Content Standard 13.2

Profit and Loss Appropriation Account

Akaun Pengasingan Untung Rugi

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Explanation

The Profit and Loss Appropriation Account is an additional account prepared by a partnership after the Income Statement (the Profit and Loss Account) is completed. Its purpose is to separate and distribute the net profit (or net loss) of the business among all partners according to the terms agreed in the Partnership Agreement (Ikatan Perkongsian). Unlike a sole proprietorship, where profit flows directly to a single owner's Capital Account, a partnership has more than one owner, so profit must be shared fairly after accounting for special rewards such as interest on capital, salary and bonus. This account is prepared as a continuation of the Income Statement, not as part of the Trading Account.

The format begins with net profit brought down from the Income Statement on the credit side. Interest on drawings charged to the partners is then added. Next, the amounts due to partners before the profit is shared are deducted, namely interest on capital, partners' salary or allowance, and bonus. The remaining balance is called the residual profit (distributable profit) and is shared among the partners in the profit-sharing ratio. Each item has a double entry whose opposite side is recorded in each partner's Current Account (Akaun Semasa), because the Current Account records annual dealings such as salary, interest, drawings and share of profit.

Interest on capital (faedah atas modal) is a reward to partners for investing capital in the business; it is calculated as a fixed percentage of the partner's capital balance (usually the opening capital, unless stated otherwise). Salary, allowance and bonus reward partners who work in or contribute more to the business. Both are appropriations of profit, not real business expenses, so they are recorded in the Appropriation Account and not the Income Statement. The entry is: Debit Profit and Loss Appropriation Account; Credit partner's Current Account. Interest on drawings (faedah atas ambilan) is charged to partners for withdrawing cash or goods for personal use; it increases the distributable profit, with the entry Debit partner's Current Account; Credit Profit and Loss Appropriation Account.

Interest on a partner's loan (faedah atas pinjaman pekongsi) must be carefully distinguished from interest on capital. When a partner lends money to the partnership (separate from capital), the interest on that loan is a business expense. It is therefore recorded in the Income Statement (the Profit and Loss Account) as an expense, before the net profit is transferred to the Appropriation Account. The entry is: Debit Interest on partner's loan (Profit and Loss Account); Credit partner's Current Account (or paid in cash). As a result, this loan interest reduces the net profit that will be distributed, whereas interest on capital, salary and bonus merely divide up the profit that already exists.

The final step is to distribute the profit, that is, to share the distributable profit in the profit-sharing ratio. If the Partnership Agreement is silent on the ratio, the Partnership Act provides that profit is shared equally. The simple formula is: Net profit plus interest on drawings, minus interest on capital, minus salary/allowance/bonus, equals distributable profit; then divide by the ratio. Each partner's share of profit is recorded as Debit Profit and Loss Appropriation Account; Credit partner's Current Account. Students must make sure both sides of the account balance and that every appropriation is transferred accurately to the correct partner's Current Account.

Worked examples

Example 1: Preparing the Appropriation Account (Maju Jaya Enterprise)

Aminah and Bakri are partners in Maju Jaya Enterprise (a fictional business). Net profit for the year ended 31 December is RM60,000. Opening capital: Aminah RM80,000, Bakri RM40,000. Interest on capital is 5% per year. Bakri is entitled to a salary of RM12,000 a year. Interest on drawings: Aminah RM500, Bakri RM400. Profit-sharing ratio 3:2.

Interest on capital: Aminah 5% x RM80,000 = RM4,000; Bakri 5% x RM40,000 = RM2,000. Entry: Debit Profit and Loss Appropriation Account RM6,000; Credit Aminah's Current Account RM4,000 and Bakri's Current Account RM2,000.

Bakri's salary RM12,000: Debit Profit and Loss Appropriation Account RM12,000; Credit Bakri's Current Account RM12,000. Interest on drawings RM900: Debit Aminah's Current Account RM500 and Bakri's RM400; Credit Profit and Loss Appropriation Account RM900.

Distributable profit = RM60,000 + RM900 - RM6,000 - RM12,000 = RM42,900. Sharing 3:2: Aminah 3/5 x RM42,900 = RM25,740; Bakri 2/5 x RM42,900 = RM17,160. Entry: Debit Profit and Loss Appropriation Account RM42,900; Credit Aminah's Current Account RM25,740 and Bakri's Current Account RM17,160.

Example 2: Effect of interest on a partner's loan (Seri Delima Enterprise)

Chong and Devi are partners in Seri Delima Enterprise (a fictional business). Profit before loan interest is RM50,000. Chong lends RM20,000 to the partnership at 6% interest per year. Profit is shared equally.

Interest on the partner's loan = 6% x RM20,000 = RM1,200. Because this is a business expense, it is recorded in the Income Statement: Debit Interest on partner's loan RM1,200; Credit Chong's Current Account RM1,200. Net profit after this expense = RM50,000 - RM1,200 = RM48,800, transferred to the Appropriation Account.

No interest on capital or salary is stated, so distributable profit = RM48,800. Shared equally: Chong RM24,400; Devi RM24,400. Entry: Debit Profit and Loss Appropriation Account RM48,800; Credit Chong's Current Account RM24,400 and Devi's Current Account RM24,400. Note that Chong receives RM1,200 loan interest in addition to his share of profit.

Practice

State the purpose of the Profit and Loss Appropriation Account and explain why interest on a partner's loan is not included in this account.

Answer: The purpose of the Profit and Loss Appropriation Account is to distribute the net profit (or net loss) of the partnership among all partners according to the terms of the Partnership Agreement, that is, after accounting for interest on capital, salary/allowance/bonus and interest on drawings. Interest on a partner's loan is not included in this account because it is a business expense, not an appropriation of profit. It is therefore recorded in the Income Statement (the Profit and Loss Account) before net profit is transferred to the Appropriation Account. The entry is Debit Interest on partner's loan; Credit the lending partner's Current Account.

Farah and Gopal share profit 2:1. Net profit is RM45,000. Capital: Farah RM60,000, Gopal RM30,000; interest on capital 5%. Gopal's salary RM9,000. Interest on Farah's drawings RM600. Calculate distributable profit and each partner's share of profit.

Answer: Interest on capital: Farah 5% x RM60,000 = RM3,000; Gopal 5% x RM30,000 = RM1,500; total RM4,500. Distributable profit = RM45,000 + RM600 (interest on drawings) - RM4,500 (interest on capital) - RM9,000 (salary) = RM32,100. Sharing 2:1: Farah 2/3 x RM32,100 = RM21,400; Gopal 1/3 x RM32,100 = RM10,700. Distribution entry: Debit Profit and Loss Appropriation Account RM32,100; Credit Farah's Current Account RM21,400 and Gopal's Current Account RM10,700.

Hafiz and Ismail share equally. Profit before any adjustment is RM40,000. Ismail lends RM25,000 to the partnership at 8% per year. There is no interest on capital or salary. Show the treatment of the loan interest and the final profit distribution.

Answer: Interest on the partner's loan = 8% x RM25,000 = RM2,000. This is a business expense, recorded in the Income Statement: Debit Interest on partner's loan RM2,000; Credit Ismail's Current Account RM2,000. Net profit after the expense = RM40,000 - RM2,000 = RM38,000, transferred to the Appropriation Account. Distributable profit = RM38,000. Shared equally: Hafiz RM19,000; Ismail RM19,000. Ismail receives RM2,000 loan interest in addition to his RM19,000 share of profit.

Explain the double entry for (i) interest on capital and (ii) interest on drawings, and describe the effect of each on distributable profit.

Answer: (i) Interest on capital: Debit Profit and Loss Appropriation Account; Credit partner's Current Account. It reduces distributable profit because it is allocated to partners before the residual is shared. (ii) Interest on drawings: Debit partner's Current Account; Credit Profit and Loss Appropriation Account. It increases distributable profit because it is charged to partners as a penalty for making drawings. In short, interest on capital reduces distributable profit while interest on drawings increases it.

Exam tips

Key terms

Profit and Loss Appropriation Account: The account that distributes a partnership's net profit among partners according to the Partnership Agreement.
Interest on capital: A reward to partners for investing capital, calculated as a percentage of the capital balance; it is an appropriation of profit.
Interest on drawings: A charge on partners for making drawings; it increases the distributable profit.
Distributable profit: The residual profit after interest on capital, salary and bonus, which is shared in the profit-sharing ratio.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 5

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