Fundamentals of Partnership-Level 1
About Lesson

Interest on capital

Interest on capital is actually a compensation to partners due to some inherent extra contribution by one over the other partner so that all their returns from firm business remain fair in comparison to each other.

 

Why do the question of interest arises

 

Following two situations may force partners to consider Interest on capitals in the business: –

 

  • when the partners contribute unequal amounts of capitals but share profits equally,
  • where the capital contribution is same but profit sharing is unequal.

 

When is interest allowed on Capital

 

Interest on capital is allowed

 If it is expressly agreed among the partners.

  • When the Deed specifically provides for it, interest on capital is credited to the partners
  • The rate is the agreed rate with reference to the time period for which the capital remained in business during a financial year.
  • Due allowance is given for addition or withdrawals of capital during the accounting period

Which Capital Amount to consider while computing interest

When there are both addition and withdrawal of capital by the partners during a financial year, the interest on capital is calculated as follows:

 

(i) On the opening balance of the capital accounts of partners, interest is calculated for the whole year;

 

(ii) On the additional capital brought in by any partner during the year, interest is calculated from the date of introduction of additional capital to the last day of the financial year.

 

(iii) In case of withdrawal of capital, interest on capital will be calculated as:

On opening capital from the beginning of the year till date of capital withdrawn and then on the reduced capital for the remaining time period.

Alternatively, it can be calculated with respect of amount remained in business for the relevant period.

Example: –

 

A, B, C are partners with 1:1:1 ratio

Accounting Year Jan – Dec

Rate of interest is    5% P.A

Capitals: –

Partner

01 Jan Cap

Addition on

01 Aug

Withdrawal

on 01 Aug

A

25,000

Nil

Nil

B

35,000

15,000

Nil

C

70,000

Nil

2,000

First Approach: – Balance change Approach

 

A – 25000 x 5/100 = 1,250

 

B – 35000 x (5/100) x (7/12) = 1020.83

      (35000+15000) x (5/100) x (5/12) = 1041.67

      Interest = 1020.83 +1041.67= 2,062.5

 

C – 70000x (5/100) x (7/12) = 2041.67

       (70000-2000) x (5/100) x (5/12) = 1416.67

       Interest = 2041.67 +1416.67 = 3,458.34          

 

Alternative Approach: – Amount remains in business approach

A – 25000 x 5/100 = 1,250              (Jan to Dec )

B- 35000 x (5/100) = 1,750             (Jan to Dec)

     15000 x (5/100) x(5/12) =312.50 (Aug to Dec)

        1750+312.50= 2062.50

C – (70000-2000) x (5/100)  = 3400 (Jan to Dec)

       2000 x(5/100) (7/12)     =    58.33( Jan to July )

    3400+58.33 = 3458.33

Exercise Files
9. Interest on Capital.pdf
Size: 121.68 KB
9. Interest on Capital- Class notes 1 pk.pdf
Size: 775.75 KB
Join the conversation

This Is A Custom Widget

This Sliding Bar can be switched on or off in theme options, and can take any widget you throw at it or even fill it with your custom HTML Code. Its perfect for grabbing the attention of your viewers. Choose between 1, 2, 3 or 4 columns, set the background color, widget divider color, activate transparency, a top border or fully disable it on desktop and mobile.

This Is A Custom Widget

This Sliding Bar can be switched on or off in theme options, and can take any widget you throw at it or even fill it with your custom HTML Code. Its perfect for grabbing the attention of your viewers. Choose between 1, 2, 3 or 4 columns, set the background color, widget divider color, activate transparency, a top border or fully disable it on desktop and mobile.
Go to Top