Interest on Capital
Owners may seek a return on investment in form of fixed rate of
interest to the extent of amount employed by them in the business. In order to
ascertain a true picture of the business’ profitability, it is a common
practice to provide interest on capital. Journal entry for interest on capital
includes two accounts; Capital A/c & Interest
on Capital A/c
Interest on capital is an
expense for the business and is added to the capital of the proprietor thereby
increasing his total capital in the business. It is not paid in cash or by the
bank.
Journal entry for interest on capital is;
|
Interest on Capital A/c
|
Debit
|
Debit the increase in expense
|
|
To Capital A/c
|
Credit
|
Credit the increase in capital
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Example
Provide 10% interest on capital at the end of the year to Raman.
His contribution to the business is 1,00,000.
|
Interest on Capital A/c
|
10,000
|
|
To Raman Capital A/c
|
10,000
|
(Interest provided at 10% on 1,00,000 at the end of the year)
This shows that the company’s interest to be paid on capital has
been increased by 10,000 consequently Raman capital has also been increased
equally because of interest earned by him on capital.
This will not be paid in cash or deposited in his bank account,
although, it will increase his total capital investment in
the business by 10%.
The End