There are three problems relating to the Interest on capital:

(a) Rule regarding……whether to allow or not (as already discussed).

(b) Treatment…………Journal entries and Ledger accounts (as already discussed).

(c) Calculation………The amount of Interest on Capital (now being discussed).

Calculation

Interest on Capital is always calculated on the basis of Opening Capital, and with respect to the period it has been used in the business. Simple Interest formula is to be used:

Interest on capital = (Amount*Rate*Months)/1200

Example:

Interest on Capital @ 6% p.a. on ₹30,000 for the whole year can be calculated as under:

Interest on Capital= (30,000*6*12)/100*12= 1,800 or directly=6% of 30,000 (for full year).

In case of Additional Capital brought during the year many times, Product method can be used as under:

Amount of capital No. of Months for which the amount was used by the business during the accounting year Product( of the first two columns)
Product Total

Interest on Capital= (Product Total*Rate)/1200

Sometimes Opening Capital is to be calculated from Closing capital, for calculating Interest on Capital. In that case following formula may be used:

Opening Capital=Closing capital + Drawings – Net Profit-Additional Capital if any.

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