The Profit and Loss Appropriation Account is prepared by a partnership firm to distribute the net profit among partners according to the partnership deed or law. It is an extension of the Profit and Loss Account and deals only with appropriation of profit, not expenses. The account is credited with net profit and interest on drawings, and debited with interest on capital, partners’ salary, commission, and transfers to reserves. The remaining profit is then shared among partners in their profit-sharing ratio as mentioned in deed.
Journal Entries relating to Profit and Loss Appropriation Account:
1. For Transfer of Net profit:
The net profit from Profit and Loss A/c is transferred to Profit and Loss Appropriation A/c to appropriate and distributed among the partners. Net profit is credited to Profit and Loss Appropriation A/c.
2. For Interest on Drawings:
Drawings are amounts withdrawn by partners for personal use, either in cash or in kind. When cash is withdrawn, the partner’s Capital/Current Account is debited and Cash/Bank is credited; when goods are withdrawn, the partner’s account is debited and Purchases Account is credited. At the end, drawings are transferred to the partner’s Capital Account. Interest on drawings is charged only if stated in the partnership deed, calculated for the period of use, debited to the partner’s account, and credited to the Profit and Loss Appropriation Account
A. On Charging Interest on Drawings:
B. For Transferring Interest on Drawings to Profit and Loss Appropriation A/c:
Or, alternatively one entry can be passed:
3. For Interest on Capitals:
Interest on Capital is given to partners only when the Partnership Deed allows it. Interest on Capital is allowed at the given rate for the time period for which capital has been used. On the opening balance of the partner's capital, interest on capital is allowed. On additional capital being introduced or withdrawal of capital during the year, interest on capital is allowed for the period for which it has stayed in the business.
When the Partnership Deed is silent, interest on capital is not allowed. When Partnership Deed is silent as to the treatment of interest on capital as a charge against profit or appropriation, interest on capital is not allowed. When the business incurs a loss, interest on capital is allowed at the agreed rate in case of profit, and when the profit is less than the interest on capital to be provided, profit is distributed in the ratio of interest on capital of each partner.
A. On Allowing Interest on Capital:
B. For Transferring Interest on Capital to Profit and Loss Appropriation A/c:
Or, alternatively one entry can be passed:
4. For Partners' Salary/Commission:
Salary/Commission provided to partner if the Partnership Deed allows. Salary/Commission to partner is an appropriation out of profits and not a charge against profit. The commission is allowed to partners on either net profit before charging such commission or net profit after charging such commission.
A. On Salary/Commission Payable to Partners:
B. For Transferring Salary/Commission to Profit and Loss Appropriation A/c:
5. For Transfer to Reserve:
Reserve is a part of profit kept aside to meet uncertain future financial requirements. It is a fund created for purposes like strengthening the financial position, meeting the anticipated or specific liability, etc. After the appropriation of profit among the partners related to interest on capital, interest on drawings, salary/commission to partners, a part of the net profit is transferred to the reserve account. The Reserve A/c created is credited and the Profit and Loss Appropriation A/c is debited.
6. For Transfer of Credit Balance (being Profit):
Net profit after the appropriation of interest on drawings, interest on capital, partner's salary and commission, and transfer to reserve, is distributed among the partners in the profit sharing ratio. Partner's Capital ( Current A/c, if capital is fixed) A/c is credit and Profit and Loss A/c is debited.
Format of Profit and Loss Appropriation Account:
Illustration:
M, A and N started a business Man Ltd. with capitals ₹80,000, ₹50,000 and ₹65,000, respectively and agreed to share profit and losses in the ratio 5:3:4. Drawings made by the partners during the year were ₹ 7,100, ₹5,300 and ₹6,400, respectively. Net Profit for the year was ₹ 72,000 for the year ended on 31.3.2022. In the Partnership Deed, the following were mentioned:
1. Interest on capital to be allowed @ 7% p.a.
2. ₹ 9,500 p.a. salary to be paid to partners.
3. Interest on Drawings to be charged @ 5% p.a.
4. ₹ 13,000 to be transferred to Reserve.
Pass necessary Journal entries related to the division of profit and prepare Profit and Loss Appropriation A/c for the year ending on 31st March,2022.
Solution:
