Kgosi and Mpho: Appropriating Profit Fairly
Kgosi and Mpho have traded in partnership since 2019, sharing profits 3:2. Their capital accounts at 1 January 2024 were Kgosi P120,000 and Mpho P80,000, and their current accounts were Kgosi P15,000 credit and Mpho P4,000 debit. Mpho introduced a further P40,000 of capital on 1 October 2024. The partnership agreement provides for interest on capital at 8% a year, an annual salary of P24,000 to Mpho, and interest on drawings at 5%. Drawings during 2024 were Kgosi P30,000 and Mpho P22,000. Profit for the year before appropriation was P96,000. Mpho argues that his salary should be treated as an expense of the business, and that interest on capital should be calculated on the closing capital balances.
1. Prepare the partnership appropriation account for the year ended 31 December 2024.
Read the worked answer
Workings
- Interest on capital: Kgosi 120,000 × 8% = P9,600. Mpho: 80,000 × 8% × 9/12 = 4,800, plus 120,000 × 8% × 3/12 = 2,400, total P7,200. The new capital was only in the business for three months, so it earns three months' interest.
- Interest on drawings: Kgosi 30,000 × 5% = P1,500; Mpho 22,000 × 5% = P1,100.
Appropriation account for the year ended 31 December 2024
| P | P | |
|---|---|---|
| Profit for the year | 96,000 | |
| Less: Salary - Mpho | (24,000) | |
| Less: Interest on capital - Kgosi 9,600; Mpho 7,200 | (16,800) | |
| Add: Interest on drawings - Kgosi 1,500; Mpho 1,100 | 2,600 | |
| Profit available for sharing | 57,800 | |
| Share of profit - Kgosi 3/5 | 34,680 | |
| Share of profit - Mpho 2/5 | 23,120 | |
| 57,800 |
Note that partner's salary and interest on capital are appropriations of profit, not business expenses, so they are shown after the profit figure and not in the income statement.
2. Prepare the partners' current accounts for the year ended 31 December 2024 and state the closing balances.
Read the worked answer
Current accounts
| Kgosi (P) | Mpho (P) | |
|---|---|---|
| Opening balance | 15,000 Cr | 4,000 Dr |
| Interest on capital | 9,600 Cr | 7,200 Cr |
| Salary | - | 24,000 Cr |
| Share of profit | 34,680 Cr | 23,120 Cr |
| Drawings | (30,000) Dr | (22,000) Dr |
| Interest on drawings | (1,500) Dr | (1,100) Dr |
| Closing balance | 27,780 Cr | 27,220 Cr |
Workings: Kgosi 15,000 + 9,600 + 34,680 − 30,000 − 1,500 = 27,780. Mpho −4,000 + 7,200 + 24,000 + 23,120 − 22,000 − 1,100 = 27,220.
Both partners' current accounts are in credit, so each is owed money by the firm - this is not capital and will be paid or left on loan according to the agreement. Mpho's opening debit balance means he had drawn P4,000 more than he was entitled to in earlier years; that deficit has been cleared by this year's appropriations.
3. Evaluate Mpho's two arguments about the salary and the interest on capital.
Read the worked answer
Argument 1 - 'my salary should be an expense'. A partner is an owner, not an employee, so a partner's salary is a distribution of profit, not a cost of earning it. Treating it as an expense would understate the partnership's true operating profit and would be inconsistent with the treatment of Kgosi, who receives no salary.
Importantly, the argument has no effect on Mpho's total income. If P24,000 were charged as an expense: profit becomes 96,000 − 24,000 = 72,000; less interest on capital 16,800, plus interest on drawings 2,600 = 57,800 to share - exactly the same P57,800 as before. His share is still 23,120 plus salary 24,000. What changes is only presentation: the income statement would show a smaller profit, and the appropriation would show a smaller share of profit for each partner. Consistency of treatment across years matters more than the label.
Argument 2 - 'interest on capital should use closing balances'. This is wrong and would be unfair to Kgosi. Interest on capital compensates a partner for the funds actually at risk during the period. Mpho's extra P40,000 was only in the business for three months (1 October to 31 December), so it earns 3/12 of 8%: 120,000 × 8% × 3/12 = P2,400, not P9,600. Using closing balances would give Mpho an extra 40,000 × 8% = P3,200 of appropriation and cut Kgosi's share of the residual profit, even though Kgosi's money was invested for the whole year. Interest must therefore be time-apportioned whenever capital changes during the year.