The net profit of a partnership is shared out between them according to the terms of their agreement. This sharing out is shown in a profit and loss appropriation account, which follows on from the profit and loss account itself.
The accounting entries are:
- Profit and loss account with net profit c/d – Debit
Profit and loss appropriation account with net profit b/d – Credit
- Profit and loss appropriation account – Debit
The current accounts of each partner – Credit
With an individual share of profits for each partner
The way in which profit is shared out depends on the terms of the partnership agreement. The steps to take are as follows.
- Step 1. Establish how much the net profit is.
- Step 2. Appropriate interest on capital and salaries first. Both of these items are an appropriation of profit and are not expenses in the profit and loss account.
- Step 3. If partners agree to pay interest on their drawings during the year
Current account – Debit
Appropriation of profit account – Credit
- Step 4. Residual profits, the difference between net profits plus any interest charged on drawings and appropriations for interest on capital and salaries is the residual profit. This is shared out between partners in the profit sharing ratio.
- Step 5. Each partner’s share of profits is credited to his current account.
- Step 6. The balance on each partner’s drawings account is debited to his current account.
In Practice each partner’s capital account will occupy a separate ledger account, as will his current account.