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Interest on capital

Meaning

Interest on Capital is paid by the firm to compensate a partner for contributing capital to the firm in excess of profit sharing ratio. In simple words, interest on capital is the interest paid to partners for providing the required money to the firm to start a business.

  • It is shown on the credit side of the partners capital account.
  • It is calculated at the agreed rate for the period capital has been used in the business.
  • it is always allowed on the opening balance of the partner’s capital.
  • It is calculated on time basis, taking into consideration any additional capital introduced or any existing capital withdrawn.
  • The maximum rate of interest can be 12% as per the Income Tax Act.

Journal Entry for Interest on Capital

 

Particulars

Dr/Cr

Debit (Rs)

Credit (Rs)

Allow interest on capital

Interest on Capital A/c

Dr.

XXXX

 

To Partners Capital/Current A/c

Cr.

 

XXXX

Closing entry

Profit & Loss Appropriation A/c 

Dr.

XXXX

 

To Interest on Capital A/c

Cr.

 

XXXX

 

How interest on capital will be computed?

Interest on capital will be calculated using the formula given below-

Total Capital X Rate/100 X No. of months/12

Note,

  1. Interest is to be provided on the Opening Capital.
  2. If a partner has neither introduced additional capital not withdrawn during the year, closing balance of the capital amount of the previous year is the opening balance in the capital account of the current year.
  3. Opening Capital is calculated by adding the items like share of loss, drawings, interest on drawings and by deducting the items which are already been added to the capital for example additional capital, interest on capital profit already created.


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CA Rupali Gupta

CA Rupali Gupta