It is the interest that is provided on the amount invested by a proprietor in the business. It represents the cost of capital invested in the business. As we know that owners are considered as a separate entity from their business, so the amount invested by the owners becomes a liability for a business. Therefore, any interest paid on capital is considered as an expense and is shown in the Profit and Loss Account.
When Interest on Capital is given outside the Trial Balance
Treatment of interest on capital in the final accounts is as follows.
First, interest on capital is shown on the Debit side of the Profit and Loss Account.
Secondly, it is added to the amount of capital on the Liabilities side of the Balance Sheet.
When Interest on Capital is given Inside the Trial Balance
There may be a situation when interest on capital is given inside the Trial Balance. In such a case, capital in the Trial Balance is already appearing after adjusting the amount of interest on capital to it. Therefore, there is no need to add this interest to the capital in the Balance Sheet. It is shown only on the debit side of the Profit and Loss Account like any other expense.
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Interest on Drawings
Treatment of interest on drawings in the final accounts is as follows. Firstly, interest in drawings is shown on the credit side of the Profit and Loss Account.
What is Operating Profit?
Operating Profit can be defined as the profit earned by carrying the normal business activities. It is computed by subtracting the operating expenses from the gross profit.
Balance Sheet
The balance sheet is the last financial statement that is prepared by any organization. This statement helps to ascertain the true financial position of an enterprise at the end of an accounting period
Profit and Loss Account
A profit and Loss Account is the second financial statement prepared by an organization. This account is prepared to ascertain the net results of a firm in form of net profit earned or net loss incurred during an accounting period.
What are Adjusting Entries?
In order to incorporate adjustments in the financial statements, we pass the required Journal entries, which are termed as adjusting entries.