Adjustment of Interest on Capital in Final Accounts (Financial Statements)

Interest on Capital means when the proprietor renders money to the firm for running the business, in turn, the firm provides interest on capital to the proprietor. The rate of interest shall be pre-determined on the basis of the time period. For example, if the proprietor has lent an amount at the beginning of the given period, he shall receive an interest on capital for the whole period and if it is lent between the year then the rate of interest on capital shall be calculated accordingly in the proportion of time.

Adjustment:

A. If Interest on Capital is given outside the trial balance:

In such case, two effects will take place:

• Interest on Capital will be shown on the debit side of the Profit & Loss A/c, being an item of expense for a business.
• It will be added to the Capital A/c in the Liabilities side of the Balance Sheet.

B. If Interest on Capital is given inside the trial balance:

In such a case, Interest on Capital will be shown only in the Dr. side of the Profit & Loss A/c, being an expense for a business.

Illustration:

The following adjustments were noted:

• Interest on capital @ 5% to be provided.
• Interest on Drawings is to be charged at 10% p.a. These Drawings have been made at the beginning of the year.
• Salary to be provided to proprietor i.e. 5000.
• Interest on loan to be provided at 6% p.a.
• Interest on Bank Deposits is to be provided @ 4%.

Solution: