This blog post will aim to explain a little bit more on the reasons why you need to follow the format of Limited Liabilities Company’s Appropriation Account and the failure to do so will result in you losing marks. You will still need to get familiar with some of the introductory terms from earlier posts. If you have not, please revisit them here.
For ease of reference, I have also included similar content from previous topic on Profit and Loss Appropriation Account.
In general, let me classified everything in its simplest form into:
- Government (for Tax), and
1. If you owe bank money, you are absolutely required under contractual obligation to pay back bank on time! This is actually quite logical. The bank do not need to know how the business is performing. Their only concern will be on whether the business is paying the bank on time! In your Profit and Loss, as can be seen from sole proprietorship and partnership account, this will appear in the debit side of the profit and loss. The same thing applies to a corporate account. But remember that you will be expected to see a new term called debenture loan. The next time you see a debenture loan, treat it as an expense to the Profit and Loss Account!
2. The next person you are required to settle as soon as possible will be the government, because not paying them is a criminal offense! If you refer to the picture above, you will see that tax appears after profit before tax.
3. The last person to receive remaining profit will be the shareholders. Shareholders participate in dividend payment and capital appreciation (increase in stock price). Shareholders also have rights in decision making for the company. With that being said, shareholders are actually at an advantageous position due to their (usually) higher return. As a result of assuming the highest risk of the company, they were the last to receive any returns (whether big or small) from the company.
Shareholders are further classified into preference and ordinary shareholders. Preference shareholders were the first one to receive dividend before ordinary shareholders. You might be questioning why but if you look at how preference share behaves, it is actually quite similar to debenture loan (i.e. earning fixed return) with no voting rights. If you refer back to the picture above, you will be able to see that preference dividend appears first, followed by ordinary dividend.
In summary, the order of your P&L Appropriation Account will be:
- Interest on Loan,
- Debenture Loan,
- Tax (to government),
- Preference Dividend, and
- Ordinary Dividend.