Distribution of profit in partnership

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

Profits or losses, made by a firm should be divided among its partners in accordance with the provision of their Partnership Deed. However, if there is no written or oral agreement among the partners, the Law prescribes that profits and losses should be shared equally by the partners.
It is important to note that under the Law, no partner is entitled to get anything out of his firm except a share in profits. This means that whatever benefits or allowances the partners may be entitled to by the provisions of their partnership deed must be given to them out of firm’s profits only.
The implication of this statement is that no allowance or benefit allowed to a partner can be debited to the firm’s Profit and Loss Account. Thus if one of the partners is an active partner and their partnership deed allows him a salary of, say $600,000 per annum, this sum cannot be debited to the firm’s Profit and Loss Account as an expense. The Law does not recognize any payment made to a partner by his firm
as an expense.
At the end of each financial year, after the firm’s net profit (or loss) has been ascertained, i.e. after the firm’s Trading and Profit and Loss Account (or Income Statement) has been prepared, there is prepared an additional account, called Profit and Loss Appropriation Account. in which is shown the distribution of profit or loss among the partners. Entries appearing in this account may be summarised as follows:
Net Profit is transferred from Profit and Loss Account to Profit & Loss Appropriation Account by:

    • Debiting the Profit and Loss Account
    • Crediting the Profit and Loss Appropriation Account.

In case of a net loss:

  • Profit and Loss Appropriation Account is debited
  • Profit and Loss Account is credited.

Any benefit or allowance made to a partner (e.g. interest-on fixed capitals, salary, commission, bonus, etc.) is:

  • Debited to Profit and Loss Appropriation Account
  • Credited to Current Account of the relevant partner.

Any charge made by the firm on the partners (e.g. interest on drawings) is:

  • Debited to the Current Account of the relevant partner
  • Credited to Profit and -Loss Appropriation Account.

After the above adjustments have been made, the balance left on the Profit and Loss Appropriation Account represents a distributable profit or loss. If the balance is a credit balance. it represents a distributable profit which is:

  • Debited to Profit and Loss Appropriation Account
  • Credited to the Current Accounts of partners in their agreed profit and loss sharing ratio.

If the balance left on Profit and Loss Appropriation Account after the various appropriations is a debit balance, it represents a distributable loss which should be:

  • Debited to the Current Accounts of partners in their agreed profit and loss sharing ratio
  • Credited to Profit and Loss Appropriation Account.

Example:

The balances left in the ledger of John and Harry after they had prepared their Trading Account for the year ended 31 December 2018 is given below. Based on these balances and additional information given after it, prepare:

  • Firm’s Profit and Loss Account for the year 2018
  • Firm’s Profit and Loss Appropriation Account for the same year.
  • Partners’ Current Accounts, in ledger form
  • Firm’s Balance Sheet on 31 December 2018.

Distribution of profit in partnership
Additional Information:

  • 20% depreciation is to be provided on motor vehicles, furniture and fittings.
  • A provision for bad debts is to be created at 2% of debtors.
  • Loan was acquired on 1 July 2018 and carries 9% interest. No interest payment has been made in the year.
  • John is entitled to 10% of net profit as commission while Harry entitled to a monthly salary of $25,000.
  • 8% interest is to be allowed on fixed capitals and 10% interest is to be charged on drawings.
  • The balance of the profit or loss is to be shared in the ratio of 3:2 between John and Harry.

Solution:

Preliminary Calculations:
Depreciation on motor vehicles: 20% on $1,850,000 = $370,000.
Depreciation on furniture and fittings: 20% on $360,000 = $72,000
Provisions for Bad Debts: 2% of $1,200,000 = $24,000
Interest on Loan (for half a year): 1/2 x 9% of $1,000,000 = $45,000
Interest on Capitals: John: 8% of $2,000,000 = $160,000.
Harry: 8% of $1,500,000 = $120,000.
Interest on Drawings:John: 10% on $160,000 = $16,000.
Harry: 10% on $240,000 = $24,000.
Harry’s salary: $25,000 per month x 12 = $300,000 for the year.
Profit and loss account partnership
Profit and loss appropriation account partnership
Distribution of profit and loss in partnership
Distribution of profit in partnership 1
Balance sheet of distribution of profit in partnership

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