Partnership Firm Accounting: Fundamentals and Final Accounts

Posted on Sep 9, 2025 in Commercial and Financial Management

Fundamentals of Partnership Firm

Meaning of Partnership

A partnership is a business organization where two or more people join hands to run a business and share profits and losses.

Legal Definition (Sec 4 of 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.”

Characteristics of a Partnership

Partnership Deed

What is a Partnership Deed?

A written legal document that defines the duties, rights, and responsibilities of each partner. It is crucial for avoiding disputes.

Important Clauses in the Deed

1. Name and address of the firm and partners
2. Nature of the business
3. Capital contribution of each partner
4. Profit and loss sharing ratio
5. Interest on capital and drawings
6. Salary or commission payable to partners
7. Rules for admission, retirement, and death of partners
8. Method of settlement upon dissolution of the firm

If No Partnership Deed Exists

The provisions of the Indian Partnership Act, 1932, apply by default:

Final Accounts of a Partnership Firm

Components of Final Accounts

1. Trading Account
2. Profit and Loss Account
3. Profit and Loss Appropriation Account
4. Balance Sheet

Step-by-Step Preparation of Final Accounts

A. Trading Account

Used for calculating Gross Profit or Gross Loss.
Formula:
Gross Profit = Sales - (Opening Stock + Purchases + Direct Expenses - Closing Stock)

B. Profit and Loss Account

Used for calculating Net Profit or Net Loss.
Formula:
Net Profit = Gross Profit – Indirect Expenses + Indirect Incomes

C. Profit and Loss Appropriation Account

This account is unique to partnerships, used to distribute profits among partners.
Format:

D. Balance Sheet

The Balance Sheet lists all assets and liabilities, including partner’s capital accounts after all necessary adjustments.

Admission of a New Partner

When a New Partner is Admitted

A new partner contributes capital and often goodwill, and gains a share in the firm’s future profits.

Main Adjustments Required Upon Admission

1. New Profit Sharing Ratio
   • Determine the new profit-sharing ratio among all partners.
   • This ratio is used to calculate the sacrificing ratio.
2. Sacrificing Ratio
   Sacrificing Ratio = Old Ratio - New Ratio
   • The old partners give up a portion of their share.
   • The new partner compensates for this sacrifice by contributing goodwill.
3. Goodwill Treatment
   • If goodwill is brought in cash: Credit the old partners in their sacrificing ratio.
   • If goodwill is not brought in cash: Adjust it through the new partner’s capital account.
4. Revaluation of Assets and Liabilities
   • Assets and liabilities may be revalued to their current market values.
   • Any profit or loss arising from revaluation is shared among the old partners in their old ratio.
5. Reserves and Accumulated Profits
   • Existing reserves and accumulated profits (e.g., General Reserve) are distributed among the old partners in their old ratio.
6. Capital Adjustment
   • The partners’ capital accounts may need to be adjusted to reflect the new profit-sharing ratio.