There are three problems relating to the Interest on loan:

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

(b) Calculation………The amount of Interest on Loan (now being discussed).

Calculation of Interest on Loan

Interest on Loan is always calculated with respect to the period it has been used in the business. Simple Interest formula is to be used:

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

Example:

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

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

Example:

Interest on Loan @ 6% p.a. on ₹30,000 advanced on 1st July can be calculated as under:

Interest on Loan= (30,000*6*6)/100*12= 900.

(c) Treatment…………Journal entries and Ledger accounts

Treatment:

(a) Interest on Loan A/c                             Dr.

To Partner’s Loan A/c

(b)Profit and Loss A/c                                Dr.

To Interest on Loan A/c

Note: In no case Interest on Loan should be recorded in Profit and loss account or Capital account of the partners.