A & B Electrical: Interest, Salary and a Partner's Complaint
Ade Mohammed and Bea Charles have traded as A & B Electrical for several years, sharing profits and losses 3:2. Their capital accounts stand at $120,000 (Ade) and $80,000 (Bea); current accounts are $15,000 credit (Ade) and $4,000 debit (Bea). The partnership agreement provides for interest on capital at 5% per annum, a salary of $24,000 to Bea for managing the shop, and interest on drawings at 4% per annum. Drawings for the year were $30,000 (Ade) and $18,000 (Bea), on which interest has been calculated at $1,200 and $720 respectively. Profit for the year before any appropriation is $96,000. Bea argues that because she works in the shop full time and Ade does not, the profit should simply be split equally, and she also wants her $4,000 debit current account balance deducted from her capital so the accounts 'look cleaner'. Ade insists the agreement must be followed.
1. Prepare the partnership appropriation account for the year and show each partner's total share.
Read the worked answer
| Appropriation account | $ | $ |
|---|---|---|
| Profit before appropriation | 96,000 | |
| Less Interest on capital: Ade 6,000; Bea 4,000 | (10,000) | |
| Less Salary - Bea | (24,000) | |
| Add Interest on drawings: Ade 1,200; Bea 720 | 1,920 | |
| Profit available for sharing | 63,920 |
Shares: Ade 3/5 × 63,920 = $38,352; Bea 2/5 × 63,920 = $25,568.
Total to each partner:
| Ade $ | Bea $ | |
|---|---|---|
| Interest on capital | 6,000 | 4,000 |
| Salary | - | 24,000 |
| Share of residual profit | 38,352 | 25,568 |
| Less interest on drawings | (1,200) | (720) |
| Total | 43,152 | 52,848 |
Check: 43,152 + 52,848 = 96,000, the whole profit before appropriation.
2. Calculate the balance on each partner's current account at the year end and state how the debit balance on Bea's account should be shown.
Read the worked answer
Ade: 15,000 credit + 43,152 = $58,152 credit. Bea: (4,000) debit + 52,848 = $48,848 credit.
A debit balance on a current account means the partner has withdrawn more than the share of profit credited to her - the account is effectively overdrawn. It is shown as a deduction within the partners' funds section of the statement of financial position, not as an asset and not netted against her capital account. Capital accounts record the partners' permanent investment and normally change only on admission, retirement or a formal revaluation; current accounts record the running flow of profits, drawings and appropriations. Keeping them separate preserves the record of what each partner actually put in and allows the drawdown to be corrected from future profits. Deducting it from capital, as Bea suggests, would conceal an overdrawn position from the other partners and from anyone assessing the firm's capital base.
3. Evaluate Bea's two proposals, supporting your answer with the figures.
Read the worked answer
Equal split: If the $96,000 were divided equally and the agreement ignored, each partner would receive $48,000 before any adjustment for drawings. Under the agreement Bea actually receives $52,848 and Ade $43,152. Bea's salary of $24,000 plus 5% interest on her larger drawings base more than offsets her smaller profit share, so she already gains $4,848 from the agreement relative to an equal split. Her argument therefore fails on the numbers: the salary provision is precisely the mechanism that rewards her full-time work.
Offsetting the current account against capital: This should be resisted. It has no effect on total partners' funds ($58,152 + $48,848 = $107,000 either way), so it does not make the firm stronger - it only makes an overdrawn partner look fully funded. It also weakens the audit trail and would need the consent of both partners to alter the agreement.
A better response is to agree a lower drawings limit for Bea for the coming year.