What is a profit and loss suspense account?

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 a temporary account created to record the estimated profit for the current financial year during the ‘Reconstitution of the Partnership firm’.

It is used to record some fictitious profits during the year. The profit of the current year is calculated either on the basis of the last year’s profit or the average profit. The proportionate profit thus found is recorded in the Profit and Loss Suspense A/c.

The balance of the Profit and Loss Suspense account is transferred to the balance sheet of the new firm i.e. after the reconstitution of the partnership.

 

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 the –

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

 

As stated above 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 the case of the retirement or death of a partner in the middle of the year or on any given date, 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 retired partner is calculated through the Profit and Loss Suspense Account.

 

Calculation of Profit and Loss Suspense A/c

Proportionate profit for the part of the year is calculated from the date of the opening Balance Sheet to the date of retirement or death. Share of Retiring/Deceased partner is calculated on the basis of proportionate profit.

Proportionate profit can be calculated on the basis of the previous year’s profit or average profits in the past years. The estimated profit for the entire year is proportioned till the date of retirement/death of the partner and their share of the profit is settled in cash, loan, or their current 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 the profit

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

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

For transfer of such Profit or Loss following journal entries are drafted in the books of the firm.

journal entry for Profit and loss suspense account

 

Extract of Balance Sheet as of 15th April YYYY is given below:

extract of balance sheet