by There are several distinct transactions associated with a partnership that are not found in other types of business organization. These transactions are:
- Contribution of funds. When a partner invests funds in a partnership, the transaction involves a debit to the cash account and a credit to a separate capital account. A capital account records the balance of the investments from and distributions to a partner. To avoid the commingling of information, it is customary to have a separate capital account for each partner.
- Contribution of other than funds. When a partner invests some other asset in a partnership, the transaction involves a debit to whatever asset account most closely reflects the nature of the contribution, and a credit to the partner’s capital account. The valuation assigned to this transaction is the market value of the contributed asset.
- Withdrawal of funds. When a partner extracts funds from a business, it involves a credit to the cash account and a debit to the partner’s capital account.
- Withdrawal of assets. When a partner extracts asset other than cash from a business, it involves a credit to the account in which the asset was recorded, and a debit to the partner’s capital account.
- Allocation of profit or loss. When a partnership closes its books for an accounting period, the net profit or loss for the period is summarized in a temporary equity account called the income summary account. This profit or loss is then allocated to the capital accounts of each partner based on their proportional ownership interests in the business. For example, if there is a profit in the income summary account, then the allocation is a debit to the income summary account and a credit to each capital account. Conversely, if there is a loss in the income summary account, then the allocation is a credit to the income summary account and a debit to each capital account.
- Tax reporting. In the United States, a partnership must issue a Schedule K-1 to each of its partners at the end of its tax year. This schedule contains the amount of profit or loss allocated to each partner, and which the partners use in their reporting of personal income earned.
Capital Accounts of Partners:
A partnership organisation maintains accounts of its transactions in the same manner as a Sole Trader ship. Since partnership has two or more partners, separate capital account for each partner has to be maintained. Usually every partner contributes something in cash or in kind to provide funds for the running of a business. The amount of contribution is mutually settled and need not necessarily be equal.
The sum of the contributions represents the capital of the firm. The partnership deed usually mentions the method of maintaining capital accounts of partners. There are two methods by which capital accounts are maintained i.e., Fixed Capital and Fluctuating Capital.
Fluctuating Capital:
Fluctuating Capital is one which changes from year to year. There is only one account for each partner in case 6of fluctuating capital system. All entries relating to introduction of fresh capital, interest on capital, salary, commission, share of profit etc. are credited to the capital account and similarly capital account is debited with drawings, interest on drawing, losses etc.
All entries for all items are passed through his capital accounts; as such, the amounts of his capital at the end of the year will be different from what it was at the beginning of the year. The balance of the capital goes on fluctuating year after year and is known as Fluctuating Capital.
In the absence of the contract to the contrary, capital accounts are fluctuating. Partner’s drawings are, however, recorded in his Drawings Account which will be closed at the end of the year, by transferring to the capital accounts.
Loan Account:
Where advance is made by a partner, credit is given to him by opening his separate Loan Account and not through his capital account. In the absence of agreement to the contrary, the Partnership Act provides that interest at 6% p.a. shall be allowed on such loan, irrespective of profits. Interest on such advance or loan should be credited to Loan Account or Current Account.
Unless the Partnership Deed expressly lays down that the partners Capital Accounts shall be kept fixed, they are treated as fluctuating.
Fixed Capital:
When the partners agree to keep their capital at their original figures, year after year, they are said to have fixed capitals. They continue to appear at their original figures unless contribution is made by way of additional capital or refund is allowed of the surplus capital, if any. Under the fixed capital, separate CURRENT ACCOUNT of each partner is opened.
This current account will be credited at the end of every year with his:
(a) Share of profits,
(b) Interest on capital and
(c) Salary or any other remuneration; and debited with his
(a) Drawings
(b) Interest on Drawings and
(c) Share of loss, if any.
The current account may show credit and debit balance at the end of the year. If they show Credit balances, they appear on the liability side of the Balance Sheet of the firm along with Fixed Capitals. If the Current Accounts show Debit balances, they appear on the asset side of the Balance Sheet.
A Debit Balance of the Current account implies that the concerned member has overdrawn his Current account and owes that amount to the firm. A Credit balance of the Current account represents the amount which a partner is entitled to draw but has not actually drawn.
In some cases, interest is allowed on the credit balance and charged to the debit balance; if so entries are passed through respective partners Current accounts.
Drawings:
The Partnership Deed may allow partners to withdraw money or goods from the business to meet their private requirements. The amount of withdrawals at each interval need not be equal. To avoid congestion entries in Capital or Current Account, in respect of withdrawals, a separate Drawing Account is opened for each partner.
The amount drawn at each time is debited therein. At the closing date, the Drawings Account is closed by transferring it to Capital Account, if Capital Account is fluctuating, or to Current Account, if the Capital Account is fixed. But the Current Account is not transferred to Capital Account.
Interest on Drawings:
Interest on Drawings also depends upon the Partnership Deed. There are many cases, where Capitals bear interest but Drawings are not Chargeable with interest. Generally, Partnership Deed stipulates the maximum amount that each partner is permitted to withdraw, without paying interest.
If any partner exceeds the limit, he has to pay interest on Drawings. Where the withdrawals of the partners are unequal, partner’s accounts are equitably adjusted through the mechanism of interest on drawings.
To the firm it is an income and therefore the Capital or Current Accounts of the partners are debited and Interest on Drawing Account is credited. Interest on Drawings is a loss to the partners. To make calculation of the interest on Drawings, three things must be present – the interest rates the amount and the period.
Interest on Capital:
Interest on Capital is usually allowed by an agreement between the partners. The Partnership Act is silent on this point that is, no interest on capital is allowed. Interest on capital is generally allowed on capitals so that the partner who contributes more than the proportionate capitals is properly compensated.
If partners contribute equal amounts of capital and share profits equally, no need arises for any interest to be allowed on capital. Where capital contributions are equal but the profit sharing ratios are unequal, a partner, with a lower share of profit, stands to lose. Besides, where capitals are unequal but profit sharing ratios are equal, a partner with large capital contribution is affected financially.
Interest on capital tends to balance capital account equitably, without allowing any partner to enjoy an unfair advantage over the others. Interest on capital is a loss or expense to the firm and thus debited to Interest on capital account and finally transferred to Profit and Loss Appropriation Account. And it is an income or gain to the partners and their Capital Account or Current Account is credited with the amount of interest.
Commission to Partners:
Under the partnership law all partners are supposed to devote their time to the affairs of the firm but in practice many partners may not devote any time and some of the partners may have to carry on the entire work of the firm. Thus, a percentage of profit is paid to a partner for the special work or service done. This commission may be payable before charging such commission or after charging such commission.
Profit and Loss Appropriation Account:
The Profit and Losses of the partnership are divisible equally or in any other manner agreed upon by the partners. In case of partnership accounting, it is usual that adjustments relating to Interest on Capital Interest on Drawings, Salary, Commission, Share of profits etc. to be made through the Profit and Loss Appropriation Account.
