AQA A-Level Accounting (7127)

## Learning Outcomes

- Understand the difference between a partnership income statement and a partnership appropriation account
- Identify the items that belong in the appropriation account and the items that do not
- Apply partnership agreements and the default rules of the **Partnership Act 1890**
- Calculate residual profit or residual loss and share it correctly between partners
- Complete partners’ current accounts from appropriation figures
- Avoid common exam errors involving partner salaries, drawings and loan interest

## AQA A-Level Accounting (7127) Syllabus

For the AQA A-Level Accounting (7127), you are expected to understand partnership income statements and appropriation accounts, with a focus on the following syllabus points:

- Know that the income statement calculates **profit for the year**, while the appropriation account shows how that profit or loss is shared between partners
- Identify the appropriation items: partners’ salaries, interest on capital, interest on drawings, and the share of residual profit or loss
- Explain the difference between an appropriation item and an ordinary business expense
- Understand how to calculate **residual profit** after salary allowances and interest on capital, and after adding interest on drawings
- Distinguish between **interest on capital** and **interest on a partner’s loan**
- Apply the default rules of the **Partnership Act 1890** where there is no partnership agreement
- Show how appropriation entries affect partners’ **current accounts**
- Recognise how debit and credit balances arise on current accounts

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. What is the difference between a partnership income statement and a partnership appropriation account?
2. Why are partners’ salaries not treated as an expense in the income statement?
3. How is residual profit calculated before it is shared between partners?
4. What are the default rules if a partnership has no partnership agreement?
5. How is interest on a partner’s loan treated differently from interest on capital?

## Introduction

A partnership prepares financial statements in much the same way as a sole trader, but there is one major extra step: after calculating **profit for the year**, the business must show how that profit is divided between the partners. That is the job of the **appropriation account**.

This topic is examined regularly because it tests both accounting technique and understanding of partnership rules. Students need to be clear about what belongs in the income statement, what belongs in the appropriation account, and how the figures then move into partners’ current accounts.

> **Key Term: appropriation account**
> A section following the income statement that shows how the partnership’s profit or loss is shared between partners.

### The two-stage process: income statement first, appropriation second

For partnership accounts, always think in two stages.

Stage 1 is the **income statement**. This calculates the business profit in the normal way:

- revenue
- less cost of sales
- less expenses
- equals **profit for the year**

Stage 2 is the **appropriation account**. This takes the profit for the year and divides it between the partners according to the partnership agreement, or the default rules if there is no agreement.

> **Key Term: profit for the year**
> The profit calculated in the income statement after deducting all business expenses from revenue.

A key distinction is that items such as partners’ salaries and interest on capital are **not** operating expenses of the business. They are ways of sharing profit between owners.

> **Key Term: partners’ salaries**
> Amounts credited to partners as part of profit-sharing; they are appropriations of profit, not business expenses.

Why does this matter? Because if you put a partner’s salary into the income statement, you reduce profit too early and the whole question goes wrong.

Items that belong in the income statement:

- wages and salaries of employees
- rent and rates
- depreciation
- irrecoverable debts
- loan interest on a partner’s loan

Items that belong in the appropriation account:

- partners’ salaries
- interest on capital
- interest on drawings
- share of residual profit or loss
  > **Test Tip:** In exam questions, ask yourself: “Is this a business expense, or is it a way of sharing profit between owners?” If it is owner-related, it is usually an appropriation item.

### What goes into the appropriation account

A standard appropriation account usually starts with **profit for the year** from the income statement.

Then:

1. **Add** interest on drawings
2. **Deduct** partners’ salaries
3. **Deduct** interest on capital
4. Share the remaining amount as **residual profit** or **residual loss**

This can be shown as a formula:

Residual profit
= Profit for the year + Interest on drawings − Partners’ salaries − Interest on capital

If the result is negative, it is a **residual loss** instead.

> **Key Term: residual profit**
> The profit left after adding interest on drawings and deducting partners’ salaries and interest on capital, before sharing the balance in the profit-sharing ratio.

Interest on drawings is added because it is income charged to the partners. It increases the amount available for distribution.

Interest on capital and partners’ salaries are deducted because they are allocations to specific partners before the remaining balance is shared.

If there is a loss for the year, the same logic still applies. You may still add interest on drawings and deduct salaries and interest on capital before arriving at a residual loss.

#### Worked example: appropriation of profit

Suppose a partnership has:

- Profit for the year: **£50,500**
- Salary to Partner B: **£12,000**
- Interest on capital: Partner A **£4,000**, Partner B **£3,000**
- Interest on drawings: Partner A **£1,280**, Partner B **£920**
- Profit-sharing ratio: **60:40**

Step 1: Start with profit for the year  
£50,500

Step 2: Add interest on drawings  
£1,280 + £920 = **£2,200**

Revised amount available:  
£50,500 + £2,200 = **£52,700**

Step 3: Deduct salary  
£52,700 − £12,000 = **£40,700**

Step 4: Deduct interest on capital  
£4,000 + £3,000 = **£7,000**

Residual profit:  
£40,700 − £7,000 = **£33,700**

Step 5: Share residual profit in ratio 60:40  
Partner A: £33,700 × 60% = **£20,220**  
Partner B: £33,700 × 40% = **£13,480**

Final appropriations:

- Partner A: interest on capital £4,000 + share of residual profit £20,220
- Partner B: salary £12,000 + interest on capital £3,000 + share of residual profit £13,480
  > **Test Tip:** Do not share profit too early. Always adjust for salary, interest on capital and interest on drawings before applying the profit-sharing ratio.

Common student errors:

- putting drawings in the appropriation account
- forgetting to add interest on drawings
- sharing the full profit before deducting salary and interest on capital
- treating a partner’s salary as an expense in the income statement

### Partnership agreements and default rules

Most partnerships have a **partnership agreement**. This sets out how profits and losses are shared.

It may include:

- profit-sharing ratio
- partners’ salaries
- interest on capital
- interest on drawings
- interest on partner loans

If there is no partnership agreement, the default rules come from the **Partnership Act 1890**.

> **Key Term: Partnership Act 1890**
> The law that provides default accounting rules for partnerships where the partners have not agreed different terms.

The main default rules are:

- profits and losses shared equally
- no partner salary
- no interest on capital
- no interest on drawings
- a partner making a loan or advance beyond agreed capital is entitled to **5% per annum**

That last point is often tested because it is easy to confuse a partner’s loan with capital.

> **Key Term: partner’s loan**
> Money lent by a partner to the partnership separately from capital; it is treated as a liability and earns interest separately from profit appropriation.

A partner’s loan:

- is not part of capital
- does not receive a share of profit
- interest on it is an expense in the income statement
- if no rate is stated, default interest is **5%**

By contrast, interest on capital:

- is not a business expense
- is an appropriation of profit
- appears in the appropriation account
- is credited to the partner’s current account

#### Side-by-side comparison: interest on capital vs interest on partner’s loan

| Feature            | Interest on capital               | Interest on partner’s loan                |
| ------------------ | --------------------------------- | ----------------------------------------- |
| Nature             | Appropriation of profit           | Business expense                          |
| Statement shown in | Appropriation account             | Income statement                          |
| Account affected   | Current account                   | Loan account or as stated                 |
| Default rule       | None under Act                    | 5% under Partnership Act 1890             |
| Share of profit?   | Yes, partner still shares profits | No, loan is separate from ownership share |

Common student errors:

- putting loan interest in the appropriation account
- giving loan interest a share of profit
- applying 5% to capital instead of only to the loan/advance

### From appropriation account to partners’ current accounts

Once the appropriation has been calculated, the entries move to the partners’ **current accounts**.

Credit entries on a current account:

- opening credit balance
- share of profit
- partner salary
- interest on capital

Debit entries on a current account:

- drawings
- goods for own use
- interest on drawings
- share of loss
  > **Key Term: current account**
  > A fluctuating partner account used to record the ongoing entitlements and withdrawals of a partner, such as share of profit, drawings and interest.

A credit balance means the partner has left value in the business.  
A debit balance means the partner has withdrawn more than the amount standing to their credit.

#### Worked example: current account balance

A partner starts the year with a **£550 debit** balance.

During the year:

- interest on capital **£900**
- partnership salary **£10,000**
- drawings **£14,000**
- share of profit **£4,230**

Step 1: Start with opening balance  
Debit £550

Step 2: Add credit entries  
£900 + £10,000 + £4,230 = **£15,130 credit**

Step 3: Add debit entries  
Opening debit £550 + drawings £14,000 = **£14,550 debit**

Step 4: Compare sides  
Credit £15,130 − Debit £14,550 = **£580 credit**

So the closing current account balance is **£580 credit**.

This type of calculation is very common in multiple-choice and short-answer questions.

Common student errors:

- putting the opening debit balance on the wrong side
- reversing interest on drawings
- forgetting that drawings are a debit
- failing to distinguish opening balance from year’s movements

### How to structure an evaluative answer

Some questions ask you to comment, explain or discuss partnership accounting treatments. For stronger AO3 marks, avoid generic statements.

A good evaluative paragraph should include:

- the **financial evidence** from the question, such as profit figures, current account balances, or the effect of equal sharing versus an agreed ratio
- the **accounting rule** being applied, such as a partnership agreement or the Partnership Act 1890
- the **effect on each partner**, especially fairness and incentives
- any **limitation**, such as the absence of a written agreement or the fact that salary is not an expense but only a profit-sharing device

For example, if asked whether a partnership agreement is useful, you could discuss:

- clarity over salary, capital interest and drawings interest
- fairer allocation where capital contributions differ
- fewer disputes between partners
- better accuracy when preparing accounts

If asked about current accounts, include:

- that a credit balance shows retained value in the business
- that a debit balance may indicate over-withdrawal
- that separate capital and current accounts improve clarity but require more bookkeeping time
  > **Test Tip:** For comment questions, do not just define terms. Explain the accounting treatment, then say what it means for fairness, control or the partners’ financial position.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- A partnership income statement calculates **profit for the year**
- The appropriation account shows how that profit or loss is shared between partners
- Partners’ salaries are appropriations of profit, not business expenses
- Interest on capital is deducted in the appropriation account
- Interest on drawings is added in the appropriation account
- **Residual profit** is shared in the agreed profit-sharing ratio
- A **residual loss** is also shared in the agreed profit-sharing ratio
- Drawings themselves do not appear in the appropriation account
- Interest on a partner’s loan is treated separately as an expense in the income statement
- If there is no agreement, the **Partnership Act 1890** default rules apply
- Current accounts are credited with salary, interest on capital and share of profit
- Current accounts are debited with drawings, interest on drawings and share of loss

## Key Terms and Concepts

- appropriation account
- profit for the year
- partners’ salaries
- residual profit
- Partnership Act 1890
- partner’s loan
- current account


Partnership accounts - Income statement and appropriation account