Harshad and Dhiman are in partnership since April 01, 2019. No Partnership agreement was made. They contribute

Numerical Questions · Q3

Q. Harshad and Dhiman are in partnership since April 01, 2019. No Partnership agreement was made. They contributed Rs. 4,00,000 and 1,00,000 respectively as capital. In addition, Harshad advanced an amount of Rs. 1,00,000 to the firm, on October 01, 2019. Due to long illness, Harshad could not participate in business activities from August 1, to September 30, 2016. The profits for the year ended March 31, 2020 amounted to Rs. 1,80,000. Dispute has arisen between Harshad and Dhiman. Harshad Claims:

(i) he should be given interest @ 10% per annum on capital and loan;

(ii) Profit should be distributed in proportion of capital; Dhiman Claims:

(i) Profits should be distributed equally;

(ii) He should be allowed Rs. 2,000 p.m. as remuneration for the period he managed the business, in the absence of Harshad;

(iii) Interest on Capital and loan should be allowed @ 6% p.a. You are required to settle the dispute between Harshad and Dhiman. Also prepare Profit and Loss Appropriation Account.

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Concept understanding — Partnership Profit Distribution Rules

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.

Note

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

Watch out

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.

Since no partnership deed exists, the provisions of the Indian Partnership Act, 1932 apply. Let’s settle each claim in order.

Harshad’s claims:

Interest on capital @ 10% p.a. — Not allowed. In the absence of a deed, no interest on capital is payable.
Interest on loan @ 10% p.a. — Allowed at 6% p.a. (the Act specifies 6% p.a. on advances, not the claimed 10%).
Profit sharing in capital ratio — Not allowed. The Act prescribes equal sharing when no deed exists.

Dhiman’s claims:

Equal profit sharing — Correct. The Act mandates equal distribution.
Remuneration of ₹2,000 per month for managing during Harshad’s absence — Not allowed. No partner is entitled to salary/remuneration without a deed.
Interest on capital and loan @ 6% p.a. — Interest on capital is not allowed; interest on loan at 6% p.a. is correct.

Interest on Harshad’s loan:

Loan of ₹1,00,000 advanced on October 1, 2019. Period from Oct 1, 2019 to March 31, 2020 = 6 months.

Interest = ₹1,00,000 × 6% × 6/12 = ₹3,000.

Profit distribution:

Net profit = ₹1,80,000. Deduct interest on loan (charge against profit, not an appropriation) = ₹3,000.

Profit after interest = ₹1,80,000 – ₹3,000 = ₹1,77,000.

This is divided equally: Harshad = ₹88,500, Dhiman = ₹88,500.

Profit and Loss Appropriation Account (only the interest on loan appears here as a charge, but in appropriation format it is shown as a debit):

Particulars	Amount (₹)	Particulars	Amount (₹)
To Interest on Harshad’s Loan A/c	3,000	By Profit & Loss A/c (Net Profit)	1,80,000
To Profit transferred to:
Harshad’s Capital A/c	88,500
Dhiman’s Capital A/c	88,500
Total	1,80,000	Total	1,80,000

✓Final answer

Harshad receives ₹88,500 and Dhiman receives ₹88,500 as profit share, with Harshad additionally entitled to ₹3,000 interest on loan.

There is no partnership deed, so the Indian Partnership Act, 1932 applies: no interest on capital, no partner's salary, profits shared equally, and interest on a partner's loan at 6% p.a. Harshad's ₹1,00,000 loan (advanced 1 October 2019) earns ₹3,000 interest for six months. After this charge, the profit of ₹1,77,000 is divided equally — Harshad ₹88,500, Dhiman ₹88,500.

Concept First: The Partnership Act Fills the Gaps

When partners have no written agreement, the Indian Partnership Act, 1932 supplies the rules, and they override each partner's personal claims:

Interest on capital — not allowed at all without a deed. Harshad's claim for 10% and Dhiman's for 6% both fail.
Interest on a partner's loan/advance — allowed at 6% p.a. (Section 13). This is a charge against profit, deducted before the profit is divided. Harshad's claim of 10% on the loan is reduced to 6%.
Partner's salary or remuneration — not payable without a deed. Dhiman's claim of ₹2,000 per month for running the business in Harshad's absence is not admissible.
Profit-sharing ratio — equal, by Section 13(b). Harshad's claim to share in the capital ratio fails.

Settling the Dispute

Claim	Verdict under the Act
Harshad — interest on capital @ 10%	Not allowed (no deed)
Harshad — interest on loan @ 10%	Allowed only @ 6% p.a.
Harshad — profit in the capital ratio	Not allowed; profit is shared equally
Dhiman — profit shared equally	Correct
Dhiman — salary ₹2,000 p.m.	Not allowed (no deed)
Dhiman — interest on capital and loan @ 6%	Interest on capital not allowed; interest on loan @ 6% is correct

Working Notes

WN1: Interest on Harshad's loan. ₹1,00,000 advanced on 1 October 2019; period to 31 March 2020 = 6 months; rate 6% p.a. Interest = ₹1,00,000 × 6% × 6/12 = ₹3,000.

WN2: Profit available for the partners. Net profit ₹1,80,000 − interest on loan ₹3,000 (a charge) = ₹1,77,000.

WN3: Distribution. Shared equally: Harshad ₹88,500, Dhiman ₹88,500.

Profit and Loss Appropriation Account for the year ended March 31, 2020

Particulars	Amount (₹)	Particulars	Amount (₹)
To Interest on Harshad's Loan A/c	3,000	By Profit and Loss A/c (Net Profit)	1,80,000
To Profit transferred to:
Harshad's Capital A/c	88,500
Dhiman's Capital A/c	88,500
Total	1,80,000	Total	1,80,000

Watch out

The most common mistakes here are to allow interest on capital (it is not payable without a deed), to allow it at the claimed 10%, or to grant Dhiman a salary for the extra work. Under the Act none of these is admissible; only interest on the loan, at 6% p.a., is allowed, and it is a charge, not an appropriation.

Tip

When a partner advances a loan to the firm, always charge interest from the date of the advance to the year-end (here, 1 October to 31 March = 6 months). Being a charge, it is settled before the profit is shared among the partners.

✓Final answer

The dispute is settled by the Partnership Act, 1932: no interest on capital, no salary, equal profit sharing, and interest on Harshad's loan at 6% p.a. (₹3,000). Harshad and Dhiman each receive a profit share of ₹88,500 .

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Concept First: The Partnership Act Fills the Gaps

Settling the Dispute

Working Notes

Profit and Loss Appropriation Account for the year ended March 31, 2020

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