What is Interest on capital ?
A Business invested money is business in exchange of that he will earn profit or sometime it is also possible there can be any loss in the business .
If in some case it he not invested that money in business he will keep that money in Bank or invested in some securities and exchange of that he will get profit but now the business has invested money in business therefore he has taken some risk his business may run or his business may fail. To avoid such circumstances the business give some interest to Businessman which is known as Interest on Capital.
Interest on capital is expensive by nature, therefore, it is shown in the debit side of the Profit and loss account and on the other hand it will be added to capital in the liability side of the Balance sheet.
Note:
Interest on capital is just an accounting entry that affects the profit and loss accounts of the business. It does not mean that a business gives interest on capital to the owner in cash or through a bank.
It increases the capital of the businessman at the end of the accounting year.
This entry of interest on capita is only made if its given the deed how much interest on capital to be paid to the owner of the company it is generally in the percentage of capital invested in business
Example of Interest on capital
Example of interest on capital
Mr. Mohan Invested Rs . 100000 in business on 1 April 2000 and interest in capital @ 5% is paid at the end of the accounting period.
When business is started, the accounting entry will be
Cash A/c Dr 100000
To capital A/c 100000
(being business started with cash)
Now the end of the accounting year, which is 31 March 2021, an entry of interest on capital to be made.
interest on capital journal entry
Interest on Capital A/c 5000
To Capital A/c 5000
(being interest on capital to be given to owner)
Interest on capital Account in Profit and Loss Accounts
Particular | Amount | Particular | Amount |
To interest on capital A/c | 5000 |
Interest on capital Accounts is shown in the debit side of Profit and loss accounts as it is an expense for the business because it has to be paid to the owner as adding it to the capital of the businessman.
Interest on capital Account in Balance sheet
Liability | Amount | Assets | Amount |
Capital A/c 100000 + interest on capital A/c 5000 | 5000 |
Interest on capital is added to the capital of business as it is given to the owner of the business