If any partner advances an amount over and above his/her commitment then it is considered as a partners' loan to the firm with a view to getting it back in the days to come from the partnership as per the valid partnership deed agreed upon. Whenever a partner provides a loan capital to the firm, then it should not be mixed up with his/her originally contributed capital account. Instead of writing in the capital account, a separate account is opened as partners' loan account. The logic behind the separation of capital and loan account is:
- Partners' loan is repayable on dissolution in priority to capital
- In the absence of a valid agreement, partners are entitled to get interest on loan, whereas the partners not getting interest on capital.
- In the absence of a valid agreement, partners are entitled to get interest on loan, whereas the partners not getting interest on capital.
There should be a valid written document between the firm and among the partners for the legal purposes. It is hereby advisable ti treat and record the loan provided by the firm to a partner in the partners' loan account instead of recording to partners' drawing account.
Interest on partners' loan to the firm is a charge against profit. Such interest is to be allowed whether there are profit or not. So, interest as a partners' loan is credited to his loan account and later on it is transferred to the debit of profit and loss account.
Interest on partners' loan A/C........................Dr.
To partners' loan A/C
Profit and loss A/C ..........................Dr.
To interest on partners' loan A/C
However, interest on partners' loan may also be taken as an appropriation of profits. So, the following accounting treatment can also be followed:
If the partner receives the interest in cash:
Profit and loss appropriation A/C.....................Dr.
To Interest (cash)