Success Roar Classes

Interest on Capital

Interest on capital - Success Roar Classes

What is Interest on capital?

The interest on capital is allowed(given) by the firm to the partners for contributing the capital introduced by the partners in the firm. So, it is-

“INTEREST”  On  “CAPITAL”

What are the features of Interest on capital?

  1. Nature of Interest on capital– It is an appropriation of profit. Hence it is to be shown in the Profit and Loss appropriation account.
  2. Income for the partner- Interest on capital is an appropriation (expense) for the firm and income for the partner. Hence it is debited to the Profit and Loss Appropriation account and credited to the partner’s capital account i.e. increase in partner’s capital.

3. It is allowed as per the partnership deed. If nothing is given in the partnership deed or there is no partnership deed, no interest will be allowed to the partners. (Indian partnership Act,1932)

4. Entry for Interest on capital

DueTransfer to Profit and Loss Appropriation Account
Interest on Capital A/c         To Partner’s Capital/Current A/c (Being interested on capital allowed @… % p.a.)Profit and Loss Appropriation A/c Dr.       To Interest on Capital A/c. (Being interest on capital transferred to P&L Appropriation A/c)

How to calculate Interest on capital?

Amount of Opening capital x Rate/100 x Time/12

  1. Amount- Interest on capital is always calculated on the opening capital balance.
  2. Rate of Interest- It is the rate agreed among the partners. In the absence of any agreement, no interest on capital will be allowed to partners. In case of the absence of p.a. word, interest will be calculated for the whole year.
  3. Time- The interest will be calculated on the basis of time factor. The Interest will be calculated from-
    • For Opening Capital – from first day of the year (1st April) till the end of the accounting year.
    • For additional capital- from the date of contribution till the end of the accounting year.

How to calculate Opening capital?

When capitals are fixed

ParticularsAmount
Capitals at the end of the year 
Add: Drawings against capital 
Less: Additional Capital introduced during the year 
Capitals in the beginning of the year (Opening Capital)  

When capitals are Fluctuating

ParticularsAmount
Capitals at the end of the year 
Add: Drawings against capital 
Add: Drawings against Profit 
Add: Interest on Drawings 
Add: Share of loss for the year* 
Total 
Less: Additional Capital introduced during the year 
Less: Interest on capital / Salary/Commission etc. 
Less: Share of the profit for the year* 
Capitals in the beginning of the year (Opening Capital)  

*Either loss or profit will appear at a time.

** Alternatively opening capital balance can be calculated by preparing partner’s capital account.

Interest on capital in different Cases

S. No.CasesAdditional situationTreatment
1When Partnership agreement is silent about IOC No IOC
2When there is provision in partnership agreement regarding IOC but silent about the nature (Charge/Appropriation)a. Profit >= IOCFull IOC
b. Profit< IOCAllowed up to the amount of profit In the ratio of IOC of each partner
c. LossNo IOC
3When partnership agreement treats IOC as a charge. Full Interest is allowed whether profit or loss

Note:

  1. Appropriation of Profit-
    1. This is distribution of profit hence It is to be allowed only in case of profit.
  2. Charge-
    1. It indicates expenses to be deducted from profits even if firm there is a loss.

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