Q.Azad and Benny are equal partners. Their fixed capitals are Rs. 40,000 and Rs. 80,000, respectively. After the accounts for the year have been prepared it is discovered that interest at 5% p.a. as provided in the partnership agreement, has not been credited to the capital accounts before distribution of profits. It is decided to make an adjustment entry at the beginning of the next year. Record the necessary journal entry.
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Start your 14-day free trial to unlock the full solution →The omission of interest on capital is corrected by debiting Azad’s capital account with ₹1,000 and crediting Benny’s capital account with ₹1,000 — this reverses the excess profit already taken by Azad and gives Benny his rightful interest.
Concept and Treatment
When a partnership deed provides for interest on capital, that interest is a charge against profits — it must be credited to each partner’s capital account before the remaining profit is distributed. Here, the firm’s accounts for the year have already been finalised and profits distributed without first crediting this interest. The error is discovered after the books are closed, so we cannot reopen last year’s Profit and Loss Appropriation Account. Instead, we make a single adjustment entry at the start of the next year to correct the partners’ capital balances.
The logic is straightforward:
- Interest on capital should have increased each partner’s capital account (credit entry).
- Since profits were distributed without this adjustment, the partner who was entitled to more interest effectively received less profit than he should have, and the partner entitled to less interest received more profit.
- The adjustment entry simply transfers the excess from the over-receiver to the under-receiver.
Let’s compute the interest that should have been credited.
Working Notes
1. Interest on Capital at 5% p.a.
| Partner | Fixed Capital (₹) | Interest @ 5% (₹) |
|---|---|---|
| Azad | 40,000 | 2,000 |
| Benny | 80,000 | 4,000 |
2. Profit already distributed (without interest)
Since the partners are equal, any profit was split 1:1. The interest that was omitted is a total of ₹6,000 (₹2,000 + ₹4,000). This ₹6,000 should have been first credited to the partners as interest, and then the remaining profit (if any) divided equally. But because the accounts are closed, we only need to adjust the net effect on each partner’s capital.
3. Net effect of the omission
- Azad should have received ₹2,000 as interest.
- Benny should have received ₹4,000 as interest.
- The total profit available for distribution was reduced by ₹6,000 if interest had been charged. Since it wasn’t, the profit pool was ₹6,000 larger, and that extra ₹6,000 was split equally — Azad got an extra ₹3,000, Benny got an extra ₹3,000.
So, comparing what each actually got versus what they should have got:
| Partner | Should have received (Interest + share of remaining profit) | Actually received (share of full profit) | Difference |
|---|---|---|---|
| Azad | Interest ₹2,000 + (half of remaining profit) | Half of full profit (which includes the ₹6,000) | Azad got ₹1,000 more than he should have |
| Benny | Interest ₹4,000 + (half of remaining profit) | Half of full profit | Benny got ₹1,000 less than he should have |
The shortcut: the difference in interest (₹4,000 – ₹2,000 = ₹2,000) is shared equally between the partners. So Azad must give ₹1,000 to Benny. …
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