Appropriation Account Definition
An appropriation account shows how we divide the firm’s Net profit, i.e., how much is used to pay income tax, how much is paid as a dividend to shareholders, and how much is set aside as retained earnings. It is mainly prepared by the partnership firm, Limited liabilityLimited LiabilityLimited liability refers to that legal structure where the owners' or investors' personal assets are not at stake. Their accountability for business loss or debt doesn't exceed their capital investment in the company. It is applicable in partnership firms and limited liability companies.read more Company (LLC), and government. Here we will discuss the Profit and loss appropriation account prepared by Partnership firms. Appropriations are made only when there are profits.
How does Appropriation Account Works?
The appropriation account is prepared after preparing Profit & Loss A/c. In the case of partnership firms, it is prepared to show how profits are distributed among the partners involved in the partnership.
In the case of LLC, the purpose of preparing this account is the same, but the format is different. We will start with the profit of the year before the taxation figure from which we will subtract corporate taxes and dividends to find the retained earnings for the yearRetained Earnings For The YearRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more.
In the case of government, the appropriation account is used to show the funds allocated to a specific project. Any expenses are reduced from the funds allocated.
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For eg:
Source: Appropriation Account (wallstreetmojo.com)
Profit and Loss (P&L) Appropriation Account
P&L Appropriation Account is prepared to show how the company appropriates or distributes the profit earned during the year. It is an extension of Profit and loss a/c. It is prepared after the preparation of profit and loss a/c at the end of every financial year.
The purpose is to allow the adjustments to be made to the profits so that the final income can be divided among the partners as per the agreed terms.
It is a nominal accountNominal AccountNominal Accounts are the general ledger accounts which are closed by the end of an accounting period. Their balance at the end of period comes to zero so they don't appear in the balance sheet.read more, which means all the expense items of the firm are debited, and income items are credited.
Format of Profit and Loss (P&L) Appropriation Account
Below is the format of the profit and loss appropriation account.
P&L Appropriation A/C for the Year Ended 31/12/XXXX
| Particulars | Debit Amount ($) | Particulars | Credit Amount ($) |
|---|---|---|---|
| Transfer to Reserves | XXXX | Net Profit (P&L) | XXXX |
| Interest on Capital | Interest on Drawings | ||
| – Partner A | XXXX | – Partner A | XXXX |
| – Partner B | XXXX | – Partner B | XXXX |
| Salary to Partner | XXXX | ||
| Commission to Partner | XXXX | ||
| Net Profit Transferred to Partner’s Account | |||
| – Partner A | XXXX | ||
| – Partner B | XXXX | ||
| Total | Total |
Following are the adjustments/items included in this account:
- Net Profit: This is the opening balance of appropriation a/c. This balance is taken from Profit & Loss a/c after making all the necessary adjustments for the period.
- Interest on Capital: It is the expense for the company as a partner will be paid interest on the amount of capital investedCapital InvestedInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash read more in the business.
- Interest on Drawings: It is an income for the company. The company will charge interest from the partner on any amount of capital withdrawn during the year.
- Partner’s Salary: It is pre-agreed as per the partnership deed and is an expense for the business.
- Partner’s Commission: It is pre-agreed as per the partnership deed and is an expense for the business.
- Net Profit transferred to Partner’s Account: This is the final profit amount after making all the above adjustments.
Example of Profit & Loss (P&L) Appropriation A/c
A & B started a partnership firm on 01.01.2017. They contributed $50,000 each as their capital. The terms of a partnership are as under:
- A& B to get monthly salary of $1,000 & $1,500 respectively
- B is allowed a commission at the rate of 5% of Net profit
- Interest on capital & drawings will be 10% p.a.
- Sharing of profit & Loss will be in the ratio of capital sharing.
The profit for the year ending 31.12.2018, before making the above appropriations, is $75,000. Drawings of A & B were $10,000 & $20,000 respectively. Prepare Profit & Loss Appropriation Account.
Solution
Working
WN 1 Interest on Capital @10% of the Capital Invested
- Partner A = 50000*10% = 5000
- Partner B = 50000*10% = 5000
WN2 Commission @5% of Net Profits
- Partner B = 75000*10% = 3750
WN3 Interest on Drawings @ 10% of Amount of Drawings
- Partner A = 10000*10% = 1000
- Partner B = 20000*10% = 2000
WN4 Net Profit divided among partners in ratio of their capital i.e 50% each
Partner A = (78000-(5000+5000+12000+18000+3750))/2
=17125
Partner B =(78000-(5000+5000+12000+18000+3750))/2
=17125
Importance of Appropriation Account
- This account shows the number of profits which can be divided among various heads.
- It shows the number of profits transferred to reserves, distributed as dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more.
- It gives information on how the profits are divided among partners and how the various adjustments are made during the year.
Conclusion
Hence, the appropriation account is used to show how the profits are appropriated or distributed among various heads. This account is prepared on behalf of the firm.
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