Q.______ is the basis of relationship between the partners to run the partnership business. (A) Offer (B) Agreement (C) Understanding (D) Acceptance
Concept understanding — Partnership Deed Definition
Let’s start with something you already know. Suppose you and two friends decide to start a small business together — say, a tiffin service. You each bring in some money, you decide who will cook, who will deliver, and who will keep accounts. But after a month, one friend says, “I should get extra pay because I do all the cooking.” Another says, “I put in more money, so I should get more profit.” Without a written agreement, you’ll argue endlessly. That’s exactly why a Partnership Deed exists.
Everyday Intuition
A partnership deed is simply the rulebook that partners agree to follow. It’s like the constitution of the partnership. It answers questions like: How much capital did each partner bring? How will profits be shared? Will partners get a salary or interest on their capital? What happens if a partner wants to leave? Without this rulebook, the law (the Indian Partnership Act, 1932) steps in with default rules — but those may not suit your business.
Precise Meaning (as per NCERT Class-12 Accountancy)
A Partnership Deed is a written document that contains the terms and conditions of the partnership. It is signed by all partners and is legally binding. While the law does not compel a written deed (an oral agreement is also valid), a written deed is strongly recommended to avoid disputes.
The deed typically includes:
- Name and address of the firm and partners
- Nature of business
- Capital contribution by each partner
- Profit-sharing ratio
- Interest on capital, drawings, and loans
- Salary or commission to partners
- Admission, retirement, or death of a partner
- Method of valuing goodwill
- Settlement of accounts on dissolution
If no partnership deed exists, the Indian Partnership Act, 1932 applies default rules: profits/losses shared equally, no interest on capital, no salary to partners, interest on drawings at 6% p.a., and interest on partner’s loan at 6% p.a.
Why It Matters in Accounting
The partnership deed is the source document for all accounting entries related to partners. Every adjustment — interest on capital, salary, commission, profit share — is based on what the deed says. If the deed is silent, the Act’s default rules apply.
For example:
- If the deed says “Interest on capital @ 10% p.a.”, you must calculate and record it.
- If the deed says “Partner A gets a salary of ₹5,000 per month”, you must debit the Profit and Loss Appropriation Account.
Accounting Treatment
All items related to partners (interest on capital, salary, commission, profit share) are recorded in the Profit and Loss Appropriation Account (a special account that shows how net profit is distributed among partners). The final amounts are then transferred to the Partners’ Capital Accounts (or Current Accounts, if the firm uses fixed capital method).
Key Rules (NCERT-based):
| Item | Debit | Credit |
|---|---|---|
| Interest on Capital | Profit & Loss Appropriation A/c | Partner’s Capital/Current A/c |
| Partner’s Salary | Profit & Loss Appropriation A/c | Partner’s Capital/Current A/c |
| Partner’s Commission | Profit & Loss Appropriation A/c | Partner’s Capital/Current A/c |
| Interest on Drawings | Partner’s Capital/Current A/c | Profit & Loss Appropriation A/c |
| Share of Profit | Profit & Loss Appropriation A/c | Partner’s Capital/Current A/c |
| Share of Loss | Partner’s Capital/Current A/c | Profit & Loss Appropriation A/c |
In the fixed capital method, partners have two accounts: a fixed Capital Account (unchanged except for additional capital or permanent withdrawal) and a Current Account (for all other transactions like salary, interest, drawings, profit share). In the fluctuating capital method, only one Capital Account is used, and all items are recorded there.
Format of Profit and Loss Appropriation Account (as per NCERT)
This is the proforma you’ll see in your textbook. It shows how net profit is appropriated (distributed) according to the partnership deed.
Profit and Loss Appropriation Account
(for the year ended ………)
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|---|---|---|
| To Interest on Capital: | By Net Profit (transferred from P&L A/c) | XXX | |
| Partner A | XXX | By Interest on Drawings: | |
| Partner B | XXX | Partner A | XXX |
| To Partner’s Salary: | Partner B | XXX | |
| Partner A | XXX | ||
| To Partner’s Commission: | |||
| Partner B | XXX | ||
| To Profit transferred to: | |||
| Partner A’s Capital A/c | XXX | ||
| Partner B’s Capital A/c | XXX | ||
| Total | XXX | Total | XXX |
A common mistake: students forget that interest on drawings is credited to the Appropriation Account (it increases the profit available for distribution), while interest on capital and salary are debited (they reduce the profit).
Formula for Interest on Capital
If the deed provides for interest on capital, the formula is:
Interest on Capital = Capital × Rate of Interest × (Period / 12)
For example, if Partner A brings ₹1,00,000 as capital on 1st April, and the deed says interest on capital @ 10% p.a., the interest for the year ending 31st March is:
₹1,00,000 × 10/100 × 12/12 = ₹10,000
If capital is introduced during the year (say on 1st October), the period is 6 months:
₹1,00,000 × 10/100 × 6/12 = ₹5,000
Final Takeaway
The partnership deed is not just a legal formality — it is the blueprint for every accounting entry you will make in a partnership firm. Without it, you cannot decide how much interest to pay, who gets salary, or how to share profits. In exams, always read the question carefully: if a deed exists, follow its terms; if not, apply the default rules of the Indian Partnership Act, 1932.
(a) Basis of partnership = Agreement (B). (b) Reserves transferred in the Old profit sharing ratio (C).
Under the Indian Partnership Act, 1932, partnership arises from an agreement (oral or written) between persons to share the profits of a business. An offer (A) is a mere proposal, "understanding" (C) is not a legal term, and acceptance (D) is only one element of an agreement.
(B) Agreement.
Concept understanding — Partnership Capital Accounting
Partnership Capital Accounting — A First Look
Think of a partnership like a group of friends pooling money to start a roadside food stall. Each friend brings in some cash — that’s their capital. But unlike a simple piggy bank, a partnership needs a clear record of who put in how much, because profits (and losses) are shared in a fixed ratio, and partners may withdraw money, lend extra funds, or take a salary.
That record is what Partnership Capital Accounting is about.
What It Really Means
In accounting, capital is the amount a partner contributes to the firm. But it’s not just a one-time number. Over time, a partner’s capital changes due to:
- Additional capital introduced
- Drawings (money or goods taken out)
- Share of profit or loss
- Interest on capital, interest on drawings, partner’s salary, commission
The Capital Account of each partner tracks all these changes. It answers: What does the firm owe to this partner at any point?
Why It Matters
Without proper capital accounting, you cannot:
- Determine each partner’s claim on the firm’s assets
- Calculate interest on capital correctly
- Prepare the Profit and Loss Appropriation Account
- Settle accounts when a partner retires or dies
The NCERT textbook emphasises that capital accounts are personal accounts of the partners — they show the firm’s liability towards each partner.
Two Methods of Maintaining Capital Accounts
The NCERT Class 12 Accountancy textbook (Part II, Chapter 2) describes two methods:
1. Fixed Capital Method
Under this method, the capital account remains constant (except when additional capital is introduced or capital is withdrawn permanently). All other transactions — share of profit, drawings, interest, salary — are recorded in a separate Current Account.
In the Fixed Capital Method, the Capital Account shows only the permanent capital. The Current Account shows the fluctuating balance.
2. Fluctuating Capital Method
Here, all transactions are recorded directly in the Capital Account. The capital balance changes every year.
Accounting Treatment — Which Account is Debited/Credited
Let’s take the most common entries. I’ll show the journal entry first, then explain.
Entry 1: Capital Introduced
When a partner brings in cash or assets:
| Date | Particulars | L.F. | Debit (Rs) | Credit (Rs) |
|---|---|---|---|---|
| Cash/Bank A/c | Dr. | xxx | ||
| To Partner’s Capital A/c | xxx |
Why? Cash comes in (asset increases — debit), and the firm’s liability to the partner increases (capital is a liability — credit).
Entry 2: Drawings
When a partner withdraws cash or goods for personal use:
| Date | Particulars | L.F. | Debit (Rs) | Credit (Rs) |
|---|---|---|---|---|
| Partner’s Capital/Current A/c | Dr. | xxx | ||
| To Cash/Bank/Purchases A/c | xxx |
Why? The firm’s liability to the partner decreases (debit the capital/current account), and cash or goods go out (credit).
Entry 3: Interest on Capital
This is an appropriation of profit. The formula (as per NCERT) is:
Interest on Capital = Capital × Rate of Time × Time (in months)/12
Journal entry:
| Date | Particulars | L.F. | Debit (Rs) | Credit (Rs) |
|---|---|---|---|---|
| Interest on Capital A/c | Dr. | xxx | ||
| To Partner’s Capital/Current A/c | xxx |
Then, at the end of the year, Interest on Capital is transferred to the Profit and Loss Appropriation Account:
| Date | Particulars | L.F. | Debit (Rs) | Credit (Rs) |
|---|---|---|---|---|
| Profit and Loss Appropriation A/c | Dr. | xxx | ||
| To Interest on Capital A/c | xxx |
Entry 4: Partner’s Salary
If the partnership deed allows a salary:
| Date | Particulars | L.F. | Debit (Rs) | Credit (Rs) |
|---|---|---|---|---|
| Salary to Partner A/c | Dr. | xxx | ||
| To Partner’s Capital/Current A/c | xxx |
Again, this is transferred to the Profit and Loss Appropriation Account.
Entry 5: Share of Profit
At the end of the year, after all appropriations, the remaining profit is distributed:
| Date | Particulars | L.F. | Debit (Rs) | Credit (Rs) |
|---|---|---|---|---|
| Profit and Loss Appropriation A/c | Dr. | xxx | ||
| To Partner’s Capital/Current A/c | xxx |
Formats as per NCERT
Format of Capital Account (Fluctuating Method)
| Particulars | Amount (Rs) | Particulars | Amount (Rs) |
|---|---|---|---|
| To Drawings A/c | xxx | By Balance b/d | xxx |
| To Interest on Drawings A/c | xxx | By Cash/Bank (additional capital) | xxx |
| To Balance c/d | xxx | By Interest on Capital A/c | xxx |
| By Salary to Partner A/c | xxx | ||
| By Share of Profit A/c | xxx | ||
| Total | xxx | Total | xxx |
Format of Capital and Current Accounts (Fixed Method)
Capital Account (remains fixed unless permanent change):
| Particulars | Amount (Rs) | Particulars | Amount (Rs) |
|---|---|---|---|
| To Balance c/d | xxx | By Balance b/d | xxx |
| By Cash/Bank (additional capital) | xxx | ||
| Total | xxx | Total | xxx |
Current Account (records all other transactions):
| Particulars | Amount (Rs) | Particulars | Amount (Rs) |
|---|---|---|---|
| To Drawings A/c | xxx | By Balance b/d | xxx |
| To Interest on Drawings A/c | xxx | By Interest on Capital A/c | xxx |
| To Balance c/d | xxx | By Salary to Partner A/c | xxx |
| By Share of Profit A/c | xxx | ||
| Total | xxx | Total | xxx |
A Common Mistake to Avoid
Many students debit the Profit and Loss Account directly for interest on capital or partner’s salary. That is wrong. These are appropriations of profit, not expenses. They go to the Profit and Loss Appropriation Account, not the Profit and Loss Account.
The Big Picture
Partnership Capital Accounting is simply a way to keep track of what the firm owes each partner. The two methods — fixed and fluctuating — are just different ways of organising that record. The NCERT textbook uses both, and you need to be comfortable with both formats.
Start with the intuition: Every partner is both an owner and a creditor of the firm. The capital account shows the owner’s stake; the current account (if used) shows the temporary claims. Once you see that, the debits and credits fall into place.
(a) Basis of partnership = Agreement (B). (b) Reserves transferred in the Old profit sharing ratio (C).
Accumulated reserves represent past profits earned under the existing (old) ratio. On a change in profit-sharing ratio they are transferred to Partners' Capital Accounts in the old profit sharing ratio, so no partner gains or loses on past profits. Sacrificing/gaining ratios are used for goodwill adjustment, not for distributing reserves.
(C) Old profit sharing ratio.
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