Accountancy · Ch 3 — Accounts of Partnership Firms – Fundamentals
Profit and Loss Appropriation Account
Profit and Loss Appropriation Account
Once the firm's Trading and Profit and Loss Account has been prepared in the ordinary way and the net profit for the year has been arrived at, a sole trader would simply add that net profit to his capital. A partnership cannot do this directly, because the net profit almost never belongs to the partners in one single, undivided lump — the deed usually promises several partners several different things out of it first (interest on capital, a salary, a commission, a transfer to reserve) before whatever is left over is divided in the profit-sharing ratio. The Profit and Loss Appropriation Account is the account that carries out this division. It is best understood as a direct continuation of the Profit and Loss Account — the net profit is transferred ("brought down") from the P&L Account into the Appropriation Account, and every appropriation is worked out and recorded there, never inside the P&L Account itself.
The reason the two accounts are kept strictly separate is conceptual, not just a matter of presentation: the Profit and Loss Account measures how much profit the business actually earned by running its trade — it is a measure of business performance. The Profit and Loss Appropriation Account decides how that already-measured profit is distributed among the owners under their private agreement — it is a division of spoils, not a further measurement of performance. Interest on capital, salary to a partner, and commission to a partner are not business expenses in the way rent or wages are; they are simply the partners' own agreed way of splitting what the business earned, which is exactly why they are kept out of the Trading and Profit and Loss Account and appear only in the Appropriation Account.
A Profit and Loss Appropriation Account is built up logically, item by item, in this order:
| Step | Item | Effect |
|---|---|---|
| 1 | Net Profit brought down from P&L A/c | Starting point (credit side) |
| 2 | Less Interest on Capital allowed to partners | Reduces amount available |
| 3 | Less Salary / Commission payable to partner(s) | Reduces amount available |
| 4 | Less Transfer to General Reserve, if the deed requires it | Reduces amount available |
| 5 | Add Interest on Drawings charged to partners | Increases amount available (it is income recovered from partners) |
| 6 | = Divisible Profit | The balance now shared in the profit-sharing ratio |
Note step 5 carefully: unlike every other appropriation, interest on drawings is charged to the partners and is therefore a gain to the firm — so it is added on the credit side of the Appropriation Account (increasing what is available to distribute), the exact opposite of interest on capital, salary, and reserve, which are all amounts the firm gives up. …
A nominal account, prepared immediately after (and as a continuation of) the Profit and Loss Account, that shows how the firm's net profit is distributed among the partners — interest on capital, salary/commission, transfer to reserve, interest on drawings, and finally the division of th …
The balance of net profit that remains after all appropriations (interest on capital, salary/commission, transfer to reserve) have been deducted and interest on drawings has been added back. This is the amount actually shared amon …
An amount set aside out of profit, before dividing the rest among partners, to strengthen the firm's financial position or meet future contingencies — treated as an appropriation of profit (debited in the Appropriati …