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Partnership and LLP Accounts

"Two heads are better than one—but the accounting gets complicated!"

When two or more people come together to run a business and share profits, it's called a Partnership. Think Infosys (founded by seven engineers) or a local law firm (multiple partners).

What is a Partnership?

Definition (Section 4, Indian Partnership Act, 1932): "Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all."

Key Features

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Limited Liability Partnership (LLP)

"Best of both worlds: Partnership flexibility + Company protection."

Introduced in India in 2008, LLP combines the flexibility of partnership with the limited liability of a company.

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Final Accounts of Partnership Firm

Partnership accounts are prepared in two stages:

1. Profit & Loss Account
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2. Profit & Loss Appropriation A/c

Profit & Loss Appropriation Account

"How to divide the pie."

This account shows how the net profit is distributed among partners.

Format:

ParticularsDr. (₹)ParticularsCr. (₹)
To Interest on Capital (Partner A)XXXBy Net Profit (from P&L A/c)XXX
To Interest on Capital (Partner B)XXXBy Interest on Drawings (Partner A)XXX
To Salary to PartnersXXXBy Interest on Drawings (Partner B)XXX
To Commission to PartnersXXX
To Net Profit transferred to:
Partner A's Capital (Profit Share)XXX
Partner B's Capital (Profit Share)XXX
TotalXXXTotalXXX

Goodwill in Partnership

"The reputation and customer loyalty you've built."

Goodwill is the intangible value of a firm's reputation, brand, customer base, etc. It becomes important when:

  • A new partner joins (admitted).
  • A partner leaves (retires/dies).
  • The firm dissolves.

Valuation Methods

  1. Average Profit Method:

    Goodwill = Average Profit × Number of Years' Purchase

    Example: Average profit = ₹2 Lakhs, Purchase = 3 years → Goodwill = ₹6 Lakhs

  2. Super Profit Method:

    Super Profit = Actual Profit - Normal Profit
Goodwill = Super Profit × Number of Years

  3. Capitalization Method:

    Goodwill = (Capitalized Value of Firm) - (Net Assets)

Admission of a New Partner

When a new partner joins, two major accounting issues arise:

  1. Adjustment for Goodwill
  2. Re adjustment of Capital (if needed)

Why Adjust Goodwill?

The new partner enjoys the existing goodwill built by old partners. So, the new partner must compensate the old partners.

Treatment:

  • New partner brings premium for goodwill (cash/kind).
  • This is distributed to old partners in their old profit-sharing ratio.

Entry:

Cash/Bank A/c                      Dr.
    To Old Partner A's Capital A/c
    To Old Partner B's Capital A/c

Retirement of a Partner

When a partner retires, we must:

  1. Calculate their final dues (capital + share of profit + goodwill).
  2. Adjust goodwill (firm's value decreases).
  3. Pay off the retiring partner (cash/loan account).

Entry for Payment:

Retiring Partner's Capital A/c     Dr.
    To Cash/Bank A/c

If paid in installments:

Retiring Partner's Capital A/c     Dr.
    To Retiring Partner's Loan A/c

Death of a Partner

Similar to retirement, but the amount due is paid to the deceased partner's legal heir/executor.

Special Consideration: Profit up to the date of death must be calculated and credited.

Dissolution of Partnership Firm

"When the partnership ends."

Types of Dissolution

  1. Dissolution of Partnership: Partnership ends, but firm continues (e.g., one partner retires, remaining continue).
  2. Dissolution of Firm: Firm itself shuts down completely.

Procedure for Dissolution

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Realization Account

A special account to record:

  • Debit: All assets (except cash/bank) and dissolution expenses.
  • Credit: All liabilities and proceeds from sale of assets.
  • Profit/Loss on Realization: Transferred to partners' capital in profit-sharing ratio.

Piecemeal Distribution

"Selling assets bit by bit and distributing cash as it comes."

When assets are sold gradually (not all at once), cash is distributed to partners after each sale using:

  • Maximum Loss Method: Assume all remaining assets are worthless, find who gets paid first.
  • Proportionate Capital Method: Distribute in ratio of partners' final claims.

Real-World Example

Tech Startup Partnership:

  • Partners: Arvind (60%), Bharat (40%)
  • Net Profit: ₹10 Lakhs
  • Interest on Capital: Arvind ₹50,000, Bharat ₹30,000
  • Partner Salary: None

Distribution:

Total to distribute = ₹10,00,000 + ₹0 (interest on drawings)
                    = ₹10,00,000

Less: Interest on Capital = ₹50,000 + ₹30,000 = ₹80,000
Remaining Profit = ₹9,20,000

Arvind's Share = ₹50,000 + (60% of ₹9,20,000) = ₹5,02,000
Bharat's Share = ₹30,000 + (40% of ₹9,20,000) = ₹3,98,000

Quiz: Partnership Accounts

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