# Profit/Loss a/c - Appropriation of profits, Charge against profits

## Ascertaining Profits

### Transfer of balances between ledger accounts

Consider the transaction paid cash into bank 1,00,000.

The Journal entry to be recorded and the ledger accounts affected by the transaction would be

Journal in the books of ___ for the period from ___ to ___
DateR/V
No.
ParticularsL/FAmount
DebitCredit
Bank a/c
To Cash a/c
Dr. -
-
1,00,000
1,00,000
[For the amount of cash paid into bank.]

When there is available cash, Cash account has a debit balance.

Paying cash into bank will result in bank account being debited and cash account being credited.

This can be interpreted as

• Transferring a Debit balance from Cash account to Bank account.
• Transferring a Credit balance from Bank account to Cash account.
[Though a possibility, this is an inappropriate interpretation in this case.]

Dr Cash a/c Cr
Particulars Amount Particulars Amount
To Balance b/d
1,25,000

By Bank a/c
By Balance c/d
1,00,000
25,000
1,25,000 1,25,000
To Balance b/d 25,000
Dr Bank a/c Cr
Particulars Amount Particulars Amount
To balance b/d
To cash a/c
1,50,000
1,00,000
By Balance c/d
2,50,000

2,50,000 2,50,000
To Balance b/d 2,50,000
Transferring a debit balance from one account to another, results in the second (transferee) account being debited and the first (transferor) account being credited.

Transferring a debit balance from here to there, results in a debit there and a credit here.

Transferring a credit balance from one account to another, results in the second (transferee) account being credited and the first (transferor) account being debited.

Transferring a credit balance from here to there, results in a credit there and a debit here.

### Nominal Accounts to ascertain profits

The principle of debit and credit in relation to nominal accounts
- debit all expenses and losses, credit all incomes and gains.

From this principle we can conclude that the nominal accounts hold all the information relating to expenses, losses, incomes and gains.

Apart from the information relating to the expenses, losses, incomes and gains, organisations intend to know/have the information about the affect of these over a period. The net affect of expenses, losses, incomes and gains over a period is what we call the profit/loss for that period.

To obtain such information, they prepare one or more ledger accounts, at the end of the period, to which the balances in all the nominal accounts are transferred. Manufacturing a/c, Trading a/c, Profit and Loss a/c are all such accounts.

All nominal accounts are closed at the end of the accounting period by transfer to either the manufacturing a/c, trading a/c or profit and loss a/c as the case may be.

Since the information in these accounts is an aggregate of the information in the nominal accounts, we can say that these accounts are also nominal accounts.

Any account prepared to ascertain profits or losses out of a set of transactions is a nominal account.

Profits/Losses from Manufacturing a/c and Trading a/c are transferred to the profit and loss account. Manufacturing a/c and Trading a/c being nominal accounts are also closed by transferring the balance which represents either Manufacturing/Trading Gross Profit to the profit and loss account.

### Interpretation of Debits and Credit

Since the postings to Profit & Loss a/c are on account of a transfer, we can say that
• Debits to Profit & Loss a/c represents
1. transfer of debit balances from other nominal accounts to this account.
These postings represents expenses or losses.
2. transfer of credit balances to other nominal accounts
These postings represent transfer of profits.
• Credits to Profit & Loss a/c represents
1. transfer of credit balances from other nominal accounts to this account.
These postings represents incomes or gains.
2. transfer of debit balances to other nominal accounts
These postings represent transfer of losses.

## Charges against/on Profits

### Charge

#### Meaning

1. Assign a duty, responsibility or obligation to
2. Attribute responsibility to

1. Bind
2. Commit
3. Obligate
4. Entrust
5. Burden

### Charge on/against profits

A debit in a nominal account for ascertaining profits like the Trading and Profit and Loss account which represents a transfer of debit balance from some other nominal account (representing an expenditure or loss) to that account is said to be a charge on/against profits.

#### Example

Transfer of Salaries to Profit and Loss account i.e. closing the Salaries account by transfer to the profit and loss account at the end of the accounting period.
Journal in the books of ___ for the period from ___ to ___
DateR/V
No.
ParticularsL/FAmount
DebitCredit
Profit and Loss a/c
To Salaries a/c
Dr. -
4,50,000
4,50,000
[For closing the salaries account at the end of the accounting period by transfer to the profit and loss account.]

Ledger Show

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
...
...
To Salaries a/c

4,50,000

Dr Salaries a/c Cr
Particulars Amount Particulars Amount

...
...

-

By Profit & Loss a/c

4,50,000
4,50,000  4,50,000

Profit and Loss account will have a credit balance when there are profits. Transfer of expenditure i.e. debit balance from the salaries account to the profit and loss account will result in the the Profit and Loss account being debited and the salaries account being credited.

### Effect of Charge on Profit

The charge on/against profits would reduce the available profits or increase the existing losses.

When there is no charge on account of Salaries

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Interest
To Taxes
To Depreciation
To General Reserve
To Net Profit
2,50,000
12,40,000
14,00,000
2,10,000
50,000
22,50,000
By Gross Profit
54,00,000
54,00,000 54,00,000

When there is no charge on account of Salaries

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To General Reserve
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
50,000
18,00,000
By Gross Profit
54,00,000
54,00,000 54,00,000

But for the charge on account of salaries, the net profit would have been Rs. 22,50,000.

## Appropriation of Profits

### Appropriate

#### Meaning

1. Give or assign a resource to a particular person or cause
2. Setting aside money for a specific purpose

#### Synonyms

1. allocation
2. setting aside

### Appropriation of Profits

A debit in a nominal account for ascertaining profits like the Trading and Profit and Loss account which represents a transfer of credit balance from to some other nominal account (holding profits kept aside) is said to be an appropriation of profits. Such accounts to which credit balances (profits) are transferred to are generally named reserve, provision or fund.

Even these transfers of profits would reduce the available profits, but not in the real sense.

#### Example

Creation of General Reserve.
Journal in the books of ___ for the period from ___ to ___
DateR/V
No.
ParticularsL/FAmount
DebitCredit
Profit and Loss a/c
To General Reserve a/c
Dr. -
-
50,000
50,000
[For the amount of reserve created out of profits.]

Ledger Show

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
...
...
To General Reserve a/c

50,000

Dr General Reserve a/c Cr
Particulars Amount Particulars Amount

By Profit & Loss a/c

50,000

Profit and Loss account will have a credit balance when there are profits and a debit balance when there are losses. Transfer of profit i.e. credit balance from the profit and loss account to the General Reserve account will result in the General Reserve account being credited and the Profit and Loss account being debited.

Transfer of credit balance from one account to a second results in the second being credited, thereby increasing the credit balance in the second account.

### Effect of appropriation on Profit

The appropriation of profits would reduce the available profits or increase the existing losses.

When there is no appropriation to General Reserve

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
18,50,000
By Gross Profit
54,00,000
54,00,000 54,00,000

When profits have been appropriated to the general reserve

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To General Reserve
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
50,000
18,00,000
By Gross Profit
54,00,000
54,00,000 54,00,000

But for the appropriation to general reserve, the net profit would have been Rs. 18,50,000.

Both charge on profits and appropriation of profits would result in a debit to the profit and loss account resulting in a reduction in the available profit or increase in existing losses.

Appropriation would result in the profit being transferred to another account whereby we can say that the profits are being maintained in multiple accounts instead of a single account.

Appropriation is transfer from the profit and loss account and charge is transfer to the profit and loss account.

## Accruals to Profits

### Accrue

#### Meaning

2. Come into possession of

### Accrue to profits

A credit in a nominal account for ascertaining profits like the Trading and Profit and Loss account which represents a transfer of credit balance from some other nominal account (representing an income or gain) to that account is said to be an accrual of profit.

#### Example

Transfer of Commission Received to Profit and Loss account i.e. closing the Commission Received account by transfer to the profit and loss account at the end of the accounting period.
Journal in the books of ___ for the period from ___ to ___
DateR/V
No.
ParticularsL/FAmount
DebitCredit
To Profit and Loss a/c
Dr. -
14,000
14,000
[For closing the commission received account at the end of the accounting period by transfer to the profit and loss account.]

Ledger Show

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
...
...
...

14,000

Particulars Amount Particulars Amount

To Profit & Loss a/c

14,000

-
14,000  14,000

Profit and Loss account will have a credit balance when there are profits. Transfer of income i.e. a credit balance from the commission received account to the profit and loss account will result in the Commission Received account being debited and the Profit and Loss account being credited.

### Effect of Accrual on Profit

The accrual to profits would increase the available profits or reduce the existing losses.

When there is no accrual of profit on account of Commission Received

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To General Reserve
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
50,000
18,00,000
By Gross Profit
54,00,000
54,00,000 54,00,000

When there is accrual of profit on account of Commission Received

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To General Reserve
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
50,000
18,14,000
By Gross Profit
54,00,000
14,000
54,14,000 54,14,000

But for the accrual on account of commission received, the net profit would have been Rs. 18,00,000.

## Absorption of Losses

### Absorption

#### Meaning

1. Take up, as of debts or payments
2. Assimilate or take in

### Absorption of Losses

A credit in a nominal account for ascertaining profits like the Trading and Profit and Loss account which represents a transfer of debit balance to some other nominal account (holding profits kept aside or losses) is said to be an absorption of loss.

#### Example

Transfer of loss to Contingency Reserve.
Journal in the books of ___ for the period from ___ to ___
DateR/V
No.
ParticularsL/FAmount
DebitCredit
Contingency Reserve a/c
To Profit and Loss a/c
Dr. -
-
15,000
15,000
[For the amount of loss transferred to contingency reserve.]

Ledger Show

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
...
...

By Contingency Reserve a/c

14,000

Dr Contingency Reserve a/c Cr
Particulars Amount Particulars Amount

To Profit & Loss a/c

14,000

Profit and Loss account will have a credit balance when there are profits. Transfer of loss i.e. debit balance from the profit and loss account to the Contingency Reserve account will result in the Contingency Reserve account being debited and the Profit and Loss account being credited.

Transfer of debit balance from one account to a second results in the second being debited, thereby reducing the credit balance (or increasing the debit balance) in the second account.

### Effect of absorption on Net Loss

The absorption of loss would increase the available profits or reduce the existing loss.

When there is no absorption to Contingency Reserve

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
18,50,000
By Gross Profit
54,00,000
54,00,000  54,00,000

When loss has been absorbed by the contingency reserve

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
18,64,000
By Gross Profit
To Contingency Reserve
54,00,000
14,000
54,14,000  54,14,000

But for the absorption of loss by the contingency reserve, the net profit would have been Rs. 18,50,000.

Both accruals to profits and absorptions of losses result in a credit to the profit and loss account resulting in an increase in the available profit or a decrease in the existing loss.

Absorption would result in the loss being transferred to another account whereby we can say that the losses are being absorbed by multiple accounts instead of a single account.

Absorption is transfer from the profit and loss account and Accrual is transfer to the profit and loss account.

## Capital generated/accumulated through profits

### Core Profits/Losses from various activities

Manufacturing a/c, Trading a/c, Consignment a/c, Joint Venture a/c, Contract a/c etc., represent the ledger accounts used for ascertaining the core profit out of a certain kind of activity. Each of these account show up a certain amount of profit/loss which represents the core profit/loss from that activity.

An organisation may be carrying on one or more of such activities. Depending on the number of such activities being carried on by the organisation we find the relevant accounts in the books of accounts of the organisation.

#### Only one Profit/Loss account

Whatever may be the kind and number of such accounts being maintained by an organisation, there would be only one profit and loss account for an organisation.

All expenses/losses, incomes/gains that are not considered in such accounts are transferred to the profit and loss account.

All profits/losses revealed by such accounts are also transferred to the profit and loss account i.e. all such accounts (which are also nominal accounts) are closed at the end of the accounting period by transfer to the profit and loss account.

### Net Profit/Loss

Profit and loss account reveals the final profit/loss left with or made by the organisation from all the activities taken up by the organisation.

Profit and loss account is also a nominal account. It is closed at the end of the accounting period by transfer to the Capital account or the Profit and Loss appropriation account. This amount that has been transferred represents the capital accumulated through profits of the current accounting period.

### Appropriations and Absorptions

The appropriations of profits or absorptions of losses may be recorded through the profit and loss account directly in which case the postings relating to such appropriations and absorptions are present in the profit and loss account.
Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To General Reserve
To Special Reserve
To Goodwill Written off
To Discount on issue of Shares

To Net Profit
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
42,000
1,50,000
50,000
25,000
30,000

15,67,000
By Gross Profit
By Contingency Reserve

54,00,000
14,000
54,14,000  54,14,000

The Net Profit revealed by the Profit and Loss account would be the profit after appropriations and absorptions. The capital accumulated through the current period profits would be a figure that is different from the figure of net profit.

### Appropriations and Absorptions through Profit and Loss Appropriation account

Where the organisation intends to have a clear idea of the Net profit earned through operations and the net profit remaining after appropriations and absorptions, it would maintain a separate account by name Profit and Loss Appropriation account for the purpose.
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 Net Profit after taking into consideration all the charges and accruals would be transferred from the profit and loss account to the Profit and Loss account Appropriation account and the appropriations and absorptions are recorded through that account.

Dr Profit and Loss a/c Cr
Particulars Amount Particulars Amount
To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To Goodwill Written off
To Discount on issue of Shares

To Net Profit (unappropriated)
2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
42,000
25,000
30,000

17,53,000
By Gross Profit

54,00,000
54,14,000  54,14,000
Dr Profit and Loss Appropriation a/c Cr
Particulars Amount Particulars Amount
To General Reserve
To Special Reserve

To Net Profit
1,50,000
50,000

15,67,000
By Net Profit (unappropriated)
By Contingency Reserve

17,53,000
14,000
17,67,000  17,67,000

### Closing the appropriation account

The appropriation account may be treated like any other nominal account. It may be closed by transferring the balance to capital account. Every accounting period the appropriation account would be created afresh.
Dr Capital a/c Cr
Particulars Amount Particulars Amount
To Balance c/d

64,03,000

By Balance b/d
By Net Profit

48,36,000
15,67,000
64,03,000  64,03,000

Note: Of the opening balance of capital,

• Capital invested by owners - 15,00,000. Capital
• Capital accumulated through profits - 33,36,000.

Where the appropriation account is closed by transferring the balance to capital account, the capital accumulated through profits earned through operations gets added up to the capital account every year.

Balance Sheet of M/s ___ as on ___
Liabilities Amount Assets Amount
Capital
64,03,000
...
...

The information relating to the capital investment made by the ownership and the capital accumulated through profits may not be readily available in the balance sheet.

### Carrying forward appropriation account balance

The appropriation account may be treated as a special nominal account. Its balance may be carried forward to the subsequent accounting periods. It would be shown distinctly under capital and reserves on the liabilities side of the balance sheet.
Dr Profit and Loss Appropriation a/c Cr
Particulars Amount Particulars Amount
To General Reserve
To Special Reserve

To Net Profit
1,50,000
50,000

49,03,000
By Balance b/d
By Net Profit (unappropriated)
By Contingency Reserve

33,36,000
17,53,000
14,000
51,03,000  51,03,000
By Balance b/d 49.03,000

In such a case, the capital accumulated through profits earned through operations over the various accounting periods gets accumulated in the appropriation account and the Capital account balance indicates the amount of capital brought in by the organisational ownership.

Dr Capital a/c Cr
Particulars Amount Particulars Amount
To Balance c/d

15,00,000

By Balance b/d

15,00,000
15,00,000  15,00,000
Balance Sheet of M/s ___ as on ___
Liabilities Amount Assets Amount
Capital
Profit and Loss Appropriation
15,00,000
49,03,000
...
...

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