The Basic Characteristics of a Partnership
Describe the basic characteristics of a partnership
proprietorship form of ownership suffers from certain limitations such
as limited resources, limited skill and unlimited liability. Expansion
in business requires more capital and managerial skills and also
involves more risk. A proprietor finds him unable to fulfill these
requirements. This call for more persons come together, with different
edges and start business. For example, a person who lacks managerial
skills but may have capital.
person who is a good manager but may not have capital. When these
persons come together, pool their capital and skills and organise a
business, it is called partnership. Partnership grows essentially
because of the limitations or disadvantages of proprietorship.
  1. More Persons:
    As against proprietorship, there should be at least two persons subject
    to a maximum of ten persons for banking business and twenty for
    non-banking business to form a partnership firm.
  2. Profit and Loss Sharing: There is an agreement among the partners to share the profits earned and losses incurred in partnership business.
  3. Contractual Relationship: Partnership is formed by an agreement-oral or written-among the partners.
  4. Existence of Lawful Business:
    Partnership is formed to carry on some lawful business and share its
    profits or losses. If the purpose is to carry some charitable works, for
    example, it is not regarded as partnership.
  5. Utmost Good Faith and Honesty: A partnership business solely rests on utmost good faith and trust among the partners.
  6. Unlimited Liability:
    Like proprietorship, each partner has unlimited liability in the firm.
    This means that if the assets of the partnership firm fall short to meet
    the firm’s obligations, the partners’ private assets will also be used
    for the purpose.
  7. Restrictions on Transfer of Share: No partner can transfer his share to any outside person without seeking the consent of all other partners.
  8. Principal-Agent Relationship:
    The partnership firm may be carried on by all partners or any of them
    acting for all. While dealing with firm’s transactions, each partner is
    entitled to represent the firm and other partners. In this way, a
    partner is an agent of the firm and of the other partners.
The Importance of Mutual Agency and Unlimited Liability to a Person about to become a Partner
Explain the importance of mutual agency and unlimited liability to a person about to become a partner
The Advantages and Disadvantages of the Partnership as a Form of Business
Discuss the advantages and disadvantages of the partnership as a form of business
As an ownership form of business, partnership offers the following advantages:
  1. Easy Formation:
    Partnership is a contractual agreement between the partners to run an
    enterprise. Hence, it is relatively ease to form. Legal formalities
    associated with formation are minimal. Though, the registration of a
    partnership is desirable, but not obligatory.
  2. More Capital Available:
    We have just seen that sole proprietorship suffers from the limitation
    of limited funds. Partnership overcomes this problem, to a great extent,
    because now there are more than one person who provide funds to the
    enterprise. It also increases the borrowing capacity of the firm.
    Moreover, the lending institutions also perceive less risk in granting
    credit to a partnership than to a proprietorship because the risk of
    loss is spread over a number of partners rather than only one.
  3. Combined Talent, Judgement and Skill:
    As there are more than one owners in partnership, all the partners are
    involved in decision making. Usually, partners are pooled from different
    specialised areas to complement each other. For example, if there are
    three partners, one partner might be a specialist in production, another
    in finance and the third in marketing. This gives the firm an advantage
    of collective expertise for taking better decisions. Thus, the old
    maxim of “two heads being better than one” aptly applies to partnership.
  4. Diffusion of Risk:
    You have just seen that the entire losses are borne by the sole
    proprietor only but in case of partnership, the losses of the firm are
    shared by all the partners as per their agreed profit-sharing ratios.
    Thus, the share of loss in case of each partner will be less than that
    in case of proprietorship.
  5. Flexibility: Like
    proprietorship, the partnership business is also flexible. The partners
    can easily appreciate and quickly react to the changing conditions. No
    giant business organisation can stifle so quick and creative responses
    to new opportunities.
  6. Tax Advantage: Taxation rates applicable to partnership are lower than proprietorship and company forms of business ownership.
In spite of above advantages, there are certain drawbacks also associated with the partnership form of business organisation.
Descriptions of these drawbacks/ disadvantages are as follows:
  1. Unlimited Liability:
    In partnership firm, the liability of partners is unlimited. Just as in
    proprietorship, the partners’ personal assets may be at risk if the
    business cannot pay its debts.
  2. Divided Authority:
    Sometimes the earlier stated maxim of two heads better than one may
    turn into “too many cooks spoil the broth.” Each partner can discharge
    his responsibilities in his concerned individual area. But, in case of
    areas like policy formulation for the whole enterprise, there are
    chances for conflicts between the partners. Disagreements between the
    partners over enterprise matters have destroyed many a partnership.
  3. Lack of Continuity:
    Death or withdrawal of one partner causes the partnership to come to an
    end. So, there remains uncertainty in continuity of partnership.
  4. Risk of Implied Authority:
    Each partner is an agent for the partnership business. Hence, the
    decisions made by him bind all the partners. At times, an incompetent
    partner may lend the firm into difficulties by taking wrong decisions.
    Risk involved in decisions taken by one partner is to be borne by other
    partners also. Choosing a business partner is, therefore, much like
    choosing a marriage mate life partner.
Difference between an Ordinary Partnership and Limited Partnership
Distinguish between an ordinary partnership and limited partnership
partnership (also referred to as a general partnership) is a business
arrangement where two or more people (who are not husband and wife) are
owners of a business. Unlike a corporation, you do not need to file any
documents with the state to make your business a partnership. A
partnership is created by default, unless the business is specifically
formed as some other type of business entity, such as a corporation, a
limited liability company, or a limited partnership.
general partnership is one in which all of the partners have the
ability to actively manage or control the business. This means that
every owner has authority to make decisions about how the business is
run as well as the authority to make legally binding decisions. Unless
the partners have a partnership agreement, each partner will have equal
in a general partnership don’t have any limit on their personal
responsibility for the debts of the business. This means that the
partner could lose more than just his investment in the business –
personal assets would have to be used to pay business debts if
necessary. Each partner in a general partnership is also “jointly and
severably” liable for debts of the business. Joint and severable
liability means is that each partner is equally liable for the debts of
the business, but each is also totally liable. So if a creditor can’t
get what he is owed by one or more of the partners, he can collect it
from another partner, even if that partner has already paid his share of
the total debt. If someone sues your partnership and obtains a large
judgment, and your partner doesn’t have the money to pay his share of
it, you will have to pay the entire amount.
limited partnership is different from a general partnership in that it
requires a partnership agreement. Some information about the business
and the partners must be filed with the appropriate state agency
(usually the secretary of state).
a limited partnership has both limited and general partners. A limited
partner is one who does not have total responsibility for the debts of
the partnership. The most a limited partner can lose is his investment
in the business. The trade off for this limited liability is a lack of
management control: A limited partner does not have the authority to run
the business. He is really more or less an investor in the business.
limited partnership must have at least one general partner. The general
partner or partners are responsible for running the business. They have
control over the day-to-day management of the business and have the
authority to make legally binding business decisions. The partnership
agreement will specify exactly which partner or partners have certain
responsibilities and which have certain authority. General partners are
also subject to unlimited personal liability for the debts of the
business. The general partners of a limited partnership are also jointly
and severably liable for the debts of the business, just like partners
in a general partnership. If you need a business type that limits the
liability of all partners.
The Formation of a Partnership
Account for the formation of a partnership
Partnership agreement
agreement (also known as the partnership deed) is the agreement between
the partners. It is ideally in written form and it documents the rights
and responsibilities of the partners and addresses other matters to
which the partners agree at the time of partnership formation.
partners have to satisfy the relevant state’s legal requirements
related to formation of partnerships, obtain tax number for the
business, obtain any required licenses (such in public accounting, etc.)
and agree on the terms of the partnership with each other.
Accounting for partnership formation
of a partnership involves investment by the partners in the partnership
either in the form of cash or in the form of assets. When partners
introduce cash or any other asset, cash or the other asset account is
debited at the value agreed by the partners and the corresponding
partner’s capital account is credited by the same amount.
Example 1
Consultancy is a partnership established by Jazz and Indigo. The
business is engaged in providing consultancy to telecommunication
companies on revenue assurance. On 1 January 20X2, Jazz contributed
contribute cash of $300,000 while Indigo introduced a vehicle with a
written down value of $40,000 and fair value of $80,000, paid 2 years
prepaid rent for office building of $70,000 and introduced technical
equipment of $60,000 and marketable securities of $100,000. A firm of
Indigo’s friend did the furnishing work for $70,000 and JI Consulting
agreed to pay off the loan in the first week of the partnership’s
formation. Journalize the formation of the partnership.
formation of partnership would involve recording the assets on the
partners’ balance sheet and creating corresponding capital accounts by
the following journal entry:
Cash 300,000
Marketable securities 100,000
Prepaid 70,000
Furniture and fittings 70,000
Vehicles 80,000
Equipment 60,000
Sales 70,000
Sales 300,000
Sales 310,000
Example 2
B and C are partners in a partnership firm with capital A- Rs.5,00,000;
B- Rs.7,00,000 and C- Rs4,00,000. During the year 2012, the firm earned
a net profit of Rs. 2,00,000. The partners are to entitled to an
interest on capital @ 6% p.a. They also made some drawings on which
interest to be charged is A-Rs.400; B-Rs 500 and C- Rs250. A is entitled
to Rs.2000 p.m. as salary. B is to get 5% of the net profit after all
adjustments as commission. Also 10% of the profits remaining before
providing commission to B is to be transferred to General Reserve.
Profit are shared among A, B and C in the ratio 1:1:2 respectively.
Prepare Profit and Loss Appropriation account to show the above
Profit and Loss Appropriation Account
Particulars Amount(Rs) Particulars Amount(Rs)
To Interest on Capital: By Net Profit 2,00,000
A-Rs. 30,000 By Interest On Drawings
B-Rs. 42,000 A- 400
C-Rs.24,000 96,000 B- 500
To Salary (A) 24,000 C-250 1,150
To General Reserve 8,115
To Commission (B) 7,303
To Profit transferred to:
C-32,866 65,732
2,01,150 2,01,150
Earnings to Partners: On a Sated Fractional Basis; In the Partners
Capital Ratio and through the Use of Salary and Interest Allowances
partnership earnings to partners: On a stated fractional basis; In the
partners capital ratio and through the use of salary and interest
Activity 1
partnership earnings to partners: On a stated fractional basis; In the
partners capital ratio and through the use of salary and interest
The Admission of New Partner
Account for the admission of new partner
Admission of a Partner: Goodwill, Revaluation and Other Calculations!
Treatment of Goodwill:
upon the share of profits to be given to the new partner, either a sum
of money will be directly paid by him to the old partners (through the
firm or privately) or after recording new partner’s capital, new
partner’s capital account will be debited with his share of goodwill,
the credit being given to the old partners in the ratio of their
sacrifice of future profits. The latter is an indirect method of payment
for goodwill by the new partner. The payment is justified became the
new partner will take a share of profits which comes out of the shares
of other partners. The old partners must be compensated for such a loss.
The various possibilities as regards goodwill are:
  1. The new partner brings goodwill in cash which is left in the business.
  2. The new partner brings goodwill in cash but the cash is withdrawn by the old partners.
  3. The amount of goodwill is paid by the new partner to the old partners privately.
  4. The
    new partner does not bring in cash for goodwill as such; but an
    adjustment entry is passed by which the new partner’s capital account is
    debited with his share of goodwill and the amount is credited to old
    partners’ capital accounts in the ratio of sacrifice. This entry reduces
    the capital of the new partner by the amount of his share of goodwill
    and results in payment for goodwill by the new partner to the old
considering the entries to be made in the above cases, one must decide
regarding the ratio in which goodwill is to be credited to the old
partners. Traditionally, goodwill was credited to the old partners in
the old profit-sharing ratio and, if the amount was to be written off as
in case (v) above, it was written off to all the partners in the new
profit-sharing ratio.
would be no doubt that this should be the case when, on the admission
of a new person as partner, the ratio as among the old partners does not
change. But what if on the admission of a new partner, the
profit-sharing ratio of old partners as among themselves is also
one treats paying sums in respect of goodwill to old partners as
compensation for their surrendering to the new partner a part of their
profits, then obviously the amount to be credited to partners should be
in then ratio of loss of profits. Suppose, A and B, sharing in the ratio
of 3: 2, admit C as partner and it is agreed that the new
profit-sharing ratio is 2: 2: 1. It is obvious that B does not suffer at
all on Cs admission. He previously received 2/5ths of profits; he still
receives 2/5ths of profits. It is A alone who has suffered and,
therefore, any amount brought in as goodwill by C should be credited to
only A. Thus, it is proper to credit goodwill brought in by a new
partner to the old partners in the ratio in which they suffer on the
admission of the new partner.
The entries to be passed in the four cases given above are:
Example 3
Illustration 1:
and B share profits in the ratio: A, 5/8 and B 3/8. C is admitted as
partner. He brings in Rs 70,000 as his capital and Rs 48,000 as
goodwill. The new profit-sharing ratio among A, B and C respectively is
agreed to be 7: 5: 4 respectively. Pass Journal entries.
the above illustration, the old partners have allowed the amounts of
goodwill credited to their capital accounts remain in the business.
However, the arrangement may allow the old partners to wholly or partly
withdraw the amounts of goodwill credited to their capital accounts.
Suppose, in the above illustration, A and B withdraw their shares of
goodwill A and B withdraw their shares of goodwill brought in by C.
Then, the following additional journal entry will have to be passed:
the case is that the amount of goodwill is paid by the new partner to
the old partners privately, no entry is passed in the books of the firm.
But the calculations have to be made in the same manner as shown above.
Example 4
Illustration 2:
and B are partners sharing profits and losses in the ratio 3:2
respectively. They admit C as partner who is unable to bring goodwill in
cash but pays Rs 96,000 as his capital. The goodwill of the firm is to
be valued at two years’ purchase of three years’ profits. The profits
for the three years were Rs 30,000, Rs 24,000 and Rs 27,000. An
adjustment entry is to be passed for C’s share of goodwill. The new
ratio will be 5: 2: 2. Pass journal entries.
Example 5
Illustration 3:
and Y were partners sharing profits in the ratio of 5:4 respectively.
On 1st April, 2012 they admitted Z as a new partner; all the partners
agreeing to share future profits equally. On the date of admission of
the new partner, there was a goodwill account in the old firm’s ledger
showing a balance of Rs 18,000. The current value of firm’s goodwill was
placed at Rs 36,000. Z paid Rs 50,000 by way of his capital. He also
paid an appropriate amount for his share of goodwill. X and Y wrote off
the goodwill account before Z’s admission.
Pass the necessary journal entries.
Revaluation of Assets and Liabilities:
a new partner is admitted, it is natural that he should not benefit
from any appreciation in the value of assets which has occurred (nor
should he suffer because of any fall which has occurred up to the date
of admission) in the value of assets. Similarly, for liabilities.
assets and liabilities are revalued and the old partners are debited or
credited with the net loss or profit, as the case may be, in the ratio
in which they have been sharing profits and losses hitherto. Partners
may agree that the change in the value of assets and liabilities is to
be adopted and figures changed accordingly or that the assets and
liabilities should continue to appear in the books of the firm at the
old figures.
  1. Values
    to be altered in books. In this case, a Profit and Loss Adjustment
    Account (or Revaluation Account) is opened and the following steps
    should be taken
If the values of assets increase, the particular assets should be
debited and the Revaluation Account credited with the increases only.
If the values of assets fall, the Revaluation Account should be debited
and the particular assets credited with the fall in values.
the value of debtors, investments or stock falls, the entry should be
to debit the Revaluation Account and credit a suitable provision
account. Thus, suppose it is desired to record a fall in value of
investments to the extent of Rs 9,500.
The entry is:
there is already a provision against a particular asset and the value
of that asset increases, the entry should be to debit the Provision and
credit Revaluation Account rather than to follow (a) above.
(c) Increase in the amounts of liabilities is a loss.
Hence, the entry is:
If an increase is not definite but is expected, the credit should be to a suitable provision account.
Any reduction in the amounts of liabilities is a profit and hence the
liabilities accounts should be debited and Revaluation Account credited
with the difference between the old and present figures.
The Revaluation Account should then be closed by transfer to old
partners’ capital (or current) accounts in the old profit-sharing ratio.
If debits exceed the credits, it is a loss and the entry is to debit
partners’ capital (or current) accounts and credit Revaluation Account.
Reverse entry is made when the credits exceed debits.
Example 6
A and B share profits in the proportions of three-fourths and one-fourth respectively.
Their balance sheet on March 31, 2012 was as follows:
On April 1, 2012 C was admitted into partnership on the following terms:
  1. That C pays Rs 40,000 as his capital for a fifth share.
  2. That C pays Rs 20,000 for goodwill. Half of this sum is to be withdrawn by A and B.
  3. That
    Stock and Fixtures be reduced by 10% and a Provision for Doubtful Debts
    amounting Rs 950 be created on Sundry Debtors and Bills Receivable.
  4. That the value of Land and Buildings be appreciated by 20%.
  5. There being a claim against the firm of damage, a liability to the extent of Rs 1,000 should be created.
  6. An item of Rs 650 included in Sundry Creditors is not likely to be claimed and hence should be written off.
journal entries for the above-mentioned transactions excluding cash
transactions; prepare cash book and important ledger accounts. Also
prepare the balance sheet of the firm immediately after Cs admission.
Assume the profit-sharing ratio as between A and B has not changed.
When values are not to be altered. In this case, the increases and
decreases in the values of assets and liabilities are entered in a
Memorandum Revaluation Account without passing corresponding entries in
the assets and liability accounts. The balance is transferred to old
partners’ capital accounts in the old profit-sharing ratio. Then,
entries passed in Memorandum Revaluation Account for increases and
decreases in the values of assets and liabilities are reversed, again
without passing any entry in the assets and liability accounts. The
balance of Memorandum Revaluation Account is, this time, transferred to
all partners (including the new one) in the new profit-sharing ratio.
the illustration above, the Memorandum Revaluation Account and the
capital accounts will appear as follows if this method is to be
Journal entries regarding revaluation in the case discussed above will be:
New Profit-Sharing Ratio:
out the new profit-sharing ratio might involve a little calculation.
The language of the agreement is the most important factor. In some
cases, the new ratio is given. In others, only the share to be given to
the new partner is given; the assumption is that as amongst the old
partners, the ratio does not change. In such a case, one should deduct
from 1 the share of the new partner and then divide the remainder among
the old partners in the old ratio. Suppose, A and B are partners sharing
profits and losses in the ratio of 5: 3 respectively. They admit C and
agree to give him 3/10 of the profits.
Then, the new ratio will be calculated as follows:
certain cases, the incoming partner “purchases” his share from the
other partners in different proportions. Suppose, A and B sharing
profits in the ratio of 5: 3 respectively admit C giving him a 3/10
share of profits of the firm. If C acquires 4/20 share from A and 2/20
share from B, the new ratio will be
Example 7
Glucose and Cibazol have a practice producing Rs 3,72,900 per annum,
which they divide in proportions of 17/33 and 16/33. They admit Dr.
Zambuck to partnership on the basis of his buying, at 2 years’ purchase,
5/17 of Dr. Glucose’s share and 4/16 of Dr. Cibazol’s share. After the
lapse of three years, they permit Dr. Zambuck to purchase a further 1/12
of their remaining shares. How much did Dr. Zambuck pay to each of the
others on each occasion, and what is the ultimate share of each partner
in the practice?
first, Dr. Zambuck buys 5/17 of Dr. Glucose’s share. That comes to
(5/17) x (17/33) or 5/33 Dr. Glucose’s share, therefore, is
(17/33)-(5/33) or 12/33. Dr. Zambuck acquires (4/16)x (16/33) or 4/33
from Dr. Cibazol whose share, therefore, is (16/33)-(4/33) = 12/33.
Total share of Dr. Zambuck is [(5/33) + (4/33)] or 9/33. Goodwill is
valued at Rs 3,72,900 x 2 or Rs 7,45,800. Therefore, Dr.Zambuck has to
pay Rs 7,45,800 x 9/33 or Rs 2,03,400 which is shared by Dr. Glucose and
Cibazol in the ratio of 5 : 4 (the ratio in which they lose profits).
Rs 1, 13,000 will go to Dr. Glucose and Rs 90,400 to Dr. Cibazol. The
new ratio is 12/33,12/33 and 9/33. Later, Dr. Zambuck acquires 1/12 of
each partner’s share. Hence, he acquires 12/33 x 1/12 or 1/33 from both
the other partners. The share of Dr. Glucose is reduced to 12/33-1/33 or
11/33. So also for Dr. Cibazol. The share of Dr. Zambuck comes to be
9/33 + 1/33 + 1/33 = 11/33. Hence, all partners are now equal. Dr.
Zambuck will have to pay 7,45,800 x 1/33 or ? 22,600 to each of the
other two partners by way of goodwill.
Reserves, etc., Created Out of Profits:
existing at the time of the admission of a new partner should always be
transferred to the capital or current accounts of the old partners in
the profit-sharing ratio. Students should remember to do this even if
the question is silent on the point.
Capitals of Partners to be Proportionate to Profit-Sharing Ratio:
is often agreed on admission of a partner that the capitals of all
partners should be in proportion to their respective shares in profits.
The starting point may be the new partner’s capital or the new partner
himself may be required to bring in capital equal to his share in the
firm. If the new partner’s capital is given, one should find out the
total capital of the firm on the basis of his share.
the capital required of other partners should be ascertained. Suppose, C
is admitted in a firm with a 1/4 share of the profits of the firm. C
contributes Rs 15,000 as his capital, A and B, the other two partners,
were sharing profits in the ratio of 3: 2.
Then, the required capital of A and B should calculate as follows:
is similar if the basis is the existing partners’ capitals and the new
partner is required to bring in proportionate capital. Suppose, after
making all adjustments as regards goodwill and revaluation of assets,
etc., the capitals of A and B are ?20,000 and Rs 16,000. The profits and
losses are shared by A and B in the ratio of 5: 3 respectively. C is
admitted and is to be given 1/4th share of profits. He has to bring in
capital representing his share. C gets 1/4, 3/4 is left for A and B.
the combined capital of A and B, viz., Rs 36,000 represents 3/4 share.
Total capital should be 36,000 x4/3 or Rs 48,000. C should bring Rs
12,000, i.e., 48,000 x 1/4. In other words, C’s share is 1/3 of the
combined shares of A and B (1/4:3/4); his capital should be 1/3 of the
combined capitals of A and B.
the actual capital of a partner is more than his proportionate share,
the difference should be credited to his current account. If the actual
is less, he should being in the requisite amount of cash or else his
current account should be debited. If the Partnership Deed requires
capitals to be proportionate to the profit-sharing ratio, the capitals
should be treated as fixed.
Example 8
Illustration 1:
following was the Balance Sheet of A, B and C sharing profits and
losses in the proportion of 6/14, 5/14 and 3/14 respectively:
They agreed to take D into partnership and give 1/8th share of profits on the following terms:
  1. (1) That D brings in Rs 48,000 as his capital.
  2. That furniture be written down by Rs 2,760 and stock be depreciated by 10%.
  3. That provision of Rs 3,960 be made for outstanding repair bills.
  4. That the value of land and buildings be written up to Rs 1,95,300.
  5. That the value of goodwill be fixed at Rs 28,000 and an adjustment entry be passed for D’s share of goodwill.
  6. That the capitals of A, B and C be adjusted on the basis of D’s capital by opening current accounts.
Give the necessary journal entries, and the balance sheet of the firm as newly constituted.
Example 9
Illustration 2:
balance sheet of a partnership firm of X and Y, who were sharing
profits in the ratio of 5: 3 respectively, as on 31st March, 2012 was as
On the above date, Z was admitted on the following terms:
  1. Z would get 1/5th share in the profits.
  2. Z would pay Rs 1, 20,000 as capital and Rs 16,000 for his share of goodwill.
  3. Machinery
    would be depreciated by 10% and building would to be appreciated by
    30%. A provision for bad debts @ 5% on debtors would be created. An
    unrecorded liability amounting to Rs 3,000 for repairs to building would
    be recorded in the books of account.
  4. Immediately after Z’s
    admission, goodwill account would be written off. Thereafter, the
    capital accounts of the old partners would be adjusted through the
    necessary current accounts in such a manner that the capital accounts of
    all the partners would be in their profit showing ratio. Prepare
    revaluation account, capital accounts and the initial balance sheet of
    the new firm.


Departmental Accounts
The Trading Account for a Departmental Store
Draw up the trading account for a departmental store
Accounts are accounts relating to the several departments or sections
of a busi­ness drawn up with a view to ascertaining their individual
performances. A business may have a number of departments each dealing
in a different type of goods. For instance, Departmental Store is an
example of large scale trading by a retail trader.
order to carryout business more efficiently, a businessman divides his
store into many sections, each section is called a Department. In order
to ascertain the profit or loss made by each department, it is desirable
to prepare separate Trading and Profit and Loss Account for each
preparation of such Trading and Profit and Loss Account separately for
each department enables to compare the results of trading activities; in
  1. It
    enables to compare the performance of one department with that of
    another and to mea­sure the progress of the department itself by
    comparing year-wise performance.
  2. It enables to measure the
    profitability of each department. In the absence of departmental
    accounting, if there is a loss, the businessman thinks that the whole
    business is at loss. Thus he may stop the business and may start a new
    business, because he is unable to understand the performance of each
    department. But, by preparing departmental accounts separately, the
    contribution of profit made by each department can be known. Thus a good
    profit- making department can be developed and the department which
    gives small margin of profit or no profit can be closed down. It is also
    possible to check the profit of a department, not to be eaten away by
    the department which makes no profit.
  3. It helps in formulating
    new policies and to adopt new and latest techniques in the depart­ments,
    thereby further profitability of the department can be expected.
  4. Departmental
    Managers of the profit-making department can be encouraged by adopting a
    method of commission on the basis of departmental profit. This step
    will further boost the profit-making department.
Accounting Procedure:
There are two methods of keeping departmental accounts:
  1. Independent
    Basis: In this method, accounts of each department are maintained
    separately. Each department pre­pares Trading and Profit and Loss
    Account. Finally, the profit or loss of each department is trans­ferred
    to the (General) Profit and Loss Account for all the departments. The
    independent departmen­tal book-keeping is an expensive one.
  2. Columnar
    Basis: In this method, there is a single set of books. All accounts of
    all the departments are maintained together, but in a columnar or
    tabular form. In order to enable the preparation of departmental trading
    and profit and loss accounts, various subsidiary books, such as
    purchases, sales, returns books, are prepared in a columnar form and
    this shows the record, in detail, for each department.
The following is the specimen of a purchase book and a sales book:
The same pattern of rulings may be followed in case of other subsidiary books.
The Overheads Expenses to Department
Apportion the overheads expenses to department
ofoverheadcosts means to divide total cost ofoverheadamong different
departments or branches or cost centers of a company. We need the steps
of apportionment ofoverheadcosts when there are many departments or cost
centers of any company because when we know theoverheadcost of each
department, we can find the total cost of department. With this, we can
compare the revenue of each department with their total cost. After
this, we can take many decisions relating to particular department.
The Methods Used in Apportioning Overhead Expenses
Explain the methods used in apportioning overhead expenses
determination of a suitable basis is of primary importance and the
following principles are useful guides to a cost accountant:
  1. Service or Use or Benefit Derived:If
    the service rendered by a particular item of expense to different
    departments can be measured, overhead can be conveniently apportioned on
    this basis. Thus, the cost of maintenance may be apportioned to
    different departments on the basis of machine hours or capital value of
    the machines, rent charges to be distributed according to the floor
    space occupied by each department.
  2. Ability to Pay Method:Under
    this method, overhead should be distributed in proportion to the sales
    ability, income or profitability of the departments, territories, basis
    of products etc. Thus, jobs or products making higher profits take a
    higher share of the overhead expenses. This method is inequitable and is
    not generally advisable to relieve inefficient units at the cost of
    efficient units.
  3. Efficiency Method:Under this
    method, the apportionment of expenses is made on the basis of production
    targets. If the target is exceeded, the unit cost reduces indicating a
    more than average efficiency. If the target is not achieved, the unit
    cost goes up, disclosing thereby the inefficiency of the department.
  4. Survey Method:In
    certain cases it may not be possible to measure exactly the extent of
    benefit wick the various departments receive as this may vary from
    period to period, a survey is made of the various factors involved and
    the share of overhead costs to be borne by each cost centre is
    determined.Thus, the salaries of foreman serving two departments can be
    apportioned after a proper survey which may reveal that 30% of such
    salary should be apportioned to one department and 70% to the other
    department. The cost of lighting, when not metered, may similarly be
    apportioned on a survey of the number and wattage of light points and
    the hours of use in each cost centre.
The Profit and Loss Account in Columnar Form
Draw the profit and loss account in columnar form
Activity 1
Draw the profit and loss account in columnar form
The Departmental Trading, Profit and Loss Account
Draw the departmental trading, profit and loss account
Departmental Trading and Profit and Loss Account:
the books and accounts are maintained on a columnar basis, Trading and
Profit and Loss Account can also be prepared on columnar basis. There
arises no difficulty in finding out gross profit and net profit for each
department separately. From the analytical ledger accounts and
subsidiary books department-wise figures are readily available. If an
item of expenses definitely identified with a particular department, it
can be termed as direct expenses with reference to the department.
instance, salary of Manager and salesman of a particular department,
special advertising, separately metered electricity etc. are expenses
and exclusively meant for and identified with particular departments.
Apart from this, there are some expenses termed as indirect expenses.
types of expenses are not readily identifiable departmentally and the
benefit of such type of expenses goes to all departments. And such types
of expenses, called joint expenses, are incurred for the business as a
instance, rent, depreciation, selling expenses, welfare expenses,
advertising etc. Allocation of such expenses among the various
departments becomes indispensable on an equitable basis at the date of
account. The important point in such cases is to fix the basis on which
the different revenueitems are to be split up. It is neither possible nor desirable to sub-divide all items on equal basis.
Allocation of Common Expenses:
all direct expenses are charged to the respective departments, in case
of indirect or general expenses, proper allocation among the departments
must be made in order to ascertain the profit and loss made by each
department. Each department is charged with proper business expenses. If
the basis for such allocation is not specially mentioned, then the
following procedure may be followed.
expenses cannot be apportioned and no basis of apportionment is
practicable. For in­stance, interest on Loan, Income Tax, Salary to
General Manager, Share Transfer expenses, Bank charges, Audit fees etc.
Here these expenses can safely be transferred to General Profit and Loss
income of general nature such as Interest on Calls-in-arrears, Interest
on Invest­ment, fees on share transfer etc. credited to General Profit
and Loss Account. The Departmental Trading Account shows the Gross
Profit or Loss and Departmental Profit and Loss Account shows the Net
Profit or Loss earned or suffered by each department.
Example 1
Illustration 1:
proprietor of a large retail store wished to ascertain approximately
the net profit of the X, Y and Z departments separately for the three
months ended 31st March 2006. It is found impracticable actually to take
stock on that date, but an adequate system of departmental accounting
is in use, and the normal rates of gross profit for the three
departments concerned are respectively 40%, 30% and 20% on turnover
before charging the direct expenses. The indirect expenses are charged
in propor­tion to departmental turnover.
The following are the figures for the departments:
total indirect expenses for the period (including those relating to
other departments) were Rs. 5,400 on the total turnover of Rs. 1,
08,000. Prepare a statement showing the approximate net profit, making a
stock reserve of 10% for each department on the estimated value on
Example 2
Illustration 3:
Department C – 2,496 units @ Rs 25 each
The rate of Gross Profit is the same in each case. Prepare Departmental Trading Account.
Inter-Departmental Transfers:
are often supplied from one Department to another – Inter-Departmental
transfer. Such transfer must be credited to Supplying Department and
debited to Receiving Department. If the trans­fers are made at cost
price, then it can be treated as mere transfer. No further adjustment is
if the transfers of goods are made at selling price, then a profit is
earned by the supply­ing department of the same organisation. When the
goods, transferred from one department to an­other, still remain unsold
with the transferee department, at the end of the accounting period,
there arises a necessity to eliminate the unrealised profit on such
stock on hand. This is because, so much of issuing department’s profit
(notional) remain unrealised from the viewpoint of the firm as a whole.
The reserve will be equal to the profit included in respect of unsold
goods at the end of closing.
The entry is:
General Profit and Loss Account Dr.
To Stock Reserve
certain cases, the transferee department may have some stock in the
beginning of the account­ing period, against which stock reserve was
already created in the previous year, will also be trans­ferred to
General Profit and Loss Account by means of Journal entry:
Stock Reserve Account Dr.
To General Profit and Loss Account
a single journal entry can be passed for the unrealised profit on the
basis of the difference between unrealised profit included in opening
and closing stock.
Example 3
Illustration 1:
firm has two departments — Piece goods and readymade dresses. All goods
purchased by the readymade department from Piece goods department are
charged at the usual selling price.
From the following particulars prepare departmental trading and profit and loss accounts for the year ended Dec. 31, 2005:
stocks in the readymade department are considered as consisting of 75%
cloth supplied from Piece goods dept. and 25% expenses and cloths from
outside. The Piece goods department earned gross profit in 2004 at the
same rate as in 2005. General expenses of the business as a whole in
2005 amounted to Rs 45,000.
Example 4
Illustration 2:
the following balances extracted from the books of a firm, prepare
Departmental Trading and General Profit and Loss Account for the year
ended 31st December 2005 and a Balance Sheet as on that date after
adjusting the unrealised departmental profits, if any.
Additional information:
  1. Closing stock of Dept. A – Rs 13,000 including goods from Dept. B Rs 4,000 at cost to Dept. A.
  2. Closing stock of Dept. B – Rs 26,000-including goods from Dept. ARs 9,000 at cost to Dept. B.
  3. Sales
    Dept. A includes transfer of goods to Dept. B of the value of Rs 20,000
    and sales of Dept. B includes transfer of goods to Dept. A of the value
    of Rs 30,000 both at market price to transferor departments.
  4. Opening
    stock of Dept. A and Dept. B includes goods to the value of Rs 1,000
    and Rs 1,500 taken from Dept. B and Dept. A respectively at cost price
    to transferor departments.
  5. Depreciate land and buildings by 5% and furniture by 10% p.a.
There is no need for any adjustment for opening stock which includes
inter-departmental transfers. This is because goods have been valued at
cost to the transferor department and not to transferee departments.
Exercise 1
company has two departments viz. Piece goods and Tailoring. All goods
purchased by the Tailoring Department from Piece goods Department are
sold at normal market prices, same as prices charged to outside
the following particulars prepare Departmental Trading and Profit and
Loss Account and a Balance Sheet as on 31st March 2005.
A Department Balance Sheet
Draw a department balance sheet
Example 5
Illustration 2:
the following particulars you are required to prepare Trading and
Profit and Loss Accounts for the year ended 31st December 2005, showing
the gross and net profits of each department. Apportion the general
expenses of the business on the basis of turnover. Also prepare the
Balance Sheet.
Stock in hand Dec. 31, 2005 Dept. A Rs 30.000 and B Rs 20,500.
sales are Rs 1.20.000 i.e., Dept. A Rs 80.000 and B Rs 40.000.
Proportion of general or indirect expenses chargeable to A 2/3 and B
1/3. (B.Com. Madurai. MS. Bharathiar)


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