Profit and Loss Appropriation Account

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Profit and loss appropriation account is used to distribute profit among partners in the case of partnership business. The net profit as shown by the profit and loss account of a partnership firm needs certain adjustments with regard to interest on drawings, interest on capitals, salary/commission to the partners, if provided, under the agreement. Profit and Loss Appropriation Account is important account for partnership business. Rules followed for calculation of net profit of a partnership firm are similar to the rules followed for preparation of final account of a sole proprietorship business. In the absence of partnership agreement, specific rules related to the following:

(a) No interest on capital should be given to partners.

(b) No interest on drawings should be charged from the partners of the amount of withdrawals.

(c) Profit and losses to be shared equally by all the partners of the firm.

(d) The partners are entitled for 6% p.a. interest on the loan advanced by them to the firm.

(e) No salary/commission should be given to any partner.

(f) Personal profit earned by a partner from a competing business or in his capacity as a partner, shall be accounted for and paid to the firm by partner concerned. Thus, net profit of the firm includes personal profit.

After determining the net profit of the firm, it is allocated between partners in accordance with Partnership Act. For this purpose, ‘Profit and Loss Appropriation Account’ may be prepared. This is merely an extension of the profit and loss account and is prepared to show how net profit is to be distributed among the partners.

Profit and loss appropriation account is credited with net profit and interest on drawings, and debited with salary or commission to partners and interest on capitals. If, however, the profit and loss appropriation account shows a net loss, it will be shown on the debit side of the profit and loss appropriation account. After these adjustments have been made, the Profit and Loss Appropriation Account will show the amount of profit or loss, which shall be distributed among the partners in the agreed profit sharing ratio.

Profit and Loss Appropriation Account Format

Profit and loss appropriation account format is presented below:

Example 1:

The partnership agreement between Haseeb and Azkia provides the following information for preparing firm’s accounts:

(a) Profit and loss will be shared equally;

(b) 6% interest will be charged on partner’s drawings accounts;

(c) 8% interest will be allowed on partner’s fixed capital;

(d) Haseeb will be allowed a salary of Rs. 500 p.m.;

(e) Azkia is a sales manager will allow a commission of 10% of the net profits, after allowing Haseeb’s salary;

(f) The fixed capital of Haseeb Rs. 120,000 and Azkia Rs. 140,000. The net profit for the year ending December 31^st, 2019 amounted to Rs. 50,000.

(g) The Annual drawings of Haseeb Rs. 30,000 and Azkia Rs. 50,000.

Required: Prepare Profit and Loss Appropriation Account at December 31^st, 2019.

Solution:

Journal Entries for Profit and Loss Appropriation Account

For preparing the profit and loss appropriation account, the following journal entries have to be recorded for various items:

Interest on Capital

Interest on Drawings

Partner’s Salary/Commission

Transfer to Reserve

Share of Profit or Loss on Appropriation (In case of Profit)

Share of Profit or Loss on Appropriation (In case of Loss)

Example 2:

Janat and Batool start a partnership on January 01, 2019. They contributed Rs. 80,000 and 70,000 respectively as their capital and decided to share profit and loss in the ratio of 4/6 and 2/6. The partnership deed provided that Janat is to be paid a salary of Rs. 3,000 per month and Batool a commission of 20% on net profit. It is also provided that interest on capital is allowed at 8 percent per annum and interest on drawing at 6% per annum. The drawings were Janat Rs. 10,000 and Batool Rs. 15,000. The net amount of profit as per profit and loss account for the year 2019 was 150,000.

Requirements: You are required to pass necessary journal entries relating to the appropriation of profit, prepare profit and loss appropriation account and partners’ capital accounts.