Interest on Capital, Journal entry for Interest on capital
Interest is generally allowed on capitals of the partner Interest on capital of partners is calculated for the relevant period for which the amount of cap.
- The amount of interest is debited to interest on capital accounts and credited to the capital accounts, if capitals are fluctuating and current accounts, if capitals are fixed. Interest on capital account is then closed by transfer to profit and loss appropriation account.
- Alternatively, credit the capital (or current) account of the partner concerned and debit the profit and loss appropriation account.
Interest on CapitalIn More Simple Worlds -The interest will be payable only out of profits. As a general rule, interest on capital subscribed by partners is not allowed unless there is an agreement or usage to that effect. The principle underlying this provision of law is that regards the capital brought by a partner in the business, he is not a creditor of the firm but an adventure. In case of fixed capital accounts, interest is calculated on the balance of capital accounts only and no interest is payable / chargeable on the balance of current accounts. Subject to contract between the partners, interest-on capitals is to be provided out of profits only. Thus in case of loss, no interest is provided. But in case of insufficient profits( i.e., net profit less than the amount of interest-on capital), the amount of profit is distributed in the ratio of capital as partners get profit by way of interest-on capital only For example, before charging interest on-capital a business earned for one year a net profit of 4000 and the capital at the beginning of the year was 10000. If the trader had invested this amount in government securities he would have earned (say) 8% interest per year. That is 800. As such the real business profit that is, the profit after charging normal interest on capital would be 3200.
Journal entry for Interest on capital
To allow interest on capital
interest on Capital – Debit 800
Capital Account – Credit 800
Closing Entry to transfer Interest on-capital to P& L Account.
Profit & Loss A/c—- Debit 800
To Interest on capital —Credit 800