Partnership Account II – SS3 Book Keeping Lesson Note (Second Term)

A profit and loss appropriation account is a partnership account that shows how the net profit is shared among the partners and how much is kept in reserve.

Behavioural objectives

By the end of the lesson, students should be able to:

1. Define a profit and loss appropriation account.
2. State the items that appear in a profit and loss appropriation account.
3. Describe the format of a trading, profit and loss and appropriation account.
4. Prepare a trading, profit and loss and appropriation account from given figures.
5. Distinguish between the profit and loss account and the appropriation account.

What is a profit and loss appropriation account?

It is the account prepared after the profit and loss account to share the net profit among the partners.

• Starting point: it begins with the net profit or net loss from the profit and loss account.
• Sharing: the profit left is divided in the profit-sharing ratio.
• Basis: it follows the partnership agreement signed by the partners.
• Reserves: any amount the partners agree to keep in the business is also taken here.

Why is the profit and loss appropriation account important?

It shows clearly how the profit of the firm is distributed.

• Clear picture: every partner can see what was given to each partner and why.
• Fewer disputes: sharing follows the agreement, so conflicts among partners are reduced.
• Record of reserves: it shows how much profit was kept in the business.

What are the objectives of preparing the profit and loss appropriation account?

The account is prepared to show the adjustments between partners before the final profit is shared.

• Show adjustments: it shows interest on capital, partners’ salaries, commission and interest on drawings.
• Show reserves: it shows how much profit is transferred to reserves.
• Share profit: it divides the remaining profit among the partners in their profit-sharing ratio.

What are the features of the profit and loss appropriation account?

The account has four main features.

• Partnership only: it is prepared by partnerships (limited companies have a similar account).
• Order: it is prepared after the trading account and the profit and loss account.
• Agreement: it follows the partnership agreement.
• Reserves: amounts are transferred to reserves through this account.

What items appear in the profit and loss appropriation account?

The items are net profit, interest on drawings, interest on capital, partners’ salaries, reserves and the share of residual profit.

Credit side (additions)

• Net profit: brought down from the profit and loss account.
• Interest on drawings: charged to partners for money taken out, so it adds to the profit shared.

Debit side (deductions)

• Interest on capital: paid to partners for the capital they put in, usually as a percentage of capital.
• Partners’ salaries: paid to partners who work full time in the business, if the agreement allows.
• Commission: paid to a partner, if the agreement allows.
• Transfer to general reserve: profit kept in the business.
• Share of residual profit: the balance shared among partners in the profit-sharing ratio.

What if there is no partnership agreement?

• Profit sharing: profits and losses are shared equally.
• Interest on capital: none is allowed.
• Partners’ salaries: none are allowed.
• Interest on drawings: none is charged.

What is the format of a trading account and a profit and loss account?

These two accounts give the gross profit and the net profit used in the appropriation account.

Trading account

1. Start with sales, then subtract returns inwards to get net sales.
2. Add opening stock and purchases, then add carriage inwards.
3. Subtract returns outwards and closing stock to get the cost of goods sold.
4. Gross profit is net sales less cost of goods sold.

Profit and loss account

1. Start with the gross profit from the trading account.
2. Add other incomes, such as discount received.
3. Subtract expenses, such as rent, wages and discount allowed.
4. The balance is the net profit, carried to the appropriation account.

How do you prepare a profit and loss appropriation account?

Follow these steps in order.

1. Write down the net profit from the profit and loss account.
2. Add interest on drawings charged to each partner.
3. Deduct interest on capital for each partner.
4. Deduct partners’ salaries and commission.
5. Deduct any transfer to reserve.
6. Share the balance (residual profit) in the profit-sharing ratio.

Worked example

Ade and Bola share profits and losses in the ratio 3:2, and their net profit for the year is N60,000.

• Interest on capital: 10% a year on capital of N100,000 (Ade) and N50,000 (Bola).
• Salary: Bola receives N8,000 a year.
• Interest on drawings: Ade N1,000 and Bola N500.
• Reserve: N5,000 is transferred to general reserve.

Profit and loss appropriation account for the year

• Check: N20,100 plus N13,400 equals N33,500.

How does the profit and loss appropriation account differ from the profit and loss account?

The profit and loss account finds the net profit or loss of a business for a period.

The profit and loss appropriation account shares that net profit or loss among the partners.

Instructional techniques

• Identification
• Explanation
• Questions and answers
• Demonstration
• Videos from source

Instructional materials

• Videos
• Loudspeaker
• Textbook
• Pictures

Evaluation

1. What is a profit and loss appropriation account?
2. List four items that appear on the debit side of the appropriation account.
3. Describe the format of a trading account.
4. State four differences between the profit and loss account and the profit and loss appropriation account.

Classwork: As in the evaluation.

Assignment

Chike and Dayo share profits in the ratio 3:1 and the net profit for the year is N40,000. Interest on capital is 5% a year (Chike N80,000, Dayo N40,000). Dayo’s salary is N6,000 and N3,000 goes to general reserve. Prepare the profit and loss appropriation account and state each partner’s share of the residual profit.