In a partnership, there can be two or more partners, and they or may not have equal rights to the overall profit of the firm. Therefore, there are some rules for the distribution of profit among partners in a partnership firm. Most of the distributions in a partnership take place according to the partnership deed. However, when there is no partnership deed, the distribution of profit takes place according to the law where all partners get equal shares of profit. Let’s discuss how this distribution takes place.
It must be noted that distributable profits and losses of a partnership firm are not directly transferred to partners’ accounts. Instead, a profit and loss appropriation account is created and after various types of debits and credits, the final distributable amounts are transferred to the partners’ accounts.
Distribution of profits is one of the major processes the partners are interested in because it is the process that gives them the returns on their investments. Every partner wants to earn maximum profit and hence the outcome of the profit and loss calculator is a matter of concern to every partner.
The profits and losses incurred by the firm are distributed among the partners with respect to the provisions of the partnership deed. However, if there is no partnership deed or when the partnership deed is silent about distributions, sharing of profit and losses is made equally among the partners.
However, certain adjustments, including interest on drawings and capital, salary, and commission to partners need to be made while distributing profits or losses to the partners of a firm. For such purposes, it is important and needful to create a Profit and Loss Appropriation Account for the firm. The final figures of loss or profit to be distributed among the partners are adjudged by the Profit and Loss Appropriation Account.
Once the Profit and Loss Account is ready, Profit and Loss Account Appropriation is created for the firm. This account shows how the profit or loss among the partners of the firm is distributed. All adjustments in the distribution of profit among partners, such as payments of partner’s salary, partner’s commission, interest on capital, interest on drawings, etc . are made through this account.
It begins with the net profit/net loss depending on the profit and the loss account which is transferred to this account.
The required journal entries for preparing the profit and Loss Appropriation Account and making needed adjustments through it are given as follows −
The partnership deed is the document that offers an insight into the process of delivering the profits and losses to the partners. However, when there is an absence of a partnership deed, the distribution of profits and losses is made according to the law.
Under the law, partners are entitled not to get shares out of their firm except a share in profits. Therefore, the benefits and allowances made to their partners are made from the profits of the firms. This means that the mentioned benefits or allowances the partners are entitled to by the provisions of their partnership deeds must be given to them out of the partnership firm’s profits only.
In terms of accountancy, this statement directly implies that no allowances or benefits allowed to a partner of the firm can be debited to the firm’s profit and loss account.
If in a partnership firm, only one of the partners is active and their partnership deed allows him a salary of, say, Rs10, 00,000 per year, this payment cannot be debited to the profit and loss account as an expense. It is important to note that the law regarding the distribution of profit and loss does not recognize any payment, direct or indirect, made to a partner by their firm as an expense.
When a financial year ends, after the firm’s net profit (or net loss) has been calculated, i.e., once the firm’s trading and profit and loss account (or the income statement) have been generated, the profit and loss appropriation account is created by the firms. The profit and loss appropriation account shows the nature and form of distribution of profit or loss among the partners.
Net profit is taken from the profit and loss account to the profit and loss appropriation account by -
Debiting the profit and loss account
Crediting the profit and loss appropriation account
In the case of a net loss -
The profit and loss appropriation account is debited
The profit and loss account is credited
Any benefit or allowance made to a partner, such as interest on fixed capital, salary, commission, bonus, and so on, is -
Debited to the profit and loss appropriation account
Credited to the current account of the relevant partner
Any charge made by the firm on the partners, such as interest on drawings is -
Debited to the current account of the relevant partner
Credited to profit and loss appropriation account
Once the above adjustments are made, the balance left on the profit and loss appropriation account shows the distributable profit or loss. When the balance is a credit balance, it is a profit that can be distributed.
It is -
Debited to the profit and loss appropriation account
Credited to the current accounts of the partners in the pre-agreed profit and/ or loss sharing ratio
When the left balance on the profit and loss appropriation account after the various appropriations are made is a debit balance, it is a distributable loss which should be -
Debited to the current accounts of partners according to the agreed profit and loss sharing ratio
Credited to the profit and loss appropriation account
In partnership firms, it is important to distribute the profit among partners. Whereas there is no doubt that the profits may be transferred to partners’ accounts without creating an appropriation account, the creation of a profit appropriation account helps to equidistribute and balance the payments.
It is needful to understand how profits and losses and various other transactions are debited and credited between profit and loss and profit and loss appropriation accounts to have a balanced approach in distributing the profits among partners in a partnership firm.
The notable thing to observe is that although the creation of a profit and loss appropriation account does not seem necessary, it plays a key role in the distribution process. The debits and credits made between various accounts are therefore important to ascertain before distributing the profit or losses to the partners.
Q1. What is the process of profit distribution in a partnership?
Ans. Profit is distributed according to the pre-decided profit-sharing ratio among the partners mentioned in a partnership deed. If there is no partnership deed and there is no oral agreement, profits should be distributed equally among the partners of a partnership firm.
Q2. What happens to profit sharing when one partner Contributes more capital than the other?
Ans. Partners usually get equal shares of profit when there is no written partnership deed that shows how profit will be shared between the partners. However, if one partner contributes more capital than the other, the partner investing more capital may be entitled to get more share of the profits. This will, however, depend on the terms of the partnership agreement. If there is no agreement, the matter will depend on state law.
Q3. Why distribution of profit among partners is an important matter?
Ans. Distribution of profit is important because it gives the returns on investments to the partners. It is the ultimate objective of partners to earn profits and hence the distribution process is the most important part of partnership businesses.
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