Q.Explain, with the double effect, how 'Interest on Capital' and 'Interest on Drawings' are treated while preparing Final Accounts of a proprietary concern.

Interest on Capital rewards the owner for money invested; Interest on Drawings charges the owner for money taken out early — one is a business expense, the other a business income. …

Interest on Capital. Interest allowed to the proprietor on the capital he/she has invested in the business is treated as a genuine cost of the business using that capital, so that the true return the business itself earns (separate from a mere return on the owner's investment) can be judged. Double effect: (i) it is debited to the Profit and Loss Account as an expense (reducing Net Profit), and (ii) it is added to Capital on the liability side of the Balance Sheet (since the owner is now entitled to this additional amount, on top of Net Profit already added). …

Reversing the two — crediting Interest on Capital instead of debiting it, or debiting Interest on Drawings instead of crediting it; forgetting that both items ultimately still affect the SAME Capital figure in the Balance …