Distribution of Profit among Partners

The core purpose of a partnership is to share the fruits of the joint effort. Once the firm's profit or loss is calculated in the Profit and Loss Account, it cannot be directly divided among the partners. Several adjustments must be made first — interest on capital, interest on drawings, salary to partners, and commission to partners. These are not expenses of the business in the usual sense; they are appropriations of profit. To handle this, the firm prepares a special account called the Profit and Loss Appropriation Account.

This account starts with the net profit (or loss) from the Profit and Loss Account. All the adjustments that are a charge against profit (like partner's salary or commission) or an appropriation of profit (like interest on capital) are recorded here. The final balance — the residual profit or loss — is then distributed among the partners in their profit-sharing ratio.

If the partnership deed is silent on the profit-sharing ratio, the law steps in: profits and losses are shared equally by all partners.

The Profit and Loss Appropriation Account Format

The account is a two-sided ledger account. The debit side records all appropriations (what is taken out of the profit), and the credit side records the net profit brought in and any additions (like interest on drawings).

Key Adjustments Explained

1. Interest on Capital

Partners may be entitled to interest on the capital they have contributed. This is an appropriation of profit, not a charge against profit (unless the deed says otherwise). It is calculated as:

Interest on Capital = Capital × Rate of Interest × (Period/12)

If the partnership deed is silent, no interest on capital is allowed.

2. Interest on Drawings

If a partner withdraws money from the firm for personal use, the firm may charge interest on those drawings. This is a gain for the firm and is credited to the Profit and Loss Appropriation Account. It is calculated using either the Product Method or the Average Period Method.

• Product Method: Multiply each drawing amount by the number of months (or days) remaining until the end of the accounting year. Sum these products. Then, Interest = (Sum of Products × Rate × 1/12) for monthly periods.
• Average Period Method: Used when drawings are of a fixed amount made at regular intervals. Average Period = (Total of time periods)/Number of installments. Then, Interest = Total Drawings × Rate × (Average Period/12).

If the partnership deed is silent, no interest on drawings is charged.

3. Partner's Salary and Commission

A partner may be entitled to a salary or commission for managing the firm. This is also an appropriation of profit. It is debited to the Profit and Loss Appropriation Account and credited to the partner's capital or current account.

Journal Entries for Appropriations

The accounting entries for these adjustments are straightforward: