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Partnership Accounts/Accounting - Profit and Loss Appropriation

    • Impose a Financial liability
    • encumbrance
    A charge can be interpreted as a debit to the profit and loss account which represent an expenditure or loss. A charge will result in reduction of profits. All expenses and losses are a charge against profits.

    Salaries, Wages, Rent, Depreciation, Loss on Sale of Assets etc., are all charges against profits.

    • Give or assign profits for a particular person or cause
    • Setting aside profits for a specific purpose
    • reserve
    • set aside

    Profit appropriated is profit set aside for being used in the future for some purpose specified or unspecified. It is not for the purpose of an expenditure that has already been committed or incurred. For this reason, appropriation of profits does not result in a reduction of profits.

    Creation of reserves is an example of profit appropriation.

    Reserves are created by transferring credit balance (a certain amount of profit) from the profit and loss account to the reserve account.

    Journal
    Particulars Amount
    (Dr)
    Credit
    (Cr)
    General Reserve a/c Dr
    [For the amount transferred to the general reserve.]
    Reserves are created by charging profits. Creation of reserves is an appropriation of profits.
    • The Profit and Loss account is debited both while profits are charged as well as when profits are appropriated.
    • Creation of a reserve results in the profit being maintained/shown in two different accounts or profit being transferred to a different account.
    Explanation

    Profit for the year - 2,00,000.

    Profits ultimately are transferred to the capital accounts of the partners X and Y who have equal shares.

    Journal
    Profit and Loss a/c To X's Capital a/c
    To Y's Capital a/c
    Dr 2,00,000 1,00,000

    1,00,000

    Partners Capital a/c's
    DrCr
    Particulars X Y Particulars X Y
    To Balance c/d 3,45,000 4,20,000 By Bal b/d
    By P/L a/c
    2,45,000
    1,00,000
    3,20,000
    1,00,000
      1,96,450 2,50,700   3,45,000 4,20,000
          By Balance b/d 3,45,000 4,20,000

    The total capital of the firm would be

    Balance Sheet
    Liabilities Amount Amount Assets Amount Amount
    Capital 3,45,000

    4,20,000

    7,65,000

    If the partners come to an agreement that the profits so added to capital may be taken away by the partners and the partners take it away, the extra capital that is accumulated through profits would not be available for the purposes of business.

    Journal
    X's Capital a/c
    Y's Capital a/c
    Dr 1,00,000
    1,00,000

    2,00,000

    > 3,20,000

    Partners Capital a/c's
    DrCr
    Particulars X Y Particulars X Y
    To Bank a/c
    To Balance c/d
    1,00,000
    2,45,000
    1,00,000
    3,20,000
    By Bal b/d
    By P/L a/c
    2,45,000
    1,00,000
    3,20,000
    1,00,000
      3,45,000 4,20,000   3,45,000 4,20,000
          By Balance b/d 2,45,000

    The total capital of the firm would be

    Balance Sheet
    Liabilities Amount Amount Assets Amount Amount
    Capital 2,45,000

    3,20,000

    5,65,000

    This may be ok when the firm is making good amounts of profits and there is no need for additional capital. However if the organisation intends to retain certain amount of profit for the purposes of the business, it has two alternatives. Say the organisation intends to retain 80,000.

    • Distribute the profits and ensure that the owners take away only that much amount which would leave the additional capital that the organisation wants to retain.
      Partners Capital a/c's
      DrCr
      Particulars X Y Particulars X Y
      To Bank a/c
      To Balance c/d
      60,000
      2,85,000
      60,000
      3,60,000
      By Bal b/d
      By P/L a/c
      2,45,000
      1,00,000
      3,20,000
      1,00,000
        3,45,000 4,20,000   3,45,000 4,20,000
            By Balance b/d 2,85,000 3,60,000
      Balance Sheet
      Liabilities Amount Amount Assets Amount Amount
      Capital 2,85,000 3,60,000

      6,45,000

    • Make only the profits that the owners can take away available to them by creating a reserve out of profits.
      Journal
      Profit and Loss a/c Dr 80,000
      80,000
      X's Capital a/c
      Y's Capital a/c
      Dr 60,000
      60,000

      1,20,000

      Partners Capital a/c's
      DrCr
      Particulars X Y Particulars X Y
      To Bank a/c
      To Balance c/d
      60,000
      2,45,000
      60,000
      3,20,000
      By Bal b/d
      By P/L a/c
      2,45,000
      60,000
      3,20,000
      60,000
        3,05,000 3,80,000   3,05,000 3,80,000
            By Balance b/d 2,45,000 3,20,000
      General Reserve a/c
      DrCr
      Particulars Amount Particulars Amount
      To Balance c/d 80,000 By P/L a/c 80,000
        80,000   80,000
          By Balance b/d 80,000
      Balance Sheet
      Liabilities Amount Amount Assets Amount Amount
      Capital General Reserve 2,45,000 3,20,0005,65,000

      80,000

      The total capital 6,45,000 available to the organisation would be now represented by the partners capital account and the reserve together (5,65,000 + 80,000).

    Why Create Reserves?

    Theoretically the above situation can be managed even without creating a reserve. However the presence of the reserve account gives clear information relation to the profits that are meant to be used for some future purposes. The basic purpose of accounting is derivation of information. The more the information we need, the more the accounting heads we need to maintain.

    The balance in the reserve accounts also belong to the ownership. Capitals and Reserves together indicate the value that belongs to the ownership.


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