Division of profit among partners

The essentials

After calculating net profit, a firm rewards partners according to the deed before dividing the balance. Interest on capital compensates partners for funds invested; salary and commission reward effort; interest on drawings charges partners for withdrawing money during the year. Interest on capital is normally allowed only out of profits: if there is a loss, no interest is allowed, and if profit is insufficient, the available profit is shared in the ratio of interest due.

Key points

• Interest on capital = Capital × Rate × Period. Additional capital earns interest from the date it is introduced.
• Interest on drawings for equal monthly amounts uses the average period: beginning of each month 6.5 months, middle 6 months, end 5.5 months (for 12 months).
• Interest on drawings = Total drawings × Rate × Average period ÷ 12.
• When the date of drawings is not given, charge interest for 6 months on the total.
• Commission as a % of net profit after charging such commission = Profit before commission × Rate ÷ (100 + Rate).

Exam tips

Always note the timing of drawings (beginning, middle or end of month or quarter). For quarterly drawings at the beginning of each quarter, the average period is 7.5 months; at the end, 4.5 months.

Common mistakes

• Charging interest on drawings for 12 months instead of the average period.
• Calculating commission "after charging commission" as a simple percentage of profit.
• Allowing interest on capital when the firm has made a loss and the deed treats it as an appropriation.