Definition
A Profit and Loss Appropriation Account (P&L Appropriation Account) is a financial statement that details how the net profits or losses of a company are allocated. After calculating the net profit or loss for the period, this account shows how the income is appropriated or distributed among various stakeholders, such as shareholders and partners.
In corporations, the retained earnings brought forward from previous periods are added to the net profit for the current year. This total amount is then adjusted by deducting taxation, dividends paid and proposed, and other transfers to and from reserves as required.
In partnership accounts, the profit or loss available for appropriation is given at the beginning of the statement. The statement enumerates each partner’s entitlement to interest on drawings and capital, along with any salaries. The remaining balance is shared between the partners in the profit-sharing ratio agreed upon in the partnership agreement.
Examples
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Corporation Example:
- Net Profit for the year: $50,000
- Retained Earnings brought forward: $20,000
- Total: $70,000
- Less: Taxation ($10,000), Dividends proposed ($15,000)
- Balance: $45,000
- Transfer to General Reserve: $10,000
- Retained Earnings Carried Forward: $35,000
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Partnership Example:
- Net Profit: $30,000
- Partner A’s Salary: $5,000
- Partner B’s Salary: $5,000
- Interest on A’s Capital: $1,000
- Interest on B’s Capital: $1,000
- Balance for appropriation: $18,000
- Profit-sharing Ratio (1:1): Partner A - $9,000, Partner B - $9,000
Frequently Asked Questions (FAQs)
1. What is the purpose of a Profit and Loss Appropriation Account?
The primary purpose is to show how the net profit or loss is distributed among stakeholders such as shareholders in corporations and partners in partnerships.
2. Are Dividends included in the Profit and Loss Appropriation Account?
Yes, dividends paid or proposed are included as deductions from the net profit in the Profit and Loss Appropriation Account.
3. How are retained earnings handled in the Profit and Loss Appropriation Account?
Retained earnings brought forward are added to the current year’s net profit, and the resulting total is adjusted by various appropriations before determining the retained earnings carried forward.
4. What does the profit-sharing ratio mean in a partnership?
The profit-sharing ratio determines how the remaining profits (after salaries and interests) are distributed among the partners.
5. Can there be a loss in the Profit and Loss Appropriation Account?
Yes, if the operational activities result in a net loss, the account will adjust for appropriations accordingly, impacting the retained earnings negatively.
6. How does the P&L Appropriation Account differ for corporations and partnerships?
In corporations, it involves taxation, dividend declarations, and transfer to reserves, while in partnerships, it includes partner salaries, interests, and profit-sharing arrangements.
7. What are reserves in the context of the Profit and Loss Appropriation Account?
Reserves are portions of profit set aside for specific purposes like future expansion, contingency funds, etc., and they impact retained earnings.
8. What happens to profits not appropriated or distributed?
Unappropriated profits typically remain in retained earnings and can be reinvested in the business, used for future dividend declarations, or held as reserve funds.
9. Can interest on drawings be a component of the Profit and Loss Appropriation Account?
Yes, in partnership accounts, interest on drawings by partners is deducted from the profits before sharing the remaining balance.
10. How frequently is the Profit and Loss Appropriation Account prepared?
It is usually prepared annually but may also be constructed for shorter financial periods depending on the company’s or partnership’s accounting practices.
Related Terms With Definitions
- Retained Earnings: Earnings not distributed as dividends and reinvested back into the business.
- Partnership Accounts: Financial statements tailored to reflect the financial situation and profit-sharing among partners.
- Drawings: Withdrawals by partners or business owners for personal use.
- Profit-sharing Ratio: Agreed proportion in which partners distribute the remaining profits after appropriations.
- Dividends: Distribution of a portion of a company’s earnings to its shareholders.
- Reserves: Allocations of retained earnings set aside for specific purposes.
- Taxation: Government levies on corporate profits.
Online References
- Investopedia: Profit and Loss Statement
- Accounting Coach: Partnership Accounting
- Corporate Finance Institute: Retained Earnings
Suggested Books for Further Studies
- Financial Accounting by Walter T. Harrison Jr. and Charles T. Horngren
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Accounting for Partnerships and Limited Companies by Pauline Weetman
Accounting Basics: “Profit and Loss Appropriation Account” Fundamentals Quiz
Thank you for exploring the intricacies of the Profit and Loss Appropriation Account with our detailed guide and challenging quiz questions. Stay diligent in your financial studies!
