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Accounting for Partnership: Basic Concepts – Class 12 Accountancy notes, important questions and MCQs

NCERT Class 12 Accountancy, chapter 1. Notes, key terms, important questions with answers and MCQs.

Chapter overview

A partnership is the relation between persons who agree to share the profits of a business carried on by all or any of them acting for all, as defined in Section 4 of the Indian Partnership Act, 1932. Partners usually sign a partnership deed. Partners' capital accounts may be fixed or fluctuating, and profits are distributed through a profit and loss appropriation account after interest on capital, salaries and other appropriations. Goodwill is the value of a firm's reputation.

Partnership and the deed

Features: two or more persons, an agreement, a lawful business, sharing of profits and mutual agency.
The partnership deed covers capital, profit-sharing ratio, interest on capital and drawings, salaries, and rules for admission, retirement and dissolution.
In the absence of a deed: profits are shared equally, no interest on capital, no interest on drawings, no salary to partners, and interest on a partner's loan at 6 per cent per annum.

Capital accounts and appropriation

Fixed capital method: capital accounts stay unchanged; interest, salary, drawings and profit share go to separate current accounts.
Fluctuating capital method: all adjustments are made in the capital accounts, so balances change.
The profit and loss appropriation account distributes net profit: interest on capital, partners' salaries and commission are debited, interest on drawings is credited, and the balance is shared in the profit-sharing ratio.
Interest on drawings made evenly through the year is charged for an average period of six months.

Guarantee, past adjustments and goodwill

A partner may be guaranteed a minimum profit, with any deficiency borne by the guaranteeing partners.
Past adjustments correct errors or omissions of earlier years through an adjustment entry among partners.
Goodwill is the value of reputation that brings extra profit; it depends on location, quality, management, market position and customer base.
Methods of valuing goodwill: average profits, super profits (profit above normal profit) and capitalisation.

Key terms

Partnership deed: the written agreement among partners stating the terms of partnership
Profit and loss appropriation account: an account showing how net profit is distributed among partners
Fixed capital method: a method in which partners' capital accounts remain unchanged and adjustments go to current accounts
Goodwill: the value of a firm's reputation that enables it to earn more than normal profit
Super profit: the excess of actual average profit over normal profit

Important questions with answers

What are the provisions of the Indian Partnership Act, 1932 in the absence of a partnership deed?2 marks

In the absence of a deed: profits and losses are shared equally; no interest is allowed on capital; no interest is charged on drawings; no salary or commission is allowed to any partner; and interest on a partner's loan to the firm is allowed at 6 per cent per annum.

Distinguish between the fixed and fluctuating capital methods.3 marks

Under the fixed capital method, partners' capital accounts remain unchanged except for additional capital or withdrawal of capital, and items such as interest on capital, salary, drawings and share of profit are recorded in separate current accounts; two accounts are kept for each partner. Under the fluctuating capital method, only capital accounts are kept and all these items are recorded in them, so the balance changes every year.

What is goodwill? Explain the factors affecting it and the methods of valuing it.5 marks

Goodwill is the value of the reputation of a firm that enables it to earn more profit than a normal business with similar capital. It is an intangible asset. Factors affecting goodwill include the nature of business, a convenient location, efficient management, quality of products, market situation such as monopoly, a loyal customer base, special advantages such as licences or patents, and the length of time the business has been running. Goodwill may be valued by three main methods. Under the average profits method, goodwill equals average profit multiplied by an agreed number of years' purchase; a weighted average may be used if profits show a trend. Under the super profits method, goodwill equals super profit, that is average profit minus normal profit (capital employed × normal rate of return), multiplied by the number of years' purchase. Under the capitalisation method, either the average profit is capitalised at the normal rate of return and capital employed is subtracted, or the super profit is capitalised directly at the normal rate. For example, if average profit is ₹60,000 and normal profit is ₹40,000, super profit is ₹20,000 and goodwill at three years' purchase is ₹60,000.

Quick revision

Partnership Act 1932, Section 4.
No deed: equal profit, no interest on capital, 6 per cent on partner's loan.
Fixed vs fluctuating capital; P&L appropriation account.
Goodwill: average profit, super profit, capitalisation.

Exam tips

Learn the five provisions that apply when there is no partnership deed.
For goodwill by super profit, write: super profit = average profit − normal profit; goodwill = super profit × number of years' purchase.

Practice MCQs

Partnership in India is governed by the
1. Companies Act, 2013
2. Indian Partnership Act, 1932
3. Contract Act only
4. Income Tax Act
Show answer
Answer: (b) Indian Partnership Act, 1932. Section 4 defines partnership.
In the absence of a partnership deed, profits are shared
1. in capital ratio
2. equally
3. in the ratio of experience
4. as decided by the senior partner
Show answer
Answer: (b) equally. This is the legal provision.
The value of a firm's reputation is called
1. capital
2. profit
3. reserve
4. goodwill
Show answer
Answer: (d) goodwill. It brings extra profit.
In the absence of a deed, interest on a partner's loan is allowed at
1. 5 per cent
2. 6 per cent
3. 8 per cent
4. 12 per cent per annum
Show answer
Answer: (b) 6 per cent. It is a charge against profit.
Under the fixed capital method, partners' salary is credited to
1. capital accounts
2. P&L account
3. current accounts
4. cash account
Show answer
Answer: (c) current accounts. Capital stays fixed.
Interest on drawings made evenly throughout the year is charged for an average of
1. 3 months
2. 6 months
3. 9 months
4. 12 months
Show answer
Answer: (b) 6 months. Drawings are spread over the year.
Average profit ₹60,000; normal profit ₹40,000; goodwill at 3 years' purchase of super profit is
1. ₹1,80,000
2. ₹20,000
3. ₹1,20,000
4. ₹60,000
Show answer
Answer: (d) ₹60,000. 20,000 × 3.
Which item is credited to the profit and loss appropriation account
1. interest on drawings
2. interest on capital
3. partner's salary
4. commission to partner
Show answer
Answer: (a) interest on drawings. It is income for the firm.

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Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.