There is often confusion among students regarding the terms “Charge against Profits” vs “Appropriation of Profits”. Some of them are unable to differentiate between these two terms while some other finds them as same. So let us first understand the meaning of these two terms –
Charge against Profits – Those items or heads are considered as charge against profits which are deducted from the revenue while arriving at the figure of profit. They are required to be deducted from the revenue in order to arrive at the correct profit earned by the business. These expenses are often paid to or incurred in relation to the parties who are external to the business entity or who are not the owners of the business.
Examples of charge against profits are – Payment made against purchase of goods, rent, salaries, wages, interest, carriage or other expenses paid or incurred by the business entity.
These items are required to be deducted from the revenue of the business entity even if their deduction results in a loss to the entity.
Place in the Accounts – The items representing charge against profits are placed in Profit and Loss Account or Income Statement of the entity.
Effect while calculating Income Tax – Income Tax is calculated on the amount arrived at after deducting charge against profits from the revenue. So the heads or items representing charge against profits are allowed as deduction while calculating the profits of the business.
Appropriation of Profits – Those heads or items which are deducted from the profits in order to place into effect the terms of Partnership Agreement of Principle of Prudence is appropriation of profits. They are deducted only if there is a profit taking place in the business. These are paid or incurred to the parties which are internal to the organisation such as retained in the business itself, or paid to partners etc.
Examples of Appropriation of Profits – Part of profits transferred to reserves, Salary, Commission or Interest on Capital paid or payable to Partners are some examples of appropriation of profits.
These items are deducted from the divisible profits of the entity. i.e, profits available after payment of Income Tax.
Place in the Accounts – The items representing appropriation of profits are placed in Profit and Loss Appropriation Account of the entity. These are called appropriation as they are appropriated from the profits for future purposes or to affect the provisions of the partnership deed.