on capital

b. Provide Interest on capital though it is not authorised by the partnership agreement

c. Provide Interest on capital at the wrong rate

d. Omission of Interest on drawings

e. Charge Interest on drawings though it is not authorised by the partnership agreement

f. Charge Interest on drawings at the wrong rate.

g. Omission of recording of the outstanding expenses and Incomes.

Recording of the past adjustment in the books of the accounts

It has been explained assuming that there is omission of Interest on capital

Step 1 – Calculate the total amount of interest on capital omitted to be provided

Omission of the interest on capital means that amount of profit equal to amount of interest on capital has been wrongly distributed in the profit sharing ratio. (This logic has to be viewed from the point of view of capital accounts of the partners)

Step 2 – Debit the total amount of interest, as calculated above, in the partners account in the profit
sharing ratio

Step 3 – Credit the partner’s account with the amount of interest on capita; which each partner is
entitled to

Step 4 – Pass the necessary journal entry among the capital accounts of the partners on basis of the
net debit or credit in the account of the partners as worked out in the step 1 & 2.

The past adjustments are nothing less than the rectification of the errors, the errors being committed last year i.e rectification entry is to be passed after the close of previous accounting year. So questions relating to past adjustments can be proceed in a way, rectification entry are passed.

This being illustrated in the following way:-

Ø Suppose Interest on Capitals are wrongly provided to the extent of Rs. 2000 and Rs. 3000 to A and B. They are sharing equally.

Since in the last year, partners has been excess credited ( & Profit & Loss Appropriation account) with the amount of interest on capital, so for rectifying this error following entry will be passed:

As Capital A/C – Dr 2000

B’s Capital A/c – Dr 3000

To Profit & Loss Appropriation A/c 5000

Now since profit & loss appropriation account has been credited (there is the profit to the firm to the extent of Rs.5000), same should be distributed between the partners equally by following entry:-

Profit & Loss appropriation A/c 5000

To A’s Capital A/c 2500

To B’s Capita; A/c 2500

Thus the net effect of both the rectifying entries are that A’s Capital account is to be credited with Rs. 500 and B’s Capital account is to be debited with Rs. 500 by following entry:-

B’s Capital A/c 500

To A’s Capital Account 500

Thus above two rectifying entries be shown in the working Notes and net effect should form part of the main answer.

Ø Suppose Interest on drawings are omitted to charge from the partners to the extent of Rs. 1000 and Rs. 2000 from partners A and B. They are sharing equally

Now in the last year, partners are not debited with the interest on drawings and now they will be debited and profit & loss appropriation account will be credited by following entry:-

As Capital A/C – Dr 1000

B’s Capital A/c – Dr 2000

To Profit & Loss Appropriation A/c 3000

Now since profit & loss appropriation account has been credited (there is the profit to the firm to the extent of Rs.3000), same should be distributed between the partners equally by following entry:-

Profit & Loss appropriation A/c 3000

To A’s Capital A/c 1500

To B’s Capita; A/c 1500

Thus the net effect of both the rectifying entries are that A’s Capital account is to be credited with Rs. 500 and B’s Capital account is to be debited with Rs. 500 by following entry:-

B’s Capital A/c 500

To A’s Capital Account 500

Thus in the same way a student can think of the effect of error on the capital account , then on the profit & loss appropriation account and balance in the profit & loss appropriation should be distributed among the partners in profit sharing ratio.

Q1. A, B and C are partners sharing profit & losses in the ratio of 3:2:1. For the financial year

ended 31.3.99 they had committed the following errors :

a. Omitted to provide interest on capital at the rate of 10%.

b. Wrongly Provide interest on capital @ 12% which they are not entitled to.

c. Provide interest on capital @ 10% instead of right rate of 12%.

d. Provide interest on capital @ 10% instead of right rate of 8%.

Pass the necessary journal entry to rectify the above mentioned mistake, assuming that the opening balance of capital account of the partners are as follow:

A Rs. 50,000

B Rs.40,000

C Rs. 30,000

Q2. X, Y and Z are partners sharing profit & losses in the ratio of 3:2:1. Their Drawings during the
financial year ended 31.3.98 their drawings were as follow:

X – Rs. 500 per month at the beginning of the month

Y – Rs. 400 per month at the mid of the month

Z – Rs. 400 per month at the end of the month.

At the end of the year they realised that they had committed the following mistake:

a. Omitted to Charge interest on drawings at the rate of 10%.

b. Wrongly charge interest on drawings @ 12% which they are not liable to.

c. Charge interest on drawings @ 10% instead of right rate of 12%.

d. Charge interest on drawings @ 10% instead of right rate of 8%.

Pass the necessary journal entry to rectify the above-mentioned mistake.

Guarantee of Minimum of profit to a partner

Some times person is admitted as a partner on the condition that he will be entitled to the minimum profit whatever may be the profit of the firm. In such situation where the profit of the firm is not sufficient, then the partner who is given a guarantee is given his minimum guaranteed profit and the remaining profit is distributed among the remaining partners in such away that they also bears the deficiency in regard to the excess profit paid to the guarantee partner over his normal share i.e share which he his entitled according to the normal profit sharing ratio.

The deficiency of the guarantee partner may be born by:

1. Existing partner in their profit sharing ratio or by the firm

2. Existing partner in specific ratio

3. By one partner only

Accounting Treatment:

Step-1: Calculate the amount of profit, which is distributable among the partners on the basis of the profit sharing ratio

Step-2: If the profit as calculated at (1) is insufficient i.e the profit payable to the guarantee profit according to the profit sharing ratio is less the guaranteed profit, then credit the such partner account with the amount of guarantee profit

Step-3: Calculate the adjusted profit i.e profit calculated at (1) minus share of profit which would have been payable to the guarantee partner according to the profit sharing ratio, and credit the remaining partners account with the amount of the adjusted profit in their profit sharing ratio

Step-4: Calculate the deficiency i.e-minimum or guarantee profit paid to the guarantee partner minus share of profit which would have been payable to the guarantee partner according to the profit sharing ratio, and debit the partners account with amount of deficiency in the ratio in which they have given the guarantee.

ILLUSTRATION

A and B are partners sharing profit in the ratio of 3:2. They admit C as a new partner for 1/6^th share subject to the condition that his share of profit in any year will not be less than Rs. 12,000 and any deficiency will be born by the partners equally. During the year the firm earned a profit of Rs. 60,000. Show the distribution of the profit among the partners.

ANSWER

Step-1: Rs. 60,000

Step-2: Profit share of C according to the profit sharing ratio = 10,000

Guarantee profit = 12,000

So he will be given or credited with Rs. 12,000

Step-3: Adjusted profit = 50,000 [ 60,000 – 10,000]

Distribute or credit the account of the A and B with Rs. 50,000 in the ratio of 3:2 i.e A- Rs. 30,000 and B – Rs. 20,000

Step-4: Deficiency = 2,000 [ 12,000 – 10,000]

This deficiency will be borne by A and B in the ratio of 1:1 i.e A and B account will be debited with Rs. 1000 each

So after above adjustment the amount which will be paid to each partner will appear as follow in the profit & loss appropriation account:

To A’s capital By profit & loss account 60,000

[30,000 – 1000] 29,000

To B’s capital

[20,000 – 1000] 19,000

To C’s capital 12,000

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60,000 60,000

Accountancyfor12th

Saturday, 12 July 2014