Accounting Treatment For Partners' Interest On Capitals

Interest on capital is allowable only if there is enough profits to cover it up otherwise not as well as it should be cleared to all that partners shall not be entitled any interest on capital, unless specifically given or written in the partnership agreement. Interest on capital introduced by the partners is calculated on the basis of time of contribution and it should also be considered the introduction of fresh capital by any partner as well as drawings made by the partners. It is important to note here that, the interest on capital provided to a partner is a compensation given to him for his/her investment in the firm foregoing the alternative risk free/risky investment available with even higher return. Interest on capital is necessary to partners because they always not share the profit on the basis of capital contribution ratio rather sometime equally even through the capital contribution is unequal. So, it equalizes the weight to maintain a parity the interest on capital plays a vital role among partners.
The interest on capital is an appropriation of profits, so, it is charge to profit and loss appropriation account and credited to respective partners' capital account or current account.

Interest on capital......................Dr.
To partners' capital A/C

Profit and loss appropriation A/C ...............Dr.
To Interest on capital A/C