Accountancy · Ch 13 — Final Accounts of Sole Proprietors – II
Interest on Capital and Interest on Drawings
Interest on Capital and Interest on Drawings
Interest on Capital
Meaning: interest allowed to the proprietor on the capital invested in the business, treated as a business expense (compensating the owner for the opportunity cost of tying up funds in the business) even though the business has only one owner.
Double effect:
- Debited to the Profit and Loss Account as an expense.
- Credited (added) directly to the Capital Account in the Balance Sheet — this is a DIRECT credit to Capital, separate from (in addition to) the year's Net Profit figure.
Interest on Drawings
Meaning: interest charged TO the proprietor for amounts withdrawn from the business during the year, treated as an income to the business (compensating the business for funds temporarily taken out of it).
Double effect:
- Credited to the Profit and Loss Account as an income.
- Debited (deducted) directly from the Capital Account in the Balance Sheet, in addition to the ordinary deduction of Drawings — a DIRECT charge against Capital, separate from the year's Net Profit figure.
A step easy to under-apply …
Interest allowed to the proprietor on capital invested; debited to the P&L Account as an expense and credited directly to the Capital Account in the Balance Shee …
Interest charged to the proprietor on amounts withdrawn; credited to the P&L Account as an income and debited directly from the Capital Account in the Balance Sh …