Forming a partnership: capital, current accounts and appropriation
Partners share profits by their partnership agreement. The appropriation account deals out salaries, interest on capital and the residual profit in the agreed ratio.
What a partnership is
A partnership is the relationship between persons who carry on a business together with a view to profit. Partners usually sign a partnership agreement (deed) setting out the capital each brings, the profit-sharing ratio, any salaries, interest on capital, interest on drawings, and what happens when a partner joins or leaves. Each partner's equity is recorded separately. Unlike a company, an ordinary partnership is not a separate legal person, and the partners are generally liable for the firm's debts.
When the agreement is silent (the usual textbook rules)
- Profits and losses are shared equally.
- No interest is allowed on capital and no salaries are paid to partners.
- No interest is charged on drawings.
- Confirm these default rules in your course notes, because they come from partnership law.
Fixed and fluctuating capital
Worked example: the appropriation account
Amal and Nuwan run a hardware business in Matara, sharing profits 3:2. Fixed capitals: Amal Rs. 1,500,000, Nuwan Rs. 1,000,000. The agreement allows interest on capital at 10% a year and a salary of Rs. 240,000 a year to Nuwan. Interest on drawings: Amal Rs. 12,000, Nuwan Rs. 8,000. Profit for the year ended 31 March 2026, before appropriation, is Rs. 1,180,000.
- Add interest on drawings: 1,180,000 + 12,000 + 8,000 = 1,200,000 available.
- Less Nuwan's salary: 240,000.
- Less interest on capital: Amal 10% × 1,500,000 = 150,000; Nuwan 10% × 1,000,000 = 100,000; total 250,000.
- Residual profit: 1,200,000 − 240,000 − 250,000 = 710,000.
- Share 3:2: Amal 710,000 × 3/5 = 426,000; Nuwan 710,000 × 2/5 = 284,000.
- Check: 426,000 + 284,000 = 710,000.
Residual profit Rs. 710,000: Amal Rs. 426,000, Nuwan Rs. 284,000.
Partners' current accounts for the year (Rs.)
| Item | Amal | Nuwan |
|---|---|---|
| Opening balance (credit) | 40,000 | 15,000 |
| Add: salary | 240,000 | |
| Add: interest on capital | 150,000 | 100,000 |
| Add: share of residual profit | 426,000 | 284,000 |
| Less: drawings | (300,000) | (260,000) |
| Less: interest on drawings | (12,000) | (8,000) |
| Closing balance (credit) | 304,000 | 371,000 |
Worked example: check the current accounts
Verify the closing current account balances and the partners' total funds.
- Amal: 40,000 + 150,000 + 426,000 = 616,000; 616,000 − 300,000 − 12,000 = 304,000.
- Nuwan: 15,000 + 240,000 + 100,000 + 284,000 = 639,000; 639,000 − 260,000 − 8,000 = 371,000.
- Partners' funds: capitals 1,500,000 + 1,000,000 = 2,500,000; current accounts 304,000 + 371,000 = 675,000; total 3,175,000.
Current accounts: Amal Rs. 304,000 Cr, Nuwan Rs. 371,000 Cr. Total partners' funds Rs. 3,175,000.
Points to remember
- Salaries and interest on capital are appropriations of profit, not expenses.
- Interest on drawings is added to the profit available, because partners pay it to the firm.
- If profit is too small to cover salaries and interest, the shortfall is shared as a loss in the profit ratio.
- A partner's loan to the firm is a liability; interest on it is an expense, charged before appropriation.
Many Sri Lankan family businesses, audit firms and law firms are run as partnerships. A clear partnership deed on capital, salaries and profit share prevents disputes when the business grows or a partner leaves.
Short answer: “What is interest on drawings and how is it treated?” A charge on partners for withdrawing money; it is added to the profit available in the appropriation account and debited to each partner's current account.
Structured question: “Distinguish the fixed capital method from the fluctuating capital method.” Fixed: capital accounts unchanged, current accounts take salaries, interest, profit and drawings. Fluctuating: one capital account takes everything. Show a short example of each.
Essay: “Prepare the appropriation account and the partners' current accounts from the given data.” Profit + interest on drawings − salaries − interest on capital = residual profit, shared in the ratio; then each current account with opening balance, credits and debits.
Appropriation order: profit + interest on drawings − salaries − interest on capital = residual profit, then split it in the profit-sharing ratio.