Interest on Capital
Interest on capital is the amount of fixed return that the owner getting from their investment. It is the interest on share capital paid to the investor for the amount they agree to invest and start a business. It is a similar treatment for the loan but obtains from the owner (partner).
The partner will receive the interest for the capital extending beyond the total capital. It is mostly happening in the partnership, however, the company did not pay cash to the partner but increase the partner’s capital.
Interest on Capital will be deducted from the company profit and loss statement. It is classified as the expense on the debit side and credit the partner’s capital account.
Interest on Capital Formula
| Interest on Capital = Capital Invest x Interest Rate |
- Capital Invest: is the additional capital that one partner has invest in addition to total capital.
- Interest rate: is the agreed rate between all partners.
Interest on Capital Journal Entry
Interest on capital will record into expenses on the income statement. The other side will record in the capital section of the balance sheet.
| Account | Debit | Credit |
|---|---|---|
| Interest on Capital Expense | 0000 | |
| Share Capital | 0000 |
Example of Interest on Capital
Company XYZ has three partners who are Mr. A, Mr. B, and Mr. C. They have invested $ 50,000 from each partner. The total capital supply is $ 150,000 which use to operate the business. Due to a huge loss at the beginning of the business, the cash runs out very quickly.
The business needs $ 100,000 to operate before making a profit. However, Mr. A & B does not have the capital to invest. Only Mr. C agree to invest $ 100,000 to support the company. All three partners agree to pay interest of 8% and the interest will increase the share capital of Mr. C.
Interest on Capital = $ 100,000 * 8% = $ 8,000
Interest in Capital-Journal Entry
| Account | Debit | Credit |
|---|---|---|
| Interest on Capital | 8,000 | |
| Share Capital, Mr. C | 8,000 |
The company will increase the expense of $ 8,000 in the income statement, but there is no cash flow to Mr. C. We only increase his share capital which is the interest earn from his investment.