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Interest on capital
Interest on capital is the interest allowed on capital of the partners. In general, if the capitals of partners are disproportionate to the profit sharing ratio the partners may agree to allow interest on capital. It will compensate the partners who have contributed high amount towards capitals. The rate of interest on capital is generally agreed by the partners and is mentioned in the partnership deed. It is allowed only when there is profit and it is provided before division of profits among the partners. No interest is allowed on the capitals of partners, if it is not specifically mentioned in the partnership deed.
When the firm incurs loss, interest on capital will not be provided. If there is insufficient profit, that is, the net profit is less than the amount of interest on capital, interest on capital will not be provided, but the profit will be distributed among the partners in their capital ratio.
Following are the journal entries to be made in the books of the partnership firm.
Note: Interest on capital is due to the partners from the firm hence partner’s capital/current account is credited and interest on capital account is debited.
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