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Guide to practice accounts: How profit is allocated to the partners

Practice profits are normally divided into two categories - a top slice from income earned by individual partners and the remainder, the pool of profit in which all partners share. By Liz Densley.

iStockphoto.com
iStockphoto.com

 The top slice is known as the pre-shares or prior shares. The partnership agreement should highlight which items of income belong to the individual partners earning them and which form part of the profit-sharing pool. Similarly, there will be costs associated with items of income earned by individual partners that are prior-charged to them.

Examples of prior shares of profit include:

  • Seniority payments
  • Out-of-hours earnings
  • Private fees
  • Internal locums (where a partner locums for another partner)
  • Property income (where partners do not own the property in their income-sharing ratios), net of property owner costs

Examples of prior charges include:

  • Employer element of partners’ superannuation contributions, shown as a charge in the income and expenditure account
  • Locum costs (where an individual partner is responsible for the cost)

The remaining pool of profit will be shared in the profit-share ratios set out in the partnership agreement or any subsequent agreement.

Sometimes this is expressed as sessions worked and sometimes as a percentage share. Often, new partners join at a lower share and work their way up to parity (for example, a full share).

Example
Partner A works nine sessions, partner B works nine sessions, partner C works six sessions and partner D works nine sessions (but is only entitled to 90% of a full share).

This could be expressed as:

Partner Sessions Fractions based on sessions % shares
A
9  9/32.1  28.04
B
9  9/32.1  28.04
C
6  6/32.1  18.69
D
8.1 (9 x 90%)  8.1/32.1  25.23
Total shares 32.1   100%

It is often easier for partners to understand if shares are expressed in terms of sessions, rather than percentages. This also avoids rounding problems where the calculated percentages do not add up to 100%. Arithmetically, both come out to the same answer.

Profit-sharing ratios often change during the year – for example, when a partner leaves or joins, there are changes in sessions or a partner reaches parity. In this event, the differing ratios will apply to each part of the year. Where profits do not arise evenly over the year, adjustments may need to be made so the correct pool is used for each period.

Example
A two-partner practice shares profits equally. Partner 1 retires six months into the year and is replaced temporarily by a locum. Profits for the year are £150,000 after the £50,000 locum costs. If the profits are shared equally, the shares would be:

 Period Total Partner 1 Partner 2

First half year profit

75,000

37,500

37,500

Second half year profit

75,000

0

75,000

Total shares

150,000

37,500

112,500

However, this means partner 1 is, in effect, being charged for the locum. A fairer way of allocating the profits, assuming that formal accounts are not produced for the six months to retirement date, would be:

  Total Partner 1 Partner 2

Prior charge of locum costs

-50,000

 

-50,000

Balance of profit to share

200,000

   

First half year

100,000

50,000

50,000

Second half year

100,000

0

100,000

Total shares

150,000

50,000

100,000

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