How to prepare the Profit and Loss Appropriation Account

Accounting for Partnerships

What you need

• The net profit (or net loss) for the financial year brought down from the Profit and Loss Account.
• The Partnership Agreement stating the rate of interest on capital, interest on drawings, the amount of partners' salaries and the profit-sharing ratio.
• Each partner's capital balance and the total of their drawings during the year.
• Each partner's Current Account to receive the transfer entries (double entry).

Step by step

1. 1

   Gather information and transfer the net profit

   Collect all information from the Partnership Agreement and transfer the net profit from the Profit and Loss Account to the credit side of the Appropriation Account. Example: Setia Jaya Partnership, owned by Amir and Bala, earned a net profit of RM60,000 for the year ended 31 December. Entry: Debit Profit and Loss Account RM60,000; Credit Appropriation Account RM60,000. This RM60,000 is the starting point before any distribution is made.

2. 2

   Add interest on drawings

   Interest charged on the partners' drawings increases the profit available for distribution, so it is recorded on the credit side of the Appropriation Account. Amir is charged interest on drawings of RM500 and Bala RM300, totalling RM800. Entry: Debit Current Account Amir RM500 and Debit Current Account Bala RM300; Credit Appropriation Account RM800. The accumulated profit is now RM60,000 + RM800 = RM60,800.

3. 3

   Deduct interest on capital

   Interest on capital rewards partners for the capital they invested, so it is an appropriation and is recorded on the debit side of the Appropriation Account. The rate is set at 5% per year. Amir's capital of RM80,000 gives interest of RM4,000 and Bala's capital of RM40,000 gives interest of RM2,000, totalling RM6,000. Entry: Debit Appropriation Account RM6,000; Credit Current Account Amir RM4,000 and Credit Current Account Bala RM2,000.

4. 4

   Deduct partners' salaries

   A partner's salary is not an expense in the Profit and Loss Account; it is an appropriation of profit, so it is recorded on the debit side of the Appropriation Account. In Setia Jaya Partnership, Bala receives a salary of RM6,000 per year because he manages the business full time. Entry: Debit Appropriation Account RM6,000; Credit Current Account Bala RM6,000.

5. 5

   Calculate the profit available for distribution

   Subtract all the debit-side appropriations from the accumulated profit to find the balance left to be shared in the ratio. Balance = accumulated profit RM60,800 - interest on capital RM6,000 - partners' salary RM6,000 = RM48,800. This RM48,800 is the residual profit to be shared according to the profit-sharing ratio.

6. 6

   Share the residual profit in the ratio

   Divide the residual profit according to the agreed sharing ratio, namely Amir : Bala = 3 : 2. Amir's share = 3/5 x RM48,800 = RM29,280 and Bala's share = 2/5 x RM48,800 = RM19,520. Entry: Debit Appropriation Account RM48,800; Credit Current Account Amir RM29,280 and Credit Current Account Bala RM19,520.

7. 7

   Check the balance and post to Current Accounts

   Make sure the debit-side total equals the credit-side total. Debit side = RM6,000 + RM6,000 + RM48,800 = RM60,800; credit side = RM60,000 + RM800 = RM60,800. The account balances. Finally, confirm that every item (interest on capital, salary, interest on drawings and share of profit) has been posted correctly to the respective partner's Current Account to complete the double entry.

Second example

Now consider Indah Maju Partnership, owned by Chin and Devi, with a net profit of RM30,000. The agreement allows no interest on capital or drawings; Chin receives a salary of RM8,000 per year; and the remaining profit is shared equally (1 : 1). The steps: transfer the net profit RM30,000 to the credit side of the Appropriation Account, then deduct Chin's salary of RM8,000 (Debit Appropriation Account RM8,000; Credit Current Account Chin RM8,000). The balance left is RM22,000.

The RM22,000 balance is split equally: Chin RM11,000 and Devi RM11,000 (Debit Appropriation Account RM22,000; Credit Current Account Chin RM11,000 and Credit Current Account Devi RM11,000). So Chin receives RM8,000 + RM11,000 = RM19,000 while Devi receives RM11,000. Notice that even though the residual is shared equally, the salary makes Chin's total larger. This is why salaries and interest are recorded separately first, before the residual profit is shared in the ratio.

Common mistakes

Related chapter: Accounting for Partnerships →

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