# Appropriation

• Give or assign a resource to a particular person or cause
• Setting aside Money for a specific purpose
• reserve
• set aside

In a partnership firm, the act of distributing profits among the partners is identified as Appropriation of profits.

# Factors of Production and Returns

In economic terms, the four basic factors of production are Land, Labour, Capital and Organisation. Each of these factors would be compensated by sharing a part of the income earned. What a factor gets as its share is what is called the return for the factor.
• Rent is the return for Land;
• Wages are the returns for Labour/Labor;
• Interest is the return for Capital; and
• Profits are the returns for the Organisation.
Thus profit earned by the partnership firm can be said to be the returns earned by the Organisation.

In case of a sole proprietary concern, there is only a single person who contributes the capital of the organisation (the sole proprietor) and as such all the organisation's returns belong to the owner. For this reason the net profit is generally transferred to the Capital a/c in total.

In case of a partnership firm there would be two or more persons contributing the capital of the organisation and as such the organisation's returns have to be equitably distributed among them.

# Organisation - Partnership Firm

Land, Labour and Capital are factors of production which we see or feel.

Organisation is an intangible factor that combines these three factors to achieve the intended objective. Organisation in one way can be understood as, the efforts made by those who have contributed capital in conducting the affairs of the organisation to achieve its objectives. These efforts may take many different forms.

# What constitutes Organisation in a Partnership Firm

In a partnership firm partners contribute capital. They also make contributions to the organisation in many other forms. All the contributions other than capital that partners contribute to the firm constitute the factor we call Organisation.

Partners contribution to the firm takes many different forms which may be tangible or intangible. Some of them are

• ## Time

Partners spend their time and efforts in working for the firm by looking after the day to day affairs of the firm. This contribution may be full time, part time or intermittent.

Partners through their personal contacts in the society bring in customers which may result in more sales.
• ## Intelligence

Partners use their intelligence and abilities in various situations like in solving problems faced by the firm, tiding over tough situations, overcoming competitions etc.

## Why is not Capital included

We do not consider the Capital contributed by the partners as a part of the factor organisation, since Capital itself is considered a distinct factor.

## Varied Contributions of Partners towards the Organisation

Since no two beings can be having with the same capabilities, the contributions made by the partners for the factor called organisation varies from partner to partner. Each partner contributes according to his/her abilities and possibilities.

# Remunerating the Factors of Production in a Partnership Firm

We are limiting our discussion to remunerating the two factors of production Capital and Organisation only.

# Judicious Distribution of the Firms Profits

A, B and C are partners in a firm. The firm has made a profit of 3,00,000. What would be the judicious share of profit to be distributed to each partner A, B and C.

## Share Equally

A, B and C sharing 1,00,000 each.

This sounds prudent if the contributions of A, B and C towards the firm is the same in all respects.

Say, A, B and C
• are of the same intelligence level,
• work for the same time for the firm,
• have contributed the same amount of Capital for the firm,
• are having more or less the same contacts outside through which sales are generated,
• have all withdrawn the same amounts of money for their personal uses (drawings)

In such a situation it would be appropriate to give each an equal share.

# when equal Share is not Judicious

Practically, contributions of all the partners being equal in all respects being a no possibility, sharing the profits of the firm equally amongst partners would not be the judicious way. In such cases we would try to adjust for the differences in the following ways.

# Unequal Capital Contributions

The Capital Contributed by A, B and C is 2,00,000, 75,000 and 1,00,000 respectively. Now, since A, B and C have contributed varied amounts of Capital towards the firm, it would not be appropriate to share the profits equally among them.

## Compensate by paying Interest on Capital.

Compensate for the uneven contributions towards capital by paying interest on their capital contributions. Greater the Capital contributed, greater the interest earned. This would set right the difference in contributions in the form of capital.

Profit equal to the total "Interest on Capital" on all the capital of the firm is set aside and is distributed to the partners in the ratio of their capitals.

Rest of the profits can be shared equally if all other contributions are equal.

# Unequal time and efforts

B works full time in the firm and A and C are passive partners. Now, since A, B and C have contributed varied amounts of time and efforts in conduce of the affairs of the firm, it would not be appropriate to share the profits equally among them.

## Compensate by paying Salary to Partner.

Compensate for the uneven contributions of time and efforts towards the firm by paying salary to partner. The salary paid to B would be compensation for his greater contribution.

Profit equal to the total "Salary to Partners" to all the partners who have made a contribution in this respect is set aside and is distributed to them in proportion to the value of their contributions as agreed upon between partners.

Rest of the profits can be shared equally if all other contributions are equal.

# Public Relations/Contacts

C has greater contacts in the outside world, a lot of customers are C's contacts. Now, the contribution of C towards the sales of the firm through his contacts is greater than that of A and B. Therefore, it would not be appropriate to share the profits equally among them.

## Compensate by paying Commission to Partner.

Compensate C for providing more customers to the business by paying commission on sales. The commission paid to C for sales made to customers who are his contacts would be compensation for his greater contribution.

Profit equal to the total "Commission to Partners" to all the partners who have made a contribution in this respect is set aside and is distributed to them in proportion to the value of their contributions as agreed upon between partners.

Rest of the profits can be shared equally if all other contributions are equal.

# Drawings

The Drawings of A, B and C are respectively, 2,000, 15,000 and 5,000 respectively.

Assume that drawings are being recorded using the 'Drawings a/c' which is the general convention. Therefore, the Capital a/c balances are not affected by drawings made by partners.

The net capital contribution at any time can be obtained by setting off the Capital a/c and Drawings a/c balances.

The net capital account balances of the partners are not in proportion to their capital account balances. Therefore paying interest on capital based on capital account balances would be unjust.

## Remedy - charge Interest on Drawings.

Greater the drawings greater the interest payable by the partners. This would compensate the unevenness in drawings made by the partners.

# Remunerating Organisation = distributing Profits

As can be seen, Interest on Capital, Salary to Partners, Commission to Partners, etc., are all paid out of profits made and as such form appropriations of profits. All these appropriations are intended to ensure an equitable distribution of profits among the partners based on their contributions for the firm.

All the contributions other than capital together are identified as 'organisation' and it is rightly said that remuneration for organisation is profit.

# Profit Distribution - Accounting Treatment

Consider the following information in relation to M/S ABC and CO., a partnership firm with A, B and C as partners.

## Illustration : Problem

1. Net Profit - 3,74,000
2. Interest on Capital @ 5% - A : 10,000; B : 3,750 and C : 5,000
3. Salary to Partner - B : 24,000
4. Commission to Partner - C : 52,000
5. Interest on Drawings @ 5% - A : 1,000; B : 100 and C : 750

## Illustration : Solution

Since Interest on Capital, Salary to Partners etc., are arrangements in the process of distribution of profit, they are to be made after ascertaining profits. Accounting for the distribution of profits among partners is a process that follows the ascertainment of net profits.

P/L a/c and the Partners Capital accounts would be as below.

Profit and Loss a/c
DrCr
Particulars Amount Amount Particulars Amount Amount

To Net Profit

3,74 ,000

21,33,000     21,33,000
To A's Cap
(interest on capital)
To B's Cap
(interest on capital)
To C's Cap
(interest on capital)
To B's Cap (salary)
To C's Cap (commission)

To balance c/d
(distributable profit)
10,000

3,750

5,000

24,000
52,000

18,750

24,000
52,000

2,81,100
By Net Profit b/d
By A's Cap
(interest on drawings)
By B's Cap
(interest on drawings)
By C's Cap
(interest on drawings)

1,000

100

750
3,74,000

1,850
3,75,850     3,75,850
To A's Cap
(share of profit)
To B's Cap
(share of profit)
To C's Cap
(share of profit)
93,700

93,700

93,700

2,81,100
By balance b/d
(distributable profit)
2,81,100
2,81,100     2,81,100
Partners Capital a/c's
DrCr
Particulars A B C Particulars A B C
To P/L a/c
(Interest on
drawings)
To Drawings

To Balance c/d
1,000

20,000

2,82,700
100

2,000

1,94,350
750

15,000

2,34,950
By Bal b/d
By P/L a/c
(Interest on
capital)
By P/L a/c
(salary)
By P/L a/c
(commission)
By P/L a/c
(profit)
2,00,000
10,000

93,700
75,000
3,750

24,000

93,700
1,00,000
5,000

52,000

93,700
3,03,700 1,96,450 2,50,700   3,03,700 1,96,450 2,50,700
By Balance b/d 2,82,700 1,94,350 2,34,950

## Note

• Since all the amounts are being transferred from the Profit and Loss a/c, the journal entry for recording any appropriation of profit to the partners capital account would be the same.

For the interest on capital payable or salary payable or share of profit to B, the journal entry would be

Journal
Particulars Amount
(Dr)
Credit
(Cr)
Profit and Loss a/c
To B's Capital a/c
Dr

For the interest on drawings payable by B, the journal entry would be

Journal
Particulars Amount
(Dr)
Credit
(Cr)
B's Capital a/c
To Profit and Loss a/c
Dr

The additional wordings written within brackets are written to provide a hint to us while working out problems. In practical situations such wordings are not present and if this approach is adopted, all the postings would look the same.

• # Distribution of Profits among Partners

Partners profit sharing ratio  A : B : C = 1 : 1 : 1 = $\frac{1}{3}:\frac{1}{3}:\frac{1}{3}$

Partners Share of Profits = Distributable Profit × Profit Sharing Proportion.

Therefore

 A's Share : $2,81,100×\frac{1}{3}$ = 93,700 B's Share : $2,81,100×\frac{1}{3}$ = 93,700 C's Share : $2,81,100×\frac{1}{3}$ = 93,700 2,81,100
• The account is balanced to carry down the distributable profit so that we can have the figure which is to be used for calculating the partners share of profits.

# Ledger Postings - Unavailability of information

Since all the transactions relating to appropriations of profits to partners are posted using the same journal entry, all the postings relating to these entries would appear the same, both in the Profit and Loss a/c as well as the Partners Capital a/c's.
Profit and Loss a/c
DrCr
Particulars Amount Amount Particulars Amount Amount
To A's Cap a/c
To B's Cap a/c
To C's Cap a/c
To B's Cap a/c
To C's Cap a/c
To balance c/d
10,000
3,750
5,000

18,750
24,000
52,000
2,81,100
By Net Profit b/d
By A's Cap
By B's Cap
By C's Cap

1,000
100
750
3,74,000

1,850
3,75,850     3,75,850
To A's Cap
To B's Cap
To C's Cap
93,700
93,700
93,700

2,81,100
By balance b/d   2,81,100
2,81,100     2,81,100
Partners Capital a/c's
DrCr
Particulars A B C Particulars A B C
To P/L a/c
To Drawings
To Balance c/d
1,000
20,000
2,82,700
100
2,000
1,94,350
750
15,000
2,34,950
By Bal b/d
By P/L a/c
By P/L a/c
By P/L a/c
By P/L a/c
2,00,000
10,000

93,700
75,000
3,750
24,000

93,700
1,00,000
5,000

52,000
93,700
3,03,700 1,96,450 2,50,700   3,03,700 1,96,450 2,50,700
By Balance b/d 2,82,700 1,94,350 2,34,950

The only conclusion that can be drawn straight away reading the postings would be that there is a transfer to or from the Profit and Loss a/c.

# Information not available

From a ledger account, we would be able to identify the reason for a debit or credit posting by the posting itself except in very exceptional cases. In this case, it is impossible to reach a conclusion straight away, as a posting is capable of being interpreted in different ways.

A debit reading 'To B's Cap' in the Profit and Loss account or 'By P/L a/c' in B's Capital account would mean interest on capital, salary to partner or share of profit payable to B

# Solution !!

To derive the information that we need we create additional account heads and flow the information through those accounts to enable providing a clearer picture.

The basic purpose of accounting is derivation of information. The more information we need, the more accounting heads we need to maintain.

To segregate transactions relating to transfer of profits to partners from the other transactions that affect the profit and loss account, we use a ledger account by name 'Profit and Loss Appropriation a/c'.

# Classification of Debits to Profit and Loss account

If we consider a single profit and loss account in use, we can classify all the debits being made to the account into two as
• # Charge on/against Profits

• 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.

• # Appropriation of Profit

• 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
To Profit and Loss 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.

 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
X
Y

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.

 X's Capital a/c Y's Capital a/c To Bank a/c Dr 1,00,000 1,00,000 2,00,000
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 3,20,000

The total capital of the firm would be

Balance Sheet
Liabilities Amount Amount Assets Amount Amount
Capital
X
Y

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.

• ## Restrict Capital from being taken away

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
X
Y

2,85,000
3,60,000

6,45,000
• ## Create Reserve

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

2,45,000
3,20,000

5,65,000
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.

# Interest on Capital, Salary, Commission etc., to Partners - Appropriations

Distribution of profit to partners is appropriation of profits. It can be understood as profit being kept aside to be given to the owners as a return for their contributions.

"Interest on Capital", "Salary to Partners", 'commission to partners' etc., paid to partners are different methods adopted to compensate their varied contributions to ensure equitable distribution of profits. Therefore all these payments made to partners would also be appropriations of profits and do not constitute a charge against profits.

# Segregating charges and appropriations

To segregate charges and appropriations of profits being made to the profit and loss account, the P/L a/c is divided into two by creating a new account by name "Profit and Loss Appropriation a/c".

The net profit is transferred to "P & L Appropriation a/c" and all the appropriations are made from this account.

Profit and Loss a/c
DrCr
Particulars Amount Particulars Amount

To Net Profit

3,74 ,000

21,33,000   21,33,000
Profit and Loss Appropriation a/c
DrCr
Particulars Amount Amount Particulars Amount Amount
To A's Cap
(interest on capital)
To B's Cap
(interest on capital)
To C's Cap
(interest on capital)
To B's Cap (salary)
To C's Cap (commission)

To balance c/d
(distributable profit)
10,000

3,750

5,000

24,000
52,000

18,750

24,000
52,000

2,81,100
By Net Profit b/d
By A's Cap
(interest on drawings)
By B's Cap
(interest on drawings)
By C's Cap
(interest on drawings)

1,000

100

750
3,74,000

1,850
3,75,850     3,75,850
To A's Cap
(share of profit)
To B's Cap
(share of profit)
To C's Cap
(share of profit)
93,700

93,700

93,700

2,81,100
By balance b/d
(distributable profit)
2,81,100
2,81,100     2,81,100
Partners Capital a/c's
DrCr
Particulars A B C Particulars A B C
To P/L Appr a/c
(Interest on
drawings)
To Drawings

To Balance c/d
1,000

20,000

2,82,700
100

2,000

1,94,350
750

15,000

2,34,950
By Bal b/d
By P/L Appr a/c
(Interest on
capital)
By P/L Appr a/c
(salary)
By P/L Appr a/c
(commission)
By P/L Appr a/c
(profit)
2,00,000
10,000

93,700
75,000
3,750

24,000

93,700
1,00,000
5,000

52,000

93,700
3,03,700 1,96,450 2,50,700   3,03,700 1,96,450 2,50,700
By Balance b/d 2,82,700 1,94,350 2,34,950

# What difference does using Appropriation a/c make ?

Using P & L Appropriation account would enable us to view all the information relating to appropriation of profits in a separate account. But, when we come to reading the postings in the appropriation account as well as the Capital accounts, the only difference we can see is that "P & L a/c" is replaced by "P & L Appropriation a/c" in the Capital accounts.

## absence of information

Even after replacing the P & L a/c with the P & L appropriation a/c, we will not get the information as to the reason for which the debits and credits are being made in the capital accounts. The postings can only be interpreted as transfer from or to profit and loss appropriation account whereby we can say that they are related to appropriations. But we will not be able to identify which posting is on account of what transaction straight away from the posting.

# Transfer through Intermediary Accounts

The basic purpose of accounting is derivation of information. The more information we need, the more accounting heads we need to maintain.

To derive the information that we need we create additional ledger accounts. A distinct ledger account for each kind of appropriation being made is maintained. The total amount to be appropriated for that purpose is first transferred to that account. Each partner is credited/debited his/her share by transferring his/her relevant share from that account.

Consider Interest on capital payable to partners.

• An Intermediary account by name "Interest on Capital" would be created. The account head would be indicative of the reason for appropriation.
• The interest on capital payable to partners as a whole would be transferred from the "Profit and Loss Appropriation a/c" to the "Interest on Capital a/c" and
• From the "Interest on Capital a/c" the interest payable to each partner is transferred to his/her Capital a/c.
Journal
Particulars Amount
(Dr)
Credit
(Cr)
Profit and Loss Appropriation a/c
To Interest on Capital a/c
Dr 18,750
18,750
[For the total amount of interest on capital payable to partners appropriated from profits.]
Interest on Capital a/c
To A's Capital a/c
To B's Capital a/c
To C's Capital a/c
Dr 18,750

10,000
3,750
5,000
[For the interest payable to each partner transferred to his Capital account.]

If this is done the postings in the "Profit and Loss Appropriation a/c" would read "To Interest on Capital" and in the Partners Capital Accounts would read "By Interest on Capital". This would give a clear understanding on the entries that are posted.

One should note that the "Interest on Capital a/c" being a intermediary account is raised and written off immediately, thus having nil balance. If we assume presence of intermediary accounts, we can use meaningful phrases to represent postings in ledger accounts.

# Common Intermediary accounts

The most common Intermediary accounts used are
• # Interest on Capital

For recording Interest on Capital Payable to Partners
• # Interest on Drawings

For recording Interest on Drawings Charged to Partners
• # Salary to Partners

For recording Salary payable to partners
• # Commission to Partners

For recording Commission payable to partners
• # Brokerage to Partners

For recording Brokerage payable to partners
• # Share of Profits

For recording the share of distributable profits credited to partners.

## Illustration

Postings in the "Profit and Loss Appropriation a/c" and the "Partners Capital Accounts" using the above controlling accounts would read
Profit and Loss Appropriation a/c
DrCr
Particulars Amount Particulars Amount
To Interest on Capital
To Salary to Partners
To Commission to Partners
To Distributable profits
18,750
24,000
52,000
2,81,100
By Net Profit b/d
By Interest on drawings
3,74,000
1,850
3,75,850   3,75,850
Interest on Capital a/c
DrCr
Particulars Amount Particulars Amount
To A's Capital
To B's Capital
To C's Capital
10,000
3,750
5,000
By Profit and Loss Appr 18,750
18,750   18,750
Salary to Partners a/c
DrCr
Particulars Amount Particulars Amount
To B's Capital 24,000 By Profit and Loss Appr 24,000
24,000   24,000
Commission to Partners a/c
DrCr
Particulars Amount Particulars Amount
To C's Capital 52,000 By Profit and Loss Appr 52,000
52,000   52,000
Interest on Drawings a/c
DrCr
Particulars Amount Particulars Amount
To Profit and Loss Appr 1,850 By A's Capital
By B's Capital
By C's Capital
1,000
100
750
1,850   1,850
Distributable Profits a/c
DrCr
Particulars Amount Particulars Amount
To A's Capital
To B's Capital
To C's Capital
93,700
93,700
93,700
By Profit and Loss Appr 2,81,100
3,75,850   3,75,850
2,81,100   2,81,100
Partners Capital a/c's
DrCr
Particulars A B C Particulars A B C
To Interest
on Drawings
To Drawings
To Balance c/d

1,000
20,000
2,82,700

100
2,000
1,94,350

750
15,000
2,34,950
By Balance b/d
By Interest
on Capital
By Salary
to Partners
By Commission
to Partners
By Distributable
Profits
2,00,000

10,000

93,700
75,000

3,750

24,000

93,700
1,00,000

5,000

52,000

93,700
3,03,700 1,96,450 2,50,700   3,03,700 1,96,450 2,50,700
By Balance b/d 2,82,700 1,94,350 2,34,950

Both the appropriation account as well as the partners capital accounts provide a clear information as to the postings.

# Computerised Accounting

In manual accounting, the presence of intermediary accounts may be assumed sometimes and not having created those accounts might not pose a problem since they show a nil balance and in majority of the cases the debits and their balancing credits happen almost instantaneously thereby leaving them with a nil balance. This would be the case mostly in problem solving.

However, in case of computerised accounting, if we intend to use such a facility, we need to create all those accounts which we identify as intermediary accounts and ensure that the journal entries that are required (if the intermediary accounts are used) are also recorded.