What is a profit and loss suspense account?

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Profit and Loss Suspense Account

An entity prepares a profit and loss suspense account when either the partner is retired or in case of the death of a partner at any time before the end of the reporting period. It is used to record some fictitious profits during the year.

 

Why do we Prepare the Profit and Loss Suspense Account?

Generally, an organization prepares its financial statements at the end of its reporting period. The financial statements of typically a partnership firm include –

  • Trading and Profit and Loss Account or
  • Income and Expenditure account
  • Balance Sheet.

 

As stated above since these financial statements are prepared at the end of an accounting period. The partner may die or decide to retire on any given date. In case if the partner retires or dies in the middle of the year or on any given date then it shall be a tedious task for an entity to distribute the profits. 

Hence to eliminate the hardships, the “Profit and Loss Suspense Account” is created and the share of profit of such deceased or the retired partner is calculated through Profit and Loss Suspense Account.

 

For Example,

Mr Alex, Ms Anna and Mr John are in partnership sharing profits and losses in the ratio of 2:2:1. Mr Alex died on 15th April, YYYY. The firm closes its books of account on 31st December every year. So the executor of Mr Alex is entitled to 3 and 1/2 months profit. Ms Anna and Mr John decided to pay the profit immediately to the executor of Mr Alex. The profit of the previous accounting period was 1,20,000.

Here, The proportionate profit for 3 and 1/2 months

= 1,20,000 x 3.5months/12months

= 35,000

Mr Alex’s share of profit

= 35,000 x  2/5 (his share in the partnership)

= 14,000 (for 3 and 1/2 months)

The above calculation shall be journalised as;

Journal Entry

 

Extract of Balance Sheet as of 15th April YYYY:

Presentation of profit and loss suspense account