Sunday, August 10, 2014

AHSEC - 12: Accounting for Partnership including Goodwill Important Questions for Feb' 2017 Exam

Unit – 2: Accounting For Partnership Firms
Q.1. Define the term “Partnership”. What are its essentials?
Ans: Partnership: 2004, 2010, 2011,
In India, Partnership firm is governed by the Indian Partnership Act 1932. Section 4 of this act defines partnership as: "The relationship between persons, who have agreed to share the profits of a business carried on by all or any one of them acting for all."
According to Prof. Haney, partnership is "the relation between persons competent to make contract who agree to carry on a lawful business in common with a view to private gain."
Partnership in this way is an agreement, between two or more persons to carry on legal business with profit motive, which is carried on by all or any one of them acting for all.
Essential (Characteristics) of Partnership: 2008, 2009
a)      Contract: Partnership is the result of contract between the partners. It arises from contract and not from status.
b)      Number of Persons: In a partnership firm there must be at least two people to form the business. Partnership Act 1932, does not specifies the maximum numbers of persons, but the Indian Company Act 1956, restricts the number of Partners to 10 for a partnership carrying on banking business and 20 in case of other kinds of business.
c)       Profit-Sharing: The agreement between/among partners must be to share profit or losses.
d)      Business: Business must be carried on by all the partners or any one of them acting as agent of other partners.

e)      Motive: For a partnership firm there must be motive to earn profit.
Q.2. What is Partnership Deed? What are its contents?
Ans: Partnership deed: Meaning 1999, 2003, 2007, 2009, 2014
A partnership is formed by an agreement. This agreement may be oral or in writing. Though the law does not expressly require that the partnership agreement should be in writing, it is desirable to have it in writing. A document, which contains the terms of partnership, as agreed to by the partners is called ‘Partnership Deed.’
Contents (Clauses) of the Deed:
a)      Name of the firm and its permanent address.
b)      Names and addresses of the partners.
c)       Nature of Business.
d)      Methods of evaluating of assets and liabilities.
e)      Date of commencement of partnership.
f)       Amount of capital to be contributed by each partner.
g)      Interest of Capital, if provided the rate of interest must be specified.
h)      Drawings by the partners.
i)        Interest on Drawings, if charged, the rate of interest should also be specified.
j)        Others
Q.3. Mention three Rights and Duties of Partners.           2009, 2014
Ans: Duties (Obligations) of a Partner: It is the duty of Partners:
a)      To devote his full attention and time to the firm.
b)      To carry on the business with the greatest common advantage and diligently.
c)       To act within the authority and to be just and faithful to other partners.
d)      Not to engage in competition against the firm.
Rights of a Partner:
a)      Every partner has a right to part in the conduct and management of the business.
b)      Every partner has a right to be consulted in the matters of the partnership.
c)       Every partner has a right to share profits (or losses) with others in the agreed ratio.
d)      Partners have a right of free access to all records, books of accounts and also to examine and copy them.
Q.4. What is fixed and fluctuating capital? Distinguish between them.  2007
Ans: Fixed Capital Accounts: A partnership firm can maintain the capital accounts of partners as fixed capital accounts or Fluctuating capital Accounts. In case capital accounts are fixed, the opening and closing balances of capital accounts normally remain unchanged. However in case some additional capital is introduced during the accounting year then closing capital will differ from opening capital.  But for this purposes a separate current account is opened in the name of each partner.
Current Accounts: When the fixed capital account is operated in the firm, all the transactions between firm and partner such as; salary, fees, bonus, commission, interest on capital, share in profits, reserves, goodwill etc, payable to partners, and Drawings, interest on drawings, share in losses, all these are recorded in Current Accounts. So current account is opened for each partner separately when the capital account is fixed.
Fluctuating Capital Accounts: A partnership firm may keep fluctuating capital accounts of partners, if it is provided in the partnership deed. Fluctuating capital accounts of partners means where in all the transactions relating to partners e.g. salary, fees ,commission, interest on capital, share in profits, goodwill, reserves, drawings etc., are recorded along with the opening balance of capital and additional capital introduced in the firm. In case of fluctuating capital accounts, current accounts of partners are not opened.
Difference between fixed capital accounts and fluctuating capital Accounts:
Basic of difference
Fixed Capital Account
Fluctuating Capital Accounts
1. Opening and Closing balance
Opening and Closing balances normally remains same
Opening & Closing bal. change due to adjustment in capital account.
2. Current account
Current accounts of partners are opened in this case.
Current accounts of partners are not opened in this case.
3. Adjustment relating to capital
All adjustment relating to partners capital accounts are made in current account.
All such adjustments are made in capital account itself.
4. Closing capital
The closing balance is always a credit balance.
The closing balances of partner’s capital account may be debit or credit.
 Q.5. What is Profit and Loss appropriation Account? Mention the adjustment entries for P/L appropriation account.
Ans: Profit or loss appropriation account: In case of partnership, profit earned by the firm is distributed among partner in their profit sharing ratio. If ratio is not specified, partners are assumed to be equal. Divisible profit is subject to certain adjustments such as interest on capital, drawings, interest on loan, salaries and commission to partners. These transactions are not charges against profit, so they are not mixed up with general trading transactions.
Accordingly an additional account known as profit and loss appropriation accounts is prepared. It is on extension of profit and loss accounts. The net profit disclosed by profit and loss accounts is transferred to these accounts.
Adjustment entries for P/L Appropriation account                          1999, 2003, 2012,
When Capitals are Fixed
When Capitals are Fluctuating
1. For Interest on Capital
Interest on Capital A/c Dr.
Partner’s Current A/c Cr.
Interest on Capital A/c Dr.
Partner’s Capital A/c Cr.
2. For Interest on Drawing
Partner’s Current A/c Dr.
Interest on Drawings A/c Cr.
Partner’s Capital A/c Dr.
Interest on Drawings A/c Cr.
3. For Partner’s Salaries
Partner’s Salaries A/c Dr.
Partner’s Current A/c Cr.
Partner’s Salaries A/c Dr.
Partner’s Current A/c Cr.
4. Interest on Partner’s loan
Interest on Partner’s Loan A/c Dr.
Partner’s Loan A/c Cr.

Q.6. What do you mean by Guarantee in Partnership?
Ans: Guarantee in partnership: Sometimes on the admission of a new person into a partnership the old partner may agree that the new partner would be entitled to receive a minimum amount of profits, irrespective of the actual profit earned by the business. The old partners thus offer a guarantee of the minimum amount of profits to new partner in case his actual share of profit is less than the stipulated amount. The old partners may bear this loss from their own share of the profit in proportion to their sharing ratio or the loss may be borne by only of the old partners.
Q.7. What are the rules to be followed in the absence of Partnership agreement between partners? 2000, 2002, 2009, 2011, 2014
Ans: According to Indian Partnership Act 1932 (sec. 4), the following provision are applicable in the absence of partnership deed:
·         Profit Sharing Ratio: In the absence of partnership deed all partners will share Profit or losses in equal ratio.
·         Interest on Capital: No interest will be given to any partner on his capital. In case, there is a partnership deed, which allows interest on capital, it will be allowed in case of profit but not in case of loss in the business.
·         Interest on Drawings: No interest will be charged on drawing in the absence of partnership deed.
·         Partner’s Salary/Commission: No salary or commission will be given to any partner in the absence of partnership deed.
·         Interest on Partner’s Loan: Interest on partner’s loan will be given @ 6% p.a. Such interest is payable even if there are losses.
Q.8. What is Joint Venture? Write two similarities and difference between Joint venture and Partnership.
Ans: Meaning of Joint Venture 1999, 2000, 2003, 2011
A joint venture is the combination of two or more persons into a single activity. It is a form of partnership which is limited to a specific venture. It is exactly the same as partnership, with the exception that it is one of a business that is to be terminated.  Since the business is to be terminated after completion of the venture, a firm name is not generally used. Thus the joint venture is like a temporary partnership without a firm name. It can also be said a particular partnership or partnership for a particular object.
Similarities between Partnership and Joint Venture:
Joint Venture
It is association of two or more partners.
A joint venture is the combination of two or more persons into a single activity.
Distribution of Profits
Primary aim of partners is to distribute profit between them.
The profits are ascertained for each venture separately and distributed between covertures.
Difference between Partnership and Joint Venture:
Basis of Difference
Joint Venture
Going Concern
It is a going concern.
It is a terminable venture.
It always has a name.
It may not bear a name.
Persons carrying on business are called partners.
Persons carrying on business are called co-ventures.
Ascertainment of profit
Profits are ascertained at regular intervals, i.e., annually.
The profits are ascertained for each venture separately.

Q.9. What do you mean by Goodwill? What are its various types? Why it is valued?
Ans: Goodwill: Goodwill is the value of the reputation of a firm in respect of profits expected in future over and above the normal profits.
In the words of Eric L. Kohler “Goodwill is the present value of expected future income in excess of a normal return on the investment in tangible assets.”
Types of Goodwill
Goodwill is mainly of two types:
1.       Purchased Goodwill
2.       Non-Purchased Goodwill
Purchased Goodwill: When one business is taken over by another business, the excess of purchase consideration over its net value (assets-liabilities) is termed to as purchased Goodwill.
Non Purchased Goodwill: Non Purchased Goodwill is an internally generated goodwill which arises because of favourable factors that a business possesses (e.g., favourable location, time factor and efficiency of management).
Reasons for Valuation of Goodwill                         2009, 2012
In case of a partnership firm, the need for valuation of goodwill may arise under the following circumstances:
·         When a new partner is admitted,
·         When a partner retires or dies,
·         When the firm is sold as a going concern,
·         When there is a change in profit sharing ratio among partners,
·         When partnership firm is sold to a company.
Q.10. What is Goodwill? What are its characteristics? What are the factors affecting the value of goodwill?
Ans: Nature and Characteristics of Goodwill
·         It is an intangible and not a fictitious asset.
·         It helps in earning more than normal profit.
·         It is an attractive force which brings in customers to old place of business.
·         It is composed of variety of elements.
·         It is difficult to ascertain the exact value of goodwill.
Factors affecting the value of Goodwill are:                       2007
·         Skill in Management: If the management is capable, the firm will earn good profits and that will raise the value of goodwill.
·         Location Factor: If the business is located at a favourable place, resulting in good sale or in economics, the value of goodwill will be correspondingly higher.
·         Favourable Contracts: Sometimes, a firm enters into long term contracts for sale and purchase of goods at favourable prices. This will also affect profits and goodwill of the firm.
·         Risk Involved: When the risk is less in the business it creates more goodwill but if the risk is more, it creates less goodwill.
Q.11. Explain various methods for valuation of Goodwill.                            2008, 2013, 2015
Ans: Methods of Valuation of Goodwill:
1)      Average profits method
2)      Weighted average profit method
3)      Super profit method                              2012
4)      Capitalisation method                            2016
5)      Annuity method
1)      Average Profits Method: In this method, normal profits of business of a number of years are taken into account. Such profits are totaled up and their average is arrived at. The average profits are multiplied by the number year’s purchases to arrive at the value of goodwill.
For calculation of goodwill following steps are to be followed
ü  Calculate past normal profit. Past Normal Profit = Net Profit + Abnormal loss – Abnormal Gain
ü  Calculate Average normal Profit = Total Past normal profit/no of years
ü  Calculate goodwill = Average normal profit x no. of year’s purchase
2)      Weighted average method: This method is a modified version of average profit method. In this method each year profit is assigned a weight i.e. 1, 2, 3, 4 etc. Thereafter each year profit is multiplied by the weight and find product. The total of products is divided by the total of weight. As a result we find the weighted average profit. After this the value of goodwill is calculated by multiplying the weighted average profit with the agreed number of year’s purchase. Thus the goodwill is calculated as follows:
ü  Weighted average profit = (Total Product of Profit / Total of Weights)
ü  Value of goodwill  = Weighted average profit × number of year of purchase
3)      Super Profit Method: Super Profits means profits earned in excess of the normal Profit, i.e., Actual Profit –Normal. Normal profits mean the profit which the firms could normally earns in a particular business.
Under this method, the following steps are to be followed for calculation of goodwill:
ü  Calculate average normal profit of business as mentioned above
ü  Calculate normal profit
ü  Calculate super profit. Super profit is the excess of average normal profit over normal profit
ü  Calculate goodwill = super profit x no. of year’s purchase
4)      Capitalization Method: Under this method, the value of goodwill is obtained by capitalizing the average profit or super profit of the basis of normal rate.
Value of goodwill under capitalization of average profit is
Goodwill = (Average normal profit of the business/ rate of return) – capital employed
Value of goodwill under capitalization of super profit is
Goodwill = Super profit/ rate of return
5)      Annuity Method: Goodwill = Annuity Factor x Super Profit


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