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

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.

• Business Relations

  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

Judicious Distribution of the Firms Profits

Share Equally

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

• 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• have all withdrawn the same amounts of money for their personal uses (drawings)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

Unequal Capital Contributions

Compensate by paying Interest on 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

Compensate by paying Salary to Partner.

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

Compensate by paying Commission to Partner.

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

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.

Remunerating Organisation = distributing Profits

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

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.

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	:	$2,81,100\times \frac{1}{3}$	=	93,700
  B's Share	:	$2,81,100\times \frac{1}{3}$	=	93,700
  C's Share	:	$2,81,100\times \frac{1}{3}$	=	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.

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

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.

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

• 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.

  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 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.

  Journal

  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.

    Journal

    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

"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

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

What difference does using Appropriation a/c make ?

absence of information

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.

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.

• 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

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

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.