A. Fundamentals of Partnership

This part lays the foundation of partnership accounts: what makes a business a partnership, which rules of the Indian Partnership Act, 1932 apply when the partners have no deed, and how a firm keeps its partners' accounts.

Fundamentals of Partnership has three sub-lessons. Key Features of Partnership explains the legal meaning of partnership and its features: an agreement, a business, sharing of profits, mutual agency, unlimited liability and no separate legal entity. Provisions in the Absence of Partnership Deed lists the rules the Act supplies when partners have not agreed otherwise, such as equal sharing of profits and 6% interest on partners' loans. Accounting Aspects shows how capital accounts are kept under the fixed and fluctuating methods and how profit is distributed through the Profit and Loss Appropriation Account. Together they prepare you for goodwill and for the reconstitution of a firm.

Partnership accounts start from three questions: what is a partnership, which rules govern it, and how are the partners' dealings recorded? The three sub-lessons answer them in turn.

1. Key Features of Partnership. Section 4 of the Indian Partnership Act, 1932 defines partnership as "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." The features you must be able to explain follow from this definition:

• an agreement between two or more persons, oral or written; a written agreement is called the partnership deed;
• a business carried on with a view to profit;
• sharing of profits and losses in an agreed ratio;
• mutual agency: each partner is an agent of the firm and of the other partners, so one partner's acts in the course of business bind them all;
• unlimited liability: partners are personally liable for the debts of the firm;
• no separate legal entity: in law the firm is not distinct from its partners.

2. Provisions in the Absence of Partnership Deed. Where the partners have not agreed on a matter, the Act fills the gap:

• profits and losses are shared equally;
• no interest is allowed on capital and none is charged on drawings;
• no salary or commission is paid to any partner;
• a partner who lends money to the firm, over and above his capital, receives interest at 6% per annum on that loan.

For example, if Arjun lends ₹50,000 to the firm and there is no deed, he is entitled to interest of ₹3,000 a year (6% of ₹50,000). Because it is interest on a loan, it is payable whether the firm makes a profit or a loss.

3. Accounting Aspects. This sub-lesson covers how the partners' accounts are kept:

• Capital accounts follow either the fixed capital method, with a capital account that normally stays unchanged and a current account for interest, salary, drawings and share of profit, or the fluctuating capital method, with a single capital account through which all these items pass.
• The Profit and Loss Appropriation Account distributes the net profit: interest on capital, partners' salaries and commission are debited to it, interest on drawings is credited to it, and the balance is shared in the profit-sharing ratio.
• Interest on a partner's loan, by contrast, is a charge against profit and is debited to the Profit and Loss Account, not to the appropriation account.

These ideas carry straight into the rest of the chapter: goodwill, admission, retirement and dissolution all build on the profit-sharing ratio and the capital accounts set up here.