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INTEREST ON CAPITAL

Capital is the liability of the business. It is proprietor’s claim against the firm. The business assumes capital as amount borrowed from the proprietors of the firm. Interest payable on this liability will be an expense of the business. It will therefore be debited to profit and loss account Interest on capital at the same time will increase the balance of proprietor’s capital, so it should also be added to capital account at the liabilities side. For example, the from started its business on January 1, 2004 with $ 2,00,000. It was decided to charge interest on capital at the rate of 12%. The total interest on capital due to proprietors will be $ 24,000, 12 i.e., 2,00,000 *12/100.

Interest on capital has been debited as an expense, so it will be posted at the debit side of profit and loss account. Capital account has been credited in the journal entry, so capital will also increase with the amount of interest on capital at the liabilities side of the Balance Sheet.

If interest on capital account appears in the Trial balance, it will be posted to the debit side of profit and loss account only.