Class 12 Accountancy Notes
Unit – 2: Accounting for Partnership Firms
Accounting for Partnership Firms including Goodwill Important Notes for March 2025 Exam
Q.1.
Define the term “Partnership”, Partners, Firm and Firm name. What are
essentials of partnership? Mention its merits and demerits.
Ans:
Partnership: 2004, 2010, 2011,
Partnership is an association of two
or more persons who agreed to do business and share profits and losses arises
from it in an agreed ratio. The partners act both as agents and principals of
the firm.
In India, Partnership firm is governed
by the Indian Partnership Act 1932. Section 4 of this act defines partnership
as: "The relationship between persons, who have agreed to share the
profits of a business carried on by all or any one of them acting for
all."
Partnership in this way is an
agreement, between two or more persons to carry on legal business with profit
motive, which is carried on by all or any one of them acting for all.
Partners, Firm and Firm name: The
persons who have entered into a partnership with one another are individually
called partners and collectively a firm. The name under which the business is
carried is called firm name.
Essential
(Characteristics) of Partnership: 2008, 2009, 2020, 2023
a)
Agreement: Partnership is the result
of an agreement, either written or oral, between two or more persons. It arises
from contract and not from status or process of law.
b)
Number of Persons: In a partnership
firm there must be at least two people to form the business. Partnership Act
1932, does not specifies the maximum numbers of persons, but the Indian Company
Act 2013, restricts the number of Partners to 100 for a partnership firm. But
in case of limited liability partnership there is no maximum limit.
c)
Business: There must be a legal
business. Business includes trade, vocation and profession.
d)
Profit-Sharing: The agreement
between/amongst the partners must be to share profit or losses arise from the
business.
e)
Agents and principals: The partners
act both as agents and principals of the firm. Partnership firm can be carried
on by all or any of them acting on behalf of all the partners.
f)
Separate legal entity: Partnership is
a separate legal entity from the accounting point of view. But from the legal
view point firm is not separate from its partners. If a firm is bankrupt,
private estate of the partners is liable to meet firm’s obligations.
Merits
of partnership:
1. Easy to form a partnership firm as
compared to company 2. Facility of large financial resources 3. Better
management of operations 4. Sound decisions 5. Sharing of risks 6. Flexibility
in operations 7. Greater motivation because of unlimited liability 8.
Maintenance of secrecy 9. Easy to dissolve the firm
Limitations
of Partnership: 2023
1. Less capital as compared to a
company 2. Unlimited liability of partners 3. Conflict between partners 4. Slow
decision making 5. Non- public confidence 6. Uncertain life of the firm
Q.2. What
is Partnership Deed? What are its contents? 1999,
2003, 2007, 2009, 2014, 2018, 2019
Ans:
Partnership deed: Meaning
A partnership is formed by an
agreement. This agreement may be oral or in writing. Though the law does not
expressly require that the partnership agreement should be in writing, it is
desirable to have it in writing. A written agreement, which contains the terms
of partnership, as agreed to by the partners is called ‘Partnership Deed.’
Importance: It is a very important
document of the firm which defines relationship amongst the partners. It is
necessary to avoid disputes amongst the partners and can be presented in the
court as evidence.
Contents
(Clauses) of the Deed:
a)
Name and address of the firm.
b)
Names and addresses of the partners.
c)
Nature of Business.
d)
Amount of capital to be contributed by
each partner.
e)
Profit or loss sharing ratio.
f)
Date of commencement of partnership.
g)
Interest of Capital, if provided the
rate of interest must be specified.
h)
Partner’s salaries and commission, if
provided.
i)
Interest on Drawings, if charged, the
rate of interest should also be specified.
Q.3. What
are the rules to be followed in the absence of Partnership agreement between
partners? 2000, 2002, 2009, 2011, 2014
Ans: According to Indian Partnership Act 1932
(sec. 4), the following provision are applicable in the absence of partnership
deed:
a)
Profit Sharing Ratio: In the absence
of partnership deed all partners will share Profit or losses in equal ratio.
b)
Interest on Capital: No interest will
be given to any partner on his capital in the absence of partnership deed. In
case, there is a partnership deed, which allows interest on capital, it will be
allowed in case of profit but not in case of loss in the business.
c)
Interest on Drawings: No interest will
be charged on drawing in the absence of partnership deed.
d)
Partner’s Salary/Commission: No salary
or commission will be given to any partner in the absence of partnership deed.
e)
Interest on Partner’s Loan: Interest
on partner’s loan will be given @ 6% p.a. Such interest is payable even if
there are losses.
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ALSO READ (AHSEC ASSAM BOARD CLASS 12):
1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES
2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)
3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)
4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)
5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)
6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS
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Q.4.
Mention three Rights and Duties of Partners. 2009,
2014, 2022, 2023, 2024
Ans:
Duties (Obligations) of a Partner: It is the duty of Partners:
a)
It is the duty of every partner to
devote his full attention and time to the firm.
b)
It is the duty of every partner to act
honestly for the benefit of the firm.
c)
It is the duty of every partner to not
to carry similar business.
d)
Every partner must share losses of the
firm.
e)
It is the duty of every partner to
maintain secrecy and does not share business secrets with others.
Rights of
a Partner:
a)
Every partner has a right to take part
in the conduct and management of the business.
b)
Every partner has a right to be
consulted in the matters of the partnership.
c)
Every partner has a right to share
profits with others in the agreed ratio.
d)
Partners have a right of free access
to all records, books of accounts and also to examine and copy them.
e)
Every partner has the right not to
allow the admission of a new partner.
f)
Every partner has the right to retire
from the firm after giving proper notice.
Q.5. What
are various types of partners and partnership?
Ans: Types of Partners:
a)
Active
partner: An active partner is a partner who gives
capital, participates in management,
shares the profits and losses and has unlimited liability.
b)
Sleeping
partner or Dormant Partner: A Partner who do not take part in the
business activities.
c)
Secret
partner: A partner who has association with the firm
but unknown to the public.
d)
Nominal
partner: A partner who allows his name to be used by
the firm is called nominal partner.
e)
Partner by
estoppel: A person who by behaviour sets an impression
to others that he/she is a partner of the firm.
f)
Partner by
holding out: A person who is not a partner but allows
himself to be represented as partner in a firm.
Kinds
of Partnership:
Partnership firms are of two types’
viz., General Partnership and Limited Partnership.
1. General Partnership: In this case the liability of all the
partners is unlimited. General
Partnership can be further divided into two types i.e. (i) Partnership at Will,
and (ii) Particular Partnership. These are explained as under:
(i) Partnership at will: When a partnership firm is constituted
for unspecified period, it is known as Partnership at will. It can be dissolved
by any partner by giving a notice indicating that he wants to withdraw his
interest from the firm.
(ii) Particular partnership: As
the very name suggests, this type of partnership is formed for conducting
business of specific or temporary nature. The partnership comes to an end
either on the accomplishment of the task for which the partnership was
undertaken or on the expiry of the time period for which the firm was
constituted.
2. Limited Partnership: Under
this type of partnership some of the partners have unlimited liability while
others have limited liability up to their individual share in the capital of
the firm.
Q.6. What
is Profit and Loss Appropriation Account? Mention its purpose and features. Distinguish
between profit and loss account and profit and loss appropriation account. 2020, 2022, 2023, 2024
Ans:
Profit or loss appropriation account: For the
purpose of distribution of net profit between or amongst the partners, an
additional account known as profit and loss appropriation accounts is prepared.
This account is nominal in nature. It is prepared after profit and loss
accounts to show the distribution of net profit amongst the partners after all
appropriations. It is credited with net profit as shown by profit and loss
account, interest on drawings and fines/penalty charged on partners and debited
with interest on capital, partner’s salaries & commission and transfer to
reserves. The balance of this account is distributed between/amongst the
partners in their agreed profit sharing ratio.
Purpose
of preparing profit and loss appropriation: In case of
sole trade business, the whole of the net profit is credited to the
proprietor’s capital and the capital account is debited for any drawings. But
in case of partnership business, a separate account is needed for appropriation
and distribution of profits between or amongst the partners. So, a new account
is added after profit and loss account which is prepared only in case of
partnership business. This account will show how the net profit of the business
is being appropriated among partners.
Features
of Profit and loss Appropriation account:
a) It is an extension of the profit
and loss account.
b) It is a nominal account.
c) It is prepared by partnership firms
only.
d) It is prepared as per the contents
of partnership deed.
e) It shows the appropriation of
profit for the accounting period.
Difference
between Profit and loss account and Profit and loss appropriation account: 2024
|
Profit and loss
Account |
Profit and loss
appropriation account |
|
1. It is prepared after trading account. 2. This account is prepared by every form of
business organisation. 3. Items debited in profit and loss account
are all expenses.
4. At the time of preparing this account,
matching concept is followed. 5. This account is the basis of calculation
of income tax. |
1. It is prepared after profit and loss
account. 2. This account is prepared by partnership
firm only.
3. Items debited in profit and loss
appropriation account are all appropriations. 4. At the time of preparing this account, no
matching concept is followed. 5. This account is not the basis of
calculation of income tax. |
Q.7. What
is fixed and fluctuating capital? Distinguish between them. 2007, 2020, 2022, 2023, 2024
Ans: In case of a partnership firm, a separate
account is maintained for each partner to record various transactions between
the firm and partners and to find the capital balance of each partner at the
end of the year. This separate account is called partner’s capital account. A
partnership firm can maintain the capital accounts of partners as fixed capital
account method or Fluctuating Capital Accounts method.
A)
Fixed Capital Account method: Fixed capital means capital balance of
the partners shall remain unchanged except in certain cases. When fixed capital
method is followed, two accounts i.e., A Capital Account and a Current Account
for each partner are maintained.
Capital
Accounts: In case capital accounts are fixed, the
opening and closing balances of capital accounts normally remain unchanged.
But, if additional capital is introduced or drawings are made out of capital
during the accounting year then closing capital will differ from opening
capital. Fixed capital account always shows credit balance.
Current
Accounts: When capital account is fixed, then current
account is opened for each partner separately to record all the transactions, other
than capital contribution and withdrawal of capital, between the firm and the partner.
It is credited with partner’s salary, fees, bonus, commission, interest on
capital, share in profits, partners’ share in reserves and goodwill and debited
with Drawings out of profit, interest on drawings and share in losses. Current
account of the partners may show both credit or debit balance.
B)
Fluctuating Capital Account Method: Under
fluctuating capital account method, only Capital account is maintained for each
partner. Fluctuating capital method is normally followed for maintaining
capital accounts in the absence of any instructions. Fluctuating capital
accounts of partners means where in all the transactions relating to partners
e.g. salary, fees, commission, interest on capital, share in profits, goodwill,
reserves, drawings etc., are recorded along with the opening balance of capital
and additional capital introduced in the firm. In case of fluctuating capital
accounts, current accounts of partners are not opened. The closing balances of
partner’s capital account may show debit or credit balance.
Difference
between capital accounts and current Accounts: 2023
|
Basic of difference |
Capital Account |
Current Account |
|
1. Method |
Capital Account is prepared under fixed
capital method. |
Current account is prepared under
fluctuating capital method. |
|
2. Transactions recorded |
In capital account only capital introduced
and withdrawn is recorded. |
All order transactions between the firm and
partners is recorded in the current account. |
|
3. Interest |
Interest is sometimes paid on capital
account. |
No such interest is payable on current
account balances. |
Difference
between fixed capital accounts and fluctuating capital Accounts: 2018, 2022
|
Basic of difference |
Fixed Capital Account |
Fluctuating Capital Accounts |
|
1. Opening and Closing balance |
Opening and Closing balances normally
remains the same. |
Opening and Closing balance changed due to
adjustment in capital account. |
|
2. Current account |
Current accounts of partners are opened in
this case. |
Current accounts of partners are not opened
in this case. |
|
3. Adjustment relating to capital |
All adjustment relating to partners’ capital
accounts are made in current account. |
All such adjustments are made in capital
account itself. |
|
4. Closing capital |
The closing balance of capital account always
shows a credit balance. |
The closing balances of partner’s capital
account may be debit or credit. |
|
5. Number of Accounts |
Two accounts i.e. capital and current
account is maintained. |
Only one account i.e. capital account is
maintained. |
|
6. Specific mention |
If capital is fixed, then it should be
specifically mentioned in the deed. |
It is not necessary to be mentioned in the
deed. |
Q. 8. Mention
the adjustment entries for P/L appropriation account. 1999, 2003, 2012,
Ans: Adjustment entries for P/L Appropriation account
|
Particulars |
When
Capitals are Fixed |
When
Capitals are Fluctuating |
|
1. For Interest on Capital (Adjustment Entries) |
Interest on Capital A/c Dr. Partner’s Current A/c Cr. |
Interest on Capital A/c Dr. Partner’s Capital A/c Cr. |
|
Transferring
interest of capital to p/l appropriation account |
Profit and Loss Appropriation A/c Dr. To Interest on
Capital A/c |
|
|
2. For Interest on Drawing |
Partner’s Current A/c Dr. Interest on Drawings A/c Cr. |
Partner’s Capital A/c Dr. Interest on Drawings A/c Cr. |
|
Transferring
interest of Drawings to p/l appropriation account |
Interest on
Drawings A/c Dr. To Profit and
Loss Appropriation A/c
|
|
|
3. For Partner’s Salaries/ bonus /commission |
Partner’s Salaries A/c Dr. Partner’s Current A/c Cr. |
Partner’s Salaries A/c Dr. Partner’s Current A/c Cr. |
|
Transferring
interest of Partner’s salaries/bonus/commission to p/l appropriation account |
Profit and Loss Appropriation A/c Dr. To Partner’s
salaries/bonus/commission A/c |
|
|
4. Interest on Partner’s loan |
Interest on Partner’s Loan A/c Dr. Partner’s Loan A/c Cr. |
Interest on Partner’s Loan A/c Dr. Partner’s Loan A/c Cr. |
|
Transferring
interest on partner’s loan to profit and loss account |
Profit
and Loss Account Dr. To Interest on Partner’s
Loan A/c |
|
|
5. Creation of reserve |
Profit and Loss Appropriation A/c Dr To General Reserve A/c |
|
Q.9. What
do you mean by Guarantee in Partnership and Past Adjustments?
Ans:
Guarantee in partnership: A new partner may be admitted into
the firm for the promotion and expansion of business. Sometimes on the
admission of a new person into a partnership the old partner may agree that the
new partner would be entitled to receive a minimum amount of profits,
irrespective of the actual profit earned by the business. This is called
guarantee of share of profit in partnership. In such a case, the old partners offer
a guarantee of the minimum amount of profits to new partner in case his actual
share of profit is less than the stipulated amount. The deficiency arises due
to such guarantee will be borne by the partners who have given the guarantee in
their respective profit or loss sharing ratio.
Past
Adjustments: Sometimes profits or losses of the firm are
distributed amongst the partners for a particular period without giving due
consideration to the terms and conditions contained in the partnership deed.
Those ignored or omitted terms and conditions may require to be adjusted after
the close of the accounting period. Since some accounting treatment is required
to correct the past errors or omission, therefore, treatment is called past
adjustments.
Q.10. What
is Joint Venture? Write two similarities and difference between Joint venture
and Partnership.
Ans: Meaning of Joint Venture 1999, 2000,
2003, 2011
A joint venture is the combination of
two or more persons into a single activity. It is a form of partnership which
is limited to a specific venture. It is exactly the same as partnership, with
the exception that it is one of a business that is to be terminated after the
completion of the particular business.
Since the business is to be terminated after completion of the venture,
a firm name is not generally used. Thus the joint venture is like a temporary
partnership without a firm name. It can also be said a particular partnership
or partnership for a particular object.
Similarities
between Partnership and Joint Venture:
|
Basis |
Partnership |
Joint Venture |
|
Association |
It is association of two or more partners. |
A joint venture is the combination of two or
more persons into a single activity. |
|
Distribution
of Profits |
Primary aim of partners is to distribute
profit between them. |
The profits are ascertained for each venture
separately and distributed between covertures. |
Difference
between Partnership and Joint Venture:
|
Basis of
Difference |
Partnership |
Joint Venture |
|
Going
Concern |
It is a going concern. |
It is a terminable venture. |
|
Name |
It always has a name. |
It may not bear a name. |
|
Parties |
Persons carrying on business are called
partners. |
Persons carrying on business are called
co-venturers. |
|
Ascertainment
of profit |
Profits are ascertained at regular
intervals, i.e., annually. |
The profits are ascertained for each venture
separately. |
|
Accounts |
Maintenance of separate account is
mandatory.` |
Maintenance of separate account is not
necessary. |
Q.11. What
do you mean by Goodwill? What are its various types? Why it is valued? 2017, 2019, 2023
Ans:
Goodwill: Goodwill is an intangible asset which
indicates the value of the reputation of a firm. It comes into existence due to
various favourable factors such as favourable location, efficient management, good
quality of product and services etc. It is one factor which distinguishes an
old established business from a new business. It can also be defined as the
capacity of a business to earn extra income.
In the words of Eric L. Kohler
“Goodwill is the present value of expected future profits in excess of a normal
return on the investment in tangible assets.”
Types
of Goodwill
Goodwill is mainly of two types:
1.
Purchased Goodwill
2.
Non-Purchased Goodwill
Purchased Goodwill: It is that
goodwill which is acquired by making a payment. When one business is taken over
by another business, the excess of purchase consideration over its net value
(assets-liabilities) of the business which is taken over is termed to as
purchased Goodwill. This type of goodwill is shown in the balance sheet.
Non-Purchased Goodwill: Non Purchased
Goodwill is an internally generated goodwill which arises because of favourable
factors that a business possesses (e.g., favourable location, time factor and
efficiency of management). This type of goodwill is not to be recognised as an
asset hence not shown in balance sheet.
Situations/Reasons
for Valuation of Goodwill 2009,
2012, 2019
In case of a partnership firm, the
need for valuation of goodwill may arise under the following circumstances:
a)
When a new partner is admitted,
b)
When a partner retires from the firm
c)
When a partner dies
d)
When there is a change in profit
sharing ratio among partners,
e)
When the firm is sold as a going
concern,
f)
When two or more firms amalgamated.
Q.12. What
are various characteristics of goodwill? What are the factors affecting the
value of goodwill?
Ans:
Nature and Characteristics of Goodwill
a)
It is an intangible and not a
fictitious asset.
b)
It indicates the capacity of a firm to
earn extra income.
c)
It comes into existence due to various
favourable factors such as favourable location, efficient management, good
quality of product and services etc.
d)
It is difficult to ascertain the exact
value of goodwill.
e)
It can be sold along with the sale of
the business.
Factors
affecting the value of Goodwill are: 2007,
2019
a)
Skill in Management: If the management
is capable and efficient, the firm will earn good profits and that will raise
the value of goodwill.
b)
Location Factor: If the business is
located at a favourable place, it can increase the volume of sales which
correspondingly increases the value of goodwill.
c)
Quality: If the quality of goods and
services are high, then there will be a ready market for the goods and the
value of its goodwill will be high.
d)
Favourable Contracts: Sometimes, a
firm enters into long term contracts for sale and purchase of goods at
favourable prices. This will also affect profits and goodwill of the firm.
e)
Risk Involved: When the risk is less
in the business it creates more goodwill but if the risk is more, it creates
less goodwill.
f)
Market situation: If a firm deal in a
product whose demand is higher than the supply, it will lead to a higher profit
thereby increasing the value of goodwill of the firm.
ALSO READ: ACCOUNTANCY CHAPTERWISE COMPLETE NOTES
1. BASICS OF PARTNERSHIP (INCLUDING GOODWILL)
2. RECONSTITUTION OF PARTNERSHIP (ADMISSION, RETIREMENT AND DEATH)
3. DISSOLUTION OF PARTNERSHIP FIRM
4. ACCOUNTING FOR SHARE CAPITAL
5. ISSUE AND REDEMPTION OF DEBENTURES
6. FINANCIAL STATEMENTS OF A COMPANTY
7. FINANCIAL STATEMENTS ANALYSIS
8. RATIO ANALYSIS
9. CASH FLOW STATEMENTS
Q.13.
Explain various methods for valuation of Goodwill. 2008, 2013, 2015, 2017, 2024
Ans:
Methods of Valuation of Goodwill:
1)
Average/Simple Average profits method 2019,
2023, 2024
2)
Weighted average profit method
3)
Super profit method 2012, 2019, 2020
4)
Capitalisation method 2016
5)
Annuity method
1)
Average
Profits Method: In this method, Actual maintainable profits
of business over a number of years are taken into account. Actual maintainable
profits earned over a number of years are totalled and average is determined by
dividing total with number of years. The average profits so determined are
multiplied by the number of year’s purchases to arrive at the value of
goodwill.
For calculation of goodwill following steps are to be followed
1.
Calculate Actual maintainable profits
with the help of following formula. Actual maintainable profits = Net Profit +
Abnormal loss – Abnormal Gain – regular business expenses not considered in
accounts.
2.
Calculate Average Maintainable Profit
= Total Actual maintainable profits /no of years.
3.
Calculate goodwill = Average
maintainable Profit x no. of year’s purchase
2)
Weighted
average method: This method is a modified version of average
profit method. In this method each year profit is assigned a weight i.e. 1, 2,
3, 4 etc. Thereafter each year profit is multiplied by the weights so assigned
and the sums of the products are calculated. The total of products is divided
by the total of weights. As a result, we find the weighted average profit.
After this the value of goodwill is calculated by multiplying the weighted
average profit with the agreed number of year’s purchase.
For
calculation of goodwill following steps are to be followed:
1.
Total of Product of Profits: Sum of
product of each year’s profit with weights.
2.
Weighted average profit = (Total of Product
of Profits / Total of Weights)
3.
Value of goodwill = Weighted average
profit × number of year of purchase
3)
Super
Profit Method: Super Profits means excess of actual average
maintainable profits over normal Profit of a firm. Normal profits mean the
profit which the firms could normally earns in a particular business. It is
calculated by multiplying capital employed in the firm with normal rate of
return. Goodwill under this method is calculated by multiplying super profit
with the agreed number of year’s purchase.
Under this
method, the following steps are to be followed for calculation of goodwill:
1.
Calculate average maintainable profit
with the help of following formula: Total Actual maintainable profits /no of
years.
2.
Calculate normal profit by multiplying
capital employed with normal rate of return.
3.
Calculate super profit. Super profit
is the excess of average maintainable profit over normal profit.
4.
Calculate the value of goodwill =
super profit x no. of year’s purchase
4)
Capitalization
Method: Under this method, the value of goodwill is
obtained by capitalizing the average profit or super profit of the basis of
normal rate.
Value of goodwill under capitalization of average profit is
Goodwill =
(Average normal profit of the business/ rate of return) – capital employed
Value of goodwill under capitalization of super profit is
Goodwill =
Super profit/ rate of return
5)
Annuity Method: Under this
method, goodwill is calculated on the basis of super profit of a definite
period of time. Super profit so calculated is discounted at a given rate of
interest to find the present value of super profit. The present value so
calculated is the required amount of goodwill of the firm under annuity method.
In this method, goodwill is calculated
with the help of following formula:
Goodwill = Annuity Factor X Super
Profit