Lesson Notes By Weeks and Term v3 - Senior Secondary 2
Profit and Loss Appropriation
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Profit and Loss Appropriation
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Subject: Financial Accounting
Class: Senior Secondary 2
Term: 1st Term
Week: 2
Theme: Manufacturing And Partnership Account
This page supports the lesson note with a companion video and a short classroom-ready summary.
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This topic introduces students to the crucial aspect of profit distribution within a partnership business structure. After the determination of net profit or loss in the Profit and Loss Account, partners need to share this profit or loss according to their agreed-upon terms. The Profit and Loss Appropriation Account serves this specific purpose, detailing how the residual profit is allocated among partners by considering items such as partners' salaries, interest on capital, interest on drawings, and profit-sharing ratios.
Manufacturing And Partnership Account Partner A has ₦1,000,000 capital, Partner B has ₦800,000 capital. Interest on capital is 5% per annum.
Partner A: 5% of ₦1,000,000 = ₦50,000 Partner B: 5% of ₦800,000 = ₦40,000 Total Interest on Capital to be debited in P&L Appropriation = ₦90,000
3. Partners' Salaries: Explanation: An agreed-upon remuneration paid to active partners for their services rendered to the business. This is not an expense in the same way employee salaries are (i.e., it is not debited to the P&L Account before net profit calculation) but rather an appropriation of profit. It is debited to the Appropriation Account and credited to partners' current accounts.
Example: Partner C is entitled to a salary of ₦120,000 per annum, and Partner D, ₦90,000 per annum. Total Partners' Salaries to be debited in P&L Appropriation = ₦120,000 + ₦90,000 = ₦210,000
4. Interest on Drawings: Explanation: A charge to partners for withdrawing cash or goods for personal use from the business during the year. This discourages excessive withdrawals and compensates the business for the use of its funds by partners. It is credited to the Appropriation Account and debited to individual partners' current accounts.
Calculation: Usually calculated as a percentage of the total drawings. If the date of drawings is specified, interest is calculated for the period the money was drawn. If not specified, it's often calculated for an average of six months, or as per the agreement.
Formula: Interest on Drawings = Drawings Rate (Months/12)
Example: Partner E drew ₦60,000 during the year. Partner F drew ₦40,
0
0
0. Interest on drawings is 10% per annum. Assume drawings were made evenly throughout the year (average 6 months).
Partner E: 10% of ₦60,000 (6/12) = ₦3,000 Partner F: 10% of ₦40,000 (6/12) = ₦2,000 Total Interest on Drawings to be credited in P&L Appropriation = ₦5,000
5. Commission to Partners: Explanation: Sometimes, a partner may be entitled to a commission based on sales or profit, as stipulated in the partnership agreement, particularly if they are actively involved in generating revenue. This is also an appropriation of profit.
Example: Partner G is entitled to 5% commission on net profit before charging such commission. If Net Profit is ₦500,000, commission = 5% of ₦500,000 = ₦25,000.
6. Transfer to General Reserve: Explanation: A portion of the profit may be transferred to a general reserve fund to strengthen the business's financial position, for future expansion, or to cover unforeseen contingencies. This reduces the amount available for distribution to partners.
Example: Partnership agreement states 10% of distributable profit (after all other appropriations) to be transferred to General Reserve.
7. Residual (Divisible)
Profit or Loss: Explanation: After all the above appropriations (salaries, interest on capital/drawings, commission, reserves) have been accounted for, the remaining profit or loss is the "residual" or "divisible" profit/loss. This amount is then distributed among partners according to their agreed profit-sharing ratio.
Example: Partners H and I share profits in the ratio 3:
2. If the residual profit is ₦150,
0
0
0. Partner H: (3/5) ₦150,000 = ₦90,000 Partner I: (2/5) ₦150,000 = ₦60,000
D. Format of Profit and Loss Appropriation Account (T-Account Format): Profit and Loss Appropriation Account For the Year Ended 31st December, 20XX | Particulars | ₦ | Particulars | ₦ | | :------------------------ | :----- | :------------------------ | :----- | | Interest on Capital: | | Net Profit (from P&L A/c) | XXXXX | | Partner A | XXX | Interest on Drawings: | | | Partner B | XXX | Partner A | XXX | | Partners' Salaries: | | Partner B | XXX | | Partner A | XXX | | | | Partner B | XXX | | | | Commission to Partner A | XXX | | | | Transfer to General Reserve | XXX | | | | Share of Profit: | | | | | Partner A | XXX | | | | Partner B | XXX | | | | Total | XXXXX | Total | XXXXX |
Note: If there is a Net precise. Chike's Drawings (₦80,000) for 6 months: 5% of ₦80,000 (6/12) = ₦2,000 Emeka's Drawings (₦60,000) for 6 months: 5% of ₦60,000 (6/12) = ₦1,500 Total Interest on Drawings = ₦2,000 + ₦1,500 = ₦3,500
Commentary: Interest on drawings is a credit entry in the Profit and Loss Appropriation Account, effectively increasing the profit available for distribution. The assumption of 6 months average is crucial when exact dates of drawings are not provided.
Question 3: Using the information from Questions 1 and 2, and adding that Chike is entitled to a salary of ₦80,000 per annum. The remaining profit/loss is shared in their capital ratio. Prepare the Profit and Loss Appropriation Account for Chike and Emeka for the year.
Solution 3: Additional Calculation: Profit Sharing Ratio (Capital Ratio): Chike's Capital: ₦900,000 Emeka's Capital: ₦700,000 Ratio: 900,000 : 700,000 = 9:7 Calculations for Divisible Profit: Net Profit ₦320,000 Add: Interest on Drawings ₦3,500 Less: Interest on Capital (₦96,000)
Less: Chike's Salary (₦80,000) Divisible Profit ₦147,500 Share of Profit (Ratio 9:7): Total Ratio Parts = 9 + 7 = 16 Chike's Share = (9/16) ₦147,500 = ₦82,968.75 (approx. ₦82,969) Emeka's Share = (7/16) ₦147,500 = ₦64,531.25 (approx. ₦64,531) Chike and Emeka Partnership Profit and Loss Appropriation Account For the Year Ended 31st December 20XX | Particulars | ₦ | Particulars | ₦ | | :------------------------ | :------- | :------------------------ | :------- | | Interest on Capital: | | Net Profit (from P&L A/c) | 320,000 | | Chike | 54,000 | Interest on Drawings: | | | Emeka | 42,000 | Chike | 2,000 | | | 96,000 | Emeka | 1,500 | | Chike's Salary | 80,000 | | 3,500 | | Share of Profit: | | | | | Chike (9/16) | 82,969 | | | | Emeka (7/16) | 64,531 | | | | | 147,500 | | | | Total | 323,500 | Total | 323,500 |
Commentary: This question integrates all key components. Students must correctly calculate each appropriation item and then subtract/add them to the net profit to arrive at the divisible profit. The final step is to apply the profit-sharing ratio correctly. Rounding up/down for shares of profit should be consistent.
5. Independent Practice (Questions Only)
Question 1: Adebisi and Chinedu operate a fabric retail business in Onitsha, sharing profits in the ratio 2:
1. For the year ended 31st December 2023, their Net Profit was ₦750,
0
0
0. Calculate each partner's share of profit if there are no other appropriation items.
Question 2: Tolu and Kemi are partners in a catering service in Ibadan. Their capital balances are ₦600,000 and ₦400,000 respectively. The partnership agreement allows for interest on capital at 8% per annum. Calculate the interest on capital for each partner.
Question 3: Deji and Femi run a transport company. Deji is entitled to a monthly salary of ₦25,000, and Femi receives an annual salary of ₦300,
0
0
0. What is the total partners' salary for the year?
Question 4: Binta and Zainab are partners in a fashion design studio. Binta's drawings for the year amounted to ₦120,000, and Zainab's drawings were ₦90,
0
0
0. Interest on drawings is charged at 6% per annum. Calculate the total interest on drawings, assuming drawings were made evenly throughout the year.
Question 5: Ayo, Banke, and Caro are partners in "ABC Logistics," sharing profits and losses in the ratio 4:3:
3. The net profit for the year was ₦980,
0
0
0. The partnership agreement provides for: i.
Interest on Capital: Ayo ₦75,000, Banke ₦60,000, Caro ₦50,000. ii.
Partners' Salaries: Ayo ₦120,000, Banke ₦80,000. iii.
Interest on Drawings: Ayo ₦8,000, Banke ₦6,000, Caro ₦4,000. iv.
Transfer to General Reserve: 10% of the distributable profit after all other appropriations. Prepare the Profit and Loss Appropriation Account for "ABC Logistics" for the year.
Question 6: Kunle and Ladi are partners with capital balances of ₦500,000 and ₦300,000 respectively.
Their profit-sharing ratio is 2:
1. The partnership deed states: i. Interest on capital at 10% per annum. ii. Kunle is to receive an annual salary of ₦90,000. iii.
Drawings were: Kunle ₦80,000, Ladi ₦50,
0
0
0. Interest XXX | Partner A | XXX | | Partners' Salaries: | | Partner B | XXX | | Partner A | XXX | | | | Partner B | XXX | | | | Commission to Partner A | XXX | | | | Transfer to General Reserve | XXX | | | | Share of Profit: | | | | | Partner A | XXX | | | | Partner B | XXX | | | | Total | XXXXX | Total | XXXXX |
Note: If there is a Net Loss, it appears on the debit side, and Interest on Drawings would still be a credit. The debit side would likely be larger, resulting in a share of loss for partners.
E. Worked
Example: Question: Adamu and Bola are partners in "A&B Ventures," a provision store in Lagos, sharing profits and losses in the ratio 3:2 respectively. Their partnership agreement provides for the following: i. Interest on capital at 5% per annum. ii. Interest on drawings at 10% per annum (assume drawings are made evenly throughout the year). iii. Adamu is entitled to an annual salary of ₦60,000. iv. Bola is entitled to a commission of 5% on the net profit before appropriations.
Their balances on 31st December 2023 were: Capital: Adamu ₦1,200,000; Bola ₦800,
0
0
0. Drawings: Adamu ₦100,000; Bola ₦80,
0
0
0. Net Profit for the year ended 31st December 2023 was ₦450,
0
0
0. Required: Prepare the Profit and Loss Appropriation Account for A&B Ventures for the year ended 31st December
2
0
2
3. Solution: Calculations:
1. Interest on Capital: Adamu: 5% of ₦1,200,000 = ₦60,000 Bola: 5% of ₦800,000 = ₦40,000 Total Interest on Capital = ₦100,000
2. Interest on Drawings: (Assuming 6 months for average drawings)
Adamu: 10% of ₦100,000 (6/12) = ₦5,000 Bola: 10% of ₦80,000 (6/12) = ₦4,000 Total Interest on Drawings = ₦9,000
3. Adamu's Salary: ₦60,000
4. Bola's Commission: 5% of Net Profit (₦450,000) = 0.05 ₦450,000 = ₦22,500
5. Divisible Profit: Net Profit ₦450,000 Add: Interest on Drawings ₦9,000 Less: Interest on Capital (₦100,000)
Less: Adamu's Salary (₦60,000)
Less: Bola's Commission (₦22,500) Divisible Profit ₦276,500
6. Share of Profit (Ratio 3:2): Adamu: (3/5) ₦276,500 = ₦165,900 Bola: (2/5) ₦276,500 = ₦110,600 A&B Ventures Profit and Loss Appropriation Account For the Year Ended 31st December 2023 | Particulars | ₦ | Particulars | ₦ | | :------------------------ | :------- | :------------------------ | :------- | | Interest on Capital: | | Net Profit (from P&L A/c) | 450,000 | | Adamu | 60,000 | Interest on Drawings: | | | Bola | 40,000 | Adamu | 5,000 | | | 100,000 | Bola | 4,000 | | Adamu's Salary | 60,000 | | 9,000 | | Bola's Commission | 22,500 | | | | Share of Profit: | | | | | Adamu (3/5) | 165,900 | | | | Bola (2/5) | 110,600 | | | | | 276,500 | | | | Total | 459,000 | Total | 459,000 |
3. Teaching and Learning Activities
A. Teacher Activities:
1. Introduction & Review (10 mins): Begin by reviewing the concept of Net Profit/Loss derived from the Profit and Loss Account, which was covered in previous lessons. Introduce partnerships as a business structure common in Nigeria and explain that profits of partnerships are shared differently from sole proprietorships. Briefly explain the necessity of the Profit and Loss Appropriation Account.
2. Explanation of Key Concepts (20 mins): Define partnership and the importance of a partnership agreement (deed). Explain the nature and purpose of the Profit and Loss Appropriation Account, distinguishing it from the regular P&L Account.
Elaborate on each appropriation item: Interest on Capital, Partner's Salary, Interest on Drawings, Commission, Transfer to General Reserve, and the distribution of residual profit/loss. Use simple, relatable Nigerian business scenarios (e.g., two friends running a tailoring business, legal partners) for illustrations.
3. Demonstration with Worked Example (25 mins): Present the worked example provided in Section 2(E) on the whiteboard or projector. * Go through each calculation step-by-step, clearly explaining the logic