Interest on Capital of the Partners
There are three issues relating to the Interest on capital:
(a) Rule regarding, whether to allow or not (as already discussed). IOC Rule
(b) Treatment, Journal entries and Ledger accounts (as already discussed). IOC Journal Entries
(c) Calculation, the amount of Interest on Capital (discussed here).
Calculation of Interest on Capital
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:
You can calculate, Interest on Capital @ 6% p.a. on ₹30,000 for the whole year, 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 during the year many times, You can use Product method as under:
| Amount of capital | No. of Months of using the amount during the accounting year | Product( of the first two columns) |
| Product Total |
Interest on Capital of the Partner = (Product Total*Rate)/1200
Calculating Opening Capital from Closing capital:
Opening Capital = Closing capital + Drawings - Net Profit - Additional Capital.
You can watch videos here:
Simple Method: Interest on Capital
Product Method: Interest on Capital