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Interest on Capital

Interest will be allowed to each partner on the capital contributed by him. Interest on capital of the partners is calculated for the relevant period for which the amount of capital has been used in the business. Capital introduced or withdrawn by a partner during the accounting year has to be taken for the purpose of calculation. The following are the points in relation to interest on a partner’s capital:

  • In case the profit before interest is less than the interest on capital, the profit will be distributed in the ratio of capital contributed by each partner.
  • Interest on capital is an expense to the firm and is debited to the profit and loss appropriation account.
  • Interest is payable to the partners and hence, the partner’s capital account is credited with the amount of interest.
  • In case of loss, no interest will be allowed on capital.
The journal entries to be passed to record interest on capital are as follows:


Note: If the partnership agreement is silent, no interest will be allowed on capital.


Illustration 1


X, Y and Z are partners in a firm. The balances in their capital accounts as on 1st April 2013 were ₹ 2,00,000, ₹ 1,00,000 and ₹ 60,000, respectively. They share profits and losses equally. Interest on capital is allowed at 12 per cent p.a. On 1st October 2013, the partners decided that their capital should be ₹1,00,000 each. The necessary adjustment in the capital is to be made by introducing or withdrawing cash. X was also entitled to a salary of ₹ 5,000. Profit for the year ended on 31st March 2014 before charging interest on capital amounts to ₹ 1,00,000. You are required to prepare a profit and loss appropriation account showing the distribution of profit among the partners.






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