SPECTRUM STUDY CIRCLE

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15/22 2 FLOOR ASHOK NAGAR ND-18 (PH- 55711031, 9810378235)
CLASS: XII ACCOUNTANCY Page 1 of 4

Definition of Partnership
According to the Indian Partnership Act, 1932 (Sec. 4), “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.”
According to Prof. L.H. Haney, “Partnership is the relation existing between persons,
competent to make contracts who have agreed to carry on a lawful business in common with a
view to private gain.”
The persons who have entered into a partnership with one another are called individually
“partners” and collectively “a firm” and the name under which the business is carried is called “the
firm’s name”.

Name and Characteristics of Partnership

The essential elements or characteristics of partnership are as follows:
(1) Association of two or more persons. There should be at least two competent persons to
form a partnership. The maximum number of partners in a firm carrying on banking
business should not exceed ten and in any other business twenty.
(2) Agreement or contract. The partnership comes into existence by an agreement between
the partners. The agreement may be express (i.e. oral or written) or implied. A written
agreement, called partnership deed, is preferred to avoid any future disputes.
(3) Business. A partnership can be formed only for the purpose of carrying on some business
to earn a profit. Business includes very trade, occupation or profession.
(4) Sharing of profits. The object of partnership must be to earn profits. Profits must be
distributed among partners in an agreed ratio. The sharing of profits also includes sharing
of losses.
(5) Mutual agency. The business of partnership may be carried on by all the partners or any
of them acting for all. It means that each partner has right to participate in the conduct and
management of the firm. Each partner is bound by the acts of other partners, done on the
behalf of the firm.
(6) Unlimited liability. Liability of a partnership firm is unlimited. It means that if firm’s assets
are insufficient to meet its liabilities in full then the personal assets of the partners can also
be used to meet firm’s liability.

Partnership Deed – Meaning and Contents

The agreement creating partnership may be express (i.e. oral or written) or implied. However, it is
in the interest of the partners that the agreement must be i writing. Partnership deed is a
document which contains this agreement. All the terms and conditions of partnership including the
rights and obligations of partners are set out in it. The deed must be signed by all the partners
and be stamped properly.

Rules Applicable in Absence of Partnership Deed

As per the partnership Act, 1932, following are the important rules which are applicable in the
absence of partnership agreement/deed:
(a) Profit Sharing Ratio. Profits or losses are divided equally among the partners irrespective
of capital contributed by them.
(b) Interest on Capital. No interest is allowed on Partners’ capital.
(c) Interest on Drawings. No interest is allowed on partners’ capital.
(d) Interest on Partner’s Loan. Interest is payable on the amount of loan advanced by a
partner to the firm at an agreed rate of interest. If rate of interest is not given in the
partnership deed, interest should be allowed to the partner @ 6% p.a.
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15/22 2 FLOOR ASHOK NAGAR ND-18 (PH- 55711031, 9810378235)
CLASS: XII ACCOUNTANCY Page 2 of 4
(e) Salary to a Partner. No salary or commission is allowed to any partner, irrespective of time
devoted by the partners.
(f) It should be noted that partners may change any of the above provisions by making contrary
provision in their partnership deed.

Capital Accounts of Partners

Capital accounts of the partners can be maintained in the following two ways:
(i) Fixed Capital. Capital accounts are said to be fixed when the partners are not allowed
to change their capital during the life time of business except in extraordinary
circumstances. The balance of fixed capital accounts remain unaltered. If fixed capital
is changed by partner’s agreement, additional capital introduced or withdrawn will be
recorded in capital Account.
All other entries relating to drawings, interest on drawings, interest on capital, salary or
commission, share in profits or losses, etc. are recorded in a separate account which is
known as “Partner’s Current Account or Drawings Account.” The balance of this
account may be debit or credit. Credit balance of current account will be shown on the
liability side of the balance sheet and debit, balances, if any, on the asset side of the
balance sheet.
(ii) Fluctuating capital. Capital accounts are called fluctuating when the balance of capital
accounts do not remain the same but fluctuate frequently. All the entries relating to
drawings, interest on drawings, interest on capital, salary or commission, share in profits
or losses, etc. are recorded in capital accounts.
In the absence of any instruction, the partners’ capital accounts should be prepared under
fluctuating capital method.
Difference between Fixed Capital and Fluctuating Capital
Basic of difference Fixed Capital Fluctuating Capital
1. Change of Under this method the balance of Under this method the balance of
Capital capital account normally remains fixed the capital account fluctuates from
during the life of the firm except in one year to another.
extra ordinary circumstances.
2. Number of Under this method, two accounts are Under this method only one
Account prepared for each partner – (i) Fixed account, i.e. capital account is
Capital account (ii) Current account. opened.
3. Adjustment Under this method, adjustment entries Under this method all adjustment
relating to drawings, salary, share in entries are recorded in the
profit/loss, etc. are not recorded in partner’s capital account.
capital account.
4. Debit balance Fixed capital A/c always shows credit Fluctuating capital A/c usually
balance while current account can also shows a credit balance but may
show a debit balance show a debit balance in
exceptional cases.
“GOODWILL”
Meeting of Goodwill
According to Lord Macnagnten, “Goodwill is the benefit and advantage of the good name
reputation and connections of a business. It is the attractive force, which brings in customers. It is
one thing which distinguishes an old established business from a new business at its first start”.
Goodwill may be defined as the value of the earning capacity by which the firm earns more
profit than the normal profits.
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15/22 2 FLOOR ASHOK NAGAR ND-18 (PH- 55711031, 9810378235)
CLASS: XII ACCOUNTANCY Page 3 of 4

Nature and Characteristics of Goodwill

To understand the nature of goodwill, we have to study the characteristics of goodwill which are as
follows:
(i) It is an intangible asset of business.
(ii) It is not fictitious asset in case of a profitable concern.
(iii) It helps in earning excess profits.
(iv) It is an attractive force, which brings in customer to old place of business.

Factors Affecting the Value of Goodwill

Goodwill of a firm is affected by all factors which increase the earning capacity of the firm. The
following are the important factors affecting the value of goodwill:
(i) Management. If there is efficient management and is capable to fulfill the requirements
of the customers. The firm will earn good profits and that will raise the value of goodwill.
(ii) Quality. The firm providing the goods and service of high quality, can earn reputation in
comparison to other firms.
(iii) Location. If the business is located at a favourable place, resulting in good sales or in
economies, it will increase its goodwill.
(iv) Access to raw material. When supplies of raw materials difficult to get, there will be a
high a\value of goodwill of a firm which has access to raw materials.
(v) Contracts. If a firm has long-term contract for sale of its products or for purchase of
materials at favourable prices. This will increase the goodwill of the firm.
(vi) Other factors. Following are the other factors affecting the value of goodwill: (a)
Patents, (b) After sale service, (c) Past performance of the firm etc.

Need for Valuation of Goodwill for Partnership Firms

For partnership firms the need for valuation of goodwill arises in the following circumstances:
(a) A change in the profit sharing ratio of the existing partners.
(b) When a new partner is admitted;
(c) When a partner retire or dies;
(d) When the business is sold or partnership is converted into a joint stock company.
(e) When two or more firms are amalgamated.

Method of Valuation of Goodwill

The value of goodwill is affected by many factors. In case of sale of business, goodwill is valued
by purchaser and seller of the business. Following are the methods for valuation of goodwill.
(1) Average profit method. In this method goodwill is calculated on the basis of average of
profits earned by the firm in the past years. Steps are as follows:
(i) First of all average profits are calculated on the basis of past years’ profits.
Average Profits = Total Profit for N years
N (No. of years)
While calculating average profits, abnormal profits, should be deducted and abnormal
losses should be added back to profits. An adjustment should be made for further incomes
and expenses.
(ii) To find out goodwill average profits are multiplied by a certain number of years, called
number of years purchased
Goodwill = Average profits × No. of years purchased
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CLASS: XII ACCOUNTANCY Page 4 of 4

(2) Super profit method. The excess of average actual profit over the normal profit is
called super profit. In this method, goodwill is valued on the basis of super profits earned
by firm and the same multiplied by the number of years purchased. Steps are as follows:
(i) Calculation of average profits (already explained).
(ii) Calculation of normal profits:
(iii)
Normal Profits = Capital Employed × Normal Rate of Profit
100
If capital employed is not given, then it will be calculated by using accounting equation, i.e.,
Capital = Assets – Liabilities
(iii) Calculation of super profits:
Super Profits = Actual average profit – Normal profits
(iv) Valuation of goodwill:
Goodwill = Super profits × No. of years’ purchased

(3) Capitalisation method. This method is based on the capitalized value of the firm which
is calculated on the basis of capitalization of actual profits on the basis of normal rate. Of
profits. under this method goodwill can be calculated in two ways:
(a) Capitalisation of Average Profits – Under this method, to calculate the value of
goodwill actual capital employed is deducted from the capitalized value of the
average profits on the basis of normal rate of profits. Formula is as follows:

Average Profit × 100 - Capital Employed

Normal Rate of Return

(b) Capitalisation of Super Profits. Under this method goodwill is calculated by capitalizing
super profits by the rate of normal profits. Formula is as given below:
Super Profits × 100
Normal Rate of Return