Fundamentals of partnership and Goodwill Test - 5

Insurance Premium paid for business is a charge against the profit. It means this transaction will reduce the profit of the firm. All charge items are shown in profit and loss account only. That’s why Insurance Premium paid for business is shown in profit and loss account and not in profit and loss appropriation account.

When partnership deed provides for the interest on drawings but dates of withdrawal of drawings are not given, in such a case average time period should be taken as six months. Interest on Drawings = Total Drawings × Rate/100 × 6/12

Liabilities side is also known as credit side, all credit balances are shown in the balance sheet (personal accounts). This is the only reason that credit balance of capital accounts and current accounts of the partners are shown in the liabilities side of balance sheet.

Guarantee of minimum amount can be given by a single partner, some of the partners or by all the partners in an agreed ratio. If guarantee is given by only one partner then it is known as guarantee by partner but if guarantee is given by the firm (all partners) then it is known as guarantee by firm.

Anything which will reduce the net profit of the firm is called charge. Normally interest on capital is an appropriation; it means it will be paid out of profits and up to the profits only. But in some cases it is paid as a charge, it means whether there is profit or loss, it will be paid. Only in such cases interest on capital is treated as a charge.

When interest on capital is treated as charge, amount of interest will be paid in full irrespective or profits/losses. In a normal situation, interest on capital is an appropriation; it means it will be paid out of profits and up to the profits only. But in some cases it is paid as a charge, it means whether there is profit or loss, it will be paid. Only in such cases interest on capital is treated as a charge.

Calculation of interest on capital should be always done on the opening capital first and after that on additional capital introduced (if any) by the partner during the year. Interest on opening capital and additional capital should be shown in a combined manner as total interest on capital during the year.

The word per annum is the key element in the calculation of interest on drawings. When per annum word is given, it means interest on drawings is to be calculated on the time basis or for a particular time period. When word per annum is not given with the rate of interest on drawings, it means interest on drawings is to be calculated for the full year irrespective of time period.

When capitals of the partners are fixed, two accounts are prepared at that time i.e. Partners Fixed capital account and Partners Current account. Partners fixed capital account shows only capital balance and additional capital or withdrawl of some part of capital permanently (if any). That’s why this account cannot show a negative balance.