Comprehensive Notes on Partnership Final Accounts and P&L Appropriation

Logistics and Course Overview

• Homework Schedule:

  • Goodwill homework assigned on Monday is due for Wednesday.

  • Specific homework for tomorrow includes Illustration 1 and Illustration 2 (to be solved with a pencil in the textbook).

  • Students are required to read through Illustratons 3, 4, 5, 6, 7, 8, 9, 10, and 11 independently before the next class.

  • Preparation time for tomorrow's work is approximately $30\,mths$ to $35\,mths$.

• Course Progress and Testing:

  • A test on Goodwill is scheduled for Friday during class.

  • The Partnership chapter is expected to take approximately $2\text{ to }2.5\,weeks$ to complete including the class test.

  • Following this chapter, only Cash Flow remains in the syllabus.

• Board Examination Context:

  • The Partnership chapter is a compulsory $10\,marker$ question.

  • It typically appears as the second-to-last question in the board exam.

  • Students are offered two options for this specific sum and must select one.

  • The chapter contains a total of $97$ illustrations.

Fundamentals of Partnership

• Definition and Capacity:

  • A partnership firm requires a minimum of $2$ partners and can have a maximum of $50$ partners.

  • For practical classroom and examination purposes, sums will primarily involve $2$ or occasionally $3$ partners.

• The Partnership Deed:

  • A Partnership Deed is the agreement formed between partners.

  • It can be either oral or written; both forms are legally accepted throughout India (specifically mentioned as common in Maharashtra).

  • It is highly recommended to have a written deed to settle legal disputes effectively.

Provisions of the Indian Partnership Act, 1932

In the absence of a written partnership deed, the following provisions from the Indian Partnership Act, 1932, are applicable (referred to as the "Pink Box" rules):

• Distribution of Profits and Losses: Shared equally among partners, regardless of individual capital contributions or prior verbal agreements (e.g., a $60:40$ agreement becomes $50:50$ legally without a written deed).

• Interest on Capital (IOC): No interest is allowed to partners on their capital.

• Interest on Drawings (IOD): No interest is charged on the drawings made by partners.

• Interest on Loan by a Partner to the Firm: A compulsory rate of $6\%\,p.a.$ must be paid by the firm to the partner.

• Interest on Loan by the Firm to a Partner: No interest is charged by the firm.

• Remuneration (Salary/Commission): No salary or commission is allowed to any partner.

• Admission of a Partner: A new partner cannot be admitted unless all existing partners agree.

Profit and Loss (P&L) Appropriation Account

• Purpose and Preparation:

  • Prepared after the Profit and Loss Account.

  • Used specifically for recording transactions between the partnership firm and its partners.

• Structure of the Account:

  • Credit Side:

    • Starts with "By P&L Account" (Net Profit transferred from P&L).

    • "By Interest on Drawings" (Partner to Firm payment).

    • Adjustments: Positive Interest on Loan to partner, negative Interest on Loan by partner, negative Rent to partner.

  • Debit Side:

    • "To Interest on Capital" (Firm to Partner payment).

    • "To Salary/Remuneration/Commission" to partners.

    • "To Reserves".

    • Distribution of divisible profit among partners in their Profit Sharing Ratio (PSR).

• Charge against Profit vs. Appropriation of Profit:

  • Charge against Profit: Expenses that must be paid whether the firm makes a profit or a loss (e.g., Interest on Partner\'s Loan).

  • Appropriation of Profit: Distribution of profits that occurs only if the firm earns a profit (e.g., IOC, Partner Salary).

Detailed Illustration Analysis

Illustration 14: Adjustments for Net Profit

• Initial Net Profit: $120\,000\,units$.

• The "After" Rule: If a profit is given "after charging" a partner's salary, and that salary is an appropriation, it must be added back to the net profit to find the correct starting point for the appropriation account.

  • Calculation: $120\,000 + 30\,000\text{ (Bharat's Salary)} = 150\,000$.

• Manager's Commission: This is a charge, not an appropriation. It must be subtracted from the corrected net profit before starting the appropriation.

  • Calculation: $5\% \times 150\,000 = 7\,500$.

  • Final P&L transfer: $150\,000 - 7\,500 = 142\,500$.

Illustration 17: Inadequate Profits (The Expense Ratio Rule)

• Scenario: The firm owes partners more (for IOC and Salary) than the total profit available.

  • Profit Available: $400\,000\,units$.

  • Total Claims: Amit ($480\,000$ IOC) and Sumit ($320\,000$ IOC + $480\,000$ Salary = $800\,000$).

• Rule: When profits are insufficient to meet all appropriations, the available profit is shared in the ratio of the claims (Expense Ratio), not the PSR.

  • Ratio: $480\,000 : 320\,000 : 480\,000 \rightarrow 48:32:48 \rightarrow 3:2:3$.

  • Distribution of $400\,000$: Amit ($150\,000$), Sumit IOC ($100\,000$), Sumit Salary ($150\,000$).

Illustration 52: Commission Calculations (Before vs. After)

• Standard Commission (Before Charging): $\text{Profit} \times \frac{\%)}{100}$.

• After Charging Commission: $\text{Profit} \times \frac{\%)}{100+\%)}$.

• After "All" Commissions: Requires subtracting prior commissions from the profit before applying the "after" formula.

  • Correction for Parul in Illus 52: $(960\,000\text{ Net Profit} - 96\,000\text{ Pawan's Commission}) \times \frac{8}{108} = 64\,000$.

Illustration 53: Loss Scenarios

• If a firm incurs a loss, interest on capital and salaries are generally not provided unless they are stated as charges.

• Interest on Drawings Timing Rule: If fixed amounts are drawn at the beginning of each month, interest is calculated for $6.5\,months$.

Comprehensive Review of Illustration 54 (Tej, Partho, and Guinea)

• Account Typology: This illustration distinguishes between Fixed Capital and Fluctuating Capital.

  • If a "Current Account" is mentioned, it is a Fixed Capital method.

  • All appropriations (Salary, IOC, Commission) must be transferred to the Current Account.

• Interest on Current Account:

  • Allowed: Paid by the firm on Credit balances (recorded on the Debit side of P&L Appropriation).

  • Charged: Collected by the firm on Debit balances (recorded on the Credit side of P&L Appropriation).

• Calculations for Illustration 54:

  • Corrected Net Profit: $2\,070\,000 + 30\,000\text{ (Partho salary error)} = 2\,100\,000$.

  • Interest on Drawings (6% p.a.):

    • Tej ($2\,000\,p.m.$ beginning): $24\,000 \times 6\% \times \frac{6.5}{12} = 780$.

    • Partho ($4\,000\,p.m.$ end): $48\,000 \times 6\% \times \frac{5.5}{12} = 1\,320$.

    • Guinea ($18\,000$ lump): $18\,000 \times 6\% \times \frac{6}{12} = 540$.

  • Tej Commission (5% after charging): $2\,100\,000 \times \frac{5}{105} = 100\,000$.

  • Interest on Current Accounts (4% p.a.):

    • Tej (85k Dr balance): $3\,400$ (Credit side of P&L App).

    • Partho (60k Dr balance): $2\,400$ (Credit side of P&L App).

    • Guinea (100k Cr balance): $4\,000$ (Debit side of P&L App).