Interest on Capital

Interest on Capital meaning

Every business owner will be looking out for getting a return on the money invested in the business in the form of a fixed rate interest. This is known as the interest on capital.

In other words, interest on capital is the interest paid to owners for providing a firm with the required capital to start a business. It is similar to obtaining a loan from any financial institution.

The partners are paid interest on the capital that remains outstanding. The maximum rate of interest that can be paid to the owners is 12% as per the Income Tax Act u/s 40(b).

If a partner introduces any further capital to the business then the additional capital is also taken into account for providing interest.

Accounting Treatment of Interest on Capital

Interest on capital is considered as an expense for the business and is added to the owner’s capital, which increases the overall capital of the owner in the business. Two accounts are involved in the accounting for interest on capital which is Capital A/c and Interest on Capital A/c.

The following journal entries are made to account for interest on capital

Interest on Capital A/c Dr.

To Capital A/c

Example of Interest on Capital

Rahul is an owner in a firm named ABC Solutions. His contribution to the business is ₹100,000. Provide interest on capital @ 10% to Rahul at the end of the year.

Interest on capital calculated as

Interest on capital = (Amount*Rate*Months)/12*100

Interest on capital = (100,000*10*12)/ 12*100

= 10,000

The journal entry for the same will be:

Interest on Capital A/c Dr. 10,000

To Rahul’s Capital A/c 10,000

This concludes the topic of Interest on Capital, which is regarded as an important concept of Accountancy for students of Commerce. For more such interesting topics, stay tuned to BYJU’S.

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